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1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
__X___ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________________________
Commission File Number: 0-8354
nSTOR TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its Charter)
Delaware 95-2094565
(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Century Blvd.
West Palm Beach, FL 33417
(Address of principal executive office)
(561) 640-3103
(Registrant's telephone number)
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 _____
Number of shares outstanding of the Registrant's Common Stock,
par value $.05 per share, as of July 31, 1999: 22,637,258
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nSTOR TECHNOLOGIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Page
Number
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30,
1999 (Unaudited) and December 31, 1998 3
Consolidated Statements of Operations
(Unaudited) for the three and six months
ended June 30, 1999 and 1998 4
Consolidated Statements of Stockholders'
Equity (Unaudited) for the six months
ended June 30, 1999 5
Consolidated Statement of Cash Flows
(Unaudited) for the six months ended
June 30, 1999 and 1998 6-7
Notes to Consolidated Financial Statements
(Unaudited) 8-14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14-21
Item 3. Not applicable
Part II. OTHER INFORMATION 21-23
SIGNATURES 23
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3
PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
June 30,
1999 Dec. 31,
ASSETS (Notes 2 and 4) (unaudited) 1998
---------------------- --------- --------
Current assets:
Cash and cash equivalents:
Unrestricted ....................................... $ 362 $ 147
Restricted ......................................... 23 21
Accounts receivable (Note 3) ........................ 11,032 2,462
Inventories (Note 3) ................................. 9,302 3,028
Prepaid expenses and other ........................... 1,626 364
------- -------
Total current assets .............................. 22,345 6,022
Property and equipment, net (Note 3) .................. 4,117 1,653
Goodwill and other intangible assets,
net (Notes 2 and 3) .................................. 16,427 5,953
Restricted cash and other non-current
assets (Note 4) ..................................... 658 500
------- -------
$43,547 $14,128
LIABILITIES ======= =======
-----------
Current liabilities:
Current maturities of long-term debt (Note 4) ........ $ 165 $ 500
Accounts payable and other ........................... 13,624 3,435
------- -------
Total current liabilities ......................... 13,789 3,935
Long-term debt (Note 4) ............................... 19,943 7,043
Minority interests ..................................... 79 --
------- -------
Total liabilities ................................. 33,811 10,978
------- -------
Commitments and contingencies
STOCKHOLDERS' EQUITY (Notes 2 and 5)
------------------------------------
Preferred stock, $.01 par; shares authorized
1,000,000; shares issued and outstanding at
June 30, 1999 Series A, Series C, Series D,
Series E and Series F Convertible Preferred Stock,
1,667, 3,000, 2,700, 3,500 and 4,654 shares,
respectively; at December 31, 1998 - Series A,
C and D Convertible Preferred Stock, 1,667,
3,000 and 2,700 shares, respectively - -
Common stock, $.05 par; shares authorized 40,000,000;
22,637,258 and 20,515,425 shares issued and outstanding
at June 30, 1999 and December 31, 1998, respectively . 1,131 1,025
Additional paid-in capital ............................. 53,937 40,409
Deficit ................................................ (45,332) (38,284)
-------- --------
Total stockholders' equity ........................ 9,736 3,150
-------- --------
$ 43,547 $ 14,128
======== ========
See accompanying notes to consolidated financial statements.
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(dollars in thousands, except per share data)
Three Months Six Months
Ended June 30, Ended June 30,
------------------ ------------------
1999 1998 1999 1998
(unaudited) (unaudited)
-------- -------- -------- --------
Sales ................................ $ 9,398 $ 5,738 $ 10,809 $ 9,344
Cost of sales ........................ 8,166 4,727 9,489 7,685
-------- -------- -------- --------
Gross profit .................... 1,232 1,011 1,320 1,659
-------- -------- -------- --------
Operating expenses:
Selling, general and
administrative ..................... 3,447 2,500 4,882 4,693
Research and development ........... 699 581 1,218 1,149
Depreciation and amortization ...... 583 349 978 630
-------- -------- -------- --------
Total operating expenses ........ 4,729 3,430 7,078 6,472
-------- -------- -------- --------
Loss from operations ............ (3,497) (2,419) (5,758) (4,813)
Interest and other income ............ 8 24 108 40
Interest expense ..................... (491) (319) (801) (481)
Minority interests ................... 36 -- 36 --
-------- -------- -------- --------
Net loss ............................. (3,944) (2,714) (6,415) (5,254)
Preferred stock dividends ............ (174) (60) (306) (60)
Embedded dividends attributable to
beneficial conversion privileges and
warrants issued in connection with
Convertible Preferred Stock ........ (240) (722) (327) (722)
-------- -------- -------- --------
Net loss applicable to common stock .. ($ 4,358) ($ 3,496) ($ 7,048) ($ 6,036)
======== ======== ======== ========
Basic and diluted net loss per
common share ....................... ($ .19) ($ .19) ($ .32) ($ .32)
