Securities and Exchange Commission


Washington, DC 20549





REPORT ON FORM 10-Q





(Mark One)





[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES EXCHANGE ACT OF 1934





For the quarterly period ended October 31, 2002





[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE


SECURITIES EXCHANGE
ACT OF 1934





For the transition period from
             to





Commission file number 0-21053





PROCOM TECHNOLOGY, INC.


(Exact name of registrant as specified in its charter)





California

33-0268063(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification
No.)58 Discovery, Irvine California

92618(Address of principal executive office)

(Zip Code)


(949) 852-1000


(Registrants telephone number, including area code)





(Former name, former address and
former fiscal year, if changed since last report.)





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 whether the registrant


is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).


Yes [    ] No [X]





The number of shares of Common Stock, $.01 par value,


outstanding on December 16, 2002 was 16,084,708.




---

PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES





TABLE OF CONTENTS





PART 1FINANCIAL INFORMATION


PAGEItem 1.

Condensed Consolidated Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of October 31, 2002 and July 31, 2002

2Condensed Consolidated Statements of Operations for the three months ended October 31, 2002 and 2001

3Condensed Consolidated Statements of Shareholders Equity and Comprehensive Loss for the three months ended October 31, 2002 and the year ended July 31, 2002

4Condensed Consolidated Statements of Cash Flows for the three months ended October 31, 2002 and 2001

5Notes to Condensed Consolidated Financial Statements

6Item 2.

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

10Item 3.

Quantitative and Qualitative Disclosures About Market Risk

21Item 4.

Disclosure Controls and Procedures

21PART IIOTHER INFORMATIONItem 1.

Legal Proceedings

22Item 5.

Other Information

22Item 6.

Exhibits and Reports on Form 8-K

22SIGNATURES




1




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PART I


FINANCIAL INFORMATION





ITEM 1. FINANCIAL STATEMENTS.





PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED BALANCE SHEETS


(UNAUDITED)





OCTOBER 31, 2002


JULY 31,2002ASSETSCurrent assets:Cash and cash equivalents

$
11,501,000


$
10,845,000Accounts receivable, less allowances for doubtful accounts and sales returns of $7,955,000 and $8,090,000,
respectively


3,905,000



4,845,000Inventories


5,786,000



6,764,000Income taxes receivable


251,000



2,282,000Prepaid expenses


427,000



542,000Other current assets


380,000



346,000Total current assets


22,250,000



25,624,000Property and equipment, net


16,106,000



16,357,000Other assets


53,000



28,000Total assets

$
38,409,000


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

$
95,000


$
46,000Flooring line obligation


319,000



251,000Current portion of long-term debt


172,000



172,000Accounts payable


2,348,000



2,837,000Accrued compensation


521,000



752,000Current portion of payable to related parties


1,072,000



1,632,000Accrued expenses and other current liabilities


2,850,000



2,734,000Deferred service revenues


659,000



548,000Income taxes payable


104,000



56,000Total current liabilities


8,140,000



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


8,434,000



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


1,048,000



1,213,000Total liabilities


17,622,000



18,718,000Commitments and contingenciesShareholders 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, 16,084,708 shares issued and outstanding


161,000



161,000Additional paid-in capital


58,696,000



58,696,000Accumulated deficit


(38,219,000
)


(35,703,000
)Accumulated other comprehensive income


149,000



137,000Total shareholders equity


20,787,000



23,291,000Total liabilities and shareholders equity

$
38,409,000


$
42,009,000





See accompanying notes to condensed consolidated financial statements.




2




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)





THREE MONTHS ENDED OCTOBER 31,2002


2001Net sales

$
5,122,000


$
8,290,000Cost of sales


2,808,000



4,394,000Gross profit


2,314,000



3,896,000Selling, general and administrative


3,656,000



7,234,000Research and development


1,002,000



1,651,000Total operating expenses


4,658,000



8,885,000Operating loss


(2,344,000
)


(4,989,000
)Interest income


50,000



191,000Interest expense


(181,000
)


(514,000
)Loss before income taxes


(2,475,000
)


(5,312,000
)Provision for income taxes


41,000



Net loss

$
(2,516,000
)

$
(5,312,000
)Net loss per common share:Basic and diluted

$
(0.16
)

$
(0.33
)Weighted average number of common shares:Basic and diluted


16,085,000



15,997,000





See accompanying notes to condensed consolidated financial statements.







