STORAGE COMPUTER CORP, 10KSB, 1998-03-13

STORAGE COMPUTER CORP
10KSB, 1998-03-13
COMPUTER PERIPHERAL EQUIPMENT, NEC

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<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-KSB
-----------

Annual Report Pursuant to Section 13 or
15(d) of the Securities and Exchange
Act of 1934 for the fiscal year
ended December 31, 1997

STORAGE COMPUTER CORPORATION
----------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 02-0450593
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

11 RIVERSIDE STREET NASHUA, NEW HAMPSHIRE 03062-1373
(Address of Principal Executive Offices) (Zip Code)

(603) 880-3005
(Registrant's telephone number, including area code)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:

COMMON STOCK $0.001 PAR VALUE AMERICAN STOCK EXCHANGE
- ----------------------------- -----------------------
(Title or Class)

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
--- ---

Indicate by check mark if the disclosure of delinquent filers pursuant to
Item 405 of Regulation S-B is not contained herein, and will not be contained,
to the best of the Registrant's knowledge, in a definitive proxy or information
statement incorporated in Part III of this Form 10-KSB or any amendments to this
Form 10-KSB. X
---

The aggregate market value of the Common Stock of the Registrant held by
non-affiliates was approximately $20,288,500 at March 6, 1998.

At December 31, 1997 there were issued and outstanding 11,149,016 shares of the
Registrant's Common Stock, with a par value of $.001.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Company's Proxy Statement relating to the Company's Annual
Meeting of Stockholders to be held on May 18, 1998 are incorporated by reference
into Part III hereof.

<PAGE> 2

STORAGE COMPUTER CORPORATION

Securities and Exchange Commission
ITEM NUMBERS AND DESCRIPTION
----------------------------
PART I PAGE
----

ITEM 1 Business............................................... 3
ITEM 2 Properties............................................. 9
ITEM 3 Legal Proceedings...................................... 9
ITEM 4 Submission of Matters to a Vote of Security Holders.... 9

PART II

ITEM 5 Market for Registrant's Common Equity
and Related Stockholder Matters........................ 10
ITEM 6 Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 12
ITEM 7 Financial Statements and Supplementary Data............ 16
ITEM 8 Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure................. 16

PART III

ITEM 9 Directors, Executive Officers, Promoters and Control Persons,
Compliance with Section 16(a) of the Exchange Act...... 17
ITEM 10 Executive Compensation................................. 17
ITEM 11 Security Ownership of Certain Beneficial Owners
and Management......................................... 17
ITEM 12 Certain Relationships and Related Transactions......... 17
ITEM 13 Exhibits and Reports on Form 8-K....................... 18

Inasmuch as the calculation of shares of Registrant's voting stock held by
non-affiliates requires a calculation of the number of shares held by
affiliates, such figure, as shown on the cover page hereof, represents the
Registrant's best good faith estimate for purposes of this Annual Report on Form
10-KSB, and the Registrant disclaims that such figure is binding for any other
purpose. The aggregate market value of Common Stock indicated is based upon the
closing sale price of the Common Stock ($6.25) as reported by the American Stock
Exchange for trading on March 6, 1998. All outstanding shares beneficially owned
by executive officers and directors of the Registrant or by any shareholder
beneficially owning more than 5% of Registrant's common stock, as disclosed
herein, were considered solely for purposes of this disclosure to be held by
affiliates.

<PAGE> 3

PART I

ITEM 1. BUSINESS

THE COMPANY

Storage Computer Corporation (the "Company" or "SCC") designs, manufactures
and integrates software-driven storage solutions which automate the management,
tuning and migration of core business applications stored on multiple open
systems servers. The Company pioneered the RAID 7(R) technology incorporated in
its Virtual Storage Architecture(TM), which forms the basis for its StorageSuite
product family. Based upon this performance-optimized architecture, the
StorageSuite family combines high-end controller technology, disk drives,
scalable centralized and distributed memory mechanisms, proprietary memory
mapping techniques and a real-time operating system to deliver high-performance,
fault-tolerant storage solutions in capacities ranging from 54 gigabytes to over
4 terabytes of shared storage.

COMPANY HISTORY

The Company's predecessor, Cab-Tek, Inc., began development of RAID
("Redundant Array of Independent Disks") in late 1984. From 1984 to 1990,
products at RAID levels 3, 4, 5 and 6 were developed and tested. Development
then commenced on the Virtual Storage Architecture to overcome the performance
bottlenecks inherent in other RAID implementations and to achieve fault tolerant
storage without impeding performance. The resultant RAID 7 technology was
transferred to the Company, which was incorporated in Delaware in August, 1991.
Products based upon the Company's RAID 7 technology began shipping to customer
production sites in the second half of 1992.

Pursuant to the Agreement and Plan of Organization dated October 4, 1994, as
amended by a First Amendment to the Agreement and Plan of Organization dated
January 31, 1995, Vermont Research Products, Inc. ("VRP"), a wholly-owned
subsidiary of the Company, acquired the entire business and substantially all
the property and assets of Vermont Research Corporation ("VRC") in exchange for
shares of the Company's Common Stock (the "Reorganization"). The Reorganization
became effective on March 6, 1995 and was accounted for as a pooling of
interests.

INDUSTRY OVERVIEW

The computer systems market is undergoing a dramatic shift to new
information processing modes, such as client/server computing incorporating
enterprise databases, data warehousing, image processing, multi-media, video-
on-demand, virtual reality processing and Internet/Intranet services. These new
application modes are increasing demand for data storage that is scalable in
terms of capacity, performance, connectivity and manageability. The market for
high performance storage is also driven by host computing platforms which
continue to make quantum leaps in processing performance. The Company believes
that users and networks will increasingly demand high-performance storage
systems to eliminate performance bottlenecks and to take full advantage of
increased server/workstation processing power. The U.S. Department of Commerce
estimates the data storage market in 1997 to be $100 billion, and predicts that
it will grow to $1 trillion by the year 2004.

<PAGE> 4

RAID TECHNOLOGY

RAID storage technology links together several industry standard disk drives
into a single large disk drive using a combination of hardware, firmware and
software to achieve extremely fast data transfer rates, high levels of
redundancy and large storage capacities at a relatively lower cost than embedded
storage solutions.

The following is a discussion of the performance capabilities of various
RAID levels as well as some of the common applications of RAID technologies at
such levels:

<TABLE>
<CAPTION>
RAID LEVEL ATTRIBUTES APPLICATIONS
<S> <C> <C>
RAID 0 Offers disk stripping without Quick reads and writes for large files
parity without parity protection

RAID 1 High data reliability but high High reliability and fast data transfer
Disk Mirroring cost due to duplication of disk rates more than storage capacity and
drives and associated hardware. cost.

RAID 3 Highest data transfer rate for Large block and high data transfer
large block sizes (high rates, required for film/video
bandwidth) such as images. animation or special effects, satellite
analysis, video-on-demand.

RAID 5 High data transfer rate for small Applications that require frequent
Independent transaction files access to small blocks of data.
Data Access

RAID 7 Combines a totally Multi-host environments with a mix of
Asynchronous asynchronous hardware application types.
Data Access environment with a multi-tiered
cache memory controlled by an
embedded real-time operating
system

OMNIRAID Concurrent multiple RAID For mixed applications and data types.
(Transaction- levels applied to data, not to Protection levels provides performance
optimized raid) physical array topology. scaling.

</TABLE>

VIRTUAL STORAGE ARCHITECTURE

Storage Computer's unique Virtual Storage Architecture(TM) (VSA) forms the
basis for all its StorageSuite(TM) product families. VSA views the storage area
as a whole, coherent and extendible space, a "storage fabric," which can be
allocated to multiple hosts concurrently.

The intelligent storage management system controls the interaction between
the attached host processors and the physical drives. It tracks the location of
every piece of information and allows the host to access that data. Employing
dedicated independent I/O channels for each disk drive, the system transfers
data to the hosts and the processors asynchronously. In the extensions to the
architecture, additional performance optimizations are achieved by fully
distributing the intelligence, memory, parity and flow control throughout the
array. By controlling data flow, the system reduces or eliminates the processing
bottlenecks inherent in many other storage implementations.

