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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
---------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
--------------------------------------------
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 1-13616
STORAGE COMPUTER CORPORATION
----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0450593
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
11 RIVERSIDE DRIVE NASHUA, NH 03062
-----------------------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(603) 880-3005
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Number of shares outstanding of the registrant's class of common stock, as of
the latest practicable date.
OUTSTANDING AT
CLASS JULY 31, 2002
----- -------------
Common Stock ..................................... 20,232,090
PART I -- FINANCIAL INFORMATION
Page
----
Item 1. Financial Statements (Unaudited).
Consolidated Balance Sheets - June 30, 2002 3
and December 31, 2001.
Consolidated Statements of Operations - Three and six months 4
ended June 30, 2002 and 2001.
Consolidated Statements of Cash Flows - Six months 5
ended June 30, 2002 and 2001.
Notes to Consolidated Financial Statements - June 30, 2002. 6
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings. 17
Item 2. Changes in Securities and Use of Proceeds. 18
Item 3. Defaults Upon Senior Securities. 18
Item 4. Submission of Matters to a Vote of Security Holders. 18
Item 5. Other Information. 18
Item 6. Exhibits and Reports on Form 8-K. 18
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Storage Computer Corporation
Consolidated Balance Sheets
JUNE 30, DECEMBER 31,
2002 2001
---- ----
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 2,399,721 $ 5,627,855
Accounts receivable, net 1,091,170 1,644,366
Inventories 4,063,045 3,811,658
Due from officers and directors 129,710 356,269
Other current assets 541,129 799,530
------------ ------------
Total current assets 8,224,775 12,239,678
Property and equipment, net 712,434 828,817
Goodwill, net 16,973,947 16,973,947
Other intangibles, net 2,838,977 3,272,870
Other assets 1,062,440 394,902
------------ ------------
Total assets $ 29,812,573 $ 33,710,214
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 871,942 $ 802,015
Accrued expenses 2,084,061 1,533,689
Deferred revenue 405,132 492,987
Current maturities of long-term debt 1,048,700 285,254
------------ ------------
Total current liabilities 4,409,835 3,113,945
------------ ------------
Long-term debt, less current maturities 168,947 328,184
------------ ------------
Commitments and contingencies
Redeemable convertible preferred stock 3,827,285 3,725,015
------------ ------------
Stockholders' equity:
Preferred stock 1,426,137 1,178,319
Common stock 19,846 19,135
Additional paid-in capital 78,878,581 76,001,699
Accumulated deficit (58,918,058) (50,656,083)
------------ ------------
Total stockholders' equity 21,406,506 26,543,070
------------ ------------
Total liabilities and stockholders' equity $ 29,812,573 $ 33,710,214
============ ============
See Notes to Consolidated Financial Statements.
-3-
Storage Computer Corporation
Statements of Consolidated Operations (Unaudited)
Three Months Ended Six Months Ended
------------------ ----------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
---- ---- ---- ----
Revenues:
Products and services $ 586,993 $ 950,913 $ 1,352,996 $ 3,010,275
License fees -- -- -- --
------------ ------------ ------------ ------------
Total Revenues $ 586,993 $ 950,913 $ 1,352,996 $ 3,010,275
------------ ------------ ------------ ------------
Costs and expenses:
Cost of products and services 598,440 973,956 1,320,140 2,336,520
Cost of license fees, primarily legal fees 1,305,963 289,241 1,985,077 330,607
Research and development 866,460 1,111,000 1,886,129 2,336,763
Sales and marketing 926,461 1,154,696 1,943,187 1,812,580
General and administrative 726,832 797,674 1,528,361 1,497,446
Amortization of intangibles 193,821 701,938 433,893 1,415,868
------------ ------------ ------------ ------------
Total costs and expenses 4,617,977 5,028,505 9,096,787 9,729,784
------------ ------------ ------------ ------------
Operating loss (4,030,984) (4,077,592) (7,743,791) (6,719,509)
------------ ------------ ------------ ------------
Other income (expense):
Interest income (expense), net (16,197) 77,590 (19,454) 188,668
Other income (expense) (34,590) (12,330) 16,269 102,980
------------ ------------ ------------ ------------
Total (50,787) 65,260 (3,185) 291,648
------------ ------------ ------------ ------------
Loss before income taxes (4,081,771) (4,012,332) (7,746,976) (6,427,861)
------------ ------------ ------------ ------------
Provision (credit) for
income taxes -- (1,889) -- 1,214
------------ ------------ ------------ ------------
Net loss (4,081,771) (4,010,443) (7,746,976) (6,429,075)
Dividends on preferred
stock including
amortization of the
beneficial conversion
features (257,955) (1,905,836) (514,999) (3,495,203)
------------ ------------ ------------ ------------
Net loss applicable to
common stockholders $ (4,339,726) $ (5,916,279) $ (8,261,975) $( 9,924,278)
============ ============ ============ ============
Loss applicable to common
stockholders per basic
and dilutive share $(.22) $(.37) $(.43) $(.64)
============ ============ ============ ============
Basic and dilutive shares 19,571,851 15,777,717 19,375,148 15,593,664
============ ============ ============ ============
See Notes to Consolidated Financial Statements.