3




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE LOSS


(UNAUDITED)





COMMON STOCK

ADDITIONAL PAID-IN CAPITAL

ACCUMULATED DEFICIT


ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

TOTALSHARES

AMOUNTBALANCE AT JULY 31, 2002

16,084,708

$
161,000

$
58,696,000

$
(35,703,000
)

$
137,000

$
23,291,000Comprehensive loss:Net loss










(2,516,000
)





(2,516,000
)Foreign currency translation adjustment














12,000


12,000Comprehensive loss

















(2,504,000
)BALANCE AT OCTOBER 31, 2002

16,084,708

$
161,000

$
58,696,000

$
(38,219,000
)

$
149,000

$
20,787,000





See accompanying notes to condensed consolidated financial statements.







4




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)





THREE MONTHS ENDEDOCTOBER 31,2002


2001CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(2,516,000
)

$
(5,312,000
)Adjustments to reconcile net loss to net cash provided by (used in) operating activities:Depreciation and amortization


309,000



549,000Provisions for bad debt and sales returns


83,000



2,665,000Amortization of debt issuance costs






153,000Compensatory stock options






18,000Changes in operating accounts:Accounts receivable


857,000



(1,639,000
)Inventories


978,000



259,000Income taxes receivable


2,031,000



4,000Prepaid expenses


115,000



(24,000
)Other current assets


(34,000
)


31,000Other assets


(25,000
)


(20,000
)Accounts payable


(489,000
)


(786,000
)Accrued compensation


(231,000
)


(291,000
)Payable to related parties


(725,000
)


Accrued expenses and other liabilities


116,000



421,000Deferred service revenues


111,000



57,000Income taxes payable


48,000



Net cash provided by (used in) operating activities


628,000



(3,915,000
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property and equipment


(58,000
)


(86,000
)CASH FLOWS FROM FINANCING ACTIVITIES:Repayment of long-term debt


(43,000
)


Net borrowings on lines of credit


49,000



(8,000
)Flooring line obligation


68,000



492,000Proceeds from exercise of stock options






23,000Net cash provided by financing activities


74,000



507,000Effect of exchange rate changes


12,000



161,000Increase (decrease) in cash and cash equivalents


656,000



(3,333,000
)Cash and cash equivalents at beginning of period


10,845,000



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

$
11,501,000


$
22,086,000Supplemental disclosures of cash flow information:CASH PAID (RECEIVED) DURING THE PERIOD:Interest

$
154,000


$
150,000Income taxes

$
(2,031,000
)

$
(38,000
)





See accompanying notes to condensed consolidated financial statements.




5




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PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES


NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1. General





The accompanying financial information is unaudited, but in the opinion of management, reflects all adjustments (which include only normal
recurring adjustments) necessary to present fairly the financial position of Procom Technology, Inc. and its consolidated subsidiaries (the Company) as of the dates indicated and the results of operations and cash flows for the periods
then ended. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the
rules and regulations of the Securities and Exchange Commission. Certain amounts from prior periods have been reclassified to conform to current period presentation. While the Company believes that the disclosures are adequate to make the
information presented not misleading, the financial information should be read in conjunction with the audited financial statements and notes thereto included in the Companys Annual Report on Form 10-K for fiscal 2002. Results for the interim
periods presented are not necessarily indicative of the results for the entire year.





2. Use of Estimates





The preparation of the condensed consolidated financial statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. On an on-going basis, the Company evaluates its estimates, including those related to product returns, bad debts, inventories, and
contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.





3. Summary of Significant Accounting Policies





Revenue recognition and allowances





The Companys NAS 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.





Delivery Has Occurred. The Companys product is physically delivered to its 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 the Companys facility prior to shipment and does not require significant production, modification, or customization at the
customers 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 performed. Revenue from support and upgrade contracts
is recognized as revenue ratably over the term of the support period of one to three years.




6




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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 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. Revenue is not recorded for evaluation
units until the customer has purchased the products.





Valuation of accounts receivable





The Company maintains a separate allowance for doubtful accounts for estimated losses resulting from the inability of its
customers to make required payments. The Company analyzes 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 the Companys customers deteriorates, resulting in an impairment of their ability to make payments, additional allowances may be required.





