<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
------- Exchange Act of 1934.
For the quarterly period ended September 30, 1998.
Transition report pursuant to Section 13 or 15(d) of the Securities
------- Exchange Act of 1934.
For the transition period from __________________ to ___________________
Commission File Number 333-2600
ALVEY SYSTEMS, INC.
9301 Olive Boulevard
St. Louis, MO 63132
(314) 993-4700
I.R.S. Employment I.D. 43-0157210
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter periods that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past ninety days.
Yes X No
------ -------
The number of shares of common stock outstanding at October 31, 1998 was 1,000
shares.
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
Page
Number
<S> <C>
Part I - Financial Information
Item 1. Financial Statements
Consolidated Statement of Operations -
three and nine months ended September 30, 1998
(Unaudited) and 1997 (Unaudited) 3
Consolidated Balance Sheet - September 30, 1998
(Unaudited) and December 31, 1997 4
Consolidated Statement of Cash Flows nine months
ended September 30, 1998 (Unaudited)
and 1997 (Unaudited) 5-6
Consolidated Statement of Net Investment
of Parent for the nine months ended September 30,
1998 (Unaudited) 7
Notes to Consolidated Financial Statements
(Unaudited) 8-15
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 15-24
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K 24
Signature 25
</TABLE>
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1997 1998 1997
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
Net sales $ 73,410 $ 78,152 $ 228,909 $ 221,579
Cost of goods sold 53,003 60,116 170,541 173,096
-------------- ----------- ----------- ------------
Gross profit 20,407 18,036 58,368 48,483
Selling, general and administrative expenses 14,277 12,722 40,563 37,676
Research and development expenses 1,235 709 3,510 2,308
Restructuring costs - - - 11,334
Amortization expense 204 282 699 851
Operating loss (income) from divested operations 2,180 (1,591) 3,810 (546)
Other income, net 44 51 539 33
-------------- ----------- ----------- ------------
Operating income (loss) 2,555 5,965 10,325 (3,107)
Interest expense 3,222 3,409 9,924 10,384
-------------- ----------- ----------- ------------
Income (loss) before income taxes (667) 2,556 401 (13,491)
Income tax expense (benefit) 914 826 1,792 (4,547)
-------------- -------------- ----------- ------------
Net income (loss) $ (1,581) $ 1,730 $ (1,391) $ (8,944)
-------------- -------------- ----------- ------------
-------------- -------------- ----------- ------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-3-
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
(UNAUDITED)
------------------- -----------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 3,162 $ 2,760
Receivables:
Trade (less allowance for doubtful accounts of $692 and $1,272, respectively) 28,506 38,754
Unbilled and other 2,672 7,340
Accumulated costs and earnings in excess of billings on uncompleted contracts 4,766 11,667
Inventories:
Raw materials 14,177 14,297
Work in process 4,296 2,881
Deferred income taxes 9,799 10,608
Net assets of divested operations 20,643 17,968
Prepaid expenses and other assets 1,339 868
--------------- --------------
Total current assets 89,360 107,143
Property, plant and equipment, net 30,990 31,290
Other assets 5,949 6,814
Goodwill, net 19,967 20,572
--------------- --------------
$ 146,266 $ 165,819
--------------- --------------
--------------- --------------
LIABILITIES AND NET INVESTMENT OF PARENT
Current liabilities:
Current portion of long-term debt $ 241 $ 274
Accounts payable 18,654 27,279
Accrued expenses 33,962 37,664
Customer deposits 3,912 7,105
Billings in excess of accumulated costs and earnings on uncompleted contracts 25,449 21,986
Deferred revenues 1,590 1,483
Taxes payable 1,104 833
--------------- --------------
Total current liabilities 84,912 96,624
Long-term debt 100,525 106,930
Other long-term liabilities 8,653 8,777
Deferred income taxes 2,102 2,016
Commitments and contingencies (Note 7)
Net investment of Parent (49,926) (48,528)
--------------- --------------
$ 146,266 $ 165,819
--------------- --------------
--------------- --------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-4-
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
--------------- -----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss), excluding operating income (loss)
from divested operations $ 2,419 $ (9,490)
Adjustments to reconcile net income (loss) to net cash
provided by (used for) operating activities:
Depreciation 3,198 2,753
Amortization 699 851
Operating activities of divested operations (862) (671)
Other - 248
Deferred taxes, net of effect of acquisitions 895 (4,230)
(Increase) decrease in assets, excluding effect
of acquisitions and divested operations:
Receivables 14,916 2,105
Accumulated costs and earnings in excess of
billings on uncompleted contracts 6,901 1,907
Inventories (1,295) (660)
Other assets 300 852
(Decrease) increase in liabilities, excluding
effect of acquisitions and divested operations:
Accounts payable (8,625) (5,643)
Accrued expenses (3,702) (254)
Customer deposits (3,193) (4,930)
Billings in excess of accumulated costs and
earnings on uncompleted contracts 3,463 6,609
Deferred revenues 107 303
Taxes payable 271 (674)
Other liabilities 26 2,064
--------------- -----------------
Net cash provided by (used for) operating activities 15,518 (8,860)
--------------- -----------------
INVESTING ACTIVITIES:
Additions to property, plant and equipment (2,898) (2,487)
Investing activities of divested operations (5,623) (2,020)
Other (150) (569)
--------------- -----------------
Net cash used for investing activities (8,671) (5,076)
--------------- -----------------
</TABLE>
(continued)
See accompanying Notes to Consolidated Financial Statements.
-5-
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED)
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1998 1997
--------------- -----------------
<S> <C> <C>
FINANCING ACTIVITIES:
Proceeds of borrowings 42,350 79,325
Payments of debt and capital leases (48,788) (68,138)
Net contributions from (to) Parent (7) (128)
--------------- -----------------
Net cash provided by (used for) financing activities (6,445) 11,059
--------------- -----------------
Net increase (decrease) in cash and cash equivalents 402 (2,877)
Cash and cash equivalents, beginning of period 2,760 4,540
--------------- -----------------
Cash and cash equivalents, end of period $ 3,162 $ 1,663
--------------- -----------------
--------------- -----------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest on financings $ 12,003 $ 12,440
Income taxes 517 1,532
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-6-
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF NET INVESTMENT OF PARENT
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED NET INVESTMENT
SEPTEMBER 30, 1998 OF PARENT
<S> <C>
Balance December 31, 1997 $ (48,528)
Net income (1,391)
Net contributions to Parent (7)
-------------------
Balance September 30, 1998 $ (49,926)
-------------------
-------------------
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
-7-
<PAGE>
ALVEY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of Alvey
Systems, Inc. ("Alvey" or the "Company") have been prepared in
accordance with the instructions for Form 10-Q and do not include all
of the information and footnotes required by generally accepted
accounting principles for complete financial statements. However, in
the opinion of management, such information includes all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the results of operations for the periods presented.
Operating results for any quarter are not necessarily indicative of
the results for any other quarter or for the full year. These
statements should be read in conjunction with the consolidated
financial statements and notes to the consolidated financial
statements thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 1997.
2. PRINCIPLES OF CONSOLIDATION, EARNINGS PER SHARE INFORMATION
Alvey is a wholly-owned subsidiary of Pinnacle Automation, Inc.
