UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 29, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _______.
Commission File No. 0-13576
ENCORE COMPUTER CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 04-2789167
(State of Incorporation) (I.R.S. Employer Identification No.)
6901 West Sunrise Blvd.
Fort Lauderdale, Florida 33313
(Address of Principal Executive Offices) (Zip Code)
Telephone: 954-316-4400
Securities registered pursuant to Section 12(g) of the Act:
Title of each class
Common Stock, par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. [X] Yes [ ] No
The number of shares outstanding of the registrant's only class of Common Stock
as of May 13, 1998 was 67,447,309.
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ENCORE COMPUTER CORPORATION
Index
Page
Part I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements 3
Notes to Condensed Consolidated
Financial Statements 8
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
Part II OTHER INFORMATION 21
Signature Page 22
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ENCORE COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(IN THOUSANDS EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
-----------------------
MARCH 29, MARCH 30,
1998 1997
--------- ---------
Net sales:
Equipment $1,543 $ 4,183
Service 3,179 4,150
------ --------
Total 4,722 8,333
------ --------
Costs and expenses:
Cost of equipment sales 590 7,176
Cost of service sales 1,972 4,269
Research and development 416 7,269
Sales, general and administrative 1,652 7,638
Termination charge 744 -
------ --------
Total 5,374 26,352
------ --------
Operating loss (652) (18,019)
Interest expense, principally
related parties in 1997 (12) (1,399)
Interest income 226 29
Other expense, net (324) (663)
------ --------
Loss before income taxes (762) (20,052)
Provision for income taxes 4 (29)
------ --------
Net loss $ (766) $(20,023)
====== ========
Net loss per common share:
Net loss attributable to common
shareholders $ (766) $(26,883)
====== ========
Basic and diluted loss per common share $(0.01) $ (0.72)
====== ========
Weighted average shares
of common stock 67,447 37,276
====== ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA)
(UNAUDITED)
MARCH 29, DECEMBER 31,
1998 1997
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,453 $ 14,544
Restricted cash 5,438 14,083
Accounts receivable, less allowance 5,622 5,752
Inventories (Note E) 114 246
Prepaid expenses and other current assets 747 855
--------- ---------
Total current assets 27,374 35,480
Property and equipment, net 937 1,063
Other assets 542 908
--------- ---------
Total assets $ 28,853 $ 37,451
========= =========
LIABILITIES AND CAPITAL DEFICIENCY
Current liabilities:
Accounts payable and accrued liabilities (Note F) $ 14,265 $ 22,097
Due to Gould Electronics (Note B) 35,000 35,000
--------- ---------
Total current liabilities 49,265 57,097
Capital deficiency:
Common stock, $.01 par value;
authorized 200,000,000 shares; issued
67,447,309 and 37,298,306 in 1998 and
1997, respectively 674 674
Additional paid-in capital 427,012 427,012
Accumulated deficit (448,098) (447,332)
--------- ---------
Total capital deficiency (20,412) (19,646)
--------- ---------
Total liabilities and capital deficiency $ 28,853 $ 37,451
========= =========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(IN THOUSANDS)
THREE MONTHS ENDED
-----------------------
MARCH 29, MARCH 30,
1998 1997
--------- ---------
Cash flows from operating activities:
Net loss $ (766) $(20,023)
Adjustments to arrive at net cash used in
operating activities:
Depreciation and amortization 190 2,043
Termination charges 744 -
Net changes in operating assets and liabilities:
Accounts receivable 130 4,732
Inventories 132 1,796
Prepaid expenses and other current assets 108 619
Other assets 306 (5)
Accounts payable and accrued liabilities (8,576) 1,823
Other liabilities - (29)
------- --------
Net cash used in operating activities (7,732) (9,044)
------- --------
Cash flows from investing activities:
Additions to property and equipment (4) (725)
------- --------
Cash flows from financing activities:
Net borrowings under revolving loan
agreements - 10,857
Principal payments of long term debt - (46)
Issuance of common stock - 28
------- --------
Net cash provided by financing activities - 10,839
------- --------
Increase (decrease) in cash and cash equivalents (7,736) 1,070
Decrease in restricted cash 8,645
------- --------
909 1,070
Cash and cash equivalents, beginning 14,544 3,936
------- --------
Cash and cash equivalents, ending $15,453 $ 5,006
======= ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental disclosure of cash flow information (in thousands):
THREE MONTHS ENDED
-----------------------
MARCH 29, MARCH 30,
1998 1997
--------- ---------
Cash paid during the period for interest $ 12 $ 29
Cash paid during the period for income taxes $819 $ 485
Non-cash investing and financing activities:
Indebtedness exchanged for preferred stock $ - $40,000
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
CONDENSED STATEMENTS OF CAPITAL DEFICIENCY
(unaudited)
(IN THOUSANDS EXCEPT SHARE DATA)
COMMON STOCK
------------------ ADDITIONAL
PAR PAID-IN ACCUMULATED CAPITAL
SHARES VALUE CAPITAL DEFICIT DEFICIENCY
---------- ----- ---------- ----------- ----------
Balance December 31, 1997 67,447,309 $674 $427,012 $(447,332) $(19,646)
Net loss (766) (766)
---------- ---- -------- --------- --------
Balance March 29, 1998 67,447,309 $674 $427,012 $(448,098) $(20,412)
========== ==== ======== ========= ========
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND OTHER MATTERS
The accompanying condensed consolidated financial statements are unaudited and
have been prepared by Encore Computer Corporation ("Encore" or the "Company") in
accordance with generally accepted accounting principles. Certain information
and footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted. It is suggested that these
condensed consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 1997.
