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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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, 1998
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 Jurisdiction of I.R.S. Employer Identification No.)
Incorporation or Organization)
One Sheila Drive, Tinton Falls, New Jersey
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(Address of Principal Executive Offices)
(732) 747-6995
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(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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- ------------------------ -----------------------------------------
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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: $11,597,948 at February 26, 1999 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 26, 1999:
Class Number of Shares
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Common Stock, $.01 par value 11,027,084
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 1999 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.................................................. 1
2. Properties................................................ 13
3. Legal Proceedings......................................... 14
4. Submission of Matters to a Vote of Security Holders....... 14
PART II 5. Market For the Company's Common Equity and Related
Shareholder Matters....................................... 15
6. Selected Consolidated Financial Data...................... 17
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 18
8. Financial Statements and Supplementary Data............... 28
9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure....................... 28
PART III 10. Directors and Executive Officers of the Company........... 29
11. Executive Compensation.................................... 29
12. Security Ownership of Certain Beneficial Owners
and Management............................................ 29
13. Certain Relationships and Related Transactions............ 29
PART IV 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................... 30
SIGNATURES................................................................ 31
EXHIBIT INDEX............................................................. 33
FINANCIAL STATEMENTS...................................................... F-1
-i-
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" or the "Company") 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: component quality and
availability, changes in business conditions, Year 2000 compliance of the
Company's and other vendors' products and related issues, including impact of
the Year 2000 problem on customer buying patterns, 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.
PART I
Item 1. Business.
General
ECCS provides intelligent solutions to store, protect and access mission
critical information for the Open Systems and related markets. The Company
designs, manufactures and sells high performance, fault tolerant data storage
solutions for a wide range of customer requirements. ECCS' flagship product,
Synchronix, which the Company began selling in 1996, is a full feature fault
tolerant RAID (redundant array of independent disks) product family designed for
use in NT and UNIX clustered environments. The Company's products are compatible
with most Open System computing platforms and enable customers to store, protect
and access data and to centralize data management functions across an
organization's disparate computer environments.
ECCS' core technology provides data-intensive environments with protection
against the loss of critical data and provides performance and reliability
characteristics of a mainframe, at a fraction of the cost. The Company's
products offer users (i) fast data transfer rates by spreading and retrieving
data simultaneously among various disk drives, (ii) fault tolerance through the
use of redundant components that can be "hot swapped" during repair and (iii)
high storage capacity.
From its founding until 1994, the Company's principal business was the
value added resale of NCR products. Sales to AT&T business units made up a large
portion of such business. During 1994, as a result of AT&T's acquisition of NCR
and subsequent change in its purchasing policies, the Company undertook a
product development initiative to reposition the Company as a provider of
proprietary mass storage enhancement products. A number of products have
resulted from these efforts including Synchronix and Synchronection, a fault
tolerant network file server. During 1997 and 1998, approximately 93% and 96% of
the Company's sales were derived from sales of the Company's proprietary
products, respectively. The Company was incorporated in New Jersey in February
1980 under the name The Word Store, Inc. The Company's name was changed to ECCS,
Inc. in November 1985. Unless the context otherwise requires, the terms
"Company" and "ECCS" refer to ECCS, Inc. and its subsidiaries. The address of
the Company's principal corporate offices is One Sheila Drive, Tinton Falls, New
Jersey 07724, and its telephone number is 732-747-6995.
"RAID 10 Performance Manager," "Intelligent Rebuild," "Split Mirror,"
"Examodule," "Synchronix," "Inverse Mirroring," "Synchronection" and "Split
Volume" are United States trademarks of the Company. All other trade names,
trademarks or service marks appearing in this Annual Report on Form 10-K are the
property of their respective owners and are not the property of the Company.
Industry Background
In response to competitive pressures, businesses and other organizations
have become increasingly dependent on their computing resources which enable
these organizations to increase productivity through the distribution of
computing power across their enterprise, providing large numbers of users with
access to applications, information and data. In this environment, it has become
important for organizations to manage the storage of and access to large volumes
of data, which increasingly represent critical information resources.
These "data-intensive" computing environments require large volumes of
data, perform intensive processing and involve frequent user access to data.
Increasingly, organizations are deploying data-intensive applications and
services as core business resources. In addition, Internet and on-line server
related businesses have grown significantly. The data-intensity of the network
environment is expected to continue to increase substantially due to the
development of new applications and services and the more prevalent use of
stored digital graphic, voice and video, requiring dramatically more data
capacity than equivalent alphanumeric information. The increased data intensity
of computing environments has created demand for fault tolerant features which
are now being included in standard operating systems, including Windows NT.
In this context, data management has become increasingly complex and
challenging. For data-intensive environments, three significant requirements
have emerged: (i) data access performance, (ii) data administration and (iii)
data availability and reliability.
Data Access Performance. Traditionally, management information systems
managers and network providers improved performance on a network by increasing
central processing unit ("CPU") performance or increasing the underlying network
bandwidth. In data-intensive network
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environments, performance of applications and services is increasingly limited
by the time to read or write to hard disk drives. Improvements in performance
for most applications and services have been limited by disk I/O performance,
which because of the mechanical nature of disk drives, has not improved as
rapidly as CPU performance or network bandwidth.
Data Administration. A key requirement in data administration is the
management of hardware and software systems that store data. In the
data-intensive network environment, data management is difficult and complex due
to the large number of users accessing the data, the multiple servers storing
the data and the large volume of data. Furthermore, because data may be widely
distributed throughout the network, administrative functions such as back-up or
expansion of the file system become substantially more difficult. Finally, the
budgetary constraints of most organizations require that this increasingly
complex administration be accomplished cost-effectively, without increased
staffing.
Data Availability and Reliability. As the data-intensive network
environment grows, data availability becomes critical to the organization's
productivity, time-to-market and responsiveness to customers. Achieving a high
level of data availability is particularly difficult because hard disk drives
are mechanical devices, which are prone to failure over extended periods of
intensive use. An organization may experience costly down-time or loss of data
from the failure of a single low-cost, network-attached disk drive. This is
particularly important to network service providers whose business is providing
network-stored data to their user. Therefore, it is imperative that systems
which are repositories of network-based data and services have low failure
rates, rapid recovery times and the ability to provide uninterrupted service in
the event of failure of a disk drive. Organizations often improve data
reliability through the use of RAID technology, which consists of using parallel
disk drives that work together as a single unit. RAID technology provides
data-intensive Open Systems with protection against the loss of critical data in
addition to the performance and reliability characteristics of a mainframe, at a
fraction of the cost.
The ECCS Approach
ECCS designs, manufactures and markets a comprehensive range of high
performance, user-definable, fault tolerant storage subsystems for Open Systems
and proprietary systems needs. The Company believes that its proprietary mass
storage enhancement products provide a level of performance or features not
generally available from competitors.
The following are the key attributes of the ECCS approach:
High Level of Data Access Performance. The Company's product offerings
address RAID's inherent performance limitations relating to the speed of data
access. The Company's products are designed to provide a high level of data
access performance through the utilization of (i) multiple RAID levels on a wide
variety of disks that possess varying performance characteristics, (ii) larger
and upgradeable cache size to improve speed by avoiding the need for mechanical
access to RAID, (iii) solid state disks for dedicated memory for frequently
accessed information and (iv) proprietary technology for different software
applications.
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Improved Data Administration Capabilities. The Company's products utilize
an intuitive, customizable Graphical User Interface (GUI) which allows for the
monitoring and management of virtually all systems functions, including
configuration, cache policies and data rebuild. These features allow for the
management of data by both sophisticated and unsophisticated users.
Enhanced Data Availability. The Company's products enhance data
availability by offering array-based failover, complete fault tolerance,
multiple host connectivity across various Open Systems platforms, on-line
firmware upgrades, on-line systems maintenance and hot-swappable component
replacement. The Company's array-based failover enables failover protection at
the storage array without host intervention.
Scalability. The Company's products provide maximum scalability as a
customer's needs change by using a modular approach in designing and configuring
its storage solutions. Customers can purchase from 10 to 90 disk drives per
footprint. This scalability allows the Company to provide solutions for a broad
range of storage requirements, from low capacity users to enterprise-wide
environments.
Host or Network Attached. The Company's products allow users the choice of
either direct attachment to a host/platform or a fault tolerant network attached
storage device.
Strategy
ECCS' objective is to further establish and solidify its position in the
rapidly growing Open Systems fault tolerant storage market. The Company's
strategic focus centers around serving users whose mission critical applications
require high performance and high reliability storage products. The Company's
strategy incorporates the following key elements: develop and broaden end user
sales revenues of all its products; increased focus on fault tolerant network
attached storage, focus on furthering the development of clustering technologies
and distributed file systems that offer unique value-added features; broaden its
marketing penetration into the Federal business sector; continue to pursue
alternate channels of sales for the Company's products; and protect its
technological edge.
The Company continues to focus on offering superior, value-added product
features to the Open Systems storage market. The Company is developing products
to meet this objective and plans to make several enhancements to its product
offerings this year.
First Mover Position in Emerging Technologies. The Company intends to
continue to establish itself as the data storage solution of choice for emerging
clustering technologies such as Microsoft Cluster Server technology (MSCS). In
addition, the Company has started development of new technologies that will
offer control of files at the storage system level. If successful, this
development would enable the Company to offer file management features superior
to product offerings available in the industry today. The Company also plans to
develop several product features to enhance performance, backup and storage
control.
Sales to End Users. The Company will place emphasis on the marketing of
fault tolerant network-attached storage products developed by the Company which
incorporate the Synchronix
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family systems. Network-attached products are increasingly gaining acceptance as
a method to attach storage. The Company believes that its network-attached
storage products offer significant value compared to other available offerings.
The Company anticipates that increased sales of its network-attached products
will provide an increased momentum and referral base necessary for the Company
to successfully implement this strategy. The Company will continue to offer all
of its other fault tolerant products, Synchronix 1000 and 2000, Raven, and
vanity-based solutions to this market. The end user sales organization is being
increased in order to focus sales efforts on commercial and government end user
accounts. Direct sales generally carry higher gross margins.
Federal Sales. The Company has maintained a significant volume of sales to
the Federal Government, principally the U.S. Air Force through several Federal
integrators. The Company plans to broaden its sales base to include additional
Federal Government entities by establishing direct contact with such entities in
conjunction with the use of select Federal Government resellers. In 1998, the
Company had limited sales to other Federal Government entities, including the US
Navy. The Company will continue to develop products that meet the anticipated
needs of these customers.
Protect Technological Edge. ECCS intends to continue to improve upon its
current products as well as develop, or acquire for resale, new product for data
storage. The Company believes that it possesses substantial technical expertise
gained through years of internal research and development. ECCS holds several
patents on its RAID controller and associated technology. ECCS believes that its
development efforts have produced a product line with advanced features and
functionality that provide it with a competitive advantage in the marketplace.
The Company further believes that its position as an innovator of fault tolerant
storage systems will continue due to its ongoing investment in engineering and
the Company's understanding of its customers changing needs.
Alternate Channel Sales. The Company markets its products to several
organizations that provide their own sales forces to resell the Company's
products. These efforts offer the Company significant revenue opportunities. The
use of alternate channel partners provides the Company increased visibility in
the industry, additional marketing opportunities and the ability to leverage
additional sales organizations.
The Company continues its efforts to market its products to larger OEM
companies and believes that several of its products under development will
attract the interest of these customers. The Company's OEM sales efforts are
divided into two broad groups through which the Company markets its products
and/or services.
o Resellers and Value Added Resellers (VARs) - The Company has several
resellers that it currently engages to resell the Company's full line of
products. These resellers augment the end user effort and contribute to the
revenue goals of the Company. The Company actively focuses on identifying
resellers that will be able to take advantage of the Company's products
and/or offer additional services to end users.
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o OEMs - In addition to its relationship with Unisys and Tandem, the Company
continues efforts to establish potential OEM relationships for versions of
all of its product lines. There can be no assurance, however, that such
additional relationships will be established, or if established, that they
will decrease the Company's reliance on the established relationships.
The Company is actively pursuing each element of its strategy. No assurance
can be given, however, as to when or if these goals will be achieved.
Products and Technology
The Company's family of mass storage enhancement products includes fault
tolerant RAID products, external disk, optical and tape systems and internal
disk and tape storage devices and storage related software. The Company designs
its fault tolerant RAID products to comply with standards adopted by the
industry and the RAID Advisory Board.
All the Company's products are compatible with the SCSI (Small Computers
Systems Interface) protocol, an industry standard interface for peripheral
devices supported by the vast majority of computer manufacturers, as well as
with SCSI 2, an enhancement of the SCSI protocol and fiber protocol. The
Company's products operate with many major Open Systems hardware platforms and
operating systems environments.
