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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
--------------------
FORM 10-K
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
- ------- EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ------- AND EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File Number: 08354
nStor Technologies, Inc.
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(exact name of registrant as specified in its charter)
Delaware 95-2094565
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(State of Incorporation) (I.R.S. Employer ID No.)
6190 Corte Del Cedro, Carlsbad, California 92009
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(Address of principal executive offices)
Registrant's telephone number, including area code: (760) 683-2500
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
------------------- ---------------------
None None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.05 per share
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(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 _____
2
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.[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act): Yes _____ No X
AGGREGATE MARKET VALUE OF THE VOTING COMMON STOCK
HELD BY NONAFFILIATES OF THE REGISTRANT
Common Stock, par value $.05 per share (Common Stock), was the only class of
voting common equity of the Registrant outstanding on December 31, 2002. Based
on the last sales price of the Common Stock on the American Stock Exchange
(AMEX) on June 28, 2002 ($.23), the aggregate market value of the approximately
36,959,000 shares of the voting Common Stock held by non-affiliates was
approximately $8.5 million.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the Registrant has filed all documents and
reports required to be filed by Section 12, 13, or 14(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes ___ No ____
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the latest practicable date:
142,076,947 shares of Common Stock, par value $.05 per
share, were outstanding as of February 28, 2003.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement of nStor Technologies, Inc.
for the 2003 Special Meeting of Stockholders
(incorporated in Part III)
3
PART I
Item 1. Business
GENERAL
nStor Technologies, Inc., through its wholly-owned subsidiary, nStor
Corporation, Inc. designs, develops and manufactures external data storage
solutions, including high density storage enclosures, storage management
software and RAID (Redundant Array of Independent Disks) controller technology
(Storage Solutions). In addition, since our June 2002 acquisition of 100% of
Stonehouse Technologies, Inc. (Stonehouse), we are a provider of
telecommunications software and services solutions (Telecommunication Solutions)
that help large enterprises manage their communications expenses, assets and
processes. We incorporated as a Delaware corporation in 1959 and initially
acquired our Storage Solutions business in 1996. References in this Form 10-K to
"we", "our", "us", the "Company", and "nStor" refer to nStor Technologies, Inc.
and its consolidated subsidiaries.
Our Storage Solutions product line supports a variety of operating systems,
including Windows NT and Windows 2000, UNIX, Linux, and Macintosh, and utilizes
technology architectures such as Fibre Channel, Fibre-to-SCSI (Small Computer
Systems Interface), and SCSI. Our RAID solutions provide data storage solutions,
particularly for storage-intensive environments and mission-critical
applications requiring substantial storage performance and capacity, such as
document imaging, video and multimedia, or transaction-intensive environments,
such as banking and order entry systems.
We market our Storage Solutions products through direct sales personnel in the
United States and indirectly through a global network of channel and Original
Equipment Manufacturer (OEM) partners.
Our Telecommunication 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. We market our Telecommunication Solutions through a direct sales force
and indirectly through channel partners.
Through the end of 2002, our executive and business headquarters were located in
San Diego, California. During December 2002, we relocated our headquarters to
6190 Corte Del Cedro, Carlsbad, California 92009 and our telephone number is
(760) 683-2500. Our principal engineering offices for our Storage Solutions
business is located at 100 Technology Park, Suite 175 , Lake Mary, Florida
32746. The headquarters for our Telecommunication Solutions business is located
at 2740 North Dallas Parkway, Plano, Texas 75093 and our telephone number is
(972) 543-2100.
STORAGE SOLUTIONS
INDUSTRY
The demand for increased information and data storage capacity has grown
dramatically as new storage applications create greater efficiencies. A
significant growth in Internet users and Internet business transactions has
resulted in the creation of millions of new web sites. Environments that have
traditionally been paper-intensive such as insurance, healthcare, education, law
firms, and government agencies have embraced the use of document imaging
technology. Specific sectors such as broadcasting, entertainment, music, and
animation have now fully transitioned their operations to the digital realm.
This exponential growth of computerized data has accelerated the need for
available and reliable data storage solutions. To meet this need, companies are
investing in new centralized storage infrastructures that not only meet their
demands today, but also lay the groundwork for their future needs.
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As corporate IT (Information Technology) environments increase their
server-based infrastructure to include storage-centric solutions, the areas of
fault-tolerance and storage management play a vital role in protecting
businesses' critical data. To meet this escalating demand, storage suppliers are
transitioning their RAID solutions into SAN's (Storage Area Networks) and
Network Attached Storage (NAS) environments, the two fastest growing sectors in
the data storage marketplace. To successfully compete in this aggressive market,
companies need innovative products, strong integration expertise, and excellent
support services.
PRODUCT STRATEGY
We offer a diverse product line with high levels of performance, scalability,
and reliability that meet the demands of today's storage-intensive requirements.
Our interoperability lab ensures the compatibility of our products with other
key system components making the installation and utilization of our products
seamless and cost-effective even in the most complicated system environments.
We believe our NexStor 4000 Series 2U (3.5 inches) product line is one of the
industry leaders in terms of rack space density. The product line is offered for
Fibre Channel, SCSI, and Fibre-to-SCSI environments. Our storage enclosures
feature fully redundant, hot-swappable components and support the industry's
fastest and most dense disk drives. NexStor's advanced design and capability are
targeted to the mid-range to enterprise computing environment. The NexStor
products designed by us include SAF-TE (SCSI Access Fault-Tolerant Enclosure
Services) and SES-compliant (SCSI Enclosure Services) modules that can store up
to 1.76TB (Terabytes) of data in a 3.5-inch, or 2U, increment of rack space,
available in 12-bay versions.
Our 4000 Series SCSI enclosure architecture is designed to provide Ultra320 SCSI
connectivity, leverage our 2U design, and permits the integration of two SCSI
RAID controllers within the same 3.5-inch form factor, eliminating the
dependency of an additional RAID controller subsystem. This design is targeted
to the cost-sensitive, entry-level SCSI marketplace.
Our Fibre Channel products include SAN-ready Fibre RAID and RAID-ready Fibre
JBODs (Just a Bunch of Disks). The 2Gbit (2GB/sec) Fibre Channel 4000 Series
products provide high-availability storage with flexibility and scalability to
meet a customer's growing storage requirements. Our family of flexible 2Gbit
Fibre Channel Wahoo RAID controllers, released to OEMs and System Integrators
(SIs) in early 2003, allow us to act as a single source storage solution
provider (enclosure technology and RAID controller, managed by our StorView
Storage Management Software) and to continuously add new features and meet
demanding customer support requirements. Fibre Channel has been the choice for
mid-range to enterprise-level storage, and we expect that it will continue to
grow as cost savings are realized by sharing the same managed storage pool for
multiple servers.
Our StorView Software complements our NexStor product line as a web-based
Storage Management Software suite that is used to configure RAID controllers,
monitor and report storage status, and manage disk arrays. StorView provides
local or remote monitoring and management with remote notification (e-mail
and/or pager alerts to individuals or groups) for Windows, Linux and UNIX
environments, allowing users to manage data from remote locations.
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CURRENT PRODUCT OFFERINGS
Through the fourth quarter of 2002, our Fibre Channel products included the
SAN-ready 3150F and 3250F complimented by the RAID-ready 802F and 1202F. This
product line was phased out in favor of the next generation 2Gbit Fibre Channel
4000F Series.
Our SCSI product line included the NexStor 802S, Ultra160 SCSI JBOD product in
its 2U form factor, and served as the foundation for the later release of RAID
and 12-bay Ultra160 SCSI designs. The NexStor 802S/3150S and 1202S/3250S filled
a direct-connect SCSI requirement and like our Fibre Channel product, offered an
easy JBOD to RAID upgrade path. This product line was phased out in the third
quarter of 2002 in favor of the next generation 4000S Series.
In 2002, we re-designed our chassis to improve its price points and feature
sets. The new line of products, the 4000 Series, provides modular electronics
and mechanical designs that allow us to take advantage of new host and disk
drive interface technologies more efficiently, while reducing overall
manufacturing costs.
NexStor 4000F and 4100F/4150F - Fibre Channel JBOD (RAID-ready) and RAID
Systems
Our recently introduced 2Gbit Fibre product line encapsulates both SAN-ready
RAID and RAID-ready JBOD storage solutions within the same 2U form factor and
has complete 2Gbit host to drive connectivity. Since drive manufacturers are
focused on only releasing 1-inch low-profile disk drives, the 4000F Series is a
12-bay enclosure system that can be a standalone JBOD (4000F), a single RAID
controller system (4100F) or a dual RAID controller system (4150F). The 4000F
JBOD system protects a customer's storage investment as RAID controllers can be
simply integrated into the back of the enclosure for instant RAID protection in
the same 2U form factor. With twelve 144GB disk drives, the 4000F Series scales
up to 18TB in 1.76TB, 3.5-inch modular increments. This modular design allows
customers the `pay as you grow' ability in a space-saving, high-performance,
high-availability storage system.
The 4000F Series was designed to be a direct replacement of nStor's 3000F
Series. Production shipments began at the end of the fourth quarter of 2002.
NexStor 4000S and 4100S/4150S - SCSI JBOD (RAID-ready) and RAID Systems
Our SCSI product line was re-designed to add the latest Ultra320 technology and
provide a more cost-effective storage system for the price sensitive SCSI
marketplace. The initial introduction of the 4000 Series products was a SCSI
version with Ultra320 JBOD and Ultra160 RAID host connectivity.
The 4000S Series also incorporates a 12-bay enclosure technology and houses the
latest, high-performance 15,000RPM and highest capacity 144GB disk drives. The
4000S JBOD has an Ultra320 bus architecture that provides 320 MB/s single and
640 MB/s dual bus data paths. The 4000S JBOD is easily upgraded to the 4100S
single RAID controller or the 4150S dual RAID controller system by simply
integrating RAID controllers into the back of the enclosure. The ability to
integrate the SCSI RAID controllers directly into the back of the enclosure
eliminates the cost to convert a JBOD into a high-availability RAID system.
The 4000S Series was designed to be a direct replacement of our 3000S product
line. Production shipments began during the third quarter of 2002.
NexStor 4300F and 4500F - Fibre Channel RAID Systems
In February 2003, we announced the release of our two new 2Gbit Fibre RAID
Solutions intended for entry to mid-range enterprise class storage applications.
The NexStor 4300F and 4500F are based on our Wahoo and WahooXP 2Gbit Fibre
Channel RAID controllers integrated into our 2U 12 drive 4000F Series
enclosures, fully supported by the web-based StorView Software.
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Wahoo Controller
Our Wahoo controller is available as an economical single board version (Wahoo)
or as an extended processing (WahooXP) version with a powerful co-processor and
extended cache. Having two versions of the controller based on the same firmware
allows an OEM or SI to address either price sensitive requirements or higher
performance feature rich requirements without having to qualify different
firmware code sets. Our StorView Storage Management Software fully supports the
Wahoo family of controllers.
Wahoo is a 2Gb 2x2 Fibre to Fibre RAID controller designed for high performance
storage solutions and is intended to be used in stand-alone (single controller)
applications as well as robust Active-Active and remote mirrored configurations
where single points of failure cannot be tolerated. As a single or dual board
external RAID controller, Wahoo is intended to be used with our 2U RAID Fibre
Channel enclosures as well as non-nStor Fibre Channel enclosures. Wahoo includes
512MB of write-protected cache, dual Fibre host and drive channels, and complete
fabric log on. Wahoo supports up to 124 drives and does not require hard
addressing, providing increased flexibility in configuration. Wahoo disk drive
and host interface uses dual fibre controllers to take full advantage of dual
loops on each Fibre Channel disk drive for performance and fault tolerance. In
addition, Wahoo provides two independent host ports and is designed to be
plugged into a passive back panel with removable port bypass modules. WahooXP
meets the increased performance commands of intense transaction or video
streaming applications with dual processors and 1GB of write-protected cache.
StorView
Our StorView Storage Management Software suite allows IT administrators to
configure, manage, and monitor the entire network from anywhere in the world.
Written in HTML-based GUI (Geographical User Interface) to manage the NexStor
4300F and 4500F Series, our web-based StorView works with the industry's leading
web browsers making it easy to customize local or network based management and
fault reporting. StorView is the fifth generation of software management tools
developed by us and is the first module of our NSM (Network Storage Management)
architecture. With access through a secure firewall, IT administrators have the
ability to change RAID configurations and LUN permissions on the fly without
server re-boots or disruption to data access. Some of the capabilities of
StorView include:
o Highly visual and intuitive user interface, making it easy to use and
learn;
o HTML allows it to work in any browser and makes it simple to
customize;
o Local or network based management and fault reporting;
o Automatic detection of servers on the network minimizes setup and
support;
o Redundant server operation for continuous management and monitoring;
o Portable and operating system independent architecture;
o Call home alert notification of a failure or of a system reaching an
environmental threshold.
Technical Service
We offer a range of full-time service and support programs through a third party
service company, providing customers with a variety of on-site and help-desk
support services (see Technical Support and Customer Service).
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SAN Solutions
As an alternative to direct-connect server-attached storage, networked storage
architectures have been gaining popularity. SANs provide the scalability,
accessibility, and manageability to satisfy present and future business
computing requirements.
We develop, test, and install high availability SAN storage solutions in both
clustered and heterogeneous server environments. In addition to our SAN-ready
Fibre Channel products, we also offer pre-tested and certified switches and
attach kits necessary for a complete SAN architecture.
As the need for storage continues to grow, the physical space required to hold
racks of storage systems becomes a premium. We believe our focus on providing
space-sensitive, high capability, and fully integrated SAN solutions will help
us compete successfully in this growing market. We believe our enhanced SAN
features included in our StorView Storage Management Software, further extends
our SAN installation and integration capabilities. However, there can be no
assurance that we will be successful in these efforts due to the possibility of
increased competition, the development or advancement of alternative
technologies, and other factors.
PROPRIETARY TECHNOLOGY
We rely upon various patents, copyrights and trademarks, as well as
non-disclosure and confidentiality agreements with employees and customers, to
establish, protect and preserve our proprietary rights. Our registered patents
include (i) data storage chassis with adjustable rack mounting, (ii) disk drive
storage enclosure with isolated cooling path for storage media, and (iii) front
bezel for disk drive storage enclosure. For a discussion of certain risks
relating to the protection of our intellectual property rights, see Risk Factors
- - Potential Infringement of Intellectual Property Rights.
SALES AND MARKETING
We market our products and services through direct sales personnel to end-users
in the United States and indirectly through a global network of OEM partners and
volume channels such as SIs and Value Added Resellers (VARs).
Direct and indirect product sales represented 34% and 61%, respectively, of our
total sales in 2002, compared to 43% and 35%, respectively, in 2001, reflecting
the shift in our sales and marketing strategy to provide greater technical
marketing and sales support to our indirect sales function. In 2002, sales to a
single indirect customer accounted for 43% of our Storage Solutions sales.
Service contracts, principally with end-users, represented 1% and 22% of our
total Storage Solutions revenues during 2002 and 2001, respectively. In August
2001, we sold substantially all of our servicing business, which we currently
contract through a third party service company.
OEM-grade products are primarily sold directly to OEMs for integration into
their product offerings. Generally, the OEM products are labeled under the OEMs'
brand name where our products are frequently packaged as part of a complete data
processing system or combined with other storage devices to deliver a storage
subsystem. We believe OEM channel sales provide significant revenue opportunity,
market visibility and credibility, and can serve as a proving ground for new
technologies that can later be marketed and sold in the distribution channel.
OEMs are strategic in nature and, therefore, require unique sales strategies.
The sales and support organization must be highly technical and generally
involves several corporate resources.
8
The sales model for product distribution in Europe and the Asia/Pacific-Rim is
similar to the domestic OEM and channel model, utilizing SIs and VARs.
Complementary pricing, margin structures and marketing programs support each
sales channel. We believe this strategy allows our customers to effectively sell
and market our products to their specific marketplace while maintaining channel
integrity.
Our marketing plan utilizes a variety of programs to promote and develop new and
expanding markets for our product lines and to support our sales strategy. The
focal points of this plan include a supply of highly focused promotional
material including product specification literature and application notes, web
site innovation, development and promotion of the distribution channel,
strategic media placement, tradeshow participation, and public relations.
TECHNICAL SUPPORT AND CUSTOMER SERVICE
We provide technical support for pre-sales system design and manage post sales
service through our enterprise resource planning software. Products are tracked
through each stage of engineering, manufacturing and distribution for the entire
life of a product, and our customer service department can view the history of
each individual system.
We have a dedicated Help Desk to ensure the proper routing and support of all
incoming technical support calls. Our Help Desk collects the necessary
information, documents the trouble call and then tracks that call throughout the
support.
Our staff is a team of professionals who are prepared to assist customers with
any challenges they might encounter with regard to their nStor equipment. We
respond quickly to technical issues by providing a toll-free phone number, a fax
response line, and the convenience of e-mail.
Our standard warranty is a three-year return-to-factory policy, which covers
both parts and labor. We pass on to the customer the warranty provided by the
manufacturers for products that we distribute, including a five-year warranty
for disk drives. We have not experienced material warranty claims; however,
there can be no assurance that future warranty claims will not have a material
adverse effect on our future financial condition and operating results. We also
offer various levels of on-site service for our products, for which we contract
primarily with third-party service providers.
MANUFACTURING AND SUPPLIERS
In July 2002, we entered into a contract with Varian, Inc. (Varian), for
outsourcing the production of our 4000S Series of products. Based on forecasts
provided by us, Varian purchases most of the materials and components and
produces our products utilizing their own assembly and test labor. We continue
to purchase certain critical components such as power supplies and provide those
components to Varian. This agreement resulted in immediate improvements in our
operating margins by lowering manufacturing costs, as well as reducing overall
operating costs. Our 4000F Series is currently being assembled by an interim
outside contractor. As a result of the decision to utilize outsource
manufacturing, our manufacturing operations, previously located in San Diego,
California, were phased out at the end of the third quarter of 2002.
Our products are assembled from components and prefabricated parts, such as
controllers, cabinets, disk drives and power supplies, manufactured and supplied
by others. We work closely with a group of regional, national and international
suppliers, that are selected based on their ability to provide quality parts and
components that meet our specifications and volume requirements. A number of our
parts and components are designed specifically for integration into our
products.
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We depend heavily on our suppliers to provide high quality materials on a timely
basis and at reasonable prices. Although many of the components for our products
are currently available from numerous sources at competitive prices, some of the
components used in our products are presently available from a limited number of
suppliers, or from a single supplier. Further, because of increased industry
demand for many of those components, their manufacturers may, from time to time,
be unable to make delivery of our orders on a timely basis. In addition,
manufacturers of components on which we rely may choose, for numerous reasons,
not to continue to make those components, or the next generation of those
components, available to us. The inability to obtain a key product component as
needed may cause a reduction in our sales volume.
We have no long-term supply contracts. There can be no assurances that we will
be able to obtain, on a timely basis, all of the components we require. If we
cannot obtain essential components as required, we could be unable to meet
demand for our products, thereby materially adversely affecting our operating
results and allowing competitors to gain market share. In addition, scarcity of
such components could result in cost increases, which could materially adversely
affect our operating results.
The sophisticated nature of our products requires extensive testing by skilled
personnel. We utilize specialized testing equipment and maintain an internal
test-engineering group to provide this product support.
BACKLOG
Our products are manufactured based on a forecast of near-term demand.
Accordingly, we maintain inventory in advance of receipt of firm orders from
customers. Shipments are generally made shortly after receipt of a firm order.
We have no long-term purchase commitments from our customers and, in general,
customers may cancel or reschedule orders on 30 days notice with little or no
penalty. As a result, our backlog at any given time is not necessarily
indicative of future sales levels.
There can be no assurances that orders from existing customers will continue at
their historical levels, that we will be able to obtain orders from new
customers, or that existing customers will not develop their own storage
solutions internally and as a result reduce or eliminate purchases. Loss of one
or more of our principal customers, or cancellation or rescheduling of material
orders already placed, could materially and adversely affect our operating
results.
RESEARCH AND DEVELOPMENT
We have two engineering centers to facilitate our product development. Each of
these centers of competency is focused on a different aspect of our product
development strategy.