("Pinnacle" or "Parent"). Pinnacle does not have any operations or
assets other than its investment in Alvey. The Company's financial
statements include the accounts of Alvey and Alvey's wholly-owned
subsidiaries: McHugh Software International, Inc. ("McHugh") and its
wholly-owned subsidiaries, Weseley Software Development Corp.
("Weseley" or "WSDC"), Software Architects, Inc. ("SAI") and Gagnon &
Associates, Inc. ("Gagnon"); Busse Bros., Inc. ("Busse"); The Buschman
Company ("Buschman"); White Systems, Inc. ("White"); and Real Time
Solutions, Inc. ("RTS"). All significant intercompany transactions,
which primarily consist of sales, have been eliminated. See footnote 8
for discussion of the spin-off of McHugh and its subsidiaries which
was effected on October 27,1998.
Given the Company's historical organization and capital structure,
earnings per share information is not considered meaningful or
relevant and has not been presented in the accompanying unaudited
consolidated financial statements or notes thereto.
8
<PAGE>
3. ACQUISITIONS
SAI ACQUISITION
On April 1, 1998, McHugh purchased all of the outstanding capital
stock of SAI for $1.5 million in cash. The acquisition was financed
through the Company's working capital facility. In addition, subject
to their continued employment, certain employees of SAI have an
opportunity to earn stay bonuses in the aggregate of $1,125,000 per
year for each of the next four years. At closing, McHugh also granted
options to purchase an aggregate number of shares of the common stock
of McHugh equal to 1.5% of the common stock of McHugh. Additional
options in an aggregate amount corresponding to 0.5% of the common
stock of McHugh will be awarded to certain SAI employees on the first
through the fourth anniversaries of the acquisition date, commencing
April 1, 1999. The exercise price of all such options is equal to the
fair market value of the common stock of McHugh on the option grant
date. The options vest ratably over four years, expire on the eighth
anniversary of the date of grant and are only exercisable upon the
occurrence of certain trigger events set forth in the option
agreements. The excess of the cost of the acquisition over the
estimated fair value of net assets acquired (including purchased
in-process research and development, as further described below) of
$149,000 was recorded as goodwill and is being amortized over a period
of five years. The consolidated financial statements of the Company
include the results of operations and cash flows of SAI from its date
of acquisition.
On a preliminary basis, $1.0 million of the SAI purchase price was
allocated to in-process research and development costs at the date of
acquisition and was recorded as a write-off of purchased in-process
research and development during the second quarter of 1998. An
independent appraisal to finalize the value of the in-process research
and development is being conducted and may result in a purchase
accounting adjustment. Any change in the value assigned to in-process
research and development is expected to correspondingly adjust the
amount of goodwill from the SAI acquisition.
GAGNON ACQUISITION
On May 15, 1998, McHugh purchased all of the outstanding capital stock
of Gagnon for $1.9 million in cash. The acquisition was financed
through the Company's working capital facility. In addition, subject
to their continued employment, certain employees of Gagnon have an
opportunity to earn stay bonuses in the aggregate of $600,000 per year
for each of the next three years. At closing, McHugh also granted
options to purchase an aggregate number of shares of the common stock
of McHugh equal to 0.25% of the common stock of McHugh. Additional
options in an aggregate amount corresponding to 0.25% of
9
<PAGE>
the common stock of McHugh will be awarded to certain Gagnon employees
on the first through the third anniversaries of the acquisition date,
commencing May 15, 1999. The exercise price of all such options is
equal to the fair market value of the common stock of McHugh on the
option grant date. The options vest ratably over four years, expire on
the eighth anniversary of the date of grant and are only exercisable
upon the occurrence of certain trigger events as set forth in the
option agreements. The excess of the cost of the acquisition over the
estimated fair value of net assets acquired (including purchased
in-process research and development, as further described below) of
$370,000 was recorded as goodwill and is being amortized over a period
of five years. The consolidated financial statements of the Company
include the results of operations and cash flows of Gagnon from its
date of acquisition.
On a preliminary basis, $1.7 million of the Gagnon purchase price was
allocated to in-process research and development costs at the date of
acquisition and was recorded as a write-off of purchased in-process
research and development during the second quarter of 1998. An
independent appraisal to finalize the value of the in-process research
and development is being conducted and may result in a purchase
accounting adjustment. Any change in the value assigned to in-process
research and development is expected to correspondingly adjust the
amount of goodwill from the Gagnon acquisition.
The pro-forma results of the Company would not have been materially
different had either or both of the SAI and Gagnon acquisitions taken
place on January 1, 1998 or 1997, respectively. Accordingly, pro forma
financial information for the SAI and Gagnon acquisitions is not
presented.
As described in footnote 8 herein, McHugh and its subsidiaries,
including SAI and Gagnon, were spun-off by Alvey to Pinnacle and from
Pinnacle to its common stockholders on October 27, 1998. The operating
results, including the write-offs of purchased in-process research and
development described above, and net assets of McHugh and its
subsidiaries are recorded in the statement of operations as operating
loss (income) from divested operations and in the balance sheet as net
assets of divested operations, respectively.
4. RESTRUCTURING CHARGES
During the second quarter of 1997, the Company established a
restructuring reserve which included costs to discontinue offering
certain proprietary systems software products at one subsidiary, to
reorganize and reduce the size of the Company's corporate organization
and to restructure and streamline the executive and marketing
functions at McHugh. Costs to discontinue certain proprietary software
products consisted primarily of costs to complete certain projects
incorporating this software, payroll and facility charges during the
phase-
10
<PAGE>
out of the product, severance charges, sales returns and allowances
(relative to prior period sales) anticipated as a result of the
discontinuance, the write-off of assets that became obsolete or
slow-moving as a result of the discontinuance and other miscellaneous
restructuring costs. The corporate reorganization and McHugh
reorganization charges are primarily severance costs. The 1998
year-to-date reduction of accrued restructuring costs consisted
primarily of the recording of payroll and facility costs associated
with the discontinued software products, costs to complete projects
involving the discontinued products, severance, sales allowances and
other costs. It is anticipated that costs accrued as restructuring by
non-divested operations will be fully paid by December 31, 1999 and
costs accrued as restructuring by divested operations will be fully
paid by April 30, 2004. Costs relative to the McHugh reorganization
(included in the table below) are included in net assets of divested
operations in the consolidated balance sheet of the Company. (See
footnote 8.)
