Procom Technology, Inc. Form 10-Q January 31, 2002

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PdYPa2CyMS3qzS509M3pub220FslzC8THT6sOon/300biRhWqGWL9Oe81JPqCeiC qcY0Cptr6j/3btX9vlGf8w== 0000892569-02-000524.txt : 20020415 0000892569-02-000524.hdr.sgml : 20020415 ACCESSION NUMBER: 0000892569-02-000524 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20020131 FILED AS OF DATE: 20020318 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROCOM TECHNOLOGY INC CENTRAL INDEX KEY: 0001025711 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 330268063 STATE OF INCORPORATION: CA FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21653 FILM NUMBER: 02577851 BUSINESS ADDRESS: STREET 1: 58 DISCOVERY CITY: IRVINE STATE: CA ZIP: 92618 BUSINESS PHONE: 9497944257 MAIL ADDRESS: STREET 1: 58 DISCOVERY CITY: IRVINE STATE: CA ZIP: 92618 10-Q 1 a79955e10-q.htm FORM 10-Q QUARTER ENDED JANUARY 31, 2002 Procom Technology, Inc. Form 10-Q January 31, 2002

Securities and Exchange Commission
Washington, DC 20549

REPORT ON FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended January 31, 2002

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____________ to _______________

Commission file number 0-21053

PROCOM TECHNOLOGY, INC.
(Exact name of registrant as specified in its charter)


California (State or other jurisdiction of incorporation or organization)		33-0268063 (IRS Employer Identification No.)

58 Discovery, Irvine California (Address of principal executive office)		92618 (Zip Code)

(949) 852-1000
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report.)

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 [ ]

The number of shares of Common Stock, $.01 par value, outstanding on March 1, 2002 was 16,023,633.

TABLE OF CONTENTS


PART I FINANCIAL INFORMATION
	ITEM 1. FINANCIAL STATEMENTS.
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS.
PART II OTHER INFORMATION
	Item 4. Submission of Matters to a Vote of Security Holders.
SIGNATURES
INDEX TO EXHIBITS
EXHIBIT 10.1

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

PART 1 — FINANCIAL INFORMATION


			PAGE

Item 1.	Condensed Consolidated Financial Statements (Unaudited)
		Condensed Consolidated Balance Sheets as of January 31, 2002 and July 31, 2001	2
		Condensed Consolidated Statements of Operations for the three and six month periods ended January 31, 2002 and 2001	3
		Condensed Consolidated Statements of Shareholders’ Equity for the six month period ended January 31, 2002 and the year ended July 31, 2001	4
		Condensed Consolidated Statements of Cash Flows for the six month periods ended January 31, 2002 and 2001	5
		Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		8
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		21

PART II — OTHER INFORMATION

Item 4.	Submission of Matters to Vote of Security Holders		23

SIGNATURES

PART I
FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS.

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)


				JANUARY 31,			JULY 31,
				2002			2001

ASSETS
Current assets:
	Cash and cash equivalents			$	16,552,000		$	25,419,000
	Accounts receivable, less allowances for doubtful accounts and sales returns of $9,993,000 and $6,412,000, respectively				11,209,000			11,979,000
	Inventories				6,386,000			6,292,000
	Income tax receivable				13,000			18,000
	Prepaid expenses				1,267,000			1,184,000
	Other current assets				275,000			310,000

		Total current assets			35,702,000			45,202,000
Property and equipment, net					17,113,000			17,766,000
Other assets					2,037,000			2,259,000

		Total assets		$	54,852,000		$	65,227,000

LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Lines of credit			$	39,000		$	8,000
	Current portion of long-term debt				172,000			—
	Accounts payable				3,923,000			4,151,000
	Flooring line obligation				946,000			531,000
	Accrued expenses and other current liabilities				2,288,000			2,052,000
	Accrued compensation				1,219,000			1,194,000
	Deferred service revenues				608,000			447,000
	Income taxes payable				7,000			51,000
	Convertible debenture				—			9,726,000

		Total current liabilities			9,202,000			18,160,000
	Long-term debt, net of current portion				8,578,000			—

			Total liabilities		17,780,000			18,160,000

Commitments and contingencies
Shareholders’ equity:
	Preferred stock, no par value; 10,000,000 shares authorized, no shares issued and outstanding				—			—
	Common stock, $.01 par value; 65,000,000 shares authorized, 16,023,633 and 15,993,564 shares issued and outstanding, respectively				160,000			160,000
	Additional paid-in capital				58,681,000			58,575,000
	Accumulated deficit				(21,469,000	)		(11,343,000	)
	Accumulated other comprehensive loss				(300,000	)		(325,000	)

		Total shareholders’ equity			37,072,000			47,067,000

		Total liabilities and shareholders’ equity		$	54,852,000		$	65,227,000

The accompanying notes are an integral part of these condensed
consolidated financial statements.

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)


		THREE MONTHS ENDED						SIX MONTHS ENDED

		JANUARY 31,			JANUARY 31,			JANUARY 31,			JANUARY 31,
		2002			2001			2002			2001

Net sales		$	7,797,000		$	11,722,000		$	16,087,000		$	24,986,000
Cost of sales			4,293,000			7,108,000			8,687,000			15,490,000

	Gross profit		3,504,000			4,614,000			7,400,000			9,496,000
Selling, general and administrative expenses			6,441,000			4,298,000			13,675,000			8,967,000
Research and development expenses			1,584,000			1,681,000			3,235,000			3,453,000
In-process research and development			—			4,262,000			—			4,262,000

Total operating expenses			8,025,000			10,241,000			16,910,000			16,682,000

	Operating loss		(4,521,000	)		(5,627,000	)		(9,510,000	)		(7,186,000	)
Interest income			144,000			236,000			335,000			458,000
Interest expense			(437,000	)		(423,000	)		(951,000	)		(571,000	)

	Loss before income taxes		(4,814,000	)		(5,814,000	)		(10,126,000	)		(7,299,000	)
Income tax provision (benefit)			—			54,000			—			(340,000	)

	Net loss	$	(4,814,000	)	$	(5,868,000	)	$	(10,126,000	)	$	(6,959,000	)

Net loss per common share:
	Basic and diluted	$	(0.30	)	$	(0.50	)	$	(0.63	)	$	(0.60	)

Weighted average number of common shares:
	Basic and diluted		16,007,000			11,806,000			16,002,000			11,688,000

The accompanying notes are an integral part of these condensed
consolidated financial statements.

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(UNAUDITED)


									RETAINED
		COMMON STOCK							EARNINGS			ACC. OTHER
						ADDITIONAL			(ACCUMULATED			COMPREHENSIVE
		SHARES		AMOUNT		PAID IN CAPITAL			DEFICIT)			GAIN (LOSS)			TOTAL

BALANCE AT JULY 31, 2000			11,531,357		115,000		19,685,000			8,007,000			(251,000	)		27,556,000
Comprehensive loss:
Net loss			—		—		—			(19,350,000	)		—			(19,350,000	)
Foreign currency translation adjustment			—		—		—			—			(74,000	)		(74,000	)

	Comprehensive loss															(19,424,000	)
Issuance of common stock through public offering, net of issuance costs of $2.7 million			3,800,000		38,000		31,453,000			—			—			31,491,000
Acquisition of business			480,000		5,000		5,755,000			—			—			5,760,000
Compensatory stock options			—		—		41,000			—			—			41,000
Exercise of employee stock options			157,401		2,000		845,000			—			—			847,000
Issuance of stock to employees			24,806		—		234,000			—			—			234,000
Issuance of stock warrant to investor			—		—		562,000			—			—			562,000

BALANCE AT JULY 31, 2001			15,993,564		160,000		58,575,000			(11,343,000	)		(325,000	)		47,067,000

Comprehensive loss:
Net loss			—		—		—			(10,126,000	)		—			(10,126,000	)
Foreign currency translation adjustment			—		—		—			—			25,000			25,000

	Comprehensive loss															(10,101,000	)
Additional issuance costs relating to common stock public offering in fiscal 2001			—		—		(23,000	)		—			—			(23,000	)
Compensatory stock options			—		—		36,000			—			—			36,000
Issuance of stock to employees			25,569		—		70,000			—			—			70,000
Exercise of employee stock options			4,500		—		23,000			—			—			23,000

BALANCE AT JANUARY 31, 2002			16,023,633	$	160,000	$	58,681,000		$	(21,469,000	)	$	(300,000	)	$	37,072,000

The accompanying notes are an integral part of these condensed
consolidated financial statements.

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)


				SIX MONTHS ENDED JANUARY 31,

				2002			2001

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss				$	(10,126,000	)	$	(6,959,000	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization				962,000			670,000
	Amortization of debt issuance costs related to stock warrant				274,000			—
	Compensatory stock options				36,000			20,000
	In-process research and development				—			4,262,000
	Deferred income taxes				—			(327,000	)
	Changes in operating accounts:
		Accounts receivable			770,000			(4,560,000	)
		Inventories			(94,000	)		(1,055,000	)
		Income tax receivable			5,000			2,699,000
		Prepaid expenses			(83,000	)		(713,000	)
		Other current assets			35,000			(3,000	)
		Other assets			(19,000	)		(273,000	)
		Accounts payable			(228,000	)		(3,001,000	)
		Accrued expenses and compensation			261,000			870,000
		Deferred service revenues			161,000			(43,000	)
		Income taxes payable			(44,000	)		53,000

			Net cash used in operating activities		(8,090,000	)		(8,360,000	)

CASH FLOWS FROM INVESTING ACTIVITIES:
	Purchase of property and equipment				(68,000	)		(1,770,000	)
	Acquisition of business, net of cash acquired				—			(250,000	)

			Net cash used in investing activities		(68,000	)		(2,020,000	)

CASH FLOWS FROM FINANCING ACTIVITIES:
	Issuance of convertible debenture				—			15,000,000
	Repayments of convertible debenture				(10,000,000	)		—
	Borrowings (repayments) of long term debt				8,750,000			(10,750,000	)
	Net borrowings on lines of credit				31,000			3,508,000
	Flooring line obligation				415,000			(130,000	)
	Proceeds from exercise of stock options				23,000			600,000
	Common stock issuance costs				(23,000	)		—
	Issuance of common stock to employees				70,000			145,000

			Net cash provided by (used in) financing activities		(734,000	)		8,373,000
Effect of exchange rate changes					25,000			(38,000	)

Decrease in cash and cash equivalents					(8,867,000	)		(2,045,000	)
Cash and cash equivalents at beginning of period					25,419,000			15,515,000

Cash and cash equivalents at end of period				$	16,552,000		$	13,470,000

Supplemental disclosures of cash flow information:
CASH PAID (RECEIVED) DURING THE PERIOD:
	Interest			$	370,000		$	112,000
	Income taxes			$	—		$	(2,733,000	)
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:
	Common stock warrant issued to convertible debenture investor			$	—		$	582,000

The accompanying notes are an integral part of these
condensed consolidated financial statements.

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. GENERAL.

The accompanying financial information is unaudited, but in the opinion of management, reflects all adjustments (which include only normal recurring adjustments) necessary to present fairly the financial position of Procom Technology, Inc. and its consolidated subsidiaries (the “Company”) as of the dates indicated and the results of operations for the periods then ended. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. While the Company believes that the disclosures are adequate to make the information presented not misleading, the financial information should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Report on Form 10-K for fiscal 2001. Results for the interim periods presented are not necessarily indicative of the results for the entire year.

NOTE 2. CRITICAL ACCOUNTING POLICIES AND ESTIMATES.

The preparation of the condensed consolidated financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, and contingencies. The Company bases its 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 may differ from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its condensed consolidated financial statements.

The Company sells NAS appliances primarily through direct sales channels and resellers. Revenue is generally recorded upon product shipment. The Company maintains reserves, which are adjusted at each reporting date, to estimate anticipated returns based on historical rates of sales returns. In addition, the Company sells service contracts for certain of its appliances that extend for a specified period of time, usually one to three years. Revenue from these service contracts is recorded ratably over the life of the service agreement. The Company sells its Legacy products primarily through distributors. Revenue is recorded from these Legacy sales when the distributor receives the product. The agreements with the Company’s distributors allow limited product returns, including stock balancing and price protection privileges. The Company maintains reserves, which are adjusted at each financial reporting date, to estimate anticipated returns, including stock balancing and price protection claims, relating to each reporting period. The reserves are based on historical rates of sales and returns, including stock balancing and price protection claims, and the level of the Company’s product held by its customers in their inventory. If the Company were to experience a significant increase in product sales returns, additional sales reserves may be required. In addition, until the Company's collection experience improves in certain European countries, the Company is recording revenue from certain customers in European countries using the cost recovery method beginning in the second quarter of fiscal 2002.

The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, or if the Company’s receivable aging continues to lengthen for some of our European customers, additional allowances may be required.

The Company writes down its inventory for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

NOTE 3. INVENTORIES.

Inventories are summarized as follows:


	January 31, 2002		July 31, 2001

Raw materials	$	2,454,000	$	2,472,000
Work in process		614,000		283,000
Finished goods		3,318,000		3,537,000

Total	$	6,386,000	$	6,292,000

NOTE 4. NET LOSS PER SHARE.

Basic net loss per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed using the weighted average number of shares of common stock outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of stock options and warrants. For the periods presented, basic and diluted net loss per share was based on the weighted average number of shares of common stock outstanding during the period. As of January 31, 2002 and 2001, stock options and warrants to purchase 2,148,000 shares and 1,828,000 shares of common stock, respectively, were outstanding. The dilutive effect of these stock options and warrants were not included in the computation of net loss per share as the effect would have been antidilutive.

NOTE 5. COMPREHENSIVE LOSS.

For the six months ended January 31, 2002 and 2001, the only differences between reported net loss and comprehensive loss was a foreign currency translation adjustment gain of $25,000 and a loss of $38,000, respectively.

NOTE 6. BUSINESS SEGMENT INFORMATION.

The Company operates in one industry segment: The design, manufacture and marketing of data storage devices. The Company has two major distinct product families: network attached storage products (“NAS”) and other data storage products (“Legacy”), which includes disk drive storage upgrade systems, CD/DVD-ROM servers and arrays and tape backup products. Net sales of NAS products represented 83% and 76% of total product net sales for the three months ended January 31, 2002 and 2001, respectively, and 83% and 67% of total net sales for the six months ended January 31, 2002 and 2001, respectively.

International sales as a percentage of net sales amounted to 54% and 60% for the three months ended January 31, 2002 and 2001, respectively, and 52% and 63% for the six months ended January 31, 2002 and 2001, respectively. International sales were primarily to European customers. Identifiable assets used in connection with the Company’s foreign operations were $6.9 million at January 31, 2002 and $8.5 million at July 31, 2001.

For the six months ended January 31, 2002, four customers accounted for 24% of net sales, while one customer accounted for 20% of net sales for the six months ended January 31, 2001.

NOTE 7. LINES OF CREDIT, CONVERTIBLE DEBENTURE AND LONG-TERM DEBT.

On October 10, 2000, the Company entered into a term loan agreement and a three-year working capital line of credit with The CIT Group/Business Credit (“CIT”). A term loan of $4.0 million, due and payable upon the Company’s finalization of a long-term mortgage on its corporate headquarters or paid in 12 monthly installments commencing April 1, 2001, was fully repaid in May 2001. An initial term loan of $1.0 million, due and payable in 90 days, was fully repaid on November 1, 2000. The term loans under the agreement incurred interest at the lender’s prime rate, plus .5%, with increases if the outstanding principal was not reduced according to a fixed amortization. The working capital line of credit allows for the Company to borrow, on a revolving basis, for a period of three years, a specified percentage of its eligible accounts receivable (approximately $2.3 million at January 31, 2002), up to a limit of $5.0 million. Amounts outstanding under the working capital line bear interest at the lender’s prime rate plus .25%. At January 31, 2002, no amounts were outstanding under the various credit arrangements. The lender charged approximately $130,000 for the credit facility which is being amortized as interest expense over the term of the credit agreement. The line of credit accrues various monthly maintenance, minimum usage and early termination fees. The line of credit is collateralized by certain assets of the Company. The line of credit requires certain financial and other covenants, including the maintenance of a minimum EBITDA requirement for rolling 12-month periods ending on each fiscal quarter. For the 12-month period ended on January 31, 2002, the Company was not in compliance with the minimum EBITDA requirement. The lender has agreed that the Company’s non-compliance with this covenant for this period will not be deemed a default or constitute an event of default under the line of credit.