Lake Mary, Florida is the competency center for (i) our enclosure technology and
development, and (ii) for the development of our RAID controller technology and
Fibre Channel drive firmware qualification for these controllers. In addition to
designing, developing and testing our storage enclosures, engineers in Lake Mary
are also responsible for the design, development and successful integration of
controllers (both nStor-developed controllers as well as third-party products)
into our enclosure technology. All disk drive compatibility testing with nStor's
product lines (SCSI and Fibre Channel) is conducted in Lake Mary.
In late December 2002, we relocated our San Diego, California competency center
for our integrated solutions, including our SAN integration lab, to Carlsbad,
California. Engineers in Carlsbad integrate the total SAN and general storage
solutions that include internally developed and third party software and
hardware components. The SAN interoperability lab focuses on SAN component
selection and validation, integration and delivery of end-user solutions as well
as solution testing for all our SAN-related products and services. In
conjunction with the interoperability lab, Carlsbad hosts the StorView software
development and testing.
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The information storage industry is subject to rapid technological change. Our
ability to compete successfully is largely dependent upon the timely development
and introduction of new products and our ability to anticipate and respond to
change. We use engineering design teams that work with marketing managers,
application engineers and customers to develop products and product
enhancements. Computer I/O interface standards are maintained and an extensive
disk drive qualification program is in place to monitor disk drives to ensure
the quality and performance of the disk drives integrated into our disk arrays.
As part of our development strategy, we actively seek industry leaders with whom
we can initiate co-development activities in the hardware, software and systems
businesses.
COMPETITION
The market for storage solutions is subject to intense competition. We compete
not only with other enclosure and disk array manufacturers, but also with
manufacturers of proprietary integrated computer systems and SIs who sell
computer systems containing general purpose RAID subsystems, most of which may
have significantly greater financial and technological resources or larger
distribution capabilities than nStor.
Certain competitors may offer their products at lower sales prices than ours.
Accordingly, we must often compete on the basis of product quality, performance
and reliability in specific applications. Our continued ability to compete will
largely depend upon our ability to continue to develop high performance products
at competitive prices while continuing to provide superior technical support and
customer service. For a discussion of certain of our major competitors, see Risk
Factors - Intense Competition.
TELECOMMUNICATION SOLUTIONS
BACKGROUND
Our entry into the Telecommunication Solutions business began on June 7, 2002
when we acquired 100% of Stonehouse, a Plano, Texas based operation with
regional offices in Florida and Virginia. Stonehouse is a comprehensive resource
for Communications Services Management applications and services providing
software and services solutions to help large enterprises manage their
communications expenses, assets and processes.
Stonehouse was established in 1978 as an independent consulting firm providing
telemanagement solutions to the operators of both public and private
telecommunications networks. In 1983, Stonehouse introduced its MONIES(R)
telemanagement software, positioning Stonehouse as a leader in comprehensive
telemanagement systems. In 2002, Stonehouse completed the development of
MONIESWeb(R), a web-based telemanagement software solution. Stonehouse has
experience in providing telemanagement systems to manage large, complex voice
and data networks in both the private and government arenas, and has licensed
systems to many customers in the U.S., Mexico, Canada, Australia, Saudi Arabia,
and Japan. See Target Market for a discussion of industries and organizations in
which we provide services.
Stonehouse solutions include a suite of modular applications, with multiple
delivery options, consulting services provided by hands-on professionals, and
outsourced managed services. Stonehouse's Communications Services Management
solutions enable enterprises to manage voice, data and wireless services by
providing a systematic approach to automate order processing, monitor expenses,
manage vendor invoices, track inventory of assets and accurately allocate costs.
Customers realize benefits of cost savings, increased management control, and
productivity improvements.
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INDUSTRY
With telecommunication deregulation and the onset of the Internet, businesses
are facing an increasingly complex operating environment and escalating
expenses. Today's corporate telecommunications managers have to keep track of
local, long distance and wireless services and equipment, wide-area networking,
Internet access, voice and data circuits, pagers and other wireless devices. In
addition to the increasing number of service plans, there are a growing number
of providers, all of whom have their own billing formats, pricing schemes, and
service level guarantees. Organizations today are devoting more and more
financial and human resources to managing their communications function, while
pressure increases for reducing expense. The management issue is becoming even
more complex as networks converge where multiple voice and data services are
provided via a single network and managers are forced to track how bandwidth is
used and allocated. Most companies are currently managing their communications
services expenses and assets with point solutions and homegrown spreadsheets. As
businesses manage complex and evolving communications services, the need for a
comprehensive, systematic solution is growing daily.
These trends have offered us a window of opportunity to participate in the
telecommunications services management market and growth. We believe we have
competitive advantages, including a comprehensive suite of applications used by
Fortune 300 and large government organizations; customers who have been with
Stonehouse, on average, over ten years; a recurring revenue stream from product
maintenance; and an experienced management team.
PRODUCTS AND SERVICES
Our principal business is to provide applications, professional and managed
services for solving day-to-day challenges in managing communication services
expenses, assets and processes.
Communication Services Management Applications
MONIES(R)
MONIES(R) (Management of Network Income, Expense, and Services), a modular,
fully integrated suite of applications which assists customers in centralizing
their processing and tracking of communications assets and expenses, reduces
billing errors, consolidates inventory and invoice data, and streamlines
internal ordering processes. Modules include:
o Order management for streamlining the service request process for
move, adds, and changes, and automatically updating the inventory
database;
o Inventory management to centralize data on assets and services,
including the tracking of cable plant;
o Invoice management to consolidate bills and reconcile against
inventory;
o Billing management to efficiently allocate expenses;
o MasterMined for collecting and processing call records and detecting
fraud and abuse;
o Network analysis to optimize trunk utilization;
o Problem management to process trouble tickets, track and report on
network troubles;
o Report writer for generating standard and ad-hoc management reports;
and
o Web-based Bill Presentment for distributing usage and charge-back data
to end-users.
MONIES(R) is available as an on-site solution or as a hosted application in an
ASP (Hosted Application Services) environment. The ASP offering provides full
remote access to the Communication Services Management solution with minimal
up-front investment in hardware, software and personnel. The MONIES(R) features
include built in security, on-line access, over 200 reports and virtually
unlimited multi-site, multi-user capability. Access to the data center can be
direct or over the Internet.
12
MONIES(R) is available in several versions including: (i) Mainframe, designed
for IBM SNA environments, (ii) RS/390 servers and in OS/2 or UNIX AIX (RS/390)
environments, or (iii) a Windows GUI version available with Windows. Our hosted
applications service does not require the customer to secure on-site processing
equipment, is available to multiple customers and is running on an IBM 390.
MONIESWeb(R)
MONIESWeb(R), a web-based software solution built on a component-based
architecture using standard operating software, is implemented using the Oracle
Database Management System and JAVA. Requiring only a browser, MONIESWeb(R)
provides total workstation independence for the end-user. Implemented using JAVA
standards, this product runs on Windows NT, UNIX, Oracle and most enterprise
JAVA application servers. MONIESWeb(R) provides a feature-rich browser-based web
interface enabling users to access the system from anywhere with an Internet
connection.
MONIESWeb(R) was developed during 2002 and has been available to our customers
since the first quarter of 2003.
Professional Services
We offer a flexible range of Professional Services and a standard services
methodology, Pathway, to assist with implementation and provide assessments,
reviews and advice. Experienced industry professionals provide:
o Process and procedure optimization;
o Vendor invoice review and audit;
o Comprehensive asset inventory creation;
o Requirements definition and RFP (Request for Proposal) support;
o Applications installation and implementation; and o Customized product
and process training.
Managed Services
We offer customers the convenience of implementing flexible outsourcing
services. Our Managed Services team offers outsourced services such as:
o Moves, adds and changes;
o Asset and service inventory tracking;
o Cost controls and expense allocation;
o Vendor invoice reconciliation and verification;
o Help desk services; and
o Contract negotiation and vendor management.
Our Professional Services team provides the installation, integration, training
and consulting support. As customer requirements expand, we also offer turnkey
managed solutions from assuming responsibility for one function, such as billing
management, to complete outsourcing of a customer's communications operations.
Implementing our applications and services can help companies reduce
communications services expenses, improve productivity, and gain management
control of its operating environment.
13
SALES AND MARKETING
Target Market
Our applications and services are targeted to large corporations (greater than
1,000 employees), educational institutions, state governments and other
organizations with large and complex public, private, and hybrid communications
networks. The solution set is aimed at organizations that require comprehensive
management, including billing, work order, inventory, and problem management as
well as network and traffic analysis functions. Our target markets include
industries and organizations in government, education, finance, petroleum and
chemical, transportation, entertainment, utilities and telecommunications.
Distribution Strategy
Currently, we market our products and services through a direct sales force as
our primary source of distribution, augmented by informal co-marketing and other
partnership arrangements.
EMPLOYEES
As of February 28, 2003, we employed 81 full-time employees, of which 48 are
employed in our Storage Solutions business (27 in engineering, product
development and technical support, 9 in sales and marketing, 5 in manufacturing
and operations, and 7 in finance, management and administration) and 33 are
employed in our Telecommunication Solutions business (4 in sales and marketing,
9 in custom operations/outsourcing, 4 in customer care, 9 in technology services
and 7 in finance, management and administration). Our employees are not covered
by collective bargaining agreements and there have been no work stoppages. We
believe our employee relations are good.
We believe that our future success will largely depend upon our ability to
continue to attract, employ and retain competent qualified technical, marketing
and management personnel. Experienced personnel are in great demand and we must
compete with other technology firms, some of which may offer more favorable
economic incentives to attract qualified personnel.
RISK FACTORS
In addition to the various risks ordinarily attendant to investments in entities
in the technology industry, certain other material risk factors relating to our
company and its business present a particularly high degree of risk. The
specific risks set forth below are not considered, or deemed, to be exhaustive
or definitive of all the material risks involved in our business.
Recent Losses; Capital Needs
We have experienced negative cash flows from operations, decreased sales
revenues and substantial net losses for the years ended December 31, 2002, 2001,
and 2000 of $8 million, $14 million and $21.9 million, respectively. As of
December 31, 2002, we had negative working capital of $6.9 million. There can be
no assurances that we will be able to achieve or maintain profitability on a
quarterly or annual basis or that we will be able to achieve revenue growth.
Since January 1, 2001, and through February 28, 2003, we obtained $21.7 million
of equity and debt financing from private investors. Of these amounts, $12.1
million was received from Maurice Halperin, the Company's Chairman of the Board
since August 2001 and a principal stockholder, or companies controlled by Mr.
Halperin (collectively, Mr. Halperin), consisting of $6 million in cash and $6.1
million in marketable securities (see Note 3 to Consolidated Financial
Statements). Equity and debt financing obtained from January 2001 through
February 28, 2003, also included $6.9 million from H. Irwin Levy, our Chief
Executive Officer, Vice Chairman of the Board and a principal shareholder, or
companies controlled by Mr. Levy (collectively, Mr. Levy).
14
We are currently exploring alternatives for raising additional debt or equity
capital to finance our short-term and long-term plans as well as operating
deficits expected to be incurred until we begin to generate positive operating
cash flows. However, due to conditions in the technology-related financial
markets and other uncertainties, many of which are outside our control, there
can be no assurances that such required additional funds will be available on
terms acceptable to us, if at all, or that we will be able to generate positive
cash flows from operating activities in the future.
Fluctuations in Operating Results
We have experienced significant period-to-period fluctuations in our operating
results. These fluctuations are partially due to product design, development,
manufacturing and marketing expenditures. If significant variations were to
occur between forecasts and actual orders with respect to our products, we may
not be able to reduce our expenses proportionately and operating results could
be materially adversely affected. Our revenues in any period are dependent on
the timing of product shipments, the status of competing product introductions,
as well as the availability from suppliers of component parts required for our
products. Like many other technology companies, a disproportionately large
percentage of our Storage Solutions sales may occur in the closing weeks of each
period. Any forward-looking statements about operating results made by members
of our management will be based on assumptions about the likelihood of closing
anticipated sales and other factors management considers reasonable based in
part on knowledge of performance in prior periods. The failure to consummate any
of those sales may have a disproportionately negative impact on our operating
results, due to our fixed costs, and may thus prevent management's projections
from being realized.
Inability to Attract and Retain Qualified Employees
Our ability to provide high-quality products on a timely basis requires that we
employ an adequate number of skilled engineers and technicians. Accordingly, our
ability to increase our productivity and profitability will be limited by our
ability to attract and retain skilled personnel. We may not be able to maintain
an adequate skilled labor force necessary to operate efficiently and to support
our growth strategy and our labor expenses may increase as a result of a
shortage in the supply of skilled personnel.
New Line of Products
During 2002, we introduced new products in both our Storage Solutions and
Telecommunication Solutions businesses and are encouraging our customers to
migrate to these new products. These activities entail a number of risks and
uncertainties, all of which could have a material and adverse affect on our
business. Those risks and uncertainties, include, but are not limited to, the
following:
o customer orders may be delayed while customers evaluate new products;
o the new line of products may contain unknown defects or "bugs";
o customers may not purchase the new products; and
o it may be more difficult to accurately predict future sales and
financial performance.
Rapid Technological and Customer Preference Changes
Our businesses are characterized by rapid technological change, frequent new
product introductions and evolving industry standards. Customer preferences in
this market are difficult to predict and changes in those preferences could
render our current or future products unmarketable. The introduction by our
competitors of products embodying new technologies and the emergence of new
industry standards could render our existing products as well as our new
products being introduced obsolete and unmarketable. For example, if customers
were to turn away from open systems computing, our Storage Solutions revenues
would decline dramatically.
15
Our success depends upon our ability to address the increasing technical
requirements of customers, to enhance existing products and to develop and
introduce, on a timely basis, new competitive products (including new software
and hardware and enhancements to existing software and hardware) that keep pace
with technological developments and emerging industry standards. If we cannot
successfully identify, manage, develop, manufacture and market product
enhancements or new products, our business will be materially and adversely
affected.
Intense Competition
The markets in which our businesses operate are intensely competitive. For
example, in our Storage Solutions business, we compete with traditional
suppliers of computer systems such as Hewlett-Packard, Sun Microsystems, IBM and
Dell, which market storage systems as well as other computer products, and which
recently have become more focused on marketing storage systems. We also compete
against independent storage system suppliers including, but not limited to, EMC,
including its Clariion division, MTI Technologies and Dot Hill. Major
competitors in our indirect customer business include Eurologic Systems, Xyratex
and JMR Electronics.
In our Telecommunication Solutions business, we compete with a variety of
specialized software and outsourcing service providers. Many of these providers
offer more limited software and services solutions than the solutions offered by
Stonehouse.
Many of these competitors are significantly larger than our company, and have
significantly greater financial, technical, marketing, purchasing and other
resources than we do, and as a result may be able to respond more aggressively
to new or emerging technologies and changes in customer requirements, or devote
greater resources to the development, promotion and sale of products than we
can, or to deliver competitive products at a lower price.
Increased competition is likely to result in price reductions, reduced operating
margins and loss of market share, any of which could have a material adverse
effect on our business, operating results or financial condition. In fact,
competitive pricing pressures have had, and may continue to have, an adverse
effect on our revenues and earnings.
If we are unable to develop and market products to compete with our competitors'
products, our business will be materially adversely affected. In addition, if
major customers who are also competitors cease purchasing our products so that
they can concentrate on sales of their own products, our business could be
materially adversely affected.
Pending Litigation
In June and August 1996, our company and two of our then directors were served
with two separate complaints filed in the Supreme Court of the State of New
York, County of Nassau, in which the plaintiffs claim to have had contractual
and proprietary interests in the prospect of a transaction to purchase certain
net assets acquired by us. The plaintiffs seek compensatory damages, punitive
damages, and equitable relief for alleged interference with the plaintiffs'
alleged rights and for alleged breach of contract. Our counsel believes that we
have good defenses to both claims and that we will not incur any material
liability. We are not aware of any facts that would support any of the
plaintiffs' claims and, accordingly, we believe that the claims are without
merit.
16
In February 2002, W. David Sykes, our former Executive Vice President of
Marketing and Sales filed a complaint against us in the Circuit Court of Palm
Beach County, Florida, in which he claims he was wrongfully terminated under
provisions of his employment agreement with us. We believe that we acted in
accordance with the termination provisions of the agreement and that no further
compensation or benefits are due. We believe that we have good defenses to the
claim and that we will not incur any material liability.
Lack of Long Term Contracts
We generally do not enter into long-term purchase commitments with our customers
and customers generally have certain rights to extend or to delay the shipment
of their orders, as well as the right to return products and cancel orders under
certain circumstances. The cancellation or rescheduling of orders placed by our
customers, or the return of products shipped to them, could materially and
adversely affect our business.
Product Defects
Our products may contain undetected software or firmware errors or hardware
failures when first introduced or as new versions are released. We cannot be
certain that, despite testing, errors will not be found in new products after
commencement of commercial shipments.
Our standard warranties provide that if a system does not function to published
specifications we will repair or replace the defective component without charge.
Although warranty costs have not been material, unexpected significant warranty
costs could have a material adverse effect on our business.
Availability of Competing Products
In the United States, we sell our Storage Solutions through both a direct sales
force and through indirect sale channels. Our OEMs, VARs and SIs may also carry
competing product lines, and could reduce or discontinue sales of our products,
which could have a material adverse effect on our operating results.
A Significant Percentage Of Our Expenses Are Fixed Which May Affect Our
Operating Results
Our expense levels are based in part on our expectations as to future sales, and
a significant percentage of our expenses are fixed, which limits our ability to
reduce expenses quickly in response to any revenue shortfalls. As a result, if
revenues do not meet our revenue projections, operating results may be
disproportionately affected. We may experience revenue shortfalls for various
reasons, including:
o sudden shortages of raw materials or fabrication, test or assembly
capacity constraints that lead our suppliers to allocate available
supplies or capacity to other customers, which, in turn, may harm our
ability to meet our sales obligations; and
o the reduction, rescheduling or cancellation of customer orders.
In addition, we typically plan our Storage Solutions production and inventory
levels based on internal forecasts of customer demand, which is highly
unpredictable and can fluctuate substantially. In response to anticipated long
lead times from our outside suppliers, we generally order certain materials in
advance of anticipated customer demand. This advance ordering may result in
excess inventory levels or unanticipated inventory write-downs if expected
orders fail to materialize.
17
Lengthy Sales Cycles
Customer orders generally range in value from a few thousand dollars to hundreds
of thousands of dollars. The length of time between initial contact with a
potential customer and sale of a product or service, or "sales cycle", also can
vary greatly and can be as long as twenty-four months. This is particularly true
for the sale and installation of complex, turnkey solutions. Our revenues are
likely to be affected by the timing of larger orders, which makes it difficult
for us to predict such revenues. Revenue for a period could be reduced if large
orders forecasted for a certain period are delayed or are not realized. Factors
that could delay or defer an order include:
o time needed for technical evaluation by customers;
o customer budget restrictions and changes to budgets during the course
of a sales cycle;
o customer internal review and testing procedures; and
o engineering work needed to integrate our solutions with a customer's
system.
Potential Infringement of Intellectual Property Rights
We rely on a combination of trade secrets, copyrights, trademarks, patents,
domain names and employee and third-party nondisclosure agreements to protect
our intellectual property rights. The steps taken to protect our rights may not
be adequate to prevent misappropriation of our technology or to preclude
competitors from developing products with features similar to our products.
Furthermore, third parties may assert infringement claims against us or with
respect to our products for which we have indemnification obligations to certain
of our customers. Asserting our rights or defending against third-party claims
could involve substantial expense, which could have a material adverse effect on
our operating results. In the event a third party were successful in a claim
that one of our products infringed the third party's proprietary rights, we may
have to pay substantial damages or royalties, remove that product from the
marketplace or expend substantial amounts in order to modify the product so that
it no longer infringes such proprietary rights, any of which could have a
material adverse effect on our operating results.
Loss of Key Suppliers
We rely on other companies to supply certain key components for our Storage
Solutions products. Our products are typically designed to operate with unique
components that are available from a single source. For example, certain of our
products are dependent upon RAID controllers designed by one supplier. Although
we can use other suppliers, the delay in integrating these parts into our
systems will increase product costs. Other critical components, while not
dependent on one source, may, from time to time, be in short supply or
unavailable for a period of time while alternative sources can be identified.