The condensed consolidated financial statements, in the opinion of the Company,
reflect all adjustments (including normal recurring accruals) necessary for a
fair statement of the results for the interim periods. All adjustments made
during the interim periods are normal recurring adjustments. The year-end
condensed balance sheet data is derived from audited financial statements but
does not include all disclosures required by generally accepted accounting
principles. Certain reclassifications have been made to conform prior period
data to current period presentation.
The results of operations for the interim periods are not necessarily indicative
of the results of operations for the fiscal years.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130
established standards of 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 has no impact on the Company's financial statements.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 established standards
for public business enterprises to report information about operating segments
in annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes the standards for related disclosures about
products and services, geographic areas, and major customers. SFAS 131 requires
a public business enterprise report financial and descriptive information about
its reportable operating segments. The financial information is required to be
reported on the basis that it is used internally for evaluation segment
performance and deciding how toallocate resources to segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. SFAS 131 is effective for financial statements for periods
beginning after December 15, 1997. Management does not believe that the
requirements of SFAS 131 will have a material impact on the Company's financial
statements.
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BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As of March 29,
1998, 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.
EARNINGS PER SHARE
Basic earnings per common share calculations are determined by dividing earnings
available to common shareholders by the weighted average number of shares of
common stock outstanding during the year. Diluted earnings per common share
calculations are determined by dividing earnings available to common
shareholders by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding. Basic and diluted earnings per
share were the same for all periods presented because the effect of common stock
equivalents would be anti-dilutive.
Net loss per common share was determined by dividing the net loss, as adjusted,
by applicable shares outstanding. The loss was adjusted by the aggregate amount
of dividends on the Company's preferred stock. Preferred stock dividends
amounted to $0 and $6,859,600 for the three month periods ended March 29, 1998
and March 30, 1997, respectively. Based on capital deficiencies, the Company was
precluded from paying dividends on its preferred stock outstanding. Accordingly,
the Company accumulated preferred stock dividends since July 15, 1996. All
preferred stock dividends other than those accumulated at March 29, 1998 have
been paid in additional shares of the appropriate class of preferred stock.
B. ASSET PURCHASE AGREEMENT WITH SUN MICROSYSTEMS
On November 24, 1997 (the "Closing"), pursuant to an Asset Purchase Agreement
dated as of July 17, 1997 (the "Agreement"), the Company sold substantially all
of the assets associated with its storage products business to Sun. The
Agreement had contemplated that the aggregate consideration to be paid to the
Company by Sun for such assets was to be $185,000,000, of which $150,000,000 in
cash was to be paid at the closing (the "Closing Payment") and $35,000,000 was
to be payable on July 1, 1998 (the "Second Payment"). Pursuant to the terms of a
Modification Agreement, dated as of November 24, 1997, among Encore and Sun, the
parties agreed that the final amount of the Closing Payment would be reduced to
$149,882,683 to reflect that Sun was assuming certain liabilities of certain
non-U.S. subsidiaries of the Company in the amount of $117,317, which Sun had
not previously agreed to assume under the terms of the Agreement. In addition,
the parties further agreed that Sun was to pay an additional amount of
$1,285,544 to Encore for the purchase by Sun of certain finished storage product
units, as contemplated by the terms of the Agreement. Thus, the aggregate amount
paid by Sun to Encore at the Closing was $151,168,227 (the "Total Cash Closing
Payment"), which was paid by Sun to Encore as follows: (i) at the Company's
request, $118,550,972.57 was paid to Gould Electronics Inc. ("Gould"), which
represented payment by Encore to Gould for (I) the aggregate amount of
outstanding principal amount of indebtedness, and accrued interest thereon, owed
by the Company to Gould and (II) a portion of the cost of redeeming Encore's
outstanding Preferred Stock, all of which was then owned by Gould and an
affiliate of Gould, pursuant to an agreement dated July 17, 1997 between the
Company and Gould (the "Gould 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
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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. In light of the
uncertainties about the amount which will be received with regard to the Second
Payment, the Company has not recorded the Second Payment as an asset and will
not do so until the amount that will be paid can be ascertained with reasonable
certainty. Because the Company is required to make the $35 million payment to
Gould to the extent the Second Payment is less than that amount, the decision to
defer recognition of the Second Payment as an asset has resulted in the
Company's carrying the entire $35 million obligation to Gould as a liability
without an offsetting asset. 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.