The following table displays a roll-forward of the liabilities, both
current and long- term, for restructuring from December 31, 1997 to
September 30, 1998 (unaudited) (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 REDUCTIONS/ 1998
TYPE OF COST BALANCE PAYMENTS BALANCE
-------------- ----------------- ----------------- ----------------
<S> <C> <C> <C>
Costs to discontinue
product offerings $2,922 ($2,376) $546
Corporate
reorganization 1,416 (772) 644
McHugh
reorganization 3,204 (807) 2,397
----------------- ----------------- ----------------
Total $7,542 ($3,955) $3,587
----------------- ----------------- ----------------
----------------- ----------------- ----------------
</TABLE>
5. SUPPLEMENTAL BALANCE SHEET INFORMATION
Accrued expenses include the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
(UNAUDITED)
-------------------- ------------------
<S> <C> <C>
Project expenses $5,838 $6,651
Bonuses, incentives and profit sharing 7,859 7,829
Wages and salaries 2,561 2,024
Vacation and other employee costs 7,128 7,021
Interest expense 1,961 4,867
Restructuring costs, current portion 957 3,627
Other expenses 7,658 5,645
---------- ----------
$33,962 $37,664
---------- ----------
---------- ----------
</TABLE>
11
<PAGE>
6. LONG-TERM DEBT
Effective October 27, 1998, the Company's $30 million revolving credit
facility was amended to (i) allow the spin-off of McHugh as described
in footnote 8, (ii) allow a $10 million increase in the commitment
amount of the facility within 60 days of the amendment with certain
restrictions, and (iii) amend certain debt covenants. At September 30,
1998, the Company was in compliance with such covenants as amended. As
of the date of this filing, the Company has not increased the
commitment amount under the revolving credit facility. Debt issuance
costs approximating $618,000 were incurred in amending the revolving
credit facility at October 27, 1998 and will be amortized with certain
other costs over the life of the remaining facility. Unamortized costs
incurred in 1996 with the original issuance of the revolving credit
facility total $332,000. These costs, net of applicable income tax
benefits of $133,000, will be written off during the fourth quarter of
1998 and accounted for as an extraordinary loss.
In connection with the spin-off of McHugh on October 27, 1998, as
described in footnote 8, the holders of Alvey's Senior Subordinated
Notes due 2003 (the "Notes") consented to an amendment of the
indenture for the Notes to, among other things, (i) permit the
spin-off of McHugh, (ii) permit Alvey to increase borrowings under the
revolving credit facility by $10 million, and (iii) make modifications
to certain covenants. Alvey and the trustee for the bondholders
entered into the First Supplemental Indenture evidencing such terms on
September 30, 1998. To obtain the consent of its bondholders, Alvey
agreed to, among other things, (i) pay a consent premium of $46.00 in
cash for each $1,000 principal amount of Notes for which a consent was
properly delivered prior to the expiration of the consent solicitation
(approximately $4.6 million) and (ii) immediately after the
consummation of the spin-off, commence an offer to all of its
bondholders, on a pro rata basis, to purchase up to $30 million in
aggregate principal amount of the Notes at a cash purchase price equal
to 113% of the principal amount thereof plus accrued and unpaid
interest thereon, if any, to the date of purchase (approximately $33.9
million in total assuming the tender, acceptance and repurchase of $30
million of Notes). In connection with obtaining bondholder consent,
the Company incurred other expenses totaling $518,000. The consent
premium, the premium on the Notes repurchased and other expenses
incurred (approximating $9.0 million) along with the write-off of
unamortized costs remaining from the original indenture totaling $4.1
million, will be recorded as an extraordinary loss, less related tax
benefits of $5.2 million, in the fourth quarter of 1998. Debt issuance
costs incurred related to the indenture amendment totaling $1.6
million will be amortized over the remaining term of the Notes.
12
<PAGE>
7. COMMITMENTS AND CONTINGENCIES
The Company is involved in various litigation consisting almost
entirely of product and general liability claims arising in the normal
course of its business. After deduction of a per occurrence
self-insured retention, the Company is insured for losses of up to $27
million per year for products and general liability claims. The
Company has provided reserves for the estimated cost of the
self-insured retention; accordingly, these actions, when ultimately
concluded, are not expected to have a material adverse effect on the
financial position, results of operations or liquidity of the Company.
On January 13, 1998, Mitchell J. Weseley, former President and Chief
Executive Officer of WSDC, commenced an arbitration in Connecticut
Superior Court against WSDC alleging breach of contract and violation
of the Connecticut Unfair Trade Practices Act ("CUTPA"). On January
28, 1998, WSDC filed counterclaims against Mr. Weseley principally
alleging that he had breached his contractual obligations and
fiduciary duty to WSDC by soliciting WSDC employees to resign from
WSDC, by disparaging the management of Pinnacle and McHugh and by
breaching the terms of a covenant not to compete contained in Mr.
Weseley's employment contract. Arbitration proceedings concluded on
June 3, 1998 and on August 31, 1998, a decision was rendered in the
arbitration hearings in favor of Mr. Weseley. McHugh has resumed
payments to Mr. Weseley of his salary, bonus and benefits, of which
future payments will total approximately $2.4 million. The liability
for such payments is recorded in the restructuring accrual related to
the McHugh reorganization as discussed in footnote 4 above. Damages,
if any, will be determined by the arbitrator either ex parte or as
part of a second hearing. To the extent such amounts paid pursuant to
judgements related to lawsuits with Mr. Weseley exceed $3.4 million,
Alvey has agreed to pay any such excess liability up to a maximum of
$4 million, and McHugh has agreed to deliver a promissory note
evidencing McHugh's obligation to repay Alvey any amounts so paid by
Alvey.
On April 16, 1998, Mannesmann Dematic Rapistan Corp. ("Rapistan")
filed suit against Buschman in the United States District Court for
the Western District of Michigan alleging infringement of three
Rapistan patents relating to Buschman induction systems (the "Rapistan
Dispute"). Rapistan is seeking to permanently enjoin Buschman from
infringing those patents and both compensatory and treble damages. The
Company believes Rapistan's claims are without merit and intends to
vigorously defend this action. Related to Buschman's counterclaims and
affirmative defenses raised in this litigation, on June 5, 1998 the
Company filed a separate suit against Mannesmann Corporation
("Mannesmann") in the United States District Court for the Southern
District of New York on the basis of the representations, warranties
and disclosure obligations of Mannesmann with respect to the patents
subject to the Rapistan Dispute at the time the Company acquired
Buschman from Mannesmann in 1992. Pursuant to the spin-off as
13
<PAGE>
discussed in footnote 8, Pinnacle and the Company have agreed to
indemnify certain parties (primarily McHugh) for any and all
liabilities arising from the Rapistan Dispute whether arising prior
to, concurrent with or after the spin-off.
8. SUBSEQUENT EVENT
On October 27, 1998, the Company effected a spin-off of the common
stock of McHugh to Pinnacle's stockholders (after an initial
spin-off of such stock from the Company to Pinnacle). Subsequent to
the spin-off and a sale of a minority interest in McHugh for $50
million in cash, Alvey received a cash payment from McHugh of
approximately $36.6 million representing the repayment of McHugh's
intercompany debt to Alvey totaling approximately $35.9 million on
the date of the spin-off and the payment of a tax free dividend
from McHugh to Alvey of approximately $722,000. The amounts of
intercompany debt at the date of closing and the tax free dividend
are preliminary, subject to adjustment based on the audit of
McHugh's closing balance sheet. As discussed in footnote
6, Alvey will use $33.9 million of the proceeds to repurchase $30
million of its Notes at a premium of $3.9 million. Such payment is
expected to occur in November 1998. As a part of these
transactions, the holders of Pinnacle Series A, Series B and Series
C Preferred Stock (collectively, the "Pinnacle Preferred Stock")
exchanged Pinnacle Preferred Stock with a liquidation preference of
$18.6 million for $26.5 million of newly created classes of common
stock of McHugh. A portion of the original issuance costs of the
Pinnacle Preferred Stock approximating $659,000, net of applicable
tax benefits, will be recorded as an extraordinary loss in the
fourth quarter of 1998.
