UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
For the Fiscal Year Ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Fiscal Year Ended December 31, 1997
Commission File No. 0-13576
ENCORE COMPUTER CORPORATION
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(Exact name of registrant as specified in its charter)
DELAWARE 04-2789167
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(State of Incorporation) (I.R.S. EMPLOYER I.D. NO.)
6901 WEST SUNRISE BOULEVARD
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:
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 or15(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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Aggregate market value, as of April 13, 1998 of Common Stock held by
non-affiliates of the registrant: $20,023,420.
The number of shares outstanding of the registrant's only class of Common Stock
as of April 13, 1998 was 67,447,309
PART OF DOCUMENT
DOCUMENTS INCORPORATED BY REFERENCE: IN WHICH INCORPORATED
---------------------
A list of all exhibits to this Form 10-K is on Page 52.
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PART I
ITEM 1 BUSINESS
(A) GENERAL DEVELOPMENT OF BUSINESS
Encore Computer Corporation ("Encore" or the "Company"), founded in 1983,
designs, manufactures, distributes and supports scalable real-time computer
systems. Headquartered in Fort Lauderdale, Florida, the Company sells its
products direct and through distributors in the United States, Canada, Europe
and the Far East.
In 1989, Encore acquired the assets and assumed the liabilities of the Gould
Electronics Inc. Computer Systems Division (the "Computer Systems Business"), a
business that was significantly larger than the Company itself. Since 1989,
Japan Energy Group and its wholly owned subsidiaries, Gould Electronics Inc.
("Gould") and EFI International Inc. ("EFI"), have been the principal source of
the Company's financing by either directly providing or guaranteeing the
Company's loans. Since late 1996 however, the credit agreements did not provide
committed financing to the Company and all financing was solely at Gould's
discretion.
From 1989 through November 1997, the Company borrowed a total of $418 million
from Japan Energy Group (consisting of Japan Energy Corporation ("JEC"), EFI and
Gould), investing heavily in research and development activities to integrate
both businesses' technologies into a single, high performance open system
architecture. In 1994, the Company announced its Infinity SP Universal Storage
Processor with DataShareTM Facilities to establish a presence in the
multibillion dollar storage marketplace. However, the Company was unable to
penetrate the storage marketplace utilizing its direct sales and distributor
sales approach and was unsuccessful in attracting OEM partners to provide the
necessary distribution channels. As a result, the Company continued to incur
losses.
As more fully discussed in Management's Discussion and Analysis of Financial
Condition and Results of Operations and in Notes to Consolidated Financial
Statements, on November 24, 1997, 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 product business to Sun Microsystems, Inc.,
("Sun") (the "Sun Transaction"). The Agreement had contemplated that the
aggregate consideration to be paid to the Company by Sun for such assets was to
be $185 million, of which $150 million in cash was to be paid at the closing and
$35 million was to be payable on July 1, 1998 (the "Second Payment"). Pursuant
to a Modification Agreement dated November 24, 1997, Sun paid to Encore
$151,168,227 at the closing, reflecting additional amounts paid for certain
finished storage product units, offset by certain liabilities assumed by Sun,
not contemplated in the Agreement.
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
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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.
The Company's real-time computer systems are used for the acquisition,
processing and interpretation of data primarily in three market niches: (i)
simulation; (ii) energy; and (iii) transportation. Sales of real-time products
and services were approximately $25 million in fiscal 1997, and accounted for
approximately 84% of Encore's net sales in fiscal 1997. However, sales of
real-time products continue to decline as certain of the Company's traditional
products have reached the end of their product life cycle. Additionally,
real-time service sales continue to decline as a result of (i) the Company's
prolonged decline in equipment sales, (ii) the price competitiveness of the
marketplace, (iii) the completion of long running government programs and (iv)
subsequent deinstallation of systems.
The newest real-time product is the Infinity /TM/. The performance features of
the Infinity /TM/, based on scalable system elements, along with the Company's
reputation in real-time computing have captured the attention of many of its
traditional customers. The Infinity /TM/ has significant price performance
advantages in the real-time market. This, coupled with Encore's proprietary
software, yields highly deterministic open systems solutions. These solutions
range from Encore's traditional markets in simulation, energy, and data
acquisition to newly developed market opportunities in transportation and
process control.
Approximately 21% of 1997 revenues, and approximately 23% of 1997 real-time
revenues, were derived through sales to various U.S. government agencies.
Certain of these agencies, such as the Department of Defense, are precluded from
awarding contracts which require access to classified information to foreign
owned or controlled companies. As discussed more fully in Management's
Discussion and Analysis of Financial Condition and Results of Operations, on
November 24, 1997, in conjunction with the Sun Transaction, Gould converted its
Series A and Series B Preferred Stock to Common Stock and all other series of
Preferred Stock were retired. As a result, JEC beneficially owns 48.4% of the
Company's common stock. Gould also holds four of the six seats on the Company's
Board of Directors. In light of limitations on the ability of certain U.S.
government agencies to transact business with foreign owned or controlled
companies, Encore and JEC have proactively worked to comply with all U.S.
requirements. The United States Defense Investigative Service ("DIS") has
accepted the changes in the Company's ownership and control in conjunction with
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 try to find a purchaser for its real
time computer systems 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 is subject
to completion by Gores of due diligence and to negotiation and execution of
definitive agreements. If agreements are signed, the transaction will be subject
to approval by the Company's shareholders. If the Company sells its real time
computer systems business to Gores or to any other purchaser, the Company no
longer will have any business operations. Therefore, if the Company's
shareholders are asked to approve a sale of the real time computer systems
business, they almost surely will also be asked to approve a
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liquidation of the Company and a distribution of the Company's remaining assets
to the shareholders.
At December 31, 1997, the Company had total assets of $37,451,000, including
restricted cash of $14,083,000, and cash and cash equivalents of $14,544,000 and
had liabilities of $57,097,000, including $13,655,000 of estimated severance
costs and other costs related to the sale of the Company's storage products
business and the $35,000,000 payable to Gould. The assets of the Company
available for distribution to shareholders on liquidation would be (i) the
Company's assets, plus the Second Payment net of any set off (see Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Note B of Notes to Consolidated Finanial Statements), less its liabilities, at
December 31, 1997, plus or minus (ii) the Company's net positive or negative
cash flow between January 1, 1998 and the date of the liquidation (including any
amount by which the severance and other costs related to the sale of the storage
products business paid after December 31, 1997 are greater or less than the
estimated amount reflected on the Company's December 31, 1997 balance sheet),
minus (iii) the termination charge of $743,500 related to the Board's decision
to discontinue efforts to develop clustering software in a Windows NT
environment, plus or minus (iv) the gain or loss from the sale of the Company's
real time computer systems business, minus (v) costs of the liquidation and
reserves for any contingent liabilities, including any pending litigation (See
Item 3-Legal Proceedings).
(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company operates in a single industry segment as described in Item 1(c)
below. Certain required segment information related to the Company's financial
operations for the last three years is included in Note L of Notes to
Consolidated Financial Statements.
(C) NARRATIVE DESCRIPTION OF THE BUSINESS
The Company operates in various market niches of a single industry segment, the
information technology industry, which includes the design, manufacture, sale
and service of computer systems, software and other related equipment on a
worldwide basis.
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PRINCIPAL MARKETS
REAL-TIME MARKETS
The Company's real-time computer systems, the Infinity R/T (TM) Family, are used
for the acquisition, processing and interpretation of data primarily in three
market niches; (i) simulation, (ii) energy and (iii) transportation.
Simulation is the Company's largest real-time market niche. Encore products are
widely used in simulators that duplicate complex situations in controlled
environments. The Company's installed simulation systems are used to safely and
economically train commercial and military personnel to operate and maintain
complex systems such as space vehicles, aircraft, weapons systems, ships,
ground-based vehicles and nuclear power plants.
Encore also competes in the power and electric utility market niches of the
energy marketplace where the Company's real-time systems typically acquire,
monitor and provide supervisory and closed loop control in energy management,
power plant monitoring and control and power plant simulation systems. The
Company's systems monitor the transmission and distribution of electrical power
from generation to substation to end use. The system also facilitates the
training of power plant operators by putting them in simulated environments to
prepare them for emergency situations. Within the energy marketplace as a whole,
Encore systems provide the same real-time capability of data acquisition and
control to other market niches such as seismic, oil exploration and off-shore
oil platforms.
Within the transportation market niche, the Company's products are installed in
a variety of rapid transit/metro rail and marine transportation applications.
Strategically, the Company has been focusing on other developing niches within
this marketplace including intelligent vehicular highway systems .
The Company's real-time customers include original equipment manufacturers
(OEMs) and systems integrators who combine Encore products with other hardware
and/or application software for resale to end users. The Company also sells its
products to end users who require a compatible range of high performance systems
which are used as the basis for major internal installations.
The Encore customer base in the real-time market place is technology and life
cycle cost driven and constantly in need of increased performance at lower
costs. The Company's sales efforts in the real-time market have been
concentrated on system sales, including continued demand for upgrades and spare
parts as well as ongoing maintenance.
PRINCIPAL PRODUCTS
Encore offers two principal families of computer systems targeted at the
real-time computing marketplace of the information technology industry discussed
above. These product families are the Infinity R/T (TM) Series and the RSX
systems.
INFINITY R/T (TM)
The Encore Infinity R/T (TM) offers high performance real-time solutions with
the latest in processor technology. The Infinity R/T is specifically designed to
incrementally migrate CONCEPT/32 legacy applications to an open systems
environment by maintaining object code and bus compatibility.
The Infinity R/T (TM) Model 500 Modular Computing Family is Encore's entry level
PCI bus based system, powered by Digital Equipment Corporation's Alpha (R)
and/or Intel Corporation's Pentium processor. This provides unprecedented
modularity and flexibility with tremendous price/performance leadership. The
Infinity R/T (TM) Model 400 Family of systems is comprised of state-of-the-art
departmental and enterprise Symmetrical multi-processing computers, powered by
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Digital's Alpha micro-processors and is based on the latest PCI bus technology.
Encore's Real-Time software and hardware enables users to derive ultra high
performance without sacrificing the Real-Time requirements of low latency, high
determinism and fast I/O response. Both models are compatible with Encore's new
PCI Reflective Memory subsystem that provides high-speed R/T (TM) connectivity
for up to 256 clustered nodes.
RSX SYSTEM
Encore's RSX computer is a RISC processor with dual high- performance modes of
operation, RISC and CONCEPT/32 compatability. Innovations such as large
multiported Direct Mapped Cache (DMC), separate real-time I/O bus, and
state-of-the-art RISC technology enhance Encore's proven real-time capabilities.
RSX serves as a perfect 'bridge' enabling Encore CONCEPT/32 users to move to the
price/performance advantages of RISC technology without requiring any changes to
current software.
CUSTOMER SERVICE
Service and support are critical elements in maintaining customer satisfaction.
The Company offers its customers a variety of service and support programs for
both hardware and software products principally through its own customer service
organization supplemented by third party maintenance partners with locations
throughout the world. The Company also offers maintenance service for selected
third party equipment. Specific service and support programs include preventive
maintenance, resident labor service, customer training and education, logistics
support programs, data facility management and custom technical and consulting
services. In addition, the Company provides a dial in hotline as well as remote
diagnostic capabilities to allow problem resolution from Encore's home office.
The Company provides a standard product warranty on its computer systems for
parts and labor which generally extends ninety days from the date of
installation.
SALES AND DISTRIBUTION
Encore uses multiple channels of distribution to sell its products. The primary
channel for real-time system sales has been its direct sales force located in
the United States, Canada and Western Europe. The Company also has other
arrangements with distributors throughout the world.
The Company's general policy is to sell rather than lease its products. The
Company generally has a policy of no returns and does not typically extend
payment terms beyond those prevalent in the computer industry. A significant
portion of the Company's sales typically occur in the last month of a fiscal
quarter, a pattern that is not uncommon in the computer industry. The Company
seeks to minimize the time from receipt of a purchase order for a computer
system to delivery of the system. Accordingly, the Company does not believe
backlog reported at any point in time aids materially in the overall
understanding of the business. Encore's business is not subject to pronounced
seasonal fluctuations.
During the years reported, the Company has not been dependent upon any one
customer for a material part of its business with no single customer accounting
for more than 10% of its sales. However, in fiscal 1997, 1996 and 1995,
approximately 21%, 22%, and 24%, respectively, of its sales, and approximately
23%, 26% and 24%, respectively, of its real-time sales, were derived either
directly or indirectly from various United States government agencies. None of
the Company's contracts with United States government agencies are subject to
the renegotiation of profits or termination at the election of the government.
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RESEARCH AND DEVELOPMENT
REAL -TIME
Encore's research and development strategy is defined around the following
targets of opportunity:
-Encore's existing customer base: "Systems, SEL, Gould" -
simulation, telemetry, energy and transportation.
-Digital Equipment Corporation customers who need real-time
capabilities, integration and high speed interconnectivity:
- Digital UNIX real-time enhancements
- Real-time option modules
- VME Alpha (R) Systems
- Deterministic SMP Alpha (R) Systems
- High Speed Clustering
-Other opportunities in which high speed interconnectivity of
systems (extreme low latency and greater throughput than
networking) is a critical aspect of the application.
The Company has a long history of proprietary design (SEL, Concept, RSX, Encore
91/93) and a large installed base. In real- time/technical computing, the key
trend of the 90s has been to utilize PC and PC-bus technologies because of their
price and performance advantages. The traditional competition has not reacted to
this trend and has lost major market share by continuing to do proprietary
designs. The new competition is made up of UNIX Servers and PCUs augmented with
third party offerings to provide reasonable real-time capabilities. Encore
seeing this trend has implemented a research and development strategy in which
we utilize industry standard technology (Pentium Pro, Alpha (R), UNIX, Windows
NT, PC buses, etc.). Encore's value-add is that the Company has developed a set
of real-time software, scaling technologies, cluster interconnects, real-time
options, and third party integration to provide true real-time capabilities
while maintaining industry price and performance curves.