======== ======== ======== ========
Average number of common shares
outstanding, basic and diluted 22,488,906 18,670,477 21,838,532 18,670,477
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
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<TABLE>
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(dollars in thousands)
<CAPTION>
Preferred Addi-
Common Stock Stock tional
----------------- ------------- Paid-In
Shares Amount Shares Amount Capital Deficit Total
---------- ------ ------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, December
31, 1998 20,515,425 $1,025 7,367 $ - $40,409 ($38,284) $ 3,150
Issuance of Convertible
Preferred Stock:
Series E 3,500 - 3,500 3,500
Series F 4,654 - 4,654 4,654
Issuance of common stock in
connection with:
Satisfaction of borrowings 645,000 32 1,258 1,290
Exercise of options and
warrants 976,833 49 1,505 1,554
Other 500,000 25 975 1,000
Common stock warrants issued
in connection with:
Long-term debt 791 791
Acquisition 200 200
Common stock options granted
to non-employees 318 318
Preferred stock dividends (306) (306)
Embedded dividend attribut-
able to beneficial conver-
sion privilege of Series A
Convertible Preferred Stock 176 (176) -
Embedded dividend attributable
to common stock warrants issued
in connection
with Series E Convertible
Preferred Stock 151 (151) -
Net loss for the six
months ended June 30, 1999 (6,415) (6,415)
---------- ------ ------ ------ ------- ------- -------
Balances, June 30,
1999 (unaudited) 22,637,258 $1,131 15,521 $ - $53,937 ($45,332) $ 9,736
========== ====== ====== ====== ======= ======= =======
See accompanying notes to consolidated financial statements.
</TABLE>
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
Six Months
Ended June 30,
-------------------
1999 1998
(unaudited) (unaudited)
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 6,415) ($ 5,254)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 978 630
Provision for losses on accounts receivable 853 225
Provision for inventory obsolescence 707 -
Amortization of deferred financing costs 284 86
Amortization of deferred compensation 116 -
Minority interests and other 94 -
Changes in assets and liabilities,
net of effects from acquisitions:
(Increase) decrease in accounts receivable (2,713) 193
(Increase) decrease in inventories (765) 395
Decrease (increase) in prepaid expenses
and other 140 (77)
Decrease in accounts payable and other (534) (2,736)
-------- --------
Net cash used by operating activities (7,255) (6,538)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (216) (417)
Cash paid for acquisitions (1,250) (379)
-------- --------
Net cash used by investing activities (1,466) (796)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds (repayments)on revolving
credit facilities 363 (402)
Additions to other borrowings 5,407 6,315
Repayment on other borrowings (1,100) (1,865)
Issuance of preferred stock, net 2,000 3,245
Proceeds from exercise of stock options
and warrants 1,554 -
Issuance of common stock 1,000 -
Cash paid for preferred stock dividends (288) -
-------- --------
Net cash provided by financing activities 8,936 7,293
-------- --------
Net increase (decrease) in unrestricted cash
and cash equivalents during the period 215 (41)
Unrestricted cash and cash equivalents at the
beginning of the period 147 61
-------- --------
Unrestricted cash and cash equivalents at the
end of the period $ 362 $ 20
======== ========
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
(concluded)
Six Months
Ended June 30,
-------------------
1999 1998
(unaudited) (unaudited)
---------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 454 $ 329
======== ========
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
NON-CASH INVESTING ACTIVITIES:
Acquisitions (Note 2):
Fair value of assets acquired $ 27,986 $ 527
Liabilities assumed (16,782) -
Acquisition Notes issued (5,100) -
Series F Convertible Preferred Stock issued (4,654) -
Warrants issued (200) (148)
-------- --------
Cash paid $ 1,250 $ 379
======== ========
NON-CASH FINANCING ACTIVITIES:
Issuance of common stock in satisfaction of
borrowings (Note 4) $ 1,290 $ -
======== ========
Issuance of preferred stock in satisfaction
of borrowings (Note 4) $ 1,500 $ -
======== ========
See accompanying notes to consolidated financial statements.
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nSTOR TECHNOLOGIES, INC.
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 majority owned subsidiaries (the "Company").
Significant intercompany balances and transactions have been eliminated in
consolidation.
In the opinion of management, the unaudited consolidated financial statements
furnished herein include all adjustments, consisting only of recurring
adjustments necessary for a fair presentation of the results of operations for
the interim periods presented. These interim results of operations are not
necessarily indicative of results for the entire year. The consolidated
financial statements contained herein should be read in conjunction with the
consolidated financial statements and related notes contained in the Company's
1998 Annual Report on Form 10-K/A.
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required for complete financial statements.
Certain items in the consolidated financial statements as of June 30, 1998 have
been reclassified to conform with the current presentation. These
reclassifications had no impact on operating results previously reported.
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.
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.
