10-Q 1 a70584e10-q.txt FORM 10-Q PERIOD END JANUARY 31, 2001 1 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, 2001 [ ] 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 33-0268063 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 58 Discovery, Irvine California 92618 (Address of principal executive office) (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 February 9, 2001, was 12,136,860. 2 PART I FINANCIAL INFORMATION ITEM 1. Financial Statements. PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS
January 31, July 31, 2001 2000 ------------ ------------ ASSETS Current assets: Cash ................................................. $ 1,085,000 $ 1,450,000 Short-term marketable securities, held to maturity ... 12,385,000 14,065,000 Accounts receivable, less allowance for doubtful accounts and sales returns of $3,006,000 and $2,752,000, respectively ........................... 11,270,000 6,699,000 Inventories, net ..................................... 9,485,000 8,430,000 Income tax receivable ................................ -- 2,699,000 Deferred income taxes ................................ 2,160,000 1,833,000 Prepaid expenses ..................................... 1,085,000 372,000 Other current assets ................................. 299,000 296,000 ------------ ------------ Total current assets ............................. 37,769,000 35,844,000 Property and equipment, net ............................ 17,388,000 16,034,000 Other assets ........................................... 2,831,000 918,000 ------------ ------------ Total assets ..................................... $ 57,988,000 $ 52,796,000 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Lines of credit ...................................... $ 4,118,000 $ 610,000 Loan payable ......................................... -- 10,750,000 Convertible debenture ................................ 14,486,000 -- Flooring line obligation ............................. 1,641,000 1,511,000 Accounts payable ..................................... 5,736,000 8,888,000 Accrued expenses and other current liabilities ....... 2,708,000 1,837,000 Accrued compensation ................................. 1,212,000 1,213,000 Deferred service revenues ............................ 388,000 431,000 Income taxes payable ................................. 53,000 -- ------------ ------------ Total current liabilities ........................ 30,342,000 25,240,000 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, 12,136,010 and 11,531,357 shares issued and outstanding, respectively ............... 121,000 115,000 Additional paid-in capital ........................... 26,766,000 19,685,000 Retained earnings .................................... 1,048,000 8,007,000 Accumulated other comprehensive loss ................. (289,000) (251,000) ------------ ------------ Total shareholders' equity ....................... 27,646,000 27,556,000 ------------ ------------ Total liabilities and shareholders' equity ............. $ 57,988,000 $ 52,796,000 ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements 3 PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
QUARTERS ENDED SIX MONTHS ENDED -------------- ---------------- JANUARY 31, JANUARY 31, JANUARY 31, JANUARY 31, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Net sales $ 11,722,000 $ 16,327,000 $ 24,986,000 $ 35,236,000 Cost of sales 7,108,000 12,521,000 15,490,000 26,189,000 ------------ ------------ ------------ ------------ Gross profit 4,614,000 3,806,000 9,496,000 9,047,000 Selling, general and administrative expenses 4,298,000 6,209,000 8,967,000 12,260,000 Research and development expenses 1,681,000 1,742,000 3,453,000 3,387,000 In-process research and development 4,262,000 -- 4,262,000 -- ------------ ------------ ------------ ------------ Operating loss (5,627,000) (4,145,000) (7,186,000) (6,600,000) Interest income 236,000 280,000 458,000 566,000 Interest expense (423,000) (7,000) (571,000) (8,000) ------------ ------------ ------------ ------------ Loss before income taxes (5,814,000) (3,872,000) (7,299,000) (6,042,000) Provision (benefit) for income taxes 54,000 (1,191,000) (340,000) (1,785,000) ------------ ------------ ------------ ------------ Net loss $ (5,868,000) $ (2,681,000) $ (6,959,000) $ (4,257,000) ============ ============ ============ ============ Net loss per common share: Basic $ (0.50) $ (0.24) $ (0.60) $ (0.38) ============ ============ ============ ============ Diluted $ (0.50) $ (0.24) $ (0.60) $ (0.38) ============ ============ ============ ============ Weighted average number of common shares: Basic 11,806,000 11,295,000 11,688,000 11,262,000 ============ ============ ============ ============ Diluted 11,806,000 11,295,000 11,688,000 11,262,000 ============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. 4 PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK ACC. OTHER ---------------------------- ADDITIONAL RETAINED COMPREHENSIVE SHARES AMOUNT PAID IN CAPITAL EARNINGS INCOME (LOSS) TOTAL ------------ ------------ --------------- ------------ ------------- ------------ BALANCE AT JULY 31, 1998 11,178,742 $ 112,000 $ 17,751,000 $ 18,866,000 $ 3,000 $ 36,732,000 Comprehensive loss: Net loss (2,875,000) (2,875,000) Foreign currency translation adjustment -- -- -- -- (18,000) (18,000) ------------ Comprehensive loss (2,893,000) Exercise of employee stock options 41,013 -- 152,000 -- -- 152,000 Issuance of stock to employees 5,531 -- 39,000 -- -- 39,000 Tax benefit from stock option exercises -- -- 71,000 -- -- 71,000 Stock repurchases (77,845) (1,000) (400,000) -- -- (401,000) Acquisitions 79,600 1,000 585,000 -- -- 586,000 ------------ ------------ ------------ ------------ ------------ ------------ BALANCE AT JULY 31, 1999 11,227,041 112,000 18,198,000 15,991,000 (15,000) 34,286,000 Comprehensive loss: Net loss -- -- -- (7,984,000) -- (7,984,000) Foreign currency translation adjustment -- -- -- -- (236,000) (236,000) ------------ Comprehensive loss (8,220,000) Compensatory stock options -- -- 62,000 -- -- 62,000 Exercise of employee stock options 278,587 3,000 1,112,000 -- -- 1,115,000 Issuance of stock to employees 25,729 -- 313,000 -- -- 313,000 ------------ ------------ ------------ ------------ ------------ ------------ 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 -- -- -- (6,959,000) -- (6,959,000) Foreign currency translation adjustment -- -- -- -- (38,000) (38,000) ------------ Comprehensive loss (6,997,000) Acquisition of Scofima 480,000 5,000 5,755,000 -- -- 5,760,000 Compensatory stock options -- -- 20,000 -- -- 20,000 Exercise of employee stock options 111,556 1,000 599,000 -- -- 600,000 Issuance of stock to employees 13,097 -- 145,000 -- -- 145,000 Issuance of stock warrant to investor -- -- 562,000 -- -- 562,000 ------------ ------------ ------------ ------------ ------------ ------------ BALANCE AT JANUARY 31, 2001 12,136,010 $ 121,000 $ 26,766,000 $ 1,048,000 $ (289,000) $ 27,646,000 ============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of these condensed consolidated financial statements. 5 PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JANUARY 31, ------------------------------- 2001 2000 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ............................................... $ (6,959,000) $ (4,257,000) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization, including amortization of debt issuance costs ............ 670,000 449,000 Compensatory stock options ......................... 20,000 -- In-process research and development ................ 4,262,000 -- Changes in assets and liabilities, net of effects of acquisitions: Accounts receivable .............................. (4,560,000) 3,015,000 Inventories ...................................... (1,055,000) (336,000) Income tax receivable ............................ 2,699,000 -- Deferred income taxes ............................ (327,000) (745,000) Prepaid expenses ................................. (713,000) (207,000) Other current assets ............................. (3,000) 3,000 Other assets ..................................... (273,000) (25,000) Accounts payable ................................. (3,001,000) (1,745,000) Flooring line obligation ......................... (130,000) 305,000 Accrued expenses and compensation ................ 870,000 826,000 Deferred service revenues ........................ (43,000) (331,000) Income taxes payable ............................. 53,000 (18,000) ------------ ------------ Net cash used in operating activities ......... (8,490,000) (3,066,000) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment ................. (1,770,000) (1,107,000) Acquisition of business, net of cash acquired ...... (250,000) -- ------------ ------------ Net cash used in investing activities ......... (2,020,000) (1,107,000) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of convertible debt ....................... 15,000,000 -- Repayment of loan ................................. (10,750,000) 1,000,000 Net borrowings (repayments) on lines of credit ..... 3,508,000 (115,000) Issuance of common stock ........................... 145,000 142,000 Stock option exercises ............................. 600,000 586,000 ------------ ------------ Net cash provided by financing activities ..... 8,503,000 1,613,000 Effect of exchange rate changes .................. (38,000) (141,000) ------------ ------------ Decrease in cash ................................. (2,045,000) (2,701,000) Cash and cash equivalents at beginning of period ....... 15,515,000 22,433,000 ------------ ------------ Cash and cash equivalents at end of period ............. $ 13,470,000 $ 19,732,000 ============ ============ Supplemental disclosures of cash flow information: CASH PAID (RECEIVED) DURING THE PERIOD FOR: Interest ........................................... $ 112,000 $ 8,000 Income taxes ....................................... $ (2,733,000) $ (1,097,000)
The accompanying notes are an integral part of these condensed consolidated financial statements. 6 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY 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 2000. Results for the interim periods presented are not necessarily indicative of the results for the entire year. NOTE 2. INVENTORIES. Inventories are summarized as follows:
January 31, 2001 July 31, 2000 ---------------- ---------------- Raw materials $ 5,132,000 $ 4,225,000 Work-in process 628,000 255,000 Finished goods 3,725,000 3,950,000 ---------------- ---------------- Total $ 9,485,000 $ 8,430,000 ================ ================