Valuation of inventory





The Company writes down its inventory, including estimated excess and obsolete inventory, to the estimated net realizable value based upon assumptions about future demand
and market conditions. Although the Company strives to ensure the accuracy of its forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of its
inventory, and its reported results. If actual market conditions are less favorable than those projected, additional write-downs against earnings may be required.





Accounting Standards Adopted





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, the Company determined that all of its existing goodwill and other intangible assets were impaired, and the Company recorded an impairment charge of approximately $2.4 million. Accordingly, upon
adoption of SFAS No. 142 on August 1, 2002, the Company did not have any goodwill or other intangible assets, and therefore, the adoption of the statement did not have an impact on the Companys 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 the Companys fiscal year beginning August 1, 2002. The Company has adopted SFAS No. 144 in fiscal 2003 and its impact did not have a material impact on the Companys financial statements.





4. Inventories





Inventories are summarized as follows:





October 31, 2002

July 31,2002Raw materials

$
3,026,000

$
3,087,000Work in process


807,000


840,000Finished goods


1,953,000


2,837,000Total

$
5,786,000

$
6,764,000





5. Net Loss Per Share





Basic net loss per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed using
the weighted average number of shares of common stock outstanding and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of stock options and warrants. For the periods presented, basic and
diluted net loss per share was based on the weighted average number of shares of common stock outstanding during the period, as all potentially dilutive instruments were antidilutive. For the three months ended October 31, 2002 and 2001,
approximately 0 and 71,000 shares, respectively, would have been included in the computation of diluted earnings per share if a net loss had not been incurred.




7




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6. Comprehensive Loss





For the three months ended October 31, 2002 and 2001, the only differences between reported net loss and comprehensive loss was a foreign currency translation adjustment of
$12,000 and $161,000, respectively.





7. Business Segment Information





The Company operates in one industry segment: The design, manufacture and marketing of data storage devices. The Company has two major distinct product families: network
attached storage products (NAS) and other data storage products (Legacy), which includes disk drive storage upgrade systems, CD/DVD-ROM servers and arrays and tape backup products. Net sales of NAS products represented 89%
and 82% of total product net sales for the three months ended October 31, 2002 and 2001, respectively.





International sales as a percentage of net sales amounted to 28% and 50% for the three months ended October 31, 2002 and 2001, respectively. Identifiable assets used in connection with the Companys foreign operations were $2.0
million at October 31, 2002 and $3.1 million at July 31, 2002.





For the three months ended October 31, 2002, one
customer accounted for 26% of net sales and 34% of net accounts receivable. No one customer accounted for more than 10% of net sales or net accounts receivable for the three months ended October 31, 2001.





8. Lines of Credit and Long-Term Debt





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 provides for borrowings, on a revolving
basis, for a period of three years, in an amount based upon a specified percentage of the Companys eligible accounts receivable (approximately $1.6 million at October 31, 2002), up to a limit of $5.0 million. Amounts outstanding under the
working capital line bear interest at the lenders prime rate plus .25%. At October 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 October 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.





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 October 31, 2002, the interest rate on the loan was 7.0%. Principal reduction 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 October 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 October 31, 2002 has committed to make $0.5 million in flooring inventory commitments available to the Company
(the flooring line commitment was reduced from $2.0 million at July 31, 2002). Subsequent to October 31, 2002, the Company, at the request of IBM Credit, established an irrevocable letter of credit totaling $0.5 million to collateralize purchases
under the flooring line. As of October 31, 2002 and July 31, 2002, the Company owed $319,000 and $251,000, respectively, under the flooring line. The flooring line is also collateralized by the specific inventory purchased pursuant to the flooring
commitments. CIT and IBM Credit have entered into an intercreditor agreement which determines the level of priority of each 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 terms of the flooring line at October 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 October 31, 2002.





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 October 31, 2002, the amount outstanding under these lines was $95,000.




8




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9. 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 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. Additionally, the Company will need to demonstrate compliance with NASDAQ rules requiring it to have three independent directors on its board. Due to the resignation of one of its
independent directors in September 2002, the Company has been seeking to appoint a third independent director. The Company has been informed by NASDAQ that it has until December 31, 2002 to appoint a third independent director or it may face
de-listing from NASDAQ at that time. 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 or that the Companys stock will not be de-listed from the NASDAQ Stock Market.