Recent advances in the speed and capacity of servers in network
environments often have exceeded the growth in capability of traditional
off-the-shelf storage systems. In anticipation of and in response to these
industry trends, the Company has focused its product development efforts on
advanced storage products including the following:
Synchronix is a full feature product family designed for use in UNIX and NT
environments, including Microsoft Cluster Server and UNIX clustered
environments. Synchronix features a high performance, fault tolerant
architecture to satisfy large-scale, mission critical applications for Open
Systems environments, redundant controllers, cross-platform and dual host
support, cache management, hot swappable components and array-based automatic
server failover, and provides a scalable, continuously available feature
flexible data storage solution. The Synchronix family, which supports RAID
levels 0, 1, 3, 5 and 10, also includes varying offerings of the Synchronix
Storage Management Subsystem, which provide concurrent, user-definable
implementations of RAID fault tolerance and non-RAID configurations. The
Synchronix family of products provides ECCS' customers with a GUI which allows
for the monitoring and management of virtually all systems functions, including
configuration, cache policies, data rebuild and load balancing. The Company has
received the Fault Tolerant Disk System+ (FTDS+) rating from the RAID Advisory
Board for the Synchronix Storage System. ECCS' product is one of only three
products to have received this fault tolerant rating at this time. Synchronix
can be configured to provide capabilities ranging from just an array of
independent disks through multiple levels of RAID and can incorporate advanced,
easy to utilize storage management and system administration capabilities.
Synchronix became commercially available in the first quarter of 1996.
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During 1998, the Company announced the introduction of the Synchronix 2000,
the Company's next generation of high performance, continuously available data
storage system. In addition to the original Synchronix features and
functionality, the Synchronix 2000 has been uniquely packaged using independent
controller enclosures known as the Array Controller Enclosure (ACE) and separate
disk drive array packaging or Disk Array Enclosure (DAE). The Company believes
that the use of redundant active/active RAID controllers with dual Ultra SCSI
host busses and fully protected mirrored cache, combined with five Ultra SCSI
data busses, delivers superior performance over competing products.
Synchronection-FT features a high performance, fault tolerant network file
server coupled with all of the continuous availability features of Synchronix,
and provides complete network access in a centralized storage repository for all
network storage requirements. All active components including disk drives, power
supplies, fans and system controllers are fully redundant, hot-swappable and can
be monitored on-line through the GUI. Synchronection combines the Company's
Synchronix product family with network software, offering storage capability up
to 1.6 terabytes. Synchronection, due to its software component, offers more
flexibility and a greater degree of compatibility with most network systems,
reducing the need for customized solutions and extensive testing periods.
Synchronection-FT became available during the second quarter of 1996.
Raven UX 410 is a powerful, flexible, all-in-one server for departmental,
Internet and Intranet requirements. The Raven UX 410 offers high performance,
with a scalable server which provides for continuous availability server
application with integrated RAID protection. The storage offered on the Raven UX
410 includes disk, tape, CD-ROM and floppy devices and RAID with processor in
one small desktop, deskside or rackmount footprint. The Raven UX 410 can be
optionally configured with industry standard tape drives, CD-ROMs and floppy
disks. The Company sells Raven UX primarily to the Federal Government.
Synchronix FibrePACC combines the speed and scalability of Fibre Channel
Arbitrated Loop (FC-AL), with high performance datapool, RAID data protection
and high availability cluster options in a flexible space-efficient package for
fibre channel drives. The Company introduced Synchronix FibrePACC in September
1998.
Historically, certain computer programs have been written using two digits
rather than four to define the applicable year, which could result in the
computer recognizing a date using "00" as the year 1900 rather than the Year
2000. This, in turn, could result in major system failures or miscalculations,
and is generally referred to as the "Year 2000 Problem." The Company believes
that each of Synchronix, Synchronection-FT, Raven UX 410 and Synchronix
FibrePACC is Year 2000 compliant. There can be no assurances, however, that such
products are Year 2000 compliant. Although the Company believes its products are
Year 2000 compliant, the purchasing patterns of customers and potential
customers may be affected by issues associated with the Year 2000 Problem. As
companies expend significant resources to correct their current data storage
solutions, these expenditures may result in reduced funds available to purchase
products such as those offered by the Company. There can be no assurance that
the Year 2000 Problem will not adversely affect the Company's business,
operating results and financial condition.
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Sales and Marketing
The Company markets its products through alternate channel partners,
including OEMs, VARs and distributors, and directly to Federal and commercial
end users through its internal sales force.
Relationships with Unisys and Tandem. Sales under the Company's OEM
agreement with Unisys commenced in 1996. All sales to Unisys have been sales of
mass storage enhancement products. Such agreement, as subsequently amended,
grants to Unisys exclusive world-wide rights to sell and distribute certain of
the Company's proprietary products and a non-exclusive world-wide right to sell
and distribute certain other products. The agreement provides that product
pricing shall remain in effect throughout the term of the agreement unless
market conditions dictate that the Company should provide more favorable pricing
terms to Unisys. The agreement is for an initial five-year term beginning May 1,
1995, and Unisys has the right to extend such term for successive one-year
periods upon appropriate written notice. The agreement may be terminated under
certain conditions and Unisys may, subject to certain conditions, terminate the
agreement in the event that the Company fails to timely perform its delivery
obligations under the agreement. The Company's sales are made by purchase order.
Therefore, the Company has no long-term commitments from Unisys and Unisys
generally may cancel orders on 30 days notice. There can be no assurance that
orders from Unisys will continue at their historic levels or that the Company
will be able to obtain any new orders from Unisys.
Compaq Computer Corp. ("Compaq"), the corporate owner of Tandem Computers
Incorporated ("Tandem"), acquired Digital Equipment Corporation ("Digital"), a
competitor of the Company, in 1998. On March 24, 1998, the Company announced a
relationship with Tandem pursuant to which Tandem could purchase Synchronix from
the Company and resell Synchronix under a private label with Tandem's own
systems. Although Tandem purchased product from the Company throughout 1998, the
acquisition of Digital by Compaq has adversely effected the Company's sales to
Compaq/Tandem. As a result of Compaq's acquisition of Digital, whose products
included a similar storage system to that of ECCS, Compaq decided to focus its
marketing efforts on its own products in lieu of outsourced products. The
Company was informed that Tandem intends to discontinue the marketing of the
Company's product after the second quarter of 1999. Accordingly, the Company
notified Tandem that it would terminate the contract effective February 15,
1999, which, pursuant to the reseller agreement, would give Tandem an additional
ninety days to purchase product from the Company.
In August 1998, the Company executed an agreement with Hewlett Packard
Company ("HP") pursuant to which HP may resell the Company's Synchronix products
and services through HP's North American Local Product Organization. This
agreement provides the Company with an additional alternate channel partner. The
Company believes that HP provides ECCS with an established reseller capability
in a wide range of markets. In addition, HP customers will now be able to
acquire ECCS' product and services as part of an integrated HP solution. There
can be no assurance, however, that the Company's sales or Synchronix products,
or other products, will increase as a result of its agreement with HP. In 1998,
there were no significant sales to HP.
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The Company continues efforts to establish potential OEM relationships for
specialized and standard versions of its Synchronix product line, in addition to
its relationships with Unisys and Tandem. There can be no assurance, however,
that such additional relationships will be established, or if established, that
they will decrease the Company's reliance on its previously established OEM
relationships with Unisys and Tandem.
Direct Sales. ECCS currently focuses its direct sales efforts on commercial
and government end user accounts. The Company's direct sales force consists of
twenty-three people. The Company conducts sales and marketing from its corporate
headquarters in New Jersey and from its offices in Alpharetta, Georgia; Herndon,
Virginia; San Jose, California; and Houston Texas. The Company believes that
direct sales and support can lead to better account penetration and control,
better communications and long-term relationships with end user customers,
opportunities for follow-on sales to the existing customer base and more
accurate identification of current and future end user customer requirements
with which to guide product specification and development efforts. The sales
activities of the Company's direct sales force include cold calling, attending
trade shows and exhibitions and pursuing sales leads provided by current
customers.
The Company uses its direct sales force to market to the U.S. Air Force,
primarily through several Federal Government integrators. There are no minimum
purchase requirements. The Company plans to broaden its sales base to include
additional Federal Government entities by establishing direct contact with such
entities in conjunction with the use of select Federal Government resellers.
There can be no assurance that there will be additional sales to Federal
Government entities.
Customer Support
The Company also provides technical support services to OEMs (third tier
support) and to end users. The Company's technical support specialists are
divided into three "tiers" or "levels" of support, and are thus 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. The Company tracks service reports through a customer database which
maintains current status reports as well as historical logs of customer
interaction.
The Company has also established a Professional Services organization that
provides, on a contract basis, a variety of services, including hardware and
software installation, training, configuration analysis, integration testing and
application development. The Professional Services organization also provides
pre- and post-sales support.
Competition
ECCS is engaged in fields within the data processing industry characterized
by a high level of competition. Many established companies, including
manufacturers of computers, systems integrators and manufacturers of mass
storage enhancement products and networking products compete with the Company.
Many of such competitors have resources greater than those of the
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Company. There can be no assurance that the Company will be able to continue to
compete successfully with existing or new competitors.
ECCS also believes it distinguishes itself from its competitors on the
basis of the combination of its technical expertise, its product uniqueness, its
systems integration services and its service and customer support. The Company
believes it distinguishes itself from competitors through the available
features, price and performance of its own mass storage enhancement products.
The Company believes that the currently available alternative mass storage
devices are not adequate substitutes with respect to the particular applications
addressed by the Company's products. Such alternatives address different
requirements for characteristics such as storage capacity, data access speed,
reliability, fault tolerance and price/performance. Most computer systems
companies and companies that offer memory enhancement products also offer fault
tolerant, mass storage and backup products and technologies, or are undertaking
development efforts, which compete or may compete with the Company in the mass
storage marketplace for Open Systems-based networked computers, including
companies considerably larger and with greater resources than those of the
Company. To the Company's best knowledge, current providers of fault tolerant
products and technology in the Open Systems marketplace on an OEM basis and/or
to end users include, among others, EMC, Data General, Digital and LSI Logic.
Many larger companies currently provide fault tolerant solutions for the
mainframe and mini-computer market segments. There can be no assurance that such
companies will not enter the fault tolerant RAID marketplace for Open
Systems-based non-mainframe, non-mini-computer computers.
Competitive factors include relative price/performance; product features,
quality and reliability; adherence to industry standards; financial strength;
and service, support and reputation. For certain of the Company's products, an
important factor in competition may be the timing of market introduction of its
or its competitors' products, relative time to market of products and product
availability. Accordingly, the relative speed with which the Company can develop
products and bring them to market also are important competitive factors.
Manufacturing and Suppliers
ECCS relies on outside manufacturers to manufacture and produce certain of
the Company's products for use in the Company's proprietary systems, as well as
for the direct sale to end users, and relies on outside suppliers to supply
subassemblies, component parts and computer systems for resale. Certain
components used in the Company's business are available only from a limited
number of sources. Any delays in obtaining component parts could adversely
affect the Company's results of operations. Manufacturing by the Company
consists primarily of light assembly, systems integration, testing and quality
assurance. The Company relies on independent contractors and outside suppliers
to manufacture subassemblies to the Company's specifications. Each of the
Company's products undergoes testing and quality inspection at the final
assembly stage. The Company has not experienced material problems with its
proprietary systems manufacturers or its suppliers of subassemblies. There can
be no assurance, however, that material problems will not arise in the future
that could significantly impede or interrupt the
10
Company's business. Although no assurances may be given, the Company anticipates
that its current facilities coupled with the Company's ability to hire contract
manufacturers will adequately satisfy its manufacturing requirements for the
foreseeable future.
Significant vendors to the Company include Unisys, Bell Microproducts,
Seagate Technology and Anthem Electronics, Inc. ("Anthem"). During 1997,
purchases from these vendors totaled $7.8 million or 32%, $4.2 million or 17%,
$3.3 million or 14% and $1.1 million or 5%, respectively, of the Company's total
purchases and, for 1998, $6.6 million or 30%, $5.1 million or 23%, $2.6 or 12%
and $.5 million or 2%, respectively, of the Company's total purchases.
On June 27, 1995, the Company entered into a Manufacturing Services
Agreement with Unisys (the "Manufacturing Services Agreement"), its primary
manufacturer, that defines the terms of sales and support services. Pursuant to
such agreement, Unisys will manufacture certain of the Company's products for
use in the Company's proprietary systems as well as for the direct sale to
end-users. 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 the Company to Unisys.
In February 1999, Unisys, the primary outside manufacturer for the
Synchronix system, notified the Company that Unisys was closing its Winnipeg
computer storage systems manufacturing plant by July 31, 1999 and accordingly,
the Manufacturing Service Agreement will be terminated at that time. The Company
plans to locate another third party manufacturer and/or manufacture such systems
in-house. Although the Company anticipates that it has sufficient facilities and
expertise to manufacture the Synchronix 1000 and Synchronix 2000 in-house, there
can be no assurance that material problems will not arise in the future that
could materially adversely effect the Company's results of operations.
In February 1999, the Company received ISO 9001 certification. Such
certification reflects uniform, industry-wide standards of quality control for
manufacturing data-storage products. There can be no assurance that the Company
will continue to meet the industry-accepted standards necessary to maintain ISO
9001 certification.
The Company has purchase order supply arrangements with Bell Microproducts
and Anthem pursuant to which the Company orders on terms negotiated at the time
of each such order. There are no minimum purchase requirements. These
arrangements are terminable by either party at any time.