Modification to the particular products, requalification of the products with
applicable regulatory agencies, and additional testing to assure software and
hardware is compatible can result in lost or deferred revenue as well as higher
product costs.
In addition, we resell subsystems, software and services from others. This
leaves us vulnerable to inadequate supply, uneven allocation in times of
shortage, delays in order fulfillment, and order cancellations.
Concentrated Customer Base
In 2002, sales to two customers accounted for 43% and 13% of our Storage
Solutions sales and sales to a single customer accounted for 29% of our
Telecommunication Solutions sales. Based on a revised agreement with this
particular Telecommunication Solutions customer, we expect a decrease in
revenues in 2003 attributable to this customer. In 2001, one customer accounted
for 12% of our Storage Solutions sales.
18
The recent economic downturn in technological spending in addition to an
economic downturn in general in any industry or geographical area targeted by
us, or the loss of one or more customers, particularly a significant customer,
could result in a material decrease in revenues, thereby materially adversely
affecting our operating results.
Volatile Stock Price
Our common stock has experienced in the past, and could experience in the
future, substantial price volatility as a result of a number of factors,
including:
o quarter to quarter variations in actual or anticipated financial
results;
o announcements by us, our competitors or our customers;
o government regulations; and
o developments in the information storage and telecommunication
management industries.
The stock market has also experienced extreme price and volume fluctuations
which has affected the market price of many companies and which has at times
been unrelated to the operating performance of the specific companies whose
stock is traded. Broad market fluctuations, developments in the technology
industry, general economic conditions and political and current events may
adversely affect the market price of our common stock.
In addition, if our current security holders sell substantial amounts of our
common stock, in the public market, the market price of our common stock could
fall.
Insufficient Funding
We have expended and may be required to expend substantial funds for research
and development, and for other aspects of our business. Accordingly, we may need
or elect to raise additional capital. Our capital requirements will depend on
many factors, including:
o the problems, delays, expenses and complications frequently
encountered by technology companies;
o the progress of our research, development and product testing
programs;
o the success of our sales and marketing programs;
o costs in filing, prosecuting, defending and enforcing intellectual
property rights;
o the extent and terms of any collaborative research, manufacturing,
marketing or other arrangements; and
o changes in economic, regulatory or competitive conditions or our
planned business.
Estimates about the adequacy of funding for our activities are based on certain
assumptions, including the assumption that research, development and testing
related to our products under development can be conducted at projected costs
and within projected time frames and that such products can be successfully
marketed.
To satisfy our capital requirements, we may seek to raise funds in the public or
private capital markets. Our ability to raise additional funds in the public or
private markets will be adversely affected if the results of our ongoing or
future research and development programs are not favorable. We may seek
additional funding through corporate collaborations and other financing
vehicles. Such funding may not be available, or if available, it may not be
available on acceptable terms. If adequate funds are not available, we may be
required to curtail our operations significantly, or we may be required to
obtain funds through arrangements with future collaborative partners or others
that may require us to relinquish rights to some or all of our technologies or
products under development. If we are successful in obtaining additional
financing, the terms of the financing may have the effect of diluting or
adversely affecting the holdings or the rights of the holders of our common
stock.
19
Our Auditor's Have Expressed Substantial Doubt as to Our Ability to
Continue as a "Going Concern"
The auditors' reports for our consolidated financial statements for the years
ended December 31, 2002, 2001 and 2000 state that given our recurring operating
losses and our continued experience of negative cash flows from operations,
there is substantial doubt about our ability to continue as a going concern. A
"going-concern" opinion indicates that although there is substantial doubt, the
financial statements have been prepared on a going-concern basis and do not
include any adjustments to reflect the possible future effects on the
recoverability and classification of assets or the amounts and classification of
liabilities that may result from the outcome of this uncertainty.
Maintenance of American Stock Exchange (AMEX) Listing
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 stock being delisted. We believe that we will be
successful in regaining compliance, although there can be no assurance that we
will regain such compliance or that we will remain listed on AMEX. Delisting of
our common stock may have an adverse impact on the market price and liquidity of
our common stock.
Item 2. Properties
In December 2002, we relocated our principal executive, administrative, sales
and operating activities from San Diego, California to Carlsbad, California
where we currently sublease approximately 20,000 square feet through September
2005. The present annual base rent for our Carlsbad facility is $188,000.
We lease approximately 7,000 square feet of office and warehouse space in Lake
Mary, Florida, under a lease agreement that expires in May 2006. The present
annual base rent is approximately $53,000.
Our telecommunications headquarters consists of 12,500 square feet in Plano,
Texas under a lease that expires in August 2003. The present annual base rent is
$256,000.
We believe our existing facilities are adequate to meet future needs. See Note
17 to Consolidated Financial Statements for information regarding the Company's
obligations under its facilities leases.
Item 3. Legal Proceedings
In June 1996, Jack Ehrenhuas, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud
Mendelson and Susan Felton filed a Complaint in the Supreme Court of the State
of New York, County of Nassau, against us and Michael Wise, our then Chairman of
the Board and a current director. The plaintiffs claim to have contractual and
proprietary interests in the prospect of a transaction to purchase certain net
assets acquired by us and seek compensatory damages plus punitive damages.
20
In August 1996, The Nais Corporation, Mark Schindler, Eugene Stricker, Amnon
Damty, Ehud Mendelson and Susan Felton filed a Complaint in the same Court
making similar allegations against one of our subsidiaries, its then president,
R. Daniel Smith, and a company controlled by Mr. Smith. In this action, the
plaintiffs seek compensatory damages plus punitive damages for alleged breach of
contract.
Both cases are currently in discovery. Our counsel believes that we have good
defenses to both claims and that we will not incur any material liability. We
are unaware of any facts that would support any of the plaintiffs' claims and,
accordingly, we believe that the claims are without merit.
In February 2002, W. David Sykes, our former Executive Vice President of
Marketing and Sales, filed a complaint against us in the Circuit Court of Palm
Beach County, Florida, in which Mr. Sykes claims he was wrongfully terminated
under provisions of his employment agreement with us. We believe that we acted
in accordance with the termination provisions of the agreement and that no
further compensation or benefits are due to Mr. Sykes. We believe that we have
good defenses to the claim and that we will not incur any material liability.
From time to time, we are subject to legal proceedings and other claims arising
in the ordinary course of business. In our opinion, we are not a party to any
litigation the outcome of which would have a material adverse effect on our
business or operations.
Item 4. Submission of Matters to a Vote of Security Holders
On October 8,2002, we held our Annual Meeting of Stockholders. At the meeting,
the shareholders approved all matters considered with the following vote
distributions:
Items:
To approve the issuance of (a) 4,527,027 shares of nStor Technologies, Inc.
common stock upon conversion of nStor's Series L Convertible Preferred Stock,
and (b) up to 8,687,258 shares of nStor common stock as earn-out consideration,
to Pacific Technology Group, Inc.:
FOR AGAINST ABSTAIN
83,670,767 177,378 22,515,509
---------- ------- ----------
To approve the issuance of shares of nStor common stock to Halco Investments,
L.C. in connection with the potential conversion of a $3,100,000 promissory
note:
FOR AGAINST ABSTAIN
64,130,617 179,806 42,053,233
---------- ------- ----------
To approve the issuance of shares of nStor common stock to H. Irwin Levy in
connection with the potential conversion of a $650,00 promissory note:
FOR AGAINST ABSTAIN
83,662,982 131,429 22,569,243
---------- ------- ----------
21
To approve the issuance of up to 30,000,000 shares of nStor common stock upon
the potential exercise of an option granted to Pacific Technology Services,
Inc.:
FOR AGAINST ABSTAIN
106,117,267 174,124 72,263
----------- ------- ------
To approve an amendment to nStor's Certificate of Incorporation increasing the
number of authorized shares of common stock from 200,000,000 to 230,000,000:
FOR AGAINST ABSTAIN
106,060,160 289,085 14,409
----------- ------- ------
To amend nStor's 2001 Stock Option Plan to increase the number of shares
reserved for issuance from 5,000,000 to 7,500,000:
FOR AGAINST ABSTAIN
120,353,128 700,945 13,811
----------- ------- ------
To elect five persons to nStor's board of directors:
FOR VOTE WITHHELD
Roger H. Felberbaum 120,746,710 321,183
----------- -------
Bernard R. Green 120,746,502 321,282
----------- -------
Maurice A. Halperin 120,139,202 928,682
----------- -------
H. Irwin Levy 120,676,097 391,787
----------- -------
Michael L. Wise 120,727,466 340,418
----------- -------
To ratify the re-appointment of Swenson Advisors LLP as nStor's independent
auditors for 2002:
FOR AGAINST ABSTAIN
120,959,762 64,357 43,765
----------- ------ ------
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters
Our common stock is traded on the AMEX under the symbol NSO. The following table
sets forth the high and low sales prices of our common stock for each quarter
during the years ended December 31, 2002 and 2001 as reported by AMEX. During
that period, we did not pay dividends on our common stock and we do not expect
to pay any dividends in the near future.
Market Price Range
--------------------
2002 High Low
---- -------- --------
First quarter $ .48 $ .20
Second quarter .41 .21
Third quarter .30 .20
Fourth quarter .27 .19
2001
----
First quarter $ 2.00 $ .60
Second quarter .90 .30
Third quarter .58 .35
Fourth quarter .49 .23
22
As of February 28, 2003, we had 142,076,947 shares of common stock outstanding
and approximately 1,775 holders of record of such stock.
Recent Sales of Unregistered Securities and Use of Proceeds
Effective October 8, 2002, we issued 4,527,027 shares of our common stock to
Pacific Technology Group, Inc. upon the conversion of our Series L Convertible
Preferred Stock (see Note 2 to Consolidated Financial Statements). This issuance
was exempt from registration under Section 4(2) of the Act.
Item 6. Selected Financial Data
(dollars in thousands, except per share data)
The following table summarizes certain selected consolidated financial data for
the five years ended December 31, 2002.
Certain amounts for years prior to 2002 have been reclassified to conform to the
2002 presentation. These reclassifications had no impact on operating results
previously reported. The selected financial data has been derived from our
audited consolidated financial statements and is qualified by reference to, and
should be read in conjunction with, the Consolidated Financial Statements and
Notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations", included elsewhere in this report:
Year Ended December 31,
------------------------------------------------------------------
2002(1) 2001 2000 1999(4) 1998
-------- -------- -------- -------- ---------
Sales $10,790 $17,886 $40,197 $41,089 $18,026
Gross margin 2,898 2,049 9,872 9,763 2,768
Net loss (7,984) (13,958) (21,921)(3) (18,704)(5) (10,407)
Net loss available to
common stock (7,984) (18,518)(2) (22,606) (19,938) (11,888)
Basic and diluted net loss
per common share (.06) (.41) (.69) (.89) (.63)
Weighted average number of common
shares considered outstanding,
basic and diluted 128,899,148 44,832,503 32,789,832 22,505,084 18,888,911
At end of year:
Total assets 14,182 11,968 15,722 34,041 14,128
Long-term debt 3,100 3,600 7,258 6,329 7,043
Shareholders' equity (deficit) 1,620 487 ( 7,526) 6,273 3,150
- -------
(1) Includes results of operations of Stonehouse beginning June 2002, as a
result of our acquisition which was accounted for using the purchase method of
accounting.
(2) Includes non-cash charge of $3 million for induced conversion of convertible
preferred stock.
(3) Includes charge of $12 million for impairment of unamortized goodwill
related to an acquisition completed in 1999 and gain of $5.6 million on the sale
of assets.
(4) Includes results of operations of Andataco, Inc. beginning June 1999, as a
result of our acquisition which was accounted for using the purchase method of
accounting.
(5) Includes charge of $4.6 million for impairment of unamortized goodwill
related to an acquisition completed in 1996.
23
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
With the exception of the discussion regarding historical information,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and other discussions elsewhere in this Form 10-K contain
forward-looking statements. Such statements inherently involve risks and
uncertainties that could cause actual results 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 (SEC). Historical results are not necessarily
indicative of the operating result 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-K and in other reports we filed 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.
Overview
Since June 1996, we have been a designer, developer and manufacturer of Storage
Solutions. In June 2002, we entered the Telecommunication Solutions business
with our acquisition of Stonehouse. Accordingly, we believe that the comparison
between 2002 and 2001 may not be meaningful in certain respects. In addition,
due to the fact that Stonehouse's operating results were not included in our
consolidated financial statements until June 2002, we expect that many of the
components of our future operating results will increase in 2003.
Going-Concern
With respect to our consolidated financial statements, for the years ended
December 31, 2002, 2001 and 2000, we have received a "going-concern" opinion
from our auditors. As more fully described in the notes to the consolidated
financial statements, our recurring operating losses and our continued
experience of negative cash flows from operating activities raise substantial
doubt about our ability to continue as a going concern. A "going-concern"
opinion indicates that although there is substantial doubt, the financial
statements have been prepared on a going-concern basis and do not include any
adjustments to reflect the possible future effects on the recoverability and
classification of assets or the amounts and classification of liabilities that
may result from the outcome of this uncertainty.
Comparison of Years Ended December 31, 2002 and 2001
For the year ended December 31, 2002, we reported a net loss of $8 million as
compared to a net loss of $14 million for the year ended December 31, 2001.
24
Sales
Sales for 2002 were $10.8 million as compared to $17.9 million in 2001, a
decrease of $7.1 million. Included in sales for 2002 was $2.9 million
attributable to our Telecommunication Solutions business following our June 2002
acquisition of Stonehouse. The 56% decline in our Storage Solutions sales
reflects the economic downturn that has caused customer delays in acquiring
technology and other capital equipment, in addition to the transition from our
older technology legacy products to our new product family centered around our
NexStor 4000 Series.
During 2002, indirect sales to OEMs and other channel business represented 64%
of our Storage Solutions revenue, compared to 34% for direct sales to end users.
Indirect, direct and service revenues represented 35%, 43% and 22%,
respectively, of our 2001 revenues. The increased proportion of indirect sales
in 2002 reflects a strategy shift to provide a greater technological marketing
and sales support to our indirect sales function. Service revenues were
insignificant in 2002 as result of our August 2001 sale of substantially all our
service business (see Note 12 to Consolidated Financial Statements for a
discussion of Segment Information and Sales to Significant Customers).
Cost of Sales / Gross Margins
Gross margins realized by our Storage Solutions business in 2002 improved to 17%
compared to 11% reported for 2001. During the second half of 2002, we realized
gross margins of 36%, representing a significant improvement over the first half
of 2002 when we realized 0% gross margins. This improvement reflects
significantly lower material costs attributable to the commencement during the
third quarter of (i) outsourcing the manufacturing of our products and (ii)
shipments of our new 4000 Series storage systems. Positive gross margins were
not achieved during the first half of 2002 primarily due to (i) economies of
scale attributable to the level of fixed costs inherent in our operations,
coupled with significantly lower revenues, and (ii) the price we paid for
certain materials in connection with our 3000 Series storage systems prior to
the commencement of our manufacturing outsource agreement for our new 4000
Series. As a result of outsourcing our production, we phased out our
manufacturing facility in San Diego, California during the third quarter of
2002. A contributing factor to the low gross margins for 2001 was a fourth
quarter $2.5 million increase in inventory reserves due to obsolete inventory.
Our Telecommunication Solutions business experienced a 53% gross margin for the
seven months ended December 31, 2002. Combined gross margins for our Storage
Solutions and Telecommunication Solutions for 2002 amounted to 27% (see Note 12
to Consolidated Financial Statements for a discussion of Segment Information and
Significant Customers).
We expect an overall improvement in our gross margins in 2003 primarily as a
result of a full year of gross margins attributable to our Telecommunication
Solutions business, in addition to anticipated improved gross margins
attributable to our 4000 Series Storage Solutions.
Our gross margins are dependent, in part, on product mix, which fluctuates from
time to time. Our material costs are subject to fluctuations experienced during
business cycles that create shortages and excess supplies of some critical
components, thereby creating increases and decreases in costs.
Selling, General and Administrative Expenses (SG&A)
SG&A decreased to $5.3 million in 2002 from $10.4 million in 2001. The $5.1
million decrease principally resulted from the reduction of our overall work
force and related costs including occupancy expenses, partially offset by $1.2
million in SG&A incurred by our Telecommunication Solutions business. We expect
SG&A to increase in 2003 as we incur a full twelve months of SG&A attributable
to our Telecommunication Solutions business.
25
Research and Development (R&D)
Total R&D expenses decreased to $3.1 million in 2002 from $3.6 million in 2001.
We incurred $314,000 in R&D expenses attributable to our Telecommunication
Solutions business following our acquisition, which was more than offset by an
$800,000 decrease in R&D associated with our Storage Solutions business. This
decrease was primarily the result of an overall decrease in R&D expenses
following the development of our 4000 Series of storage systems. We believe that
considerable future investments in R&D will be required to remain competitive in
both our businesses.
R&D costs associated with MONIESWeb(R) software production in 2002 were expensed
as incurred until technological feasibility was established. Thereafter,
MONIESWeb(R) software production costs were capitalized until the product was
available for general release to customers in early 2003. Capitalized software
costs will be amortized beginning in 2003 based on the greater of (i) the
estimated economic life on the straight-line method, or (ii) the ratio that
current revenues attributable to MONIESWeb(R) revenues bears to total current
and estimated future revenues for MONIESWeb(R). Other R&D costs were expensed as
incurred. R&D costs may fluctuate considerably from time to time depending on a
variety of factors. These costs are incurred substantially in advance of related
revenues, and in certain situations, may not result in generating revenues. As
of December 31, 2002, we capitalized $300,000 in software development costs
associated with the development of MONIESWeb(R).
Depreciation and Amortization
Depreciation and amortization decreased to $1.5 million in 2002 from $1.6
million in 2001. The $151,000 decrease reflects the adoption of Statement of
Financial Accounting Standards No. 142 (SFAS 142), Goodwill and Intangible
Assets, which resulted in the discontinuation of amortization of goodwill with a
carrying value of approximately $2 million effective January 1, 2002, partially
offset by $214,000 in amortization of other intangible assets of $2.8 million
resulting from the Stonehouse acquisition (see Note 2 to Consolidated Financial
Statements). Amortization of goodwill for 2001 amounted to $408,000.
Realized and Unrealized Losses on Marketable Securities, Net
For 2002 and 2001, we recorded net losses on marketable securities of $1.1
million and $800,000, respectively. See Note 6 to the Consolidated Financial
Statements for a detailed discussion.
Other Income, Net
Other income, net amounted to $1.3 million in both 2002 and 2001. See Note 11 to
Consolidated Financial Statements for a detailed break down of the components of
Other Income, Net.
Fair Value of Option Granted to Customer
During 2002, we recorded a $600,000 non-cash charge for the fair value of an
option granted to a customer. See Note 9 to Consolidated Financial Statements
for a detailed discussion.
Interest Expense
Interest expense amounted to $629,000 in 2002 as compared to $912,000 in 2001.
The decrease is primarily attributable to significantly lower average borrowings
and lower interest rates.
26
Income Taxes
We have recorded a 100% valuation-allowance for deferred income tax assets,
which, more likely than not, will not be realized, based on recent operating
results.
Comparison of Years Ended December 31, 2001 and 2000
For the year ended December 31, 2001, we reported a net loss of $14 million as
compared to a net loss of $21.9 million for the year ended December 31, 2000.
Results of operations for 2000 include a net gain of $5.6 million from the sale
of assets of a subsidiary and a charge of $12 million for impairment of
unamortized goodwill.
Sales
Sales for 2001 were $17.9 million as compared to $40.2 million in 2000, a
decrease of $20.3 million. The significant decrease reflects the transition from
our older technology legacy products to our technology products centered around
our NexStor 2U storage enclosures and RAID systems as well as the economic
downturn causing customer delays in acquiring technology and other capital
equipment.
During 2001, we began to expand our indirect channel business and shift our
sales and marketing strategy to provide greater technical marketing and sales
support to our indirect sales function. As part of that strategy, beginning in
January 2001, we significantly reduced our direct sales personnel and related
costs, and refocused our direct sales force to targeted markets and existing
customers.