10.
Liquidity and Capital Resources





For the three months ended October 31, 2002 and the fiscal year ended July
31, 2002, the Company incurred net losses of $2.5 million and $24.4 million, respectively. At October 31, 2002, the Company had working capital of $14.1 million and cash and cash equivalents of $11.5 million. The Company believes it has sufficient
resources to continue as a going concern through at least October 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 and 2003,
including an additional reduction in headcount of 37 employees in the first quarter of fiscal 2003. Severance costs incurred as part of the reduction in workforce were not significant relative to the Companys financial statements. The
Companys plan to address its liquidity issues is to generate cash flow from operations by increasing sales and cutting costs. There can be no assurance that the Company will be able 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. Additionally, there can be no assurance 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.





11. Commitments and Contingencies





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.





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 in the fourth quarter of fiscal 2002. At October 31, 2002, the outstanding amount payable totaled $410,000 and is
included in the payable to related parties on the balance sheet.





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. Both complaints have been filed with the District Court. The complaints allege
violations of Section 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934. Specifically,




9




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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.





Employment Agreements





In May 2002, the employment for 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 fiscal 2002, the Company accrued
approximately $1.9 million for the present value of the remaining unpaid severance and employee benefits. As of October 31, 2002, the remaining balance is $1.7 million and is included in payable to related parties in the condensed consolidated
balance sheet.





Item 2.Managements Discussion and Analysis of Financial Condition and Results of Operations





We develop, manufacture and market NAS appliances which consist of our Data FORCE and Net FORCE product lines and other storage devices for a wide range of computer networks and operating systems. 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 Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities
and Exchange Commission. 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, 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; and
| | - |  | -------------------------------------




| |  |  | valuation of inventory.
| | - |  | -----------------------




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




10




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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.





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 October 31, 2002 and July 31, 2002, inventory related to evaluation units was $0.4 million and $1.0 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 our inventory, including our estimated excess and obsolete inventory, to the estimated net realizable 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 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 and other charges against earnings may be required.





New
Accounting Standards





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




11




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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. 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:





THREE MONTHS ENDED OCTOBER 31,2002


2001STATEMENT OF OPERATIONSNet sales

100.0
%

100.0
%Cost of sales

54.8


53.0Gross profit

45.2


47.0Operating expenses:Selling, general and administrative

71.4


87.3Research and development

19.5


19.9Total operating expenses

90.9


107.2Operating loss

(45.7
)

(60.2
)Interest expense, net

(2.6
)

(3.9
)Loss before income taxes

(48.3
)

(64.1
)Provision for income taxes

(0.8
)

Net loss

(49.1
)%

(64.1
)%





COMPARISON OF THREE MONTHS ENDED OCTOBER 31, 2002 AND 2001





Net sales decreased by 38.2% to $5.1 million for the three months ended October 31, 2002, from $8.3 million for the three months ended
October 31, 2001. The decrease was due primarily to a decline in product sales in international markets for our NAS and Legacy products and a drop in domestic product sales of our Legacy products. This decrease was partially offset by a 5.1%
increase in domestic NAS product sales.





Net sales of our NAS products decreased 33.4% to $4.5 million for the
three months ended October 31, 2002, from $6.8 million for the comparable quarter in fiscal 2002. The decrease was due primarily to a decline in international NAS product sales partially offset by a 5.1% increase in domestic NAS sales. As a
percentage of total net sales, NAS product sales increased to 89% for the three months ended October 31, 2002 from 82% for the three months ended October 31, 2001.





International sales were $1.4 million, or 27.5% of our net sales, for the three months ended October 31, 2002, compared to $3.9 million, or 49.5% of our net sales, for the
three months ended October 31, 2001. The decrease was due primarily to lower overall sales of NAS and Legacy products to international customers, primarily in Asia and 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 40.6% to $2.3 million for the three months ended October 31, 2002, from $3.9 million for the three months ended October 31, 2001. The decrease in gross profit was due primarily
to lower overall sales. Gross margin for the three months ended October 31, 2002 of 45.2% was comparable to the 47.0% gross margin for the three months ended October 31, 2001.





Selling, general and administrative expenses decreased 49.5% to $3.7 million for the three months ended October 31, 2002, from $7.2 million for the three months ended
October 31, 2001, and decreased as a percentage of net sales to 71.4% from 87.3%, respectively. In the first quarter of fiscal 2003 and 2002, based on our analysis of our accounts receivable, we increased our allowance for bad debt by $0.1 million
and $2.8 million, respectively. Excluding these additional provisions, selling, general and administrative expenses decreased $0.7 million, or 16.7%, from $4.4 million in the first quarter of fiscal 2002 to $3.6 million in the comparable period in
fiscal 2003. This decrease is due primarily to a decrease in sales and administrative salaries and commissions and decreases in general administrative costs of our European subsidiaries. We expect overall selling, general and




12




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administrative expenses in fiscal 2003 to continue 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.





