-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PU6yo9RbpeRipcXOqKo0uCqm7k2IVZJ2cye6U0fb9sM/vvs9B25X51v8AF6ygCHV mzYaeTq2G7fvi/m7ir6eqQ== 0000075448-99-000003.txt : 19990416 0000075448-99-000003.hdr.sgml : 19990416 ACCESSION NUMBER: 0000075448-99-000003 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NSTOR TECHNOLOGIES INC CENTRAL INDEX KEY: 0000075448 STANDARD INDUSTRIAL CLASSIFICATION: [9995] IRS NUMBER: 952094565 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12895 FILM NUMBER: 99594203 BUSINESS ADDRESS: STREET 1: 100 CESNTURY BLVD STREET 2: 19146 LYONS ROAD CITY: WEST PALM BEACH STATE: FL ZIP: 33417 BUSINESS PHONE: 4078293500 MAIL ADDRESS: STREET 1: 100 CENTURY BOULEVARD CITY: WEST PALM BEACH STATE: FL ZIP: 3333417 FORMER COMPANY: FORMER CONFORMED NAME: IMGE INC DATE OF NAME CHANGE: 19960627 FORMER COMPANY: FORMER CONFORMED NAME: IMNET INC /DE/ DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: COMMUNICATIONS & CABLE INC DATE OF NAME CHANGE: 19890413 10-K 1 FORM 10-K FOR Y/E 12/31/98 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 --------------------- FORM 10-K X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR _______ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission File Number: 08354 nStor Technologies, Inc. (exact name of registrant as specified in its charter) Delaware 95-2094565 (State of Incorporation) (I.R.S. Employer ID No.) 450 Technology Park, Lake Mary, Florida 32746 (Address of principal executive offices) Registrant's telephone number, including area code: 407-829-3500 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.05 per share (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] AGGREGATE MARKET VALUE OF THE VOTING COMMON STOCK HELD BY NONAFFILIATES OF THE REGISTRANT Common Stock, par value $.05 per share ("Common Stock"), was the only class of voting common equity of the Registrant outstanding on December 31, 1998. Based on the last sales price of the Common Stock on the American Stock Exchange ("AMEX") on March 31, 1999 ($2.125), the aggregate market value of the approximately 16,279,000 shares of the voting Common Stock held by persons other than officers, directors and persons known to the Registrant to be the beneficial owners (as that term is defined under the rules of the Securities and Exchange Commission) of more than five percent of the Common Stock on that date was approximately $34.6 million. By the foregoing statements, the Registrant does not intend to imply that any of these officers, directors or beneficial owners are affiliates of the Registrant or that the aggregate market value, as computed pursuant to rules of the Securities and Exchange Commission, is in any way indicative of the amount which could be obtained for such shares of Common Stock. APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check mark whether the Registrant has filed all documents and reports required to be filed by Section 12, 13, or 14(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ____ No ____ (APPLICABLE ONLY TO CORPORATE REGISTRANTS) Indicate the number of shares outstanding of each of the Registrant's classes of common stock, as of the latest practicable date: 21,492,258 shares of Common Stock, par value $.05 per share, were outstanding as of March 31, 1999. DOCUMENTS INCORPORATED BY REFERENCE Definitive Proxy Statement of nStor Technologies, Inc. for the 1999 Annual Meeting of Stockholders (incorporated in Part III) 2 PART I Item 1. Business GENERAL nStor Technologies, Inc., through its operating subsidiary, nStor Corporation, Inc. (collectively, "nStor" or "the Company") is engaged as a manufacturer and supplier of high-performance information storage solutions, including external RAID (Redundant Array of Independent Disks) subsystems, Network Attached Storage, data storage enclosures, storage management software solutions and AdaptiveRAID technology (see "Current Product Offerings"). Our RAID subsystems provide high-availability (ability to remain on line and accessable), high-performance (ability to record and access data with the greatest amount of speed and accuracy), enterprise-wide storage solutions for critical data on PC-LAN and UNIX platforms, utilizing the latest technology architectures, including Fibre Channel, Ultra2 LVD (low voltage differential) SCSI (Small Computer Systems Interface), and Ultra SCSI. Our product line supports a variety of operating systems, including Microsoft Windows NT, Novell NetWare, IBM OS/2, Mac, SCO UNIX, UnixWare, SGI IRIX, Sun Solaris, and Linux. Our RAID subsystems provide data storage solutions, particularly for applications requiring substantial storage performance and capacity, such as document imaging, video and multimedia, or transaction-intensive environments, such as banking and order entry systems. We sell our RAID products through a network of original equipment manufacturers ("OEM's") and a two-tier channel distribution through vertical and geographical distributors/resellers located worldwide. Our executive and business headquarters are located at 450 Technology Park, Lake Mary, Florida 32746 and our telephone number is (407) 829-3500. Information regarding nStor can be accessed through the World Wide Web at http:// www.nStor.com. Recent Developments Proposed Acquisition In March 1999, we entered into an agreement to purchase 75% of the outstanding common stock of Andataco, Inc. ("Andataco") from its principal stockholder, David Sykes. That agreement also contemplates that we would purchase from Mr. Sykes a note in the principal amount of $5,196,000, issued to him by Andataco. Following the purchase of Mr. Sykes' shares, he would continue to serve as President of Andataco, pursuant to a proposed three-year employment agreement. The purchase 3 is contingent on our raising the capital necessary to fund the acquisition. If the transaction is completed, it would be our intention to acquire the remaining Andataco shares as soon as possible following an independent professional determination of the fair value of such shares. We are currently negotiating with unrelated private investors to obtain approximately $15 million in a private placement of convertible preferred stock (the "Private Placement"). Proceeds from the Private Placement would be used to finance the proposed Andataco acquisition, if consummated, and to provide additional working capital for our company. There can be no assurance, however, that we will be successful in obtaining the funds necessary to finance the proposed acquisition nor that the acquisition will be completed. Significant New OEM In March 1999, we received the initial purchase order under a recently established OEM relationship to supply high-performance RAID storage enclosures to Silicon Graphics, Inc. (SGI), a major computer server manu- facturer. The purchase order calls for us to ship approximately $5.8 million of products to SGI commencing in the second quarter of 1999. The initial term of the OEM arrangement is expeced to be for three (3) years. A discontinuation or significant reduction of this relationship could have a material adverse effect on our business. INDUSTRY During recent years, the demand for increased information storage capacity has grown dramatically. Businesses today often rely on computing resources 7 days a week, 24 hours a day. This increased demand for information has created a growing market for companies that provide bundled or totally integrated storage products and services. Fault-tolerant storage management plays a vital part in protecting critical data in every aspect of the economy. The explosion of the Internet/Intranet and the creation of millions of web sites worldwide has accelerated this need for available, reliable data storage. The digital content creation and multimedia industry, with its intense storage/retrieval requirements, continually requires larger reliable storage systems, including those used for photo retouching, video editing, graphic designers and graphic animation products. Libraries, hospitals, law firms and government entities all use document imaging to store millions of records each year and computer data storage systems must accommodate search requests quickly and consistently. According to DataQuest, a unit of Gartner Group, Inc. that provides global market research and consulting services for the information technology industry, estimated network and RAID-based storage 4 revenue will approach $27.4 billion in 1999. The market is also expected to show strong growth through the rest of the decade, with DataQuest forecasting storage revenues to surpass $32 billion in 2000. While the revenue forecast for the RAID industry is estimated at a 17% compounded annual growth rate through 2002, DataQuest estimates that the demand for storage capacity in terabytes (TB) will grow at a rate of 81% compounded annual growth rate for the same period. This growth supports the increasing demand for more storage capacity. Significant factors contributing to the growth of the industry include: the rapid adoption of Windows NT, migration of storage into larger disk arrays, and the changing landscape in interface and connectivity of storage devices. Currently, UNIX and Windows NT operating system platforms make up more than 80% of the combined RAID revenue estimate. Although UNIX provides a larger installed base, Strategic Research Corporation estimates that more than 80% of all networks have mixed operating systems. The mixed operating system environment, coupled with the rapidly changing storage architectures, supports the rapidly increasing demand for Windows NT. Additionally, the strong growth rate in the Windows NT operating system space has accelerated add-on purchases of external RAID systems. RAID technology is an effective tool to protect network computer users from the loss of critical disk data. We believe that RAID subsystems will continue to play a significant role as the preferred method for data storage in network environments. We also believe that we are well positioned to provide fault-tolerant information storage systems to all segments of the market and will be able to participate in the forecasted growth in the information storage market. However, there can be no assurance that we will be successful in these efforts due to the possibility of increased competition, the development of alternative technologies, and other factors. RAID TECHNOLOGY RAID, a concept developed in 1988 by a team of researchers from the University of California at Berkeley, is an information storage technology consisting of three or more disk drives working together as one, using proprietary hardware and software to achieve extremely fast data transfer and Input/Output (I/O) rates, high levels of redundancy and large storage capacities. RAID subsystems are able to achieve much faster data transfer rates than individual disk drives because of their ability to spread data among all of the component disk drives and retrieve the data from all drives simultaneously at very fast speeds. They are also able to achieve much faster I/O rates than individual disk drives because of their ability to spread I/O's among all of the component disk drives. (An I/O represents a user-requested read or write 5 (opening or saving) of data from the disk.) Redundancy refers to the replication of certain data within the RAID subsystem so that if one disk drive or other redundant component, such as a power supply, fails within the disk array, no data is lost and the application continues uninterrupted. In the event of such a failure, the failed component can be "hot-swapped" for a new component (exchanged without system shut down). By linking together multiple disk drives, RAID subsystems significantly enhance storage capacities. The recent proliferation of Internet, video and multimedia applications, coupled with the continued installation of client/server-based networks, has placed continuing demand on disk storage resources in terms of capacity, performance and fault-tolerance. The RAID technology initially introduced in 1988 was specifically designed to improve the performance and fault tolerance of disk-based subsystems. The algorithms and features of "first-generation" RAID products have been widely implemented. However, since its introduction, many of the technology's initial shortcomings and limitations still exist, such as the inability to adapt to I/O workload and dedicated RAID levels, complex system configuration and performance tuning, performance limitations as a result of writing in one of the RAID levels (RAID-5) and limited or no online capacity expansion. With the forecasted growth in the demand for RAID products, a significant market opportunity exists for our "next-generation" RAID products (see Current Product Offerings). PRODUCTS Product Strategy The technology used as the foundation for the nStor RAID product family was first introduced in 1994, when the storage systems division of Conner Peripherals ("Conner"), which previously owned our RAID business, began investing in the CR8 RAID subsystem. Over the next two years, several additional products were added to the RAID family and the nStor brand name was adopted. In 1995, Intel Corporation approached Conner to co-develop the SAF-TE (SCSI Accessed Fault-Tolerant Enclosures) specification and to disseminate the specification free of charge to the computer industry. The SAF-TE specification plays a significant role in lowering the total cost of computer system ownership by providing a standard method for sending and receiving information using standard interfaces as well as new SCSI standards and protocols as they evolve. Products compliant with the SAF-TE specification reduce the cost of managing storage enclosures, making it easier for the LAN ("local area network") administrator to obtain base-level, fault-tolerant, alert notification and status information. We have continued to introduce new SAF-TE compliant storage 6 subsystems based on the latest SCSI I/O, subsystem and network management technologies. Additional information about the SAF-TE specification can be found on the World Wide Web at http://www.safte.org. Designed to reduce the cost of computer system ownership, our external RAID subsystems employ hot swap components, advanced cooling systems and redundant N+1 architectures ("N+1 Architecture") to improve data reliability and availability. (N+1 Architecture requires the minimum number of components installed to support the system plus one additional hard drive as a backup.) Hot swap drives, power supplies and cooling fans eliminate single points of failure within an individual storage device, keeping data online and available when needed. Every 5-degrees centigrade increase in operating system temperature reduces drive MTBF (Mean Time Between Failure) by 10%. Inadequate cooling can result in reduced drive life and lost data. Our air- plenum design provides uniform, adequate cooling regardless of the number of drives in use. Current Product Offerings AdaptiveRAID List price range: $799-$23,774(a) AdaptiveRAID is a patented next-generation RAID technology that offers fault tolerance and data protection, along with the highest performance presently available by automatically determining the optimal RAID level and eliminating RAID 5 write performance limitations and many of the RAID limitations currently associated with adding disk drives to an array. Additional disk drives can be added to increase storage capacity without downing the server, regardless of operating system environment. To maximize array capacity and allow users to add additional disk capacities without regard to prior disk capacity purchases, the AdaptiveRAID technology allows disks of varying sizes to be configured into an array without sacrificing disk capacity or performance. NexStor 8Le List price range: $9,159-$27,151(a) The NexStor 8Le is the first of nStor's next-generation line of high-performance fault tolerant disk subsystems. Offered as a turnkey solution with an integrated Ultra2 or Fibre-to-Ultra2 RAID controller and a configurable Operator Control Panel, the NexStor 8Le offers operating system independence. The 8-bay rack-mount or deskside tower enclosure supports 4, 9 or 18GB (gigabytes) disk drives, offering a total capacity of 144GB per enclosure. Additional features include: redundant, hot-swappable disk drives, fans, and power supplies; capacity expansion; RAID level migration; and AdminiStor Management Software which provides system management tools such as alerts and other monitoring functions. 7 NexStor 18F List price range: $8,249-$32,250(a) The NexStor 18F, currently the industry's highest density storage solution, accommodates eighteen 9GB or 18GB disk drives (up to 324GB) in a compact 19-inch rack enclosure. Supporting both a JBOD (Just a Bunch of Disks) configuration or an optional single-loop or dual-loop Fibre Channel RAID controller, the NexStor 18F provides the greatest presently available cross-platform scalability (ability to expand capacity) and high availability for document imaging, web servers, on-line transaction processing, data warehousing, video and multimedia systems. Our NexStor 18F enclosure features a cable-less, passive dual Fibre Channel Arbitrated Loop backplane (to which many of the storage devices are connected) engineered to incrementally boost performance and availability through a modular design that provides the maximum level of reliable fault tolerance and performance. The air-plenum cooling design provides support for 7,200 RPM (rotations per minute) and 10,000 RPM disk drives, as well as support for the higher capacity 36GB disk drives when they are available. Other system features include data transfer rates up to 200MB (megabytes)/second, support for up to 126 storage devices, dual power cords, support for cable lengths up to 30 meters utilizing a copper interface or up to 10 kilometers utilizing fibre optics, and redundant, hot-swappable disk drives, fans, power supplies and loop resiliency circuits. CR8e List price range: $4,159-$26,230(a) The SAF-TE compliant CR8e is an 8-bay rack-mountable or deskside tower RAID subsystem containing 4, 9 or 18 GB disk drives (up to 144 GB's of storage per enclosure). Features include Ultra/Wide SCSI (40MB/second) performance and enhanced fault tolerant features such as hot-swap drives; dual, redundant hot-swap power supplies and variable-speed fans; disk capacity expansion without shutting down; RAID level migration, and AdminiStor Management Software. CR8L List price range: $4,229-$25,131(a) The CR8L is an OEM-grade 8-bay subsystem, available in either a 19" rack mount or tower-based configuration. The CR8L supports 4GB, 9GB, and 18GB (7,200 or 10,000 RPM) disk drives, providing 144GB of storage per system. Multiple CR8L systems can be combined to provide scalable storage capacities in excess of 2 TB. The Ultra2 (LVD) SCSI-3 architecture provides data transfer speeds up to 80MB/second and supports 15 SCSI storage devices per channel, as well as cable lengths up to 12 meters. Features include a cable-less backplane design, support for global and hot spares, redundant 8 dual power supplies and cooling fans that are hot swappable under load conditions, and improved data availability and reliability. An Operator Control Panel provides subsystem component status, temperature control monitoring, alarm threshold settings, assignment of SCSI-IDs, password control, diagnostic results, firmware information and protection for critical menu items. CR8F List price range: $4,439-$28,440(a) The CR8F is an external 8-bay tower or rack-mountable enclosure based on the Fibre Channel-Arbitrated Loop interconnect standard. Designed to offer maximum fault tolerance and performance (up to 200MB per second, dual loop), the passive, cable-less backplane design improves reliability and data integrity. The highly scalable enclosure is currently available with up to eight 9GB or 18GB disk drives, providing up to 144GB of high performance storage per enclosure. For maximum scalability, the CR8F supports 126 storage devices per loop and over 2TB of storage on a single Arbitrated Loop (interconnecting 16 enclosures) to meet the storage needs for mid-to-large-sized networks. CR8DF List price range: $2,365-$20,127(a) Designed for the storage-intensive digital-content creation market, the CR8DF delivers scalable Fibre Channel-Arbitrated Loop performance (up to 200MB/second). Featuring a 9-inch by 12-inch desktop footprint, the high-performance JBOD 8-bay mini-tower desktop storage enclosure features a cable-less, passive dual Fibre Channel and support for up to eight 9GB or 18GB disk drives, offering up to 144GB of desktop storage per enclosure. For maximum scalability, the CR8DF supports 126 storage devices per loop and over 2TB of storage. The CR8DF enclosure design includes additional cooling and power capacity, and supports both the 7,200 RPM and 10,000 RPM disk drives. CR8j List price range: $1,380-$19,052(a) The CR8j is an 8-bay desktop enclosure that supports 4, 9 or 18GB disk drives (up to 144GB). Positioned as a JBOD, the CR8j offers Ultra/Wide SCSI-3 performance with data transfer rates up to 40 MB/per second. thinStor 300 List price: $2,770 thinStor 300 is a more economical, desktop option which enables storage devices such as CR8e and CR8j to attach to a network. thinStor 300 offers up to 432GBs (144GB in a single enclosure) of easily accessible RAID storage anywhere on the network. thinStor 9 features a 200 MHz Pentium processor with 32MB of memory, dual Ultra/Wide SCSI ports, an auto-sensing 10/100MB per second Ethernet port connection, three enhanced security modes, and a printer port for network printing. Multi-network client support includes Windows 95/98, Windows NT, OS/2, WARP 4, NetPC, NC, and UNIX. Multi-protocol support for TCP/IP, SMB, HTTP and NSF Version 2 enables concurrent transparent file sharing between UNIX and Windows NT. thinStor also offers local tape backup capability and supports most SCSI tape storage devices, Advanced Intelligent Tape and Digital Linear Tape, either as single tape drives or tape drives with stack (auto-loading) capabilities. A browser-based configuration and management utility facilitates installation. ________ (a) The lower list price reflects an enclosure only; the higher list price reflects an enclosure which contains the maximum number of drives available for that enclosure. The Company offers certain discounts for volume purchases. Y2K Compliance We have evaluated our existing products and policies as well as our plans for future products to ensure that they are Year 2000 compliant. Any date-dependent software developed by our company has been validated as being Year 2000 compliant using commercially acceptable methods including: Expanding year fields to four digits Windowing Date encoding techniques In addition, other nStor products have been verified as Year 2000 compliant based on the absence of date dependencies in hardware, software, and firmware code. Functional performance testing and transitioning among critical dates have been used to confirm compliance of these products. Since our products may also incorporate hardware and software from outside vendors, we are working closely with these vendors to ensure Year 2000 compliance. We believe that hardware, software, and firmware products developed, manufactured, and distributed under the nStor name accurately record, store, process and present calendar date data from the 20th Century and into the 21st Century. However, if additional non-nStor equipment is used with or connected to nStor products, it is the user's responsibility to ensure that such 10 equipment is Year 2000 compliant. PROPRIETARY TECHNOLOGY We rely upon patents, copyright and trademark protection, as well as non-disclosure confidentiality agreements with employees and customers, to establish, protect and preserve our proprietary rights. We own the following trademarks and copyrights: nStor AdaptiveRAID AdminiStor Smart Cabinet StorView nTera nVantage DirectStor For the life of your data There can be no assurance that the steps taken to protect our rights will be adequate to prevent misappropriation of our technology or to preclude competitors from developing products with features similar to our products. Although we believe our products and other proprietary rights do not infringe the proprietary rights of others, there can be no assurance that, in the future, third parties will not assert infringement claims against us or with respect to our products for which we have indemnification obligations to certain of our customers. Asserting our rights or defending against third-party claims could involve substantial expense. In the event a third party were successful in a claim that one of our products infringed the third party's proprietary rights, we may have to pay substantial damages or royalties, remove that product from the marketplace or expend substantial amounts in order to modify the product so that it no longer infringes such proprietary rights, any of which could have a material adverse effect on our business. SALES AND MARKETING Our products are marketed and sold as alternatives to products offered by server vendors, as part of a team-based sales strategy utilizing traditional sales channels (OEM and distribution) and territories. The sales process requires interaction with several levels within a customer's organization, and the typical sales cycle can range from three months to one year, depending on the actual sales channel. 11 OEM OEM-grade products are primarily sold directly to OEM server manufacturers for integration into their product offerings. Generally, the OEM products are labeled under the OEM's brand name. The OEM channel is significant in terms of revenue opportunity, market visibility and credibility and as a proving ground for new technologies that can later be marketed and sold in the distribution channel. OEMs are strategic in nature and therefore require unique sales strategies and support. We utilize a multi-tiered sales and support structure to support and recruit OEMs. This structure includes the sales organization as well as the technical/product marketing, manufacturing and engineering organizations. OEM sales accounted for 51% of our sales for the year ended December 31, 1998. In March 1999, we received the initial purchase order under a recently established OEM relationship to supply high-performance RAID storage enclosures to Silicon Graphics, Inc.(SGI), a major computer server manufact- urer. The purchase order calls for us to ship approximately $5.8 million of products to SGI commencing in the second quarter of 1999. The initial term of the OEM arrangement is expected to be for three (3) years. A discontin- uation or significant reduction of this relationship could have a material adverse effect on our business. Two OEM customers, Discreet Logic and Intergraph Corp., accounted for 27% and 13%, respectively, of net sales for 1998 and 11% and 10%, respectively, for 1997. One customer, Intergraph Corp., accounted for 53% of net sales for the year ended October 31, 1996. Distribution Our nStor branded products are sold through a two-tier distribution channel, arranged by specific geographical territories, each being assigned a regional manager, multiple district managers as well as an inside account manager (ISAM). To maximize our visibility within each territory, regional and district managers are located within their respective territories and are supported by corporate-based ISAMs. We seek to achieve greater territorial coverage by selectively placing manufacturer's representatives in certain key areas such as Washington, DC and Dallas, Texas. Managed by the territorial district managers, manufacturer's representatives are selected based on product focus, customer base and experience. The sales model for product distribution in Europe, the Asia/Pacific-Rim and Latin America is similar to the domestic model, utilizing manufacturer's representatives. 