UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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 June 28, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _______.
Commission File No. 0-13576
ENCORE COMPUTER CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-2789167
(State of Incorporation) (I.R.S. Employer Identification No.)
6901 WEST SUNRISE BLVD.
FORT LAUDERDALE, FLORIDA 33313
(Address of Principal Executive Offices) (Zip Code)
Telephone: 954-316-4400
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, par value $.01 per share
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. X Yes _______ No
The number of shares outstanding of the registrant's only class of Common Stock
as of August 10, 1998 was 67,450,907.
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ENCORE COMPUTER CORPORATION
Index
PAGE
----
Part I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements 3
Notes to Condensed Consolidated
Financial Statements 8
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Part II OTHER INFORMATION 25
Signature Page 26
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ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Operations
- --------------------------------------------------------------------------------
(Unaudited)
(in thousands except per share data)
- --------------------------------------------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
1998 1997 1998 1997
---------- ---------- ---------- ----------
Net sales:
Equipment $ 1,826 $ 3,411 $ 3,369 $ 7,594
Service 3,055 3,943 6,234 8,093
--------- --------- ---------- -----------
Total 4,881 7,354 9,603 15,687
--------- --------- ---------- -----------
Costs and expenses:
Cost of equipment sales 1,109 6,122 1,699 13,298
Cost of service sales 2,130 4,285 4,102 8,554
Research and development 296 7,152 712 14,421
Sales, general and
administrative 2,452 7,580 4,104 15,218
Termination charge 826 0 1,570 0
--------- --------- ---------- -----------
Total 6,813 25,139 12,187 51,491
--------- --------- ---------- -----------
Operating loss (1,932) (17,785) (2,584) (35,804)
Interest expense, principally
related parties in 1997 (9) (1,355) (21) (2,754)
Interest income 246 32 472 61
Other (expense)/income, net 19 (500) (305) (1,163)
Gain on Sun Transaction 25,308 - 25,308 -
--------- --------- ---------- -----------
Income (loss) before income taxes 23,632 (19,608) 22,870 (39,660)
Prov (credit) for income taxes (112) 196 (108) 167
--------- --------- ---------- -----------
Net income (loss) $ 23,744 $ (19,804) $ 22,978 $ (39,827)
========= ========= ========== ===========
Net income (loss) per common share:
Net income (loss) attributable
to common shareholders $ 23,744 $ (27,066) $ 22,978 $ (53,949)
========= ========= ========== ===========
Basic and diluted income
(loss) per common share $ 0.35 $ (0.72) $ 0.34 $ (1.44)
========= ========= ========== ===========
Weighted average shares
of common stock 67,449 37,417 67,450 37,347
========= ========= ========== ===========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
Condensed Consolidated Balance Sheets
- --------------------------------------------------------------------------------
(in thousands except share data)
- --------------------------------------------------------------------------------
UNAUDITED
JUNE 28, DEC 31,
1998 1997
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents $ 16,194 $ 14,544
Restricted cash 1,271 14,083
Accounts receivable, less allowance 6,050 5,752
Due from Gores 287 -
Inventories (Note E) 707 246
Prepaid expenses and other current assets 874 855
---------- ---------
Total current assets 25,383 35,480
Property and equipment, net 791 1,063
Other assets 490 908
---------- ---------
Total assets $ 26,664 $ 37,451
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Current liabilities:
Accounts payable and accrued liabilities (Note F) $ 13,640 $ 22,097
Due to Gould Electronics (Note B) 9,692 35,000
---------- ---------
Total current liabilities 23,332 57,097
Shareholders' Equity (Capital Deficiency):
Common stock, $.01 par value; authorized 200,000,000
shares; issued 67,450,907 and 67,447,309 in 1998
and 1997, respectively 674 674
Additional paid-in capital 427,012 427,012
Accumulated deficit (424,354) (447,332)
---------- ---------
Total shareholders' equity (capital deficiency) 3,332 (19,646)
---------- ---------
Total liabilities and shareholders' equity
(capital deficiency) $ 26,664 $ 37,451
========== =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
(Unaudited)
(in thousands)
- --------------------------------------------------------------------------------
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 28, JUNE 29,
1998 1997
Cash flows from operating activities:
Net income (loss) $ 22,978 $ (39,827)
Adjustments to arrive at net cash used in
operating activities:
Gain on Sun Transaction (25,308) -
Depreciation and amortization 586 3,897
Inventory obsolescence and writedown to lower of cost
or market - 540
Bad debt provision - 408
Termination charge 1,570 0
Net changes in operating assets and liabilities:
Accounts receivable (298) 6,553
Inventories (461) 3,881
Prepaid expenses and other current assets (19) 58
Other assets 298 2
Accounts payable and accrued liabilities (10,027) (372)
Other liabilities - 130
-------- ---------
Net cash used in operating activities (10,681) (24,730)
-------- ---------
Cash flows from investing activities:
Proceeds from Sun Transaction 25,308 -
Additions to property and equipment (194) (690)
-------- ---------
Net cash provided by (used) in investing activities 25,114 (690)
-------- ---------
Cash flows from financing activities:
Net borrowings under revolving loan agreements - 24,402
Net advances under revolving loan agreements (287) -
Principal payments of long term debt - (92)
Issuance of common stock - 329
Payment of Due to Gould (25,308) -
-------- ---------
Net cash (used in) provided by financing activities (25,595) 24,639
-------- ---------
Decrease in cash and cash equivalents (11,162) (781)
Decrease in restricted cash 12,812 -
-------- ---------
1,650 (781)
Cash and cash equivalents, beginning 14,544 3,936
-------- ---------
Cash and cash equivalents, ending $ 16,194 $ 3,155
======== =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
Supplemental disclosure of cash flow information (in thousands):
SIX MONTHS SIX MONTHS
ENDED ENDED
JUNE 28, JUNE 29,
1998 1997
----------- ----------
Cash paid during the period for interest $ 22 $ 55
Cash paid during the period for income taxes $ 722 $ 1,212
Non-cash investing and financing activities:
Indebtedness exchanged for preferred stock $ 0 $ 40,000
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Shareholders' Equity (Capital Deficiency)
for the six months ended June 28, 1998
- --------------------------------------------------------------------------------
(unaudited)
(in thousands except share data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
COMMON STOCK SHAREHOLDERS'
------------------------ ADDITIONAL EQUITY
PAR PAID-IN ACCUMULATED (CAPITAL
SHARES VALUE CAPITAL DEFICIT DEFICIENCY)
---------- --------- -------------- ------------- ----------------
<S> <C> <C> <C> <C> <C>
Balance December 31, 1997 67,447,309 $ 674 $ 427,012 $ (447,332) $ (19,646)
Shares issued through employee stock purchase
plan at a price of $.23 per share 3,596 - - -
Net income 22,978 22,978
---------- --------- -------------- ------------- ----------------
Balance June 28, 1998 67,450,907 $ 674 $ 427,012 $ (424,354) $ 3,332
========== ========= ============== ============= ================
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND OTHER MATTERS
The accompanying condensed consolidated financial statements are unaudited and
have been prepared by Encore Computer Corporation ("Encore" or the "Company") in
accordance with generally accepted accounting principles. Certain information
and footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted. It is suggested that these
condensed consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 1997.
The condensed consolidated financial statements, in the opinion of the Company,
reflect all adjustments (including normal recurring accruals) necessary for a
fair statement of the results for the interim periods. All adjustments made
during the interim periods are normal recurring adjustments. The year-end
condensed balance sheet data is derived from audited financial statements but
does not include all disclosures required by generally accepted accounting
principles. Certain reclassifications have been made to conform prior period
data to current period presentation.