<PAGE> 5

THE STORAGESUITE(TM) PRODUCT FAMILY

SERIES:70 DESKTOP STORAGE SERVER: A high-performance storage server for LAN's
and workgroups. It provides an economical storage solution for users
who require small to medium capacity systems. The desktop server is
scalable from 54 GB to 138 GB and supports two external channels.

SERIES:71 STORAGE SERVER: A high-performance storage server for LAN's and
workgroups. It provides an economical storage solution for users who
require medium to large capacity systems. The storage server is
scalable from 54 GB to 575 GB and supports four external channels.

SERIES:72 OMNIRAID(TM) SERVER: An enhanced performance storage system which
includes scalable data protection and performance. The OMNIRAID server
provides customizable high-performance storage by allowing the user to
select the appropriate parity protection at the transaction or dataset
level, rather than at the level of the physical array topology. The
OMNIRAID server is scalable to 1 TB and supports up to 12 external host
connections.

OMNIRAID CLUSTER ARRAY: Especially suited to NT clustered servers and
multi-host applications, the OMNIRAID Cluster Array delivers
consistent, high performance for all sizes and types of data transfer
found in today's dynamic NT environments. The OMNIRAID Cluster Array is
unique in that it automates data protection on a transaction versus
application level, thereby eliminating the need to continually manage
RAID levels for different applications stored on multiple NT or Unix
servers. The OMNIRAID Cluster Array supports multiple NT clusters,
simplifies the migration of data from Unix, Novell to NT, and
streamlines the implementation and management of centralized storage
strategies.

SERIES:73 OMNIRAID SUPERSERVER(TM): Built upon extensions to the storage
architecture, the OMNIRAID SuperServer/ES provides enterprise-class
storage services for open systems. The OMNIRAID SuperServer/ES includes
the full OMNIRAID feature set (Table Vector Parity, Post Write Parity,
Pipelining and Online Expansion) and is especially suited to high
performance commercial applications and high bandwidth applications.
This ultra-high performance storage server is scalable to 4 TB and
supports up to 48 external channels in clustered environments.

SERIES:74 OMNIRAID SUPERSERVER/ES: Based upon the extended Virtual Storage
Architecture, the OMNIRAID SuperServer/ES provides data protection with
the full OMNIRAID feature set. The unit is fully front- serviceable and
provides a larger storage capacity in a smaller footprint. This
ultra-high performance storage server is scalable to 16 TB and supports
up to 48 external channels in clustered environments.

DISASTER RECOVERY AND BUSINESS CONTINUANCE PRODUCTS

OMNIFORCE is an online data protection facility to allow primary production
sites to be multi-level mirrored, locally and/or remotely, to ensure "hot
recovery" of critical data to keep the business running with minimal
interruption of service. OMNIFORCE offers scalable data continuity features,
such as the ability to configure multiple concurrent levels of local and remote
data protection, based on data prioritization. OMNIFORCE provides fully user-
scalable protection at the file level, rather than the array level. Six levels
of mirroring are supported: intramirroring, local, cross, remote, replicated,
and reflective.

STORAGE MANAGEMENT

STORAGE ADMINISTRATOR(TM) enhances the monitoring and control of the
Company's storage product using an open, standards-based management protocol,
SNMP (Simple Network Management Protocol), the industry-standard IP (Internet)
communications protocol and a built-in Ethernet LAN (local area network)
connection. This "open systems" design allows information from the Storage
Administrator to be accessed through any SNMP management station, and alarm
conditions can be sent to multiple managers simultaneously, anywhere in the
world, over local
5

<PAGE> 6

or remote network connections. Mission-critical applications requiring
uninterrupted access to data on the arrays are protected by operational controls
within the Storage Administrator which enable early detection and automatic
alert notification when any user-defined alarm thresholds are reached.

CUSTOMERS AND APPLICATIONS

The Company has an extensive worldwide customer list. Products based upon
the Virtual Storage Architecture have been sold to customers across a broad
range of industries including banking and financial services, education,
technology, telecommunications, military/aerospace, general services,
government, and manufacturing. It is the goal of the Company to continue to
market to existing customers to leverage its multiple product offerings and to
continue to expand its customer base for its high-performance storage solutions.

CUSTOMER SERVICE AND SUPPORT

The Company offers its customers a full array of customizable support
options and programs. Customers have the option to decide how they want their
service and support structured, so that the maintenance of the customer's data
storage equipment fits into the customer's business model. Storage Computer's
technical services organization comprises a group of skilled support personnel,
located at Storage Computer's corporate headquarters in Nashua, New Hampshire
and in field locations in the United States, Europe and Asia.

In addition to the Company's own support engineers and technicians, its
strategic service alliances with third-party service providers enable it to
offer comprehensive, high-quality programs to support customers on a worldwide
basis. Storage Computer's strategic service alliances formed with third-party
providers include some of the largest and most highly respected organizations in
the service industry. Those alliances include IBM Service Organization,
Technology Service Solutions (a subsidiary of IBM) and DecisionOne. All in-house
and third-party service technicians supporting the Company's customers are
trained by Storage Computer, and service parts are generally stocked in local
service offices. Service technicians are backed by a technical support hotline
staffed by support analysts at Storage Computer. Storage Computer always takes
the initial service call, determines the logistics of the support plan, and
manages the process. Onsite services may be tailored to customer requirements in
terms of hours covered, response times and onsite hardware service providers.

COMPETITION

The information storage market is extremely competitive. Companies such as
Data General Corporation, Digital Equipment Corporation, EMC Corporation, IBM
Corporation, Hewlett-Packard, NCR Corporation, Storage Technology, Sun
Microsystems, and more than 100 other public and private companies provide disk
arrays for a wide variety of computer systems, workstations and PCs. Although
SCC is currently unaware of any other vendor offering an asynchronous transfer
RAID 7 disk array, there can be no assurance that the Company will be able to
compete successfully against existing companies or future entrants to the
marketplace. While the Company believes that the price-performance
characteristics of its products are currently competitive, increased competition
including the introduction of new products by the Company's competitors, could
result in price reductions, reduced gross margin and loss of market share, any
of which could materially adversely affect the Company's business, operating
results and financial condition. Many of the Company's current and potential
competitors have significantly greater financial, technical, marketing and other
resources than the Company. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements, or
to devote greater resources to the development, promotion, sale and support of
their products than the Company. In addition, current and potential competitors
have established or may establish cooperative relationships among themselves or
with third parties. Accordingly, it is possible that new competitors or
alliances among competitors may emerge and rapidly acquire significant market
share.

<PAGE> 7

SALES AND MARKETING

Domestic. The Company's products are sold domestically through a combination
of direct sales personnel, value-added resellers and other distributors. The
Company's direct sales organization coordinates the activities of the Company's
resellers and distributors and seeks to actively participate with them in
selling efforts in order to enable the Company to establish strong direct ties
with its customers and end users.

International. The Company has established several different operational
methods in order to penetrate and develop international markets. The Company
uses distributors and value-added resellers, combined with the selling efforts
of wholly-owned subsidiaries, and affiliated, minority-owned entities, to
penetrate certain international markets and maximize returns on its marketing
and sales efforts.

Storage Computer Europe, GmbH, a wholly-owned subsidiary of the Company
located in Kelkheim, Germany, provides sales and product support throughout
Central and Eastern Europe. In September 1992, the Company entered into a joint
venture agreement as a minority shareholder and formed Storage Computer (Asia)
Ltd. for the purpose of selling and servicing the Company's products in Hong
Kong and China. Similarly, in December 1995, the Company made a minority equity
investment in Open Storage Solutions, S.A., in France, for the purpose of
collaborating to sell and service products in France. Storage Computer (UK) Ltd.
manufactures products and supports the sales and service of the Company's
products in certain countries in Western Europe. In February of 1998 the Company
formed Storage Computer Pty., Ltd. for the purpose of sales and support in
Australia.

The remaining international markets served by the Company are coordinated
and supported from the United States through the use of the Company's
independent distributor network. The Company's distributors are responsible for
penetrating and developing their respective markets, providing support and
maintenance services and maintaining an inventory of spare parts. The
distributors are also responsible for establishing relationships with
value-added resellers, who sell the Company's products to final end users.