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Net Loss Per Common Share ("EPS")
The effect of including potentially dilutive securities in the EPS calculation
would have been anti-dilutive. Accordingly, basic and diluted EPS for all
periods presented are equivalent.
As of June 30, 1999, outstanding potentially dilutive securities include
2,591,000 shares underlying stock options, 10,084,667 shares underlying
convertible preferred stock, 2,420,133 shares underlying warrants and 160,000
shares underlying convertible debt.
(2) ACQUISITION
On June 8, 1999, the Company acquired approximately 76% of the outstanding
common stock of Andataco, Inc. ("Andataco") from affiliates of W. David Sykes
("Mr. Sykes"), Andataco's president (the "Andataco Acquisition"). In addition,
the Company acquired a promissory note in the amount of $5.2 million payable by
Andataco to Mr. Sykes. The aggregate purchase price was $10.5 million,
consisting of: (i) $.5 million in cash, (ii) $5.1 million in promissory notes
("Acquisition Notes" - Note 4), (iii) $4.7 million of Series F Convertible
Preferred Stock (Note 5) which is convertible into 1,551,333 shares of the
Company's common stock and (iv) warrants to purchase 155,133 shares of the
Company's common stock, exercisable upon issuance for three years at $3.30 per
share, valued at $.2 million on the date of closing using the Black-Scholes
option pricing model. In addition, the Company incurred transaction costs of $.7
million. Andataco is a publicly held company headquartered in San Diego,
California which designs, manufactures and distributes information storage
solutions for Windows NT and UNIX environments.
The Andataco Acquisition was accounted for using the purchase method of
accounting with assets acquired and liabilities assumed recorded at their fair
values as of June 1, 1999, the effective acquisition date, and the results of
Andataco's operations included in the Company's consolidated financial
statements from that date. Allocation of the purchase price of the Andataco
Acquisition has been made on a preliminary basis subject to adjustment should
new or additional facts about the business become known. The excess of the
purchase price over the fair value of net assets acquired (goodwill)
approximated $10.8 million and is being amortized over seven years.
On July 16, 1999, the Company acquired 1,612,904 shares of newly issued Andataco
common stock from Andataco for $.5 million in cash, increasing the Company's
ownership to approximately 77% (Note 4(b)). On August 5, 1999, the Board of
Directors of Andataco approved the Company's proposed acquisition of the
remaining approximately 23% of Andataco's outstanding common shares for an
aggregate purchase price of approximately $1.8 million, to be paid with the
Company's common stock based on the average closing price for the ten days
immediately prior to the closing of the proposed acquisition. The proposed
acquisition is subject to various conditions, including approval by the
stockholders of both companies. The Company expects the closing to occur in the
fourth quarter of 1999. There can be no assurance, however, that the proposed
acquisition will be consummated.
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(3) BALANCE SHEET COMPONENTS (in thousands)
Substantially all assets are pledged as collateral for indebtedness (Note 4).
June 30, Dec.31,
1999 1998
(unaudited)
-------- -------
Accounts Receivable
Trade receivables ................................ $ 12,545 $ 2,964
Less allowance for doubtful accounts ............. (1,513) (502)
-------- -------
$ 11,032 $ 2,462
======== =======
Inventories
Raw materials .................................... $ 7,774 $ 2,641
Work-in-process .................................. 446 95
Finished goods ................................... 1,082 292
-------- -------
$ 9,302 $ 3,028
======== =======
Inventories 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 and slow moving inventory to estimated net
realizable value.
June 30, Dec.31,
1999 1998
(unaudited)
------- -------
Property and Equipment
Equipment ..................................... $ 3,556 $ 1,313
Computer software ............................. 749 729
Furniture and fixtures ........................ 505 288
Leasehold improvements ........................ 871 332
Other ......................................... 292 243
------- -------
5,973 2,905
Less accumulated depreciation ................. (1,856) (1,252)
------- -------
$ 4,117 $ 1,653
======= =======
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
Goodwill ........................................ $ 17,392 $ 6,545
Intellectual assets ............................. 347 347
-------- -------
17,739 6,892
Less accumulated amortization ................... (1,312) (939)
-------- -------
$ 16,427 $ 5,953
======== =======
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Goodwill represents the excess cost of acquired businesses over the fair value
of net assets acquired. Intellectual assets consist of trademarks and
proprietary technology. Goodwill and intellectual assets are carried at cost and
are being amortized on a straight-line basis over seven to fifteen years.
Amortization of intangible assets was $251,000 and $373,000 for the three and
six months ended June 30, 1999, respectively, and $119,000 and $225,000 for the
three and six months ended June 30, 1998, respectively.
