<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q/A
(X) Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1998
or
( ) Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
Commission File Number 0-12194
ZITEL CORPORATION
(Exact name of Registrant as specified in its charter)
California 94-2566313
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
47211 Bayside Parkway 94538-6517
Fremont, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (510) 440-9600
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 such shorter period that the Registrant was required to file
such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
The number of shares of the Registrant's Common Stock outstanding
as of June 30, 1998, was 17,766,606.
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
INDEX
Page
Number
PART I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
June 30, 1998 (unaudited) and September 30, 1997 ..... 3
Condensed Consolidated Statements of
Operations (unaudited) - Three and Nine Months
Ended June 30, 1998 and 1997 ........................ 4
Condensed Consolidated Statements of
Cash Flows (unaudited) - Nine Months Ended
June 30, 1998 and 1997 ............................... 5
Notes to Condensed Consolidated
Financial Statements ................................. 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results
of Operations ................................. 14
Page 2
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($000's)
<TABLE>
<CAPTION>
(UNAUDITED)
June 30, September 30,
1998 1997
----------- -------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 11,751 $ 4,224
Short-term investments 0 9,596
Accounts receivable, net 3,762 6,547
Inventories 207 3,050
Deferred and refundable taxes 208 3,540
Other current assets 1,935 993
-------- --------
Total current assets 17,863 27,950
Fixed assets, net 1,442 3,700
Intangible assets, net 4,581 5,846
Other assets, net 9,396 11,798
-------- --------
Total assets $ 33,282 $ 49,294
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,200 $ 4,768
Accrued liabilities 4,523 4,419
-------- --------
Total current liabilities 8,723 9,187
Convertible subordinated debt 15,372 24,161
-------- --------
Total liabilities 24,095 33,348
-------- --------
Shareholders' equity:
Common stock 48,835 27,081
Accumulated deficit (39,648) (11,135)
-------- --------
Total shareholders' equity 9,187 15,946
-------- --------
Total liabilities and
shareholders' equity $ 33,282 $ 49,294
-------- --------
-------- --------
</TABLE>
The accompanying notes are an integral part of these financial
statements.
Page 3
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands except per share data)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------ ------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net sales $ 4,591 $ 2,215 $ 16,137 $ 7,057
Royalty revenue 749 1,137 1,541 4,651
-------- -------- -------- --------
Total revenue 5,340 3,352 17,678 11,708
Cost of goods sold 4,445 1,707 10,240 6,243
Research and development
expenses 1,616 1,671 5,567 4,906
Selling, general &
administrative expenses 7,614 3,291 19,474 8,789
Loss on impairment
of assets 1,956 0 1,956 0
Acquisition of
in-process R&D 0 6,600 0 6,600
-------- -------- -------- --------
Operating loss (10,291) (9,917) (19,559) (14,830)
Interest expense 1,401 1,397 2,409 1,397
Other (income) expense 288 (234) (2) (1,269)
-------- -------- -------- --------
Loss before income taxes (11,980) (11,080) (21,966) (14,958)
Provision for (benefit
from) income taxes 6,547 (3,107) 6,547 (4,503)
-------- -------- -------- --------
Net loss $(18,527) $ (7,973) $(28,513) $(10,455)
-------- -------- -------- --------
-------- -------- -------- --------
Basic and diluted loss
per share $ (1.07) $ (.52) $ (1.73) $ (.69)
-------- -------- -------- --------
-------- -------- -------- --------
Number of shares used in
basic and diluted loss
per share calculations 17,235 15,280 16,528 15,157
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
The accompanying notes are an integral part of these financial
statements.
