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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] Annual Report pursuant to Section 13 or 15 (d) of the Securities and
Exchange Act of 1934.
For the fiscal year ended December 31, 1996 or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934.
Commission file Number 0-10370
IPL SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
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MASSACHUSETTS 04-2511897
(State or jurisdiction of (I.R.S. Employer Indentification No.)
incorporation or organization)
124 Acton Street, Maynard, Massachusetts 01754
(Address of principal executive offices and Zip Code)
(508) 461-1000
(Registrant's Telephone Number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, $.01 Par Value
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(Title of Class)
Indicate by a check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities and Exchange Act
of 1934 during the preceding 12 months (or for such shorter periods that the
Registrant was required to file such reports), and (2) has been subject to
filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definative proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [X]
The aggregate market value of Class A Common Stock held by non-affiliates of the
Registrant as of March 12, 1997 was: $ 10,888,232
The number of shares outstanding of the Registrant's Class A Common Stock as of
March 12, 1997 was: 5,633,819
DOCUMENTS INCORPORATED BY REFEREENCE
Portions of the Registrant's Proxy Statement for the 1997 Annual Meeting are
incorporated by reference into Part III of this Form 10-K.
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PART Item 1. Business
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GENERAL
IPL Systems, Inc. ("IPL" or the "Company") provides open-architecture storage
solutions for Hewlett Packard, Sun Microsystems, DEC Alpha, and IBM RS/6000 and
AS/400 Business servers, as well as Novell NetWare and Windows NT environments.
IPL design, manufactures, services and sells its products through direct,
indirect and OEM sales and service channels worldwide.
IPL has entered into an Agreement and Plan of Merger and Reorganization (the
"Merger Agreement"), dated as of February 28, 1997, among IPL, IPL Acquisition
Corp. ("Merger Sub"), a Delaware corporation and a wholly-owned subsidiary of
IPL, ANDATACO ("ANDATACO"), a California corporation, and W. David Sykes, the
controlling shareholder of ANDATACO providing for the merger (the "Merger") of
Merger Sub with and into ANDATACO. The Merger would result in former holders of
ANDATACO equity (including options, warrants and other rights to acquire
ANDATACO Common Stock, $1.00 par value per share) owning 74.8% of the
post-merger IPL Stock on a fully diluted basis. It is anticipated that approval
of matters related to the Merger will be submitted to the shareholders of IPL
and, if approved, will be consummated in the second quarter of 1997. In
addition to approval by the Company's shareholders, the Merger Agreement is
subject to several conditions, including those concerning the accuracy of the
Company's representations and warranties, the performance by the Company of
certain covenants, the agreement by a member of the Company's board of
directors to serve as Chief Executive Officer of ANDATACO following the Merger
and the expiration or early termination of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. There can be
no assurance that these or any other conditions to the Merger will be satisfied
or that the Merger will be consummated. For additional information regarding
the terms of the Merger and the Merger Agreement, see the Company's Current
Report on Form 8-K filed on March 25, 1997.
IPL was incorporated in Massachusetts on January 15, 1973. The Company's
principal office is located at 124 Acton Street, Maynard, Massachusetts 01754,
and its telephone number at that address is (508) 461-1000.
The discussion contained in this section as well as elsewhere in this report may
contain forward-looking statements based on the current expectations of the
Company's management. Such statements are subject to certain risks and
uncertainties which could cause actual results to differ materially from those
projected. See "Important Factors Regarding Forward-Looking Statements of IPL
Systems, Inc." attached hereto as Exhibit 99.1 and incorporated by reference
into this report. Readers are cautioned not to place undue reliance on these
forward-looking statements which speak only as of the date hereof. The Company
undertakes no obligation to publicly release the result of any revisions to
these forward-looking statements which may be made to reflect events or
circumstances occurring after the date hereof or to reflect the occurrence of
unanticipated events. See Rider re Exhibit 99.1.
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RECENT DEVELOPMENT OF BUSINESS
In 1996, IPL's strategy was to continue its focus on the large and growing
market for open systems storage. The Company's DataBase RAID (Redundant Array
of Independent Disks) architecture provides data management solutions for
users of large relational databases (such as Oracle, Sybase and Informix).
Several factors during 1996 adversely affected the Company's ability to fully
exploit the potential of its products in the market. These factors included the
inability to market and sell the Company products effectively, which resulted
in part from the departure of certain key sales personnel, and the delayed
introduction of certain strategic technology.
PRODUCT DEVELOPMENT
The Company's product development strategy is to identify opportunities for new
storage solutions for the open systems Very Large Database ("VLDB") market.
Typically, the Company will identify new devices available from third parties
which may bring significant benefits to users of IPL's targeted computer
platforms. The Company then adapts or develops its proprietary controllers to
provide an interface between these devices and the host computer without
requiring changes to the host's hardware or software. This approach is intended
to decrease development costs, accelerate new product development cycles and
enable the Company to be early to market with its storage offerings. See
"Research and Development" below.
In the fourth quarter of 1996, the Company introduced dual active controller
arrays for the open systems storage market. RAIDTower II's dual controllers
handle data simultaneously (active-active), as opposed to most implementations
in which one controller is active while the other sits idle (active-passive),
waiting for the other controller to fail. RAIDTower II's dual active
controllers accelerate performance because of multiple data paths from the host
IOPs. The protection of dual controller redundancy, combined with fast
performance, may make RAIDTower II an attractive solution for VLDB users whose
business operations demand high performance and high availability of critical
information. IPL expects that the product's success in the market will depend
upon customer demand for active-active solutions and its ability to expand
sales channels in the U.S.
MARKETS
Industry analysts from the International Data Corporation ("IDC") project that
the multi-billion dollar open systems storage market will continue to grow for
the next several years, at the rate of 20-30% annually. IPL's target customer in
this environment is the VLDB user whose storage needs range from 20-30 gigabytes
to multiple terabytes of data. Typically, this data is distributed across
multiple servers in data warehouse and on-line transaction processing ("OLTP")
applications in which data must be available at all
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times, and data loss is unacceptable. IPL products are designed to address the
requirements of these environments.
During 1996, the Company concentrated primarily on UNIX platforms (including
Hewlett Packard and Sun business servers), and added windows NT connectivity
during the course of the year. UNIX is expected to continue as the primary
market in 1997.
SALES AND DISTRIBUTION
The Company's new focus on open systems required adjustment in 1996 to the
direct sales force in North America, including some restaffing and significant
training of IPL personnel to support users in UNIX multi-server environments. By
the end of 1996, the 15 member sales team in North America consisted of 9 sales
representatives, 3 inside sales staff supporting the field, and 3 field
engineers.
In connection with the Merger Agreement, IPL engaged ANDATACO as a
non-exclusive worldwide reseller of IPL's products pursuant to an OEM Agreement
dated as of February 25, 1997. Shortly thereafter, IPL discontinued direct
sales, which included the termination of its direct sales force. The Company
now relies almost exclusively on ANDATACO as the primary distributor of its
products. ANDATACO has hired many of the prior IPL employees, as well as
certain representatives who had previously left IPL to work with other
companies. The OEM Agreement can be terminated by either party on thirty day's
notice. If the OEM Agreement is terminated, there can be no assurance that the
Company will be able to access alternative distribution channels and may,
therefore, confront significant difficulties marketing its products. There also
can be no assurance that the Company's relationship with ANDATACO will
ultimately prove successful.
In addition to its existing agreements with its STARs in the U.S., during 1996,
the Company continued to market its technology, on a limited basis, through
independent non-exclusive distributors worldwide. In Europe, these distributors
included Decision Systems International (DSI), an affiliate of Ing.C.Olivetti &
C.,S.p.A. ("Olivetti"), and GUWA Computer Systems. In Asia, these distributors
included Kanamatsu Electric LTD (KEL). The Company's international distributors
remained focused on the IBM AS/400 market during 1996. While some overseas
customers are beginning to move toward open systems technology, the pace of
adoption overseas is still expected to lag behind the U.S. The Company is not
currently attempting to engage new distributors and is relying primarily on its
relationship with ANDATACO for growth. The Company expects that its
relationship with ANDATACO may improve sales; however there can be no
assurance of such improvement or, if its relationship with ANDATACO is
unsuccessful or only moderately successful, that the Company could expand sales
through other distributors. Overall, the Company continues to have difficulty
penetrating markets, both in the U.S. and abroad, and no assurance can be given
that the Company's efforts, including the transition out of direct sales, will
be able to reverse this trend.
