Back to GetFilings.com
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, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 0-21600
STORAGE ENGINE, INC. (formerly known as ECCS, Inc.)
---------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
New Jersey 22-2288911
- ------------------------------- -----------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Sheila Drive, Tinton Falls, New Jersey 07724
- -------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(732) 747-6995
-------------------------
(Registrant's telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on Which Registered
------------------- -----------------------------------------
- ----------------------------- -----------------------------------------
- ----------------------------- -----------------------------------------
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
- --------------------------------------------------------------------------------
(Title of Class)
- --------------------------------------------------------------------------------
(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:
------- -------
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 common equity held by
non-affiliates of the Registrant: $1,913,760 at February 28, 2002 based on the
last sales price on that date.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of February 28, 2002:
Class Number of Shares
- ----- -----------------
Common Stock, $.01 par value 2,521,970
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 2002 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Report.
TABLE OF CONTENTS
-----------------
Item Page
----- ----
PART I 1. Business................................................ 2
2. Properties.............................................. 22
3. Legal Proceedings....................................... 22
4. Submission of Matters to a Vote of Security Holders..... 24
PART II 5. Market For the Company's Common Equity and Related
Shareholder Matters..................................... 24
6. Selected Consolidated Financial Data.................... 28
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 29
7A. Quantitative and Qualitative Disclosures About Market
Risk.................................................... 40
8. Financial Statements and Supplementary Data............. 41
9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure..................... 41
PART III 10. Directors and Executive Officers of the Company......... 41
11. Executive Compensation.................................. 41
12. Security Ownership of Certain Beneficial Owners
and Management.......................................... 41
13. Certain Relationships and Related Transactions.......... 41
PART IV 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K................................. 42
SIGNATURES............................................................ 43
EXHIBIT INDEX......................................................... 45
FINANCIAL STATEMENTS.................................................. F-1
1
FORWARD LOOKING STATEMENTS
The statements contained in this Annual Report on Form 10-K that are not
historical facts are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995). Such forward-looking
statements may be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy that involve risks and uncertainties.
These forward-looking statements, such as statements regarding anticipated
future revenues, capital expenditures, research and development expenditures and
other statements regarding matters that are not historical facts, involve
predictions. Storage Engine, Inc.'s ("SEI," the "Company," "We," "Us," or "Our")
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:
our liquidity and capital resources, component quality and availability, changes
in business conditions, changes in our sales strategy and product development
plans, changes in the data storage or network marketplace, competition between
SEI and other companies that may be entering the data storage host/network
attached markets, competitive pricing pressures, continued market acceptance of
our open systems products, delays in the development of new technology, and
changes in customer buying patterns.
Explanatory Note: All dollar amounts, other than share and per share
amounts, are in thousands.
PART I
Item 1. Business.
General
- -------
We supply and support fault tolerant storage solutions that store, protect
and ensure access to an organization's critical data. Our products include high
performance, fault tolerant storage subsystems that meet a wide range of
customer applications for Open Systems-based networks, such as NT, UNIX and
Linux operating systems and our Raven family of integrated solutions with Sun
processors and storage. Our fault tolerant enterprise storage solutions address
all three storage markets: Direct Attached Storage ("DAS"), in which the storage
device is connected directly to a server; Network Attached Storage ("NAS"), in
which the storage device is installed on a network; and Storage Area Network
("SAN"), in which the storage device is used in a specialized network. These
connectivity options provide our customers the flexibility to choose and deploy
a particular storage solution to meet their needs. As data requirements change,
customers can migrate their existing storage investments to different
connectivity options. We believe our products reduce the total cost of ownership
of data storage by allowing end users to use the products across various
operating systems.
A number of products resulted from our product development efforts over the
last five years, including our Synchronism Storage Management System, Synchronix
and Synchronection product lines. We are a supplier of high performance, highly
scalable, fault tolerant data storage solutions. Our direct sales force
concentrates on sales to commercial end users and Federal and
2
local government end users. Our direct sales force also works with selected
Value Added Resellers ("VARs") and assists them in their sales to commercial end
users. During the three years prior to 1998, we had focused our sales and
marketing efforts through our primary alternate channel partners and OEMs like
Unisys Corporation and Tandem Computers, Inc. As a result of industry
consolidation and competitive factors, sales to Unisys and Tandem declined
significantly in 2000 and 2001. We do not expect sales to these alternate
channel partners to constitute a significant part of our net sales in fiscal
2002.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
On January 8, 2001, the Company announced it had discontinued the SANStar
development effort that had been underway since 1998. The SANStar product did
not account for any revenues to date, but represented a substantial portion of
engineering costs which were capitalized in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
In September 2000, we introduced the Synchronix 3000 (SX3000), our high
performance fault tolerant data storage engine that delivers high speed, storage
capacity, data protection and storage management, along with the advantages of
full-fibre connectivity. The Synchronix 3000 offers enhanced RAID technology
(redundant array of independent disks) and can become the central data storage
for different networks, including DAS, NAS and SAN. We strive to configure
solutions that meet the needs of our customers. At times this includes the
incorporation of third party products to complete the solution. We marketed and
sold the SX3000 product throughout 2001. In 2001, we upgraded the SX3000 to
accept 180GB drives as well as 15K RPM drives for increased performance. In
addition in 2001, the Company received certification by Microsoft that its fault
tolerant, high performance, fibre-based Synchronix 3000 storage system was
compliant with Microsoft's Windows NT 4.0 and Windows 2000.
On May 22, 2001, we significantly enhanced our product offering by
introducing the Synchronism Storage Management System. Synchronism is an
enterprise class storage solution/system which utilizes our Synchronix 3000
product. Synchronism aggregates, virtualizes and manages diverse storage
resources and provisions these resources over IP (internet protocol).
Synchronism provides full redundancy and unifies SAN and NAS systems to provide
the best of SAN-type storage management, while integrating NAS applications in a
more extensive and accessible storage network.
On October 22, 2001, we signed a systems integration and reseller agreement
with LSI Corporation whereby we will market and sell LSI storage offerings. This
broadens our product offerings to enterprise level storage including a 2GB fibre
interface product.
In response to competitive and financial pressures, during the first
quarter of 2001, we reduced our workforce by up to 40% across most departments.
Additionally, our executive officers agreed to salary reductions.
3
We announced on February 11, 2002, that we had reduced our staff by
seventeen. These reductions did not affect our sales and marketing departments.
As a result, we will take a charge of approximately $100 in the first quarter of
2002. We were incorporated in New Jersey in February 1980 under the name The
Word Store, Inc. Our name was changed to ECCS, Inc. in November 1985. Our name
was changed to Storage Engine, Inc. in July 2001. The address of SEI's principal
corporate offices is One Sheila Drive, Tinton Falls, New Jersey 07724 and our
telephone number is 732-747-6995.
Industry Background
- -------------------
In recent years there has been a significant increase in the volume of data
created, processed, stored and accessed throughout an enterprise. As a result,
the demand for sophisticated storage systems to house this data has grown.
However, in its first decline since 1998, the disk storage systems hardware
market in the U.S. fell by $5.7 billion or 18.2% in 2001, according to a study
by International Data Corporation (IDC). IDC estimates that worldwide market for
disk storage hardware, software and services decreased about 6% in 2001 to about
$57 billion but are expected to increase to $70.6 billion by 2004.
The U.S. economic recession and the decline of the dot-com companies, plus
price competition in the U.S., sent the disk storage market into a recession
that is expected to continue worldwide as reported in "2001 Disk Storage Systems
Forecast and Analysis, 2000-2005" by IDC. Although, the report predicts that the
U.S. disk storage market will improve in the second half of 2002, the worldwide
market is expected to fall by 1.7% this year according to IDC. By 2003, IDC is
predicting the disk storage systems hardware market will again see growth
worldwide of 5.2%.
In particular, IDC identified areas of growth in the disk storage market,
which experienced increases of 8.3% for the NAS and SAN technologies due to the
growth of storage consolidation and the need to centralize and manage storage
resources efficiently.
IDC estimates that the worldwide market for disk storage hardware, software
and services are estimated to increase to $70.6 billion in 2004. Contributing to
this growth has been the emergence of data-intensive applications, such as
online transaction processing, data warehousing, data mining and enterprise
resource planning, and the use of multimedia-based information. This demand is
compounded when organizations create redundant sources of data to enable
continuous error-free access to data in the post September 11 market. As a
result, the need for high-capacity, high-performance storage devices and systems
is increasing. The growth in stored data has been facilitated by the continued
decline in the cost per unit of storage capacity.
Data has also become increasingly important as a critical business asset.
In addition to being relied upon by an organization's employees, corporate data
is also being directly accessed by customers and suppliers. As a result, storage
systems and servers must handle greater volumes of input and output
transactions, or I/Os, and provide continuous availability of data. Data must be
continuously available as the cost of downtime or sub-optimal performance could
adversely affect a business' competitive advantage. These requirements have
placed significant stress on currently installed storage products, many of which
were not designed to handle large volumes of dispersed data.
4
In addition, the increased use of Open Systems computing environments, such
as NT, UNIX and Linux, creates the need for flexible and comprehensive data
storage solutions capable of serving multiple computer platforms. Open Systems
architecture permits organizations to utilize hardware and software products
from various suppliers in order to process, share, manage and protect mission
critical information throughout an enterprise. Whereas organizations
historically purchased their storage from the same vendor that provided their
server technology, storage purchases are increasingly being made independent of
server purchase decisions.
As the number, importance and complexity of storage systems have increased,
the management of the data-intensive network environment has become more
difficult. While data administration is a key requirement for organizations,
their budgetary constraints often require that this increasingly complex task be
accomplished cost-effectively, without increased staffing.
To address the evolving storage requirements of organizations, three
storage architectures have emerged. DAS has been the storage architecture
traditionally employed and has historically represented the vast majority of
storage purchases. NAS and SAN are more recent innovations in the storage
marketplace. NAS is expected to represent over 19% of worldwide storage systems
sales by 2005. SANs currently represent 25% of the storage market and are
expected to represent 46% of such market in 2005. The following is a brief
description of these storage architectures:
o DAS - Storage devices that are directly attached to the host computer.