The results of operations for the interim periods are not necessarily indicative
of the results of operations for the fiscal years.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 established standards
for public business enterprises to report information about operating segments
in annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes the standards for related disclosures about
products and services, geographic areas, and major customers. SFAS 131 requires
a public business enterprise to report financial and descriptive information
about its reportable operating segments. The financial information is required
to be reported on the basis that it is used internally for evaluation segment
performance and deciding how to allocate resources to segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. SFAS 131 is effective for financial statements for periods
beginning after December 15, 1997. Management does not believe that the
requirements of SFAS 131 will have a material impact on the Company's financial
statements.
BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The Company has
agreed to sell its principal operating assets and plans to liquidate after
November 24, 1998. The Company will incur substantial expenses in connection
with a liquidation. The accompanying condensed consolidated financial statements
do not reflect either the effects of the proposed sale of the Company's
principal operating assets or the expenses it will incur in connection with its
liquidation. The Company has a substantial obligation to Gould Electronics Inc.
under an agreement by which the Company sold its storage products
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business to Sun. Sun has withheld a portion of that Second Payment, because of
claimed offsets. If Sun does not make the balance of the Second Payment, the
Company's obligation to Gould (which is reflected on its balance sheet) plus
expenses incurred in connection with the Company's liquidation (which are not
reflected on its balance sheet) are likely to exceed its assets. The ultimate
resolution of these matters are not presently determinable.
EARNINGS PER SHARE
Basic earnings per common share calculations are determined by dividing earnings
available to common shareholders by the weighted average number of shares of
common stock outstanding during the year. Diluted earnings per common share
calculations are determined by dividing earnings available to common
shareholders by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding. Basic and diluted earnings per
share were the same for all periods presented because the effect of common stock
equivalents would be anti-dilutive.
Net income (loss) per common share was determined by dividing the net income
(loss), as adjusted for the aggregate amount of dividends on the Company's
preferred stock, by applicable shares outstanding. There were no preferred stock
dividends for the three and six month periods ended June 28, 1998. Preferred
stock dividends amounted to $7,262,500 and $14,122,100 for the three and six
month periods ended June 29, 1997, respectively. Based on capital deficiencies,
the Company was precluded from paying dividends on its preferred stock
outstanding. Accordingly, the Company accumulated preferred stock dividends
since July 15, 1996. All preferred stock dividends other than those accumulated
at June 28, 1998 have been paid in additional shares of the appropriate class of
preferred stock. On July 31, 1998 all accumulated preferred stock dividends were
issued to Gould in connection with the Gould Agreement as discussed more fully
in Note B of Notes to Condensed Consolidated Financial Statements.
B. ASSET PURCHASE AGREEMENT WITH SUN MICROSYSTEMS
On November 24, 1997 (the "Closing"), pursuant to an Asset Purchase Agreement
dated as of July 17, 1997 (the "Agreement"), the Company sold substantially all
of the assets associated with its storage products business to Sun. The
Agreement had contemplated that the aggregate consideration to be paid to the
Company by Sun for such assets was to be $185,000,000, of which $150,000,000 in
cash was to be paid at the closing (the "Closing Payment") and $35,000,000 was
to be payable on July 1, 1998 (the "Second Payment"). Pursuant to the terms of a
Modification Agreement, dated as of November 24, 1997, among Encore and Sun, the
parties agreed that the final amount of the Closing Payment would be reduced to
$149,882,683 to reflect that Sun was assuming certain liabilities of certain
non-U.S. subsidiaries of the Company in the amount of $117,317, which Sun had
not previously agreed to assume under the terms of the Agreement. In addition,
the parties further agreed that Sun was to pay an additional amount of
$1,285,544 to Encore for the purchase by Sun of certain finished storage product
units, as contemplated by the terms of the Agreement. Thus, the aggregate amount
paid by Sun to Encore at the Closing was $151,168,227 (the "Total Cash Closing
Payment"), which was paid by Sun to Encore as follows: (i) at the Company's
request, $118,550,972.57 was paid to Gould Electronics Inc. ("Gould"), which
represented payment by Encore to Gould for (I) the aggregate amount of
outstanding principal amount of indebtedness, and accrued interest thereon, owed
by the Company to Gould and (II) a portion of the cost of redeeming Encore's
outstanding Preferred Stock, all of which was then owned by Gould and an
affiliate of Gould, pursuant to an agreement dated July 17, 1997 between the
Company and Gould (the "Gould
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Agreement"); (ii) at the Company's request, $11,876 was paid in French Francs to
Encore Computer, S.A, a wholly-owned subsidiary of Encore; (iii) $22,000,000 was
paid to First Trust of California, National Association, as escrow agent,
pursuant to the terms of an escrow arrangement between Encore and Sun; and (iv)
the remainder was paid to the Company. The purchase price for the sale of assets
in the Sun Transaction, and the modifications thereto as described above, were
determined as a result of arms-length negotiations between Encore and Sun.
In connection with the Gould Agreement, the Company agreed to redeem all of the
Preferred Stock held by Gould and EFI at the Closing for $60 million in cash, of
which $25 million was paid from the Total Cash Closing Payment as described
above and the balance paid by assigning to Gould the right to receive the Second
Payment. However, under the Agreement, Sun has the right to set off against the
Second Payment, any amounts owed to Sun by Encore pursuant to its
indemnification obligations. If the amount paid to Gould by Sun on July 1, 1998
was less than $35 million due to the inaccuracy of any representation or
warranty of Encore in the Agreement, the failure by Encore to fulfill any
obligation under the Agreement, or any other act or omission of Encore, under
the Gould Agreement, Encore would be indebted to Gould for the amount by which
such payment is less than $35 million. In addition, if the $35 million was not
paid to Gould by July 31, 1998, Gould would be entitled to receive from Encore
shares of Series B, D, E, F, G, H, and I Preferred Stock which represent accrued
but unpaid dividends on Gould's Preferred Stock as of November 24, 1997. These
unpaid dividends represent 426,784 shares with a liquidation preference of
$42,678,400 (the "Unpaid Dividend Shares"). If the full $35 million was paid to
Gould by July 31, 1998, Gould would waive its right to receive these accrued but
unpaid dividends. Additionally, Gould had agreed to waive any right it may have
had as a holder of Common Stock to participate in the first $30 million which
the Company could distribute to its shareholders as a liquidating dividend in
any liquidation within two years after the Closing. In light of the
uncertainties about the amount which would be received with regard to the Second
Payment, the Company did not record the Second Payment as an asset as of
December 31, 1997. Because the Company was required to make the $35 million
payment to Gould to the extent the Second Payment was less than that amount, the
decision to defer recognition of the Second Payment as an asset resulted in the
Company's carrying the entire $35 million obligation to Gould as a liability
without an offsetting asset at December 31, 1997.