MANUFACTURING

The Company's manufacturing operations, which are located in Nashua, New
Hampshire, U.S.A. and Leatherhead, England, undertake procurement of materials,
product assembly, product assurance, quality control and final testing. The
Company's manufacturing strategy has been to develop close relationships with
its suppliers and subcontractors and to exchange critical information, in order
to minimize capital investment and overhead expenditures and create flexibility
for rapid expansion.

The Company relies upon a limited number of suppliers of several key
components utilized in the assembly of the Company's products. The Company
purchases disk drives and enclosures from a number of major disk drive
suppliers. The Company's reliance on its suppliers involves certain risks,
including a potential inability to obtain an adequate supply of required
components, price increases, timely delivery and component quality. This risk is
particularly significant with respect to suppliers of disk drives because in
order to meet product performance requirements, the Company must obtain disk
drives with extremely high quality and data storage capacity. In addition, there
is currently a significant market demand for disk drives and for semiconductor
memory components, which could result in component shortages, selective supply
allocations and increased prices of such components. Although to date the
Company has been able to purchase its requirements of such components, there is
no assurance that the Company will be able to obtain its full requirements of
such components in the future or that prices of such components will not
increase. In addition, there can be no assurance that problems with respect to
yield and quality of such components and timeliness of deliveries will not
occur. Disruption or termination of the supply of these components could delay
shipments of the Company's products and could have a material adverse effect on
the Company's business, operating results and financial condition.

RESEARCH AND DEVELOPMENT

Since its inception, the Company has made substantial investments in
research and development. The Company believes that its future performance will
depend in large part on its ability to maintain and enhance its current
products, develop new products that achieve market acceptance, maintain
technological competitiveness

<PAGE> 8

and meet an expanding range of customer requirements. The Company's future
growth depends substantially upon the success of the Company's RAID 7 Virtual
Storage Architecture and related products as well as new products which may be
developed; however, there can be no assurance that the Company's products will
attain broad market acceptance. Due to the complexity of the engineering effort
required to produce new data storage subsystem products, the development and
commercial exploitation of new products are subject to significant technical
risks. There can be no assurance that new products will be introduced on a
timely basis or at all. If new products are delayed or do not achieve market
acceptance, the Company's business, operating results and financial condition
will be materially adversely affected. In addition, there can be no assurance
that customers will not defer orders in anticipation of new product
introductions by the Company or its competitors.

Products like those offered by the Company may contain undetected software
errors or failures when first introduced or as new versions are released. There
can be no assurance that, despite testing by the Company and by current and
potential customers, errors will not be found in new products after commencement
of commercial shipments, resulting in loss of or delay in market acceptance,
which could have a material adverse effect upon the Company's business,
operating results and financial condition.

The Company's total expenses for research and development for fiscal years
1997, 1996 and 1995 were $2,852,000, $2,785,000 and $2,117,000 respectively. The
Company anticipates that research and development expenses will increase in
absolute dollars in future periods; however, the amount of such increases cannot
be accurately predicted. Research and development efforts are expected to be
focused on increasing the individual capabilities and performance of existing
products and developing new value added software and hardware products to
provide the Company's installed base with greater functionality, as well as to
attempt to expand that installed base.

PROPRIETARY RIGHTS

The Company's policy is to protect its technology by, among other things,
filing patent applications with respect to technology considered important to
the development of its business. The Company has been awarded certain U.S.
patents and has additional U.S. patent applications pending. Foreign
counterparts of certain of these applications have been filed or may be filed at
the appropriate time. The Company decides on a case-by-case basis whether and in
what countries it will file foreign counterparts of a U.S. patent application.
Although the Company often seeks patents on its products, the Company believes
that patents are of less significance in its industry than such factors as
innovative skills and technical expertise, frequency of product enhancements and
timeliness and quality of support services provided by the Company.

The Company believes that its products, trade marks and service marks do not
infringe on the proprietary rights of third parties. There can be no assurance,
however, that third parties will not assert infringement claims against the
Company in the future. If such a claim is made, the Company will evaluate the
claim as it relates to its products and, if appropriate, may seek a license to
use the protected technology. There can be no assurance that the Company would
be able to obtain a license to use any such protected technology or that any
such license could be obtained on terms that would not have a material adverse
effect on the Company. If the Company or its suppliers are unable to license any
such protected technology, the Company could be prohibited from incorporating or
marketing such products. The Company could also incur substantial costs to
redesign its products or to defend any legal action taken against it. Should the
Company's products be found to infringe protected technology, the Company could
be required to pay damages to the infringed party or be enjoined from
manufacturing and selling such products.

The Company requires all employees, and technical and other consultants and
advisors to execute confidentiality agreements upon the commencement of
employment or consulting relationships with the Company. These agreements
generally provide that all confidential information developed or made known to
the individual during the course of the individual's relationship with the
Company is to be kept confidential and not disclosed to third parties except in
specific circumstances. All of the Company's key technical employees have also
entered into agreements providing for the assignment of rights to inventions
made by them while in the employ of the Company. Although the Company continues
to take protective measures to protect its

<PAGE> 9

proprietary technology, there can be no assurance that these measures will be
successful. In addition, the laws of certain foreign countries may not protect
the Company's rights to the same extent as U.S. law.

EMPLOYEES

As of December 31, 1997, the Company had 138 full time employees. Of the
total, 110 were based in North America, 11 in the United Kingdom and 17 in
Germany. The Company's ability to develop, manufacture and market its products
and to establish and maintain a competitive position in its industry will
depend, in large part, upon its ability to attract and retain qualified
technical, marketing and managerial personnel, of which there can be no
assurance. The Company believes that its relations with its employees are good.
None of the Company's employees are represented by a collective bargaining
agreement.

ITEM 2. PROPERTIES

The Company currently leases, from an affiliate, a 35,000 sq. ft. facility
which is occupied by its light manufacturing, research and development and
office operations in Nashua, New Hampshire. In 1997, the Company paid a monthly
rental of $16,300 to lease this facility. The current monthly rental is $16,800,
which the Company believes is comparable to rentals of similar properties in the
area and indicative of the fair market rental which could be obtained from an
unrelated third party in an arm's-length transaction, see "Item 12 Certain
Relationships and Related Transactions." The Company leases all of its domestic
and international outside sales offices. All Company properties and premises are
adequately protected by insurance coverage. The Company believes that its
existing facilities are adequate for its current needs and that additional space
will be available as needed.

ITEM 3. LEGAL PROCEEDINGS

On December 14, 1994, Raul Kacirek, a former employee of the Company,
instituted a suit against the Company and its President, in Superior Court,
Cheshire County, New Hampshire (Dkr. No. 94-E-0102), alleging in part that he
properly exercised an employee stock option and is entitled to have up to
300,000 shares of Common Stock issued to him, but did not seek monetary damages.
In May 1997 Mr. Kacirek amended his suit to include several causes of action for
monetary damages against the Company and Mr. Goodlander. The Company and Mr.
Goodlander filed responsive pleadings (including motions and counterclaims) and
defended these actions vigorously in a non-jury trial in superior Court,
Cheshire County, New Hampshire, which concluded on February 11, 1998. The
Company is awaiting the court's decision on the merits.

The Company does not believe that its continuing involvement in any judicial
decision rendered, or the resolution of the legal proceeding, will have a
material effect upon the Company's business, operating results, or financial
condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

<PAGE> 10

PART II

ITEM5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock is traded on the American Stock Exchange under
the symbol "SOS".

The following table sets forth the range of the high and low closing sales
prices for the Common Stock of the Company for the fiscal years ended December
31, 1997 and 1996, as reported by the American Stock Exchange.

FISCAL 1997 HIGH LOW
----------- ---- ---

First Quarter................... $19.63 $11.25
Second Quarter.................. $14.38 $10.88
Third Quarter................... $14.00 $10.75
Fourth Quarter.................. $12.00 $5.00

FISCAL 1996 HIGH LOW
----------- ---- ---
First Quarter................... $ 11.00 $ 8.25
Second Quarter.................. $ 18.375 $ 8.25
Third Quarter................... $ 19.00 $ 12.25
Fourth Quarter.................. $ 15.00 $ 10.375

On December 31, 1997, there were 650 record holders of the Company's Common
Stock. The Company believes the actual number of beneficial owners of the Common
Stock is greater than the stated number of holders of record because a number of
the shares of the Company's Common Stock is held in custodial or nominee
accounts for the benefit of persons other than the record holder.