Because Encore's value-adds have been developed as layered products, which sit
above industry solutions, they are quickly ported to the diverse and ever
changing technology. Therefore, the Company's products avoid the classic lag
time associated with adding real-time capabilities to the industry's leading
technology.
MANUFACTURING AND RAW MATERIALS
The Company's ISO 9002 certified manufacturing operation was sold to Sun
Microsystems as part of the Sun Transaction. Pursuant to the "At Will Shared
Services Agreement" dated November 24, 1997, Sun agreed, among other things, to
provide manufacturing support to Encore through February 28, 1998.
The Company's current manufacturing operation, which has been integrated into
the Fort Lauderdale headquarters, consists primarily of the assembly and
integration of purchased parts, components, and subassemblies into computer
systems. All printed circuit board assembly is currently outsourced to various
manufacturing vendors. Each vendor must meet ISO 9002 certification to be
eligible to manufacture for the Company. All peripherals are purchased from
third party vendors. Extensive testing and burn in is performed at the board,
component and sub-assembly level and at final systems integration.
Encore's products are comprised of a wide variety of electronic and mechanical
components, raw materials and supplies. The Company relies heavily on external
sources of supply for these items as well as for other supplies and services.
Neither the Company's customers nor its vendors require Encore to carry
significant amounts of inventory to meet rapid delivery requirements or to
assure
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itself of a continuous allotment of goods from suppliers. The Company has
developed multiple commercial sources for most components and raw materials used
in the manufacture of its computer systems. However, because of the
attractiveness of employing the latest technology in its product line, Encore
does utilize several single source vendors for certain critical components in
the Infinity R/T (TM) product line. While delays in delivery of such single
source components could cause unplanned delays in the shipment of certain
products, at this time, the Company has no reason to believe any of its single
source vendors present a serious business risk to the Company.
COMPETITION
The computer industry is intensely competitive and is characterized by rapid
technological advances, decreasing product life cycles and price reductions. The
principal competitive factors are total system performance and functionality,
quality, reliability, price, compatibility/connectivity to other vendors'
systems, along with long term service and support.
The primary competitors in the Company's real-time market are established
companies, such as Concurrent Computer Corporation, Digital Equipment
Corporation and Silicon Graphics.
Many of Encore's competitors have greater financial, technical, and marketing
resources than Encore. In some cases, this places the Company at a disadvantage.
PATENTS AND LICENSES
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.
Encore has entered into licensing agreements with several third party software
developers and suppliers. The licenses generally allow for use and sublicense of
certain software provided as part of the computer systems marketed by the
Company. Encore is licensed by the Santa Cruz Operation to use and sublicense
their UNIX operating system in the Company's computer systems.
ENVIRONMENTAL MATTERS
Compliance with Federal, state and local provisions which have been enacted or
adopted regulating the discharge of materials into the environment, or otherwise
relating to the protection of the environment are not expected to have a
material effect on the capital expenditures, operations or competitive posture
of the Company or its subsidiaries.
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EMPLOYEES
As of December 31, 1997, Encore had 121 full-time employees engaged in the
following activities:
EMPLOYEES
---------
Customer Service 29
Manufacturing 10
Research and Development/Custom Products 29
Sales and Marketing 30
General and Administrative 23
---
Total 121
===
The Company's future success will depend in large part on its ability to attract
and retain highly skilled and motivated personnel, who are in great demand
throughout the industry. None of the Company's domestic employees are
represented by a labor union.
EXECUTIVE OFFICERS OF THE COMPANY
The names of the Company's executive officers at December 31, 1997 and certain
information about them are set forth below.
NAME AGE POSITION WITH COMPANY
---- --- ---------------------
Kenneth G. Fisher 67 Chairman of the Board
and Chief Executive Officer
Rowland H. Thomas, Jr. 62 President and
Chief Operating Officer
Charles S. Anderson 68 Vice President,
Corporate Relations
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Ziya Aral 45 Vice President, Systems Engineering
and Chief Technology Officer
Charles S. Namias 39 Vice President,
Corporate Alliances
George S. Teixeira 41 Vice President,
Product Business Group
Mr. Fisher is a founder of the Company and has served as a Director, Chairman
and Chief Executive Officer of the Company since the Company's inception in May
1983. He was the Company's President from its inception until December 1985 and
also served in that capacity from December 1987 to January 1991. From January
1982 until May 1983, Mr. Fisher was engaged in private venture transactions.
From 1975 to 1981, Mr. Fisher was President and Chief Executive Officer of
Computervision (formerly Prime Computer, Inc.). Before joining Computervision,
Mr. Fisher was Vice President of Central Operations for Honeywell Information
Systems, Inc.
Mr. Thomas has been a member of the Board of Directors since December 1987 and
Chief Operating Officer since June 1989. He presently serves as President of the
Company, a position to which he was elected in January 1991. From June 1989 to
January 1991, Mr. Thomas served as Executive Vice President of the Company. In
February 1988, he was named President and Chief Executive Officer of Netlink
Inc. Prior to joining Netlink, Mr. Thomas was Senior Executive Vice President of
National Data Corporation ("NDC"), a transaction processing company, a position
he held from June 1985 to February 1988. From May 1983 through June 1985, Mr.
Thomas was Executive Vice President and Senior Vice President at NDC.
Mr. Anderson, joined the Company in 1985. From 1984 until joining the Company,
Mr. Anderson served as Director of Human Resource Operations at Data General
Corporation. Before joining Data General, Mr. Anderson was with Honeywell
Information Systems, Inc. serving in various management positions since 1970,
most recently as Director of Employee Relations.
Mr. Aral joined the Company in 1987 and was appointed to the position of Chief
Technology Officer in 1993, a position he held until January 1998, when he left
the Company in connection with the Board of Directors decision not to pursue the
development of clustering software. Since 1987, he has held various positions of
increasing responsibility within the Company including Vice President of Systems
Engineering and Senior Technology Consultant. Prior to joining Encore, Mr. Aral
was employed by the Reed- Prentice Division of PMCo. in a variety of software
engineering positions.
Mr. Namias joined the Company in 1983 as Director of Processor Engineering. From
1986 to 1989 he held direct sales and several field sales management positions.
In 1990, he was promoted to Director, Strategic Business Alliances and in 1992
promoted to Vice President, Business Development. In 1993, Mr. Namias was
appointed Vice President, Corporate Alliances and an officer of the Company,
positions he held until January 1998, at which time he left the Company. Prior
to joining the Company, Mr. Namias was employed by Digital Equipment Corporation
and Raytheon Missile Systems.
Mr. Teixeira assumed his position as Vice President Product Group in 1994, a
position he held until January 1998, when he left the Company in connection with
the Board of Directors decision not to pursue the development of clustering
software. From 1991 to 1994, he held the position of Vice President, Product
Development. Prior to 1991, Mr. Teixeira held the positions of Vice President of
Marketing and Vice President of Product Management. Mr. Teixeira was Director of
Product Marketing and Management for the Computer Systems Business of Gould
Electronics Inc. which the
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Company acquired in 1989. Prior to 1989 he held several progressively more
responsible positions since joining Gould Electronics Inc. in 1981.
(D) INTERNATIONAL OPERATIONS
The Company maintains sales and service operations in Europe and Canada through
wholly-owned subsidiaries, and distributor agreements throughout the Pacific
Rim. In 1997, approximately 50% of consolidated net sales were derived from
foreign operations. The Company believes that its overall profit margins with
respect to foreign sales are not materially different from profit margins from
domestic sales. In view of the locations and diversification of its foreign
activities, the Company does not believe that there are any unusual risks beyond
the normal business risks attendant to activities abroad. Encore attempts to
limit its foreign currency denominated assets and liabilities to reduce its
exposure to foreign currency fluctuations. Additional information relating to
the Company's international operations, including financial information
segregated by major geographic area, is contained in Note L of the Notes to
Consolidated Financial Statements.
ITEM 2 PROPERTIES
Listed below are the Company's principal facilities as of December 31, 1997.
OWNED OR APPROXIMATE
LOCATION PRINCIPAL USE LEASED SQUARE FEET
-------- ------------- -------- -----------
Ft. Lauderdale, FL Administrative/ Leased 53,000
Development/
Marketing
London, England Sales/Service Leased 35,000
Paris, France Sales/Service Leased 23,000
In addition to the facilities listed above, Encore also leases space in various
other domestic and foreign locations for use as sales and service offices.
ITEM 3 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.
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ITEM 4 SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual and Special Meeting of Shareholders of the Company was held at the
Company's offices in Fort Lauderdale, Florida on November 24, 1997. At the
meeting the shareholders voted: (1) to approve the Sun Transaction ; (2) to
elect six (6) directors; and (3) to approve the selection by the Board of
Directors of Coopers & Lybrand L.L.P. as the Company's independent auditors for
the fiscal year ending December 31, 1997. The results of the votes for each of
these proposals were as follows:
AGAINST/
FOR ABSTAIN
--- --------
1 Sun Transaction 43,839,042 19,106,917
2 Election of Directors:
Kenneth G. Fisher 52,789,250 10,156,709
Rowland H. Thomas 52,866,499 10,079,460
Robert J. Fedor 53,108,089 9,837,870
C. David Ferguson 53,101,155 9,844,804
Thomas N. Rich 53,109,135 9,836,824
Michael C. Veysey 53,109,135 9,836,824
3 Approval of Independent
Auditors 54,890,505 8,055,454
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PART II
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the OTC Bulletin Board under the symbol
ENCC.
The high and low closing sale prices of Encore's common stock are shown for
fiscal years 1997 and 1996 in the table below:
FISCAL 1997 FISCAL 1996
----------------- -----------------
HIGH LOW HIGH LOW
---- --- ---- ---
1st Quarter 1 15/16 1 3/16 3 7/16 1 5/8
2nd Quarter 2 1/4 1 3/16 3 13/16 2 7/16
3rd Quarter 1 3/32 5/8 3 1/32 1 11/16
4th Quarter 25/32 9/64 1 31/32 1
The First National Bank of Boston is the stock transfer agent and registrar of
the Company's common stock, and maintains shareholder records. The agent will
respond to questions on change of ownership, lost stock certificates,
consolidation of accounts and change of address. Shareholder correspondence on
these matters should be addressed to:
The First National Bank of Boston
Shareholder Services Division
P.O. Box 644
Boston, Massachusetts 02109.
As of April 13, 1998, there were approximately 2,469 holders of record of the
Company's common stock. The Company has never paid cash dividends on its common
stock.
ITEM 6 SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
(in thousands except -------------------------------------------------------------
per share data) 1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Net sales $ 29,486 $ 47,627 $ 49,328 $ 76,550 $ 93,532
Operating loss (76,528) (67,218) (77,796) (50,848) (62,085)
Gain on Sun Transaction 119,890 -- -- -- --
Net income (loss) 34,164 (70,732) (81,354) (54,556) (69,565)
Basic earnings (loss) per common
share (1) 0.11 (2.61) (2.88) (2.05) (2.47)
Weighted average shares of
common stock outstanding (1) 40,568 36,810 34,923 33,391 31,909
Working capital (deficiency) (21,617) (67,295) 5,490 20,237 3,499
Total assets 37,451 69,256 72,537 99,021 84,070
Long term debt -- 476 40,812 89,249 112,919
Shareholders' equity
(capital deficiency) (19,646) (34,010) 2,514 (22,040) (66,560)
------ ------- ----- ------- -------
13
<PAGE>
<FN>
- ----------
(1) During 1997, 1996, 1995, 1994 and 1993, preferred stock dividends amounted
to $29,579,900, $25,413,000, $19,061,600, $13,986,600 and $9,184,700,
respectively. All preferred stock dividends were paid in additional shares of
preferred stock or were accumulated.
</FN>
</TABLE>
14
<PAGE>
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THE SUN TRANSACTION
Encore was founded in May 1983 and was in the development stage until October
1986. During this period, the Company was primarily involved in the research,
development and marketing of UNIX based computers and terminal servers. In 1989,
Encore significantly increased its size and worldwide marketing presence when it
acquired substantially all of the assets of the Computer Systems Division of
Gould. This was a significantly larger business than the Company and one which
for over twenty-five years provided real- time computer systems solutions to the
simulation, transportation, and energy marketplaces.
During the late 1980s, product demand in the computer marketplace began to
migrate from more traditional proprietary computing technologies towards an open
systems technology. The Company targeted its research and development efforts
towards programs to develop a new generation of open system computers. Since the
beginning of 1995, the Company spent approximately $87,000,000 in research and
development activities. This resulted in the availability of a family of storage
systems and open system computers including; (i) the Infinity SPTM Storage
Processor with DataShare FacilitiesTM, and (ii) the Infinity R/T (TM). The
Company targeted the multibillion dollar storage market as a strategic growth
market. However, the Company was unable to penetrate the storage marketplace
utilizing its direct sales and distributor sales approach and was unsuccessful
in attracting OEM partners to provide the necessary distribution channels.
Concurrently, the Company's real-time market revenues have decreased from
$130,893,000 in 1992 to $24,722,000 in 1997 and as a result the Company
continued to incur significant net losses.
Since 1989, the Japan Energy Group has been the principal source of financing
for the Company by either directly providing or guaranteeing the Company's
loans. Since late 1996 however, the credit agreements did not provide committed
financing to the Company and all financing was solely at the discretion of
Gould. From 1989 through November 1997, the Company borrowed a total of $418
million from the Japan Energy Group.
OVERVIEW
On November 24, 1997 (the "Closing"), pursuant to the Sun Transaction 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
15
<PAGE>
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.