Consistent with industry practice, the Company provides its distributors with
discounts from IPL list prices, which are based on a number of factors,
including the nature and volume of the distributor's business and its sales
territory. Generally, IPL's agreements with its distributors establish
territories and pricing and may be canceled on short notice and/or contain no
firm purchase commitments.
All of the Company's sales in 1996 were in U.S. dollars. For additional
information regarding the Company's export sales, see Note 11 of the Notes to
Consolidated Financial Statements contained elsewhere in this report.
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BACKLOG
The Company believes that sales backlog is generally not material to its
business because the Company usually ships products within 30 days from receipt
of orders.
MANUFACTURING AND SUPPLIERS
Manufacture of the Company's disk drive sub-systems and tape drive systems
involves the assembly of purchased electro/mechanical components, custom-made
printed circuit boards fabricated in accordance with the Company's proprietary
designs, storage devices, standard integrated circuits and power supplies. All
products manufactured by IPL in this manner are then tested in the Company's
quality assurance program.
The Company has and will continue to rely on outside vendors to manufacture
certain electronic components and subassemblies used in the production of the
Company's products. Certain components, subassemblies, materials and equipment
necessary for the manufacture of the Company's products are obtained from a sole
supplier or a limited group of suppliers. The Company's reliance on sole
suppliers or a limited group of suppliers involves several risks, including a
potential inability to obtain an adequate supply of required products and
reduced control over the price, timely delivery, reliability and quality of
finished products. The Company does not have any long-term supply agreements
with its suppliers. Certain of the Company's suppliers have relatively limited
financial and other resources. Any inability to obtain timely deliveries of
products and services having acceptable qualities, or any other circumstance
that could require the Company to seek alternative sources of supply or to
manufacture its own electronic components, subassemblies and manufacturing
equipment internally, could delay the Company's ability to ship its products.
Any such delay could damage relationships with customers and could have a
material adverse effect on the Company's business and operating results.
COMPETITION
The computer data storage industry is intensely competitive and is characterized
by rapid technological change and constant pricing pressure. IPL competes with a
number of companies offering computer data storage, backup and recovery systems.
In the open systems storage market, EMC , Data General Corporation, server
systems manufacturers and resellers of servers are the major competitors, but
the Company believes that to date no dominant suppliers have emerged in the very
large database segment of the open systems storage market. Because IPL's systems
have to be compatible with the systems of the principal manufacturers of
UNIX-based open systems computers and the relational database software programs,
IPL's competitive position and operating results may be adversely affected by,
among other factors, modifications in the design of such systems or programs,
the introduction of new products by such manufacturers or other competitors,
reductions in the pricing of storage solutions in these markets, or the
implementation of new marketing strategies by any of its principal competitors.
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Today IPL focuses less on the AS/400 market than in prior years, but continues
to support its AS/400 customers. In this market, competitors include
International Business Machines ("IBM") and others. In both the UNIX and AS/400
markets, the company's competitors may have substantially greater financial,
product development marketing distribution resources than the Company.
There are several elements of competition in the market for computer storage
solutions. Principal among them are product quality and reliability, time to
market, price/performance characteristics, service and support, marketing and
distribution capability and the ability to deliver products in large volumes.
IPL believes that it competes favorably with respect to these elements, except
for marketing and distribution capabilities.
PRODUCT WARRANTY AND SERVICE
Disk and tape drive products have a warranty that covers defective material and
workmanship during the warranty period. Installation and maintenance service is
available to customers through various service providers, including Olivetti
North America, a U.S. affiliate of Olivetti, and DecisionOne. Certain of the
Company's major distributors also provide similar services. Technical support
for these services is provided from the Company's Maynard, Massachusetts, and
Brussels, Belgium offices.
RESEARCH AND DEVELOPMENT
IPL's ability to compete successfully depends upon the identification and
development of new storage, backup, and recovery solutions for the open systems
market. To achieve this goal, the Company's engineering group continuously
monitors hardware and software product development.
With the Company's focus on integrated hardware and software solutions, IPL has
developed software to further enhance its storage products. This software
includes the Centralized Management Systems ("CMS"), which monitors, tunes and
services IPL storage in local and distributed environments, and the software
component in ParellelBACK. Continued research and development in software is
intended to enhance ease of use, maintenance, and functionality of the Company's
storage solutions.
With respect to hardware, IPL will often evaluate and test a major component
that becomes available in the market, and subject it to IPL's own reliability
testing procedures to enable IPL to select the best available products with
adaptive potential for its markets. Once such a component has been identified
and qualified under IPL's reliability testing procedures, IPL then applies its
knowledge of host systems to adapt one of its proprietary controllers or develop
a new controller to provide an interface between the peripheral storage device
and the identified host computer. To facilitate this process, IPL has designed
standard controllers for several of the existing peripheral interfaces.
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To the extent that IPL is able to use its proprietary controllers for new
subsystems, the Company has been able to develop new products quickly at low
expense. However, because the computer industry is subject to rapid
technological development, there can be no assurance that IPL will be able to
respond in an effective or timely fashion to such changes. Historically, IPL
has been able to respond to technological changes introduced to the AS/400
market. In 1996, the Company responded to demand in the open systems market for
new dual controller technology by introducing the RAIDTower II. To date, IPL
remains one of a limited number of manufacturers delivering dual
(active-active) controller subsystems. Despite this early introduction,
however, the Company has had limited initial success in marketing this product.
The Company expects, subject to the risk factors mentioned herein, that this
ability to respond should continue with manufacturers in the open systems
business for which the Company currently develops storage and backup
technology. These manufacturers include Hewlett Packard, Sun Microsystems and
others.
During its fiscal year ended December 31, 1996, the Company incurred costs of
$1,439,000 for engineering and product development, compared to $1,317,000 in
1995 and $1,784,000 in 1994. The Company's research and development efforts
continue to focus on new products that utilize the Company's engineering
expertise in the design of storage products.
PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY
The Company believes that its success in developing new products depends
primarily upon the technical competence and creative skills of its personnel
rather than on the ownership of copyrights or patents. The Company has no
patents on its current products, but in 1995 the Company filed applications for
patents in the United States and foreign countries with respect to the
ParallelBACK product and another product introduced in 1996. The status of
patents involves complex legal and factual questions and the breadth of claims
allowed is uncertain. There can be no assurance as to the likelihood that
pending patents will be issued or that any such patents will afford protection
against competitors with similar technology. In addition, patent applications
filed in foreign countries may provide significantly less patent protection than
the United States. No assurances can be given that patents issued to the Company
will not be infringed upon or designed around by others.
Due to the rapid technological development of the computer data storage industry
with concurrent extensive patent coverage and with the rapid rate of issuance of
new patents, certain aspects of the Company's products may infringe patents
unknown to the Company. Patent protection may also be obtained in the future on
new inventions and designs for peripheral storage subsystems or the computers to
which the Company's subsystems attach. Although the Company believes that its
products and other proprietary rights do not infringe the proprietary rights of
third parties, there can be no assurance that other third parties will not
assert infringement claims against the Company or that such claims will not be
successful. If any infringement exists or any such patents
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are issued, the Company would seek, based upon industry practice, licenses to
such patents, but there can be no assurance that the Company will be able to
obtain any such licenses on terms which would not have a material adverse effect
on its business.
The Company also relies on unpatented proprietary technology, and there can be
no assurance that others may not independently develop the same or similar
technology or otherwise obtain access to the Company's proprietary technology.
To protect its rights in these areas, the Company requires all employees to
enter into confidentiality agreements. There can be no assurance that these
agreements will provide meaningful protection for the Company's trade secrets,
know-how or other proprietary information in the event of any unauthorized use,
misappropriation or disclosure of such trade secrets, know-how or other
proprietary information. If the Company is unable to maintain the proprietary
nature of its technologies, the Company's business could be adversely affected.
