CONFORMED COPY
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, 2002
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21600
STORAGE ENGINE, INC. (formerly known as ECCS, Inc.)
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(Exact Name of Registrant as Specified in Its Charter)
New Jersey 22-2288911
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
One Sheila Drive, Tinton Falls, New Jersey 07724
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(Address of Principal Executive Offices) (Zip Code)
(732) 747-6995
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(Registrant's telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of Each Exchange on Which Registered
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None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
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(Title of Class)
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(Title of Class)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ X ]
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes: No: X
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The aggregate market value of the voting common equity held by
non-affiliates of the Registrant on June 28, 2002, based on $1.13 per share, the
last reported sale price on the NASDAQ SmallCap Market on that date, was
$ 2.8 million.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of March 28, 2003:
Class Number of Shares
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Common Stock, $.01 par value 2,662,519
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 2003 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Report.
TABLE OF CONTENTS
Item Page
PART I 1. Business..................................................... 1
2. Properties................................................... 23
3. Legal Proceedings............................................ 24
4. Submission of Matters to a Vote of Security Holders.......... 26
PART II 5. Market For the Company's Common Equity and Related
Shareholder Matters.......................................... 27
6. Selected Consolidated Financial Data......................... 30
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 31
7A. Quantitative and Qualitative Disclosures About Market Risk... 43
8. Financial Statements and Supplementary Data.................. 43
9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.......................... 43
PART III 10. Directors and Executive Officers of the Company.............. 44
11. Executive Compensation....................................... 44
12. Security Ownership of Certain Beneficial Owners
and Management and Related Shareholder Matters............... 44
13. Certain Relationships and Related Transactions............... 44
14. Controls and Procedures...................................... 44
PART IV 15. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K...................................... 45
SIGNATURES ........................................................ 46
CERTIFICATIONS .......................................................... 48
EXHIBIT INDEX ........................................................ 52
FINANCIAL STATEMENTS ...................................................... F-1
-i-
FORWARD LOOKING STATEMENTS
The statements contained in this Annual Report on Form 10-K that are not
historical facts are forward-looking statements (as such term is defined in the
Private Securities Litigation Reform Act of 1995). Such forward-looking
statements may be identified by, among other things, the use of forward-looking
terminology such as "believes," "expects," "may," "will," "should" or
"anticipates" or the negative thereof or other variations thereon or comparable
terminology, or by discussions of strategy that involve risks and uncertainties.
These forward-looking statements, such as statements regarding anticipated
future revenues, capital expenditures, research and development expenditures and
other statements regarding matters that are not historical facts, involve
predictions. 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
the Company 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
The Company is a provider of document imaging solutions and fault tolerant,
cost effective enterprise data storage solutions that serve a wide range of
business and government markets. We believe we have significant experience with
handling, designing, engineering, architecting, installing and implementing
information storage solutions to solve data storage needs. Having manufactured
products for OEMs as well as end users, our knowledge and quality practices
ensure that our data storage products provide the reliability demanded by our
customers. Our goal is to meet and exceed our customers' expectations. The
Company earned ISO 9001 certification in 1999 and has continued to maintain this
certification status of quality.
Through our knowledge of Direct Attached Storage (DAS), Network Attached
Storage (NAS), Storage Area Networks (SAN) and the centralization of those
technologies/resources, including disaster recovery and backup technologies, we
seek to design and implement the optimal storage solution to meet users' needs,
including our
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data intensive imaging customers. All of our products and services are measured
to exacting standards while offering considerable savings. We offer specific
solutions, as well as comprehensive information management systems, that make
storing, capturing and distributing information easy and affordable, including
document conversions, workflow and day forward solutions for private or web
enabled content. Our product solutions address centralized data storage, server
consolidation, backup enhancements and centralized management of new and
existing data storage resources.
We offer complete information storage implementations, from the beginning
of the planning process through successful implementation - including 24x7
service and support - all from a single provider.
Our storage products and services include our Synchronix and Synchronism
product lines which supplies our customers with 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,
MS, 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: DAS, in which the storage device is
connected directly to a server; NAS, in which the storage device is installed on
a 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.
