SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
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(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
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OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NUMBER 1-13616
STORAGE COMPUTER CORPORATION
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(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 02-0450593
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(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
11 RIVERSIDE DRIVE NASHUA, NH 03062
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)
(603) 880-3005
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Number of shares outstanding of the registrant's class of common stock, as of
the latest practicable date.
OUTSTANDING AT
CLASS MAY 15, 2002
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Common Stock.......................... 19,803,917
PART I -- FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited). Page
Consolidated Balance Sheets -- March 31, 2002 3
and December 31, 2001.
Consolidated Statements of Operations - Three months 4
ended March 31, 2002 and 2001.
Consolidated Statements of Cash Flows - Three months 5
ended March 31, 2002 and 2001.
Notes to Consolidated Financial Statements - March 31, 2002. 6
Item 2. Management's Discussion and Analysis of Financial Condition and 7
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 13
PART II -- OTHER INFORMATION
Item 1. Legal Proceedings. 14
Item 2. Changes in Securities and Use of Proceeds. 14
Item 3. Defaults Upon Senior Securities. 14
Item 4. Submission of Matters to a Vote of Security Holders. 15
Item 5. Other Information. 15
Item 6. Exhibits and Reports on Form 8-K. 15
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Storage Computer Corporation
Consolidated Balance Sheets
MARCH 31, DECEMBER 31,
2002 2001
---- ----
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $3,496,193 $5,627,855
Accounts receivable, net 1,357,602 1,644,366
Inventories 4,017,285 3,811,658
Due from officers and directors 127,934 356,269
Other current assets 692,714 799,530
------------ ------------
Total current assets 9,691,728 12,239,678
Property and equipment, net 803,734 828,817
Goodwill, net 16,287,911 16,287,911
Other intangibles, net 3,718,834 3,958,906
Other assets 388,829 394,902
------------ ------------
Total assets $30,891,036 $33,710,214
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $942,145 $802,015
Accrued expenses 1,524,657 1,533,689
Deferred revenue 445,688 492,987
Current maturities of long-term debt 1,053,967 285,254
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Total current liabilities 3,966,457 3,113,945
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Long-term debt, less current maturities 258,279 328,184
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Commitments and contingencies
Redeemable convertible preferred stock 3,776,150 3,725,015
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Stockholders' equity:
Preferred stock 1,302,228 1,178,319
Common stock 19,200 19,135
Additional paid-in capital 76,147,054 76,001,699
Accumulated deficit (54,578,332) (50,656,083)
------------ ------------
Total stockholders' equity 22,890,150 26,543,070
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Total liabilities and stockholders' equity $30,891,036 $33,710,214
============ ============
See Notes to Consolidated Financial Statements.
- 3 -
Storage Computer Corporation
Consolidated Statements of Operations (Unaudited)
Three Months Ended
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MARCH 31, MARCH 31,
2002 2001
---- ----
Revenues:
Products and services $766,003 $2,059,362
License fees -- --
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Total revenues $766,003 $2,059,362
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Costs and expenses:
Cost of products and services 721,700 1,362,564
Cost of license fees, primarily legal fees 679,114 41,366
Research and development 1,019,669 1,225,763
Sales and marketing 1,016,726 657,884
General and administrative 801,529 699,772
Amortization of intangibles 240,072 713,930
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Total costs and expenses 4,478,810 4,701,279
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Operating loss (3,712,807) (2,641,917)
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Other income (expense):
Interest income (expense), net (3,257) 111,078
Other income 50,859 115,310
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Total 47,602 226,388
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Loss before income taxes (3,665,205) (2,415,529)
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Provision for income taxes -- 3,103
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Net loss (3,665,205) (2,418,632)
Dividends on preferred stock including
amortization of the beneficial conversion features (257,044) (1,589,367)
------------ ------------
Net loss applicable to common stockholders $(3,922,249) $(4,007,999)
============ ============
Net loss applicable to common stockholders per
basic and dilutive share $(0.20) $(.26)
============ ============
Basic and dilutive shares 19,176,260 15,427,876
============ ============
See Notes to Consolidated Financial Statements.