These storage devices are dedicated to and accessed through the host
computer;
o NAS - Storage devices that are connected to a local or wide area
network. NAS devices incorporate their own processing power in order
to store and retrieve data. NAS storage devices allow more than one
host server and users of different operating systems to access data;
and
o SAN - Storage devices that are connected to an additional,
specialized, high speed network, dedicated to providing I/O. The use
of a SAN offloads a significant amount of data traffic and overhead
from the local or wide area network, resulting in improved overall
network performance. SAN storage devices enable users on one operating
system to access data stored on a different type of operating system.
The Storage Engine Approach
- ---------------------------
We believe that our storage solutions appeal to the market by providing an
enhanced combination of performance and features, which we expect to deliver
increasingly through software-based product offerings. The following are the key
attributes of our approach:
o RANGE OF MIGRATABLE SOLUTIONS. We offer a range of products to operate
in DAS, NAS and SAN environments which allows our customers to utilize
the storage architecture that best suits their requirements. As the
data storage needs of our customers expand and evolve, our
comprehensive solutions can be redeployed from one environment to
another, thereby protecting a customer's storage investment.
o SCALABILITY. Our products provide maximum scalability as a customer's
needs change by using a modular approach in designing and configuring
our storage solutions.
5
Customers can purchase from 100 gigabytes to multiple terabytes,
adding storage capacity as required. This scalability allows us to
provide solutions for a broad range of storage requirements, from low
capacity users to enterprise-wide environments.
o COMPETITIVE PRICING. Our products generally provide end users with the
same features as similar solutions, but at a lower cost. In addition,
our modular product approach offers customers more attractive initial
entry costs.
o ENHANCED DATA AVAILABILITY. Our products enhance data availability by
offering array-based failover, fault tolerant, multiple host
connectivity across various Open Systems platforms, on-line firmware
upgrades, on-line systems maintenance and hot-swappable component
replacement.
o HIGH LEVEL OF I/O PERFORMANCE. Our products provide a high level of
I/O performance by using (i) multiple RAID levels that possess varying
performance characteristics, (ii) larger cache sizes to improve speed
and (iii) solid state disks for dedicated memory for frequently
accessed information.
o ENHANCED DATA ADMINISTRATION CAPABILITIES. Our products utilize an
intuitive, customizable GUI (graphical user interface) which allows
for the remote monitoring and management of virtually all functions,
including system configuration, cache policies and data rebuild upon
system failure. These features allow for the management of data by
both sophisticated and unsophisticated users. Our products also
provide automatic notification of system errors via a "call home"
feature that automatically notifies our customer service personnel by
e-mail and paging.
Strategy
- --------
Our objective is to further establish and solidify our position in the
rapidly growing Open Systems storage market. Our strategic focus centers around
serving users whose mission critical applications require high performance and
high reliability storage products. We intend to establish SEI as the data
storage solution of choice for companies with growing and increasingly complex
data needs. Our strategy incorporates the following key elements:
o FOCUS OUR DIRECT SALES CHANNEL. To better address commercial customers
and Federal and local government markets, we intend to refine and
expand our direct sales team where needed. We believe that a well
trained and effective direct sales force will enable us to offer
consultative sales and better address customer needs for the markets
we serve as well as identify current and future end user needs and
enhance opportunities for follow-on sales.
o TARGET COMMERCIAL CUSTOMERS WITH GROWING STORAGE REQUIREMENTS. We
intend to concentrate our sales efforts on commercial customers with
data intensive applications and data rich computing environments.
Within the commercial end user market, we will target companies
conducting e-commerce.
o SUPERIOR PRE-SALE AND POST-SALE SUPPORT. We have significant technical
resources available to assist the sales team and customers in
designing and implementing
6
specific data storage solutions needed by the customer. We believe our
superior support and service enhances our ability to identify and
satisfy our customers' needs.
o VERTICAL IMAGING MARKET. We have identified a vertical imaging market
that we are pursuing for our solutions and those of our partners. In
this market we are providing a seamless data storage approach for
document management and handling with current technology in a cost
effective and centralized means.
o TECHNOLOGICAL EDGE. We believe that we possess substantial technical
expertise gained through years of internal research and development,
particularly in the area of fault tolerant enterprise storage
solutions. We hold several patents on our RAID controller. We intend
to improve upon our current product offerings as well as develop or
obtain new products for data storage.
o REDUCE TOTAL COST OF OWNERSHIP. We believe we deliver solutions that
reduce the total cost of ownership of data storage. Such cost includes
the purchase price and maintenance and management costs over one year.
Our competitively priced, high performance enterprise storage
solutions are scalable and migratable across various operating
systems. A customer can further protect its storage investment by
redeploying our solutions to and from NAS, DAS and SAN.
Products and Technology
- -----------------------
Our core technology provides data-intensive environments with protection
against the loss of critical data and provides the performance and reliability
characteristics of more expensive solutions at a more competitive price. Our
products offer users:
o the ability to deploy in major Open Systems-based networks, such as
NT, UNIX and Linux;
o scalable storage capacity;
o fault tolerance;
o fast data transfer rates; and
o ease of storage system management.
Our families of products include the following:
Synchronism Storage Management System, which utilizes our Synchronix 3000
product, and is an enterprise class storage solution/system that aggregates,
virtualizes and manages diverse storage resources and provisions these resources
over IP. Synchronism provides full redundancy and unifies NAS and SAN to provide
the best of SAN-type storage management, while integrating NAS applications in a
more extensive and accessible storage network.
Synchronism offers the following major features:
o storage virtualization which allows for the pooling of an enterprise's
data storage over different physical storage devices;
7
o SAN over IP which allows a user to incorporate our SAN offering using
Ethernet-based networks such as LANS (local area networks) and WANS
(wide area networks) or fibre;
o remote replication/disaster recovery;
o zero-impact back-up; and
o centralized management.
SYNCHRONIX 3000 is our fault-tolerant data storage engine introduced in
September 2000 that delivers superior performance in speed, storage capacity,
data protection and storage management, along with the advantages of the
full-fibre connectivity in the SAN as well as DAS and NAS environments. The
Synchronix 3000 achieves real large-block transfer speeds of 190MB per second
for two channels and storage capacity of 65TB with three standard 70" cabinets.
In addition, the Synchronix 3000 incorporates all of the major features that are
found in our Synchronix 2000 product line.
SYNCHRONIX 2000 is our DAS product offering. The major features of
Synchronix 2000 include:
o support for multiple levels of RAID;
o scalable to multiple terabytes;
o array-based failover which allows failover without disruption of the
host server;
o fault tolerance due to fully redundant and hot swappable active
components;
o active/active controllers processing data simultaneously which
enhances performance and protects against system failure;
o graphical user interface that provides access to all operational,
maintenance and monitoring functions; and
o event notification or "call home" features that automatically notifies
our customer service personnel of any system failure or problem.
LSI STORAGE PRODUCTS are offered by SEI including the E4600 2GB fibre
array, the industry's fastest performing array, the E4400, and the Continustor
product.
SYNCHRONECTION is our NAS product offering. Synchronection incorporates
Synchronix features with greater storage capacity redundant file servers. Rather
than limiting access to a user of a specific operating system, Synchronection
allows access by users of multiple operating systems.
RAVEN is our product family that offers powerful, flexible, all-in-one
server storage for departmental, Internet and Intranet requirements. The Raven
products are sold primarily to the U.S. Air Force. The Raven products offer high
performance and a scalable server which provides for continuous availability
with integrated RAID protection.
8
PRODUCTS UNDER DEVELOPMENT. We continue to enhance our current product
offerings, primarily through integration of third party hardware and software
for our Synchronism, Synchronix and Synchronection families of products.
Sales and Marketing
- -------------------
We market our products directly to commercial, Federal and local government
end users and indirectly through our select alternate channel partners.
DIRECT SALES. Our direct sales efforts focus on commercial and Federal and
local government end user accounts, as well as assisting selected VARs in their
sales to these end users. Our direct sales team consists of thirteen people. We
conduct sales and marketing from our corporate headquarters in New Jersey and
from our offices in a few select other locations. We believe that direct sales
has a number of advantages, including:
o better customer account penetration, loyalty and diversity;
o opportunities for follow-on sales to our existing customer base;
o opportunities for increased customer referrals; and
o more accurate identification of current and future end user customer
requirements with which to guide product specification and development
efforts.
We plan to concentrate our sales efforts on customers with data intensive
computing environments such as companies conducting e-commerce.
INDIRECT SALES THROUGH ALTERNATE CHANNEL PARTNERS. Our alternate channel
effort is focused on a select few resellers that possess the knowledge, skill or
other benefits to help further the sale of our products. We continue to identify
resellers that will be able to take advantage of our products and/or offer
additional services to end-users. These resellers allow us to market our
products on a broader basis.
We also offer software and hardware from other vendors in order to design
customized storage solutions and infrastructures needed by our customers.
Customer Support and Service
- ----------------------------
We provide 24 x 7 technical support services to end users and alternate
channel partners. Our technical support specialists provide three "tiers" or
"levels" of support, and are able to diagnose and solve technical problems, and
to assist customers with systems integration and use. Customers have toll-free
telephone access (1-800-2-GET-HLP) to technical specialists who respond to
hardware, software and applications questions. We track service reports through
a customer database which maintains current status reports as well as historical
logs of customer interaction. The "call home" feature of our Synchronix family
of products automatically notifies our customer service personnel of any system
failure or problem. We provide technical support under annual maintenance
contracts which are offered to all of our customers. Technical support includes
problem identification, work-around solutions and engineering services.
9
We further differentiate our company by maintaining ISO 9001 registration
for our principal facility. We utilize ISO 9001 standards throughout our
organization to consistently maintain high quality design, development,
integration and manufacturing, installation and service processes. Our emphasis
on providing high quality customer service enhances our sales and marketing
efforts and supplier relationships.