REGULATORY APPROVALS
All of the Company's current and proposed products have to comply with and have
regulatory or independent laboratory approval based on emissions and safety
standards for computing equipment. Delays in complying with such standards or in
obtaining any such approvals could delay introductions of new products.
International sales are subject to compliance with laws of various countries,
import/export restrictions and tariff regulations. While IPL is aware that it
may be subject to export restrictions with respect to certain countries, it has
not experienced difficulty in obtaining export licenses from the United States
Department of Commerce for sales into countries where it presently sells.
EMPLOYEES
On March 18, 1997, the Company had 61 full-time employees. The Company believes
it has a satisfactory relationship with its employees. The success of the
Company's operations depends, in part, on the Company's ability to attract and
retain experienced technical, sales, marketing and management personnel. Such
experienced personnel are in great demand and the Company must compete for their
services. None of the Company's employees is covered by a collective bargaining
agreement.
Item 2. Properties.
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The Company currently occupies approximately 59,000 square feet of leased office
and manufacturing space worldwide, with an average annualized rental cost, net
of sub-lease/income, of approximately $370,000 for 1996. Since April 1995, the
Company's lease of its facility located in Maynard Massachusetts covers 123,700
square feet of office and manufacturing space for a term extending through March
31, 1998. During 1995, the Company consolidated its activities into
approximately 42,000 square feet in the Maynard facility and has offered the
remaining space for sublease (See Notes 6 and 12 of
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Notes to the Consolidated Financial Statements). In March 1996 the Company
subleased an additional 36,700 square feet of its Maynard facility for a term
commensurate with the prime lease. In February 1997 the Company subleased an
additional 5,425 feet of its Maynard facility with options for a term
commensurate with the prime lease. In support of its direct sales program, the
Company had 9 regional offices which generally consisted of not more than
approximately 1,000 square feet, made available to the Company under occupancy
and service agreements with terms ranging between twelve and thirty-six months
all of which are expected to be terminated within months in connection with the
Company's transition out of Direct Sales in the U.S.
Item 3. Legal Proceedings.
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There are no legal proceedings to which the Company is a party, other than
routine litigation incidental to the business, none of which is believed to be
material.
Item 4. Submission of Matters to a Vote of Security Holders.
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No matter was submitted to a vote of the Company's security holders during the
quarter ended December 31, 1996.
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PART II
Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS.
The Company's Class A Common Stock is traded on the Nasdaq Stock Market system
under the symbol IPLS. The following table reflects, for the period indicated,
the high and low sales prices for the Class A Common Stock as reported by
Nasdaq.
Price
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Year High Low
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1996 First Quarter 5 7/8 2 1/2
Second Quarter 8 1/4 3 1/2
Third Quarter 4 1/4 1 7/8
Fourth Quarter 2 1/2 1 1/4
Year
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1995 First Quarter 5 1/2 2
Second Quarter 6 3/4 3 5/8
Third Quarter 7 7/8 5 3/8
Fourth Quarter 6 5/16 2 3/4
On March 12, 1997 the last sale price of the Company's Class A Common Stock was
$2.313, and there were approximately 280 record holders and more than 2400
beneficial holders of the Company's Class A Common Stock.
The Company has never paid a cash dividend on its Class A Common Stock and it is
currently anticipated that cash dividends will not be paid to holders of Class A
Common Stock in the foreseeable future.
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Item 6. Selected Financial Data.
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1996 1995 1994 1993 1992
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Five-year Financial Summary Revenues $ 17,064 $ 24,764 $ 29,949 $ 39,721 $ 53,572
Dollars in thousands
(except per share amounts) Net income (loss) $ (2,142) $ (3,464) $ (15,046) $ (2,451) $ 3,053
Net income (loss)
per share $ (0.38) $ (0.63) $ (2.80) $ (0.47) $ 0.56
Weighted average
common shares
outstanding 5,617,926 5,469,177 5,381,519 5,235,964 5,435,649
Working capital $ 4,921 $ 6,195 $ 8,285 $ 21,549 $ 25,935
Total assets $ 10,614 $ 13,742 $ 18,764 $ 37,757 $ 39,355
Long-term debt $ -- $ -- $ -- $ -- $ --
Shareholder's
equity $ 6,550 $ 8,543 $ 11,352 $ 26,398 $ 28,399
Current ratio 2.2:1 2.2:1 2.1:1 2.9:1 3.4:1
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
The discussion contained in this item may contain forward-looking statements
based on the current expectations of the Company's management. Such statements
are subject to certain risks and uncertainties which would cause actual results
to differ materially from those projected. See "Important Factors Regarding
Forward-Looking Statements of IPL Systems, Inc." Filed as Exhibit 99.1 to this
report which is incorporated by reference into this report . Readers are
cautioned not to place undue reliance on these forward-looking statements which
speak only as of the date hereof. The Company undertakes no obligation to
publicly release the result of any revisions to these forward-looking statements
which may be made to reflect events or circumstances occurring after the date
hereof or to reflect the occurrence of unanticipated events.
The Company and ANDATACO entered into a definitive agreement dated as of
February 28, 1997 to merge the two companies. See Item 1, "Business - General"
above. IPL management believes that a successful merger would allow the Company
to obtain greater penetration into the rapidly expanding open systems storage
market and provide a broader revenue base to enable the Company access to
additional capital resources and reduction in overhead costs as a percentage of
revenues. In the absence of such a merger, management believes, based on its
cash flow estimates, that overhead cost burdens could be reduced in order to
provide a break-even cash flow and permit the Company's continuance as a going
concern only if recent revenue levels increased. Absent the Merger or an
alternative third-party channel of distribution, through ANDATACO or otherwise,
management does not believe that the Company will be able to achieve any such
increase in revenue.
The Company's net loss for 1996 was $2,142,000, or $0.38 per share, compared
with a net loss of $3,464,000, or $0.63 per share in 1995. The lower net loss
in 1996 resulted from higher gross margins from the sale of open systems
products, as well as reduced expenses. The Company has experienced increased
expenses in 1997 in connection with the Merger Agreement. The Company has
discontinued direct sales. In the foreseeable future, the Company intends to
sell almost exclusively pursuant to arrangements with ANDATACO. See Item 1
above. The pace of early sales under the Company's new marketing approach have
been disappointing and there can be no assurance that sales will ultimately
improve. Furthermore, the Company's reliance on one primary distributor is
inherently risky.
RESULTS OF OPERATIONS 1995 COMPARED WITH 1994
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Revenues in 1996 were $17,064,000 compared with $24,764,000 in 1995. This 31%
decrease in revenue compared to a year ago is the result of several factors,
including continued competitive pressures; changes in the business priorities of
the Company's major European distributors; the departure of several U.S. sales
representatives employed
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by IPL and the delay in releasing certain strategic new technology. Total open
systems products sales grew from 26% of total product revenue in 1995 to 54% in
1996. Total U.S. sales were 73% and international sales were 27% in 1996
compared with 66% and 34%, respectively, for 1995. Disk revenue was 75% of total
revenue in 1996 and 77% in 1995 respectively.
Gross margins were 44% in 1996 compared with 38% in 1995. The improvement is
the result of reduced costs, increased gross margins on U.S. open systems
product sales, and higher extended warranty revenues as well as partial
recoveries of a doubtful accounts receivable that was reserved in an earlier
period which totalled $1,550,000 in 1996 and $1,767,000 in 1995. Selling,
general and administrative expenses decreased approximately 26% to $8,501,000
in 1996 compared with $11,436,000 in 1995. This $2,935,000 decrease is
primarily due to IPL employing fewer sales representatives and ongoing expense
control as well as the reduction in revenue.
Engineering and development expenses were $1,439,000 in 1996 compared with
$1,317,000 in 1995. These additional expenses permitted the Company to develop
new storage backup and disaster recovery solutions for the database segment of
the UNIX market. On October 3, 1996, the Company announced the RAIDTower II
storage system with dual active technology.
Restructuring expenses were increased $497,000 in 1995 to cover the entire
occupancy cost for unused space for the balance of the lease term of the
Company's Maynard facility. In 1994, the Company recorded a $1,971,000
restructuring charge in connection with substantially reducing the scale of its
operations, and refocused on product development and sales efforts on the open
systems market.