The Company has never paid any dividends and does not anticipate paying any
dividends in the foreseeable future. The Company is also restricted from paying
dividends under the terms of its bank credit facility.

<PAGE> 11

QUARTERLY FINANCIAL INFORMATION
- -------------------------------

The following selected financial information is derived from the Company's
financial statements and should be read in conjunction with those statements.

1997 QUARTER ENDING

MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
<S> <C> <C> <C> <C>
Revenue $8,454,913 $9,660,453 $7,647,253 $11,383,484
Gross margin 4,307,757 4,915,497 3,854,838 5,915,033
Income before taxes 1,138,143 1,878,959 400,872 2,837,779
Net income 928,143 1,095,359 114,472 1,753,779
Net income per diluted share $.08 $.09 $.01 $.15

1996 QUARTER ENDING

MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
Revenue $6,035,258 $7,321,410 $7,470,830 $10,183,931
Gross margin 2,904,516 3,461,405 3,792,100 5,526,499
Income before taxes 753,473 1,081,012 1,007,183 2,660,863
Net income 540,371 609,012 677,006 3,235,162(a)
Net income per diluted share $.05 $.05 $.06 $.27(a)
</TABLE>

(a) Fourth quarter 1996 income includes non-recurring favorable tax adjustments
of $1,716,000, or $.14 per diluted share.

<PAGE> 12

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

The following table presents the Company's consolidated statement of
operations stated as a percentage of revenue for the years ended December 31,
1997, 1996 and 1995.

<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Revenue.................................... 100.00% 100.00% 100.00%
Product cost............................... 48.90 49.40 52.10
------ ------ ------
Gross margin............................... 51.10 50.60 47.90
------ ------ ------
Operating Expenses
Research and development.............. 7.70 9.00 9.10
Selling and marketing................. 21.40 19.70 23.60
General and administrative............ 4.10 3.80 4.70
------ ------ ------
Total................................. 33.20 32.50 37.40
------ ------ ------
Operating income........................... 17.90 18.10 10.50
------ ------ ------
Other income (expense)..................... (1.00) (.40) .20
------ ------ ------
Income before income taxes................. 16.90 17.70 10.70
------ ------ ------
Provision for income taxes ..............
Current tax ......................... 5.40 6.00 3.70
Deferred tax (benefit)................ 1.00 (4.60) (3.90)
------ ------ ------
Total................................. 6.40 1.40 ( .20)
------ ------ ------
Net income................................. 10.50% 16.30% 10.50%
------ ------ ------
</TABLE>

REVENUE

Revenue for the year ended December 31, 1997 was $37,146,000, reflecting an
increase in combined product sales of $6,135,000, or 20%, compared with the year
ended December 31, 1996. Revenue for the year ended December 31, 1996 was
$31,011,000, reflecting an increase in combined product sales of approximately
$7,881,000 or 34% compared with the year ended December 31, 1995.

The increase in revenue in 1997 and 1996 is attributed to new product
introductions, increased international and domestic distribution channels
utilizing value-added resellers, and expansion of the direct sales force. In
June of 1997 the company initiated pricing adjustments related to changes in the
cost of purchased materials and to value-added features. This action did not
have a significant impact on revenues.

<PAGE> 13

Revenue by geographic region expressed as a percentage is as follows:

<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
----------------- ----------------- -----------------
<S> <C> <C> <C>
North America................ 50% 47% 39%
Far East..................... 23% 28% 20%
European Sales............... 26% 23% 38%
Other Regions................ 1% 2% 3%
</TABLE>

The increase in the percentage of North American revenue results from
increased maintenance sales, the expansion of the United States direct sales
force and a decrease in the rate of revenue growth in the Far East.

All United States export sales are denominated in United States dollars to
limit the amount of foreign currency risk. Export sales from the European sales
offices are denominated in United States dollars. Sales which occur through the
Company's subsidiaries located in England and Germany are conducted in the local
functional currency.

PRODUCT COST

Product cost for the years ended December 31, 1997, 1996 and 1995 was
$18,153,000, $15,327,000 and $12,054,000, or 49%, 49%, and 52% of revenue,
respectively.

For 1997 and 1996 the product cost percentage remained constant at 49%. The
decrease in the purchase cost of components parts was offset by increased
expenditures to expand the field service organization to support the increases
in the number of storage systems deployed.

The decrease in product cost percentage between 1996 and 1995 of
approximately 3 percentage points was primarily caused by the reduction in
component costs and the allocation between product cost and other operating
expenses. The decrease was offset in part as a result of the sales mix shifting
to larger system sales that incorporate a larger percentage of non-proprietary
components, such as disk drives, which have a lower gross profit margin.

RESEARCH AND DEVELOPMENT

Research and development expenses for the years ended December 31, 1997,
1996 and 1995 were $2,852,000, $2,785,000 and $2,117,000, or 8%, 9% and 9% of
revenue, respectively.

In 1997 the Company increased the personnel in research and development to
21 employees from 15 employees at December 31, 1996. This increase in personnel
cost was offset in part by a reduction of indirect costs allocated to this
department. The Company's intention is to increase the staffing in this
department in 1998 by a similar percentage to provide the resources necessary to
bring to market certain product enhancements.

The stabilization of the research and development expenses between 1996 and
1995 is directly attributable to the consolidation of the research and
development efforts to one location and the allocation of costs associated with
research and development efforts.

SALES AND MARKETING

Sales and marketing expenses for the years ended December 31, 1997, 1996
and 1995 were $7,960,000, $6,118,000, and $5,466,000 or 21%, 20% and 24% of
revenue, respectively.

<PAGE> 14

The increase in expenditures during this period is primarily attributed to
increased cost associated with the continued development and expansion of
international sales and marketing activities and expansion of domestic sales and
marketing efforts. Since the middle of 1996, the Company has added 30 employees
or contract personnel to strengthen and expand the domestic and international
sales and marketing organization to provide the platform for revenue growth.

The 1995 selling and marketing expense included $649,000 of royalty
payments to a related party. The royalty agreement was terminated in 1995 by
mutual consent.

GENERAL AND ADMINISTRATIVE

General and administrative expenses for the years ended December 31, 1997,
1996 and 1995 were approximately $1,526,000 $1,186,000, and $1,090,000, or 4.1%,
3.8% and 4.7% of revenue, respectively. The absolute dollar increases in each
year result primarily from employee-related costs associated with the increase
in revenue.

OTHER INCOME (EXPENSE)

The major component of other income (expense) is interest expense, which
aggregated $466,000, $209,000 and $238,000 in the years 1997, 1996 and 1995,
respectively. The increase in interest expense from 1996 to 1997 is the result
of increased short-term borrowing under the Company's line of credit to support
revenue growth and the resulting increase in accounts receivable, capital
additions, and increases in inventory due to new products and customer product
evaluations.

PROVISION FOR FEDERAL AND STATE INCOME TAXES

The provision for federal, state and foreign income taxes aggregate
$2,364,000, $440,980 and $(27,038) for the years 1997 through 1995. The
aggregate tax rate percentage was 37.8%, 8.0% and (1.1)% for the same periods.

The tax provisions for 1996 and 1995 include a reduction in the provisions
for deferred taxes in the amounts of $1,716,000 and $947,000, respectively,
related to the recognition of certain operating loss carryforwards for financial
reporting purposes. The aggregate tax rate percentage for 1996 and 1995, prior
to recognition of such favorable tax adjustments, was 39.2% and 37.4%,
respectively. Such favorable non-recurring tax adjustments had the effect of
increasing net income and net income per diluted share in 1996 and 1995 by
$1,716,000 ($.14 per diluted share) and $947,000 ($.08 per diluted share).

The provision for income taxes for 1997 does not include the benefit from
such non-recurring favorable tax adjustments. In 1997 the Company realized for
tax purposes cash savings from utilizing the operating loss carryforwards in the
amount of $365,000.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow

The cash flow used for the operating activities of the Company is
principally the result of the growth of the Company, causing fluctuations in
accounts receivable, which are impacted by the timing of product shipments and
inventory purchases to support new product introductions and revenue growth.