12 Each sales channel is supported by complementary pricing and margin structures. This strategy allows us and our customers to effectively sell and market our products across multiple channels while still maintaining channel integrity. Distribution accounted for 43% of our sales for the year ended December 31, 1998. Our sales and marketing team consisted of 19 employees as of December 31, 1998. Our sales organization recruits new OEM's, distributors and resellers, supports existing resellers, markets products to OEMs and system integrators and participates in trade shows. Our marketing plan utilizes a variety of programs to promote and develop new and expanding markets for the nStor product line and to support the sales strategy. The focal points of this plan include development and promotion of the distribution channel, strategic media placement, active regional, national and international tradeshow participation, aggressive public relations, web site innovation, and the development of highly focused collateral material. TECHNICAL SUPPORT AND CUSTOMER SERVICE Total customer satisfaction is our attitude and philosophy toward customer service. Through a sophisticated enterprise resource planning software implementation, we provide support from order entry to post sales service. Products are tracked through each stage of engineering, manufacturing and distribution for the entire life of a product, and our customer service department can view the history of each individual system. We believe that our ability to provide prompt and reliable technical support has enhanced our marketing efforts. A toll-free telephone number is provided for support to all OEM's, channel partners (resellers and integrators) and end users. We employ an engineering and support staff (26 people as of December 31, 1998) who have extensive training and strive to work with all levels of distribution and end users in order to satisfy our customers. In addition, we provide a limited three-year warranty that permits customers to return for repair or replacement all enclosures not operating as warranted. Disk drives are warranted for five years through the manufacturer. Thus far, we have not experienced material warranty claims; however, there can be no assurance that warranty claims will not have a material adverse effect on our future operating results. 13 In 1998, we entered into an agreement with Alpha-MicroSystems to introduce the nVantage on-site warranty service program for nStor storage subsystems. nVantage consists of two on-site service plans, each structured to provide the user with a different level of on-site warranty service depending on individual site requirements. MANUFACTURING AND SUPPLIERS Strategic Partners/Suppliers Our products are assembled at a separate manufacturing facility in Lake Mary, Florida, from components and prefabricated parts, such as controllers, cabinets, multiple disk drives and power supplies, manufactured and supplied by others. Strategic relationships have been established with a number of suppliers to manage inventory, including American Megatrends, Mylex, Chapperal, Seagate Technologies, Quantum, IBM, Creative Design Solutions, Q-Logic, Microsoft, Vitesse, and Symbios Logic. We depend heavily on our suppliers to provide high quality materials on a timely basis and at reasonable prices. Although many of the components for our products are currently available from numerous sources at competitive prices, certain of the components used in our products are presently available from a limited number of suppliers, or from a single supplier. Furthermore, because of increased industry demand for many of those components, their manufacturers may, from time to time, not be able to make delivery of orders on a timely basis. In addition, manufacturers of components on which we rely may choose, for numerous reasons, not to continue to make those components, or the next generation of those components, available to us. We have no long-term supply contracts. There can be no assurance that we will be able to obtain, on a timely basis, all of the components we require. If we cannot obtain essential components as required, we could be unable to meet demand for our products, thereby materially adversely affecting our operating results and allowing competitors to gain market share. In addition, scarcity of such components could result in cost increases and adversely affect our operating results. Production and Delivery The sophisticated nature of our products requires extensive testing by skilled personnel. We utilize specialized testing equipment and maintain an internal test-engineering group of three people to provide this product support. 14 ISO 9002 Certification We are in the process of applying for ISO 9002 certification, an internationally recognized Quality Assurance/Quality Control standard that requires a defined process of procedures, forms and work instructions that must be followed. There can be no assurance, however, that we will meet the industry-accepted standards necessary to obtain ISO 9002 certification. BACKLOG We manufacture our products based on a forecast of near-term demand and maintain inventory in advance of receipt of firm orders from customers. Shipments are generally made shortly after receipt of a firm order. We have no long-term purchase commitments from our customers and, in general, customers may cancel or reschedule orders on 30 days notice with little or no penalty. As a result, our backlog at any given time is not necessarily indicative of future sales levels. In March 1999, we received the initial purchase order under an EOM agreement to supply high-performance RAID storage enclosures to a major computer server manufacturer. The initial purchase order calls for us to ship approximately $5.8 million of products to the server manufacturer commencing in the second quarter of 1999. There can be no assurance that orders from existing customers, including our principal customers, will continue at their historical levels, that we will be able to obtain orders from new customers, or that existing customers, including our principal customers, will not develop their own storage solutions internally and as a result reduce or eliminate purchases. Loss of one or more of our principal customers, or cancellation or rescheduling of material orders already placed, could materially and adversely affect our operating results. RESEARCH AND DEVELOPMENT The information storage industry is subject to rapid technological change. Our ability to compete successfully is largely dependent upon the timely development and introduction of products and our ability to anticipate and respond to change. We use engineering design teams that work with marketing managers, application engineers and customers to develop products and product enhancements. Computer I/O interface standards are maintained and an extensive disk drive qualification program is in place to monitor disk drives to ensure the quality and performance of the disk drives integrated into our disk arrays. As part of our 15 development strategy, we actively seek industry leaders with whom we can initiate co-development activities in the hardware, software and systems businesses. In April 1998, we acquired Borg Adaptive Technologies, Inc. ("Borg"), a privately owned company headquartered in Boulder, Colorado, and formed a new engineering facility based in Boulder. Borg developed AdaptiveRAID (see Current Product Offerings), which overcomes many of the shortcomings and limitations of first-generation RAID technology by offering improved disk array performance and greater ease-of-use features. The Boulder facility is responsible for overseeing the design and implementation of our line of next-generation RAID products utilizing the AdaptiveRAID technology. We believe that the Borg acquisition will enable us to differentiate our RAID products in the rapidly expanding, mid-range Windows NT market. However, there can be no assurance that other companies may not develop products with better performance and thus reduce demand for our products, which could materially and adversely affect our operating results. Research and development expenses during the year ended December 31, 1998 amounted to $2.6 million, all of which were expensed as incurred. As of December 31, 1998, we had 26 full-time employees engaged in research and development. COMPETITION The market for all levels of RAID subsystems is subject to intense competition. We compete not only with other disk array manufacturers, but also with manufacturers of proprietary, integrated computer systems and system integrators which sell computer systems containing general purpose RAID subsystems, some of which may have significantly greater financial and technological resources or larger distribution capabilities than we do. Certain competitors may offer their products at lower sales prices than we do; accordingly, we must often compete on the basis of product quality, performance and reliability in specific applications. Our continued ability to compete will largely depend upon our ability to continue to develop high performance products at competitive prices while continuing to provide superior technical support and customer service. EMPLOYEES As of December 31, 1998, we employed 73 full-time employees, of which 26 were involved in engineering, product development and technical support, 19 in sales and marketing, 16 in manufacturing and operations, and 12 in finance, management and administration. 16 Our employees are not covered by a collective bargaining agreement, there have been no work stoppages and we believe our employee relations are good. We also believe that our future success will largely depend upon our ability to continue to attract, employ and retain competent qualified technical, marketing and management personnel. Experienced personnel are in great demand and we must compete with other technology firms, some of which may offer more favorable economic incentives to attract qualified personnel. CERTAIN TRANSACTIONS AND RELATIONSHIPS Hilcoast Advisory Services, Inc. ("Advisor") From July 1, 1996 through October 31, 1997, we paid $6,000 per month, plus reimbursement of out-of-pocket expenses, to Advisor for certain financial consulting and administrative services provided to us. H. Irwin Levy, Chairman of the Board of Directors and a major stockholder of the Company, is the Chairman of the Board, Chief Executive Officer and a majority shareholder of Advisor's parent. We believe that the terms of this agreement were no less favorable to us than those that would have been received from other sources. Intelligent Manufacturing Systems, Inc. ("IMS") R. Daniel Smith, a former director and president of our company ("Mr. Smith"), was also the Chief Executive Officer and sole shareholder of IMS, which specialized in providing software solutions. In July 1996, we purchased an integrated software package from IMS, including installation, consulting and training support, at a cost of approximately $272,000. The software package was purchased to facilitate our internal operation, sales and marketing, service and engineering modules. In June 1997, we acquired the assets of IMS for approximately $135,000 which was based on the net book value of the assets acquired. We believe that the terms of these transactions were no less favorable to us than those that would be paid to other vendors. Item 2. Properties We lease approximately 40,000 square feet of office and warehouse space in Lake Mary, Florida, under lease agreements for 22,000 square feet and 18,000 square feet, which expire in April 2000 and February 2002, respectively, at present annual base rents of approximately $149,000 and $119,000, respectively. The larger facility accommodates our executive offices, administration and 17 management, engineering, sales and marketing. The smaller facility accommodates manufacturing and technical support. We also lease 7,750 square feet of office space in Boulder, Colorado under a lease which expires in 2001, at a present annual base rent of $124,000. We believe our existing facilities are adequate to meet our future needs. Item 3. Legal Proceedings In June 1996, Jack Ehrenhuas, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud Mendelson and Susan Felton filed a Complaint in the Supreme Court of the State of New York, County of Nassau, against us and, Michael Wise (presently a director and Vice Chairman of the Board of Directors). The plaintiffs claim to have contractual and proprietary interests in the prospect of a transaction to purchase certain net assets we acquired (see Note 2 to Consolidated Financial Statements) and seek compensatory damages plus punitive damages. In August 1996, The Nais Corporation, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud Mendelson and Susan Felton filed a Complaint in the same Court making similar allegations against Mr. Smith, IMS and the Company. In this action, the plaintiffs seek compensatory damages plus punitive damages for alleged breach of contract. Both cases are currently in discovery. Our counsel believes that we have good defenses to both claims and that we will not incur any material liability. We are unaware of any facts that would support any of the plaintiffs' claims and, accordingly, we believe that the claims are without merit. In June 1998, a Complaint was filed in the Supreme Court of the State of New York by AIBC Investment Services Corp. ("AIBC") claiming that our company and Mr. Smith breached an agreement with AIBC in which AIBC was allegedly engaged as placement agent in connection with raising funds for us. AIBC seeks damages of not less than $262,500 plus interest, warrants to purchase our common stock at a price to be determined and punitive damages. The case is in the initial stages of discovery and we believe that the claims are without merit and will not result in any material liability. From time to time, we are subject to legal proceedings and other claims arising in the ordinary course of business. In our opinion, we are not a party to any litigation, the outcome of which would have a material adverse effect on our business or operations. 18 Item 4. Submission of Matters to a Vote of Security Holders Effective November 17, 1998, stockholders holding approximately 9,600,000 shares of our common stock voted, by written consent, to remove R. Daniel Smith as a Director of our company. PART II Item 5. Market for Our Common Equity and Related Stockholder Matters Our common stock commenced trading on the American Stock Exchange ("AMEX") in April 1997 under the symbol NSO. Prior to that time, our common stock traded on the over-the-counter ("OTC") market under the symbol NSTT. The following table sets forth the market price range of our common stock for each quarter during the years ended December 31, 1998 and 1997, based on the high and low closing sales prices as reported by AMEX or the National Association of Securities Dealers' Automated Quotation System. During that period, we did not pay any dividends on the common stock and we do not expect to pay any dividends in the near future. In addition, our asset based revolving credit facility prohibits us from declaring or paying cash dividends on any of our stock, other than preferred stock. Market Price Range -------------------- 1998 High Low ---- -------- -------- First quarter 2-1/16 1-9/16 Second quarter 1-9/16 1 Third quarter 7/8 3/8 Fourth quarter 2-5/8 7/16 1997 ---- First quarter 2-25/32 1-7/8 Second quarter 2-15/16 1-3/4 Third quarter 2-5/16 1/9/16 Fourth quarter 2-3/4 1-5/8 As of March 31, 1999, we had 21,492,258 shares of common stock outstanding and approximately 1,728 holders of record of such stock. 19 Changes in Securities and Use of Proceeds Effective April 14, 1998, we issued and sold in a private placement to certain accredited investors a total of 3,500 shares (including 1,000 shares to H. Irwin Levy, Chairman of the Board of Directors and a major stockholder - "Mr. Levy") of 8% Convertible Preferred Stock, Series A (the "Series A Preferred Stock") at a purchase price of $1,000 per share, resulting in gross proceeds to the Company of $3.5 million. The shares of Series A Preferred Stock were convertible into shares of our common stock at the lesser of $1.44 per share or 77% of the market value of the common stock on the date of conversion. In connection with the sale of the Series A Preferred Stock, we issued warrants to purchase 280,000 shares of our common stock (including 80,000 warrants to Mr. Levy) exercisable at any time through April 2001 at an exercise price of $1.50 per share. On June 1, 1998, we created a new class of 8% Convertible Preferred Stock, Series B (the "Series B Preferred Stock"), which was identical to the Series A Preferred Stock with the single exception that under certain limited circumstances, we could redeem the Series B Preferred Stock for cash in the amount of 130% of the purchase price of the Series B Preferred Stock. On June 9, 1998, each holder of the Series A Preferred Stock exchanged their shares of Series A Preferred Stock for an equal number of shares of Series B Preferred Stock and, on June 12, 1998, we filed a Certificate of Elimination with the Secretary of State of Delaware to formally eliminate the Series A Preferred Stock. On July 7, 1998, we borrowed $1 million from a private, accredited investor under an 8% Convertible Subordinated Debenture (the "Debenture") which matured on September 25, 1998, as extended. In September 1998, the Debenture was converted into 1,667 shares of a newly created Series A Preferred Stock with a stated value of $600 per share. The Series A Preferred Stock accrues dividends at 8% per annum, payable quarterly, is convertible, commencing July 7, 1999 into shares of our common stock at a fixed conversion price of $.60 per share and contains an automatic conversion feature in which each share not converted as of July 7, 2000 automatically converts into shares of our common stock. On October 30, 1998, we redeemed $2.3 million of our Series B Preferred Stock held by unrelated private investors for approximately $2.5 million in cash (including a premium of $115,000 and accrued dividends of $102,000) and warrants to purchase 300,000 shares of our common stock, exercisable upon issuance at $1.00 per share and expiring in October 2001. In conjunction with this redemption, effective October 28, 1998, we issued 1,000 shares of Series C Convertible Preferred Stock with a stated value of $1,000 per share (the "Series C Preferred Stock") in exchange for the 20 remaining 1,000 shares of Series B Preferred Stock held by Mr. Levy. The Series C Preferred Stock accrues dividends at 8% per annum, payable quarterly, is convertible commencing July 7, 1999 into shares of our common stock at a fixed conversion price of $1.00 per share and contains an automatic conversion feature in which each share not converted as of July 7, 2000 automatically converts into shares of our common stock. During September and October 1998, we issued 2,000 additional shares of Series C Preferred Stock to Mr. Levy, in satisfaction of $2 million we owed to Mr. Levy. In October 1998, we created 8% Convertible Preferred Stock, Series D (the "Series D Preferred Stock") which accrues dividends at 8% per annum, is convertible into shares of our common stock commencing six months from the date of issue based on a fixed conversion price of $1.00 per share and has an automatic conversion feature for all shares not converted within three years from the date of issue. Effective October 30, 1998, we issued and sold in a private placement to certain accredited investors a total of 2,700 shares of Series D Preferred Stock at a purchase price of $1,000 per share, resulting in gross proceeds to our company of $2.7 million, of which approximately $2.5 million was used to redeem $2.3 million of our Series B Preferred Stock, as discussed above. Item 6. Selected Financial Data (dollars in thousands, except per share data) The following table summarizes certain selected consolidated financial data for our company for the year ended December 31, 1998 and 1997, for the two month transition period ended December 31, 1996, and for each of the years ended in the three year period ended October 31, 1996. In November 1996, we changed our fiscal year from October 31 to December 31, effective with the calendar year beginning January 1, 1997. Certain amounts for years prior to fiscal 1998 have been reclassified to conform to the 1998 presentation. These reclassifications had no impact on operating results previously reported. The selected financial data has been derived from our audited consolidated financial statements and is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations", included elsewhere in this report: 21 Two Months Year Ended Ended December 31, December Year Ended October 31, --------------------- 31, ------------------------------- 1998 1997 1996 1996 1995 1994 ---------- ---------- ---------- ---------- ---------- --------- Sales $18,026 $26,244 $ 4,739 $ 5,619 $ - $ - Gross profit 2,768 4,783 1,348 2,072 - - Net income (loss) (10,407) (7,886) (43) 12,798(1) (61) (272) Net income (loss) applicable to common stock (11,888) (7,886) (43) 12,798(1) (61) (272) Basic and diluted net income (loss) per common share (.63) (.42) (.00) .73 (.00) .02 Average number of common shares out- standing 18,888,911 18,670,477 18,670,477 17,606,477 17,600,477 17,600,477 At end of period: Working capital (deficit) $ 2,087 ($ 1,434) $5,852 $11,045 $11,408 ($586) Total assets 14,128 16,762 20,067 15,677 12,054 26 Long-term debt 7,043 1,504 516 510 476 444 Shareholders' equity (deficit) 3,150 5,037 12,817 12,390 10,932 (1,030) - ---------- (1) Principally consists of $11,955 gain from the sale of IMNET stock (see Note 3 to Consolidated Financial Statements). Also includes extraordinary gain of $566 ($.03 per basic and diluted share) (see Note 7 to Consolidated Financial Statements). 22 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements With the exception of the discussion regarding historical information, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other discussions elsewhere in this Form 10-K contain forward looking statements. Such statements are based on current expectations subject to uncertainties and other factors which may involve known and unknown risks that could cause actual results of operations to differ materially from those projected or implied. Further, certain forward looking statements are based upon assumptions about future events which may not prove to be accurate. Risks and uncertainties inherent in forward looking statements include, but are not limited to, our future cash flows and ability to obtain sufficient financing, timing and volume of sales orders, level of gross margins and operating expenses, lack of market acceptance of our new product lines, price competition, conditions in the technology industry and the economy in general, our customers and vendors ability to achieve year 2000 functionality, as well as legal proceedings. The economic risk associated with materials cost fluctuations and inventory obsolescence is significant to our company. The ability to manage our inventories through procurement and utilization of component materials could have a significant impact on future results of operations or financial condition. Historical results are not necessarily indicative of the operating results for any future period. Subsequent written and oral forward looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by cautionary statements in this Form 10-K and in other reports we filed with the Securities and Exchange Commission. The following discussion should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included elsewhere in this filing. Overview We are engaged as a manufacturer and supplier of high-performance information storage solutions, including external RAID (Redundant Array of Independent Discs) subsystems, Network Attached Storage, data storage enclosures, storage management software solutions and AdaptiveRAID technology. We design, manufacture and sell high performance fault tolerant data storage solutions supporting a variety of operating system environments for a wide range of customer requirements. 23 Our company has grown through several acquisitions (see Note 2 to Consolidated Financial Statements), the first of which occurred in June 1996 when we acquired the RAID business from Seagate Peripherals, Inc. In December 1996, we acquired substantially all the net assets of Parity Systems, Inc. (the "Parity Acquisition"). In April 1998, we acquired Borg Adaptive Technologies, Inc. ("Borg"). Allocations have been made to reflect the estimated fair values of the net assets acquired resulting in asset bases which differ from those of the previous owners. In addition, certain operating policies and accounting procedures are different from those of the previous owners. Accordingly, comparative financial data of the acquired businesses for periods prior to the acquisitions are not presented in this section since they would be neither comparable nor informative. Prior to the first acquisition in June 1996, our only assets were securities issued by IMNET Systems, Inc. ("IMNET" - see Note 3 to Consolidated Financial Statements), which we had acquired in October 1992 in exchange for substantially all of the Company's operating assets. During the time in which we owned the IMNET securities, our only activities consisted of monitoring our investment in IMNET and evaluating potential business opportunities. As a result of declining sales during 1998, we undertook an initiative to eliminate positions no longer needed and to increase operating efficiencies. This strategy resulted in significant workforce reductions, a realignment of certain operating expenses and the elimination of certain less profitable products. As a result, in July 1998 we announced that we would focus on our core storage technology and executed an orderly transition to phase out all non-storage related businesses, including our memory division. Effective October 1, 1998, we sold to an unrelated party our integrated systems division which installed and supported enterprise resource planning manufacturing software for a net sales price of $111,000. Results of Operations The following table sets forth, for the periods indicated, certain operating data as a percentage of sales. 