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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2003
OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ___________ to ______________
Commission File Number: 0-8354
nSTOR TECHNOLOGIES, INC.
(Exact name of registrant as specified in its Charter)
Delaware 95-2094565
-------- ----------
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6190 Corte Del Cedro, Carlsbad, California 92009
(Address of principal executive offices)
(760) 683-2500
(Registrant's telephone number)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No _____
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): Yes ______ No X
Number of shares outstanding of the Registrant's Common Stock,
par value $.05 per share, as of April 30, 2003: 153,091,995
2
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page
Number
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 (Unaudited)
and December 31, 2002 3
Consolidated Statements of Operations (Unaudited) for the
three months ended March 31, 2003 and 2002 4
Consolidated Statement of Shareholders' Equity (Unaudited)
for the three months ended March 31, 2003 5
Consolidated Statements of Cash Flows (Unaudited) for the
three months ended March 31, 2003 and 2002 6
Notes to Consolidated Financial Statements (Unaudited) 7-19
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19-24
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 24
Item 4. Controls and Procedures 24
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 25
SIGNATURE 26
CERTIFICATIONS 27-28
3
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
Mar. 31,
2003 Dec. 31,
(unaudited) 2002
ASSETS --------- ---------
Current assets:
Cash and cash equivalents $ 299 $ 293
Accounts receivable, net 730 934
Inventories 1,407 1,079
Prepaid expenses and other 284 224
------- -------
Total current assets 2,720 2,530
Property and equipment, net of $118 and $88 of
accumulated depreciation 309 303
Goodwill and other intangible assets, net of $1,113
and $1,021 in accumulated amortization 11,460 11,349
------- -------
$14,489 $14,182
======= =======
LIABILITIES
Current liabilities:
Bank line of credit $ 229 $ 200
Other borrowings 7,046 4,684
Accounts payable and other 2,566 3,177
Deferred revenue 1,112 1,401
------- -------
Total current liabilities 10,953 9,462
Long-term debt - 3,100
------- -------
Total liabilities 10,953 12,562
------- -------
SHAREHOLDERS' EQUITY
Preferred stock, $.01 par; 1,000,000 shares authorized;
0 shares issued and outstanding - -
Common stock, $.05 par; 230,000,000 shares
authorized; 153,091,995 and 142,076,947 shares issued
and outstanding at March 31, 2003
and December 31, 2002, respectively 7,654 7,103
Deferred stock compensation (597) -
Additional paid-in capital 105,444 101,847
Deficit (108,965) (107,330)
------- -------
Total shareholders' equity 3,536 1,620
------- -------
$14,489 $14,182
======= =======
See accompanying notes to consolidated financial statements.
4
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
(unaudited)
Three Months
Ended March 31,
--------------------
2003 2002
------- -------
Sales $2,334 $1,559
Cost of sales 1,473 1,675
------ ------
Gross margin (loss) 861 (116)
------ ------
Operating expenses:
Selling, general and administrative 1,339 1,530
Research and development 590 737
Amortization of non-cash deferred stock
compensation (1) 233 -
Depreciation and amortization 122 243
------ ------
Total operating expenses 2,284 2,510
------ ------
Loss from operations (1,423) (2,626)
Realized losses on marketable securities - (1,329)
Fair value of option granted to customer - (670)
Interest expense (240) (137)
Other income (expense), net 28 (40)
------ ------
Net loss $(1,635) $(4,802)
====== ======
Basic and diluted net loss per common share $( .01) $( .04)
====== ======
Weighted average number of common shares
considered outstanding, basic and diluted 142,566,505 114,940,708
=========== ===========
- --------
(1) If amortization of non-cash deferred stock compensation were not reported
separately, the compensation expense would be included in selling, general and
administrative.
See accompanying notes to consolidated financial statements.