During 2001, direct, indirect and service revenues represented 43%, 35% and 22%,
respectively, of our sales revenues, compared to 75%, 14% and 11%, respectively,
in 2000. In August 2001, we sold substantially all of our service business. The
higher service revenues in 2001 relate to the recognition as revenue of the
remaining unamortized deferred revenues following the sale of our service
business.
Cost of Sales / Gross Margins
Gross margins decreased from 25% in 2000 to 11% in 2001. Gross margins in both
periods were adversely affected by (i) the level of fixed costs inherent in our
operations as compared with significantly lower than expected sales levels, and
(ii) increases in inventory reserves due to obsolete inventory of $2.5 million
and $1.6 million in 2001 and 2000, respectively. Our gross margins are
dependent, in part, on product mix, which fluctuates from time to time. Our
material costs are subject to fluctuations experienced during business cycles
that create shortages and excess supplies of some critical components, thereby
creating increases and decreases in costs.
Selling, General and Administrative Expenses
SG&A decreased to $10.4 million in 2001 from $16.2 million in 2000. The $5.8
million decrease is primarily the result of our overall work force reduction
previously discussed under "Sales".
Research and Development
R&D expenses amounted to $3.6 million in 2001, as compared to $3.5 million in
2000. Amounts in both years reflect the costs incurred to develop our NexStor
3000 and 4000 2U product lines. R&D costs were expensed as incurred,
substantially in advance of related revenues, and in certain situations, did not
result in generating revenues.
27
Depreciation and Amortization / Impairment of Goodwill
Depreciation and amortization decreased to $1.6 million in 2001 from $4.5
million in 2000. The decrease was due to reduced amortization resulting from the
fourth quarter 2000 write-down of $12 million of goodwill which was determined
to have been impaired because of our projected inability to generate sufficient
future operating income from the assets acquired in a 1999 acquisition.
Amortization of goodwill for the year ended December 31, 2001 amounted to
$408,000.
Realized and Unrealized Losses on Marketable Securities, Net
During 2001, we recognized $811,000 in net losses on marketable securities
composed of an $86,000 realized gain and an $897,000 unrealized loss. See Note 6
to Consolidated Financial Statements for a detailed discussion.
Other Income, Net
Other income, net amounted to $1.3 million in 2001. See Note 11 to Consolidated
Financial Statements for a detailed breakdown of the components of Other Income,
Net. Other income was not significant in 2000.
Interest Expense
Interest expense decreased $377,000 to $912,000 in 2001. The decrease was
primarily attributable to decreased lower average borrowings and lower interest
rates.
Income Taxes
We have recorded a 100% valuation-allowance for deferred income tax assets,
which, more likely than not, will not be realized based on recent operating
results.
Net Loss Available to Common Stock
Preferred Stock Dividends
During 2001 and 2000, with the exception of our Series K Preferred Stock, all
classes of our convertible preferred stock required dividends at 8%-10% per
annum. Preferred stock dividends increased by $875,000 to $1.6 million during
2001 principally due to the issuance of $2 million and $11.9 million of
preferred stock in December 2000 and April 2001, respectively, partially offset
by the automatic conversion of $3 million and $2 million of preferred stock to
common stock in July 2000 and October 2001, respectively. In connection with the
Halco Investment (see Note 3 to Consolidated Financial Statements), which closed
in November 2001, all of our remaining convertible preferred stock and accrued
dividends thereon were converted to common stock.
Induced Conversion of Convertible Preferred Stock
In November 2001, as a result of inducement shares issued in connection with the
conversion of our convertible preferred stock as a condition to the Halco
Investment (see Note 3 to Consolidated Financial Statements), we recorded a $3
million non-cash charge to arrive at net loss available to common stock,
representing the fair value of the inducement shares issued. The fair value was
based on $.23 per share, the price paid by Halco for its purchase of 39 million
shares of our common stock.
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. As
shown in the consolidated financial statements, we have experienced negative
cash flows from operating activities, decreased sales revenues and recurring net
losses of $8 million, $14 million and $21.9 million for the years ended December
31, 2002, 2001 and 2000, respectively. In addition, we have negative working
capital of $6.9 million as of December 31, 2002. These matters, among others,
raise substantial doubt about our ability to continue as a going-concern.
28
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.
These efforts include a significant reduction in our direct sales personnel and
related costs as part of our strategy to provide greater technical, marketing
and sales support to expand the our indirect customer channel base. Additional
personnel reductions have been implemented to reflect our lower sales levels,
our recent manufacturing outsourcing agreement described below and to provide
certain cost efficiencies. Further efforts to reduce our fixed operating costs
resulted in the relocation of our executive and business headquarters to a more
economical facility in Carlsbad, California in December 2002.
In July 2002, we entered into a contract with Varian for outsourcing the
production of our 4000S Series of storage enclosures. Our 4000F Series is
currently being assembled by an interim outside contractor. As a result, we
phased out our San Diego, California manufacturing facility during the third
quarter of 2002. The outsourcing agreement has resulted in a significant
improvement in our operating margins by lowering manufacturing costs and overall
operating costs.
Since January 1, 2001, and through February 28, 2003, we obtained $21.7 million
of equity and debt financing from private investors. Of these amounts, $12.1
million was received in 2001 from Maurice Halperin, our Chairman of the Board
since August 2001 and a principal shareholder, or companies controlled by Mr.
Halperin (collectively Mr. Halperin), consisting of $6 million in cash and $6.1
million in marketable securities (see Note 3 to Consolidated Financial
Statements). Equity and debt financing obtained from January 2001 through
February 28, 2003 also included $6.9 million from H. Irwin Levy, our Chief
Executive Officer, Vice-Chairman of the Board and a principal shareholder, or
companies controlled by Mr. Levy (collectively, Mr. Levy). In addition, in
connection with our outsourcing contract, Mr. Levy provided collateral for a
bank to issue a $1 million letter of credit (LC) for the benefit of Varian. The
LC was subsequently reduced to $750,000. We have agreed to indemnify Mr. Levy
for any amounts drawn upon the LC by Varian.
In August 2002, we entered into an Agreement For Purchase of Accounts with a
financial institution (Purchaser), providing for a $750,000 line of credit under
which we may sell customer invoices to the Purchaser. The Purchaser advances 80%
of the net face amount of qualified invoices and remits the remaining 20%, less
its fees, upon collecting the invoice in full. We are obligated to repay the
Purchaser for invoices not paid within 90 days.
In an effort to increase our cash flow and profitability, among other reasons,
on June 7, 2002, we acquired 100% of the outstanding capital stock of
Stonehouse. The acquisition has had a positive impact on our gross margins and
has contributed to our cash flow (see Note 2 of Consolidated Financial
Statements).
We are currently exploring alternatives for raising additional debt or equity
capital to finance our short-term and long-term plans as well as operating
deficits expected to be incurred until we begin to generate positive operating
cash flows. However, due to conditions in the technology-related financial
markets and other uncertainties, many of which are beyond our control, there can
be no assurances that such required additional funds will be available on terms
acceptable to us, if at all, or that we will be able to generate positive cash
flows from operating activities in the future. We currently have insufficient
liquidity to fund our operating needs for the next twelve months.
29
The consolidated financial statements do not include any adjustments to reflect
the possible future effects on the recoverability and classification of assets
or the amounts and classification of liabilities that may result from our
inability to continue as a going concern.
Cash Flow Results
Operating Activities
Net cash used in operating activities amounted to $451,000 and $10.3 million for
2002 and 2001, respectively. The most significant use of cash for both years was
our loss from operations (before depreciation, amortization and other non-cash
items) of $3.3 million in 2002 and $8.1 million in 2001. The most significant
source of cash was the net reduction of accounts receivable and prepaid expenses
of $2.5 million in 2002 and $2.3 million in 2001. In addition, in 2002 and 2001,
cash was provided by the net reduction in inventories of $524,000 and $653,000,
respectively. During 2002 and 2001, we used cash of $200,000 and $5.2 million,
respectively, in the reduction of deferred revenue, accounts payable and other
liabilities.
Investing Activities
Net cash provided by investing activities for 2002 of $130,000 was the result of
$298,000 in cash acquired in the Stonehouse acquisition, net of $168,000 cash
used for purchases of property and equipment. Net cash used in investing
activities amounted to $163,000 in 2001 for purchases of property and equipment.
Financing Activities
Net cash used in financing activities for 2002 amounted to $243,000 resulting
from net repayments of our revolving credit facility of approximately $3
million, substantially offset by proceeds from borrowings from Mr. Levy of $2.7
million. Net cash provided by financing activities for 2001 amounted to $11.3
million, principally consisting of borrowings from private investors of $11.2
million (including $3.3 million from Mr. Levy and $5 million from Mr. Halperin)
of which $7.2 million was satisfied by issuing convertible preferred stock and
common stock (including $2.8 million from Mr. Levy and $1.9 million from Mr.
Halperin). An additional $1.2 million of cash was provided in 2001 by issuing
convertible preferred stock to private investors (including $1 million from Mr.
Halperin), substantially offset by net repayments of our revolving credit
facility of approximately $1.1 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 stock 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.
30
Critical Accounting Policies and Estimates
Storage Solutions revenues are recognized as of the date shipments are made to
customers, net of an allowance for returns. 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.
R&D costs associated with our Telecommunication Solutions business for software
production are expensed as incurred until technological feasibility is
established. Thereafter, software production costs are capitalized until the
product is available for general release to customers. Amortization commences
only when the product is available for general release and is recorded as
amortization rather than R&D costs. Capitalized software costs are amortized
over the greater of (i) the estimated economic life on the straight-line method,
or (ii) the ratio that current revenues for the product bears to the total
current and anticipated future revenues for the product.
Our preliminary allocation of the Stonehouse purchase price included $6.5
million in goodwill and $2.8 million in other intangible assets in accordance
with Statement of Financial Accounting Standard (SFAS) No. 141, Business
Combinations. These values were based on a valuation analysis completed by an
independent valuation firm. In addition, we have unamortized goodwill of
approximately $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, Goodwill and Other Intangible Assets (see Note 5 to Consolidated
Financial Statements).
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.
Effects of Inflation
During recent years, inflation has not had an impact on our operations and we do
not expect that it will have a material impact in 2003.
Item 7a. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk for changes in interest rates relates to our
Stonehouse variable rate bank line of credit under which we may borrow up to
$500,000.
31
Item 8. Financial Statements and Supplementary Data
Table of Contents to Consolidated Financial Statements
Page
Report of Independent Certified Public Accountants 32
Report of Independent Certified Public Accountants 33
Consolidated Financial Statements:
Balance Sheets - December 31, 2002 and 2001 34
Statements of Operations - Years Ended
December 31, 2002, 2001 and 2000 35
Statements of Shareholders' Equity
Years Ended December 31, 2002, 2001 and 2000 36-37
Statements of Cash Flows - Years Ended
December 31, 2002, 2001 and 2000 38-39
Notes to Consolidated Financial Statements 40-67
Report of Independent Certified Public Accountants 68
Report of Independent Certified Public Accountants 69
FINANCIAL STATEMENT SCHEDULES. The following financial statement schedules of
nStor Technologies, Inc. for the years ended December 31, 2002, 2001 and 2000
are filed as part of this Report on the page number so indicated and should be
read in conjunction with the Consolidated Financial Statements of nStor
Technologies, Inc.:
Schedule I - Condensed Financial Information of Registrant 70-72
Schedule II - Valuation and Qualifying Accounts 73
Schedules not listed above are omitted because they are not applicable or are
not required or the information required to be set forth therein is included in
the Consolidated Financial Statements or Notes thereto.
32
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
nStor Technologies, Inc.
We have audited the accompanying consolidated balance sheets of nStor
Technologies, Inc. and subsidiaries (the "Company") as of December 31, 2002 and
2001, and the related consolidated statements of operations, shareholders'
equity and cash flows for the years then ended. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audit.
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 nStor Technologies,
Inc. and subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for the years then ended in conformity with
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has significant recurring losses,
negative working capital and serious liquidity concerns. These matters, among
others, raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1. The accompanying consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
The consolidated financial statements of nStor Technologies, Inc. and
subsidiaries as of December 31, 2000 were audited by other auditors whose report
dated February 9, 2001 on those statements included an explanatory paragraph
describing conditions that raise substantial doubt about the Company's ability
to continue as a going concern.
/S/ Swenson Advisors, LLP
Swenson Advisors, LLP
San Diego, California
March 14, 2003
33
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
nStor Technologies, Inc.
We have audited the accompanying consolidated statements of operations,
shareholders' (deficit) equity and cash flows of nStor Technologies, Inc. and
subsidiaries (the "Company") for the year ended December 31, 2000. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audit.
We conducted our audit 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 audit provides a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of their operations and their cash
flows of nStor Technologies, Inc. and subsidiaries for the year ended December
31, 2000 in conformity with accounting principles generally accepted in the
United States of America.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered substantial
recurring losses from operations, has a working capital deficiency, a
shareholders' deficit and is in default under its existing credit facility.
These matters, among others, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1. The accompanying consolidated financial statements
do not include any adjustments that might result from the outcome of this
uncertainty.
/S/ BDO SEIDMAN, LLP
BDO SEIDMAN, LLP
Costa Mesa, California
February 9, 2001
34
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
=========================================
(dollars in thousands)
December 31,
-----------------
ASSETS 2002 2001
------ ------- -------
Current assets:
Cash and cash equivalents $ 293 $ 857
Marketable securities - 4,255
Accounts receivable, net 934 1,925
Inventories 1,079 1,364
Prepaid expenses and other 224 211
-------- -------
Total current assets 2,530 8,612
Property and equipment, net of $88 and $5,641 in
accumulated depreciation 303 1,367
Goodwill and other intangible assets, net of $1,021
and $807 in accumulated amortization 11,349 1,989
-------- -------
$ 14,182 $11,968
LIABILITIES ======== =======
-----------
Current liabilities:
Bank line of credit $ 200 $ 2,991
Other borrowings 4,684 1,100
Accounts payable and other 3,177 3,790
Deferred revenue 1,401 -
------- -------
Total current liabilities 9,462 7,881
Long-term debt 3,100 3,600
------- -------
Total liabilities 12,562 11,481
------- -------
Commitments, contingencies and subsequent events
SHAREHOLDERS' EQUITY
---------------------
Preferred stock, $.01 par; 1,000,000 shares authorized;
0 shares assumed issued and outstanding at December 31,
2002 and 2001 - -
Common stock, $.05 par; 230,000,000 shares authorized;
142,076,947 and 114,603,144 shares assumed issued and
outstanding at December 31, 2002 and 2001, respectively 7,103 5,729
Additional paid-in capital 101,847 94,104
Deficit (107,330) (99,346)
------- -------
Total shareholders' equity 1,620 487
------- -------
$14,182 $11,968
======= =======
See Report of Certified Public Accountants and accompanying notes
to consolidated financial statements
35
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
=========================================
(dollars in thousands, except per share data)
Years Ended December 31,
------------------------------
2002 2001 2000
--------- --------- --------
Sales $10,790 $17,886 $40,197
Cost of sales 7,892 15,837 30,325
-------- -------- --------
Gross margin 2,898 2,049 9,872
-------- -------- --------
Operating expenses:
Selling, general and administrative 5,251 10,354 16,232
Research and development 3,085 3,579 3,504
Depreciation and amortization 1,471 1,622 4,468
Impairment of goodwill - - 11,959
-------- -------- --------
Total operating expenses 9,807 15,555 36,163
-------- -------- --------
Loss from operations (6,909) (13,506) (26,291)
Gain on sale of assets of subsidiary - - 5,575
Realized and unrealized losses on
marketable securities, net (1,123) (811) -
Other income, net 1,277 1,271 84
Fair value of option granted to customer (600) - -
Interest expense, net (629) (912) (1,289)
-------- -------- --------
Net loss before preferred stock dividends
and induced conversion (7,984) (13,958) (21,921)
Preferred stock dividends - (1,560) (685)
Induced conversion of convertible
preferred stock - (3,000) -
-------- --------- --------
Net loss available to common stock ($7,984) ($18,518) ($22,606)
======== ========= ========
Basic and diluted net loss per
common share ($ .06) ($ .41) ($ .69)
======== ========= ========
Weighted average number of common
shares considered outstanding,
basic and diluted 128,899,148 44,832,503 32,789,832
=========== ========== ==========
See Report of Certified Public Accountants and accompanying notes
to consolidated financial statements
36
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
===============================================
(dollars in thousands)
Preferred Addi-
Common Stock Stock tional
---------------------- ----------------- Paid-in
Shares Amount Shares Amount Capital Deficit Total
----------- ------ ------ ------ -------- ---------- -------
Balances, January 1, 2000 26,517,824 $1,331 14,921 $ - $ 63,164 $ (58,222) $ 6,273
Issuance of common stock
in connection with:
Conversion of convertible
preferred stock 6,477,467 324 (8,699) - (324) -
Acquisition of assets 776,119 39 2,561 2,600
Exercise of options and
warrants 635,589 32 1,146 1,178
Equity line of credit,
net of issuance costs of $87 508,857 25 936 961
Satisfaction of borrowings 439,154 22 1,228 1,250
Executive termination 123,479 - - -
Issuance of preferred stock
in satisfaction of borrowings
from director 2,000 - 2,000 2,000
Compensation expense resulting
from modifications to stock
options and warrants in
connection with the sale of
the assets of subsidiary 818 818
Preferred stock dividends (685) (685)
Net loss for the year
ended December 31, 2000 (21,921) (21,921)
----------- ------ ------ ------ -------- ---------- -------
Balances, December 31, 2000 35,478,489 1,773 8,222 - 71,529 (80,828) (7,526)
Issuance of convertible
preferred stock in
connection with:
Satisfaction of borrowings,
net of issuance costs of $15 11,942 - 11,927 11,927
Private placement 250 - 250 250
Halco Investment, net of
issuance costs of $28 8,970 - 8,941 8,941
Issuance of common stock in
connection with:
Conversion of Series D & F
convertible preferred stock 2,240,533 112 (2,722) - (112) -
Halco Investment (issued
January 11, 2002 upon
shareholder approval-Note 3)
including conversion of
Series H, I, & K convertible
preferred stock 76,884,122 3,844 (26,662) - (2,075) 1,769
Common stock option and warrants
issued in connection with:
Borrowings 554 554
Other 90 90
Preferred stock dividends (1,560) (1,560)
37
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
===============================================
(dollars in thousands) (concluded)
Preferred Addi-
Common Stock Stock tional
---------------------- ----------------- Paid-in
Shares Amount Shares Amount Capital Deficit Total
----------- ------ ------ ------ -------- ---------- -------
Induced conversion of
convertible preferred
stock 3,000 (3,000) -
Net loss for the year ended
December 31, 2001 (13,958) (13,958)
----------- ------ ------ ------ -------- ---------- -------
Balances, December 31, 2001 114,603,144 5,729 - - 94,104 (99,346) 487
Issuance of common stock
in connection with:
Acquisition of 100% of
common stock of Stonehouse
Technologies, Inc.