In addition to the CIT line of credit noted above, the Company has a flooring line with IBM Credit, which has committed to make $2.5 million in flooring inventory commitments available to the Company. As of January 31, 2002 and July 31, 2001, we owed $946,000 and $531,000, respectively, under the flooring line. The flooring line is collateralized by the specific inventory purchased pursuant to the flooring commitments. CIT and IBM Credit have entered into an intercreditor agreement which determines the level of priority of either lender’s security interest. The flooring line requires the maintenance by the Company of a minimum net worth of $16.0 million. The Company was in compliance with the terms of the flooring line at January 31, 2002. The flooring line also requires the Company not to be in default of any covenants in the CIT agreement. IBM Credit has waived compliance with that requirement at January 31, 2002.

On October 31, 2000, the Company issued a $15.0 million convertible unsecured debenture to a private investor. The debenture carried interest at 6.0% per annum, and was repayable in full on October 31, 2003, unless otherwise converted into the common stock of the Company. In connection with the issuance of the debenture, the Company issued to the investor a 5-year warrant to purchase up to 32,916 shares of its common stock at an initial exercise price of $32.55 per share, with the number of shares for

which the warrant is exercisable and the exercise price subject to antidilution adjustments. The value of the warrant of $562,000 was computed using the Black-Scholes model, with the following assumptions: Expected life — 5 years, Risk free interest rate — 6%, and Volatility — 1.20. On October 31, 2001, the debenture amount repayable was $10,000,000 with an unamortized warrant value of $121,000, for a net debenture value of $9,879,000. In the second quarter of fiscal 2002, the Company paid the investor the remaining $10,000,000 principal amount of the debentures and expensed the remaining unamortized debt issuance and warrant costs of $260,000 to interest expense.

In June 2001, the Company completed the sale of 3,800,000 shares of common stock raising gross proceeds of approximately $34.2 million before offering costs of $2.7 million. As a result of this offering, the exercise price of the warrant was adjusted to $27.95 and the number of shares issuable upon exercise of the warrant pursuant to anti-dilution provisions of the warrant were adjusted to 38,333.

In December 2001, the Company borrowed $8.75 million under a financing arrangement secured by the Company’s corporate headquarters. The principal amount outstanding bears interest at prime plus 1.0% per annum, but not less than 7.0% per annum. Under certain conditions, the Company has the right to request that portions of the principal amount outstanding under the note shall bear interest at a LIBOR based rate, but not less than 7.0%. As of January 31, 2002, the interest rate on the loan was 7.0%. Principal reduction payments of $14,400 plus accrued interest are due each month beginning February 1, 2002 with the remaining principal balance and unpaid interest due at the maturity date of January 1, 2007. Debt issuance costs totaled $201,800 and are being amortized over the term of the loan. Up to an additional $1.0 million may be borrowed under this financing arrangement to cover leasing costs and tenant improvements on the vacant, unimproved space within the corporate headquarters. As of January 31, 2002, the outstanding principal balance of the loan totaled $8.75 million.

In addition to the line of credit, our foreign subsidiaries in Germany, Italy and Switzerland have lines of credit with banks in their respective countries that are utilized primarily for overdraft and short-term cash needs. At January 31, 2002, the amount outstanding under these lines was $39,000.

NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS.

In July 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 141, all business combinations initiated after June 30, 2001 must be accounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually for impairment (or more frequently if indicators of impairment arise). Separable intangible assets that are not deemed to have indefinite lives will continue to be amortized over their useful lives (but with no maximum life). The amortization provisions of SFAS No. 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, the Company is required to adopt SFAS No. 142 effective August 1, 2002.

As of the date of adoption, the Company expects to have unamortized goodwill in the amount of $1,140,000, and unamortized identifiable intangible assets in the amount of $630,000, all of which will be subject to the transition provisions of SFAS 141 and 142. Amortization expense related to goodwill was $241,000 and $102,000 for the six months ended January 31, 2002 and 2001, respectively. Because of the extensive effort needed to comply with adopting SFAS 141 and 142, it is not practicable to reasonably estimate the impact of adopting these statements on the Company’s financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as a cumulative effect of a change in accounting principle.

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement is effective for fiscal years beginning after December 15, 2001. Adoption of this statement will not have a material impact on the Company’s consolidated financial position or results of operations.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

We develop, manufacture and market NAS appliances and other storage devices for a wide range of computer networks and operating systems. Our NAS appliances, which consist of our DataFORCE and NetFORCE product lines, provide end-users with faster access to data at a lower overall cost than other storage alternatives. We refer to these products collectively as our NAS appliances. In addition, we sell disk drive storage upgrade systems, CD/DVD-ROM servers and arrays and tape backup products, which we refer to collectively as our Legacy products. Over the last four years, we have significantly increased our focus on the development and sale of NAS appliances. We continue to develop more advanced NAS appliances and expect this business to be our principal business in the future. We are currently analyzing the market demands and opportunities for all of our Legacy products, and we hope to transition users of these products to our growing line of more robust, generally higher margin NAS solutions.

Changing Business Mix.

We have experienced significantly reduced demand, revenues and gross margins for our Legacy products and, as a result, have discontinued some of these Legacy products. The demand for our CD servers and arrays has declined and we have experienced increased pricing pressures on our disk drive storage upgrade systems, resulting in lower overall revenues and gross margins. Our gross margins vary significantly by product line, and, therefore, our overall gross margin varies with the mix of products we sell. For example, our sales of CD servers and arrays have historically generated higher gross margins than those of our tape back-up and disk drive products. In future periods, as sales of our higher margin NAS appliances continue to increase as a percentage of total sales, we expect our overall gross margins to be positively affected.

Our revenues and gross margins have been and may continue to be affected by a variety of factors including:

       •    new product introductions and enhancements;

       •    competition;

       •    direct versus indirect sales;

       •    the mix and average selling prices of products; and

       •    the cost of labor and components.

Revenue and Revenue Recognition.

We sell Legacy products primarily through distributors. Revenue is recorded from these Legacy sales when the distributor receives the product. Our agreements with our distributors allow limited product returns, including stock balancing and price protection privileges. We maintain reserves, which are adjusted at each financial reporting date, to estimate anticipated returns, including stock balancing and price protection claims, relating to each reporting period. The reserves are based on historical rates of sales and returns, including price protection and stock balancing claims, and the level of our product held by our customers in their inventory.

In addition, under a product evaluation program established by us, our indirect channel partners and end-users generally are able to receive appliances on a trial basis and return the appliances within a specified period, generally 30-60 days, if they are not satisfied. The period may be extended if the customer needs additional time to evaluate the product within the customer’s particular operating environment. The value of evaluation units at customer sites at a financial reporting date are included in inventory as finished goods. At both January 31, 2002 and July 31, 2001, inventory related to evaluation units was approximately $2.3 million. We do not record evaluation units as sales until the customer has notified us of acceptance of these units. In addition, until our collection experience improves in certain European countries, we are recording revenue from certain customers in European countries using the cost recovery method beginning in the second quarter of fiscal 2002.

Cost of Sales.

Our cost of sales consists primarily of the cost of components produced by our suppliers, such as disk drives, cabinets, power supplies, controllers and CPUs, our direct and indirect labor expenses and related overhead costs such as rent, utilities and manufacturing supplies and other expenses. In addition, cost of sales includes third party license fees, warranty expenses and reserves for excess and obsolete inventory.

Selling, General and Administrative Expenses.

Selling expenses consist primarily of costs directly associated with the selling process such as salaries and commissions of sales personnel, marketing, direct and cooperative advertising and travel expenses. General and administrative expenses include our general corporate expenses, such as salaries and benefits, rent, utilities, bad debt expense, legal and other professional fees and expenses, depreciation and amortization of goodwill. These costs are expensed as incurred.

Research and Development Expenses.

Research and development expenses consist of the costs associated with software and hardware development. Specifically, these costs include employee salaries and benefits, consulting fees for contract programmers, test supplies, employee training and other related expenses. The cost of developing new appliances and substantial enhancements to existing appliances are expensed as incurred.

The following table sets forth consolidated statement of operations data as a percentage of net sales for each of the periods indicated:


			THREE MONTHS ENDED JANUARY 31,						SIX MONTHS ENDED JANUARY 31,

STATEMENT OF OPERATIONS			2002			2001			2002			2001

Net sales				100.0	%		100.0	%		100.0	%		100.0	%
Cost of sales				55.1			60.6			54.0			62.0

	Gross profit			44.9			39.4			46.0			38.0
Operating expenses:
	Selling, general and administrative			82.6			36.7			85.0			35.9
	Research and development			20.3			14.3			20.1			13.8
	In-process research and development			—			36.4			—			17.1

		Total operating expenses		102.9			87.4			105.1			66.8

Operating loss				(58.0	)		(48.0	)		(59.1	)		(28.8	)
Interest expense, net				(3.8	)		(1.6	)		(3.8	)		(0.5	)

Loss before income taxes				(61.8	)		(49.6	)		(62.9	)		(29.3	)
Provision (benefit) for income taxes				—			0.5			—			(1.4	)

Net loss				(61.8	)%		(50.1	)%		(62.9	)%		(27.9	)%

CRITICAL ACCOUNTING POLICIES AND ESTIMATES.

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, we evaluate our estimates, including those related to product returns, bad debts, inventories, and contingencies. 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 may differ from these estimates under different assumptions or conditions.

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.

We sell NAS appliances primarily through direct sales channels and resellers. Revenue is generally recorded upon product shipment. We maintain reserves, which are adjusted at each reporting date, to estimate anticipated returns based on historical rates of sales returns. In addition, we sell service contracts for certain of our appliances that extend for a specified period of time, usually one to three years. Revenue from these service contracts is recorded ratably over the life of the service agreement. We sell our Legacy products primarily through distributors. Revenue from these Legacy sales is recorded when the distributor receives the product. The agreements with our distributors allow limited product returns, including stock balancing and price protection privileges. We maintain reserves, which are adjusted at each financial reporting date, to estimate anticipated returns, including stock balancing and price protection claims, relating to each reporting period. The reserves are based on historical rates of sales and returns, including stock balancing and price protection claims, and the level of our product held by our customers in their inventory. If we were to experience a significant increase in product sales returns, additional sales reserves may be required. In addition, until our collection experience improves in certain European countries, we are recording revenue from certain customers in European countries using the cost recovery method beginning in the second quarter of fiscal 2002.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, or if our receivable aging continues to lengthen for some of our European customers, additional allowances may be required.

We write down our inventory for estimated obsolescence equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required.

COMPARISON OF THREE AND SIX MONTHS ENDED JANUARY 31, 2002 AND 2001

Net sales decreased by 33.3% to $7.8 million for the three months ended January 31, 2002, from $11.7 million for the three months ended January 31, 2001. The decrease resulted from a decrease in sales of our NAS and Legacy products. Net sales decreased 35.6% to $16.1 million for the six months ended January 31, 2002, from $25.0 million in the comparable period of fiscal 2001. The decrease was due primarily to lower sales of our Legacy products and sales in fiscal 2001 of $5.0 million to a European storage service provider that were not repeated in fiscal 2002.

Net sales of our NAS products decreased 23.5% to $6.5 million for the three months ended January 31, 2002, from $8.5 million for the comparable period in fiscal 2001. Net sales of our NAS products decreased 18.9% to $13.3 million for the six months ended January 31, 2002, from $16.4 million for the prior year. Excluding sales of $5.0 million to a European storage service provider in fiscal 2001 that were not repeated in fiscal 2002, NAS sales increased $1.9 million, or 16.7%, for the six months ended January 31, 2002 compared to the same period in fiscal 2001. As a percentage of total net sales, NAS product sales increased to 82.8% from 76.2% and to 82.5% from 66.6% for the three and six months ended January 31, 2002 and 2001, respectively.

International sales were $4.2 million, or 53.7% of our net sales, for the three months ended January 31, 2002, compared to $7.4 million, or 62.8% of our net sales, for the three months ended January 31, 2001. International sales were $8.3 million, or 51.5% of our net sales, for the six months ended January 31, 2002, compared to $15.0 million, or 60.2% of net sales, for the comparable period of fiscal 2001. The decrease was due primarily to lower overall sales of NAS and Legacy products to international customers and sales of $5.0 million to a European storage service provider in fiscal 2001 that were not repeated in fiscal 2002. In addition, until our collection experience improves in certain European countries, we are recording revenue from certain customers in European countries using the cost recovery method beginning in the second quarter of fiscal 2002.

Gross profit decreased 23.9% to $3.5 million for the three months ended January 31, 2002, from $4.6 million for the three months ended January 31, 2001. Gross profit for the six month period ended January 31, 2002 decreased 22.1% to $7.4 million from $9.5 million for the same period the prior fiscal year. The decrease in gross profit for both periods was due primarily to lower overall sales. Gross margins increased to 44.9% and 46.0% of net sales for the three and six months ended January 31, 2002 and 2001, respectively, from 39.4% and 38.0% of net sales for the comparable three and six month periods in fiscal 2001. The increase in gross margin was primarily the result of the higher percentage of NAS sales, which have higher margins than non-NAS products.

Selling, general and administrative expenses increased 48.8% to $6.4 million for the three months ended January 31, 2002, from $4.3 million for the three months ended January 31, 2001, and increased as a percentage of net sales to 82.6% from 36.7%. In the second quarter of fiscal 2002, we increased our accounts receivable reserves by $1.0 million to reflect the aging of certain accounts receivable from customers in Switzerland and Italy. Excluding this additional provision, selling, general and administrative expenses for the second quarter of fiscal 2002 increased by $1.1 million over their levels for the second quarter of fiscal 2001 due primarily to increased sales and administrative salaries and commissions in support of NAS sales, increased general administrative expenses and currency translation losses as the U.S. dollar strengthened against both the Euro and Swiss Franc during the second quarter of fiscal 2002.

For the six months ended January 31, 2002, selling, general and administrative expenses increased to $13.7 million from $9.0 million for the comparable period of fiscal 2001. In the first six months of fiscal 2002, we increased our accounts receivable reserves by $3.8 million due to the financial instability of three of our international customers and to reflect the aging of accounts receivable from the Swiss and Italian customers referred to above. Beginning in the third quarter of fiscal 2002, we implemented numerous initiatives to improve our international credit and collection efforts, including the implementation of more stringent credit policies and procedures. However, no assurance can be given that any improvements to the credit and collection policies and procedures will result in better collections in the future. Excluding the additional provision for accounts receivable, selling, general and administrative expenses for the six months ended January 31, 2002 increased by $0.9 million from their levels for the comparable period of fiscal 2001, due primarily to increased sales and administrative salaries and commissions in support of NAS sales, increased general administrative expenses and currency translation losses as the U.S. dollar strengthened against both the Euro and Swiss Franc during this six month period.

Research and development expenses decreased 5.8% to $1.6 million, or 20.3% of net sales in the second quarter of fiscal 2002 from $1.7 million, or 14.3% of net sales, for the comparable period of fiscal 2001. For the six months ended January 31, 2002, research and development expenses decreased 6.3% to $3.2 million, or 20.1% of net sales, from $3.5 million, or 13.8% of net sales, in the same period in fiscal 2001. The dollar decrease for both periods was due primarily to reduced expenses for outside programmers slightly offset by increased compensation expense for additional NAS software programmers and hardware developers.

In-process research and development. In December 2000, we acquired the outstanding shares of Scofima Srl, an Italian company engaged in software development. We employed an appraiser to value the assets of Scofima, and the appraiser assigned a value of approximately $4.3 million for the research and development expenses relating to software being developed by Scofima which has not yet reached technological feasibility, and for which no alternative future use is available. We incurred this charge in the second quarter of fiscal 2001.

Interest income decreased 39.0% to $144,000 for the three months ended January 31, 2002, from $236,000 for the comparable period of fiscal 2001. For the six months ended January 31, 2002, interest income decreased 26.9% to $335,000 from $458,000 for the comparable period of fiscal 2001. The decrease for both periods was attributable to a decline in the average interest rates earned on our invested cash balance.

Interest expense increased 3.5% to $437,000 for the three months ended January 31, 2002, from $423,000 for the comparable period of fiscal 2001. For the six months ended January 31, 2002, interest expense increased 66.6% to $951,000 from $571,000 for the comparable period of fiscal 2001. The increase was due primarily to the issuance of the $15.0 million convertible debenture on October 31, 2000 and the amortization of debt issuance costs.

