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SECURITIES AND EXCHANGE COMMISSION


Washington, DC 20549





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FORM 10-K





| ̈ |  | FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------------------------




|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ------------------------------------------------------------------------------------




| |  | For the fiscal year ended July 31, 2002
| |  | ---------------------------------------




Commission file number 0-21053





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PROCOM TECHNOLOGY, INC.


(Exact name of registrant as specified in its charter)





California

33-0268063(State or other jurisdiction of

(IRS Employerincorporation or organization)

Identification No.)





58 Discovery, Irvine, California

92618(Address of principal executive office)

(Zip Code)





(949) 852-1000


(Registrants telephone number, including area code)





http://www.procom.com


(Registrants Web Site)





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Securities registered pursuant to Section 12(b) of the Act:





None.





Securities registered pursuant to Section 12(g) of the Act:





Common Stock, $.01 Par Value


(Title of Class)





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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ̈





Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
Registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ̈





As of October 29, 2002 the aggregate market value of the voting
stock of the Registrant held by non-affiliates of the Registrant was approximately $2.8 million.





The number of
shares of Common Stock, $.01 par value, outstanding on October 29, 2002, was 16,084,708.





DOCUMENTS INCORPORATED BY
REFERENCE





Information required by Part III is incorporated by reference to portions of the Registrants
Proxy Statement for the 2003 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after the close of the 2002 fiscal year.





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PROCOM TECHNOLOGY, INC.





INDEX TO ANNUAL REPORT ON FORM 10-K


FOR THE FISCAL YEAR ENDED JULY 31, 2002





PagePART IItem 1.

Business

3Item 2.

Properties

20Item 3.

Legal Proceedings

20Item 4.

Submission of Matters to a Vote of Security Holders

21PART IIItem 5.

Market for Registrants Common Stock and Related Stockholder Matters

21Item 6.

Selected Financial Data

22Item 7.

Managements Discussion and Analysis of Financial Condition and Results of Operations

23Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

31Item 8.

Financial Statements and Supplementary Data

33PART IIIItem 10.

Directors, Executive Officers and Certain Significant Employees of the Registrant

57Item 11.

Executive Compensation

58Item 12.

Security Ownership of Certain Beneficial Owners and Management

58Item 13.

Certain Relationships and Related Transactions

59PART IVItem 14.

Exhibits, Financial Statement Schedules and Reports on Form 8-K

60





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THE INFORMATION CONTAINED IN THIS REPORT ON FORM 10-K INCLUDES FORWARD-LOOKING STATEMENTS. WHEN USED IN THIS REPORT, THE WORDS ANTICIPATES, BELIEVES, EXPECTS, INTENDS,
FORECASTS, PLANS, FUTURE, STRATEGY OR WORDS OF SIMILAR IMPORT ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS. OTHER STATEMENTS OF THE COMPANYS PLANS AND OBJECTIVES MAY ALSO BE CONSIDERED TO
BE FORWARD-LOOKING STATEMENTS. SUCH STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES, WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO PLACE UNDUE
RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE HEREOF. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLISH REVISED FORWARD-LOOKING STATEMENTS TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS OR CIRCUMSTANCES AFTER THE
DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS. READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE BY THE COMPANY TO ADVISE INTERESTED PARTIES OF CERTAIN RISKS AND OTHER FACTORS THAT MAY AFFECT THE
COMPANYS BUSINESS AND OPERATING RESULTS, INCLUDING THE DISCLOSURES MADE UNDER THE CAPTION RISK FACTORS IN THIS REPORT.





The Companys principal executive offices are located at 58 Discovery, Irvine, CA 92618; its telephone number is (949) 852-1000 and its web site is HTTP://WWW.PROCOM.COM.




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PART I





Item 1.Business





General





We are a designer and provider of networked data storage appliances. Appliances are specialized devices that perform a specific function
within the computer network. Data storage appliances have emerged as the solution of choice to manage the rapidly growing data storage requirements of computer networks. These appliances provide superior performance at a lower cost than
general-purpose computers used as file servers. We have developed network attached storage, NAS, appliances that we believe are faster, more reliable and easier to install and operate than similarly configured and comparably priced appliances. We
achieve these advantages by integrating into our appliances specialized operating system software optimized for data storage and retrieval. We are ISO 9001 certified and have been since 1999.





Industry Overview





Large and Growing Need for
Data Storage





Companies increasingly view data as a strategic asset that creates a competitive advantage.
Continuous and rapid access to this data is critical to managing a business effectively. The volume of data produced and stored by businesses is growing rapidly. The factors contributing to the growth in network storage requirements include:





| |  |  | new communication media such as e-mail, digital imaging and video storage
| | - |  | -------------------------------------------------------------------------




| |  |  | widespread use of enterprise applications, including enterprise resource planning, sales force automation, supply chain and customer relationship management
systems
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------




As a result of these factors, expenditures for data storage are growing and consuming
an increasing percentage of total information technology expenditures. Specifically, networked storage is rapidly becoming the dominant method for data management and sharing. According to a recent Gartner study, network attached storage is
projected to experience a 18% CAGR (compounded annual growth rate) from 2002-2006. We are focused on delivering solutions to meet the requirements of the mid-range ($10,000-$400,000) price band, which we believe will be a growing segment of the NAS
market.





Common Solutions to Network Storage Requirements





There are several approaches to providing network data storage capacity. These approaches include:





| |  |  | General Purpose Servers.    Companies can increase their data storage capacity by adding general purpose computers as data file
servers or by attaching external storage devices directly to existing servers. General purpose servers are designed to execute computer applications and perform a wide variety of functions, including providing database, electronic mail, network
management, file management and application services. They are not specifically designed to store and retrieve files. As a result, general purpose computers used as file servers often provide unsatisfactory file input/output, or I/O, performance, do
not support computing platforms other than that of the server itself, and require significant maintenance and support. Moreover, because of their complexity, general purpose servers often cost more to purchase and operate than other alternatives and
therefore represent a poor long-term value when used principally as storage devices.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Storage Area Networks.    A storage area network, or SAN, is a self-contained fiber-optic network of high-speed storage devices.
While SANs may be the preferred storage solution in very large computing environments with particular data access characteristics, they also have a number of disadvantages. SAN installations require the implementation and maintenance of a completely
separate Fibre Channel
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | network, are consequently very expensive and difficult to maintain, and frequently suffer from compatibility problems between constituent components from differing manufacturers.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Network Attached Storage.    NAS appliances have been developed to offload basic file I/O tasks from general purpose servers. NAS
appliances are designed to store and retrieve larger amounts of data more quickly than general purpose servers. Freed of all hardware and operating system elements unrelated to file I/O tasks, NAS appliances provide greater file throughput, usually
for less cost. Unlike SAN devices, NAS appliances can be easily connected to an existing computer network, with additional capacity added over time as storage needs grow. NAS appliances can also complement a SAN deployment. These characteristics
make NAS appliances a scalable, versatile and cost-effective data storage solution.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The
advantages of NAS have been acknowledged in the marketplace. Because storage appliances are designed to perform specific dedicated functions, NAS appliances are ideal for companies seeking a storage solution that:





| |  |  | provides heterogeneous (UNIX & Windows) file sharing;
| | - |  | -----------------------------------------------------




| |  |  | is easy to install, use and administer;
| | - |  | ---------------------------------------




| |  |  | is easy to integrate with existing infrastructure components;
| | - |  | -------------------------------------------------------------




| |  |  | provides a return on investment through server consolidation;
| | - |  | -------------------------------------------------------------




| |  |  | has a low acquisition price and low total cost of ownership; and
| | - |  | ----------------------------------------------------------------




| |  |  | provides high speed data access, high capacity and scalability.
| | - |  | ---------------------------------------------------------------




Specific Challenges in Data Management





In general,
enterprises using networked computing environments face challenges in managing rapidly growing volumes of distributed data. These challenges include:





| |  |  | Back up of Data.    Protecting mission-critical data via tape backup is, almost without exception, a universal problem facing
todays businesses. With exponential data growth and shrinking backup windows, backup technologies must provide data protection without impacting business operations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Poor Data Access Performance.    Data access performance across networks has historically been improved by increasing processor
performance or by increasing network bandwidth. However, this approach has its limits. The remaining bottleneck in data access performance is caused by the file servers operating system, which must also perform many additional tasks unrelated
to data access. These unrelated tasks slow the servers ability to respond to file I/O requests.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Difficulties Accessing Shared Data.    Organizations require solutions that provide access to shared data. These organizations often
install applications that run on differing and incompatible computing operating systems. However, many of these operating systems are incapable of accessing or sharing data created or stored on other systems without the assistance of additional
software.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Unavailable Data.    Unavailable data can result in costly business interruptions. Data availability is critical to worker
productivity, making it imperative that network data storage devices have low failure rates, rapid recovery times and the ability to provide uninterrupted data service. Data unavailability can be caused by hardware and/or software failure.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Data Administration.    Network data administration, including the backup and expansion of data storage capacity, requires the
management of both hardware and software systems. This becomes more complex with large volumes of data, increasing numbers of users accessing data and wide distribution of data stored across the network. Storage devices that cannot be managed
remotely place an added burden on technical personnel and resources.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Scalability.    Given the continuing increase in data storage needs, effective storage solutions will provide a simple and economical
means to increase capacity over time. Preferred solutions allow enterprises to modify their existing infrastructure and incur only incremental costs as they grow rather than to make extensive and expensive modifications to their computing networks.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | High Total Cost of Ownership.    The total cost of ownership for a storage solution includes not only the initial system purchase
price, but also the costs associated with ongoing maintenance and support. Systems that require frequent service can have total ownership costs significantly greater than their initial purchase price.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




The Procom Solution





Our NAS appliances are well suited to address the growth in data storage as well as the specific challenges of data management. A key element of our solution is our proprietary operating system software, which we integrate with
high-performance, industry-standard hardware components to provide our customers with the following benefits:





| |  |  | Fast Backup and Recovery of Data.    Our appliances enable NAS-optimized backup and recovery of data with simplified management via
compliance with industry-standard NDMP (Network Data Management Protocol). With Fibre-Channel, LAN or direct-attached tape library connectivity, flexible architectures allow the correct solution to be implemented.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Fast File Service Response Times.    Our NAS appliances are designed to achieve rapid I/O response times. We have developed
proprietary operating system software optimized for data access and storage. This software enables our NAS appliances to execute user read and write requests significantly faster than general purpose computers used as file servers.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Cross-Platform Compatibility.    Our NAS appliances provide native support and enable simultaneous shared file services for
environments using UNIX, including Linux, and Windows NT operating systems. As a result, users can share data across multiple operating systems, eliminating the need to duplicate data or have separate storage devices for each computing environment.
This functionality allows organizations to consolidate their data storage onto fewer devices, providing performance efficiencies and lower total cost of ownership.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | High Levels of Data Availability and Product Reliability.    Our appliances are designed to provide high levels of data availability
with minimal incremental cost. Data journaling and hardware redundancies help ensure the protection and availability of data in the event of hardware component failure. Moving basic storage functions from a server to a NAS appliance improves the
servers reliability and its ability to process non-storage functions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Ease of Installation, Administration and Maintenance.    Our appliances are easier to install and operate than both general purpose
computers and NAS appliances from other vendors. Our NAS appliances are specifically designed to be installed easily and quickly, some in just minutes. Moreover, our appliances management software is accessible via a Web browser, making remote
initiation of diagnosis and management utilities possible. In general, our appliances simplify system administration and permit more efficient use of technical personnel.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Scalable Solution.    Our appliances are designed so that storage capacity can grow on an incremental and cost-effective basis while
maintaining high throughput levels. A system administrator can incrementally increase storage capacity by adding disk drives to an existing appliance, or by adding additional NAS appliances to the existing network infrastructure without an
interruption in access to stored data. Adding one of our NAS appliances to a network takes less time than adding a general purpose file server. This capability allows customers to expand their storage capacity incrementally without significant
changes to their network infrastructure.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | File and Block access to data.    Through our available DUET option, our NetFORCE 3000 series of products can be configured to
deliver both file and block level access to data. This capability positions
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | Procom to uniquely deliver targeted solutions to those applications that require block level access to data, including Microsoft Exchange and SQL Server.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Low Total Cost of Ownership.    We reduce the initial cost of ownership by taking advantage of the price and performance of
commercial off-the-shelf hardware components. Our products are easy to install, which also helps to reduce the initial cost of ownership. We reduce the ongoing cost of ownership by providing products with exceptional reliability and low maintenance
costs.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Products





We were formed in 1987 to develop and market storage-related computer products. In 1996, we began developing CD/DVD-ROM based, read only NAS storage devices, and in 1999, we began the development of
disk-based, read and write NAS storage appliances.





We currently offer two broad categories of products: NAS
appliances and other data storage products. During fiscal 2002, sales of NAS and related technologies represented the majority of our overall business. Our NAS appliances represented 27.6%, 67.8% and 79.5% of our net sales in fiscal 2000, 2001 and
2002, respectively. Domestic non-OEM NetFORCE sales doubled in fiscal 2002 as compared to fiscal 2001.





Network Attached Storage
Products





NetFORCE.    Our NetFORCE appliances are disk-based, read and write NAS
storage appliances with optimized software providing faster I/O performance than stand-alone file servers and direct attached storage products. The NetFORCE product line ranges from an entry level, plug and play, 1/2 terabyte (TB) capacity storage
device designed for remote offices and small-sized computer workgroups to our highest performance, fault tolerant network data server that provides up to 17 terabytes of storage capacity. The list prices for our NetFORCE product line range from
approximately $14,000 to over $500,000, depending primarily on the model purchased and the product configuration specified by the customer. The table below describes the key features and target markets for each of these appliances.





DataFORCE.    Our DataFORCE appliances are CD/DVD-ROM-based, read only NAS storage devices. The
product line consists of devices that provide a high-speed economical number of DVD drives. In 1999, DataFORCE was awarded Editors Choice Award by Network Computing magazine and Product of the Year by Imaging and
Documents Solutions magazine. The table below also describes the key features and target markets for each of these products we currently offer.





Product

Key Features

Target MarketsNetFORCE 3500/3600C

      High performance, high availability filers, with Fibre Channel
backend.        3600C features active-active cluster failover
capability, with no single point of failure        Files
accessed and shared by both Windows and UNIX-based systems        Snap shot, NDMP and dynamic expansion capabilities        Web-based remote device management        Fully supports Microsoft ADS and domain architecture and ACLs        Capacity of 100GB to 17TB

Businesses requiring the highest level of data availability and integrity, including storage intensive enterprises using Windows NT, UNIX and Linux-based
systems.




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Product

Key Features

Target MarketsNetFORCE 1750

      High performance, high capacity mid-range filer        Excellent price/performance        Complete feature set, including snap shots, NDMP support, ADS,
ACLs        Simple, 15 minute plug and play installation
Capacity of 100GB to 4TB

Workgroups using Windows NT, UNIX and Linux-based systems, especially mid-sized e-businesses and engineering intensive environments.NetFORCE 800

      Mid-size storage product for the small & mid-size business markets
seeking excellent features normally found in much more costly solutions.        Capacity of 100GB to 1.28TB

Workgroups or regional offices using Windows NT, UNIX and Linux-based systems.DUET

      Integrates NAS and SAN functionality in a pre-tested, pre-configured
software solution        File and Block access to
data        Successfully completed Microsoft HCL
testing        Integrated management, monitoring and failover
capabilities        Fully supports Microsoft Cluster
Servers

Installations requiring both file and block access to data. This includes Microsoft Exchange and SQL Server.ProMirror

      Highly reliable, Safe-Asynchronous Mirroring(SAM) architecture
software        Highly cost effective, using existing IP
infrastructure        Near real-time reflection of data
between source and target servers        Continuous
bi-directional or many-to-one replication of data, with fast reversion from source to target in case of primary site failure

Businesses requiring uninterrupted flow of data. As an integrated part of a disaster recovery solution. ProMirror delivers highly advanced capabilities very
cost effectively.      Software features are available on all NetFORCE filers.
       Web-based, easy to use management toolsDataFORCE 1000R Rack-mountable

      DVD or CD-ROM capability        Web-based remote device management and modular fault tolerant
design        Supports Windows NT, UNIX, Novell and Macintosh
environments

Organizations that use document imaging and firms with extensive data access needs, including libraries, law firms, accounting firms, educational and other
institutions.




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Product

Key Features

Target MarketsDataFORCE 200/300

      DVD or CD-ROM capability with web-based remote device
management        Easy to install        Supports Windows NT, UNIX, Novell and Macintosh environments


Organizations that use document imaging technologies. Also, libraries, law firms, accounting firms, educational and other institutions.





We are currently in the process of developing our next generation
NetFORCE appliances. These new appliances are expected to provide even greater performance and capacity at the high end, and deliver even greater value and capabilities at the low end of our product spectrum. We continue to invest in research and
development to deliver solutions that are easily integrated within our customers information technology infrastructure.





Other
Data Storage Products





We also develop and market a number of other data storage products, including disk
drive upgrades, standalone and networked CD/DVD-ROM servers and arrays, as well as market tape backup products. Our disk drive upgrades allow users to increase the storage capacity of their laptop and desktop computers, extending the life of their
initial hardware investment. Our CD/DVD-ROM servers and arrays allow users to access software and data stored on these media.





Together, these products constituted 20.5% of our total net sales in fiscal 2002, 32.2% in fiscal 2001, and 72.4% in fiscal 2000.





Technology





Our NAS operating system and the associated software and hardware components
are designed to achieve the following objectives:





| |  |  | provide high-speed access to data by optimizing network, computer processor and hard drive features and interfaces
| | - |  | ------------------------------------------------------------------------------------------------------------------




| |  |  | allow files created in both UNIX and Windows environments to be shared simultaneously while protecting the integrity of the underlying data
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | support the native security features of both UNIX and Windows
| | - |  | -------------------------------------------------------------




| |  |  | support remote management and monitoring of the NAS device via Web-based software
| | - |  | ---------------------------------------------------------------------------------




| |  |  | enable ease of installation by the user
| | - |  | ---------------------------------------




| |  |  | support the backup and restore functionality of commonly used storage management software applications
| | - |  | ------------------------------------------------------------------------------------------------------




| |  |  | provide both file and block level access to data through DUET
| | - |  | -------------------------------------------------------------




| |  |  | provide business continuance capabilities through ProMirror
| | - |  | -----------------------------------------------------------




Our core technical competence is in the development of storage systems. A key element of our design philosophy is the leveraging of this expertise by rapidly integrating
our software with industry-standard, best-of-breed hardware from third party vendors. This approach allows us to benefit from both the technological advances of numerous competing hardware vendors and the ongoing price erosion in some hardware
sectors. Moreover, this philosophy reduces our dependence on any one supplier. We intend to improve the performance of our storage systems, incorporate advances in disk drive and computer processor hardware, and support some complementary storage
technologies and software applications.




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Customers





The customers that use our NAS appliances and our other data storage products represent a broad array of enterprises within diverse industry and government sectors, including e-businesses, financial
services, communications, healthcare and governmental agencies. Generally, NAS customers are organizations that require highly reliable, readily accessible, and easily managed storage. These organizations rely on data-intensive applications, such as
Web servers, search engines, imaging, data warehousing and data mining, multimedia, engineering, digital video production, and ERP. No one customer accounted for more than 10% of our net sales for fiscal 2002.