Competition
- -----------
We are engaged in fields within the data processing industry that are
characterized by a high level of competition. Competitive factors include:
o relative price/performance;
o product features, quality and reliability;
o speed to market;
o adherence to industry standards;
o financial strength; and
o service, support and reputation.
Many of our competitors have financial, technical, manufacturing, sales,
marketing and other resources which are substantially greater than our own. We
cannot be certain that we will be able to continue to compete successfully with
existing or new competitors. Recent acquisitions of several of our competitors
by large companies, consolidation of smaller market participants and other
market activities have increased the competition in our marketplace.
In addition, we compete with a broad range of businesses with varying
degrees of experience, resources and development, including established computer
manufacturers, systems integrators and manufacturers of enterprise storage
products and networking products. We compete with different companies depending
on the specific application or market. With respect to DAS products, EMC Corp.,
along with large server vendors such as Compaq and Sun Microsystems, among
others, are significant competitors. In the NAS market, our primary competitor
is Network Appliance Inc. As we continue to introduce new fault tolerant SAN
products, we expect to compete with a number of existing and new competitors
introducing products in this emerging market.
Competitive pricing pressures exist in the data storage market and may in
the future have an adverse effect on our revenues and earnings. Certain
competitors have reduced prices in order to preserve or gain market share. If
our competitors continue to make price cuts, our financial results may be
adversely affected. We believe that pricing pressures are likely to continue.
Manufacturing and Suppliers
- ---------------------------
We rely on outside suppliers to supply subassemblies, component parts and
computer systems for resale. Our in-house manufacturing consists primarily of
light assembly, systems integration, testing and quality assurance.
10
Unisys, formerly our primary outside manufacturer for our Synchronix
system, closed its Winnipeg computer storage systems manufacturing plant in July
1999 and terminated its manufacturing service agreement with us. We manufactured
such systems in-house from August to December 1999. In September 1999, we
entered into a Master Sale Agreement with Hitachi Computer Products (America),
Inc. Pursuant to such agreement, Hitachi began assembling the Synchronix 2000 in
January 2000. The agreement does not contain specific quantity commitments and
purchases are made on a purchase order basis. The agreement does not include any
long-term commitment by either party. In 1999, purchases from Hitachi totaled
$2,540 or 10.3% of all purchases. In 2000, such purchases totaled $1,053 or 6.6%
of all purchases, and in 2001, such purchases totaled $155 or 4.5% of all
purchases.
On June 22, 2001 we notified Hitachi of our intent to terminate the Master
Sale Agreement as of September 22, 2001 in accordance with the requirements of
such agreement. We have been assembling the Synchronix product previously
assembled by Hitachi in our New Jersey facility. Hitachi was refusing to deliver
certain goods which we had paid for in full. On October 10, 2001, we filed suit
against Hitachi in Federal District Court in New Jersey seeking specific
performance on the delivery of such goods. In December 2001, both parties agreed
to resolve this matter in binding arbitration. The date of arbitration has not
yet been established. As part of this arbitration arrangement, Hitachi agreed to
deliver to us the goods which we had paid for in full. We agreed to post a
letter of credit in the amount of $162, representing Hitachi's claim against us
associated with the purchase of excess component parts used to assemble our
product. Such letter of credit was posted in the first quarter of 2002. We deny
having ordered such component parts.
Certain components used in our products are available only from a limited
number of sources. Any delays in obtaining such components could adversely
affect our results of operations. We cannot be certain that material problems
will not arise in the future with our vendors that could significantly impede or
interrupt our business. We cannot be certain that our relationships with our
suppliers will continue or that we would be able to obtain alternative sources
of supply without a material disruption in our ability to provide products to
our customers if our relationships with our existing suppliers are terminated.
We rely on certain distributors to supply us with component products from
Sun Microsystems and Seagate Technologies. Although we believe alternative
distributors of these products are available, we cannot be certain that we can
obtain them on a timely and cost-effective basis. Our primary vendor for these
third party products is Bell Microproducts. During fiscal 2001, purchases from
Bell totaled $1,822, or 52.7%, of our total purchases. We purchase products from
Bell on a purchase order basis. There are no minimum purchase requirements. This
arrangement may be terminated by either party at any time.
In February 1999, we received ISO 9001 certification. This certification,
which is evaluated regularly, reflects uniform, industry-wide standards of
quality control for manufacturing data-storage products. We cannot be certain
that we will continue to meet the industry-accepted standards necessary to
maintain ISO 9001 certification.
Research and Development
- ------------------------
We participate in an industry that is subject to rapid technological
change, and our ability to remain competitive depends upon, among other things,
our ability to maintain a technological edge. As a result, we have devoted
resources to product development. Our research and development expenditures were
$3,150 and $1,308, of which $1,038 and zero were capitalized in
11
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 in 2000 and 2001, respectively.
Our research and development expenditures are related to the following
projects:
o integration of third party hardware and software for the Synchronix,
Synchronism and Synchronection families of products;
o improvements to the Synchronism, Synchronix and Synchronection
families of products; and
o new interface connectivities.
In June 2000, we announced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues but represented a
substantial portion of engineering costs in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
Intellectual Property and Other Proprietary Rights
- --------------------------------------------------
Proprietary protection for our technological know-how, products and product
candidates is important to our business. We rely upon patents, trade secrets,
know-how and continuing technological innovation to develop and maintain our
competitive position. We also rely on a combination of copyright and trade
secret protection and non-disclosure agreements to establish and protect our
proprietary rights. We have filed numerous patent applications covering various
aspects of our Synchronix product family. In addition, we cannot be certain that
any patents issued to us will not be challenged, invalidated or circumvented, or
that issued patents will provide us with a competitive advantage. Although we
continue to implement protective measures and intend to defend our proprietary
rights, policing unauthorized use of our technology or products is difficult and
we cannot be certain that these measures will be successful.
Although management believes that patents will provide some competitive
advantage, our success is dependent to a great extent on our proprietary
knowledge, innovative skills, technical expertise and marketing ability. Because
of rapidly changing technology, our present intention is not to rely primarily
on patents or other intellectual property rights to protect or establish our
market position.
In February 2001, as part of the sale of our SANStar assets, we sold
certain patent applications to Ciprico, Inc.
We have registered trademarks for STORAGE ENGINE, RAID 10 PERFORMANCE
MANAGER, INTELLIGENT REBUILD, SPLIT MIRROR, EXAMODULE, SYNCHRONIX, INVERSE
MIRRORING, SYNCHRONECTION and SPLIT VOLUME. We have applied for
12
trademark registration for SYNCHRONISM and EASY BACKUP. We cannot be certain
that trademarks will be issued for such applications.
We require all employees, consultants and contractors to execute
non-disclosure agreements as a condition of employment or engagement by us. We
cannot be certain, however, that we can limit unauthorized or wrongful
disclosures of unpatented trade secret information.
Employees
- ---------
In response to market conditions, we reduced our workforce by up to 40%
across most departments during the first quarter of 2001. We announced on
February 11, 2002 that we had reduced our staff by seventeen. These reductions
did not affect our sales and marketing departments. As a result, we will take a
charge of approximately $100 in the first quarter of 2002.
As of March 15, 2002, we employed 39 persons, of whom 13 were engaged in
marketing and sales; 4 in engineering and research and development; 8 in
operations, including customer and technical support, manufacturing and
fulfillment; 6 in professional services; and 8 in finance, administration and
management. None of our employees are covered by collective bargaining
agreements. We believe our streamlined workforce will enable us to meet our
business objectives on a more competitive basis. We also believe that we have
been successful in retaining skilled and experienced personnel; however,
competition for such personnel is intense. Our future success will depend in
part on our ability to continue to attract, retain and motivate highly qualified
technical, manufacturing, marketing and management personnel. We consider
relations with our employees to be good.
Additional Factors That May Affect Future Results
- -------------------------------------------------
WE RELY SUBSTANTIALLY ON KEY CUSTOMERS.
Our customer base is highly concentrated. Our top 10 customers in 1999,
2000 and 2001 accounted for, in the aggregate, approximately 82.6%, 64.5% and
79.3% respectively, of net sales in those periods. Sales to the U.S. Air Force,
through Federal integrators, accounted for 58.4%, 30.5% and 47.2% of net sales
in 1999, 2000 and 2001, respectively. Federal integrators are government
contractors who sell directly to U.S. government entities. We believe that a
substantial portion of our net sales and gross profits will continue to be
derived from sales to a concentrated group of customers. However, the volume of
sales to a specific customer is likely to vary from period to period, and a
significant customer in one period may not purchase our products in a subsequent
period. In general, there are no ongoing written commitments by customers to
purchase our products. All our product sales are made on a purchase order basis.
Our net sales in any period generally have been and likely will continue to be
in the near term, derived from a relatively small number of sales transactions.
Therefore, the loss of one or more major customers could materially adversely
affect our results of operations.
13
WE MAY REQUIRE ADDITIONAL FINANCING TO CONTINUE OPERATIONS WHICH MAY BE
DIFFICULT TO OBTAIN AND MAY DILUTE OUR EXISTING OWNERS' INTERESTS.
We may need significant financing to grow our business. Historically, we
have operated with cash from our initial public offering, cash from the private
sales of securities and cash flow from operations. Our cash balance was $3,146
at December 31, 2001.
If we cannot raise more funds, we could be required to reduce our capital
expenditures, scale back our research and product developments, reduce our
workforce and license to others products or technologies we would otherwise seek
to commercialize ourselves.
We may seek additional funding through collaborative arrangements,
borrowing money and by the sale of additional equity securities. Any sales of
additional equity securities are likely to result in further dilution to our
then existing shareholders. Further, if we issue additional equity securities,
the new equity securities may have rights, preferences or privileges senior to
those of existing holders of our capital stock. Alternatively, we may borrow
money from conventional lenders, possibly at high interest rates, which may
affect the value of our common stock. Despite our efforts, funding may not be
available to us at all or only on terms that are unacceptable to us. We also
could be required to seek funds through arrangements with collaborative partners
or others that may require us to relinquish rights to certain of our
technologies or products which we would otherwise pursue on our own.