- 4 -
Storage Computer Corporation
Consolidated Statements of Cash Flows (Unaudited)
Three Months Ended
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MARCH 31, MARCH 31,
2002 2001
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Cash flows from operating activities:
Net loss $(3,665,205) $(2,418,632)
Reconciliation to operating cash flows:
Depreciation and amortization of property
and equipment 124,980 127,290
Amortization of goodwill -- 473,858
Amortization of other intangibles 240,072 240,072
Stock issued to 401(k) plan 18,786 6,561
Changes in operating assets and liabilities:
Accounts receivable 286,764 (870,506)
Inventories (276,315) 109,630
Due from officers and directors 1,000,000 --
Other current assets 106,816 113,499
Accounts payable and accrued expenses 49,355 (404,260)
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Net cash used in operations (2,114,747) (2,622,488)
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Cash flows from investing activities:
Capital expenditures (15,442) (27,911)
Other assets 6,073 122,658
CyberStorage acquisition costs -- (985)
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Net cash provided by (used in) investing activities (9,369) 93,762
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Cash flows from financing activities:
Reduction of long-term debt (72,857) (65,223)
Net proceeds from issuance of common stock
for stock options 79,078 5,724
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Net cash provided by (used in) financing activities 6,221 (59,499)
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Effect of exchange rate changes on cash (13,767) (25,901)
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Net decrease in cash and cash equivalents (2,131,662) (2,614,126)
Cash and cash equivalents-beginning of period 5,627,855 14,852,259
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Cash and cash equivalents-end of period $ 3,496,193 $12,238,133
=========== ===========
Supplemental cash flow information:
Cash payments of interest $16,478 $38,538
Preferred stock dividends paid in common stock $47,556 $--
See Notes to Consolidated Financial Statements.
-5-
Storage Computer Corporation
Notes to Consolidated Financial Statements
March 31, 2002
Note A - The Company and Basis of Presentation
Storage Computer Corporation ("Company", "we" and "us") and our subsidiaries are
engaged in the development, manufacture, and sale of computer disk arrays and
computer equipment worldwide. The consolidated financial statements include the
accounts of the Company and those of our wholly-owned subsidiaries CyberStorage
Systems Corporation, Storage Computer Europe GmbH, Vermont Research Products,
Inc., Storage Computer UK, Ltd., and Storage Computer France SAS. All
significant intercompany accounts and transactions have been eliminated in
consolidation. We have a 20% investment in Storage Computer (Asia) Ltd. which is
accounted for by the equity method.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. Accordingly, they do not include all the information and
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the financial
statements and related notes included in our Annual Report on Form 10-K filed
with the Securities and Exchange Commission, containing our financial statements
for the fiscal year ended December 31, 2001. In management's opinion, the
accompanying financial statements reflect all adjustments, all of which are of a
normal, recurring nature, to fairly present our consolidated financial position,
results of operations and cash flows. The results of operations for the three
months ended March 31, 2002 are not necessarily indicative of the results to be
expected for the full year.
Certain 2001 amounts have been reclassified to conform with the current period
presentation. These reclassifications did not change previously reported total
assets, liabilities, stockholder's equity or net loss.
Note B - Stockholders' Equity
A summary of changes in stockholders' equity in the quarter ended March 31, 2002
follows:
Preferred Stock Common Stock
-------------------- ----------------- Additional Retained Total
Carrying Par Paid-In Earnings Stockholders'
Shares Value Shares Value Capital (Deficit) Equity
------ ----- ------ ----- ------- --------- ------
Balance--December 31, 2001 2,500 $1,178,319 19,134,773 $19,135 $76,001,699 $(50,656,083) $26,543,070
Exercise of stock options 43,500 43 79,035 79,078
Stock issued to 401(k) plan 2,935 3 18,783 18,786
Amortization of beneficial
conversion feature of
preferred stock 123,909 (175,044) (51,135)
Dividends on preferred stock 18,507 19 47,537 (82,000) (34,444)
Net loss (3,665,205) 3,665,205
----- ---------- ---------- ------- ----------- ------------ -----------
Balance-March 31, 2002 2,500 $1,302,228 19,199,715 $19,200 $76,147,054 $(54,578,332) $22,890,150
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Note C - Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. The FASB also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and ceases
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized.
The Company's acquisition of CyberStorage Systems in 2000 was accounted for
using the purchase method. All future business combinations will be accounted
for under the purchase method, which may result in the recognition of goodwill
and other intangible assets, some of which may subsequently be charged to
operations, either by amortization or impairment charges. As of March 31, 2002,
the net carrying amount of goodwill is $16,288,000 and other intangible assets
is $3,719,000. Amortization expense during the three-month period ended March
31, 2002, which represents amortization of other intangible assets only,
amounted to $240,072. Currently, the Company is assessing but has not yet
determined how the adoption of SFAS 141 and SFAS 142 will impact its financial
position and results of operations. The Company will complete this assessment in
the quarter ended June 30, 2002.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment of
Long-Lived Assets," which addresses financial accounting and reporting for the
impairment or disposal of long-lived assets. This statement supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of," and APB Opinion No. 30, "Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions for
the Disposal of a Segment of a Business." SFAS No. 144 became effective for
fiscal years beginning after December 15, 2001. The Company reviews the carrying
values of its long-lived and identifiable intangible assets for possible
impairment whenever events or changes in circumstances indicate that the
carrying amounts of the assets may not be recoverable. Any long-lived assets
held for disposal are reported at the lower of their carrying amounts or fair
values less costs to sell. The Company has adopted SFAS No. 144 during the first
quarter of 2002 and has determined that the adoption of SFAS No. 144 has had no
impact on its financial position or results of operations for that period.