-4-
Storage Computer Corporation
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended
----------------
JUNE 30, JUNE 30,
2002 2001
---- ----
Cash flows from operating activities:
Net loss $(7,746,976) $(6,429,075)
Reconciliation to operating cash flows:
Depreciation and amortization of property
and equipment 250,283 256,804
Amortization of goodwill -- 935,724
Amortization of other intangibles 433,893 480,144
Stock issued to 401(k) plan 40,761 20,958
Changes in operating assets and liabilities:
Accounts receivable 553,196 146,455
Inventories (389,483) (191,664)
Due from officers and directors 998,224 --
Other current assets 258,401 3,558
Accounts payable and accrued expenses 415,089 (82,873)
----------- -----------
Net cash used in operations (5,186,612) (4,859,969)
----------- -----------
Cash flows from investing activities:
Capital expenditures (49,445) (109,797)
Other assets (667,538) 126,270
CyberStorage acquisition cost adjustments -- 238,890
----------- -----------
Net cash provided by (used in) investing activities (716,983) 255,363
----------- -----------
Cash flows from financing activities:
Reduction of long-term debt (167,457) (119,227)
Net proceeds from issuance of common stock
for stock options 115,662 8,715
Sale of common stock to investors, net of costs 2,673,614 --
Redemption of preferred stock -- (2,130,548)
----------- -----------
Net cash provided by (used in) financing activities 2,621,819 (2,241,060)
----------- -----------
Effect of exchange rate changes on cash 53,642 (41,288)
----------- -----------
Net decrease in cash and cash equivalents (3,228,134) (6,886,954)
Cash and cash equivalents-beginning of period 5,627,855 14,852,259
----------- -----------
Cash and cash equivalents-end of period $ 2,399,721 $ 7,965,305
=========== ===========
Supplemental cash flow information:
Cash payments of interest $ 35,732 $ 75,444
Preferred stock dividends paid in common stock $ 47,556 $ 333,081
See Notes to Consolidated Financial Statements.
-5-
Storage Computer Corporation
Notes to Consolidated Financial Statements
June 30, 2002
Note A - The Company and Basis of Presentation
Storage Computer Corporation ("Company", "we" and "us") and our subsidiaries are
engaged in the development, manufacture, and sale of computer disk arrays and
computer equipment worldwide. The consolidated financial statements include the
accounts of the Company and those of our wholly-owned subsidiaries CyberStorage
Systems Corporation, Storage Computer Europe GmbH, Vermont Research Products,
Inc., Storage Computer UK, Ltd., and Storage Computer France SAS. All
significant intercompany accounts and transactions have been eliminated in
consolidation. We have a 20% investment in Storage Computer (Asia) Ltd., which
is accounted for by the equity method.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the financial
statements and related notes included in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission, containing our financial statements
for the fiscal year ended December 31, 2001. In management's opinion, the
accompanying financial statements reflect all adjustments, all of which are of a
normal, recurring nature, to fairly present our consolidated financial position,
results of operations and cash flows. The results of operations for the six
months ended June 30, 2002 are not necessarily indicative of the results to be
expected for the full year.
Certain 2001 amounts have been reclassified to conform to the current period
presentation. These reclassifications did not change previously reported total
assets, liabilities, stockholders' equity or net loss.
Note B - Stockholders' Equity
A summary of changes in stockholders' equity for the six months ended June 30,
2002 follows:
Preferred Stock Common Stock
--------------- ------------
Additional Total
Carrying Par Paid-In Accumulated Stockholders'
Shares Value Shares Value Capital Deficit Equity
------ ----- ------ ----- ------- ----------- ------
Balance--December 31, 2001 2,500 $1,178,319 19,134,773 $19,135 $76,001,699 $(50,656,083) $ 26,543,070
Exercise of stock options 84,522 85 115,577 115,662
Stock issued to 401(k) plan 7,137 7 40,754 40,761
Sale of common stock to
institutional investors,
net of costs 600,000 600 2,673,014 2,673,614
Amortization of beneficial
conversion feature of
preferred stock 247,818 (350,088) (102,270)
Dividends on preferred stock 18,507 19 47,537 (164,911) (117,355)
Net loss (7,746,976) (7,746,976)
----- ---------- ---------- ------- ----------- ------------ -----------
Balance-June 30, 2002 2,500 $1,426,137 19,844,939 $19,846 $78,878,581 $(58,918,058) $21,406,506
===== ========== ========== ======= =========== ============ ===========
-6-
Note C - Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. The FASB also
requires, upon adoption of SFAS 142, the Company to reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and ceases
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized.
All of the Company's goodwill and other intangibles resulted from our
acquisition of CyberStorage Systems in 2000 that was accounted for using the
purchase method. In connection with the implementation of SFAS 141 and 142 as of
January 1, 2002, approximately $686,000 of other intangibles has been
reclassified to goodwill. We have ceased amortizing goodwill and determined that
our entire business constitutes one reporting unit for purposes of assessing
potential impairment of goodwill. A fair value approach will be used to test
existing goodwill for impairment. An impairment charge will be recognized for
the amount, if any, which the carrying amount of goodwill exceeds its implied
fair value. We have completed Step 1 of SFAS 142 and deemed a potential
impairment exists. We are in the process of testing for impairment (Step 2 of
SFAS 142) and expect to complete the process in the third quarter of 2002. We
currently do not have any reasonable estimate of the amount of impairment, which
could range from $0 to the entire goodwill being carried at $16,993,947. We have
also reassessed the useful lives of our other intangibles and determined that
they are appropriate. We do not have any other intangibles with indefinite
useful lives.
