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 March 31, 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.)
450 Technology Park
Lake Mary, FL 32746
(Address of principal executive office)
(407) 829-3500
(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 April 30, 1999: 22,639,258
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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 March 31,
1999 (Unaudited) and December 31, 1998 3
Consolidated Statements of Operations
(Unaudited) for the three months ended
March 31, 1999 and 1998 4
Consolidated Statements of Stockholders'
Equity for the three months ended
March 31, 1999 (Unaudited) 5
Consolidated Statements of Cash Flows
(Unaudited) for the three months ended
March 31, 1999 and 1998 6-7
Notes to Consolidated Financial Statements
(Unaudited) 8-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations 15-22
Item 3. Not applicable
Part II. OTHER INFORMATION
Item 1. Not Applicable
Item 2. Changes in Securities and Use of Proceeds 22
Item 3,4 and 5. Not Applicable
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURES 23
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PART 1. FINANCIAL INFORMATION
Item 1. Financial Statements
nSTOR TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands)
Mar. 31,
1999 Dec. 31,
ASSETS (Note 3) (unaudited) 1998
---------------- --------- ---------
Current assets:
Cash and cash equivalents:
Unrestricted $ 221 $ 147
Restricted 23 21
Accounts receivable (Note 2) 2,313 2,462
Inventories (Note 2) 3,714 3,028
Prepaid expenses and other 935 364
------- -------
Total current assets 7,206 6,022
Restricted cash (Note 3) 500 500
Property and equipment, net (Note 2) 1,509 1,653
Goodwill and other intangible assets, net (Note 2) 5,831 5,953
------- -------
$15,046 $14,128
======= =======
LIABILITIES
-----------
Current liabilities:
Borrowings (Note 3) $ 165 $ 500
Accounts payable and other 3,049 3,435
------- -------
Total current liabilities 3,214 3,935
Long-term debt (Note 3) 7,563 7,043
------- -------
Total liabilities 10,777 10,978
------- -------
Commitments and contingencies
STOCKHOLDERS' EQUITY (Note 4 and 6)
----------------------------------
Preferred stock, $.01 par; shares authorized
1,000,000; shares issued and outstanding at
March 31, 1999 and December 31, 1998 -
Series A, Convertible Preferred Stock, 1,667;
Series C, Convertible Preferred Stock, 3,000;
Series D, Convertible Preferred Stock, 2,700; - -
Common stock, $.05 par; shares authorized
40,000,000; 22,139,258 and 20,515,425 shares
issued and outstanding at March 31, 1999 and
December 31, 1998, respectively 1,106 1,025
Additional paid-in capital 44,137 40,409
Deficit (40,974) (38,284)
------- -------
Total stockholders' equity 4,269 3,150
------- -------
$15,046 $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
Ended March 31,
--------------------
1999 1998
(unaudited)
--------- ---------
Sales $ 1,411 $ 3,606
Cost of sales 1,323 2,958
------- -------
Gross profit 88 648
------- -------
Operating expenses:
Selling, general and administrative 1,435 2,193
Research and development 519 568
Depreciation and amortization 395 281
------- -------
Total operating expenses 2,349 3,042
------- -------
Loss from operations (2,261) (2,394)
Interest and other income 100 16
Interest expense (310) (162)
------- -------
Net loss (2,471) (2,540)
Preferred stock dividends (132) -
Embedded dividend attributable to
beneficial conversion privilege of
Convertible Preferred Stock (87) -
------- -------
Net loss applicable to common stock ($ 2,690) ($ 2,540)
======= =======
Basic and diluted net loss per
common share ($ .13) ($ .14)
======= =======
Average number of common shares
outstanding, basic and diluted 21,182,665 18,670,477
========== ==========
See accompanying notes to consolidated financial statements.
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
(dollars in thousands)
Preferred Addi-
Common Stock Stock tional
----------------- ------------- Paid-In
Shares Amount Shares Amount Capital Deficit Total
---------- ------ ------ ------ ------- ------- -------
Balances, December
31, 1998 20,515,425 $1,025 7,367 $ - $40,409 ($38,284) $ 3,150
Issuance of common
stock in connec-
tion with:
Satisfaction of
borrowings 645,000 32 1,258 1,290
Exercise of
options and
warrants 978,833 49 1,505 1,554
Common stock
warrants issued
in connection
with long-term
debt 560 560
Common stock options
granted to non-
employees 318 318
Preferred stock
dividends (132) (132)
Embedded dividend
attributable to
beneficial con-
version privilege
of Series A
Convertible
Preferred Stock 87 (87) -
Net loss for the
three months
ended March
31, 1999 (2,471) (2,471)
---------- ------ ------ ------ ------- ------- -------
Balances, March 31,
1999 (unaudited) 22,139,258 $1,106 7,367 $ - $44,137 ($40,974) $ 4,269
========== ====== ====== ====== ======= ======= =======
See accompanying notes to consolidated financial statements.