Note C - Subsequent Event
On May 3, 2002 the Company completed a $3,000,000 financing through a private
placement of common stock to a group of four European and US based institutional
investors. The Company sold 600,000 shares of common stock at $5.00 per share
and issued 260,000 warrants to purchase common stock at $6.18 per share that are
exercisable over a five-year period.
-6-
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
CAUTIONARY STATEMENT
Forward-looking Statements
THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1996 CONTAINS CERTAIN SAFE
HARBORS REGARDING FORWARD-LOOKING STATEMENTS. FROM TIME TO TIME, INFORMATION
PROVIDED BY US OR STATEMENTS MADE BY OUR DIRECTORS, OFFICERS OR EMPLOYEES MAY
CONTAIN "FORWARD-LOOKING" INFORMATION SUBJECT TO NUMEROUS RISKS AND
UNCERTAINTIES. ANY STATEMENTS MADE HEREIN THAT ARE NOT STATEMENTS OF HISTORICAL
FACT ARE FORWARD-LOOKING STATEMENTS INCLUDING, BUT NOT LIMITED TO, STATEMENTS
CONCERNING THE CHARACTERISTICS AND GROWTH OF OUR MARKETS AND CUSTOMERS, OUR
OBJECTIVES AND PLANS FOR FUTURE OPERATIONS AND PRODUCTS AND OUR EXPECTED
LIQUIDITY AND CAPITAL RESOURCES. SUCH FORWARD-LOOKING STATEMENTS ARE BASED ON A
NUMBER OF ASSUMPTIONS AND INVOLVE A NUMBER OF RISKS AND UNCERTAINTIES, AND,
ACCORDINGLY, ACTUAL RESULTS COULD DIFFER MATERIALLY. FACTORS THAT MAY CAUSE SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO: THE CONTINUED AND FUTURE ACCEPTANCE
OF OUR PRODUCTS; THE RATE OF GROWTH IN THE INDUSTRIES OF OUR PRODUCTS; THE
PRESENCE OF COMPETITORS WITH GREATER TECHNICAL, MARKETING AND FINANCIAL
RESOURCES; OUR ABILITY TO PROMPTLY AND EFFECTIVELY RESPOND TO TECHNOLOGICAL
CHANGE TO MEET EVOLVING CUSTOMER NEEDS; RISKS ASSOCIATED WITH SALES IN FOREIGN
COUNTRIES; AND OUR ABILITY TO SUCCESSFULLY EXPAND OUR OPERATIONS.
INTRODUCTION
This discussion summarizes the significant accounting policies, accounting
estimates and other significant factors affecting the liquidity, capital
resources and result of all operations for the periods ended March 31, 2002 and
2001. The discussion should be read in connection with the Consolidated
Financial Statements and other financial information included in our 2001 Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We prepare our financial statements in conformity with accounting principles
generally accepted in the United States of America. These accounting principles
require management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosure of contingent assets and
liabilities at the date of the financial statements. Our management is also
required to make certain judgments that affect the reported amounts of revenues
and expenses during the reporting period. We periodically evaluate our estimates
including those relating to the allowance for doubtful accounts; inventory
reserves for lower of cost or market adjustments, excess quantities and
discontinued products; estimated lives and impairment of tangible and intangible
long-life assets; restructuring costs; litigation and other contingencies. We
base our estimates on historical experience and various other assumptions that
we believe to be reasonable based on the specific circumstances, the results of
which form the basis for making judgments about the carrying value of certain
assets and liabilities that are not readily apparent from other sources. Actual
results could differ from these estimates.
We believe the following critical accounting policies impact the most
significant judgments and estimates used in the preparation of our consolidated
financial statements:
Revenue Recognition
We recognize revenue from product sales at the time of shipment. Revenue from
services is recognized over the contract period or as services are provided.
Revenue from license fees is recognized over the contract period or when
received for fully-paid license agreements. These revenue accounting policies do
not require significant estimates by management.
Impairment of Goodwill and Intangible Assets
Goodwill and other intangible assets that resulted from our acquisition of
CyberStorage Systems in 2000 which was accounted for as a purchase, are recorded
at amortized cost. We periodically review the carrying amounts of these
intangible assets for indications of impairment based on the integration of the
acquired technology into our product lines and market conditions for the sale of
these products. If indications of impairment are present, we assess the value of
the intangible assets. During 2001 and continuing into the first quarter of
2002, considerable turmoil existed in storage technology markets and the impact
of overall economic conditions on introduction of our new products, signaled an
indication of the potential for impairment. On the other hand, the events of
September 11th created a strong focus on business continuance practices and
information storage and redundancy. We have analyzed the positioning of our
existing and new product technologies in our market place and concluded that
there was no impairment in the value of our various intangible assets. Future
events could cause us to conclude that impairment indicators exist and that
intangible assets associated with acquired businesses are impaired.