On June 25, 1998, Sun informed Encore of their intent to setoff $10,062,000 less
$370,000 subsequently reimbursed, for a total setoff of $9,692,000. The setoff
relates to the following: (i) $1,025,000 claim by Sun that Encore was unable to
deliver to Sun the right to use certain Test Software; (ii) $5,000 outside legal
fees and other expenses incurred regarding a threatened action by Memorex Telex
Italia relating to an alleged breach of Encore's promise to deliver certain
product features, as well as a $1,000,000 demand by Memorex for compensation
relating to their claim of lost sales and their exclusion from competing for
future storage bids at Telecom Italia; (iii) $350,000 relating to Sun's claim
for indemnifiable costs associated with obtaining proper CSA/VDE/UL/TUV
certification of Encore's SP40/A7000 and Remote Dual Copy hardware; (iv)
$7,200,000 relating to Sun's claim for indemnifiable costs associated with the
repair or replacement of storage products sold by Encore prior to the closing
which Sun claims have failed to conform to Encore's warranties, customer
commitments, product specification and/or quality standards. Encore has
requested Sun to provide documentation regarding these claims; however, the
ultimate resolution of these matters is not presently determinable. On July 1,
1998, Sun paid Gould $25,308,000 with regard to the Second Payment, which was
recorded as income in June 1998. Therefore, Encore owes Gould $9,692,000 under
the Agreement and that amount was not paid by July 31, 1998. In order to avoid
the need for Encore to make a payment of $9,692,000 to Gould by July 31, 1998,
or be irrevocably obligated to issue the Unpaid
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Dividend Shares, without knowing the amount, if any, it might recover through
future payments of additional portions of the Second Payment, Gould gave Encore
the option (the "Option") to repurchase the Unpaid Dividend Shares at any time
on or before July 31, 1999 for an amount equal to (a) $35,000,000, minus (b) all
sums Gould receives with regard to the Second Payment, plus (c) interest on that
amount at 8.5% per annum from August 1, 1998 to the day the Option is exercised.
On July 16, 1998, a committee of the Board of Directors approved the issuance of
the dividend shares to Gould which were issued on July 31, 1998. If Encore does
not exercise its Option by July 31, 1999, Gould's Preferred Stock will absorb
all of the liquidation proceeds, if any, as discussed more fully in Note D of
Notes to Condensed Consolidated Financial Statements.
In connection with the sale of the storage products business to Sun, the Company
charged to operations a termination charge of $17,685,000 related to: (i)
severance and benefit pay of $6,323,000 as a result of a 542 person reduction in
workforce, including severance for employees contracted by Sun, as the Company
agreed to pay the difference between the completion bonus offered to contractors
by Sun at the end of their contract and the amount of severance they were
entitled to had they been terminated by the Company; (ii) $4,722,000 of
retention payments pursuant to written agreements between the Company and each
of approximately 49 employees; (iii) $1,000,000 of incentive bonuses to certain
key employees; (iv) $3,390,000 relating to the termination of European facility
and automobile leases, and $350,000 relating to a domestic equipment lease; (v)
an estimated $500,000 for leasehold improvements to be made at the Company's
Fort Lauderdale facility which is leased from Sun; (vi) $1,150,000 in estimated
legal and other fees associated with the Sun Transaction; and (vii) $250,000
accrued for legal fees in connection with pending legal action brought by
certain shareholders in connection with the Sun Transaction (the "Shareholders
Suit").
In connection with the Agreement and for a one-year period following the
Closing, Gould has agreed to take all actions necessary to ensure that Encore
remains solvent. In addition, Gould and certain of its affiliates have agreed,
among other things, that, if within two years following the Closing, the Company
commences an insolvency proceeding and the Sun Transaction is challenged in that
proceeding, that Gould and such affiliates will indemnify Sun for losses arising
therefrom.
Restricted cash of $1,271,000 and $14,083,000 at June 28, 1998 and December 31,
1997, respectively, represents cash held in an escrow account pursuant to an
escrow agreement dated November 24, 1997 between the Company and Sun. The escrow
arrangement was established to ensure that certain of the Company's liabilities
at the closing date of the Sun Transaction, would be paid when due. As the
Company pays these liabilities, escrow funds are released to the Company. These
funds are invested in a U.S. Bank money market fund and will be made available
to the Company pursuant to the terms of the escrow agreement.
C. TERMINATION CHARGES
During the quarter ended June 28, 1998, pursuant to the Asset Purchase Agreement
(the "Asset Purchase Agreement") with Gores Technology Group ("Gores"),
discussed more fully in Note D of Notes to Condensed Consolidated Financial
Statements, the Company recorded a termination charge of $826,000 relating to
severance and benefit pay as a result of a 19 person reduction in workforce,
including severance for employees which may be borne by Gores in accordance with
a Management Agreement (the "Management Agreement") entered into on June 1,
1998, as discussed more fully in Note D of Notes to Condensed Consolidated
Financial Statements
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When the Company completed the sale of its storage products business, the Board
of Directors decided the Company should, at least until the Board's January 1998
meeting, (a) explore the possibility of attempting to develop and market
clustering software in a Windows NT environment for various types of computer
hardware, and (b) explore the feasibility of continuing, and attempting to
expand, its real time computer systems business. In January 1998, the Board of
Directors (i) decided the Company should discontinue its efforts to develop
clustering technology in a Windows NT environment for various types of computer
hardware resulting in a termination charge of $743,500, and (ii) authorized the
Company to retain an investment banker to explore strategic options with respect
to the real time business.
D. PROPOSED SALE TO GORES TECHNOLOGY GROUP
On March 2, 1998, the Company signed a letter of intent with Gores Technology
Group to sell the assets of the Company's real-time business for approximately
$5.5 million based on a projected December 31, 1997 balance sheet for the
Real-Time Business. The transaction was subject to the satisfactory completion
of due diligence by Gores, the negotiation and execution of a definitive asset
purchase agreement and the satisfaction of any closing conditions.
On June 4, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire substantially all of the Company's assets, other than cash, and assume
substantially all of its liabilities related to the real-time business. The
purchase price is $3 million in cash, all of which would be paid at closing. The
reduction in price from that contemplated in the letter of intent reflects
changes to the balance sheet of the real-time business since the projected
12/31/97 balance sheet which was the basis for the price set forth in the letter
of intent. Gould Electronics Inc., the Company's principal shareholder, will be
jointly and severally liable with the Company for indemnification obligations to
Gores under the agreement. Encore's real-time business in France is expected to
be addressed separately in an agreement to be negotiated locally with Gores.
Pending the closing, Gores is operating the real-time business in accordance
with a Management Agreement (the "Management Agreement"), retaining any positive
cash flow and bearing any negative cash flow, pursuant to a management contract
which provides for a monthly management fee of $100,000 which will be fully
refunded to Encore on closing. The Management Agreement provides that: (i) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated negative cash flow from
June 1, 1998 until such termination, Gores will refund to Encore the amount of
the negative cash flow up to the amount of monthly management fees paid; (ii) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated positive cash flow from
June 1, 1998 until such termination, Gores will retain the positive cash flow
and the management fees paid; : (iii) if the Asset Purchase Agreement is
approved by the shareholders, and the real-time business has generated negative
cash flow from June 1, 1998 until such approval, Gores will refund to Encore the
amount of the negative cash flow and the management fees paid; (iv) if the Asset
Purchase Agreement is approved by the shareholders, and the real-time business
has generated positive cash flow from June 1, 1998 until such approval, Gores
will retain the positive cash flow and return the management fees paid. Due to
the uncertainty of the outcome of the Gores Transaction, the possible income or
expense impact associated with the termination or closing of the Asset Purchase
Agreement has not been recorded in the Company's Statement of Operations at June
28, 1998. Encore has provided a $2 million line of credit to Gores to fund the
operations of the real-time business until the closing. By June 28, 1998, Gores
had borrowed $287,000 under this line of credit. The closing is subject to
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customary conditions, including the approval of the Encore shareholders at a
meeting which is expected to be held on September 11, 1998.