Research and Development
The Company participates in an industry that is subject to rapid
technological changes, and its ability to remain competitive depends on, among
other things, its ability to anticipate such changes. As a result, the Company
has devoted substantial resources to product development. The Company's research
and development expenditures were $1,466,000 in 1996, $2,289,000 in 1997 and
$3,592,000 in 1998, of which $439,000, $602,000 and $909,000, respectively, were
11
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.
Research and development expenditures in 1998 related to the Company's
continued investment in and enhancements to the Company's current mass storage
enhancement products. Research and development projects for which the Company
expects to devote resources in the near future relate to: (i) improvements to
the next generation of the Synchronix family of products; (ii) the development
of a distributed file system storage architecture; and (iii) new interface
connectivities. In 1998, the Company discontinued its efforts to develop a fibre
controller and a controller design that incorporates Tandem's Server Net
Technology. As a result, the Company incurred a one-time charge in 1998 of
$366,000.
Intellectual Property and Other Proprietary Rights
Proprietary protection for the Company's technological know-how, products
and product candidates is important to its business. The Company relies upon
patents, trade secrets, know-how and continuing technological innovation to
develop and maintain its competitive position. The Company also relies on a
combination of copyright and trade secret protection and non-disclosure
agreements to establish and protect its proprietary rights. The Company has
filed numerous patent applications covering various aspects of its Synchronix
product family. There can be no assurance 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, there can be no assurance that any patents that may be issued to the
Company, or which the Company may license from third parties, will not be
challenged, invalidated or circumvented, or that any rights granted thereunder
will provide proprietary protection to the Company. Although the Company
continues to implement protective measures and intends to defend its proprietary
rights, policing unauthorized use of the Company's technology or products is
difficult and there can be no assurance that these measures will be successful.
Although management believes that patents will provide some competitive
advantage, the Company's success is dependent to a great extent on its
proprietary knowledge, innovative skills, technical expertise and marketing
ability. Because of rapidly changing technology, the Company's present intention
is not to rely primarily on patents or other intellectual property rights to
protect or establish its market position.
The Company has registered trademarks for RAID 10 PERFORMANCE MANAGER,
INTELLIGENT REBUILD, SPLIT MIRROR, EXAMODULE, SYNCHRONIX, INVERSE MIRRORING,
SYNCHRONECTION and SPLIT VOLUME. The Company has applied for trademark
registration for SYNCHRONISM and EASY BACKUP. There can be no assurance that
trademarks will be issued for such applications.
Since 1989, the Company has required that all new employees, consultants
and contractors execute non-disclosure agreements as a condition of employment
or engagement by the Company. There can be no assurance, however, that the
Company can limit unauthorized or wrongful disclosures of unpatented trade
secret information.
12
Seasonality
The Company's operating results are affected by seasonal factors,
particularly the spending fluctuations of its largest customers including
Unisys, Tandem and the Federal Government. Due to the relatively fixed nature of
certain of the Company's costs, a decline in net sales in any fiscal quarter
typically results in lower profitability in that quarter. The Company does not
expect such spending fluctuations to be altered in the future. A significant
reduction in orders from any of the Company's largest customers could have a
material adverse effect on the Company's results of operations. There can be no
assurance that the Company's largest customers will continue to place orders
with the Company or that orders of its customers will continue at their previous
levels.
Backlog
Because the Company generally ships product within 30 days of receiving an
order, the Company does not customarily have a significant backlog and, based on
the timing of such product shipments, the Company does not believe that projects
in process at any one time are a reliable indicator or measure of expected
future revenue.
Employees
As of December 31, 1998, the Company employed 125 persons, of whom 31 were
engaged in marketing and sales; 39 in engineering and research and development;
24 in operations, including customer and technical support, manufacturing and
fulfillment; 11 in Professional Services; and 20 in finance, administration and
management. None of the Company's employees are covered by collective bargaining
agreements. The Company believes that it has been successful in attracting
skilled and experienced personnel; however, competition for such personnel is
intense. The Company's future success will depend in part on its ability to
continue to attract, retain and motivate highly qualified technical,
manufacturing, marketing and management personnel. The Company considers
relations with its employees to be good.
Item 2. Properties.
The Company leases facilities in Tinton Falls, New Jersey totaling 32,000
square feet. One lease covers 22,000 square feet and expires on December 31,
2000. Such lease contains a renewal option for an additional four-year term. A
second lease covers 10,000 square feet and expired on March 31, 1998, and was
renewed for an additional 33 months on substantially the same terms as the
original lease. The leased space in New Jersey is used for research and
development, manufacturing, quality assurance, a substantial portion of sales
and marketing and administration. The Company also leases sales offices in
Alpharetta, Georgia; Herndon, Virginia; San Jose, California; and Houston,
Texas. The Company believes that its facilities are sufficient to meet current
needs for its research and development, manufacturing, quality assurance, sales,
marketing and administrative requirements.
13
Item 3. Legal Proceedings.
There are no individual material litigation matters pending to which the
Company is a party or to which any of its property is subject.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
14
PART II
Item 5. Market For the Company's Common Equity and Related Shareholder Matters.
The Company's common stock, $.01 par value (the "Common Stock") is traded
on the Nasdaq SmallCap Market under the symbol ECCS. The following table sets
forth, for each of the quarters listed below, the high and low sales prices per
share of Common Stock as reported by the Nasdaq SmallCap Market for each of the
quarters ended March 31, 1997 through December 31, 1998.
Quarter Ended High Low
------------------------------------- ------------- ---------
March 1997............................ 5.50 3.625
June 1997............................. 6.00 4.125
September 1997........................ 8.50 4.25
December 1997......................... 9.75 5.00
March 1998............................ 7.00 3.750
June 1998............................. 4.063 2.375
September 1998........................ 3.250 1.00
December 1998......................... 3.125 0.906
The prices shown above represent quotations among securities dealers, do
not include retail markups, markdowns or commissions and may not represent
actual transactions.
On February 26, 1999, the last sales price of the Common Stock as reported
by the SmallCap Market was $1.25 per share. The approximate number of
shareholders of record on February 26, 1999 was 160.
The Company has never declared or paid any dividends on Common Stock. The
Company intends to retain any earnings to fund future growth and the operation
of its business and, therefore, does not anticipate paying any cash dividends in
the foreseeable future. The Company's factoring facility with NationsBanc
Commercial Corporation ("NCC") restricts the Company's ability to pay certain
dividends without NCC's prior written consent. The Company's line of credit
facility with The Finova Group Inc. also prohibits the payment of dividends. For
a discussion of the Company's credit facilities, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Liquidity and
Capital Resources."
On October 28, 1997, the Company granted options to purchase 498,400 shares
of its Common Stock (the "Options"), outside of the Company's registered stock
option plans, to certain officers and employees at an exercise price of $8.00
per share. In mid-February 1998, the Company canceled the Options previously
granted on October 28, 1997. In addition, at that time, the Company reissued the
Options, outside of the Company's registered stock option plans, to certain
officers and employees at an exercise price of $4.00 per share.
15
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 which were exchanged for
New Options was 1,487,159. The New Options were granted from both the 1996
Option Plan and the Non-Qualified Stock Option pools.
No underwriter was employed by the Company in connection with the issuances
and sales of the securities described above. The Company believes that the
issuances and sales of all of the foregoing securities were exempt from
registration under either (i) Section 4(2) of the Securities Act of 1933, as
amended (the "Act") as transactions not involving any public offering, or (ii)
Rule 701 under the Act as transactions made pursuant to a written compensatory
benefit plan or pursuant to a written contract relating to compensation. No
public offering was involved and the securities were acquired for investment and
not with a view to distribution. Appropriate legends will be affixed to the
stock certificates issued upon the exercise of such options. All recipients had
adequate access to information about the Company.
16
Item 6. Selected Consolidated Financial Data.
The selected consolidated financial data for the five years ended December
31, 1998, are derived from the Company's audited financial statements. The
following should be read in conjunction with the consolidated financial
statements and notes thereto and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere in this
Annual Report on Form 10-K.
------------------------------------------------------------------
Year Ended December 31,
------------------------------------------------------------------
1994(1) 1995 1996 1997 1998
------- ---- ---- ---- ----
Statement of Operations Data:
Net sales........................... $ 42,738 $ 31,174 $22,604 $ 34,001 $28,466
Cost of sales..................... 36,563 23,256 15,165 24,226 20,452
-------- -------- -------- ------ -------
Gross profit........................ 6,175 7,918 7,439 $ 9,775 8,014
Selling, general and
administrative expenses........ 12,415 9,967 6,907 6,838 8,378
Research and development
expenses....................... 978 1,123 1,027 1,687 2,683
-------- -------- -------- ------- -------
Operating income (loss)............. (7,218) (3,172) (495) 1,250 (3,047)
Net interest expense (income) .... 764 487 274 28 (390)
-------- -------- -------- ------- -----------
Income (loss) before extraordinary
item................................ (7,982) (3,659) (769) 1,222 (2,657)
Extraordinary item.................. -- -- -- 120 --
-------- -------- -------- ------- ----------
Income (loss) from operations
before provision (benefit)
for income taxes.................... (7,982) (3,659) (769) 1,102 (2,657)
Provision (benefit) for
income taxes................... (1,192) -- -- -- --
-------- -------- -------- -------- -------
Net income (loss)................... (6,790) (3,659) (769) 1,102 (2,657)
Preferred dividends............... -- 79 248 192 --
-------- -------- -------- -------- -------
Net income (loss) applicable
to common shares.................. $ (6,790) $ (3,738) $ (1,017) $ 910 $(2,657)
======== ======== ======== ======= =======
Net income per share
before extraordinary item-basic... $ -- $ -- $ -- $ 0.16 $ --
Net income (loss) per
share - basic..................... $ (1.63) $ (0.88) $ (0.23) $ 0.14 $ (0.24)
Net income (loss) per share before
extraordinary item - diluted...... $ (1.63) $ (0.88) $ (0.23) $ 0.12 $ (0.24)
Net income (loss) per share - diluted $ (1.63) $ (0.88) $ (0.23) $ 0.11 $ (0.24)
Weighted average common
shares outstanding basic............ 4,160 4,232 4,346 6,702 10,969
Weighted average common
shares outstanding diluted.......... 4,160 4,232 4,346 10,035 10,969
Balance Sheet Data:
Cash................................ $ 1,670 $ 1,514 $ 4,393 $11,625 $ 5,374
Working capital..................... 2,932 1,134 4,280 15,260 11,969
Total assets........................ 21,507 12,435 14,552 24,992 21,374
Loans payable....................... 4,089 1,849 1,762 1,031 1,231
Series B redeemable
convertible preferred stock....... -- 1,794 -- -- --
Shareholders' equity................ 5,673 2,122 6,177 17,643 15,232
- ----------
(1) Includes $380,000 related to the write-down of certain capitalized
software, $374,000 related to employee termination costs and $3,500,000 of
inventory adjustments.
17
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
ECCS is a provider of enterprise storage solutions to protect and ensure
access to critical data for server attached, Storage Area Networks (SAN), Fibre
Channel Storage, and Network Attached storage markets. ECCS designs,
manufactures, sells and supports high performance, user-definable, fault and
non-fault tolerant storage subsystems to meet a wide range of customer
applications, needs and Operating Systems (NT and UNIX). These connectivity
options enable storage users the flexibility to choose and deploy a particular
storage solution to meet their needs, accommodating both centralized to
distributed storage environments.
ECCS products are sold globally through OEMs, VARs and System Integrators
and domestically on a direct basis. ECCS' customers cross all industries,
including large database companies (or those that use databases), financial
enterprises, retail, non-profit organizations, Internet Service Providers,
imaging users, telecommunications and the Federal Government.
The Company's revenues are generated from three primary sources: (i)
revenues derived from sales of mass storage enhancement products, which include
sales of all ECCS mass storage enhancement products, including the Synchronix
family of products, and sales of certain third party component products that are
incorporated into such mass storage enhancement systems; (ii) revenues generated
by the Company as a VAR which include the Company's sales to AT&T business units
for non-storage related products; and (iii) revenues derived from services and
other revenue which include professional services and maintenance contracts. The
Company believes that revenues generated by the Company as a VAR, which include
sales to AT&T business units of non-storage related products, will be minimal in
the future.
The following table sets forth, for the periods indicated, the percentage
of net sales derived from each of the product groupings the Company uses to
analyze sales and revenue:
Year Ended December 31,
-----------------------
1996 1997 1998
---- ---- ----
ECCS mass storage enhancement products
(including all ECCS proprietary products and
certain third party component products).............. 80.0% 92.5% 96.0%
Value added resales.................................... 8.3% 1.1% -0-
Services and other revenues............................ 11.7% 6.4% 4.0%
The year to year percentage increases in sales by the Company of is
proprietary systems, as well as the year to year percentage decreases in sales
by the Company in its capacity as a VAR are due, primarily, to the Company's
repositioning as a provider of its own proprietary mass storage enhancement
systems including storage subsystems.