Beginning in 2002, the method for assessing potential impairments of intangibles
will change based on new accounting rules issued by the Financial Accounting
Standards Board (FASB). The Company has not yet determined how the
pronouncements will affect its future financial position and results of
operations. The Company will complete its assessment of the impact of the new
pronouncement in the quarter ended June 30, 2002. The new accounting rules have
resulted in the elimination of the non-cash charge to our operations for
amortization of goodwill in the quarter ended March 31 2002.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts to reflect the expected
non-collection of accounts receivable based on past collection history and
specific risks identified in our portfolio of receivables. If the financial
condition of our customers deteriorates resulting in an impairment of their
ability to make payments, or if payments from customers are significantly
delayed, additional allowances might be required.
Restructuring Costs
During 2000, we recorded significant restructuring accruals in connection with
the integration of our acquisition of CyberStorage Systems into our existing
business. These accruals included estimated costs to settle certain contractual
obligations, personnel related costs for benefit programs and redundancy, and
charges related to excess inventory quantities and parts for discontinued
products. The majority of our estimates were based on reasonably determinable
facts and circumstances and our actual costs incurred were consistent with our
estimates. During 2001 additional reserves were provided for inventories related
to discontinued products.
Intellectual Property Rights, Contingencies and Litigation
We have a substantial portfolio of patents, claims and other intellectual
property rights. Costs and expenses in connection with the development of and
the enforcement of our rights are expensed when incurred. Certain contingent
fees for legal services are due upon the receipt of license fees over contract
periods or upon receipt of payment for paid-up license arrangements. We
currently are in legal proceedings in connection with the enforcement of our
intellectual property rights the results of which cannot be predicted. Our
failure to successfully enforce our patent rights could have a material adverse
effect on our business, operating results and financial condition.
In the normal course of our business, we are subject to various other
proceedings, lawsuits and claims relating to product, technology, labor and
other matters as further described in Part II, Item 1. Legal Proceedings. We are
required to assess the likelihood of any adverse outcomes and the potential
range of probable losses in these matters. The amount of loss accrual, if any,
is determined after careful analysis of each matter, and is subject to
adjustment if warranted by new developments or revised strategies. We believe
that none of the existing matters will result in a material adverse effect on
our business, operating results and financial condition.
LIQUIDITY AND CAPITAL RESOURCES
Our future success depends on maintaining adequate liquidity and working capital
to meet our operational requirements. On May 3, 2002 we completed a $3,000,000
financing through a private placement of common stock to a group of four
European and US based institutional investors. The Company sold 600,000 shares
of common stock at $5.00 per share and issued 260,000 warrants to purchase
common stock at $6.18 per share that are exercisable over a five-year period.
However, given the continued volatility in the securities markets and, in
particular, the securities of technology companies, we cannot assure you that
continuing investors' investments will be available to us or that we will
receive additional equity financing. Our failure to maintain adequate liquidity
and working capital could have a material adverse impact on us.
We continue to incur operating losses in 2002. While development and
introduction of our new products continues and our marketing and sales
activities have increased, we have implemented cost reductions programs where
possible, primarily in employee headcount and the use of independent software
contractors. Management believes that available working capital coupled with the
ability for raising additional equity financing will support the Company's
operating plan. We continue to evaluate opportunities for raising additional
financing and believe that such will be available on reasonable terms to the
Company.
CASH FLOW
Operations used $2,115,000 of cash during the first quarter of 2002 compared to
$2,622,000 in the first three months of 2001.
The use of cash by operations in the first three months of 2002 resulted from
the net loss for the quarter which was offset in part by net cash from changes
in operating assets and liabilities, non cash charges related to depreciation
and amortization and the repayment of an advance by one of our officers. The use
of cash by operations in the first three months of 2001 resulted from the net
loss for the quarter and net cash from changes in operating assets and
liabilities, which were partially offset in part by non cash charges relating to
depreciation and amortization.
Investing activities used $9,000 of cash in the first three months of 2002
primarily for the purchase of capital items offset in part by change in other
assets. Investing activities generated positive cash flow of $94,000 in the
first three months of 2001 from other assets partially offset by capital
expenditures.
Financing activities provided $6,000 of cash in the first three months of 2002
from the proceeds of employee stock option exercises offset by scheduled
payments of long-term debt. Financing activities used $59,000 of cash in the
first three months of 2001 relating to scheduled payment of long-term debt
partially offset by the proceeds of employee stock option exercises.