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months
Ended March 31,
-------------------
1999 1998
(unaudited) (unaudited)
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ($ 2,471) ($ 2,540)
Adjustments to reconcile net loss to net
cash used by operating activities:
Depreciation and amortization 395 281
Amortization of deferred financing costs 99 -
Amortization of deferred compensation 28 -
Provision for losses on accounts receivable 30 -
Provision for inventory obsolescence 75 -
Other 128 -
Changes in assets and liabilities:
Decrease in accounts receivable 119 405
(Increase) decrease in inventories (761) 411
Increase in prepaid expenses and other (281) (11)
Decrease in accounts payable and other (361) (2,340)
-------- --------
Net cash used by operating activities (3,000) (3,794)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (129) (290)
-------- --------
Net cash used by investing activities (129) (290)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net repayments on revolving credit facility (994) (195)
Additions to other borrowings 3,100 4,710
Repayment on other borrowings (300) (410)
Proceeds from exercise of stock options
and warrants 1,554 -
Cash paid for preferred stock dividends (157) -
-------- --------
Net cash provided by financing activities 3,203 4,105
-------- --------
Net increase in unrestricted cash and cash
equivalents during the period 74 21
Unrestricted cash and cash equivalents at the
beginning of the period 147 61
-------- --------
Unrestricted cash and cash equivalents at the
end of the period $ 221 $ 82
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for:
Interest $ 206 $ 154
======== ========
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nSTOR TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(concluded)
Three Months
Ended March 31,
-------------------
1999 1998
(unaudited) (unaudited)
-------- --------
NON-CASH FINANCING ACTIVITIES:
Issuance of common stock in satisfaction of
borrowings (Note 3) $1,290 $ -
====== ======
Embedded dividend attributable to beneficial
conversion privilege of Series A
Convertible Preferred Stock $ 87 $ -
====== ======
Deferred financing costs arising from
issuance of warrants under borrowings $ 560 $ -
====== ======
Granting of options:
Outside director $ 266 $ -
Legal settlement 52 -
------ ------
$ 318 $ -
====== ======
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 wholly-owned subsidiaries (collectively,
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 March
31, 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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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.
Research and Development Costs
Research and development costs are expensed as incurred.
Net Income (Loss) Per Common Share ("EPS")
The effect of including potentially dilutive securities, (convertible
preferred stock, stock options and warrants) in the EPS calculation
would have been anti-dilutive. Accordingly, basic and diluted EPS for
all periods presented are equivalent.
As of March 31, 1999, outstanding potentially dilutive securities
include 2,429,333 shares underlying stock options, 7,366,667 shares
underlying convertible preferred stock, 1,898,334 shares underlying
warrants and 160,000 shares underlying convertible debt.
(2) BALANCE SHEET COMPONENTS (in thousands)
Substantially all assets are pledged as collateral for
indebtedness. See Note 3 to Consolidated Financial Statements.
Mar.31, Dec.31,
1999 1998
------ ------
Accounts Receivable
Trade receivables $2,826 $2,964
Less allowance for doubtful accounts (513) (502)
------ ------
$2,313 $2,462
====== ======
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Mar.31, Dec.31,
1999 1998
------ ------
Inventories
Raw materials $3,184 $2,641
Work-in-process 320 95
Finished goods 210 292
------ ------
$3,714 $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 inventory to
estimated net realizable value.
Property and Equipment
Computer equipment $1,414 $1,313
Computer software 732 729
Furniture, fixtures
and office equipment 288 288
Leasehold improvements 332 332
Other 268 243
------ ------
3,034 2,905
Less accumulated depreciation (1,525) (1,252)
------ ------
$1,509 $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 $6,545 $6,545
Intellectual assets 347 347
------ ------
6,892 6,892
Less accumulated amortization (1,061) (939)
------ ------
$5,831 $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 ten to fifteen
years.