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 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
is 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 will be indebted to Gould for the amount by which such payment
is less than $35 million. In addition, if the $35 million is not paid to Gould
by July 31, 1998, Gould will 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 is paid to Gould by July 31, 1998, Gould will waive its
right to receive these accrued but unpaid dividends. Additionally, if the full
$35 million is paid to Gould by July 31, 1998, 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 (See Note N of Notes to
Consolidated Financial Statements). In light of the uncertainties associated
with the Second Payment, Encore has reflected the above $35 million as a
liability to Gould and deferred recognition of the gain on the Sun Transaction
to that extent until such time as resolution of the matter is ascertained.
Management feels that any set off to the Second Payment will not be material,
based on all current information, and intends to make all efforts to collect the
Second Payment in its entirety. However, the ultimate resolution of these
matters is not presently determinable.
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.
16
<PAGE>
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 is subject
to completion by Gores of due diligence and to negotiation and execution of
definitive agreements. If agreements are signed, the transaction will be subject
to approval by the Company's shareholders. If the Company sells its real time
computer systems business to Gores or to any other purchaser, the Company no
longer will have any business operations. Therefore, if the Company's
shareholders are asked to approve a sale of the real time computer systems
business, they almost surely will also be asked to approve a liquidation of the
Company.
At December 31, 1997, the Company had total assets of $37,451,000, including
restricted cash of $14,083,000 and cash and cash equivalents of $14,544,000 and
had liabilities of $57,097,000, including $13,655,000 of estimated severance
costs and other costs related to the sale of the Company's storage products
business and the $35,000,000 payable to Gould. The assets of the Company
available for distribution to shareholders on liquidation would be (i) the
Company's assets, plus the Second Payment net of any set off, less its
liabilities, at December 31, 1997, plus or minus (ii) the Company's net positive
or negative cash flow between January 1, 1998 and the date of the liquidation
(including any amount by which the severance and other costs related to the sale
of the storage products business paid after December 31, 1997 are greater or
less than the estimated amount reflected on the Company's December 31, 1997
balance sheet), minus (iii) the termination charge of $743,500 related to the
Board's decision to discontinue efforts to develop clustering software in a
Windows NT environment, plus or minus (iv) the gain or loss from the sale of the
Company's real time computer systems business, minus (v) costs of the
liquidation and reserves for any contingent liabilities, including any pending
litigation (See Item 3-Legal Proceedings).
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As of December 31, 1997, the
Company has a net capital deficiency and a working capital deficiency. If Sun
does not make the Second Payment in full, the Company will be obligated to pay
the difference to Gould, and may not be able to satisfy its obligations.
Management feels that any set off to the Second Payment will not be material,
based on all currrent information, and intends to make all efforts to collect
the Second Payment in its entirety. However, the ultimate resolution of these
matters is not presently determinable.
COMPARISON OF 1997, 1996 AND 1995.
Net sales for 1997 were $29,486,000 compared to net sales for 1996 and 1995 of
$47,627,000 and $49,328,000, respectively. 1997 equipment sales decreased 49% to
$14,163,000 when compared to $27,600,000 in 1996. Equipment sales in 1995 were
$22,005,000. Service revenues for 1997, 1996, and 1995 were $15,323,000,
$20,027,000 and $27,323,000, respectively. 1997 real-time equipment sales were
$9,399,000 compared to $20,997,000 in 1996 and $22,005,000 in 1995. 1997 storage
product sales were $4,764,000 compared to $6,603,000 and $0 in 1996 and 1995,
respectively. Real-time service revenues were $15,323,000 in 1997, compared to
$20,027,000 in 1996 and $27,323,000 in 1995. No service revenues were derived
from the storage product business. The Company's operating loss for 1997 was
$76,528,000 compared to operating losses of $67,218,000 and $77,796,000 for 1996
and 1995, respectively. The 1997 gain resulting from the Sun Transaction was
$119,890,000.
Equipment sales as a percentage of total net sales in 1997, 1996 and 1995 were
48%, 58%, and 45%, respectively. For real-time equipment sales, the respective
percentages were 32%, 44% and 45% of total net sales in 1997, 1996 and 1995. For
storage product sales the respective percentages were 16%, 14% and 0% in 1997,
1996 and 1995, respectively. The decrease in equipment sales in 1997 is
primarily due to; (i) the inability
17
<PAGE>
of the Company to penetrate the storage marketplace through its direct and
distributor sales channels, (ii) concerns of potential customers over the
financial viability of the Company and (iii) certain of the Company's
traditional real-time products having reached the end of their product life
cycle. Additionally, management believes the announcement of the Asset Purchase
Agreement with Sun on July 17, 1997, adversely affected storage product sales
for the balance of 1997. The net increase in 1996 was primarily due to: (i)
sales of the Company's Storage Products of $6,603,000, (ii) steady sales in
real-time and open systems computers, and (iii) the continued decline in service
sales. International equipment sales decreased 67% to $5,297,000 in 1997 as
international storage product sales declined 92% to $440,000 and international
real-time product sales decreased 55% to $4,857,000 when compared to 1996.
Domestic equipment sales decreased 23% to $8,866,000 compared to 1996 with
storage product sales increasing 233% to $4,324,000 while real-time product
sales decreased 56% to $4,542,000.
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, (iii) the completion of long running
government programs and subsequent deinstallation of systems and (iv) longer
warranty periods for equipment sales required to compete in the storage
marketplace. The Company expects this trend to continue. International service
sales decreased 24% to $9,357,000 in 1997, while domestic service sales
decreased 23% to $5,966,000 compared to 1996. International and domestic
real-time service sales were $9,357,000 and $5,966,000, respectively, for 1997,
down 24% and 23%, respectively, from 1996 international real-time service sales
of $12,277,000 and domestic real-time service sales of $7,750,000.
International net sales decreased 48% (38% for real-time) in 1997 when compared
to 1996, versus an increase of 12% (11% decrease for real-time) in 1996 compared
to 1995. Domestic net sales decreased 23% (42% for real-time) and 20% (25% for
real-time) in 1997 and 1996, respectively, when compared to the prior year.
International sales in 1997, 1996 and 1995 were $14,654,000, $28,327,000 and
25,277,000, or 50%, 59% and 51%, respectively, of total net sales. International
real-time net sales in 1997, 1996 and 1995 were $14,214,000, $23,024,000 and
$25,277,000, or 57%, 56% and 51%, respectively, of total real-time net sales.
During the three years ended December 31, 1997, no single customer accounted for
more than 10% of the Company's annual sales. However, sales to various U.S.
government agencies have represented approximately 21%, 22% and 24% of net sales
in 1997, 1996 and 1995, respectively. For the real-time business, the respective
percentages were 84%, 86% and 100% of total government sales in 1997, 1996 and
1995. The Company recognizes that reductions in current levels of U.S.
government agency spending on computers and computer related services could
adversely affect its traditional sources of revenue.
Total cost of sales decreased in 1997 to $37,332,000 ($18,624,000 for real-time
and $18,708,000 for storage product), from $53,608,000 ($32,349,000 for
real-time and $21,259,000 for storage product) in 1996 and $55,963,000
($34,577,000 for real-time and $21,386,000 for storage product) in 1995. The
decrease in all years reported was due generally to lower sales volumes and
lower spending resulting from the restructuring of manufacturing and customer
service operations during the three year period. Since the beginning of 1995,
combined manufacturing and customer service headcount has been reduced by
approximately 88%, certain customer service field operations have been closed or
scaled down, and manufacturing operations had been consolidated in Melbourne,
Florida.
Cost of equipment sales exceeded sales by $7,248,000, $8,186,000 and
$12,970,000, or (51%), (30%) and (59%) of net sales, respectively, in 1997, 1996
and 1995. However, gross margins on real-time equipment sales were $671,000,
$491,000 and $4,427,000, or 7%, 2% and 20% for 1997, 1996 and 1995,
respectively. Negative gross margins were generated by the storage product
business of $7,949,000, $8,677,000 and $17,397,000 in 1997, 1996 and 1995,
respectively. In 1997, equipment cost of sales included $684,000 of valuation
reserves for real-time products. 1996 cost of sales included $9,932,000 (28% of
equipment sales) in additional valuation reserves on storage product inventory.
Gross margins were
18
<PAGE>
reduced in 1995 due to the charges associated with the termination of the Amdahl
Reseller Agreement. As discussed in Note C of Notes to Consolidated Financial
Statements, in 1995 the Company recorded charges of $14,242,000 in connection
with the termination of the Amdahl Reseller Agreement.
The Company's ISO 9002 certified manufacturing operation was sold to Sun as part
of the Sun Transaction. Pursuant to the "At Will Shared Services Agreement"
dated November 24, 1997, Sun agreed, among other things, to provide
manufacturing support to Encore through February 28, 1998, while the Company was
integrating its manufacturing operation into their Fort Lauderdale facility. At
that time the Company established a real-time technical operations function
responsible for research and development, manufacturing/integration, as well as
pre and post sales support. This organization consists of 28 of the most highly
experienced real-time technical personnel available.
Equipment gross margins were negatively impacted in 1997 and 1996 due to the
discounting of storage products in order to penetrate the marketplace and
establish reference accounts. Warranty costs related to the Storage Product 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 all
three years.
In 1997, cost of service sales exceeded sales by $598,000, compared to gross
margins on service sales in 1996 and 1995 of $2,205,000 or 11% and $6,605,000 or
24%, respectively. For 1997, 1996 and 1995, service margins were reduced for
investments in various programs and infrastructure necessary to support the
storage product line. The Company invested $5,965,000 (39% of service sales),
$5,979,000 (30% of service sales) and $3,719,000 (14% of service sales) in
support of the storage product line during 1997, 1996 and 1995, 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 $5,367,000 (35%),
$8,184,000 (41%) and $10,324,000 (38%) in 1997, 1996 and 1995, respectively. .
Research and development expenses in 1997 were $23,953,000 compared to
$30,260,000 and $33,249,000 in 1996 and 1995, respectively. The decrease in 1997
expenses is primarily the result of lower labor costs and lower spending on
non-recurring engineering associated with prototype boards. Sun either hired or
contracted 147 or 68% of total research and development personnel. In 1995 the
Company charged research and development $500,000 for the write down of
capitalized software projects as discussed in Note C of the Notes to
Consolidated Financial Statements. Excluding this charge, 1996 expenses
decreased $2,489,000 or 8% when compared to 1995. The decrease in research and
development expenses in 1996 from 1995 is primarily related to restructuring
actions taken in the second quarter of 1995. Research and development expenses
as a percentage of net sales increased to 81% in 1997, compared to 64% and 67%
in 1996 and 1995, respectively. These increases were the result of lower net
sales.
Subsequent to the Sun Transaction, the Company also 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 N of
the Notes to Consolidated Financial Statements, the Board of Directors voted not
to pursue the NT opportunity.
Sales, general and administrative ("SG&A") expenses in 1997 were $27,044,000
compared to $30,977,000 and $33,683,000 in 1996 and 1995, respectively. The
decrease in 1997 expenses was due to reduced headcount, lower commissions and
lower advertising and promotion expenses related
19
<PAGE>
to the storage products business. In 1996, SG&A expenses decreased from 1995
levels due to management actions taken to minimize headcount, close or
consolidate marginally profitable field offices and to more effectively focus
its advertising programs. SG&A expenses include non-cash compensation charges of
$589,000 and $1,424,000 in 1996 and 1995, respectively, in connection with the
extension of the expiration date of certain individual stock option grants. As a
percentage of net sales, SG&A expenses were 92%, 65% and 68% in 1997, 1996 and
1995, respectively.
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 discussed in Note B of Notes to Consolidated Financial Statements, 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 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. (See Item 3 Legal
Proceedings).
As discussed in Note C of Notes to Consolidated Financial Statements, in the
second quarter of 1995 management evaluated the Company's financial projections,
and concluded: (i) the termination of the Amdahl Reseller Agreement resulted in
a significant delay in the realization of product revenues, (ii) the rate of
decline in real-time equipment and service revenues had exceeded its previous
estimates, and (iii) the rate of worldwide sales growth anticipated in newer
product lines remained significantly below projected levels. In light of these
conclusions, management restructured operations and recorded a charge to
operations of $4,499,000. The most significant of these restructuring actions
were: (i) a 95 person reduction in workforce primarily in manufacturing and
development, resulting in a severance charge of $1,335,000, (ii) a write down of
$782,000 in the carrying value of the equipment used in the support of the
Amdahl Reseller Agreement, and (iii) the write off of $1,624,000 of capitalized
software assets relating to the Company's UNIX based product lines.
Interest expense increased in 1997 to $6,218,000 from $3,520,000 and $2,957,000
in 1996 and 1995, respectively, primarily due to higher debt levels. Since 1995,
Encore has completed a series of refinancing agreements with the Japan Energy
Group resulting in conversions of $180,000,000 of debt to preferred stock.
Other expense, net, was higher in 1997 than in 1996 and 1995 due principally to
higher foreign exchange losses and losses on the sale of certain fixed assets.
Income taxes provided in 1997 relate to $503,000 of taxes payable by foreign
subsidiaries as well as $1,400,000 in estimated alternative minimum tax
resulting from the gain on the Sun Transaction. 1996 and 1995 taxes relate only
to taxes payable by foreign subsidiaries (see Note H of the Notes to
Consolidated Financial Statements).
LIQUIDITY AND CAPITAL RESOURCES
20
<PAGE>
The Company reported a gain on the sale of assets resulting from the Sun
Transaction of $119,890,000 in 1997. For the year, the Company reported net
income of $34,164,000 compared to a net loss of $70,732,000 in 1996. In 1997,
net cash used in operating activities was $66,730,000. Net loss, adjusted for
non cash items and the gain on the Sun Transaction was $58,812,000, as the
Company recorded termination charges of $17,685,000, depreciation and
amortization of $6,631,000 and the gain on the Sun Transaction of $119,890,000.
Working capital was reduced as accounts receivable and inventories decreased by
$8,106,000 and $9,093,000, respectively, offset by accounts payable and accrued
liabilities which decreased by $23,946,000. As of December 31, 1997, total
capital deficiency was $19,646,000 versus $34,010,000 as of December 31, 1996.