BORROWING ARRANGEMENTS
We currently have no outstanding bank loans, lines of credit, or credit
facilities.
WORKING CAPITAL
Our working capital at March 31, 2002 was $5,725,000 compared with $9,126,000 at
December 31, 2001. In management's opinion, our current working capital
position, the availability of additional equity financing and a reduction of
cash flow used by operations will be sufficient to accommodate working capital
requirements through the fiscal year ending December 31, 2002.
-7-
RESULTS OF OPERATIONS
Our operating results have fluctuated in the past and may in the future
fluctuate significantly, depending upon a variety of factors. After the
acquisition of CyberStorage Systems Corporation in September of 2000, we
commenced a corporate-wide restructuring, including the expansion of our North
America sales territories to seven regions; the initiation of the plan to
re-establish our re-seller sales channel; consolidation of our European sales,
marketing and service organizations; implemented strategic marketing initiatives
and programs for product development and repositioning. We believe these actions
and the introduction of our new products in 2002 will provide the revenue growth
that will enable us to return to profitability. Currently, we are experiencing
an extended cycle for receipt of new orders due to the introduction of our new
sales management and staff persons, the marketing and training cycles related to
the new sales staff and the introduction of our new products as well as the
current economic climate for the storage sector.
Additional factors that may contribute to variability of operating results
include: trends in national and world-wide economic growth or recession; the
pricing and mix of products offered by us; changes in pricing of our products
and services due to competitive pressures; our ability to obtain sufficient
supplies of sole or limited source components; the ability to manage future
growth and expansion; the continual development of new products; the ability to
successfully identify, target, acquire and integrate suitable acquisitions.
REVENUE
Revenues from products and services for the three-month periods ended March 31,
2002 and 2001 were $766,000 and $2,059,400, respectively. Revenues from products
and services in 2001 consists primarily of our legacy RAID products. In 2002
revenues from products and services are from our new product lines of CyerFiber
that was introduced in late 2001 and CyberNAS that was introduced in the first
quarter of 2002. Revenue for domestic and international products and services
were approximately 75% and 25% of total revenues of products and services during
both periods.
There were no revenues from license fees in the three-month periods ended March
31, 2002 and 2001.
COST OF PRODUCTS AND SERVICES
Product and service costs for the three month periods ended March 31, 2002 and
2001 were $721,700 and $1,362,600, respectively, or 94% and 66% of revenue from
products and services. The increase in the cost percentage between 2001 and 2002
of approximately 28% was a direct result of decreased sales, while factory
overheads and technical service costs remained relatively consistent with the
same period in the prior year.
COST OF LICENSE FEES
Costs associated with the enforcement of our patent and other intellectual
property rights for the periods ended March 31, 2002 and 2001 amounted to
$679,100 and $41,400, respectively. These costs relate to legal and consulting
fees and expenses incurred associated with the enforcement of our patent and
other intellectual property rights which began to increase during the second
quarter of 2001.
RESEARCH AND DEVELOPMENT
Research and development expenses for the three month periods ended March 31,
2002 and 2001 were $1,019,700 and $1,225,800, respectively. The $206,100
decrease in expenditures between the three month periods was due to the decrease
in the utilization of independent software engineers and other subcontractors
for short term assignments.
-8-
SELLING AND MARKETING EXPENSES
Selling and marketing expenses for the three month periods ended March 31, 2002
and 2001 were $1,016,700 and $657,900, respectively. The increase in expenses
between the three month periods ended March 31, 2002 and the comparable period
of 2001 of $358,800, was principally due to the increased head count in
corporate marketing and staffing of the field sales organizations.
GENERAL AND ADMINSTRATIVE EXPENSES
General and administrative expenses for the three month periods ended March 31,
2002 and 2001 were $801,500 and $699,800, respectively. The increase in general
and administrative expenses between the three month periods ended March 31, 2001
and 2002 of $101,700 resulted primarily from an increase in the allowance for
doubtful accounts and increased legal fees relating to equity financing and
other corporate matters.
OTHER INCOME (EXPENSE)
Interest income (expense), net was $(3,257) and $111,078 for the three month
periods ended March 31, 2002 and March 31, 2001, respectively. The reduction in
interest income is directly related to reduced cash balances when compared to
the same period last year. Interest expense has remained relatively constant
during both periods.
Other income relates primarily to translation adjustments which decreased in the
current period due to reduced changes in translation rates.
-9-
FACTORS THAT MAY AFFECT FUTURE RESULTS
OUR STOCK PRICE IS VOLATILE
Our stock price, like that of other technology companies, is subject to
significant volatility because of factors such as:
- the announcement of new products, services or technological
innovations by us or our competitors
- quarterly variations in our operating results
- changes in revenue or earnings estimates by the investment community
- speculation in the press or investment community
- failure to meet earning expectations
In addition, our stock price may be affected by general market conditions and
domestic and international economic factors unrelated to our performance.