5
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(dollars in thousands)
(unaudited)
Deferred Addi-
Common Stock Stock tional
-------------------- Compen- Paid-In
Shares Amount sation Capital Deficit Total
----------- ------- -------- -------- --------- -------
Balances, December 31, 2002 142,076,947 $7,103 $ - $101,847 $(107,330) $ 1,620
Issuance of common stock in
satisfaction of convertible
note and accrued interest 11,015,048 551 2,754 3,305
Deferred stock compensation (830) 830 -
Amortization of deferred stock
compensation 233 233
Fair value of warrants issued
in connection with borrowings 13 13
Net loss for the three months
ended March 31, 2003 (1,635) (1,635)
----------- ------ ----- -------- --------- ------
Balances, March 31, 2003 153,091,995 $7,654 $(597) $105,444 $(108,965) $3,536
=========== ====== ===== ======== ========= ======
See accompanying notes to consolidated financial statements.
6
nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months
Ended March 31,
---------------
2003 2002
(unaudited)
------ ------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($1,635) ($4,802)
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
Proceeds from the sale of marketable securities - 2,926
Realized losses on the sale of marketable securities - 1,329
Fair value of option granted to customer - 670
Capitalized software costs (203) -
Amortization of deferred stock compensation expense 233 -
Depreciation and amortization 122 243
Other 31 104
Changes in assets and liabilities:
Decrease in accounts receivable 274 693
(Increase)decrease in inventories (443) 429
(Increase)decrease in prepaid expenses and other (60) 91
(Decrease) increase in deferred revenue, accounts payable
and other liabilities (618) 559
------ ------
Net cash (used in) provided by operating activities (2,299) 2,242
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (36) (59)
------ ------
Net cash used in investing activities (36) (59)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds (net repayments) of revolving credit facilities 29 (2,012)
Additions to other borrowings 2,667 -
Repayments on other borrowings (355) -
------ ------
Net cash provided by (used in) financing activities 2,341 (2,012)
------ ------
Net increase in cash and cash equivalents during the period 6 171
Cash and cash equivalents at the beginning of the period 293 857
------ ------
Cash and cash equivalents at the end of the period $ 299 $1,028
====== ======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 41 $ 126
====== ======
NON-CASH FINANCING ACTIVITIES:
Issuance of common stock in satisfaction of borrowings and
accrued interest $3,305 $ -
====== ======
See accompanying notes to consolidated financial statements.
7
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.
Basis of Presentation
In the opinion of management, the unaudited consolidated financial statements
furnished herein include all adjustments, consisting only of recurring
adjustments necessary for a fair presentation of the results of operations for
the interim periods presented. These interim results of operations are not
necessarily indicative of results for the entire year. The consolidated
financial statements contained herein should be read in conjunction with the
consolidated financial statements and related notes contained in the Company's
Form 10-K for the year ended December 31, 2002.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required for complete financial statements.
Going Concern
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. This contemplates the
realization of assets and the satisfaction of liabilities in the normal course
of business. The Company has experienced negative cash flows from operating
activities, declining sales, and recurring net losses of $1.6 million for the
three months ended March 31, 2003 and $8 million and $14 million for the years
ended December 31, 2002 and 2001, respectively. Declining sales have reflected
the global reduction in business demand for technology products. In addition,
the Company has negative working capital of $8.2 million as of March 31, 2003,
which reflects borrowings of $4 million from the Company's Chairman of the
Board, Chief Executive Officer and a significant shareholder, and $1.7 million
from a second significant shareholder. 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 increasing future
sales revenues and 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 other costs as part of its strategy to provide greater emphasis on
indirect customer channels (original equipment manufacturers (OEMs), resellers
and system integrators (SIs)) and to provide certain cost efficiencies in
response to the Company's lower sales levels. Significant cost reductions have
been achieved from outsourcing the manufacturing of the Company's storage
enclosure products since mid 2002 and from the relocation of the Company's
executive and business headquarters to a more economical facility in Carlsbad,
California in December 2002. The outsourcing contract has produced a significant
improvement in gross margins by lowering manufacturing costs, and also allowed
the Company to reduce its overall operating costs, principally as a result of
the phase out of the Company's manufacturing facility during the 2002 third
quarter.