(3) BORROWINGS
The Company's borrowings consisted of the following (in thousands):
Mar.31, Dec.31,
1999 1998
------ ------
Subordinated Loans (net of $244 and
$287 unamortized discount) $4,756 $4,713
Promissory Notes (net of $504
unamortized discount) 1,296 -
Asset based revolving credit facility
(the "Revolver") 744 1,738
Convertible Notes (net of $14 and $22
unamortized discount) 602 592
Other 330 500
------ ------
7,728 7,543
Less current maturities (165) (500)
------ ------
$7,563 $7,043
====== ======
Subordinated Loans
At March 31, 1999, the Company's borrowings included $5 million
under promissory notes (the "Subordinated Loans") which bear
interest at 10% per annum, payable monthly, mature on September 5,
2000, as extended, are subordinated to the Revolver and are
collateralized by substantially all assets of the Company. The
Subordinated Loans 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 ("Mr. Green"), a director,
$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.
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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 333,333 held by Mr. Levy, 83,333 by Mr. Green,
41,666 by a company controlled by Mr. Mark Levy and 41,667 by a
company controlled by other members of Mr. Levy's family, 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 as of their respective dates
of issuance aggregating $424,000 and were recorded as a discount to
the Subordinated Loans, of which $43,000 has been amortized as
interest expense for the three months ended March 31, 1999. During
December 1998 and January 1999, all of the warrants were exercised
except for 333,334 held by an unrelated private investor.
Promissory Notes
In January 1999, the Company borrowed $1.8 million from four unrelated
private investors (the "Promissory Notes"). The Promissory Notes bear
interest at 8% per annum, payable monthly, mature on September 5, 2000,
and are subordinated to the Revolver.
In connection with the Promissory Notes, the Company issued warrants to
purchase 600,000 shares of the Company's common stock, exercisable upon
issuance at $3.00 per share and expiring January 25, 2002. The warrants
were valued under the Black-Scholes option-pricing model as of the date
of issuance at $560,000 and were recorded as a discount to the Promissory
Notes, of which $56,000 has been amortized as interest expense for the
three months ended March 31, 1999.
Revolving Credit Facilities
In August 1998, the Company entered into an asset based revolving credit
facility, the Revolver, which provides for borrowings based on the lesser
of $5 million or 80% of the Company's eligible accounts receivable, as
defined. The Revolver bears interest, payable monthly, based on prime plus
2% (9-3/4% at March 31, 1999), 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 Revolver are
collateralized by substantially all assets of the Company, including $.5
million reflected as Restricted Cash. The Revolver provides for certain
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financial covenants including current ratio and net worth requirements,
limitations on operating losses for the period commencing July 1, 1998 and
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 declaring
a default.
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 $216,000 and $214,000 at March 31,
1999 and December 31, 1998, 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).
Other Borrowings
Included in current maturities at December 31, 1998 was $.3 million
due to Mr. Levy. The loan bore interest at 10% per annum, payable
monthly, and was repaid by the Company in February 1999.
Pursuant to promissory notes dated March 1, 1999 and March 15,
1999, the Company borrowed $.8 million from Mr. Levy and $.5
million from an unrelated private investor, respectively. Both
notes bore interest at 10% per annum, payable monthly, and were
payable through September 1999. Effective as of March 30, 1999,
the Company agreed to issue 645,000 of newly issued shares of the
Company's common stock (including 395,000 shares to Mr. Levy) in
satisfaction of both notes.
From April 1, 1999 through May 14, 1999, Mr. Levy advanced an
additional net amount of $.7 million to the Company (consisting of
$1.1 million advanced, less $.4 million repaid) under promissory
notes, which allow the Company to borrow up to an aggregate of $1.5
million, bear interest at 10% per annum, payable monthly, and which
are due 30 days from demand.
(4) CONVERTIBLE PREFERRED STOCK
The Company has three classes of convertible preferred stock
(Series A, C and D) with an aggregate stated value of $6.7 million
(including $3 million held by Mr. Levy). The preferred stock
accrues dividends at 8% per annum, is payable quarterly, and is
convertible into an aggregate of 7,366,667 shares of the Company's
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common stock, based on an average fixed conversion price of $.91
per share, commencing April 27, 1999 (as to 2,700,000 shares) and
July 7, 1999 (as to 4,666,667 shares). The preferred stock 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.
(5) 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.