24 Year Ended Two Months December 31, Ended Year Ended ------------------ December 31, October 31, 1998 1997 1996 1996 -------- -------- ----------- ----------- Sales 100% 100% 100% 100% Cost of sales 85 82 72 63 ---- ---- ---- ---- Gross profit 15 18 28 37 Selling, general and administrative 46 34 23 21 Research and development 14 10 6 13 Depreciation and amortization 8 3 1 1 ---- ---- ---- ---- Income (loss) from operations (53) (29) (2) 2 Interest expense (income) net 5 - (1) (3) ---- ---- ---- ---- Income (loss) before income taxes (58%) (29%) (1%) 5%(a) ==== ==== ==== ==== - -------- (a) Percentage of income before income taxes excludes gains from non- recurring transactions such as the gain reported from the sale of IMNET Systems, Inc. stock of $11,955,000 and the extraordinary gain from debt extinguishment of $566,000. Comparison of Fiscal Years Ended December 31, 1998 and December 31, 1997 The Company reported a net loss applicable to common stock of $11.9 million for the year ended December 31, 1998 as compared to a net loss of $7.9 million from the year ended December 31, 1997. Sales Sales for the year ended December 31, 1998 were $18 million as compared to $26.2 million during the preceding year, a decrease of $8.2 million or 31%. Factors contributing to this sales decline included: (i) delays in customer deliveries and in some cases, missed sales orders in early 1998, caused by our inability to meet customer production schedules brought about by our cash flow difficulties at that time; (ii) lost sales opportunities while reorganizing and training our sales force under new executive sales management; and (iii) entering 1998 with a significantly lower balance of sales orders than were in place as of the beginning of 1997. Another significant factor was a $3.8 million decrease in non-storage related product sales, including memory products and enterprise resource planning manufacturing software ("Software"), 25 as a result of our decision to phase out our non-storage related businesses. The following table sets forth sales by product type (in thousands): 1998 1997 ------- ------- Storage $16,439 $20,856 Memory 511 2,930 Software 1,076 2,458 ------- ------- $18,026 $26,244 ======= ======= Our company's sales growth in 1999 is dependent on our ability to develop and market new products, expand the applications of existing products into targeted market sectors and expand our sales distribution channels through the addition of new distributors, value added resellers and manufacturers sales representatives. Cost of Sales/Gross Profit Gross profit decreased to 15% for the year ended December 31, 1998, as compared to 18% for the previous year. Our gross profit is dependent, in part, on product mix which fluctuates from time to time. The decline in gross profit is primarily due to a decreased sales level of products with overall higher margins and certain cash flow difficulties which limited our ability to purchase products in the most cost efficient manner. Excluding additions to inventory reserves, the overall gross profit for 1998 would have been 23% as compared to 24% for 1997. We expect our gross profits to improve during 1999 partially due to the elimination of certain products with lower gross profits. Operating Expenses Selling, General and Administrative Expenses Selling, general and administrative expenses were $8.3 million (46% of sales) and $8.9 million (34% of sales) for the year ended December 31, 1998 and 1997, respectively. The $.6 million decrease is principally attributable to overall reduced spending levels resulting from planned cost reductions, primarily advertising and travel, which were implemented as a result of the lower sales levels. Selling, general and administrative costs as a percentage of sales increased 12% during 1998 principally attributable to the level of certain fixed costs we incurred while sales levels declined. 26 We do not expect selling, general and administrative expenses to significantly increase in the near future, except to the extent that sales commissions and other marketing costs may increase due to increases in sales revenue. Research and Development Research and development expenses were $2.6 million for the year ended December 31, 1998 and remained relatively unchanged from the preceding year. Certain of these expenses decreased as a result of the continued integration of previously acquired engineering activities. This decrease was offset by increased engineering staffing and related overhead of $.6 million resulting from the Borg acquisition in April 1998, and increased project costs in connection with the development of new products. We believe that considerable investments in research and development will be required to remain competitive and expect that these expenses will increase in future periods. Research and development costs are expensed as incurred and may fluctuate considerably from time to time depending on a variety of factors. These costs are substantially incurred in advance of related sales, or in certain situations, may not ultimately generate sales. Depreciation and Amortization Depreciation and amortization increased $.6 million for the year ended December 31, 1998 as compared to 1997, primarily due to additions to test equipment and computer software. Interest Expense Interest expense in 1998 increased $.7 million over 1997 as a result of a significant increase in net average borrowings and the amortization of loan costs in connection with certain indebtedness (see Note 6 to Consolidated Financial Statements). Preferred Stock Dividends In March 1997, the Securities and Exchange Commission Staff (the "Staff") announced its position on accounting for preferred stock which is convertible into common stock at a discount from the market rate at the date of issuance. The Staff indicated that a preferred stock dividend attributable to such a beneficial conversion privilege should be recorded for the difference between the conversion price and the quoted market price of common stock at 27 the date of issuance. Accordingly, during 1998 we recorded $1,218,000 as an embedded dividend attributable to the beneficial conversion privilege, including $1,045,000 on our Series B Convertible Preferred Stock and $173,000 on our Series A Convertible Preferred Stock (see Note 10 to Consolidated Financial Statements). In addition, for the year ended December 31, 1998, all classes of our convertible preferred stock required cumulative dividends at 8% and aggregated $263,000. Absent significant conversions to common stock, such dividends are expected to increase as a result of a full twelve months dividends in 1999 on certain classes that were issued in September and October 1998. Comparison of Fiscal Years Ended December 31, 1997 and October 31, 1996 We reported a net loss of $7.9 million for the year ended December 31, 1997 as compared to net income of $12.8 million for the year ended October 31, 1996. For the two month transition period ended December 31, 1996, we reported a net loss of $43,000. Results of operations for fiscal 1996 included a gain of $11,955,000 resulting from the disposition of 100% of our investment in IMNET (see Note 3 to Consolidated Financial Statements) and an extraordinary gain of $566,000 on extinguishment of debt (see Note 7 to Consolidated Financial Statements). Sales Sales increased to $26.2 million for fiscal 1997 from $5.6 million for the year ended October 31, 1996. From January 1, 1996 until our initial acquisition of the RAID Business in June 1996, there were no sales reported by our company. Accordingly, the year ended October 31, 1996 included sales for the initial five months of operation of the RAID Business and does not include sales generated from the Parity Acquisition effective December 1, 1996. Sales for the two month transition period amounted to $4.7 million and included only one month of sales resulting from our company's Parity Acquisition. Sales levels were adversely affected during 1997 by delays in completing the integration of our new product CR8e RAID subsystem. We were dependent upon the development of a third party controller product that was delivered to us more than six months late which resulted in reduced sales volume and pricing for our CR8e subsystem. We also suffered disruptions in manufacturing associated with the transfer and integration of production from California to Florida after the Parity Acquisition. 28 Cost of Sales/Gross Profit Gross profit for the year ended December 31, 1997 decreased to 18% from 37% for the year ended October 31, 1996. Gross profit for the two month transition period ended December 31, 1996 was at 28%. Our gross profit is dependent, in part, on product mix which will fluctuate from time to time. Reduced gross profit for 1997 is primarily the result of an approximate $2.9 million write-down of inventory resulting from our revaluation of certain inventory acquired in the Parity Acquisition, potential obsolete inventory, transitional issues associated with the implementation of a new materials requirement planning system, lower sales volume and sales prices for our storage subsystems and overall lower margins from the sale of our memory products. Selling, General and Administrative Expenses Selling, general and administrative costs for the year ended December 31, 1997 increased to $8.9 million (34% of sales) from $1.2 million (21% of sales) for the year ended in October 31, 1996. This increase was primarily the result of twelve months of operations in 1997 as compared to only five months included in fiscal 1996, the latter period excluding the Parity Acquisition effective December 1, 1996. The most significant increase in 1997 expenses resulted from compensation and related benefits of additional employees brought about by the Parity Acquisition. Research and Development Research and development expenses for the year ended December 31, 1997 amounted to $2.6 million, representing 10% of sales as compared to the year ended October 31, 1996 when expenses were $.7 million or 13% of sales. The increase in research and development expenses was principally the result of twelve months of operations in 1997 as compared to only five months included in fiscal 1996, costs associated with redesigning, standardizing and obtaining agency certification for new product development and expenses associated with preparation for our anticipated future growth. Depreciation and Amortization Depreciation and amortization increased to $.8 million for the year ended December 31, 1997 from $.1 million for the year ended October 31, 1996, principally due to only five months of expense included in 1996. 29 Liquidity and Capital Resources Consolidated Statements of Cash Flows Operating Activities Net cash used by operating activities amounted to $10.5 million and $6.3 million for the years ended December 31, 1998 and 1997, respectively. The most significant use of cash for both fiscal years was our loss from operations (before changes in assets and liabilities) of $6.7 million in 1998 and $4.9 million in 1997. In addition, net cash was used by a $3.5 million decrease in our accounts payable and other liabilities in 1998 and a $1.9 million increase in our inventories in 1997. Investing Activities Net cash used by investing activities for the years ended December 31, 1998 and 1997 amounted to $.8 million and $1.5 million, respectively, primarily resulting from additional investments in property and equipment. Cash used by investing activities for acquisitions for the year ended December 31, 1998, the two month transition period ended December 31, 1996 and the year ended October 31, 1996 amounted to $.4 million, $2.8 million and $.6 million, respectively. In addition, during the year ended October 31, 1996, we received approximately $12 million cash from the sale of our IMNET Systems, Inc. stock (see Note 3 to Consolidated Financial Statements). Financing Activities Net cash provided by financing activities for 1998 amounted to approximately $11.4 million, and primarily consisted of net borrowings of $5.9 million (including $3 million subsequently converted into Convertible Preferred Stock), $3.5 million of net proceeds from the issuance of convertible preferred stock (net of $2.4 million we used to redeem a prior issuance of convertible preferred stock) and $1.7 million from the exercise of stock warrants. Net cash provided by financing activities for 1997 amounted to $3.2 million, consisting of $4.2 million in borrowings, less $1 million used as restricted cash under borrowings. For the two month transition period ended December 31, 1996, net cash provided by financing activities amounted to $2.7 million principally from the repayment of borrowings in connection with our Parity Acquisition. 30 Asset Based Credit Facilities In May 1997, we obtained an asset based revolving bank credit facility (the "Revolver"), under which we could borrow up to $7 million. Subsequently, we were not consistently in compliance with certain financial covenants of the Revolver; however, under amendments to the Revolver in December 1997 and in February 1998, the bank waived compliance and the maximum borrowings were reduced to $3,250,000 through June 30, 1998 with gradual reductions to $2.4 million thereafter until maturity on July 31, 1998. The Revolver was collateralized by substantially all of our assets, including approximately $1 million reflected as Restricted Cash at December 31, 1997. On August 3, 1998, we repaid the Revolver with a replacement asset based revolving credit facility (the "New Revolver") which provides for borrowings based on the lesser of $5 million or 80% of the Company's eligible accounts receivable, as defined. The New Revolver bears interest, payable monthly, based on prime plus 2% (9-3/4% at December 31, 1998), is guaranteed by our company and matures on August 3, 2000. We pay a facility fee equal to 1% per annum on the total facility of $5 million. Advances under the New Revolver are collateralized by substantially all of our assets, including $.5 million reflected as Restricted Cash at December 31, 1998. The loan agreement provides for certain financial covenants including current ratio and net worth requirements, limitations on operating losses and restrictions on the incurrence of additional debt, capital expenditures and the payment of dividends, other than preferred stock dividends. At December 31, 1998, we were not in compliance with the financial covenant concerning our operating losses for 1998; however, effective February 4, 1999, the lender agreed to forbear declaring a default. Financing Activities With Private Investors In late 1997, we determined that amounts available under the Revolver would not be sufficient to satisfy our cash requirements and, therefore, additional debt and/or equity financing would be necessary. Subsequently, through December 31, 1998, we obtained net cash proceeds of $13.5 million ($1 million in 1997 and $12.5 million in 1998) from private investors, consisting of $3.5 million of 8% Convertible Preferred Stock (net of $2.4 million used to redeem a prior issuance of 8% Convertible Preferred Stock - see Note 10 to Consolidated Financial Statements), $3 million which was initially in the form of debt and subsequently converted to 8% Convertible Preferred Stock, $5.3 million of net borrowings, principally 10% subordinated loans (the "Subordinated Loans" - see Note 6 to Consolidated Financial Statements), which mature on September 5, 2000, and $1.7 million received from the exercise of stock warrants. 31 Of these amounts, as of December 31, 1998, H. Irwin Levy, Chairman of the Board of Directors and a principal stockholder, and a privately owned corporation controlled by Mr. Levy (collectively, "Mr. Levy") held $3 million of 8% Convertible Preferred Stock, $1 million of Subordinated Loans (net of $1 million sold by Mr. Levy as participation interests) and $300,000 of short-term loans which were repaid in February 1999. In addition, in December 1998 we received approximately $400,000 when Mr. Levy exercised warrants to purchase 333,332 shares of our common stock. Through December 31, 1998, Mr. Levy also advanced an additional $3.4 million, which we repaid by December 31, 1998. Pursuant to a Promissory Note, dated March 1, 1999, Mr. Levy has agreed to loan us up to an additional $1 million through September 30, 1999. From March 1, 1999 through March 31, 1999, we have borrowed an additional $790,000 under that Note. In addition, in February and March 1999, we borrowed $2.3 million from three unrelated private investors, of which $1.8 million matures in September 2000 and $500,000 in June 1999. We also received approximately $1.6 million from the exercise of warrants and options to purchase 978,833 shares of our common stock. In April 1999, we issued 500,000 shares of newly issued common stock to an unrelated private investor for $1 million. We believe that amounts expected to be available under lending arrangements with financial instiutions, from the proceeds received from issuance of common stock and from Mr. Levy will be sufficient to satisfy our working capital needs during 1999, as presently contemplated. There can be no assurance, however, that we may not require additional capital beyond our current forecasted needs nor that any such additional required funds would be available on terms acceptable to us, if at all, at such time or times as required by us. Recent Development In March 1999, we entered into an agreement to purchase 75% of the outstanding common stock of Andataco, Inc. ("Andataco") from its principal stockholder, David Sykes. That agreement also contemplates we would purchase from Mr. Sykes a note in the principal amount of $5,196,000, issued to him by Andataco. Following the purchase of Mr. Sykes' shares, he would continue to serve as President of Andataco, pursuant to a proposed three-year employment agreement. The purchase is contingent on our raising the capital necessary to fund the acquisition. If the transaction is completed, it would be our intention to acquire the remaining Andataco shares as soon as possible following an independent professional determination of the fair value of such shares. 32 We are currently negotiating with unrelated private investors to obtain approximately $15 million in a private placement of convertible preferred stock (the "Private Placement"). Proceeds from the Private Placement would be used to finance the proposed Andataco acquisition, if consummated, and to provide additional working capital for our company. There can be no assurance, however, that we will be successful in obtaining the funds necessary to finance the proposed acquisition nor that the acquisition will be completed. Effect of Inflation During recent years, inflation has not had an impact on our operations and we do not expect that it will have a material impact in 1999. Recently Issued Accounting Pronouncements 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 requires companies to recognize all derivative contracts as either assets or liabilities in the balance sheet and to measure them at fair value. SFAS 133 is effective for periods beginning after June 15, 1999. Historically, we have not entered into derivative contracts. Accordingly, the adoption of this pronouncement is not expected to have a material impact on our financial statements or disclosures. Year 2000 Issue As many computer systems, software programs and other equipment with embedded chips or processors (collectively, "Information Systems") use only two digits rather than four to define the applicable year, they may be unable to process accurately certain data, during or after the year 2000. As a result, business and governmental entities are at risk for possible miscalculations or systems failures causing disruptions in their business operations. This is commonly known as the Year 2000 ("Y2K") issue. The Y2K issue concerns not only Information Systems used solely within a company but also concerns third parties, such as customers, vendors and creditors, using Information Systems that may interact with or affect a company's operations. 33 The Company's State of Readiness We have implemented a Y2K readiness program with the objective of having all of our significant Information Systems functioning properly with respect to Y2K before January 1, 2000. The first component of our readiness program was to identify our internal Information Systems that are susceptible to system failures or processing errors as a result of the Y2K issue. This effort is substantially complete and no material issues requiring remediation or replacement have been identified. The review of our financial systems has been completed and no issues have been identified. As to the second component of the Y2K readiness program, we intend to identify our significant customers, vendors and creditors that are believed, at this time, to be critical to business operations subsequent to January 1, 2000. We expect to reasonably ascertain their respective stages of Y2K readiness through the use of questionnaires, interviews and other available means. We will take appropriate action based on those responses, but there can be no assurance that the Information Systems provided by or utilized by other companies which affect their operations will be timely converted in such a way as to allow them to continue normal business operations or furnish products, services or data to us without disruption. Risks If needed remediations and conversions to the Information Systems are not made on a timely basis by our materially-significant customers or vendors, we could be affected by business disruption, operational problems, financial loss, legal liability to third parties and similar risks, any of which could have a material adverse effect on our operations, liquidity or financial condition. Factors which could cause material differences in results, many of which are outside our control, include, but are not limited to, the accuracy of representations by manufacturers of our Information Systems that their products are Y2K complaint, the ability of our customers and vendors to identify and resolve their own Y2K issues and our ability to respond to unforeseen Y2K complications. Y2K Costs Our total cost of these Y2K compliance activities has not been and is not anticipated to be material to our business, results of operations or financial condition. The costs and time necessary to complete the Y2K modification and testing processes are based on management's best estimates, which were derived utilizing numerous assumptions of future events including the continued availability of certain resources, third party modification plans and other factors. However, there can be no assurance that these estimates will be achieved and actual results could differ from the 34 estimates. Our Y2K readiness program is an ongoing process and the estimates of costs and completion dates for various components of the Y2K readiness program described above are subject to change. Item 8. Financial Statements and Supplementary Data Table of Contents to Consolidated Financial Statements Page Report of Independent Certified Public Accounts 36 Consolidated Financial Statements: Balance sheets - December 31, 1998 and 1997 37 Statements of Operations - Year Ended December 31, 1998 and 1997, Two Months Ended December 31, 1996, and Year Ended October 31, 1996 38 Statements of Comprehensive Income - Year Ended December 31, 1998 and 1997, Two Months Ended December 31, 1996 and Year Ended October 31, 1996 39 Statements of Stockholders' Equity - Year Ended December 31, 1998 and 1997, Two Months Ended December 31, 1996, and Year Ended October 31, 1996 40-41 Statements of Cash Flows - Year Ended December 31, 1998 and 1997, Two Months Ended December 31, 1996, and Year Ended October 31, 1996 42-43 Notes to Consolidated Financial Statements 44-63 Schedules are omitted because they are not required, or because the information required therein is set forth in the Consolidated Financial Statements or the notes thereto. 35 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Board of Directors of nStor Technologies, Inc. We have audited the accompanying consolidated balance sheets of nStor Technologies, Inc. and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, comprehensive income, stockholders' equity and cash flows for the years ended December 31, 1998 and 1997, October 31, 1996, and the two months ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of nStor Technologies, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for the years ended December 31, 1998 and 1997, October 31, 1996 and for the two months ended December 31, 1996, in conformity with generally accepted accounting principles. BDO SEIDMAN, LLP Orlando, Florida March 5, 1999, except for Note 15, which is as of April 15, 1999 36 nStor TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ========================================= (dollars in thousands) December 31, ----------------- ASSETS (Note 6) 1998 1997 --------------- ------- ------- Current assets: Cash and cash equivalents: Restricted $ 21 $ 1,024 Unrestricted 147 61 Accounts receivable (Note 4) 2,462 3,863 Inventories (Note 4) 3,028 3,577 Prepaid expenses and other 364 262 ------- ------- Total current assets 6,022 8,787 Restricted cash (Note 6) 500 - Property and equipment, net of $1,251 and $457 accumulated depreciation (Note 4) 1,653 2,060 Goodwill and other intangible assets, net of $939 and $470 accumulated amortization (Note 4) 5,953 5,915 ------- ------- $14,128 $16,762 LIABILITIES ======= ======= ----------- Current liabilities: Borrowings (Note 6) $ 500 $ 3,445 Accounts payable and other 3,435 6,776 ------- ------- Total current liabilities 3,935 10,221 Long-term debt (Note 6) 7,043 1,504 ------- ------- Total liabilities 10,978 11,725 ------- ------- Commitments, contingencies and subsequent events (Notes 9, 13 and 15) SHAREHOLDERS' EQUITY (Notes 2, 6, 10, 11 and 15) ------------------------------------------------ Preferred stock, $.01 par; shares authorized 1,000,000; shares issued and outstanding at December 31, 1998 - Series A, Convertible Preferred Stock, 1,667; Series C, Convertible Preferred Stock, 3,000; Series D, Convertible Preferred Stock, 2,700; none outstanding at December 31, 1997 - - Common stock, $.05 par; shares authorized 40,000,000; 20,515,425 and 18,670,477 shares issued and outstanding at December 31, 1998 and December 31, 1997, respectively 1,025 934 Additional paid-in capital 40,409 30,499 Deficit (38,284) (26,396) ------- ------- Total shareholders' equity 3,150 5,037 ------- ------- $14,128 $16,762 ======= ======= See accompanying notes to consolidated financial statements. 37 nStor TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ========================================= (dollars in thousands, except per share data) Two Year Ended Months Year December 31, Ended Ended ------------------ December October 1998 1997 31, 1996 31, 1996 -------- -------- -------- -------- Sales (Note 8) $18,026 $26,244 $ 4,739 $ 5,619 Cost of sales 15,258 21,461 3,391 3,547 ------- ------- ------- ------- Gross profit 2,768 4,783 1,348 2,072 ------- ------- ------- ------- Operating expenses: Selling, general and administrative 8,335 8,909 1,081 1,188 Research and development 2,572 2,618 293 701 Depreciation and amortization 1,352 777 79 68 ------- ------- ------- ------- Total operating expenses 12,259 12,304 1,453 1,957 ------- ------- ------- ------- Income (loss) from operations (9,491) (7,521) (105) 115 Gain from sale of IMNET Systems, Inc. stock (Note 3) - - - 11,955 Interest income 71 120 87 234 Interest expense (987) (247) (25) (72) ------- ------- ------ ------- Income (loss) before income taxes and extraordinary gain (10,407) (7,648) (43) 12,232 Extraordinary gain from debt extinguishment (Note 7) - - - 566 ------- ------- ------ ------- Income (loss) before income taxes (10,407) (7,648) (43) 12,798 Income tax expense (Note 5) - (238) - - ------- ------- ------ ------- Net income (loss) (10,407) (7,886) (43) 12,798 Preferred stock dividends (263) - - - Embedded dividend attributable to beneficial conversion privilege of Convertible Preferred Stock (Note 10) (1,218) - - - ------- ------- ------ ------- Net income (loss) applicable to common stock ($11,888) ($ 7,886) ($ 43) $12,798 ======= ======= ====== ======= Basic and diluted net income (loss) per common share: Income (loss) before extra- ordinary gain ($ .63) ($ .42) ($ .00) $ .70 Extraordinary gain - - - .03 ------- ------- ------ ------- Net income (loss) per common share ($ .63) ($ .42) ($ .00) $ .73 ======= ======= ====== ======= Average number of common shares outstanding, basic and diluted 18,888,911 18,670,477 18,670,477 17,606,477 ========== ========== ========== ========== See accompanying notes to consolidated financial statements. 38 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME =============================================== (dollars in thousands) Two Year Ended Months Year December 31, Ended Ended ------------------ December October 1998 1997 31, 1996 31, 1996 -------- -------- -------- -------- Net income (loss) ($10,407) ($7,886) ($43) $12,798 Other comprehensive income: Unrealized gain on securities held for sale (Note 3) - - - (12,023) -------- -------- --- ------- Comprehensive income (loss) ($10,407) ($7,886) ($43) $ 775 ======== ======== === ======= See accompanying notes to consolidated financial statements. 39 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (NOTES 2, 6, 10 and 14) =============================================== (dollars in thousands)
