Item 2. Properties. ----------
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
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.
Item 3. Legal Proceedings. -----------------
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.
Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------
No matter was submitted to a vote of the Company's security holders during the quarter ended December 31, 1996.
PART II
Item 5.
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 ----- Year High Low - ---- ---- ---
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 - ----
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.
Item 7.
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 - ---------------------------------------------
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
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.
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
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.
Item 8.
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:
Item 9.
Item 9. CHANGES IN AND DISAGREEMENT WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
Item 10.
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.
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.
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.
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.
PART IV
Item 14.
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.
(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.
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.
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.
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)
IPL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995
See notes to consolidated financial statements.
IPL SYSTEMS, INC.
See notes to consolidated financial statements.
IPL SYSTEMS, INC.
See notes to consolidated financial statements.
IPL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
See notes to consolidated financial statements.
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.
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.
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:
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)% ==== ===== ====
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.
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.
8. EMPLOYEE STOCK PLANS (CONTINUED)
The following table presents activity under the:
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:
The following table sets forth information regarding options outstanding at December 31, 1996 under the Director Plan:
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.
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.
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.
12. RESTRUCTURING EXPENSES (CONTINUED)
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