18
Most of the Company's proprietary products are manufactured under contract
by Unisys pursuant to the Company's specifications. In accordance with the
Company's instructions, Unisys ships the finished product directly to the
Company's customers. The Company believes that by outsourcing certain
manufacturing requirements, the Company benefits from the greater purchasing
power of the manufacturers, reduction of inventory carrying costs and the
avoidance of certain investments in plant, property and equipment. In February
1999, Unisys, the primary outside manufacturer for the Synchronix system,
notified the Company that Unisys was closing its Winnipeg computer storage
systems manufacturing plant by July 31, 1999 and accordingly the Manufacturing
Services Agreement will be terminated at that time. The Company plans to locate
another third party manufacturer and/or manufacture such systems in-house.
Although the Company anticipates that it has sufficient facilities and expertise
to manufacture the Synchronix 1000 and Synchronix 2000 systems in-house, there
can be no assurance that material problems will not arise in the future that
could materially adversely effect the Company's results of operations.
In February 1999, the Company received ISO 9001 certification. Such
certification reflects uniform, industry-wide standards of quality control for
manufacturing data-storage products. There can be no assurance that the Company
will continue to meet the industry-accepted standards necessary to maintain ISO
9001 certification.
Product sales revenue is generally recognized upon product shipment.
Periodically, however, 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.
The Company's cost of revenues relating to product sales consists primarily
of the costs of purchased material, direct labor and related overhead expenses,
and amortization of capitalized software. An increase in proprietary product
sales combined with the anticipated continued reduction in the sale of third
party product, which typically carries lower margins, is expected to lower cost
of revenues as a percentage of sales. Costs of revenues related to services are
comprised primarily of direct labor and related overhead expenses.
The Company's OEM sales to date have been primarily to Unisys and Tandem.
In March 1997, the Company commenced sales of products to Tandem for resale. On
March 24, 1998, the Company announced that it had signed a corporate purchasing
agreement with Tandem pursuant to which Tandem has the ability to purchase
Synchronix from the Company and resell Synchronix under a private label with
Tandem's own systems. The Company's sales to Tandem will be made by purchase
order. Therefore, the Company has no long-term commitments from Tandem and
Tandem generally may cancel orders upon appropriate written notice to the
Company. As a result of Compaq's acquisition of Digital, whose products included
a similar storage system to that of ECCS, Compaq decided to focus its marketing
efforts on its own products in lieu of outsourced products. The Company was
informed that Tandem intends to discontinue the marketing of the Company's
product after the second quarter of 1999. Accordingly, the Company notified
Tandem that it would terminate the contract effective February 15, 1999, which,
pursuant to the reseller agreement, would give Tandem an addional ninety days to
purchase product from the
19
Company. There can be no assurance that orders from Tandem will continue at
their historic levels or that the Company will be able to obtain any new orders
from Tandem.
The profitability of any particular quarter is significantly affected by
the relative sales levels of each of the Company's primary sales channels: OEM,
Federal and commercial. Gross margins on products shipped to commercial
customers generally provide higher margins, followed by OEM and Federal. To the
extent that the Company is successful in increasing its sales of Synchronix and
Synchronection to the commercial market directly and through OEM arrangements,
the Company believes gross margins should improve accordingly.
Selling, general and administrative (SG&A) expenses consist of salaries,
commissions and travel costs for sales and marketing personnel, trade shows and
expenses associated with the Company's management, accounting, contract and
administrative functions. The Company anticipates that SG&A spending levels will
decrease as a percentage of sales to the extent sales to OEMs increase as a
percentage of sales. Sales to OEMs typically absorb much of the administrative
burden otherwise incurred by the Company.
Since 1994, the Company has increased its research and development activity
in connection with the development of Synchronix and Synchronection. Research
and development expenses consist primarily of salaries and related overhead
expenses paid to engineers and programmers. Research and development expenses
are anticipated to be a substantial part of the Company's cost structure in the
near future to enable the Company to update and expand upon its existing product
offerings.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward looking statements that involve risks and
uncertainties, many of which may be beyond the Company's control. See "Forward
Looking Statements."
20
Results of Operations (Dollars in Thousands)
The following table sets forth for the periods indicated certain financial
data as a percentage of net sales.
Year Ended December 31,
-----------------------
1996 1997 1998
---- ---- ----
Net sales............................................ 100.0% 100.0% 100%
Cost of sales...................................... 67.1 71.3 71.9
------- ------- -------
Gross profit......................................... 32.9 28.7 28.1
Selling, general & administrative expenses......... 30.6 20.1 29.4
Research & development expenses.................... 4.5 5.0 9.4
------- ------- -------
Operating income (loss).............................. (2.2) 3.6 (10.7)
Net interest expense............................... 1.2 .1 (1.4)
------- ------- -------
Income (loss) before extraordinary item.............. (3.4) 3.5 (9.3)
Extraordinary item................................... -- .3 --
------- ------- -----
Income (loss) before benefit for income taxes........ (3.4) 3.2 (9.3)
Benefit for income taxes........................... -- -- --
------- -------- -----
Net income (loss).................................... (3.4)% 3.2% (9.3)%
======== ======== =======
Comparison of Years Ended December 31, 1997 and 1998
----------------------------------------------------
Net Sales
Net sales decreased by approximately $5,535 or 16%, in 1998 as compared to
net sales in 1997. Sales of the Company's proprietary mass storage enhancement
systems, including sales of certain third party component products, accounted
for 93% and 96% of net sales in 1997 and 1998, respectively. As expected, sales
by the Company in its capacity as a VAR continued to be minimal and accounted
for 1% and 0% of net sales in 1997 and 1998, respectively. Services and other
revenues accounted for 6% and 4% of net sales in 1997 and 1998, respectively.
The decrease in 1998 net sales resulted primarily from a decrease in sales of
the Company's mass storage enhancement systems, including sales to the U.S. Air
Force through Federal integrators.
Sales to the U.S. Air Force through Federal integrators accounted for
approximately 44% and 33% of net sales in 1997 and 1998, respectively. The
Company believes that sales to the U.S. Air Force will continue to comprise a
significant portion of the Company's net sales for the next 12 months. There can
be no assurance that the U.S. Air Force will continue to purchase from the
Company at historical levels, if at all.
Sales to alternate channel partners accounted for approximately 37% and 38%
of net sales in 1997 and 1998, respectively. Sales to the Company's primary
alternate channel partner, Unisys, accounted for approximately 28% of the
Company's net sales in 1998. There can be no assurance
21
that Unisys will continue to place orders with the Company or that orders from
Unisys will continue at their previous levels.
Sales to Tandem, another of the Company's alternate channel partners,
accounted for approximately 10% of the Company's net sales in 1998. Although
Tandem purchased product from the Company throughout 1998, the acquisition of
Digital by Compaq has adversely affected the Company's sales to Compaq/Tandem.
As a result of Compaq's acquisition of Digital, whose products included a
similar storage system to that of ECCS, Compaq decided to focus its marketing
efforts on its own products in lieu of outsourced products. The Company was
informed that Tandem intends to discontinue the marketing of the Company's
product after the second quarter of 1999. Accordingly, the Company notified
Tandem that it would terminate the contract effective February 15, 1999, which,
pursuant to the reseller agreement, would give Tandem an additional ninety days
to purchase product from the Company.
Sales to the Company's commercial customers were $7,960 in 1998, or
approximately 28% of net sales. Such sales represent a 17% increase over sales
to commercial accounts in the year ended 1997. Such increase was primarily due
to the Company's continued focus on commercial sales of its Synchronix product
line offering.
Gross Profit
The Company's gross profit decreased by approximately $1,761 in 1998 to
approximately $8,014, from $9,775 in 1997. Such decrease in gross profit is due
primarily to the lower volume of sales to the U.S. Air Force through Federal
integrators during 1998, a large portion of which consists of third-party
components integrated with the Company's proprietary mass storage enhancement
products.
Operating Expenses
Selling, general and administrative (SG&A) expenses increased by $1,540 to
$8,378 in 1998 from $6,838 in 1997. Selling, general and administrative expenses
increased as a percentage of net sales representing 20% and 29% for 1997 and
1998, respectively. Such increase was due primarily to the hiring of additional
sales and marketing personnel, coupled with enhanced efforts to market the
Company's current and new product offerings. SG&A expenses increased as a
percentage of revenue as a result of a combination of higher SG&A expenses and
lower sales volume. Salaries, commissions, bonuses, employee benefits and
payroll taxes were the largest components of selling, general and administrative
expenses, accounting for 70% and 66% of such expenses in 1997 and 1998,
respectively. The Company anticipates that SG&A spending levels will decrease as
a percentage of sales to the extent sales to OEMs increase as a percentage of
sales. Sales to OEMs typically absorb more of the administrative expenses
otherwise incurred by the Company.
Research and development expenses increased in 1998 by $996 or 59% from
$1,687 in 1997. This increase is due primarily to the hiring of additional
engineers to continue the product development initiative associated with the
enhancements to the Company's proprietary mass storage products and to the
development of a new technology center. Such expenses for 1998
22
represented approximately 9.4% of the Company's net sales and, including the
amount capitalized in accordance with SFAS No. 86, represented approximately 16%
of the Company's net sales. Research and development projects for which the
Company expects to devote resources in the near future relate to: (i) a next
generation of the Synchronix family of products; (ii) the development of a
distributed file system storage architecture; (iii) new interface
connectivities; and (iv) customized OEM products. The Company believes that the
anticipated increase in its research and development investment could adversely
affect earnings in the first six months of 1999; however, such adverse impact,
if any, may be offset in part by the Company's decision to discontinue the
development of its new technology center. In addition, in 1998 the Company
discontinued its efforts to develop a fibre controller and a controller design
that incorporates Tandem's Server Net Technology. As a result, the Company
incurred a one-time charge in 1998 of $366,000.
Net Interest Expense
Net interest income for 1998 was $390, while net interest expense was $28
in 1997. Such fluctuation was due principally to higher cash balances resulting
from cash generated by the Company's follow-on public offering in 1997 and a
reduction in the borrowings against the Company's accounts receivable line of
credit.
Comparison of Years Ended December 31, 1996 and 1997
----------------------------------------------------
Net Sales
Net sales increased by approximately $11,397 or 50%, in 1997 as compared to
net sales in 1996. Sales of the Company's proprietary mass storage enhancement
systems, including sales of certain third party component products, accounted
for 80% and 93% of net sales in 1996 and 1997, respectively. Sales by the
Company in its capacity as a VAR accounted for 8% and 1% of net sales in 1996
and 1997, respectively. Services and other revenues accounted for 12% and 6% of
net sales in 1996 and 1997, respectively. The increase in 1997 net sales
resulted primarily from an increase in sales of the Company's mass storage
enhancement systems, including sales to Federal customers, as well as sales
through relationships with OEMs, offset, in part, by a decrease in value added
resales.
Sales to the U.S. Air Force through Federal integrators accounted for
approximately 25% and 44% of net sales in 1996 and 1997, respectively.
Sales to alternate channel partners accounted for approximately 38% and 37%
of net sales in 1996 and 1997, respectively. Sales to the Company's primary
alternate channel partner, Unisys, accounted for approximately 18% of the
Company's net sales in 1997. Sales to Tandem, another of the Company's alternate
channel partners, accounted for approximately 13% of the Company's net sales in
1997.
Gross Profit
The Company's gross profit increased by approximately $2,336 in 1997 to
approximately $9,775 from $7,439 in 1996. The increase in 1997 resulted from
increased sales volume. The
23
Company's gross margin as a percentage of net sales decreased to 29% in 1997, as
compared to 33% in 1996. The decrease in gross margin percentage was due
primarily to the higher volume of sales to the U. S. Air Force through Federal
integrators during 1997, a large proportion of which consisted of third party
components integrated with the Company's proprietary mass storage enhancement
products. Third party components generally have lower gross margins than the
Company's proprietary products.
Operating Expenses
Selling, general and administrative expenses decreased by $69 to $6,838 in
1997 from $6,907 in 1996. Selling, general and administrative expenses decreased
as a percentage of net sales representing 31% and 20% for 1996 and 1997,
respectively. Such decreases were primarily due to higher sales volume in 1997.
Salaries, commissions, bonuses, employee benefits and payroll taxes were the
largest components of selling, general and administrative expenses, and
accounted for 66% and 70% of such expenses in 1996 and 1997, respectively.
Research and development expenses increased in 1997 by $660 or 64% from
$1,027 in 1996. This increase was due primarily to the Company's continued
investment in and enhancements to the Company's current mass storage enhancement
products. Such expenses for 1997 represented approximately 5% of the Company's
net sales and, including the amount capitalized in accordance with SFAS No. 86,
represented approximately 7% of the Company's net sales.
Net Interest Expense
Net interest expense for 1997 decreased by $246 as compared to 1996, due
principally to a reduction in the borrowings against the Company's accounts
receivable line of credit and an increase in interest income that was due to
higher cash balances resulting from cash generated by the Company's Offering.
Extraordinary Item
An extraordinary item for 1997 consisted primarily of a one-time charge
incurred in connection with the termination of the Company's financing facility
with its former lender.
Liquidity and Capital Resources (Dollars in Thousands)
Since 1994, the Company has funded its operations primarily from cash
generated by operations augmented with funds from borrowings under a line of
credit and inventory financing and through private and public sales of equity
securities. On December 31, 1998, the Company's cash balance was approximately
$5,374.
Net cash used in operations was $782 and $3,200 in 1997 and 1998,
respectively. Such use of cash in 1998 resulted primarily from the net loss from
operations. Net cash provided by financing activities was $9,425 in 1997 and net
cash used in financing activities was $551 in 1998.