Net cash used in 1996 operating activities increased by $10,975,000 from 1995,
reflecting the increase in working capital of $8,600,000, primarily increased
inventory. Additionally, for 1996, the net loss, as adjusted for non cash items,
exceeded the 1995 net loss by $2,029,000.
Expenditures for property and equipment during 1997, 1996 and 1995 were
$1,525,000, $7,433,000 and $7,335,000, respectively. The decrease in 1997
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. Proceeds
from the Sun Transaction were $151,168,000.
Net cash used in financing activities in 1997 was $57,954,000. Cash was provided
through financing activities of $68,707,000 and $58,658,000, in 1996 and 1995,
respectively. The principal source of financing has been through various
agreements provided by the Japan Energy Group. As of December 31, 1996, Encore
owed to Gould $72,659,000 in principal, plus $10,791,000 in accrued interest. On
January 9, 1997 Gould and Encore agreed to amend the credit agreement to
increase the maximum amount of revolving loans to $80,000,000, however, any
revolving loan exceeding $65,000,000 would be made at the discretion 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. In a letter to the Company dated July 17, 1997, Gould
confirmed that it was not obligated to provide any additional financing to the
Company but that so long as Gould was convinced that the sale of the storage
product business to Sun would take place, it was likely that Gould would
continue to provide financing to the Company but only to the extent absolutely
necessary to enable the transaction to be consummated. On November 24, 1997 (the
"Closing"), the Company paid to Gould $93,551,000 in principal and accrued
interest owed at that date.
Restricted cash of $14,083,000 at December 31, 1997 was 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
agreement. At March 30, 1998, $1,235,000 in cash remained in escrow. The
majority of cash and cash equivalents at December 31, 1997 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.
21
<PAGE>
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 is subject
to completion by Gores of due diligence and to negotiation and execution of
definitive agreements. If agreements are signed, the transaction will be subject
to approval by the Company's shareholders. If the Company sells its real time
computer systems business to Gores or to any other purchaser, the Company no
longer will have any business operations. Therefore, if the Company's
shareholders are asked to approve a sale of the real time computer systems
business, they almost surely will also be asked to approve a liquidation of the
Company.
At December 31, 1997, the Company had total assets of $37,451,000, including
restricted cash of $14,083,000, and cash and cash equivalents of $14,544,000 and
had liabilities of $57,097,000, including $13,655,000 of estimated severance
costs and other costs related to the sale of the Company's storage products
business and the $35,000,000 payable to Gould. The assets of the Company
available for distribution to shareholders on liquidation would be (i) the
Company's assets, plus the Second Payment net of any set off, less its
liabilities, at December 31, 1997, plus or minus (ii) the Company's net positive
or negative cash flow between January 1, 1998 and the date of the liquidation
(including any amount by which the severance and other costs related to the sale
of the storage products business paid after December 31, 1997 are greater or
less than the estimated amount reflected on the Company's December 31, 1997
balance sheet), minus (iii) the termination charge of $743,500 related to the
Board's decision to discontinue efforts to develop clustering software in a
Windows NT environment, plus or minus (iv) the gain or loss from the sale of the
Company's real time computer systems business, minus (v) costs of the
liquidation and reserves for any contingent liabilities, including any pending
litigation (See Item 3-Legal Proceedings).
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As of December 31, 1997, the
Company has a net capital deficiency and a working capital deficit. If Sun does
not make the Second Payment in full, the Company will be obligated to pay the
difference to Gould, and may not be able to satisfy its obligations. Management
feels that any set off to the Second Payment will not be material, based on all
current information, and intends to make all efforts to collect the Second
Payment in its entirety. However, the ultimate resolution of these matters are
not presently determinable.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gain and losses) in a full set of general-purpose financial
statements. SFAS 130 requires that an enterprise classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated balance of other comprehensive income separately from retained
earnings and additional paid-in capital in the equity section of the balance
sheet. SFAS 130 is effective for fiscal years beginning after December 15, 1997.
In June 1997, the FASB issued SFAS No. 131 "Disclosure about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes 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 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 evaluating 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 is currently evaluating the requirements of SFAS 130 and SFAS 131 to
determine whether additional disclosure is required.
22
<PAGE>
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, 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 applications 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:
decline in demand for the Company's products; 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.)
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders and Directors
of Encore Computer Corporation
We have audited the consolidated financial statements and the financial
statement schedule of Encore Computer Corporation and Subsidiaries listed in
Item 14 (a) of this Form 10-K. These financial statements and financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Encore Computer
Corporation and Subsidiaries as of December 31, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1997 in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information required to be included therein.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As of December 31, 1997, the
Company has a net capital deficiency and a working capital deficiency. These
matters raise substantial doubt about the Company's ability to continue as a
going concern. Management's plans regarding these matters are described in Note
O of Notes to Consolidated Financial Statements. The consolidated financial
statements do not include any adjustments that might result from the outcome of
these uncertainties.
As disclosed in Note N of Notes to Consolidated Financial Statements the Company
has entered into a letter of intent to sell its remaining business operations.
If consummated, it is likely the Company will propose a plan of liquidation that
will result in the distribution to its shareholders, the remaining net assets of
the Company. The amount of such distribution, if any, is not presently
determinable.
Coopers & Lybrand L.L.P.
Miami, Florida
MARCH 17, 1998
23
<PAGE>
ENCORE COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED
----------------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
----------------------------------------------------------
<S> <C> <C> <C>
Net sales:
Equipment $ 14,163 $ 27,600 $ 22,005
Service 15,323 20,027 27,323
------------ ------------ ------------
Total 29,486 47,627 49,328
Costs and expenses:
Cost of equipment sales (Note C) 21,411 35,786 34,975
Cost of service sales 15,921 17,822 20,718
Research and development 23,953 30,260 33,249
Sales, general and administrative 27,044 30,977 33,683
Termination charge (Note B) 17,685 - 4,499
------------ ------------ ------------
Total 106,014 114,845 127,124
------------ ------------ ------------
Operating loss (76,528) (67,218) (77,796)
Interest expense, principally
related parties (6,218) (3,520) (2,957)
Interest income 335 196 171
Other income (expense), net (1,412) (554) 75
Gain on Sun Transaction 119,890 - -
------------ ------------ ------------
Net income (loss) before income taxes 36,067 (71,096) (80,507)
Provision for income taxes 1,903 (364) 847
------------ ------------ ------------
Net income (loss) $ 34,164 $ (70,732) $ (81,354)
============ ============ ============
Net income (loss) per common share:
Net income (loss) attributable to
common shareholders $ 4,584 $ (96,145) $ (100,416)
============= ============= ============
Basic and diluted earnings (loss)
per common share $ 0.11 $ (2.61) $ (2.88)
============= ============= ============
Weighted average shares
of common stock 40,568 36,810 34,923
============= ============= ============
</TABLE>
The accompanying notes are an integral part of the consolidated
financial statements.
24
<PAGE>
ENCORE COMPUTER CORPORATION
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 14,544 $ 3,936
Restricted cash 14,083
Accounts receivable, less allowances of $681 and $614 in 1997
and 1996, respectively 5,752 14,970
Inventories 246 13,896
Prepaid expenses and other current assets 855 1,409
------------ ------------
Total current assets 35,480 34,211
Property and equipment, net 1,063 33,376
Other assets 908 1,669
------------ ------------
Total assets $ 37,451 $ 69,256
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
Current liabilities:
Current portion of long term debt-related parties $ - $ 72,659
Current portion of long term debt-other - 182
Accounts payable and accrued liabilities 22,097 28,665
Due to Gould Electronics (Note B) 35,000 -
------------ ------------
Total current liabilities 57,097 101,506
Long term debt - other - 476
Other liabilities - 1,284
------------ ------------
Total liabilities 57,097 103,266
------------ ------------
Commitments and contingencies (Note I)
Shareholders' equity (capital deficiency) (Note K) :
Preferred stock, $.01 par value; authorized 10,000,000 shares:
Series A Convertible Participating Preferred, issued
73,641 shares in 1996 - 1
6% Cumulative Series B Convertible Preferred, issued 728,722
in 1996 with an aggregate liquidation preference of $78,272,200 - 7
6% Cumulative Series D Convertible Preferred, issued 1,115,074
in 1996 with an aggregate liquidation preference of $111,507,400 - 11
6% Cumulative Series E Convertible Preferred, issued 1,139,782
in 1996 with an aggregate liquidation preference of $113,978,200 - 11
6% Cumulative Series F Convertible Preferred, issued 533,333
in 1996 with an aggregate liquidation preference of $53,333,300 - 5
6% Cumulative Series G Convertible Preferred, issued 572,289
in 1996 with an aggregate liquidation preference of $57,228,900 - 6
6% Cumulative Series H Convertible Preferred, issued 350,000
in 1996 with an aggregate liquidation preference of $35,000,000 - 4
Common stock, $.01 par value; authorized 200,000,000 shares; issued
67,447,309 and 37,270,457 in 1997 and 1996, respectively 674 373
Additional paid-in capital 427,012 447,068
Accumulated deficit (447,332) (481,496)
------------ ------------
Total shareholders' equity (capital deficiency) (19,646) (34,010)
------------ ------------
Total liabilities and shareholders' equity (capital deficiency) $ 37,451 $ 69,256
============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
25
<PAGE>
ENCORE COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
(IN THOUSANDS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED
-----------------------------------------------------
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1997 1996 1995
-----------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 34,164 $ (70,732) $ (81,354)
Adjustments to arrive at net cash provided (used)
in operating activities:
Depreciation and amortization 6,631 10,747 11,750
Non cash compensation (Note K) - 589 1,424
Inventory obsolescence and writedown to lower
of cost or market 684 11,013 12,367
Equity in loss of joint venture 355 253 773
Bad debt provision (credit) 149 (550) 2,735
Termination charges 17,685 - 4,499
Gain on SUN Transaction (119,890) - -
Foreign exchange loss (gain) 937 412 (134)
Loss on disposal of property and equipment-Other 473 138 1,839
Net changes in operating assets and liabilities:
Accounts receivable 8,106 (1,750) 4,514
Inventories 9,093 (8,888) (608)
Prepaid expenses and other current assets 444 (89) 375
Other assets 24 36 381
Accounts payable and accrued liabilities (23,946) (1,922) (8,330)
Other liabilities (1,639) (1) -
------------ ------------ ------------
Net cash used in operating activities (66,730) (60,744) (49,769)
------------ ------------ ------------
Cash flows from investing activities:
Additions to property and equipment (1,525) (7,433) (7,335)
Proceeds from SUN Transaction 151,168 - -
Proceeds from sale of property and equipment-Other 42 114 14
Capitalization of software costs - - (673)
------------ ------------ ------------
Net cash provided (used) in investing activities 149,685 (7,319) (7,994)
------------ ------------ ------------
Cash flows from financing activities:
Net borrowings (payments) under revolving loan
agreements (32,659) 67,505 56,733
Principal payments of long term debt (658) (171) (194)
Dividends paid on Preferred Stock - (2) (1)
Retirement of Preferred Stock (25,000) - -
Issuance of Common Stock 363 1,375 2,120
------------ ------------ ------------
Net cash provided (used) in financing activities (57,954) 68,707 58,658
------------ ------------ ------------
Effect of exchange rate changes on cash (310) (198) 78
------------ ------------ ------------
Increase in cash and cash equivalents 24,691 446 973
Restricted cash (14,083) - -
------------ ------------ ------------
10,608 446 973
Cash and cash equivalents, beginning 3,936 3,490 2,517
Cash and cash equivalents, ending $ 14,544 $ 3,936 $ 3,490
============ ============ ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
26
<PAGE>
ENCORE COMPUTER CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
Supplemental disclosure of cash flow information (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Cash paid during the period for interest $ 17,807 $ 150 $ 1,354
Cash paid during the period for income taxes $ 2,099 $ 631 $ 1,273
Non-cash investing and financing activities:
Indebtedness exchanged for preferred stock $ 40,000 $ 35,000 $ 105,000
Due to Gould Electronics in connection with
the Sun Transaction $ 35,000 $ - $ -
Accruals originally established for transaction
costs related to Gould capital transactions
credited to additional paid-in capital $ - $ - $ 400
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
27
<PAGE>
ENCORE COMPUTER CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (CAPITAL DEFICIENCY)
- --------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PREFERRED STOCK
-----------------------------------------------------------
SERIES A SERIES B SERIES D
------------------ --------------- ----------------
PAR PAR PAR
SHARES VALUE SHARES VALUE SHARES VALUE
------ ----- ------- ----- --------- -----
<S> <C> <C> <C> <C> <C> <C>
Balance December 31, 1994 73,641 $ 1 666,453 $ 7 1,019,787 $ 10
Common stock options exercised,
$.63 to $2.31 per share
Shares issued through employee stock purchase
plan of an average price of $1.75 per share
Issuance of Series F and Series G Convertible
Preferred Stock
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F and G 40,892 -- 62,575 1
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Adjustment of estimated transaction costs
relating to Gould capital transactions
Net loss
------ ----- ------- ----- --------- -----
Balance December 31, 1995 73,641 1 707,345 7 1,082,362 11
Common stock options exercised,
$.69 to $2.00 per share
Shares issued through employee stock purchase
plan at an average price of $1.52 per share
Issuance of Series H Convertible
Preferred stock
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F, and G 21,377 32,712
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Net loss ------ ----- ------- ----- --------- -----
Balance December 31, 1996 73,641 1 728,722 7 1,115,074 11
Common stock options exercised,
$.69 to $1.56 per share
Shares issued through employee stock purchase
plan of an average price of $0.74 per share
Issuance of Series I Convertible
Preferred Stock
Retirement of Preferred Stock relating
to the Sun Transaction (1,115,074) (11)
Conversion of Series A and B Preferred
Stock to Common Stock (73,641) (1) (728,722) (7)
Net income
------- ------ -------- ----- --------- -----
Balance December 31, 1997 -- $ -- -- $ -- -- $ --
======= ====== ======== ===== ========= =====
SERIES E SERIES F SERIES G
----------------- --------------- ----------------
PAR PAR PAR
SHARES VALUE SHARES VALUE SHARES VALUE