8
Since January 1, 2001 and through April 30, 2003, the Company obtained $25
million of equity and debt financing from private investors. Of these amounts,
(i) $12.1 million was received in 2001 from Maurice Halperin, the Company's
Chairman of the Board until his death in April 2003, 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); (ii) $6.9 million
from H. Irwin Levy, the Company's current Chairman of the Board, Chief Executive
Officer and a principal shareholder, or companies controlled by Mr. Levy
(collectively, "Mr. Levy"); and (iii) $3.9 million from Bernard Marden, a
shareholder who beneficially owns in excess of 10% of the Company's common
stock, or a trust controlled by Mr. Marden (collectively "Mr. Marden").
In addition, in connection with the Company's outsourcing contract, Mr. Levy has
provided collateral for a bank to issue a $1 million letter of credit ("LC"),
subsequently reduced to $500,000, for the benefit of the contractor (see Note 6
to Consolidated Financial Statements).
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 6 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 the Company 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. At the current sales level, the Company has insufficient
liquidity to fund its operating needs for the next twelve months; however, the
Company believes that a reasonable increase in its future sales revenues would
provide sufficient working capital to fund its operations during the next twelve
months. There can be no assurance, however, that the Company will be able to
realize an increase in sales revenues.
The consolidated financial statements do not include any adjustments to reflect
the possible future effects of the recoverability and classification of assets
or the amounts and classification of liabilities that may result from the
inability of the Company to continue as a going concern.
Business
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.
9
In June 2002, the Company acquired Stonehouse (see Note 2 to Consolidated
Financial Statements). Stonehouse is a provider of telecommunications software
and services solutions ("Telemanagement Solutions") that help large enterprises
manage their communications expenses, assets and processes. These solutions
include a suite of modular applications and consulting services, which allow
enterprises to manage voice, data and wireless services by providing a
systematic approach to automate order processing, monitor expenses, manage
vendor invoices, track asset inventory and allocate costs.
Revenue Recognition
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.
Telemanagement Solutions
In accordance with provisions of the AICPA Statement of Position (SOP) 97-2,
Software Revenue Recognition, and related accounting guidance, 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.
Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year's presentation. These reclassifications had no impact on operating results
previously reported.
Research and Development Costs ("R&D")
Storage Solutions
R&D costs associated with our Storage Solutions business are expensed as
incurred.
10
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.
Net Loss Per Common Share ("EPS")
Basic EPS is calculated by dividing the net loss available to common stock by
the weighted average number of common shares considered outstanding for the
period, without consideration for common stock equivalents. Diluted EPS includes
the effect of potentially dilutive securities. For the periods presented, the
effect of potentially dilutive securities would have been antidilutive.
Accordingly, basic and diluted EPS for those periods are the same.
Stock Options
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 2001 Stock Option Plan (the "2001 Plan"), stock options to
purchase up to 7.5 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 2001 Plan have a maximum term of ten years and generally vest
over three years annually on an equal basis.
Upon shareholder approval of the 2001 Plan in January 2002, the Company ceased
granting options under its 1996 Stock Option Plan (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.
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. As discussed in
Note 1 to the Consolidated Financial Statements, Recent Accounting
Pronouncements, the Company adopted the disclosure requirements under SFAS No.
148 regarding prominent disclosures in interim financial statements.
During the three months ended March 31, 2003 and 2002, options to purchase
740,000 shares of common stock and 20,000 shares of common stock, respectively,
were granted by the Company. 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:
11
Three Months Ended
March 31, 2003 March 31, 2002
-------------------------------
Risk-free interest rates 2.75%- 2.92% 4.37%
Expected lives (in years) 5 5
Expected volatility 80.00%-82.51% 90.88%
Expected dividend yield 0% 0%
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, as amended by SFAS No. 148, 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):
Three Months ended March 31,
------------------------------
2003 2002
-------- --------
Net loss available to common stock:
As reported ($1,635) ($4,802)
Add total stock-based employee compensation
expense using the fair value method ( 189) ( 182)
------ ------
Pro forma ($1,824) ($4,984)
======= ======
Basic and diluted net loss per common share:
As reported ($.01) ($.04)
Pro forma ($.01) ($.04)
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. 28
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.
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. In
January 2003, the Company adopted the disclosure requirements of SFAS No. 148.