Page 4
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($000's)
<TABLE>
<CAPTION>
(UNAUDITED)
Nine Months Ended
June 30,
1998 1997
-------- --------
<S> <C> <C>
Cash flows provided by (used in) operating activities:
Net loss $(28,513) $(10,455)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Acquisition of in-process R&D 0 6,600
Decrease (increase) in deferred and
refundable taxes 6,509 (4,745)
Loss on impairment of assets 1,956 0
Writedown of inventory 1,655 0
Writeoff of patents 387 0
Adjustment of goodwill and purchased technology 658 0
Discount amortization on subordinated debentures 1,111 1,204
Amortization of capitalized financing costs 672 0
Depreciation and amortization 2,338 923
Provision for doubtful accounts 155 147
Provision for inventory allowances 160 360
Gain on sale of trading securities 0 (777)
Equity in loss of unconsolidated company 410 0
Change in operating assets and liabilities:
Decrease (increase) in accounts receivable 2,630 (1,642)
Decrease in inventories 1,028 469
Increase in other current assets (942) (192)
Increase (decrease) in accounts payable (568) 2,000
Increase in accrued liabilities 719 1,764
-------- --------
Net cash used in operating activities (9,635) (4,344)
-------- --------
Cash flows provided by (used in) investing activities:
Purchase of fixed assets (549) (1,980)
Purchase of other assets (1,180) (618)
Investment in unconsolidated company (1,510) (2,024)
Proceeds from sale of marketable securities 9,596 3,159
Purchase of companies, net of cash acquired 0 (11,062)
-------- --------
Net cash provided by (used in)
investing activities 6,357 (12,525)
-------- --------
</TABLE>
Page 5
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
($000's)
<TABLE>
<CAPTION>
(UNAUDITED)
Nine Months Ended
June 30,
1998 1997
-------- -------
<S> <C> <C>
Cash flows provided by financing activities:
Issuance of common stock $ 1,238 $ 1,200
Issuance of subordinated debentures 9,567 23,795
------- -------
Net cash provided by financing activities 10,805 24,995
------- -------
Net increase in cash 7,527 8,126
Cash and cash equivalents, beginning of year 4,224 9,216
------- -------
Cash and cash equivalents, end of period $11,751 $17,342
------- -------
------- -------
Supplemental non-cash investing and financing activities:
Issuance of common stock in business combination $ 0 $ 1,200
------- -------
------- -------
Professional costs incurred in placement of
subordinated debentures $ 558 $ 1,205
------- -------
------- -------
Conversion of 5% subordinated debt and
accrued interest $18,791 $ 0
------- -------
------- -------
Common stock purchase warrants $ 614 $ 0
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these financial
statements.
Page 6
<PAGE>
ZITEL CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(Amounts in thousands except per share data)
1. The condensed consolidated financial statements included herein have been
prepared by the Company, without audit, pursuant to the rules and regulations
of the Securities and Exchange Commission and should be read in conjunction
with the audited financial statements of the Company. Certain information
and footnote disclosures, normally included in financial statements prepared
in accordance with generally accepted accounting principles, have been
condensed or omitted although the Company believes the disclosures which are
made are adequate to make the information presented not misleading. Further,
the condensed consolidated financial statements reflect, in the opinion of
management, all adjustments necessary to present fairly the financial
position and results of operations as of and for the periods indicated. The
results of operations for the period ended June 30, 1998 are not necessarily
indicative of the results expected for the full year. The Company has
sustained recurring losses related primarily to lower than anticipated
revenues.
2. Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting
Comprehensive Income". SFAS No. 130 establishes standards for the reporting
and display of comprehensive income and its components in a full set of
general purpose financial statements. Comprehensive income is defined as the
change in equity of a business enterprise during a period from transactions
and other events and circumstances from non-owner sources. The impact of
adopting SFAS No. 130, which is effective for the Company in fiscal year
1999, has not been determined.
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information". SFAS No. 131 requires
publicly-held companies to report financial and other information about key
revenue-producing segments of the entity for which such information is
available and is utilized by the chief operations decision maker. Specific
information to be reported for individual segments includes profit or loss,
certain revenue and expense items and total assets. A reconciliation of
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<PAGE>
segment financial information to amounts reported in the financial statements
would be provided. SFAS No. 131 is effective for the Company in fiscal year
1999 and the impact of adoption has not been determined.