("Stonehouse") 22,500,000 1,125 5,850 6,975
Payment of accrued
dividends on Series D
convertible preferred
stock 446,776 23 116 139
Issuance of Series L convertible
preferred stock in connection
with Stonehouse acquisition 1,000 - 1,403 1,403
Conversion of Series L convertible
preferred stock upon
shareholder approval 4,527,027 226 (1,000) - (226) -
Fair value of option granted
to customer 600 600
Net loss for the year ended
December 31, 2002 (7,984) (7,984)
----------- ------ ------ ------ -------- ---------- -------
Balances, December 31, 2002 142,076,947 $7,103 - $ - $101,847 $(107,330) $1,620
=========== ====== ====== ====== ======== ========== =======
See Report of Certified Public Accountants and accompanying notes
to consolidated financial statements
38
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
=====================================
(in thousands)
Years Ended December 31,
--------------------------------
2002 2001 2000
CASH FLOWS FROM OPERATING ACTIVITIES: -------- -------- --------
Net loss ($7,984) ($13,958) ($21,921)
Adjustments to reconcile net loss to
net cash used in operating activities:
Proceeds from sales of marketable securities 3,132 1,047 -
Depreciation and amortization 1,471 1,622 4,468
Other income, net (1,277) (1,496) -
Realized and unrealized losses on marketable
securities, net 1,123 811 -
Capitalized research and development (300) - -
Fair value of option granted to customer 600 - -
Provision for inventory obsolescence (239) 2,500 3,988
Provision for uncollectible accounts receivable 211 1,069 912
Gain on sale of assets of subsidiary - - (5,575)
Amortization of deferred loan costs and other - 280 21
Impairment of goodwill - - 11,959
Changes in assets and liabilities, net of
effects from acquisitions:
Decrease in accounts receivable 2,398 1,201 2,108
Decrease (increase) in inventories 524 653 (2,875)
Decrease in prepaid expenses and other 91 1,090 293
Decrease in deferred revenue, accounts
payable and other liabilities (201) (5,152) (2,807)
-------- -------- --------
Net cash used in operating activities (451) (10,333) (9,429)
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net proceeds from sale of assets of subsidiary - - 7,013
Net cash acquired (paid) in acquisitions 298 - (293)
Additions to property and equipment, net (168) (163) (853)
-------- -------- --------
Net cash provided by (used in) investing activities 130 (163) 5,867
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments of revolving bank credit facilities (2,991) (1,095) (1,025)
Additions to other borrowings 2,748 11,249 4,858
Repayments on other borrowings - - (2,285)
Issuance of convertible preferred stock - 1,221 -
Issuance of common stock, net of issuance costs - - 961
Proceeds from exercise of stock options and warrants - - 1,178
Cash paid for preferred stock dividends - (59) (761)
-------- -------- --------
Net cash (used in) provided by financing activities (243) 11,316 2,926
-------- -------- --------
Net (decrease) increase in cash and cash
equivalents during the year (564) 820 (636)
Cash and cash equivalents at beginning of year 857 37 673
-------- -------- --------
Cash and cash equivalents at end of year $ 293 $ 857 $ 37
======== ======== ========
39
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
=====================================
(in thousands) (concluded)
Years Ended December 31,
--------------------------------
2002 2001 2000
-------- -------- --------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 283 $ 504 $ 1,297
======== ======== ========
NON-CASH INVESTING ACTIVITIES:
Acquisitions:
Fair value of assets acquired $11,081 $ - $ 2,938
Liabilities assumed and incurred (3,001) - (45)
Common stock and convertible preferred
stock issued to sellers (8,378) - (2,600)
-------- -------- --------
Cash (acquired) paid $( 298) $ - $ 293
======== ======== ========
Convertible preferred stock issued to Halco
in exchange for marketable securities $ - $ 6,113 $ -
======== ======== ========
Modifications to stock options and warrants
in connection with the sale of assets of a
subsidiary $ - $ - $ 818
======== ======== ========
NON-CASH FINANCING ACTIVITIES:
Issuance of common and convertible preferred
stock in satisfaction of borrowings, accrued
dividends and accrued interest $ 139 $ 15,568 $ 3,250
======== ======== ========
Deferred loan costs arising from issuance
of warrants under borrowings $ - $ 554 $ -
======== ======== ========
See Report of Certified Public Accountants and accompanying notes
to consolidated financial statements
40
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
==========================================
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of nStor
Technologies, Inc. ("nStor") and all wholly-owned subsidiaries (collectively,
the "Company"). Significant intercompany balances and transactions have been
eliminated in consolidation.
Liquidity and 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. As shown in the consolidated financial statements, the Company has
experienced negative cash flows from operating activities, decreases in sales
revenues and substantial recurring net losses of $8 million, $14 million and
$21.9 million, for the years ended December 31, 2002, 2001 and 2000,
respectively. The sales declines have reflected the global reduction in business
demand for technology products. In addition, the Company has negative working
capital of $6.9 million as of December 31, 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.
These efforts include a significant reduction in the Company's direct sales
personnel and related costs as part of its strategy to provide greater
technical, marketing and sales support to expand the Company's indirect customer
channel base (original equipment manufacturers (OEMs), resellers and system
integrators (SIs)). Additional personnel reductions have been implemented to
reflect the Company's lower sales levels, the Company's recent manufacturing
outsourcing described below and to provide certain cost efficiencies. Further
efforts to reduce the Company's fixed operating costs resulted in the relocation
of the Company's executive and business headquarters to a more economical
facility in Carlsbad, California in December 2002.
In July 2002, the Company entered into a contract with Varian, Inc. ("Varian")
for outsourcing the production of the Company's 4000S Series of storage
enclosures. The Company's 4000F Series is currently being assembled by an
interim outside contractor. As a result, the Company phased out its San Diego,
California manufacturing facility during the third quarter of 2002. The
outsourcing arrangement has resulted in a significant improvement in the
Company's operating margins by lowering manufacturing costs and overall
operating costs.
Since January 1, 2001, and through February 28, 2003, the Company obtained $21.7
million of equity and debt financing from private investors. Of these amounts,
$12.1 million was received in 2001 from Maurice Halperin, the Company's Chairman
of the Board since August 2001 and a principal shareholder, or companies
controlled by Mr. Halperin (collectively "Mr. Halperin"), consisting of $6
million in cash and $6.1 million in marketable securities (see Note 3 to
Consolidated Financial Statements). Equity and debt financing obtained from
January 2001 through February 28, 2003 also included $6.9 million from H. Irwin
Levy, the Company's Chief Executive Officer, Vice-Chairman of the Board and a
principal shareholder, or companies controlled by Mr. Levy (collectively, "Mr.
Levy"). In addition, in connection with the Company's outsourcing contract, Mr.
Levy provided collateral for a bank to issue a $1 million letter of credit
("LC") for the benefit of Varian. The LC was subsequently reduced to $750,000.
In August 2002, the Company entered into an Agreement For Purchase of Accounts
with a financial institution, providing for a $750,000 line of credit under
which the Company may sell customer invoices to the financial institution (see
Note 8 to Consolidated Financial Statements).
41
In an effort to increase the Company's cash flow and profitability, among other
reasons, on June 7, 2002, the Company acquired 100% of the outstanding capital
stock of Stonehouse Technologies, Inc. ("Stonehouse"). The acquisition has had a
positive impact on our gross margins and cash flow (see Note 2 to Consolidated
Financial Statements).
The Company is currently exploring alternatives for raising additional debt or
equity capital to finance its short-term and long-term plans as well as
operating deficits expected to be incurred until it begins to generate positive
operating cash flows. However, due to conditions in the technology-related
financial markets and other uncertainties, many of which are outside the
Company's control, there can be no assurance that such required additional funds
will be available on terms acceptable to management, if at all, or that the
Company will be able to generate positive cash flows from operations in the
future. The Company has insufficient liquidity to fund its operating needs for
the next twelve months.
The consolidated financial statements do not include any adjustments to reflect
the possible future effects on 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
The Company, through its wholly-owned subsidiary nStor Corporation, is a
designer, developer and manufacturer of external data storage solutions,
including high-density storage enclosures, storage management software and RAID
(Redundant Array of Independent Disks) controller technology ("Storage
Solutions"). The Company's product line supports a variety of operating systems,
including Windows NT and Windows 2000, UNIX, Linux, and Macintosh. Designed for
storage intensive environments 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 (see Note 2 to Consolidated
Financial Statements). Stonehouse is a provider of telecommunications software
and services solutions ("Telecommunication 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.
Cash and Cash Equivalents
Cash and cash equivalents consist of highly liquid investment instruments with
original maturities, when purchased, of three months or less.
Marketable Securities
In accordance with Statement of Financial Accounting Standard No. 115,
Accounting for Certain Investments in Debt and Equity Securities, marketable
securities held by the Company at December 31, 2001 were classified as trading
securities and reported at fair value with unrealized gains and losses
recognized in earnings.
42
Inventories
Inventories, consisting of raw materials, work-in-process and finished goods,
are stated at the lower of cost or market, with cost being determined based on
the first-in, first-out (FIFO) method. Reserves are recorded as necessary to
reduce obsolete inventory to estimated net realizable value (see Note 4 to
Consolidated Financial Statements).
Revenue Recognition
Storage Solutions
Revenue from the sale of products is recognized as of the date shipments are
made to customers, net of an allowance for returns. Prior to August 2001, the
Company contracted with outside vendors to provide services relating to various
on-site warranties which were offered for sale to customers. On-site warranty
revenues and amounts paid in advance to outside service organizations were
recognized in the financial statements in sales and cost of goods sold,
respectively, over the life of the service contracts. In August 2001, the
Company sold substantially all of its servicing business. The remaining
unamortized deferred revenue was recognized as revenue following the sale.
Telecommunication Solutions
In accordance with provisions of the AICPA Statement of Position (SOP) 97-2,
Software Revenue Recognition, 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.
Long-Lived Assets
In accordance with the provisions of Statement of Financial Accounting Standard
No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
long-lived assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by comparison of the carrying amount of an asset to
future net cash flows expected to be generated by the asset. If such assets are
considered impaired, the impairment to be recognized is measured by the amount
by which the carrying amount of the assets exceeds the fair value of the assets.
Assets to be disposed of are reported at the lower of the carrying amount or
fair value less costs to sell.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided under the
straight-line method over the estimated useful lives, principally five years.
Leasehold improvements are amortized on a straight-line basis over the shorter
of the useful life of the asset or the lease term.
Goodwill
Goodwill represents the excess cost of the acquired businesses over the fair
value of net assets acquired (see Notes 2 and 5 to Consolidated Financial
Statements) and is carried at cost. As a result of the Company adopting
Statement of Financial Accounting Standard ("SFAS") No. 142, Goodwill and Other
Intangible Assets, the Company discontinued amortization of goodwill effective
January 1, 2002. Prior to the Company's adoption of SFAS No. 142, the Company
amortized goodwill under the straight-line method over seven years. At December
31, 2002, unamortized goodwill amounted to $9.3 million, of which $6.5 million
is attributable to the Company's June 2002 acquisition of Stonehouse (see Note 2
to Consolidated Financial Statements).
43
Management periodically reviews goodwill to determine if an impairment has
occurred. Among various considerations, this process includes evaluating
recoverability based upon cash flow forecasts. As a result of the Company's
projected inability to generate sufficient future operating income from the
assets acquired in an acquisition, during 2000 the Company recorded charges for
impairment of goodwill of $12 million eliminating all remaining unamortized
goodwill related to the 1999 acquisition of Andataco, Inc. (Andataco).
Research and Development Costs ("R&D")
Storage Solutions
R&D costs associated with our Storage Solutions business are expensed as
incurred.
Telecommunication Solutions
In accordance with Statement of Financial Accounting Standard No. 86,
"Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed", R&D costs associated with the creation of a software product are
expensed as incurred until technological feasibility is established. Thereafter,
software production costs are capitalized until the product is available for
general release to customers. Capitalized software costs are amortized over the
greater of (a) the straight-line method over the remaining estimated economic
life of the product or (b) the ratio that current gross revenues for the product
bear to the total of current and anticipated future gross revenues for that
product. Amortization begins when the product is available for general release
to customers. Other R&D costs are expensed as incurred.
Income Taxes
Income taxes are provided on the liability method whereby deferred tax assets
and liabilities are recognized for the expected tax consequences of temporary
differences between the tax bases and reported amounts of assets and
liabilities. Deferred tax assets and liabilities are computed using enacted tax
rates expected to apply to taxable income in the years in which temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities from a change in tax rates is recognized in income in the
period that includes the enactment date.
The Company provides a valuation allowance for certain deferred tax assets, if
it is more likely than not that the Company will not realize tax assets through
future operations.
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 all periods presented, the
effect of including dilutive securities would have been antidilutive.
Accordingly, basic and diluted EPS for all periods presented are the same.
44
As of December 31, 2002 and 2001, outstanding common stock equivalents included
the following, respectively: 7,414,333 and 2,871,294 shares underlying stock
options; 1,982,500 and 3,304,299 shares underlying warrants; and 59,877,432
shares underlying convertible preferred stock at December 31, 2001. 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. As part of the issuance of
the New Common Shares, all of the Company's convertible preferred stock was
converted to common stock.
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 materially differ from those
estimates.
Financial Instruments
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments", requires
disclosure of fair value information about financial instruments. Fair value
estimates discussed herein are based upon certain market assumptions and
pertinent information available to management as of December 31, 2002 and 2001.
The respective carrying value of certain on-balance-sheet financial instruments
approximated their fair values. These financial instruments include cash and
cash equivalents, accounts receivable, accounts payable and accrued liabilities.
Fair values were assumed to approximate carrying values for these financial
instruments since they are short term in nature and their carrying amounts
approximate fair values or they are receivable or payable on demand. The
carrying value of the Company's marketable securities equaled their quoted
market value at December 31, 2001. The fair value of the Company's borrowings
(current and long-term) is estimated based upon quoted market prices for the
same or similar issues or on the current rates offered to the Company for debt
of the same remaining maturities. The carrying value approximates their fair
value.
Dependence on Suppliers
The Company has and will continue to rely on outside vendors to manufacture
certain subsystems and electronic components and subassemblies used in the
production of the Company's Storage Solutions products. Certain components,
subassemblies, materials and equipment necessary for the manufacture of the
Company's Storage Solutions products are obtained from a sole supplier or a
limited group of suppliers. The Company performs ongoing quality and supply
evaluation reviews with its outside vendors. Supply, delivery and quality of
subsystems and electronic components and subassemblies have been adequate to
fulfill customer orders and management does not expect any vendor problems in
the next twelve months.
Reclassifications
Certain prior years' amounts have been reclassified to conform to the current
year's presentations. These reclassifications had no impact on operating results
previously reported.
45
Comprehensive Income
SFAS No. 130, Reporting Comprehensive Income, established rules for the
reporting and display of comprehensive income (loss) and its components in a
full set of general-purpose financial statements. The Company had no
comprehensive income (loss) for all periods presented.
Recent Authoritative Pronouncements
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation- Transition and Disclosure",
an amendment to SFAS No. 123, "Accounting for Stock-Based Compensation" and
Accounting Principles Board ("APB") Opinion No. 28, "Interim Financial
Reporting." SFAS No. 148 provides for alternative methods of transition for an
entity that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 (i) amends the
disclosure provisions of SFAS No. 123 to require prominent disclosure about the
effects on reported net income of an entity's accounting policy decisions with
respect to stock-based employee compensation; and (ii) amends APB Opinion No.
128 to require disclosure about those effects in interim financial information.
Provisions of SFAS No. 148 relating to amendments to SFAS No. 123 are effective
for financial statements for fiscal years ending after December 31, 2002.
Earlier application of certain transition provisions is permitted for entities
with a fiscal year ending prior to December 15, 2002, provided that financial
statements for the 2002 fiscal year had not been issued as of the date SFAS No.
148 was issued. Provisions of SFAS No. 148 relating to amending APB Opinion No.
28 are effective for financial reports for interim periods beginning after
December 15, 2002. The Company does not anticipate the adoption of this
statement will have a material effect on the Company's financial position or
results of operations.
In November 2002, the FASB issued Interpretation No. 45 (FIN), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others", an interpretation of SFAS No. 5, 57 and
107 and rescission of FIN No. 34, which addresses disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. Provisions of FIN No. 45 related to
recognition and initial measurement are to be applied on a prospective basis to
guarantees issued or modified after December 31, 2002. Provisions of FIN No. 45
related to disclosure requirements are effective for financial statements of
interim and annual periods ending after December 15, 2002. The Company does not
anticipate the adoption of this pronouncement will have a material effect on the
Company's financial position or results of operations.
In July 2002, the FASB issued 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 effect on the
Company's financial position or results of operations.
In April 2002, the FASB issued 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 meet the criteria of
APB Opinion No. 30, Reporting the Results of Operations.
46
The amendment of SFAS No. 13 is effective for transactions occurring on or after
May 15, 2002. Although the rescission of SFAS No. 4 is effective January 1,
2003, the FASB has encouraged early application of the provisions of SFAS No.
145. Effective in the third quarter of 2002, the Company adopted SFAS No. 145
and determined that gains and losses previously reported as extraordinary items
during 2002 and 2001 no longer meet the criteria as set forth under APB Opinion
No. 30 and have reported those items as Other Income in the accompanying
consolidated financial statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 establishes the accounting model
for long-lived assets to be disposed of by sale and applies to all long-lived
assets, including discontinued operations. SFAS No. 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. SFAS No. 144 was effective for financial statements issued for
fiscal years beginning after December 15, 2001 and, generally, was to be applied
prospectively. SFAS No. 144 was effective for the Company commencing January 1,
2002 and had no impact on the Company's financial position or results of
operations.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which addresses how intangible assets that are acquired individually or
with a group of other assets should be accounted for upon their acquisition.
SFAS No. 142 also addresses how goodwill and other intangible assets should be
accounted for after they have been initially recognized in the financial
statements. SFAS No. 142 was effective for fiscal years beginning after December
15, 2001, with earlier adoption permitted. The Company's implementation of SFAS
No. 142 in 2002 resulted in the discontinuation of amortization of goodwill with
a carrying amount of approximately $2 million as of December 31, 2001.
Amortization for the years ended December 31, 2001 and 2000 amounted to $408,000
and $2.6 million, respectively. Goodwill is subject to an annual review for
impairment.
In July 2001, the FASB issued SFAS No. 141, "Business Combinations", which
requires business combinations initiated after June 30, 2001 to be accounted for
using the purchase method of accounting. In addition, SFAS No. 141 specifies the
types of acquired intangible assets that are required to be recognized and
reported separately from goodwill. SFAS No. 141 impacted the Company's
Stonehouse acquisition that occurred in June 2002 (see Note 2 to Consolidated
Financial Statements).
(2) ACQUISITIONS
Stonehouse
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 $541,000 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 22.5 million 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 was convertible into 4,527,027
shares of common stock, subject to shareholder approval, which was obtained
effective October 8, 2002, at which time the common shares were issued in
exchange for the Series L Convertible Preferred Stock. In addition, the Company
is obligated to issue additional shares of common stock based on an earn-out
provision, whereby in the event Stonehouse's pretax income (defined in the Stock
Purchase Agreement as "Net Revenues") 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 additional common shares. The potential issuance of
such shares was also approved by the Company's shareholders on October 8, 2002.
At December 31, 2002, there was no basis for the Company to record a liability
related to the earn-out provision.
47
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 9 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. The option expired unexercised on
November 30, 2002. The Company also began exploring ways to further develop its
relationship with PEWC by combining nStor with Stonehouse.
The Company believed that the Acquisition would have a positive impact on its
operating results from a cash flow standpoint. Further, Stonehouse has an
expansive customer base, including major U.S. corporations and government
agencies, through which the Company may be able to market its Storage Solutions,
which in turn would have a positive impact on the Company's operations.
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
("AMEX").
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 SFAS No. 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
following 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 $2.8 million and goodwill of
$6.5 million. Intangible assets with finite useful lives were identified as
follows: (i) customer relationships (approximately $2 million); (ii) software
($531,000); and (iii) non-compete agreement ($224,000), 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) is subject
to an annual review for impairment in accordance with SFAS No. 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.
48
The following unaudited pro forma results of operations assume the Acquisition
occurred at the beginning of the years ended December 31, 2002 and 2001 (in
thousands, except per share data):
2002 2001
------------------------ -----------------------
Pro Pro
Historical(a) forma Historical forma
Combined Combined(b)
----------- ---------- ---------- -----------
Sales $10,790 $13,604 $17,886 $24,494
Net loss before preferred
stock dividends ($ 7,984) ($ 8,004) ($13,958) ($17,155)
Net loss applicable to
common shareholders ($ 7,984) ($ 8,004) ($18,518) ($21,715)
Basic and diluted net loss
per common share ($ .06) ($ .06) ($ .41) ($ .16)
Weighted average number of
common shares used in per
share computation, basic
and diluted 128,899 142,050 44,833 137,550
(a) Historical amounts include Stonehouse's results of operations for the seven
months ended December 31, 2002.
(b) 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.