The 1994 restructuring expense was reduced by $100,000 in the first quarter of
1996, when the Company sublet a portion of the unused space in its Maynard
facility. The occupancy cost associated with this space had been previously
expensed in the third quarter of 1995 when restructuring expenses increased
$497,000 to cover the entire occupancy cost for unused space for the balance of
the lease term of the Company's Maynard facility. In the fourth quarter of 1994,
the Company had recorded a $1,971,000 restructuring charge when it had reduced
the scale of its operation and refocused on product development and sales
efforts in the open systems market.
Other income decreased to $123,000 in 1996 from $274,000 in 1995 primarily
due to lower average cash balances during 1996.
The Company had no federal tax liability in 1996. The Company fully utilized its
benefit from the net operating loss carryback in 1994. There are approximately
$14,000,000 of federal and $26,000,000 of state tax loss carryforwards
available through 2011 and 2001, respectively. The Company's ability to use
these losses will be subject to certain annual limitations as a result of the
change in control if the proposed Merger is consummated. See Note 5 to the
Notes to Consolidated Financial Statements.
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In 1996 the Company had a net loss of $2,142,000, or $ 0.38 per share, compared
with the 1995 net loss of $3,464,000, or $0.63 per share.
1995 COMPARED WITH 1994
In 1995, the Company's revenues were $24,764,000 compared to $29,949,000 in
1994. This decline was primarily due to a significant reduction in purchases
made by the Company's European distributors who have been slow to transition to
the open systems technology. Continued competitive pressures and changes in the
business priorities of the Company's major European distributors contributed to
the decline in European sales. U.S. and non-European revenues were approximately
the same for 1995 and 1994. Open systems product sales represented 26% of total
product revenue in 1995 compared to 2% in 1994. Disk revenue was 77% of total
revenue in 1995 and 75% in 1994.
Gross margins were 38% in 1995 compared with 10% in 1994. The increase
in margins of approximately 280% was due to reduced costs, the transition from
the AS/400 market to the open systems market, and a partial recovery of a
doubtful accounts receivable in 1995 which had been fully reserved in 1994. The
1994 gross margin was reduced by $4,600,000 relating to provisions for bad
debts and excess and obsolete inventory reserves.
Selling, general and administrative expenses decreased approximately 27% in 1995
from 1994. This was primarily due to reengineering of the Company's operations
and ongoing expense control.
Engineering and development expenses decreased approximately 26% in 1995
compared with 1994 as a result of lower costs associated with the development of
open systems products.
Total other income decreased from $274,000 in 1995 to $288,000 in 1994 primarily
due to lower average cash balance during 1995.
There was no federal tax liability in 1995. The Company fully utilized its
benefit from the net operating loss carryback in 1994. The effective tax benefit
rate in 1994 was 7.2%
In 1995 the Company had a net loss of $3,464,000 or $0.63 per share, compared
with the 1994 net loss of $15,046,000 or $2.80 per share.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and equivalents as of December 31, 1996 were $2,274,000
compared with $3,595,000 at December 31, 1995. Accounts receivable decreased 41%
from $4,019,000 at December 31, 1995 to $2,391,000 at December 31, 1996. This
decrease was the result of the reduction in revenue. Inventories increased 15%
to $3,891,000 at December 31, 1996 from $3,375,000 at December 31, 1995, due
primarily
13
15
to the new RAIDTower II product and also maintaining RAIDTower I product in
anticipation of higher revenue in the fourth quarter of 1996. Accounts payable
and accrued expenses decreased $1,135,000 primarily due to reduced purchasing
requirements and operating expenses.
As of December 31, 1996, IPL had working capital of $4,921,000, a decrease of
$1,274,000, or approximately 21%, from $6,195,000 as of December 31, 1995.
IPL's current ratio remained stable at about 2.2:1 as of the end of both years.
In the year ended December 31, 1996, IPL used $1,159,000 in cash to fund the
losses of its operating activities. If IPL's operating activities continue to
generate losses and use IPL's remaining cash, IPL will need to either liquidate
assets or seek outside sources of financing, which, if available at all, may not
be available on reasonable terms. IPL's management does not anticipate any such
needs if both (i) its OEM Agreement with ANDATACO produces cash receipts
anticipated by Company management and (ii) the Merger is consummated by the end
of May. If the Merger is delayed or terminated or if projected cash receipts
from the arrangements with ANDATACO are less than management projects, IPL will
need to attempt to access outside sources of capital. There can be no
assurance, however, that such outside sources of capital will be available.
14
16
Item 8. Financial Statements and Supplementary Data.
-------------------------------------------
See Item 14 for Financial Statement filed as part of this Form 10-K.
Quarterly Financial Data (Unaudited)
Summarized unaudited quarterly financial data for 1995 and 1994 (dollars in
thousands, except per share amounts) is as follows:
1996 - Three Months Ended March 31 June 30 Sept. 30 Dec. 31
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 7,101 $ 4,464 $ 3,077 $ 2,422
Net income (loss) 230 ( 581) ( 796) ( 996)
Net income (loss) per common share .04 ( 0.10) ( 0.14) ( 0.18)
1995 - Three Months Ended March 31 June 30 Sept. 30 Dec. 31
- ----------------------------------------------------------------------------------------------------------------
Revenue $ 6,517 $ 6,707 $ 4,524 $ 7,016
Net loss ( 785) ( 389) ( 1,910) ( 380)
Net loss per common share ( 0.15) ( 0.07) ( 0.35) ( 0.07)
Item 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
None.
15
17
PART III
Item 10. Directors and Executive Officers of the Registrant.
--------------------------------------------------
The information required to be reported hereunder is incorporated by reference
to the information reported in the Company's Proxy Statement for its 1997 Annual
Meeting of Stockholders under the caption "Election of Directors", "Executive
Officers" and "Compliance with Section 16 (a) of the Securities Exchange Act of
1934".
Item 11. Executive Compensation.
----------------------
The information required to be reported hereunder is incorporated by reference
to the information reported in the Company's Proxy Statement for its 1997 Annual
Meeting of Stockholders under the caption "Executive Compensation" and "Election
of Directors -- Director Compensation."
Item 12. Security Ownership of Certain Beneficial Owners and Management.
--------------------------------------------------------------
The information required to be reported hereunder is incorporated by reference
to the information reported in the Company's Proxy Statement for its 1997 Annual
Meeting of Stockholders under the caption "Share Ownership".
Item 13. Certain Relationships and Related Transactions.
----------------------------------------------
The information required to be reported hereunder is incorporated by reference
to the information reported in the Company's Proxy Statement for its 1997 Annual
Meeting of Stockholders under the caption "Certain Transactions" and Note 10 of
the Notes to Consolidated Financial Statements contained elsewhere in this
report.
16
18
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- -------------------------------------------------------------------------
Page Number
-----------
(a) (1) The following report and financial statements of
IPL Systems, Inc. are filed as part of this Form 10-K:
Independent Auditors' Report 23
Consolidated Balance Sheets - December 31, 1996 and 1995 24
Consolidated Statements of Operations - Years Ended
December 31, 1996, 1995 and 1994 25
Consolidated Statements of Stockholders' Equity --
Years Ended December 31, 1996, 1995, and 1994 26
Consolidated Statements of Cash Flows --
Years Ended December 31, 1996,
1995 and 1994 27
Notes to Consolidated Financial Statements 28
(a) (2) The following report and financial schedule
of IPL Systems, Inc. are filed as part of the Form 10-K:
Schedule VIII -- Valuation of Qualifying
Accounts 38
Independent Auditors' Consent and Report on
Schedule 76
All other schedules are omitted because they are not applicable, or not
required, or because the required information is included in the consolidated
financial statements or notes thereto.
17
19
(a) (3) The following exhibits are filed as part of this Form 10-K:
Exhibit
Number Exhibit
- ------ -------
2.1 Agreement and Plan of Merger and Reorganization dated as of
February 28, 1997, by and among the Company, IPL Acquisition
Corp., ANDATACO and W. David Sykes, filed Exhibit 2.1 to the
Company's Current Report on Form 8-K dated as of February 28, 1997
and incorporated herein by reference.