(6) SEGMENT INFORMATION AND SIGNIFICANT CUSTOMERS
The Company operates predominantly in one business segment, information
storage solutions, including external RAID subsystems. During the three
months ended March 31, 1999, no customer accounted for more than 10% of
the Company's sales.
(7) PROPOSED ACQUISITION
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 ("Mr. 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, Mr. Sykes would continue
to serve as an executive officer 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 $7 million in a private placement of 8% 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.
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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, 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
We are 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 supporting a variety of operating system
environments for a wide range of customer requirements.
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Our company'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 March 1999, we entered into an agreement to purchase 75% of the
outstanding common stock of Andataco (see "Liquidity and Capital
Resources, Recent Developments - Proposed Acquisition"). Assuming
the proposed acquisition is consummated as expected, our results of
operations are anticipated to be significantly impacted, including,
but not limited to, increases in future sales, cost of sales, operating
expenses and interest expense. There can be no assurance, however,
that the proposed acquisition will be consummated.
Three Months Ended March 31, 1999 vs. March 31, 1998
Sales
Net sales for the three months ended March 31, 1999 were $1.4
million as compared to $3.6 million for the three months ended
March 31, 1998, a decrease of $2.2 million or 61%. The decline in
sales reflects delays in the market introduction of new generation
products with enhanced hardware and software features and our
decision to eliminate non-storage related businesses, including our
memory division.
In March 1999, we entered into a new Original Equipment Manufacturer
("OEM") relationship to supply high-performance RAID storage enclosures
to Silicon Graphics, Inc. (SGI), a major server manufacturer. We expect
to begin shipping products under SGI's initial $5.8 million purchase
order in May 1999. Accordingly, we expect sales to be positively impacted
during the remainder of fiscal 1999. The initial term of the OEM arrangement
is expected to be for three years. A discontinuation or significant
reduction of this relationship could have a material adverse effect on our
business.
In addition, assuming the proposed Andataco acquisition is consummated,
we believe that we will obtain access to additional sales distribution
channels through which we expect to increase sales of our new generation
storage systems as well as anticipated newly developed products. There can
be no assurance, however, that the proposed acquisition will be consummated.
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Cost of Sales/Gross Margins
Gross margins decreased to 6% for the three months ended March 31, 1999 as
compared to 18% for the quarter ended March 31, 1998. Our gross margins
are dependent, in part, on product mix which fluctuates from time to time.
The decline in gross margin is primarily the result of a decrease in sales
of products with overall higher margins, in addition to reduced economies
of scale attributable to the level of fixed costs inherent in our operations
coupled with significantly lower sales revenues.
Operating Expenses
Selling, General and Administrative
Selling, general and administrative expenses were $1.4 million and
$2.2 million for the three months ended March 31, 1999 and 1998,
respectively, a decrease of $.8 million or 35%. The decrease 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 during the third quarter of
1998; (ii) reduced compensation costs resulting from our decision
in 1998 to reduce our work force as a result of declining sales;
and (iii) lower sales commissions due to decreased levels of sales
during the 1999 quarter.
Research and Development
Research and development expenses were $.5 million for the three
months ended March 31, 1999 and $.6 million for the three months
ended March 31, 1998. 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 March 31, 1999 increased $.1
million as a result of the increase in borrowings and the amortization of
financing costs arising from certain indebtedness (see Note 3 to the
Consolidated Financial Statements).
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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 the date of issuance. Accordingly, for the quarter
ended March 31, 1999, we recorded $87,000 as an embedded dividend
attributable to the beneficial conversion privilege on our Series A
Convertible Preferred Stock.
In addition, for the three months ended March 31, 1999, all classes of our
convertible preferred stock required dividends at 8% per annum which
aggregated $132,000. There was no outstanding preferred stock during the
first quarter of 1998.
Liquidity and Capital Resources
Consolidated Statements of Cash Flows
Operating Activities
Net cash used by operating activities amounted to $3 million and $3.8
million for the three months ended March 31, 1999 and 1998, respectively.
The most significant use of cash was our $2.5 million loss from operations
(before changes in assets and liabilities) during both periods. During
1998, we also used cash of $2.3 million in the reduction of accounts
payable and other liabilities.
Investing Activities
Net cash used by investing activities was approximately $.1 million
and $.3 million for the three months ended March 31, 1999 and 1998,
respectively, both resulting from investments in property and equipment.