Sales and Marketing





Our NAS appliances and other data storage products are currently marketed and sold domestically and internationally primarily through distributors, VARs system integrators, and our own sales force under the Procom brand.





Sales





We use a variety of selling channels, which are selected based on the needs and characteristics of our markets and products. For example, we sell our entry-level NAS and non-NAS products principally
through VARs and distributors. We sell our high-end NAS appliances through VARs and system integrators supported by our own field sales force. We believe this hybrid approach is the most efficient and cost-effective strategy for distributing these
high-end appliances, which often require custom configuration and typically involve significant customer contact and a longer sales cycle.





Field Sales.    Our field sales force consists of domestic and international sales professionals and technical sales support specialists based in the U.S. and abroad. Our field sales force focuses
on generating and supporting sales opportunities with our channel partners, which enables cooperation between our channel partners and our field sales force.





Indirect Sales.    Our indirect channel partners consist of system integrators, VARs and distributors. Our indirect channel partners market, sell, implement and support our
products. We intend to enhance our existing relationships with these partners and develop relationships with additional indirect channel partnersespecially those that we expect to enhance our ability to penetrate target markets.





Marketing





Our marketing organization consists of product management and marketing communications groups. Product management is responsible for product direction, market opportunity identification and strategic positioning, as well as
industry research and education. Our marketing activities also include development of relationships with indirect channel partners, participation in tradeshows to promote and launch our products and coordination of our involvement in various
industry standards organizations. Procom is a voting member of the Storage Networking Industry Association (SNIA).





Our marketing communications group is responsible for increasing awareness of our company and our products. These efforts include brand promotion, public relations, advertising, industry trade show participation, speaking
engagements, seminars, direct mail and Web site content development. Our marketing communications professionals also produce data sheets, presentations, and coordinate with product management for product demonstrations.




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Customer Service and Support





We are committed to providing our customers with timely and effective service and support. Our engineers and technicians work closely with our sales personnel to provide
system integrators, VARs and distributors with pre- and post-sales support, technical support, education, training and consulting services. We provide these services by telephone and facsimile, as well as through online bulletin board services and
Web sites. In addition, we have contracted with IBM Global Services to assist with field service support. Finally, we also collaborate with our system integrators, VARs, and distributors to provide technical support and service.





Research and Development





We believe that a substantial commitment to research and development is essential to our ability to introduce new and enhanced products that address emerging market opportunities. Before we develop a new product, our
research and development engineers work with marketing managers and customers to develop specifications for product requirements. Our engineers then design the new product around those specifications. Beta Programafter we commercially release
a new product, our engineers continue to work with customers to refine the specifications for future generations and upgrades of our products.





In order to respond to the short product life cycle inherent in the industry, our research and development team monitors industry trends to aid in selecting new technologies and features for potential
development and incorporation into our appliances. We have devoted substantial resources to the development of our proprietary operating system software.





Our total expenses for research and development were $7.2 million in fiscal 2000, $6.4 million in fiscal 2001 and $6.4 million in fiscal 2002. We anticipate that the dollar amount of our research and
development expenses in the next fiscal year will decline compared to fiscal 2002.





Manufacturing and Assembly





We conduct our primary manufacturing and assembly activities at our headquarters in Irvine, California. These activities
consist of testing, assembly and component integration. We have historically operated without a significant backlog and generally purchase the major components of our products based on historical requirements and forecast needs. Some of our products
require printed circuit boards, special metal or plastic housings, software, manuals, additional hardware components and certain custom components manufactured to our specifications. We subcontract with third-party vendors for the manufacture of
these items. Our strategy has been to develop cooperative relationships with our most important suppliers, which involves exchanging critical information and implementing joint quality training programs. This strategy helps to minimize supply
disruptions and maintain component quality. We test and evaluate the components used in our products. In addition, we perform quality assurance testing on our completed products. We believe we have sufficient manufacturing capacity to meet
foreseeable production needs. In December 1999 we were awarded ISO 9001 certification.





Competition





The market for NAS appliances is rapidly evolving and highly competitive. We believe we compete with the following companies:





| |  |  | other NAS companies, such as Network Appliance, EMC and Auspex
| | - |  | --------------------------------------------------------------




| |  |  | companies which provide entry level NAS filers
| | - |  | ----------------------------------------------




| |  |  | computer manufacturers who also provide NAS solutions based on the Microsoft SAK (Server Appliance Kit) and other data storage products, such as HP, IBM, Compaq
and Dell
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Our overall success depends to a great extent on our ability to continue to
develop appliances that incorporate new and rapidly evolving technologies to provide users with cost-effective data storage and information access solutions. In our NAS business, we compete principally on the basis of:





| |  |  | product features and performance
| | - |  | --------------------------------




| |  |  | ease of installation, administration and maintenance
| | - |  | ----------------------------------------------------




| |  |  | cross-platform compatibility and scalability
| | - |  | --------------------------------------------




| |  |  | total cost of ownership
| | - |  | -----------------------




| |  |  | time to market with new features and appliances
| | - |  | -----------------------------------------------




| |  |  | technical support and customer service
| | - |  | --------------------------------------




We believe that we are competitive in each of these areas. Additionally, we believe that our accumulated expertise in developing operating system software differentiates our NAS appliances from those
of our competitors and poses a barrier to entry for current and potential competitors. We believe the price and performance characteristics of our NAS appliances provide us with a competitive advantage.





The market for our other data storage appliances is mature and intensely competitive. Within our non-NAS product businesses, we believe we
compete with the following companies in the following categories:





| |  |  | computer manufacturers which provide storage upgrades for their appliances, such as IBM, Compaq and Dell; and
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | hard drive, CD server/array and tape backup manufacturers, such as Seagate, Western Digital, Maxtor and Quantum.
| | - |  | ----------------------------------------------------------------------------------------------------------------




We believe we compete effectively with these competitors by offering a broad range of reasonably priced appliances, by maintaining
relationships with computer resellers and VARs that possess key relationships with decision makers at end users, and at the same time developing brand name identity through marketing and advertisements.





Intellectual Property





Our success and ability to compete is dependent on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing on the proprietary rights of others. We rely primarily on a combination
of copyright and trade secret protections and confidentiality agreements to establish and protect our intellectual property rights. We seek to protect our software, documentation and other written materials under trade secret, copyright and patent
laws, which afford only limited protection. We have registered our Procom name and logo. We will continue to evaluate the registration of additional trademarks as appropriate. We generally enter into confidentiality agreements with our
employees, resellers and customers. We have exclusive rights to our domain name, www.procom.com.





Employees





As of July 31, 2002, we had 135 full-time employees. Of the total, 67 are in sales, marketing, customer
service and technical support, 21 in manufacturing, 33 in engineering and product development and 14 in finance and administration. We have 116 domestic employees and 19 international employees. None of our employees is represented by any collective
bargaining agreement. We have never experienced a work stoppage and consider relations with our employees to be good.




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RISK FACTORS





The following risk factors and other information included in this Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following risks actually occurs, our business, operating results, and financial condition
could be materially adversely affected.





WE MAY NOT BE ABLE TO ACHIEVE OR SUSTAIN PROFITABILITY, AND OUR FAILURE TO DO SO WILL
REQUIRE US TO SEEK ADDITIONAL FINANCING, WHICH MAY NOT BE AVAILABLE TO US ON FAVORABLE OR ANY TERMS.





In
recent periods, we have experienced significant declines in net sales and gross profit, and we have incurred operating losses. We incurred operating losses of $12.1 million in fiscal 2000, $16.6 million in fiscal 2001 (including a charge for
in-process research and development) and $28.6 million for fiscal 2002 (including a charge of $2.4 million for asset impairment). In fiscal 2002, net cash used in operating activities was $13.3 million. We will need to increase our revenues
from our NAS products to achieve profitability. The revenue and profit potential of these products is unproven. We may not be able to generate significant or any revenues from our NAS products or achieve profitability in the future. If we are unable
to achieve profitability, we will have to seek additional financing, which may not be available to us on favorable or any terms.





INFORMATION TECHNOLOGY SPENDING ON DATA STORAGE AND OTHER CAPITAL EQUIPMENT HAS DECLINED. IF TECHNOLOGY SPENDING CONTINUES TO DECLINE, OUR SALES AND OPERATING RESULTS COULD BE HARMED.





Many companies have announced that they will reduce their spending on data storage and other capital equipment. If spending on data
storage technology products is reduced further by customers and potential customers, our sales could be harmed, and we may experience greater pressures on our gross margins. If economic conditions do not improve, or if our customers continue to
reduce their overall information technology purchases, our sales, gross profits and operating results likely would be reduced.





IF WE
FAIL TO INCREASE THE NUMBER OF INDIRECT SALES CHANNELS FOR OUR NAS PRODUCTS, OUR ABILITY TO INCREASE NET SALES MAY BE LIMITED.





In order to grow our business, we will need to increase market awareness and sales of our NAS products. To achieve these objectives, we plan to expand revenues from our indirect sales channels, including resellers and
systems integrators. To do this, we will need to modify and expand our existing relationships with these indirect channel partners, as well as enter into new indirect sales channel relationships. We may not be successful in accomplishing these
objectives. If we are unable to expand our direct or indirect sales channels, our ability to increase revenues may be limited.





IF
GROWTH IN THE NAS MARKET DOES NOT MEET OUR EXPECTATIONS, OUR FUTURE FINANCIAL PERFORMANCE COULD SUFFER.





We
believe our future financial performance will depend in large part upon the future growth in the NAS market and on emerging standards in this market. We intend for NAS products to be our primary business. The market for NAS products, however, may
not continue to grow. Long-term trends in storage technology remain unclear. For example, some analysts have questioned whether competing technologies, such as storage area networks, may emerge as the preferred storage solution. If the NAS market
grows more slowly than anticipated, or if NAS products based on emerging standards other than those adopted by us become increasingly accepted by the market, our operating results could be harmed.




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THE REVENUE AND PROFIT POTENTIAL OF NAS PRODUCTS IS UNPROVEN, AND WE MAY BE UNABLE TO ATTAIN REVENUE
GROWTH OR PROFITABILITY FOR OUR NAS PRODUCT LINES.





NAS technology is relatively recent, and our ability to be
successful in the NAS market may be negatively affected by not only a lack of growth in the NAS market but also a lack of market acceptance of our NAS products. Sales of our NAS products declined from $28.4 million in fiscal 2001 to $19.9 million in
fiscal 2002.





IF OUR CUSTOMERS CREDITWORTHINESS DETERIORATES, OR OUR RATE OF PRODUCT RETURNS INCREASES, WE MAY INCUR ADDITIONAL
BAD DEBT EXPENSE OR WE MAY EXPERIENCE REDUCED REVENUES.





At July 31, 2002, our net accounts receivable totaled
$4.8 million, which is net of allowances for doubtful accounts and sales returns of $6.1 million and $2.0 million, respectively. Although management believes that accounts receivable without an allowance are collectible, if the financial condition
of our customers were to deteriorate, it could result in an impairment of their ability to make payment. We may be required to record additional valuation allowances, which would adversely affect our operating results.





Net sales for fiscal 2002 and 2001 were $25.0 million and $41.9 million, respectively. We recognize revenue on NAS products, sold through
direct sales channels and resellers generally upon shipment of the product. In addition, we sell service contracts for certain of our appliances that usually cover one to three years. Revenue from these contracts is billed to customers at the time
of sale, but earned ratably over the life of the service agreement. Revenue is recognized on sales of our non-NAS products, which are sold primarily through distributors, when the distributor receives the product. We maintain sales reserves for
estimated reductions to revenue for anticipated returns, including stock balancing and price protection claims, based on historical rates of sales returns. If we were to experience a significant increase in product sales returns, incremental
allowances for product returns would be required. To the extent management cannot make reliable estimates of future product returns, revenue will be deferred until it is actually realized, and our revenue would be impacted negatively.





OUR STOCK MAY BE DE-LISTED FROM NASDAQ





On July 22, 2002, we received a notice from NASDAQ stating that we did not, for a period of 30 consecutive days, meet the $1 minimum bid price per share requirement for continued listing on the NASDAQ
National Market. The notice further stated that we had until October 21, 2002 to comply with the minimum bid price per share requirement for continued listing. We did not achieve compliance with this requirement. However, on October 18, 2002, we
applied to transfer the listing of our stock to the NASDAQ Small Cap Market. If this transfer is approved, we will be eligible for an additional 90 days, or until January 18, 2003, to demonstrate compliance with the $1 minimum bid price for a period
of 10 consecutive trading days. We would expect our stock to retain the trading symbol PRCM on the Small Cap Market.





We are also currently out of compliance with NASDAQs requirement that we have at least three independent directors on our Board of Directors. Effective September 16, 2002, Kevin Michaels, an independent director on our Board,
resigned, leaving us with two independent directors. We have requested a grace period from NASDAQ to regain compliance with this requirement and are awaiting a response. In the meantime, we are seeking a new independent director to replace Mr.
Michaels.





There can be no assurance that NASDAQ will grant our request to transfer the listing of our stock to
the Small Cap Market or our request for a grace period to regain compliance with the independent director requirement. There also can be no assurance that we will be able to identify and appoint an additional independent director to the Board. If we
have not met the minimum bid price requirement at the expiration of all grace periods, or if we otherwise fail to satisfy the applicable NASDAQ listing requirements, our stock could be delisted from the NASDAQ market. Any such delisting would have a
material adverse effect on our stock and would severely restrict our ability to raise additional capital.




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WE MAY ISSUE ADDITIONAL SHARES, WHICH WOULD REDUCE YOUR OWNERSHIP PERCENTAGE AND DILUTE THE VALUE OF
YOUR SHARES.





Events over which you have no control could result in the issuance of additional shares of our
common stock, which would dilute your ownership percentage. In the future, we may issue additional shares of common stock or preferred stock to raise additional capital or finance acquisitions, upon the exercise or conversion of outstanding options,
warrants and shares of convertible preferred stock, or in lieu of cash payment of dividends. Our issuance of additional shares would dilute your shares.





COMPETING DATA STORAGE TECHNOLOGIES MAY EMERGE AS A STANDARD FOR DATA STORAGE SOLUTIONS, WHICH COULD CAUSE GROWTH IN THE NAS MARKET NOT TO MEET OUR EXPECTATIONS AND CAUSE OUR FINANCIAL PERFORMANCE TO SUFFER.





The market for data storage is rapidly evolving. There are other storage technologies in use, including storage area network
technology, which provide an alternative to network attached storage. We are not able to predict how the data storage market will evolve. For example, it is not clear whether usage of a number of different solutions will grow and co-exist in the
marketplace or whether one or a small number of solutions will be dominant and displace the others. It is also not clear whether network attached storage technology will emerge as a dominant or even prevalent solution. Whether NAS becomes an
accepted standard will be due to factors outside our control. If a solution other than network attached storage emerges as the standard in the data storage market, growth in the network attached storage market may not meet our expectations. In such
event, our financial performance would suffer.





IF WE ARE UNABLE TO ATTRACT QUALIFIED PERSONNEL OR RETAIN OUR EXECUTIVE OFFICERS AND
OTHER KEY PERSONNEL, WE MAY NOT BE ABLE TO COMPETE SUCCESSFULLY.





Our continued success depends, in part, on
our ability to identify, attract, motivate and retain qualified technical and sales personnel. Competition for qualified engineers and sales personnel, particularly in Orange County, California, is intense, and we may not be able to compete
effectively to retain and attract qualified, experienced employees. Should we lose the services of a significant number of our engineers or sales people, we may not be able to compete successfully in our targeted markets and our business would be
harmed.





We believe that our success will depend on the continued services of our executive officers and other key
employees. The loss of any of these key executive officers or other key employees could harm our business.





THE RECENT TERRORIST
ATTACKS APPEAR TO BE HAVING AN ADVERSE EFFECT ON OUR BUSINESS.





The terrorist attacks in New York and
Washington, D.C. on September 11, 2001 appear to be having an adverse effect on business, financial and general economic conditions. These effects, in turn, appear to be having an adverse effect on our business and results of operations. At this
time, however, we are not able to predict the nature, extent and duration of these effects on overall economic conditions or on our business and operating results.





IF WE ARE UNABLE TO MANAGE OUR INTERNATIONAL OPERATIONS EFFECTIVELY, OUR OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.





Net sales to our international customers, including export sales from the United States, accounted for approximately 41%, 56% and 38% of our net sales for the years ended
July 31, 2000, 2001 and 2002, respectively, and approximately $9.5 million of our net sales in fiscal 2002. We have committed significant




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resources to our international operations. Our international operations will expose us to operational challenges that we would not otherwise face if we conducted our operations only in the United
States. These include:





| |  |  | currency exchange rate fluctuations, particularly when we sell our products in currencies other than U.S. dollars;
| | - |  | ------------------------------------------------------------------------------------------------------------------




| |  |  | difficulties in collecting accounts receivable and longer accounts receivable payment cycles;
| | - |  | ---------------------------------------------------------------------------------------------




| |  |  | reduced protection for intellectual property rights in some countries, particularly in Asia;
| | - |  | --------------------------------------------------------------------------------------------




| |  |  | legal uncertainties regarding tariffs, export controls and other trade barriers;
| | - |  | --------------------------------------------------------------------------------




| |  |  | the burdens of complying with a wide variety of foreign laws and regulations; and
| | - |  | ---------------------------------------------------------------------------------




| |  |  | seasonal fluctuations in purchasing patterns in other countries, particularly in Europe.
| | - |  | ----------------------------------------------------------------------------------------




Any of these factors could have an adverse impact on our existing international operations and business or impair our ability to continue
expanding into international markets. For example, our reported sales can be affected by changes in the currency rates in effect during any particular period. The effects of currency fluctuations were evident in our results of operations for the
fiscal year 2001 and fiscal 2002. During these periods, the Euro and two currencies whose values are pegged to the Euro, fluctuated significantly against the U.S. dollar. As a result, we incurred foreign currency transaction losses of approximately
$54,000 in fiscal 2001 and foreign currency transaction gains of $85,000 in fiscal 2002. Also, these currency fluctuations can cause us to report higher or lower sales by virtue of the translation of the subsidiarys sales into U.S. dollars at
an average rate in effect throughout the fiscal year. In addition, we have funded operating losses of our subsidiaries of approximately $5.9 million between the date of purchase and July 31, 2002, and if our subsidiaries continue to incur operating
losses, our cash and liquidity would be negatively impacted.





In order to increase our international sales, we
must recruit additional international distributors and resellers, and we may reduce our reliance on the existing operations of our subsidiaries in Europe. These actions will require significant management attention and financial resources. Our
foreign subsidiaries in Europe have incurred significant operating losses. To the extent that we are unable to address these concerns in a timely manner, our ability to increase or even maintain international sales may be limited, and our operating
results could be materially adversely affected.





BECAUSE WE DO NOT HAVE EXCLUSIVE RELATIONSHIPS WITH OUR DISTRIBUTORS FOR OUR NON-NAS
PRODUCTS, THESE CUSTOMERS MAY GIVE HIGHER PRIORITY TO PRODUCTS OF COMPETITORS.





Our distributors generally
offer products of several different companies, including products of our competitors. Accordingly, these distributors may give higher priority to products of our competitors, which could harm our operating results. In addition, our distributors
often demand additional significant selling concessions and inventory rights, such as limited return rights and price protection. We cannot assure you that sales to our distributors will continue, or that these sales will be profitable.