The following table shows the amount assigned to each of Stonehouse's major
assets and liabilities at the date of Acquisition (in thousands):
ASSETS
Cash $ 298
Accounts receivable 1,618
Prepaid expenses 101
-------
Total current assets 2,017
Property and equipment 89
Goodwill 6,473
Other intangible assets 2,800
-------
$11,379
=======
LIABILITIES
Bank line of credit $ 200
Accounts payable and other liabilities 556
Deferred revenue 1,704
-------
Total current liabilities 2,460
Purchase Price 8,919
-------
$11,379
=======
49
OneofUs
On January 19, 2000, the Company acquired substantially all of the assets of
OneofUs Company Limited ("OneofUs") for an aggregate purchase price of $2.9
million, consisting of $250,000 cash and 776,119 shares of the Company's common
stock with an aggregate value of $2.6 million (based on the average of the
closing prices of the Company's stock during the ten (10) trading days ended
January 19, 2000). The shares were issued to four selling stockholders pursuant
to employment agreements or a confidentiality, noncompetition and
nonsolicitation agreement. OneofUs was a Taiwan-based, privately-held designer
of high performance Fibre Channel controllers and storage solutions for open
systems and the Storage Area Network (SAN) market.
The acquisition of OneofUs was accounted for using the purchase method of
accounting with goodwill of $2.8 million recorded, which, until the Company's
adoption of SFAS No. 141 effective January 1, 2002, was being amortized on a
straight-line basis over seven years. Unamortized goodwill attributable to
OneofUs at December 31, 2002 amounted to approximately $2 million.
(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" - see Note 14 to
Consolidated Financial Statements), 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, on 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 of the board of directors.
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 million 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
$746,000 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 $300,000 owed by the Company to Mr. Levy (the "Note Shares")
based upon a conversion price of $.40 per share.
50
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. 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
===========
In accordance with the Security and Exchange Commission's staff position in an
Emerging Issues Task Force (EITF) pronouncement (Topic D-42) relating to induced
conversions of preferred stock, the Company recorded a $3 million non-cash
charge to arrive at net loss available to common stock in 2001, representing the
fair value of the Inducement Shares. The fair value was based on $.23 per share,
the price paid by Halco for its purchase of 39 million shares of the Company's
common stock.
51
(4) BALANCE SHEET COMPONENTS (in thousands)
As of December 31, 2002, substantially all the Company's assets were pledged as
collateral for indebtedness (see Note 8 to Consolidated Financial Statements).
December 31,
-----------------
2002 2001
------- -------
Accounts Receivable
Trade receivables $1,391 $ 2,113
Less allowance for doubtful accounts (457) (209)
------- -------
934 1,904
Other receivables - 21
------- -------
$ 934 $ 1,925
======= =======
Inventories
Raw materials $ 363 $ 880
Work-in-process 501 361
Finished goods 215 123
------- -------
$1,079 $ 1,364
======= =======
During 2001, the Company recorded write-downs of $2.5 million resulting from a
valuation of certain inventory (see Note 19 to Consolidated Financial
Statements).
Property and Equipment
Furniture, fixtures and office equipment $ 194 $ 325
Computer equipment 188 5,011
Computer software - 770
Leasehold improvements 9 866
Other - 36
------- -------
391 7,008
Less accumulated depreciation (88) (5,641)
------- -------
$ 303 $1,367
======= =======
Depreciation expense amounted to $1.3 million and $1.2 million for the years
ended December 31, 2002 and 2001, respectively. Principally as a result of the
Company's relocation from San Diego, California to Carlsbad, California in 2002,
the Company wrote off abandoned and fully depreciated fixed assets and
accumulated depreciation related to those assets (see Note 11 to Consolidated
Financial Statements).
Accounts Payable and Other
Accounts payable $1,658 $ 1,780
Accrued expenses and other
current liabilities 1,519 2,010
------- -------
$3,177 $ 3,790
======= =======
(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 No. 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 year ended December 31, 2002, as compared to
$408,000 and $2.6 million in 2001 and 2000, respectively.
52
In accordance with SFAS No. 142, prior period amounts are not permitted to be
restated. A reconciliation of reported net loss to net loss adjusted for the
exclusion of amortization of goodwill for the years ended December 31, 2001 and
2000 follows (in thousands, except per share):
2001 2000
----------------------------
Reported net loss applicable to common stock ($18,518) ($22,606)
Less goodwill amortization 408 2,556
----------- -----------
Adjusted net loss ($18,110) ($20,050)
=========== ===========
Weighted average number of common shares
considered outstanding 44,832,503 32,789,832
=========== ===========
Basic and diluted net loss per common
share as reported ($ 0.41) ($ 0.69)
=========== ===========
Adjusted net loss per common share ($ 0.40) ($ 0.61)
=========== ===========
During early 2003, 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, 2003.
As of December 31, 2002, the carrying amount of goodwill and other intangible
assets was approximately $8.5 million and $2.9 million, respectively, of which
$6.5 million of goodwill and $2.6 million of other intangible assets is
attributable to the June 2002 Stonehouse Acquisition (see Note 2 to Consolidated
Financial Statements). In addition, the Company capitalized $300,000 in software
development costs associated with its Telecommunication Solutions business (see
Note 1 to Consolidated Financial Statements). Amortization of other intangible
assets for the year ended December 31, 2002 was $214,000.
(6) 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. Through December 31,
2001, the Company received net cash proceeds of approximately $1 million
principally from the sale of all of the non-ARL securities, and realized a gain
of $86,000. Unrealized losses at December 31, 2001 on the ARL shares were
$897,000, resulting in a net loss of $811,000.
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 mid
March 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 approximately $1.5 million on the respective purchase
dates for an aggregate purchase price of approximately $1.2 million. 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 shares, representing all of its remaining holdings in ARL, to Mr.
Halperin for an aggregate purchase price of approximately $1.3 million, 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 for the year ended December 31, 2002, net of the $206,000 Options
proceeds.
53
(7) INCOME TAXES
The Company accounts for income taxes in accordance with SFAS No. 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 No. 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.
A reconciliation of the provision for income taxes to the amount computed by
applying the statutory federal income tax rate to loss before income taxes
follows (dollars in thousands):
Years Ended December 31,
---------------------------------
2002 2001 2000
-------- -------- --------
Amount computed at federal statutory
rate of 34% ($2,698) ($4,745) ($7,453)
Impairment of goodwill not
deductible for tax - - 4,065
Non-deductible amortization of in-
tangible assets 73 127 840
Expenses not deductible for tax
purposes 18 80 62
Losses not deductible for tax purposes - 123 425
Exercise of non-qualified stock options - - (44)
Fair value of option granted to customer 204 - -
Losses for which no current benefits
are available 2,403 4,415 2,105
-------- -------- -------
Provision for income taxes $ - $ - $ -
======== ======== =======
The tax effects of temporary differences that gave rise to significant portions
of deferred tax assets are as follows (in thousands):
December 31,
-------------------
2002 2001
------- --------
Deferred tax assets:
Net operating loss carryforwards $24,026 $18,643
Alternative minimum tax carryforwards 770 770
Research and development credit carryforwards 1,559 1,244
Depreciation and amortization 1,884 1,923
Allowance for doubtful accounts 155 3
Inventory and warranty reserves 198 1,587
------- -------
Net deferred tax assets 28,592 24,170
Less valuation allowance (28,592) (24,170)
------- -------
Deferred taxes $ - $ -
======= =======
At December 31, 2002 and 2001, a 100% valuation allowance has been provided on
the total deferred income tax assets because it is more likely than not that the
net operating loss carryforwards will not be realized based on recent operating
results.
54
As of December 31, 2002, there were unused net operating loss carryforwards (the
"NOL's") for regular federal tax purposes of approximately $70.5 million and
approximately $13.1 million for California tax purposes, expiring from 2006
through 2022 and 2004 through 2013, respectively. In addition, the Company has
research and development tax credit carryforwards of approximately $1.6 million,
which expire from 2003 through 2022 and, in conjunction with the Alternative
Minimum Tax ("AMT") rules, the Company has available AMT credit carryforwards of
approximately $.8 million at December 31, 2002, which may be used indefinitely
to reduce regular federal income taxes.
Under Internal Revenue Code Section 382, in connection with a 1999 acquisition,
the usage of approximately $8 million of federal NOL's and approximately $2
million of California NOL's is limited annually to approximately $.4 million.
Currently, California has a moratorium on the usage of its NOL's. The usage of
certain tax credit carryforwards is also subject to limitation. In addition, in
connection with the Stonehouse Acquisition, the usage of approximately $4
million of federal NOL's is limited annually to approximately $500,000.
(8) BORROWINGS
Revolving Credit Facilities
At December 31, 2001, the Company had a revolving bank credit facility (the
"Bank Line of Credit"), which provided for borrowings based on the lesser of $10
million or: (i) 85% of eligible accounts receivable, as defined, plus (ii) the
lesser of $1.3 million or 20% of eligible inventory, as defined (collectively,
the "Borrowing Base"). The Bank Line of Credit bore interest at prime plus 2.5%,
was scheduled to mature in April 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. As of December 31, 2001, the
outstanding balance of the Bank Line of Credit was $3 million.
Since the fourth quarter of 2000, the Company had not been in compliance with
the minimum net worth and net income requirements under the Bank Line of Credit.
On February 4, 2002, the bank advised the Company that the outstanding principal
balance exceeded the Borrowing Base by $1.1 million and demanded immediate
payment of the over-advance. The bank also indicated that the Company's non-bank
indebtedness of approximately $4.7 million was incurred in violation of the loan
agreement. In addition, the bank increased the interest rate to prime plus 3.5%,
decreased the overall facility to $3.5 million and advised the Company that it
did not intend to renew the Bank Line of Credit. The Company repaid the entire
outstanding balance by July 30, 2002.
In August 2002, the Company entered into an Agreement For Purchase of Accounts
with a financial institution (the "Purchaser"), which provides for a $750,000
line of credit under which the Company may sell customer invoices to the
Purchaser. The Purchaser advances 80% of the net face amount of qualified
invoices and remits the remaining 20%, less its fees, upon collection of the
invoice in full. The Company is obligated to repay the Purchaser for invoices
not paid within 90 days. The Purchaser's fees are based on a rate of .07% per
day. The Agreement is collateralized by substantially all of the assets of the
Company's Storage Solutions subsidiary. At December 31, 2002, the uncollected
balance of customer invoices sold to the Purchaser amounted to approximately
$813,000. Interest expense related to this agreement amounted to $49,000 for the
year ended December 31, 2002.
55
Stonehouse has a revolving bank credit facility (the "Stonehouse Revolver")
under which Stonehouse may borrow up to the lesser of $500,000 or specified
percentages of eligible accounts receivable, is payable upon demand and bears
interest at prime plus 1% (5.25% at December 31, 2002). Borrowings under the
Stonehouse Revolver are collateralized by accounts receivable and certain other
assets of Stonehouse. At December 31, 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):
December 31,
----------------
2002 2001
------- -------
Current:
Notes payable to Mr. Levy, interest only at
8% to 10% per annum, maturing on May 31,
2003 and June 30, 2003 (a) and (b) $3,398 $ 650
Notes payable, interest only at 8% per annum, payable
monthly, maturing on June 6, 2003 500 -
Note payable, interest at 10% per annum, payable
March 15, 2003 (c) 450 450
Other notes payable 336 -
------ ------
$4,684 $1,100
====== ======
Long-term:
Halco Note, interest only at 8% per annum, payable
quarterly, maturing on November 20, 2006 (d) $3,100 $3,100
Notes payable, interest only at 8% per annum, payable
monthly, maturing on June 6, 2003 - 500
------ ------
$3,100 $3,600
====== ======
(a) Included in Notes Payable to Mr. Levy is a 10% convertible
subordinated promissory note (the "New Levy Note") in the amount of $650,000,
dated June 14, 2002. 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 (see
d) 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. The New Levy Note is collateralized by substantially all of the
assets of the Company's Storage Solutions subsidiary.
(b) In connection with the Company's outsource contract with Varian, Mr.
Levy provided collateral for a bank to issue a $1 million LC for the benefit of
Varian, subsequently reduced to $750,000 effective December 30, 2002. The
Company has agreed to indemnify Mr. Levy for any amounts paid by Mr. Levy as a
result of Varian drawing upon the LC. From the date of issuance through February
28, 2003, no amounts had been drawn on the LC. The LC expires on April 15, 2003.
56
(c) Bernard Marden, a private investor who beneficially owns in excess
of 10% of the Company's common stock ("Mr. Marden") is the holder of the
$450,000 note, payable March 15, 2003, as extended. Mr. Marden had 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. In addition,
the note was collateralized by substantially all of the assets of the Company's
Storage Solutions subsidiary. See Note 21 to Consolidated Financial Statements
(Subsequent Events).
(d) 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 date on which the Company receives a notice of delisting
from 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
Company's common stock on the trading day immediately prior to the date of
conversion.
At December 31, 2000, the Company's aggregate borrowings were $7.3 million
including $1.7 million owed to Mr. Levy at 10% per annum. From January 2001
through March 31, 2001, the Company borrowed an additional $4.5 million
(including $1.9 million from Mr. Levy), of which $3.8 million (including $1.3
million from Mr. Levy) was convertible into the Company's common stock at $1.00
per share. In connection with certain of this debt, the Company issued warrants
to purchase an aggregate of 1,137,500 shares (including 512,500 warrants to Mr.
Levy) of the Company's common stock, principally at $1.20 per share, exercisable
at issuance and expiring principally on March 31, 2004. The warrants were valued
based on the Black-Scholes option-pricing model as of the dates of issuance at
an aggregate of $396,000 and were recorded as a discount to the notes.
Effective April 12, 2001, holders of all of the Company's notes payable totaling
$11.9 million (including accrued interest) on that date (including $3.6 million
due to Mr. Levy) exchanged their notes for Series H and Series I Convertible
Preferred Stock (see Note 14 to Consolidated Financial Statements) with a stated
value of $11.9 million.
From May 2001 through the closing of the Halco Investment in November 2001, the
Company borrowed an additional $6.9 million, including $5 million of short-term
borrowings from Halco and $1.5 million from Mr. Levy. Effective on the Closing
Date of the Halco Investment, (i) the $5 million of short-term borrowings from
Halco was satisfied by the conversion of $3.1 million into the Halco Note and
the application of $1.9 million to the amount paid by Halco for the Series K
Convertible Preferred Stock and (ii) the Company agreed to satisfy $300,000 of
borrowings from Mr. Levy by issuing 750,000 shares of the Company's common stock
(see Note 3 to Consolidated Financial Statements). In addition, in December
2001, Mr. Levy assigned $500,000 of his loans to investors in a private
transaction in which Mr. Levy purchased Series H Convertible Preferred Stock
with a face amount of $1.7 million from those investors.
In connection with certain borrowings during 2001, the Company issued warrants
to purchase an aggregate of 625,000 shares (including 400,000 warrants to Mr.
Levy) of the Company's common stock at exercise prices ranging from $.45 to $.75
per share, exercisable at issuance and expiring on June 30, 2004. The warrants
were valued based on the Black-Scholes option-pricing model as of the dates of
issuance at an aggregate of $155,000 and were recorded as a discount to the
notes.
Aggregate accrued interest payable as of December 31, 2002 was $240,000 to Mr.
Levy and $145,000 to Mr. Halperin. No interest was paid to Mr. Levy in 2002 and
2001; however, in 2000, Mr. Levy received $134,000 in interest payments.
Interest paid to Mr. Halperin was $131,000 in 2002 and $81,000 in 2001.
See Note 21 to Consolidated Financial Statements for a discussion regarding
additional indebtedness incurred by the Company subsequent to December 31, 2002.
57
Maturities
Scheduled and estimated maturities of the Company's borrowings, are as follows
(in thousands):
Years ending December 31,
2003 $4,684
2004 -
2005 -
2006 3,100
2007 -
------
Total borrowings 7,784
Less current portion (4,684)
------
Long-term portion $3,100
======
(9) 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. During the year ended February
28, 2003, PEWC did not achieve the minimum purchase requirement.
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 $600,000 as of the date
of grant based on the Black-Scholes option-pricing model and other provisions of
SFAS No. 123, Accounting for Stock Based Compensation, and related EITF
guidance. This amount was recorded as an expense in the accompanying Statement
of Operations for the year ended December 31, 2002. The option expired
unexercised on November 30, 2002.
(10) GAIN ON SALE OF ASSETS OF SUBSIDIARY
On January 10, 2000, the Company sold substantially all of the assets of Borg
Adaptive Technologies ("Borg"), a wholly-owned subsidiary of the Company, to a
wholly-owned subsidiary of QLogic Corporation, for $7.5 million cash (the "Borg
Sale"). The net book value of assets sold totaled $620,000 and included all of
the intellectual property rights relating to the Company's Adaptive RAID
technology, including software, patents and trademarks, and certain tangible
assets, including test and office equipment and tenant improvements. In
connection with the Borg Sale, the Company recorded transaction costs of
$487,000 and a gain of $5.6 million, which is net of compensation expense of
$818,000 resulting from modifications to certain stock options and warrants.
58
(11) OTHER INCOME, NET
Other income, net of other expenses consisted of the following (in thousands):
2002 2001 2000
-------- -------- -------
Reduction in carrying value of liabilities
to reflect the net amount due $ 940 $ 628 $ -
Negotiated discounts with vendors 445 1,231 -
Loss on extinguishment of debt - (362) -
Write-off of assets related to abandoned
facilities (64) (226) -
Investment income - - 44
Other(expenses)income, net (44) - 40
------ ------ -----
$1,277 $1,271 $ 84
====== ====== =====
(12) SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS
Prior to the Acquisition in June 2002, the Company operated predominantly in one
business segment, Storage Solutions. Customers of the Storage Solutions segment
include end users, OEMs, SIs and VARs (Value Added Resellers).
Following the Acquisition, the Company began operating under a second business
segment, Telecommunication Solutions. 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
year ended December 31, 2002, sales to two customers accounted for 42% and 13%
of the Company's Storage Solutions sales and sales to one customer accounted for
29% of Telecommunication Solutions sales. During the year ended December 31,
2001, sales to one customer accounted for 12% of the Company's Storage Solutions
sales. During 2000, no single customer accounted for greater than 10% of the
Company sales.
During 2002, Storage Solutions sales to geographic areas other than the United
States aggregated 19% of the Company's Storage Solutions sales, principally in
the Pacific Rim. Sales to geographic areas other than the United States were not
significant prior to 2002.
Presented below for the year ended December 31, 2002 is selected financial
information for the two segments in which the Company now operates (in
thousands). The Storage Solutions segment includes all corporate revenues and
expenses except those specifically attributable to the Telecommunication
Solutions segment. Since the Acquisition occurred in June 2002, segment
information is not applicable for the 2001 or 2000 periods.
Storage Telecommunication
Solutions Solutions (a)
-------- ------------------
Total assets $4,080 $10,102
Revenues $7,917 $ 2,873
Gross margin $1,382 $ 1,516
Net loss applicable to common stock ($7,878) ($ 106)
(a) Includes results of operations for Stonehouse for the seven months since the
Acquisition in June 2002.
59
(13) COMMITMENTS AND CONTINGENCIES
Litigation
In June 1996, Jack Ehrenhuas, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud
Mendelson and Susan Felton filed a Complaint in the Supreme Court of the State
of New York, County of Nassau, against the Company and Michael Wise, its then
Chairman of the Board and currently a director. The plaintiffs claim to have
contractual and proprietary interests in the prospect of a transaction to
purchase certain net assets acquired by the Company and seek compensatory
damages plus punitive damages.
In August 1996, The Nais Corporation, Mark Schindler, Eugene Stricker, Amnon
Damty, Ehud Mendelson and Susan Felton filed a Complaint in the same Court
making similar allegations against a subsidiary of the Company, its then
president, R. Daniel Smith (Mr. Smith), and a company controlled by Mr. Smith.
In this action, the plaintiffs seek compensatory damages plus punitive damages
for alleged breach of contract.
Both cases are currently in discovery. Counsel for the Company believes that the
Company has good defenses to both claims and that it will not incur any material
liability. The Company is unaware of any facts that would support any of the
plaintiffs' claims, and accordingly, the Company believes that the claims are
without merit.
In February 2002, W. David Sykes, our former Executive Vice President of
Marketing and Sales, filed a complaint in the Circuit Court of Palm Beach
County, Florida, against a subsidiary of the Company in which Mr. Sykes claims
he was wrongfully terminated under provisions of his employment agreement with
the Company. The Company believes it acted in accordance with the termination
provisions of the agreement and that no further compensation or benefits are
due. The Company believes that it has good defenses to the claim and that it
will not incur any material liability.