NOTE 3. 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. For the three months ended January 31, 2001 and 2000, respectively, the dilutive effect of options and warrants to purchase 872,000 and 1,251,000 shares of common stock, and for the six months ended January 31, 2001 and 2000, respectively, the dilutive effect of options and warrants to purchase 1,187,000 and 699,000 shares of common stock, respectively, were not included in the computation of net loss per share as the effect would have been antidilutive. NOTE 4. COMPREHENSIVE LOSS. For the six months ended January 31, 2001 and 2000, the only differences between reported net loss and comprehensive loss were foreign currency translation adjustments of $(38,000) and $(141,000), respectively. NOTE 5. BUSINESS SEGMENT INFORMATION. 7 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 Products") and other data storage and access products. Net sales of network attached storage (NAS) products represented approximately 72% and 24% of total product net sales for the three months ended January 31, 2001 and 2000, respectively, and 65% and 24% of total net sales for the six months ended January 31, 2001 and 2000, respectively. International sales as a percentage of net sales amounted to 63% and 48% for the three months ended January 31, 2001 and 2000, respectively. International sales for the second quarter of fiscal 2001 include sales of approximately $1.7 million in sales to a European storage service provider Storway. International sales were primarily to European customers, and, secondarily to Middle Eastern, Latin American and Pacific Rim customers. Storway accounted for approximately 20% of net sales for the first six months of fiscal 2001, and three customers, Storway, Ingram Micro and J-Dot Technology, accounted for approximately 56% of total accounts receivable as of January 31, 2001. Identifiable assets used in connection with the Company's foreign operations were $7.6 million at July 31, 2000 and $8.2 million at January 31, 2001. NOTE 6. LINES OF CREDIT AND CONVERTIBLE DEBENTURE. On October 10, 2000, the Company entered into a term loan agreement and a three-year working capital line of credit with CIT Business Credit. A term loan of $4 million is due and payable upon the Company's finalization of a long-term mortgage or sale-leaseback on its corporate headquarters, or it will be repaid in 12 monthly installments commencing April 1, 2001, while an initial term loan of $1 million was due and payable in 90 days, and was repaid on November 1, 2000. The term loans bear interest at the lender's prime rate (9.5% at January 31, 2001), plus .5%, with increases if the loan is 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 and inventories (approximately $2.9 million at January 31, 2001), up to a limit of $5 million. Amounts outstanding under the working capital line bear interest at the lender's prime rate plus .25%. At January 31, 2001, $4.0 million was outstanding under the term loan while $.1 million was outstanding under the line of credit. The lender charged approximately $130,000 for the credit facilities, which is being amortized as interest expense over the term of the loan. The lines accrue various monthly maintenance, minimum usage and early termination fees. The lines require certain financial and other covenants, including the maintenance of a minimum EBITDA requirement for each fiscal quarter beginning in the quarter ending January 31, 2001. The Company was in compliance with all covenants of the lines at January 31, 2001. The combined lines of credit are collateralized by all the assets of the Company. In addition to the two lines noted above, the Company entered into a flooring line with IBM Credit, which has committed to make $2.5 million in flooring inventory commitments available to the Company. The flooring line is collateralized by the specific inventory purchased by the Company pursuant to the flooring commitments, and IBM Credit and CIT Business 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 $16,000,000, and the Company was in compliance with the terms of the flooring line at January 31, 2001. On October 31, 2000, the Company issued a $15.0 million convertible unsecured debenture to a private investor. The debenture bears interest at 6.0% per annum, and is repayable in full on October 31, 2003, unless otherwise converted into the common stock of the Company. The debenture is convertible into the common stock of the Company at the investor's option at $22.79 per share, and at the Company's option if the common stock of the Company trades at more than $30.75 for at least 20 consecutive trading days. The investor has a "put" right, which allows the investor to require the Company to either repay in cash the face amount of the debenture put by the investor, plus any accrued but unpaid interest through such time, or pay such amount by issuing its shares at 90% of the average closing price of the Company's common stock for the five-day period preceding the time the investor makes such a demand. The investor may put up to $5 million on the 6th month anniversary, $10 million on the 12-month anniversary, and $15 million on the 18th, 24th and 30th month anniversaries of October 31, 2000. If the Company were to issue shares at 90% of the trading price as repayment of a put demand, the Company might incur a significant charge to its income statement based on the difference between the issuance price of the Company's common stock and the value of the common stock at October 31, 2000. In connection with the issuance of the debenture, the 8 Company issued to the investor a 5-year warrant to purchase up to 32,916 shares of the Company's common stock at $32.55 per share. The Company has valued the warrant using a Black-Scholes model, with the following assumptions: Expected life - 5 years, Risk free interest rate - 6%, and Volatility, 1.20. These factors yield a value of $562,000, which will be amortized over the life of the debt, or if conversion of the debenture occurs, the Company will reclass the remaining value to interest expense. A majority of the debenture may be put to the Company within one year from the date of the balance sheet and all of the debentures may be put to the Company if the Company fails to register for resale on a timely basis with the Securities and Exchange Commission the Common Stock into which the debentures are convertible. The Company is required to have the registration statement be declared effective by March 31, 2001 or upon 30 days notice thereafter the Company would be in breach of its agreement. While the investor has provided extensions in the past, the Company can not be certain that any future extensions will be granted. Accordingly, the principal amount of the debentures is classified as a current liability, net of the remaining unamortized warrant value. At January 31, 2001, the debenture amount repayable was $15,000,000, the unamortized warrant value was $514,000, for a net debenture value of $14,486,000 on the balance sheet. In addition to the warrant cost, costs of approximately $700,000 were incurred in the debt transactions noted above, and the amounts were classified as prepaid expenses, and are amortized as interest expense over the life of the debt instruments. NOTE 7. ACQUISITION On December 28, 2000, the Company acquired all of the issued and outstanding capital stock of Scofima Software S.r.l., a company organized under the laws of Italy ("Scofima"), in exchange for 480,000 shares of the Company's common stock. The Company has agreed to file a registration statement covering the resale of shares issued to the shareholders of Scofima not later than March 28, 2001. Scofima had an option to acquire a software system designed as a caching and content distribution solution. Immediately prior to the Company's acquisition of Scofima, Scofima exercised its option, and acquired exclusive rights to the software system which was being developed as discussed below. The purpose of the software is to provide functionalities that are necessary for the content delivery market of the internet. The software had been in development for approximately 2-3 years, involving 5 programmers and system developers. The software was not complete at the date of acquisition, and has yet to be determined to be technologically feasible. The Company is currently completing the software, but final release is not expected for several months. The Company issued 480,000 shares valued at $12 per share and incurred approximately $250,000 in acquisition costs in exchange for the outstanding shares of Scofima. Scofima had net assets of approximately $500,000 at the date of acquisition. The transaction was accounted for as a purchase of assets. The Company employed an appraiser to identify the values of the assets acquired, including, among other assets, certain in-process research and development costs. The amount of purchase price allocated to in-process research and development was determined by estimating the stage of development of the software, estimating future cash flows from projected revenues, and discounting those cash flows to present value. The discount rate applied was 25%. The incremental product sales resulting from the products incorporating the software are estimated to be approximately $44 million over the initial four years of sales with sales growing from approximately $1.5 million in the initial year to $13.4 million in the fourth year. The appraiser concluded, and the Company has determined that, approximately $4.3 million of the purchase price was related to the in-process research and development efforts that had not attained technological feasibility and for which no future alternative use was expected. The Company has expensed the value of the research and development as of the date of the acquisition of Scofima and capitalized the fair value of the other assets acquired as determined and allocated by the appraiser, including the value of the assembled workforce of approximately $0.2 million and developer relationships valued at $0.1 million which will be amortized over four years, with the remainder of $1.4 million assigned to goodwill, which will be amortized over four years. The following is a summary of the net fair value of the assets acquired, the liabilities assumed, and the total consideration paid for Scofima:
Net fair value of assets acquired $ 6,120,000 Liabilities assumed (110,000) Shares issued (5,760,000) ----------- Cash consideration, net of cash acquired $ 250,000 ===========
Proforma financial information has not been provided due to the limited operations of Scofima. Revenue and net income were approximately $3,000 and $100, respectively, for the ten months ended October 31, 2000 and were approximately $6,000 and $800, respectively for the year ended December 31, 1999. Total assets were approximately $120,000 at both October 31, 2000 and December 31, 1999. NOTE 8. RECENT ACCOUNTING PRONOUNCEMENTS 9 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133, as amended by SFAS 138, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. SFAS 133 establishes accounting and reporting standards for derivative instruments including derivative instruments embedded in other contracts and for hedging activities. Adoption of SFAS 133, effective August 1, 2000, did not have a material impact on the Company's consolidated financial position, results of operations or liquidity. In December 1999, the United States Securities and Exchange Commission issued Staff Accounting Bulleting (SAB) No. 101, "Revenue Recognition in Financial Statements," as amended, which for the Company is effective no later than the fourth quarter of fiscal 2001. SAB No. 101 summarizes certain of the SEC staff's views regarding the appropriate recognition of revenue in financial statements. The Company is currently reviewing SAB No. 101 and has not yet determined the potential impact on its financial statements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RESULTS FOR THE QUARTER ENDED JANUARY 31, 2001 The results for the quarter ended January 31, 2001 reported here are slightly different from the numbers reported in our press release dated February 28, 2001. Net sales for the quarter reported in the press release were $11.9 million versus the $11.7 million reported here. Sales of our NAS products for the quarter were revised from $8.6 million to $8.5 million reported here. Gross margins reported in the press release were 40.1% versus 39.4% reported here and the amount of our operating loss reported in the press release was $5.5 million versus the $5.6 million reported here. No income tax expense for the quarter was reported in the press release while a tax