Research and development expenses decreased to $1.0 million, or 19.5% of net sales, in the first quarter of
fiscal 2003 from $1.7 million, or 19.9% of net sales, for the comparable period of fiscal 2002. The dollar decrease was due primarily to a decrease in compensation expenses related to reductions in headcount in fiscal 2002 and 2003. We expect
overall research and development expenses in fiscal 2003 to continue 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.





Interest income decreased 73.8% to $50,000 for the three months ended October 31, 2002, from $191,000 for the comparable period of fiscal
2002. The decrease was attributable to a decline in interest rates along with a decrease in our investable cash balance.





Interest expense decreased 64.7% to $181,000 for the three months ended October 31, 2002, from $514,000 for the comparable period of fiscal 2002. The decrease was due primarily to the lower interest expense we incurred on our
mortgage note in the three months ended October 31, 2002, and to the fact that the first quarter of fiscal 2002 interest expense included costs related to our $15.0 million convertible debenture and higher amortization of debt issuance costs.





Provision for income taxes for the three months ended October 31, 2002 is attributable to a provision for
earnings of our Italian subsidiary.





LIQUIDITY AND CAPITAL RESOURCES





As of October 31, 2002, we had cash and cash equivalents totaling $11.5 million.





Net cash provided by operating activities was $628,000 for the three months ended October 31, 2002. Net cash provided by operating activities in the first quarter of fiscal 2003 relates primarily to
our income tax refund and decreases in our inventories and accounts receivable. These sources were partially offset by our net loss, a decrease in our accounts payable and payments to related parties accrued for in fiscal 2002. Net cash used in
operating activities in fiscal 2002 relates primarily to our net loss, an increase in our accounts receivable and a decrease in our accounts payable.





Net cash used in investing activities was $58,000 and $86,000 for the three months ended October 31, 2002 and 2001, respectively, which was the result of purchases of property and equipment.





Net cash provided by financing activities of $74,000 for the three months ended October 31, 2002 was due
primarily to borrowings under our flooring lines and international lines of credit, partially offset by payments on our long-term debt. Net cash provided by financing activities of $507,000 for the three months ended October 31, 2001 was primarily
the result of an increase in our flooring lines.





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 October 31, 2002, the interest rate on the loan was 7.0%. Principal reduction 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 October 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 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 The CIT Group/Business Credit (CIT). The working capital line of credit allows for borrowings, on a
revolving basis, for a period of three years, in an amount based upon a specified percentage of our eligible accounts receivable (approximately $1.6 million at October 31, 2002), up to a limit of $5.0 million. Amounts outstanding under the working
capital line bear interest at the lenders prime rate plus .25%. At October 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 12-month periods ending on each
fiscal quarter. For the twelve month period ended on October 31, 2002, we were not in




13




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compliance with the minimum EBITDA requirement. The lender has not waived our non-compliance with this covenant for this period and we cannot
borrow under the line.





We have a flooring line with IBM Credit, which at October 31, 2002 has committed to make
$0.5 million in flooring inventory commitments available to us (the flooring line commitment was reduced from $2.0 million at July 31, 2002). Subsequent to October 31, 2002, at the request of IBM Credit, we established an irrevocable letter of
credit totaling $0.5 million to collateralize purchases under the flooring line. As of October 31, 2002 and July 31, 2002, we owed $319,000 and $251,000, respectively, under the flooring line. The flooring line is also collateralized by the specific
inventory purchased pursuant to the flooring commitments. CIT and IBM Credit have entered into an intercreditor agreement which determines the level of priority of each lenders security interest. The flooring line requires us to maintain a
minimum net worth of $16.0 million. We were in compliance with the terms of the flooring line at October 31, 2002. The flooring line also requires us not to be in default of any covenants in the CIT agreement. IBM Credit has waived noncompliance
with that covenant at October 31, 2002.





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 October 31, 2002, amounts outstanding under these lines was $95,000.