Further, until recently, our common stock was thinly traded. Because of these
factors, recent trends should not be considered reliable indicators of future
stock prices or financial results.
- 10 -
OUR BUSINESS MAY SUFFER IF WE CANNOT PROTECT OUR INTELLECTUAL PROPERTY
We generally rely upon patent, copyright, trademark and trade secret laws and
contract rights in the United States and in other countries to establish and
maintain our proprietary rights in our technology and products. However, we
cannot assure you that any of our proprietary rights will not be challenged,
invalidated or circumvented. In addition, the laws of certain countries do not
protect our proprietary rights to the same extent, as do the laws of the United
States. Therefore, we cannot assure you that we will be able to adequately
protect our proprietary technology against unauthorized third-party copying or
use, which could adversely affect our competitive position. Further, we cannot
assure you we will be able to obtain licenses to any technology that it may
require to conduct our business or that, if obtainable, such technology can be
licensed at a reasonable cost.
INTELLECTUAL PROPERTY RIGHTS
We are aggressively pursuing the enforcement of our intellectual property rights
after an extensive patent review conducted in 1999. In 2000, we retained a major
law firm to enforce these rights against infringing parties, the number of which
management believes to be extensive. In 2001, we began bringing legal actions
against companies whose products we believed infringed on our intellectual
property rights and patent portfolio. We intend to vigorously pursue these
actions. Despite ours and our legal representatives' efforts, there can be no
assurance or predictability as to any amount of recovery or the length of time
it will take us to recover any royalties or license fees which may be
recoverable. Despite our efforts to protect our intellectual property rights,
unauthorized use may still occur, particularly in foreign countries.
DEVELOPMENT OF NEW PRODUCTS AND SOLUTIONS
We must make continuous investment in research and development to maintain our
ongoing effort to continually improve our products and provide innovative
solutions to our customers. The development of software products is a difficult
and costly process and subject to many other products' requirements. Our
inability to timely deliver new products in the past has had an adverse effect
on our operating and financial results. There can be no assurance that we will
be able to effectively develop new products in the future.
COMPETITION
We compete with many established companies in the computer storage and server
industries and certain of these companies have substantially greater financial,
marketing and technological resources, larger distribution capabilities, earlier
access to customers and more opportunity to address customers' various
information technology requirements than we do. Our business may be adversely
affected by the announcement or introduction of new products by our competitors,
including hardware, software and services, price reductions of our competitors'
equipment or services and the implementation of effective marketing strategies
by our competitors.
Competitive pricing pressures exist in the computer storage and server markets
and have had and may in the future have an adverse effect on our revenues and
earnings. There also has been and may continue to be a willingness on the part
of certain competitors to reduce prices in order to preserve or gain market
share, which we cannot foresee. We currently believe that pricing pressures are
likely to continue. The relative and varying rates of product price and
component cost declines could have an adverse effect on our earnings.
RAPID TECHNOLOGICAL CHANGES
The computer industry is changing both dramatically and rapidly. The development
of "open systems computing", the introduction of the Internet, new fibre
technologies (SAN) and the increasing storage density in disk drive
technologies, have caused an increase in new product development and shorter
time to bring the new products to market. While we believe that our Virtual
Storage Architecture, StorageSuite and CyberBORG products are advanced when
compared to competitive products, and complement many other products utilized in
total customer solutions, we cannot assure you that this will continue in the
future. The failure to remain consistently ahead of competitive technologies
would have a negative impact on our operating results and financial condition.
BUSINESS ALLIANCES
Many companies are forming business alliances with their competitors, to be able
to provide totally integrated storage solutions to their customers. One result
of these alliances is to effectively preclude competitive products from being
offered to their customers. Many of the relationships are exclusive and our
failure to develop similar relationships will effectively reduce the number of
qualified sales opportunities we will have for our products in the future. We
believe that we address this issue by our return to the reseller channel sales
model and having the integrator/solution providers/value added-resellers perform
the solution selling required. Our failure to open these sales channels will
have a negative effect on our operating results and financial condition.
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OPERATIONS
Our products operate near the limits of electronic and physical performance, and
are designed and manufactured with relatively small tolerances. If flaws in
design, production, assembly or testing were to occur by us or our suppliers, we
could experience a rate of failure in our products that would result in
substantial repair or replacement costs and potential damage to our reputation.
Continued improvement in manufacturing capabilities and control of material and
manufacturing quality and costs are critical factors in our future growth. We
frequently revise and update manufacturing and test processes to address
engineering and component changes to our products and evaluate the reallocation
of manufacturing resources among our facilities. We cannot assure that our
efforts to monitor, develop and implement appropriate test and manufacturing
processes for our products will be sufficient to permit us to avoid a rate of
failure in our products that results in substantial delays in shipment,
significant repair or replacement costs and potential damage to our reputation,
any of which could have a material adverse effect on our business, results of
operations or financial condition.