In connection with the spin-off and related transactions, two
affiliates of Pinnacle were paid consulting fees totaling $1.3
million for their services. Vestar Capital Partners ("Vestar") and
Mammoth Capital, Inc. received $900,000 and $400,000 in fees,
respectively, for services rendered to Pinnacle and Alvey pursuant
to existing consulting agreements. In addition, pursuant to an
agreement between Vestar and the placement agent for a minority
investment in McHugh, which was consummated immediately after the
spin-off, Vestar received $500,000 of the fee payable by McHugh to
the placement agent for additional services Vestar rendered to
McHugh. This fee was paid by McHugh to Vestar after the spin-off
was consummated.
The Company also expects to record a non-recurring, non-operating
charge to income approximating $1.2 million relative to costs of
the McHugh spin-off.
The operating loss (income) of McHugh is reflected in the Company's
consolidated statement of operations as operating loss (income) from
divested operations for the three and nine months ended September 30,
1998 and 1997. The net assets of McHugh are reflected in the Company's
consolidated balance sheet as net assets of divested operations at
September 30, 1998 and December 31, 1997. Primary components of the
operating income (loss) from divested operations and net assets of
divested operations are reflected below.
14
<PAGE>
Operating income (loss) from divested operations for the three and nine months
ended:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
1998 1997 1998 1997
----------- ----------- ----------- ------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net sales $19,804 $17,715 $64,548 $48,771
Cost of goods sold 14,607 10,945 44,993 29,267
----------- ----------- ------------ ------------
Gross profit 5,197 6,770 19,555 19,504
Selling, general and administrative
expenses 4,919 3,495 14,140 10,519
Research and development
expenses 2,282 1,618 6,046 4,185
Write-off of purchased research
and development costs - - 2,700 -
Restructuring costs - - - 3,950
Amortization expense 176 132 479 395
Other income, net - 66 - 91
----------- ----------- ------------ ------------
Operating income (loss) from
divested operations $ (2,180) $1,591 $ (3,810) $546
----------- ----------- ------------ ------------
----------- ----------- ------------ ------------
</TABLE>
Net assets of divested operations at:
<TABLE>
<CAPTION>
September 30 December 31,
1998 1997
------------------ ------------------
(unaudited)
<S> <C> <C>
Current assets $26,827 $24,470
Property, plant and equipment, net 5,586 4,169
Goodwill, net 4,914 4,579
Other assets 2,574 1,982
Less:
Current liabilities 16,320 13,404
Other liabilities 2,938 3,828
------------------ ------------------
Net assets of divested
operations $20,643 $17,968
------------------ ------------------
------------------ ------------------
</TABLE>
15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
When used in the following discussion, the words "believes," "anticipates" and
similar expressions are intended to identify forward-looking statements. Such
statements are subject to certain risks and uncertainties which could cause
actual results to differ materially from those projected. 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 results of any revisions to these forward-looking statements which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
GENERAL
The following discussion summarizes the significant factors affecting the
consolidated operating results and financial condition of Alvey Systems, Inc.
for the three and nine months ended September 30, 1998 compared to the three and
nine months ended September 30, 1997. This discussion should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the year ended December
31, 1997.
The Company has historically served its major markets through three groups. The
Consumer Products Group ("CPG"), which is comprised of Alvey and Busse, serves
the food, beverage and manufacturing sector of the Company's market. The
Distribution Logistics Group ("DLG"), which is comprised of Buschman, White and
RTS, serves the distribution logistics market. McHugh and its subsidiaries
Weseley, SAI and Gagnon provide logistics solutions for warehouse and
transportation management needs and represent the third group. Effective October
27, 1998, McHugh and its subsidiaries were spun-off from Alvey as described in
Note 8 to the Consolidated Financial Statements. The operating results of McHugh
for the three and nine months ended September 30, 1998 and 1997 have been
reported as operating loss (income) from divested operations herein.
16
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, net sales,
categories of expenses and income data as a percentage of net sales.
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
(unaudited) (unaudited)
---------------------------- ---------------------------
1998 1997 1998 1997
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 72.2 76.9 74.5 78.1
----------- ------------ ----------- -----------
Gross profit 27.8 23.1 25.5 21.9
Selling, general & administrative
expenses 19.4 16.2 17.7 17.0
Research & development
expenses 1.7 0.9 1.5 1.0
Restructuring costs - - - 5.1
Amortization expense 0.3 0.4 0.3 0.4
Operating loss (income) from
divested operations 3.0 (2.0) 1.7 (0.2)
Other income, net 0.1 0.1 0.2 -
----------- ------------ ----------- -----------
Operating income (loss) 3.5 7.7 4.5 (1.4)
Interest expense 4.4 4.4 4.3 4.7
----------- ------------ ----------- -----------
Income (loss) before income taxes (0.9) 3.3 0.2 (6.1)
Income tax expense (benefit) 1.3 1.1 0.8 (2.1)
----------- ------------ ----------- -----------
Net income (loss) (2.2)% 2.2% (0.6)% (4.0)%
----------- ------------ ----------- -----------
----------- ------------ ----------- -----------
</TABLE>
COMPARISON OF THE QUARTER ENDED SEPTEMBER 30, 1998 TO THE QUARTER ENDED
SEPTEMBER 30, 1997
NET SALES were $73.4 million for the quarter ended September 30, 1998, a
decrease of $4.7 million, or 6.1%, from net sales of $78.2 million for the
quarter ended September 30, 1997. Sales levels at the CPG decreased $4.6
million, or 12.6%, in the third quarter of 1998 as compared to the third quarter
of 1997, primarily due to lower demand for palletizers and systems product
lines. Sales at the DLG were flat due to a four week strike during the third
quarter of 1998.
NEW ORDER BOOKINGS were $58.2 million for the quarter ended September 30, 1998,
a decrease of $13.3 million, or 18.6%, from the quarter ended September 30,
1997. The DLG experienced a $12.1 million, or 26.2%, decrease in bookings from
the third quarter of 1997 to the third quarter of 1998. This decrease is
primarily attributable to a high level of major systems bookings in the third
quarter of 1997 as compared to the same period of 1998.
GROSS PROFIT was $20.4 million for the quarter ended September 30, 1998, an
increase of $2.4 million, or 13.1%, over the quarter ended September 30, 1997.
As a percent of
17
<PAGE>
sales, gross margins were 27.8% for the third quarter of 1998, an increase of
4.7 percentage points over the same period of 1997. Gross profit increases
occurred at both the DLG and CPG, the DLG being the leader. Both groups
experienced favorable project variances which resulted in cost underruns in the
third quarter of 1998, as compared to overruns in the third quarter of 1997; and
when combined with favorable product mix, produced a significant increase in
margins. Favorable impacts were partially offset by decreases in volume,
primarily attributable to a four week strike at Buschman which has ended, and
lower demand at the CPG in recent months.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A) were $14.3 million for the
quarter ended September 30, 1998, an increase of $1.6 million, or 12.2%, over
the quarter ended September 30, 1997. As a percentage of sales, SG&A expenses
increased from 16.2% in the third quarter of 1997 to 19.4% in the third quarter
of 1998. This increase is primarily attributable to increased payroll, incentive
and related staffing costs, primarily at the DLG, where new direct sales offices
have been established to support year-to-date higher sales volumes.
