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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21600
ECCS, INC.
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(Exact Name of Registrant as Specified in Its Charter)
New Jersey 22-2288911
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(State or Other (I.R.S. Employer Identification
Jurisdiction of No.)
Incorporation or
Organization)
One Sheila Drive, Tinton Falls, New Jersey 07724
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(Address of Principal Executive Offices) (Zip Code)
(732) 747-6995
(Registrant's telephone
number, including area
code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on Which Registered
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
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(Title of Class)
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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:
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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. [ X ]
State the aggregate market value of the voting stock held by non-affiliates
of the Registrant: $5,972,435 at February 28, 2001 based on the last sales price
on that date.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of February 28, 2001:
Class Number of Shares
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Common Stock, $.01 par value 11,562,540
The following documents are incorporated by reference into the Annual
Report on Form 10-K: Portions of the Registrant's definitive Proxy Statement for
its 2001 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Report.
TABLE OF CONTENTS
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Item Page
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PART I 1. Business................................................ 2
2. Properties.............................................. 20
3. Legal Proceedings....................................... 20
4. Submission of Matters to a Vote of Security Holders..... 21
PART II 5. Market For the Company's Common Equity and Related
Shareholder Matters..................................... 22
6. Selected Consolidated Financial Data.................... 24
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 25
7A. Quantitative and Qualitative Disclosures About Market Risk 34
8. Financial Statements and Supplementary Data............. 34
9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure..................... 34
PART III 10. Directors and Executive Officers of the Company......... 35
11. Executive Compensation.................................. 35
12. Security Ownership of Certain Beneficial Owners
and Management.......................................... 35
13. Certain Relationships and Related Transactions.......... 35
PART IV 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................. 35
SIGNATURES ........................................................ 37
EXHIBIT INDEX........................................................ 39
FINANCIAL STATEMENTS................................................. F-1
1
FORWARD LOOKING STATEMENTS
The statements contained in this Annual Report on Form 10-K that are not
historical facts are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995). Such forward-looking
statements may be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy that involve risks and uncertainties.
These forward-looking statements, such as statements regarding anticipated
future revenues, capital expenditures, research and development expenditures and
other statements regarding matters that are not historical facts, involve
predictions. ECCS, Inc.'s ("ECCS," the "Company" or "We") actual results,
performance or achievements could differ materially from the results expressed
in, or implied by, these forward-looking statements contained in this Annual
Report on Form 10-K. Factors that could cause actual results, performance or
achievements to vary materially include, but are not limited to: the Company's
liquidity and capital resources, component quality and availability, changes in
business conditions, changes in ECCS' sales strategy and product development
plans, changes in the data storage or network marketplace, competition between
ECCS and other companies that may be entering the data storage host/network
attached markets, competitive pricing pressures, continued market acceptance of
ECCS' open systems products, delays in the development of new technology, and
changes in customer buying patterns.
Explanatory Note: All dollar amounts, other than per share amounts, are in
thousands.
PART I
Item 1. Business.
GENERAL
We design, manufacture, sell and support fault tolerant enterprise storage
solutions that protect and ensure access to an organization's critical data. Our
products include high performance, fault tolerant storage subsystems that meet a
wide range of customer applications for Open Systems-based networks, such as NT,
UNIX and Linux operating systems and our Raven family of integrated solutions
with Sun processors and storage. Our fault tolerant enterprise storage solutions
address all three storage markets: Direct Attached Storage ("DAS"), in which the
storage device is connected directly to a server; Network Attached Storage
("NAS"), in which the storage device is installed on a network; and Storage Area
Network ("SAN"), in which the storage device is used in a specialized network.
These connectivity options provide our customers the flexibility to choose and
deploy a particular storage solution to meet their needs. As data requirements
change, customers can migrate their existing storage investments to different
connectivity options. We believe our products reduce the total cost of ownership
of data storage by allowing end users to use the products across various
operating systems.
A number of products resulted from our product development efforts over the
last five years, including our Synchronix and Synchronection product lines.
Today, we are a manufacturer of high performance, highly scalable, fault
tolerant data storage solutions. Our
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direct sales force concentrates on sales to commercial end users and Federal
government end users. Our direct sales force also works with selected Value
Added Resellers ("VARs") and assists them in their sales to commercial end
users. During the three years prior to 1998, we had focused our sales and
marketing efforts through our primary alternate channel partners and OEMs like
Unisys Corporation and Tandem Computers, Inc. As a result of industry
consolidation and competitive factors, sales to Unisys and Tandem declined
significantly in 1999 and 2000. We do not expect sales to these alternate
channel partners to constitute a significant part of our net sales in fiscal
2001.
In January 2000, we introduced Synchronix SAN, an enterprise storage
solution for the SAN architecture. This new product combines Fibre Channel
switched fabric and SAN management with the fault tolerant features found in our
Synchronix storage products. We believe that companies' growing storage demands
will lead them increasingly to consider SAN products.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues to date but represented a
substantial portion of engineering costs which were capitalized in 2000. The
total amount of SANStar capitalization of $1,988 was written down to $250 in
December 2000. In February 2001, we sold the assets related to the SANStar
technology, including certain patent applications, to Ciprico, Inc. for
aggregate proceeds of approximately $580, including $250 of SANStar
capitalization.
In September 2000, we introduced the Synchronix 3000, our high performance
fault-tolerant data storage engine that delivers tremendous speed, storage
capacity, data protection and storage management, along with the advantages of
full-fibre connectivity. The Synchronix 3000 offers enhanced RAID technology and
can become the central data storage for different networks, including DAS, NAS
and SAN. We strive to configure solutions that meet the needs of its customers.
At times this includes the incorporation of third party products to complete the
solution.
In response to competitive and financial pressures, during the first
quarter of 2001, we reduced our workforce by up to 40% across most departments.
Additionally, our executive officers have agreed to salary reductions.
INDUSTRY BACKGROUND
In recent years there has been a significant increase in the volume of data
created, processed, stored and accessed throughout an enterprise. As a result,
the demand for sophisticated storage systems to house this data has grown
dramatically. International Data Corporation estimates that the worldwide
storage system marketplace will exceed $46 billion in 2003. This growth has been
fueled by the rapid expansion of the Internet, measured both by the number of
users as well as the number of web-based e-commerce and corporate initiatives
which require continuous access to critical business information 24 hours a day,
seven days a week. Also contributing to this growth has been the emergence of
data-intensive applications, such as online transaction processing, data
warehousing, data mining and enterprise resource planning, and the use of
multimedia-based information. This demand is compounded when organizations
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create redundant sources of data to enable continuous error-free access to data.
As a result, the need for high-capacity, high-performance storage devices and
systems is dramatically increasing. The growth in stored data has been
facilitated by the continued decline in the cost per unit of storage capacity.
Data has also become increasingly important as a critical business asset.
In addition to being relied upon by an organization's employees, corporate data
is also being directly accessed by customers and suppliers. As a result, storage
systems and servers must handle greater volumes of input and output
transactions, or I/Os, and provide continuous availability of data. Data must be
continuously available as the cost of down-time or sub-optimal performance could
adversely affect a business' competitive advantage. These requirements have
placed significant stress on currently installed storage products, many of which
were not designed to handle large volumes of dispersed data.
In addition, the increased use of Open Systems computing environments, such
as NT, UNIX and Linux, creates the need for flexible and comprehensive data
storage solutions capable of serving multiple computer platforms. Open Systems
architecture permits organizations to utilize hardware and software products
from various suppliers in order to process, share, manage and protect mission
critical information throughout an enterprise. Whereas organizations
historically purchased their storage from the same vendor that provided their
server technology, storage purchases are increasingly being made independent of
server purchase decisions.
As the number, importance and complexity of storage systems have increased,
the management of the data-intensive network environment has become more
difficult. While data administration is a key requirement for organizations,
their budgetary constraints often require that this increasingly complex task be
accomplished cost-effectively, without increased staffing.
To address the evolving storage requirements of organizations, three
storage architectures have emerged. DAS has been the storage architecture
traditionally employed and has historically represented the vast majority of
storage purchases. NAS and SAN are more recent innovations in the storage
marketplace and are expected to represent over 37% of worldwide storage systems
sales by 2003, representing a compound annual growth rate in excess of 66%.
- DAS - Storage devices that are directly attached to the host computer.
These storage devices are dedicated to and accessed through the host
computer;
- NAS - Storage devices that are connected to a local or wide area
network. NAS devices incorporate their own processing power in order
to store and retrieve data. NAS storage devices allow more than one
host server and users of different operating systems to access data;
and
- SAN - Storage devices that are connected to an additional,
specialized, high speed network, dedicated to providing I/O. The use
of a SAN offloads a significant amount of data traffic and overhead
from the local or wide area network, resulting in improved overall
network performance. SAN storage devices enable users on one operating
system to access data stored on a different type of operating system.
We believe that Fibre Channel technology is the preferred
implementation technology for SAN storage.
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The ECCS Approach
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We believe that our enterprise storage solutions appeal to the market by
providing an enhanced combination of performance and features, which we expect
to deliver increasingly through software-based product offerings. The following
are the key attributes of our approach:
- RANGE OF MIGRATABLE SOLUTIONS. We offer a range of products to operate
in DAS, NAS and SAN environments which allows our customers to utilize
the storage architecture that best suits their requirements. As the
data storage needs of our customers expand and evolve, our
comprehensive solutions can be redeployed from one environment to
another, thereby protecting a customer's storage investment.
- SCALABILITY. Our products provide maximum scalability as a customer's
needs change by using a modular approach in designing and configuring
our storage solutions. Customers can purchase from 100 gigabytes to
multiple terabytes, adding storage capacity as required. This
scalability allows us to provide solutions for a broad range of
storage requirements, from low capacity users to enterprise-wide
environments.
- COMPETITIVE PRICING. Our products generally provide end users with the
same features as similar solutions, but at a lower cost. In addition,
our modular product approach offers customers more attractive initial
entry costs.
- ENHANCED DATA AVAILABILITY. Our products enhance data availability by
offering array-based failover, fault tolerance, multiple host
connectivity across various Open Systems platforms, on-line firmware
upgrades, on-line systems maintenance and hot-swappable component
replacement.
- HIGH LEVEL OF I/O PERFORMANCE. Our products provide a high level of
I/O performance by using (i) multiple RAID (redundant array of
independent disks) levels that possess varying performance
characteristics, (ii) larger cache sizes to improve speed and (iii)
solid state disks for dedicated memory for frequently accessed
information.
- ENHANCED DATA ADMINISTRATION CAPABILITIES. Our products utilize an
intuitive, customizable GUI (graphical user interface) which allows
for the remote monitoring and management of virtually all functions,
including system configuration, cache policies and data rebuild upon
system failure. These features allow for the management of data by
both sophisticated and unsophisticated users. Our products also
provide automatic notification of system errors via a "call home"
feature that automatically notifies our customer service personnel by
e-mail and paging.
STRATEGY
Our objective is to further establish and solidify our position in the
rapidly growing Open Systems storage market. Our strategic focus centers around
serving users whose mission critical applications require high performance and
high reliability storage products. We intend to establish ECCS as the data
storage solution of choice for companies with growing and increasingly complex
data needs. Our strategy incorporates the following key elements:
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- FOCUS OUR DIRECT SALES CHANNEL. To better address commercial customers
and Federal markets, we intend to refine and expand our direct sales
team where needed. Our direct sales force also assists selected VARs
in their sales efforts with commercial customers. We believe that a
well trained and effective direct sales force will enable us to offer
consultative sales and better address customer needs for the markets
we serve as well as identify current and future end user needs and
enhance opportunities for follow-on sales.
- TARGET COMMERCIAL CUSTOMERS WITH GROWING STORAGE REQUIREMENTS. We
intend to concentrate our sales efforts on commercial customers with
data intensive applications and data rich computing environments.
Within the commercial end user market, we will target companies
conducting e-commerce.
- SUPERIOR PRE-SALE AND POST-SALE SUPPORT. We have significant technical
resources available to assist the sales team and customers in
designing and implementing specific data storage solutions needed by
the customer. We believe our superior support and service enhances our
ability to identify and satisfy our customers' needs.
- TECHNOLOGICAL EDGE. We believe that we possess substantial technical
expertise gained through years of internal research and development,
particularly in the area of fault tolerant enterprise storage
solutions. We hold several patents on our RAID controller. We intend
to improve upon our current product offerings as well as develop or
obtain new products for data storage.
- REDUCE TOTAL COST OF OWNERSHIP. We believe we deliver solutions that
reduce the total cost of ownership of data storage. Such cost includes
the purchase price and maintenance and management costs over one year.
Our competitively priced, high performance enterprise storage
solutions are scalable and migratable across various operating
systems. A customer can further protect its storage investment by
redeploying our solutions to and from NAS, DAS and SAN environments.
PRODUCTS AND TECHNOLOGY
Our core technology provides data-intensive environments with protection
against the loss of critical data and provides the performance and reliability
characteristics of more expensive solutions at a more competitive price. Our
products offer users:
- the ability to deploy in major Open Systems-based networks, such as
NT, UNIX and Linux;
- scalable storage capacity;
- fault tolerance;
- fast data transfer rates; and
- ease of storage system management.
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Our families of products include the following:
Synchronix 2000 is our DAS product offering. The major features of Synchronix
include:
- support for multiple levels of RAID;
- scalable to multiple terabytes;
- array-based failover which allows failover without disruption of the
host server;
- fault tolerance due to fully redundant and hot swappable active
components;
- active/active controllers processing data simultaneously which
enhances performance and protects against system failure;
- graphical user interface that provides access to all operational,
maintenance and monitoring functions; and
- event notification or "call home" features that automatically notifies
our customer service personnel of any system failure or problem.
Synchronix 3000 is our fault-tolerant data storage engine introduced in
September 2000 that delivers superior performance in speed, storage capacity,
data protection and storage management, along with the advantages of the
full-fibre connectivity in the SAN as well as DAS and NAS environments. The
Synchronix 3000 achieves real large-block transfer speeds of 190 MB per second
for two channels and storage capacity of 65TB with three standard 70" inch
cabinets.
Synchronix SAN is our fault tolerant SAN solution. This product combines Fibre
Channel switched fabric and SAN management with the fault tolerant features
found in our Synchronix storage engine. This turnkey product includes the
following features:
- fibre heterogeneous file sharing which allows a user on one operating
system to access data stored on a different type of operating system;
- support for industry standards, including switched fabric support; and
- fully integrated switches, hubs, host bus adapters, storage,
management tools and software provided by us and third parties.
Synchronection is our NAS product offering. Synchronection incorporates the
features of Synchronix with greater storage capacity redundant file servers.
Rather than limiting access to a user of a specific operating system,
Synchronection allows access by users of multiple operating systems.
Raven is our product family that offers powerful, flexible, all-in-one server
storage for departmental, Internet and Intranet requirements. The Raven products
are sold primarily to the U.S. Air Force. The Raven products offer high
performance and a scalable server which provides for continuous availability
with integrated RAID protection.
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PRODUCTS UNDER DEVELOPMENT. We continue to enhance our current product
offerings, primarily through the following:
- Integration of third party hardware and software for the Synchronix
and Synchronection families of products,
- improvements to the Synchronix and Synchronection families of
products; and
- new interface connectivities.
SALES AND MARKETING
We market our products directly to commercial and Federal end users and
indirectly through our select alternate channel partners, including OEMs and
national resellers.
DIRECT SALES. Our direct sales efforts focus on commercial and Federal end
user accounts, as well as assisting selected VARs in their sales to these end
users. Our direct sales team consists of 10 to 15 people. We conduct sales and
marketing from our corporate headquarters in New Jersey and from our offices in
a few select other locations. We believe that direct sales has a number of
advantages, including:
- better customer account penetration, loyalty and diversity;
- opportunities for follow-on sales to our existing customer base;
- opportunities for increased customer referrals; and
- more accurate identification of current and future end user customer
requirements with which to guide product specification and development
efforts.
We plan to concentrate our sales efforts on customers with data intensive
computing environments such as companies conducting e-commerce.
Indirect Sales Through Alternate Channel Partners. Our alternate channel
effort is focused on a select few resellers that possess the knowledge, skill or
other benefits to help further the sale of our products.
- Resellers - We continue to identify resellers that will be able to
take advantage of our products and/or offer additional services to
end-users. These resellers allow us to market our products on a
broader basis.
In December 2000, we entered into a partnering arrangement with Brocade
Communications System, Inc. ("Brocade"), a leading provider of Storage Area
Network infrastructure, to become a Brocade Fabric Integrator. As a Brocade
Fabric Integrator, we have completed comprehensive training on the Brocade
SilkWorm family of Fibre Channel switches and software. Brocade SilkWorm fabric
switches provide a scalable, reliable networking foundation for storage
environments by connecting servers and storage systems through a
high-performance SAN. As a Brocade Fabric Integrator, we will provide Brocade
switches as a complement to our ECCS branded storage appliances. We believe our
relationship with Brocade
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will significantly contribute to our ability to expand and adapt our business in
the storage area networking industry.