In connection with the sale of the storage products business to Sun, the Company
charged to operations a termination charge of $17,685,000 related to: (i)
severance and benefit pay of $6,323,000 as a result of a 542 person reduction in
workforce, including severance for employees contracted by Sun, as the Company
agreed to pay the difference between the completion bonus offered to contractors
by Sun at the end of their contract and the amount of severance they were
entitled to had they been terminated by the Company; (ii) $4,722,000 of
retention payments pursuant to written agreements between the Company and each
of approximately 49 employees; (iii) $1,000,000 of incentive bonuses to certain
key employees; (iv) $3,390,000 relating to the termination of European facility
and automobile leases, and $350,000 relating to a domestic equipment lease; (v)
an estimated $500,000 for leasehold improvements to be made at the Company's
Fort Lauderdale facility which is leased from Sun; (vi) $1,150,000 in estima ted
legal and other fees associated with the Sun Transaction; and (vii) $250,000
accrued for legal fees in connection with pending legal action brought by
certain shareholders in connection with the Sun Transaction (the "Shareholders
Suit").
In connection with the Agreement and for a one-year period following the
Closing, Gould has agreed to take all actions necessary to ensure that Encore
remains solvent. In addition, Gould and certain of its affiliates have agreed,
among other things, that, if within two years following the Closing, the Company
commences an insolvency proceeding and the Sun
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Transaction is challenged in that proceeding, that Gould and such affiliates
will indemnify Sun for losses arising therefrom.
Restricted cash of $5,438,000 and $14,083,000 at March 29, 1998 and December 31,
1997, respectively, 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 escrow agreement.
C. TERMINATION CHARGES
When the Company completed the sale of its storage products business, the Board
of Directors decided the Company should, at least until the Board's January 1998
meeting, (a) explore the possibility of attempting to develop and market
clustering software in a Windows NT environment for various types of computer
hardware, and (b) explore the feasibility of continuing, and attempting to
expand, its real time computer systems business. In January 1998, the Board of
Directors (i) decided the Company should discontinue its efforts to develop
clustering technology in a Windows NT environment for various types of computer
hardware resulting in a termination charge of $743,500, and (ii) authorized the
Company to retain an investment banker to explore strategic options with respect
to the real time business.
D. LETTER OF INTENT WITH GORES TECHNOLOGY GROUP
On March 2, 1998, the Company signed a letter of intent with Gores Technology
Group to sell the assets of the Company's real-time business for approximately
$5.5 million. The transaction was subject to the satisfactory completion of due
diligence by Gores, the negotiation and execution of a definitive asset purchase
agreement and the satisfaction of any closing conditions.
On June 3, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire substantially all of the Company's assets, other than cash, and assume
substantially all of its liabilities related to the real-time business. The
purchase price is $3 million in cash, all of which would be paid at closing. The
price reflects changes to the balance sheet of the real-time business since the
projected 12/31/97 balance sheet which was the basis for the price set forth in
the letter of intent. Gould Electronics Inc., the Company's principal
shareholder, will be jointly and severally liable with the Company for
indemnification obligations to Gores under the agreement. Encore's real-time
business in France is expected to be addressed separately in an agreement to be
negotiated locally with Gores.
Pending the closing, Gores will operate the real-time business, retaining any
positive cash flow and bearing any negative cash flow, pursuant to a management
contract which will provide for a monthly management fee of $100,000 which will
be fully refunded to Encore on closing. Encore will provide a $2 million line of
credit to Gores to fund the operations of the real-time business until the
closing. The closing is subject to customary conditions, including Encore
shareholder approval.