MARKETS FOR BOTH OUR NAS APPLIANCES AND OUR NON-NAS PRODUCTS ARE INTENSELY COMPETITIVE, AND IF WE ARE UNABLE TO COMPETE EFFECTIVELY,
WE MAY LOSE MARKET SHARE OR BE REQUIRED TO REDUCE PRICES.





The markets in which we operate are intensely
competitive and characterized by rapidly changing technology. Increased competition could result in price reductions, reduced gross margins or loss of market share, any of which could harm our operating results. We compete with other NAS companies,
direct-selling storage providers and smaller vendors that provide storage solutions to end-users. In our non-NAS markets, we compete with computer manufacturers that provide storage upgrades for their own products, as well as with manufacturers of
hard drives, CD servers and arrays and storage upgrade products. Many of our current and




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potential competitors have longer operating histories, greater name recognition, larger customer bases and greater financial, technical, marketing and other resources than we do. As a result,
they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, devote greater resources to the development, promotion, sale and support of their products, and reduce prices to increase market share. 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. We may not be able to compete successfully against current or future competitors. In addition, new technologies may increase competitive pressures.





WE DEPEND ON A FEW CUSTOMERS, INCLUDING DISTRIBUTORS AND SPECIALIZED END-USERS, FOR A SUBSTANTIAL PORTION OF OUR NET SALES, AND CHANGES IN THE TIMING AND SIZE OF THESE CUSTOMERS ORDERS MAY
CAUSE OUR OPERATING RESULTS TO FLUCTUATE.





For fiscal 2002, no single customer accounted for more than 10% of
our net sales. In previous fiscal years, however, we have relied on single customers who accounted for more than 10% of our net sales. In fiscal 2001, one customer, Storway, a European storage service provider, accounted for 12% of our net sales. In
fiscal 2000, one customer accounted for approximately 7% of our net sales. In addition, three customers accounted for approximately 34% and 54% of our total net accounts receivable at July 31, 2002 and July 31, 2001, respectively. As we diversify
and expand our customer base for NAS products, our future success will depend to a large extent on the timing, size and gross margins of future purchase orders, if any, from significant customers. We may receive from single site purchasers of large
installations of our NAS products large volume purchases of our NAS products over relatively short periods of time. This may cause our sales to be highly concentrated and significantly dependent on one or only a few customers. If we lose a major
customer, or if one of our customers significantly reduces its purchasing volume or experiences financial difficulties and is unable to or does not pay amounts owed to us, our results of operations would be adversely affected. In fiscal 2002 and
2001, we sold our non-NAS products principally to distributors. We cannot be certain that customers that have accounted for significant revenues in past periods will continue to purchase our products or fully pay for products they purchase in future
periods.





OUR GROSS MARGINS OF OUR VARIOUS PRODUCT LINES HAVE FLUCTUATED SIGNIFICANTLY IN THE PAST AND MAY CONTINUE TO FLUCTUATE
SIGNIFICANTLY.





Historically, our gross margins have fluctuated significantly. Our gross margins vary
significantly by product line and distribution channel, and, therefore, our overall gross margin varies with the mix of products we sell. Our markets are characterized by intense competition and declining average unit selling prices over the course
of the relatively short life cycles of individual products. For example, we derive a significant portion of our sales from NAS products. The market for these products is highly competitive and subject to intense pricing pressures. If we fail to
increase sales of our NAS appliances, or if demand, sales or gross margins for our non-NAS products decline rapidly, we believe our overall gross margins may decline.





Our gross margins have been and may continue to be affected by a variety of other factors, including:





| |  |  | new product introductions and enhancements;
| | - |  | -------------------------------------------




| |  |  | competition;
| | - |  | ------------




| |  |  | changes in the distribution channels we use;
| | - |  | --------------------------------------------




| |  |  | the mix and average selling prices of products; and
| | - |  | ---------------------------------------------------




| |  |  | the cost and availability of components and manufacturing labor.
| | - |  | ----------------------------------------------------------------




IF WE ARE UNABLE TO TIMELY INTRODUCE COST-EFFECTIVE HARDWARE OR SOFTWARE SOLUTIONS FOR NAS ENVIRONMENTS, OR IF OUR PRODUCTS FAIL TO KEEP PACE WITH TECHNOLOGICAL CHANGES IN THE MARKETS WE SERVE, OUR
OPERATING RESULTS COULD BE MATERIALLY ADVERSELY AFFECTED.





Our future growth will depend in large part upon
our ability to successfully develop and introduce new hardware and software for the NAS market. Due to the complexity of products such as ours, we face significant




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challenges in developing and introducing new products. The development of new products requires significant research and development expense and effort. We may not have the financial resources to
fund the research and development efforts necessary to develop new NAS products, and we may be unable to introduce new products on a timely basis or at all. If we are unable to introduce new products in a timely manner, our operating results could
be harmed.





Even if we are successful in introducing new products, we may be unable to keep pace with
technological changes in our markets and our products may not gain any meaningful market acceptance. The markets we serve are characterized by rapid technological change, evolving industry standards, and frequent new product introductions and
enhancements that could render our products less competitive or even obsolete. As a result, our position in these markets could erode rapidly due to changes in features and functions of competing products or price reductions by our competitors. In
order to avoid product obsolescence, we will have to keep pace with rapid technological developments and emerging industry standards. We may not have the financial resources to do so or otherwise be successful in doing so, and if we fail in this
regard, our operating results could be harmed.





WE RELY UPON A LIMITED NUMBER OF SUPPLIERS FOR SEVERAL KEY COMPONENTS USED IN OUR
PRODUCTS, INCLUDING DISK DRIVES, COMPUTER BOARDS, POWER SUPPLIES, MICROPROCESSORS AND OTHER COMPONENTS, AND ANY DISRUPTION OR TERMINATION OF THESE SUPPLY ARRANGEMENTS COULD DELAY SHIPMENT OF OUR PRODUCTS AND HARM OUR OPERATING RESULTS.





We rely upon a limited number of suppliers for several key components used in our products, including disk
drives, computer boards, power supplies and microprocessors. In the past, we have experienced periodic shortages, selective supply allocations and increased prices for these and other components. We may experience similar supply issues in the
future. Even if we are able to obtain component supplies, the quality of these components may not meet our requirements. For example, in order to meet our product performance requirements, we must obtain disk drives of extremely high quality and
capacity. Even a small deviation from our requirements could render any of the disk drives we receive unusable by us. In the event of a reduction or interruption in the supply or a degradation in quality of any of our components, we may not be able
to complete the assembly of our products on a timely basis or at all, which could force us to delay or reduce shipments of our products. If we were forced to delay or reduce product shipments, our operating results could be harmed. In addition,
product shipment delays could adversely affect our relationships with our channel partners and current or future end-users.





UNDETECTED DEFECTS OR ERRORS FOUND IN OUR PRODUCTS, OR THE FAILURE OF OUR PRODUCTS TO PROPERLY INTERFACE WITH THE PRODUCTS OF OTHER VENDORS, MAY RESULT IN DELAYS, INCREASED COSTS OR FAILURE TO ACHIEVE MARKET ACCEPTANCE, WHICH
COULD MATERIALLY ADVERSELY AFFECT OUR OPERATING RESULTS.





Complex products such as those we develop and offer
may contain defects or errors, or may fail to properly interface with the products of other vendors, when first introduced or as new versions are released. Despite internal testing and testing by our customers or potential customers, we do, from
time to time, and may in the future encounter these problems in our existing or future products. Any of these problems may:





| |  |  | cause delays in product introductions and shipments;
| | - |  | ----------------------------------------------------




| |  |  | result in increased costs and diversion of development resources;
| | - |  | -----------------------------------------------------------------




| |  |  | require design modifications; or
| | - |  | --------------------------------




| |  |  | decrease market acceptance or customer satisfaction with these products, which could result in decreased sales and product returns.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



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In addition, we may not find errors or failures in our products until after
commencement of commercial shipments, resulting in loss of or delay in market acceptance, which could significantly harm our operating results. Our current or potential customers might seek or succeed in recovering from us any losses resulting from
errors or failures in our products.





OUR PROPRIETARY SOFTWARE RELIES ON OUR INTELLECTUAL PROPERTY, AND ANY FAILURE BY US TO PROTECT
OUR INTELLECTUAL PROPERTY COULD ENABLE OUR COMPETITORS TO MARKET PRODUCTS WITH SIMILAR FEATURES THAT MAY REDUCE DEMAND FOR OUR PRODUCTS, WHICH WOULD ADVERSELY AFFECT OUR NET SALES.





Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our proprietary software or technology. We
believe the protection of our proprietary technology is important to our business. If we are unable to protect our intellectual property rights, our business could be materially adversely affected. We currently rely on a combination of copyright and
trademark laws and trade secrets to protect our proprietary rights. In addition, we generally enter into confidentiality agreements with our employees and license agreements with end-users and control access to our source code and other intellectual
property. We have applied for the registration of some, but not all, of our trademarks. We have applied for U.S. patents with respect to the design and operation of our NetFORCE product, and we anticipate that we may apply for additional patents. It
is possible that no patents will be issued from our pending applications. New patent applications may not result in issued patents and may not provide us with any competitive advantages over, or may be challenged by, third parties. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. In addition, the laws of some foreign countries, and the enforcement of those
laws, do not protect proprietary rights to as great an extent as do the laws of the United States. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop
similar technology, duplicate our products or design around any patent issued to us or other intellectual property rights of ours.





In addition, we may initiate claims or litigation against third parties for infringement of our proprietary rights to establish the validity of our proprietary rights. This litigation, whether or not it is resolved in our
favor, could result in significant expense to us and divert the efforts of our technical and management personnel.





WE MAY FROM TIME
TO TIME BE SUBJECT TO CLAIMS OF INFRINGEMENT OF OTHER PARTIES PROPRIETARY RIGHTS OR CLAIMS THAT OUR OWN TRADEMARKS, PATENTS OR OTHER INTELLECTUAL PROPERTY RIGHTS ARE INVALID, AND IF WE WERE TO SUBSEQUENTLY LOSE OUR INTELLECTUAL PROPERTY
RIGHTS, OUR BUSINESS WOULD BE MATERIALLY ADVERSELY AFFECTED.





We may from time to time receive claims that we
are infringing third parties intellectual property rights or claims that our own trademarks, patents or other intellectual property rights are invalid. For example, we have been notified by Intel Corporation that our products may infringe some
of the intellectual property rights of Intel. In its notification, Intel offered us a non-exclusive license for patents in their portfolio. We are investigating whether our products infringe the patents of Intel, and we have had discussions with
Intel regarding this matter. We do not believe that we infringe the patents of Intel, but our discussions and our investigation are ongoing, and we expect we will continue discussions with Intel. We cannot assure you that Intel would not be
successful in asserting a successful claim of infringement, or if we were to seek a license from Intel regarding its patents, that Intel would continue to offer us a non-exclusive license on any terms. We expect that companies in our markets will
increasingly be subject to infringement claims as the number of products and competitors in our industry segment grows and the functionality of products in different industry segments overlaps. The resolution of any claims of this nature, with or
without merit, could be time-consuming, result in costly litigation, cause product shipment delays, require us to redesign our products or require us to enter into royalty or licensing agreements, any of which could harm our operating results.
Royalty or licensing agreements, if required, might not be available on terms acceptable to us or at all. The loss of access to any key intellectual property right could harm our business.




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IF WE FAIL TO SUCCESSFULLY MANAGE OUR TRANSITION TO A FOCUS ON NAS PRODUCTS, OUR BUSINESS AND
PROSPECTS WOULD BE HARMED.





We began developing NAS products in 1997. Since then, we have focused our efforts
and resources on our NAS business, and we intend to continue to do so. In addition, we expect to continue to rely in part upon sales of non-NAS products to fund operating and development expenses. Net sales of our non-NAS products have been
declining in amount and as a percentage of our overall net sales. If the decline in net sales of our Legacy products varies significantly from our expectations, or the decline in net sales of our non-NAS products is not substantially offset by
increases in sales of our NAS products, we may not be able to generate sufficient cash flow to fund our operations or to develop our NAS business.





We also expect our transition to a NAS-focused business to require us to continue:





| |  |  | engaging in significant marketing and sales efforts to achieve market awareness as a NAS vendor;
| | - |  | ------------------------------------------------------------------------------------------------




| |  |  | reallocating resources in product development and service and support of our NAS appliances; and
| | - |  | ------------------------------------------------------------------------------------------------




| |  |  | modifying existing and entering into new channel partner relationships to include sales of our NAS appliances.
| | - |  | --------------------------------------------------------------------------------------------------------------




In addition, we may face unanticipated challenges in implementing our transition to a NAS-focused company. We may not be successful in
managing any anticipated or unanticipated challenges associated with this transition. Moreover, we expect to continue to incur costs in addressing these challenges, and there is no assurance that we will be able to generate sufficient revenues to
cover these costs. If we fail to successfully implement our transition to a NAS-focused company, our business and prospects would be harmed.





CONTROL BY OUR EXISTING SHAREHOLDERS COULD DISCOURAGE POTENTIAL ACQUISITIONS OF OUR BUSINESS THAT OTHER SHAREHOLDERS MAY CONSIDER FAVORABLE.





As of July 31, 2002, our executive officers and directors beneficially owned approximately 5,600,000 shares, or approximately 35% of the outstanding shares of common stock.
Acting together, these shareholders would be able to exert substantial influence on matters requiring approval by shareholders, including the election of directors. This concentration of ownership could have the effect of delaying or preventing a
change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which could in turn have an adverse effect on the market price of our common stock or prevent our shareholders from realizing a premium
over the market price for their shares of common stock.





THE MARKET PRICE FOR OUR COMMON STOCK HAS FLUCTUATED SIGNIFICANTLY IN THE
PAST AND WILL LIKELY CONTINUE TO DO SO IN THE FUTURE, WHICH COULD RESULT IN A DECLINE IN YOUR INVESTMENTS VALUE.





The market price for our common stock has been volatile in the past, and particularly volatile in the last twelve months, and may continue to fluctuate substantially in the future. The value of your investment in our common stock
could decline due to the impact of any of the above or of the following factors upon the market price of our common stock:





| |  |  | fluctuations in our operating results;
| | - |  | --------------------------------------




| |  |  | fluctuations in the valuation of companies perceived by investors to be comparable to us;
| | - |  | -----------------------------------------------------------------------------------------




| |  |  | a shortfall in net sales or operating results compared to securities analysts expectations;
| | - |  | --------------------------------------------------------------------------------------------




| |  |  | changes in analysts recommendations or projections;
| | - |  | ----------------------------------------------------




| |  |  | announcements of new products, applications or product enhancements by us or our competitors; and
| | - |  | -------------------------------------------------------------------------------------------------




| |  |  | changes in our relationships with our suppliers or customers, including failures by customers to pay amounts owed to us.
| | - |  | ------------------------------------------------------------------------------------------------------------------------



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SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS.





This Report on Form 10-K contains forward-looking statements, including, without limitation, the statements under the captions Risk Factors, and
Managements Discussion and Analysis of Financial Condition and Results of Operations. You can identify these statements by the use of words like may, will, could, should,
project, believe, anticipate, expect, plan, estimate, forecast, potential, intend, continue, and variations of these words or
comparable words. In addition, all of the non-historical information in this Report on Form 10-K is forward-looking. Forward-looking statements do not guarantee future performance and involve risks and uncertainties. Actual results may and probably
will differ substantially from the results that the forward-looking statements suggest for various reasons, including those discussed under Risk Factors. These forward-looking statements are made only as of the date of this Report on
Form 10-K. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise.





Item 2.Properties





In September 2000, we
moved into our new headquarters in Irvine, California. This facility is approximately 127,000 square feet, of which we occupy approximately 60,000 square feet. Beginning in January, 2002, we subleased on a month to month basis approximately 32,000
square feet of the building. We are attempting to sublease the remaining unused space in our building. However, no assurance can be given that we will be successful in completing such a lease.





We also lease space aggregating approximately 26,300 square feet to house operations of our subsidiaries and sales offices located outside the United States in
Germany, Italy, Switzerland, Canada, China and France.





Item 3.Legal Proceedings





On September 20,
2002, a putative class action complaint styled Albert Ree v. Alex Aydin, Alex Razmjoo, and Procom Technology, Inc. was filed in the United States District Court for the Southern District of New York, Case No. 02 CV 7613. Two weeks later, on
October 4, 2002, a putative class action complaint styled Gary Squires v Alex Aydin, Alex Razmjoo, and Procom Technology, Inc. was also filed in the United States District Court for the Southern District of New York, Case No. 02 CV 7952. The
allegations of the two complaints are identical. Both actions are purportedly brought on behalf of all investors who purchased our common stock from December 9, 1999 to September 20, 2000. Although both complaints have been filed with the District
Court, neither has been served on us.





The complaints allege violations of Section 10(b) and 20(a) and Rule 10b-5
of the Securities Exchange Act of 1934. Specifically, plaintiffs allege that we violated federal securities laws by: (1) failing to fully and timely disclose purported problems with our alliance with Hewlett-Packard along with the effect
of such problems on our business prospects, and (2) overstating our receivables during the class period. For relief, plaintiffs seek compensatory damages and/or rescission from us as well as an award of the costs and disbursements of the suit. We
believe that we have substantial and meritorious defenses to each of the claims and intend to vigorously defend the actions. However, there can be no assurance that we will prevail in defending these actions. Our defense of these actions may result
in the diversion of managements time and attention and cause us to incur potentially significant legal expenses. If we are unsuccessful in defending these actions, we may be required to pay damages in an amount that would have a material
adverse effect on our results of operations and financial condition.





In December 2000, we acquired Scofima
Software, S.r.l., an Italian company. One of the shareholders of Scofima Software became our Managing Director of European Sales. The consideration issued in the transaction was 480,000 shares of our common stock and we agreed, as part of the
acquisition, to register the shares for resale under the Securities Act of 1933. The shares of common stock issued in the transaction were registered for




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resale but the former Scofima Software shareholders alleged, among other things, that delays in the registration of the shares caused them to incur substantial losses. On October 4, 2002, we
entered into a settlement agreement with the former Scofima Software shareholders under which these individuals released any and all claims against us arising from the transaction in return for a payment of $970,000, of which $560,000 was paid upon
execution of the agreement. The remaining balance is payable in the following installments: $180,000 by November 10, 2002; $70,000 by December 10, 2002; $75,000 by January 10, 2003; and the remaining $85,000 by February 10, 2003.





We are from time to time involved in litigation related to our ordinary operations, such as collection actions and vendor
disputes. We do not believe that the resolution of any such other existing claim or lawsuit will have a materially adverse affect on our business, results of operations or financial condition.





Item 4.Submission of Matters to a Vote of Security Holders





No matters were submitted to a vote of security holders during the fourth quarter of fiscal 2002.





PART
II





Item 5.Market for Registrants Common Equity and Related Stockholder Matters





(1)  Our common stock is listed on the Nasdaq National Market System under the symbol PRCM. The approximate number of holders of record of our common stock as of September 30,
2002 was 107 and the number of beneficial owners is believed to be in excess of 6,400. Our common stock was first listed on the date of our public offering of shares on December 18, 1996.





(2)  We have never paid cash dividends on our common stock. We currently anticipate retaining future earnings, if any, to internally finance growth and product
development. Payment of dividends in the future will depend upon our earnings and financial condition and various other factors our directors may deem appropriate at the time. Our line of credit agreement restricts the payment of cash dividends.