We also offer software and hardware from other vendors in order to design
customized storage solutions and infrastructures needed by our customers.
Customer Support and Service
We provide 24 x 7 technical support services to end users and alternate
channel partners. Our technical support specialists provide three "tiers" or
"levels" of support, and are able not only to diagnose and solve technical
problems, but also to assist customers with systems integration and use.
Customers have toll-free telephone access (1-800-2-GET-HLP) to technical
specialists who respond to hardware, software and applications questions. We
track service reports through a customer database which maintains current status
reports as well as historical logs of customer interaction. The "call home"
feature of our Synchronix family of products automatically notifies our customer
service personnel of any system failure or problem. We provide technical support
under annual maintenance contracts which are offered to all of our customers.
Technical support includes problem identification, work-around solutions and
engineering services.
We further differentiate our company by maintaining ISO 9001 registration
for our principal facility. We utilize ISO 9001 standards throughout our
organization to consistently maintain high quality design, development,
integration and manufacturing, installation and service processes. Our emphasis
on providing high quality customer services enhances our sales and marketing
efforts and supplier relationships.
COMPETITION
We are engaged in fields within the data processing industry that are
characterized by a high level of competition. Competitive factors include:
- relative price/performance;
- product features, quality and reliability;
- speed to market;
- adherence to industry standards;
- financial strength; and
- service, support and reputation.
Many of our competitors have financial, technical, manufacturing, sales,
marketing and other resources which are substantially greater than our own. We
cannot be certain that we will be able to continue to compete successfully with
existing or new competitors. Recent acquisitions of several of our competitors
by large companies, consolidation of smaller market participants and other
market activities have increased the competition in our marketplace.
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In addition, we compete with a broad range of businesses with varying
degrees of experience, resources and development, including established computer
manufacturers, systems integrators and manufacturers of enterprise storage
products and networking products. We compete with different companies depending
on the specific application or market. With respect to DAS products, EMC Corp.,
along with large server vendors such as Compaq and Sun Microsystems, among
others, are significant competitors. In the NAS market, our primary competitor
is Network Appliance Inc. As we introduce our fault tolerant SAN products, we
expect to compete with a number of existing and new competitors introducing
products in this emerging market.
Competitive pricing pressures exist in the data storage market and may in
the future have an adverse effect on our revenues and earnings. Certain
competitors have reduced prices in order to preserve or gain market share. If
our competitors continue to make price cuts, our financial results may be
adversely affected. We believe that pricing pressures are likely to continue.
MANUFACTURING AND SUPPLIERS
We rely on outside manufacturers to produce some of our products. We also
rely on outside suppliers to supply subassemblies, component parts and computer
systems for resale. Our in-house manufacturing consists primarily of light
assembly, systems integration, testing and quality assurance.
Unisys, formerly our primary outside manufacturer for our Synchronix
system, closed its Winnipeg computer storage systems manufacturing plant in July
1999 and terminated its manufacturing service agreement with us. We manufactured
such systems in-house from August to December 1999. In September 1999, we
entered into a Master Sale Agreement with Hitachi Computer Products (America),
Inc. Pursuant to such agreement, Hitachi began manufacturing certain of our
products in January 2000 for use in our fault tolerant enterprise storage
solutions. The agreement does not contain specific quantity commitments and
purchases are made on a purchase order basis. The agreement does not include any
long-term commitment by either party.
Certain components used in our products are available only from a limited
number of sources. Any delays in obtaining such components could adversely
affect our results of operations. We cannot be certain that material problems
will not arise in the future with our outside manufacturers or vendors that
could significantly impede or interrupt our business. We cannot be certain that
our relationships with our outside manufacturers and suppliers will continue or
that we would be able to obtain alternative sources of supply without a material
disruption in our ability to provide products to our customers if our
relationships with our existing outside manufacturers or suppliers are
terminated.
We rely on certain distributors to supply us with component products from
Sun Microsystems and Seagate Technologies. Although we believe alternative
distributors of these products are available, we cannot be certain that we can
obtain them on a timely and cost-effective basis. Our primary vendor for these
third party products is Bell Microproducts. During fiscal 2000, purchases from
Bell totaled $4,167, or 26%, of our total purchases. We purchase products from
Bell on a purchase order basis. There are no minimum purchase requirements. This
arrangement is terminable by either party at any time.
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In February 1999, we received ISO 9001 certification. This certification,
which is evaluated regularly, reflects uniform, industry-wide standards of
quality control for manufacturing data-storage products. We cannot be certain
that we will continue to meet the industry-accepted standards necessary to
maintain ISO 9001 certification.
RESEARCH AND DEVELOPMENT
We participate in an industry that is subject to rapid technological
change, and our ability to remain competitive depends on, among other things,
our ability to maintain a technological edge. As a result, we have devoted
substantial resources to product development. Our research and development
expenditures were $3,150 in fiscal 2000, of which $1,038 were capitalized in
accordance with the Statement of Financial Accounting Standards ("SFAS") No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise
Marketed.
Our research and development expenditures are related to the following projects:
- Integration of third party hardware and software for the Synchronix
and Synchronection families of products;
- improvements to the Synchronix and Synchronection families of
products; and
- new interface connectivities.
In June 2000, we announced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth Quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues but represented a
substantial portion of engineering costs in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS
Proprietary protection for our technological know-how, products and product
candidates is important to our business. We rely upon patents, trade secrets,
know-how and continuing technological innovation to develop and maintain our
competitive position. We also rely on a combination of copyright and trade
secret protection and non-disclosure agreements to establish and protect our
proprietary rights. We have filed numerous patent applications covering various
aspects of our Synchronix product family and intend to file additional
applications for products under development. We cannot be certain that patents
will issue from any applications or, if patents do issue, that any claims
allowed will be sufficiently broad to prohibit others from marketing similar
products. In addition, we cannot be certain that any patents that may be issued
to us, or which we may license from third parties, will not be challenged,
invalidated or circumvented, or that any rights granted thereunder will provide
proprietary protection. Although we continue to implement protective measures
and intend to defend our proprietary rights, policing unauthorized use of our
technology or products is difficult and we cannot be certain that these measures
will be successful.
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Although management believes that patents will provide some competitive
advantage, our success is dependent to a great extent on our proprietary
knowledge, innovative skills, technical expertise and marketing ability. Because
of rapidly changing technology, our present intention is not to rely primarily
on patents or other intellectual property rights to protect or establish our
market position.
In February 2001, as part of the sale of our SANStar assets, we sold
certain patent applications to Ciprico, Inc.
We have registered trademarks for ECCS, RAID 10 PERFORMANCE MANAGER,
INTELLIGENT REBUILD, SPLIT MIRROR, EXAMODULE, SYNCHRONIX, INVERSE MIRRORING,
SYNCHRONECTION and SPLIT VOLUME. We have applied for trademark registration for
SYNCHRONISM and EASY BACKUP. We cannot be certain that trademarks will be issued
for such applications.
We require all employees, consultants and contractors to execute
non-disclosure agreements as a condition of employment or engagement by us. We
cannot be certain, however, that we can limit unauthorized or wrongful
disclosures of unpatented trade secret information.
EMPLOYEES
In response to market conditions, we reduced our workforce by up to 40%
across most departments during the first quarter of 2001. As of March 15, 2001,
we employed 55 persons, of whom 11 were engaged in marketing and sales; 8 in
engineering and research and development; 15 in operations, including customer
and technical support, manufacturing and fulfillment; 5 in professional
services; and 16 in finance, administration and management. None of our
employees are covered by collective bargaining agreements. We believe our
streamlined workforce will enable us to meet our business objectives on a more
competitive basis. We also believe that we have been successful in retaining
skilled and experienced personnel; however, competition for such personnel is
intense. Our future success will depend in part on our ability to continue to
attract, retain and motivate highly qualified technical, manufacturing,
marketing and management personnel. We consider relations with our employees to
be good.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
WE RELY SUBSTANTIALLY ON KEY CUSTOMERS.
Our customer base is highly concentrated. Our top 10 customers in 1998,
1999 and 2000 accounted for, in the aggregate, approximately 85.6%, 82.6% and
64.5%, respectively, of net sales in those periods. Sales to the U.S. Air Force,
through Federal integrators, accounted for 33.7%, 58.4% and 30.5% of net sales
in 1998, 1999 and 2000, respectively. Federal integrators are government
contractors who sell directly to U.S. government entities. We believe that a
substantial portion of our net sales and gross profits will continue to be
derived from sales to a concentrated group of customers. However, the volume of
sales to a specific customer is likely to vary from period to period, and a
significant customer in one period may not purchase our products in a subsequent
period. In general, there are no ongoing written commitments by customers to
purchase our products. All our product sales are made on a purchase order basis.
Our net sales in any period generally have been and likely will continue to be
in the near term, derived from a relatively small number of sales transactions.
Therefore, the loss of one or more major customers could materially adversely
affect our results of operations.
12
THE FEDERAL GOVERNMENT'S INVESTIGATION INTO FEDERAL GOVERNMENT PURCHASING COULD
AFFECT OUR SALES TO THE U.S. AIR FORCE.
In late January 2000, we received a subpoena from the United States
Attorney's Office in Boston, Massachusetts for the production of documents in
connection with an investigation into Federal government purchasing. We have
been and intend to continue cooperating with the investigation and are complying
fully, and intend to continue to comply fully, with the subpoena. We sell
computer products to companies which are used by the Federal government to
supply computer products to the U.S. Air Force. In addition, subpoenas were
received by several of our employees, including certain officers, who are
expected to testify before the grand jury. Not all of such testimony has been
provided. It appears that one avenue of inquiry involves the relationships and
transactions of various suppliers, manufacturers (including us), and other
companies, with companies that provide product and product-related services to
the U.S. Air Force. We understand that the government's inquiry includes a
review of the conduct of such companies and their officers and employees. We
believe that we have not violated any federal laws in connection with our sale
of computer products ultimately received by the U.S. Air Force.
In October 2000, one of the integrators to which we sell our products, KKP
Corp., and its president pled guilty to federal charges of mail fraud and
conspiracy to defraud the United States in connection with the sale of computer
products and related services to the U.S. Air Force. We are referred to in the
court papers (known as the "Information") in such case. The Information states
that the defendants periodically issued invoices to us for fictitious services
to the U.S. Air Force that were never provided and passed such payments along to
co-conspirators. The Information also states that one of the co-conspirators
caused us "to pay a kickback of $500 for each unit sold to the Air Force, with
the proceeds going to the benefit of Co-conspirators." We are not identified as
a co-conspirator in the Information. We believe that we had a reasonable basis
to believe these services to the U.S. Air Force were performed; that all
payments made by us to KKP Corp. were properly authorized; and that we have not
violated any federal laws in connection with our sale of computer products to
KKP Corp. which were ultimately received by the U.S. Air Force.
In October 2000, two employees of a company which assisted the Air Force in
procuring computer-related products and other related parties were indicted on
multiple federal charges, including wire fraud, conspiracy to defraud the United
States and money laundering in connection with the sale of computer products and
related services from several vendors, including us, to the U.S. Air Force. The
defendants in the Indictment appear to be the co-conspirators referred to in the
Information. We are referred to in the Indictment in terms similar to the
Information. We believe that we had a reasonable basis to believe the services
to the U.S. Air Force billed by some of the defendants in the Indictment were
performed; that all payments made by us to any of the defendants in the
Indictment were properly authorized; and that we have not violated any federal
laws in connection with our sale of computer products which were ultimately
received by the U.S. Air Force.
In December 2000, the United States Attorney's Office in Boston
Massachusetts advised us through our attorneys that the United States government
has no present intentions of filing charges against us or any of our employees.
We continue to believe that we have not violated any federal laws in connection
with our sale of computer products which were ultimately received by the United
States Air Force. We continue to work closely with, sell to, and seek solutions
for, our customer, the United States Air Force.
13
WE HAVE EXPERIENCED SUBSTANTIAL VARIABILITY OF OUR QUARTERLY OPERATING RESULTS
WHICH WE EXPECT WILL CONTINUE.
Our quarterly operating results have fluctuated, and will continue to
fluctuate, significantly from period to period depending upon factors such as
the success of our efforts to expand our customer base, changes in and the
timing of expenditures relating to the continued development of products,
changes in pricing policies by us and by our competitors and certain other
factors. As a result, it is possible that in some future quarters our operating
results may be below the expectations of investors and securities analysts. If
this happens, the trading price of our common stock could decline. Due to the
relatively fixed nature of certain of our costs, a decline in net sales in any
fiscal quarter typically results in lower profitability in that quarter.
Quarterly fluctuations in sales to the U.S. Air Force are the result of several
factors over which we have no control, including funding appropriations and
departmental approvals. Although we do not anticipate that the U.S. Air Force
will continue to purchase from us at historical levels, either in absolute
dollars or as a percentage of net sales, we believe that sales to the U.S. Air
Force will continue to comprise a significant portion of our net sales. In
addition, our direct sales cycle (including sales to Federal end users) is less
predictable than our indirect sales through our alternate channel partners.
Because we generally ship products within thirty days of receiving an
order, we do not customarily have a significant backlog. Based on the timing of
such product shipments, we do not believe that projects in process at any one
time are a reliable indicator or measure of expected future revenue. None of our
customers have minimum purchase requirements.
WE MAY NOT BE ABLE TO KEEP PACE WITH ANTICIPATED RAPID TECHNOLOGICAL CHANGE.
The market for our fault tolerant enterprise storage solutions is
characterized by:
- rapid technological change;
- evolving industry standards;
- changing customer preferences; and
- new product and service introductions.
Both the needs of potential customers and the technologies available for
meeting those needs can change significantly within a short period of time. Our
future success will depend on our ability to develop solutions that keep pace
with changes in the markets in which we compete. Any failure on our part to
respond quickly, cost-effectively and sufficiently to these changes could render
our existing products, services or technologies non-competitive or obsolete.
Even if we develop new products, services or technologies, we may not be
successful in the marketplace.
Demand for our fault tolerant enterprise storage solutions depends
principally upon the demand for Open Systems-based networks, such as NT, UNIX
and Linux operating systems. Although we expect the industry to continue to
expand, our business may be adversely affected by a decline in the sales growth
of Open Systems-based networks targeted by us.
14
THERE MAY BE A LACK OF MARKET ACCEPTANCE FOR OUR NEW PRODUCTS.
We believe that our success depends, in part, on our ability to:
- enhance existing products;
- develop new products that maintain technological leadership;
- meet a wide range of changing customer needs; and
- achieve market acceptance.
Our business will be adversely affected if we fail to maintain, train and
hire as needed our direct sales force, introduce new products in a timely or
cost-effective manner, increase the functionality of our existing products to
meet customers' needs or remain price competitive. We cannot be certain that we
will be successful in our product development efforts or, even if successful,
whether our products will achieve market acceptance.
WE MAY NOT BE ABLE TO EXPAND OUR SALES AND DISTRIBUTION CHANNELS.
During 1998, we shifted our sales and marketing focus to the development of
our direct sales channel from our previous use of alternate channel partners.
During the prior three years, we had focused our sales and marketing efforts
through our primary alternate channel partners, Unisys and Tandem. As a result
of industry consolidation and competitive factors, sales to Unisys and Tandem
declined significantly in 1999 and 2000. Our direct sales force concentrates on
sales to commercial end users, the U.S. Air Force and other Federal government
end users. Our direct sales force also recruits selected VARs (value added
resellers) and assists them in their sales to commercial end users. Whether we
can successfully sell our products and enter new markets will depend on our
ability to:
- hire and maintain an adequate direct sales personnel;
- develop and enhance relationships with new and existing customers and
resellers; and
- develop software-based products attractive to large data users and
alternate channel partners.
We cannot be certain that new relationships with alternate channel partners
will be established. Furthermore, we cannot be certain that our alternate
channel partners will not develop or market products in the future that compete
with our products.
THE MARKETS WE SERVE ARE HIGHLY COMPETITIVE.
We are engaged in fields within the data processing industry that are
characterized by a high level of competition. Competitive factors include:
- relative price/performance;
- product features, quality and reliability;
15
- speed to market;
- adherence to industry standards;
- financial strength; and
- service, support and reputation.
Many of our competitors have financial, technical, manufacturing, sales,
marketing and other resources which are substantially greater than our own. We
cannot be certain that we will be able to continue to compete successfully with
existing or new competitors. Recent acquisitions of several of our competitors
by large companies, mergers of smaller market participants and other market
activities have increased the competition in our marketplace.
In addition, we compete with a broad range of businesses with varying
degrees of experience, resources and development, including established computer
manufacturers, systems integrators and manufacturers of enterprise storage
products and networking products. We compete with different companies depending
on the specific application or market. With respect to DAS products, EMC Corp.,
along with large server vendors such as Compaq and Sun Microsystems, are
significant competitiors. In the NAS market, our primary competitor is Network
Appliance Inc. As we introduce our fault tolerant SAN products, we expect to
compete with a number of existing and new competitors introducing products in
this emerging market.