In May 2002, the employment of three of our executives was terminated. Under the agreements, 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 our employee benefit, health and other insurance plans of the 36 months following their termination. In fiscal
2002, we accrued approximately $1.9 million for the present value of the remaining unpaid severance and employee benefits. As of October 31, 2002, the remaining balance is $1.7 million and is included in payable to related parties in the condensed
consolidated balance sheet.





As of October 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*

$
11,049,000

$
778,000

$
1,520,000

$
8,751,000

$
Operating Leases


830,000


371,000


268,000


135,000


56,000Scofima Settlement


410,000


410,000








Executive Severance


1,889,000


731,000


1,158,000





Total

$
14,178,000

$
2,290,000

$
2,946,000

$
8,886,000

$
56,000


|* |  | Payments are based on the current interest rate and are subject to change based on fluctuations in the rate.
|- |  | ------------------------------------------------------------------------------------------------------------




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
sufficient to meet our anticipated cash requirements through at least October 31, 2003. 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 the lender on our mortgage loan 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.







14




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RISK FACTORS





The following risk factors and other information included in this Report on Form 10-Q 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. In the three months ended October 31, 2002
and 2001, we incurred operating losses of $2.3 million and $5.0 million, respectively. We will need to increase our revenues from our NAS products to achieve and maintain 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 or sustain profitability in the future. If we are unable to achieve or sustain profitability in the future, 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 and 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.





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 of the NAS market but also the lack of market acceptance of our NAS products. Sales of our NAS products declined from $6.8
million for the three months ended October 31, 2001 to $4.5 million for the three months ended October 31, 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.




15




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At October 31, 2002, our net accounts receivable totaled $3.9 million, which is
net of allowances for doubtful accounts and sales returns of $6.2 million and $1.8 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 the three months ended October 31, 2002 and 2001 were $5.1 million and $8.3 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 have been granted an extension to December 31, 2002. We are currently 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.





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




16




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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 may, in turn, have 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 28% and 56% of our net sales for the three months ended October 31, 2002 and 2001, respectively. We have committed significant operational resources to drive our
international growth. 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. Also currency rate 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 period. In addition, we have funded operating losses of our subsidiaries of approximately $4.0 million between the date of purchase and
October 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 Legacy markets, we compete with computer manufacturers that provide storage upgrades for their own
products, as well as




17




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with manufacturers of hard drives, CD servers and arrays and storage upgrade products. Many of our current and 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 the first three months ending October 31, 2002, one customer accounted for 26% our net sales. Although no customer accounted for more than 10% of our net sales in fiscal 2002, in fiscal 2001, three customers collectively
accounted for 19% of our net sales. As we seek to 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. For the three months ended October 31, 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 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.




18




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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 of 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.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------




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.




19




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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.





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 October 31, 2002, our executive officers and directors beneficially owned approximately 5,600,000 shares, or approximately 35.0% 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 three 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;
| | - |  | --------------------------------------



20




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| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------




Item 3.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. 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 a significant reduction 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 agreement 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. At this time, we are unable to borrow under the agreement.





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%. Accordingly, if the prime
rate were to fluctuate above 6%, we would experience interest rate risk on our debt. A one percentage point increase in the interest rate would result in approximately $85,000 in additional interest expense.





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 intercompany advances and sold goods to our European subsidiaries
denominated in U.S. dollars, and those amounts are subject to currency fluctuation and require constant revaluation on our financial statements. In the three months ended October 31, 2002 and 2001, we incurred foreign currency transaction gains of
$77,000 and $205,000, 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 have to take into account 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 October 31, 2002, approximately $10.0 million in current intercompany
advances and accounts receivable from our foreign subsidiaries were outstanding. We can not 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
can not assure you that such a loss would not have an adverse material effect on our results of operations or financial condition.





Item 4.Disclosure Controls and Procedures





In the 90-day period
before the filing of this report, the chief executive officer and acting chief financial officer of the Company (collectively, the certifying officers) have evaluated the effectiveness of the Companys disclosure controls and
procedures. These disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in its periodic reports filed with the Securities and Exchange Commission (the Commission) is
recorded, processed, summarized and reported, within the time periods specified by the Commissions rules and forms, and that the information is communicated to the certifying officers on a timely basis.





The certifying officers concluded, based on their evaluation, that the Companys disclosure controls and procedures are effective for
the Company, taking into consideration the size and nature of the Companys business and operations.