On October 27, 1997, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 97-2, "Software
Revenue Recognition". SOP 97-2 establishes the standard for the appropriate
recognition of software revenue, effective for the Company in fiscal year
1999. The effect of the new SOP 97-2 has yet to be determined.
American Institute of Certified Public Accountants Statement of Position
("SOP") 98-1, "Accounting for Costs of Computer Software Developed or
Obtained for Internal Use", issued on March 4, 1998, will be effective for the
Company in fiscal year 1999. The Company believes there will not be a
significant impact upon adoption.
3. Inventories:
<TABLE>
<CAPTION>
June 30, September 30,
1998 1997
-------- -------------
<S> <C> <C>
Raw materials $ 0 $ 953
Work in process 0 576
Finished goods 207 1,521
------ ------
$ 207 $3,050
------ ------
------ ------
</TABLE>
Inventory at June 30, 1998, consists primarily of finished goods
inventory related to the Company's Year 2000 Services business. During the
quarter, the Company wrote inventory down to its net realizable value and
incurred a related write-off of $1,655 thousand in anticipation of the sale
of the storage business unit, which efforts began during the current quarter
and was finalized on July 24, 1998.
4. Intangible Assets:
Intangible assets include goodwill and purchased technology, recorded in
connection with the acquisition of the three software companies, which were
being amortized on a straight-line basis over seven and five years,
respectively. The Company periodically assesses the recoverability of the
intangible assets by determining whether the amortization of the asset
balance over its remaining life can be recovered through undiscounted future
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<PAGE>
operating cash flows of the acquired operation. The amount of impairment, if
any, is measured based on projected discounted future operating cash flows
and is recognized as a write down of the asset to net realizable value. At
June 30, 1998, a write-down of a combined total of $658 thousand was made to
goodwill and purchased technology. In addition, the amortization period of
goodwill was adjusted to five years from seven years. As of June 30, 1998,
intangible assets consist of the following:
<TABLE>
<CAPTION>
June 30, September 30,
1998 1997
-------- -------------
<C> <C> <C>
Goodwill $3,018 $3,242
Purchased technology 2,588 2,862
Less accumulated amortization (1,025) (258)
------ ------
$4,581 $5,846
------ ------
------ ------
</TABLE>
5. Deferred Software Implementation Costs:
The Company capitalizes substantially all costs related to the purchase
of software and its implementation which includes purchased software,
consulting fees and the use of certain specified Company resources, and are
being amortized on a straight-line basis over the estimated life of the
computer software, which is five years. In June 1998, the Company wrote down
the cost of amounts capitalized in the amount of $742 thousand and the
related accumulated amortization of $192 thousand. As of June 30, 1998, $351
thousand in costs remains unamortized and are included in other long-term
assets. Amortization in the amount of $170 thousand has been charged to
expense during the nine-month period in fiscal 1998. Amortization of $111
thousand had been charged to expense in fiscal year 1997.
6. Investment in Unconsolidated Company:
During the quarter ended December 31, 1997, Zitel invested an additional
$1.5 million in MatriDigm Corporation in exchange for a convertible
promissory note. The note was converted into 1,050 thousand shares of common
stock in May 1998. As of June 30, 1998, the Company's investment in
MatriDigm Corporation amounted to $7.4 million, consisting of 10.6 million
shares of preferred stock and approximately 1.6 million shares of common
stock. The Company recorded $410 thousand equity in losses of the
unconsolidated company during the quarter ended June 30, 1998. The Company
also guaranteed a bank loan in the amount of $1 million, which is classified
in other current assets.