If the sale of the real-time business is consummated, it is anticipated that the
Company will be liquidated. Gould owns48.44% 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
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prior to November 24, 1999, provided the full Second Payment of $35 million due
to Gould in connection with the Sun Transaction is received by July 31, 1998.
If the sale of the real-time business is consummated, the assets of the Company
available for distribution to shareholders on liquidation would be: (i) the
Company's assets at March 29, 1998 plus the Second Payment net of any set off,
less its liabilities at March 29, 1998 including the $35 million payable to
Gould, plus or minus; (ii) the Company's net positive or negative cash flow
between March 30, 1998 and May 31, 1998 (including any amount by which the
severance and other costs related to the sale of the storage products business
and the discontinuance of the Company's efforts to develop clustering software
in a Windows NT environment, paid after March 29, 1998 are greater or less than
the estimated amount reflected on the Company's March 29, 1998 balance sheet),
plus or minus; (iii) the proceeds from the sale of the Company's real time
computer systems business; minus (iv) costs of the liquidation and reserves for
any contingent liabilities, including any pending litigation.
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E. INVENTORIES
Inventories consist of the following (in thousands):
MARCH 29, DECEMBER 31,
1998 1997
--------- ------------
Purchased Parts $ 35 $174
Work in process 18 -
Finished goods 61 72
---- ----
$114 $246
==== ====
F. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following (in
thousands):
MARCH 29, DECEMBER 31,
1998 1997
--------- ------------
Accounts payable $ 1,216 $ 1,064
Accrued salaries and benefits 2,108 2,355
Accrued restructuring costs 8,070 13,655
Accrued taxes 284 1,048
Deferred income, principally
maintenance contracts 1,116 638
Other accrued expenses 1,471 3,337
------- -------
$14,265 $22,097
======= =======
In the first quarter of 1998, the Company recorded a termination charge of
$743,500 related to severance and benefit pay as a result of a 13 person
reduction in workforce associated with the Board of Directors decision not to
pursue the NT opportunity In addition, in the fourth quarter of 1997, in
conjunction with the Sun Transaction and subsequent reorganization, the Company
recorded a termination charge of $17,685,000 related to: (i) severance and
benefit pay of $6,323,000 as a result of a 542 person reduction in workforce,
including severance for employees contracted by Sun, as the Company agreed to
pay the difference between the completion bonus offered to contractors by Sun at
the end of their contract and the amount of severance they were entitled to had
they been terminated by the Company; (ii) $4,722,000 of retention payments
pursuant to agreements between the Company and each of approximately 49
employees; (iii) $1,000,000 of incentive bonuses to certain key employees; (iv)
$3,390,000 relating to the termination of European facility and automobile
leases, and $350,000 relating to a domestic equipment lease; (v) an estimated
$500,000 for leasehold improvements to be made at the Company's Fort Lauderdale
facility which is leased from Sun; (vi) $1,150,000 in estimated legal and other
fees associated with the Sun Transaction; and (vii) $250,000 accrued for legal
fees in connection with the Shareholders Suit.
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ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 29, 1998
COMPARED TO THE THREE MONTHS ENDED MARCH 30, 1997
The following is management's discussion and analysis of the financial condition
and the results of operations of Encore Computer Corporation ("Encore" or the
"Company") for the three month period ended March 29, 1998 compared to the three
month period ended March 30, 1997. The Company's net losses for the three month
periods ended March 29, 1998 and March 30, 1997 were $766,000 and $20,023,000,
respectively. The decreased loss for the three month period of 1998 compared to
the same period in 1997 is due principally to the sale of the storage products
business to Sun. As discussed in Note B of Notes to Condensed Consolidated
Financial Statements, as a result of the Sun Transaction, the Company reduced
its workforce by 542 employees and discontinued its storage product business.
THE SUN TRANSACTION
On November 24, 1997 (the "Closing"), pursuant to the Agreement, the Company
sold substantially all of the assets associated with its storage products
business to Sun. The Agreement had contemplated that the aggregate consideration
to be paid to the Company by Sun for such assets was to be $185,000,000, of
which $150,000,000 in cash was to be paid at the closing (the "Closing Payment")
and $35,000,000 was to be payable on July 1, 1998 (the "Second Payment").