THE FEDERAL GOVERNMENT'S INVESTIGATION INTO FEDERAL GOVERNMENT PURCHASING COULD
AFFECT OUR SALES TO THE U.S. AIR FORCE.
In late January 2000, we received a subpoena from the United States
Attorney's Office in Boston, Massachusetts for the production of documents in
connection with an investigation into Federal government purchasing. We have
been and intend to continue cooperating with the investigation and are complying
fully, and intend to continue to comply fully, with the subpoena. We sell
computer products to companies which are used by the Federal government to
supply computer products to the U.S. Air Force. In addition, subpoenas were
received by several of our employees, including certain officers, who are
expected to testify before the grand jury. Not all of such testimony has been
provided. It appears that one avenue of inquiry involves the relationships and
transactions of various suppliers, manufacturers (including us), and other
companies, with companies that provide product and product-related services to
the U.S. Air Force. We understand that the government's inquiry includes a
review of the conduct of such companies and their officers and employees. We
believe that we have not violated any Federal laws in connection with our sale
of computer products ultimately received by the U.S. Air Force.
In October 2000, one of the integrators to which we sell our products, KKP
Corp., and its president pled guilty to Federal charges of mail fraud and
conspiracy to defraud the United States in connection with the sale of computer
products and related services to the U.S. Air Force. We are referred to in the
court papers (known as the "Information") in such case. The Information states
that the defendants periodically issued invoices to us for fictitious services
to the U.S. Air Force that were never provided and passed such payments along to
co-conspirators. The Information also states that one of the co-conspirators
caused us "to pay a kickback of five hundred dollars for each unit sold to the
Air Force, with the proceeds going to the benefit of the co-conspirators." We
are not identified as a co-conspirator in the Information. We believe that we
had a reasonable basis to believe these services to the U.S. Air Force were
performed; that all payments made by us to KKP Corp. were properly authorized;
and that we have not violated any
14
Federal laws in connection with our sale of computer products to KKP Corp. which
were ultimately received by the U.S. Air Force.
In October 2000, two employees of a company which assisted the Air Force in
procuring computer-related products and other related parties were indicted on
multiple Federal charges, including wire fraud, conspiracy to defraud the United
States and money laundering in connection with the sale of computer products and
related services from several vendors, including us, to the U.S. Air Force. The
defendants in the Indictment appear to be the co-conspirators referred to in the
Information. We are referred to in the Indictment in terms similar to the
Information. We believe that we had a reasonable basis to believe the services
to the U.S. Air Force billed by some of the defendants in the Indictment were
performed; that all payments made by us to any of the defendants in the
Indictment were properly authorized; and that we have not violated any Federal
laws in connection with our sale of computer products which were ultimately
received by the U.S. Air Force.
In December 2000, the United States Attorney's Office in Boston,
Massachusetts advised us through our attorneys that the United States government
has no present intentions of filing charges against us or any of our employees.
We continue to believe that we have not violated any Federal laws in connection
with our sale of computer products which were ultimately received by the United
States Air Force. We continue to work closely with, sell to, and seek solutions
for, our customer, the United States Air Force.
WE HAVE EXPERIENCED SUBSTANTIAL VARIABILITY OF OUR QUARTERLY OPERATING RESULTS
WHICH WE EXPECT WILL CONTINUE.
Our quarterly operating results have fluctuated, and will continue to
fluctuate, significantly from period to period depending upon factors such as
the success of our efforts to expand our customer base, changes in and the
timing of expenditures relating to the continued development of products,
changes in pricing policies by us and by our competitors and certain other
factors. As a result, it is possible that in some future quarters our operating
results may be below the expectations of investors and securities analysts. If
this happens, the trading price of our common stock could decline. Due to the
relatively fixed nature of certain of our costs, a decline in net sales in any
fiscal quarter typically results in lower profitability in that quarter.
Quarterly fluctuations in sales to the U.S. Air Force are the result of several
factors over which we have no control, including funding appropriations and
departmental approvals. Although we do not anticipate that the U.S. Air Force
will continue to purchase from us at historical levels, either in absolute
dollars or as a percentage of net sales, we believe that sales to the U.S. Air
Force will continue to comprise a significant portion of our net sales. In
addition, our direct sales cycle (including sales to Federal end users) is less
predictable than our indirect sales through our alternate channel partners.
Because we generally ship products within thirty days of receiving an
order, we do not customarily have a significant backlog. Based on the timing of
such product shipments, we do not believe that projects in process at any one
time are a reliable indicator or measure of expected future revenue. None of our
customers have minimum purchase requirements.
WE MAY NOT BE ABLE TO KEEP PACE WITH ANTICIPATED RAPID TECHNOLOGICAL CHANGE.
The market for our fault tolerant enterprise storage solutions is
characterized by:
15
o rapid technological change;
o evolving industry standards;
o changing customer preferences; and
o new product and service introductions.
Both the needs of potential customers and the technologies available for
meeting those needs can change significantly within a short period of time. Our
future success will depend on our ability to develop solutions that keep pace
with changes in the markets in which we compete. Any failure on our part to
respond quickly, cost-effectively and sufficiently to these changes could render
our existing products, services or technologies non-competitive or obsolete.
Even if we develop new products, services or technologies, we may not be
successful in the marketplace.
Demand for our fault tolerant enterprise storage solutions depends
principally upon the demand for Open Systems-based networks, such as NT, UNIX
and Linux operating systems. Although we expect the industry to continue to
expand, our business may be adversely affected by a decline in the sales growth
of Open Systems-based networks targeted by us.
THERE MAY BE A LACK OF MARKET ACCEPTANCE FOR OUR NEW PRODUCTS.
We believe that our success depends, in part, on our ability to:
o enhance existing products;
o develop new products that maintain technological leadership;
o meet a wide range of changing customer needs; and
o achieve market acceptance.
Our business will be adversely affected if we fail to maintain, train and
hire, as needed, our direct sales force, introduce new products in a timely or
cost-effective manner, increase the functionality of our existing products to
meet customers' needs or remain price competitive. We cannot be certain that we
will be successful in our product development efforts or, even if successful,
whether our products will achieve market acceptance.
WE MAY NOT BE ABLE TO EXPAND OUR SALES AND DISTRIBUTION CHANNELS.
During 1998, we shifted our sales and marketing focus to the development of
our direct sales channel from our previous use of alternate channel partners.
During the prior three years, we had focused our sales and marketing efforts
through our primary alternate channel partners, Unisys and Tandem. As a result
of industry consolidation and competitive factors, sales to Unisys and Tandem
declined significantly in 2000 and 2001. Our direct sales force concentrates on
sales to commercial end users, the U.S. Air Force and other Federal government
end users. Our direct sales force also recruits selected VARs and assists them
in their sales to commercial end users. Whether we can successfully sell our
products and enter new markets will depend on our ability to:
16
o hire and maintain adequate direct sales personnel;
o develop and enhance relationships with new and existing customers and
resellers; and
o develop software-based products attractive to large data users and
alternate channel partners.
We cannot be certain that new relationships with alternate channel partners
will be established. Furthermore, we cannot be certain that our alternate
channel partners will not develop or market products in the future that compete
with our products.
THE MARKETS WE SERVE ARE HIGHLY COMPETITIVE.
We are engaged in fields within the data processing industry that are
characterized by a high level of competition. Competitive factors include:
o relative price/performance;
o product features, quality and reliability;
o speed to market;
o adherence to industry standards;
o financial strength; and
o service, support and reputation.
Many of our competitors have financial, technical, manufacturing, sales,
marketing and other resources which are substantially greater than our own. We
cannot be certain that we will be able to continue to compete successfully with
existing or new competitors. Recent acquisitions of several of our competitors
by large companies, mergers of smaller market participants and other market
activities have increased the competition in our marketplace.
In addition, we compete with a broad range of businesses with varying
degrees of experience, resources and development, including established computer
manufacturers, systems integrators and manufacturers of enterprise storage
products and networking products. We compete with different companies depending
on the specific application or market. With respect to DAS products, EMC Corp.,
along with large server vendors such as Compaq and Sun Microsystems, are
significant competitors. In the NAS market, our primary competitor is Network
Appliance Inc. As we continue to introduce our fault tolerant SAN products, we
expect to compete with a number of existing and new competitors introducing
products in this emerging market.
Competitive pricing pressures exist in the data storage market and may in
the future have an adverse effect on our revenues and earnings. Certain
competitors have reduced prices in order to preserve or gain market share. If
our competitors continue to make price cuts, our financial results may be
adversely affected. We believe that pricing pressures are likely to continue.
17
THE LIQUIDITY OF OUR COMMON STOCK COULD BE ADVERSELY AFFECTED IF WE ARE DELISTED
FROM THE NASDAQ SMALLCAP MARKET.
On March 1, 2002, we received notification from Nasdaq that our common
stock had closed below the minimum $1.00 per share requirement for the previous
30 consecutive trading days as required under Marketplace Rule 4310(c)(4). We
were provided with 180 calendar days, or until August 28, 2002, to regain
compliance by having the bid price for our common stock close at $1.00 or
greater for a minimum period of 10 consecutive trading days. As of March 28,
2002, we had not regained compliance. In the event that we do not regain
compliance, Nasdaq staff will determine whether we meet the initial listing
criteria for The Nasdaq SmallCap Market under Marketplace Rule 4310(c)(2)(A). If
we meet the initial listing criteria, staff will notify us that we have been
granted an additional 180 calendar day grace period to demonstrate compliance.
Otherwise, the staff will provide written notification that the Company's
securities will be subject to delisting from the Nasdaq SmallCap Market and
would trade on the OTC Bulletin Board. A delisting from the Nasdaq SmallCap
Market may have a material adverse effect on our stock price and our ability to
raise capital through the issuance of additional equity. In the event our common
stock is delisted from the Nasdaq SmallCap Market, it would become subject to
certain securities law restrictions requiring broker/dealers who recommend
low-priced securities to persons (with certain exceptions) to satisfy special
sales practice requirements, including making an individualized written
suitability determination for the purchaser and receive the purchaser's written
consent prior to the transaction. The securities laws also require additional
disclosure in connection with any trades involving low-priced stocks (subject to
certain exceptions), including the delivery, prior to any transaction, of a
disclosure schedule explaining the market for such stocks and the associated
risks. These requirements could severely limit the market liquidity of our
common stock and the ability of our shareholders to sell our common stock in the
secondary market.