Financing Activities
Net cash provided by financing activities for the three months ended March
31, 1999 was $3.2 million and primarily consisted of net borrowings of $2.8
million from private investors, including $.8 million from Mr. Levy, $1.6
million in proceeds from the exercise of stock options and warrants, less
net repayments of $1 million under the Revolver. Cash provided by
financing activities for the three months ended March 31, 1998 amounted
to $4.1 million and included net borrowings of $4.3 million from private
investors, including $1.3 million from Mr. Levy.
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<PAGE>
Asset Based Credit Facility
On August 3, 1998 we obtained the Revolver, an asset based
revolving credit facility which provides for borrowings based on
the lesser of $5 million or 80% of our eligible accounts
receivable, as defined. The Revolver bears interest, payable
monthly, based on prime plus 2% (9-3/4% at March 31, 1999), 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 Revolver are collateralized by
substantially all of our assets, including $.5 million reflected as
Restricted Cash. 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 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 declaring a default.
Financing Activities With Private Investors
In late 1997, we determined that amounts available under our
previous credit facility would not be sufficient to satisfy our
cash requirements and, therefore, additional debt and/or equity
financing would be necessary. Subsequently and through March 31,
1999, we obtained net cash proceeds of approximately $17.8 million
(including $4.3 million during the three months ended March 31,
1999) from private investors, consisting of $6.5 million of 8%
Convertible Preferred Stock, $8.1 million of net borrowings
(including $1.3 million which we satisfied by issuing 645,000
shares of our common stock) and $3.2 million from the exercise of
warrants and options to purchase 2,428,832 shares of our common
stock. The 8% Convertible Preferred Stock is convertible into
7,366,667 shares of our common stock based on an average fixed
conversion price of $.91 per share, commencing April 27, 1999.
Of these amounts, Mr. Levy advanced a net amount of $4.8 million
(consisting of $8.5 million advanced, less $3.7 million repaid -
see Notes 3 and 4 to Consolidated Financial Statements) and $.5
million in connection with his exercise of warrants to purchase
413,332 shares of our common stock.
From April 1, 1999 through May 14, 1999, Mr. Levy advanced an
additional net amount of $.7 million (consisting of $1.1 million
advanced, less $.4 million repaid). Mr. Levy has agreed to loan us
an additional $.8 million under a promissory note which is due 30
days from demand.
19
<PAGE>
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 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
In March 1999, we entered into an agreement to purchase 75% of the
outstanding common stock of Andataco from its principal
stockholder, Mr. 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, Mr.
Sykes would continue to serve as an executive officer 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.
We are currently negotiating with unrelated private investors to
obtain approximately $7 million in a private placement of 8%
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
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
20
<PAGE>
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.
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 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 our 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 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.
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
21
<PAGE>
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
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
Not applicable
Item 2. Changes in Securities and Use of Proceeds
Effective January 26, 1999, in connection with certain borrowings,
the Company issued warrants to purchase 600,000 shares of the
Company's common stock. The warrants are exercisable at $3.00 per
share upon the date of grant and expire January 25, 2002.
As of March 30, 1999, the Company agreed to satisfy $1.3 million of
borrowings (including $.8 million from Mr. Levy) under promissory
notes by issuing 645,000 shares (including 395,000 shares to Mr.
Levy) of the Company's common stock.
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 was not required to file Form 8-K during the
quarter for which this report is filed.
22
<PAGE>
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/ Larry J. Calise
May 14, 1998 _______________________________
Larry J. Calise,
Principal Financial and
Accounting Officer
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<NAME> NSTOR TECHNOLOGIES, INC.
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
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<INCOME-PRETAX> (2,471)
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<F1>CASH INCLUDES RESTRICTED CASH OF $21.
<F2>PP&E INCLUDES GOODWILL AND OTHER INTANGIBLE ASSETS OF $6,892.
<F3>ACCUMULATED DEPRECIATION INCLUDES AMORTIZATION OF GOODWILL AND OTHER
INTANGIBLE ASSETS OF $1,061.
<F4>PREFERRED STOCK ISSUED AND OUTSTANDING INCLUDES THE FOLLOWING: SERIES A
CONVERTIBLE PREFERRED STOCK - 1,667 SHARES; SERIES C CONVERTIBLE PREFERRED
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<F5>OTHER EXPENSES REPRESENT DEPRECIATION AND AMORTIZATION.
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