Income tax provision (benefit). For the three and six months ended January 31, 2002, we recorded no tax benefit as we recorded a valuation allowance equal to the deferred tax asset. The realization of the tax benefits relating to our net deferred tax asset will be dependent on our ability to return to profitability.

LIQUIDITY AND CAPITAL RESOURCES

As of January 31, 2002, we had cash and cash equivalents totaling $16.6 million.

Net cash used in operating activities was $8.1 million for the six months ended January 31, 2002 and $8.4 million for the six months ended January 31, 2001. Net cash used in operating activities in fiscal 2002 relates primarily to our net loss, a decrease in our accounts payable and an increase in prepaid expenses and inventories. These uses of cash were offset partially by a decrease in our accounts receivable. Net cash used in operating activities in fiscal 2001 relates primarily to our net loss, increases in our accounts receivable and inventories and decreases in accounts payable, partially offset by a reduction of approximately $2.7 million in our income tax refund receivable.

Net cash used in investing activities of $0.1 million for the six months ended January 31, 2002 was the result of purchases of property and equipment. Net cash used in investing activities of $2.0 million for the six months ended January 31, 2001 was primarily the result of expenditures of $1.5 million to complete our corporate headquarters and $0.3 million for other property and equipment.

Net cash used by financing activities of $0.7 million for the six months ended January 31, 2002 was primarily the result of a $10.0 million repayment of the convertible debenture, long-term borrowings of $8.8 million under a financing arrangement secured by our corporate headquarters and an increase in our flooring line of $0.4 million. Net cash provided by financing activities of $8.4 million for the six months ended January 31, 2001 was the result of the issuance of a $15.0 million convertible debenture, borrowings of approximately $3.5 million under the term loan line of credit agreement with The CIT Group/Business Credit and approximately $0.7 million in stock option exercises and employee stock purchases, reduced by the repayment of approximately $10.8 million in loans previously secured by our commercial paper portfolio.

On October 10, 2000, we entered into a term loan agreement and a three-year working capital line of credit with The CIT Group/Business Credit (“CIT”). A term loan of $4.0 million, due and payable upon the finalization of a long-term mortgage on our corporate headquarters or paid in 12 monthly installments commencing April 1, 2001, was fully repaid in May 2001. An initial term loan of $1.0 million, due and payable in 90 days, was fully repaid on November 1, 2000. The term loans under the agreement incurred interest at the lender’s prime rate, plus .5%, with increases if the outstanding principal was not reduced according to a fixed amortization. The working capital line of credit allows us to borrow, on a revolving basis, for a period of three years, a specified percentage of our eligible accounts receivable (approximately $2.3 million at January 31, 2002), up to a limit of $5.0 million. Amounts outstanding under the working capital line bear interest at the lender’s prime rate plus .25%. At January 31, 2002, no amounts were outstanding under the various credit arrangements. The lender charged approximately $130,000 for the credit facility, which is being amortized as interest expense over the term of the credit agreement. The line of credit accrues various monthly maintenance, minimum usage and early termination fees. The line of credit is collateralized by certain of our assets. The line of credit requires certain financial and other covenants, including the maintenance of a minimum EBITDA requirement for rolling 12-month periods ending on each fiscal quarter. For the 12-month period ended on January 31, 2002, we were not in compliance with the minimum EBITDA requirement. The lender has agreed that our non-compliance with this covenant for this period will not be deemed a default or constitute an event of default under the line of credit.

In addition to the CIT line of credit noted above, we have a flooring line of credit with IBM Credit, which has committed to make $2.5 million in flooring inventory commitments available to us. As of January 31, 2002, we owed $946,000 under the flooring line. The flooring line is collateralized by the specific inventory purchased pursuant to the flooring commitments. CIT and IBM Credit have entered into an intercreditor agreement which determines the level of priority of either lender’s security interest. The flooring line requires the maintenance of a minimum net worth of $16.0 million, and we were in compliance with this covenant at January 31, 2002. The flooring line also requires us not to be in default of any covenants in the CIT agreement. IBM Credit has waived compliance with that requirement at January 31, 2002.

On October 31, 2000, we issued a $15.0 million convertible unsecured debenture to a private investor. The debenture carried interest at 6.0% per annum, and was repayable in full on October 31, 2003, unless otherwise converted into our common stock. In connection with the issuance of the debenture, we issued to the investor a 5-year warrant to purchase up to 32,916 shares of our common stock at an initial exercise price of $32.55 per share, with the number of shares for which the warrant is exercisable and the exercise price subject to antidilution adjustments. The value of the warrant of $562,000 was computed using the Black-Scholes model, with the following assumptions: Expected life — 5 years, Risk free interest rate — 6%, and Volatility — 1.20. On October 31, 2001, the debenture amount repayable was $10,000,000 with an unamortized warrant value of $121,000, for a net debenture value of $9,879,000. In the second quarter of fiscal 2002, we paid the investor the remaining $10,000,000 principal amount of the debentures and expensed the remaining unamortized debt issuance and warrant costs of $260,000 to interest expense.

In June 2001, we completed the sale of 3,800,000 shares of common stock raising gross proceeds of approximately $34.2 million before offering costs of $2.7 million. As a result of this offering, the exercise price of the warrant was adjusted to $27.95 and the number of shares issuable upon exercise of the warrant pursuant to anti-dilution provisions of the warrant were adjusted to 38,333.

In December 2001, we borrowed $8.75 million under a financing arrangement secured by our corporate headquarters. The principal amount outstanding bears interest at prime plus 1.0% per annum, but not less than 7.0% per annum. Under certain conditions, we have the right to request that portions of the principal amount outstanding under the note shall bear interest at a LIBOR based rate, but not less than 7.0%. As of January 31, 2002, the interest rate on the loan was 7.0%. Principal reduction payments of $14,400 plus accrued interest are due each month beginning February 1, 2002 with the remaining principal balance and unpaid interest due at the maturity date of January 1, 2007. Debt issuance costs totaled $201,800 and are being amortized over the term of the loan. Up to an additional $1.0 million may be borrowed under this financing arrangement to cover leasing costs and tenant improvements on the vacant, unimproved space within the corporate headquarters. As of January 31, 2002, the outstanding principal balance of the loan totaled $8.75 million.

We are contingently liable at January 31, 2002 under the terms of repurchase agreements with several financial institutions providing inventory financing for dealers of our products. Under these agreements, dealers purchase our products, and the financial institutions agree to pay us for those purchases, less a pre-set financing charge, within an agreed payment term. Two of these institutions, Finova and IBM Credit Corporation, have also provided us with vendor inventory financing. The contingent liability under these agreements approximates the amount financed, reduced by the resale value of any appliances that may be repurchased, and the risk of loss is spread over several dealers and financial institutions. At January 31, 2002, we were contingently liable for purchases made under these agreements of approximately $280,000.

We expect to have sufficient cash generated from operations and from our recently completed common stock offering to meet our anticipated cash requirements for the next twelve months.


				Less than						After
Contractual Cash Obligations:		Total		1 year		1 to 3 years		4 to 5 years		5 years

Long Term Debt		$	8,750,000	$	172,000	$	345,000	$	8,233,000	$	—
Operating Leases			1,003,000		382,000		413,000		94,000		114,000

	Total	$	9,753,000	$	554,000	$	758,000	$	8,327,000	$	114,000

NEW ACCOUNTING STANDARDS

In October 2001, the FASB issued SFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.” SFAS 144 supersedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,” and addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement is effective for fiscal years beginning after December 15, 2001. Adoption of this statement will not have a material impact on our consolidated financial position or results of operations.

RISK FACTORS

Before investing in our common stock, you should be aware that there are risks inherent in our business, including those indicated below. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of the following risks actually occurs, our business could be harmed. In that case, the trading price of our common stock could decline, and you might lose part or all of your investment. You should carefully consider the following risk factors as well as the other information in this Report on Form 10-Q.

COMPETING DATA STORAGE TECHNOLOGIES MAY EMERGE AS A STANDARD FOR DATA STORAGE SOLUTIONS WHICH COULD CAUSE GROWTH IN THE NAS MARKET NOT TO MEET OUR EXPECTATIONS AND DEPRESS OUR STOCK PRICE.

The market for data storage is rapidly evolving. There are other storage technologies in use, including storage area network technology, which provide an alternative to network attached storage. We are not able to predict how the data storage market will evolve. For example, it is not clear whether usage of a number of different solutions will grow and co-exist in the marketplace or whether one or a small number of solutions will be dominant and displace the others. It is also not clear whether network attached storage technology will emerge as a dominant or even prevalent solution. Whether NAS becomes an accepted standard will be due to factors outside our control. If a solution other than network attached storage emerges as the standard in the data storage market, growth in the network attached storage market may not meet our expectations. In such event, our growth and the price of our stock would suffer.

IF GROWTH IN THE NAS MARKET DOES NOT MEET OUR EXPECTATIONS, OUR FUTURE FINANCIAL PERFORMANCE COULD SUFFER.

We believe our future financial performance will depend in large part upon the future growth in the NAS market and on emerging standards in this market. We intend for NAS products to be our primary business. The market for NAS products, however, may not continue to grow. Long-term trends in storage technology remain unclear and some analysts have questioned whether competing technologies, such as storage area networks, may emerge as the preferred storage solution. If the NAS market grows more slowly than anticipated, or if NAS products based on emerging standards other than those adopted by us become increasingly accepted by the market, our operating results could be harmed.

THE REVENUE AND PROFIT POTENTIAL OF NAS PRODUCTS IS UNPROVEN, AND WE MAY BE UNABLE TO ATTAIN REVENUE GROWTH OR PROFITABILITY FOR OUR NAS PRODUCT LINES.

NAS technology is relatively recent, and our ability to be successful in the NAS market may be negatively affected by not only a lack of growth of the NAS market but also the lack of market acceptance of our NAS products. Additionally, we may be unable to achieve profitability as we transition to a greater emphasis on NAS products.

IF WE FAIL TO SUCCESSFULLY MANAGE OUR TRANSITION TO A FOCUS ON NAS PRODUCTS, OUR BUSINESS AND PROSPECTS WOULD BE HARMED.

We began developing NAS products in 1997. Since then, we have focused our efforts and resources on our NAS business, and we intend to continue to do so. We expect to continue to wind down our Legacy product development and marketing efforts. In the interim, we expect to continue to rely in part upon sales of Legacy products to fund operating and development expenses. Net sales of our Legacy products have been declining in amount and as a percentage of our overall net sales, and we expect these declines to continue. If the decline in net sales of our Legacy products varies significantly from our expectations, or the decline in net sales of our Legacy products is not substantially offset by increases in sales of our NAS products, we may not be able to generate sufficient cash flow to fund our operations or to develop our NAS business.

We also expect our transition to a NAS-focused business to require us to continue:

• engaging in significant marketing and sales efforts to achieve market awareness as a NAS vendor;

• reallocating resources in product development and service and support of our NAS appliances; and

• modifying existing and entering into new channel partner relationships to include sales of our NAS appliances.

In addition, we may face unanticipated challenges in implementing our transition to a NAS-focused company. We may not be successful in managing any anticipated or unanticipated challenges associated with this transition. Moreover, we expect to continue to incur costs in addressing these challenges, and there is no assurance that we will be able to generate sufficient revenues to cover these costs. If we fail to successfully implement our transition to a NAS-focused company, our business and prospects would be harmed.

IF WE ARE UNABLE TO MANAGE OUR INTERNATIONAL OPERATIONS EFFECTIVELY, OUR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.

Net sales to our international customers, including export sales from the United States, accounted for approximately 33%, 41% and 56% of our net sales for the years ended July 31, 1999, 2000, 2001, respectively, and approximately 52% of our net sales in the six months ended January 31, 2002. We have committed significant operational resources to drive our international growth. Our international operations will expose us to operational challenges that we would not otherwise face if we conducted our operations only in the United States. These include:

       •    currency exchange rate fluctuations, particularly when we sell our products in currencies other than U.S. dollars;

       •    difficulties in collecting accounts receivable and longer accounts receivable payment cycles;

       •    reduced protection for intellectual property rights in some countries, particularly in Asia;

       •    legal uncertainties regarding tariffs, export controls and other trade barriers;

       •    the burdens of complying with a wide variety of foreign laws and regulations; and

       •    seasonal fluctuations in purchasing patterns in other countries, particularly in Europe.

Any of these factors could have an adverse impact on our existing international operations and business or impair our ability to continue expanding into international markets. For example, our reported sales can be affected by changes in the currency rates in effect during any particular period. The effects of currency fluctuations were evident in our results of operations for the fiscal year 2001 and the first six months of fiscal 2002. During this period, the Euro and two currencies whose values are pegged to the Euro, fluctuated significantly against the U.S. dollar. As a result, we incurred a foreign currency loss of approximately $54,000 in fiscal 2001 and a foreign currency loss of $63,000 in the first six months of fiscal 2002. Also, these currency fluctuations can cause us to report higher or lower sales by virtue of the translation of the subsidiary’s sales into U.S. dollars at an average rate in effect throughout the fiscal year. In addition, we have funded operational losses of our subsidiaries of approximately $1.1 million between the date of purchase and January 31, 2002, and if our subsidiaries continue to incur operational losses, our cash and liquidity would be negatively impacted.

In order to successfully expand our international sales, we must strengthen foreign operations and recruit additional international distributors and resellers. Expanding internationally and managing the financial and business operations of our foreign subsidiaries will also require significant management attention and financial resources. For example, our foreign subsidiaries in Europe have incurred operational losses. To the extent that we are unable to address these concerns in a timely manner, our growth, if any, in international sales will be limited, and our operating results could be materially adversely affected. In addition, we may not be able to maintain or increase international market demand for our products.

IF THE AGING OF OUR ACCOUNTS RECEIVABLE CONTINUES TO INCREASE OR IF WE EXPERIENCE A SIGNIFICANT INCREASE IN SALES RETURNS, WE MAY NEED TO RECORD ADDITIONAL RESERVES WHICH WOULD ADVERSELY AFFECT OUR OPERATING RESULTS.

At January 31, 2002, our net accounts receivable totaled $11.2 million, which is net of reserves for bad debts of $8.1 million and sales returns of $1.9 million. Approximately $3.6 million, or 32.1%, of our net accounts receivable were past due greater than 90 days. Although management is pursuing the collection of these accounts, if the financial condition of our customers were to continue to deteriorate, resulting in an impairment of their ability to make payments, or if our receivable aging continues to lengthen for some of our European customers, we may be required to record additional bad debt reserves which would adversely affect our operating results.

Net sales for the six months ended January 31, 2002 and 2001 were $16.1 million and $25.0 million, respectively. We recognize revenue on NAS product sales, sold through direct sales channels and resellers, generally upon shipment of the product. In addition,

we sell service contracts for certain of our appliances that require service for a specified period of time, usually one to three years. Revenue from these contracts is billed to customers at the time of sale, but earned ratably over the life of the service agreement. Revenue is recognized on sales of our Legacy products, which are sold primarily through distributors, when the distributor receives the product. We maintain sales reserves for estimated reductions to revenue for anticipated returns, including stock balancing and price protection claims, based on historical rates of sales returns. If we were to experience a significant increase in product sales returns, additional sales reserves may be required. In addition, until our collection experience improves in certain European countries, we are recording revenue from certain customers in European countries using the cost recovery method beginning in the second quarter of fiscal 2002.

THE RECENT TERRORIST ATTACKS MAY HAVE AN ADVERSE EFFECT ON OUR BUSINESS.

The terrorist attacks in New York and Washington, D.C. on September 11, 2001 appear to be having an adverse effect on business, financial and general economic conditions. These effects may, in turn, have an adverse effect on our business and results of operations. At this time, however, we are not able to predict the nature, extent and duration of these effects on overall economic conditions or on our business and operating results.

DUE TO DETERIORATING U.S. AND WORLD ECONOMIC CONDITIONS, INFORMATION TECHNOLOGY SPENDING ON DATA STORAGE AND OTHER CAPITAL EQUIPMENT COULD DECLINE. IF TECHNOLOGY SPENDING IS REDUCED, OUR SALES AND OPERATING RESULTS COULD BE HARMED.

Many of our customers are affected by economic conditions in the United States and throughout the world. Many companies have announced that they will reduce their spending on data storage and other capital equipment. If spending on data storage technology products is reduced by customers and potential customers, our sales could be harmed, and we may experience greater pressures on our gross margins. If economic conditions do not improve, or if our customers reduce their overall information technology purchases, our sales, gross profits and operating results may be reduced.