Our imaging solutions focus on providing our customers with a bundled suite
of products and services that solve all of their imaging requirements. In
addition to our storage suite of products, we offer a number of services that
provide our customers with a total solution for their imaging needs. Such
services include on/off site scanning of historical and day forward critical
documents, data base management, network and web based services and through
strategic partners, software that allows our customers to manage the scanned
documents including web based enablers and search engine capabilities.
A number of products resulted from our product development efforts over the
last five years, including our Synchronism Storage Management System and
Synchronix product lines. Our direct sales force concentrates on sales to
commercial end users and Federal and local government end users, including
imaging services. Our direct sales force also works with selected Value Added
Resellers ("VARs") and assists them in their sales to commercial end users.
On August 20, 2002, we announced our iConsole Synchronism product. The SYSM
iConsole features many storage applications such as: fault tolerance, remote
replication, improved backups, virtualization, snapshot copy, centralization,
and call
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home alerts. The SYSM iConsole is easy to implement and provides an intuitive
interface. This tool will enable many IT managers to get control of their
storage and server infrastructure and improve the quality of service. We believe
the SYSM iConsole is an ideal solution to all of today's issues facing System
and Data Managers.
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 the Company'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 is 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 "2002 Disk Storage Systems
Forecast and Analysis, 2000-2005" by IDC. Although, the report predicted that
the U.S. disk storage market would improve in the second half of 2002, the
worldwide market was expected to fall by 1.7% in 2002 according to IDC. By 2003,
IDC is predicting the disk storage systems hardware market will again see growth
worldwide of 5.2%, but is tempered by the current slow economy and geopolitical
developments.
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 further facilitated by the
continued decline in the cost per unit of storage capacity.
We believe that technology spending in 2003 will be neutral to down and
that we will continue to have to compete aggressively for every order against
our larger rivals in
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data storage. The installed vendors should benefit as they likely will see
non-competitive add-on business continue.
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.
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 by 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
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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 and imaging 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. 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.
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o Imaging. We offer a complete suite of imaging services including
our Synchronix and Synchronection product lines. We combine all
of the features of our scalability, enhanced data availability
and competitive pricing, coupled with our imaging services and
software products.
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 the Company 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, with a specific emphasis
on document imaging applications.
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 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. With the
addition of several new hires with long term experience in the
document imaging business, we believe we have accelerated our
ability to provide world class imaging services solutions.
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 intend to improve upon our
current product offerings as well as develop or obtain new
products for data storage.
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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 migrate-able 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, MS, 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;
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
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o centralized management.
We announced our iConsole Synchronism on August 20, 2002. The SYSM iConsole
features many storage applications such as: fault tolerance, remote replication,
improved backups, virtualization, snapshot copy, centralization, and call home
alerts. The SYSM iConsole is easy to implement and provides an intuitive
interface. This tool will enable IT many managers to get control of their
storage and server infrastructure and improve the quality of service. We believe
the SYSM iConsole is an ideal solution to all of today's issues facing System
and Data Managers.
SYSM iConsole Models are the: SYSM iConsole 4000 for the data center; SYSM
iConsole 4000 HA for high availability; SYSM iConsole 4000 DR for disaster
recovery; and SYSM iConsole 4000 TA for tape/backup enhancement.
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.
LSI storage products are offered by us including the E4600 2GB fibre array,
the industry's fastest performing array, the E4400, and the Continustor product.
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.
Products and Solutions under development. We continue to enhance our
current product offerings, primarily through integration of third party hardware
and software for our Synchronism and Synchronix families of products as well as
our imaging vertical solutions.
Document Imaging
We have focused our solutions on the need for rapid, uninterrupted access
to information. Our solutions provide first rate results in cost effective
document imaging. With all of the variables and choices available in data and
document management, the only criteria anyone agrees on is that the system
always must be up and running. We believe our products are state-of-the-art and
provide seamless, continuous availability of data and documents.
We, along with our selected strategic partners, provide an efficient and
economic alternative available to the "how and what" question in managing an
ever-growing quantity of paper and microfilm documents. Document imaging
alleviates most of the
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burden, whether facility or economic, in handling the paper and microfilm. Our
solution will store and retrieve documents much faster, less expensively, and
more easily than the manually processed paper and film.