The adoption of the disclosure provisions of this statement will not have a
material effect on the Company's financial position or results of operations.
12
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's
adoption of this pronouncement in January 2003 did not have a material effect on
its 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". The amendment of SFAS
No. 13 was effective for transactions occurring on or after May 15, 2002.
Although the rescission of SFAS No. 4 was effective January 1, 2003, the FASB
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 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.
(2) ACQUISITION
Terms of the Acquisition
On June 7, 2002, the Company acquired 100% of the outstanding capital stock of
Plano, Texas based Stonehouse from Pacific Technology Group, Inc. ("PTG"), a
subsidiary of Pacific USA Holdings Corp ("PUSA")(the "Acquisition"). See Note 1
to Consolidated Financial Statements for a description of the business conducted
by Stonehouse. 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. At March 31, 2003, there was no basis for the Company
to record a liability related to the earn-out provision.
13
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).
(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 an equity interest in, and made certain loans to, the Company for an
aggregate investment of $12.1 million (the Halco Investment). On the Closing
Date, Halco acquired 8,970 shares of the Company's newly created Series K
Convertible Preferred Stock (the "Series K Preferred Stock"), with a face amount
of approximately $9 million, 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.
In connection with and as a condition to the Halco Investment, it was agreed
that the Series K Preferred Stock was to be automatically converted into
39,000,000 shares of the Company's common stock (the "Halco Common Shares"),
based upon a conversion price of $.23 per share, upon approval of the Company's
shareholders. Shareholder approval was received in January 2002 at which time
the Company issued the Halco Common Shares.
14
(4) TRADING MARKETABLE SECURITIES
In connection with the Halco Investment (see Note 3 to Consolidated Financial
Statements) on November 20, 2001, the Company received marketable securities
with a quoted market value of $6.1 million, including approximately 434,000
shares of American Realty Investors Inc. ("ARL") with a quoted market value of
$5.2 million.
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. As a result of
the 2002 first quarter ARL sales, the Company realized a loss of approximately
$1.3 million.
In April 2002, the Company received $206,000 in cash proceeds from the exercise
of the Options, which amount was realized as a gain on marketable securities in
the second quarter.
(5) GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill, representing the excess of the cost of an acquired business over the
fair value of net assets acquired, is carried at cost and, through December 31,
2001, was amortized under the straight line method over seven years.
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", which requires that goodwill and certain intangible assets
no longer be amortized, but instead be tested at least annually for impairment.
Accordingly, the Company discontinued its amortization of goodwill effective
January 1, 2002.
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 March 31, 2003, the carrying amount of goodwill and other intangible
assets was approximately $8.5 million and $2.5 million, respectively, of which
$6.5 million of goodwill and $2.5 million of other intangible assets is
attributable to the Stonehouse Acquisition (see Note 2 to Consolidated Financial
Statements). In addition, as of March 31, 2003, the Company had capitalized
$502,000 in software development costs associated with its Telemanagement
Solutions business, including $202,000 during the first quarter of 2003.
Amortization of other intangible assets attributable to the Stonehouse
Acquisition amounted to $92,000 for the three months ended March 31, 2003. No
amortization was reported for the three months ended March 31, 2002.
15
(6) BORROWINGS
Revolving Credit Facilities
At March 31, 2003, the Company had 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, and which is
payable upon demand, bearing interest at prime plus 1% (5.25% at March 31,
2003). Borrowings under the Stonehouse Revolver are collateralized by accounts
receivable and certain other assets of the Company's Telemanagement Solutions
business. At March 31, 2003, the outstanding principal balance under the
Stonehouse Revolver was $229,000.
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 March 31, 2003, the uncollected
balance of customer invoices sold to the Purchaser amounted to approximately
$369,000. Interest expense related to this agreement amounted to $29,000 for the
three months ended March 31, 2003.