If the sale of the real-time business is consummated, it is anticipated that the
Company will be liquidated after November 24, 1998. Gould owns 48.44% of the
Company's outstanding common stock and has agreed to waive its right as a common
shareholder to receive any portion of the first $30 million of liquidating
distributions to the Company's shareholders in any liquidation of the Company
which occurs prior to November 24, 1999. On June 25, 1998, Sun informed Encore
of their intent to setoff $10,062,000 less $370,000 subsequently reimbursed, for
a total setoff of $9,692,000. The setoff relates to the following: (i)
$1,025,000 claim by Sun that Encore was unable to deliver to Sun the right to
use certain Test Software; (ii) $5,000 outside legal fees and other expenses
incurred regarding a threatened action by Memorex Telex Italia relating to an
alleged breach of Encore's promise to deliver certain product features, as well
as a $1,000,000 demand by Memorex for compensation relating to their claim of
lost sales and their exclusion from competing for future storage bids at Telecom
Italia; (iii) $350,000 relating to Sun's claim for indemnifiable costs
associated with obtaining proper CSA/VDE/UL/TUV certification of Encore's
SP40/A7000 and Remote Dual Copy hardware; (iv) $7,200,000 relating to Sun's
claim for indemnifiable costs associated with the costs relating to the repair
or replacement of storage products sold by Encore prior to the closing which Sun
claims have failed to conform to Encore's warranties, customer commitments,
product specification and/or quality standards. Encore has requested Sun to
provide documentation regarding these claims; however, the ultimate resolution
of these matters is not presently determinable. On July 1, 1998, Sun paid Gould
$25,308,000 with regard to the Second Payment. Therefore, Encore owes Gould
$9,692,000 under the Agreement. Because that amount was not paid by July 31,
1998, on July 31, 1998, Encore issued to Gould the Unpaid Dividend Shares with a
liquidation preference of $42,678,400, as previously unpaid dividends on
Preferred Stock Gould had owned prior to November 24, 1997. However, in order to
avoid the need for Encore to make a payment of $9,692,000 to Gould by July 31,
1998, or be irrevocably obligated to issue the Unpaid Dividend Shares, without
knowing the amount, if any, it might recover through future payments of
additional portions of the Second Payment, Gould gave Encore the option (the
"Option") to repurchase the Unpaid Dividend Shares at any time on or before July
31, 1999 for an amount equal to (a) $35,000,000, minus (b) all sums Gould
receives with regard to the Second Payment, plus (c) interest on that amount at
8.5% per annum from August 1, 1998 to the day the Option is exercised. If Encore
does not exercise its Option by July 31, 1999, Gould's Preferred Stock will
absorb all of the liquidation proceeds, if any.
If the sale of the real-time business is consummated, the assets of the Company
available for distribution to shareholders on liquidation would be: (i) the
Company's assets at June 28, 1998 plus any additional amounts received with
regard to the Second Payment, less its liabilities at June 28, 1998 including
the $9,692,000 payable to Gould, plus or minus; (ii) any amount by which the
severance and other costs related to the sale of the storage products business
and the discontinuance of the Company's efforts to develop clustering software
in a Windows NT environment as well as severance related to the Gores
Transaction, paid after June 28, 1998 are greater or less than the estimated
amount reflected on the Company's June 28, 1998 balance sheet, plus or minus;
(iii) the gain or loss from the sale of the Company's real time computer systems
business; minus (iv) costs of the liquidation and reserves for any contingent
liabilities, including any pending litigation, estimated by the Company to be
approximately $10,624,000, which has not been recorded on the books of the
Company as of June 28, 1998.
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E. INVENTORIES
Inventories consist of the following (in thousands):
June 28, December 31,
1998 1997
------------ -------------
Purchased parts $ 486 $ 174
Work in process 180 0
Finished goods 41 72
---------- -----------
Total inventory $ 707 $ 246
========== ===========
All increases in inventory are purchases on behalf of Gores in accordance with
the Management Agreement.
F. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following (in
thousands):
June 28, December 31,
1998 1997
------------ ------------
Accounts payable $ 2,374 $ 1,064
Accrued salaries and benefits 1,623 2,355
Accrued restructuring 7,445 13,655
Accrued taxes 137 1,048
Deferred income, principally
maintenance contracts 828 638
Other accrued expenses 1,233 3,337
---------- -----------
Total accounts payable and accrued liabilities $ 13,640 $ 22,097
========== ===========
During the six months ended June 28, 1998, pursuant to the Asset Purchase
Agreement with Gores Technology Group, discussed more fully in Note D of Notes
to Condensed Consolidated Financial Statements, the Company recorded a
termination charge of $826,000 relating to severance and benefit pay as a result
of a 19 person reduction in workforce, including severance for employees which
may be borne by Gores in accordance with the Management Agreement entered into
on June 1, 1998, as discussed more fully in Note D of Notes to Condensed
Consolidated Financial Statements. Additionally, the Company recorded a
termination charge of $743,500 related to severance and benefit pay as a result
of a 13 person reduction in workforce associated with the Board of Directors
decision not to pursue the NT opportunity In addition, in the fourth quarter of
1997, in conjunction with the Sun Transaction and subsequent reorganization, the
Company recorded a termination charge of $17,685,000 related to: (i) severance
and benefit pay of $6,323,000 as a result of a 542 person reduction in
workforce, including severance for employees contracted by Sun, as the Company
agreed to pay the difference between the completion bonus offered to contractors
by Sun at the end of their contract and the amount of severance they were
entitled to had they been terminated by the Company; (ii) $4,722,000 of
retention payments pursuant to agreements between the Company and each of
approximately 49 employees; (iii) $1,000,000 of incentive bonuses to certain key
employees; (iv) $3,390,000 relating to the termination of European facility and
automobile leases, and $350,000 relating to a domestic
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equipment lease; (v) an estimated $500,000 for leasehold improvements to be made
at the Company's Fort Lauderdale facility which is leased from Sun; (vi)
$1,150,000 in estimated legal and other fees associated with the Sun
Transaction; and (vii) $250,000 accrued for legal fees in connection with the
Shareholders Suit.
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ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 28, 1998
COMPARED TO THE THREE AND SIX MONTHS ENDED JUNE 29, 1997
The following is management's discussion and analysis of the financial condition
and the results of operations of Encore Computer Corporation ("Encore" or the
"Company") for the three and six month periods ended June 28, 1998 compared to
the three and six month periods ended June 29, 1997. The Company's net income
for the three and six months ended June 28, 1998 was $23,744,000 and
$22,978,000, respectively, compared to a net loss for the same periods of 1997
of $19,804,000 and $39,827,000, respectively. The 1998 income is due principally
to the recognition of the $25,308,000 gain with regard to the Second Payment due
from Sun, which was recorded in the three month period ended June 28, 1998.
THE SUN TRANSACTION
On November 24, 1997 (the "Closing"), pursuant to the Agreement, the Company
sold substantially all of the assets associated with its storage products
business to Sun. The Agreement had contemplated that the aggregate consideration
to be paid to the Company by Sun for such assets was to be $185,000,000, of
which $150,000,000 in cash was to be paid at the closing (the "Closing Payment")
and $35,000,000 was to be payable on July 1, 1998 (the "Second Payment").
