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 September 27, 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 .
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(State of Incorporation) I.R.S. Employer Identification No.)
7786 WILES ROAD
CORAL SPRINGS, FLORIDA 33067 .
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(Address of Principal Executive Offices) (Zip Code)
Telephone: 954-757-0166
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 November 10, 1998 was 67,450,907.
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ENCORE COMPUTER CORPORATION
Index
PAGE
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Part I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements 3
Notes to Condensed Consolidated
Financial Statements 8
Item 2 Management's Discussion and Analysis of Financial
Condition and Results of Operations 16
Part II OTHER INFORMATION 25
Signature Page 26
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<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Operations
(Unaudited)
(in thousands except per share data)
Three Months Ended Nine Months Ended
Sept 27, Sept 28, Sept 27, Sept 28,
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net sales:
Equipment $ 2,321 $ 3,834 $ 5,690 $ 11,428
Service 2,652 3,595 8,886 11,688
4,973 7,429 14,576 23,116
Costs and expenses:
Cost of equipment sales 1,998 4,840 3,697 18,138
Cost of service sales 1,859 3,893 5,961 12,447
Research and development 257 6,455 969 20,876
Sales, General and Admin 2,453 6,743 6,557 21,961
Termination charge 0 0 1,570 0
Total 6,567 21,931 18,754 73,422
Operating loss -1,594 -14,502 -4,178 -50,306
Interest expense, principally
related parties -133 -2,024 -154 -4,778
Interest income 203 33 675 94
Other (expense)/income, net 394 -118 89 -1,281
Gain on Sun Transaction 0 0 25,308 0
Income (loss) before income taxes -1,130 -16,611 21,740 -56,271
Provision for income taxes 596 27 488 194
Net income (loss) $ -1,726 $ -16,638 $ 21,252 $ -56,465
Net income (loss) per
common share:
Net income (loss) attributable
to common shareholders $ -1,726 $ -24,310 $ 21,252 $ -78,259
Basic and diluted income
(loss) per common share $ -0.03 $ -0.65 $ 0.32 $ -2.09
Weighted average shares
of common stock 67,451 37,560 67,449 37,419
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Condensed Consolidated Balance Sheets
(in thousands except share data)
Unaudited
Sept 27, Dec 31,
1998 1997
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 13,240 $ 14,544
Restricted cash 1,285 14,083
Accounts receivable, less allowance 6,514 5,752
Due from Gores 466 0
Inventories (Note E) 823 246
Prepaid expenses and other current assets 854 855
Total current assets 23,182 35,480
Property and equipment, net 670 1,063
Other assets 470 908
Total assets $ 24,322 $ 37,451
LIABILITIES AND SHAREHOLDERS' EQUITY
(CAPITAL DEFICIENCY)
Current liabilities:
Accounts payable and accrued liabilities (Note F) $ 13,024 $ 22,097
Due to Gould Electronics (Note B) 9,692 35,000
Total current liabilities 22,716 57,097
Shareholders' Equity (Capital Deficiency):
Preferred stock, $.01 par value; authorized 10,000,000
shares (Note B):
6% Cumulative Series B Convertible Preferred, issued
64,905 in 1998 with an aggregate liquidation
preference of $6,490,500 1 0
6% Cumulative Series D Convertible Preferred, issued
104,190 in 1998 with an aggregate liquidation
preference of $10,419,000 1 0
6% Cumulative Series E Convertible Preferred, issued
106,501 in 1998 with an aggregate liquidation
preference of $10,650,100 1 0
6% Cumulative Series F Convertible Preferred, issued
49,832 in 1998 with an aggregate liquidation
preference of $4,983,200 0 0
6% Cumulative Series G Convertible Preferred, issued
53,474 in 1998 with an aggregate liquidation
preference of $5,347,400 1 0
6% Cumulative Series H Convertible Preferred, issued
32,702 in 1998 with an aggregate liquidation
preference of $3,270,200 0 0
6% Cumulative Series I Convertible Preferred,
issued 15,180 in 1998 with an aggregate
liquidation preference of $1,518,000 0 0
Common stock, $.01 par value; authorized 200,000,000
shares; issued 67,450,907 and 67,447,309 in
1998 and 1997, respectively 674 674
Additional paid-in capital 427,008 427,012
Accumulated deficit -426,080 -447,332
Total shareholders' equity (capital deficiency) 1,606 -19,646
Total liabilities and shareholders' equity
(capital deficiency) $ 24,322 $ 37,451
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)
Nine Mos Nine Mos
Ended Ended
Sept 27, Sept 28,
1998 1997
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 21,252 $ -56,465
Adjustments to arrive at net cash used in
operating activities:
Gain on Sun Transaction -25,308 0
Depreciation and amortization 744 5,485
Inventory obsolescence and writedown to lower of cost
or market 0 810
Bad debt provision 467 378
Termination charge 1,570 0
Net changes in operating assets and liabilities:
Accounts receivable -1,229 6,665
Inventories -577 5,375
Prepaid expenses and other current assets 1 287
Other assets 288 12
Accounts payable and accrued liabilities -10,643 2,706
Other liabilities 0 516
Net cash used in operating activities -13,435 -34,231
Cash flows from investing activities:
Proceeds from Sun Transaction 25,308 0
Additions to property and equipment -201 -1,190
Net cash provided by (used) in investing activities 25,107 -1,190
Cash flows from financing activities:
Net borrowings under revolving loan agreements 0 35,757
Net advances under revolving loan agreements -466 0
Principal payments of long term debt 0 -140
Issuance of common stock 0 329
Payment of Due to Gould -25,308 0
Net cash (used in) provided by financing activities -25,774 35,946
(Decrease) increase in cash and cash equivalents -14,102 525
Decrease in restricted cash 12,798 0
-1,304 525
Cash and cash equivalents, beginning 14,544 3,936
Cash and cash equivalents, ending $ 13,240 $ 4,461
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Cash Flows
Supplemental disclosure of cash flow information (in thousands):
Nine Mos Nine Mos
Ended Ended
Sept 27, Sept 28,
1998 1997
<S> <C> <C>
Cash paid during the period for interest $ 26 $ 76
Cash paid during the period for income taxes $ 833 $ 1,210
Non-cash investing and financing activities:
Indebtedness exchanged for preferred stock $ 0 $ 40,000
</TABLE>
The accompanying notes are an integral part of the condensed consolidated
financial statements.
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<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Condensed Consolidated Statements of Shareholders' Equity (Capital Deficiency)
for the Nine Months Ended September 27, 1998
(unaudited)
(in thousands except share data)
Preferred Stock
Series B Series D Series E Series F
Par Par Par Par
Shares Val Shares Val Shares Val Shares Val
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance
Dec 31, 1997 0 $0 0 $0 0 $0 0 $0
Shares issued through
employee stock purchase
plan at a price of
$.23 per share 0 0 0 0 0 0 0 0
Issuance of Accumulated
Preferred Stock
Dividends (Note B) 64,905 1 104,190 1 106,501 1 49,832 0
Net income
Bal Sep 27, 1998 64,905 $1 104,190 $1 106,501 $1 49,832 $0
Preferred Stock
Series G Series H Series I
Par Par Par
Shares Val Shares Val Shares Val
<S> <C> <C> <C> <C> <C> <C>
Bal Dec 31, 1997 0 $0 0 $0 0 $0
Shares issued through
employee stock purchase
plan at a price of
$.23 per share 0 0 0 0 0 0
Issuance of Accumulated
Preferred Stock
Dividends (Note B) 53,474 1 32,702 0 15,180 0
Net income
Bal Sep 27, 1998 53,474 $1 32,702 $0 15,180 $0
Common Stock Shhldrs'
Addt'l Equity
Par Paid-in Accum (Capital
Shares Val Capital Deficit Def)
<S> <C> <C> <C> <C> <C>
Bal Dec 31, 1997 67,447,309 $674 $427,012 ($447,332) ($19,646)
Shares issued through
employee stock purchase
plan at a price of
$.23 per share 3,598 0 0 0 0
Issuance of Accumulated
Preferred Stock
Dividends (Note B) 0 0 -4 0 0
Net income 0 0 0 21,252 21,252
Bal Sep 27, 1998 67,450,907 $674 $427,008 ($426,080 $1,606
</TABLE>
The accompanying notes are an intergral part of the condensed consolidated
financial statements.