Net Unrealized Preferred Addi- Gain on Common Stock Stock tional Securities ----------------- ------------- Paid-in Available Shares Amount Shares Amount Capital For Sale Deficit Total ---------- ------ ------ ------ -------- --------- -------- ------- Balances, October 31, 1995 17,600,477 $ 880 - - $29,294 $12,023 ($31,265) $10,932 Change in net unrealized gain on securities available for sale (12,023) (12,023) Issuance of common stock in connection with: Acquisition of minority interest 1,000,000 50 550 600 Exercise of warrants 60,000 3 57 60 Extinguishment of debt 10,000 1 22 23 Net income for the year ended October 31, 1996 12,798 12,798 ---------- ------ ----- ------ ------- ------- ------- ------- Balances, October 31, 1996 18,670,477 934 - - 29,923 - (18,467) 12,390 Common stock warrant issued in connection with acquisition 470 470 Net loss for the two months ended December 31, 1996 (43) (43) ---------- ------ ----- ------ ------ ------- ------- ------- Balances, December 31, 1996 18,670,477 934 - - 30,393 - (18,510) 12,817 Common stock options granted to outside directors 66 61 Common stock warrants issued in connection with borrowings 45 45 Net loss for the year ended December 31, 1997 (7,886) (7,886) ---------- ------ ----- ------ ------- ------- ------- ------ Balances, December 31, 1997 18,670,477 934 - - 30,499 - (26,396) 5,037 Issuance of Convertible Preferred Stock in private placements: Series B, less $262 of issuance cost 3,500 - 3,238 3,238 Series D, less $10 of issuance cost 2,700 - 2,690 2,690
40 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (NOTES 2, 6, 10 and 14) =============================================== (dollars in thousands) (concluded)
Net Unrealized Preferred Addi- Gain on Common Stock Stock tional Securities ----------------- ------------- Paid-in Available Shares Amount Shares Amount Capital For Sale Deficit Total ---------- ------ ------ ------ -------- --------- -------- ----- Issuance of Convertible Preferred Stock in satisfaction of borrowings: Series A, less $5 of issuance cost 1,667 - 995 995 Series C, less $4 of issuance cost (a) 2,000 - 1,996 1,996 Redemption of Convertible Preferred Stock, Series B, including $120 of redemption costs (a) (2,300) - (2,420) (2,420) Issuance of common stock in connection with: Conversion of Series B Convertible Preferred Stock 394,949 18 (200) - (18) - Exercise of warrants 1,449,999 73 1,602 1,675 Preferred stock dividends (263) (263) Embedded dividend attri- butable to beneficial conversion privilege of Convertible Preferred Stock: Series B 1,045 (1,045) - Series A 173 (173) - Common stock warrants issued in connection with: Long-term debt 427 427 Acquisition 148 148 Common stock options granted to outside directors 34 34 Net loss for the year ended December 31, 1998 (10,407) (10,407) ---------- ------ ----- ------ ------- ------- ------- ------- Balances, December 31, 1998 20,515,425 $1,025 7,367 - $40,409 $ - ($38,284) $ 3,150 ========== ====== ===== ====== ======= ======= ======= =======
__________ (a) In connection with the redemption of Series B Convertible Preferred Stock, $1 million of the remaining Series B was exchanged for Series C Convertible Preferred Stock. At December 31, 1998 there were 3,000 shares outstanding of Series C Convertible Preferred Stock with an aggregate stated value of $3 million. See accompanying notes to consolidated financial statements. 41 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Note 2) ===================================== (in thousands) Two Year Ended Months Year December 31, Ended Ended ------------------ December October 1998 1997 1996 1996 CASH FLOWS FROM OPERATING -------- -------- -------- -------- ACTIVITIES: Net income (loss) ($10,407) ($ 7,886) ($ 43) $12,798 Adjustments to reconcile net income (loss) to net cash used by operating activities: Gain from sale of IMNET Systems, Inc. stock - - - (11,955) Extraordinary gain from debt extinguishment - - - (566) Depreciation and amortization 1,352 777 79 68 Provision for inventory obsolescence 1,354 1,450 - 118 Provision for uncollectible accounts receivable 837 522 - - Amortization of deferred compensation 44 40 - - Amortization of deferred loan costs 140 27 - - Deferred income taxes - 182 - (182) Minority interest in net income of consolidated subsidiary - - - 26 Changes in assets and lia- bilities, net of effects from acquisition: Decrease (increase) in accounts receivable 564 338 (442) (1,731) Increase in inventories (805) (1,912) (189) (509) Increase in prepaid expenses and other (112) (94) (23) (82) (Decrease) increase in accounts payable and other liabilities (3,453) 242 452 1,574 ------- ------- ------- ------- Net cash used by operating activities (10,486) (6,314) (166) (441) ------- ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Net proceeds from sale of IMNET Systems, Inc. stock - - - 11,955 Cash paid for acquisitions (379) - (2,800) (592) Additions to property and equipment (456) (1,453) (323) (314) ------- ------- ------- ------- Net cash (used) provided by investing activities (835) (1,453) (3,123) 11,049 ------- ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments) proceeds from revolving bank credit facility (1,507) 3,245 (2,700) - Additions to other borrowings 10,803 988 Repayments on other borrowings (3,424) - - - Issuance of Convertible Preferred Stock in private placements 5,928 - - - Redemption of Convertible Preferred Stock (2,420) - - - 42 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Note 2) ===================================== (in thousands) (concluded) Two Year Ended Months Year December 31, Ended Ended ------------------ December October 1998 1997 31, 1996 31, 1996 -------- -------- -------- -------- Proceeds from exercise of stock warrants 1,675 - - 60 Decrease (increase) in restricted cash and cash equivalents 503 (1,024) - - Cash paid for preferred stock dividends (151) - - - Cash paid for debt extinguishment - - - (75) ------- ------- ------- ------- Net cash provided (used) by financing activities 11,407 3,209 (2,700) (15) ------- ------- ------- ------- Net increase (decrease) in unrestricted cash and cash equivalents during the year 86 (4,558) (5,989) 10,593 Unrestricted cash and cash equiva- lents at beginning of period 61 4,619 10,608 15 ------- ------- ------- ------- Unrestricted cash and cash equiva- lents at end of period $ 147 $ 61 $ 4,619 $10,608 ======= ======= ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during period for: Interest $ 807 $ 140 $ - $ - ======= ======= ======= ======= Income taxes $ 3 $ 238 $ - $ - ======= ======= ======= ======= NON-CASH INVESTING ACTIVITIES: Acquisitions (Note 2): Fair value of assets acquired $ 527 $ - $10,073 $ 1,856 Liabilities assumed - - (4,103) (664) Borrowings repaid at closing - - (2,700) - Common stock issued - - - (600) Warrant issued to seller (148) - (470) - ------- ------- ------- ------- Cash paid $ 379 $ - $ 2,800 $ 592 ======= ======= ======= ======= NON-CASH FINANCING ACTIVITIES (Note 10): Embedded dividend attributable to beneficial conversion privilege of Convertible Preferred Stock: Series B $ 1,045 $ - $ - $ - Series A 173 - - - ------- ------- ------- ------- $ 1,218 $ - $ - $ - Issuance of Convertible Preferred ======== ======= ======= ======= Stock in satisfaction of borrowings (Notes 6 and 10) $ 2,991 $ - $ - $ - ======= ======= ======= ======= Deferred loan costs arising from issuance of warrants under subordinated loans (Note 3) $ 427 $ 45 $ - $ - ======= ======= ======= ======= See accompanying notes to consolidated financial statements. 43 nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ========================================== (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of nStor Technologies, Inc. and all wholly-owned subsidiaries (collectively, the "Company"). Significant intercompany balances and transactions have been eliminated in consolidation. Business The Company is engaged as a manufacturer and supplier of information storage solutions, including external RAID (Redundant Array of Independent Disks) subsystems, Network Attached Storage data storage enclosures, storage management software solutions and AdaptiveRAID technology. Prior to the acquisition of the RAID business in June 1996, the Company's only assets were securities issued by IMNET Systems, Inc. ("IMNET" - see Note 3 to Consolidated Financial Statements), which the Company had acquired in October 1992 in exchange for substantially all of the Company's operating assets. During the time in which the Company owned the IMNET securities, the Company's only activities consisted of monitoring its investment in IMNET and evaluating potential business opportunities. Fiscal Year In November 1996, the Company changed its fiscal year end from October 31 to December 31. Accordingly, the December 31, 1996 Statements of Operations and Shareholders' Equity are for the two months then ended. Cash and Cash Equivalents Cash and cash equivalents consist of highly liquid investment instruments with original maturities of three months or less. Restricted cash At December 31, 1998 and 1997, approximately $.5 million and $1 million, respectively, of cash was pledged as collateral under certain borrowings (see Note 6 to Consolidated Financial Statements), and was classified as restricted cash. 44 Investment Securities Prior to the sale of IMNET securities in 1996 (see Note 3 to Consolidated Financial Statements), the Company's investment in IMNET was classified as available for sale and stated at fair market value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity until realized. Inventories Inventories, consisting of raw materials, work-in-process and finished goods, are stated at the lower of cost or market, with cost being determined based on the first-in, first-out (FIFO) method. Reserves are recorded as necessary to reduce obsolete inventory to estimated net realizable value. See Note 4 to Consolidated Financial Statements. Revenue Recognition Sales revenue is recognized upon shipment provided that there are no significant post-sale obligations and the collectibility is reasonably assured. During the periods presented in the accompanying Consolidated Statements of Operations, there were no significant post-sales obligations except for normal warranty costs. Warranty Costs Warranty costs are provided on the basis of estimated net future costs related to products sold. Property and Equipment Property and equipment are stated at cost. Depreciation is provided under the straight-line method over the estimated useful lives, principally five years. Goodwill and Other Intangible Assets Intangible assets, substantially goodwill, are carried at cost and amortized under the straight-line method generally over 15 years, the estimated useful life. Goodwill represents the excess cost of the acquired businesses over the fair value of net assets acquired (see Note 2 to Consolidated Financial Statements). Management periodically reviews goodwill to determine if an impairment has occurred. Among various considerations, this process includes evaluating recoverability based upon cash flow forecasts. No impairment losses have been recognized in any of the periods presented. At December 31, 1998, unamortized goodwill and other intangible assets of $5.9 million was not considered to be impaired. 45 Research and Development Costs Research and development costs are expensed as incurred. Income Taxes Income taxes are provided on the liability method whereby deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the tax bases and reported amounts of assets and liabilities. Net Income (Loss) Per Common Share ("EPS") Basic EPS is calculated by dividing the income (loss) available to common shareholders by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS includes the effect of potentially dilutive securities. For all periods presented, the effect of including dilutive securities, stock options and warrants would have been antidilutive. Accordingly, basic and diluted EPS for all periods presented are equivalent. As of December 31, 1998, outstanding potentially dilutive securities include 2,946,500 shares underlying stock options, 7,366,667 shares underlying convertible preferred stock, 1,761,667 shares underlying warrants and 160,000 shares underlying convertible debt. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Financial Instruments SFAS No.107, "Disclosures about Fair Value of Financial Instruments", requires disclosure of fair value information about financial instruments. Fair value estimates discussed herein are based upon certain market assumptions and pertinent information available to management as of December 31, 1998 and 1997. The respective carrying value of certain on-balance-sheet financial instruments approximated their fair values. These financial instruments include cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities. Fair values were assumed to approximate carrying values for these financial 46 instruments since they are short term in nature and their carrying amounts approximate fair values or they are receivable or payable on demand. The fair value of the Company's current borrowings and long-term debt is estimated based upon quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of the same remaining maturities. The carrying value approximates the fair value of current borrowings and long-term debt. Reclassifications Certain prior years' amounts have been reclassified to conform to the current year's presentations. These reclassifications had no impact on operating results previously reported. Comprehensive Income During the year, the Company adopted SFAS Statement No. 130, "Reporting Conprehensive Income" (SFAS 130) which requires the reporting of compre- hensive income in addition to net income from operations. Comprehensive income is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income. Recently Issued Accounting Pronouncements In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides guidance on accounting for the various types of costs incurred for computer software developed or obtained for internal use. Also, in June 1998, the AICPA issued SOP 98-5, "Reporting on the Costs of Start-Up Activities". SOP 98-5 requires costs of start-up activities and organ- izational costs, as defined, to be expensed as incurred. The Company will adopt these SOPs on January 1, 1999; however, the Company does not expect the adoption to materially impact the Company's Consolidated Financial Statements. 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 requires companies to recognize all derivative contracts as either assets or liabilities in the balance sheet and to measure them at fair value. SFAS 133 is effective for periods beginning after June 15, 1999. Historically, the Company has not entered into derivative contracts. Accordingly, SFAS 133 is not expected to affect the Company's financial statements. 47 (2) ACQUISITIONS Effective June 3, 1996, nStor Corporation, Inc., a newly-formed subsidiary of the Company, which was 80% owned at the time (the "Subsidiary"), acquired certain net assets from Seagate Peripherals, Inc. ("Seagate") located in Lake Mary, Florida. The purchase price consisted of $592,000 in cash, including acquisition costs, and a royalty to Seagate, originally estimated at $800,000. Based upon the conclusion of certain contingencies, the royalty liability was reduced to approximately $208,000 effective December 31, 1996, with a corresponding reduction to property and equipment and intangible assets. Effective October 31, 1996, the Company acquired the remaining 20% of the Subsidiary from R. Daniel Smith, president of the Subsidiary at that time, in exchange for one million shares of the Company's common stock, valued at $600,000 (net of applicable discount) as of the date of issuance. In connection with this acquisition, the Company recorded goodwill of approximately $.3 million. Effective December 1, 1996, the Company acquired substantially all the net assets of Parity Systems, Inc. ("Parity") located in Los Gatos, California. The purchase price consisted of $2.8 million in cash and a warrant (exercisable at any time through December 1999) to purchase 500,000 shares of the Company's common stock at $2.10 per share, valued at $470,000 as of the date of acquisition. In addition, the Company recorded approximately $5.8 million in goodwill, including approximately $816,000, in certain accrued and capitalized transition costs expected to be incurred in connection with the termination and relocation of the manufacturing operations from California to Florida. A significant portion of those costs were associated with terminating and/or relocating certain Parity personnel. The relocation and integration of Parity operations was completed in May 1997. The transaction closed on December 30, 1996, on which date the Company repaid the approximately $3 million outstanding balance of Parity's bank line of credit. Certain operating policies and accounting procedures are different from those of the previous owners. Accordingly, comparative financial data of the acquired business for periods prior to the acquisition are not presented in this section since they would be neither comparable nor informative. Effective April 23, 1998, the Company acquired all the outstanding common stock of Borg Adaptive Technologies, Inc. ("Borg"), a privately owned company headquartered in Boulder, Colorado, and the developer of AdaptiveRAID, a patented next-generation RAID technology. The purchase price consisted of $379,000 in cash, including acquisition costs, and warrants to purchase 400,000 shares of the Company's common stock at $1.38 per share exercisable on May 1, 1998 and expiring on December 26, 2000, valued at $148,000 as of the date of acquisition. In addition, the Company recorded approximately $.5 million in goodwill. In accordance with the purchase agreement, the sellers of Borg (currently employees of 48 the Company) will receive a royalty payment equal to 5% of the gross sales, as defined, of a certain product for as long as the product is sold. Proforma consolidated results of operations were not prepared as if the acquisition had occurred at the beginning of fiscal 1998 since the acquisition was not significant. All three acquisitions have been accounted for under the purchase method of accounting, with assets acquired and liabilities assumed recorded at estimated fair values as of the effective acquisition dates, and the operating results of the acquired businesses included in the Company's consolidated financial statements from those dates. The excess of the purchase prices over the fair value of net assets acquired (goodwill) aggregated approximately $6.5 million and is being amortized on a straight-line basis over 10 to 15 years. The Company also recorded approximately $347,000 as intellectual assets, consisting of trademarks and proprietary technology, which are being amortized on a straight-line basis over 15 years. For the year ended December 31, 1998 and 1997, the two months ended December 31, 1996 and the year ended October 31, 1996, amortization of intangible assets approximated $469,000, $410,000, $43,000 and $17,000, respectively. (3) INVESTMENT IN IMNET SYSTEMS, INC. ("IMNET") During 1996, a subsidiary of the Company sold all of its shares of IMNET and received net proceeds of $11,955,000. For reporting purposes, the Company had written off its entire investment in IMNET in 1993, and accordingly, the Company recognized a gain of $11,955,000 during 1996. (4) BALANCE SHEET COMPONENTS (in thousands) Substantially all assets are pledged as collateral for indebtedness. See Note 6 to Consolidated Financial Statements. December 31, --------------- 1998 1997 ------ ------ Accounts Receivable Trade receivables $2,964 $4,218 Less allowance for doubtful accounts (502) (500) ------ ------ 2,462 3,718 Other receivables - 145 ------ ------ $2,462 $3,863 ====== ====== 49 Inventories Raw materials $2,641 $3,299 Work-in-process 95 - Finished goods 292 278 ------ ------ $3,028 $3,577 ====== ====== Property and Equipment Computer software $ 729 $ 907 Computer equipment 1,313 809 Furniture, fixtures and office equipment 288 286 Leasehold improvements 332 283 Other 243 232 ------ ------ 2,905 2,517 Less accumulated depreciation (1,252) (457) ------ ------ $1,653 $2,060 ====== ====== Depreciation expense amounted to approximately $883,000 and $366,000 for the years ended December 31, 1998 and 1997, respectively. Goodwill and Other Intangible Assets Goodwill $6,545 $6,038 Intellectual assets 347 347 ------ ------ 6,892 6,385 Less accumulated amortization (939) (470) ------ ------ $5,953 $5,915 ====== ====== (5) INCOME TAXES (a) As of December 31, 1998, there were unused net operating loss carryforwards (the "NOL's") for regular federal income tax purposes of approximately $18.4 million principally expiring in 2012 and 2018, for which no financial statement benefit had been recognized. In addition, the Company has research and development tax credit carryforwards of approximately $802,000 which expire from 2002 through 2018 and in conjunction with the Alternative Minimum Tax ("AMT") rules, the Company has available AMT credit carryforwards of approximately $332,000, at December 31, 1998, which may be used indefinitely to reduce regular federal income taxes. 50 (b) For the year ended December 31, 1997, the provision for federal income tax expense of $238,000 represents AMT taxes paid during 1997. (c) The tax effects of temporary differences that gave rise to significant portions of deferred tax assets and liabilities are as follows (in thousands): December 31, --------------- 1998 1997 ------ ------ Deferred tax assets: Net operating loss carryforward $6,267 $2,853 Alternative minimum tax carryforward 332 238 Research and development credit carryforward 802 637 Depreciation and amortization 148 269 Allowance for doubtful accounts - 170 ------ ------ 7,549 4,167 ------ ------ Deferred tax liabilities: Allowance for doubtful accounts 171 - Inventory and warranty reserves 222 261 ------ ------ Net deferred tax assets 7,156 3,906 Less valuation allowance (7,156) (3,906) ------ ------ $ - $ - ====== ====== (6) BORROWINGS The Company's borrowings consisted of (in thousands): December 31, --------------- 1998 1997 ------ ------ Current Asset based revolving bank credit facility (the "Revolver") $ - $3,245 Director Loans 300 - Other 200 200 ------ ------ Total current borrowings $ 500 $3,445 ====== ====== 51 Long-Term Subordinated Loans (net of discount) $4,713 $ 950 Asset based revolving credit facility (the "New Revolver") 1,738 - Convertible Notes 592 554 ------ ------ Total long-term borrowings $7,043 $1,504 ====== ====== Revolving Credit Facilities On August 3, 1998, the Company entered into the New Revolver, an asset based revolving credit facility consisting of borrowings based on the lesser of $5 million or 80% of the Company's eligible accounts receivable, as defined. The New Revolver bears interest, payable monthly, based on prime plus 2% (9-3/4% at December 31, 1998), is guaranteed by the Company and matures on August 3, 2000. The Company pays a facility fee equal to 1% per annum on the total facility of $5 million. Advances under the New Revolver are collateralized by substantially all assets of the Company, including $.5 million reflected as Restricted Cash at December 31, 1998. The loan agreement provides for certain financial covenants including current ratio and net worth requirements, limitations on operating losses and restrictions on the incurrence of additional debt, capital expenditures and the payment of dividends, other than preferred stock dividends. At December 31, 1998, the Company was not in compliance with the financial covenant concerning the Company's operating loss for 1998; however, effective February 4, 1999, the lender agreed to forbear declaring a default. Proceeds from the New Revolver were used to repay the Company's previous Revolver, which matured on July 31, 1998, as extended. Advances under the Revolver were collateralized by substantially all assets of the Company, including approximately $1 million reflected as Restricted Cash at December 31, 1997. As a result of the Company's failure to be in compliance with certain financial covenants, the Revolver was amended in December 1997 and February 1998. Among other modifications, the amendments waived compliance with the financial covenants and reduced the original maximum loan amount from $7 million to $3 million as of June 30, 1998 with gradual reductions to $2.4 million thereafter until maturity. Subordinated and Director Loans At December 31, 1997, the Company's long-term debt included $950,000 due to H. Irwin Levy, Chairman of the Board of Directors and a principal stockholder of the Company. During 1998, Mr. Levy and a company controlled by Mr. Levy (collectively, "Mr. Levy") loaned an additional net amount of $3,350,000 (consisting of 52 $6,765,000 advanced, less $3,415,000 repaid) to the Company, with interest at 10% per annum. During April 1998, Mr. Levy sold participation interests in $1,000,000 of these loans, including $750,000 to unrelated private investors, $125,000 to a company controlled by Mark F. Levy, Vice President and a Director of the Company and Mr. Levy's son, and $125,000 to a company controlled by other members of Mr. Levy's family. In September and October 1998, the Company issued 8% Convertible Preferred Stock, Series C (the "Series C Preferred Stock" - Note 10) with a stated value of $2 million to Mr. Levy in satisfaction of $2 million of Mr. Levy's loans, leaving an outstanding balance due to Mr. Levy of $1,300,000 as of December 31,1998. Of this amount, $300,000 is included in current liabilities and $1,000,000 is included in Subordinated Loans (see below). Pursuant to a Promissory Note, dated March 1, 1999, Mr. Levy has agreed to loan the Company up to an additional $1 million through September 30, 1999. From March 1, 1999 through March 31, 1999, the Company borrowed an additional $790,000 under that Note. In March 1998, three private investors loaned the Company an aggregate of $3 million (together with the aforementioned $1,000,000 due to Mr. Levy and the $1,000,000 of loans sold by Mr. Levy, hereinafter referred to as the "Subordinated Loans"). The Subordinated Loans bear interest at 10% per annum, payable monthly, mature on September 5, 2000, as extended, are subordinated to the New Revolver and are collateralized by substantially all assets of the Company. In February and March 1999, the Company borrowed $2.3 million from three unrelated private investors, of which $1.8 million matures in September 2000 and $500,000 in June 1999, all of which are subordinated to the New Revolver. In connection with the Subordinated Loans, warrants were issued to purchase an aggregate of 1,666,668 shares of the Company's common stock (including 666,666 to Mr. Levy of which 250,000 warrants were subsequently transferred to unrelated private investors, 41,666 to a company controlled by Mr. Mark Levy and 41,667 to a company controlled by other members of Mr. Levy's family, all as part of Mr. Levy's sale of participation interests) at an exercise price of $1.50 per share, exercisable on the date of grant and expiring on March 5, 2001. Effective September 22, 1998, the maturity date for the Subordinated Loans was extended for one year to September 5, 2000. As consideration for the extension, the Company replaced the previously issued warrants with new warrants under identical terms but with exercise prices as follows: (i) warrants to purchase 750,000 shares exercisable at $1.00 per share and (ii) warrants to purchase 916,668 shares exercisable at $1.25 per share. The original and replacement warrants were valued under the Black-Scholes option-pricing model on their respective dates of issuance aggregating $424,000 and were recorded as a discount to the Subordinated Loans, of which $137,000 has been amortized as 53 interest expense for the year ended December 31, 1998. In connection with loans made by Mr. Levy during 1997, the Company issued warrants to Mr. Levy to purchase 65,000 shares of the Company's common stock at a purchase price of $2.35 per share, exercisable on the dates of issuance, and expiring on October 1, 2000. The warrants were valued at $48,000 on the dates of issuance, of which $20,000 and $28,000 were amortized as interest expense for the years ended December 31, 1998 and 1997, respectively. Convertible Notes The Company has issued certain convertible notes with a face amount of $400,000, which have been discounted based on an effective interest rate of 12%, include accrued interest of $214,000 and $206,000 at December 31, 1998 and December 31, 1997, respectively, mature in 2000 and are convertible into 160,000 shares of common stock of the Company (based on one common share for each $2.50 of face amount). Maturites Scheduled and estimated maturities of the Company's borrowings are as follows: Year ending December 31, 1999 $ 500 2000 7,043 ------ $7,543 ====== (7) EXTRAORDINARY GAIN ON DEBT EXTINGUISHMENT During the year ended October 31, 1996, the Company paid $75,000 in cash and issued 10,000 shares of its common stock in full satisfaction of the $664,000 outstanding balance (including accrued interest) of notes payable which had been in dispute due to certain subordination provisions contained in the notes. As a result of this settlement, the Company recognized a $566,000 extraordinary gain from debt extinguishment. No income tax effect on the extraordinary gain was recorded due to the valuation allowance for deferred tax assets. (8) SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS The Company operates predominently in one business segment, information storge solutions, including external RAID subsystems. During 1998 and 1997, the Company had sales to two customers, 54 Discreet Logic (a Canadian customer) and Intergraph Corp., which accounted for 27% and 13%, respectively, of net sales for 1998 and 11% and 10%, respectively, for 1997. One customer, Intergraph Corp., accounted for 53% of net sales for the year ended October 31, 1996. Sales to geographic areas other than the United States and Canada have not been significant. (9) LITIGATION In June 1996, Jack Ehrenhuas, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud Mendelson and Susan Felton filed a Complaint in the Supreme Court of the State of New York, County of Nassau, against the Company and , Michael Wise (currently a Director and Vice Chairman of the Board of Directors). The plaintiffs claim to have contractual and proprietary interests in the prospect of a transaction to purchase certain net assets acquired by the Company (see Note 2 to Consolidated Financial Statements) and seek compensatory damages plus punitive damages. 