No
significant changes in the Companys internal controls or in other factors were detected that could significantly affect the Companys internal controls subsequent to the date when the internal controls were evaluated.




21




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PART II





Item 1.Legal Proceedings





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 in the fourth quarter of fiscal 2002. At October 31, 2002, the outstanding amount payable totaled $410,000 and is included in the payable to related parties on the balance sheet.





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. Both complaints have been filed with the District Court. 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.





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 existing
claim or lawsuit will have a materially adverse affect on our business, results of operations or financial condition.





Item 5.Other Information





This Quarterly Report on Form 10-Q
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 Quarterly Report on Form 10-Q
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 Quarterly Report on Form 10-Q. We do not undertake to update or revise the forward-looking statements,
whether as a result of new information, future events or otherwise.





Item 6.Exhibits and Reports on Form 8-K





None.







22




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SIGNATURES





Pursuant to the requirements 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, County of Orange, State of California, on the 16th of December, 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 on Form 10-Q has been signed below by the following persons in the capacities and on the dates indicated.





Signatures

Title

Date/s/    ALEX RAZMJOO Alex Razmjoo

Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)

December 16, 2000/s/     EDWARD KIRNBAUER Edward Kirnbauer

Controller and Acting Chief Financial Officer (Principal Accounting Officer)

December 16, 2000







23




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CERTIFICATION OF CHIEF EXECUTIVE OFFICER





I, Alex Razmjoo, certify that:





1. I have reviewed
this quarterly report on Form 10-Q of Procom Technology, Inc;





2. Based on my knowledge, this
quarterly 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 quarterly report;





3. Based on my knowledge, the financial statements, and
other financial information included in this quarterly 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 quarterly report.





4. The Registrants other certifying officers and I are responsible for establishing and
maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:





a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within the
entities, particularly during the period in which this quarterly report is being prepared.





b.
Evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation Date); and





c. Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;





5. The registrants other certifying
officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):





a. All significant deficiencies in the design or operation of internal controls which could adversely affect the
registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and





b. Any fraud, whether or not material, that involves management or other employee who have a significant role in the registrants internal controls;
and





6. The registrants other certifying officers and I have indicated in this quarterly
report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.





/s/ ALEX RAZMJOO Alex Razmjoo Chief Executive Officer





Date: December 16, 2002







24




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CERTIFICATION OF ACTING CHIEF FINANCIAL OFFICER





I, Edward Kirnbauer, certify that:





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





2. Based on my knowledge,
this quarterly 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 quarterly report; and





3. Based on my knowledge, the financial
statements, and other financial information included in this quarterly 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
quarterly report.





4. The Registrants other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:





a. Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within the entities, particularly during the period in which this quarterly report is being prepared.





b. Evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the Evaluation
Date); and





c. Presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the Evaluation Date;





5. The
registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of registrants board of directors (or persons performing the equivalent function):





a. All significant deficiencies in the design or operation of internal controls which could
adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and





b. Any fraud, whether or not material, that involves management or other employee who have a significant role in the
registrants internal controls; and





6. The registrants other certifying officers and I
have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material weaknesses.





/s/    EDWARD
KIRNBAUEREdward Kirnbauer Acting Chief
Financial Officer





Date: December 16, 2002







25




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INDEX TO EXHIBITS





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 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 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 & Trust (incorporated by
reference to Exhibit 10.1 in the Form 10-Q filed on March 18, 2002)10.4

Agreement dated May 24, 2002 between the Registrant and Alex Aydin (incorporated by reference to Exhibit 10.2 in the
Form 10-Q filed on June 14, 2002)10.5

Agreement dated May 24, 2002 between the Registrant and Nick Shahrestany (incorporated by reference to Exhibit 10.3
in the Form 10-Q filed on June 14, 2002)10.5.1

Amendment to Agreement, dated November 11, 2002 between the Registrant and Nick Shahrestany (incorporated by
reference to Exhibit 10.5.1 in the Form 10-K filed on November 13, 2002)10.6

Agreement dated May 24, 2002 between the Registrant and Frank Alaghband (incorporated by reference to Exhibit 10.4 in
the Form 10-Q filed on June 14, 2002)10.6.1

Amendment to Agreement, dated November 11, 2002 between the Registrant and Frank Alaghband (incorporated by reference
to Exhibit 10.6.1 in the Form 10-K filed on November 13, 2002)10.7

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)99.1

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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