<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 11, 1998
REGISTRATION NO. 333-48817
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
PHASE METRICS, INC.*
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 3572 33-0328048
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
10260 SORRENTO VALLEY ROAD
SAN DIEGO, CALIFORNIA 92121
(619) 646-4800
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
JOHN F. SCHAEFER
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
PHASE METRICS, INC.
10260 SORRENTO VALLEY ROAD
SAN DIEGO, CALIFORNIA 92121
(619) 646-4800
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER,
INCLUDING AREA CODE, OF AGENT FOR SERVICE)
COPY TO:
GREG T. WILLIAMS, ESQ.
BROBECK, PHLEGER & HARRISON LLP
38 TECHNOLOGY DRIVE
IRVINE, CALIFORNIA 92618
(949) 790-6300
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================
<PAGE> 2
*TABLE OF ADDITIONAL REGISTRANTS
<TABLE>
<CAPTION>
STATE OR OTHER
JURISDICTION OF PRIMARY STANDARD
INCORPORATION OR INDUSTRIAL CLASSIFICATION I.R.S. EMPLOYER
NAME, ADDRESS AND TELEPHONE NUMBER(1) ORGANIZATION CODE NUMBER IDENTIFICATION NO.
- --------------------------------------------- ----------------- ------------------------- ------------------
<S> <C> <C> <C>
Air Bearings, Incorporated................... California 3572 94-3092378
Applied Robotic Technologies, Inc............ California 3572 68-0022756
Helios, Incorporated......................... California 3572 77-0077044
Santa Barbara Metric, Inc.................... California 3572 77-0430551
</TABLE>
- ---------------
(1) The address of these additional registrants is 10260 Sorrento Valley Road,
San Diego, California 92121. Their telephone number is (619) 646-4800.
<PAGE> 3
EXPLANATORY NOTE
This Registration Statement covers the registration of an aggregate
principal amount of $110,000,000 of new 10 3/4% Senior Notes due 2005 (the "New
Notes") of Phase Metrics, Inc. (the "Company") and the guarantees related
thereto that may be exchanged (the "Exchange Offer") for equal principal amounts
of the Company's outstanding 10 3/4% Senior Notes due 2005 (the "Notes") and the
guarantees related thereto. This Registration Statement also covers the
registration of the New Notes and the guarantees related thereto for resale by
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") in market-making
transactions. The complete Prospectus relating to the Exchange Offer (the
"Exchange Offer Prospectus") follows immediately after this Explanatory Note.
Following the Exchange Offer Prospectus beginning on page B-1 are certain pages
and sections of a prospectus relating solely to any market-making transactions
by DLJ (along with the relevant pages of the Exchange Offer Prospectus, the
"Market-Making Prospectus"), including an alternate front cover page, an
alternate section entitled "Risk Factors -- Absence of Active Trading Market" to
be used in lieu of the section entitled "Risk Factors -- Absence of Trading
Market; Restrictions on Transfers," an alternate section entitled "Use of
Proceeds" and an alternate section entitled "Plan of Distribution." In addition,
the Market-Making Prospectus will not include the following sections (or the
information set forth under the captions for such sections) of the Exchange
Offer Prospectus: "Prospectus Summary -- The Note Offering" and "-- The Exchange
Offer," "Risk Factors -- Compliance with Exchange Offer Procedures; Restrictions
on Resales," "The Exchange Offer" and "Certain United States Federal Tax
Considerations." All other sections of the Exchange Offer Prospectus will be
included in the Market-Making Prospectus.
<PAGE> 4
PROSPECTUS
OFFER TO EXCHANGE
ALL OUTSTANDING
10 3/4% SENIOR NOTES DUE 2005
($110,000,000 PRINCIPAL AMOUNT OUTSTANDING)
FOR
NEW 10 3/4% SENIOR NOTES DUE 2005
($110,000,000 PRINCIPAL AMOUNT)
OF
[PHASE METRICS LOGO]
------------------------
The Exchange Offer Will Expire At 12:00 Midnight, New York City Time,
On , 1998, Unless Extended
------------------------
Phase Metrics, Inc., a Delaware corporation (the "Company"), hereby offers
(the "Exchange Offer"), upon the terms and subject to the conditions set forth
in this Prospectus and the accompanying Letter of Transmittal (the "Letter of
Transmittal"), to exchange up to an aggregate principal amount of $110,000,000
of its new 10 3/4% Senior Notes due 2005 (the "New Notes") for an equal
principal amount of its outstanding 10 3/4% Senior Notes due 2005 (the "Notes"),
in integral multiples of $1,000. The New Notes will be senior unsecured
obligations of the Company and are substantially identical (including principal
amount, interest rate, maturity and redemption rights) to the Notes for which
they may be exchanged pursuant to this Exchange Offer, except that (i) the
offering and sale of the New Notes will have been registered under the
Securities Act of 1933, as amended (the "Securities Act") and (ii) holders of
New Notes will not be entitled to certain rights under the Registration Rights
Agreement of the Company and Applied Robotic Technologies, Inc., Helios,
Incorporated, Air Bearings, Incorporated and Santa Barbara Metric, Inc., all of
which are California corporations and wholly-owned subsidiaries of the Company
(together with any future other subsidiary of the Company that executes a New
Note Guarantee, the "Subsidiary Guarantors") dated as of January 30, 1998 (the
"Registration Rights Agreement"). The New Notes will be fully and
unconditionally guaranteed on a senior unsecured basis (the "New Note
Guarantees") by, and will be joint and several obligations of the Subsidiary
Guarantors. The Notes have been, and the New Notes will be, issued under an
Indenture dated as of January 30, 1998 (the "Indenture"), among the Company, the
Subsidiary Guarantors and State Street Bank and Trust Company, as trustee (the
"Trustee"). See "Description of New Notes." There will be no proceeds to the
Company from this Exchange Offer; however, pursuant to the Registration Rights
Agreement, the Company will bear certain offering expenses.
------------------------
SEE "RISK FACTORS" COMMENCING ON PAGE 12 FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS WHO TENDER NOTES
IN THE EXCHANGE OFFER.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is , 1998.
<PAGE> 5
The Company's Japanese, Korean and Singapore subsidiaries, Phase Metrics
Japan Co. Ltd., Phase Metrics Korea Co. Ltd. and Phase Metrics Pacific PTE,
Ltd., respectively, and Phase Metrics International Incorporated, the Company's
foreign sales corporation based in Barbados (collectively, the "Non-Guarantor
Subsidiaries") have not guaranteed the Company's obligations under the Notes and
will not guarantee the Company's obligations under the New Notes. As of and for
the year ended December 31, 1997, and the three-month period ended March 31,
1998, the operating results and assets of the Non-Guarantor Subsidiaries,
individually and in the aggregate, were not material to the results of
operations and assets of the Company on a consolidated basis, net of
intercompany eliminations. See Note 12 of Notes to Consolidated Financial
Statements. The total assets, total liabilities, net sales and net income (loss)
of the Non-Guarantor Subsidiaries as a percentage of the Company's consolidated
total assets, total liabilities, net sales and net income (loss) as of and for
the year ended December 31, 1997 were 3.1%, 0.4%, 1.6% and 10.1%, respectively,
and as of and for the three-month period ended March 31, 1998, were 3.5%, 0.6%,
5.5% and 1.1%, respectively.
The Company will accept for exchange any and all Notes which are validly
tendered on or prior to 12:00 midnight New York City time, on ,
1998, unless the Exchange Offer is extended (the "Expiration Date"). Tenders of
Notes may be withdrawn at any time prior to 12:00 midnight, New York City time,
on the Expiration Date; otherwise such tenders are irrevocable. State Street
Bank and Trust Company will act as exchange agent with respect to the Notes (in
such capacity, the "Exchange Agent") in connection with the Exchange Offer. The
Exchange Offer is not conditioned upon any minimum principal amount of Notes
being tendered for exchange, but is otherwise subject to certain customary
conditions. Notes may be tendered only in denominations of $1,000 and any
integral multiple thereof. See "The Exchange Offer."
The Notes were initially sold by the Company on January 30, 1998 (the "Note
Closing") in transactions not registered under the Securities Act of 1933, as
amended (the "Securities Act") in reliance upon the exemption provided in
Section 4(2) thereof (the "Note Offering"). The Notes were subsequently resold
to qualified institutional buyers in reliance upon Rule 144A under the
Securities Act and to persons outside the United States in reliance on
Regulation S under the Securities Act. Accordingly, the Notes may not be
reoffered, resold or otherwise transferred in the United States unless
registered under the Securities Act or unless an applicable exemption from the
registration requirements of the Securities Act is available. The New Notes are
being offered hereunder in order to satisfy certain obligations of the Company
and the Subsidiary Guarantors under the Registration Rights Agreement. See "The
Exchange Offer."
The New Notes will bear interest from January 30, 1998, the date of
issuance of the Notes that may be tendered in exchange for the New Notes, at a
rate equal to 10 3/4% per annum. Interest on the New Notes will be payable
semiannually on February 1 and August 1 of each year, commencing August 1, 1998.
The New Notes are redeemable at the option of the Company, in whole or in part,
at any time on or after February 1, 2002, at the redemption prices set forth
herein, plus accrued and unpaid interest and Liquidated Damages (as defined
herein), if any, thereon to the date of redemption. See "Summary -- Summary of
Terms of New Notes."
Prior to February 1, 2001, up to 33% of the initially outstanding aggregate
principal amount of New Notes (and any Notes which remain outstanding after the
Exchange Offer) will be redeemable at the option of the Company from the net
proceeds of a public sale of the Company's Common Stock ("Common Stock") at a
price of 110.75% of the principal amount of the New Notes (and any Notes which
remain outstanding after the Exchange Offer), together with accrued and unpaid
interest and Liquidated Damages, if any, to the date of redemption; provided,
that at least 67% of the initially outstanding aggregate principal amount of New
Notes (and any Notes which remain outstanding after the Exchange Offer) remains
outstanding immediately after such redemption. Upon the occurrence of a Change
of Control (as defined herein), each Holder (as defined herein) of New Notes may
require the Company to repurchase all or a portion of such Holder's New Notes at
101% of the aggregate principal amount of the New Notes, together with accrued
and unpaid interest and Liquidated Damages, if any, to the date of repurchase.
There can be no assurance that sufficient funds will be available at the time of
any Change of Control to make any required repurchase of New Notes. See "Risk
Factors -- Payment Upon a Change of Control" and "Description of New
Notes -- Repurchase at the Option of Holders -- Change of Control."
ii
<PAGE> 6
The New Notes will be senior unsecured obligations of the Company and will
rank pari passu in right of payment to all existing and future senior
indebtedness of the Company and senior in right of payment to all existing and
future subordinated indebtedness of the Company. The New Notes will be
effectively subordinated, however, to all secured obligations of the Company,
including any borrowings under the New Credit Facility (as defined herein) to
the extent of the assets securing such obligations. The New Notes will be fully
and unconditionally guaranteed under the New Note Guarantees on a joint and
several basis by the Subsidiary Guarantors. The New Note Guarantees will be
senior unsecured obligations of the Subsidiary Guarantors and will rank pari
passu in right of payment to all existing and future senior indebtedness of the
Subsidiary Guarantors. The New Note Guarantees will be effectively subordinated,
however, to all secured obligations of the Subsidiary Guarantors, including the
guarantees of the Subsidiary Guarantors in favor of the lenders under the New
Credit Facility, to the extent of the assets securing such obligations. As of
March 31, 1998, all of the Company's indebtedness under its current revolving
credit facility (the "New Credit Facility") was secured by the assets of the
Company and the Subsidiary Guarantors, and, accordingly, the New Notes and the
New Note Guarantees were effectively subordinated to approximately $11.2 million
of obligations of the Company and the Subsidiary Guarantors as of such date,
which amount is inclusive of indebtedness under capital lease obligations. In
addition, the Notes are and the New Notes will be structurally subordinated to
all indebtedness and other obligations of the Non-Guarantor Subsidiaries,
including all accounts payable, and debt for borrowed money. As of March 31,
1998, the Non-Guarantor Subsidiaries had an aggregate of $0.5 million of such
indebtedness and other obligations outstanding, all of which ranked or will rank
effectively senior to the Notes and New Notes in right of payment. Other than
the guarantees of the Subsidiary Guarantors in favor of the lenders under the
New Credit Facility, the Subsidiary Guarantors did not, as of March 31, 1998,
have any material amount of indebtedness outstanding.
Based on interpretations of the staff of the SEC set forth in no-action
letters issued to third parties, the Company believes that any New Notes issued
pursuant to the Exchange Offer in exchange for Notes may be offered for resale,
resold and otherwise transferred by any holder thereof (other than any holder
which is an "affiliate" of the Company within the meaning of Rule 405 under the
Securities Act) without compliance with the registration and prospectus delivery
provisions of the Securities Act; provided, that such New Notes are acquired in
the ordinary course of such holder's business and that such holder does not
intend to participate in a distribution of such New Notes.
Each broker-dealer ("Participating Broker-Dealer") that receives New Notes
for its own account pursuant to the Exchange Offer must acknowledge that it will
deliver a prospectus in connection with the initial resale of such New Notes to
third parties. The Letter of Transmittal delivered with this Prospectus states
that by so acknowledging and by delivering a prospectus, a Participating
Broker-Dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act. This Prospectus, as it may be amended or
supplemented from time to time, may be used by a Participating Broker-Dealer in
connection with resales of New Notes received in exchange for Notes where such
new Notes were acquired by such broker-dealer as a result of market-making
activities or other trading activities and such broker-dealer is not an
affiliate of the Company. The Company has agreed that for a period of one year
after the consummation of the Exchange Offer, it will make this Prospectus
available to any non-affiliate Participating Broker-Dealer for use in connection
with any such resale. See "Plan of Distribution."
Any broker-dealer who is an affiliate of the Company may not rely on the
SEC staff's no-action letters referenced above and must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale of the New Notes.
Any Holder who tenders in the Exchange Offer with the intention to
participate, or for purpose of participating, in a distribution of the New Notes
also may not rely on the position of the staff of the SEC enunciated in the
no-action letters referenced above and, in the absence of an exemption
therefrom, must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale of the New
Notes. Failure to comply with such requirements in such instance may result in
such Holder incurring liability under the Securities Act for which the Holder is
not indemnified by the Company. By executing the Letter of Transmittal delivered
with this Prospectus, each Holder will acknowledge that it does not have an
arrangement or understanding with any person to participate in the distribution
of the New Notes.
iii
<PAGE> 7
The Company does not intend to list the New Notes on any securities
exchange, or to seek admission thereof to trading in the National Association of
Securities Dealers Automated Quotation System. Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ"), a significant stockholder of the Company, has
advised the Company that it intends to make a market in the New Notes; however,
DLJ is not obligated to do so and any market-making may be discontinued at any
time at the election of DLJ. In connection with DLJ's market making activities,
DLJ will be required to deliver a prospectus separate from this Prospectus
meeting the requirements of the Securities Act. DLJ may be required to
discontinue its market-making activities when the market-making prospectus used
in connection therewith must be updated for any reason. As a result, the Company
cannot determine whether an active trading market will develop for the New
Notes. To the extent that a market for the New Notes develops, their market
value will depend on market conditions (such as yields on alternative
investments), general economic conditions, the Company's financial condition and
other conditions. Such conditions might cause the New Notes, to the extent that
they are actively traded, to trade at a significant discount from their face
value. See "Risk Factors -- Absence of Trading Market; Restrictions on
Transfer."
ANY NOTES NOT TENDERED AND ACCEPTED IN THE EXCHANGE OFFER WILL REMAIN
OUTSTANDING. TO THE EXTENT ANY NOTES ARE TENDERED AND ACCEPTED IN THE EXCHANGE
OFFER, A HOLDER'S ABILITY TO SELL UNTENDERED NOTES COULD BE ADVERSELY AFFECTED.
FOLLOWING CONSUMMATION OF THE EXCHANGE OFFER, THE HOLDERS OF NOTES WILL CONTINUE
TO BE SUBJECT TO THE EXISTING RESTRICTIONS UPON TRANSFER THEREOF AND THE COMPANY
WILL HAVE FULFILLED ITS PRINCIPAL OBLIGATIONS UNDER THE REGISTRATION RIGHTS
AGREEMENT. HOLDERS OF NOTES WHO DO NOT TENDER THEIR NOTES GENERALLY WILL NOT
HAVE ANY FURTHER REGISTRATION RIGHTS UNDER THE REGISTRATION RIGHTS AGREEMENT OR
OTHERWISE. SEE "THE EXCHANGE OFFER -- CONSEQUENCES OF FAILURE TO EXCHANGE."
This Prospectus, together with the Letter of Transmittal, is being sent to
all registered holders of Notes as of , 1998.
The Company will not receive any proceeds from the Exchange Offer. No
underwriter is being used in connection with the Exchange Offer.
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED
UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY
OTHER THAN THE NEW NOTES OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL
OR THE SOLICITATION OF AN OFFER TO BUY ANY OF THE NEW NOTES TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO
SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
UNTIL , 1998 (90 DAYS AFTER COMMENCEMENT OF THIS OFFERING),
ALL DEALERS EFFECTING TRANSACTIONS IN THE NEW NOTES, WHETHER OR NOT
PARTICIPATING IN THE EXCHANGE OFFER, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"SEC" or the "Commission") a Registration Statement on Form S-4 under the
Securities Act for the registration of the New Notes
iv
<PAGE> 8
offered hereby (the "Registration Statement"). This Prospectus, which
constitutes a part of the Registration Statement, does not contain all of the
information set forth in the Registration Statement, certain items of which are
contained in exhibits and schedules to the Registration Statement as permitted
by the rules and regulations of the SEC. For further information with respect to
the Company or the New Notes offered hereby, reference is made to the
Registration Statement, including the exhibits and schedules thereto, which may
be inspected without charge at the public reference facility maintained by the
SEC at 450 Fifth Street, N.W., Room 1024, Washington, D.C. 20549, and copies of
which may be obtained from the SEC at prescribed rates. Statements made in this
Prospectus concerning the contents of any document referred to herein are not
necessarily complete. With respect to each such document filed with the SEC as
an exhibit to the Registration Statement, reference is made to the exhibit for a
more complete description of the matter involved, and each such statement shall
be deemed qualified by such reference.
The Company and the Subsidiary Guarantors are not currently subject to the
informational reporting requirements of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). As a result of the offering of the New Notes, each
of the Company and the Subsidiary Guarantors will become subject to the
informational reporting requirements of the Exchange Act. The Company will
fulfill its obligations with respect to such requirements by filing periodic
reports with the Commission on its own behalf or, in the case of the Subsidiary
Guarantors, by including information regarding the Subsidiary Guarantors in the
Company's periodic reports. Under applicable provisions of the Exchange Act, the
duty to file periodic reports under the Exchange Act shall be automatically
suspended as to any fiscal year, if, at the beginning of such fiscal year, the
securities of each class to which the registration statement relates are held of
record by less than 300 persons. As of March 31, 1998, the Notes were held of
record by less than 300 persons. If this situation continues at January 1, 1999,
the obligations of the Company to file periodic reports with the Commission
under applicable provision of the Exchange Act would be automatically suspended
for 1999.
The Company has agreed that, whether or not it is required to do so by the
rules and regulations of the Commission, for so long as any of the New Notes
remain outstanding, it will furnish to the holders of the New Notes and to the
extent permitted by applicable law or regulation, file with the Commission
following the consummation of the Exchange Offer (i) all quarterly and annual
financial information required to be contained in a filing with the Commission
on Forms 10-Q and 10-K, including for each a "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and with respect to
the annual financial statements only, a report thereon by the Company's
independent auditors and (ii) all reports required to be filed with the
Commission on Form 8-K. In addition, for so long as any of the New Notes remain
outstanding, the Company has agreed to make available to any prospective
purchaser of the New Notes or beneficial owner of the New Notes, in connection
with any sale thereof, the information required by Rule 144A(d)(4) under the
Securities Act.
Documents and other information filed by the Company with the SEC may also
be inspected and copied at the public reference facilities of the SEC at 450
Fifth Street, N.W., Room 1024, Washington, D.C. 20549, at the web site
maintained by the SEC (http://www.sec.gov) and at the regional offices of the
SEC located at 7 World Trade Center, 13th Floor, New York, New York 10048 and
500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such
materials may also be obtained from the Public Reference Section of the SEC,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at its
public reference facilities in New York, New York and Chicago, Illinois at
prescribed rates.
v
<PAGE> 9
SUMMARY
The following summary is qualified in its entirety by the more detailed
information, including "Risk Factors" and the Company's Consolidated Financial
Statements and related Notes thereto, appearing elsewhere in this Prospectus.
This Prospectus may contain forward-looking statements, including, without
limitation, the Company's future product development plans, future demand for
the Company's process and production-test equipment and the effect that certain
market conditions may have on the Company's future operating results.
Forward-looking statements necessarily involve risks and uncertainties. Market
conditions and the Company's actual results may differ materially from the
market conditions and results discussed in these statements. Factors that might
cause such a difference include, without limitation, those discussed in "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and those discussed elsewhere in this Prospectus. The
market share and competitive position data contained in this Prospectus are
based upon industry sources and Company estimates. Although such data is
inherently imprecise, based on its understanding of the markets in which the
Company competes, management believes that such data is generally indicative of
the Company's relative market share and competitive position. Unless the context
otherwise requires, all references to the "Company" and "Phase Metrics" refer to
Phase Metrics, Inc. and its consolidated subsidiaries. The definition of certain
terms may be found in the Glossary beginning on page A-1.
THE COMPANY
Phase Metrics is the leading supplier of technologically advanced process
and production-test equipment for the data storage industry. The Company's
systems are used primarily by manufacturers of disk drives, thin-film disks and
read/write heads to manage and improve their respective product yields by
analyzing product and process quality at critical stages in their production
processes. The ability to rapidly achieve and maintain yield improvements is one
of the most important determinants of profitability in the highly competitive
disk drive and disk drive component industries. The Company was formed in 1989
as a single product supplier to the data storage industry. In the last three
years, the Company has significantly expanded its product line through the
acquisition of seven specialized suppliers of complementary systems for the disk
drive and disk drive component industries. These acquisitions and an aggressive
internal research and development program have provided the Company with (i) a
significant research and development effort focused exclusively on the process
and production-test equipment market, (ii) a broad technological base and
product line with applications throughout the disk drive and disk drive
component production chains and (iii) a global infrastructure capable of
providing world-wide customer service and support.
The Company has achieved significant increases in net sales and EBITDA (as
defined in footnote 2 in "Summary Selected Consolidated Financial Data") since
1994, while cash used for operating activities has increased. From 1994 through
1997, the Company's net sales grew from $20.1 million to $184.7 million and
EBITDA grew from $2.8 million to $24.1 million. These increases resulted
primarily from the growth of the markets for the Company's products, the
Company's acquisitions, the Company's successful introduction of new products
and management's initiatives to improve productivity. Absent additional
significant acquisitions, however, the Company does not expect net sales and
EBITDA to continue to grow at the rates experienced over the last several years.
Cash used for operating activities increased from $2.0 million for 1994 to $6.4
million for 1997 due to the net loss in 1997, an increase in income taxes
receivable and prepaid expenses and other assets, larger increases year over
year in deferred income taxes and inventories, offset by increase in
depreciation, amortization and writedowns of intangible assets, interest on
convertible subordinated notes, purchased in-process research and development,
extraordinary loss net of income taxes and accounts receivable, a decrease in
accounts payable and a larger decrease year over year in customer deposits,
accrued expenses and other liabilities. Net income of $1.6 million in 1994
decreased to a net loss of $5.5 million in 1997 due to significant increases in
sales and related gross profit, offset by increased research and development
expenses, selling, general and administrative expenses, amortization and
write-downs of intangible assets and interest expense. See "Summary Selected
Consolidated Financial Data."
Demand for data storage process and production-test equipment is driven by
the overall demand for disk drives and disk drive components, rapid advances in
data storage technology, and yield management
1
<PAGE> 10
challenges and margin pressure facing data storage manufacturers. The ever
increasing need for greater data storage capacity is driven predominantly by the
development of more storage intensive software, the emergence of computer
networks within the enterprise and the overall increase in computer use. As
storage capacity demands increase, the demand for high performance disk drives
and replacement or removable drives increases. While technological advancements
are enabling manufacturers to produce significantly higher capacity disk drives
with faster data access speeds and greater transfer rates, they are also
presenting significant challenges and increasing the complexity of the
manufacturing process. The growing complexity of data storage manufacturing is
in turn increasing test and production times per product and creating pressure
on manufacturing costs. Accordingly, there is greater demand for process and
production-test equipment that is able to keep pace with advancing data storage
technologies, while enhancing manufacturing yields.
The Company's production-test systems include media certifiers, glide
testers, optical scanners and flying height and quasi-static magnetoresistive
("MR") head testers which provide in-line testing, measurement and analysis
throughout the manufacturing process, enabling manufacturers to detect defects
and make real-time process improvement decisions that can significantly impact
product yields, time-to-market, profitability and return on investment. The
Company's process systems include servowriters, disk burnishers and disk laser
texturizers which perform manufacturing process functions. The Company also
provides integrated automation systems for the disk drive, disk and read/write
head certification and manufacturing processes. The Company's products are
driven by extensive proprietary software and electronic hardware, optical and
laser systems, and mechanical componentry.
The Company sells its systems throughout the world primarily through its
direct sales force. A substantial majority of the Company's sales are made to
domestic data storage companies with production facilities in the United States
as well as Singapore, Malaysia and other parts of Southeast Asia. The Company
believes that over 80% of the purchasing decisions for its products are made by
individuals based in the United States. The Company's customers include
substantially all of the world's leading data storage manufacturers, including
Fujitsu, HMT, IBM, Iomega, Komag, Samsung, Seagate, StorMedia and Trace.
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY
PROSPECTIVE INVESTORS IN CONNECTION WITH AN INVESTMENT IN THE NEW NOTES, SEE
"RISK FACTORS."
COMPETITIVE STRENGTHS
The Company believes that it possesses key competitive strengths that have
enabled it to become the leading supplier of technologically advanced process
and production-test equipment for the data storage industry. These competitive
strengths include:
Broad Product Line and Extensive Technology Base. The Company believes that
it is a technological leader in designing, manufacturing and servicing process
and production-test systems that perform critical applications throughout the
disk drive and disk drive component production processes. These systems contain
a significant amount of proprietary software, sophisticated electronics and high
precision mechanics. As evidence of its technological leadership, the Company
believes it was the first to market with systems incorporating numerous
important new technologies, including: (i) in 1993, the first testing system
capable of accurately measuring the flying height of a read/write head below one
microinch; (ii) in 1995, the first disk (media) certifier with integrated
optical defect scanning and also the first certifier with digital glide
certification; (iii) in 1996, the first family of MR head testers to address
each stage of the manufacturing process for the rapidly growing MR head market
and (iv) in 1997, the first disk drive servowriter to incorporate non-contact,
optical encoder positioning technology. The Company currently holds 27 patents
in the United States, with an additional 72 patent applications pending in the
United States and nine pending overseas.
Largest World-Wide Installed Base of Systems. Based in part on published
industry data, the Company believes it has the largest world-wide installed base
of process and production-test systems serving the data storage industry. The
Company is able to leverage this installed base by selling these customers
additional systems as well as upgrades to existing systems to address rapidly
changing industry requirements. The
2
<PAGE> 11
Company believes that such upgrades are becoming an increasingly important
source of revenue for the Company.
Focused Research and Development. In response to rapidly changing technical
requirements in the data storage industry and to maintain its technological
leadership, the Company is continually engaged in efforts to improve its systems
and introduce innovative products and technologies. With approximately 200
engineers focused on research and development, the Company believes that it
maintains the largest engineering group in the world focusing on technological
solutions for data storage manufacturers. Moreover, in 1996, the Company formed
an advanced research department focused exclusively on developing and procuring
critical technologies for next-generation systems. In 1997 and for the three
months ended March 31, 1998, the Company invested approximately $43.6 million
and $9.5 million, respectively in its research and development efforts and
expects to continue to devote significant resources toward maintaining its
technological leadership.
Extensive Global Infrastructure. In addition to its extensive sales and
customer service and support infrastructure in the United States, since the
beginning of 1996 the Company has established sales and customer service and
support offices in Japan, South Korea, Singapore, Thailand and Taiwan. The
Company believes that substantial growth opportunities exist for sales of its
systems to domestic and foreign-based customers for use in their manufacturing
facilities located in Southeast Asia. Therefore, the Company currently has 40
dedicated customer service and support engineers and technicians in Southeast
Asia, which the Company believes is the largest foreign-based group of customer
service and support personnel of any domestic supplier of process and
production-test equipment to the data storage industry.
Experienced Management Team With Significant Ownership. The Company's
Chairman and Chief Executive Officer, John F. Schaefer, and its Vice President,
Finance and Chief Financial Officer, R. Joseph Saunders, joined the Company in
November 1994. Working with Arthur J. Cormier, the founder and previous
President of the Company, the Company assembled a group of experienced officers,
middle managers and senior technologists. Mr. Cormier is currently serving as a
director of and consultant to the Company. This senior management team has grown
the Company's sales, both internally and through acquisitions, from
approximately $20.1 million in 1994 to approximately $184.7 million in 1997. As
of February 28, 1998, the Company's directors and officers and their respective
affiliates beneficially own approximately 86.6% of the Company's capital stock.
Demonstrated Ability to Integrate Acquisitions. In order to expand its
operations and capitalize on the growing demand for process and production-test
equipment for the data storage industry, since November 1994, the Company's
management team has acquired seven specialized suppliers of process and
production-test systems or technologies. The Company believes that it has
successfully integrated each of these acquisitions into its operations.
GROWTH STRATEGY
The Company believes that it is well-positioned to grow future revenue and
cash flow. The key elements of the Company's growth strategy are as follows:
Maintain Leadership in Core Technologies. The Company intends to remain a
technological leader in its markets by continuing to work with customers,
academic institutions and independent third parties to identify emerging data
storage technology trends early in the development process and contribute to the
development of standards related to process and production-test for the data
storage industry. Because the Company's systems are integral to its customers'
manufacturing processes, the Company believes that it is well-positioned to
utilize its research and development resources to partner with its customers in
the development of next-generation products.
Leverage Installed Base of Systems. The Company intends to leverage its
installed base of systems by selling new systems to existing customers and by
continuing to develop and aggressively market system upgrade solutions in
response to rapidly changing industry requirements. In addition, because data
storage manufacturers are required to focus increasingly on their own core
competencies, the Company believes that
3
<PAGE> 12
there is a significant opportunity to increase its sales by supplying certain
process and production-test equipment to data storage manufacturers that
currently develop such systems internally.
Leverage and Expand Global Infrastructure. Due to its extensive global
service and support infrastructure, the Company believes it is well-positioned
to increase productivity and profitability. In particular, the Company believes
that it will be able to leverage the significant investment it has made in
establishing a sales and customer service and support infrastructure in
Southeast Asia to capitalize on the increasing activity in the data storage
industry in that region. As data storage manufacturers require equipment
suppliers to support their increasingly global operations, the Company intends
to continue to expand its world-wide service and support network.
Pursue Complementary Acquisitions. As with many other industries, data
storage manufacturers are increasingly attempting to rationalize their vendor
bases. As a result, there has been an increasing trend toward consolidation of
data storage equipment suppliers. The Company intends to continue to capitalize
on this trend by completing complementary acquisitions of additional product
lines, technologies and related businesses. The Company believes that its market
leadership position and demonstrated ability to successfully integrate strategic
acquisitions will continue to attract additional strategic opportunities.
THE REFINANCING
In connection with the Note Offering, Phase Metrics refinanced (the
"Refinancing") all of its then-existing term loan and revolving credit
indebtedness under its then-existing credit facility (the "Former Credit
Facility"). The net proceeds from the Note Offering, together with existing cash
and $1.6 million in initial borrowings (the "Initial Draw") under its New Credit
Facility with Fleet National Bank and Imperial Bank (the "Lenders") which it
entered into simultaneously with the Note Closing were used to repay all
outstanding indebtedness under the Former Credit Facility as well as the
expenses related to the Note Offering and the Refinancing. See "Use of
Proceeds." The New Credit Facility provides the Company with up to $25.0 million
of revolving credit, subject to certain conditions, which limit could be
increased to $40.0 million at the sole discretion of the Lenders. See
"Description of Indebtedness -- New Credit Facility." At March 31, 1998, the
Company had approximately $16.7 million of borrowing availability less $8.3
million of outstanding borrowings under the New Credit Facility.
Borrowings under the New Credit Facility are secured by substantially all
of the existing and future assets of the Company (other than the real estate
owned by the Company in San Diego, California on which its headquarters is
located) and are guaranteed on a secured basis by all Subsidiary Guarantors.
Accordingly, all borrowings under the New Credit Facility and the secured
guarantees of the Subsidiary Guarantors in favor of the Lenders effectively rank
senior to the indebtedness evidenced by the New Notes, to the extent of the
assets securing such obligations.
------------------------
The Company commenced operations in 1989 and was recapitalized in 1994 in
connection with the acquisition of two companies. The Company's principal
executive offices are located at 10260 Sorrento Valley Road, San Diego,
California 92121, and its telephone number is (619) 646-4800.
------------------------
Phase Metrics is a trademark of the Company. This Prospectus includes other
trademarks of the Company and trademarks of other companies.
4
<PAGE> 13
THE NOTE OFFERING
THE NOTES...................... The Notes were sold by the Company at the
Note Closing on January 30, 1998 and were
subsequently resold to qualified
institutional buyers pursuant to Rule 144A
under the Securities Act and to persons in
transactions outside the United States in
reliance on Regulation S under the Securities
Act. According to information received from
the Trustee, there were approximately 30
purchasers of the Notes from the Initial
Purchaser.
REGISTRATION RIGHTS
AGREEMENT...................... In connection with the Note Offering, the
Company entered into the Registration Rights
Agreement, which grants holders of the Notes
certain exchange and registration rights,
which generally terminate upon the
consummation of this Exchange Offer.
THE EXCHANGE OFFER
SECURITIES OFFERED............. $110.0 million in aggregate principal amount
of the Company's new 10 3/4% Senior Notes due
2005.
THE EXCHANGE OFFER............. $1,000 principal amount of New Notes in
exchange for each $1,000 principal amount of
the Notes issued in the Note Offering. As of
the date hereof, $110.0 million aggregate
principal amount of Notes are outstanding.
EXPIRATION DATE................ 12:00 midnight, New York City time on
, 1998, unless the Exchange Offer
is extended (which in no event shall be more
than days from such date), in which case
the term "Expiration Date" means the latest
date and time to which the Exchange Offer is
extended.
INTEREST ON THE NEW NOTES AND
THE NOTES...................... The New Notes will bear interest from January
30, 1998, the date of issuance of the Notes
that may be tendered in exchange for the New
Notes. Accordingly, holders of Notes that are
accepted for exchange will not receive
interest on the Notes that is accrued but
unpaid at the time of tender, but such
interest will be payable on the first
interest payment date on the New Notes after
the Expiration Date.
CONDITIONS TO THE EXCHANGE
OFFER.......................... The Exchange Offer is subject to certain
customary conditions, which may be waived by
the Company.
PROCEDURES FOR TENDERING
NOTES.......................... Each holder of Notes wishing to accept the
Exchange Offer must complete, sign and date
the relevant accompanying Letter of
Transmittal, or a facsimile thereof, in
accordance with the instructions contained
herein and therein, and mail or otherwise
deliver such Letter of Transmittal, or such
facsimile, together with the Notes and any
other required documentation to the Exchange
Agent at the address set forth in the Letter
of Transmittal. The enclosed Letter of
Transmittal should be used to tender Notes.
By executing the Letter of Transmittal, each
holder will represent to the Company that,
among other things, the holder or the person
receiving such New Notes, whether or not such
person is the holder, is acquiring the New
Notes in the ordinary course of business and
that neither the holder nor any such other
person has any intention or arrangement or
other understanding with any person to
participate in a distribution of such New
Notes. In lieu of physical delivery of the
certificates representing Notes, tendering
holders may transfer Notes pursu-
5
<PAGE> 14
ant to the procedure for book-entry transfer
as set forth under "The Exchange
Offer -- Procedures for Tendering."
SPECIAL PROCEDURES FOR
BENEFICIAL OWNERS.............. Any beneficial owner whose Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other
nominee and who wishes to tender should
contact such registered holder promptly and
instruct such registered holder to tender on
such beneficial owner's behalf. If such
beneficial owner wishes to tender on such
beneficial owner's own behalf, such
beneficial owner must, prior to completing
and executing the Letter of Transmittal and
delivering its Notes, either make appropriate
arrangements to register ownership of the
Notes in such beneficial owner's name or
obtain a properly completed bond power from
the registered holder. The transfer of
registered ownership may take considerable
time.
GUARANTEED DELIVERY
PROCEDURES..................... Holders of Notes who wish to tender their
Notes and whose Notes are not immediately
available or who cannot deliver their Notes
(or, in the alternative, comply with the
procedures for book-entry transfer), the
Letter of Transmittal or any other documents
required by the Letter of Transmittal to the
Exchange Agent prior to the Expiration Date
must tender their Notes according to the
guaranteed delivery procedures set forth in
"The Exchange Offer -- Guaranteed Delivery
Procedures."
WITHDRAWAL RIGHTS.............. Tenders may be withdrawn at any time prior to
12:00 midnight, New York City time, on the
Expiration Date pursuant to the procedures
described under "The Exchange Offer -- Terms
of the Exchange Offer."
ACCEPTANCE OF NOTES AND
DELIVERY OF NEW NOTES.......... The Company will accept for exchange any and
all Notes that are properly tendered in the
Exchange Offer prior to 12:00 midnight, New
York City time, on the Expiration Date. The
New Notes issued pursuant to the Exchange
Offer will be delivered promptly following
the Expiration Date. See "The Exchange
Offer -- Terms of the Exchange Offer."
FEDERAL INCOME TAX
CONSEQUENCES................... The issuance of the New Notes to holders of
the Notes pursuant to the terms set forth in
this Prospectus will not constitute an
exchange for federal income tax purposes.
Consequently, no gain or loss would be
recognized by holders of the Notes upon
receipt of the New Notes. See "Certain
Federal Income Tax Consequences of the
Exchange Offer."
USE OF PROCEEDS................ There will be no proceeds to the Company from
the exchange of Notes pursuant to the
Exchange Offer. The net proceeds to the
Company from the sale of the Notes were
approximately $105.9 million (after deducting
discounts and commissions and Note Offering
expenses payable by the Company). The Company
used all of such net proceeds, together with
the Initial Draw of approximately $1.6
million under the New Credit Facility, to
repay in full its then-existing term loan and
revolving credit indebtedness under the
Former Credit Facility, including all accrued
interest thereunder to the date of repayment,
and all expenses related to the Refinancing.
EFFECT ON HOLDERS OF NOTES..... As a result of the making of this Exchange
Offer, the Company will have fulfilled its
principal obligations under the Registration
Rights Agreement, and holders of Notes who do
not tender their
6
<PAGE> 15
Notes will generally not have any further
registration rights under the Registration
Rights Agreement or otherwise. Such holders
will continue to hold the untendered Notes
and will be entitled to all the rights and
subject to all the limitations applicable
thereto under the Indentures and Registration
Rights Agreement, except to the extent such
rights or limitations, by their terms,
terminate or cease to have further
effectiveness as a result of the Exchange
Offer. All untendered Notes will continue to
be subject to certain restrictions on
transfer. Accordingly, if any Notes are
tendered and accepted in the Exchange Offer,
the trading market, if any, for the
untendered Notes could be adversely affected.
EXCHANGE AGENT................. State Street Bank and Trust Company is
serving as Exchange Agent in connection with
the Exchange Offer. See "The Exchange
Offer -- Exchange Agent."
SUMMARY OF TERMS OF NEW NOTES
The form and terms of the New Notes are the same as the form and terms of
the Notes (which they will replace) except that (i) the New Notes have been
registered under the Securities Act and, therefore, will not bear legends
restricting the transfer thereof and (ii) holders of the New Notes generally
will not be entitled to further registration rights under the Registration
Rights Agreement. The New Notes will evidence the same debt as the Notes and
will be entitled to the benefits of the Indenture. See "Description of New
Notes."
SECURITIES OFFERED............. $110.0 million in aggregate principal amount
of the Company's 10 3/4% Senior Notes due
2005.
MATURITY DATE.................. February 1, 2005.
INTEREST RATE AND PAYMENT
DATES.......................... The New Notes will bear interest at the rate
of 10 3/4% per annum, payable semiannually in
arrears on February 1 and August 1 of each
year, commencing August 1, 1998.
OPTIONAL REDEMPTION............ The New Notes will be redeemable at the
option of the Company, in whole or in part,
at any time on or after February 1, 2002, in
cash at the redemption prices set forth
herein, plus accrued and unpaid interest and
Liquidated Damages, if any, thereon to the
date of redemption. In addition, at any time
prior to February 1, 2001, the Company may
redeem up to 33% of the initially outstanding
aggregate principal amount of New Notes at a
redemption price equal to 110.75% of the
principal amount thereof, plus accrued and
unpaid interest and Liquidated Damages, if
any, thereon to the date of redemption, with
the net proceeds of a Public Equity Offering;
provided, that at least 67% of the initially
outstanding aggregate principal amount of New
Notes remains outstanding immediately after
the occurrence of such redemption. See
"Description of New Notes -- Optional
Redemption."
CHANGE OF CONTROL.............. Upon the occurrence of a Change of Control,
each holder of New Notes will have the right
to require the Company to repurchase all or
any part of such holder's New Notes at an
offer price in cash equal to 101% of the
aggregate principal amount thereof, plus
accrued and unpaid interest and Liquidated
Damages, if any, thereon to the date of
repurchase. See "Description of New
Notes -- Repurchase at the Option of
Holders -- Change of Control." There can be
no assurance that, in the event of a
7
<PAGE> 16
Change of Control, the Company would have
sufficient funds to repurchase all New Notes
tendered. See "Risk Factors -- Payment Upon a
Change of Control."
RANKING........................ The New Notes will be senior unsecured
obligations of the Company and will rank pari
passu in right of payment with all existing
and future senior indebtedness of the Company
and senior in right of payment to all
existing and future subordinated indebtedness
of the Company. The New Notes will be
effectively subordinated, however, to all
secured obligations of the Company, including
the Company's borrowings, if any, under the
New Credit Facility, to the extent of the
assets securing such obligations. As of March
31, 1998 the Notes and the Note Guarantees
were effectively subordinated to
approximately $11.2 million of secured
obligations of the Company and the Subsidiary
Guarantors. See "Risk Factors -- Effective
Subordination; Encumbrances on Assets."
NEW NOTE GUARANTEES............ The New Notes will be fully and
unconditionally guaranteed on a joint and
several basis by all Subsidiary Guarantors.
The New Note Guarantees will be senior
unsecured obligations of the Subsidiary
Guarantors and will rank pari passu in right
of payment to all existing and future senior
indebtedness of the Subsidiary Guarantors.
The New Note Guarantees will be effectively
subordinated to all secured obligations of
the Subsidiary Guarantors, including the
guarantees of such Subsidiary Guarantors in
favor of the Lenders under the New Credit
Facility, to the extent of the assets
securing such obligations.
CERTAIN COVENANTS.............. The Indenture related to the New Notes will
contain certain covenants that will limit,
among other things, the ability of the
Company to (i) pay dividends, redeem capital
stock or make certain other restricted
payments or investments; (ii) incur
additional indebtedness or issue preferred
equity interests; (iii) merge, consolidate or
sell all or substantially all of its assets;
(iv) create liens on assets and (v) enter
into certain transactions with affiliates or
related persons. See "Description of New
Notes -- Certain Covenants."
FORM AND DENOMINATION.......... The New Notes will be represented by U.S.
Global Notes and Regulation S Permanent
Global Notes in fully registered form,
deposited with a custodian for and registered
in the name of a nominee of the Depositary.
Beneficial interests in the U.S. Global Notes
will be shown on, and transfers thereof will
be effected through, records maintained by
the Depositary and its Participants. The
Regulation S Permanent Global Notes will be
deposited with the Trustee as custodian for
the Depositary, and beneficial interests
therein may be held through Euroclear, Cedel
Bank or any other Depositary Participant. See
"Description of New Notes -- Book-Entry;
Delivery; Form and Transfer."
REGISTRATION RIGHTS............ The Company is required to file a shelf
registration statement (the "Shelf
Registration Statement") if the Exchange
Offer is not permitted by applicable law or
if any Holder of Notes or New Notes that are
Transfer Restricted Securities (as defined in
the
8
<PAGE> 17
Registration Rights Agreement) shall notify
the Company that such Holder was prohibited
from participating in the Exchange Offer or
such Holder is not able to sell any New Notes
acquired by it in the Exchange Offer to the
public without delivering a prospectus, and
this Prospectus is not appropriate or
available for such resales, or such Holder is
a broker-dealer and holds Notes acquired
directly from the Company or any of its
affiliates. If any Shelf Registration
Statement required to be filed is not filed
on or prior to the applicable filing
deadline, any such Shelf Registration
Statement has not been declared effective on
or prior to the applicable effectiveness
deadline or any Shelf Registration Statement
that is required to be filed and declared
effective but thereafter ceases to be
effective or usable for its intended purpose,
the Company and the Subsidiary Guarantors,
jointly and severally, have agreed to pay
liquidated damages in an amount equal to $.05
per week per $1,000 in principal amount for
each week or portion thereof that the
registration default continues for the first
ninety (90) day period immediately following
the occurrence of such registration default.
The amount of such liquidated damages shall
increase by an additional $.05 per week per
$1,000 in principal amount with respect to
each subsequent ninety-day period until all
registration defaults have been cured up to a
maximum amount of liquidated damages of $.25
per week per $1,000 in principal amount.
NON-GUARANTOR SUBSIDIARIES..... The Company's Non-Guarantor Subsidiaries have
not guaranteed the Company's obligations
under the Notes and will not guarantee the
Company's obligations under the New Notes. As
of and for the year ended December 31, 1997,
and the three-month period ended March 31,
1998, the operating results and assets of the
Non-Guarantor Subsidiaries, individually and
in the aggregate, were not material to the
results of operations and assets of the
Company on a consolidated basis, net of
intercompany eliminations. See Note 12 of
Notes to Consolidated Financial Statements.
The total assets, total liabilities, net
sales and net income (loss) of the
Non-Guarantor Subsidiaries as a percentage of
the Company's consolidated total assets,
total liabilities, net sales and net income
(loss) as of and for the year ended December
31, 1997 were 3.1%, 0.4%, 1.6% and 10.1%,
respectively, and as of and for the
three-month period ended March 31, 1998, were
3.8%, 0.5%, 5.5% and 1.1%, respectively.
9
<PAGE> 18
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents summary selected consolidated financial data
of the Company for the periods indicated. The summary selected consolidated
statement of operations data for the years ended December 31, 1995, 1996 and
1997 is derived from the Company's audited Consolidated Financial Statements
included elsewhere in this Prospectus. The summary selected consolidated
statement of operations data for the three month periods ended March 31, 1997
and 1998 and the summary selected consolidated balance sheet data as of March
31, 1998 are derived from the Company's unaudited interim Consolidated Financial
Statements included elsewhere in this Prospectus. The unaudited interim
Consolidated Financial Statements were prepared by management of the Company on
the same basis as the Company's audited Consolidated Financial Statements and,
in the opinion of management, include all adjustments (consisting of normal
recurring accruals) necessary to present fairly the Company's operating results
and financial position for such periods. Results of operations for the three
months ended March 31, 1998 are not necessarily indicative of the results to be
expected for the full year. The following financial data should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," the Company's Consolidated Financial Statements and
related Notes thereto included elsewhere herein and the other information
contained in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------ -----------------
1995(1) 1996(1) 1997 1997 1998
(IN THOUSANDS, EXCEPT RATIOS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales............................................. $116,894 $190,773 $184,660 $51,603 $32,502
Gross profit.......................................... 52,128 86,912 83,366 23,689 12,885
Operating expenses.................................... 40,161 98,332 81,131 19,956 15,569
Income (loss) from operations......................... 11,967 (11,420) 2,235 3,733 (2,684)
Net income (loss)..................................... 4,669 (11,990) (5,544) 764 (4,418)
OTHER DATA:
Cash provided by (used for) operating activities...... $ 18,300 $(21,402) $ (6,392) $ (394) $(4,670)
Cash used for investing activities.................... (11,102) (45,316) (17,169) (2,987) (750)
Cash provided by (used for) financing activities...... (3,099) 64,439 23,883 3,515 3,331
EBITDA(2)............................................. 27,864 21,533 24,107 8,683 1,114
Depreciation, amortization and write-downs of
intangible assets................................... 15,897 32,953 21,872 4,950 3,798
Capital expenditures.................................. 9,135 24,564 17,091 2,987 750
Ratio of earnings to fixed charges(3)................. 1.2x -- -- -- --
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1998
--------------
(UNAUDITED)
<S> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................. $ 920
Working capital........................................... 70,379
Total assets.............................................. 149,565
Long-term debt, including current portion................. 124,899
Redeemable preferred stock................................ 9,793
Stockholders' deficit..................................... (22,794)
</TABLE>
- ---------------
(1) Between June 1995 and December 1996, the Company completed six
acquisitions, including Helios, Incorporated ("Helios") in June 1995,
Applied Robotic Technologies, Inc. ("ART") in July 1995, certain net assets
of Tahoe Instruments ("Tahoe") in July 1995, Air Bearings, Incorporated
("ABI") in January 1996, Santa Barbara Metric, Inc. ("SBM") in December
1996 and a portion of the business of Kirell Development, Inc. ("Kirell")
in December 1996. See Notes 1 and 3 of Notes to Consolidated Financial
Statements. Each of these acquisitions was accounted for as a purchase for
financial reporting purposes, and, as a result, the Company's Consolidated
Statements of Operations include the operating results of Helios, ART,
Tahoe, ABI, SBM and a portion of the business of Kirell from their
respective acquisition dates.
(2) EBITDA represents income (loss) from operations before depreciation and
amortization and write-downs of intangibles. EBITDA is presented because
management believes it is a commonly accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the
basis of operating performance. EBITDA
10
<PAGE> 19
is not intended to represent cash flows for the period, nor has it been
presented as an alternative to operating income (loss) as an indicator of
operating performance and should not be considered in isolation or as a
substitute for measures of performance prepared in accordance with
generally accepted accounting principles. The Company understands that,
while EBITDA is frequently used by securities analysts in the evaluation of
companies, EBITDA as used herein is not necessarily comparable to other
similarly titled captions of other companies due to potential
inconsistencies in the method of calculation.
(3) For purposes of determining this ratio, earnings consist of income (loss)
before income taxes (benefit) and extraordinary items. Fixed charges
consist of interest expense, a portion of operating lease rental expense
that is representative of the interest factor (deemed to be one-third of
operating lease rental expense) and dividends and related accretion to
redemption value on preferred stock. For the years ended December 31, 1996
and 1997, and the three months ended March 31, 1997 and 1998, earnings were
inadequate to cover fixed charges by $24.8 million, $14.7 million, $0.2
million and $7.1 million, respectively. For the year ended December 31,
1997, and the three months ended March 31, 1998, the pro forma ratio of
earnings to fixed charges reflects an increase to interest expense of
approximately $3.3 million and $0.1 million, respectively, after giving
effect to the Note Offering as if the transaction had occurred as of
January 1, 1997. For the year ended December 31, 1997, and the three months
ended March 31, 1998, earnings were inadequate to cover fixed charges on a
pro forma basis by $18.0 million and $7.2 million, respectively.
11
<PAGE> 20
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following Risk Factors should be considered carefully before tendering Notes in
the Exchange Offer.
SUBSTANTIAL LEVERAGE; ABILITY TO SERVICE INDEBTEDNESS
In connection with the Note Offering, the Company incurred a significant
amount of indebtedness. At March 31, 1998, the Company had indebtedness of
$124.9 million. At March 31, 1998, the Company had approximately $16.7 million
of borrowing availability less $8.3 million of outstanding borrowings under the
New Credit Facility. Subject to certain limitations, the Company may also incur
additional indebtedness in the future under the terms of the Indenture related
to the New Notes and the New Credit Facility. See "Capitalization," "Description
of Indebtedness -- New Credit Facility" and "Description of New Notes."
The Company's ability to make scheduled payments of principal and interest
on, or to refinance, its indebtedness (including the New Notes), and to fund its
operations, including planned capital expenditures and research and development
expenses, depends on its future performance and financial results, which, to a
certain extent, are subject to general conditions in the data storage industry
as well as general economic, financial, competitive and other factors that are
beyond its control. For the years ended December 31, 1996 and 1997, and the
three months ended March 31, 1997 and 1998, earnings were inadequate to cover
fixed charges by $24.8 million, $14.7 million, $0.2 million and $7.1 million,
respectively. On a pro forma basis, assuming the New Notes were issued on
January 1, 1997, earnings were inadequate to cover fixed charges by $18.0
million and $7.2 million, for the year ended December 31, 1997, and the three
months ended March 31, 1998, respectively. The data storage industry in general
is currently experiencing a weakness in demand for products, intense competition
and pricing erosion, and overcapacity. Such adverse market conditions have
resulted, and may in the future result in, the deferral or cancellation of
orders for the Company's products. Delays or declines in orders for the
Company's products have had a material adverse effect on the Company's operating
results and financial condition over the last several quarters and fluctuations
in demand for the Company's products is expected to continue for at least the
balance of 1998. Under current or future market conditions there can be no
assurance that the Company's business will generate adequate cash flow or that
any growth can be achieved. If the Company is unable to generate sufficient cash
flow from operations in the future to service its debt and operate its business,
including making necessary capital expenditures, the Company may be required to
refinance all or a portion of its existing debt, including the New Notes, to
sell assets or to obtain additional financing. There can be no assurance that
any such action would be accomplished on terms acceptable to the Company or at
all.
The Company's high level of debt will have several important effects on its
future operations, including, but not limited to, (i) making it more difficult
for the Company to satisfy its obligations with respect to the New Notes, (ii)
increasing the Company's vulnerability to general adverse economic and industry
conditions, (iii) limiting the Company's ability to obtain additional financing
to fund future working capital, capital expenditures, research and development
and other general corporate requirements, (iv) requiring the dedication of a
substantial portion of the Company's cash flow from operations to the payment of
principal of, and interest on, its indebtedness, thereby reducing the
availability of such cash flow to fund working capital, capital expenditures,
research and development or other operating needs and uses and (v) limiting the
Company's flexibility in planning for, or reacting to, changes in its business.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
RESTRICTIVE FINANCING COVENANTS
The New Credit Facility and the Indenture related to the New Notes contain
a number of covenants that will significantly restrict the operations of the
Company, such as the ability of the Company to incur indebtedness, make
prepayments of certain indebtedness, pay dividends, make investments, engage in
transactions with stockholders and affiliates, create liens, sell assets and
engage in mergers and other consolidations. In addition, the Company is required
to comply with specified financial ratio tests under the New Credit Facility,
including maximum leverage and minimum interest coverage, net worth, cash flow
and
12
<PAGE> 21
profitability. There can be no assurance that the Company will be able to comply
with such conditions, covenants or restrictions in the future. The Company's
ability to comply with such conditions, covenants and restrictions may be
affected by events beyond its control, including prevailing economic and
financial conditions and general conditions in the data storage industry. Based
on the Company's currently anticipated operating results for the quarter ending
June 30, 1998, the Company believes that it will not be in compliance with the
financial covenants under the New Credit Facility. In such event, the Company
will be required to seek a waiver from or renegotiate the existing covenants, or
potentially seek alternative financing. Based on preliminary discussion with the
agent to the Lenders, the Company believes that, in the event of non-
compliance, it will be able to obtain a waiver of such non-compliance and
renegotiate the existing covenants. The agent to the Lenders has informed the
Company that the receipt of a waiver from the Lenders and the successful
renegotiation of the existing covenants is subject, among other things, to the
Lenders' receipt and approval of the Company's revised financial plan.
Accordingly, no assurance can be given that the Company will be successful in
obtaining a waiver or renegotiating its existing covenants. If the Company
becomes in breach of any covenants, restrictions or other obligations under the
New Credit Facility in the future, the Lenders under the New Credit Facility
could declare all amounts outstanding thereunder to be immediately due and
payable, together with accrued and unpaid interest, and terminate their
commitment to make further advances thereunder. See "Description of
Indebtedness -- New Credit Facility."
EFFECTIVE SUBORDINATION; ENCUMBRANCES ON ASSETS
Under the New Credit Facility, the Company granted to the Lenders security
interests in substantially all of its current and future assets (other than the
real estate owned by the Company in San Diego, California on which its
headquarters is located), including a pledge of all or a portion of the issued
and outstanding shares of capital stock of the Company's material subsidiaries.
In the event of a default thereunder (whether as a result of the failure to
comply with a payment or other covenant, a cross-default, or otherwise), the
Lenders will have a prior secured claim on the capital stock of the Subsidiary
Guarantors and substantially all of the assets of the Company and the Subsidiary
Guarantors. As a result, the secured assets of the Company and the Subsidiary
Guarantors would be available to pay obligations on the New Notes and the New
Note Guarantees only after borrowings under the New Credit Facility and other
secured indebtedness, if any, have been paid in full. If the Lenders under the
New Credit Facility should attempt to foreclose on their collateral, the
Company's financial condition and the value of the New Notes and the New Note
Guarantees would be materially adversely affected. See "Description of
Indebtedness -- New Credit Facility." As of March 31, 1998, all of the Company's
indebtedness under its New Credit Facility was secured by the assets of the
Company and the Subsidiary Guarantors, and, accordingly, the New Notes and the
New Note Guarantees would have been effectively subordinated to approximately
$11.2 million of obligations of the Company and the Subsidiary Guarantors as of
such date, which amount is inclusive of indebtedness under the Company's capital
lease obligations.
In addition, if the Company incurs any additional senior indebtedness which
would rank pari passu in right of payment with the New Notes, and even if such
indebtedness were not secured, the holder of such debt would be entitled to
share ratably with the holders of the New Notes in any proceeds distributed in
connection with any insolvency, liquidation, reorganization, dissolution or
other winding-up of the Company. This may have the effect of reducing the amount
of proceeds available to pay to holders of the New Notes upon the occurrence of
any such events.