IF WE FAIL TO INCREASE THE NUMBER OF INDIRECT SALES CHANNELS FOR OUR NAS PRODUCTS, OUR ABILITY TO INCREASE NET SALES MAY BE LIMITED.

In order to grow our business, we will need to increase market awareness and sales of our NAS products. To achieve these objectives, we plan to expand revenues from our indirect sales channels, including resellers and systems integrators. To do this, we will need to modify and expand our existing relationships with these indirect channel partners, as well as enter into new indirect sales channel relationships. We may not be successful in accomplishing these objectives. If we are unable to expand our direct or indirect sales channels, our ability to increase revenues may be limited.

BECAUSE WE DO NOT HAVE EXCLUSIVE RELATIONSHIPS WITH OUR DISTRIBUTORS FOR OUR LEGACY PRODUCTS, THESE CUSTOMERS MAY GIVE HIGHER PRIORITY TO PRODUCTS OF COMPETITORS, WHICH COULD HARM OUR OPERATING RESULTS.

Our distributors generally offer products of several different companies, including products of our competitors. Accordingly, these distributors may give higher priority to products of our competitors, which could harm our operating results. In addition, our distributors often demand additional significant selling concessions and inventory rights, such as limited return rights and price protection. We cannot assure you that sales to our distributors will continue, or that these sales will be profitable.

BECAUSE WE HAVE ONLY APPROXIMATELY FOUR YEARS OF OPERATING HISTORY IN THE NAS MARKET, WHICH IS NEW AND RAPIDLY EVOLVING, OUR HISTORICAL FINANCIAL INFORMATION IS OF LIMITED VALUE IN PROJECTING OUR FUTURE OPERATING RESULTS OR PROSPECTS.

We have been manufacturing and selling our NAS products for only approximately four years. For the years ended July 31, 1999, 2000 and 2001, these products accounted for approximately 8%, 28% and 68% of our total net sales, respectively. For the six months ended January 31, 2002, these products accounted for approximately 83% of our total net sales. We expect sales of our NAS products to represent an increasing percentage of our net sales in the future. Because our operating history in the NAS product market is only approximately four years, as well as the rapidly evolving nature of the NAS market, it is difficult to evaluate our business or our prospects. In particular, our historical financial information is of limited value in projecting our future operating results.

MARKETS FOR BOTH OUR NAS APPLIANCES AND OUR LEGACY PRODUCTS ARE INTENSELY COMPETITIVE, AND IF WE ARE UNABLE TO COMPETE EFFECTIVELY, WE MAY LOSE MARKET SHARE OR BE REQUIRED TO REDUCE PRICES.

The markets in which we operate are intensely competitive and characterized by rapidly changing technology. Increased competition could result in price reductions, reduced gross margins or loss of market share, any of which could harm our operating results. We compete with other NAS companies, direct-selling storage providers and smaller vendors that provide storage solutions to end-users. In our Legacy markets, we compete with computer manufacturers that provide storage upgrades for their own products,

as well as with manufacturers of hard drives, CD servers and arrays and storage upgrade products. Many of our current and potential competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, marketing and other resources than we do. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion, sale and support of their products, and reduce prices to increase market share. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties. Accordingly, it is possible that new competitors or alliances among competitors may emerge and rapidly acquire significant market share. We may not be able to compete successfully against current or future competitors. In addition, new technologies may increase competitive pressures.

WE DEPEND ON A FEW CUSTOMERS, INCLUDING DISTRIBUTORS AND SPECIALIZED END-USERS, FOR A SUBSTANTIAL PORTION OF OUR NET SALES, AND CHANGES IN THE TIMING AND SIZE OF THESE CUSTOMERS’ ORDERS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE.

For the six months ended January 31, 2002, four customers accounted for 24% of our net sales, while one customer accounted for 20% of our net sales for the six months ended January 31, 2001. Unless and until we diversify and expand our customer base for NAS products, our future success will depend to a large extent on the timing and size of future purchase orders, if any, from these customers. In addition, we may receive from single site purchasers of large installations of our NAS products large volume purchases of our NAS products over relatively short periods of time. This may cause our sales to be highly concentrated and significantly dependent on one or only a few customers. If we lose a major customer, or if one of our customers significantly reduces its purchasing volume or experiences financial difficulties and is unable to or does not pay amounts owed to us, our results of operations would be adversely affected. In fiscal 2001, we sold our Legacy products principally to distributors. We cannot be certain that customers that have accounted for significant revenues in past periods will continue to purchase our products or fully pay for products they purchase in future periods.

OUR GROSS MARGINS OF OUR VARIOUS PRODUCT LINES HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST AND MAY CONTINUE TO FLUCTUATE SIGNIFICANTLY. FOR EXAMPLE, WE MAY NOT EXPERIENCE INCREASED SALES OF OUR NAS APPLIANCES.

Historically, our gross margins have fluctuated significantly. Our gross margins vary significantly by product line and distribution channel, and, therefore, our overall gross margin varies with the mix of products we sell. Our markets are characterized by intense competition and declining average unit selling prices over the course of the relatively short life cycles of individual products. For example, we derive a significant portion of our sales from NAS products. The market for these products is highly competitive and subject to intense pricing pressures. If we fail to increase sales of our NAS appliances, or if demand, sales or gross margins for our Legacy products decline rapidly, we believe our overall gross margins may continue to decline.

Our gross margins have been and may continue to be affected by a variety of other factors, including:

       •    new product introductions and enhancements;

       •    competition;

       •    changes in the distribution channels we use;

       •    the mix and average selling prices of products; and

       •    the cost and availability of components and manufacturing labor.

IF WE ARE UNABLE TO TIMELY INTRODUCE COST-EFFECTIVE HARDWARE OR SOFTWARE SOLUTIONS FOR NAS ENVIRONMENTS, OR IF OUR PRODUCTS FAIL TO KEEP PACE WITH TECHNOLOGICAL CHANGES IN THE MARKETS WE SERVE, OUR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.

Our future growth will depend in large part upon our ability to successfully develop and introduce new hardware and software for the NAS market. Due to the complexity of products such as ours, we face significant challenges in developing and introducing new products. The development of new products requires significant research and development expense and effort. We may not have the financial resources to fund the research and development efforts necessary to develop new NAS products, and we may be unable to introduce new products on a timely basis or at all. If we are unable to introduce new products in a timely manner, our operating results could be harmed.

Even if we are successful in introducing new products, we may be unable to keep pace with technological changes in our markets and our products may not gain any meaningful market acceptance. The markets we serve are characterized by rapid technological change, evolving industry standards, and frequent new product introductions and enhancements that could render our products obsolete and less competitive. As a result, our position in these markets could erode rapidly due to changes in features and functions

of competing products or price reductions by our competitors. In order to avoid product obsolescence, we will have to keep pace with rapid technological developments and emerging industry standards. We may not have the financial resources to do so or otherwise be successful in doing so, and if we fail in this regard, our operating results could be harmed.

WE RELY UPON A LIMITED NUMBER OF SUPPLIERS FOR SEVERAL KEY COMPONENTS USED IN OUR PRODUCTS, INCLUDING DISK DRIVES, COMPUTER BOARDS, POWER SUPPLIES, MICROPROCESSORS AND OTHER COMPONENTS, AND ANY DISRUPTION OR TERMINATION OF THESE SUPPLY ARRANGEMENTS COULD DELAY SHIPMENT OF OUR PRODUCTS AND HARM OUR OPERATING RESULTS.

We rely upon a limited number of suppliers of several key components used in our products, including disk drives, computer boards, power supplies and microprocessors. In the past, we have experienced periodic shortages, selective supply allocations and increased prices for these and other components. We may experience similar supply issues in the future. Even if we are able to obtain component supplies, the quality of these components may not meet our requirements. For example, in order to meet our product performance requirements, we must obtain disk drives of extremely high quality and capacity. Even a small deviation from our requirements could render any of the disk drives we receive unusable by us. In the event of a reduction or interruption in the supply or a degradation in quality of any of our components, we may not be able to complete the assembly of our products on a timely basis or at all, which could force us to delay or reduce shipments of our products. If we were forced to delay or reduce product shipments, our operating results could be harmed. In addition, product shipment delays could adversely affect our relationships with our channel partners and current or future end-users.

UNDETECTED DEFECTS OR ERRORS FOUND IN OUR PRODUCTS, OR THE FAILURE OF OUR PRODUCTS TO PROPERLY INTERFACE WITH THE PRODUCTS OF OTHER VENDORS, MAY RESULT IN DELAYS, INCREASED COSTS OR FAILURE TO ACHIEVE MARKET ACCEPTANCE, WHICH COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.

Complex products such as those we develop and offer may contain defects or errors, or may fail to properly interface with the products of other vendors, when first introduced or as new versions are released. Despite internal testing and testing by our customers or potential customers, we do, from time to time, and may in the future encounter these problems in our existing or future products. Any of these problems may:

       •    cause delays in product introductions and shipments;

       •    result in increased costs and diversion of development resources;

       •    require design modifications; or

       •    decrease market acceptance or customer satisfaction with these products, which could result in product returns.

In addition, we may not find errors or failures in our products until after commencement of commercial shipments, resulting in loss of or delay in market acceptance, which could significantly harm our operating results. Our current or potential customers might seek or succeed in recovering from us any losses resulting from errors or failures in our products.

OUR PROPRIETARY SOFTWARE RELIES ON OUR INTELLECTUAL PROPERTY, AND ANY FAILURE BY US TO PROTECT OUR INTELLECTUAL PROPERTY COULD ENABLE OUR COMPETITORS TO MARKET PRODUCTS WITH SIMILAR FEATURES THAT MAY REDUCE DEMAND FOR OUR PRODUCTS, WHICH WOULD ADVERSELY AFFECT OUR NET SALES.

Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary software or technology. We believe the protection of our proprietary technology is important to our business. If we are unable to protect our intellectual property rights, our business could be materially adversely affected. We currently rely on a combination of copyright and trademark laws and trade secrets to protect our proprietary rights. In addition, we generally enter into confidentiality agreements with our employees and license agreements with end-users and control access to our source code and other intellectual property. We have applied for the registration of some, but not all, of our trademarks. We have applied for U.S. patents with respect to the design and operation of our NetFORCE product, and we anticipate that we may apply for additional patents. It is possible that no patents will issue from our currently pending applications. New patent applications may not result in issued patents and may not provide us with any competitive advantages over, or may be challenged by, third parties. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries, and the enforcement of those laws, do not protect proprietary rights to as great an extent as do the laws of the United States. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology, duplicate our products or design around any patent issued to us or other intellectual property rights of ours.

In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights to establish the validity of our proprietary rights. This litigation, whether or not it is resolved in our favor, could result in significant expense to us and divert the efforts of our technical and management personnel.

WE MAY FROM TIME TO TIME BE SUBJECT TO CLAIMS OF INFRINGEMENT OF OTHER PARTIES’ PROPRIETARY RIGHTS OR CLAIMS THAT OUR OWN TRADEMARKS, PATENTS OR OTHER INTELLECTUAL PROPERTY RIGHTS ARE INVALID, AND IF WE WERE TO SUBSEQUENTLY LOSE OUR INTELLECTUAL PROPERTY RIGHTS, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.

We may from time to time receive claims that we are infringing third parties’ intellectual property rights or claims that our own trademarks, patents or other intellectual property rights are invalid. For example, we have been notified by Intel Corporation that our products may infringe some of the intellectual property rights of Intel. In its notification, Intel offered us a non-exclusive license for patents in their portfolio. We are investigating whether our products infringe the patents of Intel, and we have had discussions with Intel regarding this matter. We do not believe that we infringe the patents of Intel, but our discussions and our investigation are ongoing, and we expect we will continue discussions with Intel. We cannot assure you that Intel would not be successful in asserting a successful claim of infringement, or if we were to seek a license from Intel regarding its patents, that Intel would continue to offer us a non-exclusive license on any terms. We expect that companies in our markets will increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. The resolution of any claims of this nature, with or without merit, could be time-consuming, result in costly litigation, cause product shipment delays, require us to redesign our products or require us to enter into royalty or licensing agreements, any of which could harm our operating results. Royalty or licensing agreements, if required, might not be available on terms acceptable to us or at all. The loss of access to any key intellectual property right could harm our business.

OUR NET SALES AND OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY, AND ANY FLUCTUATIONS COULD CAUSE THE MARKET PRICE OF OUR COMMON STOCK TO DECLINE.

We have experienced significant declines in net sales and gross profit and incurred operating losses, causing our quarterly operating results to vary significantly. If we fail to meet the expectations of investors or securities analysts, as well as our internal operating goals, as a result of any future fluctuations in our quarterly operating results, the market price of our common stock could decline significantly. Our net sales and quarterly operating results are likely to fluctuate significantly in the future due to a number of factors. These factors include:

       •    market acceptance of our new products and product enhancements or those of our competitors;

       •    the level of competition in our target product markets;

       •    delays in our introduction of new products;

       •    changes in sales volumes through our reseller and distribution channels, which have varying commission and sales discount structures;

       •    changing technological needs within our target product markets;

       •    the impact of price competition on the selling prices for our products;

       •    the availability and pricing of our product components;

       •    our expenditures on research and development and the cost to expand our sales and marketing programs; and

       •    the volume, mix and timing of orders received.

Due to these factors, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful and should not be relied upon as indicators of future performance. In addition, it is difficult for us to forecast accurately our future net sales. This difficulty results from our limited operating history in the emerging NAS market, as well as the fact that product sales in any quarter are generally booked and shipped in that quarter. Because we incur expenses, many of which are fixed, based in part on our expectations of future sales, our operating results may be disproportionately affected if sales levels are below our expectations.

Our revenues in any quarter may also be affected by product returns and any warranty obligations in that quarter. Many of our distributors have limited product return rights. In addition, we generally extend warranties to our customers that correspond to the warranties provided by our suppliers. If returns exceed applicable reserves or if a supplier were to fail to meet its warranty obligations, we could incur significant losses. In the first six months of fiscal 2002 and 2001, we experienced product return rates of

approximately 11 % and 12%, respectively. This rate may vary significantly in the future, and we cannot assure you that our reserves for product returns will be adequate in any future period.

IF WE ARE UNABLE TO ATTRACT QUALIFIED PERSONNEL OR RETAIN OUR EXECUTIVE OFFICERS AND OTHER KEY PERSONNEL, WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY.

Our continued success depends, in part, on our ability to identify, attract, motivate and retain qualified technical and sales personnel. Competition for qualified engineers and sales personnel, particularly in Orange County, California, is intense, and we may not be able to compete effectively to retain and attract qualified, experienced employees. Should we lose the services of a significant number of our engineers or sales people, we may not be able to compete successfully in our targeted markets and our business would be harmed.

We believe that our success will depend on the continued services of our executive officers and other key employees. The loss of any of these key executive officers or other key employees could harm our business.

WE MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN PROFITABILITY, AND OUR FAILURE TO DO SO COULD REQUIRE US TO SEEK ADDITIONAL FINANCING, WHICH MAY NOT BE AVAILABLE TO US ON FAVORABLE OR ANY TERMS.

In recent periods, we have experienced significant declines in net sales and gross profit, and we have incurred operating losses. We incurred operating losses of $5.2 million for fiscal 1999, $12.1 million for fiscal 2000, $16.6 million (including a charge for in-process research and development) in fiscal year 2001 and $9.5 million for the six months ended January 31, 2002. We will need to increase our revenues from our NAS products to achieve and maintain profitability. The revenue and profit potential of these products is unproven. We may not be able to generate significant or any revenues from our NAS products or achieve or sustain profitability in the future. If we are unable to achieve or sustain profitability in the future, we will have to seek additional financing in the future, which may not be available to us on favorable or any terms.

CONTROL BY OUR EXISTING SHAREHOLDERS COULD DISCOURAGE POTENTIAL ACQUISITIONS OF OUR BUSINESS THAT OTHER SHAREHOLDERS MAY CONSIDER FAVORABLE.

As of January 2002, our executive officers and directors beneficially owned approximately 5,970,000 shares, or approximately 37% of the outstanding shares of common stock. Acting together, these shareholders would be able to exert substantial influence on matters requiring approval by shareholders, including the election of directors. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could in turn have an adverse effect on the market price of our common stock or prevent our shareholders from realizing a premium over the market price for their shares of common stock.