Accounts Receivable

The increase in accounts receivable from December 31, 1996 to December 31,
1997 of approximately $4,885,000 is due to the timing of fourth quarter product
shipments, the increase in product sales, new product introductions and
expansion of

<PAGE> 15

the distribution channels for the Company's products. The Company did not change
its standard credit terms during the period and there has been no material
deterioration in the aging of accounts receivable during the period.

Inventory

Inventory increased approximately $1,605,000 from December 31, 1996 to
December 31, 1997. The investment in inventory is impacted by several factors,
including, but not limited to, new product and product enhancement introduction;
the increased value of parts associated with larger storage units; the timing of
purchase component parts such as disk drives; the non-recognition of revenue and
corresponding inventory increases due to inventory transfers deemed to be
evaluation units; the timing of inventory reductions due to intercompany
transfers; and increased inventory locations throughout the United States and
Europe.

Borrowing Arrangements

In 1997, the Company renewed the $10,000,000 unsecured demand line of credit
with a bank to be used for the working capital needs of the Company. Borrowings
against such credit facility bear interest at the bank's prime rate, or under
certain conditions, at the bank's LIBOR rate plus 150 basis points. The
agreement contains certain covenants including, but not limited to, restrictions
related to net worth and certain financial ratios. The Company was in compliance
with these covenants during 1997 and 1996. At December 31, 1997 the remaining
balance available under the credit facility was approximately $3,557,000.

The Company's working capital at December 31, 1997 was approximately
$12,606,000. In Management's opinion, the Company's current working capital
position, together with the available credit facility and cash from operations,
will be sufficient to accommodate working capital requirements through the end
of 1998.

FOREIGN CURRENCY TRANSACTIONS

Management does not currently utilize any derivative products to hedge its
foreign currency risk. The Company's foreign subsidiaries' obligations to their
parent are denominated in United States dollars. There is a potential for a
foreign currency gain or loss based upon fluctuations between the United States
dollar and its subsidiaries' functional currencies, currently the German mark
and the British pound. This exposure is limited to the period between the time
of accrual of such liability to the parent in the subsidiaries' functional
currency and the time of its payment.

Other than the intercompany balances noted above, the Company does not
believe it has material unhedged monetary assets, liabilities or commitments
which are denominated in a currency other than the operations' functional
currency. Management expects such exposure to continue until its foreign
subsidiaries reach a more mature level of operation. Management currently has no
plans to utilize any derivative products to hedge its foreign currency risk.

INFLATION

The Company does not believe that inflation has had a material impact on its
operations.

FORWARD-LOOKING STATEMENTS

The Private Securities Litigation Reform Act of 1995 contains certain safe
harbors regarding forward-looking statements. From time to time, information
provided by the Company or statements made by its directors, officers or
employees may contain "forward-looking" information subject to numerous risks
and uncertainties. Any statements made herein that are not statements of
historical fact are forward-looking statements including, but not limited to,
statements concerning the characteristics and growth of the Company's markets
and customers, the Company's objectives and plans for future operations and
products and the Company's expected liquidity and capital resources. Such
forward-looking statements are based on a number of assumptions and involve a
number of risks and uncertainties, and, accordingly, actual results could differ
materially.

<PAGE> 16

Factors that may cause such differences include, but are not limited to: the
continued and future acceptance of the Company's products; the rate of growth in
the industries of the Company's products; the presence of competitors with
greater technical, marketing and financial resources; the Company's ability to
promptly and effectively respond to technological change to meet evolving
customer needs; risks associated with sales in foreign countries; and the
Company's ability to successfully expand its operations.

ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See Index to Financial Statements (Page 21).

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

<PAGE> 17

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS

The information required by this item may be found under the sections
captioned "Election of the Directors;"and "Executive Officers," in the Company's
Proxy Statement (the "1998 Proxy Statement") for the Company's Annual Meeting of
Stockholders to be held on May 18, 1998, and is incorporated by reference.

ITEM 10. EXECUTIVE COMPENSATION

The information required by this item may be found under the section
captioned "Executive Compensation" in the Company's 1998 Proxy Statement and is
incorporated by reference.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item may be found under the section
captioned "Principal and Management Stockholders" in the Company's 1998 Proxy
Statement and is incorporated by reference.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item may be found under the section
captioned "Certain Relationships and Related Transactions" in the Company's 1998
Proxy Statement and is incorporated by reference.

<PAGE> 18

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following documents are included as part of the report:

(1) Financial Statements

The following financial statements of the Company and the report of the
independent certified public accountants are filed as part of this report:

Index to Financial Statements

Report of Independent Auditors

Consolidated Financial Position

Statement of Consolidated Operations

Statement of Consolidated Stockholders' Equity

Statement of Consolidated Cash Flows

Notes to Consolidated Financial Statements

(2) Financial Statement Schedules

None

(3) Exhibits

Certain of the exhibits listed hereunder have been previously filed with the
Commission as exhibits to certain prior registration statements and periodic
reports as indicated in the footnotes below. The location of each document so
incorporated is indicated by footnote.

*3.1 Restated Articles of Organization (Incorporated by reference as Exhibit
3.1 to the Company's Form S-4, Registration No. 33-87028, as filed on
December 2, 1994).

*3.2 Amended and Restated By-Laws (Incorporated by reference as Exhibit 3.2
to the Company's Form S-4, Registration No. 33-87028, as filed on
December 2, 1994).

*4.1 Specimen Common Stock Certificate (Incorporated by reference as Exhibit
4.1 to the Company's Form S-4, Registration No. 33-87028, as filed on
December 2, 1994).

<PAGE> 19

*10.1 Restated and Amended Stock Incentive Plan. (Incorporated by reference
as Exhibit 4.1 to the Company's Form S-8, Registration No. 333-31297,
as filed on July 14, 1997).

*10.2 Form of Restated and Amended Stock Incentive Plan, Stock Award
(Incorporated by reference as Exhibit 4.2 to the Company's Form S-8,
Registration No. 333-31297, as filed on July 14, 1997)

*10.3 Promissory Note in the principal amount of $710,000 dated December 6,
1996 made payable to Theodore J. Goodlander.

*10.4 Letter Agreement dated July 14, 1994 between the Registrant and Eddie
Lu Hwang (Incorporated by reference as Exhibit 10.8 to the Company's
Form S-4, Registration No. 33-87028, as filed on December 2, 1994).

*10.5 Joint Venture Agreement between the Registrant, Micro Research Computer
Limited and Eddie Lu Hwang (Incorporated by reference as Exhibit 10.6
to the Company's Form S-4, Registration No. 33-87028, as filed on
December 2, 1994).

*10.5b Amended and Restated 1992 Stock Incentive Plan (Incorporated by
reference as Exhibit 10.5 to Amendment No. 4 to the Company's Form S-3,
Registration No. 333-04145, as filed on September 13, 1996).

*10.6 Amendment dated August 20, 1996, to the Revolving Credit Agreement
dated August 6, 1995 between the Company and State Street Bank and
Trust Company.

*10.7 $10,000,000 Line of Credit Note from Registrant to State Street Bank
and Trust Company dated August 20, 1996.

*10.8 Loan Agreement dated August 6, 1995 between the Company and State
Street Bank and Trust Company (Incorporated by reference to Exhibit
10.2 to Amendment No. 4 to the Company's Form S-3, Registration No.
333-04145, as filed on September 13, 1996.

* 21 Subsidiaries of the Company.

23 Consent of Richard A. Eisner & Company, LLP.

27 Financial Data Schedule.

* 99 "Safe Harbor" Statement under Private Securities Litigation Reform Act
of 1995.

---------------
* previously filed

(b) Reports on Form 8-K

None.

<PAGE> 20

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in Nashua, New
Hampshire, on the 11th day of March, 1998.

STORAGE COMPUTER CORPORATION

BY: /S/ THEODORE J. GOODLANDER
-----------------------------
Theodore J. Goodlander
Chairman of the Board of
Directors, CEO
(Principal Executive Officer)

Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in their capacities and on the date indicated.