The Company's Non-Guarantor Subsidiaries have not guaranteed the Company's
obligations under the Notes and will not guarantee the Company's obligations
under the New Notes. As of and for the year ended December 31, 1997, and the
three-month period ended March 31, 1998, the operating results and assets of the
Non-Guarantor Subsidiaries, individually and in the aggregate, were not material
to the results of operations and assets of the Company on a consolidated basis,
net of intercompany eliminations. See Note 12 of Notes to Consolidated Financial
Statements. The total assets, total liabilities, net sales and net income (loss)
of the Non-Guarantor Subsidiaries as a percentage of the Company's consolidated
total assets, total liabilities, net sales and net income (loss) as of and for
the year ended December 31, 1997 were 3.1%, 0.4%, 1.6% and 10.1%, respectively,
and as of and for the three-month period ended March 31, 1998, were 3.5%, 0.6%,
5.5% and 1.1%, respectively.
13
<PAGE> 22
RECENT NET LOSSES; RETAINED DEFICIT; CASH USED BY OPERATING ACTIVITIES
The Company had net losses of approximately $12.0 million, $5.5 million and
$4.4 million for 1996 and 1997, and the three months ended March 31, 1998,
respectively. Such losses and accrual of certain preferred stock dividends and
accretion for the redemption value of such preferred stock have contributed to a
retained deficit of approximately $28.1 million as of March 31, 1998. In
addition, the Company used cash for operating activities of approximately $21.4
million, $6.4 million and $4.7 million for 1996, 1997, and the three months
ended March 31, 1998, respectively. There can be no assurance that the Company
will achieve profitability or that it will generate positive cash flow from
operating activities in the future. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
FLUCTUATIONS IN OPERATING RESULTS
The Company's operating results have fluctuated in the past and the Company
expects that its operating results will continue to fluctuate in the future from
quarter to quarter and year to year. These fluctuations have resulted from a
number of factors, including the size, timing and rescheduling or cancellation
of orders from, and shipments to, major customers; the timing of introductions
of new products and product enhancements by the Company or its competitors; the
Company's ability to develop, introduce and market new, technologically advanced
products; the cyclicality of the data storage industry; the rescheduling of
capital expenditures by the Company's customers; variations in the Company's
customer base and product mix; the level of any significant volume pricing
discounts provided by the Company; the availability and cost of key production
materials and components; the Company's ability to effectively manage its
inventory and to control costs; the financial stability of major customers; the
Company's success in expanding its operations overseas; personnel changes;
expenses associated with acquisitions; fluctuations in amortization and
write-downs of intangible assets; foreign currency exchange rate fluctuations
and general economic factors in the United States and certain foreign countries,
including Japan, South Korea, Singapore, Malaysia and other parts of Southeast
Asia.
The data storage industry in general, including many of the Company's
customers, is currently experiencing a weakness in demand for data storage
products, intense competition and pricing erosion, and overcapacity in
manufacturing operations. Such adverse market conditions have resulted in the
rescheduling or cancellation of specific orders by the Company's major customers
and has had a material adverse effect on the Company's business, results of
operations and financial condition. The Company expects order delays and
reschedulings to occur in the future. Because the Company must incur expenses
and purchase inventory based on anticipated and actual customer orders, any
significant delay, rescheduling or cancellation of such orders would have a
material adverse effect on the Company's operating results. For example, during
the second and third quarters of 1997, the Company increased its inventory
substantially in anticipation of satisfying expected demand from three of the
Company's largest customers. A significant portion of this anticipated demand
has not materialized to date due primarily to overcapacity of certain process
and production-test equipment at these customers.
The Company had net sales of $32.5 million for the first three months of
1998 compared to $51.6 million for the first three months of 1997 and $184.7
million for 1997 compared to $190.8 million in 1996. The Company had EBITDA (as
described in Footnote 2 in "Summary Selected Consolidated Financial Data") of
$8.7 million for the first three months of 1997 compared to $1.1 million for the
first three months of 1998 and $21.5 million in 1996 compared to $24.1 million
of EBITDA in 1997. Cash used for operating activities increased from $0.4
million in the first quarter of 1997 to $4.7 million in the first quarter of
1998 due to the first quarter of 1998 net loss, a decrease in amortization of
intangible assets, an increase in prepaid expenses offset by the extraordinary
loss, net of income taxes, a decrease in inventories, an increase in accounts
payable and a smaller decrease period over period of income taxes receivable.
Cash used for operating activities decreased from $21.4 million in 1996 to $6.4
million in 1997 due to a smaller net loss, smaller increases year over year in
deferred income taxes, inventories and income taxes receivable and a decrease in
prepaid expenses and other assets offset by decreases in depreciation,
amortization and writedown of intangible assets, purchased in-process research
and development, an increase in accounts receivable and larger decreases year
over year in accounts payable and customer deposits, accrued expenses and other
liabilities. Net income of $0.8 million in the first three months of 1997
decreased to a net loss of $4.4 million in the first three months of
14
<PAGE> 23
1998 due primarily to decreased net sales, lower gross profit margins, increased
interest expense and a loss from an extraordinary item, partially offset by
decreases in research and development and selling, general and administrative
expenses. A net loss of $12.0 million in 1996 decreased to a net loss of $5.5
million in 1997 related primarily to decreases in amortization and write-downs
of intangible assets and purchased in-process research and development expenses,
offset by increases in research and development and interest expense. See
"Summary Selected Consolidated Financial Data."
As indicated above, the Company's business, operating results and financial
condition are being adversely affected by a downturn in the data storage
industry and reduced or delayed capital equipment expenditures by data storage
companies. As it has done in the past, the Company is implementing certain
cost-cutting measures, including reductions in headcount, to reduce its
operating expenses to respond to this situation. Such measures will result in
severance and other costs and may result in write-downs of inventory and other
assets, the amount of which has yet to be determined by the Company. While the
Company believes such cost-cutting measures are appropriate given the Company's
current and anticipated levels of net sales, there can be no assurance that such
measures will be sufficient and that additional cost-cutting measures will not
be necessary, or that any current or future cost-cutting measures will not have
a material adverse effect on the Company's ability to increase its net sales.
The Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indicators of future performance. Quarterly results in the future may fluctuate
due to the factors discussed above or other factors. Further, the Company's
historical operating results for 1993 through the first quarter of 1998 are not
necessarily indicative of future performance for any particular period in light
of the Company's acquisition activity during those periods. There can be no
assurance that any past revenue growth or past results of operations will
continue. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
DEPENDENCE ON AND CYCLICALITY OF DATA STORAGE INDUSTRY
The Company's business depends almost entirely upon capital expenditures by
manufacturers of disk drives and disk drive components, which in turn depend
upon market demand for their products. The data storage industry is cyclical and
historically has experienced varying growth rates and periods of oversupply
causing higher than anticipated inventory levels and intense price competition.
The data storage industry is currently experiencing one of its most severe
downturns with continuing weakness in demand for products, intense competition,
significant price erosion and overcapacity. This in turn causes reduced demand
for and pricing pressures on capital equipment used in the disk drive and disk
drive component production processes, including the type of equipment sold by
the Company. In addition, since the third quarter of 1997, certain of the
Company's customers delayed or cancelled purchases of certain of the Company's
products due to overcapacity of certain process and production-test equipment at
these customers. The current downturn in the disk storage industry generally,
and the slowdown in orders from the Company's customers in the last several
quarters has had a material adverse effect on the Company's business, operating
results and financial condition. In the event the weakness in demand for disk
drives and disk drive components continues or customers continue to delay or
cancel the purchase of the Company's products, the Company's business, financial
condition and results of operations will be materially adversely affected.
Moreover, no assurance can be given that the Company's business, operating
results and financial condition will not be materially adversely affected by
future downturns in world-wide capital equipment expenditures by data storage
companies. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
RAPID TECHNOLOGICAL CHANGE
The data storage industry is characterized by rapid technological changes
and evolving industry standards. The Company's customers strive to introduce new
products and enhancements frequently, with relatively short product life cycles,
typically between nine and 18 months. In addition, the Company's customers often
develop multiple products simultaneously, such that new products could be
introduced as frequently as every three months. New product introductions by the
Company's customers typically result in new technological challenges for the
15
<PAGE> 24
Company, both with respect to its installed base and with respect to next
generation products. As a result, the Company must continue to enhance its
existing products and develop and manufacture new products with improved
capabilities. This has required and will continue to require substantial
investments by the Company in research and development. Although the Company
continually develops new products, there can be no assurance that the Company
will be able to accurately anticipate technological advances in the disk drive
market and develop products incorporating such advances in a timely manner or at
all. The Company's failure to develop, manufacture and market new or enhanced
products, would have a material adverse effect on its business, financial
condition and results of operations. The Company is highly dependent on its
close working relationships with certain of its key customers to advance its
technologies. The termination of any one of these key relationships for any
reason could have a material adverse effect on the Company's ability to
anticipate and develop necessary technological changes to its products.
The Company's customers are constantly striving to improve their production
processes, including improving the manufacturing of substrates, the deposition
of material on the substrate, the finish processing of magnetic media, and head
fabrication. To the extent that the Company's customers can improve product
quality by modifying their own design and internal production processes without
the need to add process and production-test equipment, demand for the Company's
equipment would likely decline. Further, unless the Company is able to
effectively respond to such changes, manufacturing process changes for disk
drives, disks and read/write heads could also have a material adverse effect on
the Company's business, financial condition and results of operations.
There can be no assurance that future technological innovations will not
reduce demand for disk drives. Competing technologies to disk drive based data
storage do exist, including solid state memory (flash memory), tape memory and
re-writable optical technology (CD and DVD technology). Although the current
core technology for rotating magnetic disk drive data storage has been the
predominant technology in the industry for many years, it is likely that some
day this technology will be replaced by an alternate technology. There can be no
assurance that the Company's products will be adaptable to any successor
technology. The Company's business, financial condition and results of
operations could be materially adversely affected by any significant migration
toward technology that would replace disk drives as a computer data storage
medium.
During 1995 and continuing through the first six months of 1997, the
Company experienced significant development and design problems and delays
during the attempted introduction of its MC950 series next generation disk
certifier product. These development and design problems diverted significant
research and development resources which could have been utilized for the
development of new products and various enhancements for other products. There
can be no assurance that the Company will not experience the same or similar
problems with future introductions of new products or enhancements.
CUSTOMER CONCENTRATION
There are a relatively small number of data storage manufacturers
throughout the world and the Company derives a significant portion of its net
sales from a relatively small number of customers. The Company expects that its
dependence on relatively few key customers will continue in the future.
Approximately 52.2%, 45.0%, 51.0% and 50.1% of the Company's net sales in 1995,
1996, 1997 and the first three months of 1998, respectively, were derived from
sales to the Company's three largest customers in each of those periods. Even
though the Company's customer mix will likely change from period to period in
the future, Seagate Technology, Inc. ("Seagate"), Komag Incorporated ("Komag"),
HMT Technology ("HMT"), Iomega Corporation ("Iomega") and Trace Storage
Technology USA Corporation ("Trace") have historically accounted for a
significant portion of the Company's net sales. For 1995, 1996, 1997 and the
first three months of 1998, Seagate accounted for 25.0%, 19.0%, 18.0% and 15.1%,
respectively, of net sales; Komag accounted for 10.7%, 14.5%, 15.9% and 0.3%,
respectively, of net sales; HMT accounted for 4.4%, 5.2%, 17.1% and 22.4%,
respectively, of net sales; Iomega accounted for 16.5%, 7.9%, 1.9% and 0.6%,
respectively, of net sales and Trace accounted for 6.8%, 11.5%, 4.4% and 0.2%,
respectively, of net sales. In addition, for the first three months of 1998,
Sentinel NV accounted for 12.6% of net sales. If net sales to these or any other
significant customer of the Company were to decrease in any material amount in
the future, the Company's business, results of operations and financial
condition would be materially adversely affected.
16
<PAGE> 25
In general, the Company's customers do not enter into long-term purchase
agreements with the Company. If completed orders are not replaced on a timely
basis by new orders from the same or other customers, the Company's net sales
would be materially adversely affected. In addition, the loss of a key customer;
any reduction in orders from any key customer or the rescheduling or
cancellation of a significant order from a key customer, including reductions,
delays or cancellations due to customer departures from recent buying patterns;
or economic or competitive conditions in the disk drive industry could have a
material adverse effect on the Company's business, financial condition and
results of operations. In addition, the Company has not to date incurred
significant bad debt expense as a result of the failure of any of its customers.
However, there can be no assurance that the Company will not face greater
difficulty in the future in collecting receivables or be required to offer more
favorable payment terms, particularly in a period of reduced demand for disk
drives. Any failure to collect or delay in collecting receivables could have a
material adverse effect on the Company's business, operating results and
financial condition. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
There has been a trend toward consolidation in the disk drive industry and
the Company expects this trend to continue. Certain of the Company's customers
have in the past and may in the future acquire competitors or be acquired by
competitors, causing further consolidation in the disk drive industry. Previous
acquisitions in the disk drive industry have often caused the purchasing
departments of the combined companies to reevaluate their purchasing decisions.
There can be no assurance that such acquisitions will not result in a change in
a current customer's purchasing habits, including a loss of the customer, a
decrease in orders from that customer or a rescheduling or cancellation of
orders previously made by a customer. Moreover, acquisitions involving existing
customers may cause the concentration of the Company's customer revenues to
increase thereby increasing the Company's dependence on fewer customers.
INVENTORY RISKS
Due to the cyclical nature of and rapid technological change in the disk
drive industry, the Company's inventory is subject to substantial risk. To
address these risks, the Company monitors its inventories on a periodic basis
and provides inventory write-downs intended to cover inventory risks. However,
given the Company's dependence on a few customers and a limited number of
product programs for each customer, the magnitude of the commitments the Company
must make to support its customers' programs and the Company's limited remedies
in the event a customer cancels or materially reduces one or more product
orders, or should a customer experience financial difficulties, the Company may
be required to take significant inventory charges which, in turn, could
materially and adversely affect the Company's business, operating results and
financial condition. There can be no assurance that the Company will not be
required to take additional inventory write-downs in the future, due to the
Company's inability to obtain necessary product acceptance, or due to further
cancellations by customers.
COMPETITION
The disk drive process and production-test equipment industry is highly
competitive. In each of the Company's product lines, the Company faces
substantial competition from established merchant suppliers of process and
production-test equipment, some of which have greater financial, engineering,
manufacturing, research and development and marketing resources than the
Company. For example, the Company faces competition from General Disk for
servowriters; Hitachi DECO and Sony Techtronics for disk certifiers; Swan
Instruments for MR head testers; Zygo Corporation for flying height testers,
Technastar for automation technology and Guzik Technical for spin-stands.
Historically, there has also been competition from entrepreneurs with focused
market knowledge and new technology. The Company also experiences intense
competition world-wide from Hitachi DECO, a large, full-line manufacturer of
process and production-test equipment. Hitachi DECO, a subsidiary of Hitachi
Limited Japan, has substantially greater financial, technical, marketing,
manufacturing, research and development and other resources than the Company.
The Company also experiences competition from other full-line and partial-line
manufacturers of process and production-test equipment. There can be no
assurance that the Company's competitors will not develop enhancements to, or
future generations of, competitive products that will offer price or performance
features superior to the Company's products, or that new competitors will not
enter the Company's markets. Finally, as many of the Company's competitors are
based in foreign countries, they have cost structures and equipment
17
<PAGE> 26
prices based on foreign currencies. Accordingly, currency fluctuations could
cause the Company's dollar-priced products to be less competitive than its
competitors' products priced in other currencies.
Many of the Company's competitors are investing heavily in the development
of new and enhanced products aimed at applications currently addressed by the
Company's products. The Company expects its competitors to continue to improve
the design and performance of their products and to introduce new products with
competitive price/performance characteristics. Competitive pressures often
necessitate price reductions which can adversely affect operating results. The
Company will be required to make a continued high level of investment in product
development and research, sales and marketing and ongoing customer service and
support to remain competitive. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to achieve the technological advances necessary to maintain
its competitive position.
The Company believes that its future success will be dependent, in part,
upon its ability to compete successfully in the Japanese, South Korean and
Southeast Asian markets. The Company's largest competitor, Hitachi DECO, is
headquartered in Japan which gives it a competitive advantage over the Company
in that market to the extent buying decisions are influenced by Hitachi DECO's
local presence. In addition, the Company's ability to compete in Japan, South
Korea and Southeast Asia in the future is dependent upon continuing free trade
between these countries and the United States, the continuing ability of the
Company to develop in a timely manner products that meet the technical
requirements of its foreign customers, and the continuing ability of the Company
to develop and maintain satisfactory relationships with leading companies in the
data storage industry in these areas. Moreover, the Company's sales in these
areas will be affected by the overall economies of Japan, South Korea and
Southeast Asia.
In addition to the competition the Company faces from other merchant
manufacturers of process and production-test equipment, most of the Company's
customers develop at least a portion of their own process and production-test
equipment needs internally, especially servowriters and read/write head test
equipment. Accordingly, the Company must compete against the internal
development efforts of this captive market. Manufacturers within this captive
market are often reluctant to change their production lines to incorporate
merchant-supplied process and production-test technology. Moreover, it is
possible that with the rapid changes in data storage technology, the development
of new process and production-test equipment will be so closely linked to the
Company's customers' product development cycles that certain customers and
potential customers will find it more efficient to develop their own process and
production-testing equipment needs internally, thereby placing the Company at a
competitive disadvantage.
Because of the foregoing competitive factors, there can be no assurance
that the Company will be able to compete successfully in the future. Increased
competitive pressure could cause the Company to lower prices for its products,
thereby adversely affecting the Company's business, financial condition and
results of operations.
PRODUCT CONCENTRATION
The Company derives its revenues primarily from sales of its process and
production-test systems and parts for such systems. The Company's products can
generally be categorized into four principal areas: (i) disk (media) testing and
processing, (ii) read/write head testing, (iii) disk drive testing and
processing and (iv) automation. The Company derives a significant portion of its
net sales from a relatively small number of products. In 1995, 1996, 1997 and
the first three months of 1998, the Company derived approximately 44.0%, 47.0%,
58.9% and 39.1% of its net sales, respectively, from sales of its media
certifier products (excluding parts and service), with the MG250 series
constituting a majority of the Company's media certifier sales over each of
these periods. In June 1997, the Company introduced its MC950 series media
certifier products. The Company expects that net sales from its media certifier
products, including its MG250 series and its MC950 series, will continue to
account for a substantial portion of the Company's total net sales in the
foreseeable future. Any material reduction in demand for its media certifier
products would have a material adverse effect on the Company's business, results
of operations and financial condition.
18
<PAGE> 27
DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's success is heavily dependent upon the establishment and
maintenance of proprietary technologies. Although the Company attempts to
protect its intellectual property rights through patents, copyrights, trade
secrets and other measures, there can be no assurance that the steps taken by
the Company to protect its proprietary technologies will be adequate to prevent
misappropriation by third parties or will be adequate under the laws of some
foreign countries, which may not protect the Company's proprietary rights to the
same extent as do laws of the United States. In addition, others could "reverse
engineer" the Company's products in order to determine their method of operation
and introduce competing products or develop competing technology independently.
Any such adverse circumstances could have a material adverse effect on the
Company's business, financial condition and results of operations.
Although the Company does not believe any of its products or proprietary
rights infringe the rights of third parties, there can be no assurance that
infringement claims will not be asserted against the Company in the future. Any
such claims, with or without merit, could divert the attention of management,
result in costly litigation, cause product shipment delays or require the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. If infringement were established, the Company could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, there can be no assurance that a third party's
product, if infringing on the Company's proprietary rights, may be prevented
from doing so without litigation. Any of the foregoing could have a material
adverse effect on the Company's business, financial condition and results of
operations.
No assurance can be given that the claims allowed on any patents held by
the Company will be sufficiently broad to protect the Company's technology.
Moreover, there can be no assurance that any patent owned by the Company will
not be invalidated, deemed unenforceable, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages to the Company or
that any of the Company's pending or future patent applications will be issued
with claims of the scope sought by the Company, if at all. Furthermore, there
can be no assurance that others will not develop similar products, duplicate the
Company's products or design around the patents owned by the Company. In
addition, there can be no assurance that foreign intellectual property laws or
the Company's agreements will protect the Company's intellectual property rights
in any foreign country. Any failure to protect the Company's intellectual
property rights could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company requires each of its employees to enter into a proprietary
rights and non-disclosure agreement in which the employee agrees to maintain the
confidentiality of all proprietary information of the Company and, subject to
certain exceptions, to assign to the Company all rights in any proprietary
information or technology made or contributed by the employee during his or her
employment. In addition, the Company regularly enters into non-disclosure
agreements with third parties, such as consultants, potential joint venture
partners and customers. In spite of these precautions, it may be possible for
third parties to copy, develop or otherwise obtain and use the Company's
proprietary technology without authorization or to develop similar technology
independently.
MANUFACTURING RISKS
The Company's products have a large number of components and are highly
complex. The Company has experienced and may in the future experience
manufacturing delays due to technical difficulties. In addition, many of the
Company's products must be semi-customized to meet individual product
specification requirements. The customization of a customer order may require
new technical capabilities not previously incorporated successfully into the
Company's products. As a result, the Company may be unable to complete the
customized development or technical specifications of its customers in a timely
manner. Any significant failure in this regard would have a material adverse
effect on the Company's business, financial condition and results of operations
as well as its customer relationships. In addition, due to the semi-customized
nature of many of the Company's products, the Company has in the past and may in
the future incur substantial unanticipated costs in a product's development and
production, such as increased cost of components due to
19
<PAGE> 28
expediting charges, other purchasing inefficiencies and greater than expected
engineering, quality control, installation, upgrade, post-installation service
and support and warranty costs which cannot be passed on to the customer. The
occurrence of any of such events in the future could materially adversely affect
the Company's business, financial condition and results of operations.
In certain instances the Company relies on a single source or a limited
group of suppliers for certain components and subassemblies used in its
products. Although the Company seeks to reduce its dependence on sole and
limited source suppliers, the partial or complete loss of these sources could
have at least a temporary material adverse effect on the Company's results of
operations and damage customer relationships due to the complexity of the
products they supply and the significant amount of time required to qualify new
suppliers. In addition, long lead times are often required to obtain critical
components and subassemblies used in certain of the Company's products from
these and other suppliers which could impede the Company's ability to quickly
respond to changes in demand and product specifications.
Shortages of critical components and subassemblies to manufacture the
Company's products have occurred in the past and there can be no assurance that
shortages will not occur in the future, or that materials will be available
without longer lead times. In addition, the manufacture and timely delivery of
products by the Company is often dependent on the ability of certain suppliers
to deliver subassemblies and other components in a timely manner. The failure of
such suppliers to deliver these components in a timely manner may delay the
delivery of products by the Company until alternative sourcing could be
developed. There can be no assurance that an alternative source could be located
in time to avoid penalties or cancellation of the Company's product orders. If a
significant order or orders were cancelled for this reason it could have a
material adverse effect on the Company's business, financial condition and
results of operations. Further, a significant increase in the price of one or
more components used to produce the Company's products would increase the cost
of producing the Company's products. See "Business -- Manufacturing."
The Company conducts its manufacturing activities at its facilities in San
Diego, Fremont, Concord and Hayward, California. The Company's manufacturing
facilities are located in seismically active areas. A major catastrophe (such as
an earthquake or other natural disaster) or other long-term disruption in the
Company's manufacturing activities could result in a prolonged interruption of
the Company's business. See "Business -- Manufacturing."
RISKS ASSOCIATED WITH ACQUISITIONS
While the Company currently has no commitments, agreements or
understandings with respect to any future acquisitions, its business strategy
includes the expansion of its business, products lines and technology through
acquisitions. The Company regularly reviews various acquisition prospects,
including companies, technologies or products complementary to the Company's
business and periodically engages in discussions regarding such possible
acquisitions. Acquisitions involve numerous risks, including evaluating new
technologies; difficulties in the assimilation of the operations, products,
personnel and cultures of the acquired companies; the ability to manage
geographically remote units; the diversion of management's attention from other
day-to-day business concerns; risks of entering markets in which the Company has
limited or no direct experience and the potential loss of key employees of the
acquired companies. In addition, acquisitions may result in dilutive issuances
of equity securities; the incurrence of additional debt; reduction of existing
cash balances; amortization expenses related to goodwill and other intangible
assets and other charges to operations that may materially adversely affect the
Company's results of operations. Moreover, there can be no assurance that any
equity or debt financings proposed in connection with any acquisition would be
available to the Company on acceptable terms or at all, when, and if, suitable
strategic acquisition opportunities arise. Although management expects to
carefully analyze any opportunity before committing the Company's resources,
there can be no assurance that any acquisition that is completed will result in
long-term benefits to the Company or its stockholders or that Phase Metrics'
management will be able to manage effectively the resulting business. See
"Business -- Competition."
The Company recorded write-downs totaling approximately $11.9 million and
$2.0 million for 1996 and 1997, respectively, related to impairment losses on
certain purchased technology recorded primarily in
20
<PAGE> 29
connection with the Company's acquisitions of ART and certain assets of Cambrian
and ABI. Such impairment losses were generally the result of post-acquisition
technological changes that were developed independent of purchased technologies,
causing a decline in the carrying values of such purchased technologies. There
can be no assurance that such impairments will not occur in the future or that
future acquisitions will not result in similar write-downs of acquired assets.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 1 of Notes to Consolidated Financial Statements.
CAPITAL NEEDS
The Company believes that, in order to achieve its long-term strategic
objectives and maintain and enhance its competitive position, it will need
additional financial resources over the next several years to fund acquisitions,
service debt, make capital expenditures, fund working capital and pay for
research and development. The Company has added significant manufacturing
capacity and increased its fixed costs over the past two years while expanding
its facilities in Concord, Fremont and San Diego, California, and continues to
invest in new technologies and its international infrastructure. The Company's
fixed costs may also increase if the Company elects to expand its infrastructure
in South Korea, Japan, other parts of Asia, or other locations. Any liquidity
deficiency in the future could delay or change management's plans for the
Company including curtailing its acquisition strategy, capital expenditures,
facilities expansion and research and development expenditures, which could
materially adversely affect the ability of the Company to service its debt
(including indebtedness under the New Notes) and its business, financial
condition and results of operations.
Upon completion of the Exchange Offer, the Company will continue to have
limited cash resources and significant future obligations. The precise amount
and timing of the Company's funding needs cannot be determined at this time and
will depend upon a number of factors, including the market demand for the
Company's products, the availability of strategic opportunities, the progress of
the Company's product development efforts, technological challenges that must be
overcome in connection with existing and future products, the Company's
inventory management and the Company's management of its cash and accounts
payable. The Company may not be able to obtain additional financing as needed on
acceptable terms or at all. If the Company is unable to obtain sufficient
capital, it could be required to curtail its acquisition strategy, capital
expenditures, facilities expansion and research and development expenditures,
which could materially adversely affect the Company's business, financial
condition and results of operations. See "Use of Proceeds," "Capitalization,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Based on currently available information, the Company believes that its
available cash, cash generated from operations and borrowings available under
the New Credit Facility will be adequate to fund its operations for the
foreseeable future, and for no less than the next 12 months.
DEPENDENCE UPON KEY PERSONNEL
The Company's future performance depends in significant part upon the
continued service of its Chief Executive Officer, other senior management
personnel and its key technical personnel. The Company is dependent on its
ability to identify, hire, train, retain and motivate high quality personnel,
especially highly skilled engineers involved in the ongoing developments
required to develop and enhance the Company's products and introduce new and
enhanced future products and applications. The industry in which the Company
competes is characterized by a high level of employee mobility and aggressive
recruiting of skilled personnel. The Company's employees may terminate their
employment with the Company at any time. Accordingly, there can be no assurance
that any of the Company's current employees will continue to work for the
Company. Loss of services of key employees could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company has an employment agreement with its Chief Executive Officer, but does
not maintain key-man life insurance with respect to such individual. The
employment agreement is terminable at will by either party upon 30-days written
notice and contains a covenant not to compete during the term of the agreement
and for two years thereafter. See "Business -- Employees" and
"Management -- Compensation Plans and Arrangements -- Employment Contracts and
Change in Control Arrangements."
21
<PAGE> 30
INTERNATIONAL OPERATIONS
The Company's sales and operating activities outside of the United States
are subject to inherent risks, including fluctuations in the value of the United
States dollar relative to foreign currencies, tariffs, quotas, taxes and other
market barriers, political, economic and monetary instability, restrictions on
the export or import of technology, potentially limited intellectual property
protection, difficulties in staffing and managing international operations and
potentially adverse tax consequences. There can be no assurance that any of
these factors will not have a material adverse effect on the Company's business,
financial condition or results of operations. In addition, although
substantially all of the Company's export sales to date have been denominated in
United States dollars, such sales may not be denominated in dollars in the
future. As a result, currency exchange fluctuations in countries where the
Company does business could have a material adverse effect on the Company's
business, financial condition and results of operations. In this regard, several
Asian countries including South Korea, Japan and Thailand, have recently
experienced significant economic downturns and significant declines in the value
of their currencies relative to the U.S. dollar. Due to these conditions, it is
possible that certain of the Company's customers will delay, reschedule or
cancel significant current or future orders for the Company's products. If any
such orders are delayed, rescheduled or cancelled, the Company's business,
financial condition and results of operations would be adversely affected.
ENVIRONMENTAL REGULATIONS
The Company is subject to a variety of governmental regulations relating to
the use, storage, discharge, handling, emission, generation, manufacture,
treatment and disposal of toxic or other hazardous substances, chemicals,
materials or waste. The Company believes that it is in compliance, in all
material respects, with such regulations. Any failure to comply with current or
future regulations could result in civil penalties or criminal fines being
imposed on the Company, or its officers, directors or employees, suspension of
production, alteration of its manufacturing process or cessation of operations.
Such regulations could require the Company to acquire expensive remediation or
abatement equipment or to incur expenses to comply with environmental
regulations. Any failure by the Company to properly manage the use, disposal or
storage of, or adequately restrict the release of, hazardous or toxic substances
could subject the Company to significant liabilities.
CONCENTRATION OF STOCK OWNERSHIP
The Company's directors and officers and their respective affiliates
beneficially own approximately 86.6% of the Company's capital stock as of
February 28, 1998. As a result, these stockholders, acting together, would be
able to effectively control all matters requiring approval by the stockholders
of the Company, including the election of directors and approval of significant
corporate transactions. These stockholders are parties to a Securityholders
Agreement which, among other provisions, requires such stockholders to vote
their shares of capital stock for certain nominees for directors of the Company.
See "Management," "Certain Transactions" and "Principal Stockholders."
FRAUDULENT CONVEYANCE CONSIDERATIONS
Under applicable provisions of federal bankruptcy law or comparable
provisions of state fraudulent transfer laws, if, among other things, the
Company or any Subsidiary Guarantor, at the time it incurred the indebtedness
evidenced by the New Notes or the New Note Guarantees, as the case may be,
(i)(a) was or is insolvent or rendered insolvent by reason of such occurrence or
(b) was or is engaged in a business or transaction for which the assets
remaining with the Company or such Subsidiary Guarantor constituted unreasonably
small capital or (c) intended or intends to incur, or believed or believes that
it would incur, debts beyond its ability to pay such debts as they mature and
(ii) the Company or such Subsidiary Guarantor received or receives less than
reasonably equivalent value or fair consideration for the incurrence of such
indebtedness or providing such guarantees, then the New Notes and the New Note
Guarantees could be voided or claims in respect of the New Notes or the New Note
Guarantees could be subordinated to all other debts of the Company or such
Subsidiary Guarantor, as the case may be. In addition, the payment of interest
and principal of the Company pursuant to the New Notes or the payment of amounts
by a Subsidiary Guarantor pursuant to a New Note Guarantee could be voided and
required to be returned to the person
22
<PAGE> 31
making such payment, or to a fund for the credit of the creditors of the Company
or such Subsidiary Guarantor, as the case may be.
The measures of insolvency for purposes of the foregoing considerations
will vary depending upon the law applied in any proceeding with respect to the
foregoing. Generally, however, the Company or a Subsidiary Guarantor would be
considered insolvent if (i) the sum of its debts, including contingent
liabilities, were greater than the saleable value of all of its assets at a fair
valuation or if the present fair saleable value of its assets were less than the
amount that would be required to pay its probable liabilities on its existing
debts, including contingent liabilities, as they become absolute and mature or
(ii) it could not pay its debts as they become due.
On the basis of historical financial information, recent operating history
as discussed in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and other factors, the Company and each Subsidiary
Guarantor believes that, after giving effect to the indebtedness incurred in
connection with the Note Offering, it was not insolvent, did not have
unreasonably small capital for the business in which it was engaged and had not
incurred debts beyond its ability to pay debts as they mature. There can be no
assurance, however, as to what standard a court would apply in making such
determinations or that a court would agree with the Company's or such Subsidiary
Guarantor's conclusions.
PAYMENT UPON A CHANGE OF CONTROL
The Indenture provides that, upon the occurrence of a Change of Control,
the Company will be required to make an offer to repurchase all of the New Notes
issued and then outstanding under the Indenture at a purchase price equal to
101% of the principal amount thereof plus accrued and unpaid interest and
Liquidated Damages, if any, thereon to the date of repurchase. See "Description
of New Notes -- Repurchase at the Option of Holders -- Change of Control." Any
Change of Control under the Indenture would also constitute a default under the
New Credit Facility. Therefore, upon the occurrence of a Change of Control, the
Lenders under the New Credit Facility would have the right to accelerate their
loans and holders of the New Notes would have the right to require the Company
to repurchase their New Notes. See "Description of Indebtedness -- New Credit
Facility." If a Change of Control were to occur, it is unlikely that the Company
would be able to repay all of its obligations under the New Credit Facility, the
New Notes and any other indebtedness that may become payable in such event
without refinancing its obligations thereunder. There can be no assurance that
the Company would be able to obtain any such financing on commercially
reasonable terms, or at all, and consequently no assurance can be given that the
Company would be able to repurchase any of the New Notes upon a Change of
Control.
ABSENCE OF TRADING MARKET; RESTRICTIONS ON TRANSFERS
The Notes are currently owned by a relatively small number of beneficial
owners. The Notes have not been registered under the Securities Act and will be
subject to restrictions on transferability to the extent that they are not
exchanged for New Notes. To the extent that a substantial portion of the Notes
are exchanged in connection with this Exchange Offer, any trading market that
may have existed for the Notes could be materially and adversely affected by the
substantial reduction in the amount of Notes available for trading.
The New Notes will constitute a new issue of securities with no established
trading market. Although the New Notes will generally be permitted to be resold
or otherwise transferred by holders who are not affiliates of the Company
without compliance with the registration requirements under the Securities Act,
the Company does not intend to list the New Notes on any securities exchange or
to seek admission thereof to trading in the National Association of Securities
Dealers Automated Quotation System. Although DLJ has advised the Company that it
currently intends to make a market in the New Notes, DLJ is not obligated to do
so and may discontinue such market making at any time without notice. In
addition, such market making activity will be subject to the limits imposed by
the Exchange Act. If a trading market does not develop or is not maintained,
holders of the New Notes may experience difficulty in reselling the New Notes or
may be unable to sell them at all. If a market for the New Notes develops, any
such market may be discontinued at any time. Accordingly, there can be no
assurance as to the development or liquidity of any market for the New Notes.
23
<PAGE> 32
COMPLIANCE WITH EXCHANGE OFFER PROCEDURES; RESTRICTIONS ON RESALES
Issuance of the New Notes in exchange for Notes pursuant to the Exchange
Offer will be made only after a timely receipt by the Exchange Agent of such
Notes, a properly completed and duly executed Letter of Transmittal and all
other required documents. Therefore, holders of the Notes desiring to tender
such Notes in exchange for New Notes should allow sufficient time to ensure
timely delivery. The Company is under no duty to give notification of defects or
irregularities with respect to any tender of Notes for exchange. Notes that are
not tendered or are tendered but not accepted will, following the consummation
of the Exchange Offer, continue to be subject to the existing restrictions upon
transfer thereof and, upon the Expiration Date, the principal registration
rights under the Registration Rights Agreement generally will terminate. In
addition, any holder of Notes who tenders in the Exchange Offer for the purpose
of participating in or otherwise intends to participate in a distribution of the
New Notes will be required to comply with the registration and prospectus
delivery requirements of the Securities Act in connection with any resale of the
New Notes to third parties. Each Participating Broker-Dealer that receives New
Notes for its own account in exchange for Notes, where such Notes were acquired
by such broker-dealer as a result of market-making activities or other trading
activities must acknowledge that it will deliver a prospectus in connection with
the initial resale of such New Notes to third parties. To the extent that Notes
are tendered and accepted in the Exchange Offer, the trading market for
untendered and tendered but unaccepted Notes could be adversely affected. See
"The Exchange Offer" and "Plan of Distribution."
YEAR 2000
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results as a result of this
"Year 2000" issue. The Company is assessing the readiness of its internal
computer systems, its products and its vendors for handling the Year 2000 issue.
The Company does not believe that the costs of any actions required as a result
of such assessment will have a material adverse effect on the Company's
business, financial condition or results of operations. There can be no
assurance, however, that the Company will successfully implement the correct
solutions or that there will be no delay in or increased costs associated with
the Company's Year 2000 readiness programs. The Company's inability to
successfully implement such solutions could have a material adverse effect on
the Company's business, financial condition or results of operations. In
addition, there can be no assurance that the Company's critical direct and
indirect product and service providers, and their direct and indirect critical
product and service providers, are or will become year 2000 compliant on a
timely basis both individually and as a group, including information systems
integrated among businesses, financial institutions, government agencies and
utilities. The failure of such critical product and service providers and
integrated information systems to be or become year 2000 compliant could have a
material adverse effect on the Company's business, financial condition or
results of operations.
24
<PAGE> 33
THE EXCHANGE OFFER
The following discussion sets forth or summarizes what the Company believes
are the material terms of the Exchange Offer, including those set forth in the
Letter of Transmittal distributed with this Prospectus. This summary is
qualified by reference to the full text of the documents related to the Exchange
Offer, copies of which are filed as exhibits to the Registration Statement of
which this Prospectus is a part, and are incorporated by reference herein.
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Notes were sold by the Company on January 30, 1997, and were
subsequently resold to qualified institutional buyers pursuant to Rule 144A
under the Securities Act and to certain persons in transactions outside the
United States in reliance on Regulation S under the Securities Act. In
connection with the Note Offering, the Company entered into the Registration
Rights Agreement on the date of the Note Closing, which requires, among other
things, the Company and the Subsidiary Guarantors to (i) file with the SEC a
Registration Statement under the Securities Act with respect to an issue of new
notes of the Company identical in all material respects to the Notes, (ii) use
their best efforts to cause such Registration Statement to become effective
under the Securities Act and (iii) upon the effectiveness of that Registration
Statement, offer to the holders of the Notes the opportunity to exchange their
Notes for a like principal amount of New Notes, which would be issued without a
restrictive legend and may be reoffered and resold by the Holder without
restrictions or limitations under the Securities Act (other than any such holder
that is an "affiliate" of the Company within the meaning of Rule 405 under the
Securities Act). A copy of the Registration Rights Agreement has been filed as
an exhibit to the Registration Statement of which this Prospectus is a part. The
term "Holder" as used in this Prospectus means any person in whose name the
Notes are registered on the books of the Company or Trustee, or any other person
who has obtained a properly completed bond power from the registered holder.
Because the Exchange Offer is for any and all Notes, the number of Notes
tendered and exchanged in the Exchange Offer will reduce the principal amount of
Notes outstanding. Following the consummation of the Exchange Offer, Holders of
the Notes who did not tender their Notes generally will not have any further
registration rights under the Registration Rights Agreement, and such Notes will
continue to be subject to certain restrictions on transfer. The Notes are
currently eligible for sale pursuant to Rule 144A through the PORTAL System of
the National Association of Securities Dealers, Inc. Because the Company
anticipates that most Holders of Notes will elect to exchange such Notes for New
Notes due to the absence of restrictions on the resale of New Notes under the
Securities Act, the Company anticipates that the liquidity of the market for any
untendered Notes remaining after the consummation of the Exchange Offer may be
substantially limited.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Notes
validly tendered and not withdrawn prior to 12:00 midnight, New York City time,
on the Expiration Date. The Company will issue $1,000 principal amount of New
Notes in exchange for each $1,000 principal amount of outstanding Notes accepted
in the Exchange Offer. Holders may tender some or all of their Notes pursuant to
the Exchange Offer. Notes may be tendered only in integral multiples of $1,000.
The form and terms of the New Notes are the same as the form and terms of
the Notes except that (i) the New Notes have been registered under the
Securities Act and hence will not bear legends restricting the transfer thereof
and (ii) the holders of the New Notes generally will not be entitled to any
further rights under the Registration Rights Agreement, which rights generally
will terminate upon consummation of the Exchange Offer. The New Notes will
evidence the same debt as the Notes and will be entitled to the benefits of the
Indenture.
Holders of Notes do not have any appraisal or dissenters' rights under the
Delaware General Corporation Law or the Indenture in connection with the
Exchange Offer. The Company intends to conduct the Exchange
25
<PAGE> 34
Offer in accordance with the applicable requirements of the Exchange Act and the
rules and regulations of the SEC thereunder, including Rule 14e-1 thereunder.
The Company shall be deemed to have accepted validly tendered Notes when,
as and if the Company has given oral or written notice thereof to the Exchange
Agent. The Exchange Agent will act as agent for the tendering Holders for the
purpose of receiving the New Notes from the Company.
If any tendered Notes are not accepted for exchange because of an invalid
tender, the occurrence of certain other events set forth herein or otherwise,
the certificates for any such unaccepted Notes will be returned, without
expense, to the tendering Holder thereof as promptly as practicable after the
Expiration Date.
Holders who tender Notes in the Exchange Offer will not be required to pay
brokerage commissions or fees or, subject to the instructions in the Letter of
Transmittal, transfer taxes with respect to the exchange of Notes pursuant to
the Exchange Offer. The Company will pay all charges and expenses, other than
transfer taxes in certain circumstances, in connection with the Exchange Offer.
See "-- Fees and Expenses."
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 12:00 midnight, New York City time,
on , 1998, unless the Company, in its sole discretion, extends
the Exchange Offer, in which case the term "Expiration Date" shall mean the
latest date and time to which the Exchange Offer is extended.
To extend the Exchange Offer, the Company will notify the Exchange Agent of
any extension by oral or written notice, followed by a public announcement
thereof no later than 9:00 a.m., New York City time, on the next business day
after the previously scheduled Expiration Date.
The Company reserves the right, in its reasonable judgment, (i) to delay
accepting any Notes, to extend the Exchange Offer or to terminate the Exchange
Offer if any of the conditions set forth below under "-- Conditions" shall not
have been satisfied, by giving oral or written notice of such delay, extension
or termination to the Exchange Agent or (ii) to amend the terms of the Exchange
Offer in any manner. Any such delay in acceptance, extension, termination or
amendment will be followed as promptly as practicable by a public announcement
thereof. If the Exchange Offer is amended in a manner determined by the Company
to constitute a material change, the Company will promptly disclose such
amendment by means of a supplement to this Prospectus that will be distributed
to the registered Holders, and, depending upon the significance of the amendment
and the manner of disclosure to the registered Holders, the Company will extend
the Exchange Offer for five to ten business days if the Exchange Offer would
otherwise expire during such five to ten business-day period.
If the Company does not consummate the Exchange Offer, or, in lieu thereof,
the Company does not file and cause to become effective a resale shelf
registration for the New Notes within the time periods set forth in the
Registration Rights Agreement, Liquidated Damages will accrue and be payable on
the New Notes either temporarily or permanently. See "Description of New
Notes -- Registration Rights; Liquidated Damages."
INTEREST ON NEW NOTES
The New Notes will bear interest from January 30, 1998, the date of the
Note Closing. Accordingly, Holders of Notes that are accepted for exchange will
not receive interest that is accrued but unpaid on the Notes at the time of
tender, but such interest will be payable on the New Notes on the first interest
payment date after the Expiration Date. Interest on the New Notes will be
payable semiannually on each February 1 and August 1, commencing on August 1,
1998.
PROCEDURES FOR TENDERING
Only a Holder of Notes may tender such Notes in the Exchange Offer. To
tender in the Exchange Offer, a Holder must complete, sign and date the enclosed
Letter of Transmittal, or a facsimile thereof, have the signatures thereon
guaranteed if required by the Letter of Transmittal and mail or otherwise
deliver such
26
<PAGE> 35
Letter of Transmittal or such facsimile, together with the Notes and any other
required documents, to the Exchange Agent so as to be received by the Exchange
Agent at the address set forth below prior to 12:00 midnight, New York City
time, on the Expiration Date. The Letter of Transmittal must be used to tender
Notes. Delivery of the Notes may be made by book-entry transfer in accordance
with the procedures described below. Confirmation of such book-entry transfer
must be received by the Exchange Agent prior to the Expiration Date.
By executing the Letter of Transmittal, each Holder will make to the
Company the representation set forth below in the second paragraph under the
heading "-- Resale of New Notes." The tender by a Holder and the acceptance
thereof by the Company will constitute an agreement between such Holder and the
Company in accordance with the terms and subject to the conditions set forth
herein and in the Letter of Transmittal.
THE METHOD OF DELIVERY OF NOTES AND THE LETTER OF TRANSMITTAL AND ALL OTHER
REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF THE
HOLDER. INSTEAD OF DELIVERY BY MAIL, IT IS RECOMMENDED THAT HOLDERS USE AN
OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE
ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION DATE. NO
LETTER OF TRANSMITTAL OR NOTES SHOULD BE SENT TO THE COMPANY. HOLDERS MAY
REQUEST THEIR RESPECTIVE BROKERS, DEALERS, COMMERCIAL BANKS, TRUST COMPANIES OR
NOMINEES TO EFFECT THE ABOVE TRANSACTIONS FOR SUCH HOLDERS.
Any beneficial owner whose Notes are registered in the name of a broker,
dealer, commercial bank, trust company or other nominee and who wishes to tender
should contact the registered Holder promptly and instruct such registered
Holder to tender on such beneficial owner's behalf.
Signatures on the Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by an Eligible Institution (as defined below)
unless the Notes tendered pursuant thereto are tendered (i) by a registered
Holder who has not completed the box entitled "Special Issuance Instructions" or
"Special Delivery Instructions" on the Letter of Transmittal or (ii) for the
account of an Eligible Institution. In the event that signatures on a Letter of
Transmittal or a notice of withdrawal, as the case may be, are required to be
guaranteed, such guarantee must be by a member firm of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.,
a commercial bank or trust company having an office or correspondent in the
United States or an "eligible guarantor institution" within the meaning of Rule
17Ad-15 under the Exchange Act (an "Eligible Institution").
If the Letter of Transmittal is signed by a person other than the
registered Holder of any Notes listed therein, such Notes must be endorsed or
accompanied by a properly completed bond power, signed by such registered Holder
as such registered Holder's name appears on such Notes with the signature
thereon guaranteed by an Eligible Institution.
If the Letter of Transmittal or any Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by the Company,
evidence satisfactory to the Company of their authority to so act must be
submitted with the Letter of Transmittal.
The Company understands that the Exchange Agent will make a request
promptly after the date of this Prospectus to establish accounts with respect to
the Notes at the Depository for the purpose of facilitating the Exchange Offer,
and subject to the establishment thereof, any financial institution that is a
participant in the Depository's system may make book-entry delivery of the Notes
by causing the Depository to transfer such Notes into the Exchange Agent's
account with respect to the Notes in accordance with the Depository's procedures
for such transfer. Although delivery of the Notes may be effected through
book-entry transfer into the Exchange Agent's account at the Depository, an
appropriate Letter of Transmittal properly completed and duly executed with any
required signature guarantee and all other required documents must in each case
be transmitted to and received or confirmed by the Exchange Agent at its address
set forth below on or prior to
27
<PAGE> 36
the Expiration Date, or, if the guaranteed delivery procedures described below
are complied with, within the time period provided under such procedures.
Delivery of documents to the Depository does not constitute delivery to the
Exchange Agent.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Notes and withdrawal of tendered Notes will be
determined by the Company in its sole discretion, which determination will be
final and binding. The Company reserves the absolute right to reject any and all
Notes not properly tendered or any Notes the Company's acceptance of which
would, in the opinion of counsel for the Company, be unlawful. The Company also
reserves the right to waive any defects, irregularities or conditions of tender
as to particular Notes. The Company's interpretation of the terms and conditions
of the Exchange Offer (including the instructions in the Letter of Transmittal)
will be final and binding on all parties. Unless waived, any defects or
irregularities in connection with tenders of Notes must be cured within such
time as the Company shall determine. Although the Company intends to notify
Holders of defects or irregularities with respect to tenders of Notes, none of
the Company, the Exchange Agent or any other person shall incur any liability
for failure to give such notification. Tenders of Notes will not be deemed to
have been made until such defects or irregularities have been cured or waived.
Any Notes received by the Exchange Agent that are not properly tendered and as
to which the defects or irregularities have not been cured or waived will be
returned by the Exchange Agent to the tendering Holders, unless otherwise
provided in the Letter of Transmittal, as soon as practicable following the
Expiration Date.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Notes and (i) whose New Notes are not
immediately available, (ii) who cannot deliver their Notes, the Letter of
Transmittal or any other required documents to the Exchange Agent or (iii) who
cannot complete the procedures for book-entry transfer, prior to the Expiration
Date, may effect a tender if:
(a) the tender is made through an Eligible Institution;
(b) prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice
of Guaranteed Delivery (by facsimile transmission, mail or hand
delivery) setting forth the name and address of the Holder, the
certificate number(s) of such Notes and the principal amount of Notes
tendered, stating that the tender is being made thereby and guaranteeing
that, within three New York Stock Exchange trading days after the
Expiration Date, the Letter of Transmittal (or facsimile thereof),
together with the certificates(s) representing the Notes (or a
confirmation of book-entry transfer of such Notes into the Exchange
Agent's account at the Depository) and any other documents required by
the Letter of Transmittal, will be deposited by the Eligible Institution
with the Exchange Agent; and
(c) such properly completed and executed Letter of Transmittal (or
facsimile thereof), as well as the certificate(s) representing all
tendered Notes in proper form for transfer (or a confirmation of
book-entry transfer of such Notes into the Exchange Agent's account at
the Depository) and all other documents required by the Letter of
Transmittal, are received by the Exchange Agent within three New York
Stock Exchange trading days after the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to Holders who wish to tender their Notes according to the guaranteed
delivery procedures set forth above.
WITHDRAWALS OF TENDERS
Except as otherwise provided herein, tenders of Notes may be withdrawn at
any time prior to 12:00 midnight New York City time, on the Expiration Date.
To withdraw a tender of Notes in the Exchange Offer, a written or facsimile
transmission notice of withdrawal must be received by the Exchange Agent at its
address set forth herein prior to 12:00 midnight New York City time, on the
Expiration Date. Any such notice of withdrawal must (i) specify the name of the
person having deposited the Notes to be withdrawn (the "Depositor"), (ii)
identify the Notes to be withdrawn
28
<PAGE> 37
(including the certificate number(s) and principal amount of such Notes, or, in
the case of Notes transferred by book-entry transfer, the name and number of the
account at the Depository to be credited), (iii) be signed by the Holder in the
same manner as the original signature on the Letter of Transmittal by which such
Notes were tendered (including any required signature guarantees) or be
accompanied by documents of transfer sufficient to have the Trustee with respect
to the Notes register the transfer of such Notes into the name of the person
withdrawing the tender and (iv) specify the name in which any such Notes are to
be registered, if different from that of the Depositor. All questions as to the
validity, form and eligibility (including time or receipt) of such notices will
be determined by the Company, whose determination shall be final and binding on
all parties. Any Notes so withdrawn will be deemed not to have been validly
tendered for purposes of the Exchange Offer and no New Notes will be issued with
respect thereto unless the Notes so withdrawn are validly retendered. Any Notes
which have been tendered but which are withdrawn will be returned to the Holder
thereof without cost to such Holder as soon as practicable after withdrawal or
termination of the Exchange Offer. Properly withdrawn Notes may be retendered by
following one of the procedures described above under "-- Procedures for
Tendering" at any time prior to the Expiration Date.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or to exchange New Notes for any Notes, and
may terminate or amend the Exchange Offer as provided herein before the
acceptance of such Notes, if any law, statute, rule, regulation or
interpretation by the staff of the SEC is proposed, adopted or enacted, which,
in the reasonable judgment of the Company, might materially impair the ability
of the Company to proceed with the Exchange Offer or materially impair the
contemplated benefits of the Exchange Offer to the Company.
If the Company determines in its reasonable judgment that any of the
conditions are not satisfied, the Company may in its reasonable determination
(i) refuse to accept any Notes and return all tendered Notes to the tendering
Holders, (ii) extend the Exchange Offer and retain all Notes tendered prior to
the expiration of the Exchange Offer, subject, however, to the rights of Holders
to withdraw such Notes or (iii) waive such unsatisfied conditions with respect
to the Exchange Offer and accept all properly tendered Notes which have not been
withdrawn. If such waiver constitutes a material change to the Exchange Offer
that is adverse to the Holders, the Company will promptly disclose such waiver
by means of a supplement to this Prospectus that will be distributed to the
registered Holders, and, depending upon the significance of the waiver and the
manner of disclosure to the registered Holders, the Company will extend the
Exchange Offer for a period of five to ten business days if the Exchange Offer
would otherwise expire during such five to ten business-day period.
EXCHANGE AGENT
State Street Bank and Trust Company will act as Exchange Agent for the
Exchange Offer.
Questions and requests for assistance, requests for additional copies of
this Prospectus or of the Letter of Transmittal for the Notes and requests for
copies of a Notice of Guaranteed Delivery should be directed to the Exchange
Agent, addressed as follows:
By Registered or Certified Mail, Overnight Mail or Courier Service or in
Person by Hand:
The Exchange Agent
State Street Bank and Trust Company of California, N.A.
633 West 5th Street, 12th Floor
Los Angeles, California 90071
Attention: Jeanie Mar
By Facsimile:
(213) 362-7357
29
<PAGE> 38
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telephone, facsimile or in person by officers and
regular employees of the Company and its affiliates.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers or other persons
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
the Exchange Agent for its reasonable out-of-pocket expenses in connection
therewith and pay other registration expenses, including fees and expenses of
the Trustee, SEC filing fees, blue sky fees, legal expenses and printing and
distribution expenses.
The Company will pay all transfer taxes, if any, applicable to the exchange
of the Notes pursuant to the Exchange Offer. If, however, certificates
representing the New Notes or the Notes for principal amounts not tendered or
accepted for exchange are to be delivered to, or are to be issued in the name
of, any person other than the registered Holder of the Notes tendered, or if
tendered Notes are registered in the name of any person other than the person
signing the Letter of Transmittal, or if a transfer tax is imposed for any
reason other than the exchange of the Notes for New Notes pursuant to the
Exchange Offer as provided herein, then the amount of any such transfer taxes
(whether imposed on the registered Holder or any other person) will be payable
by the tendering Holder.
ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Notes,
which is the aggregate principal amount of the Notes, as reflected in the
Company's accounting records on the date of exchange. Accordingly, no gain or
loss for accounting purposes will be recognized in connection with the Exchange
Offer. The expenses of the Exchange Offer will be amortized over the term of the
New Notes.
RESALE OF NEW NOTES
Based on interpretations by the staff of the SEC set forth in no-action
letters issued to third parties, the Company believes that New Notes issued
pursuant to the Exchange Offer in exchange for Notes may be offered for resale,
resold and otherwise transferred by any Holder of such New Notes (other than any
such Holder which is an "affiliate" of the Company within the meaning of Rule
405 under the Securities Act) without compliance with the registration and
prospectus delivery provisions of the Securities Act; provided, that such New
Notes are acquired in the ordinary course of such Holder's business and such
Holder does not intend to participate, and has no arrangement or understanding
with any person to participate, in a distribution of such New Notes. To
participate in the Exchange Offer, each Holder must represent that it is not an
affiliate of the Company, it is not engaged in, and does not intend to engage
in, and has no arrangement or understanding with any Person to participate in, a
distribution of the New Notes that are issued in the Exchange Offer and it is
acquiring the New Notes in the Exchange Offer in its ordinary course of
business. Any Holder who tenders Notes in the Exchange Offer with the intention
to participate, or for the purpose of participating, in a distribution of the
New Notes may not rely on the position of the staff of the SEC enunciated in
Exxon Capital Holdings Corporation (available April 13, 1989), Morgan Stanley &
Co., Incorporated (available June 5, 1991) and Shearman & Sterling (available
July 2, 1993), or similar no-action letters, but rather must comply with the
registration and prospectus delivery requirements of the Securities Act in
connection with any resale transaction. Any such resale transaction should be
covered by an effective registration statement containing the selling
securityholder's information required by Item 507 or 508 of Regulation S-K of
the Securities Act, as applicable. In addition, each broker-dealer that receives
New Notes for its own account in exchange for Notes, where such Notes were
acquired by such broker-dealer as a result of market-making activities or other
trading activities, may be a statutory underwriter and must acknowledge in the
Letter of Transmittal that it will deliver a prospectus in connection with any
resale of New Notes.
By tendering in the Exchange Offer, each Holder will represent to the
Company that, among other things, (i) the New Notes acquired pursuant to the
Exchange Offer are being obtained in the ordinary course of
30
<PAGE> 39
business of the person receiving such New Notes, whether or not such person is a
Holder, (ii) neither the Holder nor any such other person has an arrangement or
understanding with any person to participate in a distribution of such New Notes
and (iii) the Holder and such other person acknowledge that if they participate
in the Exchange Offer for the purpose of distributing the New Notes (a) they
must, in the absence of an exemption therefrom, comply with the registration and
prospectus delivery requirements of the Securities Act in connection with any
resale of the New Notes and cannot rely on the no-action letters referenced
above and (b) failure to comply with such requirements in such instance could
result in such Holder incurring liability under the Securities Act for which
such Holder is not indemnified by the Company. Further, by tendering in the
Exchange Offer, each Holder that may be deemed an "affiliate" (as defined under
Rule 405 of the Securities Act) of the Company will represent to the Company
that such Holder understands and acknowledges that the New Notes may not be
offered for resale, resold or otherwise transferred by that Holder without
registration under the Securities Act or an exemption therefrom.
As set forth above, affiliates of the Company are not entitled to rely on
the no-action letters referenced above with respect to resales of the New Notes
without compliance with the registration and prospectus delivery requirements of
the Securities Act. In connection with the Note Offering, the Company entered
into the Registration Rights Agreement pursuant to which the Company agreed to
file and maintain, subject to certain limitations, a registration statement that
would allow DLJ to engage in market-making transactions with respect to the New
Notes. The Company has agreed to bear all registration expenses incurred under
such agreement, including printing and distribution expenses, reasonable fees of
counsel, blue sky fees and expenses, reasonable fees of independent accountants
in connection with the preparation of comfort letters, and SEC and the National
Association of Securities Dealers, Inc. filing fees and expenses.