(3)  The range of high and low sales prices of our common stock, as reported by the Nasdaq National
Market, for each quarter of fiscal 2001 and 2002:





First Quarter

Second Quarter

Third Quarter

Fourth QuarterHigh

Low

High

Low

High

Low

High

LowFiscal 2002

$
9.20

$
1.98

$
3.95

$
1.66

$
3.20

$
1.30

$
1.40

$
0.34Fiscal 2001

$
50.00

$
21.06

$
26.44

$
11.25

$
20.38

$
5.20

$
13.50

$
6.75




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Item 6.Selected Financial Data





Financial Highlights





Year Ended July 31,1998(1)

1999(1)


2000


2001(2)


2002(2)Statements of Operations Data:(in 000s except per share data)Net sales

$
111,886

$
101,290


$
63,210


$
41,882


$
25,030Cost of sales


75,527


73,003



46,189



26,625



16,326Gross profit


36,359


28,287



17,021



15,257



8,704Selling, general and administrative


22,257


26,314



21,930



21,235



28,500Research and development


4,788


5,502



7,187



6,403



6,381In-process research and development


1,693










4,262



Impairment and restructuring charge





1,626











Asset impairment

















2,417Total operating expenses


28,738


33,442



29,117



31,900



37,298Operating income (loss)


7,621


(5,155
)


(12,096
)


(16,643
)


(28,594
)Interest income (expense), net


1,229


1,222



1,048



(907
)


(930
)Income (loss) before income taxes


8,850


(3,933
)


(11,048
)


(17,550
)


(29,524
)Provision (benefit) for income taxes


3,474


(1,058
)


(3,064
)


1,800



(5,164
)Net income (loss)

$
5,376

$
(2,875
)

$
(7,984
)

$
(19,350
)

$
(24,360
)Net income (loss) per share:Basic

$
0.48

$
(0.26
)

$
(0.70
)

$
(1.54
)

$
(1.52
)Diluted

$
0.48

$
(0.26
)

$
(0.70
)

$
(1.54
)

$
(1.52
)Weighted average number of sharesBasic


11,114


11,241



11,351



12,533



16,018Diluted


11,252


11,241



11,351



12,533



16,018Consolidated Balance Sheet Data (in 000s):Cash, cash equivalents and short-term marketable securities

$
23,362

$
22,433


$
15,515


$
25,419


$
10,845Working capital


32,873


31,245



10,604



27,042



16,596Total assets


54,439


57,088



52,796



65,227



42,009Loan payable





7,500



10,750







Long-term debt

















8,477Convertible debenture













9,726



Total shareholders equity

$
36,732

$
34,286


$
27,556


$
47,067


$
23,291


---

|(1) |  | In fiscal 1998, we acquired the assets of Invincible Technology Acquisition Corporation (ITC), and incurred a $1.7 million in-process research and
development charge. In fiscal 1999, we restructured the operations of ITC and incurred an impairment and restructuring charge of $1.6 million.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




|(2) |  | In fiscal 2001, we acquired the stock of Scofima Software, S.r.l. (Scofima), and incurred a $4.3 million in-process research and development charge.
In fiscal 2002, we incurred an asset impairment charge of approximately $2.4 million relating to the intangible assets acquired in the Scofima acquisition, as well as other intangible assets of our U.S. and European subsidiaries.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations





The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and the related notes set
forth under Item 8. Financial Statements and Supplementary Data and the Risk Factors set forth in Item 1. Business.





We develop, manufacture and market NAS appliances and other storage devices for a wide range of computer networks and operating systems. Our NAS appliances, which consist of our DataFORCE and NetFORCE
product lines, provide end-users with faster access to data at a lower overall cost than other storage alternatives. We refer to these products collectively as our NAS appliances. In addition, we sell disk drive storage upgrade systems, CD/DVD-ROM
servers and arrays and tape backup products, which we refer to collectively as our Legacy products. Over the last five years, we have significantly increased our focus on the development and sale of NAS appliances. We continue to develop more
advanced NAS appliances and expect this business to be our principal business in the future.





Critical Accounting Policies





Our discussion and analysis of financial condition and results of operations is based upon our Consolidated
Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues, and expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an ongoing basis, our estimates and judgments, including those related to sales returns, bad
debts, excess inventory, goodwill and intangible assets, restructuring accruals, income taxes, and contingencies. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances. Actual results
may differ from these estimates.





We believe the accounting policies described below, among others, are the ones
that most frequently require us to make estimates and judgments, and therefore are critical to the understanding of our results of operations:





| |  |  | revenue recognition and allowances;
| | - |  | -----------------------------------




| |  |  | valuation of accounts receivable;
| | - |  | ---------------------------------




| |  |  | valuation of inventory;
| | - |  | -----------------------




| |  |  | valuation of goodwill and other intangible assets; and
| | - |  | ------------------------------------------------------




| |  |  | valuation of deferred tax assets.
| | - |  | ---------------------------------




Revenue recognition and allowances





Our NAS products include an operating system that is
integral to the overall product and its functionality. We recognize revenue for our NAS products in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Software
Revenue Recognition with Respect to Certain Arrangements. We recognize revenue for our NAS products when:





Persuasive Evidence of an Arrangement Exists.    It is our customary practice to have a purchase order prior to recognizing revenue on an arrangement.





Delivery Has Occurred.    Our product is physically delivered to our customers, generally with standard transfer terms of FOB shipping
point. The core operating system software that the customer purchases is pre-installed and tested at our facility prior to shipment and does not require significant production, modification, or customization at the customers site; as such, the
system is functional according to our specifications at the time of shipment.




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The Price Is Fixed or Determinable.    Arrangements
with extended payment terms are not considered to be fixed or determinable. Revenue from such arrangements is recognized as the fees become due and payable.





Collection Is Probable.    Probability of collection is assessed on a customer-by-customer basis. Customers are subjected to a credit review process that evaluates the
customers financial position and ultimately their ability to pay. If it is determined from the outset of an arrangement that collection is not probable based upon our review process, revenue is recognized when realized.





We recognize revenue on multiple element arrangements using the residual method. Under the residual method, revenue is
recognized when Company-specific objective evidence of fair value exists for all of the undelivered elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. At the outset of the arrangement with
the customer, we defer revenue for the fair value of the undelivered elements such as consulting services and product support and upgrades, and recognize the revenue for the remainder of the arrangement fee attributable to the elements initially
delivered when the basic criteria in SOP 97-2 have been met. Revenue from consulting services is recognized as the related services are performed. Revenue from support and upgrade contracts is recognized as revenue ratably over the term of the
support period of one to three years.





Revenue from sales of our non NAS products is recognized in accordance with
Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. The revenue recognition criteria of SAB 101 are consistent with the NAS policies described above.





We record reductions to revenue for estimated sales returns at the time of shipment. Some of our agreements with distributors allow limited product return, stock
balancing and price protection privileges. We maintain reserves, adjusted at each reporting period, to estimate anticipated returns, including stock balancing and price protection claims, relating to each reporting period. The reserves are based on
historical rates of sales and returns, including stock balancing and price protection claims, and the level of our product held by our distribution customers in their inventory. If we were to experience a significant unexpected increase in product
sales returns, our sales return allowance may not be adequate and incremental sales reserves would be required. To the extent management cannot make reliable estimates of future product returns, revenue will be deferred until it is actually
realized.





Our product evaluation program enables the customer to receive NAS appliances on a trial basis and
return the NAS appliances within a specified period, generally 30-60 days. The period may be extended if the customer needs additional time to evaluate the product within the customers particular operating environment. The value of evaluation
units at customer sites at a financial reporting date is included in inventory as finished goods. At July 31, 2002 and 2001, inventory related to evaluation units was $1.0 million and $1.2 million, net of valuation allowances respectively.
Revenue is not recorded for evaluation units until the customer has purchased the products.





Valuation of accounts receivable





We also maintain a separate allowance for doubtful accounts for estimated losses resulting from the inability
of our customers to make required payments. We analyze accounts receivable and historical bad debts, customer concentrations, customer solvency, current economic and geographic trends, and changes in customer payment terms and practices when
evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.





Valuation of inventory





We write-down the value of our inventory, including our estimated excess and obsolete inventory, to the estimated net reliable value based upon assumptions about future demand and market conditions. Although we strive to ensure the
accuracy of our forecasts of future product demand, any significant unanticipated changes in




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demand or technological developments could have a significant impact on the value of our inventory and commitments, and our reported results. If actual market conditions are less favorable than
those projected, additional write-downs against earnings may be required.





Valuation of goodwill and other intangible assets





We periodically evaluate our goodwill and other intangible assets for indications of impairment whenever
events or changes in circumstances indicate that the carrying value may not be recoverable. Intangible assets include goodwill, purchased technology, acquired workforce and developer relationships. Factors we consider important that could trigger an
impairment review include significant under-performance relative to expected historical or projected future operating results, significant changes in the manner of our use of the acquired assets or the strategy for our overall business, or
significant negative industry or economic trends. If these criteria indicate that the value of the intangible asset may be impaired, an evaluation of the recoverability of the net carrying value of the asset over its remaining useful life is made.
If this evaluation indicates that the intangible asset is not recoverable, based on the estimated undiscounted future cash flows related to the intangible asset, the net carrying value of the related intangible asset will be reduced to fair value,
and the remaining amortization period may be adjusted. During fiscal 2002, we determined that the value of the goodwill, acquired workforce and developer relationships was impaired at our European subsidiaries. We based the determination on the
continued losses incurred at those subsidiaries, and our estimates of the future difficulties that a return to profitability would entail and the resources that would be required to effect that return to profitability. In addition, we determined
that our strategy to improve and implement betterments in technologies we had acquired and had licensed would be changed to conserve our existing cash resources. After making these determinations, we recorded an impairment charge of approximately
$2.4 million in the fourth quarter of fiscal 2002.





Valuation of deferred tax assets





We record income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. We evaluate the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered and expected
levels of taxable income.





The determination of our tax provision is subject to judgments and estimates due to the
changing nature of tax laws. Prior to the current fiscal year, we had assumed that we would not fully utilize our existing deferred tax assets, and so we had established a full valuation allowance against those assets. Because the U.S. Congress
passed, and the President signed, a law allowing further utilization of net operating losses, we were able to carry back our deferred net operating losses. The remaining deferred tax assets are still currently impaired and an offsetting valuation
allowance has been recorded due to the uncertainty regarding their realizability. Should we return to profitability or should additional legislation allow for the utilization of the deferred tax assets, our estimates of the value of our deferred tax
assets may be changed.





New Accounting Standards





In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other
Intangible Assets. Under SFAS No. 141, all business combinations initiated after June 30, 2001 must be accounted for using the purchase method. Under SFAS No. 142, goodwill and intangible assets with indefinite lives are no longer amortized
but are reviewed annually for impairment (or more frequently if indicators of impairment arise). In fiscal 2002, we determined that all of our




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existing goodwill and other intangible assets were impaired, and we recorded an impairment charge of approximately $2.4 million. Accordingly, upon adoption of SFAS No. 142 on August 1, 2002, we
will not have any net goodwill or other intangible assets, and therefore, the adoption of the statement will not have a material impact on our financial statements.





In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Assets to Be Disposed Of. Adoption of SFAS No. 144 is required for our fiscal
year beginning August 1, 2002. We are currently evaluating the potential impact of adoption of SFAS No. 144 on our financial position and results of operations and have not yet determined the impact of adopting this statement.





In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, Accounting for Costs Associated with Exit or
Disposal Activities. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring).





SFAS No. 146 requires that the liability for costs
associated with an exit or disposal activity be initially measured at fair value and recognized when the liability is incurred. In periods subsequent to initial measurement, changes to the liability are measured using the credit-adjusted risk-free
rate that was used in the initial measurement of the liability recorded. The cumulative effect of a change resulting from revisions to either the timing or the amount of estimated cash flows is recognized as an adjustment to the liability in the
period of the change and charged to the same line items in the statement of operations used when the related costs were initially recognized. Under EITF No. 94-3, a liability for an exit cost was recognized at the date of our commitment to an exit
plan.





The provisions of SFAS No. 146 are required to be applied prospectively to exit or disposal activities
initiated after December 31, 2002. We believe SFAS No. 146 may affect the timing of recognizing future restructuring costs, as well as the amounts recognized, depending on the nature of the exit or disposal activity. We are currently evaluating the
potential impact of the adoption of SFAS No. 146 upon our business, consolidated financial position, results of operations and cash flow.





Results of Operations





The following table sets forth consolidated statement of operations
data as a percentage of net sales for each of the periods indicated:


Year Ended July 31,2000


2001


2002STATEMENT OF OPERATIONSNet sales

100.0
%

100.0
%

100.0
%Cost of sales

73.1


63.6


65.2Gross profit

26.9


36.4


34.8Operating expenses:Selling, general and administrative

34.7


50.7


113.8Research and development

11.4


15.3


25.5In-process research and development




10.2


Asset impairment







9.7Total operating expenses

46.1


76.2


149.0Operating loss

(19.2
)

(39.8
)

(114.2
)Interest income (expense), net

1.7


(2.2
)

(3.8
)Loss before income taxes

(17.5
)

(42.0
)

(118.0
)Provision (benefit) for income taxes

(4.8
)

4.3


(20.6
)Net loss

(12.7
)%

(46.3
)%

(97.4
)%




26




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##### Table of Contents




Fiscal 2002 Compared to Fiscal 2001





Net sales decreased by 40.2% to $25.0 million in fiscal 2002, from $41.9 million in fiscal 2001. This decrease was due primarily to a decline in product sales in
international markets for our NAS and Legacy products, a drop in domestic product sales of our Legacy products and sales in fiscal 2001 of $5.2 million to a European storage service provider that were not repeated in fiscal 2002. This decrease was
partially offset by a 51.2% increase in domestic NetFORCE product sales in fiscal 2002.





Net sales of our NAS
products decreased 29.9% to $19.9 million in fiscal 2002, from $28.4 million in fiscal 2001. Excluding sales of $5.2 million to a European storage service provider in fiscal 2001 that were not repeated in fiscal 2002, NAS sales decreased $3.3
million, or 14.2%. This decrease was due primarily to a decline in international NAS product sales partially offset by an 17.8% increase in domestic NAS sales, consisting of a 51.2% increase in NetFORCE sales partially offset by a 51.4% decrease in
DataFORCE sales. Domestic non-OEM NetFORCE sales increased approximately 101.0% in fiscal 2002 over fiscal 2001. As a percentage of total net sales, NAS product sales increased to 79.5% in fiscal 2002 from 68.5% in fiscal 2001.





International sales were $9.5 million, or 37.9% of our net sales, for fiscal 2002 compared to $23.3 million, or 55.7% of our
net sales, in fiscal 2001. The decrease was due primarily to lower overall sales of NAS and Legacy products to international customers, primarily in Europe, and sales in fiscal 2001 to a European storage service provider discussed above. Product
sales in the Pacific Rim in fiscal 2002 were comparable to 2001. As a percentage of total net sales, international sales decreased in fiscal 2002 over fiscal 2001 due primarily to lower sales of our NAS products to customers in Europe. There can be
no assurance that our revenues of our NAS products will continue to increase in any particular quarter or period, or that any specific customers will continue to purchase our products in such period.





Gross profit decreased to $8.7 million in fiscal 2002 from $15.3 million in fiscal 2001. Gross margin decreased to 34.8% of net sales for
the year ended July 31, 2002, from 36.4% for the comparable period in fiscal 2001. The decrease in gross margin was primarily the result of additional inventory reserves recorded in the fourth quarter of fiscal 2002. We expect that gross margins may
be impacted by continuing reductions in sales of some of our higher margin non-NAS product lines, such as CD servers and arrays.





Selling, general and administrative expenses increased 34.2% to $28.5 million in fiscal 2002, from $21.2 million in fiscal 2001, and increased as a percentage of net sales to 113.9% from 50.7%. In fiscal 2002, we increased our
allowance for doubtful accounts by $7.1 million to reflect the uncollectibility of certain accounts receivable primarily in Europe and Asia, compared to an increase in our allowance for doubtful accounts of $3.7 million in fiscal 2001. In addition,
in the fourth quarter of 2002, we recorded a $1.9 million charge for the present value of severance obligations to former executives (see Note 7 to the consolidated financial statements) and a $1.0 million charge relating to the settlement agreement
with the former shareholders of Scofima Software (see Note 16 to the consolidated financial statements). Excluding these charges, selling, general and administrative expenses for fiscal 2002 were approximately $18.7 million compared to $17.9 million
(excluding a $3.7 million increase in allowance for doubtful accounts receivable fiscal 2001), a 4.5% increase over fiscal 2001. We expect overall selling, general and administrative expenses in the next fiscal year to decrease as a result of our
reductions in headcount and cost saving initiatives undertaken in fiscal 2002 and the first quarter of fiscal 2003.





The dollar increase in selling, general and administrative expenses aside from the items discussed above was primarily the result of additional sales salaries and commissions in support of NAS sales, increased general administrative
expenses of our Italian and Swiss subsidiaries, offset by a decline in general administrative costs of our German subsidiary and an increase in net currency translation gains, as the Euro and Swiss Franc strengthened against the U.S. dollar in
fiscal 2002 compared to fiscal 2001. In addition, we incurred reduced advertising and marketing costs, offset somewhat by increased legal fees and increases in the cost of personnel necessary to support our NAS sales and marketing efforts.




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Research and development expenses in fiscal 2002 remained consistent with those
for fiscal 2001 and increased to 25.5% of net sales, compared to 15.3% of net sales, in fiscal 2001. In fiscal 2002, we shifted to using our own employees for programming instead of outside programmers and consultants. We expect overall research and
development expenses to decrease in the next fiscal year as a result of our reductions in headcount and cost savings initiatives undertaken in fiscal 2002 and the first quarter of fiscal 2003.





In the fourth quarter of fiscal 2002, as a result of our change in business strategy, we recorded impairment losses of $2.4 million, consisting primarily of $1.9
million in goodwill, other intangibles and $0.5 million in prepaid license fees (see Note 13 to the consolidated financial statements).





Interest income decreased 30.7% to $0.6 million in fiscal 2002, from $0.8 million in fiscal 2001. This decrease is due primarily to a rapid decline in interest rates along with a decrease in our average investable cash
position, which we had historically invested in investment-grade commercial paper with maturities of less than 90 days, during fiscal 2001.





Interest expense decreased to $1.5 million in fiscal 2002 from $1.7 million in fiscal 2001. The decrease is attributable primarily to the lower interest expense we incurred on our mortgage note in
fiscal 2002, while prior year interest expense included costs related to our $15.0 million 6% convertible debenture, borrowings under our CIT term loan agreement and amortization of prepaid loan costs.





In fiscal 2002, we recorded a $5.2 million income tax benefit relating to recent changes in tax laws. These changes allowed us to carry
back deferred net operating losses, generated in fiscal 2001 and 2002, five years, as opposed to the two years allowed under the tax law previously in effect. Except for the tax refunds, we have recorded no benefit from our current period losses. We
have recorded a valuation allowance equal to the net deferred tax asset as we believe it is more likely than not that we will not realize the benefit of the net deferred tax asset existing at July 31, 2002 because of our continued operating losses
and uncertainty as to our ability to successfully transition to and grow NAS appliance product sales.