Page 9
<PAGE>
The following is a summary of financial information with
respect to MatriDigm:
<TABLE>
<CAPTION>
Three months ended Nine months ended
June 30, June 30,
------------------ -------------------
1998 1997 1998 1997
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
Net sales $ 2,085 $ - $ 3,975 $ -
Gross profit 1,218 - 1,478 -
Net loss (3,059) (4,518) (10,484) (10,086)
</TABLE>
7. Line of Credit:
In April 1998, the Company obtained a $1.5 million secured bank line of
credit. The line of credit expires on September 30, 1998. Advances bear
interest at the bank's prime rate plus 1% (9.5% at June 30, 1998). Under
terms of the agreement, the borrowing base is 75% of eligible domestic and
foreign insured accounts receivable. Payment of interest is on a monthly
basis, with principal limited to the borrowing base and is due upon maturity.
In addition, the Company is required to maintain certain specified financial
ratios. During the quarter ended June 30, 1998, the Company was in violation
of certain covenants, which were waived by the bank. During the quarter
ended June 30, 1998, the line of credit was not utilized.
8. Convertible Subordinated Debentures:
The current quarter includes a charge to interest expense in the amount
of $169 thousand related to the amortization of the capitalized financing
costs on the 5% convertible subordinated debentures. For the nine months
ended June 30, 1998, approximately $18.8 million was converted into 1.9
million shares of common stock at an average price of $10.068 per share.
On June 16, 1998, the Company issued $10,000,000 principal amount of 3%
Convertible Subordinated Debentures (the "Debentures") which are due June 15,
1999, and five-year common stock purchase warrants totalling 150,000 shares
of the Company's common stock. The Debentures include a 10% discount of
$1,111,000, which was charged to interest expense in the current quarter.
The Debentures accrue interest at the rate of 3% per annum and principal and
accrued interest are convertible into common stock of the Company at a price
of $3.92625. The warrants were valued at $5.1041 and will be amortized over
the life of the Debentures. Any Debentures outstanding on June 15, 1999,
will be automatically converted into common stock. The Debentures restrict
distributions and repurchases of capital stock.
Page 10
<PAGE>
Reference is made to the Company's current report on Form 8-K dated June 25,
1998 for additional information about the Debentures.
9. Earnings Per Share (EPS):
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"), effective
December 31, 1997. SFAS 128 requires the presentation of basic and diluted
earnings per share. Basic EPS is computed by dividing income available to
common stockholders by the weighted average number of common shares
outstanding for the period. Diluted EPS is computed giving effect to all
dilutive potential common shares that were outstanding during the period.
Dilutive potential common shares consist of the incremental common shares
issuable upon the conversion of convertible subordinated debt (using the "if
converted" method) and exercise of stock options and warrants for all
periods. All prior period earnings per share amounts have been restated to
comply with the SFAS 128.
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follow (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
June 30, June 30,
------------------ ------------------
l998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Numerator - Basic and Diluted EPS
Net loss $(18,527) $ (7,973) $(28,513) $(10,455)
-------- -------- -------- --------
-------- -------- -------- --------
Denominator - Basic EPS
Common stock outstanding 17,235 15,280 16,528 15,157
Common equivalent stock 0 0 0 0
-------- -------- -------- --------
17,235 15,280 16,528 15,157
-------- -------- -------- --------
Basic loss per share $ (1.07) $ (.52) $ (1.73) $ (.69)
-------- -------- -------- --------
-------- -------- -------- --------
Denominator - Diluted EPS
Denominator - Basic EPS 17,235 15,280 16,528 15,157
Effect of Dilutive Securities:
Common stock options 0 0 0 0
Convertible preferred stock 0 0 0 0
-------- -------- -------- --------
17,235 15,280 16,528 15,157
-------- -------- -------- --------
Diluted loss per share $ (1.07) $ (.52) $ (1.73) $ (.69)
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
Page 11
<PAGE>
For the quarter and nine-month period ended June 30, 1998, options to
purchase 459 thousand and 649 thousand shares, respectively, were not
included in the computation of diluted EPS because of the anti-dilutive
effect of including these shares in the calculation for both periods. For
the quarter and nine-month period ended June 30, 1997, options to purchase
1,061 thousand and 1,302 thousand shares, respectively, were not included in
the computation of diluted EPS because of the anti-dilutive effect of
including these shares in the calculation for both periods. In addition, had
the subordinated debt been converted, it would have resulted in approximately
4,129 thousand and 499 thousand shares for the three months ended and 2,482
thousand and 499 thousand shares for the nine months ended June 30, 1998 and
1997, respectively. These shares were not included in the computation due to
their anti-dilutive effect.