54 In August 1996, The Nais Corporation, Mark Schindler, Eugene Stricker, Amnon Damty, Ehud Mendelson and Susan Felton filed a Complaint in the same Court making similar allegations against a subsidiary, its then president, R. Daniel Smith ("Mr. Smith"), and Intelligent Manufacturing Systems, Inc. ("IMS"), a company for which Mr. Smith was the Chief Executive Officer and sole shareholder. In this action, the plaintiffs seek compensatory damages plus punitive damages for alleged breach of contract. Both cases are currently in discovery. Counsel for the Company believes that the Company has good defenses to both claims and that it will not incur any material liability. The Company is unaware of any facts that would support any of the plaintiffs' claims and, accordingly, the Company believes that the claims are without merit. In June 1998, a Complaint was filed in the Supreme Court of the State of New York by AIBC Investment Services Corp. ("the Plaintiff"), which claims that the Company, its wholly-owned subsidiary and Mr. Smith (the "Defendants") breached an agreement wherein the Plaintiff was allegedly engaged as placement agent in connection with raising funds for the Defendants. The Plaintiff seeks damages in the amount of not less than $262,500 plus interest, warrants to purchase the Company's common stock at a price to be determined and punitive damages. The case is in the initial stages of discovery and the Company believes that the claims are without merit and will not result in any material liability. 55 From time to time, the Company is subject to legal proceedings and other claims arising in the ordinary course of business. In the opinion of management, the Company is not a party to any litigation the outcome of which would have a material adverse effect on its business or operations. (10) 8% CONVERTIBLE PREFERRED STOCK In March 1997, the Securities and Exchange Commission Staff (the "Staff") announced its position on accounting for preferred stock which is convertible into common stock at a discount from the market rate at the date of issuance. The Staff indicated that a preferred stock dividend, attributable to such a beneficial conversion privilege should be recorded for the difference between the conversion price and the quoted market price of common stock at the date of issuance. Accordingly, during 1998, the Company recorded $1,218,000 as an additional embedded dividend attributable to the beneficial conversion privilege on its convertible preferred stock, including $1,045,000 on the Series B Preferred Stock and $173,000 on the Series A Preferred Stock (see below). Series B Effective April 14, 1998, the Company received $3.2 million in cash (net of $.3 million in issuance costs), including $1 million from Mr. Levy, from a private placement of 8% Convertible Preferred Stock, Series B (the "Series B Preferred Stock"). The Series B Preferred Stock was convertible into common stock, on various dates through April 2000, at a conversion price equal to the lesser of $1.44 per share or 77% of the market price at the date of conversion. At closing, the Company issued warrants to purchase 280,000 shares of the Company's common stock (including 80,000 to Mr. Levy), exercisable at any time through April 2001 at an exercise price of $1.50 per share. In July and September 1998, $200,000 of the Series B Preferred Stock held by unrelated private investors was converted into 394,949 shares of the Company's common stock. On October 30, 1998, the Company redeemed $2.3 million of the Series B Preferred Stock held by unrelated private investors for approximately $2.5 million in cash (including a premium of $115,000 and accrued dividends of $102,000) and warrants to purchase 300,000 shares of the Company's common stock, exercisable upon issuance at $1.00 per share and expiring in October 2001. In conjunction with this redemption, effective October 28, 1998, the Company issued Series C Preferred Stock (see below) with a stated value of $1 million in exchange for the remaining $1 million of Series B Preferred Stock which was held by Mr. Levy. 56 As a result of these two transactions, all of the Company's convertible preferred stock which was based on a variable conversion price was redeemed either for cash or preferred stock that is based on a fixed conversion price. Series A On July 7, 1998, the Company borrowed $1 million from a private investor under an 8% Convertible Subordinated Debenture (the "Debenture"), payable on September 25, 1998, as extended. In September 1998, the Debenture was converted into 1,667 shares of the Company's 8% Convertible Preferred Stock, Series A (the "Series A Preferred Stock"). The Series A Preferred Stock with a stated value of $1 million as of December 31, 1998 accrues dividends at 8% per annum, payable quarterly, is convertible into shares of the Company's common stock based on a fixed conversion price of $.60 per share, commencing July 7, 1999, and has an automatic conversion feature in which each share not converted as of July 7, 2000 automatically converts into shares of the Company's common stock. Series C The Series C Preferred Stock with a stated value of $3 million (including the $1 million that was exchanged for Series B) as of December 31, 1998 accrues dividends at 8% per annum, payable quarterly, is convertible into shares of the Company's common stock based on a fixed conversion price of $1.00 per share, commencing July 7, 1999, and has an automatic conversion feature in which each share not converted as of July 7, 2000 automatically converts into the Company's common stock. Series D During October 1998, the Company received $2.7 million in cash from unrelated private investors in a private placement of its 8% Convertible Preferred Stock, Series D (the "Series D Preferred Stock"). Of this amount, $2.5 million was used in the redemption of the Series B Preferred Stock. The Series D Preferred Stock with a stated value of $2,700,000 as of December 31, 1998, accrues dividends at 8% per annum, payable quarterly, is convertible into shares of the Company's common stock based on a fixed conversion price of $1.00 per share commencing April 27, 1999, and has an automatic conversion feature in which each share not converted into the Company's common stock within three years from the date of issuance is automatically converted. 57 (11) STOCK OPTIONS AND WARRANTS The Company applies APB Opinion 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its Option Plan (the "Plan"). Under APB Opinion 25, if options are granted at exercise prices less than fair market value, compensation expense is recorded for the excess of the fair market value on the date of grant over the exercise price. Under the Plan, qualified and nonqualified stock options to purchase up to 2.5 million shares of the Company's common stock may be granted to officers, directors, key employees and nonemployees. The maximum term of the options granted under the Plan is ten years. SFAS No.123, "Accounting for Stock-Based Compensation," requires the Company to provide pro forma information regarding net income and earnings per share as if compensation cost for stock options granted under the Plan, if applicable, had been determined in accordance with the fair value based method prescribed in SFAS 123. The Company estimates the fair value of each stock option at the grant date by using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants: no dividend yield; expected lives of ten years; volatility at 60% for 1998,ranging from 57% to 60% for 1997 and 30% for 1996, and; risk-free interest rates of 5.3% for 1998, ranging from 5.7% to 6.79% for 1997 and 6.7% for 1996. Under the accounting provisions of SFAS 123, the Company's net loss and loss per share, for the year ended December 31, 1998, would have been reduced to the pro forma amounts indicated below (in thousands, except per share): Year Ended Two Months December 31, Ended ------------------- December 31, 1998 1997 1996 Net loss: -------- -------- ------------ As reported ($10,407) ($7,886) ($ 43) Pro forma ($10,836) ($8,123) ($672) Loss per share: As reported ($.55) ($.42) ($.00) Pro forma ($.57) ($.43) ($.04) Changes in options outstanding are summarized as follows: 58 Weighted- Average Weighted- Fair Average Value Per Exercise Share of Price Options Shares Per Share Granted (in thousands) ------ --------- --------- Year ended October 31, 1996: Granted - equal to market value 1,050 $2.07 $ .91 ----- Balance, October 31, 1996 1,050 2.07 Granted - equal to market value 225 2.10 1.58 Granted - exceeds market value 200 4.00 1.37 ----- Balance, December 31, 1996 1,475 2.53 Granted - equal to market value 325 2.21 1.64 Forfeited (35) 2.10 ----- Balance, December 31, 1997 1,765 2.48 ----- Granted - equal to market value 881 1.38 1.03 Granted - exceeds market value 1,160 1.14 .52 Forfeited (860) 1.98 ----- Balance, December 31, 1998 2,946(a) 1.67 ===== __________ (a) In June 1998, the Company granted a conditional Employee Incentive Stock Option to its President, Lawrence F. Steffann, to purchase 750,000 shares of the Company's common stock. The grant is conditional because of the 2.5 million share limitation under the Plan. The agreement provides for the removal of the condition upon approval by the Company's shareholders (at its 1999 Annual Meeting of Stockholders) of an amendment to the Plan to increase the number of shares reserved for issuance under the Plan. At December 31, 1998, 1997 and 1996, a total of 1,189,000, 705,000 and 475,000, respectively, of the outstanding options were exercisable with a weighted-average exercise price of $2.31, $2.91 and $3.20, respectively, per share. 59 The following table summarizes information about fixed stock options at December 31, 1998: Weighted Weighted Average Number Average Weighted Number Exercise Outstanding Remaining Average Exercisable Price of Exercise at Dec. 31, Contractual Exercise at Dec. 31, Exercisable Prices 1998 Life Price 1998 Options (in thousands) (in thousands) - -------- ----------- ----------- -------- ----------- ----------- $.50-$1.50 1,885 9.3 years $1.20 192 $1.23 $2.00-$2.38 861 8.3 years $2.14 797 $2.14 $4.00 200 8.0 years $4.00 200 $4.00 ----- ----- 2,946 1,189 ===== ===== At December 31, 1998, the Company had outstanding warrants under which 1,762,000 shares of common stock could be acquired. Information relating to these warrants is summarized as follows: Number of Shares Expiration Subject to Exercise Date Warrants Price (in thousands) ---------- ---------- -------- December 1999 500 $2.10 October 2000 65 $2.35 December 2000 400 $1.38 March 2001 417 $1.25 April 2001 80 $1.50 October 2001 300 $1.10 ----- 1,762 ===== As of December 31, 1998, the Company had reserved common stock for the following purposes (in thousands): Convertible preferred stock 7,367 1996 Stock Option Plan 2,500 Stock Option Plan (b) 446 Stock warrants 1,762 Convertible notes payable 160 ------ 12,235 ====== 60 __________ (b) Represents the number of common shares that were conditionally granted because they exceed the 2.5 million shares reserved under the Plan. (12) RELATED PARTY TRANSACTIONS Hilcoast Advisory Services, Inc. ("Advisor") From July 1, 1996 through October 31, 1997, the Company paid $6,000 per month, plus reimbursement of out-of-pocket expenses, to Advisor for certain financial consulting and administrative services to the Company. Mr. Levy is the Chairman of the Board, Chief Executive Officer and a majority shareholder of the Advisor's parent. Management believes that the terms of this agreement were no less favorable to the Company than those that would be received from other sources. IMS In July 1996, the Company purchased an integrated software package from IMS, including installation, consulting and training support, at a cost of approximately $272,000. The software package was purchased to facilitate the internal operations of the Company and includes finance, planning and production, sales and marketing, service and engineering modules. In June 1997, the Company acquired the assets of IMS for approximately $135,000 which was based on the net book value of the assets acquired. Management believes that the terms of these transactions were no less favorable to the Company than those that would be paid to other vendors. (13) LEASES The Company leases its operating facilities under operating leases which expire at various dates through February 2002. At December 31, 1998, future minimum rental payments under operating leases that have initial or remaining terms in excess of one year were as follows (in thousands): 1999 $454 2000 317 2001 150 2002 22 ---- $943 ==== 61 Rent expense was $513,000 and $485,000 for the years ended December 31, 1998 and 1997, respectively, $57,000 for the two months ended December 31, 1996 and $62,000 for the year ended October 31, 1996. (14) 401(k) PLAN The Company's 401(k) Tax Deferred Savings Plan (the "401(k) Plan") covers substantially all employees meeting certain minimum age and service requirements. Contributions to the plan are determined by the Board of Directors. No contributions have been made by the Company to the 401(k) Plan as of December 31, 1998. (15) SUBSEQUENT EVENTS From January 1, 1999 to April 15, 1999, the Company obtained approximately $3.1 million from borrowings, consisting of $2.3 million from private investors and $790,000 from Mr. Levy (see Note 6 to Consolidated Statements), and approximately $2.6 million from the exercise of options and warrants and the issuance of 500,000 shares of newly issued common stock to a private investor. In March 1999, the Company entered into an agreement to purchase 75% of the outstanding common stock of Andataco, Inc. ("Andataco") from its principal stockholder, David Sykes. That agreement also contemplates that the Company would purchase from Mr. Sykes a note in the principal amount of $5,196,000, issued to him by Andataco. Following the purchase of Mr. Sykes' shares, he would continue to serve as President of Andataco, pursuant to a proposed three-year employment agreement. The purchase is contingent on the Company raising the capital necessary to fund the acquisition. If the transaction is completed, it would be the Company's intention to acquire the remaining Andataco shares as soon as possible following an independent professional determination of the fair value of such shares. The Company is currently negotiating with unrelated private investors to obtain approximately $15 million in a private placement of convertible preferred stock (the "Private Placement"). Proceeds from the Private Placement would be used to finance the proposed Andataco acquisition, if consummated, and to provide additional working capital for the Company. There can be no assurance, however, that the Company will be successful in obtaining the funds necessary to finance the proposed acquisition nor that the acquisition will be completed. In March 1999, the Company received the initial purchase order under a recently established OEM relationship to supply high-performance RAID storage enclosures to Silicon Graphics, Inc. (SGI), a major computer server manufacturer. The purchase order calls for the Company to ship approximately $5.8 million of products to SGI commencing in the second quarter of 1999. The 62 initial term of the OEM arrangement is expected to be for three (3) years. A discontinuation or significant reduction of this relationship could have a material adverse effect on the Company's business. (16) FOURTH QUARTER ADJUSTMENTS During the fourth quarter of 1997, the Company recorded an adjustment to write-down inventory by approximately $2.9 million resulting from a re-valuation of certain inventory acquired in the Parity acquisition, potential obsolete inventory and transitional issues associated with the implementation of a new materials requirement planning system. Management was unable to reasonably estimate the effect, if any, of certain of those adjustments on prior quarters in 1997 because of implementation issues with the materials requirement planning system. (17) COMMITMENTS As of December 31, 1998, the Company had four long-term employment agreements including an agreement with the Company's president, Lawrence F. Steffann, which expires on June 1, 2001, and agreements with three employees made in connection with the Borg acquisition, all of which expire January 31, 2003. Item 9. Disagreement on Accounting and Financial Disclosure Not Applicable PART III Item 10. Directors and Executive Officers of the Registrant For information concerning this item, see the text under the caption "Election of Directors" and "Management" in the Company's definitive Proxy Statement (the "Proxy Statement") to be filed with respect to the Company's 1999 Annual Meeting of Stockholders, which information is incorporated herein by reference. Item 11. Executive Compensation For information concerning this item, see the text and tables under the caption "Executive Compensation", "Report on Compensation" and the graph under the caption "Performance Graph", in the Proxy Statement, which information is incorporated herein by reference. 63 Item 12. Security Ownership of Certain Beneficial Owners and Management For information concerning this item, see the table and text of "Security Ownership" and "Management" in the Proxy Statement, which information is incorporated herein by reference. Item 13. Certain Relationships and Related Transactions For information concerning this item, see the text under the caption "Certain Transactions" in the Proxy Statement, which information is incorporated herein by reference. PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1) Financial Statements - See index to Consolidated Financial Statements at page 35 of this Form 10-K. (2) Financial statement schedules have been omitted because they are not required, or because the information required therein is set forth in the Consolidated Financial Statements or the notes thereto. (3) Exhibits - See Exhibit Index at page 65-69 of this Form 10-K. (b) No reports were filed or amended by the Registrant on Form 8-K during the fourth quarter of 1998. 64 EXHIBIT INDEX Exhibit Number Description 3.1 Restated Certificate of Incorporation filed with State of Delaware on November 30, 1998 3.2 By-laws of Registrant, as amended (6) 3.3 Certificate of Elimination of the Designation of the Series A Preferred Stock of Registrant (3) 4.1 Form of Warrant dated January 26, 1999 issued in connection with Promissory Note dated January 26, 1999 between Registrant, (i) Herbert Gimelstob, for 200,000 shares, (ii) Maurice Halperin, for 200,000 shares, (iii) Patricia Auld, for 100,000 shares and (iv) James P. Marden, for 100,000 shares 4.2 Certificate of Designation of Series A Convertible Preferred Stock (1) 4.3 Certificate of Designation of Series B Convertible Preferred Stock (1) 4.4 Form of Share Exchange Agreement dated June 9, 1998 between Registrant and holders of the Series A Preferred Stock whereby such holders exchanged their Series A Preferred Stock for Series B Preferred Stock (3) 4.5 Certificate of Designation of Series C Convertible Preferred Stock (1) 4.6 Certificate of Designation of Series D Convertible Preferred Stock (1) 4.7 Form of Warrant dated September 22, 1998 issued in connection with extending certain subordinated notes as follows: (i) Bernard Marden - 333,334 shares; (ii) Herbert Gimelstob - 416,667 shares; (iii) Fairway Partnership - 333,334 shares; (iv) H. Irwin Levy - 166,666 shares; (v) Bernard Green - 83,333 shares; (vi) Meyer Capital - 83,333 shares; (vii) MLL Corp. - 166,666 shares; (viii) JoJo Corp. - 41,666 shares; (ix) N&S Corp. - 41,667 shares 4.8 Subscription Agreement between Registrant and Maurice Halperin in connection with Series A Convertible Preferred Stock (1) 65 4.9 Registration Rights Agreement between Registrant and Maurice Halperin in connection with Series A Convertible Preferred Stock (1) 4.10 Form of Warrant dated October 28, 1998 issued in connection with Redemption of Series B Convertible Preferred Stock, between Registrant and (i) CPR (USA), Inc., 180,000 shares, (ii) LibertyView Fund, 23,400 shares and (iii) LibertyView Plus Fund, 96,600 shares (1) 4.11 Form of Subscription Agreement between Registrant and H. Irwin Levy for loans made by H. Irwin Levy to Registrant which were exchanged for Series C Convertible Preferred Stock (1) 4.12 Subscription Agreement between Registrant and H. Irwin Levy for the exchange of Series B Convertible Preferred Stock for Series C Convertible Preferred Stock (1) 4.13 Registration Rights Agreement between Registrant and H. Irwin Levy for Series C Convertible Preferred Stock (1) 4.14 Letter Agreement between Registrant and H. Irwin Levy regarding Series C Convertible Preferred Stock (1) 4.15 Letter Agreement between Registrant and LibertyView Capital Management, Inc. regarding the redemption of $2.3 million of Series B Convertible Preferred Stock (1) 4.16 Letter Agreement between Registrant and LibertyView Capital Management, Inc. regarding registration rights for warrants issued in connection with the redemption of $2.3 million of Series B Convertible Preferred Stock (1) 4.17 Form of Subscription Agreement for Series D Convertible Preferred Stock (1) 4.18 Form of Registration Rights Agreement for Series D Convertible Preferred Stock (1) 4.19 Restated Certificate of Incorporation of the Registrant, - see Exhibit 3.1 above 4.20 By-Laws of Registrant, as amended - see Exhibit 3.3 above (3) 4.21 8% Convertible Subordinated Debenture dated June 7, 1998 issued by Registrant to Maurice Halperin, as amended on August 7, 1998 (2) 66 10.1 Promissory Note for $500,000 dated March 15, 1999 between Registrant and Maurice Halperin 10.2 Promissory Note for $1 million dated March 1, 1999 between Registrant and H. Irwin Levy 10.3 Form of Promissory Note dated January 26, 1999 between Registrant and (i) Herbert Gimelstob ($600,000), (ii) Maurice Halperin ($600,000), (iii) Patricia Auld ($300,000) and (iv) James P. Marden ($300,000) 10.4 Loan and Security Agreement dated August 3, 1998 by and among the Registrant, nStor Corporation, Inc. and Finova Capital Corporation (2) 10.5 Form of Amended and Restated Promissory Note dated September 22, 1998 between Registrant and Bernard Marden, Herbert Gimelstob, Fairway partnership and H. Irwin Levy (1) 10.6 Security Agreement between Registrant and H. Irwin Levy dated July 31, 1998 (1) 10.7 Loan Agreement between Registrant and H. Irwin Levy dated July 31, 1998 for $1.5 million (1) 10.8 Employment Agreement between Registrant and Lawrence Steffann, President of the Registrant, dated as of June 1, 1998 10.9 Employee Incentive Stock Option Agreement between Registrant and Lawrence Steffann, dated as of June 1, 1998 10.10 Asset Purchase Agreement, dated May 23, 1996, between Seagate Peripherals, Inc. as seller and Intelligent Manufacturing Systems, Inc. as purchaser. (7) 10.11 Amendment No. 1 to the Asset Purchase Agreement, dated June 4, 1996, between Seagate Pheripherals, Inc. and Intelligent Manufacturing Systems, Inc. (7) 10.12 Assignment of Asset Purchase Agreement by Intelligent Manufacturing Systems, Inc. to nStor Corporation, Inc. (7) 10.13 Consent to Assignment of Asset Purchase Agreement by Seagate Peripherals, Inc. (7) 10.14 Asset Purchase Agreement Between Parity Systems, Inc. and nStor Corporation, Inc., dated November 30, 1996. (8) 10.15 Form of Warrant, dated December 30, 1996, granting Parity Systems, Inc. the right to purchase 500,000 shares of the Registrant's common stock. (8) 67 10.16 Agreement and Plan of Reorganization by and among nStor Technologies, Inc., nStor Corporation, Inc. and R. Daniel Smith, dated October 31, 1996. (6) 10.17 1996 Stock Option Plan, dated October 5, 1996. (6) 10.18 Promissory Note from Registrant to H. Irwin Levy dated, September 16, 1997 for $1 million. (11) 10.19 Letter Agreement between H. Irwin Levy and Registrant, dated September 16, 1997 regarding note incorporated by reference at 10.18. (11) 10.20 Amended and Restated Promissory Note dated March 5, 1998 between Registrant and H. Irwin Levy for $2 million, which amends the Note referenced at 10.18. (5) 10.21 Amended and Restated Loan Agreement dated March 5, 1998 between H. Irwin Levy and Registrant, in the amount of $2 million. (5) 10.22 Promissory Note in the amount of $1 million dated March 5, 1998 between Fairway Partnership and Registrant (Duplicate notes were also executed for the same amount between Registrant and (i) Bernard A. Marden and (ii) Herbert Gimelstob.) (5) 10.23 Amended and Restated Security Agreement dated March 5, 1998 between H. Irwin Levy, Fairway Partnership, Herbert Gimelstob, and Bernard A. Marden (collectively, referred to as "Secured Parties") (5) 10.24 Collateral Assignment of Note, Loan Agreement, Security Agreement and Security Instruments among Registrant and Secured Parties, dated March 5, 1998. (5) 10.25 Stock Purchase Agreement dated February 2, 1998 between nStor Corporation, Inc. and David Stallmo, Randy K. Hall and Gerald Hohoenstein (4) 10.26 Form of amendment to Stock Purchase Agreement at 10.30 (four amendments, all of which extended the closing date of the proposed transaction) (4) 21 Subsidiaries of the Registrant. 27 Financial Data Schedule. ______________ (1) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 10-Q for the quarter ended September 30, 1998, filed November 16, 1998. 