RESEARCH AND DEVELOPMENT EXPENSES were $1.2 million for the third quarter of
1998, an increase of $526,000 compared to $709,000 for the third quarter of
1997. This increase is primarily attributable to increased development
activities at the DLG.
OPERATING LOSS (INCOME) FROM DIVESTED OPERATIONS was a loss of $2.2 million for
the quarter ended September 30, 1998 compared to income of $1.6 million for the
quarter ended September 1997. This decrease in operating income for McHugh is
primarily attributable to a lower level of license revenue in the third quarter
of 1998 as compared to the third quarter of 1997, combined with increasing SG&A
and research and development expenses to support the growing infrastructure of
McHugh.
OPERATING INCOME for the quarter ended September 30, 1998 was $2.6 million as
compared to $6.0 million in the third quarter of 1997. Excluding operating loss
(income) from divested operations in both years, operating income increased from
$4.4 million in 1997 to $4.7 million in 1998, representing an 8.3% increase. As
a percentage of sales, operating income excluding divested operations increased
from 5.6% in the third quarter of 1997 to 6.5% for the comparable period in
1998. The increase in operating income is the result of the various factors
described above.
INTEREST EXPENSE was approximately $3.2 million for the third quarter of
1998, a decrease of $187,000 from the third quarter of 1997. This decrease is
primarily attributable to lower borrowing levels under Alvey's revolving
credit facility.
INCOME TAX EXPENSE was $914,000 for the quarter ended September 30, 1998, an
increase of $88,000 from $826,000 for the third quarter of 1997. The significant
difference between the effective tax rate on income (loss) before income taxes
and the expected statutory rates is attributable to the non-deductibility of
expenses related to the amortization of goodwill.
18
<PAGE>
NET INCOME (LOSS) was a loss of $1.6 million for the quarter ended September 30,
1998, as compared to income of $1.7 million for the quarter ended September 30,
1997. This decrease is attributable to the various factors discussed above.
COMPARISON OF THE NINE MONTHS ENDED SEPTEMBER 30, 1998 TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997
NET SALES were $228.9 million for the nine months ended September 30, 1998, an
increase of $7.3 million, or 3.3%, over net sales of $221.6 million for the nine
months ended September 30, 1997. Increased volume levels in the first half of
1998 as compared to the first half of 1997, primarily at the DLG, have been
partially offset by lower customer demand at the CPG and reduced volume,
attributable to a four week strike at Buschman, in the third quarter of 1998 as
compared to the third quarter of 1997.
NEW ORDER BOOKINGS were $232.7 million for the nine months ended September 30,
1998, a decrease of $12.0 million, or 4.9%, from the nine months ended September
30, 1997. A shortfall in bookings at the CPG was offset in part by increases at
the DLG.
GROSS PROFIT was $58.4 million for the nine months ended September 30, 1998, an
increase of $9.9 million, or 20.4%, over the nine months ended September 30,
1997. As a percentage of sales, gross profit for the first three quarters of
1998 was 25.5%, a 3.6 percentage point increase over the same period of 1997.
Gross profit increases were particularly strong at the DLG and were primarily
attributable to increased volume and productivity, but also due to the absence
of $2.2 million of asset write-down and related non-recurring charges recorded
in the second quarter of 1997. Gross profit increases at the DLG in 1998 were
restrained by the impacts of a four week strike at Buschman, but continue to
show increases over 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES were $40.6 million for the nine
months ended September 30, 1998, an increase of $2.9 million or 7.7% over the
nine months ended September 30, 1997. As a percentage of sales, SG&A was 17.7%
for the first nine months of 1998, an increase of 0.7 percentage points from the
same period of 1997. This increase is primarily attributable to increased
staffing and bonuses, primarily at the DLG, where new direct sales offices have
been established to support higher sales volumes.
RESEARCH AND DEVELOPMENT EXPENSES were $3.5 million for the first three quarters
of 1998, $1.2 million higher than in the same period of 1997. This increase is
primarily the result of increased development activities in the DLG.
RESTRUCTURING COSTS were $11.3 million for the first nine months of 1997
compared with zero for the same period of 1998. During the second quarter of
1997, the Board of Directors initiated a plan to reorganize and streamline the
Company's corporate
19
<PAGE>
structure and to restructure certain business entities within Pinnacle. In
connection with this plan, Stephen J. O'Neill, President of Alvey, was elected
to the additional positions of President of Pinnacle and CEO of both companies.
Christopher C. Cole, CEO of Buschman, was appointed to the newly created
position of COO of Pinnacle. In addition, both Messrs. O'Neill and Cole were
elected to the Boards of both Pinnacle and Alvey. Furthermore, the Board
established management priorities as: (1) satisfactory completion and
elimination of specific projects with continuing cost overruns primarily related
to products which will be discontinued, (2) restructure or eliminate, when
appropriate, products that are not strategic or profitable, (3) restructure and
streamline the Company's corporate organization and (4) eliminate redundancies
and streamline the organizational structure of McHugh by further consolidating
the now divested operations of McHugh and Weseley. The restructuring charge
included costs to discontinue offering certain proprietary systems software
products at one subsidiary, to reorganize and reduce the size of the Company's
corporate organization and to restructure and streamline the executive and
marketing functions at McHugh. Costs to discontinue certain proprietary software
products consisted primarily of costs to complete certain projects incorporating
this software, payroll and facility charges during the phase-out of the product,
severance charges, sales returns and allowances (relative to prior period sales)
anticipated as a result of the discontinuance, the write-off of assets that
became obsolete or slow-moving as a result of the discontinuance and other
miscellaneous restructuring costs. The corporate reorganization and the McHugh
reorganization charges were primarily severance costs. It is anticipated that
costs accrued as restructuring by non-divested operations will be fully paid by
December 31, 1999 and costs accrued as restructuring by divested operations will
be fully paid by April 30, 2004. (See Note 4 to the Consolidated Financial
Statements for further discussion.) Restructuring costs related to the McHugh
restructuring of $4.0 million are classified in operating loss (income) from
divested operations in the Consolidated Financial Statements.
OPERATING LOSS (INCOME) FROM DIVESTED OPERATIONS was a loss of $3.8 million for
the first three quarters of 1998 as compared to income of $546,000 for the
comparable period of 1997. This decrease is primarily attributable to a write
off of $2.7 million in purchased research and development costs in the second
quarter of 1998 related to the acquisitions of SAI and Gagnon, combined with a
lower level of high-margin license fee revenues in 1998 and increasing SG&A and
research and development costs to support McHugh's growing infrastructure. Those
impacts were partially offset by the absence in 1998 of $4.0 million of
restructuring charges that were recorded in 1997 (See explanation of
restructuring costs above).
OTHER INCOME, NET was $539,000 for the nine months ended September 30, 1998,
compared to $33,000 for the nine months ended September 30, 1997. This
improvement of $506,000 is almost entirely attributable to income recognized
from the proceeds of a life insurance settlement in the first quarter of 1998.