Pursuant to the terms of a Modification Agreement, dated as of November 24,
1997, among Encore and Sun, the parties agreed that the final amount of the
Closing Payment would be reduced to $149,882,683 to reflect that Sun was
assuming certain liabilities of certain non-U.S. subsidiaries of the Company in
the amount of $117,317, which Sun had not previously agreed to assume under the
terms of the Agreement. In addition, the parties further agreed that Sun was to
pay an additional amount of $1,285,544 to Encore for the purchase by Sun of
certain finished storage product units, as contemplated by the terms of the
Agreement. Thus, the aggregate amount paid by Sun to Encore at the Closing was
$151,168,227 (the "Total Cash Closing Payment"), which was paid by Sun to Encore
as follows: (i) at the Company's request, $118,550,972.57 was paid to Gould,
which represented payment by Encore to Gould for (I) the aggregate amount of
outstanding principal amount of indebtedness, and accrued interest thereon, owed
by the Company to Gould and (II) a portion of the cost of redeeming Encore's
outstanding Preferred Stock, all of which was then owned by Gould and EFI,
pursuant to an agreement dated July 17, 1997 between the Company and Gould (the
"Gould Agreement"); (ii) at the Company's request, $11,876 was paid in French
Francs to Encore Computer, S.A, a wholly-owned subsidiary of Encore; (iii)
$22,000,000 was paid to First Trust of California, National Association, as
escrow agent, pursuant to the terms of an escrow arrangement between Encore and
Sun; and (iv) the remainder was paid to the Company. The purchase price for the
sale of assets in the Sun Transaction, and the modifications thereto as
described above, were determined as a result of arms-length negotiations between
Encore and Sun.
In connection with the Agreement and for a one-year period following the
Closing, Gould has agreed to take all actions necessary to ensure that Encore
remains solvent. In addition, Gould and certain of its affiliates have agreed,
among other things, that, if within two years following the Closing, the Company
commences an insolvency proceeding and the Sun Transaction is challenged in that
proceeding, that Gould and such affiliates will indemnify Sun for losses arising
therefrom.
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In connection with the Gould Agreement, the Company agreed to redeem all of the
Preferred Stock held by Gould and EFI at the Closing for $60 million in cash, of
which $25 million was paid from the Total Cash Closing Payment as described
above and the balance paid by assigning to Gould the right to receive the Second
Payment from Sun. However, under the Agreement, Sun had the right to set off
against the Second Payment, any amounts owed to Sun by Encore pursuant to its
indemnification obligations. If the amount paid to Gould by Sun on July 1, 1998
was less than $35 million due to the inaccuracy of any representation or
warranty of Encore in the Agreement, the failure by Encore to fulfill any
obligation under the Agreement, or any other act or omission of Encore, under
the Gould Agreement, Encore would be indebted to Gould for the amount by which
such payment is less than $35 million. In addition, if the $35 million was not
paid to Gould by July 31, 1998, Gould would be entitled to receive from Encore
shares of Series B, D, E, F, G, H, and I Preferred Stock which represent accrued
but unpaid dividends on Gould's Preferred Stock as of November 24, 1997. These
unpaid dividends represent 426,784 shares with a liquidation preference of
$42,678,400. If the full $35 million was paid to Gould by July 31, 1998, Gould
would waive its right to receive these accrued but unpaid dividends.
Additionally, Gould agreed to waive any right it may have as a holder of Common
Stock to participate in the first $30 million which the Company may distribute
to its shareholders as a liquidating dividend in any liquidation within two
years after the Closing. In light of the uncertainties about the amount which
would be received with regard to the Second Payment, the Company did not record
the Second Payment as an asset at December 31, 1997. Because the Company was
required to make the $35 million payment to Gould to the extent the Second
Payment was less than that amount, the decision to defer recognition of the
Second Payment as an asset resulted in the Company's carrying the entire $35
million obligation to Gould as a liability without an offsetting asset at
December 31, 1997.
At the closing of the Sun Transaction, Sun and Encore entered into a Technology
License Agreement pursuant to which Sun granted to Encore a non-exclusive,
non-transferable, royalty free, worldwide license in the intellectual property
sold to Sun as part of the storage products business to create and distribute
real-time products based on the intellectual property for use by Encore in its
real-time business, subject to certain limitations, but not for any other
purpose. Encore also agreed not to use the intellectual property in any storage
products or to compete with Sun's storage products business, and to grant to Sun
a non-exclusive, royalty-free, paid up, non-terminable, worldwide license in any
derivative works created by Encore derived from the intellectual property, so
long as Sun does not use this grant back license to create or distribute
real-time products.
EVENTS FOLLOWING THE SUN TRANSACTION
When the Company completed the sale of its storage products business, the Board
of Directors decided the Company should, at least until the Board's January 1998
meeting, (a) explore the possibility of attempting to develop and market
clustering software in a Windows NT environment for various types of computer
hardware, and (b) explore the feasibility of continuing, and attempting to
expand, its real time computer systems business. In January 1998, the Board of
Directors (i) decided the Company should discontinue its efforts to develop
clustering technology in a Windows NT environment for various types of computer
hardware resulting in a termination charge of $743,500, and (ii) authorized the
Company to retain an investment banker to explore strategic options with respect
to the real time business.
On March 2, 1998, the Company signed a letter of intent to sell its real time
computer systems business to Gores Technology Group. That transaction was
subject to completion by Gores of due diligence and to negotiation and execution
of definitive agreements. Upon the sale of its real time computer systems
business to Gores or to any other purchaser, the Company no longer will have any
business operations. Therefore, when the Company's
17
<PAGE>
shareholders are asked to approve a sale of the real time computer systems
business, they will also be asked to approve a liquidation of the Company after
November 24, 1998.
On June 4, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire substantially all of the Company's assets, other than cash, and assume
substantially all of its liabilities related to the real-time business. The
purchase price is $3 million in cash, all of which would be paid at closing. The
reduction in price from that contemplated in the letter of intent reflects
changes to the balance sheet of the real-time business since the projected
12/31/97 balance sheet which was the basis for the price set forth in the letter
of intent. Gould Electronics Inc., the Company's principal shareholder, will be
jointly and severally liable with the Company for indemnification obligations to
Gores under the agreement. Encore's real-time business in France is expected to
be addressed separately in an agreement to be negotiated locally with Gores.
Pending the closing, Gores is operating the real-time business, in accordance
with a Management Agreement (the "Management Agreement"), retaining any positive
cash flow and bearing any negative cash flow, pursuant to a management contract
which provides for a monthly management fee of $100,000 which will be fully
refunded to Encore on closing. The Management Agreement provides that: (i) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated negative cash flow from
June 1, 1998 until such termination, Gores will refund to Encore the amount of
the negative cash flow up to the amount of monthly management fees paid; (ii) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated positive cash flow from
June 1, 1998 until such termination, Gores will retain the positive cash flow
and the management fees paid; : (iii) if the Asset Purchase Agreement is
approved by the shareholders, and the real-time business has generated negative
cash flow from June 1, 1998 until such approval, Gores will refund to Encore the
amount of the negative cash flow and the management fees paid; (iv) if the Asset
Purchase Agreement is approved by the shareholders, and the real-time business
has generated positive cash flow from June 1, 1998 until such approval, Gores
will retain the positive cash flow and return the management fees paid. Due to
the uncertainty of the outcome of the Gores Transaction, the possible income or
expense impact associated with the termination or closing of the Asset Purchase
Agreement has not been recorded in the Company's Statement of Operations at June
28, 1998. Encore has provided a $2 million line of credit to Gores to fund the
operations of the real-time business until the closing. By June 28, 1998, Gores
had borrowed $287,000 under this line of credit. The closing is subject to
customary conditions, including the approval of the Encore shareholders at a
meeting which is expected to be held on September 11, 1998.