24
The Company used $809 and $1,453 for the acquisition of equipment by direct
purchase during 1997 and 1998, respectively. Such expenditures in 1998 primarily
consisted of a capital investment associated with the Company's new
enterprise-wide ERP software system, as well as capital equipment relating to
the Company's research and development efforts. In 1997 and 1998, the Company
acquired equipment under capital leases of $0 and $283, respectively, and made
payments under capital leases of $88 and $49, respectively. Total capital
expenditures for 1999 are expected to be approximately $500, although such
amounts are not subject to formal commitments. The Company anticipates that such
expenditures will include the purchase of capital equipment for research and
development and general corporate use. There are no other material commitments
for capital expenditures currently outstanding. Net payments under the Company's
accounts receivable financing facility were $731 and $1,031 for 1997 and 1998,
respectively.
The Company's working capital was approximately $15,300 and $12,000 at
December 31, 1997 and 1998, respectively.
On July 9, 1997, the Company entered into a full recourse factoring
facility with NationsBanc Commercial Corporation ("NCC") 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 the Company is obligated to pay certain
annual fees. The factoring facility is for a period of three years (unless
terminated by NCC 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. As of
December 31, 1998, the Company had no outstanding balance under this full
recourse factoring facility.
The Company also has a $2,000 general line of credit with the Finova Group
Inc. ("Finova"). The agreement with Finova contains covenants relating to net
worth, total assets to debt and total inventory to debt. The Company's
obligations under the agreement with Finova are collateralized by substantially
all of the assets of the Company. Finova increased such general line of credit
to $3,000 through January 31, 1999, on the same terms and conditions. After such
date, the line returned to $2,000.
The Company uses its line of credit with Finova to augment its purchasing
ability with various vendors. The maximum amount, during the preceding twelve
months, that the Company has drawn under such general line of credit has been
approximately $1,231. As of December 31, 1998, the Company had $1,231
outstanding under this credit line, and available credit under such line towards
future inventory purchases was $769.
NCC and Finova have entered into an intercreditor subordination agreement
with respect to their relative interest in substantially all of the Company's
assets.
The Company's agreement with NCC restricts the Company's ability to pay
certain dividends without NCC's prior written consent. The Company's agreement
with Finova prohibits the payment of dividends.
25
During 1997, the Company utilized $1,118 of net operating loss carryover
("NOL") for federal tax purposes. The Company has NOL carryovers for Federal
income tax purposes of approximately $10,278, which will begin to expire in
2009. The Company also has research and development tax credit carryovers for
Federal income tax purposes of approximately $376, which will begin to expire in
2009. In addition, the Company has alternative minimum tax credits of
approximately $67. These credits can be carried forward indefinitely. The
Company experienced a change in ownership in 1996 as defined by Section 382 of
the Internal Revenue Code. Accordingly, future use of some of these NOLs and
income tax credits may be limited.
The Company also has approximately $12,965 of state NOL carryforwards which
will begin to expire in 2001 and state research and development tax credit
carryforwards of $334 as of December 31, 1998.
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 deferred tax assets since the
Company is in a cumulative loss position. Such valuation allowance will be
reassessed periodically by the Company.
In February 1998, the Company's Board of Directors authorized the
expenditure of up to $1,000 for research and new product development, including
the development of a distributed file system storage architecture and other
significant enhancements to the current Synchronix product family. Subsequently,
on November 19, 1998 the Board of Directors approved resolutions to discontinue
expenditures related to the Company's technology center in San Jose, California,
however, research and new product development will continue at the Company's
discretion.
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 which were exchanged for
New Options was 1,487,159.
Impact of the Year 2000
General
Computer systems were originally designed to recognize calendar years by
the last two digits in the date code field. Beginning in the Year 2000, these
date code field will need to accept four digit entries to distinguish
twenty-first century dates from twentieth century dates. Any of ECCS' computer
programs that have time-sensitive software may recognize a date using "00" as
26
the year 1900 rather than the Year 2000. This could result in a system failure
or miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices, or engage
in similar normal business activities. As a result, in the coming year, the
computerized systems (including both information and non-information technology
systems) and applications used by ECCS will need to be reviewed, evaluated and,
if and where necessary, modified or replaced to ensure that all financial,
information and operating systems are Year 2000 compliant.
State of Readiness
ECCS has formed an internal task force comprised of representatives of its
various relevant departments to address Year 2000 compliance matters. The task
force has undertaken a preliminary review of internal and external areas that
are likely to be affected by Year 2000 compliance matters and has classified the
various areas as mission critical, important or non-critical/non-important.
With respect to internal matters, ECCS has completed a review of its
hardware and software to determine whether its business-related applications
(including applications relating to distribution, finance, inventories,
operations, products, purchasing and sales/marketing) will be Year 2000
compliant. In addition, in 1998, programs designed to identify Year 2000
problems associated with dates embedded in certain business-related files were
created and executed to identify any Year 2000 compliance issues. The testing
unearthed a few Year 2000 problems, all of which have been addressed and
retested for Year 2000 readiness. While the results of the tests are still being
analyzed, relatively few Year 2000 problems were identified. There can be no
assurance, however, that such testing has detected, or will detect, all
compliance issues related to the Year 2000 problem.
With respect to external matters, ECCS has distributed questionnaires and
requests for certification to its mission critical vendors and in the process of
obtaining and reviewing the responses thereto. The questionnaires have requested
information concerning embedded technologies of such vendors, the hardware and
software applications used by such vendors and the Year 2000 compliance efforts
of such vendors relating thereto.
Estimated Year 2000 Compliance Costs
Through December 31, 1998, ECCS has incurred approximately $1,275 in costs
(excluding in-house labor and hardware), which includes installation of the ERP
system in 1998, in connection with Year 2000 compliance matters. ECCS estimates
that it will expend approximately $100 on additional hardware, software and
other items related to the Year 2000 compliance matters.
Risks Relating to Year 2000 Compliance Matters
ECCS' goal to become Year 2000 compliance with respect to internal matters
during calendar year 1999. Although ECCS has begun and is undertaking testing of
its internal business-related hardware and software applications, there can be
no assurances that such testing will detect all applications that may be
affected by year 2000 compliance problems. With respect to
27
external matters, due to the multi-dependent and interdependent issues raised by
Year 2000 compliance, including many factors beyond its control, ECCS may face
the possibility that one or more of its mission critical vendors, such as its
utilities, telephone carriers or equipment manufacturers, may not be Year 2000
compliance on a timely basis. Because of the unique nature of such vendors,
alternate providers may not be available.
Contingency Planning
ECCS has begun the process of assessing contingency plans that might be
available in the event of either internal or external Year 2000 compliance
problems. To this end, ECCS' various internal departments have begun to prepare
assessments of potential contingency alternatives. The task force will undertake
a review of these assessments in respect of application of contingency plans on
a department-by-department basis and on a company-wide basis. ECCS intends to
complete its contingency planning in respect to Year 2000 compliance during the
third quarter of calendar year 1999.
The Company believes that its existing available cash, credit facilities
and the cash flow expected to be generated from operations, will be adequate to
satisfy its current and planned operations for at least the next 12 months.
The Company's operating results are affected by seasonal factors,
particularly the spending fluctuations of its largest customers including
Unisys, Tandem and the Federal Government. Due to the relatively fixed nature of
certain of the Company's costs, a decline in net sales in any fiscal quarter
typically results in lower profitability in that quarter. The Company does not
expect such spending fluctuations to be altered in the future. A significant
reduction in orders from any of the Company's largest customers could have a
material adverse effect on the Company's results of operations. There can be no
assurance that the Company's largest customers will continue to place orders
with the Company or that orders of its customers will continue at their previous
levels.
Item 7A. Quantitative and Qualitative Disclosures Above Market Risk.
Not applicable.
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.
Not applicable.
28
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
1999 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 1999 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 1999
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 1999 Annual
Meeting of Shareholders is incorporated herein by reference to such proxy
statement.
29
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) (1) Financial Statements.
Reference is made to the Index to Financial Statements and
Schedule on Page F-1.
(a) (2) Financial Statement Schedule.
Reference is made to the Index to Financial Statements and
Schedule on Page F-1.
(a) (3) Exhibits.
Reference is made to the Exhibit Index on Page 33.
(b) Reports on Form 8-K.
None.
30
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,
1999.
ECCS, INC.
By: /s/Gregg M. Azcuy
-----------------------------
Gregg M. Azcuy, President and
Chief Executive Officer
31
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 Officer March 30, 1999
- ----------------------- and Director (Principal Executive
Gregg M. Azcuy Officer)
/s/ Louis Altieri Vice President, Finance and March 30, 1999
- ----------------------- Administration (Principal Financial
Louis Altieri and Accounting Officer)
/s/ Michael E. Faherty Chairman of the Board and Director March 30, 1999
- ----------------------- Director
Michael E. Faherty
/s/ Gale R. Aguilar Director March 30, 1999
- -----------------------
Gale R. Aguilar
/s/ James K. Dutton Director March 30, 1999
- -----------------------
James K. Dutton
/s/ Donald E. Fowler Director March 30, 1999
- -----------------------
Donald E. Fowler
/s/ Frank R. Triolo Director March 30, 1999
- -----------------------
Frank R. Triolo
/s/ Thomas I. Unterberg Director March 30, 1999
- -----------------------
Thomas I. Unterberg
32
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 Annual Report on Form 10-K for the annual period ended
December 31, 1995 filed on May 17, 1996.)
3.2 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.)
33
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.)
34
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 year ended December 31, 1997 filed on
March 25, 1998.)
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 year ended December 31, 1997 filed on
March 25, 1998.)
10.12* Senior Staff Change In Control Severance And Incentive
Compensation Pay Agreement by and between the Company and David
J. Boyle. (Incorporated by reference to the Company's Annual
Report on Form 10-K for the year ended December 31, 1997 filed on
March 25, 1998.)
10.13* 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 year ended December 31, 1997 filed on
March 25, 1998.)
10.14* 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.)
10.15* 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.)
10.16* 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.)
10.17* Indemnification Agreement as of July 8, 1996 by and between the
Company and David J. Boyle. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 1996, filed on November 14, 1996.)
35
Exhibit
No. Description of Exhibit
- --- ----------------------
10.18* 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).
10.19* 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.)
10.20 Manufacturing Services Agreement, dated June 15, 1995, by and
between the Company and Unisys 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).
10.21 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).
10.22 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).
21 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 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
- ---------------
* A management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to Item 14(c) of Form 10-K.
36
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULE
Page
Report of Independent Auditors..............................................F-2
Consolidated Balance Sheets as of
December 31, 1997 and 1998...............................................F-3
Consolidated Statements of Operations for
each of the three years in the period ended
December 31, 1998........................................................F-4
Consolidated Statements of Shareholders'
Equity for each of the three years in
the period ended December 31, 1998...................................... F-5
Consolidated Statements of Cash Flows
for each of the three years in the period
ended December 31, 1998..................................................F-6
Notes to Consolidated Financial Statements..................................F-7
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 sheets of ECCS, Inc.
and subsidiaries as of December 31, 1997 and 1998, and the related consolidated
statements of operations, shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the Index at Item 14 (a). These financial
statements and 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 audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 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, 1997 and 1998, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles. 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.
ERNST & YOUNG LLP
MetroPark, New Jersey
February 19, 1999
F-2
ECCS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31,
-------------------------
1997 1998
----------- --------
Assets
Current Assets:
Cash and cash equivalents........................................... $ 11,625 $ 5,374
Accounts receivable, less allowance for doubtful accounts of $297
in 1997 and $334 in 1998........................................... 5,737 6,644
Inventories......................................................... 4,596 5,563
Prepaid expenses and other receivables.............................. 506 314
--------- ---------
22,464 17,895
Property, plant and equipment (net).................................... 1,372 1,916
Capitalized software (net)............................................. 811 1,302
Other assets........................................................... 345 261
--------- ---------
Total assets................................................. $ 24,992 $ 21,374
========= =========
Liabilities and Shareholders' Equity
Current Liabilities:
Loans payable....................................................... $ 1,031 $ --
Payable to Finova Capital........................................... -- 1,231
Current portion of capital lease.................................... 11 110
Accounts payable.................................................... 3,833 2,800
Accrued expenses and other.......................................... 1,385 1,140
Warranty............................................................ 534 523
Customer deposits, advances and other credits....................... 410 122
------ -------
7,204 5,926
Capital lease obligations, net of current portion...................... -- 135
Deferred rent.......................................................... 145 81
--------- ---------
7,349 6,142
--------- ---------
Shareholders' Equity:
Preferred stock, $.01 par value per share, Authorized, 3,000,000
shares;
Zero issued and outstanding at December 31, 1997 and
December 31, 1998................................................... -- --
Common stock, $.01 par value per share, Authorized, 20,000,000 shares;
Issued and outstanding, 10,918,188 shares and 11,027,084
shares at December 31, 1997 and December 31, 1998, respectively.... 109 110
Capital in excess of par value - common............................. 25,615 25,860
Accumulated deficit................................................. (8,081) (10,738)
---------- ---------
17,643 15,232
--------- --------
Total Liabilities and Shareholders' Equity $ 24,992 $ 21,374
========= =========
See notes to consolidated financial statements.