20
<PAGE>
OPERATING INCOME (LOSS) for the first nine months of 1998 was income of $10.3
million compared to a loss of $3.1 million for the first three quarters of 1997.
However, excluding 1997 non-recurring restructuring charges of $11.3 million and
operating loss (income) from divested operations in both years, operating income
increased from $7.7 million in 1997 to $14.1 million in 1998, representing an
84.0% increase. As a percentage of sales, operating income excluding
non-recurring restructuring charges and divested operations increased from 3.5%
in the first three quarters of 1997 to 6.2% for the comparable period in 1998.
The increase in operating income reflects the various factors described above.
INTEREST EXPENSE was $9.9 million for the first three quarters of 1998, a
$460,000, or 4.4%, decrease from $10.4 million of interest expense for the first
three quarters of 1997. This decrease is primarily attributable to decreased
borrowings under the Company's working capital facility.
INCOME TAX EXPENSE (BENEFIT) was expense of $1.8 million for the nine months
ended September 30, 1998, an increase of $6.3 million from $4.5 million of tax
benefit for the first three quarters of 1997. The significant differences
between the effective tax rate on income (loss) before income taxes and the
expected statutory rates are attributable to the non-deductibility of expenses
related to the write-off of purchased research and development costs related to
the divested operations and the amortization of goodwill.
NET LOSS was $1.4 million for the nine months ended September 30, 1998, an
improvement of $7.6 million from the nine months ended September 30, 1997, as a
result of the various factors described above.
LIQUIDITY AND CAPITAL RESOURCES
CASH PROVIDED BY (USED FOR) OPERATING ACTIVITIES. During the nine months ended
September 30, 1998, cash provided by operating activities was $15.5 million
compared to cash used of $8.9 million for the first nine months of 1997. This
$24.4 million year-over-year improvement is primarily attributable to: the
significant year-over-year improvement in profitability; lower project costs in
1998 as compared to the significant use of cash to fund project overrun levels
experienced in the first half of 1997; the realization of 1997 tax benefits in
1998; and an overall improvement in the management of working capital, offset in
part by the payment of restructuring costs that were accrued in 1997. First
quarter funding of annual profit sharing plan contributions, incentive
compensation and bonus plans, disproportionate tax withholding requirements and
certain professional services historically result in a significant use of cash
in the first quarter.
CASH FLOW USED FOR INVESTING ACTIVITIES. Capital expenditures for the nine
months ended September 30, 1998 and 1997, excluding divested operations, were
$2.9 million and $2.5 million, respectively. For divested operations, capital
expenditures were $2.2 million and $2.0 million for the three quarters ended
September 30, 1998 and 1997,
21
<PAGE>
respectively. Management anticipates that current year capital expenditures,
excluding divested operations, will approximate $4.0 million. See Note 3 to the
Consolidated Financial Statements for discussions of the acquisitions (aggregate
cash purchase price of $3.5 million) of SAI and Gagnon by McHugh in the second
quarter of 1998. See Note 8 to the Consolidated Financial Statements for a
discussion of the spin-off of McHugh and related investing activities that
occurred subsequent to September 30, 1998.
CASH FLOW PROVIDED BY (USED FOR) FINANCING ACTIVITIES. Net borrowings decreased
by $6.4 million and increased by $11.2 million in the nine months ended
September 1998 and 1997, respectively. The increase in borrowings in the three
quarters of 1997 was primarily used to fund operating activities while the
year-over-year decrease primarily reflects the significant improvement in cash
provided by operating activities. See Notes 6 and 8 to the Consolidated
Financial Statements for a discussion of amendments to the revolving credit
facility and the Notes and other financing activities related to the McHugh
spin-off that occurred subsequent to September 30, 1998.
ONGOING CASH FLOWS FROM OPERATIONS. The Company believes that its funds from
operations, together with available funds under the Company's existing credit
facility, will be sufficient to meet its currently anticipated operating, debt
service and capital expenditure requirements, including capital requirements
related to potential acquisitions, although no significant acquisitions are
pending or contemplated. See Note 8 to the Consolidated Financial Statements for
a discussion of the spin-off of McHugh.
BACKLOG. As of September 30, 1998, excluding divested operations, the Company
had a backlog of $121.4 million, as compared to $126.0 million and $118.4
million as of September 30, 1997 and December 31, 1997, respectively. The
Company's backlog is based upon firm customer commitments that are supported by
purchase orders, other contractual documents and cash payments. While the level
of backlog at any particular time may be an indication of future sales, it is
not necessarily indicative of the Company's future operating performance.
Additionally, certain backlog orders may be subject to cancellation in certain
circumstances. The Company believes that virtually all orders in backlog at
September 30, 1998 will be shipped within one year.
YEAR 2000. The Company utilizes computer information systems to internally
record and track information, as well as interact with customers, suppliers,
financial institutions and other organizations. The Company also incorporates
software and computerized functions in products throughout the Company. The
Company has appointed a Director of Year 2000 Issues to coordinate and lead the
Year 2000 ("Y2K") project. Each Alvey subsidiary has appointed a Year 2000
Coordinator who reports to the Director of Year 2000 and will lead the Y2K
effort for that subsidiary. Additionally, the Company has selected a law firm to
consult on Y2K issues.
22
<PAGE>
The Company has established a corporate definition of Y2K Readiness, and
incorporated it into a position statement now being used in response to
customers' Y2K inquiries as well as in new business proposals. The Company has
also developed and presented to all subsidiaries a Year 2000 Plan Outline which
is being used as a guide, by each company, to develop individual, detailed Y2K
Readiness plans. The Director of Year 2000 has visited all but one of the
subsidiaries to review issues and analyze the current status of such. Drafts of
engineering guidelines have been issued to all subsidiaries to be used in the
development of future systems. Year 2000 Coordinators have each prepared drafts
of their detailed plans and are nearing completion of the final versions.
These plans are, in general, based on a five phase resolution process that
includes Phase I (Awareness), Phase II (Assessment), Phase III (Renovation),
Phase IV (Validation) and Phase V (Contingency Planning). Company systems have
been separated into three areas: 1) internal, 2) business partners and 3)
external customers. These areas have been subdivided to address specific issues
with: A) internally engineered systems, B) purchased systems and C) embedded
systems. Phase I is nearing completion at all companies. The companies are in
varying stages of completion of Phase II, but generally are approximately 70%
complete with this phase. All assessments are planned to be complete by the end
of 1998. As a result of early Phase II findings, Phase III work is underway and
while each subsidiary has unique issues, on average the Company believes it is
approximately 40% - 50% complete with this phase. It is planned that all
renovation work will be completed by the end of the first quarter of 1999. There
has been minimal effort to date on Phase IV; however, some testing of
manufacturing systems, internally engineered systems and computers has been
successfully completed. Completion of all testing is planned for June 1999. This
will provide the second half of 1999 for re-testing and unanticipated
renovations. Phase V (Contingency Planning) has not commenced but is planned for
completion by the end of the third quarter of 1999.