Pursuant to the terms of a Modification Agreement, dated as of November 24,
1997, among Encore and Sun, the parties agreed that the final amount of the
Closing Payment would be reduced to $149,882,683 to reflect that Sun was
assuming certain liabilities of certain non-U.S. subsidiaries of the Company in
the amount of $117,317, which Sun had not previously agreed to assume under the
terms of the Agreement. In addition, the parties further agreed that Sun was to
pay an additional amount of $1,285,544 to Encore for the purchase by Sun of
certain finished storage product units, as contemplated by the terms of the
Agreement. Thus, the aggregate amount paid by Sun to Encore at the Closing was
$151,168,227 (the "Total Cash Closing Payment"), which was paid by Sun to Encore
as follows: (i) at the Company's request, $118,550,972.57 was paid to Gould,
which represented payment by Encore to Gould for (I) the aggregate amount of
outstanding principal amount of indebtedness, and accrued interest thereon, owed
by the Company to Gould and (II) a portion of the cost of redeeming Encore's
outstanding Preferred Stock, all of which was then owned by Gould and EFI,
pursuant to an agreement dated July 17, 1997 between the Company and Gould (the
"Gould Agreement"); (ii) at the Company's request, $11,876 was paid in French
Francs to Encore Computer, S.A, a wholly-owned subsidiary of Encore; (iii)
$22,000,000 was paid to First Trust of California, National Association, as
escrow agent, pursuant to the terms of an escrow arrangement between Encore and
Sun; and (iv) the remainder was paid to the Company. The purchase price for the
sale of assets in the Sun Transaction, and the modifications thereto as
described above, were determined as a result of arms-length negotiations between
Encore and Sun.
In connection with the Agreement and for a one-year period following the
Closing, Gould has agreed to take all actions necessary to ensure that Encore
remains solvent. In addition, Gould and certain of its affiliates have agreed,
among other things, that, if within two years following the Closing, the Company
commences an insolvency proceeding and the Sun
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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. In light of the
uncertainties about the amount which will be received with regard to the Second
Payment, the Company has not recorded the Second Payment as an asset and will
not do so until the amount that will be paid can be ascertained with reasonable
certainty. Because the Company is required to make the $35 million payment to
Gould to the extent the Second Payment is less than that amount, the decision to
defer recognition of the Second Payment as an asset has resulted in the
Company's carrying the entire $35 million obligation to Gould as a liability
without an offsetting asset. 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.
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
15
<PAGE>
hardware resulting in a termination charge of $743,500, and (ii) authorized the
Company to retain an investment banker to explore strategic options with respect
to the real time business.
On March 2, 1998, the Company signed a letter of intent to sell its real time
computer systems business to Gores Technology Group. That transaction was
subject to completion by Gores of due diligence and to negotiation and execution
of definitive agreements. Upon the sale of its real time computer systems
business to Gores or to any other purchaser, the Company no longer will have any
business operations. Therefore, 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.
On June 3, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire all of the Company's assets, other than cash, and assume all of its
liabilities related to the real-time business. The purchase price is $3 million
in cash, all of which would be paid at closing. The price reflects changes to
the balance sheet of the real-time business since the preliminary 12/31/97
balance sheet which was the basis for the price set forth in the letter of
intent. Gould Electronics Inc., the Company's principal shareholder, will be
jointly and severally liable with the Company for indemnification obligations to
Gores under the agreement. Encore's real-time business in France is expected to
be addressed separately in an agreement to be negotiated locally with Gores.
Pending the closing, Gores will operate the real-time business, retaining any
positive cash flow and bearing any negative cash flow, pursuant to a management
contract which will provide for a monthly management fee of $100,000 which will
be fully refunded to Encore on closing. Encore will provide a $2 million line of
credit to Gores to fund the operations of the real-time business until the
closing. The closing is subject to customary conditions, including Encore
shareholder aproval.
At March 29, 1998, the Company had total assets of $28,853,000, including
restricted cash of $5,438,000, and cash and cash equivalents of $15,453,000, but
not including any amount for the Second Payment (which is to be $35,000,000, but
is subject to setoffs which could reduce this amount), and had liabilities of
$49,265,000, including $8,070,000 of estimated severance costs and other costs
related to the sale of the Company's storage products business and
discontinuance of its efforts to develop clustering software in a Windows NT
environment, and the $35,000,000 payable to Gould. If the sale of the real-time
business is consummated, the assets of the Company available for distribution to
shareholders on liquidation would be: (i) the Company's assets at March 29, 1998
plus the Second Payment net of any set off, less its liabilities at March 29,
1998 including the $35 million payable to Gould, plus or minus; (ii) the
Company's net positive or negative cash flow between March 30, 1998 and May 31,
1998 (including any amount by which the severance and other costs related to the
sale of the storage products business and the discontinuance of the Company's
efforts to develop clustering software in a Windows NT environment, paid after
March 29, 1998 are greater or less than the estimated amount reflected on the
Company's March 29, 1998 balance sheet), plus or minus; (iii) the proceeds from
the sale of the Company's real time computer systems business; minus (iv) costs
of the liquidation and reserves for any contingent liabilities, including any
pending litigation.