CONSEQUENCES OF FAILURE TO EXCHANGE
As a result of the making of this Exchange Offer, the Company will have
fulfilled its principal obligations under the Registration Rights Agreement, and
Holders of Notes who do not tender their Notes generally will not have any
further rights under the Registration Rights Agreement. Accordingly, any Holder
of Notes that does not exchange that Holder's Notes for New Notes will continue
to hold Notes and will be entitled to all the rights and limitations applicable
thereto under the Indenture, except to the extent that such rights or
limitations, by their terms, terminate or cease to have further effectiveness as
a result of the Exchange Offer.
The Notes that are not exchanged for New Notes pursuant to the Exchange
Offer will remain restricted securities. Accordingly, such Notes may be resold
only (i) to the Company (upon redemption thereof or otherwise), (ii) pursuant to
an effective registration statement under the Securities Act, (iii) so long as
the Notes are eligible for resale pursuant to Rule 144A, to a qualified
institutional buyer within the meaning of Rule 144A under the Securities Act in
a transaction meeting the requirements of Rule 144A, (iv) outside the United
States to a foreign person pursuant to the exemption from the registration
requirements of the Securities Act provided by Regulation S thereunder, (v)
pursuant to an exemption from registration under the Securities Act provided by
Rule 144 thereunder (if available) or (vi) to an institutional accredited
investor in a transaction exempt from the registration requirements of the
Securities Act, in each case in accordance with any applicable securities laws
of any State of the United States. See "Risk Factors -- Absence of Trading
Market; Restrictions on Transfer."
OTHER
Participation in the Exchange Offer is voluntary and Holders should
carefully consider whether to accept. Holders of the Notes are urged to consult
their financial and tax advisors in making their own decision on what action to
take.
The Company may in the future seek to acquire any untendered Notes in open
market or privately negotiated transactions, through subsequent exchange offers
or otherwise. The Company has no present plans to acquire any Notes that are not
tendered in the Exchange Offer or to file a registration statement to assist in
making resales of any untendered Notes.
31
<PAGE> 40
THE REFINANCING
The Note Offering was part of a refinancing plan of Phase Metrics' then
existing term loan and revolving credit indebtedness under its Former Credit
Facility to, among other things, (i) extend the maturity of those borrowings,
(ii) fix the interest rate of those borrowings at a rate believed by the Company
to be attractive for long-term fixed rate financing, (iii) provide the Company
with additional cash for working capital, certain capital expenditures and to
fund possible future acquisitions, and (iv) increase its operating and financial
flexibility. At March 31, 1998, the Company had approximately $16.7 million of
borrowing availability less $8.3 million of outstanding borrowings under the New
Credit Facility. Borrowings under the New Credit Facility are secured by
substantially all of the existing and future assets of the Company (other than
the real estate owned by the Company in San Diego, California on which its
headquarters is located) and are guaranteed on a secured basis by all Subsidiary
Guarantors. Accordingly, all borrowings under the New Credit Facility and the
secured guarantees of the Subsidiary Guarantors in favor of the Lenders will
effectively rank senior to the indebtedness evidenced by the New Notes, to the
extent of the assets securing such obligations. See "Use of Proceeds" and
"Business -- Growth Strategy."
USE OF PROCEEDS
There will be no proceeds to the Company from the Exchange Offer. The net
proceeds to the Company from the sale of the Notes were approximately $105.9
million (after deducting discounts and commissions and Note Offering expenses
payable by the Company). The Company used all of such net proceeds, together
with the Initial Draw of approximately $1.6 million under the New Credit
Facility, to repay in full its then-existing term loan and revolving credit
indebtedness under the Former Credit Facility, including all accrued interest
thereunder to the date of repayment, and all expenses related to the
Refinancing. The term loan portion of the Former Credit Facility bore interest
at the Company's option of prime plus 2% to 2.5% or LIBOR plus 3% to 3.5% and
the revolver portion of the Former Credit Facility bore interest at the
Company's option of prime plus 0.5% to 2% or LIBOR plus 1.5% to 3%, based on the
Company's consolidated leverage ratio as defined in the Former Credit Agreement.
The term loans and revolver matured in December 2002 and December 1999,
respectively. The Company used proceeds from the term loans and revolver to
refinance its then existing credit facility, fund capital expenditures, working
capital and certain acquisitions.
32
<PAGE> 41
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
March 31, 1998 (in thousands, except share data).
<TABLE>
<CAPTION>
MARCH 31, 1998
--------------
<S> <C>
Cash and cash equivalents................................... $ 920
========
Debt (including current portion):
New Credit Facility(1).................................... $ 8,300
Senior Notes due 2005 ($110,000 principal amount)......... 105,676
Convertible Subordinated Notes............................ 8,000
Capital lease obligations................................. 2,923
--------
Total debt (including current portion)............ 124,899
Series B redeemable preferred stock, $.0001 par value,
192,864 shares authorized, issued and outstanding
(liquidation preference of $10,759)....................... 9,793
Stockholders' deficit:
Series A preferred stock, $.0001 par value, 412,500 shares
authorized, issued and outstanding (liquidation
preference of $9,000).................................. 3
Common stock, $.0001 par value, 70,000,000 shares
authorized;
5,606,846 shares issued and outstanding................ 6,175
Retained deficit.......................................... (28,140)
Accumulated translation adjustments....................... (832)
--------
Total stockholders' deficit....................... (22,794)
--------
Total capitalization......................... $111,898
========
</TABLE>
- ---------------
(1) The Company had approximately $16.7 million of borrowing availability less
$8.3 million of outstanding borrowings under the New Credit Facility as of
March 31, 1998. See "Description of Indebtedness -- New Credit Facility."
33
<PAGE> 42
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated statement of operations data for the
years ended December 31, 1995, 1996 and 1997, and the selected consolidated
balance sheet data as of December 31, 1996 and 1997, are derived from the
Company's audited Consolidated Financial Statements included elsewhere in this
Prospectus. The selected consolidated statement of operations data for the three
month periods ended March 31, 1997 and 1998 and the selected consolidated
balance sheet data as of March 31, 1998, are derived from the Company's
unaudited interim Consolidated Financial Statements included elsewhere in this
Prospectus. The unaudited interim Consolidated Financial Statements were
prepared by management of the Company on the same basis as the Company's audited
Consolidated Financial Statements and, in the opinion of management, include all
adjustments (consisting of normal recurring accruals) necessary to present
fairly the Company's operating results and financial position for such periods.
The selected consolidated statement of operations data for the years ended
December 31, 1993 and 1994, and the selected consolidated balance sheet data as
of December 31, 1993, 1994 and 1995 are derived from the Company's audited
Consolidated Financial Statements not included in this Prospectus. Results of
operations for the three months ended March 31, 1998 are not necessarily
indicative of the results to be expected for the full year. The following
selected consolidated financial data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and related
Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------------------------------- -------------------
1993 1994(1) 1995(1) 1996(1) 1997 1997 1998
(IN THOUSANDS, EXCEPT RATIOS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Net sales......................................... $6,141 $ 20,064 $116,894 $190,773 $184,660 $ 51,603 $ 32,502
Gross profit...................................... 3,172 10,099 52,128 86,912 83,366 23,689 12,885
Operating expenses(2)............................. 2,821 8,530 40,161 98,332 81,131 19,956 15,569
Income (loss) from operations..................... 351 1,569 11,967 (11,420) 2,235 3,733 (2,684)
Interest expense.................................. -- 651 5,625 8,448 11,573 2,566 3,431
Income (loss) before income taxes and
extraordinary items............................. 361 943 6,193 (19,842) (9,812) 1,091 (6,210)
Income tax (benefit) expense(3)................... -- (611) 1,524 (8,974) (4,268) 327 (2,733)
Income (loss) before extraordinary items.......... 361 1,554 4,669 (10,868) (5,544) 764 (3,477)
Extraordinary loss, net of income taxes........... -- -- -- (1,122) -- -- (941)
Net income (loss)................................. 361 1,554 4,669 (11,990) (5,544) 764 (4,418)
OTHER DATA:
Cash provided by (used for) operating
activities...................................... 387 (1,994) 18,300 (21,402) (6,392) (394) (4,670)
Cash used for investing activities................ (122) (22,266) (11,102) (45,316) (17,169) (2,987) (750)
Cash provided by (used for) financing
activities...................................... (10) 24,455 (3,099) 64,439 23,883 3,515 3,331
EBITDA(4)......................................... 420 2,782 27,864 21,533 24,107 8,683 1,114
Depreciation, amortization and write-downs of
intangible assets............................... 69 1,213 15,897 32,953 21,872 4,950 3,798
Capital expenditures.............................. 122 293 9,135 24,564 17,091 2,987 750
Ratio of earnings to fixed charges(5)............. 11.3x 1.0x 1.2x -- -- -- --
DECEMBER 31, MARCH 31,
-------------------------------------------------- -------------------
1993 1994 1995 1996 1997 1998
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents......................... $ 732 $ 917 $ 5,016 $ 2,737 $ 2,977 $ 920
Working capital................................... 204 (15,616) (5,774) 42,681 66,075 70,379
Total assets...................................... 2,531 49,609 119,896 154,013 154,730 149,565
Long-term debt, including current portion......... 43 28,200 30,239 96,020 121,057 124,899
Redeemable preferred stock........................ -- 314 3,314 6,314 9,237 9,793
Stockholders' equity (deficit)(3)................. 395 (310) 3,592 (9,031) (17,873) (22,794)
</TABLE>
34
<PAGE> 43
- ---------------
(1) In November 1994, the Company acquired ProQuip and certain net assets of
Cambrian. Between June 1995 and December 1996, the Company completed six
additional acquisitions, including Helios in June 1995, ART in July 1995,
certain net assets of Tahoe in July 1995, ABI in January 1996, SBM in
December 1996 and a portion of the business of Kirell in December 1996. See
Notes 1 and 3 of Notes to Consolidated Financial Statements. Each of these
acquisitions was accounted for as a purchase for financial reporting
purposes, and, as a result, the Company's consolidated statements include
the operating results of ProQuip, Cambrian, Helios, ART, Tahoe, ABI, SBM and
a portion of the business of Kirell from their respective acquisition dates.
(2) Includes restructuring costs in connection with the acquisitions of ProQuip
and Cambrian. The Company incurred approximately $1.0 million of
restructuring costs in 1994, primarily related to the elimination of
duplicate facilities and information systems.
(3) Prior to the Recapitalization (as defined herein), the Company was an S
Corporation for 1994 income tax purposes and, as such, taxable income and
losses were passed on to the sole stockholder of the Company as cash
distributions. Had the Company been a C corporation, assuming a combined
statutory income tax rate of 41%, income tax expense would have been
approximately $.1 million and $.4 million for 1993 and 1994, respectively.
The Company has not declared or paid any cash dividends subsequent to its
conversion to a C Corporation and does not anticipate paying any cash
dividends in the foreseeable future. See "Certain Transactions."
(4) EBITDA represents income (loss) from operations before depreciation and
amortization and write downs of intangibles. EBITDA is presented because
management believes it is a commonly accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the basis
of operating performance. EBITDA is not intended to represent cash flows for
the period, nor has it been presented as an alternative to operating income
(loss) as an indicator of operating performance and should not be considered
in isolation or as a substitute for measures of performance prepared in
accordance with generally accepted accounting principles. The Company
understands that, while EBITDA is frequently used by securities analysts in
the evaluation of companies, EBITDA as used herein is not necessarily
comparable to other similarly titled captions of other companies due to
potential inconsistencies in the method of calculation.
(5) For purposes of determining this ratio, earnings consist of income (loss)
before income taxes (benefit) and extraordinary items. Fixed charges consist
of interest expense, a portion of operating lease rental expense that is
representative of the interest factor (deemed to be one-third of operating
lease rental expense) and dividends and related accretion to redemption
value on preferred stock. For the years ended December 31, 1996 and 1997,
and the three months ended March 31, 1997 and 1998, earnings were inadequate
to cover fixed charges by $24.8 million, $14.7 million, $0.2 million and
$7.1 million, respectively. For the year ended December 31, 1997, and the
three months ended March 31, 1998, the pro forma ratio of earnings to fixed
charges reflects an increase to interest expense of approximately $3.3
million and $0.1 million, respectively, after giving effect to the Note
Offering as if the transaction had occurred as of January 1, 1997. For the
year ended December 31, 1997, and the three months ended March 31, 1998,
earnings were inadequate to cover fixed charges on a pro forma basis by
$18.0 million and $7.2 million, respectively.
35
<PAGE> 44
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company commenced operations in 1989 as a specialized merchant supplier
of production-test equipment for the data storage industry. From its inception
to November 1994, the Company was primarily engaged in developing and selling
its flying height tester systems to read/write head manufacturers. In order to
expand its operations and capitalize on the growing demand for process and
production-test equipment for the data storage industry, in November 1994 the
Company completed the Recapitalization and commenced a series of acquisitions of
other specialized suppliers of process and production-test equipment. In
November 1994, the Company acquired ProQuip and Cambrian, suppliers of advanced
process and production-test equipment for disks and read/write heads. In June
1995, the Company acquired Helios, a supplier of advanced servowriter and other
related equipment used in the production of disk drives. In July 1995, the
Company acquired both ART, a supplier of advanced integrated automation systems
for process and production-test equipment, and Tahoe, a developer of advanced
quasi-static MR head testers used for testing MR read/write heads. In January
1996, the Company acquired ABI, a supplier of advanced air bearing spindles and
other related components used in the Company's products and by others. In
December 1996, the Company acquired both SBM, a developer of advanced spinstands
and micropositioner equipment and technology used by data storage manufacturers,
and a portion of the business of Kirell, a supplier of advanced laser
texturizers used in the production of disks. See "Certain Transactions --
Recapitalization."
The Company accounted for each of its acquisitions as a purchase, and, as a
result, the Company's consolidated statements of operations include the
operating results of the acquired businesses from their respective dates of
acquisition. In connection with certain of the acquisitions, the Company agreed
to make earnout payments based on future sales of certain products acquired in
the acquisitions. The combined stated maximum obligations under the material
arrangements totaled $14.1 million, of which $3.3 million was considered certain
and, accordingly, allocated to the original purchase price, and the remainder of
which is being charged to compensation expense as incurred. Of the $14.1 million
maximum obligation, $10.4 million had been earned as of March 31, 1998. The
remaining $3.7 million will be paid depending on actual sales of the defined
products. Also, in connection with the acquisitions, the Company recorded
capitalized intangible assets totaling $61.2 million. Capitalized intangible
assets consist primarily of purchased technology and are being amortized over
approximately three years from the respective acquisition dates. The net book
value of such capitalized intangible assets was $3.3 million as of March 31,
1998.
There are a relatively small number of data storage manufacturers
throughout the world and the Company derives a significant portion of its net
sales from a relatively small number of customers. The Company expects that its
dependence on relatively few key customers will continue in the future.
Approximately 52.2%, 45.0%, 51.0% and 50.1% of the Company's net sales in 1995,
1996, 1997 and the first three months of 1998, respectively, were derived from
sales to the Company's three largest customers in each of those periods. Even
though the Company's customer mix will likely change from period to period in
the future, Seagate Technology, Inc. ("Seagate"), Komag Incorporated ("Komag"),
HMT Technology ("HMT"), Iomega Corporation ("Iomega") and Trace Storage
Technology USA Corporation ("Trace") have historically accounted for a
significant portion of the Company's net sales. For 1995, 1996, 1997 and the
first three months of 1998, Seagate accounted for 25.0%, 19.0%, 18.0% and 15.1%,
respectively, of net sales; Komag accounted for 10.7%, 14.5%, 15.9% and 0.3%,
respectively, of net sales; HMT accounted for 4.4%, 5.2%, 17.1% and 22.4%,
respectively, of net sales; Iomega accounted for 16.5%, 7.9%, 1.9% and 0.6%,
respectively, of net sales and Trace accounted for 6.8%, 11.5%, 4.4% and 0.2%,
respectively, of net sales. In addition, for the first three months of 1998,
Sentinel N.V. accounted for 12.6% of net sales. If net sales to these or any
other significant customer of the Company were to decrease in any material
amount in the future, the Company's business, results of operations and
financial condition would be materially adversely affected.
The Company has no long-term contracts with its customers, and, in general,
the Company's customers may cancel, change or reschedule their orders with
limited or no penalty. The Company's customers often submit master purchase
orders against which they release specific product orders from time to time,
often with
36
<PAGE> 45
little lead time. Any cancellation, reduction, rescheduling or significant delay
of anticipated or actual orders from significant customers could have a material
adverse effect on the Company's business, results of operations and financial
condition. Each of the Company's customers has some unique product specification
requirements which requires the Company to provide semi-customized products. As
a result, per unit sales prices for the Company's products will generally vary
by customer and sales order. If production costs with respect to the
customization work are underestimated, there could be an adverse impact on the
Company's gross profits. In addition, the Company's products often require
post-installation, on-site customization and integration in order to tailor
products to customer specifications. Revenue and corresponding expenses for
significant post-installation services are recognized in the period such
services are provided. Inaccurate estimation of such on-site service costs could
have a material adverse effect on the Company's business, results of operations
and financial condition.
The Company derives its revenues primarily from sales of its process and
production-test systems and parts for such systems. The Company's products can
generally be categorized into four principal areas: (i) disk (media) testing and
processing, (ii) read/write head testing, (iii) disk drive testing and
processing and (iv) automation. The Company derives a significant portion of its
net sales from a relatively small number of products. In 1995, 1996, 1997 and
the first three months of 1998, the Company derived approximately 44.0%, 47.0%,
58.9% and 39.1% of its net sales, respectively, from sales of its media
certifier products (excluding parts and service), with the MG250 series
constituting a majority of the Company's media certifier sales over each of
these periods. However, since its introduction in June 1997, sales of the
Company's MC950 series media certifier products have become an increasingly
higher percentage of its media certifier product sales. Moreover, the Company
expects that net sales from its media certifier products, including its MG250
series and its MC950 series, will continue to account for a substantial portion
of the Company's total net sales in the foreseeable future. Any significant
reduction in demand for its media certifier products would have a material
adverse effect on the Company's business, results of operations and financial
condition.
The Company's operating results have fluctuated in the past and the Company
expects that its operating results will continue to fluctuate in the future from
quarter to quarter and year to year. These fluctuations have resulted from a
number of factors including the size and timing of orders from, and shipments
to, major customers; the timing of introductions of new products and product
enhancements by the Company or its competitors; the Company's ability to
develop, introduce and market new, technologically advanced products; the
cyclicality of the data storage industry; the rescheduling of capital
expenditures by the Company's customers; variations in the Company's customer
base and product mix; the level of any significant volume pricing discounts
provided by the Company; the availability and cost of key production materials
and components; the Company's ability to effectively manage its inventory and to
control costs; the financial stability of major customers; the Company's success
in expanding its operations overseas; personnel changes; expenses associated
with acquisitions; fluctuations in amortization and write-downs of intangible
assets; exchange rate fluctuations and general economic factors.
The data storage industry in general is currently experiencing a weakness
in demand for products, intense competition and pricing erosion, and
overcapacity. Such adverse market conditions have resulted, and may in the
future result in, the deferral or cancellation of orders for the Company's
products. Delays or declines in orders for the Company's products have had a
material adverse effect on the Company's operating results and financial
condition over the last several quarters and fluctuations in demand for the
Company's products is expected to continue for at least the balance of 1998.
Under current or future market conditions, there can be no assurance that the
Company's business will generate adequate cash flow or that any growth can be
achieved. Because the Company must incur expenses and purchase inventory based
on anticipated and actual customer orders, any significant delay, rescheduling
or cancellation of such orders will have a material adverse effect on the
Company's operating results. For example, during the second and third quarters
of 1997, the Company increased its inventory substantially in anticipation of
satisfying expected demand from three of the Company's largest customers. A
significant portion of this anticipated demand has not materialized to date due
primarily to overcapacity of certain process and production-test equipment at
these customers.
The Company had net sales of $51.6 million for the first three months of
1997 compared to $32.5 million for the first three months of 1998 and $190.8
million in 1996 compared to $184.7 million for 1997. The
37
<PAGE> 46
Company had EBITDA (as described in Footnote 2 in "Summary Selected Consolidated
Financial Data") of $8.7 million for the first three months of 1997 compared to
$1.1 million for the first three months of 1998, and $21.5 million in 1996
compared to $24.1 million in 1997. Cash used for operating activities increased
from $0.4 million in the first quarter of 1997 to $4.7 million in the first
quarter of 1998 due to the first quarter of 1998 net loss, a decrease in
amortization of intangible assets, and an increase in prepaid expenses, offset
by the extraordinary loss, net of income taxes, a decrease in inventories, an
increase in accounts payable and a smaller decrease period over period in income
taxes receivable. Cash used for operating activities decreased from $21.4
million in 1996 to $6.4 million in 1997 due to a smaller net loss, smaller
increases year over year in deferred income taxes, inventories and income taxes
receivable and a decrease in prepaid expenses and other assets, offset by
decreases in depreciation, amortization and writedown of intangible assets,
purchased in-process research and development, an increase in accounts
receivable and larger decreases year over year in accounts payable and customer
deposits, accrued expenses and other liabilities. Net income of $0.8 million in
the first three months of 1997 decreased to a net loss of $4.4 million in the
first three months of 1998 due primarily to decreased net sales, lower gross
profit margins, increased interest expense and the extraordinary loss, net of
income taxes, partially offset by decreases in research and development and
selling, general and administrative expenses. A net loss of $12.0 million in
1996 decreased to a net loss of $5.5 million in 1997 due primarily to decreases
in amortization and write-downs of intangible assets and purchased in-process
research and development expenses, offset by increases in research and
development and interest expense. See "Summary Selected Consolidated Financial
Data."
As indicated above, the Company's business, operating results and financial
condition are being adversely affected by a downturn in the data storage
industry and reduced or delayed capital equipment expenditures by data storage
companies. As it has done in the past, the Company is implementing certain
cost-cutting measures, including reductions in headcount, to reduce its
operating expenses to response to this situation. Such measures will result in
severance and other costs and may result in write-downs of inventory and other
assets, the amount of which has yet to be determined by the Company. While the
Company believes such cost-cutting measures are appropriate given the Company's
current and anticipated levels of net sales, there can be no assurance that such
measures will be sufficient and that additional cost-cutting measures will not
be necessary, or that any current or future cost-cutting measures will not have
a material adverse effect on the Company's ability to increase its net sales.
The Company believes that period-to-period comparisons of its results of
operations are not necessarily meaningful and should not be relied upon as
indicators of future performance. Quarterly results in the future may fluctuate
due to the factors discussed above or other factors. Further, the Company's
historical operating results for any past period are not necessarily indicative
of future performance for any particular period in light of the Company's
acquisition activity during those periods, among other factors.
Many existing computer programs use only two digits to identify a year in
the date field. These programs were designed and developed without considering
the impact of the upcoming change in the century. If not corrected, many
computer applications could fail or create erroneous results as a result of this
"Year 2000" issue. The Company is assessing the readiness of its internal
computer systems, its products and its vendors for handling the Year 2000 issue.
The Company does not believe that the costs of any actions required as a result
of such assessment will have a material adverse effect on the Company's
business, financial condition or results of operations. There can be no
assurance, however, that the Company will successfully implement the correct
solutions or that there will be no delay in or increased costs associated with
the Company's Year 2000 readiness programs. The Company's inability to
successfully implement such solutions could have a material adverse effect on
the Company's business, financial condition or results of operations. In
addition, there can be no assurance that the Company's critical direct and
indirect product and service providers, and their direct and indirect critical
product and service providers, are or will become year 2000 compliant on a
timely basis both individually and as a group, including information systems
integrated among businesses, financial institutions, government agencies and
utilities. The failure of such critical product and service providers and
integrated information systems to be or become year 2000 compliant could have a
material adverse effect on the Company's business, financial condition or
results of operations.
38
<PAGE> 47
RESULTS OF OPERATIONS
The following tables set forth for the periods indicated certain
consolidated statement of operations data in dollars, as well as such data
expressed as a percentage of net sales:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------ -----------------
1995 1996 1997 1997 1998
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales................................................... $116,894 $190,773 $184,660 $51,603 $32,502
Cost of sales............................................... 64,766 103,861 101,294 27,914 19,617
-------- -------- -------- ------- -------
Gross profit.............................................. 52,128 86,912 83,366 23,689 12,885
Operating expenses:
Research and development.................................. 11,372 31,110 43,572 10,430 9,469
Selling, general and administrative....................... 15,695 24,631 22,968 6,163 4,462
Amortization and write-downs of intangibles............... 13,094 28,656 14,591 3,363 1,638
Purchased in-process research and development............. -- 13,935 -- -- --
-------- -------- -------- ------- -------
Income (loss) from operations............................... 11,967 (11,420) 2,235 3,733 (2,684)
Interest expense............................................ 5,625 8,448 11,573 2,566 3,431
Other (income) expense -- net............................... 149 (26) 474 76 95
-------- -------- -------- ------- -------
Income (loss) before income taxes and extraordinary items... 6,193 (19,842) (9,812) 1,091 (6,210)
Income tax (benefit) expense................................ 1,524 (8,974) (4,268) 327 (2,733)
-------- -------- -------- ------- -------
Income (loss) before extraordinary items.................... 4,669 (10,868) (5,544) 764 (3,477)
Extraordinary loss, net of income taxes..................... -- (1,122) -- -- (941)
-------- -------- -------- ------- -------
Net income (loss)........................................... $ 4,669 $(11,990) $ (5,544) $ 764 $(4,418)
======== ======== ======== ======= =======
OTHER DATA:
Cash flows provided by (used for) operating activities...... $ 18,300 $(21,402) $ (6,392) $ (394) $(4,670)
Cash flows used for investing activities.................... (11,102) (45,316) (17,169) (2,987) (750)
Cash flows provided by (used for) financing activities...... (3,099) 64,439 23,883 3,515 3,331
EBITDA(1)................................................... 27,864 21,533 24,107 8,683 1,114
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------- -------------------
1995 1996 1997 1997 1998
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net sales................................................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales............................................... 55.4 54.4 54.9 54.1 60.4
------- -------- -------- -------- --------
Gross profit.............................................. 44.6 45.6 45.1 45.9 39.6
Operating expenses:
Research and development.................................. 9.7 16.3 23.6 20.2 29.1
Selling, general and administrative....................... 13.4 12.9 12.4 11.9 13.7
Amortization and write-downs of intangibles............... 11.2 15.0 7.9 6.5 5.0
Purchased in-process research and development............. -- 7.3 -- -- --
------- -------- -------- -------- --------
Income (loss) from operations............................... 10.3 (5.9) 1.2 7.3 (8.2)
Interest expense............................................ 4.8 4.4 6.3 5.0 10.6
Other (income) expense -- net............................... 0.1 -- 0.3 0.1 0.1
------- -------- -------- -------- --------
Income (loss) before income taxes and extraordinary items... 5.4 (10.3) (5.4) 2.2 (18.9)
Income tax (benefit) expense................................ 1.3 (4.7) (2.3) 0.6 (8.4)
------- -------- -------- -------- --------
Income (loss) before extraordinary items.................... 4.1 (5.6) (3.1) 1.6 (10.5)
Extraordinary loss, net of income taxes..................... -- (0.6) -- -- (2.9)
------- -------- -------- -------- --------
Net income (loss)........................................... 4.1 (6.2) (3.1) 1.6 (13.4)
======= ======== ======== ======== ========
OTHER DATA:
Cash flows provided by (used for) operating activities...... 15.7% (11.2)% (3.5)% (0.8)% (14.4)%
Cash flows used for investing activities.................... (9.5) (23.8) (9.3) (5.8) (2.3)
Cash flows provided by (used for) financing activities (2.7) (33.8) 12.9 6.8 10.2
EBITDA(1)................................................... 23.8 11.3 13.1 16.8 3.4
</TABLE>
- ---------------
(1) See "Selected Consolidated Financial Data" for definition of EBITDA.
39
<PAGE> 48
Net Sales
Net sales consist primarily of revenue from sales of the Company's process
and production-test equipment and, to a lesser extent, related upgrades, parts
and services. Net sales decreased 37.0% from $51.6 million for the first quarter
of 1997 to $32.5 million for the first quarter of 1998. This decrease was
primarily due to decreased sales of the Company's products during this period of
sustained oversupply, and unusually competitive pricing pressures in the data
storage industry. Due to the continued downturn in the data storage industry and
corresponding weakened demand for the Company's products, the Company expects
that net sales for the quarter ending June 30, 1998 will be roughly flat
compared to the quarter ended March 31, 1998. However, no assurance can be given
that the Company will not experience a delay, rescheduling or cancellation of
existing orders and, as a result, lower sales in the quarter ending June 30,
1998, compared to the quarter ended March 31, 1998. The Company's visibility
regarding the duration of the current industry downturn is limited and it is not
possible for the Company to predict its effect on the Company's operating
results and financial condition for future quarters.
Net sales decreased 3.2% from $190.8 million for 1996 to $184.7 million for
1997. This decrease was primarily due to decreased sales of the Company's
servowriter and automation systems, which was partially offset by increased
sales of media certification systems over these periods.
Net sales increased 63.2% from $116.9 million for 1995 to $190.8 million
for 1996. This increase was due primarily to increased sales of the Company's
media certification systems and automation systems for 1996 compared to 1995.
Approximately one-half of this increase in net sales for 1996 was attributable
to the effect of the Company's 1995 acquisitions of Helios, ART and Tahoe and
the inclusion of their net sales for the entire 1996 period and the Company's
acquisition of ABI and the inclusion of its net sales from the date of its
acquisition in January 1996.
Gross Profit
Cost of sales includes material costs, direct labor and overhead costs
related to the production and delivery of the Company's products, including
warranty and other service costs. Gross profit decreased from $23.7 million for
the first quarter of 1997 to $12.9 million for the first quarter of 1998. Gross
profit as a percentage of net sales ("gross margin") decreased from 45.9% for
the first quarter of 1997 to 39.6% for the first quarter of 1998. This decrease
was primarily due to underutilization of manufacturing capacity and costs
resulting from lower production volumes, as well as increased non-linearity of
production volumes during the first quarter of 1998. The Company is unable to
control with any degree of certainty its product sales volume, linearity or mix
from period to period and therefore the Company's gross margin in future periods
may fluctuate from those achieved in past periods. In any period when the
Company experiences an unfavorable product sales volume, linearity or mix and/or
provides significant volume pricing discounts, the Company's gross margin may
decrease.
Gross profit decreased from $86.9 million for 1996 to $83.4 million for
1997. Gross margin decreased from 45.6% for 1996 to 45.1% for 1997.
Gross profit increased from $52.1 million for 1995 to $86.9 million for
1996. Gross margin increased from 44.6% for 1995 to 45.6% for 1996. The
increased gross margin was primarily due to a more favorable product sales mix
and certain volume production efficiencies achieved for 1996 compared to 1995.
This increase was partially offset by the impact of volume pricing offered by
the Company.
In April 1998, the Company entered into an agreement (the "Reimbursement
Agreement") to reimburse a major customer for costs incurred in connection with
the customer's cancellation of a contract with a third party to purchase
upgrades to certain production test equipment originally purchased from the
Company. The Company took this action to protect its intellectual property and
preserve a valued customer relationship. The Company will record approximately
$6.0 million as a charge to earnings in the second quarter of 1998.
The Company will make the reimbursement provided for under the
Reimbursement Agreement by providing a credit to the customer for products to be
purchased by the customer during 1998. Products to be
40
<PAGE> 49
purchased under the Reimbursement Agreement are at favorable pricing which will
negatively impact the Company's gross profit margin during this period.
Research and Development Expense
Research and development expense consists primarily of salaries and related
costs of personnel and contract labor, project materials and other costs
associated with the Company's ongoing research and product development. Research
and development expense decreased from $10.4 million for the first quarter of
1997 to $9.5 million for the first quarter of 1998. Research and development
expense as a percentage of net sales increased from 20.2% for the first quarter
of 1997 to 29.1% for the first quarter of 1998. This percentage increase was
primarily due to the decrease in net sales, offset by a decrease in personnel
costs as a result of work force reductions in August, 1997 and January, 1998.
The Company anticipates that it will continue to devote a significant amount of
financial resources to research and product development for the foreseeable
future.
Research and development expense increased from $31.1 million for 1996 to
$43.6 million for 1997. Research and development expense as a percentage of net
sales increased from 16.3% for 1996 to 23.6% for 1997. This increase was
primarily the result of increased purchases and use of project materials and
increased personnel related to significant design improvements for existing
products, and research and development related to new and next generation
products.
Research and development expense increased from $11.4 million for 1995 to
$31.1 million for 1996. Research and development expense as a percentage of net
sales increased from 9.7% for 1995 to 16.3% for 1996. This increase was
attributable to the effect of the Company's 1995 acquisitions of Helios, ART and
Tahoe and the inclusion of their research and development expenses for the
entire 1996 period and the Company's acquisition of ABI and the inclusion of its
research and development expense from the date of its acquisition in January
1996.
A significant amount of the increased research and development expenses and
improvements in 1996 and 1997 include relatively significant development efforts
related to one of the Company's media certifier products. The Company
experienced more challenges than planned in developing this product due to its
unique technical designs and capabilities.
Selling, General and Administrative Expense
Selling, general and administrative expense primarily consists of salaries
and related personnel costs, including certain acquisition related earnout costs
incurred in connection with certain of the Company's acquisitions. See Note 9 of
Notes to Consolidated Financial Statements. Selling, general and administrative
expense decreased from $6.2 million for the first quarter of 1997 to $4.5
million for the first quarter of 1998. Selling, general and administrative
expense as a percentage of net sales increased from 11.9% for the first quarter
of 1997 to 13.7% for the first quarter of 1998. This percentage increase was
primarily due to the decrease in net sales, offset by decreases in provisions
for doubtful accounts, personnel and earnouts costs.
Selling, general and administrative expense decreased from $24.6 million
for 1996 to $23.0 million for 1997. Selling, general and administrative expense
as a percentage of net sales decreased from 12.9% for 1996 to 12.4% for 1997.
The decrease in absolute dollars was principally due to the payment of $1.5
million in special, one-time bonuses to certain senior executive officers of the
Company in December of 1996 and lower earnout costs of $2.0 million incurred for
1997 compared to $3.8 million for 1996, which were offset by increased personnel
costs.
Selling, general and administrative expense increased from $15.7 million
for 1995 to $24.6 million for 1996. Selling, general and administrative expense
as a percentage of net sales decreased from 13.4% for 1995 to 12.9% for 1996 due
to increased net sales over these periods. The increase in absolute dollars for
1996 was primarily attributable to (i) the effect of the Company's 1995
acquisitions of Helios, ART and Tahoe and the inclusion of their selling,
general and administrative expenses for the entire 1996 period and the Company's
acquisition of ABI and the inclusion of its selling, general and administrative
expense from the date of its acquisition in January 1996; (ii) the payment of
$1.5 million in special, one-time bonuses to certain senior
41
<PAGE> 50
executive officers of the Company in December 1996 and (iii) higher earnout
costs of $3.8 million incurred for 1996 compared to $1.4 million for 1995.
Amortization and Write-Downs of Intangibles
Amortization and write-downs of intangibles primarily consist of the
amortization of intangible assets, including intangible assets acquired in
connection with the acquisitions of ProQuip, Cambrian, Helios, ART and ABI
(principally purchased technology and covenants not to compete) and write-downs
related to the impairment of such assets. See Notes 1 and 3 of Notes to
Consolidated Financial Statements.
Amortization of intangible assets decreased from $3.4 million for the first
quarter of 1997 to $1.6 million for the first quarter of 1998. This decrease was
due to more intangible assets becoming fully amortized prior to or during the
first quarter of 1998.
Amortization and write-downs of intangibles decreased from $28.7 million
for 1996 to $14.6 million for 1997. This decrease was the result of write-downs
to fair value in 1996 related to impairment of certain intangible assets
recorded in connection with the Company's acquisitions of ART and Cambrian,
partially offset by write-downs to fair value in 1997, related to impairment of
certain intangible assets recorded in connection with the Company's acquisition
of ABI. Such impairments were generally the result of post-acquisition
technological changes that were developed independent of purchased technologies
causing a decline in the carrying values of such purchased technologies.
Amortization and write-downs of intangibles increased from $13.1 million
for 1995 to $28.7 million for 1996, reflecting the result of (i) a full year of
1996 amortization expense related to intangible assets recorded in connection
with the Company's June and July 1995 acquisitions of Helios, ART and a portion
of the business of Tahoe, (ii) 1996 amortization expense related to intangible
assets recorded in connection with the Company's January 1996 acquisition of ABI
and (iii) write-downs to fair value related to impairment of certain intangible
assets recorded in connection with the Company's acquisitions of ART and
Cambrian. Such impairment was generally the result of post-acquisition
technological changes that were developed independent of purchased technologies
causing a decline in the carrying values of such purchased technologies.
Purchased In-Process Research and Development
In connection with certain of the Company's acquisitions in 1996, the
Company acquired research and development projects that had not reached
technical feasibility and had no probable alternative future uses. The amount
allocated to purchased in-process research and development for the acquisition
of ABI was based on an independent third party valuation and was expensed as of
the date of the acquisition. Purchased in-process research and development
expense related to the Company's acquisition of ABI was $11.0 million for 1996.
Purchased in-process research and development expense relating, in substantial
part, to the Company's acquisition of ABI, SBM and a portion of the business of
Kirell was $13.9 million for all of 1996. In 1996 and 1997, the Company incurred
costs of approximately $1.9 million and $1.5 million, respectively, in
connection with development of crash tolerant spindle technology which comprised
the purchased in-process research and development project acquired in the ABI
acquisition. In 1997, the Company incurred costs of approximately $1.6 million
and $1.0 million, respectively, in connection with development of spinstand and
laser texturizer technology which comprised the purchased in-process research
and development projects acquired in the SBM and Kirell acquisitions. The
in-process research and development projects acquired in connection with the ABI
and Kirell acquisitions were completed successfully in 1997 with the Company's
introduction of products for sale. The in-process research and development
project acquired in connection with the SBM acquisition remains in development
The Company estimates that in 1998, it will incur costs of approximately $1.0
million in connection with development of SBM in-process technology prior to the
expected introduction and initiation of sales of the related product in 1998.
Interest Expense
Interest expense increased from $2.6 million for the first quarter of 1997
to $3.4 million for the first quarter of 1998, from $5.6 million for 1995 to
$8.4 million for 1996 and to $11.6 million for 1997. These
42
<PAGE> 51
increases primarily reflect higher interest rates as well as the increased debt
levels outstanding during the respective periods.
Income Taxes
Income tax expense (benefit) was $0.3 million for the first quarter of 1997
and ($2.7) million for the first quarter of 1998 equating to effective income
tax (benefit) rates of 30.0% and (44.0%), respectively, for such periods. Income
tax expense (benefit) was $1.5 million for 1995, $(9.0) million for 1996 and
$(4.3) million for 1997, equating to effective income tax (benefit) rates of
24.6%, (45.2%) and (43.5%), respectively, for such periods. For these periods,
the effective income tax rates differed from the applicable statutory rates due
primarily to utilization of income tax credits available for research and
development expenses and, for 1995 and 1996, to foreign sales.
Extraordinary Items
Extraordinary loss, net of income taxes, was $0.9 million for the first
quarter of 1998, and consisted of the write-off of unamortized debt issuance
costs in connection with the January 30, 1998 repayment of debt outstanding
under the Company's then-existing credit agreement.
Extraordinary loss, net of income taxes, was $1.1 million for 1996, and
consisted of the write-off of unamortized debt issuance costs in connection with
the refinancing of the Company's then-existing credit agreements in January and
December 1996, respectively.
Cash Flow from Operating Activities
Cash flow from operating activities is computed based on net income (loss)
plus depreciation, amortization and write-downs of intangibles assets, certain
other non-cash charges, purchased in-process research and development costs and
changes in certain assets and liabilities.
Cash used for operating activities increased from $0.4 million in the first
quarter of 1997 to $4.7 million in the first quarter of 1998 due to the first
quarter 1998 net loss, a decrease in amortization of intangible assets and an
increase in prepaid expenses, offset by the extraordinary loss, net of income
taxes, a decrease in inventories, an increase in accounts payable and a smaller
decrease period over period of income taxes receivable.
Cash used for operating activities decreased from $21.4 million in 1996 to
$6.4 million in 1997 due to a smaller net loss, smaller increases year over year
in deferred income taxes, inventories and income taxes receivable and a decrease
in prepaid expenses and other assets, offset by decreases in depreciation,
amortization and writedown of intangible assets, purchased in-process research
and development, an increase in accounts receivable and larger decreases year
over year in accounts payable and customer deposits, accrued expenses and other
liabilities.
Cash provided by (used for) operating activities decreased from $18.3
million provided in 1995 to $21.4 million used in 1996 due to the 1996 net loss,
decreases in accounts payable and customer deposits, accrued expenses and other
liabilities, an increase in income tax receivable, as well as larger increases
year over year in deferred income taxes, prepaid expenses and other assets,
offset by increases in depreciation, amortization and writedown of intangible
assets and purchased in-process research and development and a decrease in
accounts receivable.
EBITDA
EBITDA represents income (loss) from operations before depreciation and
amortization and write downs of intangibles. EBITDA is presented because
management believes EBITDA is a commonly accepted financial indicator used by
certain investors and analysts to analyze and compare companies on the basis of
operating performance. EBITDA is not intended to represent cash flows for the
period, nor has it been presented as an alternative to operating income (loss)
as an indicator of operating performance and should not be considered in
isolation or as a substitute for measures of performance prepared in accordance
with generally accepted accounting principles.
43
<PAGE> 52
EBITDA decreased from $8.7 million for the three months ended March 31,
1997 to $1.1 million for the three months ended March 31, 1998. This decrease
was primarily due to a decrease in net sales and gross profit margins, partially
offset by decreases in research and development and selling, general and
administrative expenses.
EBITDA increased from $21.5 million for 1996 to $24.1 million for 1997.
This increase resulted primarily from decreases in selling, general and
administrative expenses and purchased in-process research and development
partially offset by decreases in gross profit and increases in research and
development.
EBITDA decreased from $27.9 million for 1995 to $21.5 million for 1996.
This decrease was due to increases in research and development expenses,
selling, general and administrative expense and purchased in-process research
and development expenses, partially offset by increased gross profit.
LIQUIDITY AND CAPITAL RESOURCES
Since the Recapitalization in November 1994, the Company has financed its
capital requirements through (i) sales of common and preferred stock, (ii) term
and revolving debt under certain credit facilities and (iii) cash generated by
operations in 1995.
Following this Exchange Offer, the Company's principal sources of liquidity
will be cash flow from operations and borrowing availability under the New
Credit Facility. The Company's principal requirements for cash will be debt
service requirements, capital expenditures and working capital.
The New Credit Facility provides the Company with up to $25.0 million of
revolving credit, subject to certain conditions, which limit could be increased
to $40.0 million at the sole discretion of the Lenders. Borrowing availability
under the New Credit Facility is based on a borrowing base test that includes
75% of the Company's eligible receivables. If the Company meets certain
financial tests, the borrowing base test will be increased to 80% of the
Company's eligible receivables and will be expanded to include 25% of the
Company's eligible inventory (subject to a cap of $10.0 million). At March 31,
1998, the Company had approximately $16.7 million of borrowing availability less
$8.3 million of outstanding borrowings under the New Credit Facility.
Indebtedness under the New Credit Facility matures in January 2001. The Initial
Draw under the New Credit Facility was approximately $1.6 million. Borrowings
under the New Credit Facility bear interest, at the Company's option, based on
LIBOR (as defined herein) plus 3.0% or a base rate (based on the prime rate)
plus 1.0%. The Company's obligations under the New Credit Facility are secured
by substantially all of the Company's current and future assets (other than the
real estate owned by the Company in San Diego, California on which its
headquarters is located), including a pledge of the capital stock of all of its
subsidiaries, subject to certain limitations with respect to foreign
subsidiaries. In addition, the Subsidiary Guarantors have guaranteed on a
secured basis the obligations of the Company under the New Credit Facility.
Accordingly, all borrowings under the New Credit Facility and the guarantees of
the Subsidiary Guarantors in favor of the Lenders effectively rank senior to
indebtedness under the New Notes, to the extent of the assets securing such
obligations. The New Credit Facility contains financial covenants relating to
minimum interest coverage, minimum net worth, minimum cash flow and maximum
leverage. In 1998 and through the facility maturity date in January 2001, the
Company is required to generate minimum EBITDA, as defined, per quarter ranging
from $1.0 million to $5.0 million, as well as rolling annual minimum EBITDA,
computed quarterly, ranging from $10.0 million to $30.0 million. Commencing in
March 1999 and through the facility maturity date in January 2001, the Company
is subject to minimum interest coverage ratios ranging from 1.5:1 to 2.5:1,
minimum net worth to be determined based on 1998 operating results, and maximum
leverage ratios ranging from 5:1 to 3.5:1. The New Credit Facility also includes
substantial restrictions on the Company's ability to incur additional
indebtedness. See "The Refinancing" and "Description of Indebtedness -- New
Credit Facility."
Based on the Company's currently anticipated operating results for the
quarter ending June 30, 1998, the Company believes that it will not be in
compliance with the financial covenants under the New Credit Facility. In such
event, the Company will be required to seek a waiver from or renegotiate the
existing covenants, or potentially seek alternative financing. Based on
preliminary discussion with the agent to the Lenders, the Company believes that,
in the event of non-compliance, it will be able to obtain a waiver of such
non-compliance and renegotiate the existing covenants. The agent to the Lenders
has informed the Company that the receipt of a waiver from the Lenders and the
successful renegotiation of the existing covenants is subject, among other
things, to the Lenders' receipt and approval of the Company's revised financial
plan. Accordingly, no assurance can be given that the
44
<PAGE> 53
Company will be successful in obtaining a waiver or renegotiating its existing
covenants. If the Company becomes in breach of any covenants, restrictions or
other obligations under the New Credit Facility in the future, the Lenders under
the New Credit Facility could declare all amounts outstanding thereunder to be
immediately due and payable, together with accrued and unpaid interest, and
terminate their commitment to make further advances thereunder.
As of March 31, 1998, the Company's outstanding indebtedness included
$105.7 million under the New Notes, $8.3 million under the New Credit Facility,
$8.0 million under its Convertible Subordinated Notes and approximately $2.9
million of capital lease obligations. The New Notes, which bear interest at
10.75%, and the related Indenture do not contain ongoing quarterly or annual
financial covenant requirements but do contain customary covenants restricting
the Company's ability to, among other things, incur additional indebtedness,
create liens or other encumbrances, pay dividends or make other restricted
payments, make investments, loans and guarantees or sell or otherwise dispose of
a substantial portion of assets to, or merge or consolidate with, another
entity. At March 31, 1998, the Company had $6.3 million of accrued interest on
indebtedness outstanding on the Convertible Subordinated Notes. The Convertible
Subordinated Notes (including all accrued interest thereon) are convertible into
5,142,720 shares of Common Stock at the option of the holders thereof and will
automatically convert upon the consummation of an initial public offering of the
Company's Common Stock. See "Description of New Notes" and "Description of
Indebtedness -- Convertible Subordinated Notes."
Cash used for investing activities was $3.0 million in the first quarter of
1997 and $0.8 million in the first quarter of 1998, and consisted of cash used
in connection with purchases of property and equipment. Cash provided by
financing activities was $3.5 million in the first quarter of 1997 and $3.3
million in the first quarter of 1998, and consisted primarily of the net
proceeds from the New Notes and New Credit Facility, net of repayment of
borrowings under the Company's previous term notes and revolving loans. Cash
used for investing activities was $45.3 million in 1996 and consisted of cash
used in connection with the acquisitions of ABI, SBM and a portion of the
business of Kirell as well as investments in property and equipment. Cash used
for investing activities was $17.2 million in 1997 and consisted of purchases of
property and equipment. Cash provided by financing activities was $64.4 million
in 1996 and consisted of the net proceeds from the Company's January 1996 and
December 1996 refinancings of its then-existing credit facilities, as well as
the sale-lease back of the Company's information and telecommunications systems.
Cash provided by financing activities was $23.9 million in 1997 and consisted of
the net proceeds from the Company's existing revolving credit facility.
The Company plans approximately $5.0 million in capital expenditures during
the next twelve months. The Company has no material outstanding commitments with
respect to such planned expenditures.
In connection with the Reimbursement Agreement discussed in "Results of
Operations -- Gross Profit," the Company has secured a $3.7 million standby
letter of credit from a bank in favor of a customer. The standby letter of
credit balance will be reduced ratably as products are completed and become
available for shipment to the customer. The Company's borrowing availability
under its Credit Facility is reduced by the outstanding standby letter of credit
balance.
The Company's foreign subsidiaries, who represent the Non-Guarantor
Subsidiaries, have not guaranteed the Company's obligations under the Notes and
will not guarantee the Company's obligations under the New Notes. As of and for
the year ended December 31, 1997, and the three-month period ended March 31,
1998, the operating results and assets of the Non-Guarantor Subsidiaries,
individually and in the aggregate, were not material to the results of
operations and assets of the Company on a consolidated basis, net of
intercompany eliminations. See Note 12 of Notes to Consolidated Financial
Statements. The total assets, total liabilities, net sales and net income (loss)
of the Non-Guarantor Subsidiaries as a percentage of the Company's consolidated
total assets, total liabilities, net sales and net income (loss) as of and for
the year ended December 31, 1997 were 3.1%, 0.4%, 1.6% and 10.1%, respectively,
and as of and for the three-month period ended March 31, 1998, were 3.5%, 0.6%,
5.5% and 1.1%, respectively. The financial statements of the Company's foreign
subsidiaries are measured using the local currency as the functional currency.
The Company has not historically experienced material gains or losses resulting
from currency fluctuations.
45
<PAGE> 54
Based on currently available information, the Company believes that its
available cash, cash generated from operations and borrowings available,
including under the New Credit Facility, will be adequate to fund its operations
for the foreseeable future, and for no less than the next 12 months. While
operating activities may provide cash in certain periods, the Company's
operations may require additional sources of financing. The Company may also
from time to time consider additional acquisitions of complementary businesses,
products or technologies, which may require additional financing. Additional
sources of funding could include additional debt and/or equity financings. Upon
completion of this Exchange Offer, the Company will continue to have limited
capital resources and significant future obligations and expects that it will
require additional capital to support future growth, if any. The existence of
certain restrictive covenants in the New Credit Facility and the Indenture for
the New Notes may inhibit the Company's ability to raise additional financing.
There can be no assurance that the Company will be able to obtain alternative
sources of financing on favorable terms, if at all, at such time or times as the
Company may require such capital. See "Risk Factors -- Substantial Leverage;
Ability to Service Indebtedness."
46
<PAGE> 55
BUSINESS
The Company is the world's leading supplier of technologically advanced
process and production-test equipment for the data storage industry. The
Company's systems are used primarily by manufacturers of disk drives and disk
drive components (disks and read/write heads) at critical stages of their
production processes. The Company's systems, substantially all of which
incorporate significant amounts of proprietary technology and are software
intensive, include (i) media certifiers, burnishers, glide height testers,
optical scanners and laser texturizers which are used in the production of
thin-film disks (media), (ii) servowriters and electronic testers used in the
production of disk drives and high capacity disk cartridges, (iii) flying height
testers and quasi-static magnetoresistive ("MR") head testers used in the
production of read/write heads and (iv) integrated automation systems for the
disk drive, disk and read/write head test and manufacturing processes. The
Company's production-test systems (e.g., media certifiers, glide testers, flying
height testers and quasi-static MR head testers) are designed to provide in-line
testing, measurement and analysis throughout the manufacturing process, enabling
manufacturers to detect defects, sort products by performance grade and make
real-time process improvement decisions that can significantly impact product
yields, time-to-market, profitability and return on investment. The Company's
process systems (e.g., servowriters, disk burnishers and disk laser texturizers)
perform precise manufacturing process functions. Phase Metrics' customers
include substantially all of the world's leading data storage companies.
INDUSTRY BACKGROUND
The increasing demand for process and production-test equipment for the
data storage industry is driven by three primary factors: (i) the overall demand
for disk drives and disk drive components; (ii) rapid advances in data storage
technology and (iii) yield management challenges and margin pressure facing data
storage manufacturers.
Demand for Disk Drives and Disk Drive Components
Demand for PCs and workstations and the growing use of network servers is
stimulating strong demand for disk drives and disk drive components. According
to International Data Corporation ("IDC"), combined world-wide shipments of PCs,
workstations and servers are expected to reach approximately 91 million units in
1998, growing to approximately 116 million units by 2000. Moreover, unit growth
rates for disk drives and disk drive components are expected to exceed unit
growth rates for PCs, workstations and servers, due to a variety of factors,
including the rapidly increasing demand for high performance replacement disk
drives and high-capacity, removable-disk storage devices.
Increasing demand for greater data storage capacity is further stimulating
unit sales growth in disk drives and disk drive components. Factors contributing
to this increasing demand for greater storage capacity include:
- The development of more storage intensive operating systems and larger
software "suites"
- The continuing migration to networked architectures with greater storage
requirements
- Demand for more storage intensive software applications such as data
warehousing, digital image storing, enhanced graphics, multimedia and
video on demand
- Rapidly increasing Internet usage, including the ready availability of
data-intensive files which can be downloaded to a user's disk drive
Stimulated by these underlying market drivers, unit shipments of disk
drives and disk drive components have been growing rapidly over the past ten
years. According to IDC, world-wide shipments of hard disk drives are expected
to reach approximately 150 million units in 1998, growing to approximately 209
million units by 2000. In addition, according to DISK/TREND, Inc., world-wide
shipments of high-capacity, removable-disk drives are expected to reach
approximately 18 million units in 1998, growing to approximately 32 million
units by 2000. Strong world-wide demand for disk drives has resulted in a
growing demand for disks and read/write heads. According to TrendFOCUS, Inc.
("TrendFOCUS"), the number of disks and
47
<PAGE> 56
read/write heads produced is expected to reach approximately 449 million and 868
million units, respectively, in 1998, growing to approximately 602 million and
1,204 million units, respectively, in 2000. The increasing demand for disk
drives, disks and read/write heads requires manufacturers to expand their
production capacity. Based on industry data, the Company believes that major
disk drive and disk drive component manufacturers spent approximately $2.2
billion in 1997 on expanding their facilities and purchasing capital equipment
to increase production capacity.
Disk Drive Technology
The principal components of a hard disk drive are disks (media), read/write
heads, spindle, actuator mechanics and electronics. Today, each disk drive
typically contains from one to ten disks that are attached to a spindle/motor
assembly. The read/write head is a small magnetic transducer that, when the disk
is spinning, "flies" just above the disk surface. Data are written on data
storing tracks on the disk when the disk drive's electronics send current pulses
to the head. These pulses cause the magnetic layer within the disk and under the
recording head to become magnetized, resulting in the storage of data on the
disk. During the read-back process, as the read/write head scans over the disk,
magnetic flux from the disk is picked up by the head and induces an electrical
current which is converted into voltage. The voltage is then transformed into
digital data by the disk drive's electronics. Recently introduced,
high-capacity, removable-disk storage devices operate under substantially the
same principals with the added benefit of disk removability and portability. The
following diagram illustrates the principal components of a disk drive:
Disk Drive Diagram
Technological Change
The performance characteristics of disk drives are continually advancing
which in turn are requiring concurrent advancements in process and
production-test equipment technology. The critical performance characteristics
of a disk drive are: (i) capacity -- the amount of data stored, measured in
megabytes or gigabytes; (ii) transfer rate -- the speed with which data can be
transferred between the disk drive and computer, measured in megabits per second
and (iii) access speed -- the time it takes to locate data on the disk, measured
in milliseconds. Demand for greater storage capacity, faster transfer rates and
faster access speeds, all within the same or smaller form factors, has resulted
in rapid and constant advances in disk drive technology. In general, disk drive
capacity can be improved by increasing the areal density of data on a disk.
According to the International Disk Drive Equipment and Materials Association
("IDEMA"), areal density has been growing at an average compound rate of
approximately 60% per year since 1991. Areal density is the amount of data
(bits) that can be stored in a square inch on the disk and is determined by
multiplying track density (tracks per inch) by average bit density on each inch
of track (bits per inch). Therefore, the capacity of a disk drive can be
increased by increasing the number of tracks on the disk and/or increasing the
number
48
<PAGE> 57
of bits of data in an inch of track. Lower head flying heights over the disk
surface area are necessary to achieve the small bit sizes required by increasing
areal density. The lower the head flies above the disk surface, the more
accurately the head can read the magnetic signal, allowing a smaller magnetized
region on the track to store each bit of data. Accordingly, the flying height of
read/write heads on very high areal density capacity disk drives has been
reduced to less than one microinch in some cases. In addition to increasing the
capacity of a disk by increasing areal density, the transfer rate and access
time performance characteristics of a disk drive can be improved by rotating the
disk at a faster rate. In disk drives today, the spindle/motor assembly rotates
the disk at 4,500 to 10,000 revolutions per minute, compared to 3,600 to 7,200
revolutions per minute less than three years ago.
Although increases in areal density and improved disk drive performance
characteristics have resulted in significant advancements for disk drives,
demand for even greater performance enhancements is continually stimulating
development and introduction of entirely new disk drive technologies. This is
evidenced by the recent introduction of MR heads. MR heads are significantly
more sensitive than inductive heads in reading data from disks with higher areal
densities. As a result, disk drive, disk and read/write head manufacturers are
rapidly transitioning to MR technologies. According to TrendFOCUS, MR heads
represented only 12% of the overall head market in 1995, but are expected to
grow to approximately 55% of the overall head market in 1997 and over 90% by
1999.
While technological advancements are enabling manufacturers to produce
significantly higher capacity disk drives with greater transfer rates and faster
access times, they are also presenting significant technological challenges and
increasing the complexity of manufacturing processes. For example, the ability
of disk manufacturers to produce disks capable of higher areal densities is
directly related to manufacturers' ability to control critical disk attributes
such as (i) increasing the magnetic strength or "coercivity" of a disk by
providing higher quality magnetic domains and thereby reducing the potential for
"noise"; (ii) limiting surface imperfections to reduce the amount of unusable
space on a disk and (iii) controlling smoothness and flatness to allow for lower
head flying heights without head/disk contact. In addition, even though smaller
read/write heads facilitate increasing areal densities, they are more easily
damaged and are more difficult to manufacture. MR heads in particular are
difficult to manufacture because of their small size and the presence of the
delicate MR element which is highly sensitive to electro-static discharge.