Other Borrowings
The Company's other borrowings consisted of the following (in thousands):
March 31, December 31,
--------- ------------
2003 2002
--------- ------------
Current:
Notes payable to Mr. Levy:
Revolving promissory notes, interest at 8% per annum,
payable at maturity, principally June 30, 2003 $3,160 $2,748
Convertible promissory notes, interest at 8%-10% per annum,
payable at maturity, principally on June 14, 2003 (a) 850 650
------ ------
Total due to Mr. Levy 4,010 3,398
Other convertible promissory notes payable to Mr. Marden and
other private investors (b) 2,200 450
Other notes payable, interest principally at 8% per annum,
maturing through November 2003 836 836
------ ------
$7,046 $4,684
====== ======
Long-Term:
Halco Note, converted into common stock in March 2003 (c) $ - $3,100
====== ======
a) Mr. Levy's convertible notes include $650,000 convertible at the
Company's option at any time prior to maturity and after the date on which the
Company receives notice of delisting from AMEX, 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 note was originally
collateralized by substantially all of the assets of the Company's Storage
Solutions subsidiary; however, the collateral was relinquished by Mr. Levy in
March 2003.
16
The remaining $200,000 of convertible notes was originally convertible
at Mr. Levy's option at any time prior to maturity into either (i) nStor common
stock at $.29 per share (the closing market price on the date of the note) or
shares of Stonehouse common stock at $.5625 per share. In March 2003, Mr. Levy
agreed to relinquish his conversion rights into Stonehouse common stock.
In connection with the Company's outsource contract, Mr. Levy has
provided collateral for a bank to issue a $1 million LC for the benefit of the
contractor, subsequently reduced to $500,000 effective April 15, 2003. The
Company has agreed to indemnify Mr. Levy for any amounts paid by Mr. Levy as a
result of any drawing upon the LC. No amounts have been drawn on the LC which
expires on August 15, 2003, as extended.
b) At December 31, 2002, Mr. Marden was the holder of a $450,000
promissory note, which was payable March 15, 2003, was convertible at Mr.
Marden's request at any time prior to maturity into shares of the Company's
common stock based on a fixed conversion price of $.40 per share, and which was
collateralized by substantially all of the assets of the Company's Storage
Solutions subsidiary. In January and February 2003, Mr. Marden advanced the
Company an additional $700,000 under an 8% convertible promissory note which was
originally convertible at Mr. Marden's option at any time prior to maturity,
defined as thirty (30) days after notice from Mr. Marden that the outstanding
principal is due, however, such notice could not be made prior to July 1, 2003.
The note was originally convertible into shares of (i) nStor common stock at
$.29 per share (the closing market price on the date of the note) or (ii)
Stonehouse common stock at $.5625 per share. Effective March 14, 2003, Mr.
Marden committed to loan the Company an additional $1 million, and together with
the aforementioned $1.2 million in existing notes (including approximately
$50,000 in accrued interest) (collectively, the "Marden Notes"), aggregating
$2.2 million, agreed to new notes with the following terms: (i) interest at 8%
per annum, payable quarterly, (ii) convertible at any time prior to maturity on
April 1, 2004, into shares of nStor common stock at $.30 per share; and (iii)
collateralized principally by nStor's ownership interest in Stonehouse and the
intellectual property and other intangible assets of the Company's Storage
Solutions business. The closing market price of nStor common stock on March 14,
2003 was $.26. At March 31, 2003, $1.7 million was outstanding under the Marden
Notes and $500,000 was outstanding under loans from two other private investors
under the same terms as the Marden Notes.
In connection with certain borrowings from Mr. Marden during 2003, the
Company issued warrants to purchase an aggregate of 125,000 shares of the
Company's common stock exercisable upon issuance at $.25 per share and expiring
on December 31, 2005. The warrants were valued based on the Black-Scholes
option-pricing model as of the dates of issuance at an aggregate of $13,000 and
were recorded as a discount to the notes.
c) 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
was convertible at the Company's option at any time prior to maturity on
November 20, 2006 and after the date on which the Company received 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 was
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. Effective March 28, 2003, Halco converted the New Halco Note,
plus approximately $200,000 of accrued interest, into 11,015,048 newly issued
shares of common stock based upon a conversion price of $.30 per share. The
closing market price of nStor common stock on March 27, 2003 was $.27 per share.