3.1 Restated Articles of Organization dated March 24, 1981, and
Articles of Amendment, dated May 12, 1981, and July 8, 1992, filed
as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1992 (the "1992 Form 10-K"), and
incorporated herein by reference.
3.2 By-Laws, as amended, filed as Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1987
(Commission File No. 0-10370) and incorporated herein by
reference.
10.1 Stockholder Agreement dated as of April 25, 1980, as amended,
filed as Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File No. 2-71414) "1981 Registration Statement") and
incorporated herein by reference.
10.2 Second Amendment to Stockholder Agreement dated as of May 24,
1989, filed as Exhibit 10.3. to the Company's Registration
Statement on Form S-1 (File No. 33-40454) (the "1991 Registration
Statement") and incorporated herein by reference.
10.3 Form of Indemnification Agreement, filed as Exhibit 10.8 to the
Company's 1991 Registration Statement and incorporated herein by
reference.
10.4 Lease dated August 20, 1992 between the Company and Maynard
Industrial Park Associates, filed as Exhibit 10.2 to the 1992
Form 10-K and incorporated herein by reference.
10.5 1993 Director Stock Option Plan, filed as Exhibit 10.12 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1993 (the "1993 Form 10-K") and incorporated herein
by reference.
10.6 Form of Executive Severance Agreement, filed as Exhibit 10.13 to
the 1993 Form 10-K and incorporated herein by reference.
10.7 1991/1993 Consolidated Equity Incentive Plan, filed as Exhibit
10.9 to the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1994 (the "1994 Form 10-K") and
incorporated herein by reference.
18
20
10.8 Consulting Agreement dated as of January 1, 1995 between the
Company and Firecracker Technology Corp., filed as Exhibit 10.8 to
the 1994 Form 10-K and incorporated herein by reference.
10.9 Employment Agreement with Ronald J. Gellert dated as of December
4, 1995 between the Company and Ronald J. Gellert, filed as
Exhibit 10.9 to the
Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1995 (the "1995 Form 10-K") and incorporated herein
by reference.
10.10 Stock Option Agreement dated as of December 4, 1995 between the
Company and Ronald J. Gellert, filed as Exhibit 10.10 to the 1995
Form 10-K and incorporated herein by reference to the 1995 Form
10-K and incorporated herein by reference.
10.11 1996 Consolidated Equity Incentive Plan, filed herewith as
Exhibit 10.11.
10.12 Consulting Agreement dated as of October 1, 1996 between the
Company and Cornelius P. McMullan, filed herewith as Exhibit
10.12.
10.13 Consulting Agreement dated as of October 1, 1996 between the
Company and Harris Ravine, filed herewith as Exhibit 10.13.
10.14 Consulting Agreement dated as of January 1, 1997 between the
Company and BI Capital, Ltd., filed herewith as Exhibit 10.14.
10.15 Form of Consulting Agreement dated as of March 1, 1997 between
the Company and Harris Ravine, filed herewith as Exhibit 10.15.
10.16 OEM Agreement dated as of February 25, 1997 between the Company
and ANDATACO, filed herewith as Exhibit 10.16.
11 Computation of Net Income per Common Share, filed herewith as
Exhibit 11.
21.1 List of subsidiaries, filed as Exhibit 22 to the 1991 Registration
Statement and incorporated herein by reference.
23. Consent of Deloitte & Touche LLP, Independent Certified Public
Accountants, filed herewith as Exhibit 23.
99.1 Important Factors Regarding Future Results of IPL Systems, Inc.,
filed herewith as Exhibit 99.1.
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
Exhibits 10.3 and 10.5 through 10.15 to this Form 10-K are management contracts
or compensatory plan arrangements.
Reports on Form 8-K
-------------------
There were no reports on Form 8-K filed for the quarter ended December 31, 1996.
19
21
SIGNATURES
Pursuant to the requirement of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, IPL Systems, Inc. has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
IPL SYSTEMS, INC.
By: /s/ Ronald J. Gellert
-----------------------
Ronald J. Gellert
President and Chief Executive Officer
March 26, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ Ronald J. Gellert
- ----------------------------- President, Chief Executive March 26, 1997
Ronald J. Gellert Officer and Director (Principal
Executive Officer)
/s/ Eugene F. Tallone
- ----------------------------- Vice President - Finance, Chief March 26, 1997
Eugene F. Tallone Financial Officer and Treasurer
(Principal Financial and
Accounting Officer)
/s/ Stephen J. Ippolito
- ----------------------------- Director March 26, 1997
Stephen J. Ippolito
/s/ Cornelius P. McMullan
- ----------------------------- Director March 26, 1997
Cornelius P. McMullan
/s/ Harris Ravine
- ----------------------------- Director March 26, 1997
Harris Ravine
20
22
INDEPENDENT AUDITOR'S REPORT
To the Board of Directors and Stockholders of
IPL Systems, Inc.
Maynard, Massachusetts
We have audited the accompanying consolidated balance sheets of IPL Systems,
Inc. and its subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity, and cash flows for
each of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of IPL Systems, Inc. and its
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 2 to the
consolidated financial statements, the Company's losses from operations and past
and anticipated cash flow deficiencies raise substantial doubt about its ability
to continue as a going concern. Management's plans concerning these matters are
also described in Note 2. The consolidated financial statements do not include
any adjustments that might result from the outcome of this uncertainty.
As discussed in Note 14 to the consolidated financial statements, the Company
has signed a Definitive Agreement of Merger and Reorganization dated as of
February 28, 1997 with anDATAco and taken certain other related actions.
Boston, Massachusetts
February 21, 1997
(Except for Note 14, for which the date is March 7, 1997)
23
IPL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
- -----------------------------------------------------------------------------------------------------------------------------------
ASSETS 1996 1995
CURRENT ASSETS:
Cash and equivalents $ 2,274,080 $ 3,595,268
Accounts receivable - trade (net of allowance
for doubtful accounts of $353,000 and $2,111,000) 2,391,330 4,018,511
Inventories 3,891,466 3,375,652
Prepaid expenses and other current assets 428,289 404,564
----------- ------------
Total current assets 8,985,165 11,393,995
----------- ------------
EQUIPMENT, FIXTURES AND
LEASEHOLD IMPROVEMENTS:
Manufacturing equipment 4,931,807 4,883,499
Office equipment and fixtures 2,190,977 2,319,517
Customer support equipment 3,103,577 3,500,011
Leasehold improvements 1,338,598 1,334,788
----------- ------------
11,564,959 12,037,815
Less accumulated depreciation and
amortization 9,935,858 9,689,630
----------- ------------
1,629,101 2,348,185
$ 10,614,266 $ 13,742,180
============ ============
LIABILITIES AND STOCKHOLDERS'
EQUITY 1996 1995
CURRENT LIABILITIES:
Trade accounts payable $ 3,188,660 $ 3,583,605
Accrued payroll expenses 391,554 827,026
Accrued restructuring expenses 291,773 594,782
Other accrued expenses 192,307 193,959
------------ ------------
Total current liabilities $ 4,064,294 $ 5,199,372
------------ ------------
STOCKHOLDERS' EQUITY:
Class A common stock, $.01 par value -
authorized, 20,000,000 shares; issued
and outstanding, 5,633,819 shares and
5,200,590 shares at December 31, 1996
and 1995, respectively 56,338 52,006
Class C common stock, $.01 par value -
authorized, 2,250,000 shares; issued and
outstanding, 386,929 shares at
December 31, 1995 - 3,869
Additional paid-in capital 17,378,568 17,230,023
Deficit (10,884,934) (8,743,090)
------------ ------------
Total stockholders' equity 6,549,972 8,542,808
------------ ------------
$ 10,614,266 $ 13,742,180
============ ============
See notes to consolidated financial statements.