THE MARKET PRICE FOR OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE PAST AND WILL LIKELY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD RESULT IN A DECLINE IN YOUR INVESTMENT’S VALUE.

The market price for our common stock has been volatile in the past, and particularly volatile in the last twelve months, and may continue to fluctuate substantially in the future. The value of your investment in our common stock could decline due to the impact of any of the above or of the following factors upon the market price of our common stock:

       •    fluctuations in our operating results;

       •    fluctuations in the valuation of companies perceived by investors to be comparable to us;

       •    a shortfall in net sales or operating results compared to securities analysts’ expectations;

       •    changes in analysts’ recommendations or projections;

       •    announcements of new products, applications or product enhancements by us or our competitors; and

       •    changes in our relationships with our suppliers or customers, including failures by customers to pay amounts owed to us.

THE PAYMENT TO BRIGHTON CAPITAL, LTD. IN CONNECTION WITH OUR SALE OF OUR CONVERTIBLE DEBENTURES MAY BE INCONSISTENT WITH THE PROVISIONS OF SECTION 15 OF THE SECURITIES EXCHANGE ACT AND MAY ENABLE THE INVESTOR TO RESCIND ITS INVESTMENT.

We paid Brighton Capital, Ltd. $375,000 for its introduction to us of the investor in our 6% convertible debentures. The Staff of the Securities and Exchange Commission has informed us that the receipt by Brighton Capital of this payment may be inconsistent with the registration provisions of Section 15 of the Securities Exchange Act of 1934, as amended. If this payment were determined to be inconsistent with Section 15, then, under Section 29 of the Securities Exchange Act:

       •    Montrose Investments L.P., the purchaser of our debentures, might have the right to rescind its purchase of these securities, which would require us to repay to Montrose Investments L.P. the $15.0 million that it invested in us;

       •    We might be subject to regulatory action; and

       •    We might be able to recover the $375,000 fee that we paid to Brighton Capital in connection with the transaction.

WE MAY ISSUE ADDITIONAL SHARES, WHICH WOULD REDUCE YOUR OWNERSHIP PERCENTAGE AND DILUTE THE VALUE OF YOUR SHARES.

Events over which you have no control could result in the issuance of additional shares of our common stock, which would dilute your ownership percentage. Our issuance of 480,000 shares in connection with the acquisition of Scofima Software S.r.l. is an example of an issuance of additional shares to finance an acquisition that may dilute your ownership. Also in June 2001, we completed the sale of 3.8 million shares of our common stock in an offering. In the future, we may issue additional shares of common stock or preferred stock to raise additional capital or finance acquisitions, upon the exercise or conversion of outstanding options, warrants and shares of convertible preferred stock, or in lieu of cash payment of dividends. Our issuance of additional shares would dilute your shares.

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS.

This Report on Form 10-Q contains “forward-looking” statements, including, without limitation, the statements under the captions “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” You can identify these statements by the use of words like “may,” “will,” “could,” “should,” “project,” “believe,” “anticipate,” “expect,” “plan,” “estimate,” “forecast,” “potential,” “intend,” “continue,” and variations of these words or comparable words. In addition, all of the non-historical information in this Report on Form 10-Q is forward-looking. Forward-looking statements do not guarantee future performance and involve risks and uncertainties. Actual results may and probably will differ substantially from the results that the forward-looking statements suggest for various reasons, including those discussed under “Risk Factors.” These forward-looking statements are made only as of the date of this Report on Form 10-Q. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISKS

INTEREST RATE RISK

Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio as well as the fluctuation in interest rates on our various borrowing arrangements. We do not use derivative financial instruments in our investment portfolio. We invest in high-credit quality issuers and, by policy, we limit the amount of credit exposure to any one issuer. As stated in our policy, we ensure the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in safe and high-credit quality securities and by constantly positioning our portfolio to respond appropriately to a significant reduction in a credit rating of any investment issuer, guarantor or depository. The portfolio includes only marketable securities with active secondary or resale markets to help ensure reasonable portfolio liquidity.

Since October 31, 2000, we have entered into a line of credit and term loan agreements pursuant to which amounts outstanding bear interest at the lender’s prime rate plus up to .50%. Accordingly, if we were to borrow funds under such agreements, we expect that we will experience interest rate risk on our debt.

In December 2001, we borrowed $8.75 million under a financing arrangement. The principal amount outstanding bears interest at prime plus 1.0%. Accordingly, if the prime rate were to fluctuate, we would experience interest rate risk on our debt.

FOREIGN CURRENCY EXCHANGE RATE RISK

We transact business in various foreign countries, but we only have significant assets deployed outside the United States in Europe. We have effected intercompany advances and sold goods to our German subsidiary, as well as our subsidiaries in Italy and Switzerland, denominated in U.S. dollars, and those amounts are subject to currency fluctuation and require constant revaluation on our financial statements. In the six months ended January 31, 2002 and 2001, we incurred foreign currency losses of $63,000 and $59,000, respectively which are included in our selling, general and administrative expenses. We do not operate a hedging program

to mitigate the effect of a significant rapid change in the value of the Euro or the Swiss franc compared to the U.S. dollar. If such a change did occur, we would have to take into account a currency exchange gain or loss in the amount of the change in the U.S. dollar denominated balance of the amounts outstanding at the time of such change. Our net sales can also be affected by a change in the exchange rate because we translate sales of our subsidiaries at the average rate in effect during a financial reporting period. At January 31, 2002, approximately $10.8 million in current intercompany advances and accounts receivable from our foreign subsidiaries were outstanding. We can not assure you that we will not sustain a significant loss if a rapid or unpredicted change in value of the Euro or related European currencies should occur. We can not assure you that such a loss would not have an adverse material effect on our results of operations or financial condition.

PART II
OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders.

The annual meeting of shareholders was held on February 5, 2002. The shareholders elected the following seven directors to hold office until the next annual meeting and until their successors are elected and qualified.


	NUMBER OF VOTES

	FOR		WITHHELD

Alex Razmjoo		13,713,230		16,883
Nick Shahrestany		13,713,230		16,883
Kevin Michaels		13,713,230		16,883
Frank Alaghband		13,713,230		16,883
Dom Genovese		13,713,230		16,883
Alex Aydin		13,713,230		16,883
David Blake		13,713,230		16,883

In addition, the shareholders approved the following proposal:

NUMBERS OF VOTES

FOR

AGAINST

ABSTAIN

To ratify the appointment of KPMG LLP as the independent auditors of the Company for the year ending July 31, 2002

13,705,160

15,723

9,230

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, County of Orange, State of California, on the 18th of March, 2002.

PROCOM TECHNOLOGY, INC.

By: /s/ Alex Razmjoo

Alex Razmjoo
Chairman, President and
Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report on Form 10-Q has been signed below by the following persons in the capacities and on the dates indicated.


SIGNATURES	TITLE	DATE

/s/ Alex Razmjoo Alex Razmjoo	Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)	March 18, 2002

/s/ Robert Rankin Robert Rankin	Chief Financial Officer	March 18, 2002

INDEX TO EXHIBITS


EXHIBIT
NUMBER		DESCRIPTION

3.1		Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 in the Form S-1A filed on November 14, 1996)
3.2		Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 in the Form S-1A filed on November 14, 1996)
4.1		Form of Convertible Debenture dated October 31, 2000 (incorporated by reference to Exhibit 4.1 in the Registration Statement on Form S-3 filed on November 22, 2000)
4.1.1		Amendment to Convertible Debenture (incorporated by reference to Exhibit 4.1.1 in the Form S-3 filed on April 25, 2001)
4.2		Form of Common Stock Purchase Warrant dated October 31, 2000 (incorporated by reference to Exhibit 4.2 in the Report on Form 8-K filed on November 3, 2000)
4.3		Securities Purchase Agreement dated October 31, 2000 (incorporated by reference to Exhibit 4.3 in the Report on Form 8-K filed on November 3, 2000)
4.4		Registration Rights Agreement dated October 31, 2000 by and between the Registrant and Montrose Investments, Ltd. (incorporated by reference to Exhibit 4.4 in the Report on Form 8-K filed on November 3, 2000)
4.5		Subordination Agreement dated October 31, 2000 by and between the Registrant, Montrose Investments, Ltd. and CIT Group/Business Credit, Inc. (incorporated by reference to Exhibit 4.5 in the Report on Form 8-K filed on November 3, 2000)
10.1		Loan Agreement dated November 28, 2001 by and between the Registrant and First Bank & Trust