(4) LONG-TERM DEBT
(a) The Company's borrowings consisted of the following (in thousands):
June 30, Dec.31,
1999 1998
(unaudited)
-------- -------
Asset based revolving credit facilities:
Andataco Revolver (Note 4(b)) .................... $ 6,131 $ --
nStor Revolver (Note 4(c)) ....................... 1,932 1,738
Acquisition Notes, interest at 9.5%
per annum, due July 2004 (Note 2) ................ 5,100 --
Subordinated Notes (net of $795 and
$287 unamortized discount) (Note 4(d)) ............ 6,005 4,713
Notes convertible into 160,000 shares
of common stock (net of $218 and $214
unamortized discount), due in 2000 ................ 610 592
Other (Note 4(e)) ................................... 330 500
-------- -------
20,108 7,543
Less current maturities ............................. (165) (500)
-------- -------
$ 19,943 $ 7,043
======== =======
(b) Andataco Revolver
The Andataco Revolver provides for borrowings based on the lesser of $10 million
or: (i) 85% of eligible accounts receivable, as defined, plus (ii) the lesser of
$1.75 million or 23% of eligible inventory, as defined. The Andataco Revolver
currently bears interest at prime plus 1/2 percent (8.25% at June 30, 1999), is
guaranteed by Mr. Sykes and matures in December 2002. Andataco pays a facility
fee of .25% based on the average unused portion of the maximum borrowings.
Advances under the Andataco Revolver are collateralized by substantially all
assets of Andataco. The Andataco Revolver provides for certain financial
covenants, including Andataco maintaining a certain minimum working capital and
tangible net worth. During the second quarter ended June 30, 1999, Andataco was
not in compliance with the financial covenant regarding tangible net worth;
however, effective July 13, 1999, the lender agreed to waive the default,
subject to, among other things, receipt from nStor of a $.5 million capital
contribution. On July 16, 1999, nStor contributed $.5 million in cash as a
capital contribution to Andataco.
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(c) nStor Revolver
The nStor Revolver provides for borrowings based on the lesser of $5 million or
80% of eligible accounts receivable, as defined, bears interest, based on prime
plus 2% (9-3/4% at June 30, 1999), 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 nStor Revolver are collateralized by substantially all assets
of the Company (excluding Andataco), including $.5 million reflected as
Restricted Cash. The nStor Revolver provides for certain financial covenants
including current ratio and net worth requirements, limitations on operating
losses for the six month period ending December 31, 1998, 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 from declaring a default.
(d) Subordinated Notes
At June 30, 1999, the Subordinated Notes amounted to $6.8 million (including
$1.8 million borrowed from unrelated investors in January 1999). The
Subordinated Notes bear interest at 8%-10% per annum, mature on September 5,
2000 and are subordinated to the nStor Revolver. Of this amount, $5 million is
collateralized by substantially all assets of the Company (excluding Andataco).
The Subordinated Notes include $1 million held by H. Irwin Levy, Chairman of the
Board of Directors and a principal stockholder of the Company, or companies
controlled by him (collectively, "Mr. Levy"), $250,000 held by Bernard R. Green
a director, $125,000 held by a company controlled by Mark F. Levy, Vice
President and a director of the Company and Mr. Levy's son, and $125,000 held by
a company controlled by other members of Mr. Levy's family.
In connection with the Subordinated Notes, the Company issued warrants to
purchase 2,266,668 shares of the Company's common stock (including 600,000 in
1999). The warrants were valued under the Black-Scholes option-pricing model as
of their respective dates of issuance at an aggregate of $1.2 million (including
$.8 million in 1999) and were recorded as a discount to the Subordinated Notes,
of which $185,000 and $284,000 was amortized as interest expense for the three
and six months ended June 30, 1999, respectively, and $122,000 was amortized as
interest for the three and six months ended June 30, 1998.
(e) Other
Included in current maturities at December 31, 1998 was $.3 million due to Mr.
Levy. The loan bore interest at 10% per annum and was repaid by the Company in
February 1999.
In March 1999, the Company borrowed $.8 million from Mr. Levy and $.5 million
from an unrelated private investor, respectively. Both loans bore interest at
10% per annum and were payable in September 1999. Effective as of March 30,
1999, the Company issued 645,000 of the Company's common stock (including
395,000 shares to Mr. Levy) in satisfaction of both notes.
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From April 1, 1999 through June 10, 1999, Mr. Levy advanced an additional net
amount of $1.5 million to the Company (consisting of $2.3 million advanced, less
$.8 million repaid), with interest at 10% per annum. Effective June 8, 1999, the
Company issued Series E Convertible Preferred Stock with a stated value of $1.5
million in satisfaction of those borrowings (Note 5).
In July and August 1999, Mr. Levy loaned an additional net amount of $.6 million
(consisting of $.7 million advanced, less $.1 million repaid) under a promissory
note which allows the Company to borrow up to $750,000, with interest at 10% per
annum, due 30 days from demand.