On June 25, 1998, Sun informed Encore of their intent to setoff $10,062,000 less
$370,000 subsequently reimbursed, for a total setoff of $9,692,000. The setoff
relates to the following: (i) $1,025,000 claim by Sun that Encore was unable to
deliver to Sun the right to use certain Test Software; (ii) $5,000 outside legal
fees and other expenses incurred regarding a threatened action by Memorex Telex
Italia relating to an alleged breach of Encore's promise to deliver certain
product features, as well as a $1,000,000 demand by Memorex for compensation
relating to their claim of lost sales and their exclusion from competing for
future storage bids at Telecom Italia; (iii) $350,000 relating to Sun's claim
for indemnifiable costs associated with obtaining proper CSA/VDE/UL/TUV
certification of Encore's SP40/A7000 and Remote Dual Copy hardware; (iv)
$7,200,000 relating to Sun's claim for indemnifiable costs associated with the
repair or replacement of storage products sold by Encore prior to the closing
which Sun claims have failed to conform to Encore's warranties, customer
commitments, product specification and/or quality
18
<PAGE>
standards. Encore has requested Sun to provide documentation regarding these
claims; however, the ultimate resolution of these matters is not presently
determinable. On July 1, 1998, Sun paid Gould $25,308,000 with regard to the
Second Payment. Therefore, Encore owes Gould $9,692,000 under the Agreement and
that amount was not paid by July 31, 1998. In order to avoid the need for Encore
to make a payment of $9,692,000 to Gould on July 31, 1998, or be irrevocably
obligated to issue the Unpaid Dividend Shares, without knowing the amount, if
any, it might recover through future payments of additional portions of the
Second Payment, Gould is willing to give Encore the option (the "Option") to
repurchase the Unpaid Dividend Shares at any time on or before July 31, 1999 for
an amount equal to (a) $35,000,000, minus (b) all sums Gould receives with
regard to the Second Payment, plus (c) interest on that amount at 8.5% per annum
from August 1, 1998 to the day the Option is exercised. On July 16, 1998 the
Board of Directors approved the issuance of the preferred shares to Gould.
At June 28, 1998, the Company had total assets of $26,664,000, including
restricted cash of $1,271,000, and cash and cash equivalents of $16,194,000, but
not including any amount for the balance of the Second Payment, and had
liabilities of $23,332,000, including $7,445,000 of estimated severance costs
and other costs related to the proposed sale of the Company's Real-Time business
to Gores and the sale of the Company's storage products business and
discontinuance of its efforts to develop clustering software in a Windows NT
environment, and the $9,692,000 remaining payable to Gould. If the sale of the
real-time business is consummated, the assets of the Company available for
distribution to shareholders on liquidation would be: (i) the Company's assets
at June 28, 1998 plus any additional amounts received with regard to the Second
Payment, less its liabilities at June 28, 1998 including the $9,692,000 payable
to Gould, plus or minus; (ii) any amount by which the severance and other costs
related to the sale of the storage products business and the discontinuance of
the Company's efforts to develop clustering software in a Windows NT environment
as well as severance related to the Gores Transaction, paid after June 28, 1998
are greater or less than the estimated amount reflected on the Company's June
28, 1998 balance sheet, plus or minus; (iii) the gain or loss from the sale of
the Company's real time computer systems business; minus (iv) costs of the
liquidation and reserves for any contingent liabilities, including any pending
litigation.
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The Company has
agreed to sell its principal operating assets and plans to liquidate after
November 24, 1998. The Company will incur substantial expenses in connection
with a liquidation. The accompanying condensed consolidated financial statements
do not reflect either the effects of the proposed sale of the Company's
principal operating assets or the expenses it will incur in connection with its
liquidation. The Company has a substantial obligation to Gould Electronics Inc.
under an agreement by which the Company sold its storage products business to
Sun. Sun has withheld a portion of that Second Payment, because of claimed
offsets. If Sun does not make the balance of the Second Payment, the Company's
obligation to Gould (which is reflected on its balance sheet) plus expenses
incurred in connection with the Company's liquidation (which are not reflected
on its balance sheet) are likely to exceed its assets. The ultimate resolution
of these matters are not presently determinable.
RESULTS OF OPERATIONS:
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Net sales for the three and six month periods ended June 28, 1998 decreased 34%
and 39%, respectively, to $4,881,000 and $9,603,000 from $7,354,000 and
$15,687,000 for the three and six month periods of 1997. For the three and six
month periods ended June 28, 1998, equipment sales decreased 46% and 56% to
$1,826,000 and $3,369,000, respectively, when compared to $3,411,000 and
$7,594,000 for the three and six month periods ended June 29, 1997. Service
revenues for the three and six month periods ended June 28, 1998 were $3,055,000
and $6,234,000, respectively, compared to $3,943,000 and $8,093,000 for the
three and six month periods ended June 29, 1997, respectively. Real-time
equipment sales for the three and six month periods ended June 28, 1998 were
$1,826,000 and $3,369,000 compared to $2,400,000 and $5,349,000 for the same
periods in 1997. Storage product equipment sales for the three and six months
ended June 29, 1997 were $1,011,000 and $2,245,000, respectively. The Company
had no storage product equipment sales for the three and six month periods ended
June 28, 1998 as a result of the Sun Transaction. Real-time service revenues
were $3,055,000 and $6,234,000 for the three and six month periods ended June
28, 1998, compared to $3,943,000 and $8,093,000 for the same periods of 1997. No
service revenues were derived from the storage product business in the first six
months of either 1998 or 1997. The Company's operating loss for the three and
six month periods in 1998 was $1,932,000 and $2,584,000, respectively, compared
to operating losses of $17,785,000 and $35,804,000 for the same periods in 1997.
Equipment sales as a percentage of total net sales for the three and six months
ended June 28, 1998 were 37%, and 35%, respectively, compared to 46% and 48% for
the three and six month periods ended June 29, 1997, respectively. For real-time
equipment sales, the respective percentages were 37% and 35% of total net sales
in the three and six month periods ended June 28, 1998, compared to 33% and 34%
for the same periods of 1997. Storage product sales for the three and six months
ended June 29, 1997 were 14% of total net sales. The decrease in equipment sales
for the three and six month periods in 1998 is primarily due to certain of the
Company's traditional real-time products having reached the end of their product
life cycle. International equipment sales decreased 62% and 57% in the three and
six month periods ended June 28, 1998, respectively, to $483,000 and $1,353,000,
respectively, compared to $1,266,000 and $3,118,000 for the three and six month
periods of 1997, respectively, with no storage product sales in 1998 compared to
sales of $371,000 and returns exceeding sales of $104 for the three and six
months ended June 29, 1997, respectively. Domestic equipment sales decreased 37%
and 55% for the three and six month periods ended June 28, 1998 to $1,343,000
and $2,016,000, respectively, compared to $2,145,000 and $4,476,000 for the same
periods of 1997, with storage product sales decreasing to $0 from $640,000 and
$2,245,000 for the three and six month periods ended June 29, 1997.
Continued declining service revenues reflect the effect on the service business
of: (i) the Company's prolonged decline in equipment sales; (ii) the price
competitiveness of the marketplace; and (iii) the completion of long running
government programs and subsequent deinstallation of systems. International
service sales decreased 30% and 29% to $1,799,000 and $3,617,000 for the three
and six month periods ended June 28, 1998, respectively, while domestic service
sales decreased 10% and 12% to $1,256,000 and $2,617,000 compared to the three
and six month periods in 1997. No service sales were derived from the storage
product business for the periods ended June 28, 1998 and June 29, 1997.