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As of March 29,
1998, 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 not presently determinable.
RESULTS OF OPERATIONS:
16
<PAGE>
Net sales for the three month periods ended March 29, 1998 and March 30, 1997
were $4,722,000 and $8,333,000, respectively. For the three month period ended
March 29, 1998, equipment sales decreased 63% to $1,543,000 when compared to
$4,183,000 for the three month period ended March 30, 1997. Service revenues for
the three month periods ended March 29, 1998 and March 30, 1997 were $3,179,000
and $4,150,000, respectively. Real-time equipment sales for the three month
period ended March 29, 1998 were $1,543,000 compared to $2,949,000 for the same
period in 1997. Storage product equipment sales for the three months ended March
30, 1997 were $1,234,000. The Company had no storage product equipment sales for
the three month period ended March 29, 1998 as a result of the Sun Transaction.
Real-time service revenues were $3,179,000 for the three month period ended
March 29, 1998, compared to $4,150,000 for the same period of 1997. No service
revenues were derived from the storage product business in the first three
months of either 1998 or 1997. The Company's operating loss for the three month
period in 1998 was $652,000 compared to an operating loss of $18,019,000 for the
same period in 1997.
Equipment sales as a percentage of total net sales for the three months ended
March 29, 1998 and March 30, 1997 were 33%, and 50%, respectively. For real-time
equipment sales, the respective percentages were 33%, and 35% of total net sales
in the three month periods ended March 29, 1998 and March 30, 1997,
respectively. Storage product sales for the three months ended March 30, 1997
were 15% of total net sales. The decrease in equipment sales for the three month
period in 1998 is primarily due to certain of the Company's traditional
real-time products having reached the end of their product life cycle.
International equipment sales decreased 37% to $870,000 for the three months
ended March 29, 1998. International real-time product sales decreased 63% to
$870,000 from $2,327,000 for the period ended March 30, 1997. Domestic equipment
sales decreased 76% to $673,000 for the period ended March 29, 1998 compared to
the period ended March 30, 1997, with storage product sales decreasing to $0
from $2,177,000.
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; and (iii) the completion of long running
government programs and subsequent deinstallation of systems. The Company
expects this trend to continue. International service sales decreased 29% to
$1,818,000 for the three month period ended March 29, 1998, while domestic
service sales decreased 14% to $1,361,000 compared to the three month period in
1997. No service sales were derived from the storage product business for the
periods ended March 29, 1998 and March 30, 1997.
International net sales decreased 32% (45% for real-time) for the three month
period ended March 29, 1998 when compared to the same period in 1997. Domestic
net sales decreased 54% (8% for real-time) for the three month period ended
March 29, 1998 when compared to the 1997 three month period. International sales
for the three months ended March 29, 1998 were $2,688,000, or 57% of total net
sales. International real-time net sales for the three months ended March 30,
1997 were $4,888,000, or 59% of total net sales.
Total cost of sales decreased in the three month period ended March 29, 1998 to
$2,562,000 ($2,562,000 for real-time and $0 for storage product), from
$11,445,000 ($7,212,000 for real-time and $4,233,000 for storage product) from
the same period in 1997. The decrease was due generally to lower sales volumes
and lower spending resulting from the Sun Transaction.
Cost of equipment sales for the three month period ended March 29, 1998 were
$590,000 or 12% of net sales. Cost of real-time equipment sales for the three
month period ended March
17
<PAGE>
30, 1997 were $2,943,000 or 35% of net sales. Cost of storage product sales
exceeded storage product sales by $2,999,000 for the three month period ended
March 30, 1997. Gross margins on real-time equipment sales were $953,000 and
$6,000, or 62% and .2% for the three month periods ended March 29, 1998 and
March 30, 1997, respectively. A negative gross margin was generated by the
storage product business of $2,999,000 for the three month period ended March
30, 1997.