17
(7) FAIR VALUE OF OPTION GRANTED TO CUSTOMER
Effective March 1, 2002, the Company entered into a Reseller Agreement with a
wholly-owned subsidiary of Pacific Electric Wire & Cable Co., Ltd ("PEWC"), the
parent of PUSA. 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 shares of the
Company's common stock for a purchase price of $.40 per share, expiring on
November 30, 2002. The option was valued at $670,000 as of the date of grant
(subsequently adjusted to $600,000 in the fourth quarter of 2002) 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 three months ended March 31, 2002. The option expired unexercised on
November 30, 2002.
(8) INCOME TAXES
The Company accounts for income taxes in accordance with SFAS 109, "Accounting
for Income Taxes", 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
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 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.
As of December 31, 2002 there were unused net operating loss carryforwards (the
"NOL's") for regular federal income 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.
18
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.
At March 31, 2003 and December 31, 2002, a 100% valuation allowance has been
provided on the total deferred income tax assets because it is more likely than
not that the NOL's will not be realized based on recent operating results.
(9) SEGMENT INFORMATION AND SALES TO SIGNIFICANT CUSTOMERS
Prior to the Stonehouse 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 Stonehouse Acquisition, the Company began operating under a second
business segment, Telemanagement 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
three months ended March 31, 2003, sales to two customers accounted for 44% and
14% of the Company's Storage Solutions sales and sales to two customers
accounted for 30% and 12% of the Company's Telemanagement Solutions sales.
During the three months ended March 31, 2002, sales to two customers accounted
for 27% and 17% of the Company's Storage Solutions sales. For the three months
ended March 31, 2003, Storage Solutions sales to geographic areas other than the
United States aggregated 20% of the Company's Storage Solutions sales
principally in the Pacific rim. For the three month period in 2002, sales to
geographic areas other than the United States were not significant.
Presented below for the three months ended March 31, 2003 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 Telemanagement Solutions
segment. Since the Acquisition occurred in June 2002, segment information is not
applicable for the 2002 period.
Storage Telemanagement
Solutions Solutions
-------- ---------------
Total assets $4,019 $10,470
Revenues $1,187 $ 1,147
Gross margin $ 285 $ 576
Net(loss) applicable to common stock ($1,404) $ (231) (a)
(a) Net of $233,000 of amortization of non-cash deferred stock compensation
19
(10) DEFERRED STOCK COMPENSATION
In connection with an employment agreement effective as of March 1, 2003,
Stonehouse expects to issue certain options which may result in its new
President holding a minority interest in Stonehouse. The intrinsic value of the
options, valued at $830,000, is based on the excess of the fair market value of
Stonehouse common stock, as determined by an independent valuation firm, over
the exercise price of the options. The intrinsic value is reflected in
shareholders' equity as a charge to deferred stock compensation expense and is
being amortized over the vesting period of the options.
Item 2. 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" contains 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 results for any future period.
Subsequent written and oral forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by
cautionary statements in this Form 10-Q and in other reports we file with the
SEC. The following discussion should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto included elsewhere in
this report.
Overview
Since June 1996, we have been a designer, developer and manufacturer of Storage
Solutions. In June 2002, we entered the Telemanagement Solutions business with
our acquisition of Stonehouse (See Note 2 to Consolidated Financial Statements).
Accordingly, we believe that the comparison between 2003 and 2002 may not be
meaningful in certain respects.
20
Results of Operations
Three Months Ended March 31, 2003 vs. March 31, 2002
We incurred a net loss of $1.6 million for the three months ended March 31, 2003
as compared to a net loss of $4.8 million for the 2002 quarter. Included in the
2003 net loss was a non-cash charge of $233,000 for amortization of deferred
stock compensation. Included in the 2002 net loss was $1.3 million of realized
losses on marketable securities and a $670,000 charge for the fair value of an
option granted to a customer.