10. Sale of Storage Business Unit:
Due to the lack of performance of the storage business unit, on July 24,
1998, the Company completed the sale of the net assets of the business unit,
which totalled $2.1 million, for cash and a note totalling $1.0 million and
royalties of up to $4.0 million, payable over four years based on the sales
performance of the new company.
Fixed assets in the amount of $1.2 million and deferred software and
related implementation costs of $767 thousand, which related to manufacturing
modules that would no longer be used, were taken as a loss on impairment of
assets during the three months ended June 30, 1998. Inventory in the amount
of $1.7 million and patents in the amount of $389 thousand were charged
against cost of sales.
Due to the excess facility capacity resulting from the sale of the
storage business unit, a reserve in the amount of $750 thousand was recorded
in selling, general and administrative expense during the three months ended
June 30, 1998. In addition, a reserve of $1.0 million was recorded in
selling, general and administrative expense for the severance costs of the
storage business unit personnel.
11. Deferred Taxes:
Due to the uncertainty surrounding the realization of the NOL and credit
carryforwards in future tax years, the Company has established a 100%
valuation allowance against its deferred tax assets to the extent it is more
likely than not that this asset will not be realized. The valuation
allowance has increased approximately $6.5 million for the three months ended
June 30, 1998.
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<PAGE>
12. Common Stock:
Common stock activity for the period from September 30, 1997
through June 30, 1998 is as follows:
<TABLE>
<CAPTION>
Common Stock Common Stock
Shares Amount
------------ ------------
<S> <C> <C>
Balance at September 30, 1997 15,603 $27,081
Conversion of subordinated debentures 1,867 20,516
Exercise of stock options 297 1,238
------ -------
Balance at June 30, 1998 17,767 $48,835
------ -------
------ -------
</TABLE>
Page 13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The Company recorded a net loss of $18,527,000 ($1.07 per share) for the
quarter ended June 30, 1998, compared with a net loss of $7,973,000 ($0.52
per share) for the same quarter of the prior year. Included in the current
quarter results were a loss of approximately $1,400,000 related to the
operation of the Company's storage business unit, excess capacity of the
Fremont facility of $750,000, severance costs of the storage business unit of
approximately $1,000,000, write-off of assets specific to the storage
business unit of approximately $4,000,000, a discount charge of approximately
$1,111,000 related to the $10,000,000 convertible subordinated debentures
issued in June 1998, and a charge to operations of approximately $658,000 for
revaluation of goodwill and intangible assets. A loss of approximately
$410,000 was recorded which related to the Company's minority share of an
unconsolidated investment. In addition, the Company wrote down its deferred
tax assets by $6,547,000 (55% of income before income taxes). Results for
the quarter of the previous year included a one-time write off of in-process
research and development in connection with the acquisition of software
companies in June 1997. The prior year's quarter also included a discount
charge of approximately $1,204,000 related to the $25,000,000 convertible
subordinated debentures issued in May 1997 and a tax benefit of $1,077,000
(36% of income before income taxes). Weighted average shares outstanding for
the current quarter were 17,235,000 compared to 15,280,000 for the same
quarter of the prior year.
For the nine months ended June 30, 1998, the net loss was $28,513,000 ($1.73
per share) compared with a net loss of $10,455,000 ($0.69 per share) for the
same period a year earlier. Weighted average shares outstanding in the first
nine months of fiscal 1998 were 16,528,000 compared to 15,157,000 for the
same period of fiscal 1997.