-2-
24
IPL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- ---------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
REVENUES:
Product $14,593,901 $22,952,315 $ 27,511,453
Service 2,470,531 1,811,500 2,437,072
----------- ----------- ------------
17,064,432 24,763,815 29,948,525
----------- ----------- ------------
COSTS AND EXPENSES:
Cost of sales 9,488,716 15,251,668 26,938,094
Selling, general and administrative expenses 8,501,768 11,436,222 15,759,705
Engineering and development 1,438,936 1,317,299 1,784,113
Restructuring expenses (income) (100,000) 496,880 1,970,587
----------- ----------- -----------
19,329,420 28,502,069 46,452,499
----------- ----------- -----------
OPERATING LOSS (2,264,988) (3,738,254) (16,503,974)
OTHER INCOME:
Interest 118,922 199,568 162,857
Other, net 4,222 74,923 124,906
----------- ----------- -----------
LOSS BEFORE INCOME TAX BENEFIT (2,141,844) (3,463,763) (16,216,211)
INCOME TAX BENEFIT - Federal - - (1,170,000)
NET LOSS $(2,141,844) $(3,463,763) $(15,046,211)
=========== =========== ============
NET LOSS PER COMMON AND COMMON EQUIVALENT
SHARE $ (0.38) $ (0.63) $ (2.80)
=========== =========== ============
COMMON AND COMMON EQUIVALENT SHARES USED IN
CALCULATION OF NET LOSS PER SHARE 5,617,926 5,469,177 5,381,519
=========== =========== ============
See notes to consolidated financial statements.
-3-
25
IPL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- ----------------------------------------------------------------------------------------------------------------------------
Common Stock
------------------------------------------------
Class A (Voting) Class C (Voting) Additional Retained
------------------------ -------------------- Paid-in Earnings
Shares Amount Shares Amount Capital (Deficit)
BALANCE, JANUARY 1, 1994 4,501,776 $45,018 879,743 $ 8,797 $16,577,458 $ 9,766,884
Net loss for the year -- -- -- -- -- (15,046,211)
--------- ------- -------- ------- ----------- ------------
BALANCE, DECEMBER 31, 1994 4,501,776 45,018 879,743 8,797 16,577,458 (5,279,327)
Net loss for the year -- -- -- -- -- (3,463,763)
Exercise of stock options 206,000 2,060 -- -- 652,565 --
Conversion of Class C to Class A stock 492,814 4,928 (492,814) (4,928) -- --
--------- ------- -------- ------- ----------- ------------
BALANCE, DECEMBER 31, 1995 5,200,590 52,006 386,929 3,869 17,230,023 (8,743,090)
Net loss for the year -- -- -- -- -- (2,141,844)
Exercise of stock options 46,300 463 -- -- 122,517 --
Consultant's stock option compensation -- -- -- -- 26,028 --
Conversion of Class C to Class A stock 386,929 3,869 (386,929) (3,869) -- --
--------- ------- -------- ------- ----------- ------------
BALANCE, DECEMBER 31, 1996 5,633,819 $56,338 -- $ -- $17,378,568 $(10,884,934)
========= ======= ======== ======= =========== ============
Total
BALANCE, JANUARY 1, 1994 $ 26,398,157
Net loss for the year (15,046,211)
------------
BALANCE, DECEMBER 31, 1994 11,351,946
Net loss for the year (3,463,763)
Exercise of stock options 654,625
Conversion of Class C to Class A stock --
------------
BALANCE, DECEMBER 31, 1995 8,542,808
Net loss for the year (2,141,844)
Exercise of stock options 122,980
Consultant's stock option compensation 26,028
Conversion of Class C to Class A stock --
------------
BALANCE, DECEMBER 31, 1996 $ 6,549,972
============
See notes to consolidated financial statements.
-4-
26
IPL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- -------------------------------------------------------------------------------
1996 1995 1994
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(2,141,844) $(3,463,763) $(15,046,211)
Adjustments to reconcile net loss to net cash
(used for) provided by operating
activities:
Depreciation and amortization 976,561 1,213,005 2,614,596
Loss on the sale of equipment and fixtures 27,479 27,072 46,223
Consultant's stock option compensation 26,028 - -
Noncash restructuring expenses - - 1,185,790
Bad debt expense (recoveries) (432,535) (1,374,995) 3,173,526
Inventory reserves 409,473 (1,422,474) 1,382,055
Changes in assets and liabilities:
Accounts receivable - trade 2,059,716 5,971,339 6,279,971
Inventories (925,287) 1,107,188 3,436,420
Prepaid expenses and other current assets (23,725) (46,599) 177,095
Refundable income taxes - 1,425,000 475,000
Deferred income taxes - - 395,000
Trade accounts payable and accrued payroll expenses (832,069) (2,248,464) (4,506,131)
Accrued restructuring expenses (303,009) 35,496 559,286
----------- ----------- ------------
Total adjustments 982,632 4,686,568 15,218,831
Net cash (used for) provided by operating
activities (1,159,212) 1,222,805 172,620
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to equipment, fixtures and leasehold
improvements (298,895) (568,488) (2,064,398)
Proceeds from sale of equipment and fixtures 13,939 47,514 -
----------- ------------ ------------
Cash used for investing activities (284,956) (520,974) (2,064,398)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES -
Exercise of stock options 122,980 654,625 -
----------- ------------ ------------
CASH AND EQUIVALENTS:
Net (decrease) increase (1,321,188) 1,356,456 (1,891,778)
Balance, beginning of year 3,595,268 2,238,812 4,130,590
----------- ------------ -------------
Balance, end of year $ 2,274,080 $ 3,595,268 $ 2,238,812
=========== ============ =============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION - Income taxes paid $ 53,000 $ - $ 23,000
=========== ============ =============
See notes to consolidated financial statements.
-5-
27
IPL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- -------------------------------------------------------------------------------
1. INDUSTRY
IPL Systems, Inc. (the "Company"), founded in 1973, provides open
architecture database storage solutions for multi-host computer
environments. The Company supplies its products through direct, indirect
and Original Equipment Manufacturer ("OEM") sales and service channels
throughout the world.
2. GOING CONCERN MATTERS
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. As shown in
the consolidated financial statements, during the years ended December 31,
1996, 1995 and 1994, the Company incurred net losses of $2,141,844,
$3,463,763 and $15,046,211, respectively, and net cash used for operating
activities totaled $1,159,212 in 1996. In addition, the Company
anticipates, absent corrective actions, a cash flow deficiency during 1997.
These factors, among others, indicate that the Company may be unable to
continue as a going concern for a reasonable period of time.
The consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded asset amounts
or the amounts and classification of liabilities that might be necessary
should the Company be unable to continue as a going concern. The Company's
continuation as a going concern within the next year is dependent upon its
ability to generate sufficient cash flow from operations to meet its
obligations on a timely basis, and/or to obtain additional financing as may
be required. In the long-term, its success is dependent ultimately on the
attainment of successful operational results.
Management believes that a successful merger, as discussed in Note 14, will
allow the Company to realize certain cost savings, further penetrate the
rapidly expanding open architecture storage market and provide sufficient
working capital to sustain operations through 1997. In the absence of such
a merger, management believes, based on its cash flow estimates, that
overhead cost burdens could be reduced in order to provide a break-even
cash flow and result in the Company's continuance as a going concern only
if revenue levels are substantially increased over current levels. If
revenue levels do not increase, the Company would likely be forced to
either liquidate assets or seek outside sources of financing, which, if
available at all, may not be available on reasonable terms.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES - The preparation of consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates. In 1996 and 1995, the allowance for
doubtful accounts was reduced by $1,758,000 and $1,557,000, respectively,
principally as a result of partial collection of previously reserved
balances.
-6-
28
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include
the accounts of the Company and its wholly owned subsidiaries, IPL
Investments, Inc. and IPL International Sales Corporation. All intercompany
accounts and transactions have been eliminated.
FAIR VALUE - The fair value of assets and liabilities representing
financial instruments approximates their carrying value.
CASH AND EQUIVALENTS - For purposes of reporting cash flows, cash and
equivalents include cash on hand and amounts on short-term deposit with
banks or other financial institutions.
INVENTORIES - Inventories are stated at the lower of cost (based on the
first-in, first-out method) or market.
At December 31, 1996, the Company was in the process of a product
transition. Inventory levels at that time reflect raw materials,
work-in-process, and finished goods relating to new and existing products.
Management has developed a program to reduce inventory to desired levels
over the near term and believes no loss will be incurred on its
disposition.