68 (2) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 10-Q for the quarter ended June 30, 1998, filed August 13, 1998. (3) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Amendment No.1 to Registration Statement on Form S-3 filed on June 22, 1998. (4) Incorporated by reference to Exhibits previously filed as Exhibits to Registrants Form 10-Q for the quarter ended March 31, 1998, filed May 15, 1998. (5) Incorporated by reference to Exhibits filed as Exhibits to Registrants Form 10-K for the year ended December 31, 1997, filed on April 15, 1998. (6) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 10-K dated January 27, 1997, filed January 28, 1997. (7) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 8-K/A dated June 18, 1996, filed September 3, 1996. (8) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 8-K dated December 30, 1996, filed January 13, 1997. (9) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 8-K/A dated December 30, 1996, filed March 14, 1997. (10) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 10-Q for the quarter ended June 30, 1997, filed August 14, 1997. (11) Incorporated by reference to Exhibits previously filed as Exhibits to Registrant's Form 10-Q for the quarter ended September 30, 1997, filed November 13, 1997. 69 SIGNATURES Pursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. nSTOR TECHNOLOGIES, INC. /s/ Lawrence F. Steffann April 12, 1999 By:_________________________________ Lawrence F. Steffann, President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. /s/ Lawrence F. Steffann April 12, 1999 ___________________________________________ Lawrence F. Steffann, President and Director /s/ Mark F. Levy April 13, 1999 ___________________________________________ Mark F. Levy, Vice President and Director /s/ Michael L. Wise April 9 , 1999 ___________________________________________ Michael L. Wise, Vice President and Director /s/ Larry Calise April 12, 1999 ___________________________________________ Larry Calise, Principal Financial Officer and Principal Accounting Officer /s/ H. Irwin Levy April 13, 1999 ___________________________________________ H. Irwin Levy, Director April , 1999 ___________________________________________ Bernard Green, Director /s/ James E. McGrath April 14, 1999 ___________________________________________ James E. McGrath, Director EX-3 2 EXHIBITS 3 Exhibit 3.1 RESTATED CERTIFICATE OF INCORPORATION OF nSTOR TECHNOLOGIES, INC. The undersigned hereby certifies that the following Restated Certificate of Incorporation of nStor Technologies, Inc. (the "Corporation") was duly adopted in accordance with Section 245 of the Delaware General Corporation Law. This Restated Certificate of Incorporation restates and integrates but does not further amend the Certificate of Incorporation. The original Certificate of Incorporation (previously filed under the name of Pacific Coast Properties, Inc.) was filed with the Secretary of State of Delaware on November 23, 1959, a subsequent Restated Certificate of Incorporation (previously filed under the name of Communications & Cable Inc.), as amended, was filed in Delaware on July 21, 1987, and a subsequent Restated Certificate of Incorporation was filed in Delaware on June 22, 1998. ARTICLE FIRST: The name of the Corporation is nSTOR TECHNOLOGIES, INC. ARTICLE SECOND: The address of the Corporation's registered office in the State of Delaware is 15 E. North Street, City of Dover, Delaware 19901, County of Kent. The name of its registered agent at such address is United Corporate Services, Inc. ARTICLE THIRD: The nature of the business or purposes to be conducted or promoted by the Corporation is to engage in any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. ARTICLE FOURTH: (a) The total number of shares which the Corporation is authorized to issue is forty-one million (41,000,000). The Corporation is authorized to issue two classes of shares to be designated, respectively, "Preferred Stock" and Common Stock." The number of shares of Preferred Stock authorized to be issued is one million (1,000,000) and the number of shares of Common Stock authorized to be issued is forty million (40,000,000). The Preferred Stock shall have a par value of $.01 per share and the Common Stock shall have a par value of $.05 per share. The aggregate par value of all shares of Preferred Stock is $10,000 and the aggregate par value of all shares of Common Stock is $2,000,000. (b) The shares of Preferred Stock may be issued from time to time in one or more series. The Board of Directors is authorized, subject to limitations prescribed by law and the provisions of this Article Fourth, to provide for the issuance of the shares of Preferred Stock in series, and by filing a certificate pursuant to the applicable law of the State of Delaware, to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and the rights of the shares of each such series and the qualifications, limitations or restrictions thereof. (c) The authority of the Board with respect to each series shall include, but not be limited to, determination of the following: (i) The number of shares constituting that series and the distinctive designation of the series; (ii) The dividend rate on the shares of that series, whether dividends shall be cumulative, and, if so, from which date or dates, and the relative rights of priority, if any, of payment of dividends on shares of that series; (iii) Whether that series shall have voting rights, in addition to any voting rights provided by law, and, if so, the terms of such voting rights and whether the series shall have the right to vote cumulatively; (iv) Whether that series shall have conversion privileges, and, if so, the terms and conditions of such conversion, including provision for adjustment of the conversion rate in such events as the Board of Directors shall determine; (v) Whether or not the shares of that series shall be redeemable, and, if so, the terms and conditions of such redemption, including the date or dates upon or after which they shall be redeemable, and the amount per share payable in case of redemption, which amount may vary under different conditions and at different redemption dates; (vi) Whether that series shall have a sinking fund for the redemption or purchase of shares of that series, and, if so, the terms and amount of such sinking fund; (vii) The rights of the shares of that series in the event of voluntary or involuntary liquidation, dissolution or winding up of the Corporation, and the relative rights of priority, if any, of payment of shares of that series; (viii) Any other relative or participating rights, preferences and limitations of that series. (d) The number of authorized shares of Preferred Stock may be increased or decreased by the affirmative vote of the holders of a majority of the stock of the Corporation that is entitled to vote without a class vote of the Preferred Stock or any class or series thereof, except as may otherwise be provided in the resolution or resolutions affixing the voting rights of such class or series. (e) Attached hereto as Exhibits 1, 2 and 3 are copies of the Certificates of Designation of the Series A, Series C and Series D Convertible Preferred Stock filed with the Secretary of State on September 30, 1998, September 30, 1998 and October 29, 1998, respectively, which Certificates created separate series of Preferred Stock and each of which sets forth the rights and preferences of each series. ARTICLE FIFTH: The Corporation shall have perpetual existence. ARTICLE SIXTH: In furtherance and not in limitation of the powers conferred by statute, the Board of Directors is expressly authorized to make, alter, amend or repeal the bylaws of the Corporation, except to the extent that the bylaws or this Certificate of Incorporation otherwise provide. ARTICLE SEVENTH: The number of directors of the Corporation shall be fixed and may be altered from time to time in the manner provided in the bylaws of the Corporation, and vacancies in the Board of Directors and newly created directorships resulting from any increase in the authorized number of directors may be filled, and directors may be removed, as provided in the bylaws. ARTICLE EIGHTH: At all elections of directors of the Corporation, each holder of Common Stock shall be entitled to as many votes as shall equal the number of votes which (except for such provision as to cumulative voting) he would be entitled to cast for the election of directors with respect to his shares of Common Stock multiplied by the number of directors to be elected by him, and he may cast all of such votes for a single director or may distribute them among the number to be voted for, or for any two or more of them as he may see fit. ARTICLE NINTH: Meetings of stockholders may be held within or without the State of Delaware, as the bylaws may provide. The books of the Corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in the bylaws of the Corporation. ARTICLE TENTH: To the fullest extent permitted by the Delaware General Corporation Law, as the same exists or as may hereafter be amended, a director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. Neither any amendment nor repeal of this Article Tenth, nor the adoption of any provision of this Certificate of Incorporation inconsistent with this Article Tenth, shall eliminate or reduce the effect of this Article Tenth in respect of any matter occurring, or any cause of action, suit or claim that, but for this Article Tenth, would accrue or arise, prior to such amendment, repeal or adoption of an inconsistent provision. ARTICLE ELEVENTH: The election of directors need not be by written ballot unless a stockholder demands election by written ballot at a meeting of stockholders before the voting begins. ARTICLE TWELFTH: The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation. IN WITNESS WHEREOF, I have hereunto set my hand this 18TH day of November, 1998. STOR TECHNOLOGIES, INC. /s/ Mark F. Levy By:_______________________________ Mark F. Levy, Vice President Exhibits 1, 2 and 3 are omitted here. See Exhibit 4.2, 4.5 and 4.6 for incorporation by reference of these exhibits. EX-4 3 EXHIBITS 4 EXHIBIT 4.1 THIS WARRANT AND THE SECURITIES ISSUABLE UPON EXERCISE THEREOF HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "ACT"), AND MAY NOT BE OFFERED, SOLD, ASSIGNED, TRANSFERRED OR OTHERWISE DISPOSED OF UNLESS REGISTERED PURSUANT TO THE ACT OR AN OPINION OF LEGAL COUNSEL, REASONABLY SATISFACTORY TO THE COMPANY, IS OBTAINED STATING THAT AN EXEMPTION FROM REGISTRATION UNDER THE ACT IS AVAILABLE. THIS WARRANT MAY NOT BE SOLD, TRANSFERRED OR ASSIGNED EXCEPT UNDER THE LIMITED CIRCUMSTANCES DESCRIBED HEREIN. DATED: January 26, 1999 NO. __ FORM OF WARRANT nSTOR TECHNOLOGIES, INC. Warrant to Purchase _______ Shares of Common Stock, par value $.05 per share VOID AFTER 5:00 P.M., EASTERN STANDARD TIME ON JANUARY 25, 2002 The Company (as hereafter defined) has issued to Holder (as hereafter defined) that certain Promissory Note dated January 26, 1999, in the principal amount of $_______ (the "Note"). In partial consideration of Holder's agreement to deliver the proceeds of the loan to the Company, the Company desires to issue this Warrant (as hereafter defined) in accordance with the terms and conditions set forth herein. This certifies that, for value received, _____________________ or registered assigns (collectively with ___________, the "Holder"), is entitled to purchase from nStor Technologies, Inc., a Delaware corporation (the "Company"), Two Hundred Thousand (200,000) fully paid and nonassessable shares (the "Shares") of the Common Stock, par value $.05 per share, of the Company ("Common Stock") at a price of $3.00 per Share (the "Exercise Price") at any time from and after January 26, 1999 to and including 5:00 p.m. Eastern Standard Time on January 25, 2002 (the "Exercise Period"), subject to the terms, conditions and adjustments set forth in this Warrant (the "Warrant"). 1. Exercise of Warrants. This Warrant may be exercised in whole or in part by the Holder during the Exercise Period upon presentation and surrender hereof, with the attached Purchase Form duly executed, at the office of the Company located at 100 Century Boulevard, West Palm Beach, FL 33417, accompanied by full payment of the Exercise Price multiplied by the number of Shares of the Company being purchased (the "Purchase Price"), whereupon the Company shall cause the appropriate number of Shares to be issued and shall deliver to the Holder, as promptly as practicable, a certificate representing the Shares being purchased. This Warrant may be exercised for not less than 1,000 Shares and in additional increments of 1,000 Shares at any time and from time to time during the Exercise Period. Upon each partial exercise hereof, a new Warrant evidencing the remainder of the Shares will be issued to the Holder, at the Company's expense, as soon as reasonably practicable, at the same Exercise Price, for the same Exercise Period, and otherwise of like tenor as the Warrant partially exercised. The Purchase Price shall be payable by delivery of a certified or bank cashier's check payable to the Company, or by wire transfer of immediately available funds to an account designated in writing by the Company, in the amount of the Purchase Price. The Holder shall be deemed for all purposes to have become the holder of record of Shares so purchased upon exercise of this Warrant as of the close of business on the date as of which this Warrant, together with a duly executed Purchase Form, was delivered to the Company and payment of the Purchase Price was made, regardless of the date of delivery of any certificate representing the Shares so purchased, except that if the Company were subject to any legal requirements prohibiting it from issuing shares of Common Stock on such date, the Holder shall be deemed to have become the record holder of such Shares on the next succeeding date as of which the Company ceased to be so prohibited. 2. Exchange; Restrictions on Transfer or Assignment. This Warrant is exchangeable, without expense, at the option of the Holder, upon surrender hereof to the Company for other Warrants of like tenor of different denominations entitling the Holder to purchase in the aggregate the same number of Shares purchasable hereunder. This Warrant and the Holder's rights hereunder may not be transferred, assigned or subjected to a pledge or security interest, except that the Holder may transfer this Warrant in whole or in part (in minimum increments of 1,000 Shares) to a corporation controlled by or under common control with the Holder, by surrender of this Warrant to the Company at its principal office with the assignment form attached hereto duly completed and executed (with signature guaranteed), whereupon the Company, if it determines that the proposed assignment is permitted pursuant to the provisions hereof, shall register the assignment of this Warrant in accordance with the information contained in the assignment instrument and shall, without charge, execute and deliver a new Warrant or Warrants in the name of the assignee or assignees named in such assignment instrument (and, if applicable, a new Warrant in the name of the Holder evidencing any remaining portion of the Warrant not theretofore exercised, transferred or assigned) and this Warrant shall promptly be cancelled. Conditions to the transfer of this Warrant or any portion thereof shall be that (x) Holder deliver to the Company an opinion of counsel, reasonably satisfactory in form and substance to the Company's counsel, to the effect that the proposed transfer will not be in violation of the Securities Act of 1933, as amended (the "Act") or of any applicable state law and that (y) the proposed transferee deliver to the Company his or its written agreement to accept and be bound by all of the terms and conditions of this Warrant. The term "Warrant" as used herein includes any Warrants into which this Warrant may be divided or exchanged. 3. Rights and Obligations of Warrant Holders. This Warrant does not confer upon the Holder any rights as a shareholder of the Company, either at law or in equity. The rights of the Holder are limited to those expressed herein and the Holder, by acceptance hereof, consents to and agrees to be bound by and to comply with all the provisions of this Warrant. Each Holder, by acceptance of this Warrant, agrees that the Company and its transfer agent, if any, may, prior to any presentation of this Warrant for registration of transfer, deem and treat the person in whose name this Warrant is registered as the absolute, true and lawful owner of this Warrant for all purposes whatsoever and neither the Company nor any transfer agent shall be affected by any notice to the contrary. 4. Covenants and Warranties of the Company Stock. The Company covenants and agrees that (i) all Shares which may be issued and delivered upon exercise of this Warrant and payment of the Purchase Price will, upon delivery, be duly authorized, validly issued, fully-paid and nonassessable shares of Common Stock; and (ii) the Company shall at all times during the Exercise Period reserve and keep available a number of authorized but unissued shares of Common Stock sufficient to permit the exercise in full of this Warrant. The Company will take all such actions as may be necessary to assure that all shares of Common Stock may be so issued without violation by the Company of any applicable law or government regulation or any requirement of any securities exchange upon which shares of Common Stock may be listed (except for official notice of issuance, which the Company will transmit promptly upon issuance of such shares). The Company represents and warrants that: (i) the Company is a corporation duly organized, validly existing and in good standing under the laws of the state of Delaware; (ii) the Company has all requisite corporate power and authority to issue this Warrant and to consummate the transactions contemplated hereby, and such issuance and consummation will not conflict with, result in a material breach of, constitute a material default under or material violation of any provision of the Company's Certificate of Incorporation or Bylaws, and to the best knowledge of the Company, any law or regulation of any governmental authority or any provision of any agreement, judgment or decree affecting the Company; and (iii) all corporate action required to be taken by the Company in connection with the execution and delivery of this Warrant and the performance of the Company's obligations hereunder has been taken. 5. Disposition of Warrants or Shares. The Holder acknowledges that this Warrant and the Shares issuable upon exercise thereof have not been registered under the Act or applicable state law. The Holder agrees, by acceptance of this Warrant, (i) that no sale, transfer or distribution of this Warrant or the Shares shall be made except in compliance with the Act and the rules and regulations promulgated thereunder, including any applicable prospectus delivery requirements and the restrictions on transfer set forth herein, and (ii) that if distribution of this Warrant or any Shares is proposed to be made by it otherwise than by delivery of a prospectus meeting the requirements of Section 10 of the Act, such action shall be taken only after submission to the Company of an opinion of counsel, reasonably satisfactory in form and substance to the Company's counsel, to the effect that the proposed distribution will not be in violation of the Act or of applicable state law. 6. Adjustment. The number of Shares purchasable upon the exercise of this Warrant and the Exercise Price per Share are subject to adjustment from time to time as provided in this Section 6. (a) Subdivision or Combination of Shares. If the Company shall at any time subdivide its outstanding shares of Common Stock into a greater number of shares (including a stock split effected as a stock dividend) or combine its outstanding shares of Common Stock into a lesser number of shares, the number of Shares issuable upon exercise of this Warrant shall be adjusted to such number as is obtained by multiplying the number of shares issuable upon exercise of this Warrant immediately prior to such subdivision or combination by a fraction, the numerator of which is the aggregate number of shares of Common Stock outstanding immediately after giving effect to such subdivision or combination and the denominator of which is the aggregate number of shares of Common Stock outstanding immediately prior to such subdivision or combination, and the Exercise Price per Share shall be correspondingly adjusted to such amount as shall, when multiplied by the number of Shares issuable upon full exercise of this Warrant (as increased or decreased to reflect such subdivision or combination of outstanding shares of Common Stock, as the case may be), equal the product of the Exercise Price per Share in effect immediately prior to such subdivision or combination multiplied by the number of Shares issuable upon exercise of this Warrant immediately prior to such subdivision or combination. (b) Effect of Sale, Merger or Consolidation. If any capital reorganization or reclassification of the capital stock of the Company, or consolidation or merger of the Company with another corporation, or sale of all or substantially all of the Company's assets to another corporation shall be effected after the date hereof in such a way that holders of Common Stock shall be entitled to receive stock, securities or assets with respect to or in exchange for Common Stock, then, as a condition of such reorganiza- tion, reclassification, consolidation, merger or sale, lawful and adequate provision shall be made whereby the Holder shall thereafter have the right to purchase and receive, upon the basis and the terms and conditions specified in this Warrant and in lieu of the Shares immediately theretofore purchasable and receivable upon the exercise of this Warrant, such shares of stock, securities or assets as may be issued or payable with respect to or in exchange for a number of outstanding shares of Common Stock equal to the number of shares of Common Stock immediately theretofore purchasable and receivable upon the exercise of this Warrant, and in any such case appropriate provision shall be made with respect to the rights and interests of the Holder to the end that the provisions of this Warrant (including, without limitation, provisions for adjustments of the Exercise Price and of the number of Shares issuable upon the exercise of this Warrant) shall thereafter be applicable, as nearly as may be possible, in relation to any shares of stock, securities or assets thereafter deliverable upon the exercise of this Warrant. The Company shall not effect any such consolidation, merger or sale unless prior to or simultaneously with the consummation thereof the successor corporation (if other than the Company) resulting from such consolidation or merger or the corporation purchasing such assets shall assume, by written instrument executed and delivered to the Holder at its last address appearing on the books of the Company, the obligation to deliver to the Holder such shares of stock, securities or assets as, in accordance with the foregoing sentence, the Holder may be entitled to purchase. (c) Notice to Holder of Adjustment. Whenever the number of Shares purchasable upon exercise of this Warrant or the Exercise Price per Share is adjusted as herein provided, the Company shall cause to be mailed to the Holder, in accordance with the provisions of Section 10 hereof, notice setting forth the adjusted number of Shares purchasable upon the exercise of the Warrant and the adjusted Exercise Price and showing in reasonable detail the computation of the adjustment and the facts upon which such adjustment is based. (d) Notices to Holder of Certain Events. If at any time after the date hereof: (i) the Company shall declare any dividend or other distribution upon or with respect to the Common Stock payable otherwise than in cash out of the consolidated net income of the Company and any subsidiaries thereof, including any dividend payable in shares of Common Stock or other securities of the Company; or (ii) the Company shall offer for subscription to the holders of its Common Stock any additional shares of stock of any class or any other securities convertible into stock or any rights to subscribe thereto; or (iii) there shall be any capital reorganization or reclassification of the capital stock of the Company (other than a change in par value, or from par value to no par value, or from no par value to par value or as result of the subdivision or combination of shares), or any conversion of the Shares into securities of another corporation, or a sale of all or substantially all of the assets of the Company, or a consolidation or merger of the Company with another corporation (other than a merger with a subsidiary in which the Company is the continuing corporation and which does not result in any reclassification or change of the Shares issuable upon exercise of the Warrants); or (iv) there shall be a voluntary or involuntary dissolution, liquidation or winding up of the Company; then, in any one or more of said cases, the Company shall cause to be mailed to the Holder, not less than ten (10) days before any record date or other date set for the definitive action, written notice of the date upon which the books of the Company shall close or a record shall be taken for purposes of such dividend, distribution or subscription rights or upon which such reorganization, reclassification, conversion, sale, consolidation, merger, dissolution, liquidation or winding up shall take place, as the case may be. Such notice shall also set forth facts as shall indicate the effect of such action (to the extent such effect may be known at the date of such notice) on the number of Shares and the kind and amount of the shares of stock and other securities and property deliverable upon exercise of the Warrants. Such notice shall also specify the date as of which the holder of record of the shares of Common Stock shall participate in said dividend, distribution or subscription rights or shall be entitled to exchange their shares of Common Stock for securities or other property deliverable upon such reorganization, reclassification, conversion, sale, consolidation, merger, dissolution, liquidation or winding up, as the case may be (on which date in the event of voluntary or involuntary dissolution, liquidation or winding up of the Company, the right to exercise the Warrants shall terminate). (e) Fractional Shares. The Company shall not be required to issue any fraction of a Share upon the exercise of this Warrant. The number of full Shares which shall be issuable upon the full or partial exercise of this Warrant shall be computed on the basis of the aggregate number of Shares as to which this Warrant is being exercised. In lieu of any fractional interest in a Share otherwise deliverable upon the exercise of this Warrant, the Company shall pay a cash adjustment (which may be effected as a reduction of the amount to be paid by the Holder upon such exercise) in respect of such fraction of a Share in an amount equal to the same fraction multiplied by the closing sales price of the Common Stock on the principal securities exchange on which the Common Stock is traded, or if the Common Stock is not so listed for trading, the closing bid price of the Common Stock, in each case on the date of the notice of exercise required pursuant to Section 1 above, or the next succeeding trading date, if the date of such notice is not a trading date, or if the Common Stock is not traded on such dates, the next succeeding trading date on which the Common Stock is traded. (f) No Other Adjustments. No adjustment to the number of Shares subject to this Warrant or the Exercise Price per Share shall be made pursuant to this Section 6 except as expressly provided herein. 