Our imaging vertical focus provides our customers with a bundled suite of
products and services that solve all of their imaging requirements. In addition
to our Synchronix suite of products, we offer a number of services that provide
our customers with a total solution for their imaging needs. Such services
include on/off site scanning of historical and day forward critical documents,
data base management, network and web based services and through strategic
partners, software that allows our customers to manage the scanned documents
including web based enablers and search engine capabilities.
We developed this imaging offering through our experience of design,
manufacturing and integration of affordable leading edge, fault tolerant data
storage solutions and services for government and industry. We have achieved our
customers' design goals in making our storage solutions fault tolerant with
optional replication. By providing superior digital imaging technology, we are
quickly gaining recognition in the document conversion market. We believe our
solutions provide reliability and durability in document management and
retrieval.
We believe the concept of document imaging does not have to be complicated.
We offer a highly efficient and scalable solution to meet our customer's needs.
In the government segment, public buildings were not originally designed to
handle the level of foot traffic necessary to conduct today's business and meet
the new public access laws. Our imaging solutions enable an immediate
realization of cost savings and efficiencies in space utilization while freeing
space up for more logical uses. Documents digitized and made available over
intra/internet connections greatly reduce the need to accommodate foot traffic
or vehicular traffic/parking. The value of document imaging is the ability to
retrieve documents and send them back to storage until needed again.
Document imaging further improves the way an organization conducts
business. We offer workflow consultation to speed the productivity of the
customer's staff. The use of e-documents adds significant enhancement to paper
file workflow. Our imaging solutions offer a fast secure way to transmit data,
provide an audit trail, ensure security, and enable fast search and retrieval of
needed documents. In addition, we can connect our systems into existing networks
and can make this content available to all authorized users.
We are developing additional technological advances to further utilize
electronic documents in our target markets. We believe we have demonstrated
expertise in delivering proven information solutions for years. Our imaging team
has the combined experience of digitizing nearly three quarters of a billion
pages of paper and microfilm.
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The Company initially focused its products and services on the local and
county markets for its imaging solutions. While an important first step, we
needed to prove our solutions had a broader imaging reach, beyond our local
market.
We have expanded our efforts into a six state area comprised of New York,
Connecticut, New Jersey, Pennsylvania, Maryland and Virginia. Through this
period, we became more familiar with the process that each state follows for
procurement, bids and solicitations. In addition, we were able to determine the
identity of our competitors in each area.
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,
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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.
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
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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.
Our imaging vertical competitors have typically included small imaging
organizations, consulting groups, resellers, and larger players like IBM and EDS
for major project opportunities.
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.
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 in 2002 was Nu Horizons. During fiscal 2002, purchases from
Nu Horizons totaled $408, or 24.7%, of our total purchases. We did not have any
purchases from Nu Horizons in 2001. We purchase products from Nu Horizons on a
purchase order basis. There are no minimum purchase requirements. This
arrangement may be terminated by either party at any time.
The Company has a supply arrangement with Bell Microproducts pursuant to
which the Company orders from Bell Microproducts when, and as needed, and on
terms negotiated at the time of each such order. There are no minimum purchase
requirements. The arrangement may be terminated by either party at any time. In
2001 and 2002, purchases from Bell Microproducts totaled approximately $1,822,
or 52.7%, and $387 or 23.4%, of all purchases respectively.
In February 2003, we once again achieved certification with the
International Standard Organization for the new ISO 9001-2000 standard. Since we
first attained compliance with ISO 9001-1994 in February 1999, we have remained
compliant thereby
12
ensuring strict quality on all of the products offered. 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. A loss of ISO certification may adversely
impact net sales to customers that require or prefer ISO 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
$3,386, $1,308 and $683 in 2000, 2001 and 2002, respectively. In 2000, $1,274
was capitalized in accordance with the Statement of Financial Accounting
Standards ("SFAS") No. 86, "Accounting for the Costs of Computer Software to be
Sold, Leased or Otherwise Marketed". Zero was capitalized in 2001 and 2002.