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ENCORE COMPUTER CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND OTHER MATTERS
The accompanying condensed consolidated financial statements are unaudited and
have been prepared by Encore Computer Corporation ("Encore" or the "Company") in
accordance with generally accepted accounting principles. Certain information
and footnote disclosures normally included in the Company's annual consolidated
financial statements have been condensed or omitted. It is suggested that these
condensed consolidated financial statements be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 1997.
The condensed consolidated financial statements, in the opinion of the Company,
reflect all adjustments (including normal recurring accruals) necessary for a
fair statement of the results for the interim periods. All adjustments made
during the interim periods are normal recurring adjustments. The year-end
condensed balance sheet data is derived from audited financial statements but
does not include all disclosures required by generally accepted accounting
principles. Certain reclassifications have been made to conform prior period
data to current period presentation.
The results of operations for the interim periods are not necessarily
indicative of the results of operations for the fiscal years.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"). SFAS 131 established standards
for public business enterprises to report information about operating segments
in annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes the standards for related disclosures about
products and services, geographic areas, and major customers. SFAS 131 requires
a public business enterprise to report financial and descriptive information
about its reportable operating segments. The financial information is required
to be reported on the basis that it is used internally for evaluation of segment
performance and deciding how to allocate resources to segments. Operating
segments are components of an enterprise about which separate financial
information is available that is evaluated regularly by the chief operating
decision maker in deciding how to allocate resources and in assessing
performance. SFAS 131 is effective for financial statements for periods
beginning after December 15, 1997. Management does not believe that the
requirements of SFAS 131 will have a material impact on the Company's financial
statements.
BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The sale of the
Company's principal operating assets was approved at a special meeting of
shareholders held on
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September 11, 1998. The Company plans to liquidate after November 24, 1998
subject to approval of the shareholders. The Company will incur substantial
expenses in connection with a liquidation. The accompanying condensed
consolidated financial statements do not reflect either the effects of the
proposed sale of the Company's principal operating assets or the expenses it
will incur in connection with its liquidation. The Company has a substantial
obligation to Gould Electronics Inc. which was to have been satisfied with the
Second Payment due from Sun Microsystems, Inc. ("Sun") under an agreement by
which the Company sold its storage products business to Sun. Sun has withheld a
portion of that Second Payment, because of claimed offsets. If Sun does not make
the balance of the Second Payment, the Company's obligation to Gould (which is
reflected on its balance sheet) plus expenses incurred in connection with the
Company's liquidation (which are not reflected on its balance sheet) are likely
to exceed its assets. The ultimate resolution of these matters is not presently
determinable.
EARNINGS PER SHARE
Basic earnings per common share calculations are determined by dividing earnings
available to common shareholders by the weighted average number of shares of
common stock outstanding during the year. Diluted earnings per common share
calculations are determined by dividing earnings available to common
shareholders by the weighted average number of shares of common stock and
dilutive common stock equivalents outstanding. Basic and diluted earnings per
share were the same for all periods presented because the effect of common stock
equivalents would be anti-dilutive.
Net income (loss) per common share was determined by dividing the net income
(loss), as adjusted for the aggregate amount of dividends on the Company's
preferred stock, by applicable shares outstanding. There were no preferred stock
dividends for the three and nine month periods ended September 27, 1998.
Preferred stock dividends amounted to $7,672,000 and $21,794,000 for the three
and nine month periods ended September 28, 1997, respectively. Based on capital
deficiencies, the Company was precluded from paying dividends on its preferred
stock outstanding. Accordingly, the Company accumulated preferred stock
dividends since July 15, 1996. All preferred stock dividends other than those
accumulated at June 28, 1998 were paid in additional shares of the appropriate
class of preferred stock. On July 31, 1998 all accumulated preferred stock
dividends were issued to Gould in connection with the Gould Agreement as
discussed more fully in Note B of Notes to Condensed Consolidated Financial
Statements.
B. ASSET PURCHASE AGREEMENT WITH SUN MICROSYSTEMS
On November 24, 1997 (the "Closing"), pursuant to an Asset Purchase Agreement
dated as of July 17, 1997 (the "Agreement"), the Company sold substantially all
of the assets associated with its storage products business to Sun (the "Sun
Transaction"). The Agreement had contemplated that the aggregate consideration
to be paid to the Company by Sun for such assets was to be $185,000,000, 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
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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, $118,550,973 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 Company. The purchase price for the sale of assets in the Sun Transaction,
and the modifications thereto as described above, were determined as a result of
arms-length negotiations between Encore and Sun.
In connection with the Gould Agreement, the Company agreed to redeem all of the
Preferred Stock held by Gould and EFI at the Closing for $60 million in cash, of
which $25 million was paid from the Total Cash Closing Payment as described
above and the balance paid by assigning to Gould the right to receive the Second
Payment. However, under the Agreement, Sun has the right to set off against the
Second Payment, any amounts owed to Sun by Encore pursuant to its
indemnification obligations. If the amount paid to Gould by Sun on July 1, 1998
was less than $35 million due to the inaccuracy of any representation or
warranty of Encore in the Agreement, the failure by Encore to fulfill any
obligation under the Agreement, or any other act or omission of Encore, under
the Gould Agreement, Encore would be indebted to Gould for the amount by which
such payment was less than $35 million. In addition, if the $35 million was not
paid to Gould by July 31, 1998, Gould would be entitled to receive from Encore
shares of Series B, D, E, F, G, H, and I Preferred Stock which represent accrued
but unpaid dividends on Gould's Preferred Stock as of November 24, 1997. These
unpaid dividends represent 426,784 shares with a liquidation preference of
$42,678,400 (the "Unpaid Dividend Shares"). If the full $35 million was paid to
Gould by July 31, 1998, Gould would waive its right to receive these accrued but
unpaid dividends. Additionally, Gould had agreed to waive any right it may have
had as a holder of Common Stock to participate in the first $30 million which
the Company could distribute to its shareholders as a liquidating dividend in
any liquidation within two years after the Closing. In light of the
uncertainties about the amount which would be received with regard to the Second
Payment, the Company did not record the Second Payment as an asset as of
December 31, 1997. Because the Company was required to make the $35 million
payment to Gould to the extent the Second Payment was less than that amount, the
decision to defer recognition of the Second Payment as an asset resulted in the
Company's carrying the entire $35 million obligation to Gould as a liability
without an offsetting asset at December 31, 1997.