provision of $54,000 is reported here. These changes related primarily to adjustments to the net sales, pretax income and provision for tax expense of our foreign operations and as a result our net loss and net loss per share were, as reported here, $5.9 million and ($0.50) per share as compared to $5.7 million and ($0.48) per share reported in the press release. The results reported for the six months ended January 31, 2001 are also different than the results reported in our press release because of the changes to the results for the second quarter. OVERVIEW Procom develops, manufacturers and markets 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 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 non-NAS products. In the last two 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 non-NAS products, and hope to transition users of these products to our growing line of more complex, generally higher margin NAS solutions. In December 1999, we executed an agreement with Hewlett-Packard, under which we supplied a customized version of our mid-range NAS appliance hardware and software to Hewlett-Packard for resale. The agreement, which has a five-year term, has no minimum quantity commitments. We commenced shipments under the agreement in limited quantities in April 2000. Sales to Hewlett-Packard in the quarter ended January 31, 2001 were not significant. In February 2001, Hewlett- Packard notified us that they do not anticipate they will purchase additional NAS products from us in the future. While neither they nor we have formally terminated the agreement, we do not anticipate that future sales to Hewlett-Packard will be significant. Changing Business Mix. In recent periods, we have experienced significantly reduced demand, revenues and gross margins for our non-NAS products and we have discontinued some non-NAS 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. Because recently we have sold, and expect to continue to sell, fewer CD server and arrays, we expect our overall gross margins to be negatively affected. This reduction may be offset as sales of our higher margin NAS appliances increase as a percentage of total sales, in which case, 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; 10 - direct versus indirect sales; - the mix and average selling prices of products; and - the cost of labor and components. Revenue and Revenue Recognition. We generally record sales upon product shipment. In the case of sales to most of our distributors, we record sales when the distributor receives the products. We recognize our product service and support revenues over the terms of their respective contractual periods. Our agreements with many of our VARs, system integrators and distributors allow limited product returns, including stock balancing, and price protection privileges. We maintain reserves, which are adjusted at each financial reporting date, to state fairly the anticipated returns, including stock balancing, and price protection claims relating to each reporting period. We calculate the reserves based on historical rates of sales and returns, including price protection and stock balancing claims, our experience with our customers, our contracts with them, and current information as to the level of our inventory held by our customers. In addition, under a product evaluation program established by us, our indirect channel partners and end users generally are able to purchase 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 July 31, 2000 and January 31, 2001, inventory related to evaluation units was approximately $1.5 million and $1.7 million, respectively. Costs and Expenses. 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 obsolete inventory. Selling expenses include 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. Our 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 for programmers and support staff and other related expenses. The cost of developing new appliances and substantial enhancements to existing appliances are expensed as incurred. 11 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 Six Months Ended ------------------- ---------------- January 31, January 31, January 31, January 31, 2001 2000 2001 2000 --------------- --------------- --------------- --------------- (unaudited) (unaudited) (unaudited) (unaudited) Net sales .............................. 100.0% 100.0% 100.0% 100.0% Cost of sales .......................... 60.6 76.7 62.0 74.3 --------------- --------------- --------------- --------------- Gross profit ........................... 39.4 23.3 38.0 25.7 Selling, general and administrative expenses .............. 36.7 38.0 35.9 34.8 Research and development expenses ...... 14.3 10.7 13.8 9.6 Acquired research and development expenses ............................. 36.4 -- 17.1 -- --------------- --------------- --------------- --------------- Operating income (loss) ................ (48.0) (25.4) (28.8) (18.7) Interest income and (expense), net ..... (1.6) 1.7 (0.5) 1.6 --------------- --------------- --------------- --------------- Income (loss) before income taxes ................................ (49.6) (23.7) (29.3) (17.1) Provision (benefit) for income taxes ................................ 0.5 (7.3) 1.4 (5.0) --------------- --------------- --------------- --------------- Net income (loss) .................... (50.1%) (16.4%) (27.9%) (12.1%) =============== =============== =============== ===============
THREE MONTHS AND SIX MONTHS ENDED JANUARY 31, 2001 COMPARED TO THREE MONTHS AND SIX MONTHS ENDED JANUARY 31, 2001 Net Sales. Net sales decreased by 28.2% to $11.7 million for the three months ended January 31, 2001, from $16.3 million for the three months ended January 31, 2000. This decrease resulted from a significant decrease in unit sales of CD servers and arrays and disk drive storage upgrade systems, combined with the effect of significant price erosion of the average selling price of these products. In addition, sales were reduced due to lower sales of non-NAS products by our German subsidiary. Net sales for the six months ended January 31, 2001 decreased 29.1% from sales for the same period in fiscal 2000. This decline was caused by the same factors noted above, as well as our relocation to our new corporate headquarters during the first three months of fiscal 2001, which we believe caused us to lose sales during that period. We expect to see continued weakness in the demand for our disk drive storage upgrade systems and CD servers and arrays and non-NAS product sales throughout fiscal 2001, and we may accelerate the discontinuance of our non-NAS products. Net sales related to our disk based NAS appliances increased 118% to $8.5 million for the three months ended January 31, 2001, from $3.9 million for the three months ended January 31, 2000. This increase was primarily the result of increased unit sales of our NetFORCE NAS appliances, offset by decreased sales of our DataFORCE and CDFORCE NAS appliances. Net sales related to our disk based NAS appliances increased to $16.4 million for the six months ended January 31, 2001, from $8.6 million for the six months ended January 31, 2000. International sales were $7.4 million, or 63% of our net sales for the three months ended January 31, 2001, compared to $7.9 million, or 48% of our net sales in the three months ended January 31, 2000. The decrease in international sales in absolute dollars is due primarily to reduced sales of non-NAS products by our German subsidiary, while the increase as a percentage of our net sales was primarily due to sales of our NAS products to customers in Europe and Asia. International sales were $15.0 million, or 60% of our net sales for the six months ended January 31, 2001, compared to $ 15.6 million, or 44% of our net sales in the six months ended January 31, 2000. The decrease in international sales in absolute dollars is due primarily to reduced sales of non-NAS products by our German subsidiary, while the increase as a percentage of our net sales was primarily due to sales of our NAS products to customers in Europe and 12 Asia, including sales of approximately $5.0 million to a European storage service provider, Storway, included in net sales for the first six months of fiscal 2001, and other sales of NAS appliances by our German and Swiss subsidiaries and reduced U.S. sales of our CD servers and arrays. Storway accounted for approximately 20% of net sales for the first six months of fiscal 2001, and three customers, Storway, Ingram Micro and J-Dot Technology, accounted for approximately 56% of total accounts receivable as of January 31, 2001. There can be no assurance that the revenues derived from our NAS products will continue to increase in any particular quarter or period, or that any specific customers will continue to purchase our products in such period. Gross Profit. Gross profit increased to $4.6 million for the three months ended January 31, 2001, from $3.8 million for the three months ended January 31, 2000. Gross margin increased to 39.4% of net sales for the three months ended January 31, 2001, from 23.3% of net sales for the three months ended January 31, 2000. Gross margin increased from 25.7% for the six months ended January 31, 2000 to 38.0% for the six months ended January 31, 2001. The increase in gross margin for both periods was primarily the result of the higher percentage of NAS revenues of our European subsidiaries, offset to a lesser extent by a reduction in sales of CD servers and arrays, which have historically experienced higher margins. In addition, we realized reduced margins on lower sales of disk drive upgrade systems due to competition and price erosion in the disk drive upgrade industry. We expect that gross margins may be impacted by continuing reductions in sales of some of our higher margin non-NAS product lines, such as CD servers and arrays, until sales of our NAS appliances significantly increase both in absolute dollars, and as a percentage of our total sales. Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $4.3 million in the three months ended January 31, 2001, from $6.2 million in the three months ended January 31, 2000, and decreased as a percentage of net sales to 36.7% from 38.0%. Selling, general and administrative expenses decreased to $9.0 million in the six months ended January 31, 2001, from $12.3 million in the six months ended January 31, 2000. The dollar decrease in selling, general and administrative expenses was primarily the result of reduced sales and administrative salaries and commissions, reduced cooperative advertising costs, and reduced expenses of our German subsidiary, as well as net foreign currency gains of approximately $219,000 in the second quarter of fiscal 2001 incurred as the Euro, and therefore, the German mark and the Italian lira, strengthened during the quarter, more than offsetting currency losses incurred in the first quarter of fiscal 2001. In addition, we incurred reduced advertising, marketing and travel costs, offset somewhat by increased legal fees and increases in the cost of personnel necessary to support our NAS sales and marketing efforts. During the three months ended January 31, 2001, we continued to identify and eliminate certain positions and functions not related to our core NAS activities. As a result, we experienced some reductions in selling, general and administrative expenses in the past quarter. However, we expect overall selling, general and administrative expense to increase in future periods as we plan to substantially increase spending on efforts to market our NAS appliances and we expect increased facilities costs, such as utilities, taxes and maintenance, as we utilize our recently completed corporate headquarters. Research and Development Expenses. Research and development expenses decreased slightly from $1.68 million, or 10.7% of net sales in the second quarter of fiscal 2000 to $1.74 million, or 14.3% of net sales, for the three months ended January 31, 2001. The decreases for the second quarter of fiscal 2001 is due primarily to reduced tools, beta units and engineering supplies, offset by increases in expenses for outside programmers. Research and development expenses increased from $3.4 million, or 9.6% of net sales in the first six months of fiscal 2000 to $3.5 million, or 13.8% of net sales, for the first half of fiscal 2001. The increase was primarily due to compensation expense for additional NAS software programmers and hardware developers, offset by reduced costs for evaluation units and supplies. We anticipate that our research and development expenses will continue to increase, both in absolute dollars and as a percentage of net sales, with the expected addition of dedicated NAS engineering resources. In-process research and development. As discussed in Note 7 to the Condensed Consolidated Financial Statements, we acquired the outstanding shares of Scofima Software Srl, an Italian company. We employed an appraiser to value the assets of Scofima, and the appraiser assigned a value of approximately $4.3 million to in-process research and development 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. The amount of purchase price allocated to in-process research and development was determined by estimating the stage of development of the software, estimating future cash flows from projected revenues, and discounting those cash flows to present value. The discount rate applied was 25%. The incremental product sales resulting from the products incorporating the software are estimated to be approximately $44 million over the initial four years of sales with sales growing from approximately $1.5 million in the initial year to $13.4 million in the fourth year. We anticipate expending approximately $0.5 million to complete development of the software. 13 Interest Income (Expense). Interest income decreased 15.7% to $236,000 for the three months ended January 31, 2001, from $280,000 for the three months ended January 31, 2000. During the first three months of fiscal year 2001, we invested the majority of our available cash in investment-grade commercial paper with maturities of less than 90 days. As a result of a decrease in our investable cash position, interest income decreased in the first six months of fiscal 2001. During the first quarter of fiscal 2001, our new corporate headquarters was placed into service, and we began to incur interest expense on the amount we have financed for our building. (Previously, interest expense had been capitalized as part of the developmental cost of our headquarters.) We expect that interest income will be reduced in the future and that interest expense will increase significantly due to the financing of our corporate headquarters, and our need to borrow additional amounts to finance our operations. On October 31, 2000, we issued a $15 million 6% convertible debenture, and interest expense in future periods will include interest charges on the amount outstanding under the debenture agreement. Interest expense of $423,000 was incurred in the second quarter of fiscal 2001 as we borrowed under the convertible debenture, utilized our CIT term loan and expensed a pro rata share of prepaid loan costs throughout the quarter. Benefit for Income Taxes. Our effective tax provision rate for the three months ended January 31, 2001 was 0.9%, compared to an effective tax benefit rate of (30.8%) for the same period in fiscal 2000. The fiscal 2001 provision is necessary due to a provision for earnings of our Italian subsidiary, while we have taken no current benefit for our US and German losses. The corresponding fiscal 2000 effective tax rate reflects the statutory rates and unusable foreign losses, partially offset by research and development tax credits. The net deferred tax asset recorded on the balance sheet as of January 31, 2001 is based on our expectation that we will more likely than not have future taxable income against which we may apply certain tax attributes, including our net operating loss deduction. We have considered other tax planning strategies that, if implemented, would enable us to recover a portion of the value of our deferred tax asset. We believe we can return to profitability, and that it is more likely than not that future profitability will be sufficient to recover the value of our net deferred tax asset at January 31, 2001. LIQUIDITY AND CAPITAL RESOURCES As of January 31, 2001, we had cash and short-term marketable securities totaling $13.5 million. Net cash used in operating activities was $8.5 million in the first six months of fiscal 2001 and $3.1 million in the first six months of fiscal 2000. Net cash used in operating activities relates primarily to our net loss, and increases in our accounts receivable as we granted extended terms to our foreign customers. In addition, our inventories increased and accounts payable decreased, as we paid off nearly all of the costs of our corporate headquarters, which was completed in September 2001, and we utilized our IBM Credit flooring line, which requires payments at certain required dates. These uses of cash were offset by a reduction of approximately $2.7 million in our income tax refund receivable, which we received in the first six months of fiscal 2001. Net cash used in investing activities was $2.0 million in the first six months of fiscal 2001, while net cash used in investing activities was $1.1 million in the first six months of fiscal 2000. Net cash used in investing activities in the first six months of fiscal 2001 was the result of payments of $1.5 million to complete our corporate headquarters and $0.3 million of purchases of other property and equipment. Net cash used in investing activities in the first six months of fiscal 2000 resulted from the purchase of $1.1 million of property and equipment. Net cash provided by financing activities was $8.5 million in the first six months of fiscal 2001, and $1.6 million in the first six months of fiscal 2000. Net cash provided by financing activities in the first six months of fiscal 2001 resulted primarily from the issuance of a $15.0 million convertible debenture, and the closing and funding of a term loan/line of credit agreement with CIT Business Credit (see below) 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 the Company's commercial paper portfolio. At July 31, 2000, we had established a revolving line of credit with Finova Capital Corporation. The line had been based on a percentage of our eligible accounts receivable and inventory, up to a maximum of $10,000,000. We paid off all amounts outstanding under the Finova flooring line in early October 2000. 14 On October 10, 2000, we entered into a term loan agreement and a three-year working capital line of credit with CIT Business Credit. A term loan of $4,000,000 is due and payable upon our finalization of a long-term mortgage or sale-leaseback of our corporate headquarters, or it will be repaid in 12 monthly installments commencing April 1, 2001, while an initial term loan of $1 million was due and payable in 90 days and was repaid on November 1, 2000. The term loans bear interest at the lender's prime rate (9.5% at January 31, 2001), plus .5%, with increases if the loan is not reduced according to a fixed amortization schedule. The working capital line of credit allows us to borrow, on a revolving basis, for a period of three years, a specified percentage of eligible accounts receivable and inventories (approximately $2.9 million at January 31, 2001), up to a limit of $5,000,000. Amounts outstanding under the working capital line bear interest at the lender's prime rate plus .25%. At January 31, 2001, $4.1 million was outstanding under the various credit arrangements. The lender charged approximately $130,000 for the credit facilities, which is being charged as interest expense over the term of the loan. The lines accrue various monthly maintenance, minimum usage and early termination fees. The lines require certain financial and other covenants, including the maintenance of a minimum EBITDA requirement for each fiscal quarter beginning in the quarter ending January 31, 2001. We were in compliance with all covenants of the lines at January 31, 2001. The combined lines of credit are collateralized by all the our assets. In addition to the two lines noted above, we entered into a flooring line with IBM Credit, which has committed to make $2.5 million in flooring inventory commitments available to us. The flooring line is collateralized by the specific inventory purchased pursuant to the flooring commitments, and IBM Credit and CIT Business 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 us of a minimum net worth of $16,000,000, and we were in compliance with the terms of the flooring line at January 31, 2001. On October 31, 2000, we issued a $15.0 million convertible unsecured debenture to a private investor. The debenture bears interest at 6.0% per annum, and is repayable in full on October 31, 2003, unless otherwise converted into our common stock. The debenture is convertible into our common stock at the investor's option at $22.79 per share, and at our option if our common stock trades at more than $30.75 for at least 20 consecutive trading days. The investor has a "put" right, which allows the investor to require us to either repay in cash the face amount of the debenture put by the investor, plus any accrued but unpaid interest through such time, or pay such amount by issuing our shares at 90% of the average closing price of our common stock for the five-day period preceding the time the investor makes such a demand. The investor may put up to $5.0 million on the 6th month anniversary, $10.0 million on the 12 month anniversary, and $15.0 million on the 18th, 24th and 30th month anniversaries of October 31, 2000. If we were to issue shares at 90% of the trading price as repayment of a put demand, we may incur a significant charge to our income statement based on the difference between the issuance price of our common stock and the value of the common stock at October 31, 2000. 