The effect on 2001 reported net loss and loss per share excluding goodwill
amortization is as follows:
Three months Ended June 30, Six months Ended June 30,
2002 2001 2002 2001
---- ---- ---- ----
Net loss applicable to common
stockholders as reported $(4,339,726) $(5,916,279) $(8,261,975) $(9,924,278)
Goodwill amortization 461,866 935,724
----------- ----------- ----------- -----------
Adjusted net loss excluding
amortization of goodwill in 2001 $(4,339,726) $(5,454,413) $(8,261,975) $(8,988,554)
=========== =========== =========== ===========
Loss applicable to common stockholders
per basic and dilutive share
as reported $ (.22) $ (.37) $ (.43) $ (.64)
Goodwill amortization .03 .06
----------- ----------- ----------- -----------
Adjusted loss excluding
amortization of goodwill in 2001
per basic and dilutive share $ (.22) $ (.34) $ (.43) $ (.58)
=========== =========== =========== ===========
Goodwill amortization expense for the three-month and six-month periods ended
June 30, 2001 was $461,866 and $935,724, respectively. Amortization expense for
other intangibles for the three-month and six-month periods ended June 30, 2002
was $193,821 and $433,893, respectively. Amortization expense for other
intangibles for the three-month and six-month periods ended June 30, 2001 was
$240,072 and $480,144, respectively.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets," which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. This statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of," and APB Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions for
the Disposal of a Segment of a Business." SFAS No. 144 became effective for
fiscal years beginning after December 15, 2001. The Company reviews the carrying
values of its long-lived and identifiable intangible assets for possible
impairment whenever events or changes in circumstances indicate that the
carrying amounts of the assets may not be recoverable. Any long-lived assets
held for disposal are reported at the lower of their carrying amounts or fair
values less costs to sell. The Company has adopted SFAS No. 144 during the first
quarter of 2002 and has determined that the adoption of SFAS No. 144 has had no
impact on its financial position or results of operations for the six-month
period ended June 30, 2002.
-7-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
CAUTIONARY STATEMENT
Forward-looking Statements
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1996 CONTAINS CERTAIN SAFE
HARBORS REGARDING FORWARD-LOOKING STATEMENTS. FROM TIME TO TIME, INFORMATION
PROVIDED BY US OR STATEMENTS MADE BY OUR DIRECTORS, OFFICERS OR EMPLOYEES MAY
CONTAIN "FORWARD-LOOKING" INFORMATION SUBJECT TO NUMEROUS RISKS AND
UNCERTAINTIES. ANY STATEMENTS MADE HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL
FACT ARE FORWARD-LOOKING STATEMENTS INCLUDING, BUT NOT LIMITED TO, STATEMENTS
CONCERNING THE CHARACTERISTICS AND GROWTH OF OUR MARKETS AND CUSTOMERS, OUR
OBJECTIVES AND PLANS FOR FUTURE OPERATIONS AND PRODUCTS AND OUR EXPECTED
LIQUIDITY AND CAPITAL RESOURCES. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON A
NUMBER OF ASSUMPTIONS AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AND,
ACCORDINGLY, ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT MAY CAUSE SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: THE CONTINUED AND FUTURE ACCEPTANCE
OF OUR PRODUCTS; THE RATE OF GROWTH IN THE INDUSTRIES OF OUR PRODUCTS; THE
PRESENCE OF COMPETITORS WITH GREATER TECHNICAL, MARKETING AND FINANCIAL
RESOURCES; OUR ABILITY TO PROMPTLY AND EFFECTIVELY RESPOND TO TECHNOLOGICAL
CHANGE TO MEET EVOLVING CUSTOMER NEEDS; RISKS ASSOCIATED WITH SALES IN FOREIGN
COUNTRIES; AND OUR ABILITY TO SUCCESSFULLY EXPAND OUR OPERATIONS.
INTRODUCTION
This discussion summarizes the significant accounting policies, accounting
estimates and other significant factors affecting the liquidity, capital
resources and result of all operations for the periods ended June 30, 2002 and
2001. The discussion should be read in connection with the Consolidated
Financial Statements and other financial information included in our 2001 Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America. These accounting principles
require management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements. Our management is also
required to make certain judgments that affect the reported amounts of revenues
and expenses during the reporting period. We periodically evaluate our estimates
including those relating to the allowance for doubtful accounts; inventory
reserves for lower of cost or market adjustments, excess quantities and
discontinued products; estimated lives and impairment of tangible and intangible
long-life assets; restructuring costs; litigation and other contingencies. We
base our estimates on historical experience and various other assumptions that
we believe to be reasonable based on the specific circumstances, the results of
which form the basis for making judgments about the carrying value of certain
assets and liabilities that are not readily apparent from other sources. Actual
results could differ from these estimates.
We believe the following critical accounting policies impact the most
significant judgments and estimates used in the preparation of our consolidated
financial statements:
Revenue Recognition
We recognize revenue from product sales at the time of shipment. Revenue from
services is recognized over the contract period or as services are provided.
Revenue from license fees is recognized over the contract period or when
received for fully-paid license agreements. These revenue accounting policies do
not require significant estimates by management.