25 EX-10.1 3 a79955ex10-1.txt EXHIBIT 10.1 EXHIBIT 10.1 LOAN AGREEMENT BY AND BETWEEN PROCOM TECHNOLOGY, INC., A CALIFORNIA CORPORATION AND FIRST BANK & TRUST, A CALIFORNIA CORPORATION Dated: November 28, 2001 Loan No.: 406013006890 LOAN AGREEMENT TABLE OF CONTENTS
Page ---- ARTICLE I LOAN ACCOMMODATION ....................................... 1 1.01 The Loan ................................................. 1 1.02 Documents ................................................ 1 ARTICLE II REPRESENTATIONS AND WARRANTIES ........................... 2 2.01 Legal Status ............................................. 2 2.02 Authorization and Validation ............................. 2 2.03 Financial Information .................................... 2 2.04 No Defaults .............................................. 2 2.05 Correct Information ...................................... 3 2.06 Title .................................................... 3 2.07 Permits, Franchises ...................................... 3 2.08 Improvements ............................................. 3 2.09 Taxes .................................................... 3 2.10 Pending Litigation ....................................... 3 2.11 Unpaid Materialmen ....................................... 3 2.12 Agreements and Deposits .................................. 3 2.13 Encumbrances ............................................. 4 2.14 Principal Place of Business .............................. 4 2.15 Compliance ............................................... 4 ARTICLE III CONDITIONS PRECEDENT ..................................... 4 3.01 Title Policy ............................................. 4 3.02 Reports and Other Documents .............................. 4 3.03 Insurance ................................................ 4 3.04 Correctness of Representations; No Defaults .............. 5 3.05 Legal Review ............................................. 5 3.06 Owner's Equity ........................................... 5 ARTICLE IV DISBURSEMENT PROCEDURE ................................... 5 4.01 Loan Fee ................................................. 5 4.02 Costs and Expenses ....................................... 5 4.02 Payment to Owner ......................................... 6 4.04 Holdback ................................................. 6 4.05 Non-Liability of Lender .................................. 8 4.06 Security Interest in Undisbursed Funds ................... 8 ARTICLE V AFFIRMATIVE COVENANTS .................................... 8 5.01 Punctual Payments ........................................ 8 5.02 Books and Records ........................................ 8 5.03 Existence, Compliance with Law ........................... 8 5.04 Insurance ................................................ 9 5.05 Facilities ............................................... 9 5.06 Taxes and Other Liabilities .............................. 9
(i)
5.07 Litigation ............................................... 9 5.08 Other Notifications ...................................... 9 ARTICLE VI NEGATIVE COVENANTS ....................................... 9 6.01 Use of Funds ............................................. 9 6.02 Removal of Personalty .................................... 9 6.03 Assessment Districts ..................................... 10 6.04 Liens .................................................... 10 6.05 Leases ................................................... 10 ARTICLE VII EXCULPATORY PROVISIONS ................................... 10 7.01 Status as Lender ......................................... 10 7.02 Defective Construction ................................... 10 7.03 Non-Liability ............................................ 10 7.04 No Representation ........................................ 10 7.05 Brokers' Fees ............................................ 11 7.06 Indemnity ................................................ 11 ARTICLE VIII BOOKS AND RECORDS ........................................ 11 8.01 Books of Account ......................................... 11 8.02 Financial Information .................................... 11 8.03 Property Information ..................................... 12 8.04 Appraisals ............................................... 12 8.05 Lender Audit Rights ...................................... 12 8.06 Further Assurances ....................................... 12 ARTICLE IX EVENTS OF DEFAULT ........................................ 12 9.01 Events of Default ........................................ 12 ARTICLE X REMEDIES ................................................. 14 10.01 Remedies ................................................. 14 10.02 Application of Other Funds ............................... 15 10.03 Remedies Cumulative ...................................... 15 10.04 Contest of Third Party Claims ............................ 15 10.05 No Waivers ............................................... 15 ARTICLE XI SURVIVAL OF WARRANTIES AND COVENANTS ..................... 15 ARTICLE XII ASSIGNMENT ............................................... 16 12.01 Owner's Assignment ....................................... 16 12.02 Lender's Assignment ...................................... 16 12.03 Participation ............................................ 16 ARTICLE XIII WAIVER OF JURY TRIAL ..................................... 16 ARTICLE XIV MISCELLANEOUS ............................................ 17 14.01 Amendment ................................................ 17 14.02 Additional Fees .......................................... 17 14.03 Return of Documents ...................................... 17 14.04 Regulatory Restrictions .................................. 17 14.05 Notices .................................................. 17 14.06 Time of Essence .......................................... 18 14.07 No Third Parties Benefited ............................... 18 14.08 Actions .................................................. 18
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14.09 Reliance on Representations .............................. 18 14.10 Relationship ............................................. 18 14.11 Headings ................................................. 18 14.12 Governing Law ............................................ 18 14.13 Attorneys' Fees and Costs ................................ 18 14.14 Nondiscrimination ........................................ 18 Signatures ............................................................... 19
(iii) Loan No.: 406013006890 LOAN AGREEMENT THIS LOAN AGREEMENT ("Agreement") is entered into as of November 28, 2001 by and between PROCOM TECHNOLOGY, INC., a California corporation ("Owner"), and FIRST BANK & TRUST, a California corporation ("Lender"). R E C I T A L S: This Agreement is executed by Owner for the purpose of obtaining a loan from Lender, to be evidenced by a Promissory Note Secured by Deed of Trust made by Owner in favor of Lender and secured by, among other things, a Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing affecting real property in the County of Orange, State of California, described on EXHIBIT "A" attached to and made a part of this Agreement and all improvements now or in the future erected on such real property (such real property and improvements now or in the future erected on such real property are collectively hereinafter referred to as the "Property"). NOW, THEREFORE, in consideration of the foregoing recitals, the making of the loan and of the mutual promises contained in this Agreement, and of other valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: ARTICLE I LOAN ACCOMMODATION 1.01 THE LOAN. Owner agrees to take, and Lender agrees to make, upon the terms and conditions contained in this Agreement, a loan in the principal sum of Nine Million Seven Hundred Fifty Thousand Dollars ($9,750,000.00) (the "Loan"). 1.02 DOCUMENTS. In order to consummate the Loan, Owner will hand Lender the following documents, fully executed, in the form prescribed by Lender, together with any additional documents, items and funds as Lender may require in connection with this Agreement: (a) Promissory Note Secured by Deed of Trust ("Note") in the principal amount set forth above and bearing interest at the rate set forth in the Note. (b) Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing ("Deed of Trust"). (c) UCC-1 Financing Statement. (d) Assignment of Rights Under Covenants Conditions and Restrictions, Sales Agreements, Permits, and Development Documents. (e) Assignment of Leases and Rents. (f) Environmental Indemnity Agreement. (g) Corporate Borrowing Resolution. (h) Estoppel and Attornment Agreement. (i) Subordination Agreement. (j) The items described on EXHIBIT "B" attached hereto and made a part hereof. ARTICLE II REPRESENTATIONS AND WARRANTIES Owner represents and warrants to Lender that as of the date of recording the Deed of Trust: 2.01 LEGAL STATUS. Owner is a corporation duly organized and validly existing under the laws of the State of California, and is qualified and licensed to do business in all jurisdictions in which such qualification or licensing is required. 2.02 AUTHORIZATION AND VALIDATION. The execution, delivery and performance by Owner of this Agreement, the Note, and all documents securing the repayment of the indebtedness evidenced by the Note, including, without limitation, the Deed of Trust and other documents described above (all documents securing such repayment being collectively called the "Security Documents"), and the borrowings evidenced by the Note (a) are within the powers of Owner, (b) have received the approval of Owner's principals, (c) have received all necessary governmental approvals, and (d) will not violate any provisions of law, any order of any court or other agency of government, or any indenture, agreement or any other instrument to which Owner is a party or by which Owner, or any of its property, is bound, or be in conflict with, result in any breach of or constitute (with due notice and/or lapse of time) a default under any such indenture, agreement or other instrument, or result in the creation or imposition of any lien, charge or encumbrance of any nature whatsoever upon any of its property or assets, except as contemplated by the provisions of this Agreement. This Agreement, the Note and each of the Security Documents, when executed and delivered to Lender, will constitute legal, valid and binding obligations of Owner enforceable in accordance with their terms. 2.03 FINANCIAL INFORMATION. All financial data that has been given to Lender with respect to Owner and the Property (a) is complete and correct in all material respects, (b) accurately represents the financial condition of Owner and the Property as of the date on which, and the results of Owner's or the Property's operations for the period for which, the same have been furnished, and (c) has been prepared in accordance with the reporting requirements of the Securities and Exchange Commission for public companies or, if no such requirements are applicable to a particular submittal, then in accordance with generally accepted accounting principles consistently applied throughout the periods covered. All balance sheets disclose all known liabilities, direct and contingent, as of their respective dates. There has been no adverse change in the financial condition of Owner since the date of the most recent of such financial statements given to Lender other than changes in the ordinary course of business, none of which changes has been materially adverse. 2.04 NO DEFAULTS. Owner is a party to no agreement or instrument that will materially interfere with its performance under this Agreement or the Security Documents; and is not in default in the performance, observance or fulfillment of any of the material obligations, covenants or conditions set 2 forth in any agreement or instrument to which it is a party, which default would have a material and adverse effect upon its ability to perform under this Agreement or the Security Documents. 2.05 CORRECT INFORMATION. All reports, papers, data and information given to Lender with respect to Owner or the Property are accurate and correct in all material respects and complete insofar as completeness may be necessary to give Lender a true and accurate knowledge of the subject matters thereof. 2.06 TITLE. Owner has good and marketable title in fee simple to the Property and good and marketable title to all fixtures and personalty now located on the Property, free and clear of any liens, charges, encumbrances, security interests and adverse claims whatsoever except as approved in writing by Lender. 2.07 PERMITS, FRANCHISES. Owner possesses all permits, memberships, franchises, contracts, and licenses required and all trademark rights, trade names, trade name rights, patents, patent rights and fictitious name rights necessary to enable it to conduct the business in which it is now engaged without conflict with the rights of others. 2.08 IMPROVEMENTS. All improvements located upon the Property have been constructed in accordance with plans and specifications delivered to and approved by Lender and in accordance with all governmental laws, statutes, ordinances, rules and regulations and requirements; all of said improvements are structurally sound, free of construction defects and suitable for their present and intended uses; there is adequate ingress to and egress from the Property, public water service, sanitary sewer service, electricity, gas, telephone and all other utility services sufficient for the uses of the Property; the Property is zoned for its present and intended uses; and all such uses comply with any and all laws, statutes, ordinances, rules, regulations, covenants, conditions and restrictions applicable to said uses or which relate to or affect the Property. 2.09 TAXES. Owner has filed all federal, state, county and municipal income tax returns required to have been filed by it, and has paid all taxes which have become due pursuant to such returns or pursuant to any assessments received by it, and Owner does not know of any basis for additional assessment in respect of any such taxes. Owner has no knowledge of any pending assessments or adjustments of its taxes payable with respect to any year. 2.10 PENDING LITIGATION. Except as set forth in EXHIBIT "D" attached hereto, there is not now pending against or affecting Owner or the Property, nor, to the knowledge of Owner is there threatened any claim, investigation, action, suit or proceeding at law, or in equity, or before any court or administrative agency which, if adversely determined, would materially impair or affect the Property or the financial condition or business operations of Owner. 2.11 UNPAID MATERIALMEN. No person, firm or corporation has performed any construction work or furnished services in connection with any construction carried on or to be carried on at the Property who or which remains unpaid at the time of execution of this Agreement other than payments to be made in connection with the advances hereunder. 2.12 AGREEMENTS AND DEPOSITS. Owner has not received any payment, deposit, rental prepayment or other amounts of any nature from any occupant or prospective occupant, nor executed any lease or purchase agreement with any such occupant or prospective occupant, of the Property or any part thereof without the written consent of Lender. 3 2.13 ENCUMBRANCES. No other encumbrance on the Property exists or is contemplated which shall be subordinate to the Deed of Trust, and Owner agrees that no junior lien of any nature against all or any portion of the Property shall be given, permitted or suffered by Owner without Lender's written consent. Said consent shall be at Lender's sole option and discretion. 2.14 PRINCIPAL PLACE OF BUSINESS. Owner's principal place of business is at the address set forth in this Agreement as the address for notices to Owner. Owner shall promptly notify Lender of any change in Owner's principal place of business at any time prior to repayment in full to Lender of the indebtedness secured by the Security Documents. 2.15 COMPLIANCE. Owner has examined and is familiar with all conditions, restrictions, reservations and zoning ordinances affecting the Property. The Property in all material respects conforms to and complies with all of the requirements of said conditions, restrictions, reservations and zoning ordinances, including subdivision laws and environmental impact laws, and complies with all requirements of the regulatory authorities having jurisdiction thereof, and the improvements to the Property do not encroach upon any easement affecting the Property. All applicable requirements of the California Subdivision Map Act have been complied with in connection with this Loan and Owner's ownership of the Property. ARTICLE III CONDITIONS PRECEDENT As a condition to Lender's obligation to make the Loan and of Owner's right to receive any of the proceeds of the Loan, the following conditions precedent and other requirements shall have been satisfied: 3.01 TITLE POLICY. Owner shall furnish to Lender an ALTA Lender's Policy of Title Insurance with such indorsements as Lender may require, which shall insure that the Deed of Trust is a first lien on the Property, free and clear of all liens, encumbrances and restrictions or other matters except those, if any, to which Lender may agree to take subject to in writing. Said Policy of Title Insurance shall be in the principal amount of the Loan. 3.02 REPORTS AND OTHER DOCUMENTS. Owner shall furnish to Lender, at Owner's sole cost and expense, (a) a report prepared by a licensed environmental consultant acceptable to Lender indicating to Lender's satisfaction that no "Hazardous Materials" (as that term is defined in the Environmental Indemnity Agreement referred in Section 1.02 above) are present in, on, under or about the Property, (b) a soils report relating to the Property by a licensed registered soils engineer acceptable to Lender indicating to Lender's satisfaction that no unusual or hazardous soils conditions exist in, on, under or about the Property, (c) all of the documents required under Section 1.02 above, (d) the documents required by Article IV, and (e) an appraisal of the Property by or on behalf of Lender utilizing Lender's required appraiser, in form and content acceptable to Lender. 3.03 INSURANCE. Owner shall furnish to Lender, at Owner's sole cost and expense, such policies of insurance in such amounts and in accordance with the standards set forth on EXHIBIT "C" attached hereto and incorporated herein, with standard mortgagee's indorsements naming Lender as first mortgagee and as additional insured, and shall also deliver to Lender such other insurance as Lender, from time to time, may require upon notice to Owner in writing. The special form property insurance shall provide for the loss proceeds to be payable to Lender or its assigns as mortgagee. Certifications evidencing the originals of all such policies in form and content acceptable to Lender shall be deposited 4 with Lender. It is understood and agreed that the approval of any insurer by Lender shall not be deemed or construed to be any representation, warranty or determination by Lender as to the form or legal sufficiency of any insurance contract, or the solvency of any insurance company, or the sufficiency of the amounts carried for the protection of Owner or any other person, and Owner assumes the full risk, responsibility and liability, if any, with respect to such matters. If Owner fails to secure and maintain insurance as required hereunder, Lender shall have the immediate right (without waiver of any other rights Lender may have upon an Event of Default under this Agreement) to secure same in the name and for the account of Owner, in which event Owner shall pay the costs thereof upon demand by Lender with interest thereon at the default rate as set forth in the Note from the date of disbursement by Lender until paid in full, and all such amounts shall be deemed secured by the Security Documents. 3.04 CORRECTNESS OF REPRESENTATIONS; NO DEFAULTS. The representations and warranties of Owner contained in Article II hereof shall be true and correct on and as of the date of Lender's advancing any of the proceeds of the Loan, with the same effect as though such representations and warranties had been made on and as of such date, and on such date no Event of Default as defined in Article IX hereof shall have occurred and no condition, event or act which with the giving of notice or the passage or time or both would constitute such an Event of Default shall have occurred and be continuing or shall exist. 3.05 LEGAL REVIEW. All legal matters incidental to the granting of the Loan shall be satisfactory to counsel of Lender. 3.06 OWNER'S EQUITY. Prior to the funding of the Loan, Owner shall deposit with Lender, or as Lender shall direct, (a) cash in an amount to pay interest under the Note to the extent required under the Note, and (b) an appraisal of the Property prepared in accordance with Section 3.02 hereof and approved by Lender demonstrating that the Property has a stablilized appraised value as approved by Lender in an amount not less than Fourteen Million Eight Hundred Thousand Dollars ($14,800,000.00). ARTICLE IV DISBURSEMENT PROCEDURE Upon recording of the Deed of Trust, Loan funds of up to Nine Million Seven Hundred Fifty Thousand Dollars ($9,750,000.00) shall be disbursed as follows: 4.01 LOAN FEE. The sum of Ninety-Seven Thousand Five Hundred Dollars ($97,500.00) shall be disbursed as a non-refundable Loan fee to Lender. 4.02 COSTS AND EXPENSES. The sum of approximately Seventeen Thousand Five Hundred Dollars ($17,500.00) shall be disbursed for miscellaneous appraisal, consultant, legal, title and closing costs of Lender. Said sum shall include payment to Pinto & Dubia, LLP for Lender's legal fees incurred through the date of recordation of the Deed of Trust, pursuant to invoices therefor submitted by such law firm to Lender. If Loan funds allocated for all such costs and expenses are insufficient to satisfy all such costs and expenses in full, Owner agrees to immediately pay to Lender the additional sums required to satisfy all such costs and expenses in full. Any Loan funds allocated for such costs and expenses remaining after payment in full thereof shall be added to the Loan funds under Section 4.03 below. 5 4.03 PAYMENT TO OWNER. The sum of approximately Eight Million Six Hundred Thirty-Five Thousand Dollars ($8,635,000.00), increased or decreased by amounts required or remaining in connection with payment of all costs under Section 4.02 above, shall be paid to Owner as a reimbursement of certain equity contributions made by Owner in the development of the Property, and upon such payment may be used by Owner for working capital or any other purpose. 4.04 HOLDBACK. (a) The balance of the Loan funds in the sum of One Million Dollars ($1,000,000.00) shall be held back by Lender ("Holdback Funds"), and disbursed by Lender to Owner from time to time subject to and conditioned upon Owner's fulfillment of the conditions for disbursement hereinafter set forth. Said Holdback Funds shall be disbursed for payment of leasing commissions and tenant improvement costs in connection with Owner's leasing of up to 40,000 square feet of currently vacant and unimproved space at the Property. (b) In addition to the other conditions and requirements set forth in this Section 4.04, it shall be a condition to Owner's right to receive any of the Holdback Funds that Lender has received and approved of signed leases for vacant space within the Property, construction of tenant improvements in connection with such signed leases has actual commenced, and, if requested by Lender, Lender has received complete, fully-executed and acknowledged subordination and attornment agreements and/or estoppel certificates from Owner and such tenants in form and content as required by Lender. Thereafter, the Holdback Funds shall be disbursed in accordance with this Section 4.04 and each approved lease, only with respect to tenant improvements and commissions attributable to such lease. In the event of any conflict or inconsistency between the disbursement provisions contained in this Section 4.04 and the provisions of any such approved lease, the provisions of this Section 4.04 shall control. It is further understood and agreed that in no event shall disbursements for tenant improvements under any single lease exceed Thirty Dollars ($30.00) per square foot of usable space leased thereunder without the prior written approval of Lender in its sole discretion. Upon any Event of Default (as defined below), Lender shall have no further obligation to disburse, and Owner shall have no further right to receive, the Holdback Funds. Owner acknowledges and agrees that any failure to disburse and receive the Holdback Funds shall not excuse Owner of its obligation to make payments for all other disbursed Loan funds in full and when due under the Note. (c) Upon satisfaction of the conditions set forth in subparagraph (a) hereof, Owner shall submit to Lender or to Lender's designated agent a request for funds ("Request for Funds") on Lender's form "Request for Payment and Authorization to Disburse" or its equivalent acceptable to Lender, containing a statement by or on behalf of Owner setting forth the amount of disbursement sought with an itemized breakdown of those expenses comprising such requested disbursement, and accompanied by (i) documentary evidence satisfactory to Lender confirming the expenditures identified in the Request for Funds, (ii) to the extent any such expenditures are for the payment of labor performed on and/or materials stored on or incorporated into any work on the Property, lien release waivers in form and content satisfactory to Lender and executed by each engineer, contractor, subcontractor, supplier and materialmen to be paid pursuant to such Request for Funds and covering all labor, services, equipment and materials to be paid thereunder, and (iii) to the extent any such disbursements are for the payment of leasing commissions, copies of signed leases and of any commission agreements or other written evidence of such commissions being owed, all in form and content 6 acceptable to Lender. The original of such Request for Funds shall be certified in writing as true and correct by or on behalf of Owner; Owner hereby designates any two (2) of the following persons, acting jointly, as specified by their signatures set forth below, as persons authorized to sign Requests for Funds in accordance herewith: ------------------------------------------ Name: ------------------------------------ ------------------------------------------ Name: ------------------------------------ ------------------------------------------ Name: ------------------------------------ ------------------------------------------ Name: ------------------------------------ Upon verification of the accuracy of a Request for Funds, including by Lender's inspection of the Property or otherwise, and satisfaction of all applicable conditions contained herein, Lender shall make disbursements for one hundred percent (100%) of the amount set forth in such Request for Funds, to Owner's designated bank account with Lender, provided, however, that (i) Lender reserves the right, at Lender's option, to make any disbursements directly to the contractors, subcontractors, materialmen, or other vendors or payees under the Request for Funds, and (ii) it is understood and agreed that such disbursement shall only be made on the first (1st) day of each calendar month. (d) Notwithstanding anything to the contrary contained in the foregoing, in no event shall Lender be obligated to make any disbursement under this Section 4.04 (i) if an Event of Default has occurred (or an event or non-event has occurred or not occurred which with notice or the passage of time or both would become an Event of Default), or (ii) if there are unreleased and unbonded mechanics' liens or stop notices in existence, or (iii) if Lender has not received satisfactory evidence that any remaining costs of tenant improvements and/or leasing commissions after disbursement of funds approved by Lender will be or have been paid by Owner, or (iv) from and after the date which is thirty-six (36) months following the date of recordation of the Deed of Trust, it being agreed and understood that Owner shall have no further right to receive any of the Holdback Funds from and after such date. In addition, at Lender's sole and absolute discretion, in addition to the requirements of subparagraphs (b) and (c) hereof, Lender may require Owner to obtain, in connection with any or all requested disbursements under this Section 4.04, at Owner's sole cost and expense, a CLTA Form 122 Endorsement and/or such other endorsements as Lender may require, which endorsements are to be attached to and be a part of Lender's Policy of Title Insurance. Owner agrees that notwithstanding the amounts set forth in subparagraph (a) hereof for tenant improvement costs and leasing commissions, Owner shall be responsible for and shall pay all costs therefor in excess of the approved amounts under this Section 4.04. In addition, Owner shall pay all inspection, legal and other costs incurred by Lender arising out of this Section 4.04. 7 (e) Provided no Event of Default has occurred (or any event or non-event has occurred or not occurred which with notice or the passage of time or both would become an Event of Default), and further subject to and conditioned upon satisfaction of all of the other conditions set forth in subparagraph (d) hereof, upon such time that (i) not less than 32,000 square feet of currently vacant and unimproved space at the Property has been improved, leased on terms and conditions approved by Lender and occupied at a rental rate of not less than ninety-five cents ($0.95) per square foot triple net, and (ii) the Property is not less than ninety-five percent (95%) occupied by either Owner or third party tenants under leases approved by Lender with the tenants thereunder actually paying rent in amounts not less than ninety-five cents ($0.95) per square foot triple net, and so long as all of the same has occurred prior to the date which is thirty-six (36) months following recordation of the Deed of Trust, Lender shall pay to Owner any balance remaining in the Holdback Funds. 4.05 NON-LIABILITY OF LENDER. Lender shall not be liable for any error, omission, irregularity, or action taken in good faith with respect to the disbursement of the Loan funds. Owner acknowledges that it has no right to the Loan funds other than to have them disbursed by Lender in accordance with this Agreement. 4.06 SECURITY INTEREST IN UNDISBURSED FUNDS. Owner hereby irrevocably assigns to Lender, as security for the obligations secured by the Security Documents, all of Owner's right, title and interest in and to all undisbursed Loan funds, including without limitation the Holdback Funds. Upon any Event of Default, Lender may, at Lender's sole option and discretion, cease disbursing any funds from the Holdback Funds, or apply such funds to outstanding principal or accrued interest under the Note or to compensate Lender for such other losses and damages as it may incur. ARTICLE V AFFIRMATIVE COVENANTS Owner covenants that so long as the Loan remains outstanding or any liabilities (whether direct or contingent, liquidated or unliquidated) of Owner to Lender hereunder or under any contracts or instruments executed in connection herewith remain outstanding, and until payment in full of the Note, Owner shall: 5.01 PUNCTUAL PAYMENTS. Punctually pay: the interest and principal of the Note at the times and place and in the manner specified in the Note; and any fees or other liabilities due hereunder and under the Note and any of the Security Documents at the times and place and in the manner specified in this Agreement, the Note or the Security Documents, as appropriate. 5.02 BOOKS AND RECORDS. Maintain or cause to be maintained full and complete books of account and other records reflecting the results of its operations (in conjunction with its other operations as well as specifically the operation of the Property), in accordance with Article VIII below, and shall furnish or cause to be furnished to Lender, at any time and from time to time, such financial data as Lender shall reasonably request relating to the ownership or operation of the Property. 5.03 EXISTENCE, COMPLIANCE WITH LAW. Preserve and maintain its existence and all of its licenses, permits, governmental approvals, rights, privileges and franchises; conduct its business in 8 an orderly, efficient and regular manner; comply with the provisions of all documents pursuant to which Owner is organized and/or which govern Owner's continued existence; and comply with the requirements of all applicable laws, rules, regulations, orders of any governmental authority and requirements for the maintenance of Owner's insurance, licenses, permits, governmental approvals, rights, privileges and franchises. 5.04 INSURANCE. Maintain and keep in force insurance of the types, in the amounts, in the form and with the carriers required under this Agreement and under any and all of the Security Documents. 5.05 FACILITIES. Keep all of Owner's properties useful or necessary to Owner's business, including without limitation the Property, in good repair and condition, and from time to time make necessary repairs, renewals and replacements thereto so that Owner's properties, and the Property, shall be fully and efficiently preserved and maintained. 