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On June 25, 1998, Sun informed Encore of its intent to setoff $10,062,000, less
$370,000 subsequently reimbursed, for a total setoff of $9,692,000 relating to
alleged breaches of representations and warranties made by Encore
under the Agreement. The setoff relates to the following claims: (i) a
$1,025,000 claim by Sun that Encore was unable to deliver to Sun the right to
use certain software; (ii) $5,000 in outside legal fees and other expenses
incurred regarding a threatened action by its Italian distributor relating to an
alleged breach of Encore's promise to deliver certain product features to a
major customer, as well as a $1,000,000 demand relating to the distributors
claim of lost future sales to that customer; (iii) $350,000 relating to Sun's
claim for indemnifiable costs associated with obtaining proper certification of
certain hardware; (iv) a $7,200,000 claim associated with the repair or
replacement of storage products sold by Encore prior to the closing which Sun
claims have failed to conform to Encore's warranties, customer commitments,
product specification and/or quality standards; and (v) $112,000 relating to
costs incurred by Sun responding to a subpoena in connection with pending legal
action brought by certain shareholders in connection with the Sun Transaction
(the "Shareholders Suit"). Encore has requested Sun to provide documentation
regarding these claims; however, the ultimate resolution of these matters is not
presently determinable. On July 1, 1998, Sun paid Gould $25,308,000 with regard
to the Second Payment, which was recorded as income in June 1998. Therefore,
Encore owes Gould $9,692,000 under the Agreement and that amount was not paid by
July 31, 1998. In order to avoid the need for Encore to make a payment of
$9,692,000 to Gould by July 31, 1998, or be irrevocably obligated to issue the
Unpaid Dividend Shares, without knowing the amount, if any, it might recover
through future payments of additional portions of the Second Payment, Gould gave
Encore the option (the "Option") to repurchase the Unpaid Dividend Shares at any
time on or before July 31, 1999 for an amount equal to (a) $35,000,000, minus
(b) all sums Gould receives with regard to the Second Payment, plus (c) interest
on that amount at 8.5% per annum from August 1, 1998 to the day the Option is
exercised. On July 16, 1998, the Board of Directors, including those affiliated
with Gould, approved the issuance of the Unpaid Dividend Shares to Gould which
were issued on July 31, 1998. If Encore does not exercise its Option by July 31,
1999, Gould's Preferred Stock will absorb all of the liquidation proceeds, if
any, as discussed more fully in Note D of Notes to Condensed Consolidated
Financial Statements.
In connection with the sale of the storage products business to Sun, the Company
charged to operations a termination charge of $17,685,000 related to: (i)
severance and benefit pay of $6,323,000 as a result of a 542 person reduction
in workforce, including severance for employees contracted by Sun, as the
Company agreed to pay the difference between the completion bonus offered to
contractors by Sun at the end of their contract and the amount of severance they
were entitled to had they been terminated by the Company; (ii) $4,722,000 of
retention payments pursuant to written agreements between the Company and each
of approximately 49 employees; (iii) $1,000,000 of incentive bonuses to certain
key employees; (iv) $3,390,000 relating to the termination of European facility
and automobile leases, and $350,000 relating to a domestic equipment lease; (v)
an estimated $500,000 for leasehold improvements to be made at the Company's
Fort Lauderdale facility which is leased from Sun; (vi) $1,150,000 in estimated
legal and other fees associated with the Sun Transaction; and (vii) $250,000
accrued for legal fees in connection with the Shareholders Suit.
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In connection with the Agreement and for a one-year period following the
Closing, Gould has agreed to take all actions necessary to ensure that Encore
remains solvent. In addition, Gould and certain of its affiliates have agreed,
among other things, that, if within two years following the Closing, the Company
commences an insolvency proceeding and the Sun Transaction is challenged in that
proceeding, that Gould and such affiliates will indemnify Sun for losses arising
therefrom.
Restricted cash of $1,285,000 and $14,083,000 at September 27, 1998 and December
31, 1997, respectively, represents cash held in an escrow account pursuant to an
escrow agreement dated November 24, 1997 between the Company and Sun. The escrow
arrangement was established to ensure that certain of the Company's liabilities
at the closing date of the Sun Transaction, would be paid when due. As the
Company pays these liabilities, escrow funds are released to the Company. These
funds are invested in a U.S. Bank money market fund and will be made available
to the Company pursuant to the terms of the escrow agreement.
C. TERMINATION CHARGES
During the quarter ended June 28, 1998, pursuant to the Asset Purchase Agreement
(the "Asset Purchase Agreement") with Gores Technology Group ("Gores"),
discussed more fully in Note D of Notes to Condensed Consolidated Financial
Statements, the Company recorded a termination charge of $826,000 relating to
severance and benefit pay as a result of a 19 person reduction in workforce,
including severance for employees which may be borne by Gores in accordance with
a Management Agreement (the "Management Agreement") entered into on June 1,
1998, as discussed more fully in Note D of Notes to Condensed Consolidated
Financial Statements.
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.
During the fourth quarter of 1998, additional termination charges will be
recorded in connection with the sale of substantially all of the assets of the
real-time business to Gores. The amount of these charges had not yet been
determined.
D. PROPOSED SALE TO GORES TECHNOLOGY GROUP
On March 2, 1998, the Company signed a letter of intent with Gores Technology
Group to sell the assets of the Company's real-time business for approximately
$5.5 million based
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on a projected December 31, 1997 balance sheet for the Real-Time Business. The
transaction was subject to the satisfactory completion of due diligence by
Gores, the negotiation and execution of a definitive asset purchase agreement
and the satisfaction of any closing conditions.
On June 4, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire substantially all of the Company's assets, other than cash, and assume
substantially all of its liabilities related to the real-time business. The
purchase price is $3 million in cash, all of which would be paid at closing. The
reduction in price from that contemplated in the letter of intent reflects
changes to the balance sheet of the real-time business since the projected
12/31/97 balance sheet which was the basis for the price set forth in the letter
of intent. Gould Electronics Inc., the Company's principal shareholder, will be
jointly and severally liable with the Company for indemnification obligations to
Gores under the agreement. Encore's real-time business in France is expected to
be addressed separately in an agreement to be negotiated locally with Gores.
Pending the closing, Gores is operating the real-time business in accordance
with a Management Agreement (the "Management Agreement"), retaining any positive
cash flow and bearing any negative cash flow, pursuant to a management contract
which provides for a monthly management fee of $100,000 which will be fully
refunded to Encore on closing. The Management Agreement provides that: (i) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated negative cash flow from
June 1, 1998 until such termination, Gores will refund to Encore the amount of
the negative cash flow up to the amount of monthly management fees paid; (ii) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated positive cash flow from
June 1, 1998 until such termination, Gores will retain the positive cash flow
and the management fees paid; (iii) if the Asset Purchase Agreement is approved
by the shareholders, and the real-time business has generated negative cash flow
from June 1, 1998 until such approval, Gores will refund to Encore the amount of
the negative cash flow and the management fees paid; (iv) if the Asset Purchase
Agreement is approved by the shareholders, and the real-time business has
generated positive cash flow from June 1, 1998 until such approval, Gores will
retain the positive cash flow and return the management fees paid. Due to the
uncertainty of the outcome of the Gores Transaction, the possible income or
expense impact associated with the termination or closing of the Asset Purchase
Agreement has not been recorded in the Company's Statement of Operations at
September 27, 1998. Encore has provided a $2 million line of credit to Gores to
fund the operations of the real-time business until the closing. By September
27, 1998, borrowings net of obligations assumed by Gores under the Management
Agreement were $466,000. The closing was subject to customary conditions,
including the approval of the Encore shareholders.
At a special meeting of shareholders held on September 11, 1998, shareholders
approved the sale of substantially all of the assets associated with the
real-time computer system and processing business of the Company to Gores
However, shareholders were not asked to vote on the Plan of Dissolution and
Liquidation approved by the Board of Directors on
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August 6, 1998 due to Sun's refusal to consent to Gould voting for the plan
pursuant to the Inducement Agreement.