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 its common stock at $32.55 per share. We have valued the warrant using a Black-Scholes model, with the following assumptions: Expected life - 5 years, Risk free interest rate - 6%, and Volatility, 1.20. These factors yield a value of $562,000, which will be amortized over the life of the debt, or if conversion of the debenture occurs, we will reclass the remaining value to interest expense. The Company has determined that all of the principal amount of the debentures will be recorded as a current liability. The Company has made this determination based on the requirement that its registration statement pertaining to the common stock underlying the convertible debentures must be declared effective on or before March 31, 2001 or upon thirty days notice, the Company will be in breach of its agreement with the investor and the investor would, in such circumstances, be entitled to require the Company to repurchase the convertible debentures. While the investor has provided the Company with extensions of the deadline for registration and may continue to do so, the Company can not be certain that the registration statement will be effective by the deadline or that additional extensions will be obtained. At January 31, 2001, the debenture amount repayable was $15,000,000, the unamortized warrant value was $ 514,000, for a net debenture value of $14,486,000 on the balance sheet. In addition to the warrant cost, 15 costs of approximately $700,000 were incurred in the debt transactions noted above, and the amounts were classified as prepaid expenses, and are amortized as interest expense over the life of the debt instruments. In addition to the lines of credit, our foreign subsidiaries have lines of credit with two German banks, utilized primarily for overdraft and short-term cash needs. The lines allow Megabyte to borrow up to 1,000,000 German marks (approximately US$550,000), with interest at approximately 7.45%, and are not guaranteed by Procom. At January 31, 2001, there was no amount outstanding under the lines. Also, Procom Technology, SPA maintains two short-term lines of credit totaling 300 million lira (approximately US$145,000), bearing interest at 13% per annum. No amounts were outstanding under this line at January 31, 2001. In March 1999, we purchased an 8.3 acre parcel of land for $7.3 million in Irvine, California, for development as our corporate headquarters facility. Construction commenced in late 1999 and was completed in September 2000. The cost of the land together with the cost of constructing the facility, including capitalized interest and other carrying costs, is approximately $15.9 million including $0.7 million in capitalized interest costs. In addition, we may need to spend about $0.8 million to build out the remaining portion of the building if we sublease it. We have attempted to lease 47,000 square feet of the building and we are currently considering financing options including a long-term mortgage or sale/leaseback. We will be attempting to complete a sale-leaseback transaction in the next 90 days. There can be no assurance, however, that we will be successful in completing a sublease, long-term mortgage or sale/leaseback on favorable terms, if at all. On September 14, 1998, our board of directors approved an open market stock repurchase program. We were authorized to effect repurchases of up to $2.0 million in shares of our common stock. We have repurchased a total of 77,845 shares at an average cost of $5.15 per share. No repurchases were made in the six months ended January 31, 2001. In September 2000, our Board terminated the repurchase program. As is customary in the computer reseller industry, the Company is contingently liable at July 31, 2000 under the terms of repurchase agreements with several financial institutions providing inventory financing for dealers of the Company's appliances. Under these agreements, dealers purchase the Company's appliances, and the financial institutions agree to pay the Company 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 the Company 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 July 31, 2000, and January 31, 2001 the Company was contingently liable for purchases made under these agreements of approximately $560,000 and $178,000, respectively. During the three years ended July 31, 2000, and through the six months ended January 31, 2001, the Company was not required to repurchase any previously sold inventory pursuant to the flooring agreements. At January 31, 2001, we had recorded a net deferred tax asset of approximately $2.2 million, comprised of gross deferred tax assets of approximately $4.2 million, less a valuation allowance of approximately $2.0 million. The realization of the benefit of the net deferred tax asset will be dependent on our returning to profitability, thereby allowing us to utilize our net operating loss carryforward and other tax attributes, such as the difference between the book and tax basis of our reserves or depreciation against future taxable income. We believe that our current losses are primarily the result of our determination to transition from our CD-Tower and disk drive upgrade subsystems product lines (driven in part by reducing demand for those products) to more complex network attached storage products which have required significant research and development and longer market acceptance period. We have considered other tax planning strategies that, if implemented, would enable us to recover a portion of the value of our deferred tax asset. We believe we can return to profitability, and that it is more likely than not that future profitability will be sufficient to recover the value of our net deferred tax asset at January 31, 2001. On December 28, 2000, the Company acquired all of the issued and outstanding capital stock of Scofima Software S.r.l., a company organized under the laws of Italy ("Scofima"), in exchange for 480,000 16 shares, valued at $12 per share, of the Company's common stock. The Company has agreed to file a registration statement covering the shares issued to the shareholders of Scofima not later than March 28, 2001. Scofima had an option to acquire a software system designed as a caching and content distribution solution. Immediately prior to the Company's acquisition of Scofima, Scofima exercised its option, and acquired the exclusive rights to the software system, which it had been developing as discussed below. The purpose of the software is to provide functionalities that are necessary for the content delivery market of the internet. The software had been in development for approximately 2-3 years, involving 5 programmers and system developers. The software was not complete at the date of acquisition, and has yet to be determined to be technologically feasible. The Company is currently completing the software, but final release is not expected for several months. The Company issued 480,000 shares valued at $12 per share and incurred approximately $250,000 in acquisition costs in exchange for the outstanding shares of Scofima. Scofima had net assets of approximately $500,000 at the date of acquisition. The transaction was accounted for as a purchase of assets. The Company has employed an appraiser to identify the values of the assets acquired, including, among other assets, certain in-process research and development costs. The amount of purchase price allocated to in-process research and development was determined by estimating the stage of development of the software, estimating future cash flows from projected revenues, and discounting those cash flows to present value. The appraiser concluded, and the Company has determined that approximately $4.3 million of the purchase price was related to in-process research and development efforts that had not attained technological feasibility and for which no future alternative use was expected. The Company has expensed the value of the research and development as of the date of the acquisition of Scofima and capitalized the fair value of the other assets acquired as determined and allocated by the appraiser, including the value of the assembled workforce of approximately $0.2 million and developer relationships valued at $0.1 million which will be amortized over 4 years, with the remainder of $1.4 million assigned to goodwill, which will be amortized over 4 years. We transact business in various foreign countries, but we only have significant assets deployed outside the United States in Germany, Italy and Switzerland. We have effected intercompany advances and sold goods to Megabyte 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. While a significant reduction in valuation of various currencies such as the Euro (to which the value of the German mark and the Italian lira are pegged) and the Swiss franc could lead to lower sales as our products then become more expensive for foreign customers, we do not believe that the currency fluctuations have had a material impact on our liquidity. Our reported sales can be affected by changes in the currency rates in effect in any particular period. For example, in the quarter ended October 31, 2000, the Euro, and two currencies whose values are pegged to the Euro, declined in value significantly, and then increased in value significantly in the quarter ended January 31, 2001. As a result, we incurred a foreign currency loss of $160,000 in the quarter ended October 31, 2000 while we realized a gain of $219,000 in the quarter ended January 31, 2001. Also, these fluctuation gains can cause us to report more or less in sales by virtue of the translation of the subsidiary's sales into US dollars at an average rate in effect throughout the quarter. Also, we have funded operational losses of our subsidiaries of approximately $2.8 million since we purchased them, and if our subsidiaries continue to incur operational losses, our cash and liquidity would be negatively impacted. In January 2001, we filed a Registration Statement on Form S-3 with Merrill Lynch acting as a Placement Agent to effect, on a best efforts basis, the sale of approximately 2,000,000 shares of common stock. We are currently discussing the sale with various parties, but have not effected any sales. Given the current state of the stock market, we can not assure you that we can complete the offering. We expect to have sufficient cash generated from operations, through availability under lines of credit and through other sources, such as a long-term mortgage or a sale-leaseback of our facility, to meet our anticipated cash requirements for the next twelve months. 17 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 continued 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. 18 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 non-NAS product development and marketing efforts. In the interim, we expect to continue to rely in large part upon sales of our non-NAS products to fund operating and development expenses. Net sales of our non-NAS 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 non-NAS products varies significantly from our expectations, or the decline in net sales of our non-NAS 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: (a) engaging in significant marketing and sales efforts to achieve market awareness as a NAS vendor; (b) reallocating resources in product development and service and support of our NAS appliances; (c) modifying existing and entering into new channel partner relationships to include sales of our NAS appliances; and (d) expanding and reconfiguring manufacturing operations. 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. OUR AGREEMENT WITH HEWLETT-PACKARD COMPANY MAY NOT GENERATE SIGNIFICANT NET SALES. We believe our relationship with Hewlett-Packard Company helped us accomplish our strategy to increase penetration in the NAS market. However, there is no minimum purchase commitment under our agreement with Hewlett-Packard. We do not currently, and may never, generate significant net sales under this agreement. The Hewlett-Packard agreement has a five-year term, and there is no assurance that the agreement can or will be renewed. We commenced shipments under the agreement in limited quantities in April 2000 and sales to Hewlett-Packard for the three months ended January 31, 2001 were not significant. In February 2001, Hewlett-Packard notified us that they do not anticipate they will purchase additional NAS products from us in the future. While neither they nor we have formally terminated the agreement, we do not anticipate that future sales to Hewlett-Packard will be significant. 