Alvey and its subsidiaries are actively pursuing compliance statements from
suppliers and business partners. The companies plan to have compiled detailed
information regarding all of its significant suppliers and business partners by
December 1998. In addition, the companies are testing newly purchased
significant hardware and software systems in an effort to ensure their Year 2000
compliance.
As the Company has not yet completed Phase II of the Y2K process, the costs of
the Year 2000 project cannot be accurately quantified at this time. Preliminary
estimates indicate that costs incurred in 1998 will exceed $500,000 and that
costs to be incurred in 1999 will exceed 1998 levels.
Alvey is dependent upon its own internal computer technology, relies upon timely
performance by its business partners and provides computerized functions to
customers. A large-scale internal Year 2000 failure could, while believed to be
remote, impair the Company's ability to timely deliver products and services to
our customers,
23
<PAGE>
resulting in potential lost sales opportunities and additional expenses.
Significant computer failures by critical vendors could disrupt the Company's
ability to produce and timely deliver products or services. However, given the
nature of the products and services provided, the Company believes any such
disruption can be minimized through the utilization of readily available
alternative sources. In the event computerized functions provided by Alvey to
its customers encounter a Year 2000 failure, those customers may look to Alvey
to provide assistance or services. A large scale failure could exceed the
Company's ability to timely respond to the needs of these customers, resulting
in additional expenses and potential loss of customers. The Company's Year 2000
program seeks to identify and minimize this risk and includes testing of its
systems to ensure, to the extent feasible, all such systems will function
properly before and after the Year 2000. Alvey is continually refining its
understanding of the risks posed by the Year 2000, and will continue to do so
throughout 1998 and 1999.
While no assurances can be given, because of Alvey's extensive efforts to
formulate and carry-out an effective Year 2000 program, the Company believes its
program will be completed on a timely basis and should effectively minimize
disruption to Alvey's operations due to Year 2000 issues and that such issues
will not have a material adverse effect on the Company's consolidated results of
operation.
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.1 Agreement, dated as of June 1, 1998, between Vestar
Capital Partners and Pinnacle Automation, Inc.
(b) The Company filed a Current Report on Form 8-K on July 27, 1998.
24
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ALVEY SYSTEMS, INC.
/s/ J. A. Sharp
--------------------------------------------
Date: November 13, 1998 James A. Sharp
Secretary and Senior Vice President, Finance
Chief Financial Officer
(Principal Financial and Accounting Officer)
<PAGE>
EXHIBIT 10.1
VESTAR CAPITAL PARTNERS
245 Park Avenue, 41st Floor
New York, New York 10167
As of June 1, 1998
Pinnacle Automation, Inc.
9301 Olive Boulevard
St. Louis, Missouri 63132
Attn: Mr. Stephen J. O'Neill
President and Chief Executive Officer
Gentlemen:
Pursuant to the second sentence of paragraph 3 of that certain
consulting agreement among Pinnacle Automation, Inc. ("Pinnacle"), Alvey
Systems, Inc. ("Alvey") and Vestar Capital Partners ("Vestar") dated January 24,
1996, we are pleased to confirm our mutual understanding regarding the retention
of Vestar as outlined below.
1. Vestar has assisted and will continue to assist the Company
as its financial advisor and agent in connection with evaluating, negotiating
and consummating the following transactions (collectively, the "Transactions"):
(a) the spin-off of McHugh Software International, Inc. ("McHugh") from
Pinnacle's wholly-owned subsidiary Alvey and the subsequent distribution of
McHugh's stock to Pinnacle's shareholders (the "Spin-off"); (b) the sale of a
minority equity interest in McHugh to a third party investor (the "Third Party
Investment"); (c) the exchange of a portion of Pinnacle's outstanding preferred
stock for Class B Common Stock of McHugh (the "Preferred Stock Exchange"); (d)
the obtaining of consents to the amendment of the terms of Alvey's senior
subordinated notes (the "Consent"); (e) the amendment of Alvey's existing credit
facility with its senior lenders (the "Amendment") and (f) the consummation of a
credit facility by McHugh (the "McHugh Facility").
2. During the term of our engagement, we will continue to
formulate, review and analyze proposals for the Transactions and advise the
Company as to structure and valuation and assist the Company in negotiations in
connection with the Transactions. Specifically, Vestar will: (1) assist in the
valuation, structuring and negotiation of the Spin-off and the transactions
related thereto; (2) assist in the valuation, structuring and negotiation of the
Third Party Investment; (3) advise and assist in the structuring and negotiation
of the Preferred Stock Exchange; and (4) advise and assist in arranging the
Consent, the Amendment and the McHugh Facility.
3. In connection with Vestar's activities on the Company's
behalf, the Company has furnished and will continue to furnish Vestar with all
information and data concerning the Company and the Transactions (the
"Information") which Vestar deems appropriate and will continue to provide
Vestar with access to the Company's officers, directors, employees, independent
accountants and legal counsel. The Company represents and warrants that all
Information made and to be made available to Vestar by the Company, to the best
of the Company's knowledge, is and will be complete and correct in all material
respects. The Company further represents and warrants that (i) any projections
that have been provided by it to Vestar have been prepared in good faith and are
based upon assumptions which, in light of the circumstances under which they
were made, were reasonable, and (ii) any projections which will be provided by
the Company to Vestar after the date hereof will be prepared in good faith and
will be based upon assumptions which, in the light of the circumstances under
which they are made, are reasonable. The Company acknowledges and agrees that,
in rendering its services hereunder, Vestar has been and will continue to be
using and relying on the Information (and information available from public
sources and other sources deemed reliable by Vestar) without independent
verification thereof or independent appraisal of any of the
1
<PAGE>
Company's assets. Vestar does not assume responsibility for the accuracy or
completeness of the Information or any other information regarding the Company,
any third party or any of the Transactions. Any advice rendered by Vestar
pursuant to this Agreement may not be disclosed publicly without Vestar's prior
written consent.
4. In consideration of our services pursuant to this
Agreement, Vestar shall earn and be entitled to receive, and the Company agrees
to pay Vestar, the following compensation:
(a) Upon the consummation of the Spin-off, Vestar shall earn a
non-refundable cash fee of $900,000. Such fee shall be paid at the
closing of the Spin-off.
(b) Vestar shall be entitled to the fees set forth in this
paragraph 4 with respect to any Transactions consummated within twelve
months from the date hereof or consummated pursuant to any agreement in
principle or definitive agreement executed and delivered within twelve
months from the date hereof.
5. In addition to the fees described in paragraph 4 above, the
Company agrees to reimburse Vestar, upon Vestar's request from time to time, for
all reasonable out-of-pocket expenses incurred by Vestar (including fees and
disbursements of counsel) in connection with the matters contemplated by this
Agreement.
6. The Company agrees to indemnify Vestar in accordance with
the indemnification provisions (the "Indemnification Provisions") attached to
this Agreement, which Indemnification Provisions are incorporated herein and
made a part hereof.