-8-
Impairment of Goodwill and Intangible Assets
All of the Company's goodwill and other intangibles resulted from our
acquisition of CyberStorage Systems in 2000 that was accounted for using the
purchase method. In connection with the implementation of SFAS 141 and 142 as of
January 1, 2002, we have ceased amortizing goodwill and determined that our
entire business constitutes one reporting unit for purposes of assessing
potential impairment of goodwill. A fair value approach will be used to test
existing goodwill for impairment. An impairment charge will be recognized for
the amount, if any, which the carrying amount of goodwill exceeds its implied
fair value. We have completed Step 1 of SFAS 142 and deemed a potential
impairment exists. We are in the process of testing for impairment (Step 2 of
SFAS 142) and expect to complete the process in the third quarter of 2002. We
currently do not have any reasonable estimate of the amount of impairment, which
could range from $0 to the entire goodwill being carried of $16,993,947. We have
also reassessed the useful lives of our other intangibles and determined that
they are appropriate. We do not have any other intangibles with indefinite
useful lives.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts to reflect the expected
non-collection of accounts receivable based on past collection history and
specific risks identified in our portfolio of receivables. If the financial
condition of our customers deteriorates resulting in an impairment of their
ability to make payments, or if payments from customers are significantly
delayed, additional allowances might be required.
Restructuring Costs
During 2000, we recorded significant restructuring accruals in connection with
the integration of our acquisition of CyberStorage Systems into our existing
business. These accruals included estimated costs to settle certain contractual
obligations, personnel related costs for benefit programs and redundancy, and
charges related to excess inventory quantities and parts for discontinued
products. The majority of our estimates were based on reasonably determinable
facts and circumstances and our actual costs incurred were consistent with our
estimates. During 2001, additional reserves were provided for inventories
related to discontinued products.
Intellectual Property Rights, Contingencies and Litigation
We have a substantial portfolio of patents, claims and other intellectual
property rights. Costs and expenses in connection with the development of and
the enforcement of our rights are expensed when incurred. Certain contingent
fees for legal services are due upon the receipt of license fees over contract
periods or upon receipt of payment for paid-up license arrangements. We
currently are in legal proceedings in connection with the enforcement of our
intellectual property rights the results of which cannot be predicted. Our
failure to successfully enforce our patent rights could have a material adverse
effect on our business, operating results and financial condition.
In the normal course of our business, we are subject to various other
proceedings, lawsuits and claims relating to product, technology, labor and
other matters as further described in Part II, Item 1. Legal Proceedings. We are
required to assess the likelihood of any adverse outcomes and the potential
range of probable losses in these matters. The amount of loss accrual, if any,
is determined after careful analysis of each matter, and is subject to
adjustment if warranted by new developments or revised strategies. We believe
that none of the existing matters will result in a material adverse effect on
our business, operating results and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
Our future success depends on maintaining adequate liquidity and working capital
to meet our operational requirements. On May 3, 2002 we completed a $3,000,000
financing through a private placement of common stock to a group of four
European and US based institutional investors. The Company sold 600,000 shares
of common stock at $5.00 per share and issued 260,000 warrants to purchase
common stock at $6.18 per share that are exercisable over a five-year period.
However, given the continued volatility in the securities markets and, in
particular, the securities of technology companies and our success in
enforcement of our intellectual property rights, we cannot assure you that
continuing investors' investments will be available to us or that we will
receive additional equity financing. Our failure to maintain adequate liquidity
and working capital could have a material adverse impact on our ability to
operate.
We continue to incur operating losses in 2002. While development and
introduction of our new products continues and our marketing and sales
activities have increased, we have implemented cost reductions programs where
possible, primarily in employee headcount and the use of independent software
contractors. We believe that available working capital coupled with the ability
to raise additional equity financing will support our operating plan. We
continue to evaluate opportunities for raising additional financing and believe
that financing will be available on reasonable terms to the Company.
-9-
CASH FLOWS
Our cash flows, cash and cash equivalents, and working capital for the first two
quarters of 2002 and 2001 are summarized as follows:
June 30, 2002 Change March 31, 2002
------------- ------ --------------
(In thousands)
Net cash used in operations .................................. $(5,186) $(3,071) $(2,115)
Net cash used in investing activities ........................ (717) (708) (9)
Net cash provided by financing activities .................... 2,622 2,616 6
Cash and cash equivalents .................................... 2,400 (1,096) 3,496
Working capital .............................................. 3,815 (1,910) 5,725
June 30, 2001 Change March 31, 2001
------------- ------ --------------
(In thousands)
Net cash used in operations .................................. $(4,860) $(2,238) $(2,622)
Net cash provided by investing activities .................... 255 161 94
Net cash used in financing activities ........................ (2,241) (2,182) (59)
Cash and cash equivalents .................................... 7,965 (4,273) 12,238
Working capital .............................................. 9,228 (5,477) 14,705
Cash used in operations in the first six months of 2002 resulted from the net
loss for the first two quarters which was offset in part by net cash from
changes in operating assets and liabilities, non cash charges related to
depreciation and amortization and the repayment of an advance by one of our
officers. The use of cash by operations in the first six months of 2001 resulted
from the net loss for the first two quarters and net cash from changes in
operating assets and liabilities, which were partially offset by non-cash
charges relating to depreciation and amortization.
Cash used in investing activities during the first six months of 2002 relates to
an increase in other assets primarily from an additional restricted cash deposit
of $672,760 placed on account for the defense of our intellectual property
portfolio. Investing activities generated positive cash flow in the first six
months of 2001 from an increase in other assets and an adjustment of the
purchase price of CyberStorage, partially offset by capital expenditures.
Cash provided from financing activities in the first six months of 2002
represents the proceeds of employee stock option exercises and the sale of
common stock to a group of private investors in May 2002, partially offset by
payment of long-term debt. Cash used in financing activities during the first
six months of 2001 relates primarily to the redemption of preferred stock,
partially offset by payment of long-term debt
BORROWING ARRANGEMENTS
We currently have no outstanding bank loans, lines of credit, or credit
facilities.