<TABLE>
<CAPTION>
SIGNATURE CAPACITY DATE
--------- -------- ----
<S> <C> <C>
/S/ THEODORE J. GOODLANDER Chairman of the Board of Directors, CEO March 11, 1998
---------------------------- (Principal Executive Officer)
Theodore J. Goodlander

/S/ SHIGEHO INAOKA Director March 11, 1998
----------------------------
Shigeho Inaoka

/s/ Steven S. Chen Director March 11, 1998
----------------------------
Steven S. Chen

/s/ James Craig Louney Chief Financial Officer and Treasurer March 11, 1998
---------------------------- (Principal Accounting Officer)
James Craig Louney
</TABLE>

<PAGE> 21

STORAGE COMPUTER CORPORATION

- I N D E X -

Page
Number
------

Report of Independent Auditors..................... 22

Consolidated Financial Position at
December 31, 1997 and December 31, 1996............ 23

Statement of Consolidated Operations
for the Years Ended December 31, 1997,
December 31, 1996 and December 31, 1995............ 24

Statement of Consolidated Stockholders'
Equity for the Years Ended December 31,
1997, December 31, 1996 and December 31, 1995...... 25

Statement of Consolidated Cash Flows
for the Years Ended December 31, 1997,
December 31, 1996 and December 31, 1995............ 26

Notes to Consolidated Financial Statements......... 27

<PAGE> 22

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors
Storage Computer Corporation
Nashua, New Hampshire 03062

We have audited the accompanying consolidated financial position of Storage
Computer Corporation as at December 31, 1997 and December 31, 1996, and the
related statements of consolidated operations, stockholders' equity, and cash
flows for each of the years in the three-year period ended December 31, 1997.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Storage
Computer Corporation at December 31, 1997 and December 31, 1996, and the
consolidated results of its operations and consolidated cash flows for each of
the years in the three-year period ended December 31, 1997 in conformity with
generally accepted accounting principles.

Richard A. Eisner & Company, LLP

Cambridge, Massachusetts
February 25, 1998

<PAGE> 23

STORAGE COMPUTER CORPORATION

CONSOLIDATED FINANCIAL POSITION

<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996
------ -----
A S S E T S
<S> <C> <C>
Current assets:
Cash and cash equivalents.................... $ 1,113,379 $ 1,852,762
Accounts receivable.......................... 13,910,001 9,030,955
Inventories (Note B)......................... 7,879,485 6,274,244
Other current assets......................... 554,804 103,796
Deferred tax asset (Note I).................. 350,000 400,000
------------ ------------
Total current assets.................... 23,807,669 17,661,757
------------ ------------
Property and equipment (net of accumulated
depreciation of $1,507,358 in 1997
and $1,155,165 in 1996) (Note C)............. 2,520,774 1,080,002
Deferred tax asset (Note I)....................... 1,844,000 2,138,550
Other assets (Note D)............................. 2,639,510 55,000
------------ ------------
Total................................... $ 30,811,953 $ 20,935,309
============ ============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable (Note E)........................ $ 6,442,701 $ 576,421
Accounts payable............................. 1,980,721 2,231,309
Accrued expenses (Note F).................... 2,149,871 2,536,353
Accrued income taxes......................... 628,510 935,600
------------ ------------
Total current liabilities............... 11,201,803 6,279,683
------------ ------------
Long-term debt (Note E)........................... 710,000 742,672
------------ ------------
Commitments and contingencies (Notes F, G and J)

Stockholders' equity (Note H):

Preferred stock, par value $.001;
authorized 1,000,000 shares; none
issued and outstanding.

Common stock par value $.001;
authorized 25,000,000 shares;
issued and outstanding 11,149,016
shares (1997) and 10,701,341 shares (1996)... 11,149 10,701

Additional paid-in capital................... 13,385,240 12,290,245
Retained earnings............................ 5,503,761 1,612,008
------------ ------------
Total stockholders' equity.............. 18,900,150 13,912,954
------------ ------------
Total................................... $ 30,811,953 $ 20,935,309
============ ============
</TABLE>

The accompanying notes are an integral part of the financial statements.

<PAGE> 24

STORAGE COMPUTER CORPORATION

STATEMENT OF CONSOLIDATED OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
--------------- --------------- ---------------
<S> <C> <C> <C>
Revenue.............................. $ 37,146,103 $ 31,011,429 $ 23,130,413
Product cost......................... 18,152,978 15,326,909 12,054,265
------------- ------------- -------------
Gross margin.................... 18,993,125 15,684,520 11,076,148
------------- ------------- -------------
Operating expenses:
Research and development........ 2,851,739 2,785,280 2,116,542
Selling and marketing........... 7,959,521 6,117,947 5,469,238
General and administrative...... 1,526,477 1,186,239 1,089,797
------------- ------------- -------------
Total........................... 12,337,737 10,089,466 8,675,577
------------- ------------- -------------
Operating income..................... 6,655,388 5,595,054 2,400,571
------------- ------------- -------------
Other income:
Interest expense(net) (Note E) (438,649) (177,822) (153,610)
Other income.................... 39,014 85,299 212,596
------------- ------------- -------------
Total........................... (399,635) (92,523) 58,986
------------- ------------- -------------
Income before income taxes........... 6,255,753 5,502,531 2,459,557
------------- ------------- -------------
Provision for income taxes (Note I ):

Current tax................ 2,020,000 1,861,533 869,164
Deferred tax (benefit)..... 344 000 (1,420,553) (896,202)
------------- ------------- -------------
Total...................... 2,364,000 440,980 (27,038)
------------- ------------- -------------
Net income........................... $ 3,891,753 $ 5,061,551 $ 2,486,595
============= ============= =============
Net income per basic share........... $ 0.36 $ 0.47 $ 0.24
============= ============= =============
Net income per diluted share......... $ 0.33 $ 0.43 $ 0.21
============= ============= =============
Basic Shares......................... 10,825,043 10,672,764 10,556,671
============= ============= =============
Diluted shares....................... 11,960,546 11,891,373 11,784,441
============= ============= =============

</TABLE>

The accompanying notes are an integral part of the financial statements.

<PAGE> 25

STORAGE COMPUTER CORPORATION

STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
COMMON STOCK
-------------------- ADDITIONAL RETAINED
PAR PAID-IN EARNINGS
SHARES VALUE CAPITAL (DEFICIT)
------ ----- ------- ---------
<S> <C> <C> <C> <C>
Balance - December 31, 1994......... 10,381,341 $ 10,381 $ 11,597,915 $(5,936,138)

Conversion of debt into common stock 135,000 135 624,865
(Note K)..........................

Exercise of stock options........... 120,000 120 1,080

Net income.......................... 2,486,595
---------- --------- ------------ -----------

Balance - December 31, 1995......... 10,636,341 10,636 12,223,860 (3,449,543)

Exercise of stock options........... 65,000 65 66,385

Net income.......................... 5,061,551
---------- --------- ------------ -----------

Balance - December 31, 1996......... 10,701,341 10,701 12,290,245 1,612,008

Exercise of stock options........... 447,675 448 655,163

Tax benefit from stock options (Note K) 439,832

Net income.......................... 3,891,753
---------- --------- ------------ -----------

Balance - December 31, 1997 11,149,016 $ 11,149 $ 13,385,240 $ 5,503,761
========== ========= ============ ===========
</TABLE>

The accompanying notes are an integral part of the financial statements.