19 IF WE FAIL TO INCREASE THE NUMBER OF DIRECT AND 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 appliances. To achieve these objectives, we believe it will be necessary to increase the number of our direct and indirect sales channels. We plan to significantly increase the number of our direct sales personnel. However, there is intense competition for these professionals, and we may not be able to attract and retain sufficient new sales personnel. We also plan to expand revenues from our indirect sales channels, including distributors, VARs, OEMs 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 OR RESELLERS, SUCH AS INGRAM MICRO, TECH DATA, COMPUCOM, CUSTOM EDGE, AND OTHERS, THESE CUSTOMERS MAY GIVE HIGHER PRIORITY TO PRODUCTS OF COMPETITORS, WHICH COULD HARM OUR OPERATING RESULTS. Our distributors and resellers generally offer products of several different companies, including products of our competitors. Accordingly, these distributors and resellers, such as Ingram Micro, Tech Data, Compucom, Custom Edge (formerly Inacom) may give higher priority to products of our competitors, which could harm our operating results. In addition, our distributors and resellers 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 or resellers will continue, or that these sales will be profitable. BECAUSE WE HAVE ONLY APPROXIMATELY THREE 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 three years. For the year ended July 31, 2000 and the first six months of the current fiscal year 2001, these products accounted for less than 41% and 66%, respectively, 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 of our operating history in the NAS product market is only approximately three 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. 20 MARKETS FOR BOTH OUR NAS APPLIANCES AND OUR NON-NAS 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 non-NAS 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 SUCH AS INGRAM MICRO AND TECH DATA, AS WELL AS SPECIALIZED END-USERS, FOR A SUBSTANTIAL PORTION OF OUR NET SALES AND ACCOUNTS RECEIVABLE, AND CHANGES IN THE TIMING AND SIZE OF THESE CUSTOMERS' ORDERS MAY CAUSE OUR OPERATING RESULTS TO FLUCTUATE. Three customers accounted for approximately 42% and 45% of the Company's total accounts receivable at July 31, 1999 and July 31, 2000, respectively, and one individual customer accounted for approximately 9% and 7% of the Company's net sales for fiscal 1999 and 2000. One customer, Storway, a European storage service provider, accounted for approximately 20% of our net sales for the first six months of the current fiscal year 2001, and three customers, Storway, Ingram Micro and J-Dot Technology, accounted for approximately 56% of our total accounts receivable at January 31, 2001. In fiscal 1999 and 2000, we sold our non-NAS products principally to distributors and master resellers such as Ingram Micro, Tech Data, Custom Edge (previously Inacom) and Compucom. 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 expect that single site purchasers of large installations of our NAS products will purchase large volumes of our NAS products over relatively short periods of time. This will cause both our sales and our accounts receivables to be highly concentrated and significantly dependent on one or only a few customers, as has occurred during this six month period. If we lose a major customer, or 21 if one of our customers significantly reduces its purchasing volume or experiences financial difficulties and is unable to pay its debts, our results of operations could be harmed. We cannot be certain that customers that have accounted for significant revenues in past periods will continue to purchase our products 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 SEE REDUCED SALES OF HIGHER-MARGIN CD SERVICES OR NOTEBOOK UPGRADE PRODUCTS AND WE MAY NOT SEE 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, in the past we have derived a significant portion of our sales from disk drives, CD servers and arrays, and storage upgrade products. The market for these products is highly competitive and subject to intense pricing pressures and we have seen significant reduction in demand for these products during the last two years. Some of these products, such as CD servers and arrays and some laptop storage upgrade systems have historically generated high gross margins, although we have experienced significant declines in sales of these products. Sales of disk drive upgrade systems generally generate lower gross margins than those of our NAS products. If we fail to increase sales of our NAS appliances, or if demand, sales or gross margins for CD servers and arrays and our laptop storage upgrade systems decline rapidly, we believe our overall gross margins will continue to decline. Our gross margins have been and may continue to be affected by a variety of other factors, including: o new product introductions and enhancements; o competition; o changes in the distribution channels we use; o the mix and average selling prices of products; and o 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. 22 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, and the difficulty in estimating the engineering effort required to produce new products, we face significant challenges in developing and introducing new products. 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 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. 23 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: o cause delays in product introductions and shipments; o result in increased costs and diversion of development resources; o require design modifications; or o decrease market acceptance or customer satisfaction with these o 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. 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 60% of our net sales for the first six months of the current fiscal year 2001 as compared to 44% of our net sales for the first six months of the current fiscal year 2000, 41% of our net sales for the year ended July 31, 2000 and approximately 33% of our net sales for the fiscal year ended July 31, 1999. We believe that our growth and profitability will require successful expansion of our international operations to which we have committed significant resources. 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: o currency exchange rate fluctuations, particularly when we sell our products in denominations other than U.S. dollars; o difficulties in collecting accounts receivable and longer accounts receivable payment cycles; o reduced protection for intellectual property rights in some countries, particularly in Asia; o legal uncertainties regarding tariffs, export controls and other trade barriers; 24 o the burdens of complying with a wide variety of foreign laws and regulations; and o 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 first six months of the current fiscal year 2001. For example, in the quarter ended October 31, 2000, the Euro, and two currencies whose values are pegged to the Euro, declined in value significantly, and then increased in value significantly in the quarter ended January 31, 2001. As a result, we incurred a foreign currency loss of $160,000 in the quarter ended October 31, 2000 while we realized a gain of $219,000 in the quarter ended January 31, 2001. Also, these fluctuation gains can cause us to report more or less in sales by virtue of the translation of the subsidiary's sales into US dollars at an average rate in effect throughout the quarter. Also, we have funded operational losses of our subsidiaries of approximately $2.8 million since we purchased them, 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, hire additional personnel 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. 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 25 for the registration of some, but not all, of our trademarks. We have applied for one U.S. patent with respect to the design of our NetFORCE product, and we anticipate that we will 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. 26 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 recently 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 do not know how our products may infringe the patents of Intel, but we have begun to investigate 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 preliminary, and we expect we will continue discussions with Intel. We can not 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. In recent periods, 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: o market acceptance of our new products and product enhancements or those of our competitors; o the level of competition in our target product markets; o delays in our introduction of new products; 27 o changes in sales volumes through our distribution channels, which have varying commission and sales discount structures; o changing technological needs within our target product markets; o the impact of price competition on the selling prices for our non-NAS products, which continue to represent a majority of our net sales; o the availability and pricing of our product components; o our expenditures on research and development and the cost to expand our sales and marketing programs; and o 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 distribution and reseller customers have limited 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 fiscal 2000, we experienced a 14% product return rate. 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. In particular, we rely on the services of our four founders, Messrs. Razmjoo, Alaghband, Aydin and Shahrestany. We maintain employment agreements with each of our founders. We do not maintain key-person life 28 insurance policies on these individuals. The loss of any of these 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 and $5.6 million (including a charge for acquired research and development) for the first six months of the current fiscal year 2001. We expect to continue to incur operating losses through at least the third quarter of fiscal 2001. As part of our strategy to focus on the NAS market, we plan to significantly increase our direct sales force and to increase our investment in research and development and marketing efforts. We will need to significantly 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. In addition, we have invested substantial cash in our new corporate headquarters. 