Pursuant to Section 7.1(f) of the Asset Purchase Agreement between the Company
and Gores, either Gores or the Company may terminate the Agreement if the
Closing has not occurred by the earliest of (i) the date on which the Company's
shareholders vote upon and fail to approve the transactions contemplated hereby,
or (ii) October 31, 1998 or (iii) such other date, if any, as the Buyer and the
Company may agree in writing and the terminating party is not at such time in
breach of a representation or warranty or in violation of a covenant or
agreement contained herein. On October 27, 1998, pursuant to Amendment Number
One To Asset Purchase Agreement, the parties agreed to change the date in
Section 7.1(f)(ii) from October 31, 1998 to November 30, 1998.
If the sale of the real-time business is consummated, it is anticipated that the
Company will be liquidated after November 24, 1998, subject to shareholder
approval. Gould owns 48.44% of the Company's outstanding Common Stock and has
agreed to waive its right as a Common shareholder to receive any portion of the
first $30 million of liquidating distributions to the Company's shareholders in
any liquidation of the Company which occurs prior to November 24, 1999. On June
25, 1998, Sun informed Encore of its intent to setoff $9,692,000. Encore has
requested Sun to provide documentation regarding these claims; however, the
ultimate resolution of these matters is not presently determinable. On July 1,
1998, Sun paid Gould $25,308,000 with regard to the Second Payment. Therefore,
Encore owes Gould $9,692,000 under the Agreement. Because that amount was not
paid by July 31, 1998, on that date, Encore issued to Gould the Unpaid Dividend
Shares with a liquidation preference of $42,678,400, as previously unpaid
dividends on Preferred Stock which Gould had owned prior to November 24, 1997.
However, in order to avoid the need for Encore to make a payment of $9,692,000
to Gould by July 31, 1998, or be irrevocably obligated to issue the Unpaid
Dividend Shares, without knowing the amount, if any, it might recover through
future payments of additional portions of the Second Payment, Gould gave Encore
the option (the "Option") to repurchase the Unpaid Dividend Shares at any time
on or before July 31, 1999 for an amount equal to (a) $35,000,000, minus (b) all
sums Gould receives with regard to the Second Payment, plus (c) interest on that
amount at 8.5% per annum from August 1, 1998 to the day the Option is exercised.
At September 27, 1998, the amount of interest due Gould with regard to the
second payment was $128,651. If Encore does not exercise its Option by July 31,
1999, Gould's Preferred Stock will absorb all of the liquidation proceeds, if
any.
If the sale of the real-time business is consummated, the assets of the Company
available for distribution to shareholders on liquidation would be: (i) the
Company's assets at September 27, 1998 plus any additional amounts received with
regard to the Second Payment, less its liabilities at September 27, 1998
including the $9,692,000 payable to Gould, plus or minus; (ii) any amount by
which the severance and other costs related to the sale of the storage products
business and the discontinuance of the Company's efforts to develop clustering
software in a Windows NT environment as well as severance related to the Gores
Transaction, paid after September 27, 1998 are greater or less than the
estimated amount reflected on the Company's September 27, 1998 balance sheet,
plus or minus; (iii) the gain or loss from the sale of the Company's real-time
computer systems business; minus (iv) costs of the liquidation and reserves for
any contingent liabilities,
14
<PAGE>
including any pending litigation, estimated by the Company to be approximately
$10,624,000, which has not been recorded on the books of the Company as of
September 27, 1998.
E. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
Sept 27, Dec 31,
1998 1997
<S> <C> <C>
Purchased parts $ 492 $ 174
Work in process 246 0
Finished goods 85 72
Total inventory $ 823 $ 246
</TABLE>
All increases in inventory are purchases on behalf of Gores in accordance with
the Management Agreement.
F. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:
Accounts payable and accrued liabilities consist of the following (in
thousands):
<TABLE>
<CAPTION>
Sept 27, Dec 31,
1998 1997
<S> <C> <C>
Accounts payable $ 2,119 $ 1,064
Accrued salaries and benefits 1,992 2,355
Accrued restructuring 5,926 13,655
Accrued taxes 738 1,048
Deferred income, principally
maintenance contracts 799 638
Other accrued expenses 1,450 3,337
Total accounts payable and accrued liabilities $ 13,024 $ 22,097
</TABLE>
15
<PAGE>
During the nine months ended September 27, 1998, pursuant to the Asset Purchase
Agreement with Gores Technology Group, discussed more fully in Note D of Notes
to Condensed Consolidated Financial Statements, the Company recorded a
termination charge of $826,000 relating to severance and benefit pay as a result
of a 19 person reduction in workforce, including severance for employees which
may be borne by Gores in accordance with the Management Agreement entered into
on June 1, 1998, as discussed more fully in Note D of Notes to Condensed
Consolidated Financial Statements. Additionally, the Company recorded a
termination charge of $743,500 related to severance and benefit pay as a result
of a 13 person reduction in workforce associated with the Board of Directors
decision not to pursue the NT opportunity In addition, in the fourth quarter of
1997, in conjunction with the Sun Transaction and subsequent reorganization, the
Company recorded a termination charge of $17,685,000 related to: (i) severance
and benefit pay of $6,323,000 as a result of a 542 person reduction in
workforce, including severance for employees contracted by Sun, as the Company
agreed to pay the difference between the completion bonus offered to contractors
by Sun at the end of their contract and the amount of severance they were
entitled to had they been terminated by the Company; (ii) $4,722,000 of
retention payments pursuant to agreements between the Company and each of
approximately 49 employees; (iii) $1,000,000 of incentive bonuses to certain key
employees; (iv) $3,390,000 relating to the termination of European facility and
automobile leases, and $350,000 relating to a domestic 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.
16
<PAGE>
ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 27, 1998
COMPARED TO THE THREE AND NINE MONTHS ENDED SEPTEMBER 28, 1997
The following is management's discussion and analysis of the financial condition
and the results of operations of Encore Computer Corporation ("Encore" or the
"Company") for the three and nine month periods ended September 27, 1998
compared to the three and nine month periods ended September 28, 1997. The
Company's net income/loss for the three and nine months ended September 27, 1998
was a net loss of $1,726,000 and net income of $21,252,000, respectively,
compared to a net loss for the same periods of 1997 of $16,638,000 and
$56,465,000, respectively. The 1998 income is due principally to the recognition
of the $25,308,000 gain with regard to the Second Payment (as defined below) due
from Sun, which was recorded in the three month period ended June 28, 1998.
THE SUN TRANSACTION
On November 24, 1997 (the "Closing"), pursuant to the Agreement, the Company
sold substantially all of the assets associated with its storage products
business to Sun. The Agreement had contemplated that the aggregate consideration
to be paid to the Company by Sun for such assets was to be $185,000,000, of
which $150,000,000 in cash was to be paid at the closing (the "Closing Payment")
and $35,000,000 was to be payable on July 1, 1998 (the "Second Payment").
Pursuant to the terms of a Modification Agreement, dated as of November 24,
1997, among Encore and Sun, the parties agreed that the final amount of the
Closing Payment would be reduced to $149,882,683 to reflect that Sun was
assuming certain liabilities of certain non-U.S. subsidiaries of the Company in
the amount of $117,317, which Sun had not previously agreed to assume under the
terms of the Agreement. In addition, the parties further agreed that Sun was to
pay an additional amount of $1,285,544 to Encore for the purchase by Sun of
certain finished storage product units, as contemplated by the terms of the
Agreement. Thus, the aggregate amount paid by Sun to Encore at the Closing was
$151,168,227 (the "Total Cash Closing Payment"), which was paid by Sun to Encore
as follows: (i) at the Company's request, $118,550,973 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.