--------- ----- ------- ----- ------ -----
<S> <C> <C> <C> <C> <C> <C>
Balance December 31, 1994 1,042,381 $ 10 -- $ -- -- $ --
Common stock options exercised,
$.63 to $2.31 per share
Shares issued through employee stock purchase
plan of an average price of $1.75 per share 500,000 5 550,000 5
Issuance of Series F and Series G Convertible
Preferred Stock 63,962 1 17,687 5,500
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F and G
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Adjustment of estimated transaction costs
relating to Gould capital transactions
Net loss
--------- ----- ------- ----- --------- -----
Balance December 31, 1995 1,106,343 11 517,687 5 555,500 6
Common stock options exercised,
$.69 to $2.00 per share
Shares issued through employee stock purchase
plan at an average price of $1.52 per share
Issuance of Series H Convertible
Preferred Stock
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F, and G 33,439 15,646 16,789
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Net loss
--------- ----- ------- ----- --------- -----
Balance December 31, 1996 1,139,782 11 533,333 5 572,289 6
Common stock options exercised,
$.69 to $1.56 per share
Shares issued through employee stock purchase
plan of an average price of $0.74 per share
Issuance of Series I Convertible
Preferred Stock
Retirement of Preferred Stock relating
to the Sun Transaction (1,139,782) (11) (533,33) (5) (572,289) (6)
Conversion of Series A and B Preferred
Stock to Common Stock
Net income ------ ----- ------- ----- --------- -----
Balance December 31, 1997 -- $ -- -- $ -- -- $ --
====== ===== ======= ===== ========= =====
SERIES H SERIES I
----------------- ---------------
PAR PAR
SHARES VALUE SHARES VALUE
------ ----- ------- -----
<S> <C> <C> <C> <C>
Balance December 31, 1994 -- $ -- -- $ --
Common stock options exercised,
$.63 to $2.31 per share
Shares issued through employee stock purchase
plan of an average price of $1.75 per share
Issuance of Series F and Series G Convertible
Preferred Stock
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F and G
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Adjustment of estimated transaction costs
relating to Gould capital transactions
Net loss
------ ----- ------- -----
Balance December 31, 1995 0 0 -- --
Common stock options excercised,
$.69 to $2.00 per share
Shares issued through employee stock purchase
plan at an average price of $1.52 per share
Issuance of Series H Convertible
Preferred Stock 350,000 4
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F, and G
Cash paid in lieu of fractional share dividends
Extension of expiration date on outstanding
grant of common stock options
Net loss
------- ----- ------- -----
Balance December 31, 1996 350,000 4 -- --
Common stock options exercised,
$.69 to $1.56 per share
Shares issued through employee stock purchase
plan of an average price of $0.74 per share
Issuance of Series I Convertible
Preferred Stock 400,000 4
Retirement of Preferred Stock relating
to the Sun Transaction (350,000) (4) (400,000) (4)
Conversion of Series A and B Preferred
Stock to Common Stock
Net income ------ ----- ------- -----
Balance December 31, 1997 -- $ -- -- $ --
====== ===== ======= ======
COMMON STOCK SHAREHOLDERS'
--------------------- ADDITIONAL EQUITY
PAR PAID-IN ACCUMULATED (CAPITAL
SHARES VALUE CAPITAL DEFICIT DEFICIENCY)
---------- ----- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C>
Balance December 31, 1994 34,076,124 $ 341 $307,001 $(329,410) $(22,040)
Common stock options exercised, 1,568,934 16 1,363 1,379
$.63 to $2.31 per share
Shares issued through employee stock purchase
plan of an average price of $1.75 per share 422,734 4 737 741
Issuance of Series F and Series G Convertible
Preferred Stock 101,954 101,965
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F and G (2) --
Cash paid in lieu of fractional share dividends (1) (1)
Extension of expiration date on outstanding
grant of common stock options 1,424 1,424
Adjustment of estimated transaction costs
relating to Gould capital transactions 400 400
Net loss (81,354) (81,354)
---------- --------- ------- ------- -------
Balance December 31, 1995 36,067,792 361 412,876 (410,764) 2,514
Common stock options exercised,
$.69 to $2.00 per share 808,011 8 767 775
Shares issued through employee stock purchase
plan of an average price of $1.52 per share 394,654 4 596 600
Issuance of Series H Convertible
Preferred Stock 32,242 32,246
Dividends issued to Preferred Stockholders
in shares of Series B, D, E, F and G (1) (1)
Cash paid in lieu of fractional share dividends (1) (1)
Extension of expiration date on outstanding
grant of common stock options 589 589
Net loss (70,732) (70,732)
---------- --------- ------- -------- --------
Balance December 31, 1996 37,270,457 373 447,068 (481,496) (34,010)
Common stock options exercised,
$.69 to $1.56 per share 51,372 59 59
Shares issued through employee stock purchase
plan of an average price of $0.74 per share 339,165 3 301 304
Issuance of Series I Convertible
Preferred Stock 39,833 39,837
Retirement of Preferred Stock relating
to the SUN Transaction (59,959) (60,000)
Conversion of Series A and B Preferred
Stock to Common Stock 29,786,315 298 (290) 0
Net income 34,164 34,164
---------- --------- -------- --------- ---------
Balance December 31, 1997 67,447,309 $ 674 $427,012 $(447,332) $ (19,646)
========== ========= ======== ========= =========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Encore Computer Corporation ("Encore" or the "Company"), founded in 1983,
designs, manufactures, distributes and supports scalable real-time data systems
and advanced clustering technologies. Headquartered in Fort Lauderdale, Florida,
the Company has sales offices and distributors in the United States, Canada,
Europe, and the Far East.
PRINCIPLES OF CONSOLIDATION
The accompanying financial statements include the accounts of Encore and its
wholly owned subsidiaries. All material intercompany transactions have been
eliminated. The Company's 50% investment in a Japanese joint venture operation
which was liquidated in 1997 was accounted for under the equity method. The
Company had a commitment to make additional capital contributions to the joint
venture, accordingly, the Company recognized losses in excess of its investment
to the extent of this capital commitment.
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As of December 31, 1997, the
Company has a net capital deficiency and a working capital deficiency. These
matters raise substantial doubt about the Company's ability to continue as a
going concern. (See Note O of Notes to Consolidated Financial Statements).
PERVASIVENESS OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with maturities at the
date of purchase of three months or less.
REVENUE RECOGNITION
Revenue related to equipment and software sales is recognized upon shipment.
With respect to the Company's storage processor product line, during the product
introductory period, revenue was recognized upon customer acceptance. The
Company expected acceptance to occur within thirty days of shipment. Service
revenue is recognized over the term of the related maintenance agreements which
approximates the timing of services performed.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined by the
first-in, first-out method. Loaned equipment which consists primarily of
finished computer systems that are loaned to customers for test and evaluation
is classified as inventory only if the equipment is intended for resale and
anticipated to be in service for a period of less than 12 months prior to sale.
Loaned equipment in service for more than 12 months is classified as property
and equipment.
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Property and equipment includes
customer service inventory which consists principally of spare parts utilized to
support repairs at customer installations and is generally not available for
resale. Additions, renewals and improvements are capitalized, and repair and
maintenance costs are expensed. Upon an assets retirement or disposition, the
cost and related accumulated depreciation are removed from the accounts and any
resulting gain or loss is reflected in the results of operations. Depreciation
is provided on a straight line basis over the estimated lives of the assets,
generally three years for loaned equipment, five years for equipment and
customer service
29
<PAGE>
inventory, ten years for furniture and fixtures, and 25 to 30 years for
buildings. Leasehold improvements are amortized over their expected useful lives
or the lease term, whichever is shorter.
Statement of Financial Accounting Standards ("FAS") No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long- Lived Assets to be Disposed Of"
was adopted in the Company's fiscal year beginning January 1, 1996. FAS 121
requires that long- lived assets, such as property and equipment, and certain
identifiable intangibles to be held and used, be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
an asset may not be recoverable. An impairment loss, based on the fair value of
the asset, should be recognized if the expected future cash flows (undiscounted
and without interest charges) resulting from the use and eventual disposition of
the asset is less than the carrying amount of the asset.
The Company has historically written down the carrying value of long-lived
assets deemed permanently impaired. However, as contemplated by FAS 121, the
Company's history of operating and cash flow losses indicates that the
recoverability of the carrying amount of the long-lived assets should be
assessed. Based on the Company's analysis of the fair value of property and
equipment, no adjustment is required in 1997.
EMPLOYER'S POSTEMPLOYMENT BENEFITS
The Company provides employees with salary continuation in the event of an
employee's involuntary termination. The Company recognizes such costs on a
terminal accrual basis, recording the estimated cost of postemployment benefits
at the date of the event giving rise to the liability to pay those benefits.
STOCK-BASED COMPENSATION
The Company applies APB Opinion No. 25 and related Interpretations in accounting
for its stock option and stock purchase plans. Accordingly, no compensation cost
has been recognized for these plans with the exception of extension of the
expiration date of certain individual stock option grants. Pro forma disclosure
of the fair value impact on earnings and earnings per share as required in FAS
123, "Accounting for Stock-Based Compensation" is presented in Note K of the
Notes to Consolidated Financial Statements.
CAPITALIZED SOFTWARE
Through June 1995, the Company capitalized certain internal costs associated
with software development after the project reached technological feasibility.
Such costs as well as capitalized costs for purchased software, were amortized
to cost of sales by the greater of; (a) straight line amortization over the
expected commercial life of each product (three to five years), or (b) the ratio
that current revenues for a product bear to the total of current and anticipated
future revenues for that product. Software development costs incurred prior to
reaching the point of technological feasibility were considered research and
development costs and were expensed as incurred. During June 1995, as discussed
in Note C of the Notes to Consolidated Financial Statements, the Company took a
charge of $500,000 to research and development to write down capitalized
software projects in process. Since that time, all software development costs
have been expensed as incurred.
INCOME TAXES
The Company utilizes the liability method of accounting for deferred income
taxes. Under this method, deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Deferred tax assets are reduced by a
valuation allowance when, in the opinion of management, it is more likely than
not that some or all of the deferred tax assets will not be realized.
EARNINGS PER SHARE
During 1997, the Company adopted SFAS No. 128 Earnings Per Share ("EPS") ("FAS
128"), which supersedes Accounting Principales Board Opinion No. 15, 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 earnigns per
share were the same for all periods presented because the effect of common stock
equivalents would be anti-dilutive. SFAS No. 128 had no impact on the Company's
reported loss per share for 1996 or 1995.
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Preferred stock dividends amounted to $29,579,900, $25,413,000 and $19,061,600
for 1997, 1996 and 1995, respectively. Based on capital deficiencies the Company
was unable to pay dividends on its preferred stock and therefore accumulated
those dividends. All preferred stock dividends other than those accumulated,
have been paid in additional shares of the appropriate class of preferred stock.
FOREIGN CURRENCY TRANSLATION AND TRANSACTIONS;
Management has determined that the functional currency of each of the Company's
subsidiaries is the United States dollar. Consequently, assets and liabilities
of foreign operations are translated into U.S. dollars at period end exchange
rates, except that inventory and property and equipment are translated at
historical exchange rates. Income and expenses are translated at the average
rates prevailing during the year, except that cost of sales and depreciation are
translated at historical exchange rates. All gains and losses arising from
changes in exchange rates are included in operating results in the period
incurred.
WARRANTIES
The Company provides a standard product warranty on its computer systems for
parts and labor which generally extends ninety days from the date of
installation, but on certain products for up to one year. On its storage
processor product line, the standard product warranty for parts and labor
generally extended two, and in some cases, three years from the date of
installation. Sun assumed all warranty obligations relating to the Company's
installed storage product base. The estimated cost of providing warranty on
products sold is included in cost of sales at the time revenue is recognized.
These estimates are based upon historical data for mature products and
engineering estimates for new products. Actual warranty costs are reviewed on a
quarterly basis and subsequent estimates adjusted appropriately.
RECLASSIFICATIONS
Certain reclassifications have been made to conform prior years' data to the
current year presentation.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
(revenues, expenses, gain and losses) in a full set of general-purpose financial
statements. SFAS 130 requires that an enterprise classify items of other
comprehensive income by their nature in a financial statement and display the
accumulated
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balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the balance sheet. SFAS 130
is effective for fiscal years beginning after December 15, 1997.
In June 1997, the FASB issued SFAS No. 131 "Disclosure about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes 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 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 evaluating 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 is currently evaluating the requirements of SFAS 130 and SFAS 131 to
determine whether additional disclosure is required.
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, 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 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
is 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 will be indebted to Gould for the amount by which such payment
is less than $35 million. In addition, if the $35 million is not paid to Gould
by July 31, 1998, Gould will 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 is paid to Gould by July 31, 1998, Gould will waive its
right to receive these accrued but unpaid dividends. Additionally, if the full
$35 million is paid to Gould by July 31, 1998, 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 (See Note N of Notes to
Consolidated Financial Statements). In light of the uncertainties associated
with the Second Payment, Encore has reflected the above $35 million as a
liability to Gould and deferred recognition of the gain on the Sun Transaction
to that extent until such time as resolution of the matter is ascertained.
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
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$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 Sun Transaction, and (vii) $250,000 accrued for legal fees
in connection with the shareholders pending legal action.
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 $14,083,000 at December 31, 1997 was 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
agreement.