WORKING CAPITAL
Our working capital at June 30, 2002 was $3,815,000 compared with $9,126,000 at
December 31, 2001. In our opinion, our current working capital position, the
availability of additional equity financing and a reduction of cash flow used by
operations will be sufficient to accommodate our working capital requirements
and to support the Company's operating plan through the fiscal year ending
December 31, 2002.
RESULTS OF OPERATIONS
Our operating results have fluctuated in the past and may in the future
fluctuate significantly, depending upon a variety of factors. After the
acquisition of CyberStorage Systems Corporation in September 2000, we commenced
a corporate-wide restructuring, including the expansion of our North America
sales territories to seven regions; the initiation of a plan to re-establish our
re-seller sales channel; consolidation of our European sales, marketing and
service organizations; and implemented strategic marketing initiatives and
programs for product development and repositioning. We believe these actions and
the introduction of our new products in 2002 will provide the revenue growth
that will enable us to return to profitability. Currently, we are experiencing
an extended cycle for receipt of new orders due to the introduction of our new
sales management and staff persons, the marketing and training cycles related to
the new sales staff and the introduction of our new products as well as the poor
current economic climate for the storage sector.
-10-
Additional factors that may contribute to variability of operating results
include: trends in national and world-wide economic growth or recession; the
pricing and mix of products offered by us; changes in pricing of our products
and services due to competitive pressures; our ability to obtain sufficient
supplies of sole or limited source components; the ability to manage future
growth and expansion; the continual development of new products; the ability to
successfully identify, target, acquire and integrate suitable acquisitions.
REVENUE
Revenues from products and services for the three-month period and six-month
period ended June 30, 2002 were $586,993 and $1,352,996 compared to $950,913 and
$3,010,275 for the respective periods in 2001. Revenues from products and
services in 2001 consisted primarily of our legacy RAID products. In 2002
revenues from products and services are from our new product lines of CyerFiber
that was introduced in late 2001 and CyberNAS that was introduced in the first
quarter of 2002. For the three month period ended June 30, 2002, U.S. domestic
product sales and international product sales were 49% and 51%, respectively, of
total revenues from products and services compared to 45% and 55% for the same
period in 2001. For the six month period ended June 30, 2002, U.S. domestic
product sales and international product sales were 65% and 35%, respectively, of
total revenues from products and services compared to 64% and 36% for the same
period in 2001.
There were no revenues from license fees in the six-month periods ended June 30,
2002 and 2001.
COST OF PRODUCTS AND SERVICES
Product and service costs for the three month period and six month period ended
June 30, 2002 were $598,440 and $1,320,140, or 102% and 98% of revenue from
products and services, compared to $973,956 and $2,336,520, or 102% and 78% of
revenue from products and services for the respective periods in 2001. The cost
percentage between the three-month periods ended June 30, 2001 and 2002 remained
relatively consistent as a result of decreased sales, while factory overheads
and technical service costs remained consistent. The increase in the cost
percentage between the six-month periods ended June 30, 2001 and 2002 of
approximately 20% was a direct result of decreased sales, while factory
overheads and technical service costs remained relatively consistent with the
same period in the prior year.
GROSS PROFIT
Gross profit on the sale of products and services is summarized as follows:
Six months ended Three months ended
June 30, 2002 March 31, 2002
------------------- --------------------
(In thousands except for % of sales amounts)
Gross profit ............. $33 2.4% $44 5.8%
Six months ended Three months ended
June 30, 2001 March 31, 2001
------------------- --------------------
(In thousands except for % of sales amounts)
Gross profit ............. $674 22.4% $697 33.8%
Gross profits were reduced in 2002 primarily due to reduced sales only partially
offset by reduced overhead costs.
COST OF LICENSE FEES
Costs associated with the enforcement of our patent and other intellectual
property rights for the three month period and six month period ended June 30,
2002 were $1,305,963 and $1,985,077 compared to $289,241 and $330,607 for the
respective periods in 2001. These costs relate to legal fees for foreign counsel
and consulting fees and expenses incurred associated with the enforcement of our
patent and other intellectual property rights that began to increase during the
second quarter of 2001 and increased substantially in the three-months ended
June 30, 2002 due to the Court proceedings in the United Kingdom.
RESEARCH AND DEVELOPMENT
Research and development expenses for the three month period and six month
period ended June 30, 2002 were $866,460 and $1,886,129 compared to $1,111,000
and $2,336,763 for the respective periods in 2001. The $450,634 decrease in
expenditures between the six-month periods was due to the decrease in the
utilization of independent software engineers and other subcontractors for
short-term assignments. Research and development expenses for the three-month
period ended June 30, 2002 decreased over the prior quarter of 2002 due to the
reduction of internal staff and the utilization of independent software
engineers.
-11-
SELLING AND MARKETING EXPENSES
Selling and marketing expenses for the three month period and six month periods
ended June 30, 2002 were $926,461 and $1,943,187 compared to $1,154,696 and
$1,812,580 for the respective periods in 2001. The increase in expenses between
the six month periods ended June 30, 2002 and the comparable period of 2001 of
$73,549, was principally due to the increased head count in corporate marketing
and staffing of the field sales organizations.
GENERAL AND ADMINSTRATIVE EXPENSES
General and administrative expenses for the three month period and six month
periods ended June 30, 2002 were $726,832 and $1,528,361 compared to $797,674
and $1,497,446 for the respective periods in 2001. The increase in general and
administrative expenses between the six month periods ended June 30, 2001 and
2002 of $30,915 resulted primarily from an increase in the allowance for
doubtful accounts and increased legal fees relating to equity financing and
other corporate matters.