Our research and development expenditures are related to the following
projects:
o integration of third party hardware and software for the
Synchronix and Synchronism families of products;
o improvements to the Synchronism and Synchronix families of
products;
o new interface connectivities; and
o improvements to the imaging vertical hardware and software
solutions.
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.
13
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 August 2002, we sold a majority of our patents and intellectual property
to Veritas Software Corporation of Mountain View, CA for $1,000. We have
retained a perpetual, royalty free, non-exclusive license to the patents.
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 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 further reduced our staff by seventeen. These
reductions did not affect our sales and marketing departments. As a result, we
took a charge of approximately $100 in the first quarter of 2002.
As of March 15, 2003, we employed 38 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; 5 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.
14
Additional Factors That May Affect Future Results
We rely substantially on key customers.
Our customer base is highly concentrated. Our top 10 customers in 2000,
2001 and 2002 accounted for, in the aggregate, approximately 64.5%, 79.3%, and
78.4% respectively, of net sales in those periods. Sales to the U.S. Air Force,
through Federal integrators, accounted for 30.5%, 47.2% and 42.6% of net sales
in 2000, 2001 and 2002, 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 of 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.
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 $2,799
at December 31, 2002.
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.
15
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 have testified before the grand jury.
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 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.
16
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 U.S.
Air Force.
In late 2002, the Company was contacted through its counsel by an Assistant
United States Attorney in the Civil Division of the United States Attorney's
office in Boston who raised the question of whether the Company had civil
responsibility to the government for the events described above. The government
indicated its belief that it may have civil causes of action against the Company
under Federal, state and common law arising from or in connection with the work
performed for, and billings to, the Federal government. Discussions are ongoing
between the government and Company counsel regarding the merits of such causes
of action and the possible settlement of the same prior to any possible
litigation.
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:
o rapid technological change;
17
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
18
and other Federal government end users. Our direct sales force also recruits
selected VARs and assists them in their sales to commercial end users. In
addition, during the later part of 2001 and early in 2002, we began an
initiative to pursue the data intensive vertical imaging market. With respect to
this imaging market focus, we hired several individuals with imaging services
experience. Whether we can successfully sell our products and services and enter
new markets will depend on our ability to:
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
19
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.
The liquidity of our common stock could be adversely affected because we were
delisted from the Nasdaq SmallCap Market.
On May 23, 2002, the Nasdaq Qualifications Staff notified the Company that
it did not comply with either the minimum net tangible assets or the minimum
stockholders' equity requirements for continued listing set forth in Market
Place Rule 4310(2)(B). The Company began trading on the Over-the-Counter
Bulletin Board (OTCBB) effective with the opening of business on October 3,
2002.
Investors may find it more difficult to dispose of or obtain accurate
quotations as to the market value of our common stock. In addition, we would be
subject to a Rule promulgated by the Securities and Exchange Commission that, if
we fail to meet criteria set forth in such Rule, imposes various practice
requirements on broker-dealers who sell securities governed by the Rule to
persons other than established customers and accredited investors. For these
types of transactions, the broker-dealer must make a special suitability
determination for the purchaser and have received the purchaser's written
consent to the transactions prior to sale. Consequently, the Rule may deter
broker-dealers from recommending or selling our common stock, which may further
affect the liquidity of our common stock.
Trading on the OTCBB may make trading our shares more difficult for
investors, potentially leading to further declines in our share price. It could
also make it more difficult for us to raise additional capital. Further, if we
may also incur additional costs under state blue sky laws in connection with any
sales of our securities.
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.
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
20
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 an imaging services provider 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 VAR. 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.
In 2001, we began the marketing of our products into the data intensive imaging
market. Accordingly, we have a limited operating history within our current line
of business.
We incurred net losses of $12,855, $2,430,and $2,530 in fiscal 2000, 2001
and 2002 respectively. Although we had net income of $1,952 in 1999, we cannot
be certain that we will be able to attain 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 further reduced our
staff by 17; 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 took 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 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.
21
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.