Additionally, most companies in the high technology arena are under pressure to
be able to acquire and retain the services of talented individuals. At present,
there is a shortage in the number of qualified employees who are available,
creating a lucrative job market for qualified and talented high tech employees.
We have had a decline in revenue in each of the three previous years and
comparable reduction in our work force. While we believe that we have the
required core personnel to effectively manage and grow, we cannot assure you
that key employees will not leave the company in the future. The failure to
maintain key employees could adversely affect our future operating and financial
results.
LIQUIDITY AND WORKING CAPITAL
Our future success depends on maintaining adequate liquidity and working capital
to meet our operational requirements. Given the continued volatility in the
securities markets and, in particular, the securities of technology companies,
we cannot assure you that continuing investors' investments will be available to
us and that we will receive additional equity financing. Our failure to maintain
adequate liquidity and working capital could have a material adverse impact on
us.
FAILURE OF SUPPLIERS TO PROVIDE QUALITY PRODUCTS
We purchase several sophisticated components and products from one or a limited
number of qualified suppliers. These components and products include disk
drives, high density memory components and power supplies. We have experienced
delivery delays from time to time because of high industry demand or the
inability of some vendors to consistently meet our quality and delivery
requirements. If any of our suppliers were to fail to meet the quality or
delivery requirements needed to satisfy customer orders for our products, we
could lose time-sensitive customer orders and have significantly decreased
quarterly revenues and earnings, which would have a material adverse effect on
our business, results of operations or financial condition. Additionally, we
periodically transition our product line to incorporate new technologies. The
importance of transitioning our customers smoothly to new technologies, along
with our historically uneven pattern of quarterly sales, intensifies the risk
that a supplier who fails to meet its delivery or quality requirements will have
an adverse impact on our revenues and earnings.
CHANGES IN LAWS, REGULATIONS OR OTHER CONDITIONS THAT COULD ADVERSELY IMPAIR OUR
CONDITION
Our business, results of operations and financial condition could be adversely
affected if any laws, regulations or standards, both foreign and domestic,
relating to us or our products were newly implemented or changed.
LITIGATION THAT WE MAY BECOME INVOLVED IN MAY ADVERSELY AFFECT US
In the ordinary course of business, we may become involved in litigation,
administrative proceedings and governmental proceedings. Such matters can be
time-consuming, divert management's attention and resources and cause us to
incur significant expenses. Furthermore, we cannot assure you that the results
of any of these actions will not have a material adverse effect on our business,
results of operations or financial condition.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
We have the market risk inherent in financial instruments that relate
primarily to fluctuations in the prime rate of interest to be charged under the
terms of several promissory notes due from and to certain of our executive
officers and directors.
Our foreign subsidiaries' obligations to us are denominated in U.S. dollars.
There is a potential for a foreign currency gain or loss based upon fluctuations
between the U.S. dollar and its subsidiaries' functional currencies, currently
the British pound and Eurodollars. This exposure is limited to the period
between the time of accrual of such liability to us in our subsidiaries'
functional currency and the time of their payment to us in U.S. dollars.
Other than the inter-company balances noted above, we do not believe we have
material unhedged monetary assets, liabilities or commitments that are
denominated in a currency other than the operations' functional currencies. We
expect such exposure to continue until our foreign subsidiaries reach a more
mature level of operation. We currently have no plans to utilize any derivative
products to hedge our foreign currency risk.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
In December 2001, Marketlink Technologies, LLC filed a civil action against us
in the Circuit Court for Oakland County, Michigan, alleging that we owed them a
$156,000 termination payment under the terms of a manufacturers representative
agreement that we terminated for cause in April 2001 because of Marketlink's
inability to sell our products and perform the services required by the
agreement. In January 2002, we filed counterclaims against Marketlink in this
matter, including Marketlink's breach of contract. We believe the claims of
Marketlink are without merit and deny all allegations. Further, we intend to
vigorously defend this action. We are unable to predict and outcome but we do
not believe that our involvement in final settlement of or litigation costs
defending this claim will have a material effect on our business, operating
results or financial condition.