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. Our executive officers, directors and 5% or greater shareholders and their affiliates own 6,400,000 shares, or approximately 52% 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: 29 o fluctuations in our operating results; o fluctuations in the valuation of companies perceived by investors to be comparable to us; o a shortfall in net sales or operating results compared to securities analysts' expectations; o changes in analysts' recommendations or projections; o announcements of new products, applications or product enhancements by us or our competitors; and o changes in our relationships with our suppliers or customers. WE HAVE ISSUED CONVERTIBLE DEBENTURES, AND THE OBLIGATIONS OF THE DEBENTURES POSE RISKS TO THE PRICE OF OUR COMMON STOCK AND OUR OPERATIONS. On October 31, 2000, we issued 3-year $15 million convertible debentures to a private investor. The debentures provide that in certain circumstances the holder of the debentures may convert its position into our stock, or demand that we repay amounts outstanding with cash or by issuing shares of our common stock. The terms and conditions of the debentures pose unique and special risks to our operations and the price of our common stock. Some of those risks are discussed in more detail below. OUR ISSUANCE OF STOCK UPON THE CONVERSION OR "PUT" OF THE DEBENTURES AND THE EXERCISE OF THE WARRANTS, AS WELL AS ADDITIONAL SALES OF OUR COMMON STOCK BY THE HOLDER OF THE DEBENTURES, MAY DEPRESS THE PRICE OF OUR COMMON STOCK AND SUBSTANTIALLY DILUTE YOUR SHARES. We are in the process of seeking to register for resale by the holder of our debentures a total of 1,586,228 shares of our common stock issuable upon conversion of the debentures and the exercise of the warrants issued to the holder of our debentures. This number represents 200% of the number of shares of our common stock issuable if the warrants are exercised in full and our debentures remain outstanding until their stated maturity on October 31, 2003 and all interest on the debentures is paid in shares of our stock. The staff of the Securities and Exchange Commission has advised us that we cannot register for resale any shares of our common stock issuable upon exercise of the "put" right under the debentures unless and until that put right is exercised and the applicable shares are issued. While we are continuing to discuss this matter with the Staff, if the Staff does not change its view, we expect to agree with the holder of our debentures that we will register for resale the shares issuable upon exercise of the put right at the time those shares are issued. The issuance of all or any significant portion of the shares of our common stock that we are currently in the process of registering together with any additional shares that we have agreed to register for resale if the put right under the debentures is exercised and the shares issuable upon exercise of this right are issued, 30 could result in substantial dilution to the interests of our other shareholders and a decrease in the price of our stock. A decline in the price of our common stock could encourage short sales of our stock, which could place further downward pressure on the price of our stock. THE INVESTOR HAS A RIGHT TO DEMAND REPAYMENT OF PART OR ALL OF THE DEBENTURES, AND IF A DEMAND FOR REPAYMENT IS MADE, AND WE ARE UNABLE OR UNWILLING TO REPAY THE DEBENTURES IN CASH, WE MAY HAVE TO ISSUE SHARES SUBSTANTIALLY IN EXCESS OF THOSE ORIGINALLY CONTEMPLATED, AND THOSE ADDITIONAL SHARES WILL DILUTE YOUR SHARES. The debentures provide the investor with a "put" right, which is the right to demand at specified times that we repay the debentures in cash or issue shares at 90% of the then market price for shares of our common stock, but not more than $22.79 per share. Accordingly, if an investor exercises its "put" right, and we are either unwilling or unable to repay the cash, and the market price of our shares is lower than $22.79, we will have to issue shares to satisfy the "put" right of the investor. The number of shares that we may be required to issue to satisfy the investor's exercise of the "put" right could be substantial. For example, if the market price of our common stock were to decline by 75% from the market price of $11.25 per share on December 20, 2000, which represents the lowest closing price reached by our shares since the date the debentures were issued, we would be required to issue the investor approximately 5,926,000 shares, which would result in the investor owning nearly 33% of our outstanding stock. IF OUR SHARES ARE ISSUED TO THE INVESTOR, THOSE SHARES MAY BE SOLD INTO THE MARKET, WHICH COULD DEPRESS THE PRICE OF OUR STOCK AND ENCOURAGE SHORT SALES OF OUR STOCK. To the extent the debentures are converted or interest on the debentures is paid in shares of our common stock rather than cash, a significant number of these shares of our common stock may be sold into the market, which could decrease the price of our common stock and encourage short sales. Short sales could place further downward pressure on the price of our common stock. In that case, we could be required to issue an increasingly greater number of shares of our common stock upon future conversions of the debentures as a result of the adjustments described above, sales of which could further depress the price of our common stock. THE DEBENTURES PROVIDE FOR VARIOUS EVENTS OF DEFAULT THAT WOULD ENTITLE THE INVESTORS TO REQUIRE THE COMPANY TO REPAY THE ENTIRE AMOUNT OWED IN CASH WITHIN THREE DAYS. IF AN EVENT OF DEFAULT OCCURS, WE MAY BE UNABLE TO IMMEDIATELY REPAY THE AMOUNT OWED, AND ANY REPAYMENT MAY LEAVE US WITH LITTLE OR NO WORKING CAPITAL IN OUR BUSINESS. The debentures provide for various events of default, including the following: 31 o the occurrence of an event of default under our loan agreements with The CIT Group; o our failure to pay the principal, interest or any liquidated damages due under the debentures; o our failure to make any payment on any indebtedness of $1 million or more to any third party if that failure results in the acceleration of the maturity of that indebtedness; o an acquisition after October 31, 2000 by any individual or entity, other than the investor and its affiliates, of more than 40% of our voting or equity securities; o the replacement of more than 50% of the persons serving as our directors as of October 31, 2000, unless the replacement director or directors are approved by our directors as of October 31, 2000 or by successors whose nominations they have approved; o a merger or consolidation of our company or a sale of more than 50% of its assets unless the holders of our securities immediately prior to such transaction continue to hold at least a majority of the voting rights and equity interests of the surviving entity or the acquirer of our assets; o our entry into bankruptcy; o our common stock fails to be listed or quoted for trading on the New York Stock Exchange, the American Stock Exchange, the Nasdaq National Market or the Nasdaq SmallCap Market; o our completion of a "going private" transaction under SEC Rule 13e-3; o a holder of shares issuable under the debentures or the warrant is not permitted to sell those securities under our registration statement covering those shares for a period of five or more trading days; o if our registration statement covering the shares of our common stock underlying the debentures and the warrant is not declared effective by March 31, 2001, the investor thereafter may give us 30 days notice and the Company would be in default of our obligations at expiration of this period if such registration was not effected. o we fail to deliver certificates evidencing shares of our common stock underlying the debentures or the warrant within five days after the deadline specified in our transaction documents with the investor; o we fail to have a sufficient number of authorized but unissued and otherwise unreserved shares of our common stock available to issue such stock upon any exercise or conversion of the warrant and the debentures; 32 o the exercise or conversion rights of the investor under the warrant or the debentures are suspended for any reason, except as provided in the applicable transaction documents; o we default on specified obligations under our registration rights agreement with the investor and fail to cure any such default within 60 days; and o other than the specified defaults under the registration rights agreement referred to above, we default in the timely performance of any obligation under the transaction documents with the investor and fail to cure any of these defaults for 20 days after we are notified of the default. If an event of default occurs, the investor can require us to repurchase all or any portion of the principal amount of any outstanding debentures at a repurchase price equal to the greater of 110% of such outstanding principal amount, plus all accrued but unpaid interest on such outstanding debentures through the date of payment, or the total value of all of our shares issuable upon conversion of such outstanding debentures, valued based on the average closing price of our common stock for the preceding five trading days, plus any accrued but unpaid interest on such outstanding debentures. In addition, upon an event of default under the debentures, the investor could also require us to repurchase from the investor any of our shares of common stock issued to the investor upon conversion of the debentures within the preceding 30 days, which would be valued at the average closing price of our common stock over the preceding five trading days. We would be required to complete these repurchases no later than the third trading day following the date an event of default notice is delivered to us. If we were required to make a default payment at a time when all of the debentures were outstanding, the payment required would be a minimum of $16.5 million and could be substantially greater depending upon the market price of our common stock at the time. In addition, if we default in the timely performance of specified obligations under our registration rights agreement with the investor, we would also be obligated to pay as liquidated damages to the investor an amount equal to $300,000 each month until any such default is cured. Some of the events of default include matters over which we may have some, little or no control, such as various corporate transactions in which the control of our company changes, or if our common stock ceases to be listed on a trading market. If an event of default occurs, we may be unable to repay any part or all of the entire amount in cash. Any such repayment could leave us with little or no working capital for our business. THE PAYMENT TO BRIGHTON CAPITAL 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 SELLING SHAREHOLDER TO RESCIND ITS INVESTMENT. We paid Brighton Capital $375,000 for its introduction to us of the purchaser of 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 33 Securities Exchange Act of 1934, as amended. If this payment is determined to be inconsistent with Section 15, then, under Section 29 of the Securities Exchange Act: o Montrose Investments L.P., the purchaser of our debentures, may have the right to rescind their purchase of these securities, which would require us to repay to Montrose Investments L.P. the $15.0 million that it invested in us; o We may be subject to regulatory action; and o We may be able to recover the $375,000 fee that we paid to Brighton Capital in connection with the transaction. 