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 2003, we again achieved certification with the International
Standard Organization for the new ISO 9001-2000 standard. Since the Company
first attained compliance with ISO 9001-1994 in February 1999, it has remained
compliant thereby ensuring strict quality on all the products offered. 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.
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.
22
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 us, 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 2,231,250 shares are designated Series A Preferred and 768,750 shares
remain undesignated. Subject to certain rights held by our Series A Preferred
shareholders, our board of directors may issue the undesignated preferred shares
on such terms and with such rights, preferences and designations as our board
may determine without further action by our shareholders. In addition, certain
"anti-takeover" provisions of the New Jersey Business Corporation Act restrict
the ability of certain shareholders to affect a merger or business combination
or obtain control of us. These provisions could discourage bids for shares of
our common stock at a premium as well as create a depressive effect on the
market price of the shares of our common stock.
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 GMAC
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.
During 2002, the Company consolidated its two Tinton Falls, New Jersey
facilities into one location and negotiated a settlement which released the
Company from any and all obligations associated with the vacated facility. As
part of such settlement, the Company paid $71 to the landlord.
23
We occupy the following properties, which are all leased:
Location Approximate Area Use Nature of Occupancy
(in sq. feet)
- ------------------- ---------------- ------------------- ----------------------
Tinton Falls, New 22,000 Executive Office, Lease expires 12/31/05
Jersey R&D, Manufacturing four-year renewal
Business Development
Falls Church, 500 Sales Office Lease expires on
Virginia 12/31/03
Item 3. Legal Proceedings.
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 have
testified before the grand jury. 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
24
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 U.S.
Air Force.
In late 2002, the Company was contacted through its counsel by an Assistant
United States Attorney in the Civil Division of the United States Attorney's
office in Boston who raised the question of whether the Company had civil
responsibility to the government for the events described above. The government
indicated its belief that it may have civil causes of action against the Company
under Federal, state and common law arising from or in connection with the work
performed for, and billings to, the Federal government. Discussions are ongoing
between the government and Company counsel regarding the merits of such causes
of action and the possible settlement of the same prior to any possible
litigation.
We continue to work closely with, sell to, and seek solutions for, our
customer, the U.S. Air Force. 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.
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. As part of this arbitration
25
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. On February 28, 2003, the Decision of
Arbitrator was received awarding Hitachi $24, which was offset by attorney fees
awarded to us in the amount of $6, resulting in a sum payable to Hitachi of $18.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
26
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. 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 post-split common stock 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 the
Company 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".
On May 23, 2002, the Nasdaq Qualifications Staff notified the Company that
it did not comply with either the minimum net tangible assets or the minimum
stockholders' equity requirements for continued listing set forth in Market
Place Rule 4310(2)(B). The Company began trading on the Over-the-Counter
Bulletin Board (OTCBB) effective with the opening of business on October 3,
2002. The trading symbol remains SENG.
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. As
our common stock no longer trades on an exchange, we are required to report in
future filings our high and low bid information.
High Low
------- ------
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
Fiscal Year Ended December 31, 2002
First Quarter.................................. 1.480 0.500
Second Quarter................................. 1.430 0.820
Third Quarter.................................. 1.150 0.400
Fourth Quarter................................. 1.010 0.100
27
On March 28, 2003, the last reported sale price of our common stock as
OTCBB was $0.70 per share. As of March 28, 2003, the approximate number of
holders of record of our common stock was 172.
We have never paid, and do not anticipate paying, any cash dividends on our
common stock for the foreseeable future. Our factoring facility with GMAC
restricts our ability to pay certain dividends without its prior written
consent.
As of December 31, 2002, we had 1,848,328 shares outstanding of our 6%
Cumulative Convertible Preferred Stock, Series A (the "Series A Preferred
Stock"). 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 our
common stock. As a result of the one-for-six reverse stock split of our common
stock, effective July 20, 2002, 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.