F-3
ECCS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share Amounts)
1996 1997 1998
Net sales................................. $ 22,604 $ 34,001 $ 28,466
Cost of sales............................. 15,165 24,226 20,452
----------- ----------- -------------
Gross profit............................ 7,439 9,775 8,014
Operating expenses:
Selling, general & administrative....... 6,907 6,838 8,378
Research & development.................. 1,027 1,687 2,683
----------- ----------- -------------
7,934 8,525 11,061
Operating (loss) income................... (495) 1,250 (3,047)
Net interest expense (income)........... 274 28 (390)
----------- ----------- -------------
(Loss) income before extraordinary item... (769) 1,222 (2,657)
Extraordinary item...................... -- 120 --
----------- ----------- --------------
Net (loss) income ........................ $ (769) $ 1,102 $ (2,657)
------------ ----------- --------------
Preferred dividends..................... 248 192 --
------------ ----------- --------------
Net (loss) income applicable to
common shares........................... $ (1,017) $ 910 $ (2,657)
=========== =========== =============
Earnings (loss) per common share:
Net (loss) income per common share before
extraordinary item - basic ............... $ (0.23) $ 0.16 $ (0.24)
========== =========== =============
Extraordinary charge...................... $ -- $ (0.02) $ --
========== =========== =============
Net (loss) income per common
share - basic........................... $ (0.23) $ 0.14 $ (0.24)
========== =========== =============
Earnings per common share - assuming
dilution:
Net (loss) income per common share before
extraordinary item - diluted.............. $ (0.23) $ 0.12 $ (0.24)
========== =========== =============
Extraordinary charge...................... $ -- $ (0.01) $ --
========== =========== =============
Net (loss) income per common
share - diluted......................... $ (0.23) $ 0.11 $ (0.24)
========== =========== =============
Weighted average number of common and
dilutive shares - basic................... 4,346 6,702 10,969
========== ============ =============
Weighted average number of common and
dilutive shares - diluted................. 4,346 10,035 10,969
========== =========== =============
See notes to consolidated financial statements.
F-4
ECCS, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Dollars in Thousands)
Common Stock Preferred Stock
Capital in Capital in Total
Excess of Excess of Accumulated Shareholders'
Shares Amount Par Value Shares Amount Par Value Deficit Equity
------------------------------------------------------------------------------------
Balance at January 1, 1996........ 4,277,975 43 9,974 -- -- -- (7,895) 2,122
Reclassification of Series B
Convertible Preferred Stock..... -- -- -- 1,600,000 16 1,778 -- 1,794
Issuance of Series C Convertible
Preferred Stock................. -- -- -- 500,000 5 2,744 -- 2,749
Issuance of stock and stock option
exercises....................... 154,241 1 280 -- -- -- -- 281
Net loss.......................... -- -- -- -- -- -- (769) (769)
--------- ----- ------- --------- ---- ------- ------- ------
Balance at December 31, 1996...... 4,432,216 $ 44 $10,254 2,100,000 $ 21 $ 4,522 $(8,664) $ 6,177
Conversion of Series B and Series
C Convertible Preferred Stock to
Common.......................... 3,770,590 38 4,505 (2,100,000) (21) (4,522) -- --
Issuance of stock................. 2,629,018 26 10,569 -- -- -- -- 10,595
Issuance of stock and stock option
excercises...................... 86,364 1 287 -- -- -- -- 288
Dividends paid.................... -- -- -- -- -- -- (519) (519)
Net income........................ -- -- -- -- -- -- 1,102 1,102
---------- ----- ------- --------- ---- ------- ------- -------
Balance at December 31, 1997...... 10,918,188 $ 109 $25,615 $ -- $ -- $ -- $(8,081) $17,643
========== ===== ======= ========= ==== ======= ======= =======
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
========== ===== ======= ========= ==== ======= ======== =======
See notes to consolidated financial statements.
F-5
ECCS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
Years Ended December 31,
---------------------------------------------
1996 1997 1998
--------- ---------- ---------
Cash flows from operating activities:
Net (loss) income.......................................... $ (769) $ 1,102 $ (2,657)
Adjustments to reconcile net (loss) income to net
cash (used in) provided by operating activities:
Extraordinary item...................................... -- 120 --
Depreciation and amortization........................... 1,311 1,232 1,099
Write off of capitalized software
-- -- 366
Gain on sale of Illinois property....................... (145) -- --
Change in operating assets and liabilities:
Increase in accounts receivable......................... (395) (2,575) (907)
Decrease (increase) in inventories...................... 174 84 (967)
Decrease (increase) in prepaid expenses and other....... 43 (538) 276
Decrease (increase) in payable to AT&T Commercial/Finova (1,190) (64) 1,231
Increase (decrease) in accounts payable, accrued
liabilities and other................................. 1,820 281 (1,353)
Increase (decrease) in customer deposits................ (156) (424) (288)
--------- ------------ ----------
Net cash (used in) provided by operating activities......... 693 (782) (3,200)
--------- ------------ ----------
Cash flows from investing activities:
Additions to property, plant and equipment............... (642) (809) (1,453)
Gross proceeds from sale of Illinois property............ 855 -- --
Additions to capitalized software........................ (439) (602) (1,047)
--------- ------------ -----------
Net cash used in investing activities....................... (226) (1,411) (2,500)
--------- ------------ -----------
Cash flows from financing activities:
Borrowings under revolving credit agreement.............. 15,379 18,198 11,381
Repayments under revolving credit agreement.............. (15,466) (18,929) (12,412)
(Repayment of) proceeds from capital lease obligations... (29) (88) 234
Repayment of mortgage payable............................ (502) -- --
Gross proceeds from issuance of preferred stock.......... 3,000 -- --
Expenses for issuance of preferred stock................. (251) -- --
Proceeds from exercise of employee stock options and
issuance of common stock............................... 281 10,883 246
Payment of dividends..................................... -- (519) --
Cash used for extinguishment of debt..................... -- (120) --
--------- ------------ ----------
Net cash provided by (used in) financing activities......... 2,412 9,425 (551)
--------- ------------ ----------
Net increase (decrease) in cash and cash equivalents........ 2,879 7,232 (6,251)
Cash and cash equivalents at beginning of period............ 1,514 4,393 11,625
--------- ------------ ----------
Cash and cash equivalents at end of period.................. $ 4,393 $ 11,625 $ 5,374
========= ============ ===========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest............................................... $ 422 $ 148 $ 88
========= ============ ==========
See notes to consolidated financial statements.
F-6
ECCS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997 and 1998
(Dollars in Thousands Except Per Share Information)
Note 1 -- The Company
ECCS, Inc. ("ECCS" or the "Company") provides intelligent solutions to
store, protect and access mission critical information for the Open Systems and
related markets. The Company designs, manufactures and sells high performance,
fault tolerant data storage solutions for a wide range of customer requirements.
From its founding until 1994, the Company's principal business was the
value added resale of NCR products. Sales to AT&T business units made up a large
portion of such business. During 1994, as a result of AT&T's acquisition of NCR
and subsequent change in its purchasing policies, the Company undertook a
product development initiative to reposition the Company as a provider of
proprietary mass storage enhancement products. A number of products have
resulted from these efforts including Synchronix and Synchronection, a fault
tolerant network file server.
Note 2 -- Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. 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, Plant and Equipment
Property, plant and equipment are carried at cost. Depreciation and
amortization are provided on a straight-line basis over the estimated useful
lives ranging from 3 to 5 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.
Amortization of the leased property is computed using the straight-line method
over the term of the lease.
F-7
Note 2 -- Summary of Significant Accounting Policies (continued)
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.
Investment in Real Estate
In 1993, the Company purchased real estate, including a building and land,
in Romeoville, Illinois for $753. Depreciation on the building was recognized on
a straight line basis over the estimated useful life of 31.5 years. On March 19,
1996, the Company sold such property for gross proceeds of $855. These proceeds
were used, in part, to pay off the mortgage in full. Net cash proceeds to the
Company, after repayment of the mortgage, were approximately $270.
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 $544, $605 and $190 for 1996, 1997 and 1998,
respectively. At December 31, 1998, the Company has capitalized $3,661 of
software development costs, of which $366 has been written off and $1,993 has
been amortized. In 1998, the Company discontinued its efforts to develop a fibre
controller and a controller design that incorporates Tandem's Server Net
Technology. As a result, the Company incurred a one-time charge in 1998 of $366.
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 events and circumstances indicate that 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.
F-8
Note 2 -- Summary of Significant Accounting Policies (continued)
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 can realistically only be addressed 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.
Research and Development Costs
Research and development costs are expensed as incurred, except for
software development costs which are accounted for as noted 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 is measured as the excess, if any, of the quoted market price of
the Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock.
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. Diluted earnings per share
includes the dilutive effect of all such securities.
F-9
Note 2 -- Summary of Significant Accounting Policies (continued)
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 1997, the Financial Accounting Standards Board issued SFAS No. 131,
Disclosures about Segments of an Enterprise and Related Information, which is
effective for years beginning after December 15, 1997. SFAS No. 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. It also established standards for related disclosures about
products and services, geographic areas, and major customers. SFAS No. 131 is
effective for financial statements for fiscal years beginning after December 15,
1997, and therefore the Company adopted the new requirements in 1998. The
adoption of SFAS No. 131 did not affect results of operations or financial
position, but did affect the disclosure of segment information. See Note 3.
In March 1998, the Accounting Standards Executive Committee of the AICPA
issued Statement of Position (SOP) 98 -1, Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use. The SOP, which has been adopted
prospectively as of January 1, 1999, requires the capitalization of certain
costs incurred in connection with developing or obtaining internal use software.
Management does not expect the effect of adopting the SOP to have a material
affect on the Company's results of operations.
Note 3 -- Transactions with Significant Vendors and Customers
On June 27, 1995, the Company entered into a Manufacturing Services
Agreement with Unisys, its primary manufacturer, which defines the terms of
sales and support services. Pursuant to such agreement, Unisys will manufacture
certain of the Company's products for use in the Company's proprietary systems
as well as for the direct sale to end-users. 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 the Company to
Unisys. The contract had an initial term of one year, and automatically renews
for successive one year periods. The contract has been automatically renewed on
each anniversary date. Pricing and deliverables are to be negotiated each year.
Either party can terminate the agreement with written notice, provided, however,
that if Unisys cancels the agreement, it shall be obligated to continue
accepting manufacturing orders for a period of six months thereafter. In the
event that the Company terminates the agreement, the Company shall be liable for
inventory procured to fill the Company's orders. The Company primarily relies on
regular trade credit with open terms for the
F-10
Note 3 -- Transactions with Significant Vendors and Customers (continued)
financing of purchases under this agreement. The Company's purchases under this
agreement totaled $4,300, $7,800 and $6,600 in 1996, 1997 and 1998,
respectively.
In February 1999, Unisys, the primary outside manufacturer for the
Synchronix system notified the Company, that Unisys was closing its Winnipeg
computer storage systems manufacturing plant by July 31, 1999 and accordingly
the Manufacturing Services Agreement will be terminated at that time. Management
believes it will be able to locate another third party manufacturer or
manufacture the Synchronix systems in-house.
Sales to the Company's primary alternate channel partner, Unisys, accounted
for 18.0% of the Company's net sales in 1997 and 28% in 1998. All sales to
Unisys, which began in 1996, were sales of mass storage enhancement products.
Effective May 1, 1995, the Company entered into an OEM agreement with Unisys.
Such agreement, as subsequently amended, grants to Unisys exclusive world-wide
rights to sell and distribute certain of the Company's proprietary products, and
a non-exclusive world-wide right to sell and distribute certain other products.
The agreement provides that product pricing shall remain in effect throughout
the term of the agreement unless market conditions dictate that the Company
should provide more favorable pricing terms to Unisys. The agreement is for an
initial five-year term beginning May 1, 1995 and Unisys has the right to extend
such term for successive one-year periods upon appropriate written notice. The
agreement may be terminated under certain conditions and Unisys may, subject to
certain conditions, terminate the agreement in the event that the Company fails
to timely perform its delivery obligations under the agreement. While the
Company has an OEM agreement with Unisys that defines the terms of the sales and
support services provided thereunder, this agreement does not include specific
quantity commitments.
Federal systems entity sales, which are comprised of sales to the Federal
Government, represented 30%, 48% and 34%, of net sales in 1996, 1997 and 1998,
respectively. During 1996 the Company became a subcontractor to a prime
contractor, Hughes Data Systems, which was awarded a United States Air Force
Workstation Contract, along with Sun Microsystems, Inc.
The United States Air Force, an end user of the Company's products which
purchases such products through Worldwide Technologies, Hughes Data Systems and
other government contractors, purchased $15,000 of products, or 44% of the
Company's total net sales in 1997. In 1998 such sales totaled $9,579 or 34% of
total sales. There are no minimum purchase requirements.