Total revenue for the current quarter was $5,340,000 compared with total
revenue of $3,352,000 for the same quarter of the prior year, an increase of
$1,988,000. The increase in revenue is directly attributable to an increase
in net sales, partially offset by a decrease in royalty revenue. Net sales
for the current quarter were $4,591,000 versus $2,215,000 for the same
quarter of the prior year, an increase of $2,376,000. The
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<PAGE>
increase in net sales is attributable to the net sales generated by the
Company's software business unit (which was acquired June 30, 1997) of
$3,510,000, which was partially offset by a decrease of $1,318,000 in net
sales of the storage business unit. Royalty revenue for the current quarter
was $749,000 versus $1,137,000 for the same quarter of the prior year.
During the quarter, the Company negotiated and received the final payment for
all royalty obligations from IBM Corporation. In addition, the solution
services business unit recognized net sales on its first remediation
contract, approximately $328,000.
For the nine months ended June 30, 1998, total revenue was $17,678,000 versus
total revenue of $11,708,000 for the same period of the prior year, an
increase of $5,970,000. The increase in revenue is directly attributable to
an increase in net sales, partially offset by a decrease in royalty revenue.
For the nine months just ended, net sales were $16,137,000 versus $7,057,000
for the same period of the prior year, an increase of $9,080,000. The
increase in net sales is directly attributable to the net sales generated by
the Company's software business unit of $10,653,000, partially offset by a
decrease of $1,350,000 in net sales of the storage business unit. Royalty
revenue was $1,541,000 for the nine-month period just ended compared with
$4,651,000 for the same period of the prior year.
Gross margin as a percent of net sales was 3% for the quarter ended June 30,
1998 compared to 23% for the same quarter of the prior year. For the
nine-month period ended June 30, 1998, gross margin was 37% versus 12% for
the same period a year earlier. The decrease in gross margin percentage
during the current quarter is primarily attributable to the write-down of
inventory and related reserves of the Company's storage business unit. The
increase in the gross margin percentage for the nine-month period is
primarily the result of product mix as a result of net sales generated by the
software business unit.
On July 24, 1998, the Company finalized the sale of its storage business unit
for proceeds of approximately $1,000,000 with an additional $4,000,000
royalty potential based on the new company's net sales of the storage
product. The transaction involved the sale of the assets and liabilities of
this business unit. Included in the current quarter are losses of
approximately $1,400,000 related to the operation of this business unit.
Additionally, costs related to the storage business unit during the quarter
were severance costs in the amount of $1,000,000, excess capacity of the
Fremont facility of $750,000, and the write-off of assets specific to the
business
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<PAGE>
unit of approximately $4,000,000. In addition, it is anticipated that
approximately $800,000 in personnel-related costs of the storage business
unit will be incurred in the fourth quarter of the current fiscal year.
Research and development expenses for the quarter ended June 30, 1998, were
30% of total revenue compared with 50% for the same quarter of the prior
year. Actual dollars decreased $55,000. With the sale of the storage
business unit, it is anticipated that research and development spending will
decrease significantly in actual dollars.
Selling, general and administrative (SG&A) expenses were 143% of total
revenue for the current quarter versus 98% for the same quarter of the prior
year. Actual spending increased $4,323,000. The increase in spending is
attributable to the added SG&A expenses of the acquired software companies of
approximately $2,464,000, an increase of $637,000 in legal costs, $975,000
for severance for the storage business unit personnel, and $750,000 estimated
loss on excess capacity at the Fremont facility due to the sale of the
storage business unit.
For the nine-month period just ended, SG&A expenses were 110% of total
revenue compared to 75% for the same period of the prior year. Actual
spending increased $10,685,000. The increase in spending is attributable to
the additional SG&A expenses of the acquired software companies in the amount
of $6,940,000; an increase in SG&A spending of the solution services business
unit of $866,000; and the severance and facilities items indicated above.