WE DEPEND ON OUTSIDE VENDORS TO SUPPLY OUR PRODUCTS.
We rely on outside suppliers to supply subassemblies, component parts and
computer systems for resale. Our in-house manufacturing consists primarily of
light assembly, systems integration, testing, and quality assurance.
Unisys, formerly our primary outside manufacturer for our Synchronix
system, closed its Winnipeg computer storage systems manufacturing plant in July
1999 and terminated its manufacturing service agreement with us. We manufactured
such systems in-house from August to December 1999. In September 1999, we
entered into a Master Sale Agreement with Hitachi Computer Products (America),
Inc. Pursuant to such agreement, Hitachi began assembling the Synchronix 2000 in
January 2000. The agreement does not contain specific quantity commitments and
purchases are made on a purchase order basis. The agreement does not include any
long-term commitment by either party.
On June 22, 2001 we notified Hitachi of our intent to terminate the Master
Sale Agreement as of September 22, 2001 in accordance with the requirements of
such agreement. We will assemble the Synchronix product previously assembled by
Hitachi internally in our New Jersey facility. Hitachi was refusing to deliver
certain goods which we had paid for in full. On October 10, 2001, we filed suit
against Hitachi in Federal District Court in New Jersey seeking specific
performance on the delivery of such goods. In December 2001, both parties agreed
to resolve this matter in binding arbitration. The date of arbitration has not
yet been established.
18
As part of this arbitration agreement, Hitachi agreed to deliver to us the goods
which we had paid for in full. We agreed to post a letter of credit in the
amount of $162, representing Hitachi's claim against us associated with the
purchase of excess component parts used to assemble our product. Such letter of
credit was posted in the first quarter of 2002. We deny having ordered such
component parts.
Certain components used in our products are available only from a limited
number of sources. Any delays in obtaining such components could adversely
affect our results of operations. We cannot be certain that material problems
will not arise in the future with our vendors that could significantly impede or
interrupt our business. We cannot be certain that our relationships with our
suppliers will continue or that we will be able to obtain alternative sources of
supply without a material disruption in our ability to provide products to our
customers if our relationships with our existing suppliers are terminated.
We rely on certain distributors to supply us with component products from
Sun Microsystems and Seagate Technologies. Although we believe alternative
distributors of these products are available, we cannot be certain that we can
obtain them on a timely and cost-effective basis.
WE HAVE BEEN OPERATING AS A PROPRIETARY SELLER FOR A LIMITED PERIOD OF TIME AND
HAVE A HISTORY OF LOSSES.
From our inception until 1994, our principal business was the sale of NCR
products to AT&T business units as a value added reseller. During 1994, as a
result of AT&T's acquisition of NCR, AT&T discontinued purchasing our products.
We then undertook a product development initiative to reposition ourselves as a
provider of fault tolerant enterprise storage solutions. During 1996, we
completed our repositioning and began selling our fault tolerant enterprise
storage solutions. Accordingly, we have a limited operating history within our
current line of business.
We incurred net losses of $2,657, $12,855, and $7,055 in fiscal 1998, 2000
and 2001 respectively. Although we had net income of $910 in 1997 and $1,952 in
1999, we cannot be certain that we will be able to maintain profitable levels of
operations in the future.
OUR SUCCESS IS DEPENDENT UPON OUR KEY MANAGEMENT, MARKETING, SALES AND TECHNICAL
PERSONNEL.
Our future depends, in large part, upon the continued service of the key
members of our management team, as well as marketing, sales and technical
personnel. During fiscal 2000, our executive officers agreed to salary
reductions. In January 2001, we reduced our workforce by up to 40% across most
departments. We announced on February 11, 2002, that we had reduced our staff by
seventeen, however, we believe that we have retained the personnel who are key
to achieving our goals and implementing our strategies. These reductions did not
affect our sales and marketing departments. As a result, we will take a charge
of approximately $100 in the first quarter of 2002.
Equally important is our ability to attract and retain new management and
other personnel. Competition for such personnel is intense, and there can be no
assurance that we will be able to retain our key employees or that we will be
successful in attracting and retaining new personnel in the future. None of our
executive officers have entered into an employment
19
agreement. The loss of any one or more of our key personnel or the failure to
attract and retain key personnel could have a material adverse effect on our
business.
OUR FAILURE TO SUCCESSFULLY INTEGRATE FUTURE ACQUISITIONS COULD ADVERSELY AFFECT
OUR BUSINESS.
We may acquire complementary product lines, technologies and businesses as
part or our growth strategy. Although we may make such acquisitions, we may not
be able to successfully integrate them with our business in a timely manner. Our
failure to successfully address the risks associated with such acquisitions, if
consummated, could have a material adverse effect on our business and our
ability to develop and market products. The success of any acquisition will
depend on our ability to:
o successfully integrate and manage the acquired operations;
o retain the key employees of the acquisition targets;
o develop, integrate and market products and product enhancements based
on the acquired products and technologies; and
o control costs and expenses, as well as demands on our management,
associated with the potential acquisitions.
If we are not able to successfully integrate acquired products lines,
technologies or businesses with our business, we may incur substantial costs and
delays or other operational, technical or financial problems. In addition, our
failure to successfully integrate acquisitions may divert management's attention
from our existing business and may damage our relationships with key clients and
employees. To finance future acquisitions, we may issue equity securities that
could be dilutive to our shareholders. We may also incur debt and additional
amortization expenses related to goodwill and other intangible assets as a
result of future acquisitions. The interest expense related to this debt and
additional amortization expense may significantly reduce our profitability and
could have a material adverse effect on our business, financial condition and
operating results.
WE HAVE ONLY LIMITED PROTECTION OF INTELLECTUAL PROPERTY RIGHTS.
Our future success depends in part upon our intellectual property,
including patents, trade secrets, know-how and continuing technological
innovation. We cannot be certain that the steps taken by us to protect our
intellectual property will be adequate to prevent misappropriation or that
others will not develop competitive technologies or products. We have filed
numerous patent applications covering various aspects of our Synchronix product
family. In addition, we cannot be certain that any patents issued to us will not
be challenged, invalidated or circumvented, or that issued patents will provide
us with a competitive advantage. Although we believe that our products and
technology do not infringe upon proprietary rights of others, we cannot be
certain that third parties will not assert infringement claims in the future or
that such claims will not be successful. Although we continue to implement
protective measures and intend to defend our proprietary rights, policing
unauthorized use of our technology or products is difficult and we cannot be
certain that these measures will be successful.
20
WE MAY NOT BE ABLE TO COMPLY WITH INDUSTRY STANDARDS.
We design our products to comply with standards adopted by our industry,
the Storage Network Industry Association (SNIA) and the Fibre Channel Alliance
(FCA). We work closely with SNIA and FCA to ensure that our products are
compatible with industry standards. We cannot be certain that standards from
other standards-setting bodies will not become industry-accepted standards. A
shift in industry standards could have a material adverse effect on our
operations.
In February 1999, we received ISO 9001 certification. This certification
reflects uniform, industry-wide standards of quality control for manufacturing
data-storage products. There can be no assurance that we will continue to meet
the industry-accepted standards necessary to maintain ISO 9001 certification. A
loss of ISO certification may adversely impact net sales to customers that
require or prefer ISO certification.
POTENTIAL VOLATILITY OF OUR STOCK PRICE.
The market price of the shares of our common stock has been, and in the
future may be, highly volatile. Some factors that may affect the market price
include:
o actual or anticipated quarterly fluctuations in our operating results;
o changes in recommendations or earnings estimates by securities
analysts;
o announcements of technological innovations or new commercial products
or services by us or our competitors; and
o general market or economic conditions.
This risk may be heightened because our industry is characterized by rapid
technological change and susceptible to the introduction of new competing
technologies or competitors. In addition, equity securities of many technology
companies have experienced significant price and volume fluctuations. These
price and volume fluctuations often have been unrelated to the operating
performance of the affected companies. Volatility in the market price of our
common stock could result in securities class action litigation. This type of
litigation, regardless of the outcome, could result in substantial cost and a
diversion of management's attention and resources.
WE HAVE CERTAIN ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN
ACQUISITION.
Our certificate of incorporation and New Jersey law contain provisions that
could make it more difficult for a third party to acquire control of our
company, even if such change of control would be beneficial to our shareholders.
For example, our certificate of incorporation authorizes 3,000,000 shares of
preferred stock, of which 2,327,617 shares are designated Series A Preferred and
672,382 shares remain undesignated. Subject to certain rights held by our Series
A Preferred stockholders, our board of directors may issue the undesignated
preferred shares on such terms and with such rights, preferences and
designations as our board may determine without further action by our
shareholders. In addition, certain "anti-takeover" provisions of the New Jersey
Business Corporation Act restrict the ability of certain shareholders to affect
a merger or business combination or obtain control of us. These provisions could
discourage bids for shares
21
of our common stock at a premium as well as create a depressive effect on the
market price of the shares of our common stock.
WE DO NOT EXPECT TO PAY CASH DIVIDENDS ON OUR COMMON STOCK.
We have never paid, and do not anticipate paying, any cash dividends on our
common stock for the foreseeable future. Our factoring facility with Bank of
America restricts our ability to pay certain dividends without its prior written
consent. Unless we pay dividends, our shareholders will not be able to receive a
return on their shares unless they sell them.
Item 2. Properties.
Our executive and business development office is in Tinton Falls, New
Jersey. We believe that our current facilities are adequate to support our
existing operations. We also believe that we will be able to obtain suitable
additional facilities on commercially reasonable terms on an "as needed" basis.