Faster access speeds and greater transfer rates require both advanced channel
technology to improve data communications and increasing disk rotation speeds.
As a result of these complexities, disk drive and disk drive component
manufacturers are installing increasingly sophisticated manufacturing processes.
The growing complexity of disk drive manufacturing is in turn increasing test
and production times per product and creating pressure on manufacturing costs.
These trends have resulted in greater demand for sophisticated process and
production-test equipment.
Yield Management
As data storage technology advances and manufacturing processes become more
complex, maximizing yield is increasingly critical to the data storage industry.
The ability to rapidly achieve and maintain high product yield is one of the
most important determinants of profitability in this highly competitive
industry. However, as disk drives and disk drive components are designed within
more precise tolerances, product yield becomes more sensitive to increasingly
smaller irregularities in the manufacturing process. Manufacturers must
therefore rely on yield management and process monitoring equipment to improve
their product yields and remain competitive. Process and production-test
equipment enables manufacturers to increase yield more quickly when a product is
new and improve a product's time to volume. In addition, early detection of
defects in the manufacturing process with the use of production-test equipment
allows manufacturers to improve yield through the availability of test data and
on-line analysis capabilities that enable real-time process improvements.
Moreover, production processes in the data storage industry involve numerous
sequential costly process steps. Production-test equipment enables manufacturers
to identify non-conforming products early in the manufacturing process, thus
avoiding additional costly manufacturing steps and/or the addition of expensive
componentry which is later scrapped. These pressures have also resulted in
increased demand for process and production-test equipment.
49
<PAGE> 58
Market for Process and Production-Test Equipment
Major manufacturers of disk drives and disk drive components require a
variety of high precision process and production-test equipment. These
technologically advanced products combine significant amounts of software with
high precision electro-mechanical componentry to provide real-time, high
throughput processing and production management capabilities. Process equipment
is used by manufacturers to perform manufacturing processes within increasingly
precise tolerances enabling the production of higher performance data storage
devices. Such process equipment includes servowriters for writing servo tracks
on nearly completed disk drives, burnishers for removing bumps from the surface
of a disk and laser texturizers for providing required bumps on a portion of a
disk's surface to prevent "stiction," namely the head sticking to the surface of
a disk. Production-test equipment is used by manufacturers to perform precise
inline testing, measurement and analysis throughout the manufacturing process
enabling manufacturers to detect defects and make real-time production
improvement decisions that can significantly impact customers' product yield and
profitability. Production-test equipment is also used in research and
development laboratories. Production-test equipment includes media certifiers to
verify the magnetic integrity of a disk and an optical media scanner to verify
the physical integrity of the disk surface, flying height testers to determine
the height a head flies above a disk and quasi-static MR head testers to measure
MR head characteristics.
The process and production-test equipment market for the data storage
industry is served by both merchant suppliers as well as the "captive" or
internal departments of data storage companies that develop and manufacture
process and production-test equipment for their own use. Historically, disk
drive and disk drive component manufacturers developed much of their own process
and production-test equipment internally and purchased a lesser amount of such
equipment from merchant suppliers. As the production process becomes more
complex and production capacity becomes more expensive to build and maintain,
however, data storage manufacturers are focusing more on their own core
competencies -- product design and production -- to remain competitive. This in
turn has caused increasing reliance on merchant suppliers of process and
production-test equipment. The enabling tools developed by such merchant
suppliers allow disk drive and disk drive component manufacturers to incorporate
more advanced production techniques into their manufacturing processes and more
accurately measure the conformity of component parts of the disk drive to their
specifications. The growing demand for digital data storage capacity and the
increasing complexity of data storage technology and related manufacturing
challenges have caused demand for process and production-test equipment to grow
rapidly in recent years. According to Peripheral Research Corporation, merchant
suppliers are expected to sell approximately $468 million of process and
production-test equipment to the data storage industry in 1998, growing to
approximately $549 million in 1999.
The process and production-test equipment industry was characterized by a
relatively fragmented group of specialized independent equipment suppliers.
These suppliers often had limited technological competence and narrow product
offerings. In addition, most of these specialized suppliers lacked the critical
mass to support extensive research and development programs and world-wide
customer service and support. As data storage manufacturers focus more on their
own core competencies in an increasingly global marketplace they are
increasingly seeking process and production-test capital equipment suppliers
that can play a strategic role in their ongoing product development and
manufacturing processes and at the same time provide world-wide service and
support.
COMPETITIVE STRENGTHS
The Company believes that it possesses key competitive strengths that have
enabled it to become the leading supplier of technologically advanced process
and production-test equipment for the data storage industry. These competitive
strengths include:
Broad Product Line and Extensive Technology Base. The Company believes that
it is a technological leader in designing, manufacturing and servicing process
and production-test systems that perform critical applications throughout the
disk drive and disk drive component production processes. These systems contain
a significant amount of proprietary software, sophisticated electronics, and
high precision mechanics. As evidence of its technological leadership, the
Company believes it was the first to market with systems
50
<PAGE> 59
incorporating numerous important new technologies, including (i) in 1993, the
first testing system capable of accurately measuring the flying height of a
read/write head below one microinch; (ii) in 1995, the first disk (media)
certifier with integrated optical defect scanning and also the first certifier
with digital glide certification; (iii) in 1996, the first family of MR head
testers to address each stage of the manufacturing process for the rapidly
growing MR head market and (iv) in 1997, the first disk drive servowriter to
incorporate non-contact, laser positioning technology. The Company currently
holds 27 patents in the United States, with an additional 72 patent applications
pending in the United States. The Company also holds a number of foreign patents
and has filed a number of foreign patent applications.
Largest World-Wide Installed Base of Systems. Based in part on published
industry data, the Company believes it has the largest world-wide installed base
of process and production-test systems serving the data storage industry. The
Company is able to leverage this installed base by selling these customers
additional systems, as well as upgrades to existing systems to address rapidly
changing industry requirements. The Company believes that such upgrades are
becoming an increasingly important source of revenue for the Company.
Focused Research and Development. In response to rapidly changing
technical requirements in the data storage industry and to maintain its
technological leadership, the Company is continually engaged in efforts to
improve its systems and introduce innovative products and technologies. With
approximately 200 engineers focused on research and development, the Company
believes that it maintains the largest engineering group in the world focusing
on technological solutions for data storage manufacturers. Moreover, in 1996,
the Company formed an advanced research department focused exclusively on
developing and procuring critical technologies for next-generation systems. In
1997, the Company invested approximately $43.6 million in its research and
development efforts and expects to continue to devote significant resources
toward maintaining its technological leadership.
Extensive Global Infrastructure. In addition to its extensive sales and
customer service and support infrastructure in the United States, since the
beginning of 1996 the Company has established sales and customer service and
support offices in Japan, South Korea, Singapore, Thailand and Taiwan. The
Company believes that substantial growth opportunities exist for sales of its
systems to domestic and foreign-based customers for use in their manufacturing
facilities located in Southeast Asia. Therefore, the Company currently has 40
dedicated customer service and support engineers and technicians in Southeast
Asia, which the Company believes is the largest foreign-based group of customer
service and support personnel of any domestic supplier of process and
production-test equipment to the data storage industry.
Experienced Management Team With Significant Ownership. The Company's
Chairman and Chief Executive Officer, John F. Schaefer, and its Vice President,
Finance and Chief Financial Officer, R. Joseph Saunders, joined the Company in
November 1994. Working with Arthur J. Cormier, the founder and previous
President of the Company, the Company assembled a group of experienced officers,
middle managers and senior technologists. Mr. Cormier is currently serving as a
director of and consultant to the Company. This senior management team has grown
the Company's sales, both internally and through acquisitions, from
approximately $20.1 million in 1994 to approximately $184.7 million for 1997.
The Company's directors and officers and their respective affiliates
beneficially own approximately 86.6% of the Company's capital stock as of
February 28, 1998.
Demonstrated Ability to Integrate Acquisitions. In order to expand its
operations and capitalize on the growing demand for process and production-test
equipment for the data storage industry, since November 1994, the Company's
management team has acquired seven specialized suppliers of process and
production-test systems or technologies. The Company believes that it has
successfully integrated each of these acquisitions into its operations.
51
<PAGE> 60
GROWTH STRATEGY
The Company believes that it is well-positioned to grow future revenue and
cash flow. The key elements of the Company's growth strategy are as follows:
Maintain Leadership in Core Technologies. The Company intends to remain a
technological leader in its markets by continuing to work with customers,
academic institutions and independent third parties to identify emerging data
storage technology trends early in the development process and contribute to the
development of standards related to process and production-test for the data
storage industry. Because the Company's systems are integral to its customers'
manufacturing processes, the Company believes that it is well-positioned to
utilize its research and development resources to partner with its customers in
the development of next-generation products.
Leverage Installed Base of Systems. The Company intends to leverage its
installed base of systems by selling new systems to existing customers and by
continuing to develop and aggressively market system upgrade solutions in
response to rapidly changing industry requirements. In addition, because data
storage manufacturers are required to focus increasingly on their own core
competencies, the Company believes that there is a significant opportunity to
increase its sales by supplying certain process and production-test equipment to
data storage manufacturers that currently develop such systems internally.
Leverage and Expand Global Infrastructure. Due to its extensive global
service and support infrastructure, the Company believes it is well-positioned
to increase productivity and profitability. In particular, the Company believes
that it will be able to leverage the significant investment it has made in
establishing a sales and customer service and support infrastructure in
Southeast Asia to capitalize on the increasing activity in the data storage
industry in that region. As data storage manufacturers require equipment
suppliers to support their increasingly global operations, the Company intends
to continue to expand its world-wide service and support network.
Pursue Complementary Acquisitions. As with many other industries, data
storage manufacturers are increasingly attempting to rationalize their vendor
bases. As a result, there has been an increasing trend toward consolidation of
data storage equipment suppliers. The Company intends to continue to capitalize
on this trend by completing complementary acquisitions of additional product
lines, technologies and related businesses. The Company believes that its market
leadership position and demonstrated ability to successfully integrate strategic
acquisitions will continue to attract additional strategic opportunities.
PRODUCTS
The Company's process and production-test products are an integral part of
the process of manufacturing disk drives, disks and read/write heads. The
Company's products address the increasingly complex disk drive and disk drive
component production processes and the constant pressure to improve
manufacturing yields. The Company's products combine substantial proprietary
technology, including extensive software, custom electronic componentry,
micro-positioning systems, high-performance air bearing spindles, optical
detectors, and various other internally designed probes required for detection
and measurement, together with commercially available components such as high
performance lasers, DC motors and optical encoders. The proprietary software
incorporated into each of the Company's products enable real-time process and
production-test capabilities without off-line processing. The Company believes
that its proprietary software offers a competitive advantage due to its powerful
signal processing and analysis capabilities, flexible user-interface, and
adaptability to specific customer applications.
The Company's products are categorized into four principal areas: (i) disk
(media) process and production-test equipment; (ii) read/write head
production-test equipment; (iii) disk drive process and production-test
equipment and (iv) production automation equipment. The Company's products are
predominantly used in an in-line production mode by the Company's customers. As
such, the customers integrate the Company's products into their processes, using
multiple variations of test protocols available on the systems. The Company's
software facilitates this adaptation process and, accordingly, substantially all
of the Company's products are semi-customized to satisfy each customer's unique
product specifications and test
52
<PAGE> 61
requirements. The Company anticipates more extensive customization of its
products in the future due to the increasing complexity of the technology and
production processes for data storage devices. Therefore, the Company
continually endeavors to enhance its products with new features and
functionality. The Company has demonstrated the ability to provide required
customizations and product upgrades in response to changes in data storage
technology. With its substantial product development and research capability and
commitment to maintaining close relationships with its customers, the Company
believes it is well positioned to continue to provide cost-effective solutions
to the rapidly changing data storage industry.
The following tables include the Company's principal current products and
products expected to be introduced during the first nine months of 1998.
DISK (MEDIA) PROCESS AND PRODUCTION-TEST EQUIPMENT
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
PRODUCT INTRODUCTION DATE APPLICATIONS
---------------------------- ---------------------- -------------------------------------------------
<S> <C> <C> <C> <C>
MEDIA CERTIFIERS
- ---------------------------------------------------------------------------------------------------------------
MG250 February 1995 Burnishing (removes bumps and particles from the
MC950 June 1997 surface
MG250APS January 1996 of a finished disk)
MG250EPS January 1998
MC950EPS Second Quarter of 1998 Optical Scanning ("EPS" Option optically scans
MSA950 Second Quarter of 1998 the
surface of a finished disk for defects that could
damage the
glide head)
Glide Certification (verifies that the surface of
a finished
disk does not have protrusions in excess of
certain specified
limits)
Media Certification (verifies that data can be
written and
read from a finished disk within certain
specifications)
OPTICAL INSPECTION SYSTEMS
- ---------------------------------------------------------------------------------------------------------------
PS5000 September 1997 Optical Scanning (scans for defects on disk
substrates and/or finished disks)
LASER TEXTURIZER
- ---------------------------------------------------------------------------------------------------------------
LT1000 April 1997 Laser Texturizing (creates precise surface bumps
on disks for head landing zones)
MEDIA BALANCE TESTER
- ---------------------------------------------------------------------------------------------------------------
MB1000 November 1996 Media Balancing (verifies that disk substrates or
finished disks are in balance within required
specifications)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
53
<PAGE> 62
HEAD PRODUCTION-TEST EQUIPMENT
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
PRODUCT INTRODUCTION DATE APPLICATIONS
---------------------------- ---------------------- -------------------------------------------------
<S> <C> <C> <C> <C>
MR QUASI-STATIC HEAD
TESTERS
- ---------------------------------------------------------------------------------------------------------------
MRH(HGA-level Tester) September 1995 MR Quasi-static Testing (conducts critical tests
MRW(Wafer-level Tester) September 1996 at the wafer, bar, slider or HGA level of MR head
MRS(Slider-level Tester) June 1997 production, including resistance, amplitude,
MRB(Bar-level Tester) September 1997 asymmetry and stability tests)
HGA RESONANCE TESTER
- ---------------------------------------------------------------------------------------------------------------
HRT June 1994 Mechanical Resonance Testing (tests HGA for
mechanical resonance characteristics within
required specifications)
FLYING HEIGHT TESTERS
- ---------------------------------------------------------------------------------------------------------------
DFHT II September 1995 Flying Height Testing (measures head to disk
DFHT III January 1998 spacing ("flying height") under various dynamic
FH3000 June 1996 test conditions)
FH4000 September 1996
SPINSTAND
- ---------------------------------------------------------------------------------------------------------------
Metric 133 Third Quarter of 1998 Mechanics platform for head and disk testing
(used for multiple testing tasks, includes a
precision air bearing spindle, X, Y, and Z stages
and a micropositioner)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
DISK DRIVE PROCESS AND PRODUCTION-TEST EQUIPMENT
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
PRODUCT INTRODUCTION DATE APPLICATIONS
---------------------------- ---------------------- -------------------------------------------------
<S> <C> <C> <C> <C>
SERVOWRITERS
- ---------------------------------------------------------------------------------------------------------------
HS5100 March 1997 Servowriting Drives (establishes reference tracks
HS6100 September 1997 on hard disk drives to provide track/head
HS7000 September 1997 position information essential to operation)
Servowriting Media (establishes reference tracks
on high capacity removable storage devices
(cartridges), both floppy and hard disk, to
provide track/head position information essential
to operation)
DISK DRIVE SIMULATOR
- ---------------------------------------------------------------------------------------------------------------
Proteus July 1991 Electronic Disk Drive Simulator (tests disk drive
electronics)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
PRODUCTION AUTOMATION EQUIPMENT
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
PRODUCT INTRODUCTION DATE APPLICATIONS
---------------------------- ---------------------- -------------------------------------------------
<S> <C> <C> <C> <C>
AUTOMATION
- ---------------------------------------------------------------------------------------------------------------
Media Certifier Workcell August 1995 Production Media Handling (provides automated
Optical Inspection Workcell October 1997 handling of disks with certifiers, and sorts
disks into grades according to test results)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
Disk (Media) Process and Production-Test Equipment
The Company's disk-related test and certification products are used in-line
to test, certify and sort disks. The Company believes that its disk-related
products were used to test over half of the approximately
54
<PAGE> 63
449 million disks produced worldwide in 1997. The Company's customers also use
these products to provide quality control and to develop new products. The
Company's two media certifier product series and its optical inspection product
perform one or more of the following functions: (i) burnishing -- removing bumps
and particles from the surface of a finished disk; (ii) optical
scanning -- optically scanning the surface of a finished disk for defects that
could damage the glide head; (iii) glide certification -- verifying that the
surface of a finished disk does not have protrusions in excess of certain
specified limits; and (iv) media certification -- verifying that data can be
written and read from a finished disk within certain specifications. The
Company's disk-related automation products provide automated handling of disks
with certifiers, and sort disks into grades according to test results. The
Company's laser texturizer creates precise surface bumps on disks for head
landing zones, i.e., the area of the disk where the head rests when the disk
drive is not in operation. This process reduces the potential for stiction (head
sticking to the disk). The Company's media balance tester verifies that disk
substrates or finished disks are in balance within required specifications.
Designed to provide maximum throughput in high-volume, tightly controlled
disk manufacturing environments, the Company's disk-related products are
selected by Phase Metrics' customers to improve product yield, quality, and
production throughput. Based in part on published industry data, the Company
believes it has the largest installed base worldwide of disk production-test
equipment with approximately 4,000 stations.
MG250 and MG250EPS Media Certifiers. The MG250 product series certifies
disks to ensure that their magnetic integrity and physical properties meet the
stringent requirements of disk drive manufacturers. The single spindle,
spiral-type MG250 certifier incorporates the following functions: burnishing,
optical scanning (optional), glide testing, and certifying finished disks. The
MG250 offers an innovative MR-capable spiral certification approach, which
provides high process throughput. This MR-capable product is designed to perform
over a wide range of disk test conditions while operating at test frequencies up
to 50 MHz with low-glide technology to accommodate high areal density media. The
MG250 features a user-friendly interface, a fully programmable analog channel,
and automatic internal calibration algorithm. The MG250EPS incorporates
pre-glide optical scanning of the disk, which reduces operating costs by
increasing the useful life of the glide head used in the test process.
MC950 and MC950EPS Media Certifiers. The recently introduced MC950 product
series also certifies disks to ensure that their magnetic integrity and physical
properties meet the stringent requirements of disk drive manufacturers. The
MC950 incorporates two spindles and provides the functionality provided by the
MG250. However, the MC950 uses the classic step-and-repeat technology for media
certification favored by certain major customers, as opposed to the spiral
certification approach employed by the MG250. The MC950EPS will incorporate
pre-glide optical scanning of the disk, which will reduce operating costs by
increasing the useful life of the glide head used in the test process. The "EPS"
optical scanning option is expected to be available in the second quarter of
1998.
PS5000 Disk Inspection System. The PS5000 is an optical scanning system
that scans for defects on disk substrates and/or finished disks. The PS5000
stand-alone system is used by hard disk drive, substrate and media manufacturers
for failure analysis in both engineering and production environments. An
automated workcell configuration provides in-line inspection to allow substrate
or finished disk manufacturers to control and improve key process steps
producing up to 500 disks per hour and resulting in higher production yields,
output and product quality. The PS5000 has industry leading submicron-level
defect detection capability and features a spiral scanning technique for high
throughput.
LT1000 Laser Texturizer. The LT1000 is used to create precise surface bumps
on disks for head landing zones. The LT1000 also provides texture verification
to ensure that all disks are properly textured before moving to the next process
step.
MB1000 Media Balance Tester. The MB1000 verifies that disk substrates or
finished disks are in balance within required specifications. Increasing
rotation speeds used in high-end disk drives combined with more disks per drive
has tended to cause an increased sensitivity to media balance. The MB1000, which
incorporates an advanced air bearing spindle and a design that facilitates fast
disk loading and alignment,
55
<PAGE> 64
provides rapid pass/fail testing for adjustable balance criteria. Testing may be
performed at both substrate as well as finished disk levels.
Head Production-Test Equipment
The Company's head testing products are used by leading disk drive head
manufacturers in the development, design and testing of their products to
improve manufacturing yields, product performance and reliability. The Company
estimates, based on industry sources, approximately 870 million HGAs (head
gimbal assemblies) will be shipped in 1997, all of which required multiple tests
for critical performance characteristics. The majority of head tests are
completed "in-line," or during the head manufacturing process, and are completed
on 100% of the heads produced. The Company believes that it is well positioned
to benefit from this high growth market by providing the following head
production-test equipment: (i) flying height testers -- which measure head
flying heights under various dynamic test conditions; (ii) MR quasi-static
testers -- which conduct critical tests at the wafer, bar, slider or HGA level
of MR head production, including resistance, amplitude, asymmetry and stability
tests; (iii) spinstands for use with dynamic electrical head tester
electronics -- which verify the actual working performance capabilities of HGAs
while being tested on a real disk and (iv) HGA resonance testers -- which test
HGAs for mechanical resonance characteristics within required specifications.
The maximum possible hard disk drive storage capacity is a function of the
signal to noise ratio provided by the read/write head and media combination.
Since head output increases exponentially as a function of the spacing between
the disk and head, head to disk spacing, i.e., flying height, is the most
critical head/disk interface parameter related to higher drive capacity. Lower
flying heads provide greater areal density by permitting higher tracks per inch
(tpi) on the disk and greater bit per inch (bpi) on each track. In 1993, the
Company established market leadership in measuring flying height by providing
the first flying height tester to accurately measure below one microinch. The
Company's flying height testers have maintained their market leadership position
and become the industry standard by providing the best gauge repeatability and
accuracy available.
MR Quasi-static Head Testers. The Company's MR quasi-static head testers
include MRW (wafer-level tester), MRB (bar-level tester), MRS (slider-level
tester), and MRH (HGA-level tester). They are designed to provide fast, accurate
and repeatable testing of MR heads at multiple locations in the manufacturing
process from the wafer to HGA levels. With production yields often below 50% in
the MR head manufacturing process, the ability to test MR elements early in the
manufacturing process to identify nonconforming products can result in
significant cost savings. In product development, MR quasi-static head testers
also assist in the design improvement process.
HRT Resonance Tester. The HRT is a tester used by read/write head and
suspension manufacturers and disk drive manufacturers to check and analyze the
mechanical resonance characteristics of HGAs within required specifications. The
HRT is designed for testing resonant frequencies of the head suspension to
facilitate improved access times, and is capable of measuring mechanical
resonance in a wide range of suspension types and heads. The HRT's removable HGA
mounting blocks simplify setup and facilitate high throughput operation.
DFHT III and FH3000 Flying Height Testers. The DFHT III flying height
tester is the recognized disk drive industry standard for flying height testing
with what the Company believes is the largest installed base in the industry.
Flying height requirements continue to be reduced which requires constant
improvements in flying height measurement technology. Featuring the Company's
patented dynamic interferometry technology, the DFHT III provides accurate,
repeatable and correlatable flying height test measurements of both MR and
inductive heads below one microinch in both engineering and production
applications. The FH3000 Flying Height Tester utilizes the same detector
technology, electronics and software as the DFHT III with a high speed loading
capability, thus increasing throughput. The DFHT III product is used by
read/write head manufacturers in HGA production and product development; hard
disk drive manufacturers for research, product development and incoming quality
assurance; media manufacturers to check glide head performance and special head
manufacturers for product development and in-line testing in manufacturing.
56
<PAGE> 65
FH4000 Flying Height Tester. The FH4000 flying height tester utilizes the
same technology as the DFHT III with the addition of altitude chamber
technology, which addresses the difficult task of measuring flying height at
different atmospheric pressures to simulate altitude changes. Since altitude can
have a significant effect on flying height, this critical product provides the
Company's customers with a method of analyzing altitude effects on flying
height.
Metric 133 Spinstand. The Metric 133 Spinstand will offer the
micropositioning control and mechanics required for advanced MR and GMR
read/write head development and production testing. Micropositioning is required
for critical off-track testing as TPI (tracks per inch) continues to increase in
new disk drive designs. The Metric 133 will use an advanced micropositioner
embedded into the linear-motor X-Y stages to accurately locate the head gap to
the track position with a resolution of 0.04 microinches and a repeatability of
better than one microinch. This product is expected to be available in the third
quarter of 1998.
Disk Drive Process and Production-Test Equipment
The Company's disk drive processing equipment consists of servowriters and
an electronic disk drive simulator. All hard disk drives and high capacity
removable cartridges require servowriting, a process whereby precision
servowriting equipment establishes reference tracks on disk drives to provide
track/head position information essential to operation. Until servo tracks are
written, hard disks drives and high capacity removable cartridges are not
functional. Therefore, the servowriter is a critical in-line process tool for
completing drives and cartridges. Historically, larger disk drive manufacturers
produced their own servowriters due to the critical nature of this equipment and
the lack of adequate outside sources for servowriting systems.
As disk drive capacities continue to increase, the track density on disk
drives also continues to increase. The Company's research and development
efforts are designed to keep pace with this trend. Since servowriters represent
a sizable capital investment for disk drive manufacturers, there is significant
value placed on flexibility (ability to support multiple drive programs), and
upgradeability (ability to change the core positioning technology to keep pace
with increasing TPI requirements). The Company's family of hard disk drive
servowriters provide industry leading capabilities in both of these areas.
Servowriting is also a critical function in the manufacture of high-capacity
floppy disks and high-capacity removable storage cartridges. The Company is the
leading supplier of servowriters to manufacturers in this rapidly growing
segment of the data storage market.
HS5100 Servowriter. The HS5100 servowriter is designed for conventional
hard disk drives. The HS5100 incorporates optical encoder based positioning to
15,000 tracks per inch for higher accuracy and increased reliability. The HS5100
is fully compatible with MR technology, utilizes a small footprint, minimizing
cleanroom capital costs, and has been designed for high throughput and yield.
HS6100 Servowriter. The HS6100 servowriter is designed for high capacity,
removable-disk storage devices and single disk servowriting. The HS6100 combines
the features of the HS5100 with an advanced air bearing spindle with rotating
speeds up to 13,000 r.p.m. for high precision spinning of the disk during the
servowriting operation. The HS6100 also employs customized fixturing for
cartridges and disks to accommodate the various emerging standards in this
rapidly growing segment of the data storage market.
HS7000 Servowriter. The HS7000 servowriter is designed for conventional
hard disk drives and is suited for very high track density servowriting up to
20,000 tracks per inch and servo operating frequencies up to 100 MHz. The HS7000
utilizes advanced laser diode detection and positioning technology with optical
encoders. Incorporating recently introduced, non-contact, dual servo positioning
systems to eliminate contact with the drive arm, this product has been designed
for high throughput and product yield and, with the March 1998 introduction of
the HS7500, the option to utilize the system outside the cleanroom environment.
The HS7000 and HS7500 are fully compatible with MR head technology.
Proteus. The Proteus electronically simulates the mechanical head and disk
assembly (HDA) drive and provides completely programmable simulation of head
signals. This facilitates disk drive electronics testing and development. This
engineering development tool is used to test the servo electronics of a disk
drive to facilitate rapid development of servo patterns thereby decreasing the
time to market for new disk drive designs.
57
<PAGE> 66
Production Automation Equipment
The Company's automation workcells are sold with the disk production-test
equipment. Disk manufacturers demand automated handling of disks to meet
requirements for throughput, quality control, cleanliness, and process feedback.
The Company's workcells provide the disk manufacturers with the ability to
automatically sort product (disks) by different performance criteria for their
different customers. High throughput, flexibility, and statistical process
control features combine to provide low overall costs and high quality control.
Media Certifier Workcell. These automated disk handling systems offer
seamless workcell integration of the Company's MG250 and MC950 disk test
products. With advanced disk handling tools and process management and control
software, the Company's media test workcells have the highest manufacturing
throughput available. Although workcell output is a function of the product
being tested and the test set-up file being used, typical MC950 and MG250
workcells can test and sort between 3,500 and 5,000 disks per day.
Optical Inspection Workcell. The Optical Inspection Workcell incorporates
most of the certifier workcell technology, but involves different mechanical
interfaces (end effectors) and software to facilitate optical testing versus
certification. Throughput levels of up to 500 disks per hour are achievable.
CUSTOMERS, MARKETING AND SALES
The Company sells its products to virtually every major disk drive, disk
and read/write head manufacturer in the world. The following table sets forth
certain of the Company's customers during the past two years:
<TABLE>
<CAPTION>
DISK DRIVE SYSTEMS DISK SYSTEMS READ/WRITE HEAD SYSTEMS AUTOMATION
- ---------------------- ---------------------- ----------------------- ----------------------
<S> <C> <C> <C>
Avatar Systems HMT Technology Applied Magnetics HMT Technology
Corporation Corporation Corporation Corporation
Fuji Photo Film HOYA Corporation Fujitsu Limited HOYA Corporation
Company, Ltd. Komag, Incorporated International Business Seagate Technology,
Iomega Corporation MaxMedia Division, Machines Corporation Inc.
JTS Corporation Hyundai Electronics Mitsumi Electric Co., StorMedia,
Samsung Electronics America Ltd. Incorporated
Company, Ltd. Seagate Technology, Quantum Corporation Trace Storage
Inc. Read-Rite Corporation Technology
StorMedia, SAE Magnetics (H.K.) Corporation
Incorporated Ltd. Western Digital
Trace Storage Corporation
Technology
Corporation
Western Digital
Corporation
</TABLE>
There are a relatively small number of data storage manufacturers
throughout the world and the Company derives a significant portion of its net
sales from a relatively small number of customers. The Company expects that its
dependence on relatively few key customers will continue in the future.
Approximately 52.2%, 45.0%, 51.0% and 50.1% of the Company's net sales in 1995,
1996, 1997 and the first three months of 1998, respectively, were derived from
sales to the Company's three largest customers in each of those periods. Even
though the Company's customer mix will likely change from period to period in
the future, Seagate Technology, Inc. ("Seagate"), Komag Incorporated ("Komag"),
HMT Technology ("HMT"), Iomega Corporation ("Iomega") and Trace Storage
Technology USA Corporation ("Trace") have historically accounted for a
significant portion of the Company's net sales. For 1995, 1996, 1997 and the
first three months of 1998, Seagate accounted for 25.0%, 19.0%, 18.0% and 15.1%,
respectively, of net sales; Komag accounted for 10.7%, 14.5%, 15.9% and 0.3%,
respectively, of net sales; HMT accounted for 4.4%, 5.2%, 17.1% and 22.4%,
respectively, of net sales; Iomega accounted for 16.5%, 7.9%, 1.9% and 0.6%,
respectively, of net sales and Trace accounted for 6.8%, 11.5%, 4.4% and 0.2%,
respectively, of net sales. In addition, for the first three months of 1988,
Sentinel NV accounted for 12.6% of net sales. If net sales to these or any other
significant customer of the Company were to decrease in any material amount in
the future, the Company's business, results of operations and financial
condition would be materially adversely affected.
A substantial majority of the Company's sales are repeat sales to
long-standing customers in the data storage industry. Usually, multiple units
are purchased with automation as a customer either completes a
58
<PAGE> 67
major fabrication facility or upgrades an existing installed base of the
Company's products. In most instances, the decision to purchase the Company's
products is based on the customers' comparisons of multiple performance
measures, including specifications, throughput, product yield, compatibility to
the existing installed base and overall cost of the Company's product in the
process. The purchases often involve large purchase orders, against which the
customers authorize shipment releases. The substantial majority of the Company's
machines sell for between $100,000 and $200,000 per unit, with an average per
unit price of approximately $130,000. Products are often purchased in multiple
units with automation, known as work cells.
The Company has no long-term contracts with its customers. The Company's
customers often submit master purchase orders against which they "release"
specific product orders from time to time, often with little lead time. Any
cancellation, reduction, rescheduling or significant delay of orders from
significant customers could have a material adverse effect on the Company's
business, results of operations and financial condition. Each of the Company's
customers has some unique product specification requirements which requires the
Company to provide semi-customized products. As a result, per unit sales prices
for the Company's products will generally vary by customer and sales order. If
development or service costs with respect to the customization work are
underestimated, there could be an adverse impact on the Company's gross profits.
In addition, the Company's products often require post-installation, on-site
customization and integration in order to tailor products to customer
specifications. Revenue and corresponding expenses for such post-installation
services is recognized in the period such services are provided. Inaccurate
estimation of such on-site service costs could have a material adverse impact on
the Company's business, results of operations and financial condition.
The Company sells its products primarily through its direct sales force.
The sales process for the Company's systems focuses on responding to each
customer's specific needs. As a result, the selling process for the Company's
products is often a multi-level, long-term process involving individuals from
marketing, engineering, operations, customer service and senior management. The
Company's other sales and marketing activities include participating in trade
shows, publishing articles in trade journals, presenting at technical meetings
and conferences, participating in industry trade groups and consortiums and
distributing promotional literature.
In 1995, 1996, 1997 and the first three months of 1998, the Company's
export sales to unaffiliated customers constituted approximately 23.0%, 57.0%,
49.0% and 52.3%, respectively, of net sales for such periods. The export sales
were primarily to domestic data storage companies with major production
facilities located in Singapore, Malaysia and other parts of Asia. Even though
the Company exports a majority of its products, the purchasing decision for such
sales is usually made by purchasing personnel located in the United States. The
Company's direct sales staff focuses on these types of sales as well as all of
the Company's sales in the United States. In Japan, the Company sells its
products both through its wholly-owned subsidiary and Nissho Iwai, a leading
distributor in Japan. In Southeast Asia and South Korea, the Company sells its
products directly through its wholly-owned subsidiaries. The Company's own
direct sales force and a third party distributer cover markets in Hong Kong and
China. The Company expects that export sales will continue to represent a
significant portion of its net sales in the foreseeable future. See "Risk
Factors -- International Operations."
CUSTOMER SERVICE AND SUPPORT
As of February 28, 1998, the Company had a world-wide customer service and
support staff of 99 persons, consisting of applications engineers, service
engineers and technicians. The Company believes that providing highly
responsive, uninterrupted, world-wide customer service and support is essential
to providing value-added solutions for its customers. The Company's commitment
to world-wide customer support and service is evidenced by its sales and
customer support offices in South Korea, Japan, Singapore, Malaysia, Thailand
and Taiwan. To supplement its direct service and support efforts, the Company's
distributors and sales representatives in Hong Kong and Japan offer a range of
other customer service and support using personnel trained by Phase Metrics.
The Company has structured its direct service and support operations into
distinct service units based on its product lines. Each of these units offers
product installation, on-going process support, emergency system
59
<PAGE> 68
repair, internal training programs, external customer training, documentation
and formation of customer user groups. In general, the Company provides a 90-day
to one-year warranty on all equipment it sells, depending on the sales contract
and geographic location of the sale.
BACKLOG
The Company's sales have historically been made pursuant to purchase orders
rather than long-term contracts. These purchase orders are generally subject to
cancellation, modification, quantity reductions or rescheduling on short notice
and with little or no penalty. Certain of the Company's customers have recently
begun to submit master purchase orders to the Company against which they
"release" specific product orders from time to time, often with little lead time
between the order date and the expected shipment date. The Company's backlog of
purchase orders requesting delivery in the following quarter was approximately
$12.1 million as of December 31, 1997, compared to $19.0 million as of December
31, 1996. The Company does not believe its backlog as of any particular date is
indicative of sales or operating results for any future period.
COMPETITION
The disk drive process and production-test equipment industry is highly
competitive. The Company believes that the most important competitive factors in
its industry are technological innovation; equipment reliability, throughput and
uptime; customer service and support and cost of ownership. The Company believes
it competes favorably with respect to each of these factors. In each of the
Company's product lines, the Company faces substantial competition from
established merchant suppliers of process and production-test equipment, some of
which have greater financial, engineering, manufacturing, research and
development and marketing resources than the Company. For example, the Company
faces competition from General Disk for servowriters; Hitachi DECO and Sony
Techtronics for disk certifiers; Swan Instruments for MR head testers; Zygo
Corporation for flying height testers; Technastar for automation technology and
Guzik Technical for spin-stands. Historically, there has also been competition
from entrepreneurs with focused market knowledge and new technology. The Company
also experiences competition world-wide from Hitachi DECO, a large, full-line
manufacturer of process and production-test equipment. Hitachi DECO, a
subsidiary of Hitachi, Limited, has substantially greater financial, technical,
marketing, manufacturing, research and development and other resources than the
Company. The Company also experiences competition from other full-line and
partial-line manufacturers of process and production-test equipment. There can
be no assurance that the Company's competitors will not develop enhancements to,
or future generations of, competitive products that will offer price or
performance features superior to the Company's products or that new competitors
will not enter the Company's markets.
Many of the Company's competitors are investing heavily in the development
of new and enhanced products aimed at applications currently addressed by the
Company's products. The Company expects its competitors to continue to improve
the design and performance of their products and to introduce new products with
competitive price/performance characteristics. Competitive pressures often
necessitate price reductions which can adversely affect operating results. The
Company will be required to make a continued high level of investment in product
development and research, sales and marketing and ongoing customer service and
support to remain competitive. There can be no assurance that the Company will
have sufficient resources to continue to make such investments or that the
Company will be able to achieve the technological advances necessary to maintain
its competitive position.
The Company believes that its future success will be dependent, in part,
upon its ability to compete successfully in the Japanese, South Korean and
Southeast Asian markets. The Company's largest competitor, Hitachi DECO, is
headquartered in Japan which gives it a competitive advantage over the Company
in that market to the extent buying decisions are influenced by its local
presence. In addition, the Company's ability to compete in Japan, South Korea
and Southeast Asia in the future is dependent upon continuing free trade between
these countries and the United States, the continuing ability of the Company to
develop in a timely manner products that meet the technical requirements of its
foreign customers and the continuing ability of the Company to develop and
maintain satisfactory relationships with leading companies in the data storage
60
<PAGE> 69
industry in these areas. Moreover, the Company's sales in these areas will be
affected by the overall economies of Japan, South Korea and Southeast Asia.
In addition to the competition the Company faces from other merchant
manufacturers of process and production-test equipment, most of the Company's
customers develop at least a portion of their own process and production-test
equipment needs internally, especially servowriters and read/write head test
equipment. Accordingly, the Company must compete against the internal
development efforts of this captive market. Manufacturers within this captive
market are often reluctant to change their production lines to incorporate
merchant supplied process and production-test technology. Moreover, it is
possible that with the rapid changes in data storage technology, the development
of new process and production-test equipment will be so closely linked to the
Company's customers' product development cycles that certain customers and
potential customers will find it more efficient to fulfill their own process and
production-testing equipment needs internally, thereby placing the Company at a
competitive disadvantage.
RESEARCH AND DEVELOPMENT
The market for process and production-test equipment is characterized by
rapid technological changes and product innovation. The Company continually
endeavors to understand how changing data storage technology will impact its
customers' requirements for process and production-test equipment in the future.
The Company encourages its customers to work closely with its product
development and research personnel during the development cycle of new and
enhanced data storage products. In 1996, the Company formed an advanced research
department which is responsible for working with the Company's customers,
academic institutions and independent third parties to (i) identify emerging
data storage technology trends early in the development process, (ii) identify
and develop new core technologies for the Company's systems and (iii) contribute
to the development of process and production-test standards for the data storage
industry. The Company believes that continued and timely development of new
products and enhancements to its existing products are necessary to maintain its
competitive position. As of February 28, 1998, the Company employed a total of
approximately 200 degreed engineers focused on product development and research.
Research and development expenses were approximately $11.4 million, $31.1
million, $43.6 million and $9.5 million for 1995, 1996 and 1997, and the three
months ended March 31, 1998, respectively. The Company anticipates that it will
continue to devote a significant amount of financial resources to product
development and research for the foreseeable future.
MANUFACTURING
The Company conducts its manufacturing activities at its facilities in San
Diego, Fremont, Concord and Hayward, California. The Company's principal
manufacturing activities consist of quality assurance and assembling of
components designed and developed by the Company as well as other components and
subassemblies which are acquired from third party suppliers and then integrated
into the Company's finished products. Most of these components, including
substantially all of the electronic circuit boards and optical componentry
incorporated into the Company's systems, are made to the Company's exacting
specifications.
The Company's manufacturing strategy is to produce high precision,
technologically advanced, reliable products and replacement parts. To achieve
these goals, the Company must continually adjust to changes in technology. As a
result, the Company focuses on the engineering/manufacturing interface in its
product development efforts. The Company also continuously seeks to improve its
materials procurement and control processes to increase throughput and reduce
inventory levels. The Company enhanced its fully integrated computer system for
all materials procurement and control functions. The Company also continues to
consolidate its supplier base and increase its utilization of third-party
outsourcing arrangements for certain subassembly and performance test functions.
Such outsourcing arrangements provide for just-in-time delivery when possible.
In order to meet customer delivery requirements, the Company is working to
reduce the time required to manufacture its products. However, due to periodic
increases in the Company's backlog, technological advances that must be
incorporated into the Company's products, customization issues and other
reasons, the average time between order and shipment of the Company's products
may increase in the future. The
61
<PAGE> 70
Company's ability to quickly increase its manufacturing capacity could be
limited given (i) the complexity of the manufacturing process, especially if the
Company is partially customizing its products to its customers' specifications;
(ii) the lengthy lead times necessary to obtain critical components and (iii)
the need for highly skilled personnel.
In certain instances the Company relies on a single source or a limited
group of suppliers for certain components and subassemblies used in its
products. Although the Company seeks to reduce its dependence on sole and
limited source suppliers, the partial or complete loss of these sources could
have a material adverse effect on the Company's results of operations and damage
customer relationships due to the complexity of the products they supply and the
significant amount of time required to qualify new suppliers. In addition, long
lead times are often required to obtain critical components and subassemblies
used in certain of the Company's products from these and other suppliers which
could impede the Company's ability to quickly respond to changes in demand and
product specifications.
INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS
The Company believes that due to the rapid pace of innovation within the
data storage industry in general, the Company's protection of patent and other
intellectual property rights is less important than factors such as its
technological expertise, product innovation, the Company's installed base, the
marketing ability of its sales force and the ability to provide world-wide
support and service to its customers. The Company does attempt, however, to
protect its intellectual property rights through patents, copyrights, trade
secrets and other measures.
The Company currently holds 27 United States patents and has applied for 72
additional patents in the United States. The Company also holds a number of
foreign patents and has filed a number of foreign patent applications. No
assurance can be given that the claims allowed on any patents held by the
Company will be sufficiently broad to protect the Company's technology.
Moreover, there can be no assurance that any patent owned by the Company will
not be invalidated, deemed unenforceable, circumvented or challenged, that the
rights granted thereunder will provide competitive advantages to the Company or
that any of the Company's pending or future patent applications will be issued
with claims of the scope sought by the Company, if at all. Furthermore, there
can be no assurance that others will not develop similar products, duplicate the
Company's products or design around the patents owned by the Company. In
addition, there can be no assurance that foreign intellectual property laws or
the Company's agreements will protect the Company's intellectual property rights
in any foreign country. Any failure to protect the Company's intellectual
property rights could have a material adverse effect upon the Company's
business, financial condition and results of operations.
Although the Company does not believe any of its products or proprietary
rights infringe the rights of third parties, there can be no assurance that
infringement claims will not be asserted against the Company in the future. Any
such claims, with or without merit, could divert the attention of management,
result in costly litigation, cause product shipment delays or require the
Company to enter into royalty or licensing agreements. Such royalty or licensing
agreements, if required, may not be available on terms acceptable to the
Company, or at all. If infringement were established, the Company could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, there can be no assurance that a third party's
product, if infringing on the Company's proprietary rights, may be prevented
from doing so without litigation. Any of the foregoing could have a material
adverse effect upon the Company's business, financial condition and results of
operations.
The Company requires each of its employees to enter into a proprietary
rights and non-disclosure agreement in which the employee agrees to maintain the
confidentiality of all proprietary information of the Company and, subject to
certain exceptions, to assign to the Company all rights in any proprietary
information or technology made or contributed by the employee during his or her
employment. In addition, the Company regularly enters into non-disclosure
agreements with third parties, such as consultants, potential joint venture
partners and customers. In spite of these precautions, it may be possible for
third parties to copy, develop or otherwise obtain and use the Company's
proprietary technology without authorization or to develop similar technology
independently.
62
<PAGE> 71
EMPLOYEES
As of February 28, 1998, the Company had 668 full-time employees, including
207 in product development and research, 236 in manufacturing, 37 in sales and
marketing, 99 in service and support, and 89 in finance and administration
activities. Many of the Company's employees have specialized skills of
significant value to the Company, and the Company's future success will depend
in large part upon its ability to attract and retain highly skilled technical,
managerial, financial and marketing personnel, who are in great demand. The
Company believes that attracting and motivating skilled technical personnel is
vital to its success and there can be no assurance that the Company will be
successful in retaining or recruiting these and other key personnel. No employee
is represented by a union or covered by a collective bargaining agreement, and
the Company has not had a work stoppage or strike. The Company considers its
employee relations to be good.
PROPERTIES
The Company owns three buildings with a total of approximately 123,000
square feet on approximately nine acres of land in San Diego, California; leases
three buildings with a total of 175,000 square feet under leases expiring in
November and December 2000 and August 2003 in Fremont, California; leases two
buildings with a total of 38,000 square feet under leases expiring in September
1998 and May 1999 in Concord, California; and leases a 12,000 square foot
building under a month-to-month lease in Hayward, California. The Company
conducts manufacturing and research and development at all of these sites and
also has service and support capabilities at each of these locations, except
Hayward. The Company's domestic sales and marketing functions are headquartered
in its Fremont facility. For its Pacific Rim operations, the Company also leases
1,900 square feet in Tokyo, Japan; 2,700 square feet in AnSen City, South Korea;
3,300 square feet in Singapore; 800 square feet in Thailand and 1,000 square
feet in Taiwan. These facilities are primarily used as technical, applications,
and sales and service support centers for the Company's Pacific Rim customers.
The Company believes that its facilities are adequate for its current level of
business and does not anticipate any material difficulty in renewing any of its
leases as they expire or securing replacement facilities, in each case on
commercially reasonable terms.
LEGAL PROCEEDINGS
The Company is not currently involved in any material legal proceedings.
63
<PAGE> 72
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
Set forth below is certain information regarding the directors and
executive officers of the Company as of February 28, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
<S> <C> <C>
John F. Schaefer........................... 55 Chairman of the Board, President and Chief
Executive Officer
David L. Bultman........................... 50 Executive Vice President, Disk Drive and
Media Products
Neil A. Brumberger......................... 50 Vice President and General Manager, Phase
Metrics Automation
Wayne G. Erickson.......................... 40 Vice President, Sales and Marketing, Head
Products
Dennis J. Geurts........................... 48 Vice President, Fremont Operations
Dr. Michael R. Madden...................... 55 Vice President, San Diego Operations
Ronald Y. Miyahara......................... 48 Vice President and General Manager, Asia
Operations
Albertus H. Munnikhuis..................... 46 Vice President, Sales and Marketing, Disk
Drive and Media Products
Dr. Jun Zhu................................ 31 Vice President, Head Product Development
Michael G. Rogowski........................ 43 Vice President, Customer Engineering, Disk
Drive and Media Products
R. Joseph Saunders(1)...................... 60 Vice President, Finance, Chief Financial
Officer and Assistant Secretary
Dr. Heiner Sussner(1)...................... 49 Vice President, Research and Development
and Chief Technical Officer
Arthur J. Cormier(2)....................... 41 Director
Thompson Dean(2)(3)........................ 39 Director
Robert Finzi(2)(3)......................... 44 Director
Dr. Gilbert F. Amelio(1)................... 54 Director
William E. Terry(3)........................ 64 Director
</TABLE>
- ---------------
(1) Dr. Sussner, the Company's Vice President, Research and Development and
Chief Technical Officer has informed the Company that he is terminating his
employment with the Company effective June 29, 1998. Mr. Saunders, the
Company's Vice President, Finance and Chief Financial Officer will resign
from such positions, effective June 26, 1998. Brad LaLuzerne, the Company's
current Controller-Fremont Operations will become the Company's Chief
Financial Officer upon Mr. Saunders' resignation from that position.
(2) Member of Audit Committee
(3) Member of Compensation Committee
John F. Schaefer has been Chairman of the Board and Chief Executive Officer
since November 1994 and President since February 1997. From 1992 to 1994, Mr.
Schaefer was President, Chief Operating Officer and Director of McGaw
Incorporated, a provider of intravenous products and devices. From 1989 to 1991,
Mr. Schaefer was President, Chief Executive Officer and Director of Levolor
Corporation ("Levolor"), a manufacturer of window blinds and similar products.
Prior to joining Levolor in 1989, Mr. Schaefer was employed by Baker Hughes,
Inc., where he was President of the Process Equipment Group, Executive Vice
President of the Corporation, and a Director.
David L. Bultman became Executive Vice President, Disk Drive and Media
Products in June 1998. Mr. Bultman was Vice President, Product Development, Disk
Drive and Media Products from July 1996 to June 1998. From December 1994 to July
1996, Mr. Bultman was employed by Storage Dimensions, Inc., serving as Senior
Vice President, Engineering. From November 1993 to October 1994, Mr. Bultman was
Vice President,
64
<PAGE> 73
Engineering at DKI. Prior to joining DKI, Mr. Bultman was Vice President,
Engineering at Ministor Peripherals.
Neil A. Brumberger has been a Vice President of the Company and General
Manager of the Company's Automation Division since the Company's acquisition of
ART in July 1995. Mr. Brumberger founded ART, a manufacturer of integrated
automation systems for process and production-test equipment, in 1984 and, prior
to that time, he was a Project Manager and Director of Engineering for the Bay
Area Rapid Transit District for nine years.
Wayne G. Erickson became Vice President, Sales and Marketing, Head Products
in June 1998. Mr. Erickson was Vice President Sales and Marketing from November
1992 until June 1998. From January 1985 to November 1992, Mr. Erickson was
employed by Quantum/Plus Development Corporation ("Quantum"), a leading supplier
of read/write head systems, serving as OEM Marketing Manager, Product Line
Manager and National Sales Manager, Retail Channels. Prior to joining Quantum,
Mr. Erickson was Engineer and Program Manager at Shugart Corporation.
Dennis J. Geurts has been Director of Fremont Operations since October 1995
and was promoted in March 1996 to Vice President of Fremont Operations. Prior to
October 1995, Mr. Geurts held various senior management positions in the
operations, manufacturing and materials divisions of Applied Materials Inc., an
equipment supplier to the semiconductor industry, over a thirteen-year period.
Before joining Applied Materials, Mr. Geurts was Senior Manager at General
Electric -- Nuclear Division.
Dr. Michael R. Madden has been Director of Operations, San Diego since
February 1995 and was promoted to Vice President, Technology Transfer in June
1995. Prior to February 1995, Dr. Madden managed the High Reliability Products
Division of UDT Sensors, Inc. He also served as Vice President, Research
Development, for Advanced Photonix, Inc. From 1977 to 1987, Dr. Madden was the
Chief Executive Officer of Centronics Electro-Optics, Inc. and Silicon Detector
Corporation.
Ronald Y. Miyahara has been Vice President and General Manager, Asia
Operations for the Company since November 1995, having previously served as Vice
President, Operations from November 1994 through October 1995. Mr. Miyahara
previously served as President of ProQuip, Inc., a supplier of advanced process
and production-test equipment for disk manufacturers, which the Company acquired
in November 1994. Prior to the acquisition, Mr. Miyahara served in various
positions at ProQuip, Inc., including President and General Manager from 1991 to
1994, Vice President of Operations from 1989 to 1991, and Chief Financial
Officer from 1984 to 1991.
Bert Munnikhuis became Vice President, Sales and Marketing, Disk Drive and
Media Products in June 1998. He has been Senior Director of Media Products,
Sales & Marketing, since January 1997 and was Director, Media Products, Sales
and Marketing, from November 1994. Mr. Munnikhuis previously served in various
positions including Vice President of Marketing and Sales at Cambrian Systems,
Inc. from 1982 to 1994.
Brad LaLuzerne became Vice President, Finance and Chief Financial Officer
in June 1998. Prior to that, Mr. LaLuzerne was the Company's Controller, Fremont
Operations from March 1996 to June 1998. Between June 1986 and March 1996, Mr.
LaLuzerne held various positions at Harnischfeger Industries, Inc., including
Division Controller.
Dr. Jun Zhu became Vice President, Head Product Development in June 1998.
Dr. Zhu was Director, Quasistatic Products from June 1997 until June 1998. From
September 1996 to June 1997, he was a project manager for the Company. From June
1993 to September 1996, Dr. Zhu was employed by Read-Rite Corporation in various
engineering capacities.
Michael G. Rogowski has been Vice President, Customer Engineering, Disk
Drive and Media Products since November 1994 and was promoted in March 1996 to
Vice President of Customer Engineering. Prior to joining the Company, Mr.
Rogowski was Vice President of Manufacturing/Test Engineering for Cambrian
Systems, Inc., a supplier of advanced process and production-test equipment for
disk and read/write head manufacturers, which the Company acquired in November
1994. From 1992 to 1994, Mr. Rogowski was the
65
<PAGE> 74
Director of Test Engineering at Akashic Memories. Between 1979 and 1992, Mr.
Rogowski held various positions in engineering and management in the Mechanical
Integration, Test Equipment Development, and Manufacturing Test Engineering
organizations within IBM Corporation.
R. Joseph Saunders has been Vice President, Chief Financial Officer and
Assistant Secretary of the Company since November 1994. Mr. Saunders joined the
Company from Southwest Water Company, owner of two regulated public water
suppliers, where he served as Vice President-Finance, Chief Financial Officer
and Secretary between 1992 and November 1994. From 1975 to 1992, Mr. Saunders
served in a series of senior financial management positions with Baker Hughes,
Inc., including Group Vice President of Finance.
Dr. Heiner Sussner has been Vice President, Research and Development and
Chief Technical Officer since October 1996. From 1992 until October 1996, Dr.
Sussner served IBM Corporation as an executive consultant for technology
investments in Europe, as director of IBM's Almaden research facility for data
storage technology and as a manager/senior research scientist. Prior to 1992,
Dr. Sussner served in various capacities for IBM over a period of 16 years. Dr.
Sussner was awarded the IEEE Medal for Engineering Excellence for Leadership in
1994.
Arthur J. Cormier has been a consultant to the Company since February 1997.
Mr. Cormier founded the Company and has served as a Director since the Company's
inception in 1989. He has served as President and Chief Operating Officer of the
Company since its inception until February 1997. He held the position of Chief
Executive Officer until the Company's recapitalization in November 1994. From
1987 to 1989, Mr. Cormier was Applications Engineer for National Micronetics
Incorporated. Prior to joining National Micronetics, Mr. Cormier was employed by
Eastman Kodak Company from 1985 to 1987, where he was an Engineering Program
Manager.
Thompson Dean has been a Director of the Company since November 1994. Since
January 1997, Mr. Dean has been Managing Partner of DLJ Merchant Banking, Inc.,
an affiliate of DLJ. Prior to that Mr. Dean had been a Managing Director of DLJ
Merchant Banking, Inc. since May 1992. Prior to that time, Mr. Dean served as a
Managing Director of DLJ, and was employed by that firm in various capacities
from September 1988 until September 1992.
Robert Finzi has been a Director of the Company since November 1994. Since
May 1991, Mr. Finzi has been a Vice President of Sprout Group, a division of DLJ
Capital Corporation, which is the managing general partner of Sprout Growth II,
L.P. and an affiliate of DLJ. Mr. Finzi is also a general partner of a series of
investment funds managed by Sprout Group and a limited partner of the general
partner of ML Ventures II, L.P. From 1984 to 1991, Mr. Finzi was a Vice
President of Merrill Lynch Venture Capital. Mr. Finzi also serves on the Board
of Directors of The Cerplex Group, Inc., Gentle Dental Services Co. and four
privately-held companies.
Dr. Gilbert F. Amelio has been a Director of the Company since June 1995.
From 1994 until July 1997, Dr. Amelio served as a Director of Apple Computer,
Inc. ("Apple") and from February 1996 until July 1997 he served as Chairman of
the Board and Chief Executive Officer of Apple. Prior to joining Apple, Dr.
Amelio was Chairman of the Board, President and Chief Executive Officer of
National Semiconductor Corporation for five years. Dr. Amelio is an IEEE Fellow,
holder of 16 patents and is the co-author of two books, "Profit from Experience:
The National Semiconductor Story of Transformation Management" and "On the
Firing Line: My 500 Days at Apple." Dr. Amelio is currently Partner and Director
of The Parkside Group, LLC and serves on the Board of Directors of SBC
Communications.
William E. Terry has been a Director since August 1997. From 1986 until his
retirement in November 1993, Mr. Terry served as Executive Vice President and a
Director of Hewlett-Packard. Prior to that, Mr. Terry served in a number of
other senior executive positions with Hewlett-Packard. Mr. Terry currently
serves on the Board of Directors of Keytronic Corporation and Altera
Corporation.
The Board of Directors has a Compensation Committee (the "Compensation
Committee") which is responsible for making determinations regarding salaries,
bonuses and other compensation matters for the Company's executive officers. The
members of the Compensation Committee are Mr. Dean, Mr. Finzi and Mr. Terry.
None of these individuals were at any time during 1996 an officer or employee of
the Company.
66
<PAGE> 75
The Board of Directors also has an Audit Committee (the "Audit Committee")
which supervises and makes recommendations and decisions with respect to the
periodic audits of the Company's financial results. The members of the Audit
Committee are Mr. Cormier, Mr. Dean, Mr. Finzi and Dr. Amelio.
DIRECTOR COMPENSATION
Except as described below, the directors do not receive cash compensation
for services on the Board of Directors or any Committee thereof.
Dr. Amelio and Mr. Terry are each paid a retainer by the Company of $1,000
per month for their services on the Board of Directors. Dr. Amelio and Mr. Terry
also each receive $1,000 for each meeting of the Board of Directors or committee
thereof that they attend. In addition, the Company granted Dr. Amelio an option
to purchase 100,000 shares of Common Stock under the 1995 Option Plan at an
exercise price of $1.00 per share when he joined the Board in June 1995 and Mr.