Equipment gross margins for the three months ended March 29, 1998 were $953,000
or 62% of equipment sales. Equipment gross margins were negatively impacted for
the same period in 1997 due to the discounting of storage products in order to
penetrate the marketplace and establish reference accounts. Warranty costs
related to the Storage Product in 1997 were also higher than anticipated due to
engineering changes on current installations and spare part inventory. Factory
variances related to lower production volumes and underutilization of
manufacturing capacity also lowered gross margin in the three month period ended
March 30, 1997.
For the three month period ended March 29, 1998, service gross margins were
$1,207,000 compared to a loss of $119,000 for the same period in 1997. For the
three month period in 1997, service margins were reduced for investments in
various programs and infrastructure necessary to support the storage product
line. The Company invested $1,400,000 (34% of service sales) in the three month
period ended March 30, 1997. 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 $1,207,000 (38%), and
$1,281,000 (31%) for the three month periods ended March 29, 1998 and March 30,
1997, respectively.
Research and development expenses for the three month period ended March 29,
1998 were $416,000 compared to $7,269,000 for the same period in 1997. The
decrease in 1998 expenses is primarily the result of the Sun Transaction. Sun
either hired or contracted 147 or 68% of total research and development
personnel. Research and development expenses as a percentage of net sales
decreased to 9% for the three month period in 1998, compared to 87% in 1997.
In December 1997, the Company established a separate research and development
organization to focus on opportunities in the Microsoft NT environment. However,
in January 1998, as more fully discussed in Note C of the Notes to Condensed
Consolidated Financial Statements, the Board of Directors voted not to pursue
the NT opportunity.
Sales, general and administrative ("SG&A") expenses for the three month period
ended March 29, 1998 were $1,652,000 compared to $7,638,000 for the same period
in 1997. The decrease in expenses was due primarily to the Sun Transaction. As a
percentage of net sales, SG&A expenses were 35% and 92% for the three month
periods ended March 29, 1998 and March 30, 1997, 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.
18
<PAGE>
Interest expense decreased in the three month period ended March 29, 1998 to
$12,000 from $1,399,000 in the same period of 1997 due to the repayment of the
Gould debt in connection with the Sun Transaction.
Other expense, net, was lower for the three month period of 1998 than the same
period in 1997 due principally to lower foreign exchange losses and losses on
the sale of certain fixed assets.
Income taxes provided for the three month periods in 1998 and 1997 relate to
operations of foreign subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES:
For the period ended March 29, 1998, the Company reported a net loss of $766,000
compared to a net loss of $20,023,000 for the same three month period of 1997.
Net cash used in operating activities for the first quarter of 1998 was
$7,732,000 compared to $9,044,000 for the same period in 1997. Net income,
adjusted for non cash items was $167,000, as the Company recorded termination
charges of $744,000, and depreciation and amortization of $190,000. Working
capital was reduced as accounts receivable and inventories decreased by $130,000
and $132,000, respectively, offset by accounts payable and accrued liabilities
which decreased by $8,576,000. As of March 29, 1998, total capital deficiency
was $20,412,000 versus $19,646,000 as of December 31, 1997.
Expenditures for property and equipment during the quarters ended March 29, 1998
and March 30, 1997 were $4,000 and $725,000, respectively. The decrease in 1998
spending resulted from management's decision to limit capital expenditures to a
minimum in light of the sale of the storage products business to Sun and the
uncertainty of the continuing real-time business.
There were no financing activities in the first quarter of 1998. Cash was
provided through financing activities of $10,839,000 in the first quarter of
1997. The principal source of financing was through various agreements provided
by the Japan Energy Group, including Gould and other affiliates of Gould. On
March 19, 1997, the Company and Gould agreed to cancel $40,000,000 of
indebtedness owed to Gould under their loan agreement (the "Credit Agreement")
in exchange for the issuance to Gould of 400,000 shares of the Company's Series
I Convertible Preferred Stock ("Series I") with a liquidation preference of
$40,000,000. In addition to the exchange of indebtedness for shares of Series I,
the Company and Gould also agreed to amend the Credit Agreement to: (i) reduce
the maximum amount which could be borrowed by the Company from $80,000,000 to
$50,000,000; and (ii) provide that any borrowings in excess of $41,915,869 (the
principal amount outstanding on March 19, 1997 after giving effect to the
exchange of indebtedness for shares of Series I) may be made only at the
discretion of Gould. At the closing of the Sun Transaction, the Company paid to
Gould $93,551,000 in principal and accrued interest in satisfaction of its
indebtedness to Gould at that date.