7. Piggy-Back Registration. (a) In the event the Company shall, at any time prior to the expiration of this Warrant, file a registration statement with the Securities and Exchange Commission (the "SEC") to register shares of Common Stock, the Company shall furnish the Holders with at least thirty (30) days' prior written notice thereof and such Holders shall have the option to include the Shares to be issued to the Holders upon the exercise of this Warrant in such registration statement. The Holders shall exercise the "piggy-back registration rights" granted pursuant to this Section 7 by giving written notice to the Company within twenty (20) days of the receipt of the aforementioned written notice from the Company. (b) Notwithstanding any other provision of this Warrant, the Company's obligations under this Section 7 shall be subject to and limited by the following terms and conditions: (i) The obligations of the Company set forth under this Section 7 shall not arise upon the filing of a registration statement relating solely to shares of Common Stock issued pursuant to employee stock option or other benefit plans, a merger of other business combination or a registration statement which does not include substantially the same information as Form S-1, Form S-2 or Form S-3, or any successor forms thereto. (ii) If the Company files a registration statement in connection with a proposed underwritten primary or secondary public offering of Common Stock, the Company shall use its best efforts to cause the managing underwriter of the proposed offering to grant any request by the Holder that Shares purchased by the Holder upon the exercise of this Warrant be included in the proposed public offering on terms and conditions which are customary under industry practice. Notwithstanding any other provision of this Agreement, if the managing underwriter of a proposed primary or secondary public offering of the Common Stock gives written notice to the Company that, in the reasonable opinion of such managing underwriter, marketing factors require a limitation of the total number of shares of Common Stock to be underwritten, then the number of Shares purchased by the Holder upon the exercise of this Warrant which the Company shall be obligated to include in the registration statement shall be reduced in accordance with the limitations imposed by the managing underwriter. Any such limitation imposed by the managing underwriter shall be imposed pro rata among all holders of Common Stock exercising rights granted pursuant to this Section 7 or otherwise, in accordance with the amount of Common Stock which each such person requested to be included in the registration statement. (c) The Company will pay all Registration Expenses (as hereinafter defined) of all registrations under this Warrant; provided, however, that if a registration is withdrawn at the request of the Holders requesting such registration (other than as a result of information concerning the business or financial condition of the Company which is made known to the Holders after the date on which such registration was requested), each of the Holders shall pay the Registration Expenses of such registration pro rata in accordance with the number of its Shares included in such registration. For purposes of this Section 7, the term "Registration Expenses" shall mean all expenses incurred by the Company in complying with this Section 7, including, without limitation, all registration and filing fees, exchange listing fees, printing expenses, fees and disbursements of counsel for the Company, state Blue Sky fees and expenses, transfer agent fees, cost of engraving of stock certificates, costs for mailing and tombstone advertising, cost of preparing the registration statement, related exhibits, amendments and supplements thereto, underwriting documents, selected dealer agreements, preliminary and final prospectuses, and the expense of any special audits incident to or required by any such registration, but excluding underwriting discounts and selling commissions attributable to the Shares and the fees and expenses of the Holder's own counsel and accountants, which shall be borne by such holders. 8. Indemnification and Notification. (a) The Company will indemnify and hold harmless the Holders, and each person, if any, who controls such Holders within the meaning of Section 15 of the Act, from and against any and all losses, claims, damages, expenses and liabilities caused by any untrue statement of a material fact contained in any registration statement or contained in a prospectus furnished thereunder or caused by any omission to state a material fact therein necessary to make the statement therein not misleading, provided, however, that the foregoing indemnification and agreement to hold harmless shall not apply insofar as such losses, claims, damages, expenses and liabilities are caused by any such untrue statement or omissions based upon information furnished in writing to the Company by any such Holder expressly for use in any registration statement or prospectus. (b) The Holders will indemnify the Company, and each person who controls the Company within the meaning of Section 15 of the Act, from and against any and all losses, claims, damages, expenses and liabilities caused by an untrue statement of a material fact contained in any registration statement or contained in a prospectus furnished thereunder or caused by an omission to state a material fact therein necessary to make the statement therein not misleading insofar as such losses, claims, damages, expenses and liabilities caused by such untrue statement or omission based upon information furnished in writing to the Company by any such Holder expressly for use in any registration statement or prospectus. (c) Promptly after the receipt by any indemnified party of notice of the commencement of any action, said indemnified party will, if a claim in respect thereof is to be made against the indemnifying party under this Section 8, notify the indemnifying party in writing of the commencement thereof; but the omission to so notify the indemnifying party will not relieve it from any liabilities which it may have to them otherwise than under this Section 8, except if such delay prejudices the indemnifying party. In case any such action is brought against any party who may seek indemnification hereunder and the indemnifying party is notified of the commencement thereof as provided herein, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, to assume the defense thereof, with counsel satisfactory to the indemnified party, and after notice from the indemnifying party to such indemnified party of the indemnifying party's election so to assume the defense thereof, the indemnifying party will not be liable under this Section 8 for any legal or other expense subsequently incurred by such indemnified party in connection with the defense thereof other than reasonable costs of investigation. The indemnifying party will not be liable for any settlement effected without its written consent. 9. Survival. The various rights and obligations of the Holder and of the Company as set forth in Sections 4, 5, 6, 7 and 8 hereof shall survive the exercise of this Warrant and the surrender of this instrument upon such exercise. 10. Notice. All notices required by this Warrant to be given or made by the Company shall be given or made by first class mail, postage prepaid, addressed to the registered holder hereof at the address of such holder as shown on the books of the Company. 11. Loss or Destruction. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of this Warrant and, in the case of any loss, theft or destruction, upon delivery of an indemnity agreement reasonably satisfactory in form and amount to the Company and its counsel, or, in the case of any such mutilation, upon surrender and cancellation of this Warrant, the Company, at its expense, will execute and deliver, in lieu thereof, a new Warrant of like tenor. 12. Miscellaneous. (a) Neither this Warrant nor any term hereof may be changed, waived, discharged or terminated except by a written instrument executed by the Company and the Holder. (b) This Warrant shall be governed by, and construed and enforced in accordance with, the internal laws of the State of Florida, without regard to principles of conflicts of laws thereof. (c) Each provision of this Warrant shall be interpreted in such a manner as to be effective, valid and enforceable under applicable law, but if any provision of this Warrant is held to be invalid, illegal or unenforceable under any applicable law or rule in any jurisdiction, such provision will be ineffective only to the extent of such invalidity, illegality or unenforceability in such jurisdiction, without invalidating the remainder of this Warrant in such jurisdiction or any provision hereof in any other jurisdiction. (d) No course of dealing or delay or failure to exercise any right hereunder on the part of the Holder shall operate as a waiver of such right or otherwise prejudice the Holder's rights, power or remedies. (e) The Company shall pay all expenses incurred by it in connection with, and all documentary stamp and other taxes (other than stock transfer taxes) and other governmental charges that may be imposed in respect of, the issue, sale and delivery of this Warrant and the Shares issuable upon the exercise hereof. (f) This Warrant and the rights evidenced hereby shall inure to the benefit of and be binding upon the successors and assigns of the Company and the successors and permitted assigns of the Holder. IN WITNESS WHEREOF the Company has caused this Warrant to be executed by its duly authorized officer as of the date first above written. ATTEST: nSTOR TECHNOLOGIES, INC. By:________________________ By:_________________________ Name: _____________________ Name:_______________________ Title:_____________________ Title:______________________ ASSIGNMENT To be executed by the registered holder to effect a permitted transfer of the within Warrant. Capitalized terms have the same meanings ascribed to them in the within Warrant. FOR VALUE RECEIVED ______________________________ ("Assignor") hereby sells, assigns and transfers unto ___________________________________________("Assignee") (Name) ___________________________________________ (Address) ___________________________________________ the right to purchase __________ shares of Common Stock of nStor Technologies, Inc. evidenced by the within Warrant, together with all right, title and interest therein, and does irrevocably constitute and appoint _____________________________ attorney to transfer the said right on the books of said corporation with full power of substitution in the premises. In satisfaction of a condition to the effectiveness of this assignment, Assignor hereby certifies that Assignee is a corporation controlled by or under common control with Assignor. Date: ____________________ Assignor: By_________________________ Its_________________________ Signature:__________________ PURCHASE FORM To be executed upon exercise of the within Warrant. Capitalized terms have the same meanings ascribed to them in the within Warrant. TO: nStor Technologies, Inc. The undersigned hereby exercises the right to purchase _____________ Shares of Common Stock evidenced by the within Warrant, according to the terms and conditions thereof, and hereby makes payment of the Purchase Price. The undersigned requests that certificates for the Shares shall be issued in the name set forth below: Dated:________________ Name:_____________________ __________________________ (Address) __________________________ Social Security No. __________________________ or other identifying number EX-10 4 EXHIBITS 10 Exhibit 10.1 ALL INDEBTEDNESS EVIDENCED HEREBY AND REFERENCED HEREIN IS SUB- ORDINATED IN RIGHT OF PAYMENT TO THE PRIOR PAYMENT IN FULL OF ALL INDEBTEDNESS OWED TO FINOVA CAPITAL CORPORATION. PROMISSORY NOTE U.S. $500,000.00 March 15, 1999 Lawrence, New York FOR VALUE RECEIVED, the undersigned nSTOR TECHNOLOGIES, INC., a Delaware corporation with its principal place of business at 450 Technology Park, Lake Mary, Florida 32746 (hereinafter called "Maker"), hereby promises to pay to the order of Maurice Halperin, an individual resident of the State of Florida, with a business address at Suite 225, 2500 Military Trail North, Boca Raton, Florida 33431 (hereinafter called "Payee"), at the address of Payee's principal place of business stated above, or at such other place as the Payee may designate in writing, the sum of FIVE HUNDRED THOUSAND AND 00/100ths U.S. Dollars (U.S. $500,000.00) (the "Principal Amount"), plus interest on the outstanding balance of the Principal Amount at the rate of ten percent (10%) per annum, payable monthly, from the date hereof until the date when said sum is paid in full in accordance with the terms hereof. The entire Principal Amount plus all accrued interest thereon shall be due and payable in full on June 15, 1999. Upon the failure by Maker to pay the Principal Amount plus all accrued interest thereon in full on or before the date when due hereunder, the entire unpaid amount of this Note shall thereupon be immediately due and payable, and the Payee shall have all rights and remedies provided under this Note. Maker shall have the right, in Maker's discretion at any time, without payment of premium or penalty, to prepay in whole or in part the unpaid balance of this Note. This Note shall be governed by and construed under the laws of the State of Florida. The exclusive venue for any litigation in connection with or arising out of this Note shall be Palm Beach County, Florida, and the Maker hereby consents and submits to the jurisdiction of the state and federal courts sitting in Palm Beach County, Florida. MAKER HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES THE RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE. nSTOR TECHNOLOGIES, INC. /s/ Michael L. Wise By:________________________ Name: Michael L. Wise Title: Vice President Exhibit 10.2 ALL INDEBTEDNESS EVIDENCED HEREBY AND REFERENCED HEREIN IS SUB- ORDINATED IN RIGHT OF PAYMENT TO THE PRIOR PAYMENT IN FULL OF ALL INDEBTEDNESS OWED TO FINOVA CAPITAL CORPORATION. PROMISSORY NOTE U.S. $1,000,000.00 March 1, 1999 Lawrence, New York FOR VALUE RECEIVED, the undersigned nSTOR TECHNOLOGIES, INC., a Delaware corporation with its principal place of business at 450 Technology Park, Lake Mary, Florida 32746 (hereinafter called "Maker"), hereby promises to pay to the order of H. Irwin Levy, an individual resident of the State of Florida, with a business address at 100 Century Boulevard, West Palm Beach, Florida 33417 (hereinafter called "Payee"), at the address of Payee's principal place of business stated above, or at such other place as the Payee may designate in writing, the sum of ONE MILLION AND 00/100ths U.S. Dollars (U.S. $1,000,000.00) (the "Principal Amount"), plus interest on the outstanding balance of the Principal Amount at the rate of ten percent (10%) per annum, payable monthly, from the date hereof until the date when said sum is paid in full in accordance with the terms hereof. The entire Principal Amount plus all accrued interest thereon shall be due and payable in full on May 31, 1999. It is expressly agreed that this Promissory Note evidences a ONE MILLION and 00/100ths U.S. Dollars (U.S.$1,000,000.00) revolving line of credit. The Principal Amount which may be outstanding at any time under such line of credit shall not exceed ONE MILLION and 00/100ths U.S. Dollars (U.S.$1,000,000.00). However, this limitation shall not be deemed to prohibit Payee from advancing any sum which may, in Payee's sole and exclusive discretion, be necessary or desirable in order to protect and preserve the effect and enforceability of this Promissory Note. Within the limits and subject to the terms and conditions hereof, the Maker may borrow, repay and reborrow under the revolving line of credit evidenced by this Promissory Note and all shall be subject to the terms and conditions of this Promissory Note. Upon the failure by Maker to pay the Principal Amount plus all accrued interest thereon in full on or before the date when due hereunder, the entire unpaid amount of this Note shall thereupon be immediately due and payable, and the Payee shall have all rights and remedies provided under this Note. Maker shall have the right, in Maker's discretion at any time, without payment of premium or penalty, to prepay in whole or in part the unpaid balance of this Note. This Note shall be governed by and construed under the laws of the State of Florida. The exclusive venue for any litigation in connection with or arising out of this Note shall be Palm Beach County, Florida, and the Maker hereby consents and submits to the jurisdiction of the state and federal courts sitting in Palm Beach County, Florida. MAKER HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES THE RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE. nSTOR TECHNOLOGIES, INC. /s/ Michael L. Wise By:________________________ Name: Michael L. Wise Title: Vice President EXHIBIT 10.3 ALL INDEBTEDNESS EVIDENCED HEREBY AND REFERENCED HEREIN IS SUBORDINATED IN RIGHT OF PAYMENT TO THE PRIOR PAYMENT IN FULL OF ALL INDEBTEDNESS OWED TO FINOVA CAPITAL CORPORATION. FORM OF PROMISSORY NOTE U.S. $__________ January 29, 1999 Lawrence, New York FOR VALUE RECEIVED, the undersigned nSTOR TECHNOLOGIES, INC., a Delaware corporation with its principal place of business at 450 Technology Park, Lake Mary, Florida 32746 (hereinafter called "Maker"), hereby promises to pay to the order of _________________, an individual resident of the State of _________, with an address at _______________________________________________ (hereinafter called "Payee"), at the address of Payee's principal place of business stated above, or at such other place as the Payee may designate in writing, the sum of SIX HUNDRED THOUSAND DOLLARS and 00/100ths U.S. Dollars (U.S. $__________) (the "Principal Amount"), plus interest on the outstanding balance of the Principal Amount at the rate of eight percent (8%) per annum, payable monthly, from the date hereof until the date when said sum is paid in full in accordance with the terms hereof. The entire Principal Amount plus all accrued interest thereon shall be due and payable in full on September 5, 2000. Upon the failure by Maker to pay the Principal Amount plus all accrued interest thereon in full on or before the date when due hereunder, the entire unpaid amount of this Note shall thereupon be immediately due and payable, and the Payee shall have all rights and remedies provided under this Note. Maker shall have the right, in Maker's discretion at any time, without payment of premium or penalty, to prepay in whole or in part the unpaid balance of this Note. This Note shall be governed by and construed under the laws of the State of Florida. The exclusive venue for any litigation in connection with or arising out of this Note shall be Palm Beach County, Florida, and the Maker hereby consents and submits to the jurisdiction of the state and federal courts sitting in Palm Beach County, Florida. MAKER HEREBY KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES THE RIGHT IT MAY HAVE TO A TRIAL BY JURY IN RESPECT OF ANY LITIGATION BASED HEREON, OR ARISING OUT OF, UNDER OR IN CONNECTION WITH THIS NOTE. nSTOR TECHNOLOGIES, INC. /S/ Michael L. Wise By:________________________ Name: Michael L. Wise Title: Vice President EXHIBIT 10.8 EMPLOYMENT AGREEMENT THIS AGREEMENT ("Agreement") dated as of June 1, 1998, is entered into by and between nSTOR TECHNOLOGIES, INC., a Delaware corporation (the "Company"), and Larry Steffan (the "Executive"). Recitals The Company, through its Board of Directors, desires to retain the services of Executive, and Executive desires to be retained by the Company, on the terms and conditions set forth in this Agreement. Agreement For and in consideration of the foregoing and of the mutual covenants of the parties herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. EMPLOYMENT. The Company hereby employs Executive to serve in the capacities described herein and Executive hereby accepts such employment and agrees to perform the services described herein upon the terms and conditions hereinafter set forth. 2. TERM. The term of Executive's employment pursuant to this Agreement shall commence as of the date hereof and shall terminate at the close of business on June 1, 2001, subject to earlier termination in accordance the other terms and conditions set forth herein. 3. DUTIES. Executive shall serve as and have the title of the President of the Company and President of nStor Corporation, a wholly-owned subsidiary of the Company ("nStor"), shall serve on the Board of Directors of nStor and, subject to the approval of the Company's shareholders, shall serve on the Company's Board of Directors. The Executive's principal place of employment shall be Lake Mary, Florida. Executive agrees to devote his full business time, energy, skills and best efforts to such employment while so employed. Nothing in this Agreement shall preclude Executive from engaging, so long as, in the reasonable determination of the board of directors of the Company (the "Board of Directors"), such activities do not interfere with his duties and responsibilities hereunder, in charitable and community affairs, from managing any passive investment made by him or from serving, subject to the prior approval of the Board of Directors, as a member of the board of directors or as a trustee of any other corporation, association or entity. 4. COMPENSATION. (a) Base Compensation. The Company shall pay Executive, and Executive agrees to accept, base compensation at the rate of $200,000 per year, payable bi-weekly, through the term of this Agreement ("Base Compensation"). The Base Compensation specified in this Section 4(a) shall be increased to $250,000 per year on January 1, 1999. Base Compensation may also be increased annually during the term of this Agreement in the sole discretion of the Board of Directors. (b) Bonus Compensation. (i) Solely in the event that the Company has a net increase in cash and cash equivalents as a result of income from operations, and not as a result of any cash or capital infusion from a third party, during any consecutive three month period during the period commencing July 1, 1998 and ending December 31, 1998, the Company shall pay Executive a one-time bonus in the amount of $25,000 within 30 days following the preparation of financial statements for such three-month period. (ii) Subject to the attainment by the Company of certain goals to be established by the Company's Board of Directors for fiscal year 1999 and each fiscal year during the term of this Agreement thereafter, the Board of Directors may, in its sole discretion, grant Executive an annual cash bonus. (c) Stock Options. The Company shall grant Executive an option (the "Option") to purchase 750,000 shares of the common stock, par value $.05 per share, of the Company ("Common Stock") on terms set forth in the Stock Option Agreement by and between the Company and the Executive of even date herewith. 5. FRINGE BENEFITS. (a) Generally. Executive shall be eligible for fringe benefits pursuant to any insurance, pension or other employee fringe benefit plan approved by the Board of Directors that now or hereafter may be made available to employees of the Company and for which Executive will qualify according to his eligibility under the provisions thereof. (b) Health and Disability Insurance. Executive shall be entitled to participate in such health insurance plans that the Company offers to other executive officers of the Company from time to time, provided that such participation shall not exclude any pre-existing conditions with respect to the Executive or his family. The Company shall provide Employee with disability insurance covering [ ]. (c) Life Insurance. The Company shall provide Employee with $1 million of term insurance and allow the Employee to designate the beneficiary of such policy. (d) Flex Days. During the term of this Agreement, Executive shall be entitled to twenty-one (21) flex days per year which Executive may use for vacation, holidays, illness or any other purpose. (e) Relocation Expenses. Executive shall be reimbursed for: (i) all reasonable moving expenses, including packing and unpacking costs, incurred in connection with Executive's relocation from Boca Raton, Florida to the Greater Orlando area of Florida; and (ii) reasonable temporary housing expenses for a period not to exceed one year. 6. EXPENSES. The Executive shall be reimbursed for all usual expenses incurred on behalf of the Company, in accordance with Company practices and procedures, provided that: (a) Each such expenditure is of a nature deductible under Section 162 of the Internal Revenue Code of 1986, as amended (the "Code") on the Federal income tax return of the Company as a business expense and not as deductible compensation to Executive; and (b) Executive furnishes the Company with adequate documentary evidence required by the Code or any regulation promulgated thereunder for the substantiation of such expenditures as a deductible business expense of the Company and not as deductible compensation to Executive. 7. TERMINATION. The term of Executive's employment under this Agreement may be terminated prior to expiration of the term provided in Section 2 hereof in accordance with the following paragraphs. (a) For Cause. This Agreement may be immediately terminated by the Company for Cause (as herein defined) and, upon thirty (30) days written notice to Executive, without Cause, for any reason or for no reason. For purposes of this Agreement, the term "Cause" shall mean the termination of the Executive by the Board of Directors of the Company as a result of the existence or occurrence of one or more of the following conditions or events: (i) a material breach by the Executive of any provision of this Agreement, or the willful and continued failure of Executive substantially to perform his duties under his employment with the Company; (ii) Executive's willful misconduct or gross negligence in connection with the performance of his duties as an employee or officer of the Company; (iii) performance by the Executive of any act of fraud or material misrepresentation or a material act of misappropriation which results or is intended to result in Executive's personal enrichment at the expense of the Company; (iv) conviction of the Executive of any crime which constitutes either (i) a felony offense involving violence (but not involving a motorized vehicle) or fraud, embezzlement, theft or business activities, or (ii) a misdemeanor involving fraud, embezzlement or theft in the United States or which, if it had been committed in the United States, would constitute either a felony offense involving violence or fraud, embezzlement, theft or business activities or a misdemeanor involving fraud, embezzlement or theft in the United States; (v) violation by the Executive of any law which results in the entry of a judgment or order enjoining or preventing the Executive from such activities as are essential for the Executive to perform his services as required by this Agreement; or (vi) a good faith determination by the Board of Directors that Executive has engaged in conduct or activities materially damaging to the business of the Company, monetarily or otherwise, it being understood that neither conduct or activities pursuant to the Executive's exercise of his good faith business judgment nor unintentional physical damage to properties by the Executive shall be a ground for such a determination. (b) Executive. Executive may voluntarily terminate his employment hereunder upon thirty (30) days written notice to the Company. (c) Mutual. Executive's employment under this Agreement may be terminated upon mutual written agreement of the Company and the executive. (d) Death. In the event of the death of Executive, this Agreement shall terminate immediately. (e) Disability. If, during Executive's employment under this Agreement, Executive shall become permanently disabled and unable to perform his duties as required herein ("Disability") for a consecutive period of one hundred eighty (180) days, or, after being disabled, an expert medical opinion is furnished to the Company that Executive will be unable to perform his or her duties for six (6) months, then the Company may, upon thirty (30) days written notice to Executive, terminate Executive's employment under this Agreement. (f) Change of Control. In the event that following a "Change in Control" (as defined in this Section 7(f)): (i) Executive's job description, responsibilities and authority is substantially reduced and as a result, Executive elects to voluntarily resign his employment with the Company; or (ii) Employee is terminated by the Company, all options to purchase Common Stock granted to Executive shall immediately vest. Termination of Executive's employment under this Agreement pursuant to the provisions of the preceding sentence shall be deemed to be a voluntary resignation or termination by Executive and shall not be deemed a termination without Cause for purposes of Section 9 hereof. For purposes of this Agreement, a "Change in Control" shall be deemed to have occurred when: (i) there occurs any transaction (which shall include a series of transactions occurring within sixty (60) days) that has the result that shareholders of the Company immediately before such transaction cease to own at least fifty-one percent (51%) of the voting stock of the Company or any entity that results from the participation of the Company in a merger, reorganization, consolidation, liquidation or any other form of corporate transaction; (ii) the shareholders of the Company approve a plan of merger, consolidation, reorganization, liquidation or dissolution in which the Company does not survive (unless the approved merger, consolidation, reorganization, liquidation or dissolution is subsequently abandoned); (iii) the Company disposes of all or substantially all of its assets; or (iv) a majority or more of the directors nominated by the Board of Directors to serve as directors, each having agreed to serve in such capacity, fail to be elected in a contested election of directors. 