Competitive pricing pressures exist in the data storage market and may in
the future have an adverse effect on our revenues and earnings. Certain
competitors have reduced prices in order to preserve or gain market share. If
our competitors continue to make price cuts, our financial results may be
adversely affected. We believe that pricing pressures are likely to continue.
WE DEPEND ON OUTSIDE MANUFACTURERS AND VENDORS TO SUPPLY OUR PRODUCTS.
We rely on outside manufacturers to produce some of our products. We also
rely on outside suppliers to supply subassemblies, component parts and computer
systems for resale. Our in-house manufacturing consists primarily of light
assembly, systems integration, testing, and quality assurance.
Unisys, formerly our primary outside manufacturer for our Synchronix
system, closed its Winnipeg computer storage systems manufacturing plant in July
1999 and terminated its manufacturing service agreement with us. We manufactured
such systems in-house from August to December 1999. In September 1999, we
entered into a Master Sale Agreement with Hitachi Computer Products (America),
Inc. Pursuant to such agreement, Hitachi began manufacturing certain of our
products in January 2000 for use in our fault tolerant enterprise storage
solutions. The agreement does not contain specific quantity commitments and
purchases are made on a purchase order basis. The agreement does not include any
long-term commitment by either party.
Certain components used in our products are available only from a limited
number of sources. Any delays in obtaining such components could adversely
affect our results of operations. We cannot be certain that material problems
will not arise in the future with our outside manufacturers or vendors that
could significantly impede or interrupt our business. We cannot be certain that
our relationships with our outside manufacturers and suppliers will
16
continue or that we would be able to obtain alternative sources of supply
without a material disruption in our ability to provide products to our
customers if our relationships with our existing outside manufacturers or
suppliers are terminated.
We rely on certain distributors to supply us with component products from
Sun Microsystems and Seagate Technologies. Although we believe alternative
distributors of these products are available, we cannot be certain that we can
obtain them on a timely and cost-effective basis.
WE HAVE BEEN OPERATING AS A PROPRIETARY SELLER FOR A LIMITED PERIOD OF TIME AND
HAVE A HISTORY OF LOSSES.
From our inception until 1994, our principal business was the sale of NCR
products to AT&T business units as a value added reseller. During 1994, as a
result of AT&T's acquisition of NCR, AT&T discontinued purchasing our products.
We then undertook a product development initiative to reposition ourselves as a
provider of fault tolerant enterprise storage solutions. During 1996, we
completed our repositioning and began selling our fault tolerant enterprise
storage solutions. Accordingly, we have a limited operating history within our
current line of business.
We incurred net losses of $769, $2,657 and $12,855 in fiscal 1996, 1998 and
2000, respectively. Although we had net income of $1,102 in 1997 and $1,952 in
1999, we cannot be certain that we will be able to maintain profitable levels of
operations in the future.
OUR SUCCESS IS DEPENDENT UPON OUR KEY MANAGEMENT, MARKETING, SALES AND TECHNICAL
PERSONNEL.
Our future depends, in large part, upon the continued service of the key
members of our management team, as well as marketing, sales and technical
personnel. During fiscal 2000, our executive officers agreed to salary
reductions. In January 2001, we reduced our workforce by up to 40% across most
departments, however, we believe that we have retained the personnel that is key
to achieving our goals and implementing our strategies. None of our executive
officers have entered into an employment agreement. Equally important is our
ability to attract and retain new management and other personnel. Competition
for such personnel is intense, and there can be no assurance that we will be
able to retain our key employees or that we will be successful in attracting and
retaining new personnel in the future. The loss of any one or more of our key
personnel or the failure to attract and retain key personnel could have a
material adverse effect on our business.
OUR FAILURE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS COULD ADVERSELY AFFECT
OUR BUSINESS.
We may acquire complementary product lines, technologies and businesses as
part or our growth strategy. Although we may make such acquisitions, we may not
be able to successfully integrate them with our business in a timely manner. Our
failure to successfully address the risks associated with such acquisitions, if
consummated, could have a material adverse effect on our business and our
ability to develop and market products. The success of any acquisition will
depend on our ability to:
- successfully integrate and manage the acquired operations;
- retain the key employees of the acquisition targets;
17
- develop, integrate and market products and product enhancements based
on the acquired products and technologies; and
- control costs and expenses, as well as demands on our management,
associated with the potential acquisitions.
If we are not able to successfully integrate acquired products lines,
technologies or businesses with our business, we may incur substantial costs and
delays or other operational, technical or financial problems. In addition, our
failure to successfully integrate acquisitions may divert management's attention
from our existing business and may damage our relationships with key clients and
employees. To finance future acquisitions, we may issue equity securities that
could be dilutive to our shareholders. We may also incur debt and additional
amortization expenses related to goodwill and other intangible assets as a
result of future acquisitions. The interest expense related to this debt and
additional amortization expense may significantly reduce our profitability and
could have a material adverse effect on our business, financial condition and
operating results.
WE HAVE ONLY LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS.
Our future success depends in part upon our intellectual property,
including patents, trade secrets, know-how and continuing technological
innovation. We cannot be certain that the steps taken by us to protect our
intellectual property will be adequate to prevent misappropriation or that
others will not develop competitive technologies or products. We have filed
numerous patent applications covering various aspects of our Synchronix product
family and intend to file additional applications for products under
development. However, we cannot be certain that patents will issue from any
application filed by us or that, if patents do issue, the claims allowed will be
sufficiently broad to prohibit others from marketing similar products. In
addition, we cannot be certain that any patents issued to us will not be
challenged, invalidated or circumvented, or that issued patents will provide us
with a competitive advantage. Although we believe that our products and
technology do not infringe upon proprietary rights of others, we cannot be
certain that third parties will not assert infringement claims in the future or
that such claims will not be successful. Although we continue to implement
protective measures and intend to defend our proprietary rights, policing
unauthorized use of our technology or products is difficult and we cannot be
certain that these measures will be successful.
WE MAY NOT BE ABLE TO COMPLY WITH INDUSTRY STANDARDS.
We design our products to comply with standards adopted by our industry,
the Storage Network Industry Association (SNIA) and the Fibre Channel Alliance
(FCA). We work closely with SNIA and FCA to ensure that our products are
compatible with industry standards. We cannot be certain that standards from
other standards-setting bodies will not become industry-accepted standards. A
shift in industry standards could have a material adverse effect on our
operations.
In February 1999, we received ISO 9001 certification. This certification
reflects uniform, industry-wide standards of quality control for manufacturing
data-storage products. There can be no assurance that we will continue to meet
the industry-accepted standards necessary to maintain ISO 9001 certification. A
loss of ISO certification may adversely impact net sales to customers that
require or prefer ISO certification.
18
NASDAQ NATIONAL MARKET DELISTING.
On January 4, 2001, we received notification from Nasdaq that our common
stock had failed to maintain a minimum bid price of $1.00 per share for the
thirty days prior to the date of notification. We have 90 days from the notice
date to regain compliance by having the bid price for our common stock close at
$1.00 or greater for a minimum period of 10 consecutive trading days. As of
March 23, 2001, we have not regained compliance. In the event that we do not
regain compliance, we will be subject to delisting from the Nasdaq National
Market and would trade on the OTC Bulletin Board. A delisting from the Nasdaq
National Market may have a material adverse effect on our stock price and our
ability to raise capital through the issuance of additional equity.
POTENTIAL VOLATILITY OF OUR STOCK PRICE.
The market price of the shares of our common stock has been, and in the
future may be, highly volatile. Some factors that may affect the market price
include:
- actual or anticipated quarterly fluctuations in our operating results;
- changes in recommendations or earnings estimates by securities
analysts;
- announcements of technological innovations or new commercial products
or services by us or our competitors; and
- general market or economic conditions.
This risk may be heightened because our industry is characterized by rapid
technological change and susceptible to the introduction of new competing
technologies or competitors. In addition, equity securities of many technology
companies have experienced significant price and volume fluctuations. These
price and volume fluctuations often have been unrelated to the operating
performance of the affected companies. Volatility in the market price of our
common stock could result in securities class action litigation. This type of
litigation, regardless of the outcome, could result in substantial cost and a
diversion of management's attention and resources.
WE HAVE CERTAIN ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION.
Our certificate of incorporation and New Jersey law contain provisions that
could make it more difficult for a third party to acquire control of our
company, even if such change of control would be beneficial to our shareholders.
For example, our certificate of incorporation authorizes 3,000,000 shares of
preferred stock, of which 1,788,750 shares are designated Series A Preferred and
1,211,250 shares remain undesignated. Subject to certain rights held by our
Series A Preferred stockholders, our board of directors may issue the
undesignated preferred shares on such terms and with such rights, preferences
and designations as our board may determine without further action by our
shareholders. In addition, certain "anti-takeover" provisions of the New Jersey
Business Corporation Act restrict the ability of certain shareholders to affect
a merger or business combination or obtain control of us. These provisions could
discourage bids for shares of our common stock at a premium as well as create a
depressive effect on the market price of the shares of our common stock.
19
WE DO NOT EXPECT TO PAY CASH DIVIDENDS ON OUR COMMON STOCK.
We have never paid, and do not anticipate paying, any cash dividends on our
common stock for the foreseeable future. Our factoring facility with Bank of
America restricts our ability to pay certain dividends without its prior written
consent. Unless we pay dividends, our shareholders will not be able to receive a
return on their shares unless they sell them.
Item 2. Properties.
Our executive and business development office is in Tinton Falls, New
Jersey. We believe that our current facilities are adequate to support our
existing operations. We also believe that we will be able to obtain suitable
additional facilities on commercially reasonable terms on an "as needed" basis.
We occupy the following properties, which are all leased:
Approximate
Area
Location (in sq. Use Nature of Occupancy
feet)
- --------------------------------------------------------------------------------
Tinton Falls, New 22,000 Executive Office, Lease expires 12/31/05
Jersey R&D, Manufacturing with a four year renewal
Business Development option
Tinton Falls, New 10,000 R&D Manufacturing Lease expires on 12/31/05
Jersey Business Development
Falls Church, 700 Sales Office Lease expires on 3/31/02
Virginia
Item 3. Legal Proceedings.
In November 1999, Mark Ish and David Boyle, former executive officers of
our company, filed a complaint against us and Gregg M. Azcuy, our President and
Chief Executive Officer, in the Superior Court of New Jersey, Law Division,
Monmouth County. By the action, Messrs. Ish and Boyle are seeking compensatory
damages, punitive damages, attorneys' fees, interest and costs for alleged
breach of multiple contracts, fraud and defamation. We believe such claims are
without merit and we intend to vigorously defend such actions. We do not believe
that the outcome of such litigation will adversely affect our business.
In late January 2000, we received a subpoena from the United States
Attorney's Office in Boston, Massachusetts for the production of documents in
connection with an investigation into Federal government purchasing. We have
been and intend to continue cooperating with the investigation and are complying
fully, and intend to continue to comply fully, with the subpoena. We sell
computer products to companies which are used by the Federal government to
supply computer products to the U.S. Air Force. In addition, subpoenas have been
received by several of our employees, including certain officers, who are
expected to testify before the grand jury. Not all of such testimony has been
provided. It appears that one avenue of inquiry involves the relationships and
transactions of various suppliers, manufacturers (including us), and other
companies, with companies that provide product and product-related services to
the U.S. Air Force. We understand that the government's inquiry includes a
review of the conduct of such
20
companies and their officers and employees. We believe that we have not violated
any federal laws in connection with the sale of computer products ultimately
received by the U.S. Air Force.
In October 2000, one of the integrators to which we sell our products, KKP
Corp., and its president pled guilty to federal charges of mail fraud and
conspiracy to defraud the United States in connection with the sale of computer
products and related services to the U.S. Air Force. We are referred to in the
court papers (known as the "Information") in such case. The Information states
that the defendants periodically issued invoices to us for fictitious services
to the U.S. Air Force that were never provided and passed such payments along to
co-conspirators. The Information also states that one of the co-conspirators
caused us "to pay a kickback of $500 for each unit sold to the Air Force, with
the proceeds going to the benefit of Co-conspirators." We are not identified as
a co-conspirator in the Information. We believe that we had a reasonable basis
to believe these services to the U.S. Air Force were performed; that all
payments made by us to KKP Corp. were properly authorized; and that we have not
violated any federal laws in connection with our sale of computer products to
KKP Corp. which were ultimately received by the U.S. Air Force.
In October 2000, two employees of a company which assisted the Air Force in
procuring computer-related products and other related parties were indicted on
multiple federal charges, including wire fraud, conspiracy to defraud the United
States and money laundering in connection with the sale of computer products and
related services from several vendors, including us, to the U.S. Air Force. The
defendants in the Indictment appear to be the co-conspirators referred to in the
Information. We are referred to in the Indictment in terms similar to the
Information. We believe that we had a reasonable basis to believe the services
to the U.S. Air Force billed by some of the defendants in the Indictment were
performed; that all payments made by us to any of the defendants in the
Indictment were properly authorized; and that we have not violated any federal
laws in connection with our sale of computer products which were ultimately
received by the U.S. Air Force.
In December 2000, the United States Attorney's Office in Boston
Massachusetts advised us through our attorneys that the United States government
has no present intentions of filing charges against us or any of our employees.
We continue to believe that we have not violated any federal laws in connection
with our sale of computer products which were ultimately received by the United
States Air Force.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
21
PART II
Item 5. Market For the Company's Common Equity and Related Shareholder Matters.
Our common stock is quoted on the Nasdaq National Market under the symbol
"ECCS." Prior to February 22, 2000, our common stock was quoted on the Nasdaq
Small Market under the symbol "ECCS." The following table sets forth the high
and low sales price for the common stock for each of the quarters since December
31, 1999. Such quotations reflect inter-dealer prices, without retail mark-up,
markdown or commission and may not represent actual transactions.
High Low
---------- ---------
Fiscal Year Ended December 31, 1999
First Quarter............................. $2.094 $1.125
Second Quarter............................ 4.000 1.531
Third Quarter............................. 5.250 2.125
Fourth Quarter............................ 13.250 3.063
Fiscal Year Ended December 31, 2000
First Quarter............................. 25.000 10.375
Second Quarter............................ 14.250 2.438
Third Quarter............................. 6.000 2.250
Fourth Quarter............................ 2.938 0.250
On March 23, 2001, the last reported sale price of our common stock as
reported by the Nasdaq National Market was $.50 per share. As of March 23, 2001,
the approximate number of holders of record of our common stock was 146.
On January 4, 2001, we received notification from Nasdaq that our common
stock had failed to maintain a minimum bid price of $1.00 per share for the
thirty days prior to the date of notification. We have 90 days from the notice
date to regain compliance by having the bid price for our common stock close at
$1.00 or greater for a minimum period of 10 consecutive trading days. As of
March 23, 2001, we have not regained compliance. In the event that we do not
regain compliance, we will be subject to delisting from the Nasdaq National
Market and would trade on the OTC Bulletin Board.
We have never paid, and do not anticipate paying, any cash dividends on our
common stock for the foreseeable future. Our factoring facility with Bank of
America restricts our ability to pay certain dividends without its prior written
consent.
On November 10, 2000, we sought shareholder approval for the issuance of up
to 6,857,143 shares of 6% cumulative convertible preferred stock Series A to
raise up to an aggregate of $12,000 of gross proceeds. The shareholder meeting
was originally scheduled for November 30, 2000, and was adjourned twice by the
Company to December 22, 2000 in order to give shareholders the maximum
opportunity to vote. The Company was unable, however, to
22
obtain the requisite quorum to conduct a meeting within the statutory maximum
sixty-day period. As the record date for the shareholder meeting was October 26,
2000, the last day we could hold the meeting was December 25, 2000. The Company
did obtain the sufficient votes on the 61st day, or December 26, 2000. Of those
shareholders responding, an overwhelming 95.1% approved the proposed
transaction. Since the quorum was achieved past the date of the statutory
maximum, we believe it was necessary to apply to Nasdaq for an exception to
shareholder approval.
On January 25, 2001, we applied for an exception to Nasdaq Marketplace Rule
4350(i)(1) requiring the Company to receive shareholder approval of an equity
financing when such financing would result in a change of control of the issuer.
On February 23, 2001, Nasdaq determined that an exception from the
shareholder approval requirement was warranted subject to the Company mailing to
all shareholders, no later than ten days before the completion of the financing,
a letter describing the proposed transaction and alerting shareholders to the
Company's omission to seek the shareholder approval that would otherwise be
required. The letter was required to indicate that the Audit Committee of the
Board had expressly approved the exception. In addition, the Company was
required to issue a press release describing the transaction.