(5) CONVERTIBLE PREFERRED STOCK
The Company has five classes of convertible preferred stock (Series A, C, D, E
and F) with an aggregate stated value of $14.9 million (including $4.5 million
held by Mr. Levy). Series A, C and D preferred stock, with an aggregate stated
value of $6.7 million, accrues dividends at 8% per annum, payable quarterly, is
convertible at any time into an aggregate of 7,366,667 shares of the Company's
common stock, and has automatic conversion features in which each share not
converted by October 2001 (as to 2,700,000 shares) and July 2000 (as to
4,666,667 shares) is automatically converted into common stock. Series E and F
preferred stock, with an aggregate stated value of $8.2 million, accrues
dividends at 8% through June 7, 2000, 9% commencing June 8, 2000 and 10%
commencing June 8, 2001, and is convertible at any time into an aggregate of
2,718,000 shares of the Company's common stock.
In connection with the issuance of the Series E and F preferred stock in June
1999, the Company issued warrants to purchase 271,799 shares of the Company's
common stock (including 50,000 to Mr. Levy), exercisable upon issuance at $3.30
per share and expiring on June 8, 2002. The warrants issued in connection with
the Series E preferred stock (116,666 shares) were valued under the
Black-Scholes option-pricing model as of June 8, 1999 at $151,000 and were
recorded as an additional embedded dividend. The warrants issued to Mr. Sykes in
connection with the Series F preferred stock (155,133 shares) were also valued
under the Black-Scholes option-pricing model at $200,000 and were included in
the acquisition costs of Andataco (Note 2).
(6) INCOME TAXES
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.
At October 31, 1998, Andataco reported unused net operating loss carryforwards
for regular federal income tax purposes of approximately $13.9 million which
expire through 2018. Due to a change of control, nStor's ability to utilize
these carryforwards is limited.
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14
(7) SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS
The Company operates predominantly in one business segment, information storage
solutions, including external RAID subsystems. During the six months ended June
30, 1999, one customer, Silicon Graphics, Inc., accounted for 22% of the
Company's sales.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
With the exception of discussion regarding historical information, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contains 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, our
ability to effectively integrate Andataco's operations with ours, 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-Q and in other reports filed
by our company 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
nStor Technologies, Inc. through our wholly-owned operating subsidiary, nStor
Corporation, Inc. (collectively "nStor") and our 77% owned Andataco subsidiary,
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. We design,
manufacture and sell high performance fault tolerant data storage solutions that
serve both the UNIX and NT platforms.
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15
nStor's activities in the information storage industry have evolved through
several acquisitions, the first of which occurred in June 1996 when we acquired
certain assets associated with the RAID business from Seagate Peripherals, Inc.
In December 1996, we acquired substantially all the net assets of Parity
Systems, Inc. In April 1998, we acquired Borg Adaptive Technologies, Inc. which
brought to our company the next generation of RAID technology, AdaptiveRAID. In
June 1999, we acquired approximately 76% of the outstanding common stock of
Andataco (Note 2). In July 1999 we acquired an additional 1,612,904 shares of
Andataco's common stock bringing our current ownership to approximately 77%
(Note 2). As a result of the Andataco Acquisition, we believe that period to
period comparisons for the three and six months ended June 30, 1999 may not be
meaningful.
Three Months Ended June 30, 1999 vs. June 30, 1998
Sales
Net sales for the three months ended June 30, 1999 were $9.4 million as compared
to $5.7 million for the three months ended June 30, 1998, an increase of $3.7
million or 64%. A decline in nStor sales of $2.3 million was more than offset by
Andataco sales of $6 million for the month of June 1999. The decline in nStor
sales reflects delays in the market introduction of certain new generation
products and our elimination of non-storage related businesses including our
memory and integrated system divisions.
Our overall sales are expected to increase significantly during the remainder of
fiscal 1999 primarily resulting from the Andataco Acquisition and a new Original
Equipment Manufacturer ("OEM") agreement (see below). Through our affiliation
with Andataco, we expect to obtain access to additional sales distribution
channels through which we anticipate increasing sales of our new generation
storage systems as well as newly developed products. However, there is no
assurance that we will be successful in marketing our products through Andataco
sales channels.
During the second quarter, we entered into an OEM agreement to supply
high-performance RAID storage enclosures to Silicon Graphics, Inc. (SGI), a
major server manufacturer. We began shipping products under SGI's initial
purchase order in May 1999. During June 1999, nStor's sales (exclusive of
Andataco) increased to $2.5 million, representing 71% of nStor's sales for the
quarter, primarily as a result of the SGI relationship. The initial term of the
OEM agreement is for three years. A discontinuation or significant reduction
under this agreement could have a material adverse effect on nStor's business.
Cost of Sales/Gross Margins
Gross margins decreased to 13% for the three months ended June 30, 1999 as
compared to 18% for the quarter ended June 30, 1998. Contributing to the overall
decrease was a $.6 million provision for slow moving inventory (compared to $.3
million during the 1998 quarter) as well as the level of fixed costs inherent in
our operations coupled with lower nStor sales revenues. Excluding the inventory
adjustment, overall gross margins were 19% and 23% during the quarter ended June
30, 1999 and 1998, respectively. Gross margins attributable to Andataco net
sales were 24% for June 1999. Our gross margins are dependent, in part, on
product mix which fluctuates from time to time.