5.06 TAXES AND OTHER LIABILITIES. Pay and discharge promptly as and when due any and all indebtedness, obligations, assessments and taxes, both real or personal and including without limitation federal and state income taxes. 5.07 LITIGATION. Promptly give notice in writing to Lender of any litigation pending or threatened against Owner or the Property having a potential or claimed liability in excess of One Hundred Thousand Dollars ($100,000.00). 5.08 OTHER NOTIFICATIONS. Promptly (but in no event more than five (5) business days after the occurrence of each such event or matter) give notice in writing to Lender of: (a) the occurrence of any Event of Default, or any condition, event or act which with the giving of notice or the passage of time or both would constitute such an Event of Default, under this Agreement or under the Note or any of the Security Documents; (b) any default by either Owner or the lessee under any lease of all or any portion of the Property; (c) any termination or cancellation of any insurance policy which Owner is required to maintain; (d) any uninsured or partially uninsured loss through liability or property damage, or through fire, theft or any other cause affecting any of Owner's property, or the Property, in excess of Fifty Thousand Dollars ($50,000.00) in the aggregate; (e) the change in the name or the organizational structure, dissolution or adverse change in financial condition of Owner. ARTICLE VI NEGATIVE COVENANTS Owner further covenants that so long as the Loan remains outstanding or any liabilities (whether direct or contingent, liquidated or unliquidated) of Owner to Lender hereunder or under any contracts or instruments executed in connection herewith remain outstanding, and until payment in full of the Note, Owner will not without prior written consent of Lender: 6.01 USE OF FUNDS. Use any of the proceeds of the Loan for any purposes other than as stated in Article IV hereof. 6.02 REMOVAL OF PERSONALTY. Install or otherwise use any materials, equipment or fixtures incorporated into the Property purchased and/or installed under a conditional sales agreement, lease or under any security agreements or similar agreements however denominated whereby the right is reserved or accrued to anyone to remove or repossess any such items or whereby any person other than 9 Lender reserves or acquires a lien upon such items. Owner will not at any time remove or permit the removal of any of the materials, equipment or fixtures incorporated into the Property from the Property without the prior written consent of Lender unless actually replaced by an article of equal suitability and value, owned by Owner, free and clear of any lien or security interest. The foregoing does not apply to equipment which is attached to the Property that is related to the operation of the business at the Property and not to the operation of the Property itself, and which can be removed from the Property with minimal damage. 6.03 ASSESSMENT DISTRICTS. Join, participate in or consent to the formation of any special assessment or other assessment district which will result in any lien being placed on all or any portion of the Property to secure the payment thereof without the prior written approval of Lender. 6.04 LIENS. Create, suffer or permit to exist any security interest, liens, claims or encumbrances on any assets pledged to Lender, other than disclosed to Lender in writing prior to the date hereof. 6.05 LEASES. Amend, modify or cancel any existing leases of all or any portion of the Property, or enter into any new leases of all or any portion of the Property, without the prior written approval of Lender, which shall not be unreasonably withheld. ARTICLE VII EXCULPATORY PROVISIONS Owner acknowledges, understands and agrees as follows: 7.01 STATUS AS LENDER. The relationship between Owner and Lender is, and shall at all times remain, solely that of borrower and lender. 7.02 DEFECTIVE CONSTRUCTION. Lender owes no duty of care to protect Owner against negligent, faulty, inadequate or defective building or construction at the Property. Lender shall in no way be liable for any acts or omissions of Owner, or any agent, contractor or other person furnishing labor and/or materials used in relation to any construction at the Property. 7.03 NON-LIABILITY. Lender shall not be responsible or liable to Owner for any loss, damage or expense of any kind to person or property caused by Lender's activities taken in accordance with this Agreement whether as to Owner or as to any other persons or group of persons or for negligent, faulty, inadequate or defective building or construction and Owner shall protect, indemnify, defend and hold Lender free and harmless from any such liability, loss, damage or expense, including any attorneys' fees incurred. The consent or approval by Lender shall not be deemed to waive or render unnecessary the consent or approval to or of any subsequent similar act. 7.04 NO REPRESENTATION. By accepting or approving anything required to be observed, performed or fulfilled, or to be given to Lender pursuant hereto or pursuant to the Security Documents, including, but not limited to, any officer's certificate, balance sheet, statement of profit and loss or other financial statement, survey, appraisal or insurance policy, Lender shall not be deemed to have warranted or represented the sufficiency, legality, effectiveness or legal effect of the same, or of any term, provision or condition thereof, and such acceptance or approval thereof shall not be or constitute any warranty or representation to anyone with respect thereto by Lender. 10 7.05 BROKERS' FEES. Owner agrees to protect, indemnify, defend (with counsel acceptable to Lender) and hold Lender free and harmless from any responsibility, cost and/or liability, including, without limitation, any attorneys' fees and costs incurred, for the payment of any commission, charge or brokerage fees which may be payable in connection with this Loan, it being understood that any such commission, charge or brokerage fees will be paid directly by Owner to the party(ies) entitled thereto. 7.06 INDEMNITY. Owner agrees to and shall protect, indemnify, defend (with counsel acceptable to Lender) and hold Lender, its affiliates, and their directors, officers, agents, employees, successors and assigns free and harmless from and against any and all claims, actions, damages, demands, liabilities, losses, costs and expenses (including without limitation, attorneys' fees) directly or indirectly arising out of or in any way attributable to (a) all actual or alleged damage or injury of whatsoever nature arising out of or in any way connected with the Property, (b) Lender's performance of any act permitted under this Agreement, the Note or any of the Security Documents (unless arising out of Lender's willful misconduct), (c) breach of any representation or warranty made by Owner or any obligation of Owner contained in this Agreement, and (d) any allegation that Lender is liable for any act or omission committed by or on behalf of Owner in connection with the ownership, operation or development of the Property. Upon demand by Lender, Owner shall defend any action or proceeding brought against Lender covered by this indemnity, at Owner's sole cost and expense, unless Lender elects to conduct its own defense at the expense of Owner, in which event all fees and costs of such defense shall be paid by Owner upon demand and shall bear interest at the default rate set forth in the Note from the date of demand until paid. ARTICLE VIII BOOKS AND RECORDS 8.01 BOOKS OF ACCOUNT. Owner shall maintain full and complete books of account and other records reflecting the results of its operations (in conjunction with its other operations as well as specifically its operation of the Property), in accordance with the reporting requirements of the Securities and Exchange Commission for public companies or, if no such requirements are applicable to any particularly books, records, reports or data, then in accordance with generally accepted accounting principles consistently applied, and in addition to the reports and data specifically requested by Lender pursuant to this Agreement, shall furnish or cause to be furnished to Lender, at any time and from time to time, such financial data as Lender shall reasonably request relating to the ownership or operation of the Property. 8.02 FINANCIAL INFORMATION. Owner understands, acknowledges and agrees that Lender requires, as a part of Lender's standard procedures and practices, updated financial information regarding borrowers, principals of borrowers, guarantors, and such other parties as Lender relies upon in its underwritings of its loans. Accordingly, Owner hereby agrees to provide the following updated financial information to Lender for all parties and at the times herein specified: (a) Within thirty (30) days following the one (1) year anniversary of the date of the most recent financial statements provided to Lender, current, updated financial data in form and content acceptable to Lender (including without limitation annual financial statements, asset and liability statements, income and expense statements, and such other financial information as was previously provided to Lender or as Lender may request) with respect to Owner, any guarantors, and such other parties as Lender obtained financial information from in its original underwriting of the Loan (hereinafter collectively the "Updating Parties"). Notwithstanding the 11 foregoing, for so long as Owner shall be a public company, Owner shall, in lieu of the foregoing, provide to Lender within thirty (30) days following submittal by Owner to the Securities and Exchange Commission, copies of reports filed by Owner under the Securities Exchange Act of 1934, including without limitation Forms 10-K, 10-Q and 8-K; (b) Within thirty (30) days after its receipt by each of the Updating Parties, a copy of the most current federal tax return for each such party. Owner further agrees that the failure of Owner to comply or to cause compliance with the foregoing requirements within the time and in the manner set forth herein shall constitute a default under this Agreement. 8.03 PROPERTY INFORMATION. Owner shall submit to Lender semi-annual financial and operating statements of the Property, setting out in reasonable detail income and expenditures from the ownership and operation of the Property, depreciation charges, and net income before and after federal income taxes, all to be received by Lender within ninety (90) days from the end of each semi-annual period. Such statements are to be certified as true and accurate by Owner, Owner's accountant or Owner's chief financial officer, and as having been prepared in accordance with generally accepted accounting principles consistently applied. 8.04 APPRAISALS. Upon receipt of written notice from Lender that either Lender or any federal or state regulatory agencies having jurisdiction over Lender reasonably believe that the fair market value of the Property may have declined since the date of Lender's last appraisal of the Property, Owner shall obtain, as promptly as possible and at Owner's expense, an updated appraisal of the Property in form and substance satisfactory to Lender and such regulatory agencies from an appraiser satisfactory to Lender in its sole discretion. 8.05 LENDER AUDIT RIGHTS. Lender and its agents and representatives shall have the right to inspect and audit all books and records of Owner pertaining to the statements, reports and information required under this Article VIII in order to obtain and verify such information as Lender deems necessary or appropriate. The cost of any and all such inspections and audits shall be paid by Owner. Provided no Event of Default has occurred and is continuing under this Agreement, (i) Lender shall give Owner reasonable notice prior to exercising its rights hereunder, and (ii) Lender shall not audit the books and records of Owner more frequently than one (1) time per calendar year. 8.06 FURTHER ASSURANCES. Owner, upon the request of Lender, will at its expense, execute, acknowledge and deliver such further instruments (including, without limitation, a declaration of no set-off) and do such further acts as may be necessary, desirable or proper to carry out more effectively the purposes hereof and of the Security Documents, and/or subject to the liens thereof any portion of the Property or any interest relating thereto concerning which Lender may have any doubt as to its being subject to the lien or charge of the Security Documents. ARTICLE IX EVENTS OF DEFAULT 9.01 EVENTS OF DEFAULT. The occurrence of any of the following shall constitute an "Event of Default" under this Agreement: 12 (a) Owner shall fail to pay when due any principal or interest under the Note, or shall fail to pay when due any fees, costs, charges, or other amounts payable under this Agreement, the Note or any of the Security Documents; (b) Any covenant, representation or warranty made by Owner hereunder or in the Note, Security Documents or any other documents executed by Owner in connection with the Loan is or becomes false or misleading in any material respect; (c) Owner shall fail to observe or perform any nonmonetary term, obligation, agreement or other provision contained herein or in the Note, the Security Documents or in any other contract or instrument executed in connection herewith, provided however, that with respect to any nonmonetary failure which is not otherwise specifically addressed in this Article IX, and which is capable of being cured, if such failure is not cured within fifteen (15) days (provided, however, that if the nature of such failure is such that it cannot be cured within a 15-day period, then Owner shall be provided such additional reasonable period of time as may be necessary to cure such failure, provided that Owner commences the cure within the 15-day period and thereafter diligently and continuously prosecutes such cure to completion, provided further, that in no event shall the time for Owner to cure such failure exceed ninety (90) days); (d) Any default or defined event of default under the Note, any of the Security Documents or any other documents executed in connection with the Loan; (e) Owner shall become insolvent, or shall suffer or consent to or apply for the appointment of a receiver, trustee, custodian or liquidator of itself or any of its property, or shall generally fail to pay its debts as they become due, or shall make a general assignment for the benefit of creditors; (f) Owner shall file a voluntary petition in bankruptcy, or seek reorganization, in order to effect a plan or other arrangement with creditors or any other relief under the Bankruptcy Reform Act, Title 11 of the United States Code, as amended or decodified from time to time ("Bankruptcy Code"), or under any state or federal law granting relief to debtors, whether now or hereafter in effect, or any involuntary petition or proceeding pursuant to said Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors is filed or commenced against Owner, or Owner shall file an answer admitting the jurisdiction of the court and the material allegations of any involuntary petition, or Owner shall be adjudicated a bankrupt, or an order for relief shall be entered by any court of competent jurisdiction under said Bankruptcy Code or any other applicable state or federal law relating to bankruptcy, reorganization or other relief for debtors; (g) The filing of a notice of judgment lien against Owner, or the recording of any abstract of judgment against Owner, or the service of a notice of levy and/or of a writ of attachment or execution, or other like process, against the assets of Owner, or the entry of a judgment, order or decree against Owner, any or all of which would have a material and adverse effect upon Owner's ability to perform under this Agreement or the Security Documents, and which is not dismissed within thirty (30) days of when filed, recorded, served or entered, as appropriate; (h) The Deed of Trust shall cease to be a legal, valid, binding and enforceable lien or security interest on all or any portion of the property encumbered thereby with not less than the same priority as on the date of recordation of the Deed of Trust; 13 (i) The dissolution or liquidation of Owner, or Owner, its shareholders or directors shall take action seeking to effect the dissolution or liquidation of Owner; (j) If Owner shall default in the payment or performance of any obligation, or any defined event of default, under the terms of any contract or instrument pursuant to which Owner has incurred any debt or other liability to any person or entity, including without limitation Lender, which default is not cured within any grace and cure period expressly provided in such contract or instrument, which is not being contested by Owner in accordance with Section 10.04 below, and as a result of which default such other person or entity is pursuing its remedies against Owner; (k) There shall exist or occur any event or condition which Lender in good faith believes impairs, or is substantially likely to impair, the prospect of payment or performance by Owner of its obligations under this Agreement, the Note or any of the Security Documents; (l) Any default or defined event of default occurs by Owner under any lease of all or any portion of the Property which is not cured within any applicable grace and cure period expressly provided therein. ARTICLE X REMEDIES 10.01 REMEDIES. Upon or at any time after the happening of any Event of Default hereunder, Lender, in addition to any and all rights and remedies otherwise available to it by law or in equity, shall have the following rights and remedies: (a) Declare all Loan funds disbursed hereunder to be due and payable and terminate any obligation of Lender to disburse any of the funds hereunder to Owner and proceed as authorized by law to satisfy the indebtedness of Owner to Lender, and, in that regard, Lender shall be entitled to all of the rights, privileges and benefits contained in the Security Documents or any other instrument relating to the hypothecation of the Property as such collateral security for the performance by Owner of the obligations evidenced by said Note and by this Agreement. (b) Take possession of the Property and let contracts for or otherwise proceed to operate and maintain the same, and all costs of operating and maintaining the Property shall be considered and be an additional loan to the Owner and the repayment thereof, together with interest thereon at the default interest rate set forth in the Note, shall be secured by the Security Documents and shall be repaid within thirty (30) days after demand therefor, and Owner agrees to pay the same. (c) Upon the happening of any Event of Default which may be cured by payment of money, Lender shall have the right (but not the obligation) to make such payment from its own funds. The making by Lender of such payment out of the Lender's own funds shall not, however, be deemed to cure such default by Owner, and the same shall not be so cured unless and until Owner shall have reimbursed Lender for such payment. If Lender advances its own funds for such purposes, such funds shall be considered advances under the Note and shall be secured by the Security Documents, notwithstanding that such advances may cause the total amount advanced hereunder to exceed the face amount of the Note or the amount committed to be advanced pursuant to this Agreement, and Owner shall immediately upon demand reimburse 14 Lender with interest at the default interest rate provided for in the Note from the date of such advance until the date of reimbursement. 10.02 APPLICATION OF OTHER FUNDS. Upon acceleration of the due date of the Note, Lender's obligations to disburse funds under any other loans from Lender to Owner, and any other funds held on account of Owner, shall forthwith terminate; and Lender may, at its option, apply all or any part of such funds as it deems appropriate in its sole discretion, provided that such application shall not operate to waive or cure any default existing hereunder or under the Note or Security Documents, nor to invalidate any Notice of Default or any act done pursuant to such notice and shall not prejudice any rights of the Beneficiary or Trustee under the Deed of Trust. 10.03 REMEDIES CUMULATIVE. All remedies of Lender provided for herein are cumulative and shall be in addition to any and all other rights and remedies provided in the Note or Security Documents, or provided by law. The exercise of any right or remedy by Lender hereunder shall not in any way constitute a cure or waiver of default hereunder or under the Note or Security Documents, or invalidate any act done pursuant to any notice of default, or prejudice Lender in the exercise of any of its rights hereunder or under the Note or Security Documents unless, in the exercise of said rights, Lender realizes all amounts owed to it under the Note, the Security Documents and hereunder. 10.04 CONTEST OF THIRD PARTY CLAIMS. Notwithstanding anything to the contrary herein contained, Owner shall have the right to contest in good faith any claim, demand, levy or assessment by any third party, the assertion of which would constitute a default hereunder. Any such contest shall be prosecuted diligently and in a manner not prejudicial to Lender or its rights hereunder. Upon demand by Lender, Owner shall make suitable provision by deposit of funds with Lender, by bond satisfactory to Lender, or by such other device as Lender may approve in writing, for the possibility that the contest will be unsuccessful. Such provision shall be made within ten (10) days after demand therefor and, if made by deposit of funds with Lender, the amount so deposited shall be disbursed in accordance with the resolution of the contest either to Owner or the adverse claimant. 10.05 NO WAIVERS. No waiver by Lender of any default or breach by Owner hereunder shall be implied from any omission by Lender to take action on account of such default if such default persists or is repeated, and no express waiver shall affect any default other than the default in the waiver and it shall be operative only for the time and to the extent therein stated. Waivers of any covenant, term or condition contained herein shall not be construed as a waiver of any subsequent breach of the same covenant, term or condition. ARTICLE XI SURVIVAL OF WARRANTIES AND COVENANTS The warranties, representations, covenants and agreements set forth herein and in the Security Documents shall survive the making of the Loan and the execution and delivery of the Note, and shall continue in full force and effect until the indebtedness secured by the Security Documents shall have been paid in full. 15 ARTICLE XII ASSIGNMENT 12.01 OWNER'S ASSIGNMENT. Owner shall not assign this Agreement or any interest it may have in the monies due hereunder, or convey or encumber the Property, without the prior written consent of Lender. 12.02 LENDER'S ASSIGNMENT. Lender may at any time assign this Agreement, the Note and the Security Documents, and upon such assignment, Lender shall have no further obligation or liability of any nature in connection herewith. Upon such assignment, the provisions of this Agreement shall continue to apply to the Loan and such assignee shall be substituted in the place and stead of Lender hereunder with all rights, obligations and remedies of Lender herein provided, including, without limitation, the right to so further assign this Agreement, the Note and the Security Documents. 12.03 PARTICIPATION. Owner understands that Lender may transfer and assign its interest in the Loan, this Agreement and the Security Documents, pledge its interest in the Loan, this Agreement and the Security Documents or grant or sell participations in some or all of Owner's indebtedness outstanding under the Loan. In connection with any such transaction, Lender may disclose to each prospective and actual transferee, pledgee, purchaser or participant, any and all documents and information relating to the Loan. Owner shall execute such estoppels and confirmations as Lender may require in order to facilitate such financings or participations. ARTICLE XIII WAIVER OF JURY TRIAL OWNER AND LENDER EACH WAIVE THEIR RESPECTIVE RIGHTS TO A TRIAL BY JURY OF ANY CLAIM, DEMAND OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF OR RELATED TO THIS AGREEMENT, THE NOTE, THE SECURITY DOCUMENTS, OR THE TRANSACTIONS CONTEMPLATED HEREBY OR THEREBY, IN ANY ACTION, PROCEEDING OR OTHER LITIGATION OF ANY TYPE BROUGHT BY ANY OF THE PARTIES AGAINST ANY OTHER PARTY OR PARTIES, WHETHER WITH RESPECT TO CONTRACT CLAIMS, TORT CLAIMS, OR OTHERWISE. WITHOUT LIMITING THE FOREGOING, THE PARTIES FURTHER AGREE THAT THEIR RESPECTIVE RIGHT TO A TRIAL BY JURY IS WAIVED BY OPERATION OF THIS SECTION AS TO ANY ACTION, COUNTERCLAIM OR OTHER PROCEEDING WHICH SEEKS, IN WHOLE OR IN PART, TO CHALLENGE THE VALIDITY OR ENFORCEABILITY OF THIS AGREEMENT OR THE NOTE OR SECURITY DOCUMENTS, OR ANY PROVISION HEREOF OR THEREOF, OR THE RELATIONSHIP OF OWNER AND LENDER. THIS WAIVER SHALL APPLY TO ANY SUBSEQUENT AMENDMENTS, RENEWALS, SUPPLEMENTS OR MODIFICATIONS TO THIS AGREEMENT, THE NOTE AND THE SECURITY DOCUMENTS. ANY PARTY TO THIS AGREEMENT MAY FILE AN ORIGINAL COUNTERPART OR A COPY OF THIS SECTION WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RIGHT TO A TRIAL BY JURY. 16 ARTICLE XIV MISCELLANEOUS 14.01 AMENDMENT. This Agreement, the Security Documents and the Note, and the terms of each and all of them, may not be changed, waived, discharged or terminated, except by an instrument or instruments in writing signed by the party against which enforcement of the change, waiver, discharge or termination is asserted. 14.02 ADDITIONAL FEES. In the event, and if for any reason, the Loan is not paid in full on or before the Maturity Date of the Note, and Lender elects not to immediately proceed with foreclosure proceedings, whether by formal or informal agreement, Owner shall pay to Lender a fee which is to be established at the Maturity Date, for each consecutive thirty (30) day period or any portion thereof after the Maturity Date, in addition to the interest provided, which fee shall be equal to the proportionate amount of the fee for the initial period of the Loan. 14.03 RETURN OF DOCUMENTS. If the Loan is not consummated within thirty (30) days after the date hereof, Owner shall return all documents and instruments to Lender upon demand. 14.04 REGULATORY RESTRICTIONS. It is understood and agreed by Owner that Lender shall not be obligated to disburse any proceeds of the Loan, notwithstanding any language herein or in any other document or instrument executed in connection with the Loan, if and so long as the making of such disbursement would cause the Loan to be in violation of any law or regulation applicable to Lender, including but not limited to legal lending requirements. 14.05 NOTICES. All notices required or permitted by this Agreement shall be in writing and may be delivered in person to either party or may be sent by registered or certified mail, with postage prepaid, return receipt requested, or delivered by Federal Express or any other courier service guaranteeing overnight delivery, charges prepaid, or may be transmitted by facsimile with a hard copy to follow via overnight courier and addressed: If to Owner: PROCOM TECHNOLOGY, INC. 58 Discovery Irvine, California 92618 Attn: Nicholas Shahrestany If to Lender: FIRST BANK & TRUST 4301 MacArthur Boulevard, 2nd Floor Newport Beach, California 92660 Attn: Real Estate Group or such other address as shall, from time to time, be supplied in writing by any party to the others. If any notice or other document is sent by registered or certified mail, postage prepaid, with return receipt requested, addressed as above provided, the same shall be deemed served or delivered within forty-eight (48) hours after deposit in the United States mail. Notices delivered by overnight service shall be deemed to have been given twenty-four (24) hours after delivery of the same, charges prepaid, to the U.S. postal service or private courier. If any notice is sent by facsimile transmission the same shall be deemed served or delivered upon receipt if followed by overnight courier. Any notice or other document sent or delivered in any other manner shall be effective only if and when received. 17 14.06 TIME OF ESSENCE. Time is of the essence of this Agreement, and of each and every provision hereof. The waiver by Lender of any breach or breaches hereof shall not be deemed, nor shall the same constitute, a waiver of any subsequent breach or breaches. 14.07 NO THIRD PARTIES BENEFITED. This Agreement is made for the sole benefit and protection of Owner and Lender, and Lender's agents, successors and assigns, and no other person shall have any right of action or right to rely thereon and the parties hereto hereby agree that nothing contained in this Agreement shall be construed to vest in any contractor or the successors or assigns of any contractor, or any materialman or laborer, any interest in or claim upon the funds so set aside by this Agreement or any rights under this Agreement. 14.08 ACTIONS. Lender shall have the right to commence, appear in, or to defend any action or proceeding purporting to affect the rights or duties of the parties hereunder or the payment of any undisbursed Loan funds, and in connection therewith Lender may pay necessary expenses, employ counsel and pay its reasonable fees. All sums paid or expended by Lender under the terms of this Agreement in excess of the Loan amount shall be considered and be a part of the Loan and the repayment thereof, together with interest thereon at the rate specified herein, shall be secured by the Security Documents and shall be immediately due and payable upon demand, and Owner agrees to pay the same. 14.09 RELIANCE ON REPRESENTATIONS. Lender may conclusively assume that the statements, acts, information and representations made by Owner or its agents contained in any affidavits, orders, receipts or other written instruments which are filed with Lender or exhibited to it are true and correct and may rely thereon without any investigation or inquiry, and any payment made by Lender in reliance thereon shall completely release Lender from liability with respect to all sums so paid. 14.10 RELATIONSHIP. Nothing contained herein shall be deemed or construed by the parties hereto or any third person to create a partnership or joint venture or any association between the parties other than the relationship of lender and borrower. 14.11 HEADINGS. The headings of the paragraphs hereof are for convenience only and shall not be deemed to be a part of or in any way modify the terms hereof. 14.12 GOVERNING LAW. This Agreement, as well as the Note and the Security Documents, and each and every provision hereof and thereof, shall be governed by and construed in accordance with the laws of the State of California. 14.13 ATTORNEYS' FEES AND COSTS. If a dispute arises with regard to any of the terms, conditions or provisions of this Agreement, the prevailing party in such dispute shall be entitled to recover from the other party, in addition to any and all other rights, remedies and damages available to the prevailing party, its reasonable attorneys' fees and costs incurred in connection with such dispute. 14.14 NONDISCRIMINATION. During the term of this Agreement, neither Owner nor any of its affiliates, employees or agents shall unlawfully discriminate against any employee or applicant for employment, or any purchaser or lessee or prospective purchaser or lessee of all or any portion of the Property, because of race, religion, color, national origin, ancestry, physical handicap, medical condition, marital status, age (over 40) or sex. Without limiting the generality of the foregoing, all such parties shall comply with the provisions of the California Fair Employment and Housing Act (Section 12900 et seq. of the California Government Code) and the applicable regulations promulgated thereunder (California Administrative Code, Title 2, Section 7285.0 et seq.), the Unruh Civil Rights Act and the rules and regulations promulgated therein, and Title VI of the Civil Rights Act of 1964 and the rules and regulations promulgated therein. 18 IN WITNESS WHEREOF, the parties have duly executed this Agreement as of the day and year first above written. LENDER: FIRST BANK & TRUST, a California corporation By:/s/ Debra Carpenter --------------------------------------- Its: Vice President -------------------------------------- OWNER: PROCOM TECHNOLOGY, INC., a California corporation By:/s/ Robert Rankin ---------------------------------------- Its: Chief Financial Officer --------------------------------------- By: ---------------------------------------- Its: --------------------------------------- 19 List of Omitted Exhibits and Accompanying Documents --------------------------------------------------- The following exhibits and accompanying documents listed in Section 1.02 to the Loan Agreement have been omitted and shall be furnished supplementally to the Commission upon request: Exhibit A Description of Property Exhibit B Items to be Delivered to Lender Prior to Closing Exhibit C Insurance Requirements Exhibit D Litigation Promissory Note Secured by Deed of Trust Assignment of Rights Under Covenants Conditions and Restrictions, Sales Agreements, Permits and Development Documents Deed of Trust, Assignment of Leases and Rents, Security Agreement and Fixture Filing Assignment of Leases and Rents Environmental Indemnity Agreement -----END PRIVACY-ENHANCED MESSAGE-----