On March 9, 2001, we issued 1,450,000 shares of our 6% Cumulative
Convertible Preferred Stock, Series A (the "Series A Preferred Stock") to
accredited investors for an aggregate gross proceeds equal to $2,900, pursuant
to a private equity placement (the "Private Placement"). The Series A Preferred
Stock has a 6% cumulative coupon and is initially convertible into our Common
Stock on an 8-for-1 basis. The Series A Preferred Stock also has liquidation and
dividend preferences superior to those of existing stockholders. The purchasers
of Series A Preferred Stock also acquired certain anti-dilution and registration
rights. No underwriter was employed by us in connection with the issuance of the
securities in the Private Placement, however C.E. Unterberg, Towbin ("Unterberg
Towbin") acted as our placement agent. As compensation for its services,
Unterberg Towbin received a fee equal to 78,125 shares of Series A Preferred
Stock, in addition to payment of certain expenses if fully sold. Thomas I.
Unterberg, a former director of the Company, along with certain affiliates of
Mr. Unterberg, purchased 567,500 shares of Series A Preferred Stock on the same
terms and conditions as all other purchasers. Mr. Unterberg also is Chairman,
Managing Director and member of the Executive Committee of Unterberg Towbin. We
believe that the issuance of shares of Series A Preferred Stock in connection
with the Private Placement was exempt from registration under Section 4(2) of
the Securities Act of 1933, as amended (the "Act"), and Rule 506 of Regulation D
promulgated under the Act, as a transaction not involving a public offering.
Appropriate legends have been affixed to the stock certificates issued to the
purchasers of the Private Placement. All purchasers had adequate access to
information about the Company and each purchaser acquired the securities for
investment only and not with a view to distribution.
23
Item 6. Selected Consolidated Financial Data.
The following selected consolidated financial data as of and for the five years
ended December 31, 2000 are derived from our audited consolidated financial
statements. Historical results are not necessarily indicative of results to be
expected for any future period. The selected consolidated financial data set
forth below should be read in conjunction with the Consolidated Financial
Statements and Notes thereto and with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
Annual Report on Form 10-K.
Year Ended December 31,
-----------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
(in thousands, except per share amounts)
Statement of Operations Data:
Net sales........................... $22,604 $ 34,001 $ 28,466 $ 39,761 $ 15,022
Cost of sales..................... 15,165 24,226 20,452 26,777 15,268
-------- ------ ------- --------- ----------
Gross profit (deficit).............. 7,439 9,775 8,014 12,984 (246)
Selling, general and
administrative expenses........ 6,907 6,838 8,378 9,693 10,925
Research and development
expenses....................... 1,027 1,687 2,683 1,939 2,112
-------- ------- ------- ---------- -----------
Operating (loss) income............. (495) 1,250 (3,047) 1,352 (13,283)
Net interest expense (income) .... 274 28 (390) (162) (193)
-------- --------- -------- ----------- -----------
(Loss) income before income tax benefit
and extraordinary item............ (769) 1,222 (2,657) 1,514 (13,090)
Income tax benefit.................. -- -- -- (438) (235)
-------- -------- --------- ----------- -----------
(769) 1,222 (2,657) 1,952 (12,855)
(Loss) income before extraordinary item
Extraordinary item............. -- 120 -- -- --
-------- --------- ---------- --------- ---------
Net (loss) income................... (769) 1,102 (2,657) 1,952 (12,855)
Preferred dividends............... 248 192 -- -- --
-------- -------- --------- ---------- ---------
Net (loss) income applicable
to common shares.................. $ (1,017) $ 910 $(2,657) $ 1,952 $(12,855)
======== ======= ======== ======= =========
Net (loss) income per share before
extraordinary item - basic....... $ (0.23) $ 0.16 $ (0.24) $ 0.18 $ (1.12)
Net (loss) income per share - basic $ (0.23) $ 0.14 $ (0.24) $ 0.18 $ (1.12)
Net (loss) income per share before
extraordinary item - diluted..... $ (0.23) $ 0.12 $ (0.24) $ 0.16 $ (1.12)
Net (loss) income per share - diluted $ (0.23) $ 0.11 $ (0.24) $ 0.16 $ (1.12)
Weighted average common shares
outstanding - basic................ 4,346 6,702 10,969 11,093 11,490
Weighted average common shares
outstanding - diluted.............. 4,346 10,035 10,969 11,978 11,490
As of December 31,
------------------
1996 1997 1998 1999 2000
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Cash................................ $ 4,393 $11,625 $ 5,374 $ 7,993 $ 2,221
Working capital..................... 4,280 15,260 11,969 14,200 3,467
Total assets........................ 14,552 24,992 21,374 23,231 9,632
Loans payable and payable to Finova
Capital........................... 1,762 1,031 1,231 968 276
Series B redeemable
convertible preferred stock....... -- -- -- -- --
Shareholders' equity................ $ 6,177 $17,643 $15,232 $ 17,701 $ 5,145
24
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
OVERVIEW
We design, manufacture, sell and support fault tolerant enterprise storage
solutions that protect and ensure access to an organization's critical data. Our
products include high performance, fault tolerant storage subsystems that meet a
wide range of customer applications for Open Systems-based networks, such as NT,
UNIX and Linux operating systems. Our fault tolerant enterprise storage
solutions address all three storage markets: Direct Attached Storage ("DAS"), in
which the storage device is connected directly to a server; Network Attached
Storage ("NAS"), in which the storage device is installed on a network; and
Storage Area Network ("SAN"), in which the storage device is used in a
specialized network. These connectivity options provide our customers the
flexibility to choose and deploy a particular storage solution to meet their
needs. As data requirements change, customers can migrate their existing storage
investments to different connectivity options. We believe our products reduce
the total cost of ownership of data storage by allowing end users to use the
products across various operating systems.
During 1998, we shifted our sales and marketing focus to the development of
our direct sales channel from our previous use of alternate channel partners.
Our direct sales force concentrates on sales to commercial end users, and the
U.S. Air Force and other Federal government end users. Our direct sales force
also recruits selected Value Added Resellers ("VARs") and assists them in their
sales to commercial end users. During the three years prior to 1998, we had
focused our sales and marketing efforts through our primary alternate channel
partners, Unisys Corporation and Tandem Computers, Inc. As a result of industry
consolidation and competitive factors, sales to Unisys and Tandem declined
significantly in 1999 and 2000. We do not expect sales to these alternate
channel partners to constitute a significant part of our net sales in fiscal
2001.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues but represented a
substantial portion of engineering costs in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
Sales to the U.S. Air Force accounted for approximately 30.5% of net sales
in 2000. Although we do not anticipate that the U.S. Air Force will continue to
purchase from us at historical levels, either in absolute dollars or as a
percentage of net sales, we believe that sales to the U.S. Air Force will
continue to comprise a significant portion of our net sales. Quarterly
fluctuations in sales to the U.S. Air Force are the result of several factors
over which we have no control, including funding appropriations and departmental
approvals. We cannot be certain that our sales to the U.S. Air Force through
Federal integrators will not be adversely affected by the investigation
discussed in Item 3. Legal Proceedings.
25
The following table sets forth, for the periods indicated, the net sales
derived from each of our sales channels:
Year Ended December 31,
-----------------------
1998 1999 2000
---- ---- ----
Direct:
Commercial and other Federal
customers............................. $ 7,960 $12,638 $ 9,905
U.S. Air Force...................... 9,579 23,216 4,576
Indirect:
Alternate channel partners.......... 10,927 3,907 541
------ ----- ---
$28,466 $39,761 $15,022
======= ======= =======
Direct sales include sales through select resellers. All sales to the U.S.
Air Force are through Federal integrators. Federal integrators are government
contractors who sell directly to U.S. government entities. Indirect sales
include sales through OEMs and national resellers.
REVENUE
Product sales revenue is generally recognized upon product shipment and
completion of the order. Periodically, revenue is recognized for product which
is being held at the customer's request. Revenue is only recognized on such
product when all risks of ownership have passed to the customer and the Company
has no specific performance obligations remaining. Service revenue is generally
recognized as services are provided. Revenue related to maintenance contracts is
recognized over the respective terms of the maintenance contracts.
COST OF REVENUE
Our cost of revenue relating to product sales consists primarily of:
- the costs of purchased material;
- direct labor and related overhead expenses; and
- amortization and write-off of capitalized software.
Capitalized software amounts are amortized commencing with product
introduction on a straight-line basis utilizing the estimated economic life
ranging from one to three years.
Capitalized software amounts that have no future economic benefit are
written down to net realizable value in the period that such value is derived.
The profitability of any particular quarter is significantly affected by
the relative sales levels of each of our primary sales channels and types of
customers in such quarter.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist primarily of:
26
- salaries, commissions and travel costs for sales and marketing
personnel, including trade shows; and
- expenses associated with our management, legal, accounting, contract
and administrative functions.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of salaries and related
overhead expenses paid to software and hardware engineers. Research and
development costs are expensed as incurred, except for software development
costs which are capitalized after technological feasibility has been
demonstrated.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial
data expressed as a percentage of total revenue:
Year Ended December 31,
-----------------------------
1998 1999 2000
---- ---- ----
Direct net sales:
Commercial and other Federal
customers............................. 28.0% 31.8% 65.9%
U.S. Air Force........................ 33.7 58.4 30.5
Indirect net sales:
Alternate channel partners............ 38.3 9.8 3.6
----- ----- -----
Total net sales.......................... 100.0 100.0 100.0
Cost of sales.......................... 71.9 67.3 101.6
----- ----- -----
Gross profit............................. 28.1 32.7 (1.6)
Selling, general & administrative
expenses............................... 29.4 24.4 72.7
Research & development expenses........ 9.4 4.9 14.1
----- ----- -----
Operating (loss) income.................. (10.7) 3.4 (88.4)
Net interest income.................... (1.4) (0.4) (1.3)
----- ----- -----
(Loss) Income before extraordinary item
and tax benefit.......................... (9.3) 3.8 (87.1)
Extraordinary item..................... -- -- --
Benefit for income taxes............... -- (1.1) (1.6)
----- ----- -----
Net (loss) income........................ (9.3)% 4.9% (85.5)%
==== === =====
Our operating results are affected by several factors, particularly the
spending fluctuations of our largest customers, including the U.S. Air Force.
Due to the relatively fixed nature of certain of our costs, a decline in net
sales in any fiscal quarter will have a material adverse effect on that
quarter's results of operations. We do not expect such spending fluctuations to
be altered in the foreseeable future.
27
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
---------------------------------------------------------------------
NET SALES
Net sales decreased by approximately $24,739, or 62.2%, to $15,022 in 2000
from $39,761 in 1999. Sales of our fault tolerant enterprise storage solutions
accounted for 83.5% and 95.0% of net sales in 2000 and 1999, respectively. Other
revenues accounted for 16.5% and 5.0% of net sales in 2000 and 1999,
respectively. The decrease in 2000 net sales resulted primarily from lower sales
of our enterprise storage solutions to the U.S. Air Force through Federal
integrators, alternate channel partners and our commercial customers.
Sales to the U.S. Air Force through Federal integrators decreased by
approximately $18,640, or 80.3%, to $4,576 in 2000 from $23,216 in 1999. Such
sales accounted for approximately 30.5% and 58.4% of net sales in 2000 and 1999,
respectively.
Sales to alternate channel partners decreased by approximately $3,366, or
86.2%, to $541 in 2000 from $3,907 in 1999. Such sales accounted for
approximately 3.6% and 9.8% of net sales in 2000 and 1999, respectively. Such
decrease represents a decrease in sales to Unisys of approximately $2,721
combined with a $645 decrease in sales to Tandem. Sales to Unisys accounted for
approximately 3.6% and 8.0% of our net sales in 2000 and 1999, respectively.
Sales to Tandem accounted for less than 1% and 2.0% of our net sales in 2000 and
1999, respectively.
Sales to our commercial customers decreased by approximately $2,733, or
21.6%, to $9,905 in 2000 from $12,638 in 1999.
GROSS PROFIT
Our gross profit decreased by approximately $13,230, or 101.9%, to a gross
deficit of approximately $246 in 2000 from a gross profit of $12,984 in 1999.
Such decrease in gross profit is due primarily to the lower level of sales to
the U.S. Air Force through Federal integrators, alternate channel partners and
commercial customers. Our gross profit in 2000 was adversely affected by $2,523
and $1,738 of charges relating to an increase in inventory obsolescence and the
write-off of capitalized software, respectively. The charges taken in 2000 for
inventory obsolescence relate to the discontinuance of the SANStar development
effort and the repositioning of our product offering.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth Quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues to date but represented a
substantial portion of engineering costs which were capitalized in 2000. The
total amount of SANStar capitalization of $1,988 was written down to $250 in
December 2000. In February 2001, we sold the assets related to the SANStar
technology, including certain patent applications, to Ciprico, Inc. for
aggregate proceeds of approximately $580, including $250 of SANStar
capitalization.
28
OPERATING EXPENSES
Selling, general and administrative (SG&A) expenses increased by $1,232, or
12.7%, to $10,925 in 2000 from $9,693 in 1999. Such increase was primarily due
to the hiring of additional sales and marketing personnel, coupled with enhanced
efforts to market the Company's current and new product offerings. In addition,
we incurred approximately $237 associated with proposed financing activities and
approximately $807 in legal and accounting fees associated with the Federal
investigation.
SG&A expenses as a percentage of net sales represented 72.7% and 24.4% for
2000 and 1999, respectively. Such percentage increase is attributable to the
reduction in revenues combined with the overall higher spending in 2000.
Salaries, commissions, bonuses, employee benefits and payroll taxes were the
largest components of operating expenses, accounting for 59% and 70.0% of such
expenses in 2000 and 1999, respectively.
Research and development expenses increased in 2000 by $173, or 8.9%, to
$2,112 in 2000 from $1,939 in 1999. Such expenditures, before offsetting amounts
capitalized in accordance with SFAS No. 86, represented $2,662 and $3,150 for
the twelve months ending December 31, 1999 and 2000, respectively. This increase
was due primarily to an increased effort to develop the SANStar product. Such
expenses represented approximately 14.1% and 4.9% of our net sales for 2000 and
1999, respectively, and, including the amount capitalized in accordance with
SFAS No. 86, represented approximately 21.0% and 6.7% of our net sales for 2000
and 1999, respectively.
NET INTEREST INCOME
Net interest income was $193 and $162 for 2000 and 1999, respectively. The
increase in interest income was primarily due to decreased borrowings and floor
planning in 2000 compared to 1999.
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
---------------------------------------------------------------------
NET SALES
Net sales increased by approximately $11,295, or 39.7%, to $39,761 in 1999
from $28,466 in 1998. Sales of our fault tolerant enterprise storage solutions
accounted for 95.0% and 96.0% of net sales in 1999 and 1998, respectively. Other
revenues accounted for 5.0% and 4.0% of net sales in 1999 and 1998,
respectively. The increase in 1999 net sales resulted primarily from an increase
in sales of our enterprise storage solutions to the U.S. Air Force through
Federal integrators and to commercial end users, offset in part by decreases in
sales to our alternate channel partners.
Sales to our commercial customers increased by approximately $4,678, or
58.7%, to $12,638 in 1999 from $7,960 in 1998. Such increase reflects the shift
in our sales and marketing focus to direct sales and the resulting success of
sales into the e-commerce market. Such sales accounted for approximately 31.8%
and 28.0% of net sales in 1999 and 1998, respectively.
Sales to the U.S. Air Force through Federal integrators increased by
approximately $13,637, or 142.4%, to $23,216 in 1999 from $9,579 in 1998. Such
sales accounted for approximately 58.4% and 33.7% of net sales in 1999 and 1998,
respectively.
29
Sales to alternate channel partners decreased by approximately $7,020, or
64.2%, to $3,907 in 1999 from $10,927 in 1998. Such sales accounted for
approximately 9.8% and 38.3% of net sales in 1999 and 1998, respectively. Such
decrease represents a decrease in sales to Unisys of approximately $4,762
combined with a $2,258 decrease in sales to Tandem. Sales to Unisys accounted
for approximately 8.0% and 28.0% of our net sales in 1999 and 1998,
respectively. Sales to Tandem accounted for approximately 2.0% and 10.0% of our
net sales in 1999 and 1998, respectively.
GROSS PROFIT
Our gross profit increased by approximately $4,970, or 62.0%, to
approximately $12,984 in 1999 from $8,014 in 1998. Such increase in gross profit
is due primarily to the higher level of sales in 1999, coupled with favorable
gross margin percentages. Our gross profit percentage increased to 32.7% in
1999, as compared to 28.2% in the prior year. The 4.5% increase is attributable
to the higher proprietary content of product sales, favorable costs attributable
to quantity discounts received for third party component products and the lack
of one-time charges incurred in 1998 related to the discontinuation of our
efforts to develop a fibre controller and a controller design that incorporated
Tandem's ServerNet Technology.
OPERATING EXPENSES
Selling, general and administrative (SG&A) expenses increased by $1,315, or
15.7%, to $9,693 in 1999 from $8,378 in 1998. Such increase was due primarily to
higher commissions associated with higher sales levels. To a lesser extent, such
increase was due to the hiring of additional sales and marketing personnel,
coupled with enhanced efforts to market our current and new product offerings.
SG&A expenses as a percentage of net sales represented 24.4% and 29.4% for 1999
and 1998, respectively. Such percentage decrease is attributable to a higher
level of revenue in 1999. Salaries, commissions, bonuses, employee benefits and
payroll taxes were the largest components of operating expenses, accounting for
70.0% and 66.0% of such expenses in 1999 and 1998, respectively.