International net sales decreased 40% for the three and six month periods ended
June 28, 1998 (34% and 40% for real-time) when compared to the same period in
1997. Domestic net sales decreased 26% and 38% (10% and 9% for real-time) for
the three and six month periods ended June 28, 1998 when compared to the 1997
three and six month periods. International net sales for the three and six
months ended June 28, 1998 were $2,282,000
20
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and $4,970,000, or 47% and 52% of total net sales. International real-time net
sales for the three and six months ended June 29, 1997 were $3,450,000 and
$8,338,000, or 47% and 53% of total net sales.
Total cost of sales decreased in the three and six month periods ended June 28,
1998 to $3,239,000 and $5,801,000, respectively, all of which was for real-time,
from $10,407,000 and $21,852,000 ($4,691,000 and $10,545,000 for real-time and
$5,716,000 and $11,307,000 for storage product) from the same periods in 1997.
The decrease was due generally to lower sales volumes and lower spending
resulting from the Sun Transaction.
Cost of equipment sales for the three and six month periods ended June 28, 1998
were $1,109,000 and $1,699,000 or 61% and 50% of net equipment sales,
respectively. Cost of real-time equipment sales for the three and six month
periods ended June 29, 1997 were $2,359,000 and $5,302,000 or 98% and 99% of
real-time equipment sales, respectively. Cost of storage product sales exceeded
storage product sales by $4,705,000 and $9,270,000 for the three and six month
periods ended June 29, 1997. Gross margins on real-time equipment sales were
$717,000 and $1,670,000 or 39% and 50% for the three and six month periods ended
June 28, 1998, respectively, as compared to $41,000 and $47,000 or 2% and 1% for
the three and six month periods ended June 29, 1997, respectively. A negative
gross margin was generated by the storage product business of $4,705,000 and
$9,062,000 for the three and six month periods ended June 29, 1997.
Equipment gross margins for the three and six months ended June 28, 1998 were
$717,000 and $1,670,000 or 39% and 50% of equipment sales. Equipment gross
margins were negatively impacted for the same periods in 1997 due to the
discounting of storage products in order to penetrate the marketplace and
establish reference accounts. Warranty costs related to the Storage Product in
1997 were also higher than anticipated due to engineering changes on current
installations and spare part inventory. Factory variances related to lower
production volumes and underutilization of manufacturing capacity also lowered
gross margin in the three and six month periods ended June 29, 1997.
For the three and six month periods ended June 28, 1998, service gross margins
were $925,000 and $2,132,000, respectively, compared to losses of $342,000 and
$461,000 for the same periods in 1997. For the three and six month periods in
1997, service margins were reduced for expenditures on various programs and
infrastructure necessary to support the storage product line, for which no
revenues were generated. The Company spent $1,953,000 and $3,311,000 (50% and
41% of service sales) in the three and six month periods ended June 29, 1997,
respectively. Sun purchased all fixed assets and spares inventory related to the
storage product and hired all storage product service personnel.
All service sales are derived from installed real-time products and the cost
structure within the service department is highly variable due to the
utilization of service partners. Therefore, as revenues decline, costs decline
as well. Moreover, management continues to reduce fixed costs on an ongoing
basis. Gross margins on real-time service sales were $925,000 and $2,132,000
(30% and 34%) for the three and six month periods ended June 28, 1998,
respectively, compared to $1,611,000 and $2,850,000 (41% and 35%) for the three
and six month periods ended June 29, 1997, respectively.
Research and development expenses for the three and six month periods ended June
28, 1998 were $296,000 and $712,000, respectively, compared to $7,152,000 and
$14,421,000 for the same periods in 1997. The decrease in 1998 expenses is
primarily the result of the Sun Transaction. Sun either hired or contracted 147
or 68% of total research and development personnel. Research and development
expenses as a percentage of net
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sales decreased to 6% and 7% for the three and six month periods in 1998,
compared to 97% and 92% for the same periods in 1997.
In December 1997, the Company established a separate research and development
organization to focus on opportunities in the Microsoft NT environment. However,
in January 1998, as more fully discussed in Note C of the Notes to Condensed
Consolidated Financial Statements, the Board of Directors voted not to pursue
the NT opportunity.
Sales, general and administrative ("SG&A") expenses for the three and six month
periods ended June 28, 1998 were $2,452,000 and $4,104,000, respectively,
compared to $7,580,000 and $15,218,000 for the same periods in 1997. The
decrease in expenses was due primarily to the Sun Transaction. Sun hired 65
storage product sales and marketing personnel or 45% of the Company's total
sales and marketing employees. Subsequently, the Company downsized the real-time
sales and marketing organization to 30 employees. As a percentage of net sales,
SG&A expenses were 50% and 43% for the three and six month periods ended June
28, 1998, respectively, compared to 103% and 97% for the same periods of 1997.
Interest expense decreased in the three and six month periods ended June 28,
1998 to $9,000 and $21,000, respectively, from $1,355,000 and $2,754,000 in the
same periods of 1997 due to the repayment of the Gould debt in connection with
the Sun Transaction.
Other expense, net, was lower for the three month period of 1998 compared to the
same period of 1997 due to gains on foreign exchange in 1998 versus losses in
1997 as well as lower losses on the sale of certain fixed assets. Other expense,
net, was lower for the six month period of 1998 compared to the same period of
1997 due to lower foreign exchange losses as well as lower losses on the sale of
certain fixed assets.
Income taxes provided for the three and six month periods in 1998 and 1997
relate to operations of foreign subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES:
For the six month period ended June 28, 1998, the Company reported net income of
$22,978,000 (including $25,308,000 due to the receipt of a portion of the Second
Payment from Sun for the assets of the Company's former storage products
business), compared to a net loss of $39,827,000 for the same period of 1997.
Net cash used in operating activities for the first six months of 1998 was
$10,681,000 compared to $24,730,000 for the six month period of 1997. Working
capital increased as the Company recorded the receipt of the Second Payment from
Sun in the amount of $25,308,000, offset by a decrease in accounts payable and
accrued liabilities of $10,027,000. As of June 28, 1998, total shareholders'
equity was $3,332,000 versus a capital deficiency of $19,646,000 as of December
31, 1997.
Expenditures for property and equipment during the six months ended June 28,
1998 and June 29, 1997 were $194,000 and $690,000, respectively. The decrease in
1998 spending resulted from management's decision to limit capital expenditures
to a minimum in light of the sale of the storage products business to Sun and
the uncertainty of the continuing real-time business. The gain from the Sun
Transaction with respect to the Second Payment was $25,308,000.
Cash used in financing activities of $25,595,000 during the six months ended
June 28, 1998, represents the Second Payment from Sun in the amount of
$25,308,000 being paid to
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Gould as well as $287,000 loaned to Gores under a $2,000,000 line of credit to
fund operations of the real-time business until the CLOSING. Cash was provided
through financing activities of $24,639,000 in the first six months of 1997. The
principal source of financing was through various agreements provided by the
Japan Energy Group, including Gould and other affiliates of Gould. On March 19,
1997, the Company and Gould agreed to cancel $40,000,000 of indebtedness owed to
Gould under their loan agreement (the "Credit Agreement") in exchange for the
issuance to Gould of 400,000 shares of the Company's Series I Convertible
Preferred Stock ("Series I") with a liquidation preference of $40,000,000. In
addition to the exchange of indebtedness for shares of Series I, the Company and
Gould also agreed to amend the Credit Agreement to: (i) reduce the maximum
amount which could be borrowed by the Company from $80,000,000 to $50,000,000;
and (ii) provide that any borrowings in excess of $41,915,869 (the principal
amount outstanding on March 19, 1997 after giving effect to the exchange of
indebtedness for shares of Series I) may be made only at the discretion of
Gould. At the closing of the Sun Transaction, the Company paid to Gould
$93,551,000 in principal and accrued interest in satisfaction of its
indebtedness to Gould at that date.