EQUIPMENT, FIXTURES AND LEASEHOLD IMPROVEMENTS - Maintenance, repairs and
minor renewals are charged to operations as incurred. Depreciation of
equipment and fixtures is computed by the straight-line method over the
estimated useful lives of the assets which range between two and seven
years. Leasehold improvements are amortized over the term of the lease or
the useful lives of the assets, whichever is shorter. Customer support
inventory is valued at cost when available for service and is amortized
over a four-year period using the straight-line method. The Company
continually reviews its equipment, fixtures and leasehold improvements to
determine that the carrying values have not been impaired.
STOCK-BASED COMPENSATION - Effective January 1, 1995, the Company adopted
SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123").
SFAS No. 123 requires that the fair values of stock-based compensation to
employees and non-employees be either disclosed or reported in the
consolidated financial statements. Compensation expense associated with
awards of stock or options to employees is measured using the intrinsic
value method. Compensation expense associated with awards to non-employees
is measured using a fair value method. The effect of adopting SFAS No. 123
for the year ended December 31, 1996 was to increase net loss by $26,028.
REVENUE RECOGNITION - Product and parts sales are recorded when shipped
under the terms of firm purchase contracts. Service revenue includes parts
sales, warranty, extended warranty and repairs charges. Warranty and
extended warranty revenue for contracts for which the liability for on-site
service and component replacement have been transferred to or assumed by
third parties are recognized at time of sale together with the associated
costs. For those contracts which the Company is liable for any portion of
on-site service or component replacement, the Company recognizes that
portion of the warranty and extended warranty income and expense ratably
over the contract period.
INCOME TAXES - The Company utilizes the liability method of accounting for
income taxes. Deferred taxes are based on the difference between the
financial statement and tax bases of assets and liabilities, and the
deferred tax expense or credit represents the change in the deferred tax
asset or liability balance.
-7-
29
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOSS PER SHARE - Loss per common and common equivalent share is computed
based on the weighted average number of shares outstanding and the dilutive
effect (when applicable) of common share equivalents based on the treasury
stock method. Common share equivalents are not included in loss periods as
the effect is anti-dilutive.
RECLASSIFICATIONS - Certain amounts in the 1995 and 1994 consolidated
financial statements have been reclassified to conform with the 1996
presentation.
4. INVENTORIES
Inventories consist of the following at December 31:
1996 1995
Raw materials $ 1,764,001 $ 1,460,423
Work-in-process 976,978 651,245
Finished goods 1,150,487 1,263,984
------------ ------------
$ 3,891,466 $ 3,375,652
============ ============
5. INCOME TAXES
Income tax expense (benefit) consists of the following for the years ended
December 31:
1996 1995 1994
Current - federal $ - $ - $(1,565,000)
Deferred:
Federal (711,000) (974,000) (4,255,000)
State (101,000) (305,000) (1,125,000)
Change in valuation allowance 812,000 1,279,000 5,775,000
--------- ---------- -----------
$ - $ - $(1,170,000)
========= ========== ===========
The following is a reconciliation between the actual income tax benefit
and income taxes computed by applying the statutory federal income tax
rate to loss before income tax benefit for the years ended December 31:
1996 1995 1994
U.S. federal statutory rate (35.0)% (35.0)% (35.0)%
Change in valuation allowance 37.9 36.9 35.6
Benefit of prior year tax credits - - (5.3)
Other, net (2.9) (1.9) (2.5)
----- ----- ----
0.0 % 0.0 % (7.2)%
==== ===== ====
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5. INCOME TAXES (CONTINUED)
The tax effects of significant items comprising the Company's deferred tax
assets as of December 31 are as follows:
1996 1995
Reserves and accruals not currently deductible:
Accounts receivable $ 141,000 $ 865,000
Inventory 409,000 238,000
Warranty 352,000 294,000
Compensation 41,000 56,000
Restructuring 117,000 238,000
Other 1,000 131,000
---------- -----------
1,061,000 1,822,000
Depreciation 258,000 467,000
Loss carryforward amounts 6,063,000 4,280,000
Tax credits 944,000 945,000
---------- -----------
8,326,000 7,514,000
Valuation allowance (8,326,000) (7,514,000)
---------- -----------
$ - $ -
========== ===========
The Company has approximately $13,652,000 in net federal operating loss
carryforwards which expire through 2011, and approximately $25,703,000 in
state operating loss carryforwards which expire through 2001. The ability
of the Company to utilize these loss carryforward amounts will be limited
in the event of a change in control, as defined by the Internal Revenue
Code. The change in the valuation allowance represents the amount required
to fully reserve against the recorded deferred tax assets, due to
uncertainty about their future realization.
6. LEASE COMMITMENT AND RENT EXPENSE
The Company leases manufacturing and office facilities under a lease which
expires in 1998 and leases office space at various U.S. locations and in
Belgium under leases which expire through 1997. The following is a schedule
by years of future rental payments, net of related sublease income,
required under these leases:
1997 $278,682
1998 68,551
Rental expense, net of sublease income, amounted to approximately
$370,000, $493,000 and $564,000 in 1996, 1995 and 1994, respectively.
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7. CLASS C COMMON STOCK
Class C common stock was convertible into an equal number of shares of
Class A common stock at any time at the option of the holder but was
required to be converted if the number of shares of Class C common stock
outstanding became less than 5% of all shares outstanding. In 1995 and
through February 6, 1996, the Class C shares were converted to Class A
common stock.
8. EMPLOYEE STOCK PLANS
The Consolidated 1991/1993 Equity Incentive Plan (the "1993 Plan") provides
for the grant of incentive stock options, nonstatutory stock options and
stock appreciation rights to key employees and consultants, subject to
terms and conditions determined by the Company. A total of 650,000 shares
of Class A common stock has been reserved for issuance under the 1993 Plan.
In December 1995, the Company granted an option (the "1995 Plan") with
respect to 115,000 shares not covered by the 1993 Plan.
In 1996, the stockholders approved the Consolidated 1996 Equity Incentive
Plan (the "1996 Plan") to provide for grants of incentive stock options to
employees and consultants, subject to terms and conditions determined by
the Company. Upon approval of the 1996 Plan, the 1995 Plan was consolidated
with the 1996 Plan (the "Consolidated 1996 Plan"). A total of 650,000
shares of Class A common stock, which includes the 115,000 shares of the
1995 Plan, has been reserved for issuance under the Consolidated 1996 Plan.
On December 29, 1994, the Company amended incentive stock options
previously granted with respect to an aggregate of 357,000 shares of Class
A common stock under the 1993 Plan, whereby options were repriced to market
value on that date. There was no financial statement impact as a result of
this change.
Under the 1993 Director Stock Option Plan (the "Director Plan"), directors
who are not employees of the Company are granted initial options of 10,000
shares of Class A common stock, which are exercisable over five years,
subject to continued service as a director. A total of 75,000 shares of
Class A common stock has been reserved for issuance under the Director
Plan.