17
<PAGE>
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 had the right to set off
against the Second Payment, any amounts owed to Sun by Encore pursuant to its
indemnification obligations. If the amount paid to Gould by Sun on July 1, 1998
was less than $35 million due to the inaccuracy of any representation or
warranty of Encore in the Agreement, the failure by Encore to fulfill any
obligation under the Agreement, or any other act or omission of Encore, under
the Gould Agreement, Encore would be indebted to Gould for the amount by which
such payment is less than $35 million. In addition, if the $35 million was not
paid to Gould by July 31, 1998, Gould would be entitled to receive from Encore
shares of Series B, D, E, F, G, H, and I Preferred Stock which represent accrued
but unpaid dividends on Gould's Preferred Stock as of November 24, 1997. These
unpaid dividends represent 426,784 shares with a liquidation preference OF
$42,678,400. If the full $35 million was paid to Gould by July 31, 1998, Gould
would waive its right to receive these accrued but unpaid dividends.
Additionally, Gould agreed to waive any right it may have as a holder of Common
Stock to participate in the first $30 million which the Company may distribute
to its shareholders as a liquidating dividend in any liquidation within two
years after the Closing. In light of the uncertainties about the amount which
would be received with regard to the Second Payment, the Company did not record
the Second Payment as an asset at December 31, 1997. Because the Company was
required to make the $35 million payment to Gould to the extent the Second
Payment was less than that amount, the decision to defer recognition of the
Second Payment as an asset resulted in the Company's carrying the entire $35
million obligation to Gould as a liability without an offsetting asset at
December 31, 1997.
At the closing of the Sun Transaction, Sun and Encore entered into a Technology
License Agreement pursuant to which Sun granted to Encore a non-exclusive,
non-transferable, royalty free, worldwide license in the intellectual property
sold to Sun as part of the storage products business to create and distribute
real-time products based on the intellectual property for use by Encore in its
real-time business, subject to certain limitations, but not for any other
purpose. Encore also agreed not to use the intellectual property in any storage
products or to compete with Sun's storage products business, and to grant to Sun
a non-exclusive, royalty-free, paid up, non-terminable, worldwide license in any
derivative works created by Encore derived from the intellectual property, so
long as Sun does not use this grant back license to create or distribute
real-time products.
EVENTS FOLLOWING THE SUN TRANSACTION
18
<PAGE>
When the Company completed the sale of its storage products business, the Board
of Directors decided the Company should, at least until the Board's January 1998
meeting, (a) explore the possibility of attempting to develop and market
clustering software in a Windows NT environment for various types of computer
hardware, and (b) explore the feasibility of continuing, and attempting to
expand, its real-time computer systems business. In January 1998, the Board of
Directors (i) decided the Company should discontinue its efforts to develop
clustering technology in a Windows NT environment for various types of computer
hardware resulting in a termination charge of $743,500, and (ii) authorized the
Company to retain an investment banker to explore strategic options with respect
to the real-time business.
On March 2, 1998, the Company signed a letter of intent to sell its real-time
computer systems business to Gores Technology Group. That transaction was
subject to completion by Gores of due diligence and to negotiation and execution
of definitive agreements. Upon the sale of its real-time computer systems
business to Gores or to any other purchaser, the Company no longer will have any
business operations.
On June 4, 1998, the Company and Gores entered into a definitive agreement for
the sale of the real-time business on the following principal terms: Gores will
acquire substantially all of the Company's assets, other than cash, and assume
substantially all of its liabilities related to the real-time business. The
purchase price is $3 million in cash, all of which would be paid at closing. The
reduction in price from that contemplated in the letter of intent reflects
changes to the balance sheet of the real-time business since the projected
12/31/97 balance sheet which was the basis for the price set forth in the letter
of intent. Gould Electronics Inc., the Company's principal shareholder, will be
jointly and severally liable with the Company for indemnification obligations to
Gores under the agreement. Encore's real-time business in France is expected to
be addressed separately in an agreement to be negotiated locally with Gores.
Pending the closing, Gores is operating the real-time business in accordance
with a Management Agreement (the "Management Agreement"), retaining any positive
cash flow and bearing any negative cash flow, pursuant to a management contract
which provides for a monthly management fee of $100,000 which will be fully
refunded to Encore on closing. The Management Agreement provides that: (i) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated negative cash flow from
June 1, 1998 until such termination, Gores will refund to Encore the amount of
the negative cash flow up to the amount of monthly management fees paid; (ii) if
the Asset Purchase Agreement terminates prior to the sale being approved by the
shareholders, and the real-time business has generated positive cash flow from
June 1, 1998 until such termination, Gores will retain the positive cash flow
and the management fees paid; (iii) if the Asset Purchase Agreement is approved
by the shareholders, and the real-time business has generated negative cash flow
from June 1, 1998 until such approval, Gores will refund to Encore the amount of
the negative cash flow and the management fees paid; (iv) if the Asset Purchase
Agreement is approved by the shareholders, and the real-time business has
generated positive cash flow from June 1, 1998 until such approval, Gores will
retain the positive cash flow and return the management fees paid. Due to the
uncertainty of the outcome of the Gores Transaction, the possible income or
expense impact associated with the termination or closing of the
19
<PAGE>
Asset Purchase Agreement has not been recorded in the Company's Statement of
Operations at September 27, 1998. Encore has provided a $2 million line of
credit to Gores to fund the operations of the real-time business until the
losing. By September 27, 1998, borrowings net of obligations assumed by Gores
under the Management Agreement were $466,000.
On June 25, 1998, Sun informed Encore of its intent to setoff $10,062,000, less
$370,000 subsequently reimbursed, for a total setoff of $9,692,000 relating to
alleged breaches of representations and warranties made by Encore under the
Agreement. The setoff relates to the following claims: (i) a $1,025,000 claim by
Sun that Encore was unable to deliver to Sun the right to use certain software;
(ii) $5,000 in outside legal fees and other expenses incurred regarding a
threatened action by its Italian distributor relating to an alleged breach of
Encore's promise to deliver certain product features to a major customer, as
well as a $1,000,000 demand relating to the distributors claim of lost future
sales to that customer; (iii) $350,000 relating to Sun's claim for indemnifiable
costs associated with obtaining proper certification of certain hardware; (iv) a
$7,200,000 claim associated with the repair or replacement of storage products
sold by Encore prior to the closing which Sun claims have failed to conform to
Encore's warranties, customer commitments, product specification and/or quality
standards; and (v) $112,000 relating to costs incurred by Sun responding to a
subpoena in connection with pending legal action brought by certain shareholders
in connection with the Sun Transaction (the "Shareholders Suit"). Encore has
requested Sun to provide documentation regarding these claims; however, the
ultimate resolution of these matters is not presently determinable. On July 1,
1998, Sun paid Gould $25,308,000 with regard to the Second Payment. Therefore,
Encore owes Gould $9,692,000 under the Agreement. Because that amount was not
paid by July 31, 1998, on July 31, 1998, Encore issued to Gould Preferred Stock
with a liquidation preference of $42,678,400 (the "Unpaid Dividend Shares"), as
previously unpaid dividends on Preferred Stock Gould had owned prior to November
24, 1997. However, in order to avoid the need for Encore to make a payment of
$9,692,000 to Gould by July 31, 1998, or be irrevocably obligated to issue the
Unpaid Dividend Shares, without knowing the amount, if any, it might recover
through future payments of additional portions of the Second Payment, Gould gave
Encore the option (the "Option") to repurchase the Unpaid Dividend Shares at any
time on or before July 31, 1999 for an amount equal to (a) $35,000,000, minus
(b) all sums Gould receives with regard to the Second Payment, plus (c) interest
on that amount at 8.5% per annum from August 1, 1998 to the day the Option is
exercised. If Encore does not exercise its Option by July 31, 1999, Gould's
Preferred Stock will absorb all of the liquidation proceeds, if any.