We occupy the following properties, which are all leased:
Approximate
Area
Location (in sq. feet) Use Nature of Occupancy
- ----------------- ------------- --------------------- ----------------------
Tinton Falls, New 22,000 Executive Office, Lease expires 12/31/05
Jersey R&D, Manufacturing with a four year renewal
Business Development option
Tinton Falls, 10,000 R&D Manufacturing Lease expires on 12/31/05
New Jersey Business Development
Falls Church, 700 Sales Office Lease expires on 3/31/02
Virginia
We intend to renew this
lease.
Item 3. Legal Proceedings.
In November 1999, Mark Ish and David Boyle, former executive officers of
our company, filed a complaint against us and Gregg M. Azcuy, our President and
Chief Executive Officer, in the Superior Court of New Jersey, Law Division,
Monmouth County. By the action, Messrs. Ish and Boyle are seeking compensatory
damages, punitive damages, attorneys' fees, interest and costs for alleged
breach of multiple contracts, fraud and defamation. On September 28, 2001, we
received notification from the Superior Court of New Jersey, Law Division,
Monmouth County that the actions brought by Mr. Boyle have been dismissed on
summary judgment. On November 9, 2001, we settled with Mr. Ish and paid a
nominal amount.
In late January 2000, we received a subpoena from the United States
Attorney's Office in Boston, Massachusetts for the production of documents in
connection with an investigation into Federal government purchasing. We have
been and intend to continue cooperating with the investigation and are complying
fully, and intend to continue to comply fully, with the subpoena. We sell
computer products to companies which are used by the Federal government to
supply computer products to the U.S. Air Force. In addition, subpoenas have been
received by several of our employees, including certain officers, who are
expected to testify before the grand jury.
22
Not all of such testimony has been provided. It appears that one avenue of
inquiry involves the relationships and transactions of various suppliers,
manufacturers (including us), and other companies, with companies that provide
product and product-related services to the U.S. Air Force. We understand that
the government's inquiry includes a review of the conduct of such companies and
their officers and employees. We believe that we have not violated any Federal
laws in connection with the sale of computer products ultimately received by the
U.S. Air Force.
In October 2000, one of the integrators to which we sell our products, KKP
Corp., and its president pled guilty to Federal charges of mail fraud and
conspiracy to defraud the United States in connection with the sale of computer
products and related services to the U.S. Air Force. We are referred to in the
court papers (known as the "Information") in such case. The Information states
that the defendants periodically issued invoices to us for fictitious services
to the U.S. Air Force that were never provided and passed such payments along to
co-conspirators. The Information also states that one of the co-conspirators
caused us "to pay a kickback of five hundred dollars for each unit sold to the
Air Force, with the proceeds going to the benefit of the co-conspirators." We
are not identified as a co-conspirator in the Information. We believe that we
had a reasonable basis to believe these services to the U.S. Air Force were
performed; that all payments made by us to KKP Corp. were properly authorized;
and that we have not violated any Federal laws in connection with our sale of
computer products to KKP Corp., which were ultimately received by the U.S. Air
Force.
In October 2000, two employees of a company which assisted the Air Force in
procuring computer-related products and other related parties were indicted on
multiple Federal charges, including wire fraud, conspiracy to defraud the United
States and money laundering in connection with the sale of computer products and
related services from several vendors, including us, to the U.S. Air Force. The
defendants in the Indictment appear to be the co-conspirators referred to in the
Information. We are referred to in the Indictment in terms similar to the
Information. We believe that we had a reasonable basis to believe the services
to the U.S. Air Force billed by some of the defendants in the Indictment were
performed; that all payments made by us to any of the defendants in the
Indictment were properly authorized; and that we have not violated any Federal
laws in connection with our sale of computer products which were ultimately
received by the U.S. Air Force.
In December 2000, the United States Attorney's Office in Boston,
Massachusetts advised us through our attorneys that the United States government
has no present intentions of filing charges against us or any of our employees.
We continue to believe that we have not violated any Federal laws in connection
with our sale of computer products which were ultimately received by the United
States Air Force. We continue to work closely with, sell to, and seek solutions
for, our customer, the U. S. Air Force through integrators. We cannot be certain
that our sales and operating results will not be adversely affected by the
investigation discussed above.
In September 1999, we entered into a Master Sale Agreement with Hitachi
Computer Products (America), Inc. Pursuant to such agreement, Hitachi began
assembling the Synchronix 2000 in January 2000. The agreement does not contain
specific quantity commitments and purchases are made on a purchase order basis.
The agreement does not include any long-term commitment by either party. In
1999, purchases from Hitachi totaled $2,540 or 10.3% of all purchases. In 2000,
such purchases totaled $1,053 or 6.6% of all purchases, and in 2001, such
purchases totaled $155 or 4.5% of all purchases.
23
On June 22, 2001 we notified Hitachi of our intent to terminate the Master
Sale Agreement as of September 22, 2001 in accordance with the requirements of
said agreement. We used Hitachi to assemble our Synchronix 2000 products. We
have been assembling the Synchronix product previously assembled by Hitachi in
our New Jersey facility. Hitachi was refusing to deliver certain goods which we
had paid for in full. On October 10, 2001, we filed suit against Hitachi in
Federal District Court in New Jersey seeking specific performance on the
delivery of such goods. In December 2001, both parties agreed to resolve this
matter in binding arbitration. The date of arbitration has not yet been
established. As part of this arbitration agreement, Hitachi agreed to deliver to
us the goods which we had paid for in full. We agreed to post a letter of credit
in the amount of $162, representing Hitachi's claim against us associated with
the purchase of excess component parts used to assemble our product. Such letter
of credit was posted in the first quarter of 2002. We deny having ordered such
component parts.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5. Market For the Company's Common Equity and Related Shareholder Matters.
Pursuant to a decision of the Nasdaq Qualifications Panel, we transferred
the listing of our common stock from the Nasdaq National Market to the Nasdaq
SmallCap Market, effective July 5, 2001, subject to certain exceptions. In
addition, we filed with the Secretary of State of the State of New Jersey an
amendment to our amended and restated certificate of incorporation changing our
name from ECCS, Inc. to Storage Engine, Inc., effective on July 20, 2001. SEI
began trading on the Nasdaq SmallCap Market under the symbol "SENGC" on July 23,
2001 and continued to trade under this symbol during an exception period granted
by Nasdaq. Nasdaq notified SEI on August 10, 2001 that we had satisfied the
Nasdaq SmallCap Market continued listing requirements and, on August 14, 2001,
our Common Stock began trading without exception on the Nasdaq SmallCap Market
under the symbol "SENG".
Our common stock previously was quoted on the Nasdaq National Market under
the symbol "ECCS". Prior to February 22, 2000, our common stock was quoted on
the Nasdaq SmallCap Market under the symbol "ECCS." On July 10, 2001, we
announced the approval of a 1:6 reverse stock split effective on the close of
business on Friday, July 20, 2001, pursuant to which one new share of our common
stock was issued in exchange for each six outstanding shares of common stock.
Our common stock began trading at the post split price on July 23, 2001 under
the symbol "SENG". As a result, at that time we satisfied all requirements for
the continued listing on The Nasdaq SmallCap Market.
24
The following table sets forth the high and low sales price for the common
stock for each of the quarters since December 31, 1999 as adjusted to reflect
the 1:6 stock split. Such quotations reflect inter-dealer prices, without retail
mark-up, markdown or commission and may not represent actual transactions.
High Low
------------ ------------
Fiscal Year Ended December 31, 2000
First Quarter..................... $150.000 $62.250
Second Quarter.................... 85.500 14.628
Third Quarter..................... 6.000 2.250
Fourth Quarter.................... 2.938 0.250
Fiscal Year Ended December 31, 2001
First Quarter..................... 0.875 0.281
Second Quarter.................... 1.070 0.410
Third Quarter..................... 4.140 1.500
Fourth Quarter.................... 4.950 0.970
On March 28, 2002, the last reported sale price of our common stock as
reported by the Nasdaq SmallCap Market was $0.95 per share. As of March 28,
2002, the approximate number of holders of record of our common stock was 148.
We have never paid, and do not anticipate paying, any cash dividends on our
common stock for the foreseeable future. Our factoring facility with Bank of
America restricts our ability to pay certain dividends without its prior written
consent.
On January 25, 2001, we applied for an exception to Nasdaq Marketplace Rule
4350(i)(1) requiring SEI receive shareholder approval of an equity financing
when such financing would result in a change of control of the issuer.
On February 23, 2001, Nasdaq determined that an exception from the
shareholder approval requirement was warranted subject to the Company mailing to
all shareholders, no later than ten days before the completion of the financing,
a letter describing the proposed transaction and alerting shareholders to our
omission to seek the shareholder approval that would otherwise be required. The
letter was required to indicate that the Audit Committee of the Board had
expressly approved the exception. In addition, we were required to issue a press
release describing the transaction.
On March 9, 2001, we issued 1,450,000 shares of our 6% Cumulative
Convertible Preferred Stock, Series A (the "Series A Preferred Stock") to
accredited investors for an aggregate gross proceeds equal to $2,900, pursuant
to a private equity placement (the "Private Placement"). On April 4, 2001 and
April 19, 2001, we issued to accredited investors 250,000 and 300,000 shares of
additional Series A Preferred Stock, respectively. On July 10, 2001, as a result
of the 1:6 reverse stock split, such conversion ratio was changed to 1.33 shares
of common stock for every one share of Series A Preferred Stock. No underwriter
was employed by us in connection with the issuance of the securities in the
Private Placement, however C.E. Unterberg, Towbin ("Unterberg Towbin") acted as
our placement agent. As compensation for its services,
25
Unterberg Towbin received a fee equal to 125,000 shares of Series A Preferred
Stock valued at $250, in addition to payment of certain expenses if fully sold.
Thomas I. Unterberg, a current director of SEI, along with certain affiliates of
Mr. Unterberg, purchased 567,500 shares of Series A Preferred Stock on the same
terms and conditions as all other purchasers. Mr. Unterberg also is Chairman,
Managing Director and member of the Executive Committee of Unterberg Towbin. We
believe that the issuance of shares of Series A Preferred Stock in connection
with the Private Placement was exempt from registration under Section 4(2) of
the Securities Act of 1933, as amended (the "Act"), and Rule 506 of Regulation D
promulgated under the Act, as a transaction not involving a public offering.