Terry was granted an option to purchase 50,000 shares of Common Stock under the
1995 Option Plan at an exercise price of $8.75 per share when he joined the
Board in August, 1997. These options are immediately exercisable for all the
option shares, but any shares purchased under the option will be subject to
repurchase by the Company at the option exercise price paid per share if Dr.
Amelio or Mr. Terry cease serving on the Board prior to vesting in their
respective shares. As of February 28, 1998, Dr. Amelio had vested in 53,333
option shares and Mr. Terry had vested in no option shares. Dr. Amelio will vest
in his remaining option shares, as long as he remains as a member of the Board,
in a series of successive equal monthly installments upon completion of each
additional month of Board service. Mr. Terry will vest in 10,000 option shares
in August 1998, and will vest in the remaining option shares, as long as he
remains as a member of the Board, in a series of successive equal monthly
installments upon completion of each additional month of Board service. The
vesting period for the options granted to Dr. Amelio and Mr. Terry is five
years.
Mr. Cormier provides consulting services to the Company under an
arrangement which provides for payment of $1,500 per day plus expenses as
consulting services are provided, including attendance at Company meetings and
technical conferences. Under the consulting arrangement, Mr. Cormier also
receives an office and clerical assistance at the Company's facilities, and his
family receives health care insurance coverage.
All non-employee Board members are reimbursed for their out-of-pocket
expenses in serving on the Board of Directors.
67
<PAGE> 76
EXECUTIVE COMPENSATION
The following table sets forth certain summary information concerning the
compensation earned by the Company's Chief Executive Officer and its four other
most highly compensated executive officers (the "Named Executive Officers")
whose total salary and bonus for 1997 exceeded $100,000, for services rendered
to the Company in all capacities during that year. No executive who would
otherwise have been includable in such table on the basis of salary and bonus
earned for 1997 has resigned or otherwise terminated employment during 1997.
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
NAME AND -------------------------------- UNDERLYING ALL OTHER
PRINCIPAL POSITION(S) SALARY BONUS OTHER(1) OPTIONS COMPENSATION(2)
<S> <C> <C> <C> <C> <C>
John F. Schaefer....................... $325,000 $105,000 -- -- $ 6,658
Chairman and Chief Executive Officer
Dr. Heiner Sussner..................... 230,000 19,688 2,850 -- 3,169
Vice President, R&D and Chief
Technical Officer
David L. Bultman....................... 230,000 190,000(3) 3,256 -- 2,569
Vice President, Product Development
Disk Drive and Media Products
Neil A. Brumberger..................... 200,000 75,000 2,483 -- 4,904
Vice President and President, Phase
Metrics Automation
R. Joseph Saunders..................... 200,000 21,558 3,360 -- 3,678
Vice President, Finance, Chief
Financial Officer and Assistant
Secretary
</TABLE>
- ---------------
(1) Includes the value of personal use of Company automobiles.
(2) Includes the Company's matching contribution under its 401(k) Plan.
(3) Includes forgiven loans and signing bonuses totalling $150,000.
STOCK OPTIONS AND STOCK APPRECIATE RIGHTS
The following table contains information concerning the stock options
granted to the Named Executive Officers during 1997. All the grants were made
under the Company's 1995 Plan (as defined herein). No stock appreciation rights
were granted to the Named Executive Officers during 1997.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS(1)
------------------------------------------------------------------
MARKET POTENTIAL REALIZATION
NUMBER PRICE OF VALUE AT ASSUMED
OF PERCENT OF SECURITIES ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS EXERCISE UNDERLYING PRICE APPRECIATION FOR
UNDERLYING GRANTED TO PRICE OPTIONS OPTION TERM(3)
OPTIONS EMPLOYEES IN PER ON DATE EXPIRATION -----------------------
NAME GRANTED 1997 SHARE(2) OF GRANT(2) DATE 5% 10%
---- ---------- --------------- -------- ----------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
John F. Schaefer............ -- -- -- -- -- -- --
Dr. Heiner Sussner.......... 60,000 5.5% $8.75 $8.75 8/01/07 $330,170 $836,715
David L. Bultman............ 25,000 2.3 8.75 8.75 8/01/07 137,571 348,631
Neil A. Brumberger.......... -- -- -- -- -- -- --
R. Joseph Saunders.......... -- -- -- -- -- -- --
</TABLE>
- ---------------
(1) Option grants are immediately exercisable for all the option shares, but any
shares purchased under such option will be subject to repurchase by the
Company at the option exercise price paid per share.
(2) The exercise price is equal to the fair market value of the Common Stock on
the date of grant, as determined by the Board of Directors taking into
account a number of factors at the time of the grants,
68
<PAGE> 77
including, without limitation, the current status of the Company and its future
prospects, the status of the disk drive industry, values of comparable companies
and the appraisals of an independent, third-party appraiser engaged by the
Company.
(3) There can be no assurance provided to any executive officer or other holder
of the Company's securities that the actual stock price appreciation over
the ten-year option term will be at the assumed 5% and 10% levels or at any
other defined level. Unless the market price of the Common Stock appreciates
over the option term, no value will be realized from those option grants
which were made to the Named Executive Officers with an exercise price equal
to the fair market value of the option shares on the grant date.
AGGREGATE OPTION EXERCISES IN 1997 AND YEAR-END VALUES
The following table provides information, with respect to each of the Named
Executive Officers, concerning the exercise of options during 1997 and
unexercised options held by them at the end of that fiscal year. None of the
Named Executive Officers exercised any options during 1997.
<TABLE>
<CAPTION>
VALUE OF UNEXERCISED IN-THE
NUMBER OF UNEXERCISED OPTIONS MONEY OPTIONS AT
AT DECEMBER 31, 1997(#) DECEMBER 31, 1997($)(1)
------------------------------- -------------------------------
NAME EXERCISABLE(2) UNEXERCISABLE EXERCISABLE(2) UNEXERCISABLE
---- -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C>
John F. Schaefer...................... -- -- -- --
Dr. Heiner Sussner.................... 150,000(2) -- $112,500(2) --
David L. Bultman...................... 125,000(3) -- 125,000(3) --
Neil A. Brumberger.................... -- -- -- --
R. Joseph Saunders.................... -- -- -- --
</TABLE>
- ---------------
(1) Based upon the fair market value of $8.75 per share determined by the Board
of Directors at December 31, 1997, less the option exercise price (i.e., the
fair market value of the Common Stock on the date of grant, as determined by
the Board of Directors), payable per share. The Board of Directors takes
into account a number of factors in determining fair market value,
including, without limitation, the current status of the Company and its
future prospects, the status of the disk drive industry, values of
comparable companies and the appraisals of an independent, third-party
appraiser engaged by the Company.
(2) Although the options are fully exercisable, only 21,000 options had vested
as of December 31, 1997. The option shares issuable upon exercise of such
options are, prior to vesting, subject to a right of repurchase in favor of
the Company.
(3) Although the options are fully exercisable, only 28,333 options had vested
as of December 31, 1997. The option shares issuable upon exercise of such
options are, prior to vesting, subject to a right of repurchase in favor of
the Company.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The members of the Compensation Committee are Mr. Dean, Mr. Finzi and Mr.
Terry. No executive officer of the Company serves as a member of the board of
directors or compensation committee of any entity which has one or more
executive officers serving as a member of the Company's Board of Directors or
Compensation Committee.
Mr. Dean is a Managing Director of DLJ Merchant Banking Partners, L.P., and
Mr. Finzi is a General Partner of Sprout Group, both of which are affiliates of
DLJ. DLJ is a principal stockholder of the Company. In each of 1995, 1996 and
1997 the Company paid DLJ $200,000 in fees for financial advisory and certain
investment banking services provided to the Company. DLJ acted as the Initial
Purchaser in the Note Offering and received an underwriting discount of $3.575
million in connection therewith. See "Principal Stockholders" "Certain
Transactions."
COMPENSATION PLANS AND ARRANGEMENTS
Employment Contracts and Change in Control Arrangements
In November 1994, the Company entered into an employment contract with Mr.
Schaefer providing for his employment as Chief Executive Officer and Chairman of
the Board of the Company. The employment
69
<PAGE> 78
contract is terminable at will by either Mr. Schaefer or the Company upon
30-days' notice. The employment contract provides for an annual minimum base
salary of $325,000. In addition, beginning in 1996, Mr. Schaefer became eligible
to receive a bonus under the Company's bonus plan for officers. If the
employment contract is terminated by the Company other than for cause or by Mr.
Schaefer due to breach of the agreement or certain other actions by the Company,
the Company must pay Mr. Schaefer, in addition to all accrued and unpaid salary
and benefits, his salary and certain benefits for a period of 12 months from the
date of such termination. If the Company terminates Mr. Schaefer's employment
upon his permanent disability, subject to reduction for any insurance benefits
received, Mr. Schaefer is entitled to receive his salary and benefits for 12
months from the date of such termination.
In July 1995, in connection with the acquisition of ART, the Company
entered into an employment contract with Mr. Brumberger providing for his
employment as Vice President of the Company and President, Phase Metrics
Automation. The employment contract is for a minimum term of three years and is
terminable at will by Mr. Brumberger upon 30-days notice. The employment
contract provides for an annual base salary of $200,000 and a minimum annual
bonus of $75,000.
In connection with any change of control of the Company, subject to certain
limitations, outstanding options held by Dr. Sussner and Messrs. Bultman and
Saunders (as well as certain other senior executive officers) will either
immediately vest in full, or will subsequently vest in full upon the involuntary
termination of the individual's employment within 12 months thereafter.
Bonus Plan for Officers and Certain Key Employees
The Company has an established bonus plan for officers and certain key
employees, including the Named Executive Officers. Payment of bonuses under this
plan is dependent on the Company achieving its financial goals established
annually by the Compensation Committee, as well as the employee achieving
certain priorities as established by Company management. Bonus targets range
from a low of 10% of base salary for certain employees to a high of 50% of base
salary for the Chief Executive Officer. Employees can earn up to 150% of their
bonus targets, depending upon the performance of both the employee and the
Company.
1995 Stock Incentive Plan
The Company's 1995 Stock Option Plan (the "1995 Plan") became effective
when adopted by the Board of Directors (the "Board") and approved by the
Company's shareholders in April 1995. A total of 6,300,000 shares of Common
Stock have been authorized for issuance over the term of the 1995 Plan, subject
to adjustment in the event of any stock dividends, stock splits or other similar
changes affecting the Company's outstanding Common Stock.
Employees (including officers), non-employee Board members and consultants
and other advisors in the service of the Company or any parent or subsidiary
company may, at the discretion of the Plan Administrator, be granted options to
purchase shares of Common Stock at an exercise price not less than 85% of the
fair market value per share on the grant date.
The 1995 Plan is currently administered by the Board. However, the Board
may at any time delegate such administration to the Compensation Committee. The
Plan Administrator (whether the Board or such committee) has complete discretion
to determine which eligible persons are to receive option grants, the time or
times when such grants are to be made, the number of shares subject to each such
grant, the status of an option as either an incentive stock option or a
non-statutory stock option under the federal tax laws, the vesting or exercise
schedule in effect for the option and the maximum term for which any option will
remain outstanding. No option granted under the 1995 Plan may have a term in
excess of 10 years and will be subject to earlier termination following the
optionee's cessation of service with the Company.
Option grants under the 1995 Plan may either become exercisable for the
option shares in a series of installments over the optionee's period of service
with the Company or may be immediately exercisable for all the option shares,
but any shares purchased under such an immediately exercisable option will be
subject to repurchase by the Company, at the option exercise price paid per
share, should the optionee leave the
70
<PAGE> 79
Company's service prior to vesting in those shares. The Company will also have a
right of first refusal with respect to any proposed sales or transfers of the
shares of Common Stock issued under the 1995 Plan. Accordingly, the Company will
have the opportunity to match any third-party offer to acquire those shares.
However, all first refusal rights under the 1995 Plan will terminate in the
event the Company's Common Stock is publicly held.
The option exercise price will normally be payable in cash at the time of
exercise. However, the Plan Administrator may allow the optionee to deliver a
promissory note in payment of the exercise price and any withholding taxes
incurred in connection with the exercise. Any such note will bear interest at
the minimum rate required under the federal tax laws and will be secured by the
purchased shares. Following an initial public offering of the Common Stock, the
exercise price may be paid in shares of Common Stock valued at fair market value
or through a cashless exercise procedure pursuant to which the purchased option
shares are sold immediately and a portion of the sale proceeds equal to the
option exercise price for those shares are remitted to the Company.
Should the Company be acquired by merger or asset sale, all outstanding
options will immediately vest in full, except to the extent those options are
assumed by the successor entity. In the event the price payable per share of
Common Stock in the acquisition (determined on a fully-diluted basis) is at
least $7.00, the shares subject to the outstanding options under the 1995 Plan
will, whether or not those options are to be assumed by the successor entity,
vest for some option holders immediately upon such acquisition and will vest for
the remaining option holders upon the subsequent termination of their service
with the Company or the successor entity within 18 months following such
acquisition.
As of February 28, 1998, options for 2,150,134 shares of Common Stock were
outstanding under the 1995 Plan, options for 1,453,480 shares had been
exercised, and 2,696,386 shares of Common Stock were available for future option
grant. To the extent any outstanding options terminate or expire unexercised,
the shares of Common Stock subject to those options will be available for
subsequent option grants.
The Plan Administrator has the authority to effect the cancellation of
outstanding options under the 1995 Plan in return for the grant of new options
for the same or different number of option shares with an exercise price per
share based upon the fair market value of the Common Stock on the new grant
date.
The Board may amend or modify the 1995 Plan at any time. The 1995 Plan will
terminate on April 1, 2005, unless sooner terminated by the Board.
71
<PAGE> 80
CERTAIN TRANSACTIONS
Since January 1, 1997, there has not been, nor is there currently proposed,
any transaction or series of similar transactions to which the Company was or is
to be a party in which the amount involved exceeds $60,000 and in which any
director, executive officer or holder of more than five percent of the
outstanding capital stock of the Company had or will have a direct or indirect
material interest other than compensation and other arrangements, which are
described where required under "Management" and the transactions described
below.
RECAPITALIZATION
In November 1994, the Company completed a recapitalization (the
"Recapitalization") and in connection therewith entered into a Securities
Purchase Agreement (the "Securities Purchase Agreement") with DLJ Merchant
Banking Partners, L.P., a Delaware limited partnership ("DLJMBP"), DLJ
International Partners, C.V., a Netherlands Antilles limited partnership
("DLJIP"), DLJ Offshore Partners, C.V., a Netherlands Antilles limited
partnership ("DLJOP"), DLJ Merchant Banking Funding, Inc., a Delaware
corporation ("DLJMBF"), DLJ Capital Corporation, a Delaware corporation
("DLJCC"), Sprout Growth II, L.P., a Delaware limited partnership and venture
capital affiliate of DLJ ("Sprout II") and Sprout Capital VI, L.P., a Delaware
limited partnership and venture capital affiliate of DLJ ("Sprout VI")
(collectively, "DLJ and the Sprout Entities"), Mr. Arthur J. Cormier and Mr.
John T. Schaefer. In connection with the Recapitalization, the Company also (i)
entered into a Securityholders Agreement with DLJ and the Sprout Entities, Mr.
Cormier and Mr. Schaefer (the "Securityholders Agreement"), (ii) exchanged its
existing capital stock for shares of its Series A and B Preferred Stock, (iii)
issued and sold shares of its Common Stock and (iv) issued and sold $8.0 million
aggregate principal amount of its Convertible Subordinated Notes. As part of the
Recapitalization, Mr. Cormier sold his Series B Preferred Stock and certain
shares of his Series A Preferred Stock to DLJ and the Sprout Entities and Mr.
Schaefer. See "Description of Capital Stock."
In 1995, DLJMBF transferred $671,975 in aggregate principal amount of its
Convertible Subordinated Notes and 161,920 shares of its Series B Preferred
Stock to DLJ First ESC, L.L.C., a Delaware limited liability corporation ("DLJ
First"). As part of that transaction, DLJ First became a party to the Securities
Purchase Agreement and the Securityholders Agreement and is one of the "DLJ and
the Sprout Entities" as defined herein.
The outstanding shares of Series A Preferred Stock and Series B Preferred
Stock are convertible into an aggregate of 12,107,280 shares of Common Stock.
The Convertible Subordinated Notes issued to DLJ and the Sprout Entities are
convertible into an aggregate of 5,142,720 shares of Common Stock of the Company
and are subordinated in right of payment and with respect to certain other
rights to all senior debt of the Company, including indebtedness evidenced by
the New Notes and outstanding indebtedness under the New Credit Facility. See
"Description of Capital Stock."
BRIDGE FINANCING
In November 1994, the Company entered into a Bridge Securities Purchase
Agreement (the "Bridge Financing Agreement") with PM Funding, Inc., a Delaware
corporation ("PM Funding"), an affiliate of DLJ and the Sprout Entities. Under
the Bridge Financing Agreement, the Company borrowed $20.0 million from PM
Funding and issued warrants to PM Funding, DLJCC, Sprout II and Sprout VI, which
are exercisable for an aggregate of 800,000 shares of Common Stock at an
exercise price of $1.55 per share, subject to adjustment (the "Bridge Note
Warrants"). The Bridge Note Warrants expire on November 23, 2004. The loan with
PM Funding was repaid by the Company in March 1995.
SECURITYHOLDERS AGREEMENT
The Securityholders Agreement, as amended, provides that each of Messrs.
Schaefer and Cormier, DLJMBP and Sprout II, shall be entitled to designate one
director to the Company's Board, and Messrs. Schaefer and Cormier, with the
consent of DLJ and the Sprout Entities, shall have the right to designate the
fifth and sixth directors to the Company's Board. The Securityholders Agreement
also contains
72
<PAGE> 81
certain restrictions on the ability of the parties thereto to sell their shares
of stock; registration rights; preemptive rights in connection with the issuance
by the Company of additional equity securities other than upon certain defined
events, including an initial public offering by the Company; certain rights of
first refusal between the shareholders who are party to such agreement providing
each such party the right to purchase any equity securities that any of the
other parties to the agreement desire to sell to third parties and other matters
customary for such agreements. The rights of the parties to the Securityholders
Agreement with respect to certain restrictions on transfer and the preemptive
rights under such Agreement terminate in connection with certain public
offerings of Common Stock by the Company. Under the Securityholders Agreement,
the Company is obligated until November 23, 1998, to use DLJ as its exclusive
financial advisor and investment banker. In consideration for DLJ's services,
the Company has agreed to pay DLJ an annual retainer of $200,000. In each of
1995, 1996 and 1997, the Company paid DLJ $200,000 in fees for financial
advisory and certain investment banking services provided to the Company.
DLJ acted as the initial purchaser in the Note Offering and received an
underwriting discount of $3.575 million in connection therewith.
FORMER CREDIT FACILITY
In connection with the refinancing of its then-outstanding indebtedness in
December of 1996, the Company paid fees of $1.2 million for debt issuance costs
to DLJ Capital Funding, Inc. ("DLJCF"), the syndicate agent. DLJCF is an
affiliate of DLJ.
73
<PAGE> 82
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's capital stock as of February 28, 1998, by
(i) each person (or group of affiliated persons) known by the Company to
beneficially own more than five percent of any class of its capital stock, (ii)
each of the Company's directors, (iii) each of the Named Executive Officers and
(iv) all directors and executive officers of the Company as a group. Unless
otherwise indicated, the address for each stockholder is c/o Phase Metrics,
Inc., 10260 Sorrento Valley Road, San Diego, California 92121.
<TABLE>
<CAPTION>
SERIES A SERIES B
COMMON STOCK(2) PREFERRED(3) PREFERRED(4) TOTAL(5)
------------------- ------------------- ------------------- --------------------
BENEFICIAL OWNER(1) NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT NUMBER PERCENT
<S> <C> <C> <C> <C> <C> <C> <C> <C>
DLJ and the Sprout Entities
(6)............................ 5,942,720 51.5% 2,000,000 24.2% 3,857,280 100.0% 11,800,000 49.9%
Arthur J. Cormier (7)............ -- -- 4,500,000 54.5 -- -- 4,500,000 25.4
John F. Schaefer (8)............. 2,750,000 49.0 1,750,000 21.2 -- -- 4,500,000 25.4
Neil A. Brumberger(9)............ 450,000 7.6 -- -- -- -- 450,000 2.5
Wayne G. Erickson (10)........... 300,000 5.3 -- -- -- -- 300,000 1.7
R. Joseph Saunders (11).......... 150,000 2.7 -- -- -- -- 150,000 *
Dr. Heiner Sussner (12).......... 150,000 2.6 -- -- -- -- 150,000 *
David L. Bultman (13)............ 125,000 2.2 -- -- -- -- 125,000 *
Dr. Gilbert F. Amelio (14)....... 100,000 1.7 -- -- -- -- 100,000 *
William E. Terry (15)............ 50,000 * -- -- -- -- 50,000 *
Thompson Dean (6)................ -- -- -- -- -- -- -- --
Robert Finzi (6)................. -- -- -- -- -- -- -- --
All directors and executive
officers as a group (15
persons) (16).................. 4,384,567 72.0 6,250,000 75.8 -- -- 10,634,567 58.4
</TABLE>
- ---------------
* Less than one percent.
(1) Except as indicated by footnote, the Company understands that the persons
named in the table above have sole voting and investment power with respect
to all shares shown as beneficially owned by them, subject to community
property laws where applicable.
(2) Reflects the beneficial ownership of the Company's Common Stock, assuming
the conversion of the Convertible Subordinated Notes and the Bridge Note
Warrants. Shares of Common Stock subject to options, warrants or notes
which are currently exercisable or exercisable within 60 days of February
28, 1998, are deemed outstanding for computing the percentages of the
person holding such options, warrants or notes, but are not deemed
outstanding for computing the percentages of any other person. Percentage
ownership is based on 5,607,480 shares of Common Stock outstanding as of
February 28, 1998.
(3) The number of shares reflects the number of shares of Common Stock in the
aggregate issuable upon the conversion of the Series A Preferred Stock held
by each person. Each share of Series A Preferred Stock is convertible into
20 shares of Common Stock. See "Description of Capital Stock -- Series A
Preferred Stock."
(4) The number of shares reflects the number of shares of Common Stock in the
aggregate issuable upon the conversion of the Series B Preferred Stock held
by each person. Each share of Series B Preferred Stock is convertible into
20 shares of Common Stock. See "Description of Capital Stock -- Series B
Preferred Stock."
(5) Reflects the beneficial ownership of the Company's capital stock, assuming
the conversion of the Series A Preferred Stock, Series B Preferred Stock,
Convertible Subordinated Notes and the Bridge Note Warrants. Shares of
Common Stock subject to options, warrants or notes which are currently
exercisable or exercisable within 60 days of February 28, 1998, are deemed
outstanding for computing the percentage of the person holding such
options, warrants or notes, but are not deemed outstanding for computing
the percentage of any other person.
74
<PAGE> 83
(6) Consists of shares held directly by DLJMBP, DLJIP, DLJOP, DLJMBF, DLJCC,
DLJ First, PM Funding, Sprout II and Sprout VI. See "Certain Transactions."
The address of each of DLJMBP, DLJMBF, DLJCC, DLJ First and PM Funding is
277 Park Avenue, New York, New York 10172. The address of DLJIP and DLJOP
is John B. Gorsiraweg 14, Willemstad, Curacao, Netherlands Antilles. The
address of Sprout II and Sprout VI (the "Sprout Group") is 3000 Sand Hill
Road, Building 3, Suite 170, Menlo Park, California 94025. Mr. Dean, as a
Managing Director of DLJMBP, and Mr. Finzi, as a General Partner of the
Sprout Group, may be deemed to share voting and investment power over such
shares. Messrs. Dean and Finzi disclaim beneficial interest in such shares,
except to the extent of their respective interests in DLJ and the Sprout
Entities. Includes 800,000 shares of Common Stock issuable upon the
exercise of the Bridge Note Warrants at an exercise price of $1.55 per
share held by DLJCC and PM Funding. Includes an aggregate of 5,142,720
shares of Common Stock issuable upon the exercise of the Convertible
Subordinated Notes.
(7) Includes 130,000 shares held by Mr. Cormier's children and other relatives
for which Mr. Cormier maintains voting control.
(8) Includes 98,700 shares of Common Stock which are held by Mr. Schaefer's
children and other relatives for which Mr. Schaefer maintains voting
control and 657,500 shares held by Mr. Schaefer's wife as her separate
property.
(9) Includes 43,333 shares that are subject to a right of repurchase in favor
of the Company that lapse in a series of monthly installments ending in
July 2000.
(10) Includes 8,000 shares held in trust for Mr. Erickson's children for which
Mr. Erickson maintains voting control. Includes 95,000 shares that are
subject to a right of repurchase in favor of the Company that lapse in a
series of monthly installments ending in November 1999.
(11) Includes 47,500 shares that are subject to a right of repurchase in favor
of the Company that lapse in a series of monthly installments ending in
November 1999.
(12) Includes immediately exercisable options to purchase 150,000 shares.
Because of limitations under the federal tax laws for Incentive Stock
Options, only options to purchase 113,543 shares are currently exercisable
or exercisable within 60 days of February 28, 1998. The option shares
issuable upon exercise of such option are, prior to vesting, subject to a
right of repurchase in favor of the Company that lapse in a series of
monthly installments ending in October 2001.
(13) Includes immediately exercisable options to purchase 125,000 shares.
Because of limitations under the federal tax laws for Incentive Stock
Options, only options to purchase 92,449 shares are currently exercisable
or exercisable within 60 days of February 28, 1998. The option shares
issuable upon exercise of such option are, prior to vesting, subject to a
right of repurchase in favor of the Company that lapse in a series of
monthly installments ending in July 2001.
(14) Includes immediately exercisable options to purchase 100,000 shares. The
option shares issuable upon exercise of such option are, prior to vesting,
subject to a right of repurchase in favor of the Company that lapse in a
series of monthly installments ending in June 2000.
(15) Includes immediately exercisable options to purchase 50,000 shares. The
option shares issuable upon exercise of such option are, prior to vesting,
subject to a right of repurchase in favor of the Company that will lapse in
a series of annual and monthly installments ending in August 2002.
(16) See Notes 7, 8, 9, 10, 11, 12, 13, 14 and 15. Includes options exercisable
for 485,559 shares of Common Stock under the 1995 Option Plan, and 730,000
shares of Common Stock of which 248,500 shares are subject to a right of
repurchase in favor of the Company that lapses in a series of monthly
installments ending in August 2002. Excludes shares held by DLJ and the
Sprout Entities. See Note 6 above.
75
<PAGE> 84
DESCRIPTION OF INDEBTEDNESS
The following sets forth information concerning indebtedness of the
Company.
NEW CREDIT FACILITY
In connection with the Refinancing, the Company entered into the New Credit
Facility with the Lenders by amending and restating its Former Credit Facility.
The following is a summary of the material terms and conditions of the New
Credit Facility and is subject to the detailed provisions of the amended and
restated credit agreement with the Lenders and the various documents related
thereto.
The New Credit Facility provides the Company with up to $25.0 million of
revolving credit, subject to certain conditions, which limit could be increased
to $40.0 million at the sole discretion of the Lenders. The New Credit Facility
is secured by all of the Company's current and future assets other than (i) the
real estate owned by the Company in San Diego, California on which its
headquarters is located (ii) certain telephone and related equipment and (iii)
certain general intangibles not assignable or capable of being encumbered under
the terms of a license, lease or other agreement. The New Credit Facility is
guaranteed on a secured basis by the Subsidiary Guarantors. The guarantees of
the Subsidiary Guarantors in favor of the Lenders are secured by substantially
all of the existing and future assets of the Subsidiary Guarantors. The
Company's obligations under the New Credit Facility are also secured by a pledge
of all of the outstanding capital stock of the Company's domestic subsidiaries,
and 65% of the outstanding stock of the Company's foreign subsidiaries, who
provide sales support and field service to foreign customers on behalf of the
Company and the Guarantors. The Company and the Subsidiary Guarantors are
prohibited from pledging any of their assets other than under the New Credit
Facility. Indebtedness under the New Credit Facility and the related guarantees
of the Subsidiary Guarantors in favor of the Lenders, to the extent of the
assets securing such obligations, effectively rank senior to indebtedness
outstanding under the New Notes and the New Note Guarantees.
Borrowings under the New Credit Facility are available for working capital
and general corporate purposes, including the issuance of letters of credit,
subject to a borrowing base test and the achievement of certain financial ratios
and compliance with certain conditions and covenants. As of March 31, 1998, the
Company had approximately $16.7 million of borrowing availability less $8.3
million of outstanding borrowings under the New Credit Facility.
All indebtedness outstanding under the New Credit Facility will mature in
January 2001. The initial interest rate for borrowings under the New Credit
Facility will be, at the option of the Company, LIBOR plus 3.0% or the Base Rate
plus 1.0%. The Company may elect interest periods of one, three or six months
for LIBOR borrowings. Calculation of interest will be on the basis of actual
days elapsed in a year of 360 days (or 365 or 366 days, as the case may be, in
the case of Base Rate loans). The Company is obligated to pay a quarterly
commitment fee on the aggregate unused amount of the New Credit Facility at an
annual rate of 0.75% (which amount may be decreased to 0.50% beginning in 1999
under certain circumstances). The "Base Rate" is the higher of (i) the prime
commercial lending rate of Fleet National Bank and (ii) the Federal Funds
Effective Rate plus 0.5%. "LIBOR" is defined as the rate displayed for deposits
in dollars for a period equal to the relevant interest period on page 3750 of
the Telerate Screen (or such other page as may replace such page on such service
for the purpose of displaying the London interbank offered rate of major Banks
for deposits in dollars) two business days prior to the first day of the
relevant interest period. LIBOR will at all times include statutory reserves to
the extent actually incurred.
Indebtedness under the New Credit Facility may be prepaid in whole or in
part without premium or penalty (subject in some cases to interest rate breakage
costs) and the Lenders' commitments relative thereto reduced or terminated upon
such notice and in such amounts as may be agreed upon.
The New Credit Facility contains customary and appropriate representations
and warranties, including, without limitation, those relating to due
organization and authorization, no conflicts with agreements, financial
condition, no material adverse changes, litigation, compliance with laws and
environmental liabilities.
The New Credit Facility also contains, in addition to the borrowing base
test, customary and appropriate conditions to all borrowings under the New
Credit Facility including satisfaction of requirements relating to prior written
notice of borrowing, the accuracy of representations and warranties and the
absence of any default or event of default.
76
<PAGE> 85
The New Credit Facility also contains customary affirmative and negative
covenants, including, without limitation, limitations on other indebtedness,
liens, investments and guarantees, restricted payments, mergers and
acquisitions, sales of assets, capital expenditures, leases and affiliate
transactions. The New Credit Facility also contains financial covenants relating
to minimum interest coverage, minimum net worth, minimum cash flow and
profitability and maximum leverage.
Events of default under the New Credit Facility include those relating to
non-payment of interest, principal or fees payable under the New Credit
Facility; non-performance of certain covenants; cross default to other material
debt of the Company and its subsidiaries (including indebtedness under the New
Notes); bankruptcy or insolvency; judgments in excess of specified amounts;
default under certain related loan documents; materially inaccurate or false
representations or warranties and change of control.
CONVERTIBLE SUBORDINATED NOTES
In connection with the Recapitalization, the Company issued and sold $8.0
million principal amount of its Convertible Subordinated Notes (the "Convertible
Subordinated Notes") to DLJ and the Sprout Entities, pursuant to the Securities
Purchase Agreement.
The Convertible Subordinated Notes mature in July 2005. Interest accrued at
an annual rate of 25.0% for the three-year period between November 23, 1994 (the
"Original Issue Date") and November 23, 1997, and thereafter accrues at an
annual rate equal to the greater of 12.5% and the prime rate plus 2.0%. Interest
is payable at maturity. In the event the Company enters into any transaction
constituting a liquidation, dissolution or winding up of the Company, whether
voluntary or involuntary, the Company is obligated to redeem the Convertible
Subordinated Notes in cash at a price equal to the aggregate principal amount
thereof plus accrued interest (the "Accreted Amount"). The Convertible
Subordinated Notes (including all accrued interest thereon) are convertible into
an aggregate of 5,142,720 shares of the Company's Common Stock at the option of
the holders thereof, and, upon the Company's initial public offering, are
automatically convertible into that number of shares of Common Stock.
The Convertible Subordinated Notes also contain customary anti-dilution
rights and protective voting provisions that, among other things and subject to
certain qualifications, limit the Company's ability to (i) amend, alter or
repeal its Certificate of Incorporation or the charter documents of its
subsidiaries in any manner adverse to the preferences, privileges, voting rights
and powers of the holders of the Convertible Subordinated Notes; (ii)
voluntarily liquidate, dissolve or wind up the Company or any of its
subsidiaries; (iii) voluntarily convey, exchange or transfer all or
substantially all of the Company's assets; (iv) other than indebtedness
outstanding under the New Notes and the New Credit Facility, incur, assume,
refinance, renew, discharge, repay (other than pursuant to regularly scheduled
payments thereof) or cancel any indebtedness of the Company or any of its
subsidiaries, (v) pay dividends or make distributions on capital stock of the
Company and its subsidiaries and (vi) except as required under the terms of the
Indenture related to the New Notes, redeem or repurchase any shares of capital
stock of the Company, without the written consent of the holders of at least 75%
in aggregate Accreted Amount of the Convertible Subordinated Notes.
Events of default under the Convertible Subordinated Notes include, among
other things, (i) a default continuing in payment of all or any part of the
principal or interest payable thereunder when due; (ii) a default under other
Material Debt (as defined in the Convertible Subordinated Notes) of the Company
or any of its subsidiaries or under any mortgage, indenture or other instrument
under which there may be issued or by which there may be secured or evidenced
any Material Debt of the Company or any of its subsidiaries which results in the
acceleration of such indebtedness prior to its stated maturity and (iii) certain
events of bankruptcy or insolvency with respect to the Company or any of its
subsidiaries. Upon the occurrence of an event of default, the holders of a
majority of the aggregate Accreted Amount of the Convertible Subordinated Notes
may declare all outstanding amounts under the Convertible Subordinated Notes to
be immediately due and payable.
The Convertible Subordinated Notes are expressly subordinated to all senior
debt of the Company, including the indebtedness outstanding under the New Notes,
as well as any indebtedness outstanding under the New Credit Facility. The
Convertible Subordinated Notes may be amended with the written consent of the
holders of a majority in aggregate Accreted Amount of the Convertible
Subordinated Notes then outstanding.
77
<PAGE> 86
DESCRIPTION OF NEW NOTES
GENERAL
The Notes were, and the New Notes will be, issued pursuant to the Indenture
dated as of January 30, 1998, among the Company, the direct or indirect domestic
Restricted Subsidiaries of the Company (together, the "Subsidiary Guarantors")
and State Street Bank and Trust Company of California, N.A., as trustee (the
"Trustee"). The terms of the New Notes include those stated in the Indenture and
those made part of the Indenture by reference to the Trust Indenture Act of
1939, as amended (the "Trust Indenture Act"). The New Notes are subject to all
such terms, and Holders of New Notes are referred to the Indenture and the Trust
Indenture Act for a statement thereof. The terms of the New Notes are identical
in all material respects to the Notes, except that the New Notes have been
registered under the Securities Act and, therefore, will not bear restrictive
legends with respect to such registration and will not contain certain
provisions providing for an increase in the interest rate thereon under certain
circumstances described in the Registration Rights Agreement, the provisions of
which will terminate upon the consummation of the Exchange Offer. The following
summary of the material provisions of the Indenture does not purport to be
complete and is qualified by reference to the Indenture, including the
definitions therein of certain terms used below. Copies of the proposed form of
Indenture are available as set forth below under "-- Additional Information."
The definitions of certain terms used in the following summary are set forth
below under "-- Certain Definitions." For purposes of this summary, the term
"Company" refers only to Phase Metrics, Inc. and not to any of its Subsidiaries.
The New Notes will be general unsecured obligations of the Company and will
rank pari passu in right of payment with all current and future unsecured senior
Indebtedness of the Company. The Company's obligations under the New Notes will
be fully and unconditionally guaranteed on an unsecured senior basis by, and
will be joint and several obligations of, the Subsidiary Guarantors. See
"-- Note Guarantees." As of March 31, 1998, the New Notes and the New Note
Guarantees are effectively subordinated to approximately $11.2 million of
secured obligations of the Company and the Subsidiary Guarantors. The Indenture
will permit the incurrence of additional secured Indebtedness in the future. A
copy of the Indenture has been filed as an exhibit to the Registration Statement
of which this Prospectus is a part.
The operations of the Company are conducted in part through its
Subsidiaries, and the Company may, therefore, be dependent upon the cash flow of
its Subsidiaries to meet its debt obligations, including its obligations under
the New Notes. All of the existing domestic Restricted Subsidiaries of the
Company are, and all future domestic Restricted Subsidiaries are expected to be,
Subsidiary Guarantors. As of the date of the Indenture, all of the Company's
Subsidiaries will be Restricted Subsidiaries. However, under certain
circumstances, the Company will be able to designate current or future
Subsidiaries as Unrestricted Subsidiaries. Unrestricted Subsidiaries will not be
subject to many of the restrictive covenants set forth in the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The New Notes will be limited in aggregate principal amount to $110.0
million and will mature on February 1, 2005. Interest on the New Notes will
accrue at the rate of 10 3/4% per annum and will be payable semiannually in
arrears on February 1 and August 1 of each year, commencing on August 1, 1998,
to Holders of record on the immediately preceding January 15 and July 15.
Interest on the New Notes will accrue from the most recent date to which
interest has been paid or, if no interest has been paid, from the date of
original issuance. Interest will be computed on the basis of a 360-day year
comprised of twelve 30-day months. Principal, premium and Liquidated Damages, if
any, and interest on the New Notes will be payable at the office or agency of
the Company maintained for such purpose within the City and State of New York
or, at the option of the Company, payment of interest and Liquidated Damages, if
any, may be made by check mailed to the Holders of the New Notes at their
respective addresses set forth in the register of Holders of New Notes; provided
that all payments of principal, premium and Liquidated Damages, if any, and
interest with respect to New Notes the Holders of which have given wire transfer
instructions to the Company will be required to be made by wire transfer of
immediately available funds to the accounts specified by the Holders thereof.
Until
78
<PAGE> 87
otherwise designated by the Company, the Company's office or agency in New York
will be the office of the Trustee maintained for such purpose. The New Notes
will be issued in denominations of $1,000 and integral multiples thereof.
NEW NOTE GUARANTEES
The Company's payment obligations under the New Notes will be fully and
unconditionally guaranteed by the Subsidiary Guarantors on a joint and several
basis. The New Note Guarantees will be general unsecured obligations of the
Subsidiary Guarantors, will rank senior in right of payment to all subordinated
Indebtedness of the Subsidiary Guarantors and pari passu in right of payment to
all existing and future senior Indebtedness of the Subsidiary Guarantors, if
any. The obligations of any Subsidiary Guarantor under its New Note Guarantee
will be limited so as not to constitute a fraudulent conveyance under applicable
law.
The Indenture will provide that no Subsidiary Guarantor may consolidate
with or merge with or into (whether or not such Subsidiary Guarantor is the
surviving Person), another corporation, Person or entity whether or not
affiliated with such Subsidiary Guarantor unless, subject to the provisions of
the following paragraph, (i) the Person formed by or surviving any such
consolidation or merger (if other than such Subsidiary Guarantor) assumes all
the obligations of such Subsidiary Guarantor pursuant to a supplemental
indenture in form and substance reasonably satisfactory to the Trustee, under
the New Notes and the Indenture; (ii) immediately after giving effect to such
transaction, no Default or Event of Default exists; (iii) such Subsidiary
Guarantor, or any Person formed by or surviving any such consolidation or
merger, would have Consolidated Net Worth (immediately after giving effect to
such transaction) equal to or greater than the Consolidated Net Worth of such
Subsidiary Guarantor immediately preceding the transaction and (iv) the Company
would be permitted by virtue of its pro forma Fixed Charge Coverage Ratio,
immediately after giving effect to such transaction, to incur at least $1.00 of
additional Indebtedness (other than Permitted Indebtedness) pursuant to the
Fixed Charge Coverage Ratio test set forth in the covenant described below under
the caption "-- Certain Covenants -- Incurrence of Indebtedness and Issuance of
Preferred Stock." The requirements of clauses (i), (iii) and (iv) of this
paragraph will not apply in the case of a consolidation with or merger with or
into the Company or another Subsidiary Guarantor.
The Indenture will provide that (i) in the event of a sale or other
disposition of all of the assets of any Subsidiary Guarantor, by way of merger,
consolidation or otherwise, or a sale or other disposition of all of the capital
stock of any Subsidiary Guarantor, or (ii) in the event that the Company
designates a Subsidiary Guarantor to be an Unrestricted Subsidiary, or such
Subsidiary Guarantor ceases to be a Subsidiary of the Company, then such
Subsidiary Guarantor (in the event of a sale or other disposition, by way of
such a merger, consolidation or otherwise, of all of the capital stock of such
Subsidiary Guarantor or any such designation) or the entity acquiring the
property (in the event of a sale or other disposition of all of the assets of
such Subsidiary Guarantor) will be released and relieved of any obligations
under its New Note Guarantee; provided, that the Net Proceeds of such sale or
other disposition are applied in accordance with the applicable provisions of
the Indenture. See "--Repurchase at the Option of Holders." In the case of a
sale, assignment, lease, transfer, conveyance or other disposition of all or
substantially all of the assets of a Subsidiary Guarantor, upon the assumption
provided for in clause (ii) of the covenant described under the caption
"-- Certain Covenants -- Merger, Consolidation, or Sale of Assets," such
Subsidiary Guarantor shall be discharged from all further liability and
obligation under the Indenture.
79
<PAGE> 88
OPTIONAL REDEMPTION
The New Notes will not be redeemable at the Company's option prior to
February 1, 2002. Thereafter, the New Notes will be subject to redemption at any
time at the option of the Company, in whole or in part, upon not less than 30
nor more than 60 days' notice, at the redemption prices (expressed as
percentages of principal amount) set forth below plus accrued and unpaid
interest and Liquidated Damages thereon, if any, to the applicable redemption
date, if redeemed during the twelve-month period beginning on February 1 of the
years indicated below:
<TABLE>
<CAPTION>
YEAR PERCENTAGE
---- ----------
<S> <C>
2002........................................................ 105.375%
2003........................................................ 102.688%
2004 and thereafter......................................... 100.000%
</TABLE>
Notwithstanding the foregoing, at any time prior to February 1, 2001, the
Company may redeem up to 33% of the original aggregate principal amount of New
Notes at a redemption price of 110.75% of the principal amount thereof, plus
accrued and unpaid interest and Liquidated Damages thereon, if any, to the
redemption date, with the net cash proceeds of a Public Equity Offering;
provided, that at least 67% of the original aggregate principal amount of New
Notes remains outstanding immediately after the occurrence of such redemption;
and provided, further, that such redemption shall occur within 90 days of the
date of the closing of such Public Equity Offering.
SELECTION AND NOTICE
If less than all of the New Notes are to be redeemed at any time, selection
of New Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange, if any, on which the
New Notes are listed, or, if the New Notes are not so listed, on a pro rata
basis, by lot or by such method as the Trustee shall deem fair and appropriate;
provided, that no New Notes of $1,000 or less shall be redeemed in part. Notices
of redemption shall be mailed by first class mail at least 30 but not more than
60 days before the redemption date to each Holder of New Notes to be redeemed at
its registered address. Notices of redemption may not be conditional. If any New
Note is to be redeemed in part only, the notice of redemption that relates to
such New Note shall state the portion of the principal amount thereof to be
redeemed. A new note in principal amount equal to the unredeemed portion thereof
will be issued in the name of the Holder thereof upon cancellation of the
original New Note. New Notes called for redemption become due on the date fixed
for redemption. On and after the redemption date, interest ceases to accrue on
New Notes or portions of them called for redemption.
MANDATORY REDEMPTION
Except as set forth below under "-- Repurchase at the Option of Holders,"
the Company is not required to make mandatory redemption or sinking fund
payments with respect to the New Notes.
REPURCHASE AT THE OPTION OF HOLDERS
Change of Control
Upon the occurrence of a Change of Control, each Holder of New Notes will
have the right to require the Company to repurchase all or any part (equal to
$1,000 or an integral multiple thereof) of such Holder's New Notes pursuant to
the offer described below (the "Change of Control Offer") at an offer price in
cash equal to 101% of the aggregate principal amount thereof plus accrued and
unpaid interest and Liquidated Damages thereon, if any, to the date of purchase
(the "Change of Control Payment"). Within 30 days following any Change of
Control, the Company will mail a notice to each Holder describing the
transaction or transactions that constitute the Change of Control and offering
to repurchase New Notes on the date specified in such notice, which date shall
be no earlier than 30 days and no later than 60 days from the date such notice
is mailed (the "Change of Control Payment Date"), pursuant to the procedures
required by the Indenture and described in such notice. The Company will comply
with the requirements of Rule 14e-1 under the Exchange
80
<PAGE> 89
Act and any other securities laws and regulations thereunder to the extent such
laws and regulations are applicable in connection with the repurchase of the New
Notes as a result of a Change of Control.
On the Change of Control Payment Date, the Company will, to the extent
lawful, (1) accept for payment all New Notes or portions thereof properly
tendered pursuant to the Change of Control Offer, (2) deposit with the Paying
Agent an amount equal to the Change of Control Payment in respect of all New
Notes or portions thereof so tendered and (3) deliver or cause to be delivered
to the Trustee the New Notes so accepted together with an Officers' Certificate
stating the aggregate principal amount of New Notes or portions thereof being
purchased by the Company. The Paying Agent will promptly mail to each Holder of
New Notes so tendered the Change of Control Payment for such New Notes, and the
Trustee will promptly authenticate and mail (or cause to be transferred by book
entry) to each Holder a new note equal in principal amount to any unpurchased
portion of the New Notes surrendered, if any; provided, that each such new note
will be in a principal amount of $1,000 or an integral multiple thereof.
The Change of Control provisions described above will be applicable whether
or not any other provisions of the Indenture are applicable. Except as described
above with respect to a Change of Control, the Indenture does not contain
provisions that permit the Holders of the New Notes to require that the Company
repurchase or redeem the New Notes in the event of a takeover, recapitalization
or similar transaction.
The Company will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set forth
in the Indenture applicable to a Change of Control Offer made by the Company and
purchases all New Notes validly tendered and not withdrawn under such Change of
Control Offer.
The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the assets of the Company and its Subsidiaries taken as a whole. Although
there is a developing body of case law interpreting the phrase "substantially
all," there is no precise established definition of that phrase under applicable
law. Accordingly, the ability of a Holder of New Notes to require the Company to
repurchase such Notes as a result of a sale, lease, transfer, conveyance or
other disposition of less than all of the assets of the Company and its
Subsidiaries taken as a whole to another Person or group may be uncertain.
Asset Sales
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, consummate an Asset Sale unless (i) the
Company (or the Restricted Subsidiary, as the case may be) receives
consideration at the time of such Asset Sale at least equal to the fair market
value (evidenced by a resolution of the Board of Directors set forth in an
Officers' Certificate delivered to the Trustee) of the assets or Equity
Interests issued or sold or otherwise disposed of and (ii) at least 75% of the
consideration therefor received by the Company or such Restricted Subsidiary is
in the form of (a) cash or Cash Equivalents or (b) property or assets that are
used or useful in a Permitted Business, or Capital Stock of any Person primarily
engaged in a Permitted Business if, as a result of the acquisition by the
Company or any Restricted Subsidiary thereof, such Person becomes a Restricted
Subsidiary; provided, that the amount of (x) any liabilities of the Company or
any Restricted Subsidiary (other than contingent liabilities and liabilities of
the Company that are by their terms subordinated to the New Notes or any
guarantee thereof) that are assumed by the transferee of any such assets
pursuant to the customary novation agreement that releases the Company or such
Restricted Subsidiary from further liability and (y) any notes or other
obligations received by the Company or any such Restricted Subsidiary from such
transferee that are converted by the Company or such Restricted Subsidiary into
cash or Cash Equivalents (to the extent of the cash or Cash Equivalents
received) within 180 days following the closing of such Asset Sale, will be
deemed to be cash for purposes of this provision; provided, further, that the
75% limitation referred to above shall not apply to any sale, transfer or other
disposition of assets in which the cash portion of the consideration received
therefor, determined in accordance with the foregoing proviso, is equal to or
greater than what the after-tax net proceeds would have been had such
transaction complied with the aforementioned 75% limitation.
81
<PAGE> 90
Within 270 days after the receipt of any Net Proceeds from an Asset Sale,
the Company may apply such Net Proceeds, at its option, (a) to permanently repay
Indebtedness outstanding under the New Credit Facility (and to correspondingly
reduce commitments with respect to the revolving borrowings thereunder) or other
Pari Passu Indebtedness; provided, that if the Company shall so repay other Pari
Passu Indebtedness, it will equally and ratably reduce Indebtedness under the
New Notes if the New Notes are then redeemable or, if the New Notes may not be
then redeemed, the Company shall make an offer to all Holders to purchase at
100% of the principal amount thereof the amount of New Notes that would
otherwise be redeemed or (b) to an investment in property, capital expenditures
or assets that are used or useful in a Permitted Business, or Capital Stock of
any Person primarily engaged in a Permitted Business if, as a result of the
acquisition by the Company or any Restricted Subsidiary thereof, such Person
becomes a Restricted Subsidiary. Any Net Proceeds from Asset Sales that are not
applied or invested as provided in the preceding sentence of this paragraph will
be deemed to constitute "Excess Proceeds." Pending the final application of any
such Net Proceeds, the Company may temporarily reduce the revolving Indebtedness
under the New Credit Facility or otherwise invest such Net Proceeds in any
manner that is not prohibited by the Indenture. Any Net Proceeds from Asset
Sales that are not applied or invested as provided in the first sentence of this
paragraph will be deemed to constitute "Excess Proceeds." When the aggregate
amount of Excess Proceeds exceeds $15.0 million, the Company will be required to
make an offer to all Holders of New Notes (an "Asset Sale Offer") to purchase
the maximum principal amount of New Notes that may be purchased out of the
Excess Proceeds, at an offer price in cash in an amount equal to 100% of the
principal amount thereof plus accrued and unpaid interest and Liquidated
Damages, if any, thereon, to the date of purchase, in accordance with the
procedures set forth in the Indenture. To the extent that the aggregate amount
of New Notes tendered pursuant to an Asset Sale Offer is less than the Excess
Proceeds, the Company may use any remaining Excess Proceeds for general
corporate purposes. If the aggregate principal amount of New Notes surrendered
by Holders thereof exceeds the amount of Excess Proceeds, the Trustee shall
select the New Notes to be purchased on a pro rata basis. Upon completion of
such offer to purchase, the amount of Excess Proceeds shall be reset at zero.
The Company will comply with the requirements of Rule 14e-1 under the Exchange
Act and any other securities laws and regulations thereunder to the extent such
laws and regulations are applicable in connection with the repurchase of the New
Notes as a result of an Asset Sale Offer.
CERTAIN COVENANTS
Restricted Payments
The Indenture will provide that from and after the date of the Indenture
the Company will not, and will not permit any of its Restricted Subsidiaries to,
directly or indirectly: (i) declare or pay any dividend or make any other
payment or distribution on account of the Company's or any of its Restricted
Subsidiaries' Equity Interests (including, without limitation, any payment in
connection with any merger or consolidation involving the Company) or to the
direct or indirect holders of the Company's or any of its Restricted
Subsidiaries' Equity Interests in their capacity as such (other than dividends
or distributions payable in Equity Interests (other than Disqualified Stock) of
the Company); (ii) purchase, redeem or otherwise acquire or retire for value
(including without limitation, in connection with any merger or consolidation
involving the Company) any Equity Interests of the Company or any direct or
indirect parent of the Company; (iii) make any payment on or with respect to, or
purchase, redeem, defease or otherwise acquire or retire for value any Pari
Passu Indebtedness or any Indebtedness which is subordinated to the New Notes,
except scheduled payments of interest or principal at Stated Maturity of such
Indebtedness or (iv) make any Restricted Investment (all such payments and other
actions set forth in clauses (i) through (iv) above being collectively referred
to as "Restricted Payments"), unless, at the time of and after giving effect to
such Restricted Payment:
(a) no Default or Event of Default shall have occurred and be
continuing or would occur as a consequence thereof;
(b) the Company would, at the time of such Restricted Payment and
after giving pro forma effect thereto as if such Restricted Payment had
been made at the beginning of the applicable four-quarter period, have been
permitted to incur at least $1.00 of additional Indebtedness pursuant to
the Fixed
82
<PAGE> 91
Charge Coverage Ratio test set forth in the first paragraph of the covenant
described below under caption "--Incurrence of Indebtedness and Issuance of
Preferred Stock"; and
(c) such Restricted Payment, together with the aggregate amount of all
other Restricted Payments made by the Company and its Subsidiaries after
the date of the Indenture (excluding Restricted Payments permitted by
clause (ii) of the next succeeding paragraph), is less than the sum of (i)
50% of the Consolidated Net Income of the Company for the period (taken as
one accounting period) from the beginning of the first fiscal quarter
commencing after the date of the Indenture to the end of the Company's most
recently ended fiscal quarter for which internal financial statements are
available at the time of such Restricted Payment (or, if such Consolidated
Net Income for such period is a deficit, less 100% of such deficit), plus
(ii) 100% of the aggregate net cash proceeds received by the Company from
the issue or sale since the date of the Indenture of Equity Interests of
the Company (other than Disqualified Stock) or of Disqualified Stock or
debt securities of the Company that have been converted into such Equity
Interests (other than Equity Interests (or Disqualified Stock or
convertible debt securities) sold to a Subsidiary of the Company and other
than Disqualified Stock or convertible debt securities that have been
converted into Disqualified Stock), plus (iii) to the extent that any
Restricted Investment that was made after the date of the Indenture is sold
for cash or otherwise liquidated or repaid for cash, the lesser of (A) the
cash return of capital with respect to such Restricted Investment (less the
cost of disposition, if any) and (B) the initial amount of such Restricted
Investment, plus (iv) if any Unrestricted Subsidiary (A) the assets of
which are used or useful in, or which is engaged in, one or more Permitted
Businesses is redesignated as a Restricted Subsidiary, the fair market
value of such redesignated Subsidiary (as determined in good faith by the
Board of Directors) as of the date of its redesignation or (B) pays any
cash dividends or cash distributions to the Company or any of its
Restricted Subsidiaries, 50% of any such cash dividends or cash
distributions made after the date of the Indenture.
The provisions of the immediately preceding paragraph will not prohibit (i)
the payment of any dividend within 60 days after the date of declaration
thereof, if at said date of declaration such payment would have complied with
the provisions of the Indenture; (ii) the redemption, repurchase, retirement,
defeasance or other acquisition of any Indebtedness subordinated to the New
Notes or Equity Interests of the Company in exchange for, or out of the net cash
proceeds of the substantially concurrent sale or issuance (other than to a
Restricted Subsidiary of the Company) of, other Equity Interests of the Company
(other than any Disqualified Stock); (iii) the defeasance, redemption,
repurchase or other acquisition of Pari Passu Indebtedness or Indebtedness
subordinated to the New Notes with the net cash proceeds from an incurrence of
Permitted Refinancing Indebtedness; (iv) the payment of any dividend by a
Restricted Subsidiary of the Company to the holders of its Equity Interests on a
pro rata basis; (v) optional and mandatory prepayments on any revolving credit
Indebtedness incurred under the New Credit Facility or (vi) any other Restricted
Payment which, together with all other Restricted Payments made pursuant to this
clause (vi) after the date of the Indenture, does not exceed $5.0 million in the
aggregate (in each case, after giving effect to all subsequent reductions in the
amount of any Restricted Investment made pursuant to this clause (vi) either as
a result of (A) the repayment of disposition thereof for cash or (B) the
redesignation of an Unrestricted Subsidiary as a Restricted Subsidiary (valued
proportionate to the Company's equity interest in such Subsidiary at the time of
such redesignation), but, in the case of clauses (A) and (B), not to exceed the
amount of such Restricted Investment previously made pursuant to this clause
(vi); provided that in the case of each of clauses (i) through (vi) no Default
or Event of Default shall have occurred and be continuing after making such
Restricted Payment.
The Board of Directors may designate any Restricted Subsidiary to be an
Unrestricted Subsidiary if such designation would not cause a Default or Event
of Default; provided, that in no event shall the business currently operated by
any Subsidiary Guarantor be transferred to or held by an Unrestricted
Subsidiary. For purposes of making such determination, all outstanding
Investments by the Company and its Restricted Subsidiaries (except to the extent
repaid in cash) in the Subsidiary so designated will be deemed to be Restricted
Payments at the time of such designation and will reduce the amount available
for Restricted Payments under the first paragraph of this covenant. All such
outstanding Investments will be deemed to
83
<PAGE> 92
constitute Investments in an amount equal to the fair market value of such
Investments at the time of such designation (as determined in good faith by the
Board of Directors). Such designation will only be permitted if such Restricted
Payment would be permitted at such time and if such Restricted Subsidiary
otherwise meets the definition of an Unrestricted Subsidiary.
The amount of all Restricted Payments (other than cash) shall be the fair
market value on the date of the Restricted Payment of the asset(s) or securities
proposed to be transferred or issued by the Company or such Subsidiary, as the
case may be, pursuant to the Restricted Payment. The fair market value of any
non-cash Restricted Payment shall be determined in good faith by the Board of
Directors whose resolution with respect thereto shall be delivered to the
Trustee; such determination will be based upon an opinion or appraisal issued by
an accounting, appraisal or investment banking firm of national standing if such
fair market value exceeds $1.0 million. Not later than the date of making any
Restricted Payment, the Company shall deliver to the Trustee an Officers'
Certificate stating that such Restricted Payment is permitted and setting forth
the basis upon which the calculations required by the covenant "-- Restricted
Payments" were computed, together with a copy of any fairness opinion or
appraisal required by the Indenture.