7. The term of this Agreement is twelve months from the date
hereof. Either party hereto may terminate this Agreement at any time upon
written notice without liability or continuing obligation, except as set forth
in the following sentence. Neither the termination nor expiration of this
Agreement nor the completion of the assignment contemplated hereby shall affect:
(i) any compensation earned by Vestar up to the date of termination, expiration
or completion, as the case may be; (ii) the reimbursement of expenses incurred
by Vestar through the date of termination, expiration or completion, as the case
may be; or (iii) the provisions of paragraphs 6 (including the Indemnification
Provisions) through 9, inclusive, of this Agreement, all of which shall remain
operative and in full force and effect subsequent to the termination, expiration
or completion of this Agreement.
8. The validity and interpretation of this Agreement shall be
governed by the laws of the State of New York applicable to agreements made and
to be fully performed therein without regard to the conflicts of law principles
thereof.
9. The benefits of this Agreement shall inure to the
respective successors and assigns of the parties hereto and of the indemnified
parties hereunder and their successors and assigns and representatives, and the
obligations and liabilities assumed in this Agreement by the parties hereto
shall be binding upon their respective successors and assigns.
10. For the convenience of the parties, any number of
counterparts of this Agreement may be executed by the parties hereto. Each such
counterpart shall be, and shall be deemed to be, an original instrument, but all
such counterparts taken together shall constitute one and the same Agreement.
This Agreement may not be modified or amended except in writing signed by the
parties hereto.
2
<PAGE>
If the foregoing currently sets forth our agreement, please
sign the enclosed copy of this letter in the space provided and return it to us.
Very truly yours,
VESTAR CAPITAL PARTNERS
By:/s/James L. Elrod, Jr.
-----------------------------
Name: James L. Elrod, Jr.
Title: Managing Director
Confirmed and agreed to
as of June 1, 1998
Pinnacle Automation, Inc.
By:/s/James A. Sharp
-------------------------------------
Name: James A. Sharp
Title: Executive Vice President
and Chief Financial Officer
3
<PAGE>
INDEMNIFICATION PROVISIONS
Pinnacle Automation, Inc. (the "Company") agrees to indemnify
and hold harmless Vestar Capital Partners ("Vestar") against any and all losses,
claims, damages, obligations, penalties, judgments, awards, liabilities, costs,
expenses and disbursements (and any and all actions, suits, proceedings and
investigations in respect thereof and any and all reasonable legal and other
costs, expenses and disbursements in giving testimony or furnishing documents in
response to a subpoena or otherwise), including, without limitation, the
reasonable costs, expenses and disbursements, as and when incurred, of
investigating, preparing or defending any such action, suit, proceeding or
investigation (whether or not in connection with litigation to which Vestar is a
party), directly or indirectly caused by, relating to, based upon, arising out
of or in connection with (a) Vestar's acting for the Company, whether before or
after the date of the Agreement referred to below, including, without
limitation, any act or omission by Vestar in connection with acceptance of or
the performance or non-performance of its obligations under the letter agreement
dated as of June 1, 1998, between Vestar and the Company, as it may be amended
from time to time (the "Agreement"), (b) any untrue statement or alleged untrue
statement of a material fact contained in, or omissions or alleged omissions of
material fact from, any sales, information or consent materials used in
connection with the Transactions contemplated by the Agreement or similar
statements or omissions in or from any other information furnished to Vestar or
any party to any of the Transactions (as such term is defined in the Agreement)
or (c) any Transactions; PROVIDED, HOWEVER, such indemnity agreement shall not
apply to any portion of any such loss, claim, damage, obligation, penalty,
judgment, award, liability, cost, expense or disbursement to the extent it is
found in a final judgment by a court of competent jurisdiction (not subject to
further appeal) to have resulted primarily from the gross negligence or willful
misconduct of Vestar. The Company also agrees that Vestar shall not have any
liability (whether direct or indirect, in contract or tort or otherwise) to the
Company or to any person (including, without limitation, stockholders of the
Company) claiming through the Company for or in connection with the engagement
of Vestar, except to the extent that any such liability is found in a final
judgment by a court of competent jurisdiction (not subject to further appeal) to
have resulted primarily from Vestar's gross negligence or willful misconduct.
These Indemnification Provisions shall be in addition to any
liability which the Company may otherwise have to Vestar and shall extend to
Vestar and its affiliates and their respective directors, partners, officers,
employees, advisors, agents and affiliates. All references to Vestar in these
Indemnification Provisions shall be understood to include any and all of the
foregoing indemnified parties.
If any action, suit, proceeding or investigation is commenced
as to which Vestar proposes to demand indemnification, it shall notify the
Company with reasonable promptness; provided, however, that any failure by
Vestar to notify the Company shall not relieve the Company from its obligations
hereunder. Except as provided otherwise in the next sentence, the Company shall
have the right to assume the defense of such action, suit, proceeding or
investigation with counsel reasonably satisfactory to Vestar. Vestar shall have
the right to retain separate counsel in any such matter and to participate in
the defense thereof, but the fees and expenses of such counsel shall be at
Vestar's expense unless (i) the Company has agreed to pay such fees and expenses
or (ii) the indemnifying party shall have failed to assume the defense of such
matter or to retain counsel reasonably satisfactory to Vestar or (iii) the named
parties to any such matter (including any impleaded parties) include both the
Company and an indemnified party and (x) there are one or more legal defenses
available to the indemnified party which are different from or additional to
those available to the Company and which result in a conflict of interest
between the Company and such indemnified party or (y) the representation of both
parties by the same counsel would be inappropriate due to differing interests
between them, in either which case, the Company shall not have the right to
assume the defense of the matter. Vestar and the Company and their respective
counsel shall, to the extent consistent with such counsel's professional
responsibilities, cooperate with each other. The Company shall be liable for any
settlement of any claim against Vestar made with the Company's written consent,
which consent shall not be unreasonably withheld. The Company shall not, without
the prior written consent of Vestar, settle or compromise any claim, or permit a
default or consent to the entry of any judgment in respect thereof, unless such
settlement, compromise or consent includes, as an unconditional term thereof,
the giving by the claimant to Vestar of an unconditional release from all
liability in respect to such claim.
1
<PAGE>
In order to provide for just and equitable contribution, if a
claim for indemnification pursuant to these Indemnification Provisions is made
but it is found in a final judgment by a court of competent jurisdiction (not
subject to further appeal) that such indemnification may not be enforced in such
case, even though the express provisions hereof provide for indemnification in
such case, then the Company, on the one hand, and Vestar, on the other hand,
shall contribute to the losses, claims, damages, obligations, penalties,
judgments, awards, liabilities, costs, expenses and disbursements to which
Vestar may be subject in accordance with the relative benefits received by the
Company, on the one hand, and Vestar, on the other hand, and also the relative
fault of the Company, on the one hand, and Vestar, on the other hand, in
connection with the statements, acts or omissions which resulted in such losses,
claims, damages, obligations, penalties, judgments, awards, liabilities, costs,
expenses and disbursements and the relevant equitable considerations shall also
be considered. No person found liable for a fraudulent misrepresentation shall
be entitled to contribution from any person who is not also found liable for
such fraudulent misrepresentation. Notwithstanding the foregoing, Vestar shall
not be obligated to contribute any amount hereunder that exceeds the amount of
fees previously received by Vestar pursuant to the Agreement.
Neither the termination nor completion of the engagement of
Vestar referred to above shall affect these Indemnification Provisions, which
shall then remain operative and in full force and effect.
2
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