Research and development expenses decreased in 1999 by $744, or 27.7%, to
$1,939 in 1999 from $2,683 in 1998. This decrease was due primarily to our
decision to discontinue our efforts to develop a fibre controller. Such expenses
represented approximately 4.9% and 9.4% of our net sales for 1999 and 1998,
respectively, and, including the amount capitalized in accordance with SFAS No.
86, represented approximately 6.7% and 16.0% of our net sales for 1999 and 1998,
respectively.
NET INTEREST (INCOME) EXPENSE
Net interest income was $162 and $390 for 1999 and 1998, respectively. The
reduction in interest income was primarily due to lower cash balances in 1999
compared to 1998.
LIQUIDITY AND CAPITAL RESOURCES
Our cash balance was approximately $2,200 at December 31, 2000.
Net cash provided by operating activities in 1999 was $4,269. Net cash used
in operating activities was $3,450 in 2000. Net cash used in operating
activities in 2000 resulted primarily from the net loss from operations after
adding back depreciation, amortization and the write-off
30
of capitalized software, coupled with an increase in prepaid expenses, a
decrease in accounts payable, accrued liabilities, deferred rent and other
expenses, and offset in part by a decrease in accounts receivable and
inventories. Net cash used in investing activities was $1,749 in 2000. Net cash
used in financing activities was $573 in 2000.
We used $812 and $475 for the acquisition of equipment by direct purchase
during 1999 and 2000, respectively. Such expenditures in 1999 and 2000 primarily
consisted of computer equipment associated with our research and development
efforts. There are no other material commitments for capital expenditures
currently outstanding.
We had working capital of $14,200 and $3,467 at December 31, 1999 and 2000,
respectively.
On July 9, 1997, we entered into a full recourse factoring facility with
Bank of America ("BOA"), formerly known as NationsBanc Commercial Corporation,
which provides for aggregate advances not to exceed the lesser of $7,000 or up
to 85% of Eligible Receivables (as defined). Interest on such advances is
payable monthly in arrears at the prime lending rate and we are obligated to pay
certain annual fees. The factoring facility is for a period of three years
(unless terminated by BOA by providing us sixty days prior written notice)
beginning on July 30, 1997. Our obligations under such agreement are
collateralized by substantially all of our assets. As of December 31, 2000, our
balance outstanding under this full recourse factoring facility was $115. On
June 16, 2000, we signed an amendment to the factoring facility extending the
agreement until July 30, 2003, and from year to year thereafter until
terminated. Except as referenced above, the factoring facility remains
unchanged.
Our ability to borrow under a $4,000 general line of credit with the Finova
Group, Inc. ("Finova") has been terminated. The agreement with Finova contained
covenants relating to net worth, total assets to debt and total inventory to
debt. Our obligations under the agreement with Finova were collateralized by
substantially all of the assets of the Company. During 1999, Finova temporarily
increased the general line of credit to $3,000 through January 31, 2000, on the
same terms and conditions. On January 31, 2000, the amount of the line was
returned to $2,000 and the line was extended through January 31, 2001. On April
17, 2000, the line of credit extended to us by Finova was permanently increased
by $2,000, raising the total amount of funds available to us under the Finova
general line of credit to $4,000. In December 2000, Finova terminated our credit
facility with them. During 1999 and 2000 we used our general line of credit with
Finova to augment our purchasing ability with various vendors. As of December
31, 1999 and 2000, we had $968 and $115 outstanding under this credit line,
respectively.
During 1999, we utilized $1,144 of net operating loss carryover ("NOL") for
federal tax purposes. As of December 31, 2000, we have NOL carryovers for
Federal income tax purposes of approximately $18,932, which will begin to expire
in 2009. We also have research and development tax credit carryovers for Federal
income tax purposes of approximately $632, which will begin to expire in 2009.
In addition, we have alternative minimum tax credits of approximately $76, which
can be carried forward indefinitely. We experienced a change in ownership in
1996 and in 2001 as defined by Section 382 of the Internal Revenue Code.
Accordingly, future use of these NOLs and income tax credits will be limited.
31
As of December 31, 2000, we have approximately $9,400 of state NOL
carryforwards which will begin to expire in 2006 and state research and
development tax credit carryforwards of $342.
In December 2000, we sold $5,189 of State NOL carryforwards and $40 of
State Research and Development tax credits which resulted in a tax benefit of
$235.
Under SFAS No. 109, a valuation allowance is established, if based on the
weight of available evidence, it is more likely than not that a portion of the
deferred tax asset will not be realized. Accordingly, a full valuation allowance
has been provided to offset our net deferred tax assets. We will periodically
reassess the valuation allowance.
On November 10, 2000, we sought shareholder approval for the issuance of up
to 6,857,143 shares of 6% cumulative convertible preferred stock Series A to
raise up to an aggregate of $12,000 of gross proceeds. The shareholder meeting
was originally scheduled for November 30, 2000, and was adjourned twice by the
Company to December 22, 2000 in order to give shareholders the maximum
opportunity to vote. The Company was unable, however, to obtain the requisite
quorum to conduct a meeting within the statutory maximum sixty (60) day period.
As the record date for the shareholder meeting was October 26, 2000, the last
day we could hold the meeting was December 25, 2000. The Company did obtain the
sufficient votes on the 61st day, or December 26, 2000. Of those shareholders
responding, an overwhelming 95.1% approved the proposed transaction. Since the
quorum was achieved past the date of the statutory maximum, we believe it was
necessary to apply to Nasdaq for an exception to shareholder approval.
On January 25, 2001, we applied for an exception to Nasdaq Marketplace Rule
4350(i)(1) requiring the Company to receive shareholder approval of an equity
financing when such financing would result in a change of control of the issuer.
On February 23, 2001, Nasdaq determined that an exception from the
shareholder approval requirement was warranted subject to the Company mailing to
all shareholders, no later than ten days before the completion of the financing,
a letter describing the proposed transaction and alerting shareholders to the
Company's omission to seek the shareholder approval that would otherwise be
required. The letter was required to indicate that the Audit Committee of the
Board had expressly approved the exception. In addition, the Company was
required to issue a press release describing the transaction.
On March 9, 2001, we issued 1,450,000 shares of our 6% Cumulative
Convertible Preferred Stock, Series A (the "Series A Preferred Stock") to
accredited investors for an aggregate gross proceeds equal to $2,900, pursuant
to a private equity placement (the "Private Placement"). The Series A Preferred
Stock has a 6% cumulative coupon and is initially convertible into our Common
Stock on an 8-for-1 basis. The Series A Preferred Stock also has liquidation and
dividend preferences superior to those of existing stockholders. The purchasers
of Series A Preferred Stock also acquired certain anti-dilution and registration
rights. No underwriter was employed by us in connection with the issuance of the
securities in the Private Placement, however C.E. Unterberg, Towbin ("Unterberg
Towbin") acted as our placement agent. As compensation for its services,
Unterberg Towbin received a fee equal to 78,125 shares of Series A Preferred
Stock, in addition to payment of certain expenses if fully sold. Thomas I.
Unterberg, a former director of the Company, along with certain affiliates of
Mr. Unterberg,
32
purchased 567,500 shares of Series A Preferred Stock on the same terms and
conditions as all other purchasers. Mr. Unterberg also is Chairman, Managing
Director and member of the Executive Committee of Unterberg Towbin.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth Quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues but represented a
substantial portion of engineering costs in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
On January 4, 2001, we received notification from Nasdaq that our common
stock had failed to maintain a minimum bid price of $1.00 per share for the
thirty days prior to the date of notification. We have 90 days from the notice
date to regain compliance by having the bid price for our common stock close at
$1.00 or greater for a minimum period of 10 consecutive trading days. As of
March 23, 2001, we have not regained compliance. In the event that we do not
regain compliance, we will be subject to delisting from the Nasdaq National
Market and would trade on the OTC Bulletin Board. A delisting from Nasdaq
National Market may have an adverse effect on our stock price and our ability to
raise capital through the issuance of additional equity.
In response to competitive and financial pressures, during the first
quarter of 2001, we reduced our workforce by up to 40% across most departments.
Additionally, our executive officers have agreed to salary reductions. As a
result of the changes we made to our workforce, we have incurred a onetime
charge in the first quarter of 2001 of approximately $200, however, we believe
that our restructured workforce will help reduce operating expenses in 2001.
Our operating results are affected by seasonal factors, particularly the
spending fluctuations of our largest customers including the U.S. Air Force
through Federal integrators. Due to the relatively fixed nature of certain of
our costs, a decline in net sales in any fiscal quarter will have a material
adverse effect on that quarter's results of operations. We do not expect such
spending fluctuations to be altered in the future. A significant reduction in
orders from any of our largest customers could have a material adverse effect on
our results of operations. There can be no assurance that our largest customers
will continue to place orders with us or that orders of our customers will
continue at their previous levels.
Subject to the risks discussed in this Annual Report on Form 10-K, we
believe that our existing available cash, credit facilities, proceeds from the
Private Placement described above and the cash flow expected to be generated
from operations will be adequate to satisfy our current and planned operations
for at least the next 12 months. There can be no assurance, however, that our
operating results will achieve profitability or adequate cash flow in the next
twelve months. Our operating plan contains assumptions regarding revenue and
expenses. The achievement of the operating plan depends heavily on the timing of
sales and our ability to gain new customers and make additional sales to current
customers. The continuation of operating losses, together with the risks
associated with our business, and other changes in our operating assets and
liabilities, may have a material adverse affect on the our future liquidity.
Inability to
33
improve operating results may require us to seek equity financing, which, if
required, would cause dilution to our current stockholders. If needed, there can
be no assurance that we can obtain equity financing, if at all, on terms
acceptable to us.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including derivative instruments embedded in other
contracts, and for hedging activities. SFAS No. 133, as amended is now effective
for the year beginning January 1, 2001. As the Company does not have any
outstanding derivative positions at December 31, 2000, there will be no impact
to the Company's results of operations, financial position or cash flows upon
the initial adoption of SFAS No. 133.
In December 1999, the Securities and Exchange Commission Staff issued Staff
Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements." SAB No. 101, as amended, is required to be implemented in the
quarter ended December 31, 2000. The Company is currently in compliance with
such SAB, and accordingly, the implementation thereof had no effect on the
Company's financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We have limited exposure to financial market risks, including changes in
interest rates. At December 31, 2000, all our available excess funds were cash
or cash equivalents whose value is not subject to changes in interest rates. We
currently hold no derivative instruments and do not earn foreign-source income.
We expect to invest our cash only in debt obligations issued by the U.S.
government or its agencies with maturities of less than one year.
Item 8. Financial Statements and Supplementary Data.
The financial statements required to be filed pursuant to this Item 8 are
appended to this Annual Report on Form 10-K. A list of the financial statements
filed herewith is found at "Item 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K."
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
On November 15, 2000, Ernst & Young LLP ("E & Y") resigned as our
independent auditors. The report of E&Y on the Company's financial statements
for each of the two years in the periods ended December 31, 1999 and December
31, 1998, contained no adverse opinion or disclaimer of opinion and was not
qualified or modified as to uncertainty, audit scope, or accounting principles.
During the two fiscal years ended December 31, 1999 and December 31, 1998, and
during the nine-month period ended September 30, 2000, there were no
disagreements with E&Y on any matters of accounting principles or practices,
financial statement disclosure, or auditing scope and procedure, which
disagreements, if not resolved to the satisfaction of E&Y, would have caused E&Y
to make reference to the subject matter of the disagreements in its reports. E&Y
has furnished us with a letter addressed to the Securities and Exchange
Commission stating their agreement with the above statements.
34
On November 21, 2000, the Board of Directors approved and the Company
retained Richard A. Eisner & Company, LLP as its independent auditors.
PART III
Item 10. Directors and Executive Officers of the Company.
The information relating to the Company's directors, nominees for election
as directors and executive officers under the headings "Election of Directors"
and "Executive Officers" in the Company's definitive proxy statement for the
2001 Annual Meeting of Shareholders is incorporated herein by reference to such
proxy statement.
Item 11. Executive Compensation.
The discussion under the heading "Executive Compensation" in the Company's
definitive proxy statement for the 2001 Annual Meeting of Shareholders is
incorporated herein by reference to such proxy statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The discussion under the heading "Security Ownership of Certain Beneficial
Owners and Management" in the Company's definitive proxy statement for the 2001
Annual Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
Item 13. Certain Relationships and Related Transactions.
The discussion under the heading "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement for the 2001 Annual
Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) Financial Statements.
Financial Statements are included in Item 8, "Financial
Statements and Supplementary Data" as follows:
- Report of Independent Auditors - Ernst & Young LLP
- Report of Independent Auditors - Richard A. Eisner & Company LLP
- Consolidated Balance Sheets - December 31, 1999 and 2000
- Consolidated Statements of Operations - Years ended December 31, 1998,
1999, and 2000
35
- Consolidated Statements of Shareholders' Equity - Years ended December
31, 1998, 1999, and 2000
- Consolidated Statements of Cash Flows - Years ended December 31, 1998,
1999, and 2000
- Notes to Consolidated Financial Statements - December 31, 2000
(a) (2) Financial Statement Schedule.
Schedule II - Valuation and Qualifying Accounts All other
schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange
Commission are not required under the related instructions
or are inapplicable and therefore have been omitted.
(a) (3) Exhibits.
Reference is made to the Exhibit Index on Page 39.
(b) Reports on Form 8-K.
On November 22, 2000, the Company filed a report on Form 8-K
relating to a change in the Company's Certifying Accountant.
On January 31, 2001, the Company filed a report on Form 8-K
relating to the Company reaching an agreement in principal
for a private equity placement of $2,000 to $4,000 of 6%
Convertible Preferred Stock.
On February 26, 2001, the Company filed a report on Form 8-K
relating to the Company's Nasdaq waiver of shareholder
approval for a private equity placement.
On March 26, 2001, the Company filed a report on Form 8-K
relating to the issuance of 1,450,000 shares of its series A
Preferred Stock for gross proceeds of $2,900.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 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 this 30th day of March,
2001.
ECCS, INC.
By: /s/Gregg M. Azcuy
----------------------------------
Gregg M. Azcuy, President and
Chief Executive Officer
37
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.
Signature Title Date
--------- ----- ----
/s/ Gregg M. Azcuy President, Chief Executive March 30, 2001
- ---------------------- Officer and Director
Gregg M. Azcuy (Principal Executive
Officer)
/s/ Louis Altieri Vice President, Finance and March 30, 2001
- ---------------------- Administration (Principal
Louis Altieri Financial and Accounting
Officer)
/s/ Michael E. Faherty Chairman of the Board and March 30, 2001
- ---------------------- Director
Michael E. Faherty
/s/ Gale R. Aguilar Director March 30, 2001
- ----------------------
Gale R. Aguilar
/s/ James K. Dutton Director March 30, 2001
- ----------------------
James K. Dutton
/s/ Donald E. Fowler Director March 30, 2001
- -----------------------
Donald E. Fowler
/s/ Frank R. Triolo Director March 30, 2001
- -----------------------
Frank R. Triolo
38
EXHIBIT INDEX
Exhibit
No. Description of Exhibit
--- ----------------------
3.1 Certificate of Amendment to the Restated and Amended Certificate of
Incorporation, as amended. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 2000 filed on November 3, 2000.)
3.2 Certificate of Amendment to the Restated and Amended Certificate of
Incorporation, filed with the Secretary of State of the State of New
Jersey on March 8, 2001. (Incorporated by reference to the Company's
Current Report on Form 8-K filed on March 26, 2001).
3.3 By-Laws of the Company, as amended. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1997 filed on November 3, 1997.)
4.1* 1989 Stock Option Plan of the Company. (Incorporated by reference to
the Company's Registration Statement on Form S-1 (File Number
33-60986) which became effective on June 14, 1993.)
4.2* Warrant issued to Michael E. Faherty to purchase 266,601 shares of
Common Stock of the Company. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1995 filed on May 15, 1995.)
4.3* Form of Option Agreement, pursuant to which the Company granted
non-qualified stock options outside the Company's Stock Option Plan.
(Incorporated by reference to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 1995 filed on May 15,
1995.)
4.4* Option issued to Gregg M. Azcuy to purchase 80,000 shares of Common
Stock of the Company. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1995 filed on May 15, 1995.)
4.5* 1996 Stock Plan of the Company. (Incorporated by reference to the
Company's Form S-8, Registration Statement under the Securities Act of
1933 (File No. 333-15529) which became effective on November 5, 1996.)
4.6* 1996 Non-Employee Directors Stock Option Plan of the Company.
(Incorporated by reference to the Company's Form S-8, Registration
Statement under the Securities Act of 1933 (File No. 333-15529) which
became effective on November 5, 1996.)
39
Exhibit
No. Description of Exhibit
--- ----------------------
10.1 Form of Non-Competition and Non-Disclosure Agreement executed by
substantially all option holders. (Incorporated by reference to the
Company's Registration Statement on Form S-1 (File Number 33-60986)
which became effective on June 14, 1993.)