Incurrence of Indebtedness and Issuance of Preferred Stock
The Indenture provides that the Company will not, and will not permit any
of its Subsidiaries to, directly or indirectly, create, incur, issue, assume,
guarantee or otherwise become directly or indirectly liable, contingently or
otherwise, with respect to (collectively, "incur") any Indebtedness (including
Acquired Debt) and that the Company will not issue any Disqualified Stock and
will not permit any of its Subsidiaries to issue any shares of preferred stock;
provided, however, that the Company may incur Indebtedness (including Acquired
Debt) or issue shares of Disqualified Stock if the Fixed Charge Coverage Ratio
for the Company's most recently ended four full fiscal quarters for which
internal financial statements are available immediately preceding the date on
which such additional Indebtedness is incurred or such Disqualified Stock is
issued would have been at least 2.0 to 1 if the date on which the Indebtedness
is incurred is prior to February 1, 2000, and at least 2.5 to 1 if the date on
which the Indebtedness is incurred is on or after February 1, 2000, determined
on a pro forma basis (including a pro forma application of the net proceeds
therefrom), as if the additional Indebtedness had been incurred, or the
Disqualified Stock had been issued, as the case may be, at the beginning of such
four-quarter period.
The provisions of the first paragraph of this covenant will not apply to
the incurrence of any of the following items of Indebtedness (collectively,
"Permitted Debt"):
(i) the incurrence by the Company and the Subsidiary Guarantors of
Indebtedness pursuant to the New Credit Facility; provided, that the
aggregate principal amount of all such Indebtedness (with letters of credit
being deemed to have a principal amount equal to the maximum potential
liability of the Company thereunder) outstanding under the New Credit
Facility after giving effect to such incurrence does not exceed the sum of
$40.0 million;
(ii) the incurrence by the Company and its Restricted Subsidiaries of
the Existing Indebtedness;
(iii) the incurrence by the Company and the Subsidiary Guarantors of
Indebtedness represented by the New Notes and the New Note Guarantees,
respectively;
(iv) the incurrence by the Company or any of its Restricted
Subsidiaries of Indebtedness represented by Capital Lease Obligations,
mortgage financings or purchase money obligations, in each case (other than
in the case of a mortgage financing secured by the real estate (and
personal property associated with such real estate) owned by the Company in
San Diego, California on which the Company's headquarters is located on the
date of the Indenture) incurred for the purpose of financing all or any
part of the purchase price or cost of construction or improvement of
property, plant or equipment used in the business of the Company or such
Restricted Subsidiary (whether through the direct purchase of assets or the
Capital Stock of any Person owning such Assets), in an aggregate principal
amount not to exceed $10.0 million at any time outstanding;
84
<PAGE> 93
(v) the incurrence by the Company or any of its Restricted
Subsidiaries of Indebtedness in connection with the acquisition of assets
or a new Restricted Subsidiary; provided, that such Indebtedness was
incurred by the prior owner of such assets or such Restricted Subsidiary
prior to such acquisition by the Company or one of its Subsidiaries and was
not incurred in connection with, or in contemplation of, such acquisition
by the Company or one of its Subsidiaries; provided, further, that the
principal amount (or accreted value, as applicable) of such Indebtedness,
together with any other outstanding Indebtedness incurred pursuant to this
clause (v), does not exceed $5.0 million;
(vi) the incurrence by the Company or any of its Restricted
Subsidiaries of Permitted Refinancing Indebtedness in exchange for, or the
net proceeds of which are used to refund, refinance or replace Indebtedness
that was permitted by the Indenture to be incurred;
(vii) the incurrence by the Company or any of its Restricted
Subsidiaries of intercompany Indebtedness between the Company and any of
its Wholly Owned Restricted Subsidiaries or between one Wholly Owned
Restricted Subsidiary and another Wholly Owned Restricted Subsidiary;
provided, however, that (a) if the Company is the obligor on such
Indebtedness and the payee is not a Subsidiary Guarantor, such Indebtedness
is expressly subordinated to the prior payment in full in cash of all
Obligations with respect to the Notes; (b) if a Wholly Owned Restricted
Subsidiary that is not a Subsidiary Guarantor is the obligor on such
Indebtedness, such Indebtedness, to the extent owing to the Company or any
Subsidiary Guarantor, does not exceed $5.0 million in aggregate principal
amount at any time outstanding and (c) (x) any subsequent issuance or
transfer of Equity Interests that results in any such Indebtedness being
held by a Person other than the Company or a Wholly Owned Restricted
Subsidiary and (y) any sale or other transfer of any such Indebtedness to a
Person that is not either the Company or a Wholly Owned Restricted
Subsidiary shall be deemed, in each case, to constitute an incurrence of
such Indebtedness by the Company or such Restricted Subsidiary, as the case
may be, that was not permitted by this clause (vii);
(viii) the incurrence by the Company or any of its Restricted
Subsidiaries of Hedging Obligations that are incurred for the purpose of
fixing or hedging (a) currency risk or interest rate risk with respect to
any floating rate Indebtedness that is permitted by the terms of this
Indenture to be outstanding or (b) exchange rate risk with respect to
agreements or Indebtedness of such Person payable denominated in a currency
other than U.S. dollars; provided, that such agreements do not increase the
Indebtedness of the obligor outstanding at any time other than as a result
of fluctuations in foreign currency exchange rates or interest rates or by
reason of fees, indemnities and compensation payable thereunder;
(ix) the Guarantee by the Company or any of its Restricted
Subsidiaries of Indebtedness of the Company or a Restricted Subsidiary of
the Company that was permitted to be incurred by another provision of this
covenant;
(x) the incurrence by the Company's Unrestricted Subsidiaries of
Non-Recourse Debt; provided, however, that if any such Indebtedness ceases
to be Non-Recourse Debt of an Unrestricted Subsidiary, such event shall be
deemed to constitute an incurrence of Indebtedness by a Restricted
Subsidiary of the Company;
(xi) Indebtedness incurred by the Company or any of its Restricted
Subsidiaries constituting reimbursement obligations with respect to letters
of credit issued in the ordinary course of business, including without
limitation to letters of credit in respect to workers' compensation claims
or self-insurance, or other Indebtedness with respect to reimbursement type
obligations regarding workers' compensation claims; provided, however, that
upon the drawing of such letters of credit or the incurrence of such
Indebtedness, such obligations are reimbursed within 30 days following such
drawing or incurrence;
(xii) Indebtedness arising from agreements of the Company or a
Restricted Subsidiary providing for indemnification, adjustment of purchase
price or similar obligations, in each case, incurred or assumed in
connection with the disposition of any business, asset or Subsidiary, other
than guarantees of Indebtedness incurred by any Person acquiring all or any
portion of such business, assets or Subsidiary for
85
<PAGE> 94
the purpose of financing such acquisition; provided, that (a) such
Indebtedness is not reflected on the balance sheet of the Company or any
Restricted Subsidiary (contingent obligations referred to in a footnote to
financial statements and not otherwise reflected on the balance sheet will
not be deemed to be reflected on such balance sheet for purposes of this
clause (a)) and (b) the maximum assumable liability in respect of all such
Indebtedness shall at no time exceed the gross proceeds including non-cash
proceeds (the fair market value of such non-cash proceeds being measured at
the time received and without giving effect to any subsequent changes in
value) actually received by the Company and its Restricted Subsidiaries in
connection with such disposition;
(xiii) Obligations in respect of performance and surety bonds and
completion guarantees provided by the Company or any Restricted Subsidiary
in the ordinary course of business;
(xiv) the incurrence by Foreign Subsidiaries which are not Guarantors
of Indebtedness in connection with the financing of accounts or notes
receivable outside of the United States in an aggregate principal amount at
any time outstanding, including all Permitted Refinancing Indebtedness
incurred to refund, refinance or replace any other Indebtedness incurred
pursuant to this clause (xiv) not to exceed $10.0 million; provided, that
neither the Company nor any Guarantor shall have guaranteed or provided
credit support of any kind (including any undertaking, agreement or
instrument which would constitute Indebtedness) with respect to such
Indebtedness; and
(xv) the incurrence by the Company or any of its Restricted
Subsidiaries of additional Indebtedness, incurred after the date of the
Indenture, in an aggregate principal amount (or accreted value, as
applicable) at any time outstanding, including all Permitted Refinancing
Indebtedness incurred to refund, refinance or replace any other
Indebtedness incurred pursuant to this clause (xv), not to exceed $15.0
million.
For purposes of determining compliance with this covenant, in the event
that an item of Indebtedness meets the criteria of more than one of the
categories of Permitted Debt described in clauses (i) through (xv) above or is
entitled to be incurred pursuant to the first paragraph of this covenant, the
Company shall, in its sole discretion, classify such item of Indebtedness in any
manner that complies with this covenant and such item of Indebtedness will be
treated as having been incurred pursuant to only one of such clauses or pursuant
to the first paragraph hereof. Accrual of interest and the accretion of accreted
value will not be deemed to be an incurrence of Indebtedness for purposes of
this covenant.
Liens
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, create, incur, assume or otherwise cause or
suffer to exist or become effective any Lien (other than Permitted Liens) upon
any of their property or assets, now owned or hereafter acquired.
Dividend and Other Payment Restrictions Affecting Restricted Subsidiaries
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, directly or indirectly, create or otherwise
cause or suffer to exist or become effective any encumbrance or restriction on
the ability of any Restricted Subsidiary to (i) (a) pay dividends or make any
other distributions to the Company or any of its Restricted Subsidiaries (1) on
its Capital Stock or (2) with respect to any other interest or participation in,
or measured by, its profits, or (b) pay any indebtedness owed to the Company or
any of its Restricted Subsidiaries, (ii) make loans or advances to the Company
or any of its Restricted Subsidiaries or (iii) transfer any of its properties or
assets to the Company or any of its Restricted Subsidiaries, except for such
encumbrances or restrictions existing under or by reason of (a) Existing
Indebtedness as in effect on the date of the Indenture, (b) the New Credit
Facility as in effect as of the date of the Indenture, and any amendments,
modifications, restatements, renewals, increases, supplements, refundings,
replacements or refinancings thereof; provided, that such amendments,
modifications, restatements, renewals, increases, supplements, refundings,
replacements or refinancings are no more restrictive in the aggregate with
respect to such dividend and other payment restrictions than those contained in
the New Credit Facility as in effect on the date of the Indenture, (c) the
Indenture and the Notes, (d) any applicable
86
<PAGE> 95
law, rule, regulation or order, (e) any instrument governing Indebtedness or
Capital Stock of a Person acquired by the Company or any of its Restricted
Subsidiaries as in effect at the time of such acquisition (except to the extent
such Indebtedness was incurred in connection with or in contemplation of such
acquisition), which encumbrance or restriction is not applicable to any Person,
or the properties or assets of any Person, other than the Person, or the
property or assets of the Person, so acquired; provided, that, in the case of
Indebtedness, such Indebtedness was permitted by the terms of the Indenture to
be incurred, (f) customary non-assignment provisions in leases entered into in
the ordinary course of business and consistent with past practices, (g) purchase
money obligations for property acquired in the ordinary course of business that
impose restrictions of the nature described in clause (iii) above on the
property so acquired, (h) Permitted Refinancing Indebtedness; provided, that the
material restrictions contained in the agreements governing such Permitted
Refinancing Indebtedness are no more restrictive than those contained in the
agreements governing the Indebtedness being refinanced, and (i) contracts for
the sale of assets, including without limitation customary restrictions with
respect to a Subsidiary pursuant to an agreement that has been entered into for
the sale or disposition of all or substantially all of the Capital Stock or
assets of such Subsidiary.
Merger, Consolidation, or Sale of Assets
The Indenture provides that the Company may not consolidate or merge with
or into (whether or not the Company is the surviving corporation), or sell,
assign, transfer, lease, convey or otherwise dispose of all or substantially all
of its properties or assets in one or more related transactions, to another
Person unless (i) the Company is the surviving corporation or the Person formed
by or surviving any such consolidation or merger (if other than the Company) or
to which such sale, assignment, transfer, lease, conveyance or other disposition
shall have been made is a corporation organized or existing under the laws of
the United States, any state thereof or the District of Columbia; (ii) the
Person formed by or surviving any such consolidation or merger (if other than
the Company) or the Person to which such sale, assignment, transfer, lease,
conveyance or other disposition shall have been made assumes all the obligations
of the Company under the Notes and the Indenture pursuant to a supplemental
indenture in a form reasonably satisfactory to the Trustee; (iii) immediately
after such transaction no Default or Event of Default exists; (iv) except in the
case of a merger of the Company with or into a Wholly Owned Restricted
Subsidiary of the Company, the Company or the entity or Person formed by or
surviving any such consolidation or merger (if other than the Company), or to
which such sale, assignment, transfer, lease, conveyance or other disposition
shall have been made will, at the time of such transaction and after giving pro
forma effect thereto as if such transaction had occurred at the beginning of the
applicable four-quarter period, be permitted to incur at least $1.00 of
additional Indebtedness pursuant to the Fixed Charge Coverage Ratio test set
forth in the first paragraph of the covenant described above under the caption
"-- Incurrence of Indebtedness and Issuance of Preferred Stock," and (v) each
Subsidiary Guarantor, unless it is the other party to the transactions described
above, shall have by supplemental indenture confirmed that its New Note
Guarantee shall apply to such Person's obligations under the Indenture and the
New Notes.
Transactions with Affiliates
The Indenture provides that the Company will not, and will not permit any
of its Restricted Subsidiaries to, make any payment to, or sell, lease, transfer
or otherwise dispose of any of its properties or assets to, or purchase any
property or assets from, or enter into or make or amend any transaction,
contract, agreement, understanding, loan, advance or guarantee with, or for the
benefit of, any Affiliate (each of the foregoing, an "Affiliate Transaction")
unless (i) such Affiliate Transaction is on terms that are no less favorable to
the Company or the relevant Restricted Subsidiary than those that would have
been obtained in a comparable transaction by the Company or such Restricted
Subsidiary with an unrelated Person and (ii) the Company delivers to the Trustee
(a) with respect to any Affiliate Transaction or series of related Affiliate
Transactions involving aggregate consideration in excess of $1.0 million, a
resolution of the Board of Directors set forth in an Officers' Certificate
certifying that such Affiliate Transaction complies with clause (i) above and
that such Affiliate Transaction has been approved by a majority of the
disinterested members of the Board of Directors and (b) with respect to any
Affiliate Transaction or series of related Affiliate Transactions involving
aggregate
87
<PAGE> 96
consideration in excess of $5.0 million, an opinion as to the fairness to the
Holders of such Affiliate Transaction from a financial point of view issued by
an accounting, appraisal or investment banking firm of national standing;
provided, that the following shall not be deemed Affiliate Transactions: (1) any
employment agreement entered into by the Company or any of its Restricted
Subsidiaries in the ordinary course of business and consistent with the past
practice of the Company or such Restricted Subsidiary, (2) transactions between
or among the Company and/or its Restricted Subsidiaries, (3) Permitted
Investments and Restricted Payments that are permitted by the provisions of the
Indenture described above under the caption "--Restricted Payments," (4)
customary loans, advances, fees and compensation paid to, and indemnity provided
on behalf of, officers, directors, employees or consultants of the Company or
any of its Restricted Subsidiaries, (5) transactions in accordance with the
Securityholders Agreement, as amended; provided, that no such amendment contains
any provisions that are materially adverse to the Holders of the New Notes, and
(6) transactions between the Company or its Restricted Subsidiaries on the one
hand, and DLJ or its Affiliates, on the other hand, involving the provision of
financial, advisory, placement or underwriting services by DLJ; provided, that
fees payable to DLJ do not exceed the usual and customary fees of DLJ for
similar services.
Limitation on Issuances and Sales of Capital Stock of Wholly Owned Restricted
Subsidiaries
The Indenture provides that the Company (i) will not, and will not permit
any Wholly Owned Restricted Subsidiary of the Company to, transfer, convey,
sell, lease or otherwise dispose of any Capital Stock of any Wholly Owned
Subsidiary of the Company to any Person (other than the Company or a Wholly
Owned Restricted Subsidiary of the Company), unless (a) such transfer,
conveyance, sale, lease or other disposition is of all the Capital Stock of such
Wholly Owned Restricted Subsidiary and (b) the cash Net Proceeds from such
transfer, conveyance, sale, lease or other disposition are applied in accordance
with the covenant described above under the caption "--Asset Sales," and (ii)
will not permit any Wholly Owned Restricted Subsidiary of the Company to issue
any of its Equity Interests (other than, if necessary, shares of its Capital
Stock constituting directors' qualifying shares) to any Person other than to the
Company or a Wholly Owned Restricted Subsidiary of the Company.
Limitations on Issuances of Guarantees of Indebtedness
The Indenture provides that the Company will not permit any Restricted
Subsidiary, directly or indirectly, to Guarantee or pledge any assets to secure
the payment of any other Indebtedness of the Company unless either such
Restricted Subsidiary (x) is a Subsidiary Guarantor or (y) simultaneously
executes and delivers a supplemental indenture to the Indenture providing for
the Guarantee of the payment of the New Notes by such Restricted Subsidiary,
which Guarantee shall be senior to or pari passu with such Restricted
Subsidiary's Guarantee of or pledge to secure such other Indebtedness.
Notwithstanding the foregoing, any such Guarantee by a Restricted Subsidiary of
the New Notes shall provide by its terms that it shall be automatically and
unconditionally released and discharged upon any sale, exchange or transfer, to
any Person not an Affiliate of the Company, of all of the Company's stock in, or
all or substantially all the assets of, such Restricted Subsidiary, which sale,
exchange or transfer is made in compliance with the applicable provisions of the
Indenture. The form of such Guarantee is attached as an exhibit to the
Indenture.
Business Activities
The Company will not, and will not permit any Restricted Subsidiary to,
engage in any business other than a Permitted Business, except to such extent as
would not be material to the Company and its Restricted Subsidiaries taken as a
whole.
Additional Note Guarantees
The Indenture provides that (i) if the Company or any of its Restricted
Subsidiaries shall, after the date of the Indenture, transfer or cause to be
transferred, including by way of any Investment, in one or a series of
transactions (whether or not related), any assets, businesses, divisions, real
property or equipment having an aggregate fair market value (as determined in
good faith by the Board of Directors) in excess of $1.0 million
88
<PAGE> 97
to any Restricted Subsidiary that is neither a Subsidiary Guarantor nor a
Foreign Subsidiary, (ii) if the Company or any of its Restricted Subsidiaries
shall acquire another Restricted Subsidiary other than a Foreign Subsidiary
having total assets with a fair market value (as determined in good faith by the
Board of Directors) in excess of $1.0 million or (iii) if any Restricted
Subsidiary other than a Foreign Subsidiary shall incur Acquired Debt in excess
of $1.0 million, then the Company shall, at the time of such transfer,
acquisition or incurrence, (i) cause such transferee, acquired Restricted
Subsidiary or Restricted Subsidiary incurring Acquired Debt (if not then a
Subsidiary Guarantor) to execute a New Note Guarantee of the Obligations of the
Company under the New Notes in the form set forth in the Indenture and (ii)
deliver to the Trustee an Opinion of Counsel, in form reasonably satisfactory to
the Trustee, that such New Note Guarantee is a valid, binding and enforceable
obligation of such transferee, acquired Restricted Subsidiary or Restricted
Subsidiary incurring Acquired Debt, subject to customary exceptions for
bankruptcy, fraudulent conveyance and equitable principles. Notwithstanding the
foregoing, the Company or any of its Restricted Subsidiaries may make a
Restricted Investment in any Wholly Owned Restricted Subsidiary of the Company
without compliance with this covenant provided that such Restricted Investment
is permitted by the covenant described under the caption, "-- Restricted
Payments."
Reports
The Indenture provides that, whether or not required by the rules and
regulations of the Commission, so long as any New Notes are outstanding, the
Company will furnish to the Holders of New Notes (i) all quarterly and annual
financial information that would be required to be contained in a filing with
the Commission on Forms 10-Q and 10-K if the Company were required to file such
Forms, including a "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and, with respect to the annual information only, a
report thereon by the Company's certified independent accountants and (ii) all
current reports that would be required to be filed with the Commission on Form
8-K if the Company were required to file such reports. In addition, whether or
not required by the rules and regulations of the Commission, the Company will
file a copy of all such information and reports with the Commission for public
availability (unless the Commission will not accept such a filing) and make such
information available to securities analysts and prospective investors upon
request. In addition, the Company has agreed that, for so long as any New Notes
remain outstanding, it will furnish to the Holders and to securities analysts
and prospective investors, upon their request, the information required to be
delivered pursuant to Rule 144A(d)(4) under the Securities Act.
EVENTS OF DEFAULT AND REMEDIES
The Indenture provides that each of the following constitutes an Event of
Default: (i) default for 30 days in the payment when due of interest on, or
Liquidated Damages, if any, with respect to, the New Notes; (ii) default in
payment when due of the principal of or premium, if any, on the New Notes; (iii)
failure by the Company to comply with the provisions described under the
captions "-- Repurchase at the Option of Holders -- Change of Control,"
"-- Repurchase at the Option of Holders -- Asset Sales," or "-- Certain
Covenants -- Merger, Consolidation, or Sale of Assets"; (iv) failure by the
Company for 30 days after notice from the Trustee or at least 25% in principal
amount of the New Notes then outstanding to comply with the provisions described
under the captions "-- Restricted Payments" or "-- Incurrence of Indebtedness
and Issuance of Preferred Stock"; (v) failure by the Company for 60 days after
notice from the Trustee or at least 25% in principal amount of the New Notes
then outstanding to comply with any of its other agreements in the Indenture or
the New Notes; (vi) default under any mortgage, indenture or instrument under
which there may be issued or by which there may be secured or evidenced any
Indebtedness for money borrowed by the Company or any of its Subsidiaries (or
the payment of which is guaranteed by the Company or any of its Subsidiaries)
whether such Indebtedness or Guarantee now exists, or is created after the date
of the Indenture, which default (a) is caused by a failure to pay principal of
or premium, if any, or interest on such Indebtedness prior to the expiration of
the grace period provided in such Indebtedness on the date of such default (a
"Payment Default") or (b) results in the acceleration of such Indebtedness prior
to its express maturity and, in each case, the principal amount of any such
Indebtedness, together with the principal amount of any other such Indebtedness
under which there has been a Payment Default or the maturity of which has
89
<PAGE> 98
been so accelerated, aggregates $5.0 million or more; (vii) failure by the
Company or any of its Subsidiaries to pay final judgments aggregating in excess
of $5.0 million, which judgments are not paid, discharged or stayed for a period
of 60 days and (viii) certain events of bankruptcy or insolvency with respect to
the Company or any of its Subsidiaries.
If any Event of Default occurs and is continuing, the Trustee or the
Holders of at least 25% in principal amount of the then outstanding New Notes
may declare all the New Notes to be due and payable immediately. Notwithstanding
the foregoing, in the case of an Event of Default arising from certain events of
bankruptcy or insolvency, with respect to the Company or any of its Subsidiaries
all outstanding New Notes will become due and payable without further action or
notice. Holders of the New Notes may not enforce the Indenture or the New Notes
except as provided in the Indenture. If any Event of Default occurs and is
continuing, subject to certain limitations, Holders of a majority in principal
amount of the then outstanding New Notes may direct the Trustee in its exercise
of any trust or power. The Trustee may withhold from Holders of the New Notes
notice of any continuing Default or Event of Default (except a Default or Event
of Default relating to the payment of principal or interest) if it determines
that withholding notice is in their interest.
In the case of any Event of Default occurring by reason of any willful
action (or inaction) taken (or not taken) by or on behalf of the Company with
the intention of avoiding payment of the premium that the Company would have had
to pay if the Company then had elected to redeem the New Notes pursuant to the
optional redemption provisions of the Indenture, an equivalent premium shall
also become and be immediately due and payable to the extent permitted by law
upon the acceleration of the New Notes. If an Event of Default occurs prior to
February 1, 2002 by reason of any willful action (or inaction) taken (or not
taken) by or on behalf of the Company with the intention of avoiding the
prohibition on redemption of the New Notes prior to February 1, 2002, then the
premium specified in the Indenture shall also become immediately due and payable
to the extent permitted by law upon the acceleration of the New Notes.
The Holders of a majority in aggregate principal amount of the New Notes
then outstanding by notice to the Trustee may on behalf of the Holders of all of
the New Notes waive any existing Default or Event of Default and its
consequences under the Indenture except a continuing Default or Event of Default
in the payment of interest on, or the principal of, the New Notes.
The Company is required to deliver to the Trustee annually a statement
regarding compliance with the Indenture, and the Company is required upon
becoming aware of any Default or Event of Default, to deliver to the Trustee a
statement specifying such Default or Event of Default.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of the Company
or the Subsidiary Guarantors, as such, shall have any liability for any
obligations of the Company or any Subsidiary Guarantor under the New Notes, the
Indenture, the New Note Guarantees or for any claim based on, in respect of, or
by reason of, such obligations or their creation. Each Holder of New Notes, by
accepting a New Note, waives and releases all such liability. The waiver and
release are part of the consideration for issuance of the New Notes. Such waiver
is unenforceable to the extent it comports to waive compliance with the federal
securities laws and the rules and regulations thereunder and it is the view of
the Commission that such a waiver is against public policy.
LEGAL DEFEASANCE AND COVENANT DEFEASANCE
The Company may, at its option and at any time, elect to have all of its
obligations discharged with respect to the outstanding New Notes and all
obligations of the Subsidiary Guarantors under the New Note Guarantees ("Legal
Defeasance") except for (i) the rights of Holders of outstanding New Notes to
receive payments in respect of the principal of, premium and Liquidated Damages,
if any, and interest on such New Notes when such payments are due from the trust
referred to below, (ii) the Company's obligations with respect to the New Notes
concerning issuing temporary New Notes, registration of New Notes, mutilated,
destroyed, lost or stolen New Notes and the maintenance of an office or agency
for payment and money for
90
<PAGE> 99
security payments held in trust, (iii) the rights, powers, trusts, duties and
immunities of the Trustee, and the Company's obligations in connection therewith
and (iv) the Legal Defeasance provisions of the Indenture. In addition, the
Company may, at its option and at any time, elect to have the obligations of the
Company and the Subsidiary Guarantors released with respect to certain covenants
that are described in the Indenture ("Covenant Defeasance") and thereafter any
omission to comply with such obligations shall not constitute a Default or Event
of Default with respect to the New Notes. In the event Covenant Defeasance
occurs, certain events (not including non-payment, bankruptcy, receivership,
rehabilitation and insolvency events) described under "-- Events of Default"
will no longer constitute an Event of Default with respect to the New Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (i)
the Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the Holders of the New Notes, cash in U.S. dollars, non-callable Government
Securities, or a combination thereof, in such amounts as will be sufficient, in
the opinion of a nationally recognized firm of independent public accountants,
to pay the principal of, premium and Liquidated Damages, if any, and interest on
the outstanding New Notes on the stated maturity or on the applicable redemption
date, as the case may be, and the Company must specify whether the New Notes are
being defeased to maturity or to a particular redemption date; (ii) in the case
of Legal Defeasance, the Company shall have delivered to the Trustee an opinion
of counsel in the United States reasonably acceptable to the Trustee confirming
that (A) the Company has received from, or there has been published by the
Internal Revenue Service a ruling or (B) since the date of the Indenture, there
has been a change in the applicable federal income tax law, in either case to
the effect that, and based thereon such opinion of counsel shall confirm that,
the Holders of the outstanding New Notes will not recognize income, gain or loss
for federal income tax purposes as a result of such Legal Defeasance and will be
subject to federal income tax on the same amounts, in the same manner and at the
same times as would have been the case if such Legal Defeasance had not
occurred; (iii) in the case of Covenant Defeasance, the Company shall have
delivered to the Trustee an opinion of counsel in the United States reasonably
acceptable to the Trustee confirming that the Holders of the outstanding New
Notes will not recognize income, gain or loss for federal income tax purposes as
a result of such Covenant Defeasance and will be subject to federal income tax
on the same amounts, in the same manner and at the same times as would have been
the case if such Covenant Defeasance had not occurred; (iv) no Default or Event
of Default shall have occurred and be continuing on the date of such deposit
(other than a Default or Event of Default resulting from the borrowing of funds
to be applied to such deposit) or insofar as Events of Default from bankruptcy
or insolvency events are concerned, at any time in the period ending on the 91st
day after the date of deposit; (v) such Legal Defeasance or Covenant Defeasance
will not result in a breach or violation of, or constitute a default under any
material agreement or instrument (other than the Indenture) to which the Company
or any of its Subsidiaries is a party or by which the Company or any of its
Subsidiaries is bound; (vi) the Company must have delivered to the Trustee an
opinion of counsel to the effect that after the 91st day following the deposit,
the trust funds will not be subject to the effect of any applicable bankruptcy,
insolvency, reorganization or similar laws affecting creditors' rights
generally; (vii) the Company must deliver to the Trustee an Officers'
Certificate stating that the deposit was not made by the Company with the intent
of preferring the Holders of New Notes over the other creditors of the Company
with the intent of defeating, hindering, delaying or defrauding creditors of the
Company or others and (viii) the Company must deliver to the Trustee an
Officers' Certificate and an opinion of counsel, each stating that all
conditions precedent provided for relating to the Legal Defeasance or the
Covenant Defeasance have been complied with.
TRANSFER AND EXCHANGE
A Holder may transfer or exchange New Notes in accordance with the
Indenture. The Registrar and the Trustee may require a Holder, among other
things, to furnish appropriate endorsements and transfer documents and the
Company may require a Holder to pay any taxes and fees required by law or
permitted by the Indenture. The Company is not required to transfer or exchange
any New Note selected for redemption. Also, the Company is not required to
transfer or exchange any New Note for a period of 15 days before a selection of
New Notes to be redeemed.
The registered Holder of a New Note will be treated as the owner of it for
all purposes.
91
<PAGE> 100
AMENDMENT, SUPPLEMENT AND WAIVER
Except as provided in the next two succeeding paragraphs, the Indenture,
the New Notes or the New Note Guarantees may be amended or supplemented with the
consent of the Holders of at least a majority in principal amount of the New
Notes then outstanding (including, without limitation, consents obtained in
connection with a purchase of, or tender offer or exchange offer for, New
Notes), and any existing default or compliance with any provision of the
Indenture, the New Notes or the New Note Guarantees may be waived with the
consent of the Holders of a majority in principal amount of the then outstanding
New Notes (including consents obtained in connection with a tender offer or
exchange offer for New Notes).
Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any New Notes held by a non-consenting Holder): (i) reduce the
principal amount of New Notes whose Holders must consent to an amendment,
supplement or waiver, (ii) reduce the principal of or change the fixed maturity
of any New Note or alter the provisions with respect to the redemption of the
New Notes (other than provisions relating to the covenants described above under
the caption "-- Repurchase at the Option of Holders"); (iii) reduce the rate of
or change the time for payment of interest on any New Note; (iv) waive a Default
or Event of Default in the payment of principal of or premium or Liquidated
Damages, if any, or interest on the New Notes (except a rescission of
acceleration of the New Notes by the Holders of at least a majority in aggregate
principal amount of the New Notes and a waiver of the payment default that
resulted from such acceleration); (v) make any New Note payable in money other
than that stated in the New Notes; (vi) make any change in the provisions of the
Indenture relating to waivers of past Defaults or the rights of Holders of Notes
to receive payments of principal of or premium, if any, or interest on the New
Notes; (vii) waive a redemption payment with respect to any New Note (other than
a payment required by one of the covenants described above under the caption
"-- Repurchase at the Option of Holders") or (viii) make any change in the
foregoing amendment and waiver provisions.
Notwithstanding the foregoing, without the consent of any Holder of New
Notes, the Company, the Subsidiary Guarantors and the Trustee may amend or
supplement the Indenture, the New Notes or the New Note Guarantees to cure any
ambiguity, defect or inconsistency, to provide for uncertificated New Notes in
addition to or in place of certificated New Notes, to provide for the assumption
of the Company's and the Subsidiary Guarantors' obligations to Holders of New
Notes in the case of a merger or consolidation, to make any change that would
provide any additional rights or benefits to the Holders of New Notes or that
does not adversely affect the legal rights under the Indenture of any such
Holder, to comply with requirements of the Commission in order to effect or
maintain the qualification of the Indenture under the Trust Indenture Act or to
allow any Subsidiary to guarantee the New Notes.
CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Company, to obtain payment of claims in
certain cases, or to realize on certain property received in respect of any such
claim as security or otherwise. The Trustee will be permitted to engage in other
transactions; provided, that if it acquires any conflicting interest it must
eliminate such conflict within 90 days, apply to the Commission for permission
to continue or resign.
The Holders of a majority in principal amount of the then outstanding New
Notes will have the right to direct the time, method and place of conducting any
proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the conduct
of his own affairs. Subject to such provisions, the Trustee will be under no
obligation to exercise any of its rights or powers under the Indenture at the
request of any Holder of New Notes, unless such Holder shall have offered to the
Trustee security and indemnity satisfactory to it against any loss, liability or
expense.
92
<PAGE> 101
ADDITIONAL INFORMATION
Anyone who receives this Prospectus may obtain a copy of the Indenture and
Registration Rights Agreement without charge by writing to Phase Metrics, Inc.,
10260 Sorrento Valley Road, San Diego, California 92121; Attention: Chief
Financial Officer.
BOOK-ENTRY; DELIVERY; FORM AND TRANSFER
The New Notes exchanged by QIBs initially will be in the form of one or
more registered global notes without interest coupons (collectively, the "U.S.
Global Notes"). Upon issuance, the U.S. Global Notes will be deposited with the
Trustee, as custodian for The Depository Trust Company ("DTC"), in New York, New
York, and registered in the name of DTC or its nominee, in each case for credit
to the accounts of DTC's Direct and Indirect Participants (as defined below).
The New Notes exchanged for Notes that were offered and sold in offshore
transactions in reliance on Regulation S, if any, will be in the form of one or
more permanent global notes (the "Regulation S Global Notes") and deposited with
the Trustee, as custodian for DTC, in New York, New York, and registered in the
name of a nominee of DTC (a "Nominee") for credit to the accounts of Indirect
Participants at Euroclear and Cedel Bank. Beneficial interests in the Regulation
S Permanent Global Notes may be transferred to a Person that takes delivery in
the form of an interest in the U.S. Global Notes and beneficial interests in the
U.S. Global Notes may be transferred to a Person that takes delivery in the form
of an interest in the Regulation S Permanent Global Notes; provided, that in
each case, that the certification requirements described below are complied
with. See "Transfers of Interests in One Global Note for Interests in Another
Global Note." All registered global notes are referred to herein collectively as
"Global Notes."
In addition, transfer of beneficial interests in any Global Notes will be
subject to the applicable rules and procedures of DTC and its Direct or Indirect
Participants (including, if applicable, those of Euroclear and Cedel Bank),
which may change from time to time.
The Global Notes may be transferred, in whole and not in part, only to
another nominee of DTC or to a successor of DTC or its nominee in certain
limited circumstances. Beneficial interests in the Global Notes may be exchanged
for New Notes in certificated form in certain limited circumstances. See
"--Transfer of Interests in Global Notes for Certificated Notes."
Initially, the Trustee will act as Paying Agent and Registrar. The New
Notes may be presented for registration of transfer and exchange at the offices
of the Registrar.
Depository Procedures
DTC has advised the Company that DTC is a limited-purpose trust company
created to hold securities for its participating organizations (collectively,
the "Direct Participants") and to facilitate the clearance and settlement of
transactions in those securities between Direct Participants through electronic
book-entry changes in accounts of Direct Participants. The Direct Participants
include securities brokers and dealers (including DLJ), banks, trust companies,
clearing corporations and certain other organizations, including Euroclear and
Cedel Bank. Access to DTC's system is also available to other entities that
clear through or maintain a direct or indirect custodial relationship with a
Direct Participant (collectively, the "Indirect Participants"). DTC may hold
securities beneficially owned by other Persons only through the Direct
Participants or Indirect Participants and such other Persons' ownership interest
and transfer of ownership interest will be recorded only on the records of the
Direct Participant and/or Indirect Participant, and not on the records
maintained by DTC.
DTC has also advised the Company that, pursuant to DTC's procedures, DTC
will maintain records of the ownership interests of each Direct Participants in
the Global Notes and the transfer of ownership interests by and between Direct
Participants. DTC will not maintain records of the ownership interests of, or
the transfer of ownership interests by and between, Indirect Participants or
other owners of beneficial interests in the Global Notes. Direct Participants
and Indirect Participants must maintain their own records of the
93
<PAGE> 102
ownership interests of, and the transfer of ownership interests by and between,
Indirect Participants and other owners of beneficial interests in the Global
Notes.
Investors in the U.S. Global Notes may hold their interests therein
directly through DTC if they are Direct Participants in DTC or indirectly
through organizations that are Direct Participants in DTC. Investors in the
Regulation S Global Notes may hold their interests therein directly through
Euroclear or Cedel Bank or through organizations other than Euroclear and Cedel
Bank that are Direct Participants in the DTC system. Morgan Guaranty Trust
Company of New York, Brussels office is the operator and depository of Euroclear
and Citibank, N.A. is the operator and depository of Cedel Bank (each a
"Nominee" of Euroclear and Cedel Bank, respectively). Therefore, they will each
be recorded on DTC's records as the holders of all ownership interests held by
them on behalf of Euroclear and Cedel Bank, respectively. Euroclear and Cedel
Bank will maintain on their records the ownership interests, and transfers of
ownership interests by and between, their own customer's securities accounts.
DTC will not maintain records of the ownership interests of, or the transfer of
ownership interests by and between, customers of Euroclear or Cedel Bank. All
ownership interests in any Global Notes, including those of customers'
securities accounts held through Euroclear or Cedel Bank, may be subject to the
procedures and requirements of DTC.
The laws of some states require that certain Persons take physical delivery
in definitive, certificated form, of securities that they own. This may limit or
curtail the ability to transfer beneficial interests in a Global Note to such
Persons. Because DTC can act only on behalf of Direct Participants, which in
turn act on behalf of Indirect Participants and others, the ability of a Person
having a beneficial interest in a Global Note to pledge such interest to Persons
or entities that are not Direct Participants in DTC, or to otherwise take
actions in respect of such interests, may be affected by the lack of physical
certificates evidencing such interests. For certain other restrictions on the
transferability of the Notes, See "-- Regulation S Permanent Global Notes" and
"-- Transfers of Interests in Global Notes for Certificated Notes."
EXCEPT AS DESCRIBED IN "--TRANSFERS OF INTERESTS IN GLOBAL NOTES FOR
CERTIFICATED NOTES", OWNERS OF BENEFICIAL INTERESTS IN THE GLOBAL NOTES WILL NOT
HAVE NEW NOTES REGISTERED IN THEIR NAMES, WILL NOT RECEIVE PHYSICAL DELIVERY OF
NEW NOTES IN CERTIFICATED FORM AND WILL NOT BE CONSIDERED THE REGISTERED OWNERS
OR HOLDERS THEREOF UNDER THE INDENTURE FOR ANY PURPOSE.
Under the terms of the Indenture, the Company, the Subsidiary Guarantors
and the Trustee will treat the Persons in whose names the New Notes are
registered (including New Notes represented by Global Notes) as the owners
thereof for the purpose of receiving payments and for any and all other purposes
whatsoever. Payments in respect of the principal, premium, Liquidated Damages,
if any, and interest on Global Notes registered in the name of DTC or its
nominee will be payable by the Trustee to DTC or its nominee as the registered
holder under the Indenture. Consequently, neither the Company, the Subsidiary
Guarantors, the Trustee nor any agent of the Company, the Subsidiary Guarantors
or the Trustee has or will have any responsibility or liability for (i) any
aspect of DTC's records or any Direct Participant's or Indirect Participant's
records relating to or payments made on account of beneficial ownership
interests in the Global Notes or for maintaining, supervising or reviewing any
of DTC's records or any Direct Participant's or Indirect Participant's records
relating to the beneficial ownership interests in any Global Note or (ii) any
other matter relating to the actions and practices of DTC or any of its Direct
Participants or Indirect Participants.
DTC has advised the Company that its current payment practice (for payments
of principal, interest and the like) with respect to securities such as the New
Notes is to credit the accounts of the relevant Direct Participants with such
payment on the payment date in amounts proportionate to such Direct
Participant's respective ownership interests in the Global Notes as shown on
DTC's records. Payments by Direct Participants and Indirect Participants to the
beneficial owners of the New Notes will be governed by standing instructions and
customary practices between them and will not be the responsibility of DTC, the
Trustee, the Company or the Subsidiary Guarantors. Neither the Company, the
Subsidiary Guarantors nor the Trustee will be liable for any delay by DTC or its
Direct Participants or Indirect Participants in identifying the beneficial
owners of the New Notes, and the Company and the Trustee may conclusively rely
on and will be protected in relying on instructions from DTC or its nominee as
the registered owner of the New Notes for all purposes.
94
<PAGE> 103
The Global Notes will trade in DTC's Same-Day Funds Settlement System and,
therefore, transfers between Direct Participants in DTC will be effected in
accordance with DTC's procedures, and will be settled in immediately available
funds. Transfers between Indirect Participants (other than Indirect Participants
who hold an interest in the New Notes through Euroclear or Cedel Bank) who hold
an interest through a Direct Participant will be effected in accordance with the
procedures of such Direct Participant but generally will settle in immediately
available funds. Transfers between and among Indirect Participants who hold
interests in the New Notes through Euroclear and Cedel Bank will be effected in
the ordinary way in accordance with their respective rules and operating
procedures.
Subject to compliance with the transfer restrictions applicable to the New
Notes described herein, cross-market transfers between Direct Participants in
DTC, on the one hand, and Indirect Participants who hold interests in the New
Notes through Euroclear or Cedel Bank, on the other hand, will be effected by
Euroclear or Cedel Bank's respective Nominee through DTC in accordance with
DTC's rules on behalf of Euroclear or Cedel Bank; provided, that delivery of
instructions relating to crossmarket transactions must be made directly to
Euroclear or Cedel Bank, as the case may be, by the counterparty in accordance
with the rules and procedures of Euroclear or Cedel Bank and within their
established deadlines (Brussels time for Euroclear and UK time for Cedel Bank).
Indirect Participants who hold interest in the New Notes through Euroclear and
Cedel Bank may not deliver instructions directly to Euroclear's or Cedel Bank's
Nominee. Euroclear or Cedel Bank will, if the transaction meets its settlement
requirements, deliver instructions to its respective Nominee to deliver or
receive interests on Euroclear's or Cedel Bank's behalf in the relevant Global
Note in DTC, and make or receive payment in accordance with normal procedures
for same-day fund settlement applicable to DTC.
Because of time zone differences, the securities accounts of an Indirect
Participant who holds an interest in the New Notes through Euroclear or Cedel
Bank purchasing an interest in a Global Note from a Direct Participant in DTC
will be credited, and any such crediting will be reported to Euroclear or Cedel
Bank during the European business day immediately following the settlement date
of DTC in New York. Although recorded in DTC's accounting records as of DTC's
settlement date in New York, Euroclear and Cedel Bank customers will not have
access to the cash amount credited to their accounts as a result of a sale of an
interest in a Regulation S Global Note to a DTC Participant until the European
business day for Euroclear or Cedel Bank immediately following DTC's settlement
date.
DTC has advised the Company that it will take any action permitted to be
taken by a holder of New Notes only at the direction of one or more Direct
Participants to whose account interests in the Global Notes are credited and
only in respect of such portion of the aggregate principal amount of the New
Notes as to which such Direct Participant or Direct Participants has or have
given direction. However, if there is an Event of Default under the New Notes,
DTC reserves the right to exchange Global Notes (without the direction of one or
more of its Direct Participants) for New Notes in certificated form, and to
distribute such certificated forms of New Notes to its Direct Participants. See
"-- Transfers of Interests in Global Notes for Certificated Notes."
Although DTC, Euroclear and Cedel Bank have agreed to the foregoing
procedures to facilitate transfers of interests in the Regulation S Global Notes
and in the U.S. Global Notes among Direct Participants, Euroclear and Cedel
Bank, they are under no obligation to perform or to continue to perform such
procedures, and such procedures may be discontinued at any time. None of the
Company, the Subsidiary Guarantors, DLJ or the Trustee will have any
responsibility for the performance by DTC, Euroclear or Cedel Bank or their
respective Direct and Indirect Participants of their respective obligations
under the rules and procedures governing any of their operations.
The information in this section concerning DTC, Euroclear and Cedel Bank
and their book-entry systems has been obtained from sources that the Company
believes to be reliable, but the Company takes no responsibility for the
accuracy thereof.
"U.S. Person" means (i) any individual resident in the United States, (ii)
any partnership or corporation organized or incorporated under the laws of the
United States, (iii) any estate of which an executor or administrator is a U.S.
Person (other than an estate governed by foreign law and of which at least one
95
<PAGE> 104
executor or administrator is a non-U.S. Person who has sole or shared investment
discretion with respect to its assets), (iv) any trust of which any trustee is a
U.S. Person (other than a trust of which at least one trustee is a non-U.S.
Person who has sole or shared investment discretion with respect to its assets
and no beneficiary of the trust (and no settler, if the trust is revocable) is a
U.S. Person), (v) any agency or branch of a foreign entity located in the United
States, (vi) any non-discretionary or similar account (other than an estate or
trust) held by a dealer or other fiduciary for the benefit or account of a U.S.
Person, (vii) any discretionary or similar account (other than an estate or
trust) held by a dealer or other fiduciary organized, incorporated or (if an
individual) resident in the United States (other than such an account held for
the benefit or account of a non-U.S. Person), (viii) any partnership or
corporation organized or incorporated under the laws of a foreign jurisdiction
and formed by a U.S. Person principally for the purpose of investing in
securities not registered under the Securities Act (unless it is organized or
incorporated and owned, by "accredited investors" within the meaning of Rule
501(a) under the Securities Act who are not natural persons, estates or trusts);
provided, however that the term "U.S. Person" shall not include (A) a branch or
agency of a U.S. Person that is located and operating outside the United States
for valid business purposes as a locally regulated branch or agency engaged in
the banking or insurance business, (B) any employee benefit plan established and
administered in accordance with the law, customary practices and documentation
of a foreign country and (C) the international organizations set forth in
Section 902(o)(7) of Regulation S under the Securities Act and any other similar
international organizations, and their agencies, affiliates and pension plans.
Transfers of Interests in One Global Note for Interests in Another Global Note
An Indirect Participant who holds an interest in Regulation S Global Notes
will be permitted to transfer its interest to a U.S. Person who takes delivery
in the form of an interest in U.S. Global Notes only upon receipt by the Trustee
of any necessary written certification from the transferor.
A Direct or Indirect Participant who holds an interest in U.S. Global Notes
may transfer its interests to a Person who takes delivery in the form of an
interest in Regulation S Global Notes only upon receipt by the Trustee of a
written certification from the transferor to the effect that such transfer is
being made in accordance with Rule 904 of Regulation S.
Transfers involving an exchange of a beneficial interest in Regulation S
Global Notes for a beneficial interest in U.S. Global Notes or vice versa will
be effected by DTC by means of an instruction originated by the Trustee through
DTC/Deposit Withdraw at Custodian (DWAC) system. Accordingly, in connection with
such transfer, appropriate adjustments will be made to reflect a decrease in the
principal amount of the one Global Note and a corresponding increase in the
principal amount of the other Global Note, as applicable. Any beneficial
interest in the one Global Note that is transferred to a Person who takes
delivery in the form of the other Global Note will, upon transfer, cease to be
an interest in such first Global Note and become an interest in such other
Global Note and, accordingly, will thereafter be subject to all transfer
restrictions and other procedures applicable to beneficial interests in such
other Global Note for as long as it remains such an interest.
Transfers of Interests in Global Notes for Certificated Notes
An entire Global Note may be exchanged for definitive New Notes in
registered, certificated form without interest coupons ("Certificated Notes") if
(i) DTC (x) notifies the Company that it is unwilling or unable to continue as
depositary for the Global Notes and the Company thereupon fails to appoint a
successor depositary within 90 days or (y) has ceased to be a clearing agency
registered under the Exchange Act, (ii) the Company, at its option, notifies the
Trustee in writing that it elects to cause the issuance of Certificated Notes or
(iii) there shall have occurred and be continuing a Default or an Event of
Default with respect to the Notes. In any such case, the Company will notify the
Trustee in writing that, upon surrender by the Direct and Indirect Participants
of their interest in such Global Note, Certificated Notes will be issued to each
Person that such Direct and Indirect Participants and the DTC identify as being
the beneficial owner of the New Related Notes.
96
<PAGE> 105
Beneficial interests in Global Notes held by any Direct or Indirect
Participant may be exchanged for Certificated Notes upon request to DTC, by such
Direct Participant (for itself or on behalf of an Indirect Participant), to the
Trustee in accordance with customary DTC procedures. Certificated Notes
delivered in exchange for any beneficial interest in any Global Note will be
registered in the names, and issued in any approved denominations, requested by
DTC on behalf of such Direct or Indirect Participants (in accordance with DTC's
customary procedures).
Neither the Company, the Subsidiary Guarantors nor the Trustee will be
liable for any delay by the holder of the Global Notes or DTC in identifying the
beneficial owners of New Notes, and the Company, the Subsidiary Guarantors and
the Trustee may conclusively rely on, and will be protected in relying on,
instructions from the holder of the Global Note or DTC for all purposes.
Transfers of Certificated Notes
Certificated Notes may only be transferred if the transferor first delivers
to the Trustee a written certificate (and in certain circumstances, an opinion
of counsel) confirming that, in connection with such transfer, it has complied
with the restrictions on transfer described under "Notice to Investors."
Same Day Settlement and Payment
The Indenture will require that payments in respect of the New Notes
represented by the Global Notes (including principal, premium, if any, interest
and Liquidated Damages, if any) be made by wire transfer of immediately
available same day funds to the accounts specified by the holder of interests in
such Global Note. With respect to Certificated Notes, the Company will make all
payments of principal, premium, if any, interest and Liquidated Damages, if any,
by wire transfer of immediately available same day funds to the accounts
specified by the holders thereof or, if no such account is specified, by mailing
a check to each such holder's registered address. The Company expects that
secondary trading in the Certificated Notes will also be settled in immediately
available funds.
REGISTRATION RIGHTS; LIQUIDATED DAMAGES
The Company, the Subsidiary Guarantors and DLJ entered into the
Registration Rights Agreement on the date of the Note Closing. In the
Registration Rights Agreement, the Company and the Subsidiary Guarantors agreed
to file an Exchange Offer Registration Statement with the Commission within 60
days of the date of the Note Closing, and use their respective best efforts to
have it declared effective at the earliest possible time. The Company and the
Subsidiary Guarantors also agreed to use their best efforts to cause the
Exchange Offer Registration Statement to be effective continuously, to keep the
Exchange Offer open for a period of not less than 20 business days and cause the
Exchange Offer to be consummated no later than the 30th business day after it is
declared effective by the Commission. Pursuant to the Exchange Offer, the
Company is offering to the Holders of Transfer Restricted Securities who are
able to make certain representations, the opportunity to exchange their Transfer
Restricted Securities for New Notes. To participate in the Exchange Offer, each
Holder must represent that it is not an affiliate of the Company, it is not
engaged in, and does not intend to engage in, and has no arrangement or
understanding with any Person to participate in, a distribution of the New Notes
that are issued in the Exchange Offer and it is acquiring the New Notes in the
Exchange Offer in its ordinary course of business.
If (i) the Exchange Offer is not permitted by applicable law or Commission
policy or (ii) any Holder of Notes which are Transfer Restricted Securities
notifies the Company prior to the 20th business day following the consummation
of the Exchange Offer that (a) it is prohibited by law or Commission policy from
participating in the Exchange Offer, (b) it may not resell the New Notes
acquired by it in the Exchange Offer to the public without delivering a
prospectus, and the prospectus contained in the Exchange Offer Registration
Statement is not appropriate or available for such resales by it or (c) it is a
broker-dealer and holds New Notes acquired directly from the Company or any of
the Company's affiliates, the Company and the Subsidiary Guarantors will file
with the Commission a Shelf Registration Statement to register for public
97
<PAGE> 106
resale the Transfer Restricted Securities held by any such Holder who provide
the Company with certain information for inclusion in the Shelf Registration
Statement.
For the purposes of the Registration Rights Agreement, "Transfer Restricted
Securities" means each Note until the earliest of the date of which (i) such
Note is exchanged in the Exchange Offer and entitled to be resold to the public
by the Holder thereof without complying with the prospectus delivery
requirements of the Securities Act, (ii) such Note has been disposed of in
accordance with the Shelf Registration Statement, (iii) such Note is disposed of
by a Broker-Dealer pursuant to the "Plan of Distribution" contemplated by the
Exchange Offer Registration Statement (including delivery of the Prospectus
contained therein) or (iv) such Note is distributed to the public pursuant to
Rule 144 under the Securities Act.
The Registration Rights Agreement provides that (i) if the Company or the
Subsidiary Guarantors fail to file an Exchange Offer Registration Statement with
the Commission on or prior to the 60th day after the date of the Note Closing,
(ii) if the Exchange Offer Registration Statement is not declared effective by
the Commission on or prior to the 120th day after the date of the Note Closing,
(iii) the Exchange Offer is not consummated on or before the 30th business day
after the Exchange Offer Registration Statement is declared effective (iv) if
obligated to file the Shelf Registration Statement and the Company or the
Subsidiary Guarantors fail to file the Shelf Registration Statement with the
Commission on or prior to the 30th day after such filing obligation arises, (v)
if obligated to file a Shelf Registration Statement and the Shelf Registration
Statement is not declared effective on or prior to the 60th day after the
obligation to file a Shelf Registration Statement arises or (vi) if the Exchange
Offer Registration Statement or the Shelf Registration Statement, as the case
may be, is declared effective but thereafter ceases to be effective or useable
in connection with resales of the Transfer Restricted Securities, such time of
non-effectiveness or non-usability (each, a "Registration Default"), the Company
and the Subsidiary Guarantors agree to pay to each Holder of Transfer Restricted
Securities affected thereby liquidated damages ("Liquidated Damages") in an
amount equal to $0.05 per week per $1,000 in principal amount of Transfer
Restricted Securities held by such Holder for each week or portion thereof that
the Registration Default continues for the first 90 day period immediately
following the occurrence of such Registration Default. The amount of the
Liquidated Damages shall increase by an additional $0.05 per week per $1,000 in
principal amount of Transfer Restricted Securities with respect to each
subsequent 90 day period until all Registration Defaults have been cured, up to
a maximum amount of Liquidated Damages of $0.25 per week per $1,000 in principal
amount of Transfer Restricted Securities. The Company and the Subsidiary
Guarantors shall not be required to pay liquidated damages for more than one
Registration Default at any given time. Following the cure of all Registration
Defaults, the accrual of Liquidated Damages will cease.
All accrued Liquidated Damages shall be paid by the Company or the
Subsidiary Guarantors to Holders entitled thereto by wire transfer to the
accounts specified by them or by mailing checks to their registered address if
no such accounts have been specified.
CERTAIN DEFINITIONS
Set forth below are certain defined terms used in the Indenture. Reference
is made to the Indenture for a full disclosure of all such terms, as well as any
other capitalized terms used herein for which no definition is provided.
"Acquired Debt" means, with respect to any specified Person, (i)
Indebtedness of any other Person existing at the time such other Person is
merged with or into or became a Subsidiary of such specified Person, including,
without limitation, Indebtedness incurred in connection with, or in
contemplation of, such other Person merging with or into or becoming a
Subsidiary of such specified Person, and (ii) Indebtedness secured by a Lien
encumbering any asset acquired by such specified Person.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For purposes of this definition, "control"
(including, with correlative meanings, the terms "controlling," "controlled by"
and "under common control with"), as used with respect to any Person, shall mean
the possession, directly or indirectly, of the power to direct or cause the
direction of the management or policies of such Person, whether through the
98
<PAGE> 107
ownership of voting securities, by agreement or otherwise; provided, that
beneficial ownership of 10% or more of the voting securities of a Person shall
be deemed to be control.
"Asset Sale" means (i) the sale, lease, conveyance or other disposition of
any assets or rights (including, without limitation, by way of a sale and
leaseback) other than sales of inventory in the ordinary course of business
consistent with past practices (provided, that the sale, lease, conveyance or
other disposition of all or substantially all of the assets of the Company and
its Restricted Subsidiaries taken as a whole will be governed by the provisions
of the Indenture described above under the caption "-- Repurchase at Option of
Holders -- Change of Control" and/or the provisions described above under the
caption "-- Certain Covenants -- Merger, Consolidation or Sale of Assets" and
not by the provisions of the Asset Sale covenant), and (ii) the issue or sale by
the Company or any of its Restricted Subsidiaries of Equity Interests of any of
the Company's Restricted Subsidiaries, in the case of either clause (i) or (ii),
whether in a single transaction or a series of related transactions (a) that
have a fair market value in excess of $1.0 million or (b) for net proceeds in
excess of $1.0 million. Notwithstanding the foregoing: (i) a transfer of assets
by the Company to a Wholly Owned Restricted Subsidiary or by a Wholly Owned
Restricted Subsidiary to the Company or to another Wholly Owned Restricted
Subsidiary, (ii) an issuance of Equity Interests by a Wholly Owned Restricted
Subsidiary to the Company or to another Wholly Owned Restricted Subsidiary,
(iii) a sale and leaseback of the real estate (and personal property associated
with such real estate) owned by the Company in San Diego, California on which
the Company's headquarters is located on the date of the Indenture and (iv) a
Restricted Payment that is permitted by the covenant described above under the
caption "-- Certain Covenants -- Restricted Payments" will not be deemed to be
Asset Sales.
"Attributable Debt" in respect of a sale and leaseback transaction means,
at the time of determination, the present value (discounted at the rate of
interest implicit in such transaction, determined in accordance with GAAP) of
the obligation of the lessee for net rental payments during the remaining term
of the lease included in such sale and leaseback transaction (including any
period for which such lease has been extended or may, at the option of the
lessor, be extended).
"Capital Lease Obligation" means, at the time any determination thereof is
to be made, the amount of the liability in respect of a capital lease that would
at such time be required to be capitalized on a balance sheet in accordance with
GAAP.
"Capital Stock" means (i) in the case of a corporation, corporate stock,
(ii) in the case of an association or business entity, any and all shares,
interests, participations, rights or other equivalents (however designated) of
corporate stock, (iii) in the case of a partnership or limited liability
company, partnership or membership interests (whether general or limited) and
(iv) any other interest or participation that confers on a Person the right to
receive a share of the profits and losses of, or distributions of assets of, the
issuing Person.
"Cash Equivalents" means (i) United States dollars, (ii) securities issued
or directly and fully guaranteed or insured by the United States government or
any agency or instrumentality thereof having maturities of not more than one
year from the date of acquisition, (iii) certificates of deposit and Eurodollar
time deposits with maturities of one year or less from the date of acquisition,
bankers' acceptances with maturities not exceeding six months and overnight bank
deposits, in each case with any lender party to the New Credit Facility or with
any domestic commercial bank having capital and surplus in excess of $500
million and a Thompson Bank Watch Rating of "B" or better, (iv) repurchase
obligations with a term of not more than seven days for underlying securities of
the types described in clauses (ii) and (iii) above entered into with any
financial institution meeting the qualifications specified in clause (iii)
above, and (v) commercial paper having the highest rating obtainable from
Moody's Investors Service, Inc. or Standard & Poor's Rating Services and in each
case maturing within 270 days after the date of acquisition.