Fiscal 2001 Compared to Fiscal
2000





Net sales decreased by 33.7% to $41.9 million in fiscal 2001, from $63.2 million in fiscal 2000. This
decrease resulted from a significant decrease in unit sales of our legacy products, which include CD servers and arrays and disk drive storage upgrade systems, and the effect of the strategic discontinuance of specific product lines.





Net sales related to our NAS appliances increased 62.7% to $28.4 million in fiscal 2001, from $17.4 million in fiscal 2000.
This increase was primarily the result of increased unit sales of our NetFORCE NAS appliances offset by decreased sales of our DataFORCE NAS appliances.





International sales were $23.3 million, or 55.7% of our net sales, for fiscal 2001 compared to $26.2 million, or 41.4% of our net sales, in fiscal 2000. The decrease in international sales is due
primarily to reduced sales of non-NAS products by our German subsidiary. As a percentage of overall sales, international sales improved over fiscal 2000 due primarily to sales of our NAS products to customers in Europe and Asia, including sales of
approximately $5.2 million to a European storage service provider, other sales of NAS appliances by our German and Swiss subsidiaries, and reduced U.S. sales of our CD servers and arrays. There can be no assurance that our revenues of our NAS
products will continue to increase in any particular quarter or period, or that any specific customers will continue to purchase our products in such period.





Gross profit decreased to $15.3 million for fiscal 2001 from $17.0 million for fiscal 2000. Gross margin increased to 36.4% for the year ended July 31, 2001, from 26.9% for the comparable period in
fiscal 2000. The increase in gross margin was primarily the result of the higher percentage of NAS revenues, offset to a lesser extent by a reduction in sales of CD servers and arrays, which have historically experienced higher margins, and an
increase in our inventory reserves associated with the discontinuation of specific product lines in the fourth




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quarter of fiscal 2001. In addition, we realized reduced margins on lower sales of disk drive upgrade systems due to price erosion in the disk drive upgrade industry. We expect that gross margins
may be impacted by continuing reductions in sales of some of our higher margin non-NAS product lines, such as CD servers and arrays.





Selling, general and administrative expenses decreased 3.2% to $21.2 million in fiscal 2001, from $21.9 million in fiscal 2000, and increased as a percentage of net sales to 50.7% from 34.7%. The dollar decrease in selling,
general and administrative expenses was primarily the result of reduced sales and administrative salaries and commissions, reduced cooperative advertising costs and reduced expenses of our German subsidiary offset by increased selling and
administrative costs of our Italian subsidiary and a $3.3 million increase in our accounts receivables reserves due primarily to the weak economic conditions and their impact on the financial stability of several of our customers. In addition, we
incurred reduced advertising, marketing and travel costs, offset somewhat by increased legal fees and increases in the cost of personnel necessary to support our NAS sales and marketing efforts. During fiscal 2001, we continued to identify and
eliminate certain positions and functions not related to our core NAS activities. As a result, we experienced some reductions in selling, general and administrative expenses in the past year. We expect overall selling, general and administrative
expenses in the next fiscal year to continue to decrease as we continue our cost saving initiatives undertaken in fiscal 2001.





Research and development expenses decreased 10.9% to $6.4 million, or 15.3% of net sales, in fiscal 2001, from $7.2 million, or 11.4% of net sales, in fiscal 2000. The dollar decrease was due primarily to reduced costs for evaluation
units and test supplies offset slightly by increases in compensation expense for additional NAS software programmers and hardware developers.





In December 2000, we acquired the outstanding shares of Scofima, an Italian company engaged in software development. We employed an appraiser to value the assets of Scofima. The appraiser
assigned a value of approximately $4.3 million to in-process research and development relating to software being developed by Scofima which had not yet reached technological feasibility and for which no alternative future use was available. As a
result, we incurred a one-time charge of $4.3 million in the second quarter of fiscal 2001. See discussion of assumptions used by appraiser in Note 12 to the Consolidated Financial Statements.





Interest income decreased 23.3% to $0.8 million in fiscal 2001, from $1.1 million in fiscal 2000. This decrease is due primarily to a decline in our average investable
cash position, which we had historically invested in investment-grade commercial paper with maturities of less than 90 days, during fiscal 2001. This decrease was partially offset by interest earned on net proceeds received from the sale of our
common stock in the fourth quarter of fiscal 2001.





Interest expense increased to $1.7 million for the year ended
July 31, 2001 compared to the comparable period in fiscal 2000. The increase is attributable to the issuance of a $15.0 million 6% convertible debenture, borrowings under our CIT term loan agreement and amortization of prepaid loan costs, which
included a write-off of $0.3 million in debt issuance costs associated with the $5.0 million convertible debenture repayment. In addition, in the first quarter of fiscal 2001 our new corporate headquarters was placed into service and we began to
incur interest expense on the amount we have financed for our building. Previously, interest expense of approximately $142,000 had been capitalized as part of the development cost of our headquarters.





Provision (Benefit) for Income Taxes.    The fiscal 2001 provision of $1.8 million represents primarily an
increase in our deferred tax asset valuation allowance. At July 31, 2001, we recorded a valuation allowance equal to the net deferred tax asset. As to our ability to successfully transition to and grow our NAS product sales, the realization of the
tax benefits relating to our net deferred tax asset will be dependent on our ability to return to profitability.





Liquidity and
Capital Resources





As of July 31, 2002, we had cash and cash equivalents totaling $10.8 million.




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Net cash used in operating activities was $13.3 million in fiscal 2002 and $17.2
million in fiscal 2001 and $4.4 million in fiscal 2000. Net cash used in operating activities in fiscal 2002 relates primarily to our net loss, decrease in our accounts payable, and an increase in inventories. These uses of cash were slightly offset
by a decrease in our net accounts receivable of approximately $7.1 million and an increase in accrued expenses. Net cash used in operating activities in fiscal 2001 relates primarily to our net loss, increases in our accounts receivable offset by an
increase in reserves of $3.7 million and a decrease in accounts payable.





Net cash used in investing activities
was $0.2 million in fiscal 2002, and $3.0 million in fiscal 2001. Net cash used in investing activities in fiscal 2002 was the result of expenditures of $0.2 million in miscellaneous purchases of property and equipment. Net cash used in investing
activities in fiscal 2001 was the result of expenditures of $1.5 million to complete our corporate headquarters and purchases of $1.3 million of other property and equipment.





Net cash used in financing activities was $1.5 million in fiscal 2002 compared to net cash provided by financing activities of $30.2 million in fiscal 2001. Net cash used
in financing activities in fiscal 2002 resulted primarily from the borrowing of long term debt of $8.8 million offset by the repayment of the convertible debenture of $10.0 million and repayments under our flooring line. Net cash provided by
financing activities in fiscal 2001 resulted primarily from the sale of 3,800,000 shares of our common stock, the issuance of a $15.0 million convertible debenture, and approximately $1.1 million in stock option exercises and employee stock
purchases, reduced by the repayment of approximately $10.8 million in loans previously secured by our commercial paper portfolio and $5.0 million in convertible debentures.





Our long-term debt consists of $8.75 million borrowed under a financing arrangement secured by our corporate headquarters. The principal amount outstanding bears interest
at prime plus 1.0% per annum, but not less than 7.0% per annum. Under certain conditions, we have the right to request that portions of the principal amount outstanding under the note shall bear interest at a LIBOR based rate, but not less than
7.0%. As of July 31, 2002, the interest rate on the loan was 7.0%. Principal payments of $14,400 plus accrued interest are due monthly with the remaining principal balance and unpaid interest due at the maturity date of January 1, 2007. Up to an
additional $1.0 million may be borrowed under this financing arrangement to cover leasing costs and tenant improvements on the vacant, unimproved space within the corporate headquarters upon finding a qualified tenant. At July 31, 2002, the
outstanding principal balance of the loan totaled $8.6 million. Under the terms of the financing agreement, the lender may immediately accelerate all amounts disbursed under the financing agreement and terminate any further obligation of the lender
to disburse additional amounts under the financing arrangement if there exists any event or condition that the lender in good faith believes impairs (or is substantially likely to impair) the prospect of payment or performance by us of our
obligations under the applicable loan documents.





On October 10, 2000, we entered into a three-year working
capital line of credit with CIT Business Credit (CIT). The working capital line of credit provides for advances, on a revolving basis, for a period of three years, with the amount of such advances based on a specified percentage of our
eligible accounts receivable and inventories (approximately $1.8 million at July 31, 2002), up to a limit of $5.0 million or the line will be terminated. Amounts outstanding under the working capital line bear interest at the lenders prime
rate plus .25%. At July 31, 2002, no amounts were outstanding under the working capital line of credit. The line of credit accrues various monthly maintenance, minimum usage and early termination fees. The line of credit is collateralized by certain
of our assets. The line of credit requires certain financial and other covenants, including the maintenance of a minimum EBITDA requirement for rolling twelve month periods ending on each fiscal quarter. For the twelve months ended July 31, 2002, we
were not in compliance with the minimum EBITDA requirement. The lender has not waived our non-compliance with this covenant for this period and we are not able to borrow under the line.





We have a flooring line of credit with IBM Credit, which at July 31, 2002, had committed to make $2.0 million in flooring inventory commitments available to us. In
September 2002, IBM Credit notified us that our credit line was being reduced to $0.5 million, effective immediately. In addition, prior to November 18, 2002, we are required to provide IBM Credit with an irrevocable letter of credit totaling $0.5
million. At July 31, 2002, we




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owed $251,000 under the flooring line. The flooring line is collateralized by the specific inventory purchased using the flooring line. CIT and IBM Credit have entered into an inter-creditor
agreement which determines the level of priority of either lenders security interest. The flooring line requires the maintenance of a minimum net worth of $16.0 million, and we were in compliance with this covenant at July 31, 2002. The
flooring line also requires us not to be in default of any covenants in the CIT agreement. IBM Credit has waived compliance with that requirement at July 31, 2002, but has notified us of the changes to our relationship as noted above.





In addition to the line of credit, our foreign subsidiaries in Germany, Italy and Switzerland have lines of credit with banks
in their respective countries that are utilized primarily for overdraft and short-term cash needs. At July 31, 2002, the amount outstanding under these lines was $46,000.





The Job Creation and Workers Assistance Act of 2002, which became effective in February 2002, permits us to carry back certain of our previously recorded losses for
five years instead of only two years. We previously had not believed we would be able to recover a tax benefit related to prior year losses. As a result of the legislation, in April 2002, we filed amended tax returns for prior year losses, and in
June 2002, received a tax refund of $2.9 million. In addition, in August 2002, we received approximately $2.1 million in additional tax refunds for our fiscal 2002 tax return, as a result of carrying back fiscal 2002 operating losses to previous
periods. We anticipate receiving an additional refund of approximately $0.2 million. We have recorded a tax benefit in the current fiscal year of $5.2 million.





As of July 31, 2002, we had the following contractual cash obligations:





Total

Less than 1
year

1 to 3 years

4 to 5 years

After 5 yearsContractual Cash Obligations:Long-Term Debt

$
8,649,000

$
172,000

$
345,000

$
8,132,000

$
Operating Leases


876,000


401,000


311,000


96,000


68,000Scofima Settlement


970,000


970,000








Executive Severance


2,073,000


732,000


1,341,000





Total

$
12,568,000

$
2,275,000

$
1,997,000

$
8,228,000

$
68,000





We have incurred substantial losses during the last three fiscal
years and have limited resources to continue to fund cash operating losses and other contractual obligations. To address our continued losses, we have reduced our headcount, both domestically and internationally, from 211 employees at July 31, 2001
to 135 employees at July 31, 2002, and have further reduced headcount by an additional 37 employees in the first quarter of fiscal 2003, which we believe will significantly reduce cash used in operations. Based on these and other cost saving
measures, we believe that we have cash and other resources, including our income tax refunds for fiscal 2001 and 2002 of $5.2 million ($2.9 million received in the fourth quarter of fiscal 2002, $2.2 million received in the first quarter of fiscal
2003 and the remainder of $0.2 million expected in the second quarter of fiscal 2003), sufficient to meet our anticipated cash requirements for the next twelve months. If additional working capital is needed, we will consider the sale or refinancing
of our headquarters to meet our cash requirements. We cannot be certain, however, that our cost saving measures will reduce our cash used in operations to allow us to continue to fund the operating losses, contractual commitments and other working
capital requirements through the next twelve months. Additionally, we cannot assure you that our lender will not accelerate all amounts outstanding under the financing arrangement. We cannot be certain that we would be able to sell or refinance our
building, if necessary, or otherwise obtain any additional financing, on favorable or any terms.





Item 7A.Quantitative and Qualitative Disclosure about Market Risks





Interest Rate Risk





Our exposure to market risk for changes in interest rates relates
primarily to the increase or decrease in the amount of interest income we can earn on our investment portfolio as well as the fluctuation in interest rates on our various borrowing arrangements. We do not use derivative financial instruments in our
investment portfolio.




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We invest in high-credit quality issuers and, by policy, we limit the amount of credit exposure to any one issuer. As stated in our policy, we ensure the safety and preservation of our invested
principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in safe and high-credit quality securities and by constantly positioning our portfolio to respond appropriately to reductions in a
credit rating of any investment issuer, guarantor or depository. The portfolio includes only marketable securities with active secondary or resale markets to help ensure reasonable portfolio liquidity.





Since October 31, 2000, we have entered into a line of credit and term loan agreements pursuant to which amounts outstanding bear interest
at the lenders prime rate plus up to .50%. Accordingly, if we were to borrow funds under such agreements, we expect that we will experience interest rate risk on our debt.





In December 2001, we borrowed $8.75 million under a financing arrangement. The principal amount outstanding bears interest at prime plus 1.0%, although at a minimum of
7.0%. Accordingly, if the prime rate were to fluctuate above 6.0%, we would experience interest rate risk on our debt.





Foreign
Currency Exchange Rate Risk





We transact business in various foreign countries, but we only have significant
assets deployed outside the United States in Europe. We have effected inter-company advances and sold goods to our German subsidiary, as well as our subsidiaries in Italy and Switzerland, denominated in U.S. dollars, and those amounts are subject to
currency fluctuation and require constant revaluation on our financial statements. In fiscal 2002 and 2001, we incurred a net foreign currency transaction gain of $85,000 and a loss of $54,000 respectively, which are included in our selling, general
and administrative expenses. We do not operate a hedging program to mitigate the effect of a significant rapid change in the value of the Euro or the Swiss franc compared to the U.S. dollar. If such a change did occur, we would incur a currency
exchange gain or loss in the amount of the change in the U.S. dollar denominated balance of the amounts outstanding at the time of such change. Our net sales can also be affected by a change in the exchange rate because we translate sales of our
subsidiaries at the average rate in effect during a financial reporting period. At July 31, 2002, approximately $10.5 million in current inter-company advances and accounts receivable from our foreign subsidiaries were outstanding. We cannot assure
you that we will not sustain a significant loss if a rapid or unpredicted change in value of the Euro or related European currencies should occur. We cannot assure you that such a loss would not have an adverse material effect on our results of
operations or financial condition.




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##### Table of Contents

Item 8.Financial Statements and Supplementary Data





INDEX TO CONSOLIDATED FINANCIAL STATEMENTS





PageIndependent Auditors Report

34Consolidated Balance Sheets

35Consolidated Statements of Operations

36Consolidated Statements of Shareholders Equity

37Consolidated Statements of Cash Flows

38Notes to Consolidated Financial Statements

39




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##### Table of Contents

INDEPENDENT AUDITORS REPORT





The Board of Directors of Procom Technology, Inc.:





We have audited the accompanying consolidated balance sheets of Procom Technology, Inc. and subsidiaries as of July 31, 2001 and 2002, and the related consolidated statements of operations,
shareholders equity and comprehensive loss and cash flows for each of the years in the three-year period ended July 31, 2002. In connection with our audits of the consolidated financial statements, we also have audited the financial statement
schedule as of and for each of the years in the three-year period ended July 31, 2002. These consolidated financial statements and the financial statement schedule are the responsibility of the Companys management. Our responsibility is to
express an opinion on these consolidated financial statements and financial statement schedule based on our audits.





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





In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Procom Technology, Inc. and
subsidiaries as of July 31, 2001 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended July 31, 2002, in conformity with accounting principles generally accepted in the United States
of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.








KPMG LLP








Orange County, California


October 29, 2002




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##### Table of Contents

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





CONSOLIDATED BALANCE SHEETS





July 31,2001


2002ASSETSCurrent assets:Cash and cash equivalents

$
25,419,000


$
10,845,000Accounts receivable, less allowance for doubtful accounts and sales returns of $6,412,000 and $8,090,000,
respectively


11,979,000



4,845,000Inventories


6,292,000



6,764,000Income taxes receivable


18,000



2,282,000Prepaid expenses


1,184,000



542,000Other current assets


310,000



346,000Total current assets


45,202,000



25,624,000Property and equipment, net


17,766,000



16,357,000Goodwill and other intangibles, net


2,247,000



Other assets


12,000



28,000Total assets

$
65,227,000


$
42,009,000LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Lines of credit

$
8,000


$
46,000Flooring line obligation


531,000



251,000Current portion of long-term debt






172,000Accounts payable


4,151,000



2,837,000Accrued compensation


1,194,000



752,000Current portion of payable to related parties






1,632,000Accrued expenses and other current liabilities


2,052,000



2,734,000Deferred service revenues


447,000



548,000Income taxes payable


51,000



56,000Convertible debenture


9,726,000



Total current liabilities


18,160,000



9,028,000Long-term debt, net of current portion






8,477,000Payable to related parties, net of current portion






1,213,000Total liabilities


18,160,000



18,718,000Commitments, contingencies and subsequent eventsShareholders equity:Preferred stock, no par value; 10,000,000 shares Authorized, no shares issued and outstanding






Common stock, $.01 par value; 65,000,000 shares authorized, 15,993,564 and 16,084,708 shares issued and outstanding,
respectively


160,000



161,000Additional paid-in capital


58,575,000



58,696,000Accumulated deficit


(11,343,000
)


(35,703,000
)Accumulated other comprehensive income (loss)


(325,000
)


137,000Total shareholders equity


47,067,000



23,291,000Total liabilities and shareholders equity

$
65,227,000


$
42,009,000





See accompanying notes to consolidated financial statements.




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##### Table of Contents

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF OPERATIONS





Year Ended July 31,2000


2001


2002Net sales

$
63,210,000


$
41,882,000


$
25,030,000Cost of sales


46,189,000



26,625,000



16,326,000Gross profit


17,021,000



15,257,000



8,704,000Selling, general and administrative


21,930,000



21,235,000



28,500,000Research and development


7,187,000



6,403,000



6,381,000In-process research and development






4,262,000



Asset impairment










2,417,000Total operating expenses


29,117,000



31,900,000



37,298,000Operating loss


(12,096,000
)


(16,643,000
)


(28,594,000
)Interest income


1,055,000



809,000



560,000Interest expense


(7,000
)


(1,716,000
)


(1,490,000
)Loss before income taxes


(11,048,000
)


(17,550,000
)


(29,524,000
)Provision (benefit) for income taxes


(3,064,000
)


1,800,000



(5,164,000
)Net loss

$
(7,984,000
)

$
(19,350,000
)

$
(24,360,000
)Net loss per common share:Basic and diluted

$
(0.70
)

$
(1.54
)

$
(1.52
)Weighted average number of common shares:Basic and diluted


11,351,000



12,533,000



16,018,000








See accompanying notes to
consolidated financial statements.