Appropriate legends have been affixed to the stock certificates issued to the
purchasers of the Private Placement. All purchasers had adequate access to
information about SEI and each purchaser acquired the securities for investment
only and not with a view to distribution.
The terms and conditions of the Private Placement provided for a cash
payment or the issuance of additional shares of the Company's Series A Preferred
Stock if a shelf registration statement covering the shares of Common Stock
underlying the Series A Preferred Stock issued in the Private Placement was not
declared effective by the SEC within 180 days following each of three closing
dates in the Private Placement. Since a shelf registration statement covering
such shares was not declared effective by the SEC within the allowable
timeframes, the Company issued an aggregate of 106,250 additional shares of its
Series A Preferred Stock valued at $213, to its Series A Preferred Stock
shareholders on October 16, 2001.
Each share of Series A Preferred Stock was initially convertible, at the
option of its holder, at any time after issuance, into eight shares of Common
Stock. As a result of the one-for-six reverse stock split of the Company's
Common Stock, effective July 20, 2001, each share of Series A Preferred Stock is
currently convertible into one and one-third (1 1/3) shares of the our Common
Stock. The conversion ratio is subject to adjustments under certain conditions.
As of December 31, 2001, 408,125 shares of Series A Preferred Stock were
converted into 544,167 shares of Common Stock. The Series A Preferred Stock is
automatically convertible upon the consummation of the Company's sale of Common
Stock in a public offering that meets certain terms. The holders of Series A
Preferred Stock are entitled to vote on all matters that the holders of the
Company's Common Stock are entitled to vote upon, on an as-converted to Common
Stock basis. In addition, the vote of 66 2/3% of the holders of Series A
Preferred Stock is required in certain circumstances. The Series A Preferred
Stock ranks senior to the Common Stock with respect to dividends and upon
liquidation, dissolution, winding up or otherwise. The holders of the
outstanding shares of Series A Preferred Stock are entitled to receive, out of
funds legally available for the payment of dividends, quarter-annual dividends.
Each quarter-annual dividend is computed by dividing the annual dividend rate of
$0.12 per share by four and is payable in cash or, at the option of the Company,
in shares of Series A Preferred Stock. Series A Preferred Stock dividends are
cumulative, whether or not declared, and are compounded at an annual rate of 6%
on the unpaid cumulative balance. No dividends may be paid or declared upon
junior securities, including Common Stock, unless full cumulative dividends on
all outstanding shares of Series A Preferred Stock are paid or have been set
apart. Dividends may be declared on parity securities, only if dividends are
also declared on the Series A Preferred Stock ratably in proportion to
accumulated and unpaid dividends. On November 29, 2001, the Board of Directors
declared dividends in arrears valued at $193, to be paid in additional shares of
Series A Preferred Stock associated with the March 15, June 15, September 15,
and December 15, 2001 dividend payments. As a result, the Company issued 96,367
shares of Series A Preferred Stock on January 28, 2002.
26
As of December 31, 2001, approximately $11 of dividends had accumulated and
have not been declared and paid representing dividends in arrears from December
15, 2001.
The Series A Preferred Stock is subject to mandatory redemption by the
Company four years after its issuance. The Series A Preferred Stock may also be
redeemed at the option of the Company or the holder under certain conditions.
Subject to certain conditions, holders of Series A Preferred Stock have a right
of first offer with respect to the issuance of any new securities which would
reduce such holder's holdings by 10% or more.
On March 1, 2002, we received notification from Nasdaq that our common
stock had closed below the minimum $1.00 per share requirement for the previous
30 consecutive trading days as required under Marketplace Rule 4310(c)(4). We
were provided with 180 calendar days, or until August 28, 2002, to regain
compliance by having the bid price for our common stock close at $1.00 or
greater for a minimum period of 10 consecutive trading days. As of March 28,
2002, we had not regained compliance. In the event that we do not regain
compliance, the Nasdaq staff will determine whether we meet the initial listing
criteria for The Nasdaq SmallCap Market under Marketplace Rule 4310(c)(2)(A). If
we meet the initial listing criteria, the staff will notify us that it has been
granted an additional 180 calendar day grace period to demonstrate compliance.
Otherwise, the staff will provide written notification that our securities will
be subject to delisting from the Nasdaq SmallCap Market and would trade on the
OTC Bulletin Board. A delisting from the Nasdaq SmallCap Market may have a
material adverse effect on our stock price and our ability to raise capital
through the issuance of additional equity. A delisting could severely limit the
market liquidity of our common stock and the ability of our shareholders to sell
the common stock in the secondary market.
27
Item 6. Selected Consolidated Financial Data.
The following selected consolidated financial data as of and for the five
years ended December 31, 2001 are derived from our audited consolidated
financial statements. Historical results are not necessarily indicative of
results to be expected for any future period. The selected consolidated
financial data set forth below should be read in conjunction with the
Consolidated Financial Statements and Notes thereto and with "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
appearing elsewhere in this Annual Report on Form 10-K.
Year Ended December 31,
--------------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
(in thousands, except per share amounts)
Statement of Operations Data:
Net sales ............................... $ 34,001 $ 28,466 $ 39,761 $ 15,022 $ 10,022
Cost of sales ......................... 24,226 20,452 26,777 15,268 6,168
-------- -------- -------- -------- --------
Gross profit (deficit) .................. 9,775 8,014 12,984 (246) 3,854
Selling, general and
administrative expenses ............ 6,838 8,378 9,693 10,925 5,588
Research and development
expenses ........................... 1,687 2,683 1,939 2,112 1,308
-------- -------- -------- -------- --------
Operating income (loss) ................. 1,250 (3,047) 1,352 (13,283) (3,042)
Gain on sale of SANStar ............... -- -- -- -- 284
Net interest (expense) income ......... (28) 390 162 193 66
-------- -------- -------- -------- --------
Income (loss) before income tax benefit
and extraordinary item ................ 1,222 (2,657) 1,514 (13,090) (2,692)
Income tax benefit ...................... -- -- 438 235 262
-------- -------- -------- -------- --------
Income (loss) before extraordinary item . 1,222 (2,657) 1,952 (12,855) (2,430)
Extraordinary item ................. (120) -- -- -- --
-------- -------- -------- -------- --------
Net income (loss) ....................... 1,102 (2,657) 1,952 (12,855) (2,430)
Preferred dividends and accretion ..... (192) -- -- -- (4,625)
-------- -------- -------- -------- --------
Net income (loss) applicable
to common shares ...................... $ 910 $ (2,657) $ 1,952 $(12,855) $ (7,055)
======== ======== ======== ======== ========
Net income (loss) per share before
extraordinary item - basic ........... $ 0.92 $ (1.45) $ 1.06 $ (6.71) $ (3.56)
Net income (loss) per share - basic .... $ 0.81 $ (1.45) $ 1.06 $ (6.71) $ (3.56)
Net income (loss) per share before
extraordinary item - diluted ......... $ 0.60 $ (1.45) $ 0.98 $ (6.71) $ (3.56)
Net income (loss) per share - diluted .. $ 0.66 $ (1.45) $ 0.98 $ (6.71) $ (3.56)
Weighted average common shares
outstanding - basic .................... 1,117 1,828 1,849 1,915 1,982
Weighted average common shares
outstanding - diluted .................. 1,673 1,828 1,996 1,915 1,982
Year Ended December 31,
--------------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
(in thousands)
Balance Sheet Data:
Cash .................................... $11,625 $ 5,374 $ 7,993 $ 2,221 $ 3,146
Working capital ......................... 15,260 11,969 14,200 3,467 5,533
Total assets ............................ 24,992 21,374 23,231 9,632 8,077
Loans payable and payable to Finova
Capital ............................... 1,031 1,231 968 276 66
6% cumulative convertible
preferred stock Series A .............. -- -- -- -- 3,839
Shareholders' equity .................... $17,643 $15,232 $17,701 $ 5,145 $ 2,627
28
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
- --------
We design, manufacture, sell and support fault tolerant enterprise storage
solutions that protect and ensure access to an organization's critical data. Our
products include high performance, fault tolerant storage subsystems that meet a
wide range of customer applications for Open Systems-based networks, such as NT,
UNIX and Linux operating systems. Our fault tolerant enterprise storage
solutions address all three storage markets: DAS, in which the storage device is
connected directly to a server; NAS, in which the storage device is installed on
a network; and SAN, in which the storage device is used in a specialized
network. These connectivity options provide our customers the flexibility to
choose and deploy a particular storage solution to meet their needs. As data
requirements change, customers can migrate their existing storage investments to
different connectivity options. We believe our products reduce the total cost of
ownership of data storage by allowing end users to use the products across
various operating systems.
During 1998, we shifted our sales and marketing focus to the development of
our direct sales channel from our previous use of alternate channel partners.
Our direct sales force concentrates on sales to commercial end users, and the
U.S. Air Force and other Federal government end users. Our direct sales force
also recruits selected VARs and assists them in their sales to commercial end
users. During the three years prior to 1998, we had focused our sales and
marketing efforts through our primary alternate channel partners, Unisys
Corporation and Tandem Computers, Inc. As a result of industry consolidation and
competitive factors, sales to Unisys and Tandem declined significantly in 2000
and 2001. We do not expect sales to these alternate channel partners to
constitute a significant part of our net sales in fiscal 2002.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues, but represented a
substantial portion of engineering costs in 2000. The total amount of SANStar
capitalization of $1,988 was written down to $250 in December 2000. In February
2001, we sold the assets related to the SANStar technology, including certain
patent applications, to Ciprico, Inc. for aggregate proceeds of approximately
$580, including $250 of SANStar capitalization.
Sales to the U.S. Air Force accounted for approximately 58.4%, 30.5% and
47.2% of net sales in 1999, 2000 and 2001, respectively. Although we do not
anticipate that the U.S. Air Force will continue to purchase from us at
historical levels, either in absolute dollars or as a percentage of net sales,
we believe that sales to the U.S. Air Force will continue to comprise a
significant portion of our net sales. Quarterly fluctuations in sales to the
U.S. Air Force are the result of several factors over which we have no control,
including funding appropriations and departmental approvals. We cannot be
certain that our sales to the U.S. Air Force through Federal integrators will
not be adversely affected by the investigation discussed in Item 3. Legal
Proceedings.