<PAGE> 26

STORAGE COMPUTER CORPORATION
STATEMENT OF CONSOLIDATED CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
1997 1996 1995
------------- ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:

Net income................................. $3,891,753 $ 5,061,551 $2,486,595

Reconciliation to operating cash flows:

Depreciation and amortization.............. 382,836 310,505 302,041

Deferred tax provision (benefit).......... 344,000 (1,420,553) (896,202)

Foreign currency translation loss (gain)... 29,423 (29,407) (8,763)

Changes in operating assets and liabilities:

Accounts receivable........................ (4,885,160) (1,818,864) (3,487,958)

Inventories................................ (1,605,241) (1,694,178) (1,796,189)

Other current assets....................... ( 451,008) 2,955 (68,979)

Accounts payable and accrued expenses...... ( 536,998) 1,102,092 1,197,750
---------- ----------- ----------
Net cash provided (used) in operating
activities............................. (2,830,395) 1,514,101 (2,271,705)
---------- ----------- ----------
Cash flows from investing activities:

Capital expenditures....................... (1,823,608) (483,058) (388,953)

Other assets .............................. (2,583,960) (55,000)
---------- ----------- ----------
Net cash used in investing activities.. (4,407,568) (483,058) (443,953)
---------- ----------- ----------
Cash flows from financing activities:

Net proceeds from credit line.............. 5,866,280 176,448 399,973

Reduction of other long-term liabilities... (298,352) (102,263)

Net proceeds from issuance of common stock. 655,611 66,450
---------- ----------- ----------
Net cash provided (used) in financing
activities........................... 6,521,891 (55,454) 297,710
---------- ----------- ----------
Effect of exchange rate changes on cash......... (23,311) 6,072 943
---------- ----------- ----------
Net increase (decrease) in cash and cash
equivalents................................... (739,383) 981,661 (2,417,005)

Cash and cash equivalents - beginning of year... 1,852,762 871,101 3,288,106
---------- ----------- ----------
Cash and cash equivalents - end of year......... $1,113,379 $ 1,852,762 $ 871,101
=========== =========== ==========
</TABLE>

The accompanying notes are an integral part of the financial statements.

<PAGE> 27

STORAGE COMPUTER CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A - SIGNIFICANT ACCOUNTING POLICIES

Basis of presentation

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Storage Computer Europe GmBH, Vermont
Research Products, Inc. and Storage Computer UK Ltd. All significant
intercompany accounts and transactions have been eliminated. The Company also
has investments in Storage Computer (Asia) Ltd. and Storage Computer France,
S.A., 20%-owned affiliates, which are accounted for by the equity method.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Inventories

Inventories are stated at the lower of average cost (first-in, first-out
method) or market.

Property and equipment

Property and equipment are stated at cost. Depreciation of property and
equipment is computed utilizing the same accelerated methods for both financial
and tax reporting over a period not to exceed 5 years.

Revenue recognition

The Company recognizes revenue from hardware and software sales at the time
of shipment. Service revenue is recognized over the contracted period or as the
services are provided.

Cash and cash equivalents

The Company considers all highly liquid instruments with a maturity of three
months or less, when acquired, to be cash equivalents.

Earnings per share

The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 128, "Earnings per Share" ("SFAS 128") effective for
interim and annual periods ending after December 15, 1997. SFAS 128 requires
that a new calculation, net income per basic share, be reported. Basic earnings
per share is determined utilizing only the weighted average of outstanding
common shares. The effect of potentially dilutive options, warrants and other
securities is included in the calculation of net income per diluted share. There
is no difference in the numerator between the basic and diluted calculation and
the only difference in the denominator is the effect of dilutive stock options.

<PAGE> 28

Stock-based compensation

The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No. 123, "Accounting for Stock Based Compensation" ("SFAS
123"). The Company has adopted the disclosure requirements of SFAS 123 and
accounts for its employee stock option plans under Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees".

NOTE B - INVENTORIES

At December 31, 1997 and 1996 inventories consisted of raw materials of
$1,710,998 and $4,476,995; work in process of $2,631,078 and $888,396, and
finished goods of $3,537,409 and $908,853, respectively.

NOTE C - PROPERTY AND EQUIPMENT

Property and equipment are summarized as follows:

DECEMBER 31,
1997 1996
------------ ------------
Machinery and equipment................. 1,772,452 1,443,428

Office furniture and fixtures........... 324,160 220,453

Research and development equipment...... 1,706,103 310,328

Other property.......................... 225,417 260,958
----------- -----------
Total.............................. 4,028,132 2,235,167

Less accumulated depreciation........... 1,507,358 1,155,165
----------- -----------

Net property and equipment........ $ 2,520,774 $ 1,080,002
=========== ===========

NOTE D - OTHER ASSETS

At December 31, 1997 other assets include advances to an affiliate in the
amount of $600,162 and reclassification from current assets to long-term assets
of $2,039,348 due from a customer, pending the completion of agreements which
will restructure the liquidation of such amounts into current and noncurrent
balances.

NOTE E - BORROWING ARRANGEMENTS

At December 31, 1997 the Company had an unsecured demand bank line of
credit with maximum borrowings of $10,000,000. The loan bears interest at the
bank's prime rate or, under certain conditions, at the bank's LIBOR rate plus
150 basis points. The agreement contains certain covenants including, but not
limited to, restrictions related to net worth and certain financial ratios. The
Company was in compliance with these covenants during 1997 and 1996. At December
31, 1997 the remaining balance available under the credit facility was
approximately $3,557,000.

Long-term debt in the amount of $710,000 at December 31, 1997 and 1996 is
payable to an officer and stockholder of the Company. The debt is unsecured,
bears interest at prime plus 1%, and is subordinated to the demand line of
credit. Interest expense related to the obligation amounted to $66,100, $84,000,
and $91,000 for 1997, 1996 and 1995, respectively.

NOTE F - RELATED PARTY TRANSACTIONS

The Company leases plant and office facilities from an affiliated entity as
a tenant-at-will, under a triple-net lease agreement. Rent expense under this
lease for 1997, 1996 and 1995 amounted to $195,600, $187,200 and $152,576,
respectively.

<PAGE> 29

Deferred compensation payable to an officer and stockholder in the amount
of $299,500 at December 31, 1996 was rescinded in 1997.

NOTE G - COMMITMENTS

The Company leases certain property and equipment under noncancellable
leases which expire at various dates through 2001. Future minimum lease payments
are $184,000, $112,000, $29,000 and $4,000 for the years 1998 through 2001,
respectively.

Amounts charged to operations for operating leases were $286,000, $203,000
and $185,000 for the years ended December 31, 1997, 1996, and 1995,
respectively.

NOTE H - STOCK OPTION PLAN

The Company's 1994 Stock Incentive Plan, as amended, provides for the
granting of options to purchase up to 2,500,000 shares of common stock. Option
activity during 1995, 1996 and 1997 is summarized as follows:

WEIGHTED -
AVERAGE
NUMBER OF OPTION PRICE
SHARES PER SHARE
------ ---------

Balance - December 31, 1994 1,869,200 $ 1.33

Granted.................. 121,950 2.81

Exercised................ (120,000) .10

Canceled................. (363,750) 2.49
---------- -------

Balance - December 31, 1995 1,507,400 1.35

Granted.................. 382,000 10.01

Exercised................ (65,000) 1.02

Canceled................. (160,900) 3.32
---------- -------

Balance - December 31, 1996 1,663,500 3.41

Granted.................. 814,500 6.36

Exercised................ (447,675) 1.46

Canceled................. (201,425) 10.50
---------- -------

Balance - December 31, 1997 1,828,900 $ 6.47
========== =======

Options granted generally vest over a period not to exceed four years.
Options for 864,175 shares are exercisable at December 31, 1997 at exercise
prices ranging from $.10 to $19.00 and a weighted-average price of approximately
$8.53 per share, with a weighted-average remaining contractual life of
approximately 7 years. At December 31, 1997, options to purchase 68,425 shares
were available for grant under the plan.

The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," and applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plans.
There was no compensation expense recognized in 1997, 1996 or 1995. If the
Company had elected to recognize compensation cost for the plans based on the
fair value at the grant date for awards under the plans, consistent with the
method prescribed by SFAS No. 123, pro forma net income would have been
$3,539,297 in 1997, $4,874,280 in 1996, and $2,453,295 in 1995. Proforma net
income per diluted share would have been $.30 in 1997, $.41 in 1996, and would
have been unchanged in 1995.

The fair value of the Company's stock options used to compute pro forma
net income and net income per diluted share disclosures is the estimated present
value at grant date using the Black-Shoales option-pricing model with the

<PAGE> 30

following weighted average assumptions for 1995 through 1997: dividend yield of
2.5%; expected volatility of 40%; a risk free interest rate of 7.5%; and an
expected holding period of six years.