In 1996, 1997 and 1998, purchases by multiple AT&T business units
represented 14%, 3% and less than 1%, respectively of all purchases from the
Company. All such sales by the Company to AT&T were made on an individual
purchase order basis and, therefore, there were and are no ongoing written
commitments by AT&T to purchase from the Company. The Company historically sold
its mass storage enhancement systems and provided systems integration services
to AT&T, and, acting as a value added reseller ("VAR") of NCR products, sold NCR
computer hardware systems to multiple AT&T business units for either their own
use as an end
F-11
Note 3 -- Transactions with Significant Vendors and Customers (continued)
user or for resale by such business units to third parties. In 1998, the Company
purchased less than 1% of its inventory acquisitions from NCR. In 1996 and 1997,
purchases from such vendor represented 7.5% and less than 1%, respectively, of
the Company's inventory purchases.
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 1996
and 1997, purchases from Bell Microproducts totaled approximately $2,100 or
12.7% and $4,200 or 17.2% of all purchases respectively. In 1998, such purchases
totaled $5,100 or 23.3% of all purchases.
Anthem Electronics, Inc. ("Anthem") is a significant vendor to the Company.
The Company's purchases from Anthem totaled $1,200 or 7.3%, $1,100, or 4.6% and
$507 or 2.3% of the Company's total purchases in 1996, 1997 and 1998,
respectively. Such purchases consisted primarily of disk drives. The Company
purchases from Anthem on an open account basis.
Segment Information
All of the Company's revenues are generated in the United States. The
Company classifies its revenues based upon its primary sales channels: OEM,
Federal and commercial. 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 and are as follows:
Net Sales 1996 1997 1998
--------- ---- ---- ----
OEM $8,590 $12,580 $10,532
Federal 5,651 14,960 9,678
Commercial 8,363 6,461 8,256
----- ----- -----
Total $22,604 $34,001 $28,466
======= ======= =======
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,
--------------------------
1997 1998
--------- ------------
Purchased parts............................ $ 2,496 $ 2,500
Finished goods............................. 2,808 3,848
--------- -----------
5,304 6,348
Less: inventory valuation reserve........ 708 785
--------- -----------
$ 4,596 $ 5,563
========= ===========
F-12
Note 5 -- Property, Plant and Equipment
Property, plant and equipment consist of the following:
December 31,
------------------------
1997 1998
------------ ----------
Property........................................... $ 464 $ 473
Computer equipment................................. 3,808 4,929
Vehicles........................................... 47 47
Leasehold improvements............................. 373 407
Equipment under capital leases..................... 368 651
--------- --------
5,060 6,507
Less accumulated depreciation and amortization,
including $346 and $361 relating to equipment
under capital leases at December 31, 1997
and December 31, 1998, respectively.............. 3,688 4,591
--------- --------
$ 1,372 $ 1,916
========= =========
Note 6 -- Loans Payable to NCC and Finova
Until July 30, 1997, the Company had a financing facility with Fidelity
Funding of California, Inc. which provided for maximum eligible (as defined)
accounts receivable financing of $7,000 at the prime lending rate with a 0.5%
transaction fee applied to each borrowing. In addition, the agreement required a
commitment fee of 0.5% of the total available financing amount, payable annually
on each anniversary date of the agreement. The weighted average interest rate on
such line was 11.5% and 7.3% in 1996 and 1997, respectively. The obligations
under such agreement were collateralized by substantially all of the assets of
the Company. The agreement did not contain any cash withdrawal restrictions, any
requirements for maintenance of specific financial ratios or minimum net worth
or limitations on dividend payments. Such financing facility was terminated in
July 1997 in connection with the consummation of the Company's new financing
facility with NationsBanc Commercial Corporation ("NCC") and all outstanding
amounts have been repaid. In connection with the termination of such financing
facility, the Company incurred a one-time extraordinary charge of $120.
On July 9, 1997, the Company entered into a full recourse factoring
facility with NCC which provides for aggregate advances not to exceed the lesser
of $7 million or up to 85% 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 NCC 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. As of December 31, 1998, the Company had no outstanding
balance under this full recourse factoring facility.
On May 17, 1996, the Company's direct pay line of credit with AT&T-CFC was
terminated and its general line of credit with AT&T-CFC was increased to $2,000.
The agreement with AT&T-CFC contained covenants relating to net worth, total
assets to debt and
F-13
Note 6 -- Loans Payable to NCC and Finova (continued)
total inventory to debt. On December 1, 1997, 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 March 31, 1998. On October 31, 1998, Finova
increased such general line of credit to $3,000 and extended it through January
31, 1999, on the same terms and conditions. After such date, the line returned
to $2,000. The Company uses this line of credit to augment its purchasing
ability with various vendors. The Company relied on this line of credit for 9%
and 8.5% of its inventory acquisitions in 1997 and 1998, respectively, the
majority of which were purchases from Bell Microproducts and Tech Data
Corporation. The Company's obligations under the agreement with Finova are
collateralized by substantially all of the assets of the Company. The maximum
amount, during the preceding twelve months, that the Company has drawn under
such general line of credit has been approximately $1,231. As of December 31,
1998, the Company had $1,231 balance outstanding under this credit line, and
available credit under such line towards future inventory purchases was
approximately $769. The weighted average interest rate on such line was 6.8% in
1998.
Finova and NCC 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 NCC restricts the Company's ability to pay
certain dividends without NCC's prior written consent. The Company's agreement
with Finova prohibits the payment of dividends. AT&T-CFC, the previous lender
under the Finova line of credit, waived such prohibition in connection with the
dividend payments made to the holders of the Series B Preferred Stock and Series
C Preferred Stock.
Note 7 -- Mortgage Payable
On July 20, 1993, the Company entered into a mortgage agreement bearing 8%
interest with a bank for the principal amount of $529, collateralized by
property located in Romeoville, Illinois. On March 19, 1996, the Company sold
such property for gross proceeds of $855 and used a portion of such proceeds to
repay the mortgage, in full.
Note 8 -- Leases
The Company has capitalized leases for certain equipment. The capitalized
lease obligations were payable through the first quarter of 1998 and bear
interest at rates ranging from 7.2% to 19.5%. Capitalized lease obligations
entered into in 1998 are payable through the second quarter of 2000 and bear an
interest rate of approximately 3.0%. In addition, the Company is obligated
through the Year 2000 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. Rental expense for
such leases approximated $501, $507 and $523 for the years ended December 31,
1996, 1997 and 1998, 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.
F-14
Note 8 -- Leases (continued)
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, 1998:
Capitalized Operating
Leases Leases
---------- ----------
1999............................................. $ 118 $ 536
2000............................................. 118 494
2001............................................. 20 25
Thereafter....................................... -- --
------- --------
Total minimum lease payments..................... 256 $ 1,055
------- ========
Less amount representing interest................ 11
-------
Present value of net minimum lease payments...... $ 245
=======
F-15
Note 9 -- Convertible Preferred Stock
The Company has an authorized class of 3,000,000 shares of Preferred Stock,
which may be issued by the Board of Directors on such terms, and with such
rights, preferences and designations as the Board may determine. On May 19,
1995, the Company consummated a private placement of 6% Cumulative Redeemable
Convertible Preferred Stock, Series B (the "Series B Preferred Stock") pursuant
to which the Company issued and sold to certain investors 1,600,000 shares of
Series B Preferred Stock at a price per share of $1.25. The Series B Preferred
Stock was redeemable by the Company, at its option, after one year at $1.25 per
share, or $2 million in the aggregate, plus any accrued and unpaid dividends. In
addition, it was manditorily redeemable four years from the date of issuance at
the same amounts. On May 17, 1996, the Series B Preferred Stock was amended to
delete the mandatory and optional redemption provisions contained therein. As a
result of the deletion of the mandatory and optional redemption provisions, the
Series B Preferred Stock was reclassified to equity.
Also on May 17, 1996, 500,000 shares of the Company's Preferred Stock were
designated as Cumulative Convertible Preferred Stock, Series C ("Series C
Preferred Stock"). Of such shares, 462,512 were issued into escrow on May 17,
1996 at a price per share of $6.00. At any time, the Series C Preferred
Shareholders could convert their Series C Preferred Stock into Common Stock, at
the initial rate of four shares of Common Stock for each share of Series C
Preferred Stock. The Company reserved 2,000,000 shares of Common Stock for the
conversion of the outstanding Series C Preferred Stock. The 462,512 shares of
Series C Preferred Stock and the proceeds thereof were released from escrow on
May 25, 1996 upon satisfaction of all applicable conditions to release, after
denial by Nasdaq of an exception to the shareholder approval requirement. The
issuance of such shares of Series C Preferred Stock without shareholder approval
and without an exception to such requirement constituted a breach of the
Company's listing agreement with Nasdaq. Consequently, the Company was delisted
from the National Market and is now listed on the SmallCap Market. The Company's
Board of Directors had determined that the issuance of the shares of Series C
Preferred Stock without shareholder approval was necessary for the continued
financial viability of the Company.
On May 30, 1996, the Company issued directly to certain investors the
remaining 37,488 shares of Series C Preferred Stock at a price of $6.00 per
share.
In connection with the issuance of the Series C Preferred Stock and
pursuant to the anti-dilution provisions of the Series B Preferred Stock, the
conversion ratio of the Series B Preferred Stock was adjusted. As a result, the
Series B Preferred Stock was convertible into approximately 1,770,590 shares of
Common Stock.
On August 25, 1997, the Company consummated the Offering of 2,500,000
shares of its Common Stock at a price to the public of $4.50 per share. Of such
shares, 2,254,018 were issued and sold by the Company and an aggregate of
245,982 were sold by certain selling shareholders (the "Selling Shareholders").
On September 15, 1997 and as part of the Offering, an additional 375,000 shares
were issued and sold by the Company at a price to the public of $4.50 per share
F-16
Note 9 -- Convertible Preferred Stock (continued)
to cover over-allotments. The Company received net proceeds of approximately
$10,595. The Company did not receive any proceeds from the sale of shares by the
Selling Shareholders.
Upon the closing of the Offering, all 1,600,000 Shares of 6% Cumulative
Redeemable Convertible Preferred Stock, Series B (the "Series B Preferred
Stock") were automatically converted into 1,770,590 shares of the Company's
Common Stock, and all 500,000 shares of the Series C Preferred Stock were
automatically converted into 2,000,000 shares of the Company's Common Stock.
Prior to the closing of the Offering, dividends on the Series B Preferred
Stock accumulated at the rate of $0.02 per share per quarter. In addition,
interest of 6% per annum accrued on any unpaid dividends. On August 21, 1997,
the Board of Directors declared a cash dividend representing cumulative unpaid
dividends on the Series B Preferred Stock for the period from May 19, 1995
through and including August 25, 1997.
In addition, prior to the closing of the Offering, dividends on the Series
C Preferred Stock accumulated at the rate of $0.09 per share per quarter.
Interest of 6% per annum also accrued on any unpaid dividends. On August 21,
1997, the Board of Directors declared a cash dividend representing cumulative
unpaid dividends on the Series C Preferred Stock for the period from May 17,
1996 through and including August 25, 1997.
The Company used a portion of the net proceeds from the Offering to pay
approximately $317 and $242 of cumulative dividends and interest to the holders
of the Series B Preferred Stock and the Series C Preferred Stock, respectively.
Such payments represented both of the cash dividends declared by the Board of
Directors on August 21, 1997.
Note 10 -- Stock Option Plans
Statement of Financial Accounting Standards 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 is measured as the excess, if
any, of the quoted market price of the Company's stock at the date of the grant
over the amount an employee must pay to acquire the stock.
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 option price of the shares may not be less than 110%
of the fair market value on the date of grant. The incentive stock options
expire
F-17
Note 10 -- Stock Option Plans (continued)
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.
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, 1995.................. 440,917 $3.03
-----------
Options granted ......................... 270,000 $2.21
Options exercised........................ (16,375) $1.16
Options canceled......................... (99,625) $2.93
-----------
Balance at December 31, 1995................ 594,917 $2.73
-----------
Options granted ......................... 310,559 $2.76
Options exercised........................ (15,225) $3.31
Options canceled......................... (126,075) $3.22
-----------
Balance at December 31, 1996................ 764,176 $2.65
-----------
Options exercised........................ (41,283) $2.49
Options canceled......................... (27,175) $2.67
-----------
Balance at December 31, 1997................ 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 exercisable at December 31, 1998 166,760 $2.11
The weighted average remaining contractual life for the balance at December
31, 1998 in the 1989 Stock Option Plan is six (6) years and the exercise price
range is $1.00 - $3.03.
On October 6, 1994, the Board of Directors offered to reduce the exercise
price of certain options to the fair market value of the Company's Common Stock
on such date. Upon acceptance by the option holders, the vesting period began
from the date of the offer and the options become exercisable ratably over a
period of four years and expires ten years from the date of issuance.
1996 Stock Option Plan
In June 1996, the Board of Directors of the Company adopted, subject to
shareholder approval, such approval being granted in July of 1996, 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
F-18
Note 10 -- Stock Option Plans (continued)
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 option price
of the shares may not be less than 110% of the fair market value on the date of
grant. The incentive stock options expire five (5) 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 (5)
years.