Restricted cash of $5,438,000 and $14,083,000 at March 29, 1998 and December 31,
1997, respectively, 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 May 13, 1998,
$1,235,000 in cash remained in escrow. The majority of cash and cash equivalents
at March 29, 1998 consists of cash available to the Company from the total cash
closing payment from the Sun Transaction and cash at various international
subsidiaries.
19
<PAGE>
With minor exceptions, all cash in the international subsidiaries is freely
remittable to the United States.
The Company has signed a letter of intent to sell its real-time business. If the
sale is consummated, it is anticipated that the Company will be liquidated. (See
Note D of Notes to Condensed Consolidated Financial Statements).
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As of March 29,
1998, 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.
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 application of the Company's
customers or suppliers. The Company has initiated communications with a number
of its suppliers to determine the extent to which the Company's interface
systems are vulnerable to those third parties' failure to remediate their own
Year 2000 issues. The Company will continue similar communication with major
customers, and the balance of its major suppliers, during 1998 to receive
appropriate warranties and assurances that those parties are, or will be, Year
2000 compliant. Although the Company currently does not anticipate any material
impact on its operations as a result of Year 2000 issues of its customers or
suppliers, at this stage of its review, no assurance can be given that the
failure by one or more of its major suppliers or customers to become Year 2000
compliant will not have a material adverse impact on its operations.
CAUTIONARY STATEMENT RELATING TO FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial Condition and
Results of Operations contains various "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which represent the
Company's expectations and beliefs concerning future events. The Company
cautions that these statements are further qualified by important factors that
could cause actual results to differ materially from those in the
forward-looking statements, including, without limitation, the following:
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.
20
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Shortly before the Sun Transaction was closed, shareholders of the Company
brought a derivative suit in the Delaware Chancery Court against Gould and the
Company's then directors, C. David Ferguson, Robert Fedor, Rowland Thomas and
Kenneth Fisher. Three similar shareholder suits were also filed and all four
suits have been consolidated as Civil Action #16044, In Re Encore Computer
Corporation Shareholders Litigation. The suit is currently in the discovery
stage. The Company does not believe the shareholder suit will have a significant
financial impact on the Company.
The Company is subject to other legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of the
ultimate liability with respect to these actions will not materially affect the
financial position of the company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits required by Item 601 of Regulation S-K
Exhibit No. 11 - Statement re: computation of per share earnings. See
page 23.
Exhibit No. 27 - Financial Data Schedule. See page 24.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended March 29, 1998.
21
<PAGE>
ENCORE COMPUTER CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
Encore Computer Corporation
--------------------------- --------------------
Date: June 4, 1998 Kenneth G. Fisher Linda J. Matthews
Chairman of the Board Corporate Controller
and Chief Executive Officer
22
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
11 Statement re: corporation of per share earnings.
27 Financial Data Schedule.
EXHIBIT 11
ENCORE COMPUTER CORPORATION
Computation of Loss per Share
- --------------------------------------------------------------------------------
(in thousands except per share data)
THREE MONTHS ENDED
------------------------
March 29, March 30,
Basic 1998 1997
- -------------------------------------- ----------- ----------
Net loss $ (766) $ (20,023)
Series B, D, E, F, G and H accumulated
Preferred Stock Dividends (6,860)
----------- ----------
Net loss attributable to
common shareholders $ (766) $ (26,883)
=========== ==========
Weighted average common
shares outstanding 67,447 37,276
=========== ==========
Basic loss per common share $ (0.01) $ (0.72)
=========== ==========
Diluted
- --------------------------
Net loss $ (766) $ (20,023)
=========== ==========
Weighted average common
shares outstanding 67,447 37,276
Series A assumed converted 7,364
Series B assumed converted 23,392
Series D assumed converted 35,794
Series E assumed converted 36,587
Series F assumed converted 17,120
Series G assumed converted 18,370
Series H assumed converted 11,235
Series I assumed converted 1,659
Exercise of options reduced by the number
of shares purchased with proceeds 2,786
----------- ----------
Weighted average shares outstanding 67,447 191,583
=========== ==========
Diluted loss per common share: $ (0.01) $ (0.72)
=========== ==========
Basic and diluted loss per common share are the same for all periods presented
because the effect of the common stock equivalents would be antidilutive.
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<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-29-1998
<CASH> 15,453
<SECURITIES> 6,337
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<INVENTORY> 114
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<PP&E> 19,622
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<CURRENT-LIABILITIES> 49,265
<BONDS> 674
0
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<TOTAL-REVENUES> 4,722
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