Management continues to reduce operating expenses to bring them in line with
the current business operations.
Interest expense was $1,401,000 for the quarter just ended versus interest
expense of $1,397,000 in the same quarter of the prior year. For the current
quarter, interest expense included the amortization of the discount on the 3%
convertible subordinated debentures of $1,111,000 and, in the prior year, the
amortization of the discount on the 5% convertible subordinated debentures
was $1,204,000. In addition, interest expense included $290,000 interest
expense related to the convertible subordinated debentures in the current
year compared to $193,00 in the prior year.
For the nine months just ended, interest expense was $2,409,000 compared to
$1,397,000 in the prior year. Included in the current year is interest
expense in the amount of $1,296,000, which relates to the convertible
subordinated debentures.
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Other expense for the quarter just ended was $288,000 compared to income of
$234,000 in the prior year. The current quarter included $410,000 expense
related to the equity in losses of MatriDigm Corporation, an unconsolidated
company. Interest income in the current quarter is $100,000 compared to
$250,000 in the prior year.
For the nine months ended June 30, 1998, other income was $2,000 compared to
income of $1,269,000 in the prior year. Included in other income in the
prior year is $777,000 of realized gains from the sale of marketable
securities. Interest income in the current year is $395,000 compared to
$516,000 in the prior year.
Liquidity and Capital Resources
During the nine-month period ended June 30, 1998, working capital decreased
$9,623,000 and cash flow utilized by operating activities was $9,635,000.
The utilization of cash in operating activities resulted primarily from the
net loss of $28,513,000. This was partially offset by the reduction in
deferred and refundable taxes of $6,509,000, a decrease in accounts
receivable of $2,630,000 due to a decline in sales of the storage business
unit, a decrease in inventory of $1,028,000 because of reserves taken against
inventory related to the storage business unit which was in the process of
being sold, a loss on impairment of assets in the amount of $1,956,000
related to the planned sale of the storage business unit, and depreciation
and amortization in the amount of $2,338,000.
During the current year, net cash provided by investing activities was
$6,357,000. $9,596,000 was generated from the sale of marketable securities.
This was partially offset by the Company's investment of $1,510,000 in
MatriDigm Corporation, an unconsolidated company, the purchase of fixed
assets in the amount of $549,000, and the purchase of other assets of
$1,180,000.
Net cash provided by financing activities was $10,805,000 which included
$9,567,000 which was raised from the issuance of 3% convertible subordinated
debentures and $1,238,000 from the exercise of employee stock options and
from the sale of stock under the Company's employee stock purchase plan. The
Company has an unutilized $1,500,000 bank line of credit. The line expires
on September 30, 1998.
Management believes that the Company will meet its cash requirements during
the next twelve months from current cash on
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hand, other working capital, cash flow from operations, the available bank
line of credit, and the additional $10,000,000 debentures potentially
available to the Company within six months of the June 1998 private placement.
Recent Accounting Pronouncements
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income",
and SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information". In October 1997, the AICPA issued SOP 97-2, "Software Revenue
Recognition". Readers are referred to the "Recent Accounting Pronouncements"
section of the Notes to the Consolidated Financial Statements for further
discussion.
American Institute of Certified Public Accountants Statement of Position
("SOP") 98-1, "Accounting for Costs of Computer Software Developed or
Obtained for Internal Use", issued on March 4, 1998, will be effective for
the Company in fiscal year 1999. The Company believes there will not be a
significant impact upon adoption.
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This report contains forward-looking statements which are subject to
uncertainties, including those contained in the Company's annual report on
Form 10-K for the fiscal year ended September 30, 1997.
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Zitel is a registered trademark of Zitel Corporation. All other product names
and brand names are trademarks or registered trademarks of their respective
holders.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
ZITEL CORPORATION
Date: February 16, 1999 /s/ Henry C. Harris
------------------------------
Henry C. Harris
Chief Financial Officer
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