10.2 Form of Employee's Invention Assignment and Confidential Information
Agreement. (Incorporated by reference to the Company's Registration
Statement on Form S-1 (File Number 33-60986) which became effective on
June 14, 1993.)
10.3 Lease Agreements between the Company and Philip J. Bowers & Company
dated September 20, 1988 and May 13, 1991 and modified June 10, 1992
for the Company's Tinton Falls, New Jersey Facilities. (Incorporated
by reference to the Company's Registration Statement on Form S-1 (File
Number 33-60986) which became effective on June 14, 1993.)
10.4* Indemnification Agreement as of August 22, 1994 by and between the
Company and James K. Dutton. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
October 1, 1994 filed on November 8, 1994.)
10.5 Lease Agreement, dated May 15, 1994 between the Company and John
Donato, Jr., d/b/a Mid Atlantic Industrial Co., with Security
Amendment and Subordination, Attornment and Non Disturbance Agreement
dated May 25, 1994 executed by the Company, as lessee, John Donato,
Jr., as mortgagor, and Starbase II Partners, L.P., as mortgagee.
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the year ended December 31, 1994 filed on April 13, 1995.)
10.6* Indemnification Agreement as of March 1, 1995 by and between the
Company and Gale R. Aguilar. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994 filed on April 13, 1995.)
10.7* Indemnification Agreement as of April 5, 1994 by and between the
Company and Gregg M. Azcuy. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994 filed on April 13, 1995.)
10.8* Indemnification Agreement as of September 12, 1994 by and between the
Company and Louis J. Altieri. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994 filed on April 13, 1995.)
40
Exhibit
No. Description of Exhibit
--- ----------------------
10.9* Indemnification Agreement as of December 6, 1994 by and between the
Company and Michael E. Faherty. (Incorporated by reference to the
Company's Annual Report on Form 10-K for the year ended December 31,
1994 filed on April 13, 1995.)
10.10* Senior Staff Change In Control Severance And Incentive Compensation
Pay Agreement by and between the Company and Gregg M. Azcuy.
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the annual period ended December 31, 1999.)
10.11* Senior Staff Change In Control Severance And Incentive Compensation
Pay Agreement by and between the Company and Louis J. Altieri.
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the annual period ended December 31, 1999.)
10.12* Senior Staff Change In Control Severance And Incentive Compensation
Pay Agreement by and between the Company and Priyan Guneratne.
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the annual period ended December 31, 1999.)
10.13* Indemnification Agreement as of June 20, 1996 by and between the
Company and Thomas I. Unterberg. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996, filed on August 14, 1996.)
10.14* Indemnification Agreement as of June 20, 1996 by and between the
Company and Frank R. Triolo. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996, filed on August 14, 1996.)
10.15* Indemnification Agreement as of June 20, 1996 by and between the
Company and Donald E. Fowler. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1996, filed on August 14, 1996.)
10.16* Indemnification Agreement as of August 22, 1996 by and between the
Company and Priyan Guneratne. (Incorporated by reference to the
Company's Annual Report on Form 10-K/A for the annual period ended
December 31, 1996 filed on March 28, 1997).
10.17* 1995 Employee Stock Purchase Plan of the Company. (Incorporated by
reference to the Company's Form S-8, Registration Statement under the
Securities Act of 1933 (File No. 33-93480) which became effective on
June 14, 1995.)
41
Exhibit
No. Description of Exhibit
--- ----------------------
10.18 Master Sales Agreement dated September 23, 1999, by and between the
Company and Hitachi Computer Products (America) Inc., as amended.
(Incorporated by reference to the Company's Annual Report on Form 10-K
for the annual period ended December 31, 1999.)
10.19 Agreement dated August 13, 1996 by and between the Company and AT&T
Capital Corporation. (Incorporated by reference to the Company's
Annual Report on Form 10-K/A for the annual period ended December 31,
1996 filed on March 28, 1997).
10.20 Factoring Agreement dated July 9, 1997 between the Company and
NationsBanc Commercial Corporation. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1997, filed on August 6, 1997).
10.21 Series A Convertible Preferred Stock Purchase Agreement dated as of
March 9, 2001 between the Company and the Purchasers listed therein.
(Incorporated by reference to the Company's Current Report on Form 8-K
filed on March 26, 2001).
20 Listing of Subsidiaries. (Incorporated by reference to the Company's
Annual Report on Form 10-K/A for the annual period ended December 31,
1996 filed on March 28, 1997).
23.1+ Consent of Ernst & Young LLP.
23.2+ Consent of Richard A. Eisner & Company, LLP
---------------
* A management contract or compensatory plan or arrangement required to
be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
+ Filed herewith. All other exhibits previously filed.
42
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULE
Page
----
Report of Independent Auditors - Ernst & Young LLP.........................F-2
Report of Independent Auditors - Richard A. Eisner & Co. LLP ..............F-3
Consolidated Balance Sheets as of
December 31, 1999 and 2000...............................................F-4
Consolidated Statements of Operations for
each of the three years in the period ended
December 31, 2000........................................................F-5
Consolidated Statements of Shareholders'
Equity for each of the three years in
the period ended December 31, 2000.......................................F-6
Consolidated Statements of Cash Flows
for each of the three years in the period
ended December 31, 2000..................................................F-7
Notes to Consolidated Financial Statements.................................F-8
Schedule II - Valuation and Qualifying Accounts............................S-1
Schedules other than those listed are omitted as they are not applicable, or the
required or equivalent information has been included in the financial statements
or notes thereto.
F-1
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
ECCS, Inc.
We have audited the accompanying consolidated balance sheet of ECCS, Inc.
and subsidiaries as of December 31, 1999, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for the
years ended December 31, 1999 and 1998. Our audits also included the financial
statement schedule listed in the Index at Item 14(a) for the years ended
December 31, 1999 and 1998. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 consolidated financial position of
ECCS, Inc. and subsidiaries at December 31, 1999, and the consolidated results
of their operations and their cash flows for the years ended December 31, 1999
and 1998, in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related financial statement schedule
for the years ended December 31, 1999 and 1998, when considered in relation to
the basic financial statements taken as a whole, presents fairly in all material
respects, the information set forth therein.
/s/ ERNST & YOUNG LLP
MetroPark, New Jersey
February 8, 2000, except for Note 12,
as to which the date is April 14, 2000
F-2
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
ECCS, Inc.
We have audited the accompanying consolidated balance sheet of ECCS, Inc.
and subsidiaries as of December 31, 2000, and the related consolidated
statements of operations, shareholders equity, and cash flows for the year then
ended. Our audit also includes the financial statement schedule in so far as it
relates to the year ended December 31, 2000 listed in the Index at Item 14(a).
These financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule 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
the 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 consolidated financial position of
ECCS, Inc. and subsidiaries at December 31, 2000, and the consolidated results
of their operations and their cash flows for the year then ended, in conformity
with accounting principles generally accepted in the United States of America.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ RICHARD A. EISNER & COMPANY, LLP
New York, New York
March 2, 2001, except for Note 13 as to which the date is March 9, 2001.
F-3
ECCS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31,
------------
1999 2000
---- ----
Assets
Current Assets:
Cash and cash equivalents......................... $ 7,993 $2,221
Accounts receivable, less allowance for
doubtful accounts of $0 in 1999 and $310 in
2000............................................. 5,829 899
Inventories....................................... 5,570 4,452
Prepaid expenses and other receivables............ 254 294
--- ---
19,646 7,866
Property and equipment (net)........................ 1,733 1,299
Capitalized software (net).......................... 1,790 406
Other assets........................................ 62 61
-- --
Total Assets.............................. $23,231 $9,632
======= ======
Liabilities and Shareholders' Equity
Current Liabilities:
Loans payable .................................... $ -- $ 161
Payable to Finova Capital......................... 968 115
Current portion of capital lease.................. 158 114
Accounts payable.................................. 1,631 2,069
Accrued expenses and other........................ 1,874 1,150
Warranty.......................................... 746 577
Customer deposits, advances and other credits..... 69 213
-- ---
5,446 4,399
Capital lease obligations, net of current portion... 67 88
Deferred rent....................................... 17 --
----- -----
5,530 4,487
----- -----
Shareholders' Equity:
Preferred stock, $.01 par value per share, authorized
3,000,000 shares; none
issued and outstanding at December 31, 1999 and
December 31, 2000................................ -- --
Common stock, $.01 par value per share,
Authorized, 50,000,000 shares; issued and outstanding
11,341,318 shares and
11,562,540 shares at December 31, 1999 and
December 31, 2000, respectively................. 113 116
Capital in excess of par value ................... 26,374 26,670
Accumulated deficit............................... (8,786) (21,641)
------ -------
17,701 5,145
------ -----
Total Liabilities and Shareholders' Equity..... $23,231 $9,632
======= ======
F-4
ECCS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
Year Ended December 31
- --------------------------------------------------------------------------------
1998 1999 2000
---- ---- ----
Net sales.................... $ 28,466 $ 39,761 $ 15,022
Cost of sales................ 20,452 26,777 15,268
------ ------ ------
Gross profit (deficit)..... 8,014 12,984 (246)
Operating expenses:
Selling, general &
administrative............. 8,378 9,693 10,925
Research & development..... 2,683 1,939 2,112
----- ----- -----
11,061 11,632 13,037
------ ------ ------
Operating (loss) income ..... (3,047) 1,352 (13,283)
Net interest income........ (390) (162) (193)
(Loss) income before income tax
benefit ..................... (2,657) 1,514 (13,090)
Income tax benefit......... -- (438) (235)
----- ---- ----
Net (loss) income .......... $ (2,657) $ 1,952 $ (12,855)
========= ========= =========
Net (loss) income per share -
basic........................ $ (0.24) $ 0.18 $ (1.12)
========= ========= =========
Net (loss) income per share -
diluted...................... $ (0.24) $ 0.16 $ (1.12)
========= ========= =========
Weighted average number of
common shares - basic........ 10,969 11,093 11,490
====== ====== ======
Weighted average number of
common shares - diluted...... 10,969 11,978 11,490
====== ====== ======
F-5
ECCS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in Thousands)
Common Stock
------------------------------------
Capital
in
Excess Total
of Par Accumulated Shareholders'
Shares Amount Value Deficit Equity
---------- ---------- ---------- ---------- ----------
Balance at January 1, 1998..... 10,918,188 $ 109 $ 25,615 $ (8,081) $ 17,643
Issuance of stock and stock
option exercises ............ 108,896 1 245 -- 246
Net loss ...................... -- -- -- (2,657) (2,657)
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1998 .. 11,027,084 110 25,860 (10,738) 15,232
Issuance of stock and stock
option exercises ............ 314,234 3 514 -- 517
Net income .................... -- -- -- 1,952 1,952
---------- ---------- ---------- ---------- ----------
Balance at December 31, 1999 .. 11,341,318 113 26,374 (8,786) 17,701
Issuance of stock and stock
option exercises ............ 221,222 3 296 -- 299
Net loss ...................... -- -- -- (12,855) (12,855)
---------- ---------- ---------- ---------- ----------
Balance at December 31, 2000 .. 11,562,540 $ 116 $ 26,670 $ (21,641) $ 5,145
========== ========== ========== ========== ==========
F-6
ECCS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Year Ended December 31,
--------------------------------
1998 1999 2000
-------- -------- --------
Cash flows from operating activities:
Net (loss) income ................................ $ (2,657) $ 1,952 $(12,855)
Adjustments to reconcile net (loss)
income to net cash provided by (used
in) operating activities:
Depreciation and amortization ................. 1,035 1,515 1,986
Write off of capitalized software ............. 366 -- 1,738
Change in operating assets and liabilities:
(Increase) decrease in accounts
receivable ................................... (907) 815 4,930
(Increase) decrease in inventories ............ (967) (7) 1,118
Decrease (increase) in prepaid expenses
and other receivables......................... 276 259 (39)
Decrease in accounts payable, accrued
liabilities and other ........................ (1,289) (212) (472)
(Decrease) increase in customer deposits ...... (288) (53) 144
-------- -------- --------
Net cash (used in) provided by operating
activities ...................................... (4,431) 4,269 (3,450)
-------- -------- --------
Cash flows from investing activities:
Additions to property and equipment ............ (1,208) (812) (475)
Additions to capitalized software .............. (1,047) (1,072) (1,274)
-------- -------- --------
Net cash used in investing activities ............ (2,255) (1,884) (1,749)
-------- -------- --------
Cash flows from financing activities:
Borrowings under revolving credit
agreement ..................................... 11,381 16,624 17,283
Repayments under revolving credit
agreement ..................................... (12,412) (16,624) (17,122)
Decrease in payable to Finova Capital .......... 1,231 (263) (853)
Repayment of capital lease obligations ......... (11) (20) (180)
Proceeds from exercise of employee stock
options and issuance of common stock .......... 246 517 299
-------- -------- --------
Net cash provided by (used in) financing
activities ...................................... 435 234 (573)
-------- -------- --------
Net (decrease) increase in cash and cash
equivalents ..................................... (6,251) 2,619 (5,772)
Cash and cash equivalents at beginning of
period .......................................... 11,625 5,374 7,993
-------- -------- --------
Cash and cash equivalents at end of period ....... $ 5,374 $ 7,993 $ 2,221
======== ======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ...................................... $ 88 $ 135 $ 141
======== ======== ========
Supplemental disclosure of non-cash investing and
financing activities:
Property acquired under capital lease
obligations .................................. $ 245 -- 157
======== ======== ========
F-7
ECCS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1999 and 2000
(Dollars in Thousands Except Per Share Information)
Note 1 -- The Company
ECCS, Inc. ("ECCS" or the "Company") designs, manufactures, sells and
supports fault tolerant enterprise storage solutions that protect and ensure
access to an organization's critical data. The Company's products include high
performance storage subsystems that meet a wide range of customer applications
for Open Systems-based networks, such as NT, UNIX and Linux operating systems.
The Company's enterprise storage solutions address all three storage markets:
DAS, in which the storage device is connected directly to a server; NAS, in
which the storage device is installed on a network; and SAN, in which the
storage device is used in a specialized network. These connectivity options
provide storage users the flexibility to choose and deploy a particular storage
solution to meet their needs.
Note 2 -- Summary of Significant Accounting Policies
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. None of the subsidiaries are active. All
significant intercompany balances and transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers short-term investments with a maturity of three
months or less when purchased to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. Depreciation and amortization
are provided on a straight-line basis over the estimated useful lives ranging
from three to five years.
Equipment under capital leases is recorded at the lower of fair value or
present value of minimum lease payments at the inception of the lease and are
amortized over their estimated useful lives. Amortization of leasehold
improvements is computed using the straight-line method over the term of the
lease.
F-8
FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair value amounts for cash, accounts receivable and short term debt
approximate carrying amounts due to the short maturity of these instruments.
SOFTWARE DEVELOPMENT COSTS
The Company capitalizes software development costs in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 86. Such costs are
capitalized after technological feasibility has been demonstrated. Such
capitalized amounts are amortized commencing with product introduction on a
straight-line basis utilizing the estimated economic life ranging from one to
three years. Amortization of capitalized software development is charged to cost
of sales and aggregated, $190, $586 and $919 for 1998, 1999 and 2000,
respectively. At December 31, 2000, the Company has capitalized an aggregate of
$3,905 of software development costs, of which $366 was written off in 1998, as
the Company discontinued its efforts to develop a fibre controller and a
controller design that incorporated Tandem's Server Net Technology. In addition,
in 2000, $1,738 was written off in connection with the Company's discontinuation
of the SANStar project, and $1,395 has been amortized in the aggregate.
IMPAIRMENT OF LONG-LIVED ASSETS
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of", the Company
records impairment losses on long-lived assets used in operations or expected to
be disposed of when indicators of impairment exist and the cash flows expected
to be derived from those assets are less than the carrying amounts of those
assets. No such events and circumstances have occurred.
REVENUE RECOGNITION
In general, revenue is recognized upon shipment of the product or system or
as services are provided. Periodically, revenue is recognized for product which
is being held at the customer's request. Revenue is only recognized on such
product when all risks of ownership have passed to the customer and the Company
has no specific performance obligations remaining. Revenues related to
maintenance contracts are recognized over the respective terms of the
maintenance contracts. Revenue for certain major product enhancements and major
new product offerings, for which the Company believes that significant product
development risks may exist which realistically can be addressed only during
live beta testing at end-user sites, is not recognized until successful
completion of such end-user beta testing.
WARRANTY
Estimated future warranty obligations related to ECCS products are provided
by charges to operations in the period the related revenue is recognized.
F-9
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred, except for
software development costs as indicated above.
INCOME TAXES
Income taxes are accounted for by the liability method in accordance with
the provisions of SFAS No. 109 "Accounting for Income Taxes".
STOCK BASED COMPENSATION
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but
does not require companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options generally is measured as the excess, if any, of the quoted market
price of the Company's stock over the amount an employee must pay to acquire the
stock on the date that both the exercise price and the number of shares to be
acquired pursuant to the option are fixed.