NOTE I- INCOME TAXES

At December 31, 1997 and December 31, 1996, the Company has net deferred
tax assets as follows:

DECEMBER 31,
1997 1996
-------------- ----------
Deferred compensation............ $ $ 115,128

Inventory costs.................. 22,000 15,522

Deferred revenue................. 269,000 112,606

Accrued expenses................. 10,000 32,000

General business tax credits..... 360,000 360,000

Domestic operating loss carryover 1,861,000 2,061,843

Foreign operating loss carryover. 572,000 736,152
----------- ------------
Total deferred tax assets... 3,094,000 3,433,251

Valuation allowance.............. (900,000) (894,701)
----------- ------------
Net deferred tax assets.......... 2,194,000 2,538,550

Less current tax asset........... 350,000 400,000
----------- ------------
Noncurrent tax asset............. $ 1,844,000 $ 2,138,550
=========== ============

The domestic operating loss carryovers, amounting to approximately
$5,500,000 expire at various dates through 2009 and the foreign operating loss
carryovers amounting to approximately $2,300,000 can be carried forward
indefinitely. The Company is subject to Internal Revenue Code provisions which
limit the domestic net operating loss carryovers available annually. The general
business tax credits expire at various dates through 2001.

The United States, foreign, and state components of the tax provision
(benefit) are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Current:

Federal, net of business tax credits of $197,000,
$50,000 and $115,000 in 1997, 1996 and 1995,
respectively............................ $ 1,580,000 $ 1,513,533 $ 691,164

State..................................... 440,000 348,000 178,000
----------- ----------- -----------
2,020,000 1,861,533 869,164
----------- ----------- -----------
Deferred:

Federal................................... 180,000 (1,222,553) (358,202)

Foreign................................... 164,000 (198,000) (538,000)
----------- ----------- -----------
344,000 (1,420,553) (896,202)
----------- ----------- -----------
Provision (benefit) for income taxes........... $ 2,364,000 $ 440,980 $ (27,038)
=========== =========== ===========
</TABLE>

<PAGE> 31

The following table reconciles the provision for taxes with the expected
income tax obligation obtained by applying the United States federal statutory
rate to pretax income.

<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------- -------------
<S> <C> <C> <C>
Income before income taxes................................. $ 6,255,753 $ 5,502,531 $ 2,459,577
------------ ------------- -------------
Expected tax at U.S. statutory rate of 34%................. $ 2,127,000 $ 1,871,000 $ 836,000

Adjustments due to:

Difference between foreign rate and U.S. statutory rate.. 40,000 165,000 85,000

State taxes, net of federal benefit...................... 291,000 230,000 99,000

Increase (decrease) in valuation reserve................. 5,000 (1,513,000) (947,000)

Adjustment of prior years' deferred tax assets
related to foreign entities............................ (295,000)

Tax credits.............................................. (130,000) (50,000) (115,000)

Other.................................................... 31,000 32,980 14,962
------------ ------------- -------------
Provision (benefit) for income taxes....................... $ 2,364,000 $ 440,980 $ (27,038)
=========== ============= =============
</TABLE>

NOTE J - LEGAL PROCEEDINGS

The suit by a former employee against the Company and its President in
New Hampshire, Cheshire County Superior Court, (Dkt. No. 94-E-0102), was amended
by the plaintiff's new counsel to include additional alleged causes of action
for monetary damages. The Company has defended its position vigorously at
several motion sessions and in a non-jury trial which was concluded on February
11, 1998. The Company is awaiting the Court's decision on the merits. The
Company does not believe that its continuing involvement in any judicial
decision rendered, or the resolution of the legal proceeding, will have a
material effect upon the Company's business, operating results, or financial
condition.

NOTE K - SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest for the years 1997, 1996 and 1995 were $486,000,
$133,000 and $142,000, respectively. For the same periods cash payments for
income taxes were $718,000, $1,831,000 and $1,035,000. In 1997 the Company
reduced federal taxes payable and increased additional paid-in capital by
$439,832 for the tax benefits associated with the exercise of stock options. In
1995 the Company converted $625,000 of debt to equity through the issuance of
135,000 shares of common stock.

<PAGE> 32

NOTE L - BUSINESS SEGMENT INFORMATION

The company's operations are conducted in one business segment: the design,
manufacture and sale of high-performance scalable data storage. Operations by
geographic area are summarized as follows:

<TABLE>
<CAPTION>
UNITED
STATES EUROPE ELIMINATIONS CONSOLIDATED
------ ------ ------------ ------------
<S> <C> <C> <C> <C>
1997:

Domestic sales........................ $18,598,928 $ 7,825,213 $ $26,424,141

Export sales.......................... 9,078,719 9,078,719

Export sales to affiliates............ 1,643,243 1,643,243

Transfers between geographic areas.... 5,366,702 259,687 (5,626,389)
----------- ----------- ------------ -----------

Total revenue.................... 34,687,592 8,084,900 (5,626,389) 37,146,103
=========== =========== ============ ===========
Net income............................ 3,528,055 363,698 3,891,753

Identifiable assets................... 31,282,599 6,779,649 (7,250,295) 30,811,953

1996:

Domestic sales........................ 14,636,000 6,251,000 20,887,000

Export sales.......................... 8,103,000 8,103,000

Export sales to affiliates............ 2,021,429 2,021,429

Transfers between geographic areas.... 4,245,000 1,296,000 (5,541,000)
----------- ----------- ------------ -----------
Total revenue.................... 29,005,429 7,547,000 (5,541,000) 31,011,429
=========== =========== ============ ===========
Net income............................ 5,195,551 809,000 (943,000) 5,061,551

Identifiable assets................... 25,621,309 4,980,000 (9,666,000) 20,935,309

1995:

Domestic sales........................ 8,928,000 7,873,000 16,801,000

Export sales.......................... 4,628,000 4,628,000

Export sales to affiliates............ 1,701,413 1,701,413

Transfers between geographic areas.... 6,414,000 290,000 (6,704,000)
----------- ----------- ------------ -----------
Total revenue.................... 21,671,413 8,163,000 (6,704,000) 23,130,413
=========== =========== ============ ===========
Net income............................ 2,465,595 (103,000) 124,000 2,486,595

Identifiable assets................... $16,307,000 $ 3,661,000 $ (5,200,000) $14,768,000

</TABLE>

Total revenue by geographic area includes sales to unaffiliated customers,
affiliates, and transfers between geographic areas.

Export sales from the United States are summarized as follows:

1997 1996 1995
------ ------ -----

Far East......................... $ 8,631,179 $ 8,563,000 $ 4,542,000

Europe........................... 1,854,899 1,036,000 927,000

Other............................ 235,884 525,429 860,413
----------- ----------- -----------

$10,721,962 $10,124,429 $ 6,329,413
=========== =========== ===========

For the years ended December 31, 1997, December 31, 1996 and December 31,
1995 sales to one unaffiliated customer were in excess of 10% of revenues and
amounted to $7,009,000, $6,303,000, and $2,756,000, respectively.

<PAGE> 1
EXHIBIT 23

CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statement of
Storage Computer Corporation (The "Company") on Form S-8 of our report dated
February 25, 1998 on the financial statements of the Company as at December 31,
1997 and December 31, 1996 and for each of the years in the three year period
ended December 31, 1997 appearing in this annual report on Form 10-KSB of the
Company.

Richard A. Eisner & Company, LLP

Cambridge, MA
March 11, 1998

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 1,113,379
<SECURITIES> 0
<RECEIVABLES> 13,910,001
<ALLOWANCES> 0
<INVENTORY> 7,879,485
<CURRENT-ASSETS> 23,807,669
<PP&E> 4,028,132
<DEPRECIATION> 1,507,358
<TOTAL-ASSETS> 30,811,953
<CURRENT-LIABILITIES> 11,201,803
<BONDS> 0
0
0
<COMMON> 11,149
<OTHER-SE> 18,889,001
<TOTAL-LIABILITY-AND-EQUITY> 30,811,953
<SALES> 37,146,103
<TOTAL-REVENUES> 37,146,103
<CGS> 18,152,978
<TOTAL-COSTS> 12,337,737
<OTHER-EXPENSES> (399,635)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 6,255,753
<INCOME-TAX> 2,364,000
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,891,753
<EPS-PRIMARY> .36
<EPS-DILUTED> .33

</TABLE>