<PAGE>
16
We anticipate improved gross margins for the remainder of fiscal 1999 primarily
as a result of the Andataco Acquisition and as nStor utilizes Andataco's sales
channels to market our products.
Operating Expenses
Selling, General and Administrative
Selling, general and administrative expenses were $3.4 million and $2.5 million
for the three months ended June 30, 1999 and 1998, respectively, an increase of
$.9 million or 38%. This increase is primarily the result of the Andataco
Acquisition, which added $1.2 million in expenses for the month of June 1999,
and a $.8 million provision for uncollectible accounts receivable (compared to
$.2 million in 1998), partially offset by a $1.1 million reduction in nStor
operating expenses. This reduction is primarily the result of the following: (i)
reduced levels of salaries and travel costs associated with our integrated
systems division which was phased out and sold in October 1998; (ii) reduced
compensation costs resulting from a reduction in our work force as a result of
declining sales prior to June 1999; and (iii) lower sales commissions due to
decreased levels of sales. We expect selling, general and administrative costs
to increase during the remainder of fiscal 1999 principally due to the Andataco
Acquisition. However, this projected increase should be partially offset by
certain cost savings expected to result from the integration of nStor and
Andataco operations.
Research and Development
Research and development expenses were $.7 million and $.6 million for the three
months ended June 30, 1999 and 1998, respectively. 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 revenues, or in certain
situations, may not result in generating revenues.
Interest Expense
Interest expense for the three months ended June 30, 1999 increased to $.5
million from $.3 million in 1998 as a result of the increase in borrowings and
the amortization of financing costs arising from certain indebtedness ( Note 4).
Interest expense is expected to increase during the remainder of fiscal 1999
primarily as a result of the Andataco Acquisition (Notes 2 and 4).
Preferred Stock Dividends
For the quarter ended June 30, 1999, we recorded $89,000 as an embedded dividend
attributable to the beneficial conversion privilege on our Series A Convertible
Preferred Stock. In addition, in connection with our Series E Convertible
Preferred Stock issued in June 1999, we recorded $151,000 as an embedded
dividend attributable to the valuation of warrants to purchase 116,666 shares of
our common stock (Note 5). The aggregate embedded dividends amounted to $240,000
for the three months ended June 30, 1999 as compared to $722,000 during the
second quarter of 1998, which related to a series of preferred stock that was
redeemed in October 1998.
<PAGE>
17
For the three months ended June 30, 1999, all classes of our convertible
preferred stock required cash dividends at 8% per annum which aggregated
$174,000. For the three months ended June 30, 1998, we had one class of
preferred stock which earned $60,000 in dividends. We expect cash dividends to
increase during the remainder of fiscal 1999 principally due to $8.2 million of
preferred stock issued in June 1999 (Note 5).
Six Months Ended June 30, 1999 vs. June 30, 1998
Sales
Net sales for the six months ended June 30, 1999 were $10.8 million representing
an increase of $1.5 million or 16% over the six months ended June 30, 1998. A
decline in nStor sales of $4.5 million was more than offset by Andataco's sales
of $6 million for the month of June 1999. The decrease in nStor sales reflects
delays in market introduction of certain new generation products and our
elimination of non-storage related businesses including our memory and
integrated systems division (approximately $2.1 million in 1998). See the
quarterly discussion regarding SGI and Andataco for sales expectations for the
remainder of fiscal 1999.
Cost of Sales/Gross Margins
Gross margins for the six months ended June 30, 1999 were $1.3 million or 12% as
compared to $1.7 million or 18% for the six months ended June 30, 1998.
Contributing to the overall decrease was a $.7 million provision for slow moving
inventory (compared to $.3 million in 1998) as well as the level of fixed costs
inherent in our operations coupled with lower nStor sales revenues. Excluding
the inventory adjustment, overall gross margins for the six months ended June
30, 1999 were 19% as compared to 21% in 1998. Andataco's gross margins for the
month of June 1999 were 24%. Our gross margins are dependent, in part, on
product mix which fluctuates from time to time. See the quarterly discussion
regarding our expectations for gross margins for the remainder of fiscal l999.
Operating Expenses
Selling, General and Administrative
Selling, general and administrative expenses for the six months ended June 30,
1999, were $4.9 million as compared to $4.7 million for the six months ended
June 30, 1998. This $.2 million or 4% increase is primarily the result of the
Andataco Acquisition which added $1.2 million in expenses for the month of June
1999, and a $.8 million provision for uncollectible accounts receivable
(compared to $.2 million in 1998), partially offset by a $1.8 million reduction
in nStor's operating expenses. The reduction in nStor expenses is attributable
to lower sales commissions, reduced compensation and related costs resulting
from an overall work force reduction, both of which were the result of declining
sales, and the elimination of expenses associated with the integrated system
division which was sold in October 1998.