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##### Table of Contents




PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSS





Common Stock

Additional Paid-in Capital

Retained Earnings
(Accumulated Deficit)


Accumulated Other Comprehensive Income (Loss)


TotalShares

AmountBALANCE AT JULY 31, 1999

11,227,041

$
112,000

$
18,198,000

$
15,991,000


$
(15,000
)

$
34,286,000Comprehensive loss:Net loss










(7,984,000
)






(7,984,000
)Foreign currency translation adjustment














(236,000
)


(236,000
)Comprehensive loss


















(8,220,000
)Compensatory stock options







62,000










62,000Exercise of employee stock options

278,587


3,000


1,112,000










1,115,000Issuance of stock to employees

25,729





313,000










313,000BALANCE AT JULY 31, 2000

11,531,357


115,000


19,685,000


8,007,000



(251,000
)


27,556,000Comprehensive loss:Net loss










(19,350,000
)






(19,350,000
)Foreign currency translation adjustment














(74,000
)


(74,000
)Comprehensive loss


















(19,424,000
)Issuance of common stock through public offering, net of issuance costs of $2.7 million

3,800,000


38,000


31,453,000










31,491,000Acquisition of business

480,000


5,000


5,755,000










5,760,000Compensatory stock options







41,000










41,000Exercise of employee stock options

157,401


2,000


845,000










847,000Issuance of stock to employees

24,806





234,000










234,000Issuance of stock warrant to investor







562,000










562,000BALANCE AT JULY 31, 2001

15,993,564


160,000


58,575,000


(11,343,000
)


(325,000
)


47,067,000Comprehensive loss:Net loss










(24,360,000
)






(24,360,000
)Foreign currency translation adjustment














462,000



462,000Comprehensive loss


















(23,898,000
)Compensatory stock options







2,000










2,000Exercise of employee stock options

4,500





23,000










23,000Issuance of stock to employees

86,644


1,000


96,000










97,000BALANCE AT JULY 31, 2002

16,084,708

$
161,000

$
58,696,000

$
(35,703,000
)

$
137,000


$
23,291,000





See accompanying notes to consolidated financial statements.







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##### Table of Contents

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





CONSOLIDATED STATEMENTS OF CASH FLOWS





Years Ended July 31,2000


2001


2002CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(7,984,000
)

$
(19,350,000
)

$
(24,360,000
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


895,000



1,506,000



1,979,000Provisions for bad debt and sales returns


6,277,000



7,715,000



8,065,000Amortization of debt issuance costs related to stock warrant






288,000



274,000Compensatory stock options


62,000



41,000



2,000Acquired in-process research and development






4,262,000



Asset impairment










2,417,000Deferred income taxes






1,833,000



Changes in operating accounts:Accounts receivable


(4,328,000
)


(12,984,000
)


(931,000
)Inventories


1,543,000



2,138,000



(472,000
)Income taxes receivable and deferred income taxes


160,000



2,681,000



(2,264,000
)Prepaid expenses


143,000



(812,000
)


142,000Other current assets


(10,000
)


(14,000
)


(36,000
)Other assets


(17,000
)


61,000



(16,000
)Accounts payable


(413,000
)


(4,847,000
)


(1,314,000
)Accrued expenses and other liabilities


(325,000
)


215,000



682,000Accrued compensation


1,000



(19,000
)


(442,000
)Payable to related parties










2,845,000Deferred service revenues


(413,000
)


16,000



101,000Income taxes payable


(18,000
)


51,000



5,000Net cash used in operating activities


(4,427,000
)


(17,219,000
)


(13,323,000
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment


(7,289,000
)


(2,793,000
)


(240,000
)Redemption of short-term marketable securities


9,008,000







Cash used in acquisitions, net of cash acquired






(250,000
)


Net cash provided by (used in) investing activities


1,719,000



(3,043,000
)


(240,000
)CASH FLOWS FROM FINANCING ACTIVITIES:Borrowings of long-term debt


3,250,000







8,750,000Repayment of long-term debt






(10,750,000
)


(101,000
)Issuance of convertible debenture






15,000,000



Repayment of convertible debentures






(5,000,000
)


(10,000,000
)Net borrowings on lines of credit


356,000



(602,000
)


38,000Flooring line obligation






(980,000
)


(280,000
)Proceeds from issuance of common stock to employees


313,000



234,000



97,000Proceeds from exercise of stock options


1,115,000



847,000



23,000Net proceeds from issuance of common stock






31,491,000



Net cash provided by (used in) financing activities


5,034,000



30,240,000



(1,473,000
)Effect of exchange rate changes


(236,000
)


(74,000
)


462,000Increase (decrease) in cash and cash equivalents


2,090,000



9,904,000



(14,574,000
)Cash and cash equivalents at beginning of year


13,425,000



15,515,000



25,419,000Cash and cash equivalents at end of year

$
15,515,000


$
25,419,000


$
10,845,000Supplemental disclosures of cash flow information:CASH PAID (RECEIVED) DURING THE YEAR FOR:Interest

$
7,000


$
845,000


$
645,000Income taxes

$
(2,754,000
)

$
(2,765,000
)

$
(2,902,000
)SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES:Common stock warrant issued to convertible debenture investor

$



$
562,000


$
Common stock issued for acquisition of business

$



$
5,760,000


$






See accompanying notes to consolidated financial statements.




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##### Table of Contents

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS





1.    Summary
of Significant Accounting Policies





Organization





Procom Technology, Inc. (the Company) was incorporated in California in 1987. The Company develops, manufactures and markets network-attached storage (NAS)
appliances for computer networks and operating systems. The Company also sells disk storage upgrade systems, CD/DVD-Rom servers and arrays and tape backup products.





Basis of Presentation





The
consolidated financial statements include the accounts of Procom Technology, Inc. and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation. The functional currencies of the European
subsidiaries are those of their respective countries. The Company incurred net foreign currency transaction losses of approximately $213,000 and $54,000 and a transaction gain of $85,000 for the years ended July 31, 2000, 2001 and 2002,
respectively. The Company did not engage in hedging activities for any of these periods. The Company follows the provisions of Statement of Financial Accounting Standards (SFAS) 52 when translating assets and liabilities and results of
operations for each period presented.





Cash and Cash Equivalents





For statement of cash flow purposes, short term marketable securities with original maturities less than 90 days are considered cash
equivalents.





Financial Instruments





The Companys financial instruments consist of cash, cash equivalents, income tax receivable and payable, trade accounts receivable and accounts payable, lines of
credit, flooring line obligation, and long term debt. The fair value of these instruments, excluding long term debt, approximates their financial statement carrying amounts due to their short maturities. The fair value of the long term debt
approximates its carrying value since the debt bears interest at a variable rate and changes in interest do not significantly impact the fair value of the debt.





Accounts Receivable





The allowance for doubtful accounts
represents managements estimate of the amount expected not to be collected on specific accounts and on other as yet unidentified accounts included in accounts receivable. The Company does not require collateral or other security for its sales
transactions. The allowance for sales returns represents managements estimates of anticipated sales returns relating to each reporting period.





Inventories





Inventories are valued at the lower of cost
(on a first-in, first-out (FIFO) basis) or market. Allowances for obsolete inventory are based on managements estimate of the amount considered obsolete based on specific reviews of inventory items. In estimating the allowance, management
relies on its knowledge of the industry (including technological and design changes) as well as its current inventory levels. The amounts the Company will ultimately realize could differ materially from amounts estimated by management. Inventory
includes product that is sent to potential customers on an evaluation basis. At July 31, 2002 and 2001, inventory related to evaluation units was $1.0 million and $1.2 million, net of valuation allowances, respectively. Revenue is not recorded for
evaluation systems until the customer has purchased these products.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Income Taxes





The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. Management evaluates the need to establish a valuation allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be
recovered and expected levels of taxable income.





Long-Lived Assets





Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the respective estimated useful
lives of the assets, which range from three to seven years. Leasehold improvements are amortized using the straight-line method over the lesser of the lease term or the estimated useful life of the assets.





Expenditures for major renewals and betterments are capitalized, while minor replacements, maintenance and repairs that do not extend the
assets lives are charged to operations as incurred. Upon sale or disposition, the cost and related accumulated depreciation are removed from the Companys accounts and any gain or loss is included in the statement of operations. Interest
of approximately $489,000, $142,000 and $0 has been capitalized during fiscal years 2000, 2001 and 2002, respectively, and included in the cost of the Companys headquarters.





Long-lived assets, goodwill and certain identifiable intangibles are reviewed for impairment in value based upon a comparison of undiscounted future operating cash flows to
the carrying value of the asset whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If this evaluation indicates that the intangible asset is not recoverable, the amount of the impairment is measured
as the difference between the carrying value and the fair value of the impaired asset. During fiscal 2002, the Company determined that the value of the goodwill, acquired workforce and developer relationships was impaired at its European
subsidiaries. The Company based the determination on the continued losses incurred at those subsidiaries, estimates of the future difficulties that a return to profitability would entail, and the resources that would be required to effect that
return to profitability. In addition, the Company determined that its strategy to improve and implement betterments in technologies acquired and had licensed would be changed to conserve existing cash resources. After making these determinations,
the Company recorded an impairment charge of approximately $2.4 million in fiscal year 2002.





Revenue
recognition and allowances





The Companys products include an operating system that is integral to the
overall product and its functionality. The Company recognizes revenue for NAS products in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as amended by SOP 98-9, Software Revenue
Recognition with Respect to Certain Arrangements. The Company recognizes revenue for its NAS products when:





Persuasive Evidence of an Arrangement Exists.    It is the Companys customary practice to have a purchase order prior to recognizing revenue on an arrangement.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Delivery Has Occurred.    The
Companys product is physically delivered to its customers, generally with standard transfer terms of FOB shipping point. If undelivered products or services exist that are essential to the functionality of the delivered product in an
arrangement, delivery is not considered to have occurred. The core operating system software that the customer purchases is pre-installed and tested at the Companys facility prior to shipment and does not require significant production,
modification, or customization at the customers site; as such, the system is functional according to the Companys specifications at the time of shipment.





The Price Is Fixed or Determinable.    Arrangements with extended payment terms are not considered to be fixed or determinable. Revenue from such arrangements is recognized
as the fees become due and payable.





Collection Is Probable.    Probability of
collection is assessed on a customer-by-customer basis. Customers are subjected to a credit review process that evaluates the customers financial position and ultimately their ability to pay. If it is determined from the outset of an
arrangement that collection is not probable based upon our review process, revenue is recognized when realized.





The Company recognizes revenue on multiple element arrangements using the residual method. Under the residual method, revenue is recognized when Company-specific objective evidence of fair value exists for all of the undelivered
elements in the arrangement, but does not exist for one or more of the delivered elements in the arrangement. At the outset of the arrangement with the customer, the Company defers revenue for the fair value of the undelivered elements such as
consulting services and product support and upgrades and recognizes the revenue for the remainder of the arrangement fee attributable to the elements initially delivered when the basic criteria in SOP 97-2 have been met. Revenue from consulting
services is recognized as the related services are preformed. Revenue from support and upgrade contracts is recognized ratably over the term of the support period of one to three years.





Revenue from sales of the Companys non NAS products is recognized in accordance with Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial
Statements. The revenue recognition criteria of SAB 101 are consistent with the NAS policies described above.





The Companys product evaluation program enables the customer to receive appliances on a trial basis and return the appliances within a specified period, generally 30-60 days. The period may be extended if the customer needs
additional time to evaluate the product within the customers particular operating environment. Revenue is not recorded for evaluation systems until the customer has purchased these products.





Cost of Sales





The Companys cost of sales consists primarily of the cost of components produced by its suppliers, such as disk drives, cabinets, power supplies, controllers and CPUs, its direct and indirect labor expenses and related
overhead costs such as rent, utilities and manufacturing supplies and other expenses. In addition, cost of sales includes third party license fees, warranty expenses and allowances for excess and obsolete inventory.





Selling, General and Administrative Expenses





Selling expenses include costs directly associated with the selling process such as salaries and commissions of sales personnel, marketing, direct and cooperative
advertising and travel expenses. General and administrative expenses include the Companys general corporate expenses, such as salaries and benefits, rent, utilities, bad debt expense, legal and other professional fees and expenses,
depreciation and amortization. Advertising expense was $1.4 million, $0.8 million and $0.3 million during the years ended July 31, 2000, 2001 and 2002, respectively.




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Research and Development Expenses





Research and development expenses consist of the costs associated with software and hardware development. Specifically, these costs
include employee salaries and benefits, consulting fees for contract programmers, test supplies, employee training and other related expenses.





Software development costs are charged to research and development expense in the period the costs are incurred until technological feasibility is established. The Company has not capitalized any
software development costs as technological feasibility is generally not established until a working model is completed at which time substantially all development is complete. All other research and development costs are expensed as incurred.





Use of Estimates





The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.





Concentration of Credit Risk





Three customers accounted for approximately 54% and 34% of the Companys total net accounts receivable on July 31, 2001 and 2002, respectively. The loss of any one of
the Companys significant customers could have an adverse effect on the Companys business.





Net Loss
per Common Share





Basic earnings per share are computed by dividing net loss by the weighted-average number of
common shares outstanding during the period. Diluted earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding during the period increased to include the number of additional shares that would
be outstanding if dilutive potential common shares had been issued. The dilutive effect of outstanding options and warrants is reflected in diluted earnings per share by application of the treasury-stock method.





Due to the net losses in fiscal 2000, 2001 and 2002, no effect is given to the potential common stock because the effect would be
antidilutive. Approximately 1,184,000, 922,000 and 381,000 shares would have been included in the computation of diluted earnings per share if a net loss had not been incurred in fiscal 2000, 2001 and 2002, respectively.





Stock Based Compensation





The Company measures stock based compensation for option grants to employees and members of the board of directors using a method which assumes that options granted at market price at the date of grant
have no intrinsic value. Proforma net loss and net loss per share are presented in Note 10 of the consolidated financial statements as if the fair value method had been applied.





Stock options issued to non-employees are recorded at the fair value of the stock options at the performance commitment date.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Impact of Recent Accounting Pronouncements





In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. Under SFAS No. 141, all business combinations initiated after June 30, 2001 must be accounted for using the purchase method. Under SFAS No. 142, which is
effective for fiscal year 2003, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually for impairment (or more frequently if indicators of impairment arise). In fiscal 2002, the Company determined that
all of its existing goodwill and other intangible assets had been impaired, and the Company recorded an impairment charge of approximately $2.4 million. Accordingly, upon adoption of SFAS No. 142, the Company will not have any net goodwill or other
intangible assets.





In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Assets to Be
Disposed Of. Adoption of SFAS No. 144 is required for our fiscal year beginning August 1, 2002. We are currently evaluating the potential impact of adopting SFAS No. 144 on our financial position and results of operations and have not yet
determined the impact of adopting this statement.





In June 2002, the Financial Accounting Standards Board issued
SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS No. 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).





SFAS No. 146 requires that the liability for costs associated with an exit or disposal activity be initially measured at fair value and recognized when the liability is incurred. In periods subsequent to initial measurement, changes
to the liability are measured using the credit-adjusted risk-free rate that was used in the initial measurement of the liability recorded. The cumulative effect of a change resulting from revisions to either the timing or the amount of estimated
cash flows is recognized as an adjustment to the liability in the period of the change and charged to the same line items in the statement of operations used when the related costs were initially recognized. Under EITF No. 94-3, a liability for an
exit cost was recognized at the date of the companys commitment to an exit plan.





The provisions of SFAS No.
146 are required to be applied prospectively to exit or disposal activities initiated after December 31, 2002. We believe SFAS No. 146 may affect the timing of recognizing future restructuring costs, as well as the amounts recognized, depending on
the nature of the exit or disposal activity.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







2.    Inventories





A summary of inventories is as follows:








Year Ended July 31,2001

2002Raw materials

$
4,374,000

$
3,087,000Work-in-process


295,000


840,000Finished goods


1,623,000


2,837,000$
6,292,000

$
6,764,000





3.    Property and Equipment





A summary of property and equipment is as follows:





Year Ended July 31,2001


2002Computer equipment

$
3,955,000


$
4,435,000Furniture and fixtures


1,167,000



861,000Office equipment


1,216,000



1,282,000Vehicles


47,000



45,000Leasehold improvements


297,000



298,000Land


8,283,000



8,283,000Buildings


7,715,000



7,715,000Subtotal


22,680,000



22,919,000Less accumulated depreciation


(4,914,000
)


(6,562,000
)Total

$
17,766,000


$
16,357,000





Depreciation expense for fiscal 2000, 2001 and 2002 totaled
$728,000, $1,166,000 and $1,499,000, respectively.





4.    Income Taxes





Loss before income taxes consisted of the following:





Year Ended July 31,2000


2001


2002Pretax loss:United States

$
(9,772,000
)

$
(14,032,000
)

$
(18,000,000
)Foreign


(1,276,000
)


(3,518,000
)


(11,524,000
)$
(11,048,000
)

$
(17,550,000
)

$
(29,524,000
)




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







The components of the provision (benefit) for income taxes for fiscal
2000, 2001 and 2002 are summarized as follows:








Year Ended July 312000


2001


2002Current:Federal

$
(3,064,000
)

$
(69,000
)

$
(5,164,000
)State






7,000



Foreign






29,000



(3,064,000
)


(33,000
)


(5,164,000
)Deferred:Federal






1,405,000



State






428,000







1,833,000



Provision (benefit) for income taxes

$
(3,064,000
)

$
1,800,000


$
(5,164,000
)





The following table reconciles the federal statutory income tax
rate to the effective tax rate of the provision (benefit) for income taxes.





Year Ended July 312000


2001


2002Federal statutory income tax rate

(34.0
)%

(34.0
)%

(34.0
)%State income taxes, net of federal benefit

(2.4
)%

(2.9
)%

(5.8
)%Research and development tax credit

(4.7
)%

(3.9
)%

(2.7
)%Valuation allowance on net deferred tax assets

13.8
%

39.5
%

23.4
%Purchased research and development




8.3
%

Other

(0.4
)%

3.3
%

1.6
%Effective tax rate

(27.7
)%

10.3
%

(17.5
)%




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Deferred tax assets and liabilities are summarized below:





Year Ended July 31,2001


2002Deferred tax assets:Depreciation

$
13,000


$
319,000Inventory reserves


1,167,000



1,674,000Reserves for bad debts and sales returns


1,691,000



1,030,000Deferred service revenue


128,000



203,000Research and development tax credit


1,559,000



2,367,000Accrued expenses


270,000



1,564,000Net operating loss carry forwardsstate


524,000



1,957,000Net operating loss carry forwardsfederal


2,117,000



2,291,000Net operating loss carry forwardsforeign


1,974,000



5,738,000Other


17,000



19,000Total deferred tax assets


9,460,000



17,162,000Deferred tax liabilitystate tax payments


(569,000
)


(1,367,000
)Total deferred income taxes


8,891,000



15,795,000Valuation allowance


(8,891,000
)


(15,795,000
)Net deferred income taxes

$



$






A valuation allowance equal to the net deferred tax asset has been
provided as management believes it is more likely than not that the Company will not realize the benefits of the existing net deferred tax asset at July 31, 2002. The Company claimed no benefit in the current provision for some $11,302,000 in
operating losses at its foreign subsidiaries. If those subsidiaries generate taxable income in future periods, the Company may realize a tax benefit for these operating losses.