During 2001 and 2002, respectively, 408,125 and 128,141 shares of Series A
Preferred Stock were converted into 544,167 and 167,420 shares of common stock
at the request of certain Series A Preferred Stock shareholders. The Series A
Preferred Stock is automatically convertible upon the consummation of our 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
our 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 our 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. On April 26, July 25 and September
26, 2002, the Board of Directors declared dividends valued at $57 for each
declaration paid in additional shares of Series A Preferred Stock. As a result,
the Company issued 28,561 and 28,416 shares of Series A Preferred Stock for the
March 15 dividend payment and the June 15 dividend payment, respectively. As of
December 31, 2002, 28,574 shares of Series A Preferred Stock associated with the
September 15 dividend payment have not been issued.
28
As of December 31, 2002, approximately $67 of dividends had accumulated and
have not been declared and paid representing dividends in arrears for the period
from September 16, 2002 through December 31, 2002. On January 23, 2003, the
Board of Directors declared dividends valued at approximately $57 relating to
the quarterly period through December 15, 2002.
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.
29
Item 6. Selected Consolidated Financial Data.
The following selected consolidated financial data as of and for the five
years ended December 31, 2002 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,
---------------------------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands, except per share amounts)
Statement of Operations Data:
Net sales.............................. $ 28,466 $ 39,761 $ 15,022 $ 10,022 $ 5,413
Cost of sales........................ 20,452 26,777 15,268 6,168 3,606
------- -------- -------- ------- -------
Gross profit (deficit)................. 8,014 12,984 (246) 3,854 1,807
Selling, general and
administrative expenses........... 8,378 9,693 10,925 5,588 4,901
Research and development
expenses.......................... 2,683 1,939 2,112 1,308 683
------- -------- -------- ------- -------
Operating income (loss)................ (3,047) 1,352 (13,283) (3,042) (3,777)
Gain on sale of certain patents &
Intellectual property................ -- -- -- -- 1,000
Gain on sale of SANStar.............. -- -- -- 284 --
Net interest income (expense) ....... 390 162 193 66 (1)
------- -------- -------- ------- -------
(Loss) income before income tax benefit (2,657) 1,514 (13,090) (2,692) (2,778)
Income tax benefit..................... -- (438) (235) (262) (248)
------- -------- -------- ------- -------
Net (loss) income ..................... (2,657) 1,952 (12,855) (2,430) (2,530)
Preferred dividends and accretion...... -- -- -- (4,625) (227)
------- -------- -------- ------- -------
Net (loss) income applicable
to common shares..................... $ (2,657) $ 1,952 $ (12,855) (7,055) (2,757)
======== ========= ========= ======= =======
Net (loss) income per share before
extraordinary item - basic.......... $ (1.45) $ 1.06 $ (6.71) $ (3.56) $ (1.07)
Net (loss) income per share - basic... $ (1.45) $ 1.06 $ (6.71) $ (3.56) $ (1.07)
Net (loss) income per share before
extraordinary item - diluted........ $ (1.45) $ 0.98 $ (6.71) $ (3.56) $ (1.07)
Net (loss) income per share - diluted. $ (1.45) $ 0.98 $ (6.71) $ (3.56) $ (1.07)
Weighted average common
shares outstanding - basic.......... 1,828 1,849 1,915 1,982 2,577
Weighted average common shares
outstanding - diluted............... 1,828 1,996 1,915 1,982 2,577
December 31,
--------------------------------------------------------------
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands)
Balance Sheet Data:
Cash................................... $ 5,374 $ 7,993 $ 2,221 $ 3,146 $2,799
Working capital........................ 11,969 14,200 3,467 5,533 3,398
Total assets........................... 21,374 23,231 9,632 8,077 6,435
Loans payable and payable to Finova
Capital.............................. 1,231 968 276 66 484
6% cumulative convertible
preferred stock Series A............. -- -- -- 3,839 3,754
Shareholders' equity................... $ 15,232 $ 17,701 $ 5,145 $ 2,627 $ 189
30
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Overview
Storage Engine, Inc. is a provider of document imaging solutions and fault
tolerant, cost effective enterprise data storage solutions that serve a wide
range of business and government markets. We believe we have significant
experience with handling, designing, engineering, architecting, installing and
implementing information storage solutions to solve data storage needs. Having
manufactured products for OEMs as well as end users, our knowledge and quality
practices ensure that our data storage products provide the reliability demanded
by our customers. Our goal is to meet and exceed our customers' expectations. We
achieved ISO 9001 certification in 1999 and have continued to maintain this
certification status of quality.