At a special meeting of shareholders held on September 11, 1998, shareholders
approved the sale of substantially all of the assets associated with the
real-time computer system and processing business of the Company to a newly
formed subsidiary of Connection Machines, Inc., one of the Gores Technology
group of companies, pursuant to the Asset Purchase Agreement dated June 4, 1998.
However, shareholders were not asked to vote on the Plan of Dissolution and
Liquidation approved by the Board of Directors on August 6, 1998 due to Sun's
refusal to consent to Gould voting for the plan pursuant to the Inducement
Agreement.
20
<PAGE>
Pursuant to Section 7.1(f) of the Asset Purchase Agreement between the Company
and Gores dated June 4, 1998, either buyer or seller may terminate if the
Closing has not occurred by the earliest of (i) the date on which the Company's
shareholders vote upon and fail to approve the transactions contemplated hereby,
or (ii) October 31, 1998 or (iii) such other date, if any, as the Buyer and the
Company may agree in writing and the terminating party is not at such time in
breach of a representation or warranty or in violation of a covenant or
agreement contained herein. On October 27, 1998, pursuant to Amendment Number
One To Asset Purchase Agreement, the parties agreed to change the date in
Section 7.1(f)(ii) from October 31, 1998 to November 30, 1998.
At September 27, 1998, the Company had total assets of $24,322,000, including
restricted cash of $1,285,000, and cash and cash equivalents of $13,240,000, but
not including any amount for the balance of the Second Payment, and had
liabilities of $22,716,000, including $5,926,000 of estimated severance costs
and other costs related to the proposed sale of the Company's Real-Time business
to Gores and the sale of the Company's storage products business and
discontinuance of its efforts to develop clustering software in a Windows NT
environment, and the $9,692,000 remaining payable to Gould. If the sale of the
real-time business is consummated, the assets of the Company available for
distribution to shareholders on liquidation would be: (i) the Company's assets
at September 27, 1998 plus any additional amounts received with regard to the
Second Payment, less its liabilities at September 27, 1998 including the
$9,692,000 payable to Gould, plus or minus; (ii) any amount by which the
severance and other costs related to the sale of the storage products business
and the discontinuance of the Company's efforts to develop clustering software
in a Windows NT environment as well as severance related to the Gores
Transaction, paid after September 27, 1998 are greater or less than the
estimated amount reflected on the Company's September 27, 1998 balance sheet,
plus or minus; (iii) the gain or loss from the sale of the Company's real-time
computer systems business; minus (iv) costs of the liquidation and reserves for
any contingent liabilities, including any pending litigation, estimated by the
Company to be approximately $10,624,000, which has not been recorded on the
books of the Company as of September 27, 1998.
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The Company has
agreed to sell its principal operating assets and plans to liquidate after
November 24, 1998, subject to shareholder approval. The Company will incur
substantial expenses in connection with a liquidation. The accompanying
condensed consolidated financial statements do not reflect either the effects of
the proposed sale of the Company's principal operating assets or the expenses it
will incur in connection with its liquidation. The Company has a substantial
obligation to Gould which was to have been satisfied with the Second Payment
from Sun. Sun has withheld a portion of that Second Payment, because of claimed
offsets. If Sun does not make the balance of the Second Payment, the Company's
obligation to Gould (which is reflected on its balance sheet) plus expenses
incurred in connection with the Company's liquidation (which are not reflected
on its balance sheet) are likely to exceed its assets. The ultimate resolution
of these matters is not presently determinable.
RESULTS OF OPERATIONS:
21
<PAGE>
Net sales for the three and nine month periods ended September 27, 1998
decreased 33% and 37%, respectively, to $4,973,000 and $14,576,000 from
$7,429,000 and $23,116,000 for the three and nine month periods of 1997. For the
three and nine month periods ended September 27, 1998, equipment sales decreased
39% and 50% to $2,321,000 and $5,690,000, respectively, when compared to
$3,834,000 and $11,428,000 for the three and nine month periods ended September
28, 1997. Service revenues for the three and nine month periods ended September
27, 1998 were $2,652,000 and $8,886,000, respectively, compared to $3,595,000
and $11,688,000 for the three and nine month periods ended September 28, 1997,
respectively. Real-time equipment sales for the three and nine month periods
ended September 27, 1998 were $2,321,000 and $5,690,000 compared to $2,317,000
and $7,666,000 for the same periods in 1997. Storage product equipment sales for
the three and nine months ended September 28, 1997 were $1,517,000 and
$3,762,000, respectively. The Company had no storage product equipment sales for
the three and nine month periods ended September 27, 1998 as a result of the
sale of the storage product business to Sun Microsystems on November 24, 1997
(the "Sun Transaction"). No service revenues were derived from the storage
product business in the first nine months of either 1998 or 1997. The Company's
operating losses for the three and nine month periods in 1998 were $1,594,000
and $4,178,000, respectively, compared to operating losses of $14,502,000 and
$50,306,000 for the same periods in 1997.
Equipment sales as a percentage of total net sales for the three and nine month
periods ended September 27, 1998 were 47%, and 39%, respectively, compared to
52% and 49% for the three and nine month periods ended September 28, 1997,
respectively. For real-time equipment sales, the respective percentages were 47%
and 39% of total net sales in the three and nine month periods ended September
27, 1998, compared to 31% and 33% for the same periods of 1997. Storage product
equipment sales for the three and nine months ended September 28, 1997 were 20%
and 16% of total net sales, respectively. The decrease in real-time equipment
sales for the three and nine month periods in 1998 is primarily due to certain
of the Company's traditional real-time products having reached the end of their
product life cycle. International equipment sales decreased 91% and 72% in the
three and nine month periods ended September 27, 1998, respectively, to $184,000
and $1,534,000, respectively, compared to $2,082,000 and $5,408,000 for the
three and nine month periods of 1997, respectively. There were no storage
product equipment sales in 1998 compared to sales of $1,038,000 and $934,000 for
the three and nine month periods ended September 28, 1997, respectively.
Domestic equipment sales increased 22% and decreased 31% for the three and nine
month periods ended September 27, 1998 to $2,137,000 and $4,156,000,
respectively, compared to $1,752,000 and $6,020,000 for the same periods of
1997, with storage product equipment sales decreasing to $0 from $479,000 and
$2,828,000 for the three and nine month periods ended September 28, 1997.
Continued declining service revenues reflect the effect on the service business
of: (i) the Company's prolonged decline in equipment sales; (ii) the price
competitiveness of the marketplace; and (iii) the completion of long running
government programs and subsequent deinstallation of systems. International
service sales decreased 28% and 29% to $1,589,000 and $5,206,000 for the three
and nine month periods ended September 27, 1998, respectively, while domestic
service sales decreased 24% and 16% to $1,063,000 and $3,680,000 compared to the
three and nine month periods in 1997. No service
22
<PAGE>
sales were derived from the storage product business for the three and nine
month periods ended September 27, 1998 and September 28, 1997.