In March 2001, we filed an action against XIOTech Corporation ("XIOTECH") and
its parent company, Seagate Technology, Inc. ("SEAGATE INC"), in the United
States District Court for the Northern District of Texas claiming that its
products infringe one of our patents. In December, 2001, we settled all matters
in controversy that were pending in that action against XIOTECH, SEAGATE INC.,
and a related company, Seagate Technology LLC ("SEAGATE LLC"). Specifically,
such matters included the alleged infringement of one of our patents, namely our
U.S. Patent No. 5,893,919, by XIOTECH. The settlement between XIOTECH and us
includes a one-time $2,500,000 royalty payment to us by XIOTECH for a fully paid
up, royalty-free, worldwide, perpetual, license covering the `919 Patent, with
no right to sublicense, and a royalty free cross license agreement between
XIOTECH and us for all of our respective patents. Additionally, we entered into
a cross license with SEAGATE LLC providing a royalty-free, worldwide, perpetual,
cross license, with no right to sublicense, between SEAGATE LLC and us for all
of our patents and for all of SEAGATE LLC's storage system patents. All cross
license agreements entered into include all patents of Storage Computer
Corporation and XIOTECH, and all storage system patents of SEAGATE LLC,
including current and later acquired patents, domestic as well as foreign.
Further, the parties agreed to dismiss all claims against each other and entered
into certain mutual releases covering the subject matter, from any other action
that may be brought as a result of these issues. Additionally, SEAGATE LLC has
agreed to withdraw its oppositions in the European Patent Office to our `287 and
`494 patents.
During March 2001 we filed legal actions against Hitatchi Data Systems Limited
in the United Kingdom for infringement of two of the European patents in our
intellectual property portfolio. The trial date is set for June 17, 2002.
In October 2001 we filed a patent infringement action in the United States
District Court for the Northern District of Texas, against Veritas Software
Corporation and Veritas Software Global Corporation, alleging that certain
Veritas Software Corporation storage products infringe Storage Computer's
intellectual property patent number U.S. 5,893,919 entitled "Apparatus and
Method for Storing Data with Selectable Data Protection Using Mirroring and
Selectable Parity Inhibition." In February 2002, we filed an additional patent
infringement action in the United States District Court of the Northern District
of Texas, against Veritas Software Corporation and Veritas Software Global
Corporation alleging that certain Veritas Software Corporation storage products
infringe Storage Computer's intellectual property, specifically U.S. 5,257,367
entitled "Data Storage system with Asynchronous Host Operating System
Communication Link". These actions were referred to a court appointed mediator
with a mediation date in late April 2002 and such mediation has been continued
to a mutually agreeable time and place, sometime in the third quarter of 2002.
In March 2002, we filed a third patent infringement action against Veritas
Software Corporation and Veritas Software Global Corporation alleging certain
Veritas Software Corporation storage products infringe Storage Computer's
intellectual property patent number U.S. 6,098,128 entitled "Universal Storage
Management System." The Storage Computer claim is for injunctive relief, damages
and legal costs arising from the alleged infringement.
The outcome in the Hitachi and Veritas unresolved patent proceedings cannot
possibly be predicted, but we intend to vigorously pursue the enforcement of our
intellectual property rights and our claims in these actions and against other
manufacturers whose products we believe infringe on our patents and intellectual
property rights. Our failure to successfully enforce our patent rights could
have a material adverse effect on our business, operating results and financial
condition.
We are involved from time to time in various other minor legal actions in the
ordinary course of our business, which we believe do not have a material adverse
effect on our business, operating results or financial condition.
Item 2. Changes in Securities and Use of Proceeds.
During the quarter ended March 31, 2002 there were no changes in equity
securities.
Item 3. Defaults Upon Senior Securities.
There has not been any material default in the payment of principal, interest,
or any other material default not cured within 30 days with respect to any of
our indebtedness during the three month period ended March 31, 2002.
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Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the three
month period ended March 31, 2002.
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K.
A Exhibits
Number Description
------ -----------
3.1 Certificate of Incorporation of Storage Computer Corporation
dated August 23, 1991.
3.2 Certificate of Amendment of Certificate of Incorporation of
Storage Computer Corporation dated February 24, 1995.
3.3 Certificate of Amendment of Certificate of Incorporation of
Storage Computer Corporation dated August 15, 2001.
4.1 Registration Rights Agreement dated as of May 2, 2002 by and
among Storage Computer Corporation and the purchasers named
therein.
4.2 Form of warrant to purchase a total of 260,000 shares of
common stock issued May 3, 2002 to the warrant holders named
therein.
10.1 Securities Purchase Agreement dated as of May 2, 2002 by and
among Storage Computer Corporation and the purchasers named
therein.
99.1 Press release issued by Storage Computer Corporation on
May 7, 2002.
B Reports On Form 8-K
In our Report on Form 8-K filed on January 16, 2002 we reported a
press release providing estimates of our revenues and earnings for the
fourth quarter and the year ended December 31, 2001.
In our Report on Form 8-K filed on March 26, 2002 we reported a press
release giving notice and information as to the filing of an
additional patent infringement action against Veritas Software
Corporation.
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
STORAGE COMPUTER CORPORATION
----------------------------
Registrant
/s/ PETER N. HOOD
-----------------
Peter N. Hood
Chief Financial Officer
Date: May 15, 2002
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