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.
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. With the addition of
several new hires with long term experience in the document imaging business, we
believe we have accelerated our ability to provide world class imaging services
solutions.
In August 2002, we sold a majority of our patents and intellectual property
to Veritas Software Corporation of Mountain View, CA for $1,000. We have
retained a perpetual, royalty free, non-exclusive license to the patents.
Sales to the U.S. Air Force accounted for approximately 30.5%, 47.2% and
42.6% of net sales in 2000, 2001 and 2002, respectively. Although we do not
anticipate that the U.S. Air Force will continue to purchase from us at
historical levels, either in absolute dollars or as a percentage of net sales,
we believe that sales to the U.S. Air Force will continue to comprise a
significant portion of our net sales. Quarterly fluctuations in sales to the
U.S. Air Force are the result of several factors over which we have no control,
including funding appropriations and departmental approvals. We cannot be
certain that our sales to the U.S. Air Force through Federal integrators will
not be adversely affected by the investigation discussed in Item 3. Legal
Proceedings.
31
The following table sets forth, for the periods indicated, the net sales
derived from each of our sales channels:
Year Ended December 31,
----------------------------------
2000 2001 2002
----------------------------------
(in thousands)
Commercial, other Federal customers,
and alternate channel partners..............$ 10,446 $ 5,293 $ 2,682
U.S. Air Force.............................. 4,576 4,729 2,307
Imaging -- -- 424
-------- -------- ---------
$ 15,022 $ 10,022 $ 5,413
======== ======== =========
Our commercial, other Federal and imaging 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.
Neither we nor any person acting on our behalf, has, in this Annual Report
on Form 10-K or otherwise, publicly disclosed material information that includes
a non-GAAP financial measure.
Critical Accounting Policies, Estimates and Risks
Financial Reporting Release No. 60, which was 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 3 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 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.
32
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.
We believe the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
Revenue
Revenue is recognized upon shipment of the product when all risks of
ownership have passed to the customer and the Company has no specific
performance obligations remaining. Revenue related to imaging services is
recognized upon customer acceptance. Amounts received in advance of acceptance
are recorded as deferred revenue. Revenue related to maintenance contracts are
recognized over the respective terms of the maintenance contracts.
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.
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 $919, $156, and zero for 2000, 2001 and 2002, respectively. We did
not capitalize any software development costs during 2001 and 2002.
33
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
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,
2000 2001 2002
Net sales:
Commercial,other Federal, and
alternate channel partners............................. 69.5% 52.8% 49.6%
U.S. Air Force.......................................... 30.5 47.2 42.6
Imaging............................................... -- -- 7.8
--------- ---------- ----------
Total net sales............................................. 100.0 100.0 100.0
Cost of sales............................................. 101.6 61.5 66.6
--------- ---------- ----------
Gross (deficit) profit...................................... (1.6) 38.5 33.4
Selling, general & administrative expenses................ 72.7 55.7 90.6
Research & development expenses........................... 14.1 13.1 12.6
--------- ---------- ----------
Operating loss.............................................. (88.4) (30.3) (69.8)
Gain on sale of certain patents and intellectual property. -- -- 18.5
Gain on sale of SANStar................................... -- 2.8 --
Net interest income....................................... 1.3 0.7 --
--------- ---------- ----------
Loss before income tax benefit.............................. (87.1) (26.8) (51.3)
Income tax benefit ....................................... 1.6 2.6 4.6
--------- ---------- ----------
Net loss ................................................... (85.5)% (24.2)% (46.7)%
========== =========== ===========
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.
34
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
---------------------------------------------------------------------
Net Sales
Net sales decreased by approximately $4,609, or 46.0%, to $5,413 in 2002
from $10,022 in 2001. Sales of our fault tolerant enterprise storage solutions
accounted for 78.9% and 80.9% of net sales in 2002 and 2001, respectively.