C. TERMINATION OF AMDAHL RESELLER AGREEMENT
During 1994, the Company and Amdahl Corporation ("Amdahl") entered into a five
year reseller agreement (the "Amdahl Reseller Agreement") which granted Amdahl
the exclusive right to distribute the Company's Infinity Storage Products under
the Amdahl brand. The Amdahl Reseller Agreement, as amended, established
procurement schedules, which if certain product requirements were met, would
have required Amdahl to purchase a significant amount of product from the
Company. Sales under the Amdahl Reseller Agreement were anticipated to begin in
the second half of 1994 with significant sales volumes scheduled in the first
half of 1995.
During the second and third quarters of 1994 the Company delivered products to
Amdahl under the terms of the Amdahl Agreement which Encore believes conformed
fully with the agreement. However, as of December 31, 1994 Amdahl had not paid
for the products received.
The Company had continuing discussions with Amdahl requesting payment of all
past due invoices and the resumption of deliveries under the terms of the Amdahl
Agreement. In response to a February 1995 letter sent by the Company to Amdahl
notifying Amdahl of its intent to terminate the Amdahl Agreement if past due
invoices were not paid, Amdahl filed suit in the Delaware Chancery Court on
March 29, 1995 seeking to prevent Encore from terminating the agreement. On
March 30, 1995, Encore and Amdahl agreed to a "Stand-Still" Agreement which, in
effect, preserved the status quo to allow the companies time to more thoroughly
discuss the contractual issues that existed. The "Stand-Still" Agreement ran
until April 14, 1995.
Because of the uncertainties surrounding the outcome of the discussions between
the companies, management considered it prudent to establish certain reserves at
December 31, 1994.
On April 24, 1995, the companies jointly announced that they had reached an
agreement in principle as to the existing issues and the "Stand-Still" agreement
was extended to allow sufficient time to document the agreement. However, the
companies were unable to reach a final agreement. On June 8, 1995, Encore
announced that the Reseller Agreement between Encore and Amdahl for the sale of
Encore's storage products by Amdahl had been terminated.
The Company's inventory levels and overhead costs were based on a plan designed
to meet accelerating sales commitments defined in the Amdahl Reseller Agreement.
However, because of the termination of the Amdahl Reseller Agreement, product
sales fell well short of expectations and all
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elements of the Company's results of operations were adversely affected. As a
result of these events, during 1995, the Company charged operations $19,241,000,
consisting of; (i) a charge to cost of sales of $11,442,000 against $24,895,000
of Storage Product inventory to reduce carrying amounts to estimated net
realizable value, (ii) a charge to cost of sales of $2,800,000 for Amdahl
accounts receivable which were deemed uncollectible in light of the termination
of the Amdahl Agreement, (iii) a charge to research and development of $500,000
to write down capitalized software projects in process relating to the Storage
Product business, and (iv) a charge to termination costs of $4,499,000. The
termination charge related to; (i) the recognition of the permanent impairment
in value of $2,406,000 of certain long-lived assets, including capitalized
software relating to the Company's UNIX based product line and property and
equipment used in support of the Amdahl Reseller Agreement, (ii) severance and
benefit pay of $1,335,000 as a result of a 95 person reduction in workforce,
principally in manufacturing and development, and (iii) other expenses
associated with the termination of the Amdahl Reseller Agreement.
The Company's estimate of asset impairments for fiscal 1995 were based on the
status of the Amdahl negotiations at the applicable reporting date.
D. INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Purchased Parts $ 174 $ 9,357
Work in process -- 306
Finised goods 72 3,981
Loan computer equipment and
consignment inventory -- 252
------- -------
$ 246 $13,896
======= =======
During the fourth quarter of 1996, the Company provided an additional reserve of
$7,348,000 in light of the continued slow market acceptance of the Company's
storage products. Storage product inventory, amounted to $9,169,000 at December
31, 1996. All storage product inventory at a net book value of approximately
$3,860,000 was sold to Sun Microsystems in connection with the Sun Transaction.
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E. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Land $ -- $ 5,100
Buildings -- 15,238
Equipment 6,986 36,005
Customer service inventory 10,112 16,282
Furniture and fixtures 1,193 2,539
Leasehold improvements 1,327 1,298
Loaned equipment -- 4,815
-------- --------
19,618 81,277
Accumulated depreciation
and amortization (18,555) (47,901)
-------- --------
$ 1,063 $ 33,376
======== ========
Depreciation expense in 1997, 1996 and 1995 amounted to $6,175,000, $9,380,000
and $9,260,000, respectively. Fixed assets with a net book value of
approximately $27,148,000 were sold to Sun Microsystems in connection with the
Sun Transaction.
F. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following (in
thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Accounts payable $ 1,064 $ 4,976
Accrued salaries and benefits 2,355 4,034
Accrued restructuring costs (See Note B) 13,655 362
Accrued interest-related parties -- 11,614
Accrued taxes 1,048 2,760
Deferred income, principally
maintenance contracts 638 879
Other accrued expenses 3,337 4,040
------- -------
$22,097 $28,665
======= =======
Accrued interest of $10,791,000 was payable to Gould at December 31, 1996. All
accrued interest payable to Gould at November 24, 1997 was paid in connection
with the Sun Transaction
G. DEBT
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Debt consists of the following (in thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Debt to unrelated parties:
Mortgages payable $ -- $ 658
Current portion of debt -- (182)
--------- --------
Total long term debt to unrelated parties $ -- $ 476
========= ========
Debt to related parties:
Credit Agreement with Gould
Electronics Inc. $ -- $ 72,659
Current portion of debt -- (72,659)
--------- --------
Total long term debt to related parties $ -- $ --
========= ========
On March 19, 1997, the Company and Gould agreed to cancel $40,000,000 of
indebtedness owed to Gould under their loan 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. In a letter to the Company dated July 17, 1997, Gould confirmed that it
was not obligated to provide any additional financing to the Company but that so
long as Gould was convinced that the sale of the Storage Product business to Sun
would take place, it was likely that Gould would continue to provide financing
to the Company but only to the extent absolutely necessary to enable the
transaction to be consummated. On November 24, 1997, the Company paid to Gould
$93,551,000 in principal and accrued interest owed at that date.
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H. INCOME TAXES
The Company utilizes the liability method of accounting for deferred income
taxes and has recorded a provision of $1,903,000, and $847,000, for the years
ended 1997 and 1995, respectively. In 1996 a credit of $364,000 was recorded due
to overestimated tax accruals in prior years. The provision in 1997 relates to
$503,000 of taxes payable by foreign subsidiaries as well as $1,400,000 in
estimated Alternative Minimum Tax (AMT) resulting from the gain on the sale of
assets to Sun. 1996 and 1995 provisions relate only to the profitable operations
of certain foreign subsidiaries.
The financial reporting bases of investments in certain foreign subsidiaries
exceeds their tax bases. A deferred tax liability is not recorded for the excess
because the investments are essentially permanent. A reversal of the Company's
plans to permanently invest in these operations would cause the excess to become
taxable. On December 31, 1997, these temporary differences were approximately
$4,000,000. A determination of the amount of unrecognized deferred tax liability
related to these investments is not practicable.
The significant components of the deferred tax assets and liabilities as of
December 31, 1997 and 1996 were as follows (in thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Deferred tax assets:
Net operating losses $ 108,156 $ 150,195
Research and experimental credits 3,150 1,750
Capital losses -- 4,954
Allowance for doubtful accounts 197 172
Inventory reserves 2,358 9,023
Accured vacation 265 560
Various reserves/other 3,491 4,279
Depreciation 1,274 (1,863)
Accrued restructuring 5,537 7
--------- ---------
124,428 169,077
Valuation allowance (124,428) (168,739)
--------- ---------
-- 338
Deferred tax liabilities:
Capitalized software -- (338)
--------- ---------
Net $ -- $ --
========= =========
For income tax purposes the Company had a change in ownership, as defined by
Internal Revenue Code Section 382, in connection with the Gould debt exchange on
January 28, 1991. The change in ownership resulted in an annual limitation of
approximately $2,000,000 on the amount of net operating losses incurred prior to
January 28, 1991 that can be utilized to offset the Company's future taxable
income. Amounts not utilized may be carried forward and used in a subsequent
year during the carryforward period in addition to that year's annual limitation
amount. At December 31, 1997, the Company had available $14,000,000 of pre
change net operating loss carryforwards which were used to offset 1997 taxable
income.
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At December 31, 1997, the Company has available approximately $50,000,000 of
remaining pre change net operating losses. Of this amount approximately
$16,000,000 will be allowable in future years after application of the Section
382 limitation. In addition, pre change tax credit carryforwards, principally
research and development credits, of approximately $1,750,000 and post change
net operating losses of $236,000,000 will be available to offset future taxable
income. These net operating losses and tax credit carryforwards expire in the
years 1998 through 2012. For financial reporting purposes, the full amount of
the deferred tax assets was offset by a valuation allowance due to uncertainties
associated with the eventual realization of such benefits.
During 1997, the Internal Revenue Service completed their audit of the U.S.
Federal Tax Returns for 1992 through 1994. The examination resulted in no
material impact on the Company's consolidated results of operations or financial
position.
I. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases office space and equipment under operating leases. Certain
building leases have renewal options generally for periods ranging from one to
five years. Rental expenses, net of sublease income, were approximately
$2,611,000, $3,003,000 and $3,187,000 for 1997, 1996, and 1995, respectively.
Approximate future minimum rental payments under operating leases for the next
five years are as follows (in thousands):
YEAR
----
1998 $1,582
1999 1,388
2000 1,248
2001 1,636
2002 46
At December 31, 1997, the Company has accrued in termination charges $3,390,000
related to international facility and equipment leases.
JOINT VENTURE CAPITAL COMMITMENT
The Company had committed to invest up to a total of $3,250,000 for a Japanese
joint venture, of which $1,640,000 had been accrued in recognition of losses
reported through its dissolution on December 5, 1997. The $1,640,000 less
$181,000 owed to Encore by the joint venture was remitted to Japan Energy
Corporation in January 1998.
LITIGATION
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 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.
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INTELLECTUAL PROPERTY LICENSE
In connection with its recapitalization in January 1991, the Company licensed
substantially all of its intellectual property to Gould on a royalty free basis.
However, under the terms of the agreement, and in combination with certain
extensions granted by Gould, Encore retained the exclusive use of the
intellectual property through December 31, 1995. Those extensions expired and
effective January 1, 1996, both Gould and Encore had the right to use the Encore
intellectual property. The Company maintained the right to terminate the Gould
license if all Gould borrowings were repaid and the commitments under any Gould
credit agreements were terminated and one of the following four conditions was
met; (i) the 6% Cumulative Series B Convertible Preferred Stock ("Series B") was
converted into common stock or Series A Convertible Participating Preferred
Stock, or (ii) the Series B was redeemed; or (iii) the Company paid Gould the
fair value of the license, or (iv) the Company paid Gould a fixed dollar amount
equal to $46,540,000 plus 9% per annum interest compounded annually for the
period after January 28, 1996, through the date of payment.
In conjunction with 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.
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J. EARNINGS PER SHARE
The following table reconciles for the years ended 1997, 1996 and 1995, net
income (loss) and weighted average shares outstanding used to calculate basic
and diluted earnings per share (in thousands except per share data):
BASIC 1997 1996 1995
- ---------------------------------- --------- --------- ---------
Net income (loss) $ 34,164 $ (70,732) $ (81,354)
Series B,D,E,F, and G
Preferred Stock Dividends -- (11,996) (19,062)
Series B,D,D,E,F,G,H,I Accumulated
Preferred Stock Dividends (29,580) (13,417) --
--------- --------- ---------
Net income (loss) attributable to
common shareholders $ 4,584 $ (96,145) $(100,416)
========= ========= =========
Weighted average common
shares outstanding 40,568 36,810 34,923
========= ========= =========
Basic income (loss) per common share $ 0.11 $ (2.61) $ (2.88)
========= ========= =========
DILUTED
Net income (loss) $ 34,164 $ (70,732) $ (81,354)
========= ========= =========
Weighted average common
shares outstanding 40,568 36,810 34,923
Series A assumed converted -- 7,364 7,364
Series B assumed converted -- 22,544 21,242
Series D assumed converted -- 34,496 32,503
Series E assumed converted -- 35,260 33,223
Series F assumed converted -- 16,499 12,437
Series G assumed converted -- 17,704 6,388
Series H assumed converted -- 7,760 --
Exercise of options reduced by the number
of shares purchased with proceeds -- 3,158 3,349
--------- --------- ---------
Weighted average shares outstanding 40,568 181,595 151,429
========= ========= =========
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Diluted income (loss) per common share: $ .11 $ (2.61) $ (2.88)
========= ========= =========
Basic and diluted income (loss) per common share are the same because the effect
of the common stock equivalents would be anti-dilutive.
K. CAPITAL STOCK
On March 19, 1997, Gould agreed to cancel $40,000,000 of indebtedness owed to it
by the Company for 400,000 newly-issued shares of Series I Convertible Preferred
Stock ("Series I"). The canceled debt had represented a portion of the
indebtedness owed by the company to Gould under the Credit Agreement. During
1996, 350,000 shares of Series H were issued to Gould as part of an exchange of
indebtedness totaling $35,000,000. Because of the related party nature of these
transactions, the difference between the carrying amount of the indebtedness
exchanged and the par value of the securities issued and other consideration
granted has been credited to additional paid-in capital. The financial effects
of these transactions are summarized as follows (in thousands):
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
Reduction of debt $ 40,000 $ 35,000
Less:
Par value of shares issued (4) (4)
Accrued transaction costs -- (200)
Reversal of accrued interest on previous
recapitalizations 283 111
Accrued interest on remaining Gould indebtedness
for the remaining term of the agreements (446) (2,665)
-------- --------
Increase in additional paid-in capital
$ 39,833 $ 32,242
======== ========
IMPACT OF FOREIGN OWNERSHIP
41
<PAGE>
On November 24, 1997, in conjunction with the Sun Transaction, Gould converted
their Series A and Series B Preferred Stock to Common Stock and all other series
of Preferred Stock were retired. As a result, JEC beneficially owns 48.4% of the
Company's common stock. Gould also holds four of the six seats on the Company's
Board of Directors. In light of limitations on the ability of certain U.S.
government agencies to transact business with foreign owned or controlled
companies, Encore and JEC, the parent company of Gould, have proactively worked
to comply with all U.S. requirements. The United States Defense Investigative
Service has accepted the changes in the Company's ownership and control in
conjunction with the Sun Transaction.