Restricted cash of $1,271,000 and $14,083,000 at June 28, 1998 and December 31,
1997, respectively, represents cash held in an escrow account pursuant to an
escrow agreement dated November 24, 1997 between the Company and Sun. The escrow
arrangement was established to ensure that certain of the Company's liabilities
at the closing date of the Sun Transaction, would be paid when due. As the
Company pays these liabilities, escrow funds are released to the Company. These
funds are invested in a U.S. Bank money market fund and will be made available
to the Company pursuant to the terms of the escrow agreement. Restricted cash of
$14,083,000 at December 31, 1997, represents cash held in the escrow account.
The majority of cash and cash equivalents at June 28, 1998 consists of cash
available to the Company from the total cash closing payment from the Sun
Transaction and cash at various international subsidiaries. With minor
exceptions, all cash in the international subsidiaries is freely remittable to
the United States.
The Company has signed a definitive agreement to sell its real-time business. If
the sale is consummated, it is anticipated that the Company will be liquidated
after November 24, 1998. (See Note D of Notes to Condensed Consolidated
Financial Statements).
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The Company has
agreed to sell its principal operating assets and plans to liquidate after
November 24, 1998. The Company will incur substantial expenses in connection
with a liquidation. The accompanying condensed consolidated financial statements
do not reflect either the effects of the proposed sale of the Company's
principal operating assets or the expenses it will incur in connection with its
liquidation. The Company has a substantial obligation to Gould Electronics, Inc.
under an agreement by which the Company sold its storage products business to
Sun. Sun has withheld a portion of that Second Payment, because of claimed
offsets. If Sun does not make the balance of the Second Payment, the Company's
obligation to Gould (which is reflected on its balance sheet) plus expenses
incurred in connection with the Company's liquidation (which are not reflected
on its balance sheet) are likely to exceed its assets. The ultimate resolution
of these matters are not presently determinable.
YEAR 2000
The Company is currently in the process of evaluating computer software and
databases to replace its existing business systems by the end of 1998. The
selection criteria will insure that problems related to the Year 2000 will be
avoided. Year 2000 problems could cause malfunctions in certain software and
databases with respect to dates on or after January 1,
23
<PAGE>
2000. At this time, the Company has not yet determined the cost of replacing its
computer software or databases.
The Year 2000 issue may also effect the systems and application of the Company's
customers or suppliers. The Company has initiated communications with a number
of its suppliers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 issues. The Company will continue similar communication with major
customers, and the balance of its major suppliers, during 1998 to receive
appropriate warranties and assurances that those parties are, or will be, Year
2000 compliant. Although the Company currently does not anticipate any material
impact on its operations as a result of Year 2000 issues of its customers or
suppliers, at this stage of its review, no assurance can be given that the
failure by one or more of its major suppliers or customers to become Year 2000
compliant will not have a material adverse impact on its operations.
CAUTIONARY STATEMENT RELATING TO FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial Condition and
Results of Operations contains various "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which represent the
Company's expectations and beliefs concerning future events. The Company
cautions that these statements are further qualified by important factors that
could cause actual results to differ materially from those in the
forward-looking statements, including, without limitation, the following:
accelerated decline in demand for the Company's products; developments regarding
the sale of the real-time business; developments regarding the portion of the
Second Payment which Sun withheld; developments regarding the proposed
liquidation of the Company; and the effect of general economic conditions
generally and factors affecting the computer industry. These statements by their
nature involve substantial risks and uncertainties and actual events or results
may differ as a result of these and other factors. (See Exhibit 99 incorporated
herein by reference to the Company's Form 10-Q for the period ended June 30,
1996).
24
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Shortly before the Sun Transaction was closed, shareholders of the Company
brought a derivative suit in the Delaware Chancery Court against Gould and the
Company's then directors, C. David Ferguson, Robert Fedor, Rowland Thomas and
Kenneth Fisher. Three similar shareholder suits were also filed and all four
suits have been consolidated as Civil Action #16044, In Re Encore Computer
Corporation Shareholders Litigation. The suit is currently in the discovery
stage. The Company does not believe the shareholder suit will have a significant
financial impact on the Company.
The Company is subject to other legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of the
ultimate liability with respect to these actions will not materially affect the
financial position of the company.
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit No. 11 - Statement re: computation of per share earnings.
Exhibit No. 27 - Financial Data Schedule.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended June 28, 1998.
25
<PAGE>
ENCORE COMPUTER CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
Encore Computer Corporation
/s/ KENNETH G. FISHER
----------------------------
Date: August 12, 1998 Kenneth G. Fisher
Chairman of the Board
and Chief Executive Officer
/s/ LINDA J. MATTHEWS
----------------------------
Linda J. Matthews
Corporate Controller
26
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
11 Statement re: Computation of per share earnings
27 Financial Data Schedule
EXHIBIT 11
ENCORE COMPUTER CORPORATION
Computation of Loss per Share
- --------------------------------------------------------------------------------
(unaudited)
(in thousands except per share data)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------- ----------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
BASIC 1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Net income (loss) $ 23,744 $ (19,804) $ 22,978 $ (39,827)
Series B, D, E, F, G, H and I accumulated
Preferred Stock Dividends - (7,262) - (14,122)
--------- --------- ---------- ----------
Net income (loss) attributable to
common shareholders $ 23,744 $ (27,066) $ 22,978 $ (53,949)
========= ========= ========== ==========
Weighted average common
shares outstanding 67,449 37,417 67,450 37,347
========= ========= ========== =========
Basic income (loss) per share $ 0 $ (1) $ 0 $ (1)
DILUTED
Net income (loss) $ 23,744 $ (19,804) $ 22,978 $ (39,827)
========= ========= ========== ==========
Weighted average common shares outstanding 67,449 37,417 37,419 37,347
Series A assumed converted 7,364 7,364
Series B assumed converted 23,740 23,568
Series D assumed converted 36,243 36,021
Series E assumed converted 37,046 36,819
Series F assumed converted 17,335 17,229
Series G assumed converted 18,601 18,487
Series H assumed converted 11,376 11,306
Series I assumed converted 1,736 1,698
Exercise of options reduced by the number
of shares purchased with proceeds 248 282
--------- --------- ---------- ----------
Weighted average common shares outstanding 67,449 191,106 37,419 190,121
========= ========= ========== ==========
Diluted income (loss) per common share $ 0.35 $ (0.72) $ 0.34 $ (1.44)
========= ========= ========== ==========
</TABLE>
Basic and diluted income (loss) per common share are the same for all periods
presented because the effect of the common stock equivalents would be
antidilutive.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-28-1998
<CASH> 16,194
<SECURITIES> 1,271
<RECEIVABLES> 6,764
<ALLOWANCES> (714)
<INVENTORY> 707
<CURRENT-ASSETS> 25,383
<PP&E> 19,812
<DEPRECIATION> (19,021)
<TOTAL-ASSETS> 25,664
<CURRENT-LIABILITIES> 23,332
<BONDS> 0
0
0
<COMMON> 674
<OTHER-SE> 2,658
<TOTAL-LIABILITY-AND-EQUITY> 26,664
<SALES> 3,369
<TOTAL-REVENUES> 9,603
<CGS> 1,699
<TOTAL-COSTS> 5,801
<OTHER-EXPENSES> 305
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 472
<INCOME-PRETAX> 22,870
<INCOME-TAX> 108
<INCOME-CONTINUING> 22,978
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,978
<EPS-PRIMARY> 0.34
<EPS-DILUTED> 0.34
</TABLE>