At July 31, 2002, the Company had net operating loss carryforwards for federal and state income tax purposes of approximately $7,135,000 and $23,262,000, respectively,
which are available to offset future taxable income, if any, through 2022 and 2015, respectively, subject to an annual statutory limitation.





At July 31, 2002, the Company had tax credit carryforwards for federal and state income tax purpose of approximately $2,017,000 and $973,000, respectively. The federal and state carryforwards are
available to offset future tax liability, if any, through 2022. Utilization of the carryforwards may be limited under Internal Revenue Code Section 382.





The Job Creation and Workers Assistance Act of 2002, signed by the President in February 2002, permits the Company to carry back certain of its net deferred operating losses for 5 years instead
of only 2 years. The Company previously had not believed it would be able to recover a tax benefit related to its prior year losses. As a result of the legislation, in April 2002, the Company filed amended tax returns for prior year losses, and in
June 2002, the Company received a tax refund of $2.9 million. In addition, in August 2002, the Company received approximately $2.1 million in additional tax refunds when the Company filed its fiscal 2002 tax return, and carried fiscal 2002 operating
losses back to previous periods. The Company anticipates that it will receive an additional refund of approximately $0.2 million. The Company has recorded in the current year a tax benefit of $5.2 million.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







5.    Other Assets





Other assets consist of the following:





Year Ended July 31,2001


2002Goodwill and other intangibles

$
2,957,000


$
Accumulated amortization


(710,000
)


Other assets


12,000



28,000$
2,259,000


$
28,000





Goodwill and other intangibles relate to two acquisitions completed
by the Company in fiscal 1998, two acquisitions completed in fiscal 1999 and one acquisition completed in fiscal 2001. Goodwill and other intangibles had been amortized on a straight line basis over four to seven years. In fiscal 2000, 2001 and
2002, amortization of goodwill and other intangibles was $167,000, $340,000 and $480,000, respectively. At July 31, 2002, the remaining value of goodwill was determined to be impaired, and as a result, was written off.





6.    Lines of Credit, Long-Term Debt and Convertible Debenture





On July 31, 2000, the Company had established a revolving line of credit with Finova Capital Corporation. The line had been based on a percentage of the Companys
eligible accounts receivable and inventory, up to a maximum of $10,000,000. In early October 2000, the Company paid off all amounts outstanding under the Finova line of credit and replaced it with the line of credit with CIT Business Credit.





On October 10, 2000, the Company entered into a three-year working capital line of credit with The CIT
Group/Business Credit (CIT). The working capital line of credit allows for the Company to borrow, on a revolving basis, for a period of three years, a specified percentage of its eligible accounts receivable (approximately $1.8 million
at July 31, 2002), up to a limit of $5.0 million or the line will be terminated. Amounts outstanding under the working capital line bear interest at the lenders prime rate plus .25%. At July 31, 2002, no amounts were outstanding under the
working capital line of credit. The line of credit accrues various monthly maintenance, minimum usage and early termination fees. The line of credit is collateralized by certain assets of the Company. The line of credit requires certain financial
and other covenants, including the maintenance of a minimum EBITDA requirement for rolling 12-month periods ending on each fiscal quarter. For the twelve month period ended on July 31, 2002, the Company was not in compliance with the minimum EBITDA
requirement. The lender has not waived the Companys non-compliance with this covenant for this period and the Company cannot borrow under the line.





On October 31, 2000, the Company issued a $15.0 million convertible unsecured debenture to a private investor. The debenture carried interest at 6.0% per annum, and was repayable in full on October 31,
2003, unless otherwise converted into the common stock of the Company. In connection with the issuance of the debenture, the Company issued to the investor a 5-year warrant to purchase up to 32,916 shares of its common stock at an initial exercise
price of $32.55 per share, with the number of shares for which the warrant is exercisable and the exercise price subject to antidilution adjustments. The value of the warrant of $562,000 was computed using the Black-Scholes model, with the following
assumptions: Expected life5 years, Risk free interest rate6%, and Volatility1.20. In the second quarter of fiscal 2002, the Company paid the investor the remaining principal amount of the debentures and expensed the remaining
unamortized debt issuance and warrant costs of $274,000 to interest expense.







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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




In November 2001, the Company borrowed $8.75 million under a financing arrangement secured by the
Companys corporate headquarters. The principal amount outstanding bears interest at prime plus 1.0% per annum, but not less than 7.0% per annum. Under certain conditions, the Company has the right to request that portions of the principal
amount outstanding under the note shall bear interest at a LIBOR based rate, but not less than 7.0%. As of July 31, 2002, the interest rate on the loan was 7.0%. Principal payments of $14,400 plus accrued interest are due monthly with the remaining
principal balance and unpaid interest due at the maturity date of January 1, 2007. Up to an additional $1.0 million may be borrowed under this financing arrangement to cover leasing costs and tenant improvements on the vacant, unimproved space
within the corporate headquarters upon finding a qualified tenant. At July 31, 2002, the outstanding principal balance of the loan totaled $8.6 million. Under the terms of the loan agreement, the lender may immediately accelerate all amounts
disbursed under the loan agreement and terminate any further obligation of the lender to disburse additional amounts under the financing arrangement if there exists any event or condition that the lender in good faith believes impairs (or is
substantially likely to impair) the prospect of payment or performance by the Company of its obligations under the applicable loan documents.





The Company has a flooring line with IBM Credit, which at July 31, 2002 had committed to make $2.0 million in flooring inventory commitments available to the Company. In September 2002, IBM Credit
notified the Company that the credit line was being reduced to $0.5 million, effective immediately. In addition, prior to November 18, 2002, the Company is required to provide IBM Credit with an irrevocable letter of credit totaling $0.5 million. As
of July 31, 2001 and July 31, 2002, the Company owed $531,000 and $251,000, respectively, under the flooring line. The flooring line is collateralized by the specific inventory purchased using the flooring line. CIT and IBM Credit have entered into
an intercreditor agreement which determines the level of priority of either lenders security interest. The flooring line requires the maintenance by the Company of a minimum net worth of $16.0 million. The Company was in compliance with the
net worth covenant of the flooring line at July 31, 2002. The flooring line also requires the Company not to be in default of any covenants in the CIT agreement. IBM Credit has waived noncompliance with that covenant at July 31, 2002, but IBM Credit
has notified the Company of the changes to IBMs relationship with the Company, as discussed above.





The
Companys foreign subsidiaries in Germany, Italy and Switzerland have lines of credit with banks in their respective countries that are utilized primarily for overdraft and short-term cash needs. At July 31, 2002, the amount outstanding under
these lines was $46,000.





In October 2000, the Company repaid an 18-month loan payable to an investment bank of
$10.75 million. The loan, which originally matured in September 2000 but was subsequently renewed for an additional 6-month period, carried rates ranging from 6.125% to 7.4%.





7.    Commitments and Contingencies





Lease Commitments





At July 31, 2001, the Company leases facilities under non-cancelable
operating leases in Germany, Italy, Canada, France and China. In addition, the Company has various operating leases for certain office equipment and vehicles.




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







At July 31, 2002, future minimum lease payments under these leases
were as follows:





Operating LeasesFiscal year ending:2003

$
401,0002004


233,0002005


78,0002006


48,0002007


48,000Thereafter


68,000Total minimum lease payments

$
876,000





Rent expense was $1,412,000, $458,000 and $330,000 for fiscal 2000,
2001 and 2002, respectively.





Litigation





The Company is involved in routine litigation arising in the ordinary course of its business. Also, from time to time, the Company receives claims that it is infringing
third parties intellectual property rights. The Company was notified in fiscal 2001 that its products may infringe some of the intellectual property rights of Intel. Intel has offered the Company a non-exclusive license for patents in the
Intel portfolio. The Company has investigated the Intel claims, and has had negotiations with Intel. While the outcome of claim resolution or litigation cannot be predicted with certainty, the Company believes that none of the pending claims or
litigation will have a material adverse effect on the Companys financial position or results of operations.





Employment Agreements





In May 2002, the employment of three executives of the Company was
terminated. Pursuant to agreements executed between the Company and the executives, one of the executives will receive monthly payments of $18,750 for 36 months following termination, one will receive monthly payments of $18,750 for 30 months
following termination, and the third will receive monthly payments of $18,750 for 30 months following termination and monthly payments of $37,500 for six months after the last such $18,750 monthly payment. Each former executive will be entitled to
participate in the Companys employee benefit, health and other insurance plans for the 36 months following their termination. In the fourth quarter of fiscal 2002, the Company recorded a charge of approximately $1.9 million for the present
value of the remaining unpaid severance and employee benefits which is included in payable to related parties.





8.    Retirement Plan





The Company has a defined contribution plan
covering substantially all full-time employees with more than one year of service. Each participant can elect to contribute up to 15% of his or her annual compensation. While employer contributions to the plan are discretionary, during fiscal 2000,
2001 and 2002 the Company elected to make matching contributions equivalent to between 38% and 50% of the first 4% of each eligible employees contribution. Total expense for fiscal 2000, 2001 and 2002 was $86,000, $82,000 and $66,000,
respectively.





9.    Related Party Transactions





In fiscal 2001 and 2002, the Company utilized the services of Advanced Construction Solutions, Inc. (ACS), an Orange County based real estate developer and general
contractor to (a) locate a suitable facility for the Company to utilize as its corporate headquarters for approximately 18 months, (b) act as a general contractor to complete a build-out of necessary tenant improvements for the temporary facility,
and (c) locate, and then




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




negotiate the purchase of, and commence development of, a parcel of land in Irvine, California for the Companys long-term corporate headquarters. ACS is owned 50% by a brother of Frank
Alaghband, a Director of the Company. The Company also agreed to utilize ACS in the construction of the Irvine facility. The Company has expended approximately $7.7 million for construction costs through July 31, 2002. A majority of the construction
costs were paid to ACS.





10.    Stock Option Plan and Employee Stock Purchase Plan





During fiscal 1996, the Company instituted the 1995 Stock Option Plan (the 1995 Plan) for its key employees. Pursuant to the
terms of the 1995 Plan, options to purchase the Companys common stock may be granted with exercise prices equal to the fair market value of the stock on the date of grant. Options expire ten years from the date of the grant and generally vest
over a period of four years.





The following table is a summary of stock option activity for the three years ended
July 31, 2002:





Year Ended July 31,2000

2001

2002Shares


Weighted Average Exercise
Price

Shares


Weighted Average Exercise
Price

Shares


Weighted Average Exercise
PriceOutstanding at beginning of year

1,403,449


$
4.06

1,965,178


$
8.43

2,220,694


$
7.80Granted

1,085,071


$
11.91

735,579


$
6.54

127,900


$
2.88Exercised

(278,587
)

$
4.00

(157,401
)

$
5.38

(4,500
)

$
5.06Cancelled

(244,755
)

$
5.60

(322,662
)

$
9.96

(614,542
)

$
7.09Outstanding at end of year

1,965,178


$
8.43

2,220,694


$
7.80

1,729,552


$
7.69Exercisable end of year

247,748


$
4.34

528,647


$
8.10

866,205


$
7.66Weighted fair value per option granted




$
9.28




$
5.84




$
0.24





July 31, 2002Options Outstanding

Options ExercisableRange of Exercise Prices

Number

Weighted-Average Remaining Years

Weighted-Average Exercise Price

Number

Weighted-Average Exercise Price$2.50 -   3.00

58,350

7.19

$
2.77

19,450

$
2.50$4.50 -   6.48

1,208,388

7.53

$
5.52

595,664

$
5.08$8.50 - 16.25

462,814

7.56

$
13.98

251,091

$
14.171,729,552

7.52

$
7.69

866,205

$
7.66




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)







Pro forma information regarding net loss and net loss per share is
required by SFAS 123 as if the Company had accounted for its stock options under the fair value method of SFAS 123. The fair value of the Companys stock options was estimated using the Black-Scholes option valuation model. The fair value of
the Companys stock options granted to employees was $9.28, $5.84 and $0.24 in fiscal 2000, fiscal 2001 and fiscal 2002, respectively, and was estimated assuming no expected dividends and the following weighted average assumptions:





Stock Option Plan Shares2000


2001


2002Expected life (in years)

5.0


4.0


4.0Risk-free interest rate

6.0
%

4.63
%

2.82
%Volatility

0.91


1.40


1.42





For purposes of pro forma disclosures, the estimated fair values of
the options are amortized over the options respective vesting period. The Companys pro forma information follows:





2000


2001


2002Pro forma net loss

$
(8,414,000
)

$
(22,341,000
)

$
(25,604,000
)Pro forma basic and diluted net loss per share

$
(.74
)

$
(1.78
)

$
(1.60
)





In fiscal 1999, the Company adopted an employee stock purchase plan
(ESPP) that operates in accordance with Section 423 of the Internal Revenue Code whereby eligible employees may, subject to certain limitations, authorize payroll deductions of up to 10% of their salary to purchase shares of the
Companys common stock at 85% of the fair market value of the stock on the first or last date of semiannual purchase periods, whichever is less. The Company has reserved 250,000 shares of common stock for issuance under the ESPP. Approximately
26,000, 25,000 and 61,000 shares were issued under the ESPP during fiscal 2000, 2001 and 2002, respectively.





11.    Revenue by Product Area and Geographic Area





Revenues by
Product Families





The Company operates in one principal industry segment: the design, manufacture and
marketing of enterprise-wide data storage and information access solutions. No one customer accounted for more than 10% of the Companys net sales in fiscal 2000 and 2002. One customer accounted for approximately 12% of net sales in fiscal
2001.





Year Ended July 31,2000

2001

2002Net revenues:Network attached storage products

$
17,442,000

$
28,376,000

$
19,895,000Other data storage products


45,768,000


13,506,000


5,135,000Total net revenues

$
63,210,000

$
41,882,000

$
25,030,000




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)










Geographic Information





International sales as a percentage of net sales amounted to 41%, 56% and 38% for fiscal years 2000, 2001 and 2002, respectively. A
summary of the Companys net sales and gross profit by geographic area is as follows (in thousands):





Year Ended July 31,2000


2001


2002Net salesUnited States

$
37,024


$
18,567


$
15,554Foreign


26,186



23,315



9,476Total

$
63,210


$
41,882


$
25,030Gross profitUnited States

$
11,878


$
5,001


$
5,066Foreign


5,143



10,256



3,638Total

$
17,021


$
15,257


$
8,704Operating lossUnited States

$
(9,909
)

$
(15,993
)

$
(21,169
)Foreign


(2,187
)


(650
)


(7,425
)Total

$
(12,096
)

$
(16,643
)

$
(28,594
)





International sales were primarily to European and Pacific Rim
customers. The Company has identifiable assets used in connection with its foreign operations of approximately $7,565,000, $8,447,000 and $3,065,000 at July 31, 2000, 2001 and 2002, respectively.





12.    Acquisitions





On
December 28, 2000, the Company acquired all of the issued and outstanding capital stock of Scofima Software S.r.l., a company organized under the laws of Italy (Scofima), in exchange for 480,000 shares of the Companys common stock.
Pursuant to its agreement with the former shareholders of Scofima, the Company registered for resale by those shareholders the shares issued to them in the acquisition. Scofima had an option to acquire a software system designed as a caching and
content distribution solution. Immediately prior to the Companys acquisition of Scofima, Scofima exercised its option, and acquired the software system. The purpose of the software is to provide functionalities that are necessary for the
content delivery market of the internet. The software had been in development for approximately 2-3 years, involving 5 programmers and system developers. The software was not complete at the date of acquisition, and was not yet determined to be
technologically feasible. The Company issued 480,000 shares valued at $12 per share and incurred approximately $250,000 in acquisition costs in exchange for the outstanding shares of Scofima. Scofima had net assets of approximately $500,000 at the
date of acquisition. The transaction was accounted for as a purchase of assets. The Company employed an appraiser to identify the values of the assets acquired, including, among other assets, certain in-process research and development costs. The
amount of purchase price allocated to in-process research and development was determined by estimating the stage of development of the software, estimating future cash flows from projected revenues, and discounting those cash flows to present value.
The discount rate applied was 25%. The incremental product sales resulting from the products incorporating the software were estimated to be $44 million over the initial four years of sales with sales growing from approximately $1.5 million in the
initial year to $13.4 million in the fourth year. The appraiser concluded, and the Company has determined that approximately $4.3 million of the purchase price was related to the Companys research and development efforts




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




that had not attained technological feasibility and for which no future alternative use was expected. The Company has expensed the value of the research and development as of the date of the
acquisition of Scofima and capitalized the fair value of the other assets acquired as determined and allocated by the Company, with assistance from the appraiser, including the value of the assembled workforce of approximately $0.2 million and
developer relationships valued at $0.1 million, which are being amortized over 4 years, with the remainder of $1.4 million assigned to goodwill, which is being amortized over 4 years. The following is a summary of the net fair value of the assets
acquired, the liabilities assumed, and the total consideration paid for Scofima:





Net fair value of assets acquired

$
6,120,000Liabilities assumed


(110,000
)Common stock issued


(5,760,000
)Cash consideration paid, net of cash acquired

$
250,000





Proforma financial information has not been provided due to the
limited operations of Scofima. Revenue and net income were approximately $3,000 and $100, respectively, for the ten months ended October 31, 2000 and were approximately $6,000 and $800, respectively for the year ended December 31, 1999. Total assets
were approximately $120,000 at both October 31, 2000 and December 31, 1999.





13.    Impairment Losses





At July 31, 2002, as a result of the Companys change in business strategy, the Company decided to
restructure the operating activities of its subsidiaries in Switzerland, Germany and Italy. The shift in business strategy consists of selling products primarily through value added resellers (VARs) instead of a direct sales force or reliance on the
Companys historical distributors. In addition, the Company no longer emphasizes sales of non-NAS products throughout Germany and Switzerland.





In fiscal 1999, the Company acquired all of the outstanding stock of Procom Technology, AG (Switzerland), a relatively small Swiss distributor of computer storage peripherals, in exchange for 28,500
shares of stock and $22,000 in cash. The goodwill associated with the purchase totaled approximately $168,000, which was being amortized over seven years, with approximately $80,000 in unamortized goodwill at July 31, 2002, prior to any adjustment.
In addition, in fiscal 1998, the Company acquired all the outstanding shares of Megabyte Computerhandels AG (Germany), a German distributor of high-end networking solutions, in exchange for 104,144 shares of stock valued at approximately $900,000.
The goodwill associated with the purchase totaled approximately $713,000, which was being amortized over seven years, with approximately $240,000 in unamortized goodwill at July 31, 2002, prior to any adjustment. The restructuring of both
subsidiaries consisted of significantly reducing the direct sales force. As a result of the restructuring, the Company reviewed the long-lived assets purchased in both acquisitions. After comparing the carrying value of the assets to the estimated
future undiscounted cash flows from the assets, the Company determined that the value of the goodwill and certain fixed assets were impaired. As a result, the Company wrote off the remaining goodwill and certain fixed assets of approximately
$470,000.