PER SHARE INFORMATION
Per share information is presented in accordance with SFAS No. 128,
Earnings per Share. Basic earnings per share excludes any dilutive effects of
options, warrants and convertible securities. In fiscal 1999, diluted earnings
per share includes the dilutive effect of all such securities. In fiscal 2000,
diluted earnings per share does not include options, warrants and convertible
securities as they are anti-dilutive.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statement and
accompanying notes. Actual results could differ from those estimates.
NEW AUTHORITATIVE ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 133, "Accounting for Derivatives and Hedging
Activities." SFAS No. 133 establishes accounting and reporting standards for
derivative instruments, including derivative instruments embedded in other
contracts, and for hedging activities. SFAS No. 133, as amended is now effective
for the year beginning January 1, 2001. As the Company does not have any
outstanding derivative positions at December 31, 2000, there will be no impact
to the Company's results of operations, financial position or cash flows upon
the initial adoption of SFAS No. 133.
F-10
In December 1999, the Securities and Exchange Commission Staff issued Staff
Accounting Bulletin ("SAB") No. 101 "Revenue Recognition in Financial
Statements." SAB No. 101, as amended, is required to be implemented in the
quarter ended December 31, 2000. The Company is currently in compliance with
such SAB, and accordingly, the implementation thereof had no effect on the
Company's financial statements.
Note 3 -- Transactions with Significant Vendors and Customers
In 1995, the Company entered into a Manufacturing Services Agreement with
Unisys, formerly its primary manufacturer, which defined the terms of sales and
support services. Pursuant to such agreement, Unisys manufactured certain of the
Company's products for use in the Company's proprietary systems as well as for
the direct sale to end-users. In February 1999, Unisys notified the Company that
Unisys was closing its Winnipeg computer storage systems manufacturing plant by
July 31, 1999 and accordingly the Manufacturing Services Agreement was
terminated at that time. The Company's purchases under this agreement totaled
$6,600, $354 and zero in 1998, 1999 and 2000, respectively. Subsequent to the
termination of the Manufacturing Services Agreement, the Company manufactured
certain products in-house under such agreement from August to December 1999.
In September 1999, the Company entered into a Master Sale Agreement with
Hitachi Computer Products (America), Inc. Pursuant to such agreement, Hitachi
began manufacturing certain of the Company's products in January 2000 for use in
the Company's fault tolerant enterprise storage solutions. The agreement does
not contain specific quantity commitments and purchases are made on a purchase
order basis. The agreement does not include any long-term commitment by either
party. In 1999, purchases from Hitachi totaled $2,540 or 10.3% of all purchases.
In 2000, such purchases totaled $1,053 or 6.6% of all purchases.
Sales to the Company's primary alternate channel partner, Unisys, accounted
for 28.0%, 8.2% and 3.6% of the Company's total net sales in 1998, 1999 and
2000, respectively. All sales to Unisys were sales of enterprise storage
solutions.
The Company has a supply arrangement with Bell Microproducts pursuant to
which the Company orders from Bell Microproducts when, and as needed, and on
terms negotiated at the time of each such order. There are no minimum purchase
requirements. The arrangement is terminable by either party at any time. In 1998
and 1999, purchases from Bell Microproducts totaled approximately $5,100, or
23.3%, and $10,776, or 43.5%, of all purchases respectively. In 2000, such
purchases totaled $4,167, or 26.1% of all purchases.
The United States Air Force, an end user of the Company's products which
purchases such products through KKP Corporation, Worldwide Technologies and
other government contractors, purchased $9,579 of products, or 33.7% of the
Company's total net sales in 1998. In 1999 such sales totaled $23,216, or 58.4%
of total sales and for 2000 such sales totaled $4,576, or 30.5% of total sales.
The Company cannot be certain that its sales to the U.S. Airforce through
Federal integrators will not be adversely affected by the investigation further
discussed in Note 12. There are no minimum purchase requirements.
F-11
SEGMENT INFORMATION
All of the Company's revenues are generated in the United States. The
Company believes that it has one operating segment and classifies its revenues
based upon its primary sales channels: commercial and other Federal customers;
U.S. Air Force; and alternate channel partners. All Company products are
available for sale in each of the channels. Revenues by sales channel are
regularly reviewed by the chief operating decision maker. The following table
sets forth, for the periods indicated, the net sales derived from each of the
Company's sales channels:
Year Ended December 31,
-------------------------
1998 1999 2000
---- ---- ----
Direct:
Commercial and other Federal
customers......................... $ 7,960 $12,638 $ 9,905
U.S. Air Force...................... 9,579 23,216 4,576
Indirect:
Alternate channel partners.......... 10,927 3,907 541
------- ------- -------
$28,466 $39,761 $15,022
======= ======= =======
All operating expenses and assets of the Company are combined and reviewed
by the chief operating decision maker on an enterprise-wide basis, resulting in
no additional discrete financial information or reportable segment information.
Note 4 -- Inventories
Inventories consist of the following:
December 31,
------------------
1999 2000
---- ----
Purchased parts................................ $ 1,497 $ 1,610
Finished goods................................. 5,047 5,309
---------- ----------
6,544 6,919
Less: inventory valuation reserve........... 974 2,467
---------- ----------
$ 5,570 $ 4,452
========== ==========
Note 5 -- Property and Equipment
Property and equipment consist of the following:
December 31,
------------------------
1999 2000
-------- --------
Furniture and fixtures......................... $ 487 $ 493
Computer equipment............................. 5,586 6,085
Vehicles....................................... 35 35
Leasehold improvements......................... 424 398
Equipment under capital leases................. 770 931
-------- --------
7,302 7,942
Less accumulated depreciation and amortization,
including $426 and $711 relating to equipment
under capital leases at December 31, 1999
and December 31, 2000, respectively.......... 5,569 6,643
-------- --------
$ 1,733 $ 1,299
======== ========
F-12
Note 6 -- Loans Payable to Bank of America and Payable to Finova Capital
On July 9, 1997, the Company entered into a full recourse factoring
facility with Bank of America ("BOA") which provides for aggregate advances not
to exceed the lesser of $7 million or up to 85.0% of Eligible Receivables (as
defined). Interest on such advances is payable monthly in arrears at the prime
lending rate and the Company is obligated to pay certain annual fees. The
factoring facility is for a period of three years (unless terminated by BOA by
providing the Company sixty days prior written notice) beginning on July 30,
1997. The obligations of the Company under such agreement are collateralized by
substantially all of the assets of the Company. On June 16, 2000, the Company
signed an amendment to the Factoring Agreement between Bank of America and the
Company extending the Agreement until July 30, 2003, and from year to year
thereafter until terminated. Except as described above, the Factoring Agreement
remains unchanged. As of December 31, 2000, the Company had an outstanding
balance under this full recourse factoring facility of $161.
On December 1, 1997, Finova Capital Corp. ("Finova") acquired the Company's
$2,000 general line of credit with AT&T-CFC. The Company renewed its credit line
with Finova upon its expiration on January 31, 1999 and such general line of
credit was increased to $3,000 and extended through January 31, 2000, on the
same terms and conditions. On January 31, 2000, the amount of the line was
returned to $2,000 and the line was extended through January 31, 2001. On April
17, 2000, Finova approved a permanent increase in the line of $2,000, raising
the total amount of funds available to the Company under the general line of
credit to $4,000. The Company received a sixty-day notice of termination from
Finova on December 11, 2000 terminating the $4,000 general line of credit. The
Company used this line of credit to augment its purchasing ability with various
vendors.
The Company's obligations under the agreement with Finova are
collateralized by substantially all of the assets of the Company. As of December
31, 2000, the Company had a balance of $115 outstanding under this credit line
which has been subsequently repaid. The Company has certain financial covenants
with such line of credit with Finova. The Company is in compliance with such
covenants as of December 31, 2000.
Finova and BOA have entered into an intercreditor subordination agreement
with respect to their relative interests in substantially all of the Company's
assets.
The Company's agreement with BOA restricts the Company's ability to pay
certain dividends without Bank of America's prior written consent.
F-13
Note 7 -- Leases
The Company has capital leases for certain equipment. In addition, the
Company is obligated under non-cancelable operating leases for office and
warehouse space. The leases provide for all real estate taxes and operating
expenses to be paid by the Company. Under certain leases, the Company has the
option to renew for additional terms at specified rentals. Rent expense for such
leases approximated $523, $516 and $712 for the years ended December 31, 1998,
1999 and 2000, respectively.
Deferred rent on the accompanying consolidated balance sheet represents the
excess of rents to be paid in the future over rent expense recognized on a
straight-line basis.
The following is a schedule of future minimum lease payments for capital
and non-cancelable operating leases, together with the present value of the net
minimum lease payments, as of December 31, 2000:
Capitalized Operating
Leases Leases
----------- ---------
2001....................................... $ 123 $ 446
2002....................................... 63 417
2003....................................... 32 403
2004....................................... - - 406
2005....................................... - - 409
Thereafter................................. - - - -
----- ------
Total minimum lease payments............... 218 $2,081
----- =======
Less amount representing interest.......... 16
-----
Present value of net minimum lease payments $ 202
=====
Note 8 -- Stock Option Plans
The Company has the following stock option plans:
THE 1989 STOCK OPTION PLAN
Under the Company's 1989 Stock Option Plan, as amended, 900,000 shares of
common stock can be issued through incentive stock options and non-statutory
stock options. The incentive stock options allow designated full-time employees,
including officers, to purchase shares of common stock at prices equal to fair
market value at the date of grant. For individuals who own more than 10% of the
stock of the Company, the exercise price for the shares may not be less than
110% of the fair market value on the date of grant. The incentive stock options
expire five years from the date of the grant for shareholders owning more than
10% of the voting rights (as defined). The non-statutory stock options may be
granted to full-time employees, including officers and non-employee directors or
consultants at prices as determined by the Board of Directors. The stock options
are exercisable over a period determined by the Board of Directors. To date, no
options have been granted with a vesting period of more than five years.
F-14
A summary of the changes in outstanding common stock options under the 1989
Stock Option Plan is as follows:
Options Outstanding
-------------------
Weighted-Average
Shares Exercise Price
------ --------------
Balance at January 1, 1998..................... 695,718 $2.66
Options exercised........................... (25,225) 2.55
Options canceled........................... (479,734) 2.69
--------
Balance at December 31, 1998................... 190,759 2.60
Options exercised........................... (69,159) 2.02
Options canceled............................ -- --
-------
Balance at December 31, 1999................... 121,600 2.04
Options exercised........................... (33,250) 1.48
Options canceled............................ - - - -
-------
Balance at December 31, 2000................... 88,350 2.25
-------
Options exercisable at December 31, 2000....... 88,350 $2.25
The weighted average remaining contractual life for the balance of options
outstanding at December 31, 2000 in the 1989 Stock Option Plan is five years and
the exercise price range is $1.00 - $2.87.
1996 STOCK OPTION PLAN
In June 1996, the Board of Directors of the Company adopted the 1996 Stock
Plan. In June 1998, the shareholders approved an increase in the number of
shares subject to the 1996 Stock Plan. Under the 1996 Stock Plan, 1,600,000
shares of common stock currently can be issued through incentive stock options
and non-statutory stock options and/or stock purchase rights. The incentive
stock options allow designated employees, non-employee directors and consultants
to purchase shares of common stock at prices equal to fair market value at the
date of grant. For individuals who own more than 10% of the stock of the
Company, the exercise price for the shares may not be less than 110% of the fair
market value on the date of grant. The incentive stock options expire five years
from the date of grant for shareholders owning more than 10% of the voting
rights (as defined). The non-statutory stock options may be granted to
employees, non-employee directors and consultants at prices as determined by the
Board of Directors. The stock options are exercisable over a period determined
by the Board of Directors. To date, no options have been granted with a vesting
period of more than five years.
F-15
A summary of the changes in outstanding common stock options under the 1996
Stock Plan is as follows:
Options Outstanding
-----------------------------
Weighted-Average
Shares Exercise Price
------ --------------
Balance at January 1, 1998..................... 419,500 $5.28
Options granted............................. 1,408,800 1.62
Options exercised........................... (2,500) 2.88
Options canceled............................ (646,900) 4.40
---------
Balance at December 31, 1998................... 1,178,900 1.39
Options granted............................. 376,107 5.46
Options exercised........................... (81,400) 1.25
Options canceled............................ (575,250) 1.35
---------
Balance at December 31, 1999................... 898,357 2.95
Options granted............................. 452,200 6.19
Options exercised........................... (136,450) 1.27
Options canceled............................ (197,200) 4.66
---------
Balance at December 31, 2000................... 1,016,907 4.28
---------
Options exercisable at December 31, 2000....... 447,738 $ 1.60
The weighted average remaining contractual life for the balance of options
outstanding at December 31, 2000 in the 1996 Stock Option Plan is nine years and
the exercise price range is $1.25 - $17.31.
In mid-February 1998, the Company canceled options to purchase 106,000
shares of its Common Stock under the 1996 Stock Plan. The Company previously
granted such options on October 28, 1997 at an exercise price of $8.00 per
share. In addition, in mid-February 1998 the Company reissued an equivalent
number of options, to certain officers and employees, at an exercise price of
$4.00 per share.
On October 21, 1998, the Board of Directors unanimously voted in favor of
offering to all employees who were previously granted stock options an
opportunity to exchange such options for new stock options to purchase shares of
Common Stock of the Company, at an exercise price equal to $1.25 per share (the
"New Options"), the fair market value of the Company's Common Stock on such
date. The New Options are exercisable to the extent of one-half on each of the
first and second anniversary of the date of grant. The Company offered the New
Options in order to pursue its commitment to retain key employees, particularly
in light of the highly competitive labor market for technical personnel. On
November 5, 1998, the Company formally offered its employees the option to
exchange all outstanding options for the New Options pursuant to the terms of
the 1996 Stock Plan. The number of outstanding options exchanged pursuant to
this transaction was 1,487,159. The New Options were granted from both the 1996
Option Plan and the Non-Qualified Stock Option pools.
F-16
NON-QUALIFIED STOCK OPTIONS
A summary of the changes in outstanding common stock options under
Non-Qualified Agreements is as follows:
Options Outstanding
-----------------------------
Weighted-Average
Shares Exercise Price
---------- ----------------
Balance at January 1, 1998..................... 823,841 $5.82
Options granted............................. 993,209 2.97
Options exercised........................... (37,625) 2.13
Options canceled............................ (1,205,925) 5.53
----------
Balance at December 31, 1998................... 573,500 1.74
Options granted............................. 316,893 10.75
Options exercised........................... (123,691) 1.32
Options canceled............................ (500) 2.13
----------
Balance at December 31, 1999................... 766,202 5.37
Options granted............................. 884,300 2.78
Options exercised........................... -- --
Options canceled............................ (19,550) 2.74
----------
Balance at December 31, 2000................... 1,630,952 4.00
----------
Options exercisable at December 31, 2000....... 550,103 $3.18
The weighted average remaining contractual life for the balance of options
outstanding at December 31, 2000 under Non-Qualified Agreements is nine years
and the exercise price range is $1.25 - $10.75.
In mid-February 1998, the Company canceled options to purchase 498,400
shares of its Common Stock outside of the Company's registered stock option
plans. The Company previously granted such options on October 28, 1997 at an
exercise price of $8.00 per share. In addition in mid-February 1998 the Company
reissued such options, to certain officers and employees, at an exercise price
of $4.00 per share.
1996 NON-EMPLOYEE DIRECTORS STOCK OPTION PLAN
In February 1996, the Board of Directors of the Company adopted the 1996
Non-Employee Directors Stock Option Plan (the "1996 Non-Employee Directors
Plan") pursuant to which 500,000 shares of Common Stock can be issued through
non-statutory stock options. Under the terms of the 1996 Non-Employee Directors
Plan, each non-employee director who first becomes a member of the Board after
approval of such plan by the shareholders of the Company, shall be automatically
granted, on the date such person becomes a member of the Board, an option to
purchase 30,000 shares of Common Stock. In addition, each non-employee director
who is a member of the Board on the first trading day of each year shall be
automatically granted on such date, without further action by the Board, an
option to purchase 5,000 shares of Common Stock. The exercise price per share
under the 1996 Non-Employee Directors Plan shall be equal to the fair market
value (as defined) of a share of Common Stock on the applicable grant date, and
options granted under the 1996 Non-Employee Directors Plan vests over a
four-year period.
F-17
A summary of the changes in outstanding common stock options under the 1996
Non-Employee Directors Plan is as follows:
Options Outstanding
-----------------------------
Weighted-Average
Shares Exercise Price
---------- ----------------
Balance at January 1, 1998..................... 60,000 $4.38
Options granted............................. 30,000 6.50
---------
Balance at December 31, 1998 90,000 5.09
Options granted............................. 30,000 1.69
---------
Balance at December 31, 1999................... 120,000 4.23
Options granted............................. 30,000 16.94
---------
Balance at December 31, 2000................... 150,000 6.77
---------
Options exercisable at December 31, 2000.... 75,000 $4.52
The weighted average remaining contractual life for the balance of options
outstanding at December 31, 2000 under the 1996 Non-Employee Directors Plan is
eight years and the exercise price range is $1.69 - $16.94.