8. DEATH AND DISABILITY. In the event of the termination of Executive's employment under this Agreement by reason of the Executive's death or Disability, in addition to any insurance benefits provided pursuant to the provisions of Section 5 of this Agreement, the Company shall pay Executive (or his heirs and/or personal representatives), Base Compensation through the date of death or the date of termination for Disability as provided in Paragraph 7(e), respectively. 9. SEVERANCE. In the event of the termination of Executive's employment under this Agreement for any reason other than Executive's death or Disability, the Company shall provide the payments and benefits to Executive as indicated below: (a) For Cause, Voluntary Termination or Following a Change of Control. If Executive is terminated for Cause (as defined in Section 7(a) of this Agreement), Executive voluntarily terminates his employment with the Company, or Executive is terminated or resigns following a Change of Control for any reason whatsoever, the Company shall be obligated only to continue to pay to Executive his Base Compensation, if any, earned up to the date of termination and shall reimburse the Executive for any expenses to which the Executive is due reimbursement by the Company under Section 6 hereof. In addition, the Company shall pay any vested benefits, if any, owed to Executive under any plan provided for Executive under Paragraph 5 hereof in accordance with the terms of such plan as in effect on the date of termination of employment under this Paragraph 9. (b) Without Cause. If the Company terminates this Agreement without Cause, Executive shall continue to receive the Base Compensation in effect on the date of such termination until the date twelve (12) months from the date of termination under this Agreement and shall reimburse the Executive for any expenses to which the Executive is due reimbursement by the Company under Section 6 hereof. In addition, the Company shall pay any vested benefits, if any, owed to Executive under any plan provided for Executive under Paragraph 5 hereof in accordance with the terms of such plan as in effect on the date of termination of employment under this Paragraph 9. 10. CONFIDENTIAL INFORMATION. Executive recognizes and acknowledges that he will have access to certain confidential information of the Company and of corporations with whom the Company does business, and that such information constitutes valuable, special and unique property of the Company and such other corporations. During the term of this Agreement and for a period of five (5) years immediately following the date of termination of this Agreement, Executive agrees not to disclose or use any confidential information, including without limitation, information regarding research, developments, product designs or specifications, manufacturing processes, "know-how," prices, suppliers, customers, costs or any knowledge or information with respect to confidential or trade secrets of the Company, it being understood that such confidential information does not include information that is publicly available unless such information became publicly available as a result of a breach of this Agreement. Executive acknowledges and agrees that all notes, records, reports, sketches, plans, unpublished memoranda or other documents belonging to the Company, but held by Executive, concerning any information relating to the Company's business, whether confidential or not, are the property of the Company and will be promptly delivered to it upon Executive's leaving the employ of the Company. Executive also agrees to execute such confidentiality agreements that the Board may adopt, and may modify from time to time, as a standard form to be executed by all employees of the Company, to the extent such standard forms are not materially more restrictive than the provisions of this Agreement. 11. NON-SOLICITATION. At all times during the term of this Agreement and three (3) years thereafter, Executive shall not, directly or indirectly, induce, influence, combine or conspire with, or attempt to induce, influence, combine or conspire with, any of the officers, employees, agents or consultants of the Company to terminate their employment, or other relationship, with or compete against the Company or any future subsidiaries, parents or affiliates of the Company in the business of selling, distributing, installing and/or servicing microcomputers, peripherals, components and/or accessories, microcomputer software products, and custom-designed microcomputer systems (the "Business"). 12. NON-COMPETITION. Executive acknowledges that his services and responsibilities are unique in character and are of particular significance to the Company, that the Company engages in a competitive business with a national market and that Executive's continued and exclusive service to the Company under this Agreement is of a high degree of importance to the Company. Therefore, during the term of this Agreement and for a period of three (3) years thereafter (the "Noncompete Period"), Executive shall not, directly or indirectly, engage in the Business, or in any other business which, at the time of Executive's termination, the Company is actively engaged or plans to engage in (the "Future Business"), except as an employee or agent of the Company, and shall not, directly or indirectly, as owner, partner, joint venturer, employee, broker, agent, corporate officer, principal, licensor, shareholder (unless as owner of no more than five percent (5%) of the issued and outstanding capital stock of such entity if such stock is publicly traded) or in any other capacity whatsoever, engage in or have any connection with any business which is competitive with the Business or any Future Business, and which operates anywhere in the United States. In the event Executive is terminated by the Company without Cause prior to the expiration of the term of this Agreement, the Noncompete Period shall be modified such that it expires on the date of such involuntary termination. 13. RESTRICTIVE COVENANTS. (a) If, in any judicial proceedings, a court shall refuse to enforce any of the covenants included in Paragraphs 10, 11 or 12 hereof, then such unenforceable covenant shall be amended to relate to such lesser period or geographical area as shall be enforceable. In the event the Company should bring any legal action or other proceeding against Executive for enforcement of this Agreement, the calculation of the Noncompete Period, if any, shall not include the period of time commencing with the filing of legal action or other proceeding to enforce this Agreement through the date of final judgment or final resolution, including all appeals, if any, of such legal action or other proceeding unless the Company is receiving the practical benefits of this Paragraph 9 during such time. The existence of any claim or cause of action by Executive against the Company predicated on this Agreement shall not constitute a defense to the enforcement by the Company of these covenants. (b) Executive hereby acknowledges that the restrictions on his activity as contained in this Agreement are required for the Company's reasonable protection and is a material inducement to the Company to enter into this Agreement. Executive hereby agrees that in the event of the violation by him of any of the provisions of this Agreement, the Company will be entitled to institute and prosecute proceedings at law or in equity to obtain damages with respect to such violation or to enforce the specific performance of this Agreement by Executive or to enjoin Executive from engaging in any activity in violation hereof. The prevailing party in any litigation brought to enforce the restrictive provisions contained in this Agreement shall be entitled to reimbursement from the nonprevailing party for reasonable attorneys' fees and expenses incurred in connection with such litigation. (c) Notwithstanding anything to the contrary contained herein, in the event that Executive engages in any conduct prohibited by Paragraphs 10, 11 or 12 hereof for any reason whatsoever, Executive shall not receive any of the severance benefits he otherwise would be entitled to receive pursuant to Paragraph 9 hereof. 14. ARBITRATION. All disputes arising under this Agreement shall be resolved through binding arbitration. The arbitrator shall be selected by the American Arbitration Association and the arbitration shall be conducted in Palm Beach County, Florida, in accordance with the then-prevailing rules of the American Arbitration Association. The decision rendered by the arbitrator shall be binding upon the parties and judgment upon the decision or award may be entered in any court of competent jurisdiction. All costs of arbitration and reasonable attorneys' fees shall be paid by the non-prevailing party. If neither party substantially entirely prevails, the arbitrator by shall apportion the costs and reasonable attorneys' fees. 15. NOTICES. Any notice required or permitted to be given under this Agreement shall be sufficient if in writing and if sent by registered mail to the addresses below or to such other address as either party shall designate by written notice to the other: If to the Executive: To the address set forth below his signature on the signature page hereof. If to the Company: nStor Technologies, Inc. 100 Century Boulevard West Palm Beach, Florida 33417 Attention: H. Irwin Levy 16. ENTIRE AGREEMENT; MODIFICATION. (a) This Agreement contains the entire agreement of the Company and Executive, and the Company and Executive hereby acknowledge and agree that this Agreement supersedes any prior statements, writings, promises, understandings or commitments between the parties hereof. (b) No future oral statements, promises or commitments with respect to the subject matter hereof, or other purported modification hereof, shall be binding upon the parties hereto unless the same is reduced to writing and signed by each party hereto. 17. ASSIGNMENT. The rights and obligations of the Company under this Agreement shall inure to the benefit of and shall be binding upon the successors and assigns of the Company. The Executive may not assign his rights and obligations under this Agreement. 18. MISCELLANEOUS. (a) This agreement shall be subject to and governed by the laws of the State of Delaware, without regard to the conflicts of laws principles thereof. (b) The section headings contained herein are for reference purposes only and shall not in any way affect the meaning or the interpretation of this Agreement. (c) The failure of any party to enforce any provision of this Agreement shall in no manner affect the right to enforce the same, and the waiver by any party of any breach of any provision of this Agreement shall not be construed to be a waiver by such party of any succeeding breach of such provision or a waiver by such party of any breach of any other provision. (d) All written notices required in this Agreement shall be sent postage prepaid by certified or registered mail, return receipt requested. (e) In the event any one or more of the provisions of this Agreement shall for any reason be held invalid, illegal or unenforceable, the remaining provisions of this Agreement shall be unimpaired, and the invalid, illegal or unenforceable provision shall be replaced by a mutually acceptable valid, and enforceable provision which comes closest to the intent of the parties. (f) This Agreement may be executed in any number of counterparts, each of which shall constitute an original and all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties have executed this Employment Agreement as of the day and year first above written. nSTOR TECHNOLOGIES, INC. /S/ Mark F. Levy By: _____________________________ Its: Vice President EXECUTIVE /S/ Larry Steffann _________________________________ Larry Steffan Address: ___________________________ ___________________________ EXHIBIT 10.9 EMPLOYEE INCENTIVE STOCK OPTION AGREEMENT THIS AGREEMENT, made as of the 1st day of June, 1998 by and between nStor Technologies, Inc., a Delaware corporation (the "Company"), and Lawrence F. Steffann (the "Optionee"). W I T N E S S E T H: WHEREAS, the Company has established and adopted its 1996 Stock Option Plan (the "Plan"), pursuant to which it may grant options to purchase shares of its common stock, $.05 par value per share (the "Common Stock"), to its employees; WHEREAS, Optionee is an employee of the Company and has been granted options to purchase shares of Common Stock; and WHEREAS, Optionee and the Company desire to establish the terms and conditions of such options in this Agreement; NOW, THEREFORE, in consideration of the mutual covenants set forth herein, and other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, the parties hereto agree as follows: 1. Grant of Option. A. Subject to and upon the terms and conditions set forth in this Agreement, the Company hereby grants to Optionee an Incentive Stock Option (sometimes hereinafter referred to as "Option") to purchase Seven Hundred Fifty Thousand (750,000) shares (the "Option Shares") during the specified term of this Option, at a price equal to One Dollar and Twenty Cents ($1.20) per share, which price is equal to or greater than the current market value per share. This Option is granted pursuant to the terms and conditions of the Plan, all of which terms and conditions are hereby incorporated by reference into this Agreement. B. Notwithstanding anything to the contrary in this Agreement, the grant of this Option is subject to obtaining the approval of the shareholders of the Company, at the 1999 Annual Meeting of Shareholders, for an amendment to the Plan to increase the number of shares reserved for issuance under the Plan to at least _____ million shares of Common Stock (the "Plan Amendment"). In the event that the Plan Amendment is not approved by the shareholders at the 1999 Annual Meeting of Shareholders, the grant of this Option shall be null and void to the extent that the Option Shares exceed the number of shares available for issuance under the Plan of the date hereof. 2. Specified Term; Time of Exercise. This Option shall vest and shall be exercisable, subject to the provisions of Section 7 hereof, in the following amounts and on the following dates: December 1, 1998--125,000 options; June 1, 1999--125,000 options; December 1, 1999--125,000 options; June 1, 2000--125,000 options; December 1, 2000--125,000 options; and June 1, 2001--125,000 options. All Options shall expire and terminate on the date ten (10) years from the date hereof. While exercisable, Optionee may exercise all or any portion of this Option. 3. Transferability of Option. This Option shall not be transferable by the Optionee other than at death, and this Option is exercisable during the Optionee's lifetime only by the Optionee. 4. Termination of Employment. If Optionee ceases to be employed by the Company (or any of its subsidiaries) for any reason other than death or permanent and total disability, then all rights with respect to any then exercisable Option Shares shall terminate after the expiration of a period of three (3) months from the date of termination. If Optionee's employment is terminated as a result of death or "permanent and total disability" (as defined in Section 22(e)(3) of the Internal Revenue Code of 1986, as amended), then all Option Shares which would have otherwise vested and become exercisable in the one (1) year period following such event shall continue to so vest and become exercisable as so scheduled and, together with any previously exercisable Option Shares, shall be exercisable for the lesser of: (i) the remaining term of the Option or (ii) one (1) year from the date of termination of Optionee's employment as a result of death or "permanent and total disability". Notwithstanding any to the contrary set forth herein, if Optionee shall (i) commit any act of malfeasance or wrongdoing affecting the Company, (ii) breach any covenant not to compete or employment agreement with the Company, or (iii) engage in conduct that would warrant the Optionee's discharge for cause, any unexercised part of the Option shall lapse immediately upon the earlier of the occurrence of such event or the last day Optionee is employed by or affiliated with the Company. 5. Adjustment in the Event of Change in Capital Structure, Reorganization, Anti-Dilution or Accounting Changes. In the event of a change in the corporate structure or shares of the Company, subject to any required action by the shareholders, the Company shall make such equitable adjustments with respect to dilution or accretion as it may deem appropriate in the number, kind and in the exercise price of the unexercised Option Shares granted by this Agreement. For purposes of this section, a change in the corporate structure or shares of the Company shall include, but is not limited to, changes resulting from a recapitalization, stock split, reverse split, consolidation, rights offering, stock dividend, reorganization or liquidation. This Agreement shall not in any way affect the right of the Company to make changes in its capital structure including, without limitation, the issuance of any additional shares of any class of its capital stock, or to merge or dissolve, liquidate or sell all or any part of its business or assets. In no event shall Optionee be entitled to any adjustments as a result of the issuance of any additional shares of any class of the Company's capital stock where the consideration received by the Company is equal to or greater than the fair market value of such shares, as reasonably determined by the Board of Directors of the Company. 6. Privilege of Stock Ownership. Optionee shall not be deemed to be the holder of, or to have any of the rights of a holder with respect to, any Option Shares unless and until the Option shall have been exercised pursuant to the terms hereof, the Company shall have issued and delivered the shares to Optionee, and Optionee's name shall have been entered as a stockholder of record on the books of the Company. Thereupon, Optionee shall have full voting and other ownership rights with respect to such shares. 7. Manner of Exercising Option. A. This Option may be exercised only as to whole shares and only by written notice signed by Optionee (or in the case of exercise after Optionee's death or disability, by Optionee's legal representative, executor, administrator, heir or legatee, as the case may be) and mailed or delivered to the President or Secretary of the Company at its principal office, which notice shall: (i) specify the number of Option Shares with respect to which the Option is being exercised; (ii) be accompanied by payment in full in cash; (iii) if the shares of Common Stock issuable upon exercise of the Option are not then covered by a current registration statement of the Company under the Securities Act of 1933, as amended (the "Securities Act"), include a statement to the effect that Optionee, or other person exercising the Option, is purchasing the Option Shares for investment and not with a view to, or for sale in, any distribution thereof; and (iv) if the Option is being exercised by a person or persons other than Optionee, be accompanied by proof satisfactory to the Company and its counsel, that such person or persons have the right to exercise the Option. Prior to the issuance of the Option Shares hereunder, Optionee shall execute and deliver to the Company such other representations in writing as may be reasonably requested by the Company in order for it to comply with the applicable requirements of Federal and state securities laws. B. This Option shall be deemed to have been exercised with respect to the Option Shares specified in said notice at the time of receipt by the Company of: (i) the notice specified in Section 7(A) hereof; (ii) any representations reasonably required by the Company pursuant to Section 7(A) hereof; and (iii) the payment required in Section 7(A) hereof. C. Unless the shares of Common Stock issuable upon exercise of the Option are covered by a then current registration statement of the Company under the Securities Act, the certificates representing the Option Shares issued or to be issued hereunder shall be stamped or otherwise imprinted with legends substantially in the following form: THE SHARES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR THE SECURITIES LAWS OF ANY STATE, AND HAVE BEEN ACQUIRED FOR AN INVESTMENT AND MAY NOT BE SOLD, TRANSFERRED, PLEDGED, OR HYPOTHECATED IN THE ABSENCE OF AN EFFECTIVE REGISTRATION STATEMENT FOR SUCH SHARES UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR AN OPINION OF COUNSEL ACCEPTABLE TO COUNSEL FOR THE COMPANY THAT REGISTRATION IS NOT REQUIRED UNDER SUCH LAWS. 8. Securities Law Requirements. A. No Option granted hereunder shall be exercisable, in whole or in part, and the Company shall not be obligated to sell any Option Shares if such exercise and sale would, in the opinion of counsel for the Company, violate the applicable requirements of Federal or state securities laws. Each Option shall be subject to the further requirement that, if at any time the Company shall determine in its discretion that the listing or qualification of the Option Shares under any securities exchange requirements or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with, the issuance of the Option Shares, such Option may not be exercised in whole or in part unless such listing, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. B. If any law or regulation of any state or Federal commission or agency having jurisdiction shall require the Company or the Optionee to take any action with respect to the Option Shares, then the date upon which the Company shall deliver or cause to be delivered the certificate or certificates for the Option Shares shall be postponed until full compliance shall have been made with all such requirements. 9. Employment. Nothing contained in this Agreement shall be deemed to grant any right of continued employment to a participating employee or to limit or waive any rights of the Company or any subsidiary of the Company to terminate such employment at any time, with or without cause. 10. Amendments. The provisions of this Agreement may not be amended, supplemented, waived or changed orally, except by a writing signed by the party as to whom enforcement of any such amendment, supplement, waiver or modification is sought and making specific reference to this Agreement. 11. Assignments. This Agreement may not be assigned by the Optionee. 12. Further Assurances. The parties hereby agree from time to time to execute and deliver such further and other transfers, assignments and documents and do all matters and things which may be convenient or necessary to more effectively and completely carry out the intentions of this Agreement. 13. Binding Effect. All of the terms and provisions of this Agreement, whether so expressed or not, shall be binding upon, inure to the benefit of, and be enforceable by the parties and their respective administrators, executors, legal representatives, heirs, successors and permitted assigns. 14. Governing Law. This Agreement and all transactions contemplated by this Agreement shall be governed by, and construed and enforced in accordance with, the internal laws of the State of Florida without regard to principles of conflicts of laws. 15. Entire Agreement. This Agreement represents the entire understanding and agreement among the parties with respect to the subject matter hereof, and supersedes all other negotiations, understandings and representations (if any) made by and among such parties. IN WITNESS WHEREOF, the undersigned have executed this Agreement as of the date first above written. nSTOR TECHNOLOGIES, INC. /S/ Mark F. levy _________________________________ By: Mark F. Levy Its: Vice President OPTIONEE /S/ Lawrence F. Steffann _______________________________ Lawrence F. Steffann FORM OF EXERCISE (to be executed by the registered holder hereof) The undersigned hereby exercises the right to purchase ___________ shares of common stock, $.05 par value ("Common Stock"), of nSTOR TECHNOLOGIES, INC. (the "Company"), evidenced by the within Employee Incentive Stock Option Agreement and herewith makes payment of the purchase price in full. The undersigned represents to the Company that the undersigned is purchasing the Common Stock for investment and not with a view to, or for sale in, any distribution thereof. Kindly issue certificates for shares of Common Stock in accordance with the instruction given below. Dated: _____________, 19__ _______________________________ Optionee Instructions for registration of stock ____________________________________ Name (Please Print) Social Security or other identifying Number:_____________________________ Address: ____________________________________ City/State and Zip Code EX-21 5 EXHIBITS 21 (SUBSIDIARIES) EXHIBIT 21 nSTOR TECHNOLOGIES, INC. Subsidiaries of the Company and State of Incorporation or Formation nStor Corporation, Inc. Delaware Imge R & D, Inc. Delaware Imge Distribution, Inc. Delaware Imge Maketing, inc. Delaware nStor (Europe) Limited United Kingdom EX-27 6 FINANCIAL DATA SCHEDULE
5 0000075448 NSTOR TECHNOLOGIES, INC. 1,000 12-MOS DEC-31-1998 DEC-31-1998 168 0 2,964 (502) 3,028 6,022 9,797 (2,191) 14,128 3,935 0 0 0 1,025 2,125 14,128 18,026 18,097 15,258 10,907 1,352 0 987 (10,407) 0 (10,407) 0 0 0 (10,407) (.63) (.63) Cash includes restricted cash of $21. PP&E includes $6,892 of goodwill and other intangible assets. Accumulated depreciation includes $939 of accumulated amortization on goodwill and other intangible assets. Preferred stock issued and outstanding includes the following: Series A Convertible Preferred Stock - 1,667 shares; Series C Convertible Preferred Stock - 3,000 shares, and; Series D Convertible Preferred Stock - 2,700 shares. Other expenses include depreciation and amortization. Net loss does not include $1,481 of dividends on preferred stock. Net loss applicable to common stock is $11,888.
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