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, 1995................... -- --
----------
Options granted........................... 212,000 $ 4.06
Options exercised......................... -- --
Options canceled.......................... -- --
-----------
Balance at December 31, 1996................. 212,000 $ 4.06
-----------
Options exercisable at December 31, 1996..... -- --
Options granted........................... 238,500 $ 6.28
Options canceled.......................... (31,000) $ 4.80
-----------
Balance at December 31, 1997................. 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 exercisable at December 31, 1998 -- --
The weighted average remaining contractual life for the balance at December
31, 1998 in the 1996 Stock Option Plan is ten (10) years and the exercise price
range is $1.25 - $2.10.
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 such 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
F-19
Note 10 -- Stock Option Plans (continued)
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.
Non-Qualified Stock Options
On February 1, 1995, 306,000 common stock purchase options were granted by
the Board to full-time employees, including officers, and a non-employee
consultant. The exercise price is $2.13, the fair market value of the Company's
Common Stock at the date of grant. These options are exercisable over a period
of four years and expire ten years from the date of issuance. These options were
granted outside the Company's 1989 Stock Option Plan pursuant to non-qualified
stock option agreements (the "Non-Qualified Agreements"). On May 19, 1995, in
connection with the sale by the Company of 1,600,000 shares of Series B 6%
Cumulative Redeemable Convertible Preferred Stock (see Note 9), and pursuant to
an anti-dilution provision contained in certain of such options granted to an
officer of the Company, the number of options granted to such officer was
increased to 113,691. The exercise price of the 113,691 options granted to such
officer was adjusted to $1.25, the purchase price of the Series B 6% Cumulative
Redeemable Convertible Preferred Stock. The anti-dilution provision expired on
December 31, 1995. No anti-dilution provision was included in connection with
the issuance of the Series C Convertible Preferred Stock.
A summary of the changes in outstanding common stock options under the
Non-Qualified Agreements is as follows:
Options Outstanding
-----------------------------
Weighted-Average
Shares Exercise Price
------------- ---------------
Balance at January 1, 1995...................... 20,000 $ 2.38
-----------
Options granted.............................. 339,691 $ 1.83
Options exercised............................ (20,000) $ 2.38
Options canceled............................. (29,500) $ 2.13
-----------
Balance at December 31, 1995.................... 310,191 $ 1.80
-----------
Options granted ............................. 100,000 $ 3.04
Options exercised............................ (10,250) $ 2.13
Options canceled............................. (57,750) $ 2.13
-----------
Balance at December 31, 1996.................... 342,191 $ 2.53
-----------
Options granted ............................. 498,400 $ 8.01
Options exercised............................ (7,250) $ 2.13
Options canceled............................. (9,500) $ 5.22
-----------
Balance at December 31, 1997.................... 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 exercisable at December 31, 1998........ 163,145 $ 1.99
F-20
Note 10 -- Stock Option Plans (continued)
The weighted average remaining contractual life for the balance at December
31, 1998 under the Non-Qualified Agreements is nine (9) years and the exercise
price range is $1.25 - $2.88.
Subsequent to the end of the year, 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 of 1996, the Board of Directors of the Company adopted, subject
to shareholder approval, such approval being granted in July of 1996, the 1996
Non-Employee Directors Stock Option Plan (the "1996 Non-Employee Directors
Plan"). 150,000 shares of Common Stock can be issued under such plan 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 (4)
year period.
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, 1997................... -- --
Options granted........................... 60,000 $ 4.38
--------
Balance at December 31, 1997................. 60,000 $ 4.38
--------
Options granted........................... 30,000 $ 6.50
Balance at December 31, 1998 90,000 $ 5.09
--------
Options exercisable at December 31, 1998..... 24,167 $ 4.38
F-21
Note 10 -- Stock Option Plans (continued)
Stock Warrants
On December 6, 1994, common stock purchase warrants for 266,601 shares
exercisable at $1.75 per share, the fair market value of the Company's Common
Stock on such date, were granted to an officer and director of the Company.
These warrants become exercisable at various dates during the first year and
expire ten years from the date of issuance. On May 19, 1995, in connection with
the sale by the Company of 1,600,000 shares of the Series B Preferred Stock (see
Note 9), pursuant to an anti-dilution provision contained in such common stock
purchase warrants, the number of warrants granted to such officer and director
was increased to 298,848 and the exercise price was adjusted to $1.25, the
purchase price of the Series B Preferred Stock. At December 31, 1998, all such
warrants were exercisable.
The Company has reserved 2,332,007 shares of Common Stock for the exercise
of stock options and warrants as described above.
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 1996, 1997 and 1998: risk-free interest rates of between
5.48%-7.58% in 1996, 5.74%-6.73% in 1997 and 4.3%-5.74% in 1998; dividend yields
of zero; volatility factors of the expected market price of the Company's common
stock of 1.02 in 1996, .959 in 1997 and .947 in 1998; and a weighted-average
expected life of four (4) years. The weighted average fair market value of stock
options issued in 1996, 1997 and 1998 was $2.35, $3.32 and $2.20 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.
F-22
Note 10 -- Stock Option Plans (continued)
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):
1996 1997 1998
------- ---------- ---------
Net (loss) income as reported..................... $ (769) $ 1,102 $ (2,657)
Pro forma net (loss)income ....................... $(1,093) $ 383 $ (3,802)
(Loss) income per share as reported
Basic.......................................... $ (.23) $ .14 $ (.24)
Pro forma (loss) income per share
Basic.......................................... $ (.25) $ .03 $ (.35)
(Loss) income per share as reported - diluted..... $ (.23) $ .11 $ (.24)
Pro forma (loss) income per share - diluted....... $ (.25) $ .03 $ (.35)
Note 11 -- Employee Stock Purchase Plan
In June 1995, the Company adopted a 1995 Employee Stock Purchase Plan (the
"Purchase Plan") and reserved for issuance an aggregate of 150,000 shares of
Common Stock. In June 1998, the shareholders approved an increase in the number
of shares subject to the Purchase Plan to 400,000 shares. 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 1995 Employee Stock Purchase Plan. The option to purchase stock under the
Purchase Plan will terminate December 31, 1999. At December 31, 1998, 156,124
shares were issued under the Purchase Plan, of which 43,546 were issued in 1998.
Note 12 -- Income Taxes
The provision for income taxes is comprised of the following:
December 31,
------------------------------------------
1996 1997 1998
----------- ------------ ----------
Federal:
Current..................... $ -- $ -- $ --
Deferred.................... -- -- --
State:
Current..................... -- -- --
Deferred.................... -- -- --
---------- ---------- ---------
Total......................... $ -- $ -- $ --
========== ========== =========
F-23
Note 12 -- Income Taxes (continued)
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, 1997 and 1998 are as follows:
1997 1998
------------- -----------
Tax credits......................... $ 436 $ 663
Net operating losses................ 2,882 4,311
Capitalized software................ (316) (508)
Other............................... 777 648
Valuation allowance................. (3,779) (5,114)
--------- -----------
Total............................... -- --
Current............................. -- --
--------- -----------
Non-current......................... $ -- $ --
========= ===========
During 1997, the Company utilized $1,118 of net operating loss carryover
("NOL") for federal tax purposes. The Company has NOL carryovers for Federal
income tax purposes of approximately $10,278 which will begin to expire in 2009.
The Company also has research and development tax credit carryovers for Federal
income tax purposes of approximately $376 which will begin to expire in 2009. In
addition, the Company has alternative minimum tax credits of approximately $67.
These credits can be carried forward indefinitely. The Company experienced a
change in ownership in 1996 as defined by Section 382 of the Internal Revenue
Code. Accordingly, future use of some of these NOLs and income tax credits may
be limited.
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 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,
-------------------------------
1996 1997 1998
-------- ----------- ---------
Computed tax expense (benefit).......................... $ (261) $ 375 $ (903)
Increase (decrease) in federal valuation allowance
(use of NOL)........................................... 418 (222) 1,131
Research and development tax credits.................... (183) (153) (228)
Other................................................... 26 -- --
------- ------- ------
Actual tax expense (benefit)............................ $ -- $ -- $ --
======== ======= ======
F-24
Note 12 -- Income Taxes (continued)
The Company also has approximately $12,965 of state NOL carryforwards which
will begin to expire in 2001 and state research and development tax credit
carryforwards of $334 as of December 31, 1998.
Note 13 -- Computation of Basic and Diluted Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share:
1996 1997 1998
---- ---- ----
Numerator:
Net (loss) income $ (769) $ 1,102 $ (2,657)
Preferred stock dividends (248) (192) --
--------- ----------- ---------
Numerator for basic earnings per share -
(loss) income available to common shareholders (1,017) 910 (2,657)
Effect of dilutive securities:
Preferred stock dividends -- 192 --
Interest on unpaid preferred stock dividends -- 20 --
--------- ----------- ----------
-- 212 --
--------- ----------- ----------
Numerator for dilutive earnings per share -
income available to common shareholders after
assumed conversion -- 1,122 --
Denominator:
Denominator for basic earnings per share-
weighted-average shares 4,346 6,702 10,969
Effect of dilutive securities:
Employee stock options -- 819 --
Warrants -- 66 --
Convertible preferred stock -- 2,448 --
-------- ----------- --------
-- 3,333 --
Dilutive potential common shares
Denominator for diluted earnings per share
Adjusted weighted-average shares and
assumed conversion -- 10,035 --
========= ============ =========
Basic earnings per share $ (0.23) $ 0.14 $ (0.24)
========= ============ =========
Diluted earnings per share $ (0.23) $ 0.11 $ (0.24)
========= ============ =========
F-25
Note 14 -- 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.
There are no individual material litigation matters pending to which the
Company is party or to which any of its property is subject.
Note 15 -- Related Party Transaction
On June 6, 1997, the Company entered into a loan transaction with its
President and Chief Executive Officer (the "Borrower") pursuant to a $250
promissory note in favor of the Company. Interest on the outstanding principal
balance of such promissory note is payable monthly at the prime lending rate. At
December 31, 1998, the balance on such promissory note was $218. The promissory
note is payable over a five-year period beginning on May 31, 1999. In connection
with such promissory note, the Borrower granted the Company a security interest
in the Borrower's interests in the Company's 1997 Executive Compensation Plan
and any and all future executive compensation bonuses or similar compensation to
be received by the Borrower. The Borrower also pledged to the Company all of his
right, title and interest to 25,000 restricted shares of the Company's Common
Stock and options to purchase 131,000 shares of the Company's Common Stock as
security for the promissory note.
F-26
ECCS, Inc.
Schedule II - Valuation and Qualifying Accounts
(in thousands)
Column A Column B Column C Column D Column E
Additions
---------
Charged Charged to Balance at
Balance at to Other End of
DESCRIPTION Beginning Costs and Accounts- Deductions- Period
of Period Expenses Describe Describe
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
------ ----- ------ ----- ---------
YEAR ENDED December 31, 1997:
Allowance for Doubtful
Accounts & Returns/Credits................... $ 184 $ 183 $ -- $ 70 (A) $ 297
------ ----- ------ ------ ---------
Tax valuation................................ $4,072 $ -- $ -- $ 293 (C) $ 3,779
------ ----- ------ ------ ---------
Inventory.................................... $ 781 $ 840 $ -- $ 913 (B) $ 708
------ ----- ------ ------ ---------
Warranty..................................... $ 414 $ 886 $ -- $ 766 $ 534
------ ----- ------ ------- ---------
YEAR ENDED December 31, 1996:
Allowance for Doubtful
Accounts & Returns/Credits................... $ 226 $ -- $ -- $ 42 (A) $ 184
------ ----- ------ ------ --------
Tax valuation................................ $3,654 $ -- $ 418 (D) $ -- $ 4,072
------ ----- ------ ------ --------
Inventory.................................... $ 813 $ 620 $ -- $ 652 (B) $ 781
------ ----- ------ ------ --------
Warranty..................................... $ 350 $ 64 $ -- $ -- $ 414
------ ----- ------ ------ --------
(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.
EXHIBIT 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement
(Form S-8 Registration No. 33-93480) pertaining to the 1989 Stock Option Plan,
as amended (the "Option Plan"); the 1995 Employee Stock Purchase Plan (the
"Purchase Plan"); and 306,000 shares issuable under certain options granted
outside the Option Plan in February 1995 (the "February 1995 Options"); the
Registration Statement (Form S-8 Registration No. 333-15529) pertaining to the
1996 Non-Employee Directors Stock Option Plan (the "Non-Employee Plan") and the
1996 Stock Plan (the "Stock Plan") and the Registration Statement (Post
Effective Amendment No. 1 to Form S-8/S-8 Registration No. 333-8416) pertaining
to the Option Plan; the Purchase Plan; the February 1995 Options; the
Non-Employee Plan; the Stock Plan; 298,848 shares issuable under that certain
warrant granted in December 1994; 90,000 shares issuable under certain options
granted outside the Option Plan, the Stock Plan and the Non-Employee Plan in
June 1996; 10,000 shares issuable under certain options granted outside the
Option Plan, the Stock Plan and the Non-Employee Plan in December 1996; and
498,400 shares issuable under certain options granted outside the Option Plan,
the Stock Plan and the Non-Employee Plan in February 1998 of our report dated
February 19, 1999, with respect to the consolidated financial statements and
schedule of ECCS, Inc. included in the Annual Report (Form 10-K) for the year
ended December 31, 1998 filed with the Securities and Exchange Commission.
ERNST & YOUNG LLP
MetroPark, New Jersey
March 29, 1999