International net sales decreased 59% and 47% for the three and nine month
periods ended September 27, 1998, respectively, (45% and 43% for real-time) when
compared to the same periods in 1997. Domestic net sales increased 2% and
decreased 25% (an increase of 52% and 4% for real-time) for the three and nine
month periods ended September 27, 1998 when compared to the 1997 three and nine
month periods. International net sales for the three and nine months ended
September 27, 1998 were $1,773,000 and $6,740,000, or 36% and 46% of total net
sales. International real-time net sales for the three and nine months ended
September 28, 1997 were $3,243,000 and $11,789,000, or 44% and 51% of total net
sales.
Total cost of sales decreased in the three and nine month periods ended
September 27, 1998 to $3,857,000 and $9,658,000, respectively, all of which was
for real-time, from $8,733,000 and $30,585,000 ($4,162,000 and $14,707,000 for
real-time and $4,571,000 and $15,878,000 for storage product) from the same
periods in 1997. The decrease was due generally to lower sales volumes and lower
spending resulting from the Sun Transaction.
Cost of equipment sales for the three and nine month periods ended September 27,
1998 were $1,998,000 and $3,697,000 or 86% and 65% of net equipment sales,
respectively. Cost of real-time equipment sales for the three and nine month
periods ended September 28, 1997 were $1,912,000 and $7,214,000 or 83% and 94%
of net real-time equipment sales, respectively. Cost of storage product sales
exceeded storage product sales by $1,411,000 and $7,162,000 for the three and
nine month periods ended September 27, 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 business in 1997 were also higher
than anticipated due to engineering changes on current installations and spare
part inventory. Factory variances related to lower production volumes and
underutilization of manufacturing capacity also lowered gross margin in the
three and nine month periods ended September 28, 1997. Gross margins on
real-time equipment sales were $323,000 and $1,993,000 or 14% and 35% for the
three and nine month periods ended September 27, 1998, respectively, as compared
to $405,000 and $452,000 or 17% and 6% for the three and nine month periods
ended September 28, 1997, respectively.
For the three and nine month periods ended September 27, 1998, service gross
margins were $793,000 and $2,925,000, respectively, compared to losses of
$298,000 and $759,000 for the same periods in 1997. For the three and nine month
periods in 1997, service margins were reduced for expenditures on various
programs and infrastructure necessary to support the storage product line, for
which no revenues were generated. The Company spent $1,643,000 and $4,954,000
(47% and 42% of service sales) in the three and nine month periods ended
September 28, 1997, respectively. Sun purchased all fixed assets and spares
inventory related to the storage product and hired all storage product service
personnel.
All service sales are derived from installed real-time products and the cost
structure within the service department is highly variable due to the
utilization of service partners.
23
<PAGE>
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 $793,000 and $2,925,000 (30% and 33%) for the three and
nine month periods ended September 27, 1998, respectively, compared to
$1,345,000 and $4,195,000 (37% and 36%) for the three and nine month periods
ended September 28, 1997, respectively.
Research and development expenses for the three and nine month periods ended
September 27, 1998 were $257,000 and $969,000, respectively, compared to
$6,455,000 and $20,876,000 for the same periods in 1997. The decrease in 1998
expenses is primarily the result of the Sun Transaction. Sun either hired or
contracted 147 or 68% of total research and development personnel. Research and
development expenses as a percentage of net sales decreased to 5% and 7% for the
three and nine month periods in 1998, compared to 87% and 90% for the same
periods in 1997.
In December 1997, the Company established a separate research and development
organization to focus on opportunities in the Microsoft NT environment. However,
in January 1998, as more fully discussed in Note C of the Notes to Condensed
Consolidated Financial Statements, the Board of Directors voted not to pursue
the NT opportunity.
Sales, general and administrative ("SG&A") expenses for the three and nine month
periods ended September 27, 1998 were $2,453,000 and $6,557,000, respectively,
compared to $6,743,000 and $21,961,000 for the same periods in 1997. The
decrease in expenses was due primarily to the Sun Transaction. Sun hired 65
storage product sales and marketing personnel or 45% of the Company's total
sales and marketing employees. Subsequently, the Company downsized the real-time
sales and marketing organization to 30 employees. As a percentage of net sales,
SG&A expenses were 49% and 45% for the three and nine month periods ended
September 27, 1998, respectively, compared to 91% and 95% for the same periods
of 1997.
Interest expense decreased in the three and nine month periods ended September
27, 1998 to $133,000 and $154,000, respectively, from $2,024,000 and $4,778,000
in the same periods of 1997 due to the repayment of the Gould debt in connection
with the Sun Transaction.
Other expense, net, was lower for the three month period of 1998 compared to the
same period of 1997 due to gains on foreign exchange in 1998 versus losses in
1997 as well as lower losses on the sale of certain fixed assets. Other expense,
net, was lower for the nine month period of 1998 compared to the same period of
1997 due to lower foreign exchange losses as well as lower losses on the sale of
certain fixed assets.
Income taxes provided for the three and nine month periods in 1998 and 1997
relate to operations of foreign subsidiaries.
LIQUIDITY AND CAPITAL RESOURCES:
For the nine month period ended September 27, 1998, the Company reported net
income of $21,252,000 (including $25,308,000 due to the receipt of a portion of
the Second
24
<PAGE>
Payment from Sun for the assets of the Company's former storage products
business), compared to a net loss of $56,465,000 for the same period of 1997.
Net cash used in operating activities for the first nine months of 1998
was $13,435,000 compared to $34,231,000 for the nine month period of 1997.
Working capital increased as the Company recorded the receipt of a potion of the
Second Payment from Sun in the amount of $25,308,000, offset by a decrease in
accounts payable and accrued liabilities of $10,643,000. As of September 27,
1998, total shareholders' equity was $1,606,000 versus a capital deficiency of
$19,646,000 as of December 31, 1997.
Expenditures for property and equipment during the nine months ended September
27, 1998 and September 28, 1997 were $201,000 and $1,190,000, respectively. The
decrease in 1998 spending resulted from management's decision to limit capital
expenditures to a minimum in light of the sale of the storage products business
to Sun and the uncertainty of the continuing real-time business. The gain from
the Sun Transaction with respect to the Second Payment was $25,308,000.
Cash used in financing activities of $25,774,000 during the nine months ended
September 27, 1998, represents the Second Payment from Sun in the amount of
$25,308,000 being paid to Gould as well as borrowings net of obligations assumed
by Gores under the Management Agreement of $466,000. Cash was provided through
financing activities of $35,946,000 in the first nine months of 1997. The
principal source of financing was through various agreements provided by the
Japan Energy Group, including Gould and other affiliates of Gould. On March 19,
1997, the Company and Gould agreed to cancel $40,000,000 of indebtedness owed to
Gould under their loan agreement (the "Credit Agreement") in exchange for the
issuance to Gould of 400,000 shares of the Company's Series I Convertible
Preferred Stock ("Series I") with a liquidation preference of $40,000,000. In
addition to the exchange of indebtedness for shares of Series I, the Company and
Gould also agreed to amend the Credit Agreement to: (i) reduce the maximum
amount which could be borrowed by the Company from $80,000,000 to $50,000,000;
and (ii) provide that any borrowings in excess of $41,915,869 (the principal
amount outstanding on March 19, 1997 after giving effect to the exchange of
indebtedness for shares of Series I) would 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, and $25,000,000 relating to 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.
Restricted cash of $1,285,000 and $14,083,000 at September 27, 1998 and December
31, 1997, respectively, represents cash held in an escrow account pursuant to an
escrow agreement dated November 24, 1997 between the Company and Sun. The escrow
arrangement was established to ensure that certain of the Company's liabilities
at the closing date of the Sun Transaction, would be paid when due. As the
Company pays these liabilities, escrow funds are released to the Company. These
funds are invested in a U.S. Bank money market fund and will be made available
to the Company pursuant to the terms of the escrow agreement. Restricted cash of
$14,083,000 at December 31, 1997, represents cash held in the escrow account.