Certain software sublicensed to, and market by, Stonehouse (the "Software") is
collateral under a $12 million sale/leaseback agreement between PUSA and a
financial institution, consummated prior to the Stonehouse Acquisition. The
obligations of PUSA under the sale/leaseback agreement, including the obligation
to pay $381,000 per month for three years through March 2004, are supported by a
surety bond. In connection with the Stonehouse Acquisition (see Note 2 to
Consolidated Financial Statements), Stonehouse was granted an irrevocable
perpetual license to, among other items, sub-license the Software to third
parties and install, use, modify, copy or enhance the Software or prepare
derivative works from the Software, for Stonehouse's own benefit or the benefit
of any third party. At the expiration of the sale/leaseback, PUSA is required to
purchase the Software for $1 and has agreed to complete that purchase and
immediately transfer all rights and title to Stonehouse. PUSA also indemnified
Stonehouse for certain other potential obligations and breaches of certain
representations and warranties (the "Indemnifications"). In December 2002, PUSA
filed Chapter 11 proceedings in the United States Bankruptcy Court for the
Northern District of Texas. In the opinion of management, PUSA's potential
inability to satisfy its obligations in connection with the Software and the
Indemnifications will not result in the Company incurring any material
liability.
From time to time, the Company is subject to legal proceedings and other claims
arising in the ordinary course of business. In the opinion of management, the
Company is not a party to any litigation the outcome of which would have a
material adverse effect on its business, operations or cash flows.
(14) PREFERRED STOCK
Series D
The Series D Convertible Preferred Stock accrued dividends in 1999, 2000 and
2001 at 8% per annum, payable quarterly, and was convertible into shares of the
Company's common stock based on a fixed conversion price of $1.00 per share. On
February 1, 2000, 700 shares of the Series D Preferred Stock with a stated value
of $700,000 was converted into 700,000 shares of the Company's common stock.
Pursuant to an automatic conversion feature, effective October 28, 2001, the
remaining 2,000 shares with a stated value of $2 million was converted into 2
million shares of the Company's common stock.
60
Series E
In June 1999, the Company issued 3,500 shares of Series E Convertible Preferred
Stock for $3.5 million in cash, of which $1.5 million was in satisfaction of
borrowings from Mr. Levy. The Series E Preferred Stock, with a stated value of
$3.5 million as of December 31, 2000, accrued quarterly dividends at the
following annual rates: 8% during the first year, 9% during the second year and
10% thereafter. The Series E Preferred Stock was convertible into shares of the
Company's common stock based on a fixed conversion price of $3.00 per share. In
connection with the Halco Investment, on January 11, 2002, all of the Series E
Preferred Stock was converted into shares of the Company's common stock (see
Note 3 to Consolidated Financial Statements).
Series F
As part of the acquisition of Andataco in June 1999, the Company issued 4,654
shares of Series F Convertible Preferred Stock, with a stated value of $4.7
million, which accrued quarterly dividends at the following annual rates: 8%
during the first year, 9% during the second year and 10% thereafter. The Series
F Preferred Stock was convertible into the Company's common stock based on a
fixed conversion price of $3.00 per share. During 2001, 2000 and 1999, 722,
3,332 and 600 shares, respectively, representing all of the Series F Preferred
Stock, were converted into 240,533, 1,110,800 and 200,000 shares, respectively,
of the Company's common stock.
Series G
Effective December 29, 2000, the Company satisfied $2 million of borrowings from
Mr. Levy by issuing 2,000 shares of Series G Preferred Stock, with a stated
value of $2 million. The Series G Preferred Stock accrued dividends at 10%,
payable quarterly, and was redeemable at the Company's option. Attached to the
Series G Preferred Stock was a warrant to purchase 500,000 shares of the
Company's common stock at $1.50 per share, exercisable from July 1, 2001 through
December 31, 2003 (the "Warrant"). The Warrant provided that if any portion of
the Series G Preferred Stock was redeemed by the Company prior to June 30, 2001,
a corresponding pro-rata portion of the Warrant would be cancelled. Effective
April 12, 2001, the Series G Preferred Stock and accrued dividends thereon of
$57,000 were exchanged for Series I Convertible Preferred Stock, with a stated
value of $2,057,000, and the Warrant was cancelled.
Series H
Effective April 12, 2001, the Company satisfied $5.1 million of borrowings by
issuing 5,100 shares of Series H Convertible Preferred Stock. The Series H
Preferred Stock had a stated value of $5.1 million, accrued dividends at 10%
annum, payable quarterly, and was convertible into shares of the Company's
common stock based on a fixed conversion price of $.72 per share. In connection
with the Halco Investment, on January 11, 2002, all of the Series H Preferred
Stock was converted into shares of the Company's common stock (see Note 3 to
Consolidated Financial Statements).
61
Series I
Effective April 12, 2001, the Company exchanged $6,675,000 of borrowings
(including $3,550,000 from Mr. Levy), $110,000 in accrued interest, and the
Series G Preferred Stock held by Mr. Levy with a stated value of $2,057,000
(including accrued dividends) for 8,842 shares of Series I Convertible Preferred
Stock with a stated value of $8,842,000. On April 24, 2001, the Company issued
an additional 250 shares, to a private investor, of Series I Preferred Stock
with a stated value of $250,000, for $250,000 in cash. The Series I Preferred
Stock had an aggregate stated value of $9.1 million, accrued dividends at 10%
annum, payable quarterly, and was convertible into shares of the Company's
common stock based on a fixed conversion price of $.72 per share. In connection
with the Halco Investment, on January 11, 2002, all of the Series I Preferred
Stock was converted into shares of the Company's common stock (see Note 3 to
Consolidated Financial Statements).
Series K
On November 20, 2001, the Company issued 8,970 shares of Series K Convertible
Preferred Stock to Halco as part of the Halco Investment for approximately $2.9
million in cash and $6.1 million of marketable securities. The Series K
Preferred Stock had an aggregate stated value of $8,970,000, was not entitled to
receive dividends and was convertible into shares of the Company's common stock
based on a fixed conversion price of $.23 per share. On January 11, 2002, all of
the Series K Preferred Stock was converted into shares of the Company's common
stock (see Note 3 to Consolidated Financial Statements).
Series L
In connection with the Stonehouse Acquisition on June 7, 2002, the Company
issued 1,000 shares of Series L Convertible Preferred Stock with a stated value
of $1,000,000. The Series L Preferred Stock was not entitled to dividends and
was convertible into 4,527,027 shares of the Company's common stock, subject to
shareholder approval. Shareholder approval was received effective October 8,
2002 and the Series L Preferred Stock was converted into 4,527,027 shares of the
Company's common stock.
(15) STOCK OPTIONS AND WARRANTS
The Company applies APB Opinion 25, Accounting for Stock Issued to Employees,
and related interpretations in accounting for options granted to employees under
its stock option plans. Under APB Opinion 25, if options are granted at exercise
prices less than fair market value, compensation expense is recorded for the
excess of the fair market values on the date of grant over the exercise price.
Under the Company's 1996 Stock Option Plan (the "1996 Plan"), stock options to
purchase up to seven million shares of the Company's common stock were available
to be granted to officers, directors, key employees and non-employees. Options
granted under the 1996 Plan have a maximum term of ten years and generally vest
over three years annually on an equal basis.
Effective January 10, 2002, the Company's shareholders approved the Company's
2001 Stock Option Plan (the "2001 Plan"), under which stock options to purchase
up to five million shares of the Company's common stock may be issued for a
maximum term of ten years. On October 8, 2002, the Company's shareholders
approved an amendment to the 2002 Plan to increase the number of authorized
shares from 5 million to 7.5 million. In connection with the 2001 Plan, the
Company ceased granting options under the 1996 Plan and all shares reserved for
issuance under the 1996 Plan that had not yet been issued were cancelled. The
terms of options previously granted under the 1996 Plan continue to be governed
by the 1996 Plan and the option agreements currently in effect for those
options.
62
SFAS No. 123, Accounting for Stock-Based Compensation, requires the Company to
provide pro forma information regarding net income and earnings per share as if
compensation cost for stock options granted had been determined in accordance
with the fair value based method prescribed in SFAS No. 123. The Company
estimates the fair value of each stock option at the grant date by using the
Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants: no dividend yield; expected lives of five years;
volatility ranging from 87% to 95% for 2002, 90% to 111% for 2001, and 96% to
107% for 2000; and risk-free interest rates ranging from 2.7% to 4.5% for 2002,
3.1% to 3.8% for 2001, and 4.9% to 5.1% for 2000.
If the Company had elected to recognize stock-based employee compensation costs
based on the fair value on the date of grant consistent with the provisions of
SFAS No. 123, net loss available to common stock and basic and diluted net loss
per common share would have been increased to the following amounts (in
thousands, except per share):
Years Ended December 31,
------------------------------
2002 2001 2000
-------- -------- --------
Net loss available
to common stock:
As reported ($ 7,984) ($18,518) ($22,606)
Pro forma ($ 8,438) ($19,414) ($24,112)
Basic and diluted net
loss per common share:
As reported ($.07) ($.41) ($.69)
Pro forma ($.07) ($.43) ($.73)
Changes in options outstanding are summarized as follows:
Weighted- Weighted-
Average Average
Exercise Fair Value Per
Shares Price Share of Options
(in thousands) Per Share Granted
-------------- ---------- ----------------
Balance, December 31, 1999 4,623 $2.00
Granted - equal to
market value 1,657 2.78 $2.08
Granted - exceeded
market value 724 2.10 $1.36
Forfeited (2,051) 1.91
Exercised (404) 1.28
------- -----
Balance, December 31, 2000 4,549 2.40
Granted - exceeded
market value 200 1.10 $ .59
Granted - equal to
market value 533 .69 $ .50
Forfeited (2,411) 2.64
------- -----
Balance, December 31, 2001 2,871 2.45
Granted - exceeded
market value 5,719 .31 $ .16
Granted - equal to
market value 230 .26 $ .19
Forfeited (1,106) 1.83
------- -----
Balance, December 31, 2002 7,714 (a) $ .68
======= =====
63
- ----------
(a) Includes 1,825,000 shares under the 1996 Plan and 5,889,000 under the 2001
Plan
At December 31, 2002, 2001 and 2000, 1,661,060, 1,906,915 and 1,371,000,
respectively, of the outstanding options were exercisable with a
weighted-average exercise price of $1.83, $1.89 and $2.29, respectively, per
share. The number of shares available to grant under the 2001 Plan was 1,611,000
as of December 31, 2002.
The following table summarizes information about fixed stock options at December
31, 2002:
Weighted
Weighted Average
Number Average Weighted Number Exercise
Outstanding Remaining Average Exercisable Price of
Exercise at Dec. 31, Contractual Exercise at Dec. 31, Exercisable
Prices 2002 Life Price 2002 Options
(in thousands) (in thousands)
- ----------- ----------- ----------- -------- ----------- ---------
$ .24-$1.00 6,399 9.50 years $0.33 476 $0.55
$1.06-$2.00 548 7.58 years $1.54 469 $1.48
$2.06-$2.69 402 4.81 years $2.19 402 $2.19
$3.00-$3.00 20 6.34 years $3.00 20 $3.00
$3.06-$4.94 345 5.29 years $3.80 294 $3.87
------ ---------- ----- ------ -----
$ .24-$4.94 7,714 8.93 years $0.68 1,661 $1.83
====== ========== ===== ====== =====
At December 31, 2002, the Company had outstanding warrants under which 1,982,500
shares of common stock could be acquired. Information relating to these warrants
is summarized as follows:
Number of Warrant Price
Shares -------------------------
(in thousands) Per Share Total
----------- ------------ -----------
Balance, December 31, 1999 1,950 $1.25-$3.30 $ 4,380,000
Warrants issued 920 $1.50-$3.60 1,942,000
Warrants exercised (230) $2.10-$3.00 (663,000)
Warrants expired (65) $2.35 (153,000)
---------- ------------ -----------
Balance, December 31, 2000 2,575 $1.25-$3.60 5,506,000
Warrants issued 1,562 $ .45-$1.20 1,455,000
Warrants expired (333) $1.25 (417,000)
Warrants canceled (500) $1.50 (750,000)
---------- ----------- -----------
Balance, December 31, 2001 3,304 $ .45-$3.60 5,794,000
Warrants expired (1,322) $1.37-$3.30 (3,147,000)
---------- ----------- -----------
Balance, December 31, 2002 1,982 $ .45-$3.60 $ 2,647,000
========== =========== ===========
64
Number of
Shares Subject
Expiration to Warrants Exercise
Date (in thousands) Price
---------- -------------- --------
May 2003 220 $3.60
December 2003 200 $2.00
March 2004 937 $1.20
June 2004 625 $.45-$.75
--------
1,982
========
At December 31, 2002, the Company had reserved common stock for the following
purposes (in thousands):
1996 Plan:
Options outstanding 1,825
Options available to grant -
-----------
Total under 1996 Plan 1,825
-----------
2001 Plan:
Options outstanding 5,889
Options available to grant 1,611
-----------
Total under 2001 Plan 7,500
-----------
Total shares reserved under options 9,325
-----------
Warrants outstanding 1,982
-----------
Total shares reserved under options
and warrant reserved 11,307
===========
(16) RELATED PARTY TRANSACTIONS
H. Irwin Levy
See Notes 6, 8 and 14 to Consolidated Financial Statements for a discussion
of transactions involving Mr. Levy.
In addition, commencing in October 1999, the Company has been charged $5,000 per
month, plus reimbursement of out-of-pocket expenses, by Hilcoast Advisory
Services, Inc. ("Advisor") for certain financial consulting and administrative
services provided to the Company. Mr. Levy is the Chairman of the Board, Chief
Executive Officer and a majority shareholder of Advisor's parent, and Jack
Jaiven, the Company's Vice President and Treasurer, is an officer of Advisor.
Management believes that the terms of this agreement were no less favorable to
the Company than those that would be received from other sources.
Maurice Halperin
See Notes 3, 6, 8 and 14 to Consolidated Financial Statements for a discussion
of transactions involving Mr. Halperin.
Executive Management
Effective June 22, 2001, the Company and Larry Hemmerich ("Mr. Hemmerich"), the
Company's former President and Chief Executive Officer, entered into a
Separation Agreement in which Mr. Hemmerich's employment ceased and he became a
consultant to the Company through December 31, 2001. Pursuant to the Separation
Agreement, previously granted options to purchase 1,250,000 shares of the
Company's common stock were terminated and replaced with an option to purchase
300,000 shares of common stock at $.45 per share. The option was valued at
$90,000 based on the Black-Scholes option-pricing model as of the date of
issuance and was expensed as compensation over the six month period for which
Mr. Hemmerich was a consultant to the Company.
65
In connection with Mr. Hemmerich's 2000 bonus, on January 17, 2001, the Company
issued a $125,000, 10% note to Mr. Hemmerich, payable on June 30, 2001.
Effective April 12, 2001, Mr. Hemmerich exchanged this note, including the
accrued interest, for Series I Convertible Preferred Stock with a stated value
of $128,000, convertible into shares of the Company's common stock based on a
fixed conversion price of $.72 per share. Effective with the Halco Investment in
November 2001, the Series I Convertible Preferred Stock held by Mr. Hemmerich
and all accrued dividends thereon were converted to 305,585 shares of common
stock, including 106,594 Inducement Shares and 21,338 Dividend Shares (see Notes
3 and 14 to Consolidated Financial Statements).
Mr. Hemmerich served as a director of the Company until March 2002.
(17) LEASES
The Company leases its operating facilities under operating leases, which expire
at various dates through May 2006. At December 31, 2002, future minimum rental
payments under operating leases that have initial or remaining terms in excess
of one year are as follows (in thousands):
2003 $242
2004 243
2005 198
2006 19
----
$702
====
Rent expense was $527,000, $831,000 and $871,000 during 2002, 2001 and 2000,
respectively.
(18) 401(k) PLAN
The Company's 401(k) Tax Deferred Savings Plan (the "401(k) Plan") covers
substantially all employees meeting certain minimum age and service
requirements. Company contributions to the plan are determined by the Board of
Directors. The Company has made no contributions to the 401(k) Plan as of
December 31, 2002.
(19) FOURTH QUARTER ADJUSTMENTS
During the fourth quarter of 2001, the Company recorded a write-down of $2.5
million resulting from a valuation of certain inventory, which included obsolete
inventory and components associated with products, which the Company has phased
out. Management was unable to reasonably estimate the effect, if any, of these
adjustments on prior quarters in 2001.
During the fourth quarter of 2000, the Company recorded an impairment adjustment
to unamortized goodwill of $12 million (see Note 1 to Consolidated Financial
Statements). The Company also recorded a write-down of $1.4 million resulting
from a valuation of certain inventory, which included obsolete inventory and
components associated with products, which the Company had phased out.
Management was unable to reasonably estimate the effect, if any, of these
adjustments on prior quarters in 2000.
66
(20) QUARTERLY RESULTS OF OPERATIONS (Unaudited)
The following is a summary of the quarterly operations for the years ended
December 31, 2002 and 2001 (in thousands).
2002 Mar. 31 Jun. 30 Sept. 30 Dec. 31
- ---- ---------- --------- ---------- ---------
Sales $1,559 $2,451 $3,494 $3,286
Gross profit (loss) (116) 100 1,410 1,504
Loss from operations (2,626) (2,015) (1,295) (973)
Net loss (4,802) (1,806) (600) (776)
Net loss available
to common stock (4,802) (1,806) (600) (776)
Net loss per common share:
Basic and diluted ($.04) ($.01) ($.00) ($.01)
2001 (a)
Sales $6,218 $3,953 $4,016 $3,699
Gross profit (loss) 1,713 903 1,399 (1,966)
Loss from operations (3,157) (3,165) (2,171) (5,013)
Net loss (3,445) (3,880) (1,179) (5,454)
Net loss available
to common stock (3,630) (4,324) (1,665) (8,899)
Net loss per common share:
Basic and diluted ($.10) ($.12) ($.05) ($.12)
- ----------
(a) See Note 19 regarding Fourth Quarter Adjustments.
(21) SUBSEQUENT EVENTS
Subsequent to December 31, 2002 and through March 14, 2003, the Company received
$1,582,000 in borrowings under promissory notes, consisting of $882,000 from Mr.
Levy and $700,000 from Mr. Marden. Included in these borrowings is $900,000
under convertible promissory notes ($200,000 from Mr. Levy and $700,000 from Mr.
Marden) under which the outstanding principal and any accrued but unpaid
interest is convertible into shares of the Company's common stock at a
conversion price of $.29 per share based on the closing market price of the
Company's common stock on the date of the notes.
In connection with borrowings from Mr. Marden, the Company issued warrants to
purchase 125,000 shares of the Company's common stock at $.25 per share,
exercisable immediately and expiring December 31, 2005. The Company expects to
value the warrants under the Black-Scholes option-pricing model, to record the
fair value as a discount to the note and to recognize any potentially related
beneficial conversion features.
Effective March 14, 2003, the Company received a commitment from three private
investors to loan the Company an aggregate of $1.5 million under convertible
promissory notes (the "New Convertible Notes") including $1 million from Mr.
Marden. The New Convertible Notes as well as the $1.2 million of outstanding
principal and accrued interest under Mr. Marden's existing notes (including the
$700,000 discussed above) will (i) bear interest at 8% per annum, payable
quarterly, (ii) mature April 1, 2004, (iii) be convertible into newly issued
shares of the Company's common stock at $.30 per share, and (iv) be
collateralized principally by nStor's ownership interest in Stonehouse and
nStor's intellectual property and other intangible assets.
67
In February 2003, Stonehouse hired a new executive officer under an employment
arrangement whereby Stonehouse may issue options to this officer to acquire a
minority equity interest in Stonehouse.
68
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
nStor Technologies, Inc.
The audit referred to in our report dated February 28, 2003 relating to the
consolidated financial statements of nStor Technologies, Inc., which are
contained in Item 8 of this Form 10-K included the audits of the consolidated
financial statement schedules listed in the accompanying index. The consolidated
financial statement schedules are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statement schedules based upon our audits.
In our opinion, such consolidated financial statement schedules present fairly,
in all material respects, the information set forth therein.