Service revenues accounted for 16.8% and 12.2% of net sales in 2002 and 2001,
respectively. Other revenues accounted for 4.3% and 6.9% of net sales in 2002
and 2001, respectively. The decrease in 2002 net sales resulted primarily from
lower sales of our enterprise storage solutions to commercial and other Federal
customers and the U.S. Air Force through Federal integrators, partially offset
by an increase in imaging sales.
Sales to the U.S. Air Force through Federal integrators decreased by
approximately $2,422, or 51.2%, to $2,307 in 2002 from $4,729 in 2001. Such
sales accounted for approximately 42.6% and 47.2% of net sales in 2002 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.
Sales to our commercial, other Federal customers, and alternate channel
partners decreased by approximately $2,611, or 49.3%, to $2,682 in 2002 from
$5,293 in 2001. Sales to our commercial, other Federal customers and alternate
channel partners 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, other Federal customers, and alternate channel partners was
primarily due to a decrease in sales volume. We expect our sales to commercial
and other Federal customers to continue to comprise a significant portion of our
net sales as we concentrate our sales on data intensive applications. However,
we do not expect that our alternate channel partners will continue to represent
a significant portion of our net sales. Quarterly fluctuations in sales to
commercial and other Federal customers are the result of several factors over
which we have no control, including highly competitive markets where we are
competing with much larger companies. We cannot be certain that our sales to
commercial and other Federal customers will not be adversely affected by the
overall poor economic conditions.
Sales to our imaging customers increased by approximately $424, or 100%, in
2002 from zero in 2001. Such increase represents management's concerted effort
to increase sales within this vertical market. Although imaging net sales have
not historically represented a significant portion of our net sales, we expect
that our sales to imaging customers will increase as we devote additional sales
and marketing efforts to this market and we gain greater recognition in the
document conversion market.
35
Quarterly fluctuations in sales to our imaging customers are due to several
factors, including budget approval and departmental controls. We cannot be
certain that our imaging market initiative will not be adversely affected by the
overall poor economic conditions.
Gross Profit
Our gross profit decreased by approximately $2,047 to a gross profit of
approximately $1,807 in 2002 from a gross profit of $3,854 in 2001. Such
decrease in gross margin is primarily due to the overall decrease in sales. The
gross margin percentage in 2002 was 33.4% as compared to 38.5% in 2001. Such
decrease in gross margin percentage is primarily due to the lower absorption of
fixed overhead cost in 2002 as compared to 2001. We expect that we will generate
gross margins from our sales to the U. S. Air Force through integrators,
commercial, other Federal customers, and imaging customers. Our gross margins
could fluctuate depending upon the mix of net sales in any one quarter.
Operating Expenses
Selling, general and administrative (SG&A) expenses decreased by $687 or
12.3%, to $4,901 in 2002 from $5,588 in 2001. Such decrease was primarily due to
the reduction in workforce which occurred during the first quarter of 2002.
SG&A expenses as a percentage of net sales represented 90.6% and 55.7% for
2002 and 2001, respectively. Such percentage increase is attributable to the
reduction in revenues offset by the decrease in SG&A costs. Salaries,
commissions, bonuses, employee benefits and payroll taxes were the largest
components of operating expenses, accounting for 61.4% and 64.5% of such
expenses in 2002 and 2001, respectively.
Research and development expenses decreased in 2002 by $625, or 47.8%, to
$683 in 2002 from $1,308 in 2001. Such decrease represents the reduction in
payroll expense associated with the reduction in force which occurred in the
first quarter of 2002. Such expenses represented approximately 12.6% and 13.1%
of our net sales for 2002 and 2001, respectively.
We will continue to manage our overall cost structure and take the
necessary steps reduce costs where appropriate in order to return to
profitability. There can be no assurance, however, that we will be successful in
controlling costs to the extent necessary to return to profitability.
Sale of Certain Patents and Intellectual Property
In August 2002, we sold a majority of our patents and intellectual property
to Veritas Software Corporation of Mountain View, CA for $1,000. We have
retained a perpetual, royalty free, non-exclusive license to the patents.
36
Net Interest Expense/Income
Net interest expense was $1 in 2002 as compared to net interest income of
$66 for 2001. The decrease in interest income was primarily due to decreased
interest rates in 2002, and lower cash balances in 2002.
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
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