STOCK COMPENSATION PLAN
At December 31, 1997, the Company had a Long Term Performance Plan (the
"Performance Plan") which was approved by the shareholders of the Company on
June 27, 1995 and replaced all previous stock option plans. Shares of common
stock are reserved for issuance to officers, directors, employees and certain
consultants. The Company applies APB Opinion No. 25 and related Interpretations
in accounting for its plan. Accordingly, no compensation cost has been
recognized for its fixed stock option plan and its stock purchase plan. Had
compensation cost for the Company's stock based compensation plan been
determined based on the fair value at the grant dates for awards under the plans
consistent with the method of FASB Statement 123, the Company's net income
(loss) and income (loss) per share would have been reduced to the pro forma
amounts indicated below:
1997 1996 1995
------- -------- --------
Net income (loss): As reported $34,164 ($70,732) ($81,354)
Pro forma $33,424 ($71,641) ($81,942)
Basic and fully diluted
income (loss) per share: As reported $ .11 ($2.61) ($2.88)
Pro forma $ .09 ($2.64) ($2.89)
The fair value of each option grant was estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions for 1995, 1996
and 1997, respectively: risk- free interest rates of 6.0, 6.0 and 6.25 percent;
dividend yield of 0 percent; expected life of 4 years; and volatility of 104.9,
104.9 and 127.7 percent.
During 1996 and 1995, 1,119,000 and 1,652,000 options granted to certain
officers and employees of the Company were scheduled to expire if not exercised.
However, at the time the options were scheduled to expire the Company's policy
on insider trading effectively prevented the officers from exercising the
options. Accordingly, the Board of Directors approved an extension of the
expiration date until such time as the options could be exercised and the
underlying shares sold in accordance with Company policy. The extensions were
treated as cancellations of the old options and a grant of new options in the
same amounts at the same exercise prices. Non-cash compensation charges of
42
<PAGE>
$589,000 and $1,424,000, respectively, were incurred in connection with the
extension of the expiration dates of the stock options.
43
<PAGE>
A summary of the status of the Company's stock options as of December 31, 1997,
1996 and 1995, and changes during the years ending on those dates is presented
below:
<TABLE>
<CAPTION>
1997 1996 1995
---------------------- --------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE SHARES EXERCISE SHARES EXERCISE
(000) PRICE (000) PRICE (000) PRICE
------- --------- ------- --------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 9,582 $ 1.62 9,946 $ 1.50 10,11 $ 1.44
Granted
Price = Fair Value 360 $ 1.60 666 $ 2.83 1,690 $ 1.58
Price /more than/ Fair Value -- -- -- -- 15 --
Price /less than/ Fair Value 100 $ 0.39 -- -- -- --
Exercised (59) $ 1.00 (808) $ 0.96 (1,569 $ 0.88
Forfeited (963) $ 2.09 (222) $ 2.47 (302) $ 2.97
------ ------ ------
Outstanding at end of year 9,020 $ 1.56 9,582 $ 1.62 9,946 $ 1.50
====== ====== ======
Options exercisable at year end 8,280 7,445 7,290
====== ====== ======
Weighted-average fair value of
options granted during the year $ 1.09 $ 2.09 $ 1.17
====== ====== ======
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1997:
OPTIONS OPTIONS
OUTSTANDING EXCERCISABLE
- ------------------------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER REMAINING AVERAGE NUMBER AVERAGE
RANGE OF OUTSTANDING AS CONTRACTUAL EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES OF 12/31/97 LIFE PRICE AS OF 12/31/97 PRICE
- --------------- -------------- ----------- -------- -------------- -------
$0.39-$0.81 753,500 2.54 $0.7106 653,500 $0.7596
$0.94-$0.94 4,339,798 1.73 $0.9375 4,339,798 $0.9375
$1.50- $2.00 2,378,881 5.53 $1.7408 2,084,392 $1.7660
$2.38-$4.13 1,548,099 6.99 $3.4215 1,202,409 $3.5240
--------- ---------
$.039-$4.13 9,020,278 3.70 $1.5567 8,280,099 $1.5076
========= =========
EMPLOYEE STOCK PURCHASE PLAN
Under the 1991 Employee Stock Purchase Plan (the "Purchase Plan"), the Company
is authorized to issue up to 8,000,000 shares of common stock to its full-time
employees. As of December 31, 1997, 4,610,834 shares have been purchased. Under
the terms of the Purchase Plan, employees can choose each year to have up to 10
percent of their annual base earnings withheld to purchase the Company's common
stock. The purchase price per share of common stock in any offering under the
Purchase Plan is the lower of; (i) 85% of the closing price per share of common
stock on the commencement of the offering, or (ii) 85% of the closing price of a
share of common stock on the
44
<PAGE>
termination of the offering. Each offering is for a period of approximately six
months. The percentage of employees participating in the plan were 21%, 29% and
39% in 1997, 1996 and 1995, respectively. Under the Purchase Plan, the Company
issued 339,165 shares at an average price of $.74 in 1997, 394,654 shares at a
weighted average price of $1.52 in 1996, and 422,734 shares at a weighted
average price of $1.75 in 1995. Pro forma compensation cost is recognized for
the fair value of the employees' purchase rights, which was estimated using the
Black-Scholes model with the following assumptions for 1997, 1996 and 1995,
respectively: dividend yield of 0 percent; expected life of six months; expected
volatility of 127.7%, 104.9%, and 104.9%; and risk-free interest rate of 5.0%,
5.2% and 5.2%. For 1997, 1996 and 1995, the pro forma compensation costs under
the Purchase Plan were $152,000, $270,000 and $337,000, respectively.
L. SEGMENT INFORMATION
The Company operates in a single industry segment which includes developing,
manufacturing, marketing, installing and servicing business information
processing systems, principally in the United States, Europe, the Far East, and
Canada. In 1997, 1996, and 1995, no single customer accounted for as much as 10%
of revenues. During 1997, 1996 and 1995 approximately 21%, 22% and 24%,
respectively, of its revenues were directly or indirectly derived from U.S.
Government agencies.
45
<PAGE>
The Company maintains operations in Europe and Canada principally through
consolidated subsidiaries. Far East operations are through distributors
throughout the region and until December 5, 1997, a joint venture in Japan.
Information about the Company's operations for 1995, 1996, and 1997 is presented
below (in thousands). Inter-geographic net sales, operating income and assets
have been eliminated to arrive at the consolidated amounts.
<TABLE>
<CAPTION>
NET SALES INTER- OPERATING
TO UNRELATED GEOGRAPHIC TOTAL INCOME IDENTIFIABLE
ENTITIES NET SALES NET SALES (LOSS) ASSETS
------------ ----------- --------- --------- -------------
<C> <S> <S> <S> <S> <S>
1995:
United States $ 24,051 $ 7,893 $ 31,944 $(78,767) $ 55,488
Europe 23,721 -- 23,721 1,165 18,030
Other 1,556 -- 1,556 69 189
-------- -------- -------- -------- --------
Geographic Total 49,328 7,893 57,221 (77,533) 73,707
Inter-Geographic -- (7,893) (7,893) (263) (1,170)
-------- -------- -------- -------- --------
Total $ 49,328 $ -- $ 49,328 $(77,796) $ 72,537
======== ======== ======== ======== ========
1996:
United States $ 19,300 $ 12,026 $ 31,326 $(65,502) $ 46,734
Europe 26,616 -- 26,616 (968) 24,258
Other 1,711 -- 1,711 (79) 103
-------- -------- -------- -------- --------
Geographic Total 47,627 12,026 59,653 (66,549) 71,095
Inter-Geographic -- (12,026) (12,026) (669) (1,839)
-------- -------- -------- -------- --------
Total $ 47,627 $ -- $ 47,627 $(67,218) $ 69,256
======== ======== ======== ======== ========
1997:
United States $ 14,832 $ (1,193) $ 13,639 $(67,332) $ 27,909
Europe 14,219 -- 14,219 (10,381) 9,563
Other 435 -- 435 (484) 173
-------- -------- -------- -------- --------
Geographic Total 29,486 (1,193) 28,293 (78,197) 37,645
Inter-Geographic -- 1,193 1,193 1,669 (194)
-------- -------- -------- -------- --------
Total $ 29,486 $ -- $ 29,486 $(76,528) $ 37,451
======== ======== ======== ======== ========
</TABLE>
Inter-geographic net sales are recorded principally at 60% of list price;
however, inter-geographic net sales of the Company's storage processor product
line are recorded at 85% of end selling price. Identifiable assets are all
assets, including corporate assets, identified with operations in each region.
M. FINANCIAL INSTRUMENTS
CONCENTRATIONS OF CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk are limited to cash and trade receivables. The Company maintains its
cash in bank deposit accounts which, at times, may exceed federally insured
limits. The Company has not experienced any losses in such accounts.
The Company grants credit terms in the normal course of business to its
customers which are consistent with industry practices. Generally, the Company's
customers are United States government agencies or substantial international
corporations often included among the Fortune 500.
46
<PAGE>
Additionally, as part of its ongoing control procedures, the Company monitors
the credit worthiness of its major customers and establishes individual customer
credit limits accordingly. The Company performs in-depth credit evaluations for
all new customers and requires letters of credit if deemed necessary. Doubtful
accounts are adequately reserved when identified and bad debts realized by the
Company in prior years have not been excessive, except in relation to the
cancellation of the Amdahl Reseller Agreement discussed more fully in Note C of
Notes to Consolidated Financial Statements.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of cash, cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate fair value because of the short
maturity of these items.
N. SUBSEQUENT EVENTS
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 with Gores Technology
Group to sell the assets of the Company's Real-Time business for approximately
$5.5 million. The transaction is 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 set forth in such
agreement, including Encore shareholder approval.
If the sale of the real-time business is consummated, it is anticipated that the
Company will be liquidated. Gould Electronics Inc. owns 48.44% of the Company's
outstanding common stock and has agreed to waive its right 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, provided the full $35 million due to Gould in connection with the Sun
Transaction ("Second Payment") is received by July 31, 1998.
The assets of the Company available for distribution to shareholder on
liquidation would be (i) the Company's assets, plus the Second Payment net of
any set off, less its liabilities, at December 31, 1997, plus or minus (ii) the
Company's net positive or negative cash flow between January 1, 1998 and the
date of the liquidation (including any amount by which the severance and other
costs related to the sale of the storage products business paid after December
31, 1997 are greater or less than the estimated amount reflected on the
Company's December 31, 1997 balance sheet), minus (iii) the termination charge
of $743,500 related to the Board's decision to discontinue efforts to develop
clustering software in a Windows NT environment, plus or minus (iv) the gain or
loss from the sale of the Company's real time computer systems business, minus
(v) costs of the liquidation and reserves for any contingent liabilities,
including any pending litigation.
O. GOING CONCERN
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As of December 31, 1997, the
Company has a net capital deficiency and a working capital deficiency. If Sun
does not make the Second Payment in full, the Company will be obligated to pay
the difference to Gould, and may not be able to satisfy its obligations.
Management feels that any set off to the Second Payment will not be material,
based on all current information, and intends to make all efforts to collect the
Second Payment in its entirety. However, the ultimate resolution of these
matters is presently not determined. The consolidated financial statements do
not include any adjustments that might result from the outcome of these
uncertainties.
47
<PAGE>
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
Not Applicable.
48
<PAGE>
PART IV
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A)1. AND (A)2. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
FORM 10-K PAGE NUMBER
--------- -----------
Report of independent public accountants relating to
consolidated financial statements and financial
statement schedule 23
Consolidated statements of operations for the years
ended December 31, 1997, 1996 and 1995 24
Consolidated balance sheets at December 31, 1997 and
1996 25
Consolidated statements of cash flows for the years
ended December 31, 1997, 1996 and 1995 26
Consolidated statements of shareholders' equity
(capital deficiency) for the years ended December 31,
1997, 1996, and 1995 28
Notes to consolidated financial statements 29-46
The following consolidated financial statement schedule are submitted herewith:
FORM 10-K PAGE NUMBER
- --------- -----------
Valuation and qualifying accounts 50
The consolidated financial statement schedule should be read in conjunction with
the consolidated financial statements included herein. All other schedules have
been omitted since the required information is not present or is not present in
amounts sufficient to require submission of the schedule, or because the
information required is included in the consolidated financial statements and
notes thereto.
49
<PAGE>
(A)3. INDEX TO EXHIBITS
The exhibits listed on the accompanying index to exhibits immediately following
the signature page are incorporated herein by reference.
(B) REPORTS ON FORM 8-K
During the quarter ended December 31, 1997, the Company filed a report on Form
8-K in connection with the sale of substantially all of the assets associated
with its storage products business.
For purposes of complying with the amendments to the rules governing Form S-8
under the Securities Act of 1933, the undersigned registrant hereby undertakes
as follows, which undertaking shall be incorporated by reference into the
Registrant's Registration Statements on Form S-8 Nos. 33-34171 and 33-33907.
Insofar as indemnification of liabilities arising under the Securities Act of
1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by the appropriate
jurisdiction, litigate the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the final
adjudication of such issue.