34 THE DEBENTURES RESTRICT OUR ABILITY TO RAISE ADDITIONAL EQUITY, WITHOUT THE CONSENT OF THE INVESTOR, WHICH COULD HINDER OUR EFFORTS TO OBTAIN ADDITIONAL NECESSARY FINANCING TO OPERATE OUR BUSINESS, OR TO REPAY THE DEBENTURE HOLDERS. The agreements we executed when we issued these debentures prohibit us from obtaining additional equity or equity equivalent financing for a period of 90 trading days after the effective date of the registration statement covering the resale of the shares issuable upon conversion of the debentures. We also agreed that for a period of 180 trading days after the effective date of the registration statement covering the resale of the shares issuable upon conversion of the debentures, we would not, without the investor's consent, obtain additional equity or equity equivalent financing unless we first offer the investor the opportunity to provide such financing upon the terms and conditions proposed. These restrictions have several exceptions, such as issuances of options to employees and directors, strategic transactions and acquisitions and bona fide public offerings with proceeds exceeding $20 million in gross proceeds. However, the restrictions may make it extremely difficult to raise additional equity capital during the 90-day and 180-day periods. We may need to raise such additional capital, and if we are unable to do so, we may have little or no working capital for our business, and the market price of our stock may decline. WE MAY BE REQUIRED TO PAY LIQUIDATED DAMAGES IF WE DO NOT OBTAIN SHAREHOLDER APPROVAL FOR ISSUANCE OF OUR COMMON STOCK, OR IF WE ARE UNABLE TO TIMELY REGISTER THESE SHARES. We are subject to National Association of Securities Dealers Rule 4460, which generally requires shareholder approval of any transaction that would result in the issuance of securities representing 20% or more of an issuer's outstanding listed securities. Upon conversion or the payment of interest on debentures we are not able to issue more than 2,322,150 shares, or 19.99% of our outstanding common stock on October 30, 2000, the day prior to the date of issuance of the debentures. The terms of the convertible debentures purchase agreement also provide that the shareholder desiring to convert has the option of requiring us either to seek shareholder approval within 75 days of the request or to pay the converting holder the monetary value of the debentures that cannot be converted, at a premium to the converting holder. If the shareholder chooses that we convert the debentures into shares and we have not obtained the requisite shareholder approval within 75 days, we would be obligated to pay the monetary value to the purchaser as liquidated damages. Also, under the terms of the Registration Rights Agreement, we will incur liquidated damages of approximately $300,000 per month if we are unable to register the shares on or before March 31, 2001, or maintain the registration of the shares, of common stock issuable upon the conversion of the debentures and the exercise of those warrants. We currently have been informed by the Securities and Exchange Commission that we may not be able to effect the registration of some of these shares. If the debenture holder chose to enforce the agreement, we would incur the $300,000 monthly charge. However, the debenture holder has recently agreed with us that they will not declare a default, nor attempt to assess the fee, except on a 30-day notice to us. We can not assure you that the debenture holder will continue to extend or waive the default date. 35 EVEN IF WE NEVER ISSUE OUR STOCK UPON EXERCISE OR PUT OF THE DEBENTURES OR UPON EXERCISE OF THE INVESTOR'S WARRANTS, WE MAY ISSUE ADDITIONAL SHARES, WHICH WOULD REDUCE YOUR OWNERSHIP PERCENTAGE AND DILUTE THE VALUE OF YOUR SHARES. Other 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 in Procom. 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. 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. We have agreed to file a registration statement covering the resale of the shares issued to shareholders of Scofima not later than March 28, 2001. The sale of these shares could adversely affect the market price of our stock. 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. NEW ACCOUNTING STANDARDS In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended, which defines derivatives, requires that all derivatives be carried at fair value, and provides for hedge accounting when certain conditions are met. This statement is effective for the first fiscal quarter of fiscal years beginning after June 15, 2000. Adoption of this statement, effective August 1, 2000, did not have a material impact on our consolidated financial position, results of operations or cash flows. In December 1999, the United States Securities and Exchange Commission issued Staff Accounting Bulleting (SAB) No. 101, "Revenue Recognition in Financial Statements," as amended, which for the Company is effective no later than the fourth quarter of fiscal 2001. SAB No. 101 summarizes certain of the SEC staff's views regarding the appropriate recognition of revenue in financial statements. The Company is currently reviewing SAB No. 101 and has not yet determined the potential impact on its financial statements. ITEM 7A. 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 36 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. As discussed elsewhere in this Report on Form 10-Q, we have developed our headquarters in Irvine, California and we have spent approximately $15.9 million and we expect to spend $.8 million more to complete the facility. The Company is seeking long-term mortgage financing for all or some of the facility cost during the next fiscal year. The Company has not "locked" in a commitment, and may therefore find such financing to be much more expensive as a result. Since July 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 .50%. Accordingly, since we anticipate that we will be borrowing funds under such agreements, we expect that we will experience interest rate risk on our debt. As we have discussed elsewhere in this Report on Form 10-Q, we have issued a $15.0 million debenture which accrues interest at 6% annually. We do not believe that we have much interest rate fluctuation risk on the debentures. FOREIGN CURRENCY EXCHANGE RISK We transact business in various foreign countries, but we only have significant assets deployed outside the United States in Germany. We have effected intercompany advances and sold goods to Megabyte 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. During the six months ended January 31, 2001 and 2000, we incurred approximately $59,000 and $25,000, respectively, in foreign currency losses which are included in our selling, general and administrative costs. We do not operate a hedging program to mitigate the effect of a significant rapid change in the value of the Euro, the German mark, or the Italian lira 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. For example, after being weak for some months, during the quarter ended January 31, 2001, the Euro strengthened, and we recorded a currency gain of $219,000 in the quarter ended January 31, 2001 after recording a loss of $160,000 in the quarter ending October 31, 2000. Our net sales can also be effected 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, 2001, approximately $2.9 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 1. Legal Proceedings. The Company is from time to time involved in litigation related to its ordinary operations, such as collection actions and vendor disputes. The Company does not believe that the resolution of any existing claim or lawsuit will have a material adverse effect on the Company's business, results of operations or financial condition. Item 2. Changes in Securities and Use of Proceeds. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. 37 Item 4. Submission of Matters to a Vote of Security Holders. The annual meeting of shareholders was held on February 5, 2001. The shareholders elected the following six directors to hold office until the next annual meeting and until their successors are elected and qualified:
NUMBER OF VOTES ------------------------- FOR WITHHELD --------- -------- Alex Razmjoo............................ 10,816,137 59,308 Nick Shahrestany........................ 10,816,537 58,908 Frank Alaghband......................... 10,816,177 59,268 Dom Genovese............................ 10,811,437 64,008 Alex Aydin.............................. 10,816,677 58,768 David Blake............................. 10,811,487 63,958
In addition, the shareholders approved the following proposals:
NUMBER OF VOTES --------------------------------------------- FOR AGAINST ABSTAIN BROKER NON-VOTES ---------- ------- ------- --------- An Amendment of the Company's 1995 Stock Option Plan to increase the number of shares reserved for issuance thereunder by 1,000,000 shares to an aggregate of 3,590,000 shares. 6,283,456 175,566 9,337 4,407,086 To ratify the appointment of KPMG LLP as the independent auditors of the Company for the year ending July 31, 2001. 10,866,089 3,171 6,185
Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) See Exhibit Index. No Statement re Computation of Per Share Earnings is included, because the computation can be clearly determined from material contained in this Report. See the Consolidated Statements of Operations, and the Notes thereto. (b) Reports on Form 8-K. On January 12, 2001, we filed a Report on Form 8-K under Item 2 announcing the acquisition of Scofima Software Srl. 38 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 19th of March, 2001. 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.
SIGNATURE TITLE DATE --------- ----- ---- /s/ Alex Razmjoo Chairman of the Board, President March 19, 2001 ----------------------------------- and Chief Executive Officer Alex Razmjoo (Principal Executive Officer) /s/ Alex Aydin Executive Vice President, Finance March 19, 2001 ----------------------------------- and Administration (Principal Alex Aydin Financial Officer) /s/ Frederick Judd Vice President, Finance and March 19, 2001 ----------------------------------- General Counsel (Principal Frederick Judd Accounting Officer)
39 INDEX TO EXHIBITS
SEQUENTIALLY EXHIBIT NUMBERED NUMBER DESCRIPTION PAGE ------- ----------- ------------ 3.1+ Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 in the Report S-1A filed November 14, 1996) 3.2+ Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 in the Report S-1A filed 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 of Procom filed on November 22, 2000) 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+ Form of Indemnity Agreement between the Company and each of its executive officers and directors (incorporated by reference to Exhibit 3.2 in the Report S-1A filed November 14, 1996) 10.2 Form of Amended and Restated Procom Technology, Inc. 1995 Stock Option Plan (incorporated by reference to Exhibit 10.2 in the Report S-1A filed November 14, 1996) 10.2.1 Form of Procom Technology, Inc. 1999 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4 in the Form S-8 filed on July 2, 1999) 10.3 Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Razmjoo (incorporated by reference to Exhibit 10.3 in the Form S-1 filed October 30, 1996) 10.4 Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Frank Alaghband (incorporated by reference to Exhibit 10.4 in the Form S-1 filed October 30, 1996) 10.5 Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Aydin (incorporated by reference to Exhibit 10.5 in the Form S-1 filed October 30, 1996) 10.6 Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Nick Shahrestany (incorporated by reference to Exhibit 10.6 in the Form S-1 filed October 30, 1996) 10.7 Form of Registration Rights Agreement (incorporated by reference to Exhibit 10.7 in the Form S-1 filed October 30, 1996) 10.8 Lease, dated February 10, 1992, between 2181 Dupont Associates and the Company, as amended (incorporated by reference to Exhibit 10.8 in the Form S-1 dated October 30, 1996) 10.9 Loan and Security Agreement, dated November 18, 1994, by and between the Company and FINOVA Capital Corporation, as amended (incorporated by reference to Exhibit 10.9 in the Form S-1A filed December 5, 1996) 10.9.2 Amendment to FINVOVA Loan and Security Agreement dated July 30, 1997 (incorporated by reference to Exhibit 10.9 in the Report on Form 10-K dated October 29, 1997) 10.10 Asset Purchase Agreement, dated June 24, 1998, among Invincible Technologies Acquisition Corporation, Invincible Technologies Corporation, and certain stockholders of Invincible Technologies Corporation named therein (incorporated by reference to Exhibit 10.10 in the Report on Form 8-K filed October 29, 1998) 10.11 Standard Office Lease between the Company and Arden Realty, Inc. (incorporated by reference to Exhibit 10.11 on the Report on Form 10-Q filed December 14, 1998) 10.12 Agreement for Wholesale Financing (Security Agreement) between Procom Technology, Inc. and IBM Credit Corporation (incorporated by reference to Exhibit 10.1 to the Form S-3/A filed on January 16, 2001).
---------- + Previously filed