In fiscal 1999, the Company acquired all of the outstanding stock of Procom Technology, SPA (Italy), a
relatively small Italian distributor of higher-end computer storage peripherals. The goodwill associated with the purchase totaled approximately $286,000, which was being amortized over seven years, with approximately $190,000 in unamortized
goodwill at July 31, 2002, prior to any adjustment. The restructuring consisted of significantly reducing the direct sales force. As a result of the restructuring, the Company reviewed the long- lived assets purchased in the acquisition. After
comparing the carrying value of the assets to the estimated future




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




undiscounted cash flows from the assets, the Company determined that the value of the goodwill may be impaired. As a result, the Company wrote off the remaining goodwill of approximately
$190,000.





In December, 2000, the Company acquired all of the outstanding stock of Scofima Software S.r.l., in
exchange for 480,000 shares of the Companys common stock. As a result of the acquisition, the Company acquired a software system designed as a caching and content distribution solution. At the acquisition date, the software had been in
development for approximately 2-3 years, involving 5 programmers and system developers, but had not yet determined to be technologically feasible. Approximately $1,741,000 was allocated at the time of acquisition to goodwill, assembled workforce,
developer relationships and software licenses. Currently, the Company does not anticipate allocating the resources required to complete the software and incorporate it into future products. Accordingly, the carrying values of the Scofima assets
exceeds the estimated future undiscounted cash flows. As a result, the Company wrote off the associated remaining goodwill and intangibles (assembled workforce, developer relationships and software licenses) totaling approximately $1,257,000.





In fiscal 2000, the Company entered into a licensing agreement with an independent software development company,
acquiring source code for a file system which totaled $500,000. Although the Company had allocated software programmers to further develop the existing code, and prepare it for release with the Companys products, the Company does not currently
intend to continue to allocate the required resources to this product. As a result, the Company wrote off prepaid license fees of $500,000.





14.    Quarterly Statements of Operations (Unaudited)





Year Ended July 31, 2001Q1


Q2


Q3


Q4Net Sales

$
13,264,000


$
11,722,000


$
8,002,000


$
8,894,000Gross Profit

$
4,882,000


$
4,614,000


$
3,173,000


$
2,588,000Loss before Taxes

$
(1,485,000
)

$
(5,814,000
)

$
(2,979,000
)

$
(7,272,000
)Net Loss

$
(1,091,000
)

$
(5,868,000
)

$
(3,040,000
)

$
(9,351,000
)Basic and diluted EPS

$
(0.09
)

$
(0.50
)

$
(0.25
)

$
(0.64
)Year Ended July 31, 2002Q1


Q2


Q3


Q4(a)Net Sales

$
8,290,000


$
7,797,000


$
4,356,000


$
4,587,000Gross Profit

$
3,896,000


$
3,504,000


$
1,757,000


$
(453,000
)Loss before Taxes

$
(5,312,000
)

$
(4,814,000
)

$
(5,607,000
)

$
(13,791,000
)Net Loss

$
(5,312,000
)

$
(4,814,000
)

$
(1,134,000
)

$
(13,100,000
)Basic and diluted EPS

$
(0.33
)

$
(0.30
)

$
(0.07
)

$
(0.82
)


---




|(a) |  | In the fourth quarter of fiscal 2002, the Companys operating results included an increase in inventory reserves of $1.7 million, an increase in accounts
receivable reserves of $2.2 million, a severance accrual of $1.9 million, $1.0 million charge relating to the settlement agreement with the former shareholders of Scofima Software and impairment losses of $2.4 million.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




15.    NASDAQ Delisting Notice





In July 2002, the Company received a notice from NASDAQ stating that the Company did not, for a period of 30 consecutive days, meet the $1 minimum bid price per share
requirement for continued listing on the




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




NASDAQ National Market. The Notice further stated that the Company had until October 21, 2002 to comply with the minimum bid price per share requirement for continued listing. On October 18,
2002, the Company applied to transfer the listing of the Companys stock to the NASDAQ Small Cap Market. If this transfer is approved, the Company would be eligible for an additional 90 days, or until January 18, 2003, to demonstrate compliance
with the $1 minimum bid price for a period of 10 consecutive trading days. The Company expects to retain the trading symbol PRCM on the Small Cap Market. However, there can be no assurance that NASDAQ will grant the Companys
request to transfer the listing of the Companys stock to the Small Cap Market.





16.    Subsequent Events





In December 2000, the Company acquired Scofima Software, S.r.l., an Italian company. One of the former
shareholders of Scofima Software became the Managing Director of European Sales for the Company. The consideration issued in the transaction was 480,000 shares of the Companys Common Stock and the Company agreed, as part of the acquisition, to
register the shares for resale under the Securities Act of 1933. The shares of Common Stock issued in the transaction were registered for resale but the former Scofima Software shareholders alleged, among other things, that delays in the
registration of the shares caused them to incur substantial losses. On October 4, 2002, the Company entered into a settlement agreement with the former Scofima Software shareholders under which these individuals released any and all claims against
the Company arising from the transaction in return for a payment of $970,000, of which $560,000 was paid upon execution of the agreement and the remaining balance to be paid through February 2003. The settlement was charged to expense and included
in payable to related parties on the balance sheet at July 31, 2002.





On September 20, 2002, a putative class
action complaint styled Albert Ree v. Alex Aydin, Alex Razmjoo, and Procom Technology, Inc. was filed in the United States District Court for the Southern District of New York, Case No. 02 CV 7613. Two weeks later, on October 4, 2002, a
putative class action complaint styled Gary Squires v Alex Aydin, Alex Razmjoo, and Procom Technology, Inc. was also filed in the United States District Court for the Southern District of New York, Case No. 02 CV 7952. The allegations of the
two complaints are identical. Both actions are purportedly brought on behalf of all investors who purchased the Companys common stock from December 9, 1999 to September 20, 2000. Although both complaints have been filed with the District
Court, neither has been served.





The complaints allege violations of Section 10(b) and 20(a) and Rule 10b-5 of the
Securities Exchange Act of 1934. Specifically, plaintiffs allege that the Company violated federal securities laws by: (1) failing to fully and timely disclose purported problems with the Companys alliance with Hewlett-Packard
along with the effect of such problems on the Companys business prospects, and (2) overstating the Companys receivables during the class period. For relief, plaintiffs seek compensatory damages and/or rescission from the Company as well
as an award of the costs and disbursements of the suit. The Company believes that it has substantial and meritorious defenses to each of the claims and intends to vigorously defend the actions. However, there can be no assurance that the Company
will prevail in defending these actions. The Companys defense of these actions may result in the diversion of managements time and attention and cause the Company to incur potentially significant legal expenses. If the Company is
unsuccessful in defending these actions, the Company may be required to pay damages in an amount that would have a material adverse effect on the Companys results of operations and financial condition.





17.    Liquidity and Capital Resources





For the year ended July 31, 2002, the Company incurred a net loss of $24.4 million and used cash in operating activities of $13.3 million. At July 31, 2002, the Company has working capital of $16.6
million and cash and cash equivalents of approximately $10.8 million. The Company believes it has sufficient resources to




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)




continue as a going concern through at least July 31, 2003. To reduce its cash used in operations, the Company put in place various cost containment initiatives, both domestically and
internationally, during fiscal 2002, including an additional reduction in headcount of 37 employees in the first quarter of fiscal 2003.





The Companys plan to address its liquidity issues is to generate cash flow from operations by increasing sales and cutting costs. It is reasonably possible in the near-term that the Company will be unable to generate
cash flows from operations, increase its sales or further reduce costs sufficiently to provide positive cash flows from operations. If the Company is not able to generate positive cash flows from operations, the Company will need to consider
alternative financing sources including the sale or refinancing of the Companys headquarters.





Under the
terms of the Companys long-term debt, the lender may immediately accelerate all amounts disbursed and terminate any further obligation of the lender to disburse additional amounts under the financing arrangement if there exists any event or
condition that the lender in good faith believes impairs (or is substantially likely to impair) the Companys ability to repay the obligations under the financing arrangement. There can be no assurance that the lender will not accelerate the
payment of all amounts disbursed under the arrangement. In this event, it is reasonably possible in the near-term, that the Company would be able to sell or refinance the building, if necessary, or otherwise obtain any additional financing, on
favorable or any terms.







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##### Table of Contents

PART III





Item 10.Directors, Executive Officers and Certain Significant Employees of the Registrant





There is incorporated herein by reference the information required by this Item included in the Companys Proxy Statement for the 2003 Annual Meeting of Shareholders under the captions
Management, Election of Directors and Section 16(a) Beneficial Ownership Reporting Compliance, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal
year ended July 31, 2002.





Management





Our Directors, Executive Officers and Certain Significant Employees





The following
table sets forth information with respect to our officers and directors as of October 29, 2002:





Name

Age

PositionAlex Razmjoo

40

Chairman of the Board, President and Chief Executive OfficerJohn Bonne

59

Executive Vice President of Worldwide OperationsEdward Kirnbauer

38

Controller and Acting Chief Financial OfficerDom Genovese

60

DirectorDavid Blake

62

DirectorFrank Alaghband

39

DirectorNick Shahrestany

39

Director





In September 2002, Kevin Michaels and Alex Aydin resigned from our
Board of Directors.





Alex RazmjooCo-Founder, Chairman, President and Chief Executive Officer





Alex Razmjoo is a founder of Procom Technology and has served as chairman, president and chief executive
officer since the companys inception in 1987. Under his guidance, Procom has become the worlds market leader in CD-caching appliances, addressing the disk-based data storage needs of workgroup, Internet and enterprise applications.
Before forming Procom, Mr. Razmjoo was director of engineering for CMS Enhancements. He received a degree in electrical engineering from the University of California at Irvine and currently serves on the board of directors of its Graduate School of
Management.





John BonneExecutive Vice President of Worldwide Operations





John Bonne is responsible for Procoms global sales, marketing, engineering, manufacturing, technical support and MIS organizations.
Mr. Bonne has more than 30 years of experience in general management, sales and marketing. He has served as senior vice president, division general manager and board member of Sharp Microelectronics; CEO, president and board member of Sanyo Icon, a
storage company acquired by EMC; senior vice president of worldwide sales, marketing and field service at McDonnell Douglas Computer Systems Division; and manager of corporate computer sales at Xeroxs Computer System Division. Mr. Bonne
earned an MBA from the University of Chicago Graduate School of Business and a degree in mathematics and physics from Northern Illinois University.





Edward KirnbauerController and Acting Chief Financial Officer





Edward Kirnbauer is serving as Procoms controller and acting chief financial officer. Mr. Kirnbauer joined Procom in May 2001 with more than 15 years of corporate experience, having held both controller and director positions
at Capita Technologies, Inc., Bally Total Fitness Corporation and Encyclopedia Britannica. He has also




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served in various positions at The Marmon Group, Inc. and KPMG LLP. Mr. Kirnbauer is a CPA and holds an MBA from DePaul University and received an undergraduate degree in accounting from Illinois
State University.





Frank AlaghbandDirector





Frank Alaghband is a founder of Procom Technology and served as executive vice president of engineering and operations from the companys inception until 2002. While
at Procom, he led the development of several award-winning network storage products. Mr. Alaghband has been involved in product development in the storage industry since 1984, starting his career at McDonnell Douglas Computer Systems Division,
where he developed high-performance, multi-channel, caching disk controllers for the companys mini computers. He holds a degree in electrical engineering from the University of California at Irvine.





Nick ShahrestanyDirector





Nick Shahrestany, a Procom Technology founder, served as an executive vice president for the company until 2002. Previously, Mr. Shahrestany was regional sales manager for CMS Enhancements. He received
a degree in biological sciences, with a minor in electrical engineering, from the University of California at Irvine.





David BlakeDirector





David Blake has been a director of Procom Technology since 1997
and serves on the boards Audit and Compensation Committees. Mr. Blake is currently on the faculty and was formerly the dean of the Graduate School of Management at the University of California at Irvine. An authority on business strategy,
leadership and management education, Mr. Blake has served for two decades as a business school dean at such universities as Southern Methodist, Rutgers and Northeastern. He was also a professor and associate dean of the University of
Pittsburghs Katz School of Business and a professor of political science at Wayne State University. Mr. Blake holds a Ph.D. in political science and international politics from Rutgers, an MBA from the University of Pittsburgh, and a
degree in history from Dartmouth College.





Dom GenoveseDirector





Dom Genovese has been a director of Procom Technology since 1997 and serves on the boards Audit and Compensation Committees. In his
career, Mr. Genovese has been vice president of sales for Sync Research, a branch office networking solution provider, and a regional sales manager at Cisco Systems. He holds a degree in electrical engineering from the University of Maryland.





Item 11.Executive Compensation





There is
incorporated herein by reference the information required by this Item included in the Companys Proxy Statement for the 2003 Annual Meeting of Shareholders under the captions Executive Compensation, Compensation Committee
Interlocks and Insider Participation Report of the Compensation Committee and Stock Performance Graph, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal
year ended July 31, 2002.





Item 12.Security Ownership of Certain Beneficial Owners and Management





There is incorporated herein by reference the information required by this Item included in the Companys Proxy Statement for the 2003 Annual Meeting of Shareholders under the caption
Security Ownership of Beneficial Owners, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended July 31, 2002.




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##### Table of Contents







The following table highlights the
Companys equity compensation plans as of July 31, 2002:





Number of securities to be issued upon exercise of outstanding options, warrants and rights (a)

Weighted average exercise price of outstanding options, warrants and rights (b)

Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) (c)Equity compensation plans approved by security holders

1,729,552

$
7.69

1,304,350Equity compensation plans not approved by security holders












Item 13.Certain Relationships and Related Transactions





There is incorporated herein by reference the information required by this Item included in the Companys Proxy Statement for the 2003 Annual Meeting of Shareholders under the caption Certain Relationships and Related
Transactions, which will be filed with the Securities and Exchange Commission no later than 120 days after the close of the fiscal year ended July 31, 2002.




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##### Table of Contents

PART IV





Item 14.Exhibits, Financial Statement Schedules, and Reports on Form 8-K





(a) Documents Filed as a Part of This Report:





(1)  Index to Financial Statements





The financial statements included in
Part II, Item 8 of this Annual Report on Form 10-K are filed as part of this Report.





(2)  Financial Statement Schedules





The financial statement schedule is
filed as part of this Report.





All other schedules are omitted as the required information is inapplicable or the
information is presented in the consolidated financial statements or related notes.





(b) Reports on Form 8-K:





None.





(3)  Exhibits





EXHIBITS TO FORM 10-K





Exhibit Number

Description3.1

Amended and Restated Articles of Incorporation of the Company (incorporated by reference to Exhibit 3.1 in the Form
S-1A filed on November 14, 1996)3.2

Amended and Restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 in the Form S-1A filed on
November 14, 1996)4.1

Form of Convertible Debenture dated October 31, 2000 (incorporated by reference to Exhibit 4.1 in the Registration
Statement on Form S-3 of Procom filed on November 22, 2000)4.1.1

Amendment to Convertible Debenture (incorporated by reference to Exhibit 4.1.1 in the Form S-3 filed on April 25,
2001)4.2

Form of Common Stock Purchase Warrant dated October 31, 2000 (incorporated by reference to Exhibit 4.2 in the Report
on Form 8-K filed on November 3, 2000)4.3

Securities Purchase Agreement dated October 31, 2000 (incorporated by reference to Exhibit 4.3 in the Report on Form
8-K filed on November 3, 2000)4.4

Registration Rights Agreement dated October 31, 2000 by and between the Registrant and Montrose Investments, Ltd.
(incorporated by reference to Exhibit 4.4 in the Report on Form 8-K filed on November 3, 2000)4.5

Subordination Agreement dated October 31, 2000 by and between the Registrant, Montrose Investments, Ltd. and CIT
Group/Business Credit, Inc. (incorporated by reference to Exhibit 4.5 in the Report on Form 8-K filed on November 3, 2000)10.1

Form of Indemnity Agreement between the Company and each of its executive officers and directors (incorporated by
reference to Exhibit 10.1 in the Form S-1 filed on October 30, 1996)10.2

Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex
Razmjoo (incorporated by reference to Exhibit 10.3 in the Form S-1 filed on October 30, 1996)10.3*

Loan Agreement dated November 28, 2001 by and between the Registrant and First Bank & Trust10.4*

Agreement dated May 24, 2002 between the Registrant and Alex Aydin10.5*

Agreement dated May 24, 2002 between the Registrant and Nick Shahrestany10.5.1

Amendment to Agreement, dated November 11, 2002, between the Registrant and Nick Shahrestany10.6*

Agreement dated May 24, 2002 between the Registrant and Frank Alaghband10.6.1

Amendment to Agreement, dated November 11, 2002, between the Registrant and Frank Alaghband




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Exhibit Number

Description10.7

Agreement for Wholesale Financing (Security Agreement) between Procom Technology, Inc. and IBM Credit Corporation
(incorporated by reference to Exhibit 10.1 to the Form S-3/A filed on January 17, 2001)21.1

Subsidiaries of the Registrant23.1

Consent of KPMG LLP99.1

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
200299.2

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002


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|* |  | Previously filed
|- |  | ----------------



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SIGNATURES





Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Irvine, State of California, on the 13th day of November, 2002.





PROCOM TECHNOLOGY, INC.By:

/s/    ALEX RAZMJOOAlex Razmjoo Chairman,
President and Chief Executive Officer





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





Name

Title

Date/s/    ALEX RAZMJOO Alex Razmjoo

Chairman of the Board, President and Chief Executive Officer

November 13, 2002/s/    EDWARD KIRNBAUER Edward Kirnbauer

Controller & Acting Chief Financial Officer (Principal Accounting Officer)

November 13, 2002/s/    DAVID BLAKE David Blake

Director

November 13, 2002/s/    DOM GENOVESE Dom Genovese

Director

November 13, 2002/s/    FRANK ALAGHBAND Frank Alaghband

Director

November 13, 2002/s/    NICK SHAHRESTANY Nick Shahrestany

Director

November 13, 2002




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SCHEDULE II





SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS


YEARS ENDED JULY 31, 2000, 2001 AND 2002





Balance at Beginning Period

Charged to Costs
and Expenses

Deductions


Balance at End
of PeriodYEAR ENDED JULY 31, 2000:Allowance for sales returns

$
1,939,000

$
5,917,000

$
(5,781,000
)

$
2,075,000Allowance for doubtful accounts


522,000


360,000


(205,000
)


677,000YEAR ENDED JULY 31, 2001:Allowance for sales returns

$
2,075,000

$
4,043,000

$
(4,018,000
)

$
2,100,000Allowance for doubtful accounts


677,000


3,672,000


(37,000
)


4,312,000YEAR ENDED JULY 31, 2002:Allowance for sales returns

$
2,100,000

$
973,000

$
(1,056,000
)

$
2,017,000Allowance for doubtful accounts


4,312,000


7,092,000


(5,331,000
)


6,073,000




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CERTIFICATION OF CHIEF EXECUTIVE OFFICER





I, Alex Razmjoo, certify that:





1.  I have reviewed this annual report on Form 10-K of Procom Technology, Inc:





2.  Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this annual report; and





3.  Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present, in all material respects, the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.





/s/    ALEX RAZMJOOAlex Razmjoo Chief
Executive Officer





Date: November 13, 2002




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CERTIFICATION OF CHIEF FINANCIAL OFFICER





I, Edward Kirnbauer, certify that:





4.  I have reviewed this annual report on Form 10-K of Procom Technology, Inc:





5.  Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this annual report; and





6.  Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present, in all material respects, the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report.





/s/    EDWARD KIRNBAUEREdward Kirnbauer Acting Chief Financial Officer





Date: November 13, 2002




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