The majority of cash and cash equivalents at September 27, 1998 consists of cash
available to the Company from the Total Cash Closing payment from the Sun
Transaction and cash at various international subsidiaries.
25
<PAGE>
With minor exceptions, all cash in the international subsidiaries is remittable
to the United States.
The Company has signed a definitive agreement to sell its real-time business
which was approved by the shareholders on September 11, 1998. Once the sale is
consummated, it is anticipated that the Company will be liquidated subsequent to
November 24, 1998, subject to shareholders' approval. (See Note D of Notes to
Condensed Consolidated Financial Statements).
The accompanying condensed consolidated financial statements have been prepared
assuming that the Company will continue as a going-concern. The Company has
agreed to sell its principal operating assets and plans to liquidate after
November 24, 1998, subject to shareholders approval. The Company will incur
substantial expenses in connection with a liquidation. The accompanying
condensed consolidated financial statements do not reflect either the effects of
the proposed sale of the Company's principal operating assets or the expenses it
will incur in connection with its liquidation. The Company has a substantial
obligation to Gould Electronics, Inc. which was to have been satisfied with the
Second Payment due from Sun Microsystems, Inc. under an agreement by which the
Company sold its storage products business to Sun. Sun has withheld a portion of
that Second Payment, because of claimed offsets. If Sun does not make the
balance of the Second Payment, the Company's obligation to Gould (which is
reflected on its balance sheet) plus expenses incurred in connection with the
Company's liquidation (which are not reflected on its balance sheet) are likely
to exceed its assets. The ultimate resolution of these matters is not presently
determinable.
CAUTIONARY STATEMENT RELATING TO FORWARD-LOOKING STATEMENTS
The foregoing Management's Discussion and Analysis of Financial Condition and
Results of Operations contains various "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended, which represent the
Company's expectations and beliefs concerning future events. The Company
cautions that these statements are further qualified by important factors that
could cause actual results to differ materially from those in the
forward-looking statements, including, without limitation, the following:
accelerated decline in demand for the Company's products; developments regarding
the sale of the real-time business; developments regarding the portion of the
Second Payment which Sun withheld; developments regarding the proposed
liquidation of the Company; and the effect of general economic conditions
generally and factors affecting the computer industry. These statements by their
nature involve substantial risks and uncertainties and actual events or results
may differ as a result of these and other factors. (See Exhibit 99 incorporated
herein by reference to the Company's Form 10-Q for the period ended June 30,
1996.)
26
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Shortly before the Sun Transaction was closed, shareholders of the Company
brought a derivative suit in the Delaware Chancery Court against Gould
and the Company's then directors, C. David Ferguson, Robert Fedor, Rowland
Thomas and Kenneth Fisher. Three similar shareholder suits were also filed and
all four suits have been consolidated as Civil Action #16044, In Re Encore
Computer Corporation Shareholders Litigation. The suit is currently in the
discovery stage. The Company does not believe the shareholder suit will have a
significant financial impact on the Company.
The Company is subject to other legal proceedings and claims which arise in the
ordinary course of its business. In the opinion of management, the amount of
the ultimate liability with respect to these actions will not materially affect
the financial position of the company.
Item 4. Submission of Matters to a Vote of Security Holders The Special
Meeting of Shareholders of the Company was held at the Sheraton Suites in
Plantation, Florida on September 11, 1998. At the meeting the shareholders
voted: (1) to approve the Gores Transaction; (2) to elect six (6) directors; and
(3) to approve the selection by the Board of Directors of PricewaterhouseCoopers
LLP as the Company's independent auditors for the fiscal year ending December
31, 1998. The results of the votes for each of these proposals were as follows:
<TABLE>
<CAPTION>
AGAINST/
FOR ABSTAIN
---------------
<S> <C> <C>
1. Gores Transaction 42,556,340 22,562,270
2. Election of Directors 52,535,134 12,583,476
3. Approval of Independent Auditors 53,519,058 11,599,552
</TABLE>
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 27.
Exhibit No. 27 - Financial Data Schedule. See page 28.
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended September 27, 1998.
27
<PAGE>
ENCORE COMPUTER CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned.
Encore Computer Corporation
/s/ MARY MACOMBER /s/ LINDA J. MATTHEWS
---------------------- -----------------------
Date: November 18, 1998 Mary Macomber Linda J. Matthews
President Vice President
Chief Executive Officer Chief Financial Officer
28
<PAGE>
EXHIBIT INDEX
EXHIBIT DESCRIPTION
- ------- -----------
11 Statement re: computation of per share earnings.
27 Financial Data Schedule.
<TABLE>
<CAPTION>
ENCORE COMPUTER CORPORATION
Computation of Income (Loss) per Share Exhibit No. 11
(unaudited)
(in thousands except per share data)
Three Months Ended Nine Months Ended
Sept 27, Sept 28, Sept 27, Sept 28,
Basic 1998 1997 1998 1997
<S> <C> <C> <C> <C>
Net income (loss) $ -1,726 $ -16,638 $ 21,252 $ -56,465
Series B, D, E, F, G, H and
I accumulated
Preferred Stock Dividends 0 -7,672 0 -21,794
Net income (loss) attributable
to common shareholders $ -1,726 $ -24,310 $ 21,252 $ -78,259
Weighted average common
shares outstanding 67,451 37,560 67,449 37,419
Basic income (loss) per share -0.03 -0.65 0.32 -2.09
Diluted
Net income (loss) $ -1,726 $ -16,638 $ 21,252 $ -56,465
Wghtd avg common shares outstand 67,451 37,560 67,449 37,419
Series A assumed converted 0 7,364 0 7,364
Series B assumed converted 42 24,096 14 23,745
Series D assumed converted 68 36,871 23 36,334
Series E assumed converted 69 37,688 23 37,140
Series F assumed converted 32 17,635 11 17,378
Series G assumed converted 35 18,924 12 18,648
Series H assumed converted 21 11,573 7 11,405
Series I assumed converted 10 12,555 3 8,920
Exercise of options reduced by
the number of shares purchased
with proceeds 0 0 0 0
Weighted average common
shares outstanding 67,728 204,266 67,542 198,353
Diluted income (loss) per share -0.03 -0.65 0.32 -2.09
</TABLE>
Basic and diluted income (loss) per common share are the same for all periods
presented because the effect of the common stock equivalents would be
antidilutive.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-27-1998
<CASH> 13,240
<SECURITIES> 1,285
<RECEIVABLES> 7,697
<ALLOWANCES> (1,183)
<INVENTORY> 823
<CURRENT-ASSETS> 23,182
<PP&E> 20,285
<DEPRECIATION> (19,615)
<TOTAL-ASSETS> 24,322
<CURRENT-LIABILITIES> (22,716)
<BONDS> 0
0
0
<COMMON> (674)
<OTHER-SE> (932)
<TOTAL-LIABILITY-AND-EQUITY> (24,322)
<SALES> (5,690)
<TOTAL-REVENUES> (14,576)
<CGS> 3,697
<TOTAL-COSTS> 9,658
<OTHER-EXPENSES> 89
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (675)
<INCOME-PRETAX> (21,740)
<INCOME-TAX> 488
<INCOME-CONTINUING> (21,252)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (21,252)
<EPS-PRIMARY> (0.32)
<EPS-DILUTED> (0.32)
</TABLE>