50
<PAGE>
<TABLE>
<CAPTION>
Schedule II
ENCORE COMPUTER CORPORATION
Valuation and qualifying accounts
(in thousands)
ADDITIONS
BALANCE AT ------------------------------------ BALANCE AT
BEGINNING OF CHARGED TO COSTS CHARGED TO OTHER END OF
PERIOD AND EXPENSES ACCOUNTS DEDUCTIONS (1) PERIOD
------------ ---------------- ---------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1995:
Allowance for doubtful accounts $5,017 $2,735 $ -- $(5,954) $1,798
Year ended December 31, 1996:
Allowance for doubtful accounts $1,798 $ (550) $ -- $ (634) $ 614
Year ended December 31, 1997:
Allowance for doubtful accounts $ 614 $ 149 $ -- $ (82) $ 681
<FN>
- ----------
(1) Includes amounts deemed uncollectible
</FN>
</TABLE>
<PAGE>
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 as the chief accounting officer and an officer of the registrant
thereunto duly authorized.
ENCORE COMPUTER CORPORATION
(Registrant)
By: /s/ KENNETH G. FISHER By: /s/ LINDA J. MATTHEWS
----------------------- ------------------------
Kenneth G. Fisher Linda J. Matthews
Chairman of the Board Corporate Controller
Chief Executive Officer
April 20, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ KENNETH G. FISHER Chairman of the Board
- -------------------------- Chief Executive Officer April 20, 1998
Kenneth G. Fisher
/s/ ROWLAND H. THOMAS, JR President and Chief
- -------------------------- Operating Officer and
Rowland H. Thomas, Jr. Director April 20, 1998
/s/ C. DAVID FERGUSON
- -------------------------
C. David Ferguson Director April 20, 1998
/s/ ROBERT J. FEDOR
- -------------------------
Robert J. Fedor Director April 20, 1998
/s/ THOMAS N. RICH
- -------------------------
Thomas N. Rich Director April 20, 1998
/s/ MICHAEL C. VEYSEY
- --------------------------
Michael C. Veysey Director April 20, 1998
51
<PAGE>
(a)3. Index to Exhibits.
The exhibit numbers in the following index correspond to the
numbers assigned to such exhibits in the Exhibit Table of
Item 601 of Regulation S-K.
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Asset Purchase Agreement dated as of July 17,1997 among the
registrant, Encore Computer U.S., Inc., Encore Computer
International, Inc., Sun Microsystems, Inc. and Sun Microsystems
International, B.V. (without exhibits), and the Modification
Agreement thereto dated as of November 24, 1997 (incorporated
herein by reference to the Company's Form 8-K dated December 9,
1997).
2.2 Technology License Agreement entered into between the registrant
and Sun (incorporated herein by reference to the Company's Form 8-K
dated December 9, 1997).
2.3 The respective Inducement Agreements entered into by Gould and its
affiliates with Sun, and the Gould Modification Agreement among
such parties (incorporated herein by reference to the Company's
Form 8-K dated December 9, 1997).
3.1 Certificate of Incorporation of the Company, as amended
(incorporated herein by reference to the Company's Form 10-K for
the year ended December 31, 1990)
3.1a Amendment to the Certificate of Incorporation filed with the
Delaware Secretary of State on March 26, 1992 (incorporated herein
by reference to Exhibit 3.1a to the Company's Form 10-K for the
year ended December 31, 1991).
3.2 By-laws of the Company, as amended (incorporated herein by
reference to Exhibit 3.2 to the Company's Form l0-K for the year
ended December 31, 1989).
3.3 Amendment to the Certificate of Incorporation dated September 30,
1993 increasing the number of authorized common shares from
120,000,000 to 150,000,000 (incorporated herein by reference to
Exhibit 3.3 to the Company's Form l0-K for the year ended December
31, 1993).
3.4 Amendment to the Certificate of Incorporation dated August 8, 1995
increasing the number of authorized common shares from 150,000,000
to 200,000,000.
3.5 Certificate of Designations, Powers Rights and Preferences of
Series G Convertible Preferred Stock of Encore Computer Corporation
(incorporated herein by reference to Exhibit 3.1 to the Company's
Form l0-Q for the period ended October 1, 1995).
3.6 Certificate of Designations, Powers Rights and Preferences of
Series H Convertible Preferred Stock of Encore Computer Corporation
(incorporated herein by reference to Exhibit 3.1 to the Company's
Form 10Q for the period ended June 30, 1996).
3.7 Certificate of Designations, Powers Rights and Preferences of
Series I Convertible Preferred Stock of Encore Computer
Corporation.
3.8 Certificate of Designations, Powers Rights and Preferences of
Series J Convertible Preferred Stock of Encore Computer
Corporation.
4.1 Articles NINTH and TENTH of the Certificate of Incorporation of the
Company, as amended, and Certificates of Stock Designation
relating, respectively, to the Company's Series A Convertible
Participating Preferred Stock, Series B Convertible Preferred Stock
and Series C Redeemable Preferred Stock (see Exhibit 3.1).
Incorporated herein by reference to the Company's Form 10-K for the
year ended December 31,1990.
52
<PAGE>
4.2 Article 1 of the By-laws of the Company, as amended (incorporated
herein by reference to Exhibit 3.2 to the Company's Form 10-K for
the year ended December 31,1989).
4.3 Certificate of Stock Designation relating to the Company's Series D
Convertible Preferred Stock (incorporated herein by reference to
Exhibit 4.3 to the Company's Form 10-K for the year ended December
31,1992).
4.4 Certificate of Stock Designation relating to the Company's Series E
Convertible Preferred Stock (incorporated herein by reference to
Exhibit 4.4 to the Company's Form l0-K for the year ended December
31, 1993).
4.5 Certificate of Stock Designation relating to the Company's Series F
Convertible Preferred Stock
#10.1 The Company's 1983 Incentive Stock Option Plan, as amended
(incorporated herein by reference to the Company's Form S-8/Form
S-3 Registration Statement No. 33-34171).
#10.2 The Company's 1985 Non-Qualified Stock Option Plan, as amended
(incorporated herein by reference to the Company's Form S-8/Form
S-3 Registration Statement No. 33-34171).
#10.3 The Company's 1990 Employee Stock Purchase Plan as amended
(incorporated herein by reference to the Company's Form S-8/Form
S-3 Registration Statement No. 33-72458).
#10.4 Form of Indemnification Agreement between the Company and its
executive officers (incorporated herein by reference to Exhibit
10.4 to the Company's Form 10-K for the year ended December 31,
1989).
10.5 Master Purchase Agreement dated as of February 3, 1994 between the
Company and Gould Electronics Inc. (incorporated herein by
reference to Exhibit 10.7b to the Company's Form l0-K for the year
ended December 31, 1993).
10.6 Intellectual Property License Agreement dated as of January 28,
1991, among the Company, Encore Computer U.S., Inc. ("Encore U.S.")
and Gould Inc. (incorporated herein by reference to Exhibit 10.9 of
the Company's Form 10-K for the year ended December 31, 1990).
10.7a The Amended and Restated Revolving Loan Agreement dated March 31,
1992 between Encore Computer Corporation and Gould Inc.
(incorporated herein by reference to the Company's Form 10-K
Exhibit 10.13c for the year ended December 31, 1991).
10.7b The Second Amended and Restated Revolving Loan Note dated March 31,
1992 between Encore Computer Corporation and Gould Inc.
(incorporated herein by reference to the Company's Form 10-K
Exhibit 10.13d for the year ended December 31, 1991).
10.7c The Renewal Term Notes dated March 31, 1992 between Encore Computer
Corporation and Gould Inc. (incorporated herein by reference to the
53
<PAGE>
Company's Form 10-K Exhibit 10.13e for the year ended December 31,
1991).
10.7d Amendment Agreement to the Revolving Loan Agreement among the
Company and Gould Inc. and the Term Loan Agreement among the
Company and Gould Inc. dated April 12, 1993 (incorporated herein by
reference to Exhibit 10.9d to the Company's Form 10-K for the year
ended December 31, 1992).
10.7e Amended Loan Agreement and related letter agreement dated April 11,
1994 between the Company and Gould Electronics Inc. (incorporated
herein by reference to Exhibit 10.13g to the Company's Form l0-K
for the year ended December 31, 1993).
10.8 Amended and Restated General Security Agreement dated as of January
28, 1991, among the Company, Encore U.S. and Gould Inc.
(incorporated herein by reference to the Company's Form 10-K
Exhibit 10.14 for the year ended December 31,1990).
10.9 Support Services Provider Agreement dated December 9, 1993 between
Encore Computer Corporation and Halifax Corporation to subcontract
certain customer service field maintenance activities to Halifax
Corporation (incorporated herein by reference to Exhibit 10.17 to
the Company's Form l0-K for the year ended December 31, 1993).
#10.10 Amendment No. 1 to Nonqualified Stock Option Agreement between
Encore Computer Corporation and T. Mark. Morley dated November 10,
1993 (incorporated herein by reference to Exhibit 10.18 to the
Company's Form l0-K for the year ended December 31, 1993).
#10.11 Description of the Company's Corporate Executive Compensation Plan
(incorporated herein by reference to Exhibit 10.19 to the Company's
Form l0-K for the year ended December 31, 1993).
10.13 The Uncommitted Loan Agreement and certain exhibits thereto dated
as of December 21, 1994 between Encore Computer Corporation and
Gould Electronics Inc. (incorporated herein by reference to Exhibit
10.13 to the Company's Form l0-K for the year ended December 31,
1994).
10.14 The Amended and Restated Credit Agreement dated as of March 17,
1995 between Encore Computer Corporation and Gould Electronics Inc.
(incorporated herein by reference to Exhibit 10.14 to the Company's
Form l0-K for the year ended December 31, 1994).
10.15 Master Purchase Agreement dated as of March 17, 1995 between the
Company and Gould Electronics Inc. relating to the purchase of
Series F Convertible Preferred Stock, Cancellation of Indebtedness
and Related Documentation (incorporated herein by reference to
Exhibit 10.15 to the Company's Form l0-K for the year ended
December 31, 1994).
54
<PAGE>
10.16 The Second Amended and Restated Credit Agreement dated as of August
17, 1995 between Encore Computer Corporation and Gould Electronics
Inc. (incorporated herein by reference to Exhibit 10.1 to the
Company's Form l0-Q for the period ended October 1, 1995).
10.17 Certificate. Reference made to the Master Purchase Agreement dated
as of August 17, 1995 between the Company and Gould Electronics
Inc. relating to the purchase of Series G Convertible Preferred
Stock, Cancellation of Indebtedness and Related Documents
(incorporated herein by reference to Exhibit 10.2 to the Company's
Form l0- Q for the period ended October 1, 1995).
#10.18 The Company's 1985 Non-Qualified Stock Option Plan and 1995 Long
Term Performance Plan, as amended (incorporated herein by reference
to the Company's Form S-8/Form S-3 Registrations Statement No. 33-
72741).
10.19 The Third Amended and Restated Credit Agreement dated as of April
16, 1996 between Encore Computer Corporation and Gould Electronics
Inc. (incorporated herein by reference to Exhibit 10.1 to the
Company's Form l0-Q for the period ended June 30, 1996).
10.20 Certificate. Reference made to the Master Purchase Agreement dated
as of August 17, 1995 between the Company and Gould Electronics
Inc. relating to the purchase of Series H Convertible Preferred
Stock, Cancellation of Indebtedness and Related Documents
(incorporated herein by reference to Exhibit 10.2 to the Company's
Form l0- Q for the period ended June 30, 1996).
10.21 Certificate. Reference made to the Master Purchase Agreement dated
as of March 19, 1997 between the Company and Gould Electronics Inc.
relating to the purchase of Series I Convertible Preferred Stock,
Cancellation of Indebtedness and Related Documents.
*22.0 Subsidiaries of the Company.
*23.1 Consent of Independent Public Accountants.
*27 Financial Data Schedule
99 Cautionary Statement for the Purposes of the "Safe Harbor"
Provisions of the Private Securities Litigation Reform Act of 1995
(incorporated herein by reference to Exhibit 99 to the Company's
Form l0-Q for the period ended June 30, 1996).
# Management contract or compensatory plan or arrangement
* Filed herewith.
55
<PAGE>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
22.0 Subsidiaries of the Company.
23.1 Consent of Independent Public Accountants.
27 Financial Data Schedule
EXHIBIT 22
SUBSIDIARIES OF ENCORE COMPUTER CORPORATION
NAME JURISDICTION OWNERSHIP
- ---- ------------ ---------
ENCORE COMPUTER U.S., INC DELAWARE 100%
ENCORE COMPUTER INTERNATIONAL, INC. DELAWARE 100%
ENCORE COMPUTER LIMITEE CANADA 100%
ENCORE COMPUTER (U.K.) LIMITED UNITED KINGDOM 100%
ENCORE COMPUTER BELGIUM S.A. BELGIUM 100%
ENCORE COMPUTER GmbH GERMANY 100%
ENCORE COMPUTER de PUERTO RICO, INC. DELAWARE 100%
ENCORE COMPUTER S.A. FRANCE 100%
ENCORE COMPUTER (IRELAND) LIMITED IRELAND 100%
ENCORE COMPUTER ITALIA S.p.A. ITALY 100%
JAPAN ENCORE COMPUTER JAPAN 50%
ENCORE COMPUTER B.V. NETHERLANDS 100%
ENCORE COMPUTER NETHERLANDS, B.V. NETHERLANDS 100%
ENCORE COMPUTER ESPANA S.A. SPAIN 100%
ENCORE COMPUTER (IRISH PARTNERSHIP) IRELAND 50%
LAUDERDALE COMPUTER A.B. SWEDEN 100%
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Encore Computer Corporation on Forms S-8 (Registration Statement Nos. 33-10225,
33-33907, 33-34171, 33-72458 and 33-72741) and on Forms S-3 (Registration
Statement Nos. 33-121, 33-33907 and 33-34171) of our report dated March 17,
1998, on our audits of the consolidated financial statements and financial
statement schedule of Encore Computer Corporation as of December 31, 1997 and
1996 and for the years ended December 31, 1997, 1996 and 1995, which report is
included in this Annual Report on Form 10-K.
COOPERS & LYBRAND L.L.P.
Miami, Florida
April 20, 1998
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