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	•		new product introductions and enhancements;

	•		competition;

	•		direct versus indirect sales;

	•		the mix and average selling prices of products; and

	•		the cost of labor and components.

	•		reallocating resources in product development and service and support of our NAS appliances; and

	•		modifying existing and entering into new channel partner relationships to include sales of our NAS appliances.

	•		currency exchange rate fluctuations, particularly when we sell our products in currencies other than U.S. dollars;

	•		difficulties in collecting accounts receivable and longer accounts receivable payment cycles;

	•		reduced protection for intellectual property rights in some countries, particularly in Asia;

	•		legal uncertainties regarding tariffs, export controls and other trade barriers;

	•		the burdens of complying with a wide variety of foreign laws and regulations; and

	•		seasonal fluctuations in purchasing patterns in other countries, particularly in Europe.

	•		new product introductions and enhancements;

	•		competition;

	•		changes in the distribution channels we use;

	•		the mix and average selling prices of products; and

	•		the cost and availability of components and manufacturing labor.

	•		cause delays in product introductions and shipments;

	•		result in increased costs and diversion of development resources;

	•		require design modifications; or

	•		decrease market acceptance or customer satisfaction with these products, which could result in product returns.

	•		market acceptance of our new products and product enhancements or those of our competitors;

	•		the level of competition in our target product markets;

	•		delays in our introduction of new products;

	•		changes in sales volumes through our reseller and distribution channels, which have varying commission and sales discount structures;

	•		changing technological needs within our target product markets;

	•		the impact of price competition on the selling prices for our products;

	•		the availability and pricing of our product components;

	•		our expenditures on research and development and the cost to expand our sales and marketing programs; and

	•		the volume, mix and timing of orders received.

	•		fluctuations in our operating results;

	•		fluctuations in the valuation of companies perceived by investors to be comparable to us;

	•		a shortfall in net sales or operating results compared to securities analysts’ expectations;

	•		changes in analysts’ recommendations or projections;

	•		announcements of new products, applications or product enhancements by us or our competitors; and

	•		changes in our relationships with our suppliers or customers, including failures by customers to pay amounts owed to us.

	•		Montrose Investments L.P., the purchaser of our debentures, might have the right to rescind its purchase of these securities, which would require us to repay to Montrose Investments L.P. the $15.0 million that it invested in us;

	•		We might be subject to regulatory action; and

	•		We might be able to recover the $375,000 fee that we paid to Brighton Capital in connection with the transaction.


	PROCOM TECHNOLOGY, INC.

	By:	/s/ Alex Razmjoo

		Alex Razmjoo Chairman, President and Chief Executive Officer