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8. EMPLOYEE STOCK PLANS (CONTINUED)
The following table presents activity under the:
1993 AND
1996 CONSOLIDATED PLANS DIRECTOR PLAN
-------------------------------------------- ---------------------------------------
WEIGHTED WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE AVERAGE
NUMBER EXERCISE FAIR NUMBER EXERCISE FAIR
OF OPTIONS PRICE VALUE OF OPTIONS PRICE VALUE
Outstanding, January 1, 1994 590,500 $7.46 20,000 $9.25
Granted 570,000 2.90 4,000 7.25
Exercised - - - -
Terminated (520,500) 7.58 - -
------- -------
Outstanding, December 31, 1994 640,000 3.84 24,000 8.92
Granted 209,500 3.38 $1.79 20,000 4.44 $2.35
Exercised (206,000) 3.18 - -
Terminated (121,200) 7.62 (12,000) 8.92
------- -------
Outstanding, December 31, 1995 522,300 3.04 32,000 6.12
Granted 243,500 2.40 1.08 12,000 14.54 3.27
Exercised (46,300) 2.66 - -
Terminated (143,900) 3.48 (7,200) 8.92
------- -------
Outstanding, December 31, 1996 575,600 2.69 36,800 8.32
======= =======
Exerciseable, December 31, 1996 176,800 16,800
======= =======
Exerciseable, December 31, 1995 139,400 4,400
======= =======
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8. EMPLOYEE STOCK PLANS (CONTINUED)
The following table sets forth information regarding options outstanding at
December 31, 1996 under the 1993 and 1996 Consolidated Plans:
Weighted
Average
Weighted Weighted Exercise
Range Of Number Average Average Price For
Exercise Currently Exercise Remaining Currently
Number Of Options Prices Exercisable Price Life (Years) Exercisable
418,100 $2.00 - 3.00 143,500 $2.40 6.7 $2.29
153,500 3.25 - 4.88 31,300 3.31 9.0 3.04
4,000 8.75 2,000 8.75 6.6 8.75
The following table sets forth information regarding options outstanding at
December 31, 1996 under the Director Plan:
Weighted
Average
Weighted Weighted Exercise
Range Of Number Average Average Price
Exercise Currently Exercise Remaining Currently
Number Of Options Prices Exercisable Price Life (Years) Exercisable
10,000 $ 3.25 2,000 $ 3.25 8.9 $ 3.25
10,000 5.63 2,000 5.63 8.4 5.63
16,800 7.25 - 20.50 12,800 12.94 6.6 14.09
The fair value of options on their grant date under all stock option plans
was measured using the Black/Scholes option pricing model. Key assumptions
used to apply this pricing model are as follows:
1996 1995
Risk-free interest rate 6.01% 6.01%
Expected life of option grants 1-5 years 1-5 years
Expected volatility of underlying stock 80% 80%
Expected dividend payment rate, as a percentage of the
stock price on the date of grant - -
Expected terminations 50% 50%
The option pricing model used was designed to value readily tradeable stock
options with relatively short lives. The options granted to employees are
not tradeable with contractual lives of up to ten years and graded vesting
up to five years. However, management believes that the assumptions used to
value the options and the model applied yield a reasonable estimate of the
fair value of the grants made under the circumstances.
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8. EMPLOYEE STOCK PLANS (CONTINUED)
As described in Note 3, the Company uses the intrinsic value method to
measure compensation expense associated with grants of stock options to
employees. During 1996, the Company granted options to purchase 50,000
shares of Class A common stock under the 1996 Consolidated Plan to certain
Directors acting as non-employee consultants. The compensation expense
relating to those options, as valued using the fair value method,
aggregated $26,028 and is included in net loss for the year ended December
31, 1996. Had the Company used the fair value method for all options to
measure compensation, reported net income and earnings per share would have
been as follows:
1996 1995
Net loss:
As reported $ (2,141,844) $ (3,463,763)
Pro forma (2,275,376) (3,674,539)
Net loss per common share:
As reported (.38) (.63)
Pro forma (.40) (.67)
9. EMPLOYEE BENEFIT PLANS
Effective December 1, 1991, the Company adopted the IPL Systems, Inc.
401(k) Plan under Section 401(k) of the Internal Revenue Code. The 401(k)
plan covers substantially all employees who meet minimum service
requirements. The amount of the Company's annual contribution is
discretionary. No contributions were made by the Company for the years
ended December 31, 1996, 1995 and 1994.
10. RELATED PARTY
SALES - The Company has a distribution agreement with certain European
affiliates of Olivetti Holding N.V. ("Olivetti"), entered into while
Olivetti was the beneficial owner of the issued and outstanding Class C
common stock. Sales to these entities, all in Europe, totaled $2,401,000,
$3,630,000 and $7,763,000 in 1996, 1995 and 1994, respectively. Related
amounts outstanding, included in accounts receivable - trade, totaled
$318,000 and $1,147,000 at December 31, 1996 and 1995, respectively.
PURCHASES - The Company contracts with Olivetti N.A., Inc., a subsidiary of
Olivetti, to provide installation and warranty coverage for the majority of
the Company's U.S. product sales. Expenses incurred by the Company in
connection with this agreement totaled $1,114,000, $1,612,000 and
$1,759,000 in 1996, 1995 and 1994, respectively, of which $251,000 is
included in trade accounts payable at December 31, 1995.
11. SALES INFORMATION
MAJOR CUSTOMERS - The Company had sales to an unaffiliated major customer
of approximately $2,796,000 (16% of revenue) in 1996 and $3,675,000 (15% of
revenue) to a different unaffiliated customer in 1994.
EXPORTS - Export sales to unaffiliated customers which are principally in
Europe, on materially the same terms as to domestic customers, totaled
$2,190,000, $4,741,000 and $6,115,000 in 1996, 1995 and 1994, respectively.
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12. RESTRUCTURING EXPENSES
In November 1994, the Company approved and executed a restructuring program
(the "Plan") to focus future product development and sales efforts in the
open systems market. As a result of this change in product strategy, the
Company streamlined its operations by reducing its workforce, consolidating
and closing certain facilities and writing off idle and excess assets.
These costs are presented in the Company's 1994 consolidated statement of
operations as a restructuring charge of $1,970,587.
In September 1995, the Company revised its estimates of the costs
associated with the Plan and recorded an additional restructuring charge of
$496,880 related to the net lease obligation on certain idle facilities.
In March 1996, the Company changed its estimate of the cost of the Plan and
recognized a reduction in future net lease expenses in the amount of
$100,000, net of required additional leasehold improvements, following the
sublease of certain excess space to an unrelated party.
Restructuring charges were recorded and payments were made in 1996, 1995
and 1994 as follows:
1994
-----------------------------------------
BALANCE,
DECEMBER 31,
INITIAL EXPENSE PAID 1994
Excess space:
Occupancy costs, net $ 473,652 $ 2,269 $471,383
Write-down of leasehold improvements 850,914 -- --
Write-down of idle assets 334,876 -- --
Severance costs 311,145 223,242 87,903
---------- -------- --------
$1,970,587 $225,511 $559,286
========== ======== ========
1995
---------------------------------------
BALANCE
ADDITIONAL DECEMBER 31,
RESERVE PAID 1995
Excess space:
Occupancy costs, net $ 496,880 $373,481 $594,782
Severance costs -- 87,903 --
---------- -------- --------
$ 496,880 $461,384 $594,782
========== ======== ========
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12. RESTRUCTURING EXPENSES (CONTINUED)
1996
--------------------------------------------
BALANCE,
REDUCTION IN DECEMBER 31,
EXPENSES PAID 1996
Excess space - occupancy costs (income), net $(100,000) $203,009 $291,773
13. CONTINGENCIES
The Company is the subject of various legal proceedings which arose in the
normal course of business, the outcome of which management believes will
not be material to the Company's consolidated financial position,
operations or liquidity.
14. SUBSEQUENT EVENTS
The Company entered into a Definitive Agreement of Merger and
Reorganization dated as of February 28, 1997, with anDATAco, a
California-based, privately held company that designs, manufactures and
markets network storage solutions. Under the terms of the agreement, the
shareholders of anDATAco will receive approximately three shares for each
share of the Company deemed to be outstanding on a fully diluted basis. The
merger is subject to various conditions, including approval by the
stockholders of the Company and other regulatory and third-party approvals.
On February 24, 1997, the Company and anDATAco entered into a one-year
nonexclusive OEM Agreement, whereby anDATAco will purchase up to $1,500,000
of product from the Company in each of March and April 1997.
On March 7, 1997, the Company terminated the employment of its direct sales
force, many of whom were subsequently employed by anDATAco.
* * * * * *
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IPL SYSTEMS, INC.
SCHEDULE VIII
VALUATION AND QUALIFYING ACCOUNTS
DECEMBER 31, 1996 (DOLLARS IN THOUSAND)
- ----------------------------------------------------------------------------------------------------------
Charged
Balance at Charged to to Other Balance
Begining Cost and Accounts at End
of Period Expenses Describe Write off Period
Description
- -----------
DEDUCTED FROM ASSETS
TO WHICH THEY APPLY:
Allowed for doubtful
accounts - sales:
Year ending December 31,1996 2,111 (1,739) (B) (19) (A) -- 353
Year ended December 31, 1995 3,668 (1,519) (B) (38) (A) -- 2,111
Year ended December 31, 1994 463 3,165 40 (A) -- 3,668
<FN>
- ----------------------------------------------------------------------------------------------------------
(A) Charged against sales for product not returned by year end
(B) Includes partial recovery of a doubtful account receivable totaling $1,767,000 in 1995 and $1,550,000 in 1996
22