<PAGE>
18
Research and Development
Research and development expenses were $1.2 million and $1.1 million for the six
months ended June 30, 1999 and 1998, respectively. 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 revenues, or in certain situations, may not result in
generating revenues.
Interest Expense
Interest expense for the six months ended June 30, 1999 increased to $.8 million
from $.5 million in 1998 as a result of the increase in borrowings and the
amortization of financing costs arising from certain indebtedness (Note 4).
Preferred Stock Dividends
For the six months ended June 30, 1999, we recorded $176,000 as an embedded
dividend attributable to the beneficial conversion privilege on our Series A
Convertible Preferred Stock. In addition, in connection with our Series E
Convertible Preferred Stock issued in June 1999, we recorded $151,000 as an
embedded dividend attributable to the valuation of warrants to purchase 116,666
shares of our common stock (Note 5). The aggregate embedded dividends amounted
to $327,000 for the six months ended June 30, 1999 as compared to $722,000
during the six months ended June 30, 1998, which related to a series of
preferred stock that was redeemed in October 1998.
For the six months ended June 30, 1999, all classes of our convertible preferred
stock required cash dividends at 8% per annum which aggregated $306,000. For the
six months ended June 30, 1998, we had one class of preferred stock which earned
$60,000 in dividends.
Liquidity and Capital Resources
Consolidated Statements of Cash Flows
Operating Activities
Net cash used by operating activities amounted to $7.3 million and $6.5 million
for the six months ended June 30, 1999 and 1998, respectively. The most
significant use of cash was our loss from operations (before changes in assets
and liabilities) of $3.4 million and $4.3 million, respectively. Another
significant use of cash during 1999 was an increase in accounts receivables in
the amount of $2.7 million principally due to the significant increase in
nStor's June 1999 sales. During 1998, we used cash of $2.7 million in the
reduction of accounts payable and other liabilities.
Investing Activities
Net cash used by investing activities was approximately $1.5 million and $.8
million for the six months ended June 30, 1999 and 1998, respectively, with $1.2
million and $.4 million, respectively, used for acquisitions (see Note 2 to
Consolidated Financial Statements for a description of the 1999 Andataco
Acquisition).
<PAGE>
19
Financing Activities
Net cash provided by financing activities for the six months ended June 30, 1999
was $8.9 million and primarily consisted of net borrowings of $4.3 million from
private investors, including $1.5 million from Mr. Levy which was satisfied by
the issuance of convertible preferred stock, $1.5 million in proceeds from the
exercise of stock options and warrants, $1 million from the issuance of common
stock, and $2 million from the issuance of convertible preferred stock. Cash
provided by financing activities for the six months ended June 30, 1998 amounted
to $7.3 million and included net borrowings of $4.4 million from private
investors, including $2.4 million from Mr. Levy, and $3.2 million in net
proceeds from the issuance of convertible preferred stock, including $1 million
from Mr. Levy.
nStor Revolver
The nStor Revolver, our asset based revolving credit facility, provides for
borrowings based on the lesser of $5 million or 80% of our eligible accounts
receivable, as defined (Note 4). The nStor Revolver provides for certain
financial covenants including current ratio and net worth requirements,
limitations on operating losses for the six month period ended December 31,
1998, and restrictions on the incurrence of additional debt and 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 loss for 1998; however, effective February 4, 1999 the
lender agreed to forebear from declaring a default.
Indebtedness Resulting from the Andataco Acquisition
In connection with the Andataco Acquisition, we issued $5.1 million in
promissory notes due in July 2004. In addition, Andataco has an asset based
revolving credit facility (Note 4) which provides for borrowings based on the
lesser of $10 million or (i) 85% of eligible accounts receivable, as defined,
plus (ii) the lesser of $1.75 million or 23% of eligible inventory, as defined.
The Andataco Revolver provides for certain financial covenants, including
Andataco maintaining a certain minimum working capital and tangible net worth.
During the quarter ended June 30, 1999, Andataco was not in compliance with the
financial covenant regarding tangible net worth; however, effective July 13,
1999, the lender agreed to waive the default, subject to, among other things,
receipt from nStor of a $.5 million capital contribution. On July 16, 1999,
nStor contributed $.5 million in cash as a capital contribution to Andataco.
Financing Activities With Private Investors
Since late 1997, and through June 30, 1999, we have obtained net cash proceeds
of approximately $22.3 million (including $8.8 million during the six months
ended June 30, 1999) from private investors, consisting of $8.5 million of
convertible preferred stock, $9.6 million of net borrowings (including $1.3
million which we satisfied by issuing 645,000 shares of our common stock and
$1.5 million which we satisfied by issuing convertible preferred stock), $3.2
million from the exercise of warrants and options to purchase 2,428,832 shares
of our common stock and $1 million from the issuance of 500,000 shares of newly
issued common stock. Of these amounts, Mr. Levy has advanced or invested a net
amount of $6.8 million.