"Change of Control" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by way of
merger or consolidation), in one or a series of related transactions, of all or
substantially all of the assets of the Company and its Subsidiaries taken as a
whole to any "person" (as such term is used in Section 13(d)(3) of the Exchange
Act) other than the Principals or their Related Parties (as defined below), (ii)
the adoption of a plan relating to the liquidation or dissolution of the
Company, (iii) the consummation of any transaction (including, without
limitation, any merger or consolida-
99
<PAGE> 108
tion) the result of which is that any "person" (as defined above), other than
the Principals and their Related Parties, becomes the "beneficial owner" (as
such term is defined in Rule 13d-3 and Rule 13d-5 under the Exchange Act, except
that a person shall be deemed to have "beneficial ownership" of all securities
that such person has the right to acquire, whether such right is currently
exercisable or is exercisable only upon the occurrence of a subsequent
condition), directly or indirectly, of more than 50% of the Voting Stock of the
Company (measured by voting power rather than number of shares), (iv) the first
day on which a majority of the members of the Board of Directors of the Company
are not Continuing Directors or (v) the Company consolidates with, or merges
with or into, any Person or sells, assigns, conveys, transfers, leases or
otherwise disposes of all or substantially all of its assets to any Person, or
any Person consolidates with, or merges with or into, the Company, in any such
event pursuant to a transaction in which any of the outstanding Voting Stock of
the Company is converted into or exchanged for cash, securities or other
property, other than any such transaction where the Voting Stock of the Company
outstanding immediately prior to such transaction is converted into or exchanged
for Voting Stock (other than Disqualified Stock) of the surviving or transferee
Person constituting a majority of the outstanding shares of such Voting Stock of
such surviving or transferee Person (immediately after giving effect to such
issuance).
"Consolidated Cash Flow" means, with respect to any Person for any period,
the Consolidated Net Income of such Person and its Restricted Subsidiaries for
such period, plus, to the extent deducted in computing Consolidated Net Income,
(i) provision for taxes based on income or profits of such Person and its
Restricted Subsidiaries for such period, (ii) Fixed Charges of such Person for
such period, (iii) depreciation and amortization (including amortization of
goodwill and other intangibles) and all other non-cash charges (excluding any
such non-cash charge to the extent that it represents (A) an accrual of or
reserve for cash charges in any future period, or (B) amortization of a prepaid
cash expense that was paid in a prior period), (iv) any gain realized in
connection with any Asset Sale and any extraordinary or non-recurring gain, in
each case, on a consolidated basis determined in accordance with GAAP and (v)
the amount of any non-cash compensation expense incurred in connection with
issuances of securities under stock option, stock purchase and other
equity-based incentive plans. Notwithstanding the foregoing, the provision for
taxes based on the income or profits of, the Fixed Charges of, and the
depreciation and amortization and other non-cash charges of a Restricted
Subsidiary of, a Person shall be added to Consolidated Net Income to compute
Consolidated Cash Flow only to the extent (and in same proportion) that the Net
Income of such Restricted Subsidiary was included in calculating the
Consolidated Net Income of such Person.
"Consolidated Interest Expense" means, with respect to any Person for any
period, the sum of: (i) the interest expense of such Person and its Restricted
Subsidiaries for such period, on a consolidated basis, determined in accordance
with GAAP (including amortization of original issue discount, non-cash interest
payments, the interest component of all payments associated with Capital Lease
Obligations, imputed interest with respect to Attributable Debt, commissions,
discounts and other fees and charges incurred in respect of letter of credit or
bankers' acceptance financings, and net payments (if any) pursuant to Hedging
Obligations; provided, that in no event shall any amortization of deferred
financing costs be included in Consolidated Interest Expense) and (ii)
consolidated interest expense of such Person and its Restricted Subsidiaries
that was capitalized during such period, whether paid or accrued.
"Consolidated Net Income" means, with respect to any Person for any period,
the aggregate of the Net Income of such Person and its Restricted Subsidiaries
for such period, on a consolidated basis, determined in accordance with GAAP;
provided, that (i) the Net Income (but not loss) of any Person that is not a
Restricted Subsidiary or that is accounted for by the equity method of
accounting shall be included only to the extent of the amount of dividends or
distributions paid in cash to the referent Person or a Wholly Owned Restricted
Subsidiary thereof, (ii) the Net Income of any Restricted Subsidiary shall be
excluded to the extent that the declaration or payment of dividends or similar
distributions by that Restricted Subsidiary of that Net Income is not at the
date of determination permitted without any prior governmental approval (that
has not been obtained) or, directly or indirectly, by operation of the terms of
its charter or any agreement, instrument, judgment, decree, order, statute, rule
or governmental regulation applicable to that Subsidiary or its stockholders,
(iii) the Net Income of any Person acquired in a pooling of interests
transaction for any period prior to the date of such acquisition shall be
excluded, (iv) the cumulative effect of a change in
100
<PAGE> 109
accounting principles shall be excluded and (v) the Net Income of any
Unrestricted Subsidiary shall be excluded, whether or not distributed to the
Company or one of its Restricted Subsidiaries for purposes of the covenant
described under the caption "-- Incurrence of Indebtedness and Issuance of
Preferred Stock" and shall be included for purposes of the covenant described
under the caption "Restricted Payments" only to the extent of the amount of
dividends or distributions paid in cash to the Company or one of its Restricted
Subsidiaries.
"Consolidated Net Worth" means, with respect to any Person as of any date,
the sum of (i) the consolidated equity of the common stockholders of such Person
and its consolidated Subsidiaries as of such date plus (ii) the respective
amounts reported on such Person's balance sheet as of such date with respect to
any series of preferred stock (other than Disqualified Stock) that by its terms
is not entitled to the payment of dividends unless such dividends may be
declared and paid only out of net earnings in respect of the year of such
declaration and payment, but only to the extent of any cash received by such
Person upon issuance of such preferred stock, less (x) all write-ups (other than
write-ups resulting from foreign currency translations and write-ups of tangible
assets of a going concern business made within 12 months after the acquisition
of such business) subsequent to the date of the Indenture in the book value of
any asset owned by such Person or a consolidated Subsidiary of such Person, (y)
all investments as of such date in unconsolidated Subsidiaries and in Persons
that are not Subsidiaries (except, in each case, Permitted Investments) and (z)
all unamortized debt discount and expense and unamortized deferred charges as of
such date, all of the foregoing determined in accordance with GAAP.
"Continuing Directors" means, as of any date of determination, any member
of the Board of Directors of the Company who (i) was a member of such Board of
Directors on the date of the Indenture or (ii) was nominated for election or
elected to such Board of Directors with the approval of a majority of the
Continuing Directors who were members of such Board at the time of such
nomination or election.
"Default" means any event that is or with the passage of time or the giving
of notice or both would be an Event of Default.
"Disqualified Stock" means any Capital Stock that, by its terms (or by the
terms of any security into which it is convertible or for which it is
exchangeable), or upon the happening of any event, matures or is mandatorily
redeemable, pursuant to a sinking fund obligation or otherwise, or redeemable at
the option of the Holder thereof, in whole or in part, on or prior to the date
that is 91 days after the date on which the Notes mature; provided, that any
Capital Stock that would not qualify as Disqualified Stock but for change of
control provisions shall not constitute Disqualified Stock if the provisions are
not more favorable to the holders of such Capital Stock than the provisions
described under "-- Change of Control" applicable to the Holders of the Notes.
"Equity Interests" means Capital Stock and all warrants, options or other
rights to acquire Capital Stock (but excluding any debt security that is
convertible into, or exchangeable for, Capital Stock).
"Existing Indebtedness" means Indebtedness of the Company and its
Subsidiaries (other than Indebtedness under the New Credit Facility) in
existence on the date of the Indenture, until such amounts are repaid.
"Fixed Charges" means, with respect to any Person for any period, the sum,
without duplication, of (i) the Consolidated Interest Expense of such Person for
such period and (ii) any interest expense on Indebtedness of another Person that
is guaranteed by the referent Person or one of its Restricted Subsidiaries or
secured by a Lien on assets of such Person or one of its Restricted Subsidiaries
(whether or not such guarantee or Lien is called upon) and (iii) the product of
(A) all cash dividend payments of the Company and any Subsidiary Guarantor on
any series of preferred stock of the Company or such Guarantor times (B) a
fraction, the numerator of which is one and the denominator of which is one
minus the then current combined federal, state and local statutory tax rate of
such Person, expressed as a decimal, in each case, on a consolidated basis and
in accordance with GAAP.
"Fixed Charge Coverage Ratio" means with respect to any Person for any
period, the ratio of the Consolidated Cash Flow of such Person and its
Restricted Subsidiaries for such period to the Fixed Charges of such Person and
its Restricted Subsidiaries for such period. In the event that the Company or
any of its
101
<PAGE> 110
Restricted Subsidiaries incurs, assumes, guarantees, redeems or repays any
Indebtedness (other than revolving credit borrowings) or issues or redeems
preferred stock subsequent to the commencement of the period for which the Fixed
Charge Coverage Ratio is being calculated but on or prior to the date on which
the calculation of the Fixed Charge Coverage Ratio is made (the "Calculation
Date"), then the Fixed Charge Coverage Ratio shall be calculated giving pro
forma effect to such incurrence, assumption, guarantee, redemption or repayment
of Indebtedness, or such issuance or redemption of preferred stock, as if the
same had occurred at the beginning of the applicable four-quarter reference
period. In addition, for purposes of making the computation referred to above,
(i) acquisitions that have been made by the Company or any of its Subsidiaries,
including through mergers or consolidations and including any related financing
transactions, during the four-quarter period or subsequent to such reference
period and on or prior to the Calculation Date shall be deemed to have occurred
on the first day of the four-quarter reference period and Consolidated Cash Flow
for such reference period shall be calculated without giving effect to clause
(iii) of the proviso set forth in the definition of Consolidated Net Income, and
(ii) the Consolidated Cash Flow attributable to discontinued operations, as
determined in accordance with GAAP, and operations or businesses disposed of
prior to the Calculation Date, shall be excluded and (iii) the Fixed Charges
attributable to discontinued operations, as determined in accordance with GAAP,
or operations or businesses disposed of prior to the Calculation Date, shall be
excluded, but only to the extent that the obligations giving rise to such Fixed
Charges will not be obligations of the referent Person or any of its
Subsidiaries following the Calculation Date.
"Foreign Subsidiary" means a Subsidiary that is formed under the laws of
the United States of America or of a state or territory thereof, but shall
exclude any Subsidiary which is treated as a partnership or branch for United
States federal income tax purposes.
"GAAP" means generally accepted accounting principles set forth in the
opinions and pronouncements of the Accounting Principles Board of the American
Institute of Certified Public Accountants and statements and pronouncements of
the Financial Accounting Standards Board or in such other statements by such
other entity as have been approved by a significant segment of the accounting
profession, which are in effect on the date of the Indenture.
"Global Notes" means the U.S. Global Note, the Regulation S Temporary
Global Notes and the Regulation S Permanent Global Notes.
"Government Securities" means direct obligations of, or obligations
guaranteed by, the United States of America for the payment of which guarantee
or obligations the full faith and credit of the United States is pledged.
"Guarantee" means a guarantee (other than by endorsement of negotiable
instruments for collection in the ordinary course of business), direct or
indirect, in any manner (including, without limitation, letters of credit and
reimbursement agreements in respect thereof), of all or any part of any
Indebtedness.
"Hedging Obligations" means, with respect to any Person, the obligations of
such Person under (i) interest rate swap agreements, interest rate cap
agreements and interest rate collar agreements and (ii) other agreements or
arrangements designed to protect such Person against fluctuations in interest
rates or currency rates.
"Indebtedness" means, with respect to any Person, any indebtedness of such
Person, whether or not contingent, in respect of borrowed money or evidenced by
bonds, notes, debentures or similar instruments or letters of credit (or
reimbursement agreements in respect thereof) or bankers' acceptances or
representing Capital Lease Obligations or the balance deferred and unpaid of the
purchase price of any property or representing any Hedging Obligations, except
any such balance that constitutes an accrued expense or trade payable, if and to
the extent any of the foregoing indebtedness (other than letters of credit and
Hedging Obligations) would appear as a liability upon a balance sheet of such
Person prepared in accordance with GAAP, as well as all indebtedness of others
secured by a Lien on any asset of such Person (whether or not such indebtedness
is assumed by such Person) and, to the extent not otherwise included, the
Guarantee by such Person of any indebtedness of any other Person. The amount of
any Indebtedness outstanding as of any date shall be (i) the accreted value
thereof, in the case of any Indebtedness that does not require current
102
<PAGE> 111
payments of interest, and (ii) the principal amount thereof, together with any
interest thereon that is more than 30 days past due, in the case of any other
Indebtedness.
"Insolvency or Liquidation Proceedings" means (i) any insolvency or
bankruptcy case or proceeding, or any receivership, liquidation, reorganization
or other similar case or proceeding, relative to the Company or to the creditors
of the Company, as such, or to the assets of the Company, or (ii) any
liquidation, dissolution, reorganization or winding up of the Company, whether
voluntary or involuntary, and involving insolvency or bankruptcy or (iii) any
assignment for the benefit of creditors or any other marshaling of assets and
liabilities of the Company.
"Investments" means, with respect to any Person, all investments by such
Person in other Persons (including Affiliates) in the forms of direct or
indirect loans (including guarantees of Indebtedness or other obligations),
advances or capital contributions (excluding commission, travel and similar
advances to officers and employees made in the ordinary course of business),
purchases or other acquisitions for consideration of Indebtedness, Equity
Interests or other securities, together with all items that are or would be
classified as investments on a balance sheet prepared in accordance with GAAP.
If the Company or any Restricted Subsidiary of the Company sells or otherwise
disposes of any Equity Interests of any direct or indirect Restricted Subsidiary
of the Company such that, after giving effect to any such sale or disposition,
such Person is no longer a Restricted Subsidiary of the Company, the Company
shall be deemed to have made an Investment on the date of any such sale or
disposition equal to the fair market value of the Equity Interests of such
Restricted Subsidiary not sold or disposed of in an amount determined as
provided in the final paragraph of the covenant described above under the
caption "-- Restricted Payments."
"Lien" means, with respect to any asset, any mortgage, lien, pledge,
charge, security interest or encumbrance of any kind in respect of such asset,
whether or not filed, recorded or otherwise perfected under applicable law
(including any conditional sale or other title retention agreement, any lease in
the nature thereof, any option or other agreement to sell or give a security
interest in and any filing of or agreement to give any financing statement under
the Uniform Commercial Code (or equivalent statutes) of any jurisdiction).
"Net Income" means, with respect to any Person, the net income (loss) of
such Person, determined in accordance with GAAP, excluding, however, (i) any
gain (but not loss), together with any related provision for taxes on such gain
(but not loss), realized in connection with (a) any Asset Sale (including,
without limitation, dispositions pursuant to sale and leaseback transactions) or
(b) the disposition of any securities by such Person or any of its Restricted
Subsidiaries or the extinguishment of any Indebtedness of such Person or any of
its Restricted Subsidiaries and (ii) any extraordinary or nonrecurring gain (but
not loss), together with any related provision for taxes on such extraordinary
or nonrecurring gain (but not loss).
"Net Proceeds" means the aggregate cash proceeds received by the Company or
any of its Restricted Subsidiaries in respect of any Asset Sale (including,
without limitation, any cash received upon the sale or other disposition of any
non-cash consideration received in any Asset Sale), net of the direct costs
relating to such Asset Sale (including, without limitation, legal, accounting
and investment banking fees, and sales commissions) and any relocation expenses
incurred as a result thereof, taxes paid or payable as a result thereof (after
taking into account any available tax credits or deductions and any tax sharing
arrangements), and any reserve for adjustment in respect of the sale price of
such asset or assets established in accordance with GAAP.
"New Credit Facility" means that certain Amended and Restated Credit
Agreement, dated as of January 30, 1998, by and among the Company, certain
financial institutions and Fleet National Bank, as agent, including any related
notes, guarantees, collateral documents, instruments and agreements executed in
connection therewith, and, in each case, as amended, modified, renewed,
refunded, replaced or refinanced from time to time.
"Non-Recourse Debt" means Indebtedness (i) as to which neither the Company
nor any of its Restricted Subsidiaries (a) provides credit support of any kind
(including any undertaking, agreement or instrument that would constitute
Indebtedness), (b) is directly or indirectly liable (as a guarantor or
otherwise), or
103
<PAGE> 112
(c) constitutes the lender, (ii) as to which no default with respect to which
(including any rights that the holders thereof may have to take enforcement
action against an Unrestricted Subsidiary) would permit (upon notice, lapse of
time or both) any holder of any other Indebtedness (other than the New Notes
being offered hereby) of the Company or any of its Restricted Subsidiaries to
declare a default on such other Indebtedness or cause the payment thereof to be
accelerated or payable prior to its stated maturity; and (iii) as to which the
lenders have been notified in writing that they will not have any recourse to
the stock or assets of the Company or any of its Restricted Subsidiaries.
"Obligations" means any principal, interest, penalties, fees,
indemnifications, reimbursements, damages and other liabilities payable under
the documentation governing any Indebtedness.
"Pari Passu Indebtedness" means Indebtedness of the Company that ranks pari
passu in right of payment to the New Notes.
"Permitted Business" means any of the businesses and any other businesses
related to the businesses engaged in by the Company and its respective
Restricted Subsidiaries on the date of the Indenture.
"Permitted Investments" means (i) any Investment in the Company or in a
Subsidiary Guarantor and Investments in Wholly-Owned Restricted Subsidiaries
which are not Subsidiary Guarantors permitted under clauses (vii) or (ix) of the
covenant described under the caption "-- Incurrence of Indebtedness and Issuance
of Preferred Stock", (ii) any Investment in Cash Equivalents, (iii) any
Investment by the Company or any Restricted Subsidiary of the Company in a
Person, if as a result of such Investment (a) such Person becomes a Guarantor or
(b) such Person is merged, consolidated or amalgamated with or into, or
transfers or conveys substantially all of its assets to, or is liquidated into,
the Company or a Guarantor, (iv) any Investment made as a result of the receipt
of non-cash consideration from an Asset Sale that was made pursuant to and in
compliance with the covenant described above under the caption "-- Repurchase at
the Option of Holders -- Asset Sales", (v) any acquisition of assets solely in
exchange for the issuance of Equity Interests (other than Disqualified Stock) of
the Company and (vi) other Investments made after the date of the Indenture in
any Person having an aggregate fair market value (measured on the date each such
Investment was made and without giving effect to subsequent changes in value),
when taken together with all other Investments made pursuant to this clause (vi)
that are at the time outstanding, not in excess of $5.0 million.
"Permitted Liens" means (i) Liens securing Indebtedness under the New
Credit Facility that was permitted by the terms of the Indenture to be incurred
or other Indebtedness allowed to be incurred under clause (i) of the covenant
described above under the caption "Incurrence of Indebtedness and Issuance of
Preferred Stock", (ii) Liens in favor of the Company, (iii) Liens on property of
a Person existing at the time such Person is merged into or consolidated with
the Company or any Restricted Subsidiary of the Company; provided, that such
Liens were in existence prior to the contemplation of such merger or
consolidation and do not extend to any assets other than those of the Person
merged into or consolidated with the Company, (iv) Liens on property existing at
the time of acquisition thereof by the Company or any Restricted Subsidiary of
the Company; provided, that such Liens were in existence prior to the
contemplation of such acquisition; (v) Liens to secure the performance of
statutory obligations, surety or appeal bonds, performance bonds or other
obligations of a like nature incurred in the ordinary course of business, (vi)
Liens existing on the date of the Indenture, (vii) Liens for taxes, assessments
or governmental charges or claims that are not yet delinquent or that are being
contested in good faith by appropriate proceedings promptly instituted and
diligently concluded; provided, that any reserve or other appropriate provision
as shall be required in conformity with GAAP shall have been made therefor,
(viii) Liens incurred in the ordinary course of business of the Company or any
Restricted Subsidiary of the Company with respect to obligations that do not
exceed $5.0 million at any one time outstanding and that (a) are not incurred in
connection with the borrowing of money or the obtaining of advances or credit
(other than trade credit in the ordinary course of business) and (b) do not in
the aggregate materially detract from the value of the property or materially
impair the use thereof in the operation of business by the Company or such
Restricted Subsidiary, (ix) Liens to secure Indebtedness (including Capital
Lease Obligations) permitted by clause (iv) of the covenant described under the
caption "-- Incurrence of Indebtedness and Issuance of Preferred Stock" covering
only the assets acquired with such Indebtedness, together with any additions and
accessions thereto and replacements, substitutions and proceeds
104
<PAGE> 113
(including insurance proceed(s) thereof), (x) carriers', warehousemen's,
mechanics', landlords', materialmen's, repairmen's, or other like Liens arising
in the ordinary course of business in respect of obligations not overdue for a
period in excess of 30 days or which are being contested in good faith by
appropriate proceedings promptly instituted and diligently prosecuted; provided,
that any reserve or other appropriate provisions as shall be required to conform
with GAAP shall have been made therefor, (xi) easements, rights-of-way, zoning
and similar restrictions and other similar encumbrances or title defects
incurred, or leases or subleases granted to others, in the ordinary course of
business, which do not in any case materially detract from the value of the
property subject thereto or do not interfere with or adversely affect in any
material respect the ordinary conduct of the business of the Company and its
Restricted Subsidiaries taken as a whole, (xii) Liens (other than any Lien
imposed by ERISA or any rule or regulation promulgated thereunder) incurred or
deposits made in the ordinary course of business in connection with workers'
compensation, unemployment insurance, and other types of social security, (xiii)
Liens in favor of a trustee under any indenture securing amounts due to the
trustee in connection with its services under such indenture, (xiv) Liens under
licensing agreements for use of intellectual property entered into in the
ordinary course of business and (xv) Liens on inventory or cash to secure cash
advances made by customers for the purchase price of inventory.
"Permitted Refinancing Indebtedness" means any Indebtedness of the Company
or any of its Restricted Subsidiaries issued in exchange for, or the net
proceeds of which are used to extend, refinance, renew, replace, defease or
refund other Indebtedness of the Company or any of its Restricted Subsidiaries;
provided that: (i) except for Indebtedness used to extend, refinance, renew,
replace, defease or refund the New Credit Facility, the principal amount (or
accreted value, if applicable) of such Permitted Refinancing Indebtedness does
not exceed the principal amount of (or accreted value, if applicable), plus
accrued interest on, the Indebtedness so extended, refinanced, renewed,
replaced, defeased or refunded (plus the amount of reasonable expenses incurred
in connection therewith and the amount of any market-based premium paid in
connection therewith), (ii) such Permitted Refinancing Indebtedness has a final
maturity date later than the final maturity date of, and has a Weighted Average
Life to Maturity equal to or greater than the Weighted Average Life to Maturity
of, the Indebtedness being extended, refinanced, renewed, replaced, defeased or
refunded, (iii) if the Indebtedness being extended, refinanced, renewed,
replaced, defeased or refunded is subordinated in right of payment to the New
Notes, such Permitted Refinancing Indebtedness has a final maturity date later
than the final maturity date of, and is subordinated in right of payment to, the
New Notes on terms at least as favorable to the Holders of New Notes as those
contained in the documentation governing the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded and (iv) such Indebtedness
is incurred either by the Company or by the Restricted Subsidiary who is the
obligor on the Indebtedness being extended, refinanced, renewed, replaced,
defeased or refunded.
"Person" means any individual, corporation, partnership, joint venture,
association, joint stock company, trust, limited liability company,
unincorporated organization, government or any agency or political subdivision
thereof or any other entity.
"Principals" means DLJ Merchant Banking, Inc. and its Affiliates, the
Sprout Group and its Affiliates, John F. Schaefer and Arthur J. Cormier.
"Public Equity Offering" means a public offering of Equity Interests (other
than Disqualified Stock) of the Company that results in the net proceeds to the
Company of at least $25.0 million.
"Regulation S" means Regulation S promulgated under the Securities Act.
"Regulation S Global Notes" means the permanent global notes that are
deposited with and registered in the name of the Depositary or its nominee,
representing a series of Notes sold in reliance on Regulation S.
"Related Party" with respect to any Principal means (i) any controlling
stockholder, 80% (or more) owned Subsidiary, or spouse or immediate family
member (in the case of an individual) of such Principal or (ii) any trust,
corporation, partnership or other entity, the beneficiaries, stockholders,
partners, owners or Persons beneficially holding an 80% or more controlling
interest of which consist of such Principal and/or such other Persons referred
to in the immediately preceding clause (i).
"Restricted Investment" means an Investment other than a Permitted
Investment.
105
<PAGE> 114
"Restricted Subsidiary" of a Person means any Subsidiary of the referent
Person that is not an Unrestricted Subsidiary.
"Rule 144A" means Rule 144A promulgated under the Securities Act.
"Securityholders Agreement" means the Securityholders Agreement, dated as
of November 23, 1994, among the Company, John F. Schaefer, Arthur J. Cormier,
and DLJ and the Sprout Entities.
"Stated Maturity" means, with respect to any installment of interest or
principal on any series of Indebtedness, the date on which such payment of
interest or principal was scheduled to be paid in the original documentation
governing such Indebtedness, and shall not include any contingent obligations to
repay, redeem or repurchase any such interest or principal prior to the date
originally scheduled for the payment thereof.
"Subsidiary" means, with respect to any Person, (i) any corporation,
association or other business entity of which more than 50% of the total voting
power of shares of Capital Stock entitled (without regard to the occurrence of
any contingency) to vote in the election of directors, managers or trustees
thereof is at the time owned or controlled, directly or indirectly, by such
Person or one or more of the other Subsidiaries of that Person (or a combination
thereof) and (ii) any partnership (a) the sole general partner or the managing
general partner of which is such Person or a Subsidiary of such Person or (b)
the only general partners of which are such Person or of one or more
Subsidiaries of such Person (or any combination thereof).
"Subsidiary Guarantors" means each of (i) Helios Incorporated, Applied
Robotic Technologies, Inc., Air Bearings Incorporated and Santa Barbara Metric,
Inc. and (ii) any other Subsidiary that executes a New Note Guarantee in
accordance with the provisions of the Indenture, and their respective successors
and assigns.
"Unrestricted Subsidiary" means (i) any Subsidiary that is designated by a
resolution of the Board of Directors of the Company as an Unrestricted
Subsidiary; but only to the extent that such Subsidiary: (a) has no Indebtedness
other than Non-Recourse Debt; (b) is not party to any agreement, contract,
arrangement or understanding with the Company or any Restricted Subsidiary of
the Company unless the terms of any such agreement, contract, arrangement or
understanding are no less favorable to the Company or such Restricted Subsidiary
than those that might be obtained at the time from Persons who are not
Affiliates of the Company; (c) is a Person with respect to which neither the
Company nor any of its Restricted Subsidiaries has any direct or indirect
obligation (x) to subscribe for additional Equity Interests or (y) to maintain
or preserve such Person's financial condition or to cause such Person to achieve
any specified levels of operating results; (d) has not guaranteed or otherwise
directly or indirectly provided credit support for any Indebtedness of the
Company or any of its Restricted Subsidiaries and (e) has at least one director
on its board of directors that is not a director or executive officer of the
Company or any of its Restricted Subsidiaries and has at least one executive
officer that is not a director or executive officer of the Company or any of its
Restricted Subsidiaries. Any such designation by the Board of Directors of the
Company shall be evidenced to the Trustee by filing with the Trustee a certified
copy of the resolutions of the Board of Directors giving effect to such
designation and an Officers' Certificate certifying that such designation
complied with the foregoing conditions and was permitted by the covenant
described above under the caption "Certain Covenants -- Restricted Payments."
If, at any time, any Unrestricted Subsidiary would fail to meet the foregoing
requirements as an Unrestricted Subsidiary, it shall thereafter cease to be an
Unrestricted Subsidiary for purposes of the Indenture and any Indebtedness of
such Subsidiary shall be deemed to be incurred by a Restricted Subsidiary of the
Company as of such date (and, if such Indebtedness is not permitted to be
incurred as of such date under the covenant described under the caption
"Incurrence of Indebtedness and Issuance of Preferred Stock," the Company shall
be in default of such covenant). The Board of Directors of the Company may at
any time designate any Unrestricted Subsidiary to be a Restricted Subsidiary;
provided, that such designation shall be deemed to be an incurrence of
Indebtedness by a Restricted Subsidiary of the Company of any outstanding
Indebtedness of such Unrestricted Subsidiary and such designation shall be
permitted only if (i) such Indebtedness is permitted under the covenant
described under the caption "Certain Covenants -- Incurrence of Indebtedness and
Issuance of Preferred Stock," and (ii) no Default or Event of Default would be
in existence following such designation.
106
<PAGE> 115
"U.S. Global Note" means a permanent global note that is deposited with and
registered in the name of the Depositary or its nominee, representing a series
of New Notes sold in reliance on Rule 144A.
"Voting Stock" of any Person as of any date means the Capital Stock of such
Person that is at the time entitled to vote in the election of the Board of
Directors of such Person.
"Weighted Average Life to Maturity" means, when applied to any Indebtedness
at any date, the number of years obtained by dividing (i) the sum of the
products obtained by multiplying (a) the amount of each then remaining
installment, sinking fund, serial maturity or other required payments of
principal, including payment at final maturity, in respect thereof, by (b) the
number of years (calculated to the nearest one-twelfth) that will elapse between
such date and the making of such payment, by (ii) the then outstanding principal
amount of such Indebtedness.
"Wholly Owned Restricted Subsidiary" means a Subsidiary that is both a
Wholly Owned Subsidiary and a Restricted Subsidiary.
"Wholly Owned Subsidiary" of any Person means a Subsidiary of such Person
all of the outstanding Capital Stock or other ownership interests of which
(other than directors' qualifying shares) shall at the time be owned by such
Person or by one or more Wholly Owned Subsidiaries of such Person.
107
<PAGE> 116
CERTAIN UNITED STATES FEDERAL TAX CONSIDERATIONS
The following is a general discussion of certain United States federal
income and estate tax considerations relating to the acquisition, ownership and
disposition of New Notes by the original holders of the New Notes. This
discussion is based upon the Internal Revenue Code of 1986, as amended (the
"Code"), and judicial decisions and administrative interpretations thereunder,
as of the date hereof, and such authorities may be repealed, revoked, modified
or otherwise interpreted or applied so as to result in federal income tax
consequences different from those discussed below. There can be no assurance
that the Internal Revenue Service (the "IRS") will not challenge one or more of
the tax consequences described herein, and the Company has not obtained, nor
does it intend to obtain, a ruling from the IRS or an opinion of counsel with
respect to the U.S. federal tax consequences of acquiring or holding the Notes
or the New Notes.
This discussion does not purport to deal with all aspects of U.S. federal
income taxation that may be relevant to a particular holder in light of the
holder's circumstances (for example, persons subject to the alternative minimum
tax provisions of the Code). Also, certain holders (including insurance
companies, tax exempt organizations, financial institutions, subsequent
purchasers of New Notes and broker-dealers) may be subject to special rules not
discussed below. In addition, this discussion does not describe any tax
consequences arising under the laws of any state, locality or taxing
jurisdiction other than the United States federal government. In general, the
discussion assumes that a holder acquired a Note at original issuance and holds
such Note and the New Notes as a capital asset and not as part of a "hedge,"
"straddle," "conversion transaction," "synthetic security" or other integrated
investment. Prospective investors are urged to consult their tax advisors
regarding the United States federal tax consequences of acquiring, holding and
disposing of New Notes, as well as any tax consequences that may arise under the
laws of any foreign, state, local or other taxing jurisdiction.
As used herein, the term "United States Holder" means a beneficial owner of
a New Note that is, for United States federal income tax purposes, a citizen or
resident (within the meaning of Section 7701(b) of the Code) of the United
States, a corporation, partnership or other entity created or organized in the
United States or under the laws of the United States or of any political
subdivision thereof, an estate whose income is included in gross income for
United States federal income tax purposes, regardless of its source or a trust,
if a U.S. court is able to exercise primary supervision over the administration
of the trust and one or more U.S. persons have the authority to control all
substantial decisions of the trust.
UNITED STATES HOLDERS
Exchange of Notes for New Notes The exchange of a Note, by a United
States Holder, for a New Note will not constitute a taxable exchange of the
Note. As a result, a United States Holder will not recognize taxable gain or
loss upon receipt of a New Note. A United States Holder's holding period for a
New Note will generally include the holding period for the Note so exchanged and
such holder's adjusted tax basis in a New Note will generally be the same as
such holder's adjusted tax basis in the Note so exchanged.
Stated Interest. Stated interest on a New Note will be taxable to a United
States Holder as ordinary interest income at the time that such interest accrues
or is received, in accordance with the United States Holder's regular method of
accounting for federal income tax purposes. The Company expects that the New
Notes will not be considered to be issued with original issue discount for
federal income tax purposes.
Bond Premium on the New Notes. If a United States Holder of a New Note
purchased a Note for an amount in excess of the amount payable at the maturity
date (or a call date, if appropriate) of the Notes, the United States Holder may
deduct such excess as amortizable bond premium over the aggregate terms of the
Notes and the New Notes (taking into account earlier call dates, as
appropriate), under a yield-to-maturity formula. The deduction is available only
if an election is made by the United States Holder or is in effect. This
election is revocable only with the consent of the IRS. The election applies to
all obligations owned or subsequently acquired by the United States Holder. The
United States Holder's adjusted tax basis in the Notes and the New Notes will be
reduced to the extent of the deduction of amortizable bond premium. Except as
may otherwise be provided in future regulations, under the Code the amortizable
bond premium is treated as an offset to interest income on the Notes and the New
Notes rather than as a separate deduction item.
108
<PAGE> 117
Market Discount on the New Notes. The tax consequences of a disposition of
the New Notes may be affected by the market discount provisions of the Code.
These rules generally provide that if a United States Holder acquired the Notes
(other than in an original issue) or the New Notes at a market discount which
equals or exceeds 1/4 of 1% of the stated redemption price of the Notes at
maturity multiplied by the number of remaining complete years to maturity and
thereafter recognizes gain upon a disposition (or makes a gift) of the New
Notes, the lesser of (i) such gain (or appreciation, in the case of a gift) or
(ii) the portion of the market discount which accrued while the Notes or New
Notes were held by such United States Holder will be treated as ordinary income
at the time of the disposition (or gift). For these purposes, market discount
means the excess (if any) of the stated redemption price at maturity over the
basis of such Notes immediately after their acquisition by the United States
Holder. A United States Holder of the New Notes may elect to include any market
discount (whether accrued under the Notes or the New Notes) in income currently
rather than upon disposition of the New Notes. This election once made applies
to all market discount obligations acquired on or after the first taxable year
to which the election applies, and may not be revoked without the consent of the
IRS.
A United States Holder of any New Note who acquired a Note or a New Note at
a market discount generally will be required to defer the deduction of a portion
of the interest on any indebtedness incurred or maintained to purchase or carry
such Note or New Note until the market discount is recognized upon a subsequent
disposition of the New Note. Such a deferral is not required, however, if the
United States Holder elects to include accrued market discount in income
currently.
Sale, Exchange or Retirement of the New Notes. Upon the sale, exchange,
redemption, retirement, maturity or other disposition of a New Note, a United
States Holder will generally recognize taxable gain or loss equal to the
difference between the sum of cash plus the fair market value of all other
property received on such disposition (except to the extent such cash or
property is attributable to accrued interest which will be taxable as ordinary
income) and such holder's adjusted tax basis in the New Note. Gain or loss
recognized on the disposition of a New Note generally will be capital gain or
loss (except to the extent of any accrued market discount). Long-term capital
gains tax rates will apply to dispositions by individuals of New Notes held for
more than 18 months. The maximum long-term capital gains tax rate applicable to
individuals is currently 20% (10% for individuals in the 15% tax bracket).
Mid-term capital gains tax rates will apply to dispositions by individuals of
New Notes held for more than one year but not more than 18 months. The maximum
mid-term capital gains tax rate applicable to individuals is currently 28% (15%
for individuals in the 15% tax bracket).
Backup Withholding and Information Reporting. In general, a United States
Holder of a New Note will be subject to backup withholding at the rate of 31%
with respect to interest, principal and premium, if any, paid on a New Note,
unless the holder (a) is an entity (including corporations, tax-exempt
organizations and certain qualified nominees) that is exempt from withholding
and, when required, demonstrates this fact, or (b) provides the Company with its
Taxpayer Identification Number ("TIN") (which, for an individual, would be the
holder's Social Security number), certifying that the TIN provided to the
Company is correct and that the holder has not been notified by the IRS that it
is subject to backup withholding due to underreporting of interest or dividends,
and otherwise complies with applicable requirements of the backup withholding
rules. In addition, such payments of interest, principal and premium to United
States Holders that are not corporations, tax-exempt organizations or qualified
nominees will generally be subject to information reporting requirements.
The amount of any backup withholding from a payment to a United States
Holder will be allowed as a credit against such holder's federal income tax
liability and may entitle such holder to a refund, provided that the required
information is furnished to the IRS.
NON-UNITED STATES HOLDERS
Stated Interest. Interest paid by the Company to any beneficial owner of a
New Note that is not a United States Holder ("Non-United States Holder") will
generally not be subject to United States federal income or withholding tax if
such interest is not effectively connected with the conduct of a trade or
business within the United States by such Non-United States Holder and (a) such
Non-United States Holder (i) does not actually or constructively own 10% or more
of the total combined voting power of all classes of stock of the
109
<PAGE> 118
Company; (ii) is not a controlled foreign corporation with respect to which the
Company is a "related person" within the meaning of the Code and (iii) satisfies
certain certification requirements or (b) such Non-United States Holder is
entitled to the benefits of an income tax treaty under which the interest is
exempt from United States withholding tax, and such Non-United States Holder
provides a properly executed IRS Form 1001 claiming the exemption (or, after
December 31, 1998, a properly executed IRS Form W-8, which may require obtaining
a Taxpayer Identification Number and making certain certifications). Interest
effectively connected with the conduct of a United States trade or business by a
Non-United States Holder will be subject to the United States federal income tax
on net income that applies to United States persons generally (and, with respect
to corporate holders, under certain circumstances, may also be subject to the
branch profits tax).
Sale, Exchange or Retirement of the New Notes. A Non-United States Holder
will generally not be subject to United States federal income tax on gain
recognized on a sale, redemption, retirement at maturity or other disposition of
a New Note unless (i) the gain is effectively connected with the conduct of a
trade or business within the United States by the Non-United States Holder, (ii)
in the case of a Non-United States Holder who is a nonresident alien individual
and holds the Note as a capital asset, such holder is present in the United
States for 183 or more days in the taxable year and certain other requirements
are met or (iii) the Non-United States Holder is subject to tax pursuant to the
provisions of U.S. tax law applicable to certain United States expatriates.
Federal Estate Taxes. If interest on the New Notes is exempt from
withholding of United States federal income tax under clause (a) of the rules
described under "Stated Interest," the New Notes will not be included in the
estate of a deceased Non-United States Holder for United States federal estate
tax purposes.
Backup Withholding and Information Reporting. The Company will, where
required, report to the holders of New Notes and the IRS the amount of any
interest paid on the New Notes in each calendar year and the amounts of tax
withheld, if any, with respect to such payments. Copies of these information
returns may also be made available under the provisions of a specific treaty or
agreement to the tax authorities of the country in which the Non-United States
Holder resides.
Information reporting and backup withholding requirements will apply to the
gross proceeds paid to a Non-United States Holder on the disposition of the New
Notes by or through a United States office of a United States or foreign broker,
unless certain certification requirements are met or the holder otherwise
establishes an exemption. Information reporting requirements, but not backup
withholding, will also apply to a payment of the proceeds of a disposition of
the New Notes by or through a foreign office of a broker that is either a U.S.
person or a U.S. related person, unless the holder is an exempt recipient (as
demonstrated through appropriate certification) or such broker has documentary
evidence in its file that the holder of the New Notes is not a United States
person and has no actual knowledge to the contrary and certain other conditions
are met. Neither information reporting nor backup withholding generally will
apply to a payment of the proceeds of a disposition of the New Notes by or
through a foreign office of a foreign broker that is not a United States related
person. For purposes of this paragraph, a United States related person is (i) a
"controlled foreign corporation" for United States federal income tax purposes,
(ii) a foreign person 50% or more of whose gross income from all sources for the
three-year period ending with the close of its taxable year preceding the
payment (or for such part of the period that the broker has been in existence)
is derived from activities that are effectively connected with the conduct of a
United States trade or business, or (iii) with respect to payments made after
December 31, 1998, a foreign partnership that, at any time during its taxable
year is 50% or more (by income or capital interest) owned by United States
persons or is engaged in the conduct of a United States trade or business.
Backup withholding is not an additional tax. Any amounts withheld under the
backup withholding rules may be refunded or credited against the Non-United
States Holder's United States federal income tax liability, provided that the
required information is furnished to the IRS. Non-United States Holders are
urged to consult their tax advisors with respect to the application of the
backup withholding rules, as revised under the recently adopted Treasury
Regulations that will generally be effective with respect to payments made
beginning January 1, 1999, to their particular situations.
110
<PAGE> 119
NOTICE TO INVESTORS
Unless and until a New Note is exchanged for a Note pursuant to the
Exchange Offer, each Note will bear a legend to the following effect unless
otherwise agreed by the Company and the holder thereof.
"THIS NOTE (OR ITS PREDECESSOR) HAS NOT BEEN REGISTERED UNDER THE
UNITED STATES SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"),
AND, ACCORDINGLY, MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE
TRANSFERRED WITHIN THE UNITED STATES OR TO, OR FOR THE ACCOUNT OR BENEFIT
OF, U.S. PERSONS, EXCEPT AS SET FORTH IN THE SECOND SENTENCE HEREOF. BY ITS
ACQUISITION HEREOF OR OF A BENEFICIAL INTEREST HEREIN, THE HOLDER (1)
REPRESENTS THAT (A) IT IS A "QUALIFIED INSTITUTIONAL BUYER" (AS DEFINED IN
RULE 144A UNDER THE SECURITIES ACT) (A "QIB"), (B) IT IS ACQUIRING THIS
NOTE IN AN OFFSHORE TRANSACTION IN COMPLIANCE WITH REGULATION S UNDER THE
SECURITIES ACT OR (C) IT IS AN INSTITUTIONAL "ACCREDITED INVESTOR" (AS
DEFINED IN RULE 501(A)(1), (2), (3) OR (7) OF REGULATION D UNDER THE
SECURITIES ACT (AN "IAI")); (2) AGREES THAT IT WILL NOT RESELL OR OTHERWISE
TRANSFER THIS NOTE EXCEPT (A) TO THE COMPANY OR ANY OF ITS SUBSIDIARIES,
(B) TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QIB PURCHASING FOR
ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QIB IN A TRANSACTION MEETING THE
REQUIREMENTS OF RULE 144A, (C) IN AN OFFSHORE TRANSACTION MEETING THE
REQUIREMENTS OF RULE 903 OR 904 OF THE SECURITIES ACT, (D) IN A TRANSACTION
MEETING THE REQUIREMENTS OF RULE 144 UNDER THE SECURITIES ACT, (E) TO AN
IAI THAT, PRIOR TO SUCH TRANSFER, FURNISHES THE TRUSTEE A SIGNED LETTER
CONTAINING CERTAIN REPRESENTATIONS AND AGREEMENTS RELATING TO THE TRANSFER
OF THIS NOTE (THE FORM OF WHICH CAN BE OBTAINED FROM THE TRUSTEE) AND, IF
SUCH TRANSFER IS IN RESPECT OF AN AGGREGATE PRINCIPAL AMOUNT OF NOTES LESS
THAN $250,000, AN OPINION OF COUNSEL ACCEPTABLE TO THE COMPANY THAT SUCH
TRANSFER IS IN COMPLIANCE WITH THE SECURITIES ACT, (F) IN ACCORDANCE WITH
ANOTHER EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT
(AND BASED UPON AN OPINION OF COUNSEL ACCEPTABLE TO THE COMPANY) OR (G)
PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT AND, IN EACH CASE, IN
ACCORDANCE WITH THE APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED
STATES OR ANY OTHER APPLICABLE JURISDICTION AND (3) AGREES THAT IT WILL
DELIVER TO EACH PERSON TO WHOM THIS NOTE OR AN INTEREST HEREIN IS
TRANSFERRED A NOTICE SUBSTANTIALLY TO THE EFFECT OF THIS LEGEND. AS USED
HEREIN, THE TERMS "OFFSHORE TRANSACTION" AND "UNITED STATES" HAVE THE
MEANINGS GIVEN TO THEM BY RULE 902 OF REGULATION S UNDER THE SECURITIES
ACT. THE INDENTURE CONTAINS A PROVISION REQUIRING THE TRUSTEE TO REFUSE TO
REGISTER ANY TRANSFER OF THIS NOTE IN VIOLATION OF THE FOREGOING.
111
<PAGE> 120
PLAN OF DISTRIBUTION
Based on interpretations by the staff of the SEC enunciated in Exxon
Capital Holdings Corporation (available May 13, 1988), Morgan Stanley & Co.
Incorporated (available June 5, 1991), Shearman & Sterling (available July 2,
1993), K-III Communications Corporation (available May 14, 1993), and similar
no-action or interpretive letters issued to third parties, the Company believes
that the New Notes issued pursuant to the Exchange Offer in exchange for Notes
may be offered for resale, resold and otherwise transferred by any Holder
thereof (other than any such Holder which is an "affiliate" of the Company
within the meaning of Rule 405 under the Securities Act), without compliance
with the registration and prospectus delivery provisions of the Securities Act;
provided, that such New Notes are acquired in the ordinary course of such
Holder's business and such Holder is not participating, does not intend to
participate and has no arrangement or understanding with any person to
participate in a distribution of such New Notes. Accordingly, any Holder using
the Exchange Offer or intending to participate in a distribution of the New
Notes will not be able to rely on such no-action letters. Notwithstanding the
foregoing, each Participating Broker-Dealer that receives New Notes for its own
account pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with the initial sales of such New Notes to third
parties. This Prospectus, as it may be amended or supplemented from time to
time, may be used by a Participating Broker-Dealer in connection with such sales
of New Notes where such Notes were acquired as a result of market-making
activities or other trading activities. The Company has agreed that it will
under certain circumstances make this Prospectus, as amended or supplemented,
available to any Participating Broker-Dealer for use in connection with any such
resale and Participating Broker-Dealers shall be authorized to deliver this
Prospectus for a period not exceeding one year after the Expiration Date. In
addition, until 90 days after the date of this Prospectus, all dealers effecting
transactions in the New Notes may be required to deliver a prospectus.
The Company and the Subsidiary Guarantors will not receive any proceeds
from any sales of the New Notes by Participating Broker-Dealers. New Notes
received by Participating Broker-Dealers for their own account pursuant to the
Exchange Offer may be sold from time to time in one or more transactions in the
over-the-counter market, in negotiated transactions, through the writing of
options on the New Notes or a combination of such methods of resale, at market
prices prevailing at the time of resale, at prices related to such prevailing
market prices or at negotiated prices. Any such resale may be made directly to
purchasers or to or through brokers or dealers who may receive compensation in
the form of commissions or concessions from any such Participating Broker-Dealer
that resells the New Notes that were received by it for its own account pursuant
to the Exchange Offer or the purchasers of the New Notes. Any Participating
Broker-Dealer that acquired Notes as a result of market making activities or
other trading activities and who resells New Notes that were received by it
pursuant to the Exchange Offer and any broker or dealer that participates in a
distribution of such New Notes may be deemed to be an "underwriter" within the
meaning of the Securities Act and any profit on any such resale of New Notes and
any commission or concessions received by any such persons may be deemed to be
underwriting compensation under the Securities Act. The Letter of Transmittal
states that by acknowledging that it will deliver and by delivering a
prospectus, a Participating Broker-Dealer will not be deemed to admit that it is
an "underwriter" within the meaning of the Securities Act. By acceptance of the
Exchange Offer, each broker-dealer that receives New Notes pursuant to the
Exchange Offer hereby agrees to notify the Company prior to using this
Prospectus in connection with the sale or transfer of New Notes and acknowledges
and agrees that, upon receipt of notice from the Company of the happening of any
event which makes any statement in this Prospectus untrue in any material
respect or which requires the making of any changes in this Prospectus in order
to make the statements herein not misleading (which notice the Company agrees to
deliver promptly to such broker-dealer), such broker-dealer will suspend use of
this Prospectus until the Company has amended or supplemented this Prospectus to
correct such misstatement or omission and has furnished copies of the amended or
supplemented prospectus to such broker-dealer.
The Company will promptly send additional copies of this Prospectus and any
amendment or supplement to this Prospectus to any Participating Broker-Dealer
that requests such documents in the Letter of Transmittal. See "The Exchange
Offer."
112
<PAGE> 121
There is no existing market for the New Notes and there can be no assurance
as to the liquidity of any market that may develop for the New Notes, the
ability of Holders of the New Notes to sell their New Notes or the price at
which Holders would be able to sell their New Notes. Future trading prices of
the New Notes will depend on many factors, including, among other things,
prevailing interest rates, the Company's operating results, the market for
similar securities and general economic conditions. The Company has been advised
by DLJ that it intends to make a market in the New Notes, subject to the limits
imposed by the Securities Act and the Exchange Act and subject to any limits
imposed during the pendency of any registration statement or shelf registration
statement; however, DLJ is not obligated to do so, and may discontinue such
market-making at any time without notice. The Company does not currently intend
to list the New Notes on any securities exchange or the National Association of
Securities Dealers Automated Quotation System. Therefore, no assurance can be
given as to the liquidity of any trading market for the New Notes. In addition,
such market-making activities may be limited during the Exchange Offer. See
"Risk Factors -- Absence of Trading Market; Restrictions on Transfer."
Entities affiliated with DLJ (i) hold 11,800,000 shares of Common Stock of
the Company, including shares of the Company's Series A Preferred Stock and
Series B Preferred Stock which are convertible into an aggregate of 2,000,000
shares and 3,857,280 shares of the Company's Common Stock, respectively,
Convertible Subordinated Notes which are convertible into an aggregate of
5,142,720 shares of the Company's Common Stock, and Bridge Financing Warrants
which are exercisable for an aggregate of 800,000 shares of the Company's Common
Stock and (ii) pursuant to the Securityholders Agreement, are entitled to elect
two member to the Company's Board of Directors.
Under the Securityholders Agreement, the Company is obligated until
November 23, 1998, to use DLJ as its exclusive financial advisor and investment
banker. In consideration for DLJ's services, the Company has agreed to pay DLJ
an annual retainer of $200,000. In each of 1996 and 1997, the Company paid DLJ
$200,000 in fees for financial advisory and certain investment banking services
provided to the Company.
In connection with the refinancing of its then-outstanding indebtedness in
January and December of 1996, the Company paid fees of $1.2 million in the
aggregate for debt issuance costs to DLJCF. DLJCF is an affiliate of DLJ.
113
<PAGE> 122
DESCRIPTION OF CAPITAL STOCK
The authorized capital stock of the Company consists of 70,000,000 shares
of Common Stock, $.0001 par value per share, of which 5,607,480 shares were
outstanding as of February 28, 1998, and 605,364 shares of Preferred Stock,
$.0001 par value per share, 412,500 of which have been designated Series A
Preferred Stock and 192,864 of which have been designated Series B Preferred
Stock, all of which shares of Series A and B Preferred Stock are outstanding.
SERIES A PREFERRED STOCK
Each share of Series A Preferred Stock is entitled to receive dividends to
the same extent as the Common Stock. In the event of any liquidation,
dissolution or winding up of the Company, the holders of Series A Preferred
Stock are entitled to receive, subsequent to any distributions required to be
made to the holders of the Series B Preferred Stock, but prior and in preference
to any distribution of assets of the Company to the holders of Common Stock, the
amount of $21.82 per share. Each share of Series A Preferred Stock is
convertible at any time into Common Stock on a 20-for-one basis, subject to
adjustment with respect to certain dilutive issuances by the Company. In
addition, all of the shares of Series A Preferred Stock will be converted
automatically into Common Stock upon the occurrence of (i) the initial public
offering of the Company's Common Stock at a minimum price per share of $4.67 and
net proceeds to the Company of at least $15.0 million or (ii) the conversion
into Common Stock of the Convertible Subordinated Notes and/or shares of Series
B Preferred Stock representing at least 30% of the aggregate number of shares of
Common Stock into which all Convertible Subordinated Notes and shares of Series
B Preferred Stock could be converted as of the closing of the transactions
contemplated by the Securities Purchase Agreement. The holders of Series A
Preferred Stock are entitled to vote with the holders of Common Stock on an
as-converted basis on all matters presented for stockholder vote. In addition,
the Series A Preferred Stock contains customary antidilution rights in the event
of certain dilutive issuances by the Company of shares or rights to acquire
shares of its capital stock and protective voting provisions that, among other
things, limit the Company's ability to, without the affirmative vote of the
holders of at least a majority of the outstanding shares of Series A Preferred
Stock, (i) create, authorize or issue any senior class or series of stock other
than the Series B Preferred Stock or any securities on parity with the Series A
Preferred Stock, or increase the authorized number of shares of any such class
or series of stock, or reclassify any authorized stock of the Company into any
such class or series of stock, or create, authorize or issue any obligation or
security convertible into or evidencing the right to purchase any such class or
series of stock; (ii) issue additional shares of Series A Preferred Stock; (iii)
amend, alter or repeal the Certificate of Incorporation of the Company or those
of its subsidiaries in any manner adverse to the preferences, privileges, voting
rights and powers of the holders of Series A Preferred Stock and (iv)
voluntarily liquidate, dissolve or wind up the Company or any of its
subsidiaries unless payments of liquidation preferences are paid in accordance
with the Company's Certificate of Incorporation.
SERIES B PREFERRED STOCK
Each share of Series B Preferred Stock is entitled to receive cumulative
dividends at (i) a rate of 25% of $31.11 per share per annum from the date of
issuance of such shares until November 23, 1997 and (ii) the greater of (A)
12.5% of $31.11 per share per annum and (B) $31.11 multiplied by the prime rate
plus 2%, thereafter. In the event of any liquidation, dissolution or winding up
of the Company, the holders of Series B Preferred Stock shall be entitled to
receive in preference to the holders of Series A Preferred Stock and Common
Stock an amount equal to the greater of (A) $31.11 per share plus all accrued
and unpaid dividends and (B) the amount that would have been received by a
holder of one share of Series B Preferred Stock had such share been converted
into Common Stock. As amended, the Company's Certificate of Incorporation
requires the Company to redeem the Series B Preferred Stock on or after July 15,
2005, to the extent the Company has funds legally available for such payment, at
a redemption price of $31.11 per share in cash, together with accrued and unpaid
dividends. Each share of Series B Preferred Stock is convertible into Common
Stock at any time on a 20-for-one basis, subject to adjustment with respect to
certain dilutive issuances by the Company. In addition, all of the shares of
Series B Preferred Stock shall be converted
114
<PAGE> 123
automatically into Common Stock upon the occurrence of the initial public
offering of the Company's Common Stock at a minimum price per share of $4.67 and
net proceeds to the Company of at least $15.0 million. The holders of Series B
Preferred Stock shall be entitled to vote with the holders of Common Stock on an
as-converted basis on all matters presented for stockholder vote. In addition,
the Series B Preferred Stock contains customary antidilution rights in the event
of certain dilutive issuances by the Company of shares or rights to acquire
shares of its capital stock and protective voting provisions that, among other
things, limit the Company's ability to, without the affirmative vote of the
holders of at least 66 2/3% of the outstanding shares of Series B Preferred
Stock (so long as at least 25% of the aggregate number of shares of Common Stock
issuable upon conversion of the Series B Preferred Stock and Convertible
Subordinated Notes originally issued remain outstanding), (i) amend, alter or
repeal the Certificate of Incorporation of the Company or its subsidiaries in
any manner adverse to the preferences, privileges, voting rights and powers of
the holders of the Series B Preferred Stock, (ii) voluntarily liquidate,
dissolve or wind up the Company or any of its subsidiaries, (iii) voluntarily
convey, exchange or transfer all or substantially all of the Company's assets,
(iv) other than indebtedness under the New Notes and the New Credit Facility,
incur, assume, refinance, renew, discharge, repay (other than pursuant to
regularly scheduled payments thereof) or cancel any indebtedness of the Company
or any of its subsidiaries,(v) pay dividends or distributions on capital stock
of the Company and its subsidiaries and (vi) except as required under the terms
of the Indenture related to the New Notes, redeem or repurchase any shares of
capital stock of the Company.
COMMON STOCK
Each holder of Common Stock is entitled to one vote for each share held.
Holders of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors out of funds legally available therefor. In
the event of a liquidation, dissolution or winding up of the Company, holders of
Common Stock would be entitled to share ratably in the Company's assets
remaining after the payment of liabilities and the satisfaction of any
liquidation preference granted to the holders of any outstanding shares of
Preferred Stock, including the Series A and B Preferred Stock. Holders of Common
Stock have no preemptive or other subscription rights. The shares of Common
Stock are not convertible into any other security.
REGISTRATION RIGHTS
Pursuant to the Securityholders Agreement, holders (the "Registration
Rights Holders") of approximately 16.3 million shares of Common Stock (including
Common Stock issuable upon the conversion of the Series A and B Preferred
Stock), 5.1 million shares of Common Stock issuable upon the conversion of the
Convertible Subordinated Notes and 800,000 shares of Common Stock issuable upon
the exercise of the Bridge Note Warrants are entitled to certain demand and
piggy-back registration rights with respect to such shares. Pursuant to the
Securityholders Agreement, certain of the Registration Rights Holders may
currently and certain other Registration Rights Holders may, commencing six
months after a public offering by the Company of its Common Stock, request that
the Company file a registration statement under the Securities Act and, upon
such request and subject to certain conditions and restrictions, the Company
generally will be required to use its best efforts to effect each such
registration up to a maximum of three such registrations (requests for
registration on Form S-3 do not count towards the number of permitted requests
for registration). In addition, if the Company proposes to register any of its
Common Stock either for its own account or for the account of other
stockholders, the Company is required, with certain exceptions, to notify the
Registration Rights Holders and, subject to certain limitations, including in
any underwritten registration the ability to limit the number of shares included
in any such registration, to include in such registration all of the shares of
Common Stock requested to be included by the Registration Rights Holders. The
Company is generally obligated to bear the expenses, other than underwriting
discounts and sales commissions, of these registrations.