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLES
In connection with the implementation of SFAS 142, we ceased amortizing goodwill
as of January 1, 2002. Goodwill amortization expense for the three-month and
six-month periods ended June 30, 2001 was $461,866 and $935,724, respectively.
Amortization expense for other intangibles for the three-month and six-month
periods ended June 30, 2002 was $193,821 and $433,893, respectively.
Amortization expense for other intangibles for the three-month and six-month
periods ended June 30, 2001 was $240,072 and $480,144, respectively
OTHER INCOME (EXPENSE)
Interest income (expense), net was $(16,197) and $(19,454) for the three-month
and six-month periods ended June 30, 2002 compared to $77,590 and $188,668 for
the respective periods in 2001. The reduction in interest income is directly
related to reduced cash balances when compared to the same period last year.
Interest expense has remained relatively constant during both periods.
Other income relates primarily to translation adjustments that decreased in the
current period due to reduced changes in translation rates.
-12-
FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR STOCK PRICE IS EXTREMELY VOLATILE
Our stock price, like that of other technology companies, is subject to
extremely significant volatility because of factors such as:
- the announcement of new products, services or technological
innovations by our competitors or us
- quarterly variations in our operating results
- changes in revenue or earnings estimates by the investment community
- speculation in the press or investment community
- failure to meet earning expectations
- the results of intellectual property litigation
In addition, our stock price may be affected by general market conditions, short
selling activities, and domestic and international economic factors unrelated to
our performance. Further, until recently, our common stock was thinly traded.
Because of these factors, any recent trend should not be considered reliable
indicators of future stock prices or financial results.
OUR BUSINESS MAY SUFFER IF WE CANNOT PROTECT OUR INTELLECTUAL PROPERTY
We generally rely upon patent, copyright, trademark and trade secret laws and
contract rights in the United States and in other countries to establish and
maintain our proprietary rights in our technology and products. However, we
cannot assure you that any of our proprietary rights will not be challenged,
invalidated or circumvented. In addition, the laws of certain countries do not
protect our proprietary rights to the same extent, as do the laws of the United
States. Therefore, we cannot assure you that we will be able to adequately
protect our proprietary technology against unauthorized third party copying or
use, which could adversely affect our competitive position. Further, we cannot
assure you we will be able to obtain licenses to any technology that we may
require to conduct our business or that, if obtainable, such technology can be
licensed at a reasonable cost.
INTELLECTUAL PROPERTY RIGHTS
We are aggressively pursuing the enforcement of our intellectual property rights
after an extensive patent review conducted in 1999. In 2000, we retained a major
law firm to enforce these rights against infringing parties, the number of which
management believes to be extensive. In 2001, we began bringing legal actions
against companies whose products we believed infringed on our intellectual
property rights and patent portfolio. We intend to vigorously pursue these
actions. Despite our and our legal representatives' efforts, there can be no
assurance or predictability as to any amount of recovery or the length of time
it will take us to recover any royalties or license fees which may be
recoverable. Despite our efforts to protect our intellectual property rights,
unauthorized use may still occur, particularly in foreign countries.
DEVELOPMENT OF NEW PRODUCTS AND SOLUTIONS
We must make continuous investment in research and development to maintain our
ongoing effort to continually improve our products and provide innovative
solutions to our customers. The development of software products is a difficult
and costly process and subject to many other products' requirements. Our
inability to timely deliver new products in the past has had an adverse effect
on our operating and financial results. There can be no assurance that we will
be able to effectively develop new products in the future.
COMPETITION
We compete with many established companies in the computer storage and server
industries and certain of these companies have substantially greater financial,
marketing and technological resources, larger distribution capabilities, earlier
access to customers and more opportunity to address customers' various
information technology requirements than we do. Our business may be adversely
affected by the announcement or introduction of new products by our competitors,
including hardware, software and services, price reductions of our competitors'
equipment or services and the implementation of effective marketing strategies
by our competitors.
-13-
Competitive pricing pressures exist in the computer storage and server markets
and have had and may in the future have an adverse effect on our revenues and
earnings. There also has been and may continue to be a willingness on the part
of certain competitors to reduce prices in order to preserve or gain market
share, which we cannot foresee. We currently believe that pricing pressures are
likely to continue. The relative and varying rates of product price and
component cost declines could have an adverse effect on our earnings.
RAPID TECHNOLOGICAL CHANGES
The computer industry is changing both dramatically and rapidly. The development
of "open systems computing", the introduction of the Internet, new fiber
technologies (SAN) and the increasing storage density in disk drive
technologies, have caused an increase in new product development and shorter
time to bring the new products to market. While we believe that our Virtual
Storage Architecture, StorageSuite and CyberBORG products are advanced when
compared to competitive products, and complement many other products utilized in
total customer solutions, we cannot assure you that this will continue in the
future. The failure to remain consistently ahead of competitive technologies
would have a negative impact on our operating results and financial condition.
BUSINESS ALLIANCES
Many companies are forming business alliances with their competitors, to be able
to provide totally integrated storage solutions to their customers. One result
of these alliances is to effectively preclude competitive products from being
offered to their customers. Many of the relationships are exclusive and our
failure to develop similar relationships will effectively reduce the number of
qualified sales opportunities we will have for our products in the future. We
believe that we address this issue by our return to the reseller channel sales
model and having the integrator/solution providers/value added-resellers perform
the solution selling required. Our failure to open these sales channels will
have a negative effect on our operating results and financial condition.