Sales
Net sales for the three months ended March 31, 2003 were $2.3 million as
compared to $1.6 million for the three months ended March 31, 2002, a $775,000
increase. Included in the 2003 sales was $1.1 million attributable to our
Telemanagement Solutions business. The $373,000 or 24% decline in our Storage
Solutions sales reflects the global economic downturn which has caused customer
delays in acquiring technology and other capital equipment. During the quarter
ended March 31, 2003, direct sales to end users represented 13% of our sales
revenues and indirect sales to OEMs, value-added resellers (VARs) and other
channel business represented 87% of our sales revenues. During the 2002 first
quarter, our direct sales represented 25% of our sales revenues and indirect
sales represented 75% of our sales revenues (see Note 9 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 for the three months
ended March 31, 2003 improved to 24% compared to a negative 7% for the three
months ended March 31, 2002. This improvement reflects significantly lower
material costs attributable to the commencement during the 2002 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 quarter 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 4000 Series.
Our Telemanagement Solutions business experienced a 50% gross margin for the
2003 period, which is relatively consistent with gross margins realized in 2002
subsequent to our acquisition of Stonehouse in June 2002. Combined gross margins
for our Storage Solutions and Telemanagement Solutions for the three months
ended March 31, 2003 amounted to 37%.
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.
21
Operating Expenses
Selling, General and Administrative (SG&A)
Selling, general and administrative expenses were $1.3 million and $1.5 million
for the three months ended March 31, 2003 and 2002, respectively. The $191,000
net decrease was the result of a $662,000 decrease in SG&A attributable to our
Storage Solutions business through our overall work force reduction and related
costs, including occupancy expenses, partially offset by $471,000 in SG&A
incurred by our Telemanagement Solutions business in 2003.
Research and Development (R&D)
R&D expenses decreased to $590,000 for the three months ended March 31, 2003,
from $737,000 for the 2002 period. This decrease was attributable to a reduction
in R&D costs associated with our Storage Solutions business following the
development of our 4000 Series of storage systems.
R&D costs associated with our Storage Solutions business are expensed as
incurred. R&D costs incurred by our Telemanagement Solutions business relate to
the development of our MONIESWeb(R) software and were expensed as incurred until
technological feasibility was established in 2002. Thereafter, such costs are
being capitalized until the product is available for general release to
customers, expected in the second quarter of 2003, at which time we will begin
to amortize capitalized software costs 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). During the quarter ended March 31,
2003, capitalized R&D costs associated with MONIESWeb(R) software amounted to
$202,000.
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. We believe
that considerable investments in R&D will be required to remain competitive in
both our businesses.
Depreciation and Amortization
Depreciation and amortization decreased to $122,000 for the three months ended
March 31, 2003, from $243,0000 for the 2002 period, primarily the result of a
$219,000 decline in depreciation expense for our Storage Solutions business,
partially offset by $92,000 of amortization of other intangible assets resulting
from our Stonehouse acquisition (See Note 2 to Consolidated Financial
Statements).
Interest Expense
Interest expense increased to $240,000 for the three months ended March 31, 2003
from $137,000 for the 2002 quarter, principally attributable to higher average
borrowings (see Note 6 to Consolidated Financial Statements).
22
Liquidity and Capital Resources
We have received a "going-concern" opinion from our auditors for the last three
fiscal years ended December 31, 2002. As more fully described in Note 1 to the
Consolidated Financial Statements, our recurring operating losses, declining
sales, negative cash flows from operating activities and negative working
capital 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.
Since 2001 we have devoted substantial efforts to: (i) streamline our
operations; (ii) establish the foundation for increasing future sales revenues
and generating positive cash flow and operating profits; and (iii) obtain
sufficient financing to cover our working capital needs. For a description of
these efforts, see Note 1 to 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 outside our control, there
can be no assurance that such required additional funds will be available on
terms acceptable to management, if at all, or that we will be able to generate
positive cash flows from operations in the future. At the current sales level,
we have insufficient liquidity to fund our operating needs for the next twelve
months; however, we believe that a reasonable increase in our future sales
revenues would provide sufficient working capital to fund our operations during
the next twelve months. There can be no assurance, however, that we will be able
to realize an increase in sales revenues.