29
The following table sets forth, for the periods indicated, the net sales
derived from each of our sales channels:
Year Ended December 31,
-------------------------------
1999 2000 2001
-------- ------- ------
(in thousands)
Direct:
Commercial and other Federal customers.... $ 12,638 $ 9,905 $ 5,123
U.S. Air Force............................ 23,216 4,576 4,729
Indirect:
Alternate channel partners................ 3,907 541 170
---------- ----------- --------
$ 39,761 $ 15,022 $ 10,022
========== =========== =========
Direct sales include sales through select resellers. All sales to the U.S.
Air Force are through Federal integrators. Federal integrators are government
contractors who sell directly to U.S. government entities. Indirect sales
include sales through OEMs and national resellers.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60, which was recently released by the
Securities and Exchange Commission (SEC), requires all companies to include a
discussion of critical accounting policies or methods used in the preparation of
financial statements. Note 2 to the Consolidated Financial Statements includes a
summary of the significant accounting policies and methods used in the
preparation of our Consolidated Financial Statements. The following is a brief
discussion of the more significant accounting policies and methods used by us.
In addition, Financial Reporting Release No. 61 was recently released by
the SEC to require all companies to include a discussion to address, among other
things, liquidity, off-balance sheet arrangements, contractual obligations and
commercial commitments.
Our discussion and analysis of our financial condition and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States of America. The preparation of financial statements in accordance
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, including the recoverability of tangible and
intangible assets, disclosure of contingent assets and liabilities as of the
date of the financial statements, and the reported amounts of revenues and
expenses during the reported period.
On an on-going basis, we evaluate such estimates. The most significant
estimates relate to the allowance for doubtful accounts, reserve for inventory
obsolescence, reserve for warranties, reserve for employee benefits, deferred
income taxes, depreciation of fixed assets and long-lived assets, contingencies
and litigation and the recognition of revenue and profits. We base our estimates
on historical experience and on various other assumptions that are believed to
be reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results could vary from the
estimates and assumptions used in the preparation of the accompanying financial
statements.
30
We believe the following critical accounting policies affect its more
significant judgments and estimates used in the preparation of its consolidated
financial statements:
REVENUE
In general, revenue is recognized upon shipment of the product or system or
as services are provided. Revenue is only recognized on such product when all
risks of ownership have passed to the customer and the Company has no specific
performance obligations remaining. Revenues related to maintenance contracts are
recognized over the respective terms of the maintenance contracts. Revenue for
certain major product enhancements and major new product offerings, for which
the Company believes that significant product development risks may exist which
realistically can be addressed only during live beta testing at end-user sites,
is not recognized until successful completion of such end-user beta testing.
COST OF REVENUE
Our cost of revenue relating to product sales consists primarily of:
o the costs of purchased material;
o direct labor and related overhead expenses; and
o amortization and write-off of capitalized software.
The profitability of any particular quarter is significantly affected by
the relative sales levels of each of our primary sales channels and types of
customers in such quarter.
CAPITALIZED SOFTWARE
We capitalize 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.
Capitalized software amounts that have no future economic benefit are written
down to net realizable value in the period that such value is derived.
Amortization of capitalized software development is charged to cost of sales and
aggregated, $586, $919 and $156 for 1999, 2000 and 2001, respectively. At
December 31, 2001, we have capitalized an aggregate of $3,905 of software
development costs, of which $366 was written off in 1998, as we discontinued our
efforts to develop a fibre controller and a controller design that incorporated
Tandem's Server Net Technology. In addition, in 2000, $1,738 was written off and
$250 was sold in connection with our discontinuation of the SANStar project, and
$1,551 has been amortized in the aggregate. We did not capitalize any software
development costs during 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses consist primarily of:
o salaries, commissions and travel costs for sales and marketing
personnel, including trade shows; and
31
o expenses associated with our management, legal, accounting, contract
and administrative functions.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses consist primarily of salaries and related
overhead expenses paid to software and hardware engineers. Research and
development costs are expensed as incurred, except for software development
costs which are capitalized after technological feasibility has been
demonstrated.
Results of Operations
- ---------------------
The following table sets forth for the periods indicated certain financial
data expressed as a percentage of total revenue:
Year Ended December 31,
---------------------------------
1999 2000 2001
------- ------- -------
Direct net sales:
Commercial and other Federal customers .............. 31.8% 65.9% 51.1%
U.S. Air Force ...................................... 58.4 30.5 47.2
Indirect net sales:
Alternate channel partners .......................... 9.8 3.6 1.7
------- ------- -------
Total net sales ......................................... 100.0 100.0 100.0
Cost of sales ......................................... 67.3 101.6 61.5
------- ------- -------
Gross profit ............................................ 32.7 (1.6) 38.5
Selling, general & administrative expenses ............ 24.4 72.7 55.7
Research & development expenses ....................... 4.9 14.1 13.1
------- ------- -------
Operating (loss) income ................................. 3.4 (88.4) (30.3)
Gain on sale of SANStar ............................... -- -- 2.8
Net interest income ................................... 0.4 1.3 0.7
------- ------- -------
Income (loss) before income tax benefit ................. 3.8 (87.1) (26.8)
Income tax benefit .................................... 1.1 1.6 2.6
------- ------- -------
Net income (loss) ....................................... 4.9% (85.5)% (24.2)%
======= ======= =======
Our operating results are affected by several factors, particularly the
spending fluctuations of our largest customers, including the U.S. Air Force.
Due to the relatively fixed nature of certain of our costs, a decline in net
sales in any fiscal quarter will have a material adverse effect on that
quarter's results of operations. We do not expect such spending fluctuations to
be altered in the foreseeable future.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
---------------------------------------------------------------------------
NET SALES
Net sales decreased by approximately $5,000 or 33.3%, to $10,022 in 2001
from $15,022 in 2000. Sales of our fault tolerant enterprise storage solutions
accounted for 80.9% and 83.5% of net sales in 2001 and 2000, respectively.
Service revenues accounted for 12.2% and 6.8% of net sales in 2001 and 2000,
respectively. Other revenues accounted for 6.9% and 9.7% of net sales in 2001
and 2000, respectively. The decrease in 2001 net sales resulted primarily from
32
lower sales of our enterprise storage solutions to alternate channel partners
and our commercial customers, offset in part by increased sales to the U.S. Air
Force through Federal integrators.
Sales to the U.S. Air Force through Federal integrators increased by
approximately $153, or 3.3%, to $4,729 in 2001 from $4,576 in 2000. Such sales
accounted for approximately 47.2% and 30.5% of net sales in 2001 and 2000,
respectively. The increase as a percentage of sales is primarily due to the
decreases in our other sales channels.
Sales to alternate channel partners decreased by approximately $371, or
68.6%, to $170 in 2001 from $541 in 2000. Such sales accounted for approximately
1.7% and 3.6% of net sales in 2001 and 2000, respectively. Such decrease
represents a decrease in sales to Unisys of approximately $407. Sales to Unisys
accounted for approximately 1.3% and 3.6% of our net sales in 2001 and 2000,
respectively. Sales to Tandem accounted for less than 1% of our net sales in
both 2001 and 2000. We do not expect sales to alternate channel partners to
constitute a significant part of our net sales in fiscal 2002.
Sales to our commercial and other Federal customers decreased by
approximately $4,782 or 48.3%, to $5,123 in 2001 from $9,905 in 2000. Sales to
our commercial and other Federal customers decreased primarily as a result of
the U.S. economic recession and the decline of the dot-com companies. In
addition, price competition in the U.S. forced us to cut our prices in certain
cases. The decrease in sales to commercial and other Federal customers was
primarily due to a decrease in sales volume rather than a decrease in prices.
GROSS PROFIT
Our gross profit increased by approximately $4,100 to a gross profit of
approximately $3,854 in 2001 from a gross deficit of $246 in 2000. Our gross
profit in 2000 was adversely affected by $2,523 and $1,738 of charges relating
to an increase in inventory obsolescence and the write-off of capitalized
software, respectively. The charges taken in 2000 for inventory obsolescence
relates to the repositioning of our product offering and the discontinuance of
the SANStar development effort. Without these charges in 2000, our gross profit
would have been $4,015 in 2001.
In June 2000, we introduced SANStar, a file aware storage architecture
intended to unify disparate data, including NAS and SAN. In the fourth quarter
of 2000, we discontinued our SANStar development effort due to EMC's purchase of
CrosStor, the supplier of the Real Time Operating System (RTOS) used in SANStar.
The SANStar product did not account for any revenues to date but represented a
substantial portion of engineering costs which were capitalized in 2000. The
total amount of SANStar capitalization of $1,988 was written down to $250 in
December 2000. In February 2001, we sold the assets related to the SANStar
technology, including certain patent applications, to Ciprico, Inc. for
aggregate proceeds of approximately $580, including $250 of SANStar
capitalization.
OPERATING EXPENSES
Selling, general and administrative (SG&A) expenses decreased by $5,337, or
48.9%, to $5,588 in 2001 from $10,925 in 2000. Such decrease was primarily due
to the reduction in workforce by up to 40% across most departments during the
first quarter of 2001 and the salary reductions agreed to by our executive
officers.
33
SG&A expenses as a percentage of net sales represented 55.7% and 72.7% for
2001 and 2000, respectively. Such percentage decrease is attributable to the
reduction in revenues combined with decreased SG&A costs. Salaries, commissions,
bonuses, employee benefits and payroll taxes were the largest components of
operating expenses, accounting for 64.5% and 59.0% of such expenses in 2001 and
2000, respectively.
Research and development expenses decreased in 2001 by $804, or 38.1%, to
$1,308 in 2001 from $2,112 in 2000. Such decrease represents the reduction in
payroll expense associated with the reduction in force which occurred in the
first quarter of 2001. Such expenses represented approximately 13.1%