OPERATIONS
Our products operate near the limits of electronic and physical performance, and
are designed and manufactured with relatively small tolerances. If flaws in
design, production, assembly or testing were to occur by our suppliers, or us we
could experience a rate of failure in our products that would result in
substantial repair or replacement costs and potential damage to our reputation.
Continued improvement in manufacturing capabilities and control of material and
manufacturing quality and costs are critical factors in our future growth. We
frequently revise and update manufacturing and test processes to address
engineering and component changes to our products and evaluate the reallocation
of manufacturing resources among our facilities. We cannot assure that our
efforts to monitor, develop and implement appropriate test and manufacturing
processes for our products will be sufficient to permit us to avoid a rate of
failure in our products that results in substantial delays in shipment,
significant repair or replacement costs and potential damage to our reputation,
any of which could have a material adverse effect on our business, results of
operations or financial condition.
Additionally, most companies in the high technology arena are under pressure to
be able to acquire and retain the services of talented individuals. At present,
there is a shortage in the number of qualified employees who are available,
creating a lucrative job market for qualified and talented high tech employees.
We have had a decline in revenue in each of the three previous years and
comparable reduction in our work force. While we believe that we have the
required core personnel to effectively manage and grow, we cannot assure you
that key employees will not leave the company in the future. The failure to
maintain key employees could adversely affect our future operating and financial
results.
LIQUIDITY AND WORKING CAPITAL
Our future success depends on maintaining adequate liquidity and working capital
to meet our operational requirements. On May 3, 2002 we completed a $3,000,000
financing through a private placement of common stock to a group of four
European and US based institutional investors. The Company sold 600,000 shares
of common stock at $5.00 per share and issued 260,000 warrants to purchase
common stock at $6.18 per share that are exercisable over a five-year period.
However, given the continued volatility in the securities markets and, in
particular, the securities of technology companies and our success in
enforcement of our intellectual property rights, we cannot assure you that
continuing investors' investments will be available to us or that we will
receive additional equity financing. Our failure to maintain adequate liquidity
and working capital could have a material adverse impact on us.
We continue to incur operating losses in 2002. While development and
introduction of our new products continues and our marketing and sales
activities have increased, we have implemented cost reductions programs where
possible, primarily in employee headcount and the use of independent software
contractors. Management believes that available working capital coupled with the
ability for raising additional equity financing will support the Company's
operating plan. We continue to evaluate opportunities for raising additional
financing and believe that such will be available on reasonable terms to the
Company.
-14-
FAILURE OF SUPPLIERS TO PROVIDE QUALITY PRODUCTS
We purchase several sophisticated components and products from one or a limited
number of qualified suppliers. These components and products include disk
drives, high-density memory components and power supplies. We have experienced
delivery delays from time to time because of high industry demand or the
inability of some vendors to consistently meet our quality and delivery
requirements. If any of our suppliers were to fail to meet the quality or
delivery requirements needed to satisfy customer orders for our products, we
could lose time-sensitive customer orders and have significantly decreased
quarterly revenues and earnings, which would have a material adverse effect on
our business, results of operations or financial condition. Additionally, we
periodically transition our product line to incorporate new technologies. The
importance of transitioning our customers smoothly to new technologies, along
with our historically uneven pattern of quarterly sales, intensifies the risk
that a supplier who fails to meet its delivery or quality requirements will have
an adverse impact on our revenues and earnings.
CHANGES IN LAWS, REGULATIONS OR OTHER CONDITIONS THAT COULD ADVERSELY IMPAIR OUR
CONDITION
Our business, results of operations and financial condition could be adversely
affected if any laws, regulations or standards, both foreign and domestic,
relating to our products or us were newly implemented or changed.
LITIGATION THAT WE MAY BECOME INVOLVED IN MAY ADVERSELY AFFECT US
In the ordinary course of business, we may become involved in litigation,
administrative proceedings and governmental proceedings. Such matters can be
time-consuming, divert management's attention and resources and cause us to
incur significant expenses. Furthermore, we cannot assure you that the results
of any of these actions will not have a material adverse effect on our business,
results of operations or financial condition.
WE MAY NOT BE SUCCESSFUL IN OUR PATENT LITIGATION
We have been extremely aggressive and active in the legal enforcement of our
worldwide intellectual property rights. The outcome in the Hitachi and Veritas
unresolved patent proceedings cannot possibly be predicted, but we intend to
vigorously pursue the enforcement of our intellectual property rights and our
claims in these actions and against other manufacturers whose products we
believe infringe on our patents and intellectual property rights. Our failure to
successfully enforce our patent rights could have a material adverse effect on
our business, operating results and financial condition.
-15-
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We have the market risk inherent in financial instruments that relates primarily
to fluctuations in the prime rate of interest to be charged under the terms of
several promissory notes due from and to certain of our executive officers and
directors.
Our foreign subsidiaries' obligations to us are denominated in U.S. dollars.
There is a potential for a foreign currency gain or loss based upon fluctuations
between the U.S. dollar and its subsidiaries' functional currencies, currently
the British pound and Eurodollars. This exposure is limited to the period
between the time of accrual of such liability to us in our subsidiaries'
functional currency and the time of their payment to us in U.S. dollars.
Other than the inter-company balances noted above, we do not believe we have
material unhedged monetary assets, liabilities or commitments that are
denominated in a currency other than the operations' functional currencies. We
expect such exposure to continue until our foreign subsidiaries reach a more
mature level of operation. We currently have no plans to utilize any derivative
products to hedge our foreign currency risk.