The aforementioned consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has significant recurring losses,
negative working capital and serious liquidity concerns. These matters, among
others, raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans in regard to these matters are also described
in Note 1 to the aforementioned consolidated financial statements. The
aforementioned consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
The consolidated financial statements of nStor Technologies, Inc. and
subsidiaries as of December 31, 2000 were audited by other auditors whose report
dated February 9, 2001 on those statements included an explanatory paragraph
describing conditions that raise substantial doubt about the Company's ability
to continue as a going concern.
/s/ Swenson Advisors, LLP
Swenson Advisors, LLP
San Diego, California
March 14, 2003
69
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors of
nStor Technologies, Inc.
The audits referred to in our report dated February 9, 2001 relating to the
consolidated financial statements of nStor Technologies, Inc., which are
contained in Item 8 of this Form 10-K included the audit of the year 2000
consolidated financial statement schedule listed in the accompanying index. The
consolidated financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this consolidated
financial statement schedule based upon our audit.
In our opinion, such consolidated financial statement schedule presents fairly,
in all material respects, the information set forth therein.
The aforementioned consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered substantial
recurring losses from operations, has a working capital deficiency, a
shareholders' deficit and is in default under its existing credit facility.
These matters, among others, raise substantial doubt about the Company's ability
to continue as a going concern. Management's plans in regard to these matters
are also described in Note 1 to the aforementioned consolidated financial
statements. The aforementioned consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
/s/ BDO SEIDMAN, LLP
BDO SEIDMAN, LLP
Costa Mesa, California
February 9, 2001
70
nSTOR TECHNOLOGIES, INC.
Schedule I--Condensed Financial Information of Registrant
Fiscal Years Ended December 31, 2002 and 2001
The following represents the condensed unconsolidated balance sheet for nStor
Technologies, Inc. as of December 31, 2002 and 2001, and the condensed
unconsolidated statements of operations and cash flows for the years ended
December 31, 2002 and 2001.
CONDENSED UNCONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
ASSETS 2002 2001
- ------ ------- -------
Current assets:
Cash and cash equivalents $ 3 $ 399
Marketable securities - 4,255
------- -------
Total current assets 3 4,654
Investments in and receivables from
subsidiaries 8,772 384
------- -------
$ 8,775 $ 5,038
======= =======
LIABILITIES
- -----------
Current liabilities:
Borrowings $ 3,584 $ -
Accounts payable and other 471 951
------- -------
Total current liabilities 4,055 951
Long-term debt 3,100 3,600
------- -------
Total liabilities 7,155 4,551
------- -------
SHAREHOLDERS' EQUITY
- --------------------
Preferred stock, $.01 par; 1,000,000 shares
authorized; 0 shares assumed issued
and outstanding at December 31, 2002 and 2001
Common stock, $.05 par; 230,000,000 shares
authorized; 142,076,947 and 114,603,144 shares
assumed issued and outstanding at December 31,
2002 and December 31, 2001, respectively 7,103 5,729
Additional paid-in capital 101,847 94,104
Deficit (107,330) (99,346)
------- -------
Total shareholders' equity 1,620 487
------- -------
$ 8,775 $ 5,038
======= =======
71
nSTOR TECHNOLOGIES, INC.
Schedule I--Condensed Financial Information of Registrant
CONDENSED UNCONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Years Ended
December 31,
2002 2001
--------- ---------
Loss from investment in subsidiaries ($ 6,336) ($11,929)
Realized and unrealized losses on
marketable securities, net (1,123) (811)
Fair value of option granted to customer (600) -
Other income (losses), net 580 (362)
Interest expense (407) (642)
Selling, general and administrative expense (98) (214)
--------- ---------
Loss before preferred dividends and induced
conversion (7,984) (13,958)
Preferred stock dividends - (1,560)
Induced conversion of convertible
preferred stock - (3,000)
--------- ---------
Loss available to common stock ($ 7,984) ($18,518)
========= =========
72
nSTOR TECHNOLOGIES, INC.
Schedule I--Condensed Financial Information of Registrant
CONDENSED UNCONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended
December 31,
2002 2001
CASH FLOWS FROM OPERATING ACTIVITIES: --------- ---------
Net loss ($ 7,984) ($13,958)
Adjustments to reconcile net loss to
net cash used by operating activities:
Proceeds from sales of marketable securities 3,132 1,047
Realized and unrealized losses on
marketable securities 1,123 811
Fair value option granted to customer 600 -
Other (income) losses, net (578) 362
Amortization of deferred loan costs - 190
Amortization of deferred compensation costs - 90
Changes in assets and liabilities, net of
effects from acquisition:
(Increase) decrease in receivables from
subsidiaries (10) 307
Increase in accounts payable and other
liabilities 237 231
--------- ---------
Net cash used by operating activities (3,480) (10,920)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings 3,084 10,149
Issuance of convertible preferred stock,
net of costs - 1,221
Cash paid for preferred stock dividends - (59)
--------- ---------
Net cash provided by financing activities 3,084 11,311
--------- ---------
Net (decrease) increase in cash and cash equivalents
during the year (396) 391
Cash and cash equivalents at beginning of year 399 8
--------- ---------
Cash and cash equivalents at end of year $ 3 $ 399
========= =========
73
nSTOR TECHNOLOGIES, INC.
Schedule II-- Valuation and Qualifying Accounts
Fiscal Years Ended December 31, 2002, 2001 and 2000
(in thousands)
Additions
Balance Resulting Balance
at Additions from at
Beginning Charged Merger/ End of
of Year to Income Other Deductions* Year
--------- --------- --------- ---------- -------
Allowance for Doubtful
Accounts Receivable:
2002 $ 209 $ 210 $ 100 $ 62 $ 457
2001 402 1,069 200 (1,462) 209
2000 1,604 912 - (2,114) 402
Allowance for Inventory
Obsolescence:
2002 $4,345 $ (239) $ ($3,525) $ 581
2001 4,902 2,500 $ - (3,057) 4,345
2000 3,419 3,988 - (2,505) 4,902
- ---------
* Deductions represent amounts written off against the allowance, net of
recoveries
74
Item 9. Disagreement on Accounting and Financial Disclosure
Not Applicable
PART III
Item 10. Directors and Executive Officers of the Registrant
For information concerning this item, see the text under the captions "Election
of Directors" and "Management" in our definitive Proxy Statement (the "Proxy
Statement") to be filed with respect to our 2003 Annual Meeting of Stockholders,
which information is incorporated herein by reference.
Item 11. Executive Compensation
For information concerning this item, see the text and tables under the caption
"Executive Compensation", "Report on Compensation" and the graph under the
caption "Performance Graph" in the Proxy Statement, which information is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
For information concerning this item, see the tables and text under the captions
"Security Ownership", "Management" and Equity Compensation Plan Information in
the Proxy Statement, which information is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
For information concerning this item, see the text under the caption "Certain
Transactions" in the Proxy Statement, which information is incorporated herein
by reference.
Item 14. Disclosure Controls
(a) Within 90 days prior to filing this report on Form 10-K (the "Evaluation
Date"), our Chief Financial Officer and Chief Executive Officer evaluated our
disclosure controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)
promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")). Based on that evaluation, these officers have concluded that as of the
Evaluation Date, our disclosure controls and procedures were effective in timely
alerting them to material information relating to us (including our consolidated
subsidiaries) required to be included in our reports filed or submitted by us
under the Exchange Act. It should be noted that the design of any system of
controls is based in part upon certain assumptions, and there can be no
assurance that any design will succeed in achieving its stated goals.
(b) There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the time
of such evaluation.
75
PART IV
Item 15. Exhibits, Financial Statement Schedules and
Reports on Form 8-K
(a) (1) Financial Statements - See index to Consolidated Financial
Statements at page 31 of this Form 10-K.
(2) Financial Statement Schedule I - Condensed Financial Information
of Registrant - See pages 70-72 of this Form 10K.
(3) Financial Statement Schedule II-Valuation and Qualifying Accounts
- See page 73 of this Form 10-K.
(4) Exhibits - See Exhibit Index at pages 75-79 of this Form 10-K.
(5) Certifications - See pages 81-82 of this Form 10-K.
(b) No reports were filed by the Registrant during the fourth quarter of 2002.
EXHIBIT INDEX
Exhibit
Number Description
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. (4)
3.1 Certificate of Amendment to the Restated Certificate of Incorporation of
Registrant filed with the State of Delaware on October 9, 2002 (2)
3.2 Certificate Eliminating Reference to Series of Shares of Stock from the
Restated Certificate of Incorporation of Registrant filed October 9, 2002 (2)
3.3 Restated Certificate of Incorporation of Registrant filed with the State of
Delaware on October 9, 2002 (2)
3.4 Restated Bylaws of Registrant (14)
4.1 8% Convertible Promissory Note for $700,000, dated February 19, 2003,
between Registrant and Bernard Marden (1)
4.2 8% Convertible Promissory Note for $200,000, dated February 19, 2003,
between Registrant and H. Irwin Levy (1)
4.3 Form of Warrant to purchase common stock issued to Bernard Marden on January
6, 2003, January 29, 2003 and March 6, 2003 as to 40,000 shares, 60,000 shares
and 25,000 shares, respectively (1)
4.4 Certificate of Designation of Series L Convertible Preferred Stock (4)
4.5 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. (4)
4.6 Registration Rights Agreement dated June 7, 2002 between Registrant and
Pacific Technology Group, Inc. (4)
76
4.7 8% Convertible Subordinated Promissory Note for $3,100,000, dated June 7,
2002, between Registrant and Halco Investments, L.C. (4)
4.8 Option Agreement to purchase up to thirty million shares of common stock
granted to Pacific Technology Services, Inc., dated March 1, 2002 (8)
4.9 Certificate of Designation of Series K Convertible Preferred Stock (9)
4.10 Registration Rights Agreement dated November 20, 2001 issued to Halco
Investments L.C. (9)
4.11 Warrant to purchase common stock issued to H. Irwin Levy, dated May 16,
2001 (11)
4.12 Warrant to purchase common stock issued to H. Irwin Levy, dated May 21,
2001 (11)
4.13 Warrant to purchase common stock issued to H. Irwin Levy, dated May 30,
2001 (11)
4.14 Warrant to purchase common stock issued to H. Irwin Levy, dated June 5,
2001 (11)
4.15 Warrant to purchase common stock issued to The Charlotte Marden 1993 Trust,
dated June 7, 2001 (11)
4.16 Form of Warrant, between Registrant and certain private investors (12)
4.17 Form of Subscription Agreement, between Registrant and certain private
investors (12)
4.18 Form of Registration Rights Agreement, between Registrant and certain
private investors (12)
4.19 Warrant to purchase 200,000 shares of common stock issued to H. Irwin Levy,
dated December 29, 2000 (12)
4.20 Certificate of Designation of Series G Preferred Stock (12)
4.21 Warrant to purchase common stock issued to Wishmasters, dated May 9, 2000
(13)
4.22 Warrant to purchase common stock issued to Ladenburg Thalmann, dated May 9,
2000 (13)
4.23 Restated Certificate of Incorporation of Registrant - see Exhibit 3.3
4.24 By-Laws of Registrant, as amended - see Exhibit 3.4
10.1 Amended and Restated Stock Pledge Agreement between Registrant and H. Irwin
Levy and Bernard Marden in connection with 8% Convertible Promissory Notes,
dated February 19, 2003 (1)
10.2 10% Promissory Note for $500,000, dated January 6, 2003, between Registrant
and Bernard Marden (1)
10.3 Promissory Note for $560,000, dated December 30, 2002 between Registrant
and Cenvill Recreation, Inc. (1)
77
10.4 Promissory Note for $100,000 between Registrant and Hilcoast Development
Corp., dated December 12, 2002 (1)
10.5 Letter Agreement, dated December 15, 2002, extending the maturity date to
March 15, 2003 of a $450,000 note between Registrant and The Charlotte Marden
1993 Trust (1)
10.6 Letter Agreement, dated December 31, 2002, extending the maturity date to
June 30, 2003 for certain notes between Registrant and Hilcoast Development
Corp. (1)
10.7 Working Capital Assurance Agreement dated June 7, 2002, by and between
Registrant and Hilcoast Development Corp. (4)
10.8 Employment Agreement dated June 7, 2002, between John E. Gates and
Stonehouse (4)
10.9 Form of Agreement between Registrant and Hilcoast Development Corp.
regarding the purchase and option of certain shares of stock (7)
10.10 Promissory Note for $500,000, between Registrant and Hilcoast Development
Corp. dated July 31, 2002 (1)
10.11 Promissory Note for $750,000 between Registrant and Hilcoast Development
Corp., dated June 14, 2002 (3)
10.12 Promissory Note for $500,000 between Registrant and Hilcoast Development
Corp., dated May 18, 2002 (3)
10.13 Convertible Promissory Note for $650,000 between Registrant and H. Irwin
Levy, dated June 14, 2002 (3)
10.14 Promissory Note dated April 30, 2002 for $750,000 between Registrant and
Hilcoast Development Corp. (5)
10.15 Letter Agreement, dated March 25, 2002, extending the maturity date to
December 15, 2002, of certain notes, which are between nStor Corporation, Inc.
and H. Irwin Levy (8)
10.16 Letter Agreement, dated March 25, 2002, extending the maturity date to
December 15, 2002, of a note that is between nStor Corporation, Inc. and The
Charlotte Marden 1993 Trust (8)
10.17 Promissory Note for $3,100,000, dated November 20, 2001 issued to Halco
Investments L.C. (9)
10.18 Preferred Stock Purchase Agreement, dated November 20, 2001, between
Registrant, Maurice A. Halperin and Halco Investments, L.C. (9)
10.19 10% Subordinated Promissory Note for $150,000, dated August 7, 2001,
between nStor Corporation, Inc. and H. Irwin Levy (10)
10.20 10% Subordinated Promissory Note for $200,000, dated September 25, 2001,
between nStor Corporation, Inc. and H. Irwin Levy (10)
10.21 8% Promissory Note for $2,100,000, dated August 14, 2001, between
Registrant and Halco Investments, L.C. (10)
10.22 8% Revolving Credit Note for $1,000,000, dated August 14, 2001, between
Registrant and Halco Investments, L.C. (10)
10.23 8% Promissory Note for $1,275,000, dated September 10, 2001, between
Registrant and Halco Investments, L.C. (10)
78
10.24 8% Promissory Note for $332,442, dated October 29, 2001, between
Registrant and Halco Investments, L.C. (10)
10.25 Letter Agreement, dated August 31, 2001, extending the maturity date to
December 31, 2001, of certain notes, which are between nStor Corporation, Inc.
and H. Irwin Levy (10)
10.26 Letter Agreement, dated August 31, 2001, extending the maturity date to
December 31, 2001, of a note that is between nStor Corporation, Inc. and The
Charlotte Marden 1993 Trust (10)
10.27 Subordinated Promissory Note for $100,000, dated May 16, 2001, between
nStor Corporation, Inc. and H. Irwin Levy (11)
10.28 Subordinated Promissory Note for $250,000, dated May 21, 2001, between
nStor Corporation, Inc. and H. Irwin Levy (11)
10.29 Subordinated Promissory Note for $375,000, dated May 30, 2001, between
nStor Corporation, Inc. and H. Irwin Levy (11)
10.30 Subordinated Promissory Note for $75,000, dated June 5, 2001, between
nStor Corporation, Inc. and H. Irwin Levy (11)
10.31 Subordinated Promissory Note for $450,000, dated June 7, 2001, between
nStor Corporation, Inc. and The Charlotte Marden 1993 Trust (11)
10.32 Subordinated Promissory Note for $300,000, dated July 12, 2001, between
nStor Corporation, Inc. and H. Irwin Levy (11)
10.33 Letter Agreement, dated June 29, 2001, extending the maturity date to
August 31, 2001, of certain notes, which are between nStor Corporation, Inc. and
H. Irwin Levy (11)
10.34 Letter Agreement, dated June 29, 2001, extending the maturity date to
August 31, 2001, of a note, that is between nStor Corporation, Inc. and The
Charlotte Marden 1993 Trust (11)
10.35 Form of 8% Convertible Subordinated Promissory Note, between Registrant
and certain private investors (12)
10.36 Promissory Note for $600,000, dated January 16, 2001, between Registrant
and H. Irwin Levy (12)
10.37 Promissory Note for $125,000, dated January 17, 2001, between Registrant
and Larry Hemmerich (12)
10.38 2001 Stock Option Plan (6)
10.39 1996 Stock Option Plan, dated October 5, 1996 (14)
10.40 Amendment to Registrant's 1996 Stock Option Plan (15)
11 Statement Regarding Computation of Per Share Earnings for the Year Ended
December 31, 2002 (1)
21 Subsidiaries of Registrant (1)
23.1 Consent of Independent Accountants dated March 28, 2003, signed by Swenson
Advisors, LLP (1)
79
23.2 Consent of Independent Certified Public Accountants dated March 24, 2003,
signed by BDO Seidman, LLP (1)
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, signed by Registrant's Chief
Executive Officer, H. Irwin Levy (furnished herewith)
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, signed by Registrant's Chief
Financial Officer, Thomas L. Gruber (furnished herewith)
- --------------
1) Filed herewith.
2) Incorporated by reference to Exhibits previously filed with Registrant's Form
10-Q for the quarter ended September 30, 2002, filed November 13, 2002.
3) Incorporated by reference to Exhibits previously filed with Registrant's Form
10-Q for the quarter ended June 30, 2002, filed August 14, 2002.
4) Incorporated by reference to Exhibits previously filed with Registrant's Form
8-K, filed June 21, 2002.
5) Incorporated by reference to Exhibits previously filed with Registrant's Form
10-Q for the quarter ended March 31, 2002, filed May 15, 2002.
6) Incorporated by reference to Exhibits previously filed with Registrant's S-8
Registration Statement, filed April 26, 2002.
7) Incorporated by reference to Exhibits previously filed with Registrant's Form
8-K, filed April 12, 2002.
8) Incorporated by reference to Exhibits previously filed with Registrant's Form
10-K for the year ended December 31, 2001, filed April 8, 2002.
9) Incorporated by reference to Exhibits previously filed with Registrant's Form
8-K dated November 20, 2001 and filed November 28,2001.
10)Incorporated by reference to Exhibits previously filed with Registrant's
Form 10-Q for the quarter ended September 30, 2001, filed November 9, 2001.
11)Incorporated by reference to Exhibits previously filed with Registrant's
Form 10-Q for the quarter ended June 30, 2001, filed August 17, 2001.
12)Incorporated by reference to Exhibits previously filed with Registrant's
Form 10-K for year ended December 31, 2000, filed April 17, 2001.
13)Incorporated by reference to Exhibits previously filed with Registrant's
Form S-3 Registration Statement, filed June 7, 2000.
14)Incorporated by reference to Exhibits previously filed with Registrant's
Form 10-K for the year ended October 31, 1996, filed January 28, 1997.
15)Incorporated by reference to Exhibits previously filed with Registrant's
Form S-8 dated January 6, 2000, filed January 10, 2000.
80
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) 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.
/s/ Thomas L. Gruber
March 21, 2003 By:_______________________________________
Acting President, Chief Operating
and Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
________, 2003 _____________________________________________
Maurice A. Halperin, Chairman of the Board
/s/ H. Irwin Levy
March 21, 2003 _____________________________________________
H. Irwin Levy, Vice Chairman of the Board and
Chief Executive Officer
/s/ Stanley Brenner
March 25, 2003 _____________________________________________
Stanley Brenner, Director
/s/ Roger H. Felberbaum
March 24, 2003 _____________________________________________
Roger H. Felberbaum, Director
/s/ Bernard R. Green
March 21, 2003 _____________________________________________
Bernard Green, Director
/s/ Jack Jaiven
March 21, 2003 _____________________________________________
Jack Jaiven, Vice President and Treasurer
/s/ Michael L. Wise
March 24, 2003 _____________________________________________
Michael L. Wise, Director
81
CERTIFICATIONS
I, H. Irwin Levy, certify that:
1. I have reviewed this annual report on Form 10-K of nStor
Technologies, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 20, 2003
/s/ H. Irwin Levy
------------------------
H. Irwin Levy
Chief Executive Officer
82
CERTIFICATIONS
I, Thomas L. Gruber, certify that:
1. I have reviewed this annual report on Form 10-K of nStor
Technologies, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 21, 2003
/s/ Thomas L. Gruber
-----------------------
Thomas L. Gruber
Chief Financial Officer