The following table summarizes information about ECCS stock options
outstanding at December 31, 2000.
Outstanding Exercisable
----------- -----------
Range of Number of Weighted Weighted Number of Weighted
Exercise Options Average Average Options Average
Price ------- Remaining Exercise ------- Exercise
- ----- Years of Price Price
Contractual ----- -----
Life
----
$0 - $2.00 862,759 8 $1.27 806,066 $1.27
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$2.01 - $5.00 1,261,750 9 $2.94 232,750 $3.21
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$5.01 - $12.00 700,200 9 $9.02 122,375 $10.23
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
$12.01 - $20.00 61,500 9 $16.53 -- --
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TOTAL 2,886,209 1,161,191
- --------------------------------------------------------------------------------
STOCK WARRANTS
At December 31, 2000, 298,848 common stock purchase warrants with an
exercise price of $1.25 per share were outstanding to a director of the Company.
Such warrants expire in 2004. At December 31, 2000, all such warrants were
exercisable.
The Company has reserved 3,185,057 shares of Common Stock for the exercise
of stock options and warrants as described above.
F-18
FAS 123 Pro Forma Information
Pro forma information regarding net income and earnings per share is
required by Statement No. 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1999 and 2000: risk-free interest rates of between
4.3%-5.74% in 1998, 4.6%-6.3% in 1999 and 5.8%-6.65% in 2000; dividend yields of
zero; volatility factors of the expected market price of the Company's common
stock of .947 in 1998, .997 in 1999 and 1.168 in 2000; and a weighted-average
expected life of four years. The weighted average fair market value of stock
options issued in 1998, 1999 and 2000 was $2.20, $5.47 and $3.31 per share,
respectively.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows (in thousands except for earnings per share
information):
1998 1999 2000
---- ---- ----
Net income (loss) as reported........ $(2,657) $ 1,952 $(12,855)
Pro forma net income (loss).......... $(3,802) $ 1,538 $(14,814)
Income (loss) per share as reported
Basic.............................. $ (.24) $ .18 $ (1.12)
Pro forma income (loss) per share
Basic.............................. $ (.35) $ .14 $ (1.29)
Income (loss) per share as reported $ (.24) $ .16 $ (1.12)
- - diluted............................
Pro forma income (loss) per share - $ (.35) $ .13 $ (1.29)
diluted..............................
Note 9 -- Employee Stock Purchase Plan
In June 1995, the Company adopted a 1995 Employee Stock Purchase Plan (the
"Purchase Plan"). The Purchase Plan allows eligible employees to purchase Common
Stock, through payroll deductions during a Purchase Period, at a purchase price
that shall be the lesser of (a) 85% of the Fair Market Value of a share of
Common Stock on the first day of such Purchase Period, or (b) 85% of the Fair
Market Value of a share of Common Stock on the exercise Date of such Purchase
Period, as each of such terms are defined in the Purchase Plan. At December 31,
2000, 247,630 shares were issued under the Purchase Plan, of which 51,522 were
issued in 2000.
F-19
In June 1998, the shareholders approved an increase in the number of shares
reserved for issuance under the Plan to 400,000 from 150,000.
Note 10 -- Income Taxes
The provision for income taxes is comprised of the following:
December 31,
------------
1998 1999 2000
---- ---- ----
Federal:
Current................................... $ -- $ -- $ --
Deferred.................................. -- -- --
State:
Current................................... -- (438) (235)
Deferred.................................. -- -- --
----- ----- -----
Total....................................... $ -- $ (438) $ (235)
======= ====== ======
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for tax purposes. Significant components of the
Company's deferred tax balances as of December 31, 1999 and 2000 are as follows:
1999 2000
---- ----
Tax credits.................................... $ 753 $ 933
Net operating losses........................... 2,899 6,908
Capitalized software........................... (698) (158)
Inventory, warranty and other reserves......... 1,283 1,540
Valuation allowance............................ (4,237) (9,223)
------ ------
Total.......................................... -- --
======= =======
During 1999, the Company utilized $1,144 of net operating loss carryover
("NOL") for federal tax purposes. As of December 31, 2000, the Company has NOL
carryovers for Federal income tax purposes of approximately $18,932, which will
begin to expire in 2009. The Company also has research and development tax
credit carryovers for Federal income tax purposes of approximately $632, which
will begin to expire in 2009. In addition, the Company has alternative minimum
tax credits of approximately $76, which can be carried forward indefinitely. The
Company experienced a change in ownership in 1996 and in 2001 as defined by
Section 382 of the Internal Revenue Code. Accordingly, future use of these NOLs
and income tax credits will be limited. (See Note 13.)
As of December 31, 2000, the Company has approximately $9,400 of state NOL
carryforwards which will begin to expire in 2006 and state research and
development tax credit carryforwards of $342.
Under SFAS No. 109, a valuation allowance is established, if based on the
weight of available evidence, it is more likely than not that a portion of the
deferred tax asset will not be realized. Accordingly, a full valuation allowance
has been provided to off-set the Company's net
F-20
deferred tax assets since the Company is in a cumulative loss position. Such
valuation allowance will be reassessed periodically by the Company.
The differences between the provision for income taxes and income taxes
computed using the Federal income tax rate were as follows:
December 31,
-----------
1998 1999 2000
---- ---- ----
Computed tax expense (benefit)................. $ (903) $ 509 $(4,451)
Increase (decrease) in valuation
allowance (use of NOL)......................... 1,131 (682) 4,986
Research and development tax credits........... (228) -- --
Sale of state NOL and R&D credit/other......... -- (265) (770)
---- ---- ----
Actual tax expense (benefit)................... $ -- $ (438) $ (235)
====== ====== =======
During the fourth quarter of 1999, the Company sold approximately $7,100 of
state NOL carryovers and $149 of R&D tax credit carryovers to an unrelated third
party for approximately $438. During the fourth quarter of 2000, the Company
sold approximately $5,189 of state NOL carryovers and $40 of research and
development tax credit carryovers to an unrelated third party for approximately
$235.
Note 11 -- Computation of Basic and Diluted Earnings (Loss) Per Share
The following table sets forth the computation of basic and diluted earnings
(loss) per share:
1998 1999 2000
---- ---- ----
Numerator:
Net income (loss) $ (2,657) $ 1,952 $(12,855)
-------- -------- --------
Denominator:
Denominator for basic earnings per
share-weighted average shares 10,969 11,093 11,490
------ ------ ------
Effect of dilutive securities:
Employee stock options -- 727 --
Warrants -- 158 --
Convertible preferred stock -- -- --
------ ------ ------
-- 885 --
------ ------ ------
Dilutive potential common shares
Denominator for diluted earnings per
share -Adjusted weighted-average shares
and assumed conversion 10,969 11,978 11,490
====== ====== =======
Basic earnings (loss) per share $ (0.24) $ 0.18 $ (1.12)
====== ====== =======
Diluted earnings (loss) per share $ (0.24) $ 0.16 $ (1.12)
====== ====== =======
F-21
Note 12 - Commitments and Contingencies
The Company has adopted a plan whereby senior management will be entitled
to six months severance payments in the event of certain terminations after a
change-in-control of the Company, and an incentive bonus will be paid if such
persons are still in the employ of the Company at the completion of a
change-in-control.
In November 1999, Mark Ish and David Boyle, former executive officers of
the Company, filed a complaint against us and Gregg M. Azcuy, our President and
Chief Executive Officer, in the Superior Court of New Jersey, Law Division,
Monmouth County. By the action, Messrs. Ish and Boyle are seeking compensatory
damages, punitive damages, attorneys' fees, interest and costs for alleged
breach of multiple contracts, fraud and defamation. The Company believes such
claims are without merit and it intends to vigorously defend such actions. The
Company does not believe that the outcome of such litigation will adversely
affect its business.
In late January 2000, we received a subpoena from the United States
Attorney's Office in Boston, Massachusetts for the production of documents in
connection with an investigation into Federal government purchasing. We have
been and intend to continue cooperating with the investigation and are complying
fully, and intend to continue to comply fully, with the subpoena. We sell
computer products to companies which are used by the Federal government to
supply computer products to the U.S. Air Force. In addition, subpoenas have been
received by several of our employees, including certain officers, who are
expected to testify before the grand jury. Not all of such testimony has been
provided. It appears that one avenue of inquiry involves the relationships and
transactions of various suppliers, manufacturers (including us), and other
companies, with companies that provide product and product-related services to
the U.S. Air Force. We understand that the government's inquiry includes a
review of the conduct of such companies and their officers and employees. We
believe that we have not violated any federal laws in connection with our sale
of computer products ultimately received by the U.S. Air Force.
In October 2000, one of the integrators to which we sell our products, KKP
Corp., and its president pled guilty to federal charges of mail fraud and
conspiracy to defraud the United States in connection with the sale of computer
products and related services to the U.S. Air Force. We are referred to in the
court papers (known as the "Information") in such case. The Information states
that the defendants periodically issued invoices to us for fictitious services
to the U.S. Air Force that were never provided and passed such payments along to
co-conspirators. The Information also states that one of the co-conspirators
caused us "to pay a kickback of $500 for each unit sold to the Air Force, with
the proceeds going to the benefit of Co-conspirators." We are not identified as
a co-conspirator in the Information. We believe that we had a reasonable basis
to believe these services to the U.S. Air Force were performed; that all
payments made by us to KKP Corp. were properly authorized; and that we have not
violated any federal laws in connection with our sale of computer products to
KKP Corp. which were ultimately received by the U.S. Air Force.
In October 2000, two employees of a company which assisted the Air Force in
procuring computer-related products and other related parties were indicted on
multiple federal charges, including wire fraud, conspiracy to defraud the United
States and money laundering in connection with the sale of computer products and
related services from several vendors,
F-22
including us, to the U.S. Air Force. The defendants in the Indictment appear to
be the co-conspirators referred to in the Information. We are referred to in the
Indictment in terms similar to the Information. We believe that we had a
reasonable basis to believe the services to the U.S. Air Force billed by some of
the defendants in the Indictment were performed; that all payments made by us to
any of the defendants in the Indictment were properly authorized; and that we
have not violated any federal laws in connection with the our sale of computer
products which were ultimately received by the U.S. Air Force.
In December 2000, the United States Attorney's Office in Boston
Massachusetts advised us through our attorneys that the United States government
has no present intentions of filing charges against us or any of our employees.
We continue to believe that we have not violated any federal laws in connection
with our sale of computer products which were ultimately received by the United
States Air Force.
There are no other individual material litigation matters pending to which
the Company is party or to which any of its property is subject.
Note 13 - Subsequent Events
On November 10, 2000, we sought shareholder approval for the issuance of up
to 6,857,143 shares of 6% cumulative convertible preferred stock Series A to
raise up to an aggregate of $12,000 of gross proceeds. The shareholder meeting
was originally scheduled for November 30, 2000, and was adjourned twice by the
Company to December 22, 2000 in order to give shareholders the maximum
opportunity to vote. The Company was unable, however, to obtain the requisite
quorum to conduct a meeting within the statutory maximum sixty (60) day period.
As the record date for the shareholder meeting was October 26, 2000, the last
day we could hold the meeting was December 25, 2000. The Company did obtain the
sufficient votes on the 61st day, or December 26, 2000. Of those shareholders
responding, an overwhelming 95.1% approved the proposed transaction. Since the
quorum was achieved past the date of the statutory maximum, we believe it was
necessary to apply to Nasdaq for an exception to shareholder approval.
On January 25, 2001, we applied for an exception to Nasdaq Marketplace Rule
4350(i)(1) requiring the Company to receive shareholder approval of an equity
financing when such financing would result in a change of control of the issuer.
On February 22, 2001, Thomas Unterberg rendered his resignation from the
Board of Directors of ECCS, Inc.
On February 23, 2001, Nasdaq determined that an exception from the
shareholder approval requirement was warranted subject to the Company mailing to
all shareholders, no later than ten days before the completion of the financing,
a letter describing the proposed transaction and alerting shareholders to the
Company's omission to seek the shareholder approval that would otherwise be
required. The letter was required to indicate that the Audit Committee of the
Board had expressly approved the exception. In addition, the Company was
required to issue a press release describing the transaction.
F-23
On March 9, 2001, we issued 1,450,000 shares of our 6% Cumulative
Convertible Preferred Stock, Series A (the "Series A Preferred Stock") to
accredited investors for an aggregate gross proceeds equal to $2,900, pursuant
to a private equity placement (the "Private Placement"). The Series A Preferred
Stock has a 6% cumulative coupon and is initially convertible into our Common
Stock on an 8-for-1 basis. The Series A Preferred Stock also has liquidation and
dividend preferences superior to those of existing stockholders. The purchasers
of Series A Preferred Stock also acquired certain anti-dilution and registration
rights. No underwriter was employed by us in connection with the issuance of the
securities in the Private Placement, however, C.E. Unterberg, Towbin ("Unterberg
Towbin") acted as our placement agent. As compensation for its services,
Unterberg Towbin received a fee equal to 78,125 shares of Series A Preferred
Stock, in addition to payment of certain expenses if fully sold. Thomas I.
Unterberg, a former director of the Company, along with certain affiliates of
Mr. Unterberg, purchased 567,500 shares of Series A Preferred Stock on the same
terms and conditions as all other purchasers. Mr. Unterberg also is Chairman,
Managing Director and member of the Executive Committee of Unterberg Towbin. In
addition, the issuance of these shares will be considered a change in ownership
for Federal income tax purposes as defined in Section 382 of the Internal
Revenue Code, thereby limiting the Company's use of its NOL carryforwards.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data including NAS and SAN. In the fourth Quarter of
2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The total amount of SANStar capitalization of $1,988 was written down to $250 in
December 2000. In February 2001, we sold the assets related to the SANStar
technology, including certain patent applications, to Ciprico, Inc. for
aggregate proceeds of approximately $580, including $250 of SANStar
capitalization. The SANStar product did not account for any revenues, but
represented a substantial potion of the engineering costs in 2000.
F-24
Note 14 -- Quarterly Financial Information
Quarterly Financial Information
(unaudited)
1999
Q1 Q2 Q3 Q4 TOTAL
Net sales $9,433 $8,909 $11,737 $9,682 $39,761
Gross profit 2,939 3,200 3,623 3,222 12,984
Net income 73 208 701 970 1,952
Net income per
share-basic 0.01 0.02 0.06 0.09 0.18
Net income per
share-dilutive $ 0.01 $ 0.01 $0.06 $0.08 $0.16
2000
Q1 Q2 Q3 Q4 TOTAL
Net sales $4,607 $4,033 $4,429 $1,953 $15,022
Gross profit (deficit) 1,870 1,120 1,146 (4,382)* (246)
Net loss (1,234) (2,128) (1,833) (7,660) (12,855)
Net loss per
share-basic (0.11) (0.18) (0.16) (0.67) (1.12)
Net loss per
share-dilutive ($0.11) ($0.18) ($0.16) ($0.67) ($1.12)
* Included write-down of capitalized software costs of $1,738 and $.15 on a per
share basis.
F-25
ECCS, Inc. and Subsidiaries
Schedule II - Valuation and Qualifying Accounts
(in thousands)
Column A Column B Column C Column D Column E
Additions
---------
Charged Charged Balance
Balance at to to at
DESCRIPTION Beginning Costs Other Deductions- End of
of Period and Accounts- Describe Period
Expenses Describe
YEAR ENDED December 31, 2000
Allowance for Doubtful
Accounts & Returns/Credits..... $ - - $ 310 $ $ $ 310
Tax valuation.................. $ 4,237 $ $ 4,986(D) $ $9,223
Inventory...................... $ 974 $ 2,523 $ $1,030(B) $2,467
Warranty....................... $ 746 $ 38 $ $ 207 $ 577
YEAR ENDED December 31, 1999
Allowance for Doubtful
Accounts & Returns/Credits..... $ 334 $ -- $ -- $ 334(A) $ --
Tax valuation.................. $ 5,114 $ -- $ -- $ 877(C) $4,237
Inventory...................... $ 785 $ 840 $ -- $ 651(B) $ 974
Warranty....................... $ 523 $ 436 $ -- $ 213 $ 746
YEAR ENDED December 31, 1998:
Allowance for Doubtful
Accounts & Returns/Credits..... $ 297 $ 204 $ -- $ 167(A) $ 334
Tax valuation.................. $ 3,779 $ -- $ 1,335(D) $ -- $5,114
Inventory...................... $ 708 $ 667 $ -- $ 590(B) $ 785
Warranty....................... $ 534 $ 273 $ -- $ 284 $ 523
(A) Amounts written off during the year.
(B) Amounts written off during the year or obsolete inventory sold.
(C) Primarily due to utilization of net operating loss.
(D) Primarily due to increase in net operating loss.
S-1