Consolidated Statements of Cash Flows
Operating Activities
Net cash used in operating activities for the three months ended March 31, 2003
amounted to $2.3 million and primarily consisted of $1.5 million from operations
(before changes in assets and liabilities), a $618,000 reduction of deferred
revenue, accounts payable and other liabilities, and a $443,000 increase in
inventories. Net cash provided by operating activities in the 2002 period
amounted to $2.2 million and consisted of $.5 million from operations (before
changes in assets and liabilities), including $2.9 million of cash proceeds from
the sale of marketable securities and an aggregate of $1.7 million from the
reduction of accounts receivable and inventories and an increase in accounts
payable and other liabilities.
Investing Activities
Net cash used by investing activities was insignificant during both periods.
Financing Activities
Net cash provided by financing activities for the three months ended March 31,
2003 amounted to $2.3 million of net proceeds in borrowings from investors. Net
cash used in financing activities for the 2002 period amounted to $2 million
from a net reduction in our revolving credit facility.
23
American Stock Exchange (AMEX)
In May 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.
In June 2002, we submitted a plan and supporting documentation (the "Plan") to
AMEX to demonstrate our ability to regain compliance. In August 2002, AMEX
notified us that it had accepted our Plan and granted us an extension through
June 30, 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.
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 Telemanagement 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.
24
Effect 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We maintain a floating interest rate revolving credit facility ($229,000
outstanding balance at March 31, 2003). Therefore, we are subject to a market
risk arising from increases to the prime rate.
Item 4. CONTROLS AND PROCEDURES
(a) Within 90 days prior to filing this report on Form 10-Q (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.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable
Item 2. Changes in Securities and Use of Proceeds
Effective March 28, 2003, Halco Investments, LC converted its $3.1 million note
receivable from us, plus approximately $200,000 of accrued interest, into
11,015,048 newly issued shares of nStor common stock based on a conversion price
of $.30 per share.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
25
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
4.1 8% Convertible Promissory Note for $1.7 million, dated March 25, 2003,
between Registrant and Bernard Marden.
4.2 8% Convertible Promissory Note for $500,000, dated March 25, 2003,
between Registrant and The Charlotte Marden 1993 Trust.
4.3 Form of 8% Convertible Promissory Notes for $250,000 between
Registrant and Alan Miller and WRS Advisors III LC.
10.1 Security Agreement between Registrants and Bernard Marden, The
Charlotte Marden 1993 Trust, Alan Miller and WRS Advisors III LC.
10.2 Second Amended and Restated Stock Pledge Agreement between Registrant
and Bernard Marden, The Charlotte Marden 1993 Trust, Alan Miller and
WRS Advisors III LC.
10.3 Letter Agreement between Registrant and H. Irwin Levy dated March 20,
2003 regarding amendments to a $200,000 8% Convertible Promissory Note
dated February 19, 2003.
10.4 Letter Agreement between Registrant and H. Irwin Levy, dated April 1,
2003 regarding conversion into Registrant's common stock of debt owed
by Registrant to Mr. Levy.
10.5 Letter Agreement between Registrant and Hilcoast Development Corp.
dated April 30, 2003 extending the maturity date of certain promissory
notes.
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 on May 13, 2003.
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 on May 14,
2003.
(b) Reports on Form 8-K:
A report on Form 8-K dated March 28, 2003 was filed on April 15, 2003
reporting under Item 5 - Other Events in which Registrant reported the
conversion of a $3.1 million note payable into Registrant's common
stock.
26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
nSTOR TECHNOLOGIES, INC.
(Registrant)
May 13, 2003 /s/ Thomas L. Gruber
-------------------------------------
Thomas L. Gruber, Acting President,
Chief Operating and Financial Officer
27
CERTIFICATIONS
I, Thomas L. Gruber, certify that:
1. I have reviewed this quarterly report on Form 10-Q of nStor
Technologies, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 quarterly 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: May 13, 2003
/s/ Thomas L. Gruber
Thomas L. Gruber
Chief Financial Officer
28
CERTIFICATIONS
I, H. Irwin Levy, certify that:
1. I have reviewed this quarterly report on Form 10-Q of nStor
Technologies, Inc.;
2. Based on my knowledge, this quarterly 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 quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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
quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 quarterly 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: May 13, 2003
/s/ H. Irwin Levy
H. Irwin Levy
Chief Executive Officer