- 16 -
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
In December 2001, Marketlink Technologies, LLC filed a civil action against us
in the Circuit Court for Oakland County, Michigan, alleging that we owed them a
$156,000 termination payment under the terms of a manufacturers representative
agreement that we terminated for cause in April 2001 because of Marketlink's
inability to sell our products and perform the services required by the
agreement. In January 2002, we filed counterclaims against Marketlink in this
matter, including Marketlink's breach of contract. We believe the claims of
Marketlink are without merit and deny all allegations. Further, we intend to
vigorously defend this action. A trial date has not been set by the court and
the action is currently in its discovery phase. We are unable to predict the
outcome but we do not believe that our involvement in final settlement of or
litigation costs defending this claim will have a material effect on our
business, operating results or financial condition.
During March 2001 we filed legal actions against Hitachi Data Systems Limited in
the United Kingdom for infringement of two of the European patents in our
intellectual property portfolio. The trial was completed in July 2002 and we are
awaiting the judge's decision on the merits as to the validity of the two
patents and Hitachi's infringement of these patents, and we have recently been
advised that the decision will be rendered on August 21, 2002.
In October 2001, we filed a patent infringement action in the United States
District Court for the Northern District of Texas, against Veritas Software
Corporation and Veritas Software Global Corporation, alleging that certain
Veritas Software Corporation storage products infringe Storage Computer's
intellectual property patent number U.S. 5,893,919 entitled "Apparatus and
Method for Storing Data with Selectable Data Protection Using Mirroring and
Selectable Parity Inhibition." In February 2002, we filed an additional patent
infringement action in the United States District Court of the Northern District
of Texas, against Veritas Software Corporation and Veritas Software Global
Corporation alleging that certain Veritas Software Corporation storage products
infringe Storage Computer's intellectual property, specifically U.S. 5,257,367
entitled "Data Storage system with Asynchronous Host Operating System
Communication Link". These actions were referred to a court appointed mediator
with a mediation date in late April 2002 and such mediation has been continued
to a mutually agreeable time and place, sometime in the third quarter of 2002.
In March 2002, we filed a third patent infringement action against Veritas
Software Corporation and Veritas Software Global Corporation alleging certain
Veritas Software Corporation storage products infringe Storage Computer's
intellectual property patent number U.S. 6,098,128 entitled "Universal Storage
Management System." The Storage Computer claim is for injunctive relief, damages
and legal costs arising from the alleged infringement.
The outcome in the Hitachi and Veritas unresolved patent proceedings cannot
possibly be predicted, but we intend to vigorously pursue the enforcement of our
intellectual property rights and our claims in these actions and against other
manufacturers whose products we believe infringe on our patents and intellectual
property rights. Our failure to successfully enforce our patent rights could
have a material adverse effect on our business, operating results and financial
condition.
We are involved from time to time in various other minor legal actions in the
ordinary course of our business, which we believe do not have a material adverse
effect on our business, operating results or financial condition.
-17-
Item 2. Changes in Securities and Use of Proceeds.
On May 3, 2002 the Company completed a $3,000,000 financing through a private
placement of common stock to a group of four European and US based institutional
investors. The Company sold 600,000 shares of common stock at $5.00 per share
and issued 260,000 warrants to purchase common stock at $6.18 per share that are
exercisable over a five-year period.
Item 3. Defaults Upon Senior Securities.
There has not been any material default in the payment of principal, interest,
or any other material default not cured within 30 days with respect to any of
our indebtedness during the six month period ended June 30, 2002.
Item 4. Submission of Matters to a Vote of Security Holders.
At our Annual Meeting of Stockholders held on June 7, 2002 the following
matters were voted:
Proposal 1 - The following individuals were elected to the Board of Directors:
Votes For Votes Withheld
--------- --------------
Theodore J. Goodlander 18,735,080 47,129
Edward A. Gardner 18,752,980 47,229
Steven S. Chen 18,736,495 63,714
Roger E. Gauld 18,765,064 35,145
John Thonet 18,752,980 47,229
Thomas A. Wooters 18,765,564 34,645
Proposal 2 - The vote to ratify the action of the Board of Directors in
appointing BDO Seidman, LLP as the Company's auditors for the year ending
December 31, 2002 was:
Votes For Votes Against Votes Withheld
--------- ------------- --------------
17,802,337 9,616 5,090
Item 5. Other Information.
On July 12, 2002, Company's Board of Directors approved the implementation of
the 2002 Short-Term Deferred Compensation Plan under which all employees may
chose to defer up to 75% of their salary for a six month period to be paid at
the conclusion of the Plan in cash or in common stock based on the closing price
of the Company's common stock on the American Stock Exchange on that day of
$2.10 per share.
On July 19, 2002, the Compensation Committee of the Company's Board of Directors
approved the re-pricing of all outstanding out-of-the-money stock options to
$1.37 per share, based on the closing price of the Company's common stock on the
American Stock Exchange on that day.
Item 6. Exhibits and Reports on Form 8-K.
A Exhibits
Number Description
------ -----------
99.1 Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906
of the Sarbanes - Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section
1350, as Adopted Pursuant to Section 906
of the Sarbanes - Oxley Act of 2002.
B Reports On Form 8-K
None.
-18-
SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
STORAGE COMPUTER CORPORATION
----------------------------
Registrant
/s/ PETER N. HOOD
-----------------
Peter N. Hood
Chief Financial Officer
Date: August 14, 2002
-19-