<PAGE>
20
From July 1, 1999 through August 13, 1999, Mr. Levy advanced an additional net
amount of $.6 million under a promissory note which allows us to borrow up to
$750,000, due 30 days from demand.
We believe that amounts expected to be available under lending arrangements with
financial institutions and from Mr. Levy will be sufficient to satisfy our
working capital needs for the foreseeable future, 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 Developments - Proposed Acquisition
On August 5, 1999, the Board of Directors of Andataco approved our proposed
acquisition of the remaining approximately 23% of Andataco's outstanding common
shares for an aggregate purchase price of approximately $1.8 million, to be paid
with the Company's common stock based on the average closing price for the ten
days immediately prior to the closing of the proposed acquisition. The proposed
acquisition is subject to various conditions, including approval by the
stockholders of both companies. We expect the closing to occur in the fourth
quarter of 1999. There can be no assurance, however, that the proposed
acquisition will be consummated.
Effect of Inflation
Inflation has not had an impact on our operations and we do not expect that it
will have a material impact in 1999.
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.
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 compliant,
the ability of our customers and vendors to identify and resolve their own Y2K
issues and our ability to respond to unforeseen Y2K complications.
<PAGE>
21
Our 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 significant 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 have identified our
significant customers, vendors and creditors that are believed, at this time, to
be critical to business operations subsequent to January 1, 2000. Through the
use of questionnaires, interviews and other available means we have ascertained
that we have no significant exposure to Y2K issues at this time. However, there
can be no assurance that the representations made to us by third parties are
accurate or complete and there is a possibility that normal business operations
could be disrupted.
The third component of our Y2K readiness program was the evaluation of our
existing products', and planned future products' Y2K functionality. All of the
date dependent software which we have developed has been validated as being Y2K
compliant using commercially acceptable methods, including: expanding year
fields to four digits: windowing; and date encoding techniques. Our other
products have been verified as Y2K compliant based on the absence of date
dependencies in hardware, software and firmware code.
Y2K Costs
Our total cost of these Y2K compliance activities is not expected to exceed
$50,000. 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 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.
Part II - OTHER INFORMATION
Item 1. Legal Proceedings
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 the Company and a
former officer and director, R. Daniel Smith, breached an agreement with AIBC in
which AIBC was allegedly engaged as placement agent in connection with raising
funds for the Company. Effective June 3, 1999, the action was dismissed without
prejudice.
<PAGE>
22
Item 2. Changes in Securities and Use of Proceeds
On June 8, 1999, in a private placement, the Company issued an aggregate of
3,500 shares of Series E Convertible Preferred Stock and warrants to purchase an
aggregate of 116,666 shares of common stock, to Bernard A. Marden, Hilcoast
Development Corp. and Herbert Gimelstob for an aggregate purchase price of $3.5
million (including $1.5 million in satisfaction of debt (Part I, Item 1,
Note 4)). Such shares of Series E Convertible Preferred Stock are convertible
into 1,166,667 shares of the Company's common stock.
Also, on June 8, 1999, the Company issued 4,654 shares of Series F Convertible
Preferred Stock, and warrants to purchase 155,133 shares of common stock, to W.
David Sykes as part of the Andataco Acquisition (Part I, Item 1, Note 2), as
the purchase price for a promissory note payable by Andataco to Mr. Sykes in
the original principal amount of $5,196,000. Such shares of Series F Convertible
Preferred Stock are convertible into an aggregate of 1,551,333 shares of the
Company's common stock.
Both the Series E and F Convertible Preferred Stock accrue dividends at 8%
through June 7, 2000, 9% commencing June 8, 2000 and 10% commencing June 8,
2001.
Each of the warrants described above is exercisable commencing June 8, 1999 at
$3.30 per share.
The securities issued in the transactions described above were intended to be
exempt from registration pursuant to Section 4(2) of the Securities Act as an
offering to a limited number of persons.
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits:
(27) Financial Data Schedule
(b) Reports on Form 8-K:
The Company filed Form 8-K and Form 8-K/A during the quarter ended June 30, 1999
as follows:
(i) A report on Form 8-K dated June 8, 1999 and filed June 23, 1999, reporting
under item 2 - Acquisition or Disposition of Assets, in which the Company
announced its acquisition of 76% of the common stock of Andataco, Inc.
<PAGE>
23
(ii) A report on Form 8-K/A dated June 8, 1999 and filed July 2, 1999, reporting
under item - 2 Acquisition or Disposition of Assets, in which the aforementioned
8-K was amended.
SIGNATURE
Pursuant to the requirements 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.
(Registrant)
/s/ Jack Jaiven
August 13, 1999 _______________________________
Jack Jaiven
Principal Financial and
Accounting Officer
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