115
<PAGE> 124
WARRANTS
The Company has Bridge Note Warrants outstanding exercisable for an
aggregate of 800,000 shares of Common Stock at an exercise price of $1.55 per
share. Such warrants expire on November 23, 2004. See "Certain
Transactions -- Bridge Financing."
TRANSFER AGENT
The Company acts as the transfer agent and registrar for its Common and
Preferred Stock.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the
New Notes offered hereby will be passed upon for the Company by Brobeck, Phleger
& Harrison LLP, Newport Beach, California. Richard A. Fink, a member of Brobeck,
Phleger & Harrison LLP, is Secretary of the Company and owns 40,000 shares of
Common Stock.
EXPERTS
The annual consolidated financial statements of the Company and the
financial statements of Air Bearings, Incorporated included in this Prospectus
and the related financial statement schedule included elsewhere in the
registration statement have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their reports appearing herein and elsewhere in the
registration statement, and are included in reliance upon the reports of such
firm given upon their authority as experts in accounting and auditing.
116
<PAGE> 125
GLOSSARY
Access Speed: The time it takes to locate data on a disk, measured in
milliseconds.
Actuator Mechanics: The mechanism within the disk drive that controls
movement of a head stack assembly.
Areal Density: A measure of recording density calculated by multiplying
bits per inch (bpi) by tracks per inch (tpi).
Asperity: A bump or protrusion on the surface of a disk.
Bit: The basic unit of storage of information in a computer system. Bits
are represented by the presence or absence of changes in orientation of the
magnetic domains along a track on the storage media.
Bits Per Inch (BPI): A measure of how densely information is packed on a
storage medium.
Burnish: To remove asperities or particles from the surface of a disk.
Byte: Eight bits. A megabyte (MB) equals one million bytes. A gigabyte (GB)
equals one billion bytes. One byte is sufficient to define all the
alphanumeric characters. Storage capacity of a disk drive is commonly
measured in megabytes which is the total number of storable bits, divided
by eight million.
Disk: A magnetically coated disk substrate which spins inside a disk drive
and is used as the storage medium for digital data.
Disk Drive: The primary data storage device used by computers. Disk drives
are used to record, store and retrieve digital information in a computer
system.
Flying Height: The distance between the read/write head and the disk
surface, created by the cushion of air that results from the velocity of
the disk rotation, which keeps the two objects from touching. Closer flying
heights permit denser data storage but require more precise mechanical
designs.
Gigabyte: Equal to one billion bytes or one thousand megabytes.
Glide Height: The minimum allowable distance between the read/write head
and the surface of a disk. Glide height is measured in millionths of an
inch (or microinches). Flying the read/write head closer to the surface of
the spinning disk enhances performance in a disk drive.
Head Disk Assembly (HDA): The combination of the HSA and disk(s) as part of
the final assembly of a hard disk drive.
Head Gimbal Assembly (HGA): A magnetic recording head attached to a
flexure, or suspension arm, and a wire/tubing assembly.
Head Stack Assembly (HSA): Multiple head gimbal assemblies (HGAs).
Read/Write Head: A small magnetic transducer that flies above the surface
of the disk and performs the functions of reading and writing data onto the
disk.
MR (magnetoresistive) Head: Recording head that uses an inductive thin-film
element to write data onto the media and a separate MR element to read the
data. The use of a separate but more sensitive read element permits data to
be recorded and, subsequently, read at much higher track densities than
inductive thin-film head technology. MR head technology is regarded by many
in the industry as a means to significantly increase areal densities.
Media Certification: The process of testing the magnetic qualities of a
disk's surface.
Megabyte: Equal to one million bytes.
Microinch: One millionth of an inch. There are approximately 3000
microinches in a human hair and 200 microinches in a fingerprint.
Quasi-Static Test: A static test (not involving a spinning disk) utilizing
comparably low frequencies.
A-1
<PAGE> 126
Server: A computer generally configured for the support of concurrent
multi-user applications. The server is generally a storage repository of
software and data.
Servowrite: To write magnetic servo tracks on a disk surface which provide
track location and positioning information.
Spindle: The drive's center shaft, on which the disks are mounted. A
synchronized spindle is a shaft that allows two disks to spin
simultaneously as a mirror image of each other, permitting redundant
storage of data.
Storage Capacity: The amount of information, expressed in bytes, that can
be stored on a hard drive.
Thin Films: For magnetic disks, films thickness measured in Angstroms (250
Angstroms = one microinch).
Throughput: The number of units (disk drives, disks or read/write heads)
processed through a given manufacturing step or on a given machine per
unit.
Track: One of the many concentric magnetic circle patterns written on a
disk surface as a guide for storing and reading data.
Tracks Per Inch (TPI): The number of tracks per inch of media.
Transfer Rate: The rate at which the disk sends and receives data from the
controller.
Yield: A measure of manufacturing efficiency; the percent of acceptable
product obtained from a specific manufacturing process(es).
A-2
<PAGE> 127
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PHASE METRICS, INC.:
Independent Auditors' Report.............................. F-2
Consolidated Balance Sheets as of December 31, 1996 and
1997 and March 31, 1998 (unaudited).................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1995, 1996 and 1997 and the three months
ended March 31, 1997 and 1998 (unaudited).............. F-4
Consolidated Statements of Stockholders' Equity (Deficit)
for the years ended December 31, 1995, 1996 and 1997
and the three months ended March 31, 1998
(unaudited)............................................ F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1995, 1996
and 1997 and the three months ended March 31, 1997 and
1998 (unaudited)....................................... F-6
Notes to Consolidated Financial Statements................ F-7
AIR BEARINGS, INCORPORATED:
Independent Auditors' Report.............................. F-29
Statement of Income and Retained Earnings for the year
ended December 31, 1995................................ F-30
Statement of Cash Flows for the year ended December 31,
1995................................................... F-31
Notes to Financial Statements............................. F-32
</TABLE>
F-1
<PAGE> 128
INDEPENDENT AUDITORS' REPORT
Phase Metrics, Inc.:
We have audited the accompanying consolidated balance sheets of Phase
Metrics, Inc. and its subsidiaries as of December 31, 1996 and 1997, and the
related consolidated statements of operations, stockholders' equity (deficit)
and cash flows for each of the three years in the period ended December 31,
1997. 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 Phase Metrics, Inc. and its
subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
San Jose, California
January 30, 1998
(June 8, 1998 as to the
last 4 paragraphs of Note 11)
F-2
<PAGE> 129
PHASE METRICS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
-------------------- -----------
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 2,737 $ 2,977 $ 920
Accounts receivable -- net................................ 25,042 28,730 32,123
Inventories............................................... 51,795 55,585 52,028
Prepaid expenses and other................................ 5,734 1,975 1,718
Income taxes receivable................................... 5,000 5,156 4,465
Deferred tax assets....................................... 10,026 8,952 10,808
-------- -------- --------
Total current assets................................... 100,334 103,375 102,062
Property, plant and equipment, net.......................... 28,078 38,023 36,396
Intangible assets, net...................................... 19,477 4,966 3,326
Deferred tax assets......................................... 2,842 5,269 5,243
Other....................................................... 3,282 3,097 2,538
-------- -------- --------
Total assets................................................ $154,013 $154,730 $149,565
======== ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable.......................................... $ 18,188 $ 10,419 $ 10,438
Accrued expenses and other liabilities.................... 21,117 16,058 18,184
Customer deposits......................................... 15,885 9,038 2,100
Current portion of debt................................... 2,463 1,785 961
-------- -------- --------
Total current liabilities.............................. 57,653 37,300 31,683
Long-term liabilities:
Long-term debt............................................ 85,557 111,272 115,938
Convertible subordinated notes............................ 8,000 8,000 8,000
Accrued expenses and interest............................. 5,520 6,794 6,945
Series B redeemable preferred stock, $.0001 par value,
192,864 shares authorized, issued and outstanding
(liquidation preference of $10,578 and $10,759 at December
31, 1997 and March 31, 1998, respectively)................ 6,314 9,237 9,793
Commitments (Notes 6 and 9)
Stockholders' deficit:
Series A preferred stock, $.0001 par value, 412,500 shares
authorized, issued and outstanding (liquidation
preference of $9,000).................................. 3 3 3
Common stock, $.0001 par value, 70,000,000 shares
authorized; 5,632,500, 5,627,431 and 5,606,846 shares
issued and outstanding at December 31, 1996 and 1997
and March 31, 1998, respectively....................... 5,665 6,090 6,175
Retained deficit.......................................... (14,699) (23,166) (28,140)
Accumulated translation adjustments....................... -- (800) (832)
-------- -------- --------
Total stockholders' deficit............................ (9,031) (17,873) (22,794)
-------- -------- --------
Total liabilities, redeemable preferred stock and
stockholders' deficit..................................... $154,013 $154,730 $149,565
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 130
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------ -------------------
1995 1996 1997 1997 1998
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net sales........................................... $116,894 $190,773 $184,660 $51,603 $32,502
Cost of sales....................................... 64,766 103,861 101,294 27,914 19,617
-------- -------- -------- ------- -------
Gross profit...................................... 52,128 86,912 83,366 23,689 12,885
Operating expenses:
Research and development.......................... 11,372 31,110 43,572 10,430 9,469
Selling, general and administrative............... 15,695 24,631 22,968 6,163 4,462
Amortization and write-downs of intangibles....... 13,094 28,656 14,591 3,363 1,638
Purchased in-process research and development..... -- 13,935 -- -- --
-------- -------- -------- ------- -------
Total operating expenses....................... 40,161 98,332 81,131 19,956 15,569
-------- -------- -------- ------- -------
Income (loss) from operations....................... 11,967 (11,420) 2,235 3,733 (2,684)
Interest expense.................................... 5,625 8,448 11,573 2,566 3,431
Other (income) expense -- net....................... 149 (26) 474 76 95
-------- -------- -------- ------- -------
Income (loss) before income taxes and extraordinary
items............................................. 6,193 (19,842) (9,812) 1,091 (6,210)
Income tax expense (benefit)........................ 1,524 (8,974) (4,268) 327 (2,733)
-------- -------- -------- ------- -------
Income (loss) before extraordinary items............ 4,669 (10,868) (5,544) 764 (3,477)
Extraordinary loss, net of income taxes............. -- (1,122) -- -- (941)
-------- -------- -------- ------- -------
Net income (loss)................................... 4,669 (11,990) (5,544) 764 (4,418)
Accretion for redemption value and dividends on
Series B redeemable preferred stock............... (3,000) (3,000) (2,923) (750) (556)
-------- -------- -------- ------- -------
Net income (loss) attributable to common
stockholders...................................... $ 1,669 $(14,990) $ (8,467) $ 14 $(4,974)
======== ======== ======== ======= =======
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 131
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SERIES A
PREFERRED STOCK COMMON STOCK RETAINED ACCUMULATED
---------------- ------------------ EARNINGS TRANSLATION
SHARES AMOUNT SHARES AMOUNT (DEFICIT) ADJUSTMENTS TOTAL
------- ------ --------- ------ --------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995.............. 412,500 $3 2,750,000 $1,065 $ (1,378) $ -- $ (310)
Issuance of common stock to effect
acquisitions........................ -- -- 1,150,000 1,150 -- -- 1,150
Exercise of options................... -- -- 1,519,600 733 -- -- 733
Accrued dividends on Series B
redeemable preferred stock.......... -- -- -- -- (1,500) -- (1,500)
Accretion for redemption value on
Series B redeemable preferred
stock............................... -- -- -- -- (1,500) -- (1,500)
Compensation expense on option
grants.............................. -- -- -- 350 -- -- 350
Net income............................ -- -- -- -- 4,669 -- 4,669
------- -- --------- ------ -------- ----- --------
Balance, December 31, 1995............ 412,500 3 5,419,600 3,298 291 -- 3,592
Issuance of common stock to effect
acquisitions........................ -- -- 254,000 1,905 -- -- 1,905
Exercise of options, net of
repurchases......................... -- -- (41,100) 62 -- -- 62
Accrued dividends on Series B
redeemable preferred stock.......... -- -- -- -- (1,500) -- (1,500)
Accretion for redemption value on
Series B redeemable preferred
stock............................... -- -- -- -- (1,500) -- (1,500)
Compensation expense on option
grants.............................. -- -- -- 400 -- -- 400
Net loss.............................. -- -- -- -- (11,990) -- (11,990)
------- -- --------- ------ -------- ----- --------
Balance, December 31, 1996............ 412,500 3 5,632,500 5,665 (14,699) -- (9,031)
Exercise of options, net of
repurchases......................... -- -- (5,069) 25 -- -- 25
Accrued dividends on Series B
redeemable preferred stock.......... -- -- -- -- (1,423) -- (1,423)
Accretion for redemption value on
Series B redeemable preferred
stock............................... -- -- -- -- (1,500) -- (1,500)
Compensation expense on option
grants.............................. -- -- -- 400 -- -- 400
Net loss.............................. -- -- -- -- (5,544) -- (5,544)
Accumulated translation adjustments... -- -- -- -- -- (800) (800)
------- -- --------- ------ -------- ----- --------
Balance, December 31, 1997............ 412,500 3 5,627,431 6,090 (23,166) (800) (17,873)
Exercise of options, net of
repurchases(1)...................... -- -- (20,585) (15) -- -- (15)
Accrued dividends on Series B
redeemable preferred stock(1)....... -- -- -- -- (181) -- (181)
Accretion for redemption value on
Series B redeemable preferred
stock(1)............................ -- -- -- -- (375) -- (375)
Compensation expense on option
grants(1)........................... -- -- -- 100 -- -- 100
Net loss(1)........................... -- -- -- -- (4,418) -- (4,418)
Accumulated translation
adjustments(1)...................... -- -- -- -- -- (32) (32)
------- -- --------- ------ -------- ----- --------
Balance, March 31, 1998(1)............ 412,500 $3 5,606,846 $6,175 $(28,140) $(832) $(22,794)
======= == ========= ====== ======== ===== ========
</TABLE>
- ---------------
(1) Unaudited.
See notes to consolidated financial statements.
F-5
<PAGE> 132
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
------------------------------ -------------------
1995 1996 1997 1997 1998
-------- -------- -------- ------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating activities:
Net income (loss)............................... $ 4,669 $(11,990) $ (5,544) $ 764 $ (4,418)
Adjustments to reconcile net income (loss) to
net cash provided by (used for) operating
activities:
Depreciation, amortization and write-downs of
intangible assets.......................... 15,897 32,953 21,872 4,950 3,798
Amortization of deferred financing costs..... 1,395 644 540 126 189
Loss on disposal of property, plant and
equipment.................................. -- -- 714 -- 196
Compensation expense on option grants........ 350 400 400 100 100
Deferred income taxes........................ (10,196) (16,333) (1,353) (1,703) (1,830)
Interest on convertible subordinated notes... 2,000 2,000 1,894 500 241
Purchased in-process research and
development................................ -- 13,935 -- -- --
Extraordinary loss net of income taxes....... -- 1,122 -- -- 941
Changes in assets and liabilities:
Accounts receivable........................ (11,339) 2,442 (3,688) (3,552) (3,393)
Inventories................................ (20,107) (20,019) (4,508) (2,383) 3,557
Prepaid expenses and other assets.......... (1,415) (5,796) 3,732 2,730 (534)
Income taxes receivable.................... -- (5,000) (156) 5,000 1,430
Accounts payable........................... 19,535 (5,189) (7,769) (1,289) 19
Customer deposits, accrued expenses and
other liabilities....................... 17,511 (10,571) (12,526) (5,637) (4,966)
-------- -------- -------- ------- ---------
Net cash provided by (used for)
operating activities.................. 18,300 (21,402) (6,392) (394) (4,670)
-------- -------- -------- ------- ---------
Investing activities:
Acquisition of property, plant and equipment.... (9,135) (24,564) (17,091) (2,987) (750)
Acquisitions, net of cash acquired of $6,755 and
$1,595, respectively......................... (1,967) (20,752) -- -- --
Increase in patent costs........................ -- -- (78) -- --
-------- -------- -------- ------- ---------
Net cash used for investing
activities............................ (11,102) (45,316) (17,169) (2,987) (750)
-------- -------- -------- ------- ---------
Financing activities:
Proceeds from term notes........................ 18,000 145,000 -- -- --
Proceeds from senior notes...................... -- -- -- -- 110,000
Repayment of term and subordinated notes........ (4,850) (80,446) (1,800) (79,200)
Revolving loans -- net.......................... 4,100 (300) 26,900 3,700 (22,400)
Repayment of bridge notes....................... (20,000) -- -- -- --
Payment of debt issuance costs.................. (765) (3,872) (330) (30) (4,820)
Proceeds from sale/leaseback of equipment....... -- 4,431 -- -- --
Payments on capital lease obligations........... (317) (436) (912) (193) (234)
Net proceeds from issuance (repurchase) of
common stock................................. 733 62 25 38 (15)
-------- -------- -------- ------- ---------
Net cash provided by (used for)
financing activities.................. (3,099) 64,439 23,883 3,515 3,331
-------- -------- -------- ------- ---------
Effect of exchange rate changes on cash and cash
equivalents..................................... -- -- (82) (24) 32
-------- -------- -------- ------- ---------
Net increase (decrease) in cash and cash
equivalents..................................... 4,099 (2,279) 240 110 (2,057)
Cash and cash equivalents, beginning of period.... 917 5,016 2,737 2,737 2,977
-------- -------- -------- ------- ---------
Cash and cash equivalents, end of period.......... $ 5,016 $ 2,737 $ 2,977 $ 2,847 $ 920
======== ======== ======== ======= =========
Supplemental disclosure of cash flow information:
Interest paid................................... $ 2,789 $ 5,277 $ 9,393 $ 1,880 $ 1,357
======== ======== ======== ======= =========
Income taxes paid, (net refunds)................ $ 5,055 $ 21,857 $ (5,357) $ 225 $ (2,449)
======== ======== ======== ======= =========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE> 133
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations -- Phase Metrics, Inc. and its wholly-owned
subsidiaries (the "Company") design, manufacture and sell process and production
test equipment for the data storage industry. The consolidated financial
statements include the accounts of the Company and its wholly-owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation.
Unaudited Interim Financial Information -- The unaudited interim
consolidated financial information as of March 31, 1998 and for the three months
ended March 31, 1997 and 1998 has been prepared on the same basis as the audited
consolidated financial statements. In the opinion of management, such unaudited
information includes all adjustments (consisting of normal recurring accruals)
necessary for a fair presentation of financial position, results of operations
and cash flows for the interim periods presented. Results of these interim
periods are not necessarily indicative of the results to be expected for the
full year.
The Company's first, second and third fiscal quarters end on the Sunday
closest to March 31, June 30 and September 30, respectively. For ease of
reference, such quarter end date is used herein.
Use of Estimates in the Preparation of the Consolidated Financial
Statements -- The preparation of consolidated financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions. Assets, liabilities, revenues and expenses and
disclosures of contingent assets and liabilities are affected by such estimates
and assumptions. Actual results could differ from those estimates.
Risks and Uncertainties -- The Company is subject to certain risks and
uncertainties and believes that changes in any of the following areas could have
a material effect on the Company's future financial position or results of
operations: size and timing of orders from, and shipments to, major customers;
the timing of introductions of new products and product enhancements by the
Company or its competitors; the Company's ability to develop, introduce and
market new, technologically advanced products; the cyclicality of the data
storage industry; the rescheduling of capital expenditures by the Company's
customers; variations in the Company's customer base and product mix; the
availability and cost of key production materials and components; the Company's
ability to effectively manage its inventory and to control costs; the financial
stability of major customers; the Company's success in expanding its operations
overseas; personnel changes; expenses associated with acquisitions; fluctuations
in amortization and write-downs of intangible assets; foreign currency exchange
rate fluctuations and general economic factors.
Cash and Cash Equivalents -- The Company invests its excess cash in money
market accounts and highly liquid government securities. The Company considers
all highly liquid investments purchased with an original maturity of three
months or less to be cash equivalents.
Inventories -- Inventories are stated at the lower of cost (first-in,
first-out) or market.
Property, Plant and Equipment -- Property, plant and equipment are recorded
at cost. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the assets. Buildings and improvements
are depreciated over 39 years and equipment and furniture are generally
depreciated over three to five years. Amortization of leasehold improvements is
provided using the straight-line method over the lesser of the remaining lease
term or the life of the assets. Depreciation and amortization expense related to
property, plant and equipment totaled $2.8 million, $4.3 million, and $7.3
million for the years ended December 31, 1995, 1996 and 1997, respectively.
Intangible Assets -- Intangible assets consist primarily of purchased
technology, goodwill and covenants not to compete recorded in connection with
the Company's acquisitions (see Note 3). Purchased technology and goodwill are
amortized using the straight-line method over their expected useful lives,
generally three years. Covenants not to compete are amortized using the
straight-line method over the terms of the agreements of five to seven years.
F-7
<PAGE> 134
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
Impairment of Long-Lived Assets -- The recoverability of long-lived assets
is evaluated by an analysis of operating results and consideration of other
significant events or changes in the underlying assets and business environment.
If the Company identifies events or circumstances which indicate that an
impairment might exist, the Company determines whether the sum of the estimated
undiscounted future cash flows attributable to the assets in question is less
than their carrying amounts. If impairment exists, the Company recognizes an
impairment loss based on the excess of the carrying amount of the assets over
their fair values determined by the estimated discounted future cash flows. In
1996, the Company recorded write-downs totaling $11.9 million related to
impairment losses primarily for Cambrian Systems, Inc. ("Cambrian") and Applied
Robotic Technologies, Inc. ("ART") purchased technology. In 1997, the Company
recorded a write-down of $2.0 million related to an impairment loss for Air
Bearings, Inc. ("ABI") purchased technology (See Note 3).
Notes Payable -- Interest accrues on the $110 million principal amount
Senior Notes at 10 3/4% per annum. The Company is increasing the carrying value
of the senior notes payable to their ultimate redemption value.
Stock-Based Compensation -- The Company has elected to follow Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and
related Interpretations in accounting for its stock-based awards to employees.
Revenue Recognition -- Sales are generally recognized upon shipment. A
provision for estimated warranty and installation costs is recorded upon product
shipment.
Research and Development -- Research and development costs are expensed as
incurred. The Company's products include certain software applications that are
integral to the operation of the product. The costs to develop such software
have not been capitalized as the Company believes its current software
development process is essentially completed concurrent with the establishment
of technological feasibility of the software.
Concentrations of Credit Risk -- Financial instruments that potentially
subject the Company to concentrations of credit risk consist of cash equivalents
and accounts receivable. The Company invests its excess cash in money market
accounts and highly liquid government securities.
The Company sells its products without collateral primarily to companies located
throughout the United States and Asia. Historically, a significant portion of
the Company's sales in any particular period have been attributable to sales to
a limited number of customers. Credit is extended based on an evaluation of the
customer's financial condition. The Company estimates its potential losses on
trade receivables on an ongoing basis and provides for anticipated losses in the
period in which the sales are recognized.
Sales to customers outside the United States (primarily Asia) totaled 23%, 57%,
and 49% of net sales for the years ended December 31, 1995, 1996 and 1997,
respectively. As of December 31, 1996 and 1997, balances due from foreign
customers (primarily located in Asia) were $10.2 million and $12.0 million,
respectively.
The Company had sales to individual customers in excess of 10% of net
sales, as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Customer:
A............................................. 25% 19% 18%
B............................................. -- -- 17%
C............................................. 11% 15% 16%
D............................................. -- 12% --
E............................................. 17% -- --
</TABLE>
F-8
<PAGE> 135
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
As of December 31, 1996 and 1997, accounts receivable from individual
customers with balances due in excess of 10% of total accounts receivable
totaled $16.9 million and $17.6 million, respectively.
Reclassifications -- Certain prior year amounts have been reclassified to
conform with the current year presentation.
Fair Value of Financial Instruments -- As of December 31, 1996 and 1997,
the carrying amounts of cash and cash equivalents and borrowings outstanding
under the Company's credit agreements approximate their respective fair values.
Estimation of the fair value of the convertible subordinated notes (see Note 4)
is not deemed practicable due to the fact that there is no market for this debt
and the related party relationship. The related party is a significant
stockholder of the Company.
Foreign Currency Translation -- The financial statements of the Company's
subsidiaries outside the United States are measured using the local currency as
the functional currency. Assets and liabilities of these subsidiaries are
translated at the rates of exchange at the balance sheet date. The resultant
translation adjustments are presented as a separate component of stockholders'
deficit.
Comprehensive Income -- As of January 1, 1998, the Company adopted SFAS No.
130, "Reporting Comprehensive Income," which requires an enterprise to report,
by major components and as a single total, the change in net assets during the
period from non-owner sources. For the years ended December 31, 1995, 1996 and
1997 and the three months ended March 31, 1997 and 1998, comprehensive net
income (loss) was $4.7 million, $(12.0) million, $(6.3) million, $0.8 million
and $(4.5) million, respectively.
Recent Accounting Pronouncements -- In June 1997, SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information," was
issued. SFAS No. 131 establishes annual and interim reporting standards for an
enterprise's business segments and related disclosures about its products,
services, geographic areas and major customers. Adoption of this statement will
not impact the Company's consolidated financial position, results of operations
or cash flows. The statement is effective for fiscal years beginning after
December 15, 1997, with earlier application permitted.
2. BALANCE SHEET DETAILS
Accounts Receivable
Accounts receivable consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Trade receivables........................................ $25,788 $30,393
Allowance for doubtful accounts.......................... (746) (1,663)
------- -------
$25,042 $28,730
======= =======
</TABLE>
Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- ---------
<S> <C> <C> <C>
Raw materials and components.................. $32,012 $30,915 $28,078
Work-in-process............................... 11,466 9,796 8,151
Finished goods................................ 8,317 14,874 15,799
------- ------- -------
$51,795 $55,585 $52,028
======= ======= =======
</TABLE>
F-9
<PAGE> 136
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
<S> <C> <C>
Land.................................................... $ 2,400 $ 2,400
Buildings and improvements.............................. 4,118 9,147
Equipment and furniture................................. 22,000 30,944
Leasehold improvements.................................. 3,900 5,514
Construction in progress................................ 661 1,098
------- --------
33,079 49,103
Accumulated depreciation and amortization............... (5,001) (11,080)
------- --------
$28,078 $ 38,023
======= ========
</TABLE>
Intangible Assets
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
Purchased technology................................... $ 44,822 $ 17,598
Goodwill............................................... 4,410 --
Covenants not to compete............................... 2,175 2,175
Patents................................................ 53 131
-------- --------
51,460 19,904
Accumulated amortization and write-downs............... (31,983) (14,938)
-------- --------
$ 19,477 $ 4,966
======== ========
</TABLE>
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Accrued warranty......................................... $ 7,727 $ 5,461
Accrued compensation..................................... 6,992 6,271
Other.................................................... 6,398 4,326
------- -------
$21,117 $16,058
======= =======
</TABLE>
Accrued Expenses and Interest
Accrued expenses and interest consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------ ------
<S> <C> <C>
Accrued interest on convertible subordinated notes......... $4,208 $6,102
Other accrued expenses..................................... 1,312 692
------ ------
$5,520 $6,794
====== ======
</TABLE>
F-10
<PAGE> 137
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
3. ACQUISITIONS
In November 1994, the Company acquired all of the outstanding common stock
of ProQuip, Inc. ("ProQuip") and certain net assets of Cambrian. Concurrent with
such acquisitions, the Company restructured its combined operations.
In June 1995, the Company acquired all of the outstanding stock of Helios,
Incorporated ("Helios") and in July 1995, the Company acquired all of the
outstanding stock of ART and acquired certain net assets of Tahoe Instruments,
Inc. ("Tahoe").
In January 1996, the Company acquired all of the outstanding stock of ABI
and in December 1996, the Company acquired all of the outstanding stock of Santa
Barbara Metric ("SBM") and a portion of the business of Kirell Development, Inc.
("KDI").
The acquired companies discussed above design, manufacture and sell process
and production test equipment for the data storage industry. The acquisitions
have been accounted for in accordance with the purchase method of accounting and
the accompanying consolidated financial statements reflect the purchase price
allocated to assets acquired and liabilities assumed based upon their fair
values as of the acquisition date. The Company's results of operations include
those of the acquired companies from their respective dates of acquisition.
The fair value of significant assets acquired, liabilities assumed and
purchased in-process research and development is summarized as follows (in
millions):
<TABLE>
<CAPTION>
1994 1995 1996
------------------ --------------- --------------------
PROQUIP CAMBRIAN HELIOS ART ABI KDI & SBM
------- -------- ------ ----- ----- -----------
<S> <C> <C> <C> <C> <C> <C>
Current assets..................... $ 10.3 $ 3.5 $ 9.1 $ 5.6 $ 4.5 $ 0.5
Property and other assets.......... 1.2 0.5 -- 0.1 0.7 --
Covenant not to compete............ 1.5 0.2 -- -- -- 1.8
Purchased technology and
goodwill......................... 10.8 14.7 11.6 7.5 4.9 --
Liabilities........................ (10.2) (7.7) (13.6) (7.8) (0.1) (1.4)
Purchased in-process research and
development...................... -- -- -- -- 11.0 2.4
------ ----- ------ ----- ----- -----
Total purchase price............... $ 13.6 $11.2 $ 7.1 $ 5.4 $21.0 $ 3.3
====== ===== ====== ===== ===== =====
</TABLE>
In connection with the Company's acquisitions of ABI, SBM and a portion of
the business of KDI in 1996, the Company acquired certain research and
development projects that had not reached technological feasibility and had no
alternative future uses. Accordingly, $13.4 million of purchased in-process
research and development was expensed in 1996.
The following summarizes the cash and noncash components of the Company's
acquisitions (in millions):
<TABLE>
<CAPTION>
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
Total purchase price........................................ $24.8 $13.0 $24.3
Common stock issued......................................... -- (1.1) (1.9)
Notes payable issued........................................ -- (3.1) --
Cash acquired............................................... (2.8) (6.8) (1.6)
----- ----- -----
Cash used for acquisitions.................................. $22.0 $ 2.0 $20.8
===== ===== =====
</TABLE>
F-11
<PAGE> 138
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
The following unaudited information presents the pro forma results of
operations of the Company, after giving effect to certain adjustments including
amortization of intangible assets acquired, as if each acquisition had taken
place on January 1 of the year preceding its acquisition, with the exception of
Tahoe, KDI and SBM for which the operations were deemed immaterial. These pro
forma results have been prepared for comparative purposes only and do not
purport to be indicative of what would have occurred had the acquisitions been
made on such date, nor are they necessarily indicative of future results to be
expected (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
--------------------
1995 1996
-------- --------
<S> <C> <C>
Net sales................................................... $130,044 $190,773
======== ========
Income (loss) before extraordinary item..................... $ (2,005) $ 1,320
======== ========
Net income (loss)........................................... $ (2,005) $ 198
======== ========
</TABLE>
4. DEBT
Debt Summary -- Debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1997
------- --------
<S> <C> <C>
Credit agreements........................................... $83,800 $109,900
Convertible subordinated notes.............................. 8,000 8,000
Subordinated notes, interest at 6%, paid in 1997............ 1,000 --
Capital lease obligations with weighted average annual
interest rates
of 9%..................................................... 3,220 3,157
------- --------
Total....................................................... 96,020 121,057
Less current portion........................................ (2,463) (1,785)
------- --------
Long-term debt.............................................. $93,557 $119,272
======= ========
</TABLE>
Credit Agreements -- At December 31, 1997, the Company had a $120.0 million
credit agreement, amended in September of 1997, (the "Credit Agreement") with a
group of financial institutions (the "Lenders") which provides for (i) five-year
term loans (the "Term Loans") in the principal amount of $80.0 million, and (ii)
a three-year revolving credit facility (the "Revolver") up to $40.0 million. The
Credit Agreement was terminated and repaid in full subsequent to December 31,
1997 (See Note 11).
The Term Loans bear interest at the Company's option of (i) prime plus 2%
to 2.5% or (ii) LIBOR plus 3% to 3.5%. The Revolver bears interest at the
Company's option of (i) prime plus 0.5% to 2%, or (ii) LIBOR plus 1.5% to 3%.
The spreads depend on the Company's consolidated leverage ratio as defined in
the Credit Agreement. As of December 31, 1997, the Term Loans bore interest at
prime (8.5%) plus 2.5% and outstanding borrowings under the Revolver totaling
$3.2 million. Substantially all assets of the Company are pledged as collateral
for the Credit Agreement.
The Company pays a commitment fee on the unused portion of its Revolver.
The Credit Agreement contains certain affirmative and negative covenants
customary for this type of agreement. The Credit Agreement is guaranteed by all
of the Company's domestic subsidiaries and all such guarantees are
collateralized by first priority pledges of all outstanding capital stock of
each guarantor.
In connection with the refinancing of certain credit agreements in January
and December 1996, the related unamortized debt issuance costs were written off.
These write-offs, net of related tax benefit of
F-12
<PAGE> 139
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
$.7 million, have been reported as extraordinary items in the accompanying
consolidated statements of operations. In connection with the Credit Agreement,
the Company paid fees of $1.2 million, for debt issuance costs to the
syndication agent, a stockholder of the Company.
Through a foreign subsidiary, the Company has entered into an accounts
receivable based credit agreement. The agreement has no fixed expiration, does
not contain any covenant compliance requirements, and the interest rate is
negotiated on a customer by customer basis. The borrowings outstanding at
December 31, 1996 totaled $0.2 million and bore interest at 1.2%. There were no
borrowings outstanding as of December 31, 1997.
Convertible Subordinated Notes -- In November 1994, the Company issued and
sold $8.0 million principal amount of its convertible subordinated notes (the
"Convertible Subordinated Notes") to certain stockholders.
The Convertible Subordinated Notes currently will mature in December 2001.
Interest accrued at an annual rate of 25.0% from the date of issuance through
November 23, 1997, and thereafter accrues at an annual rate equal to the greater
of 12.5% or prime (8.5% as of December 31, 1997) plus 2.0%. The Convertible
Subordinated Notes bore interest at 12.5% as of December 31, 1997. Interest is
payable at maturity. The Company and the holders of the Convertible Subordinated
Notes agreed, effective upon the issuance of the Notes (See Note 11), to amend
the Convertible Subordinated Notes to extend the maturity date to July 15, 2005
and to eliminate all rights of redemption formerly provided for. The convertible
subordinated notes, including accrued interest: (i) are convertible into
5,142,720 shares of common stock at any time at the option of the holder, (ii)
will automatically be converted into common stock upon effectiveness of a
registration statement under the Securities Act of 1933 for the sale of common
stock with a minimum per share price of $4.665 (as adjusted to take into account
any subsequent subdivisions, combinations or reclassifications) and net proceeds
to the Company of not less than $15.0 million, and (iii) are subject to certain
anti-dilution provisions.
Long-term debt repayments (excluding capital leases) as of December 31,
1997 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- --------------------------------------------------------
<S> <C>
1998.................................................. $ 800
1999.................................................. 55,767
2000.................................................. 26,667
2001.................................................. 34,666
2002.................................................. --
--------
Total......................................... $117,900
========
</TABLE>
F-13
<PAGE> 140
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
5. INCOME TAXES
The components of income tax expense (benefit) are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
-------- -------- -------
<S> <C> <C> <C>
Current income taxes:
Federal........................................... $ 9,513 $ 6,330 $(2,915)
State............................................. 2,025 590 --
-------- -------- -------
Total..................................... 11,538 6,920 (2,915)
Deferred income taxes:
Federal........................................... (7,889) (13,610) 386
State............................................. (2,125) (3,211) (1,739)
-------- -------- -------
Total..................................... (10,014) (16,821) (1,353)
Income tax (benefit) expense before extraordinary
items............................................. 1,524 (9,901) (4,268)
Extraordinary items................................. -- 927 --
-------- -------- -------
Income tax expense (benefit)........................ $ 1,524 $ (8,974) $(4,268)
======== ======== =======
</TABLE>
The reconciliations between the statutory federal income tax rate and the
effective income tax rate for the years ended December 31, 1995, 1996 and 1997
are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1995 1996 1997
----- ------ ------
<S> <C> <C> <C>
Statutory tax rate -- expense (benefit)..................... 35.0% (35.0)% (34.0)%
Federal research and development credits.................... (4.9) (4.0) (8.2)
State income taxes, net of federal benefit.................. (1.0) (6.6) (4.2)
Foreign sales corporation, net of tax....................... (6.2) (2.4) --
Purchased in-process research and development............... -- 1.8 --
Compensation expense on option grants....................... -- 0.6 1.4
Other....................................................... 1.7 0.4 1.5
---- ----- -----
Effective tax rate -- expense (benefit)..................... 24.6% (45.2)% (43.5)%
==== ===== =====
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities used for financial
reporting and the amounts used for income tax purposes. The items comprising the
Company's deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Reserves not currently deductible........................... $ 6,023 $ 5,492
Customer deposits........................................... 1,873 1,469
Uniform capitalization adjustment........................... 1,423 707
State taxes................................................. (919) (1,345)
Purchased technology........................................ 4,972 6,540
Tax credit carryforwards (expiring through 2002)............ -- 803
Other....................................................... (504) 555
------- -------
Total............................................. $12,868 $14,221
======= =======
</TABLE>
F-14
<PAGE> 141
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
The Company believes that future taxable income will be sufficient to
utilize deferred tax assets recorded at December 31, 1997. Realization of the
Company's deferred tax assets is dependent upon the Company generating
sufficient future taxable income against which its credit carryforwards and
reversing temporary differences can be offset. Although the Company expects to
fully benefit from the recorded deferred tax assets, that expectation could
change if near-term estimates of future taxable income during the carryforward
and reversal periods are reduced.
6. LEASES
Capital Leases -- The Company incurred capital lease obligations of $1.9
million, $1.8 million, and $0.8 million in connection with lease agreements for
equipment and furniture during the years ended December 31, 1995, 1996 and 1997,
respectively. At December 31, 1996 and 1997, assets under capital leases
included in property, plant and equipment totaled $3.8 million and $4.4 million
with accumulated amortization of $0.6 million and $1.3 million, respectively.
Operating Leases -- The Company leases certain of its facilities and
certain equipment under operating leases that expire at various dates through
2003. Certain facility leases include provisions for inflation escalation
adjustments, as well as one to five year renewal options. Rent expense under
operating leases totaled $0.5 million, $3.4 million and $5.1 million for the
years ended December 31, 1995, 1996 and 1997, respectively. In June 1996, the
Company sold and leased back certain equipment under an operating lease for net
proceeds of $4.4 million. No gain or loss was recognized in connection with this
transaction.
Future minimum lease payments under capital and operating leases as of
December 31, 1997 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING
YEAR ENDING DECEMBER 31: LEASES LEASES
------------------------ ------- ---------
<S> <C> <C>
1998................................................ $1,207 $ 4,804
1999................................................ 1,082 2,500
2000................................................ 985 2,196
2001................................................ 343 928
2002................................................ 73 847
Thereafter.......................................... -- 465
------ -------
Total.......................................... 3,690 $11,740
=======
Amount representing interest............................. (533)
------
Present value of minimum lease payments.................. 3,157
Current portion.......................................... (985)
------
Long-term portion........................................ $2,172
======
</TABLE>
7. SERIES B REDEEMABLE PREFERRED STOCK
Each share of Series B redeemable preferred stock ("Series B preferred
stock"): (i) is voting, (ii) is convertible at the option of the holder into 20
shares of common stock, (iii) is entitled to preference in liquidation equal to
$31.11 per share plus all cumulative and unpaid dividends, (iv) has antidilution
rights, (v) has approval rights on new issuances of preferred stock, (vi) will
automatically be converted into common stock upon the effectiveness of a
registration statement under the Securities Act of 1933 for the sale of common
stock with a minimum per share price of $4.665 (as adjusted to take into account
any subsequent subdivisions, combinations or reclassifications) and net proceeds
to the Company of not less than $15.0 mil-
F-15
<PAGE> 142
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
lion, (vii) is redeemable by the Company at $31.11 per share after the payment
of cumulative and unpaid dividends, and (viii) is entitled to receive cumulative
minimum dividends at the rate of 25% per year on the $6.0 million redemption
value. This rate was reduced to the greater of 12.5% or prime (8.5% as of
December 31, 1997) plus 2.0% after November 22, 1997. The dividends are
cumulative at $1.5 million per year through November 1997 and thereafter at
minimum rates of $0.8 million per year. At any time after November 23, 1998, a
majority of the stockholders can request the Company to redeem all outstanding
shares at the redemption price of $31.11 per share plus all unpaid dividends. On
November 23, 2000 the Company must redeem all outstanding shares. All
redemptions are subject to funds legally available. The $6.0 million redemption
value is being accreted to retained earnings over the redemption period ending
November 23, 1998.
8. STOCKHOLDERS' EQUITY (DEFICIT)
Series A Preferred Stock -- The Series A preferred stock ranks junior to
the Series B preferred stock with respect to dividend and liquidation rights,
including liquidation rights in connection with any merger, dissolution or
winding up of operations. Each share of Series A preferred stock: (i) is voting,
(ii) is entitled to receive dividends at the same rate and time as common
stockholders when declared by the board of directors, (iii) is convertible at
the option of the holders into 20 shares of common stock, (iv) is entitled to
receive $21.82 per share upon liquidation after payment in full to Series B
preferred stockholders, (v) will automatically be converted into common stock
upon the effectiveness of a registration statement under the Securities Act of
1933 for the sale of common stock with a minimum per share price of $4.665 (as
adjusted to take into account any subsequent subdivisions, combinations or
reclassifications) and net proceeds to the Company of not less than $15.0
million, and (vi) is subject to certain anti-dilution provisions.
Common Shares Reserved -- As of December 31, 1997, the Company has reserved
the following number of shares of common stock for future issuance:
<TABLE>
<S> <C>
Conversion of Series A and B preferred stock................ 12,107,280
Conversion of subordinated notes............................ 5,142,720
Exercise and issuance of stock options...................... 4,926,570
Exercise of warrants........................................ 800,000
----------
Total............................................. 22,976,570
==========
</TABLE>
Registration Rights -- Series A and B preferred stockholders, convertible
subordinated debtholders and the holders of the common stock warrants
(collectively "securityholders") have been granted certain registration rights.
Such rights may be invoked by request of the holders of at least 25% of such
securities then outstanding or to be issued upon conversion of the Series A or
Series B preferred stock. The securityholders have been granted a right of first
refusal to purchase any outstanding capital stock offered for sale, as defined.
Warrants -- In connection with the issuance and repayment of certain debt,
the Company has outstanding warrants to acquire 800,000 shares of common stock
at $1.55 per share, subject to adjustment. The warrants expire on November 23,
2004.
Stock Option Plan -- Under the 1995 Stock Option Plan (the "Plan"), 6.3
million shares of common stock are reserved for issuance upon exercise of
options granted by the Company. Under the Plan, incentive and non-qualified
stock options may be granted to employees, officers, directors and consultants
to purchase shares of the Company's common stock. The exercise price for an
incentive stock option and a nonqualified stock option cannot be less than 100%
and 85%, respectively, of the fair market value of the Company's common stock on
the grant date as determined by the board of directors. Options vest at a rate
of 20% on the first anniversary of the vesting commencement date determined by
the Board of Directors and then ratably
F-16
<PAGE> 143
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
over the following 48 months. Options are immediately exercisable and underlying
shares are subject to the Company's repurchase rights, which lapse over a
five-year period. Options expire as determined by the Board of Directors, but
not more than 10 years after the grant date. In addition, the Company has
outstanding options to purchase an additional 100,000 shares of common stock
granted outside of the Plan.
At December 31, 1997, 2,638,386 shares were available for future option
grants. The total number of shares authorized, as well as shares subject to
outstanding options, will be appropriately adjusted in the event of certain
changes to the Company's capital structure, such as stock dividends, stock
splits or other recapitalizations.
A summary of stock option transactions is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
NUMBER OF PRICE PER
SHARES SHARE
---------- ----------
<S> <C> <C>
Balance at January 1, 1995
Granted............................................. 2,400,000 $0.89
Exercised........................................... (1,519,600) $0.49
Canceled............................................ (56,400) $0.55
----------
Balance at December 31, 1995.......................... 824,000 $1.66
Granted............................................. 1,108,000 $7.50
Exercised........................................... (35,216) $2.88
Canceled............................................ (179,983) $3.35
----------
Balance at December 31, 1996.......................... 1,716,801 $5.22
Granted............................................. 1,093,500 $8.36
Exercised........................................... (52,498) $1.69
Canceled............................................ (469,619) $6.72
----------
Balance at December 31, 1997.......................... 2,288,184 $6.49
==========
Vested at December 31, 1995........................... 21,108 $0.85
==========
Vested at December 31, 1996........................... 202,600 $1.58
==========
Vested at December 31, 1997........................... 495,833 $4.32
==========
Subject to repurchase at December 31, 1995............ 1,221,117 $0.50
==========
Subject to repurchase at December 31, 1996............ 817,679 $0.58
==========
Subject to repurchase at December 31, 1997............ 493,063 $0.55
==========
</TABLE>
The Company recognized compensation expense of $0.4 million during each of
the years ended December 31, 1995, 1996 and 1997 for the amortization of the
excess of the fair market value of the Company's common stock on the grant date
over the exercise price of stock options granted in 1995. The remaining
unamortized compensation expense related to such options is $1.1 million at
December 31, 1997, which will be recognized ratably over the remaining vesting
period.
The pro forma information required by SFAS 123 and presented below has been
determined as if the Company had accounted for its employee stock awards under
the Plan using the fair value method of that statement. The fair value for these
awards was estimated at the date of grant using the minimum value pricing model
with the following weighted-average assumptions for December 31, 1995, 1996 and
1997, respectively: weighted average risk-free interest rates of 6.29%, 5.84%
and 6.04%; no dividend yield; and a weighted average expected life of 3.3, 3.5
and 3.5 years.
F-17
<PAGE> 144
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
In management's opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock awards.
For purposes of pro forma disclosures, the estimated fair value of the
awards is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
-----------------------------
1995 1996 1997
------ -------- -------
<S> <C> <C> <C>
Pro forma net income (loss)........................... $4,383 $(12,487) $(5,976)
====== ======== =======
</TABLE>
The following table summarizes information as of December 31, 1997
concerning options outstanding:
<TABLE>
<CAPTION>
SHARES
WEIGHTED AVERAGE SUBJECT
EXERCISE OPTIONS REMAINING TO
PRICES OUTSTANDING CONTRACTUAL LIFE VESTED REPURCHASE
-------- ----------- ---------------- ------- ----------
(YEARS)
<S> <C> <C> <C> <C>
$0.37 129,400 7.33 71,198 416,685
$1.00 293,367 7.58 142,595 70,111
$5.00 130,567 7.86 56,760 --
$7.50 1,055,700 8.72 224,630 5,917
$8.75 679,150 9.50 650 350
--------- ------- -------
2,288,184 495,833 493,063
========= ======= =======
</TABLE>
The weighted average fair value of options granted during the years ended
December 31, 1995, 1996 and 1997 was $1.01, $1.33 and $1.53, respectively.
9. COMMITMENTS
Related Party Transaction -- In November 1994, the Company executed a
consulting services agreement with certain of its stockholders which provides
for the payment of $0.2 million in November of each year through 1998. As of
December 31, 1997 the present value and accrued interest related to obligations
under the agreement was $0.4 million.
Acquisition-Related Agreements -- Concurrent with the Company's
acquisitions of Helios, ART, ABI, SBM, Tahoe and KDI, the Company entered into,
among other things, (i) employment or consulting agreements with the former
principals of each respective entity for minimum terms of three years each, (ii)
non-compete agreements for periods of five to seven years, and (iii) earn-out
agreements based on units produced or sold with stated combined maximum earn-out
payments for the material arrangements totaling $14.1 million, of which $3.3
million was considered certain and, accordingly, allocated to the original
purchase price, and the remainder of which is being charged to compensation
expense as incurred. During the years ended December 31, 1995, 1996 and 1997,
$1.4 million, $3.8 million and $2.0 million, respectively, of earn-outs have
been charged to compensation expense.
10. EMPLOYEE SAVINGS PLAN
Under the Company's 401(k) plan (the "Plan"), eligible employees may defer
up to 15% of their pre tax earnings, subject to the Internal Revenue Service
annual contribution limit. Company matching contributions to the Plan totaled
$0.4 million and $0.6 million for the years ended December 31, 1996 and 1997,
respectively.
F-18
<PAGE> 145
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
11. SUBSEQUENT EVENTS
On January 30, 1998, the Company sold $110.0 million of its 10.75% Senior
Notes due 2005 (the "Notes"), in a private offering. The Notes bear interest at
10.75% per annum, payable semiannually in arrears on February 1 and August 1 of
each year, commencing August 1, 1998. The Notes are senior unsecured obligations
of the Company, and are redeemable at the option of the Company, in whole or in
part, at any time on or after January 15, 2002, in cash at redemption prices as
defined. In addition, at any time prior to January 15, 2001, the Company may
redeem up to 33% of the Notes at a redemption price as defined, with the net
proceeds of a public equity offering, as defined. The Company used the net
proceeds of the Notes of $105.9 million, together with existing cash and an
initial draw of $1.6 million under the New Credit Facility to repay in full its
existing term loans and revolving credit facility and all accrued interest
thereon, as well as to pay fees of $0.3 million for the New Credit Facility.
Concurrently with closing the sale of the Notes, the Company entered into a
$25 million revolving credit facility with a group of banks (the "New Credit
Facility"). The New Credit Facility is secured by substantially all of the
Company's assets. Borrowing availability under the New Credit Facility is
subject to a borrowing base test and may be increased at any time at the sole
discretion of the banks to up to $40 million. Borrowings under the New Credit
Facility bear interest at the lead bank's prime rate plus 1%, or at LIBOR plus
3%, at the Company's election. The New Credit Facility provides for a commitment
fee of three-fourths of one percent until March 31, 1999 and one-half of one
percent thereafter on the unused portion of the commitment amount. The New
Credit Facility will mature in January 2001.
The Notes and the New Credit Facility contain customary affirmative and
negative covenants, including limitations on other indebtedness, liens,
investments and guarantees, restricted payments, mergers and acquisitions, sales
of assets, capital expenditures, leases and affiliate transactions. The New
Credit facility also contains financial covenants relating to minimum interest
coverage, minimum net worth, minimum cash flow and maximum leverage.
Based on the Company's currently anticipated operating results for the
quarter ending June 30, 1998, the Company believes that it will not be in
compliance with the financial covenants under the New Credit Facility. In such
event, the Company will be required to seek a waiver from or renegotiate the
existing covenants, or potentially seek alternative financing. Based on
preliminary discussions with the agent to the Lenders, the Company believes
that, in the event of non-compliance, it will be able to obtain a waiver of such
non-compliance and renegotiate the existing covenants. The agent to the Lenders
has informed the Company that the receipt of a waiver from the Lenders and the
successful renegotiation of the existing covenants is subject, among other
things, to the Lenders' receipt and approval of the Company's revised financial
plan. Accordingly, no assurance can be given that the Company will be successful
in obtaining a waiver or renegotiating its existing covenants. If the Company
becomes in breach of any covenants, restrictions or other obligations under the
New Credit Facility in the future, the Lenders under the New Credit Facility
could declare all amounts outstanding thereunder to be immediately due and
payable, together with accrued and unpaid interest, and terminate their
commitment to make further advances thereunder.
In April 1998, the Company entered into an agreement (the "Reimbursement
Agreement") to reimburse a major customer for costs incurred in connection with
the customer's cancellation of a contract with a third party to purchase
upgrades to certain production test equipment originally purchased from the
Company. The Company took this action to protect its intellectual property and
preserve a valued customer relationship. The Company will record approximately
$6.0 million as a charge to earnings in the second quarter of 1998.
The Company will make the reimbursement provided for under the
Reimbursement Agreement by providing a credit to the customer for products to be
purchased by the customer during 1998. Products to be purchased under the
Reimbursement Agreement are at favorable pricing which will negatively impact
the Company's gross profit margin during this period.
In connection with the Reimbursement Agreement, the Company secured a $3.7
million standby letter of credit from a bank in favor of the customer. The
standby letter of credit balance will be reduced ratably as
F-19
<PAGE> 146
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
products are completed and become available for shipment to the customer. The
Company's borrowing availability under its Credit Facility is reduced by the
outstanding standby letter of credit balance.
12. FINANCIAL INFORMATION FOR GUARANTOR SUBSIDIARIES AND NON-GUARANTOR
SUBSIDIARIES.
The Company conducts substantially all of its business through the parent
company and its domestic and foreign subsidiaries. In January 1998, the Company
issued the Notes (see Note 11). The Notes are fully and unconditionally
guaranteed, on a joint and several basis, by all of the Company's wholly-owned
domestic subsidiaries (the "Guarantor Subsidiaries").
Presented below is condensed consolidating financial information for Phase
Metrics, Inc. (the "Parent Company"), the Guarantor Subsidiaries and the
wholly-owned foreign subsidiaries (the "Non-Guarantor Subsidiaries") for the
years ended December 31, 1995, 1996 and 1997 and the three months ended March
31, 1997 and 1998. The condensed consolidating financial information has been
presented to show the nature of assets held, results of operations and cash
flows of the Parent Company, Guarantor Subsidiaries and Non-Guarantor
Subsidiaries assuming the expected guarantee structure of the Senior Notes was
in effect at the beginning of the periods presented. Separate financial
statements for the Guarantor Subsidiaries are not presented based on
management's determination that they would not provide additional information
that is material to investors.
The supplemental condensed consolidating financial information reflects the
investments of the Parent Company in the Guarantor and Non-Guarantor
Subsidiaries using the equity method of accounting.
F-20
<PAGE> 147
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales.................................. $107,921 $8,973 $-- $ -- $116,894
Cost of sales.............................. 59,706 5,060 -- -- 64,766
-------- ------ --- ------- --------
Gross profit............................. 48,215 3,913 -- -- 52,128
Research and development expense........... 10,867 505 -- -- 11,372
Selling, general and administrative
expense.................................. 13,935 1,760 -- -- 15,695
Amortization and write-downs of intangible
assets................................... 13,094 -- -- -- 13,094
-------- ------ --- ------- --------
Income from operations................... 10,319 1,648 -- -- 11,967
Interest expense........................... 5,624 1 -- -- 5,625
Other (income) expense -- net.............. 175 (26) -- -- 149
-------- ------ --- ------- --------
Income before equity in subsidiaries and
taxes................................. 4,520 1,673 -- -- 6,193
Equity in net income of subsidiaries....... 1,261 -- -- (1,261) --
Income tax expense......................... 1,112 412 -- -- 1,524
-------- ------ --- ------- --------
Net income................................. $ 4,669 $1,261 $-- $(1,261) $ 4,669
======== ====== === ======= ========
</TABLE>
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net income................................. $ 4,669 $ 1,261 $ -- $(1,261) $ 4,669
Depreciation, amortization and
write-downs of intangible assets...... 15,877 20 -- -- 15,897
Equity in net income of subsidiaries..... (1,261) -- -- 1,261 --
Other non-cash adjustments............... 3,745 -- -- -- 3,745
Changes in working capital............... (5,038) (973) -- -- (6,011)
-------- ------- ------ ------- --------
Net cash provided by operating
activities....................... 17,992 308 -- -- 18,300
-------- ------- ------ ------- --------
Investing activities:
Acquisition of property, plant and
equipment............................. (8,902) (233) -- -- (9,135)
Acquisitions, net of cash acquired of
$6,755................................ (1,967) -- -- -- (1,967)
-------- ------- ------ ------- --------
Net cash used for investing
activities....................... (10,869) (233) -- -- (11,102)
-------- ------- ------ ------- --------
Financing activities:
Revolving loans -- net................... 4,100 -- -- -- 4,100
Proceeds from term notes................. 18,000 -- -- -- 18,000
Repayment of debt........................ (4,850) -- -- -- (4,850)
Repayment of bridge notes................ (20,000) -- -- -- (20,000)
Intercompany balances and other.......... (274) (75) -- -- (349)
-------- ------- ------ ------- --------
Net cash used for financing
activities....................... (3,024) (75) -- -- (3,099)
-------- ------- ------ ------- --------
Net increase in cash and cash
equivalents.............................. 4,099 -- -- -- 4,099
Cash and cash equivalents, beginning of
period................................... 917 -- -- -- 917
-------- ------- ------ ------- --------
Cash and cash equivalents, end of period... $ 5,016 $ -- $ -- $ -- $ 5,016
======== ======= ====== ======= ========
</TABLE>
F-21
<PAGE> 148
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1996
ASSETS
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Accounts receivable -- net................. $ 24,224 $ 629 $ 189 $ -- $ 25,042
Inventories................................ 48,946 2,150 1,768 (1,069) 51,795
Other current assets....................... 21,620 1,164 713 -- 23,497
Property, plant and equipment, net......... 26,532 1,223 323 -- 28,078
Intercompany balances...................... (4,455) 7,058 (2,603) -- --
Investment in subsidiaries................. 7,616 -- -- (7,616) --
Other...................................... 25,097 21 483 -- 25,601
-------- ------- ------- -------- --------
Total assets.......................... $149,580 $12,245 $ 873 $ (8,685) $154,013
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current liabilities.................. $ 50,781 $ 3,873 $ 536 $ -- $ 55,190
Current portion of debt.................... 2,463 -- -- -- 2,463
Long-term debt............................. 93,557 -- -- -- 93,557
Other...................................... 5,496 -- 24 -- 5,520
Redeemable preferred stock................. 6,314 -- -- -- 6,314
Stockholders' equity (deficit)............. (9,031) 8,372 313 (8,685) (9,031)
-------- ------- ------- -------- --------
Total liabilities, redeemable
preferred stock and stockholders'
equity (deficit).................... $149,580 $12,245 $ 873 $ (8,685) $154,013
======== ======= ======= ======== ========
</TABLE>
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales.................................. $162,442 $37,654 $ 4,384 $(13,707) $190,773
Cost of sales.............................. 95,285 18,217 2,521 (12,162) 103,861
-------- ------- ------- -------- --------
Gross profit............................. 67,157 19,437 1,863 (1,545) 86,912
Research and development expense........... 29,397 1,539 174 -- 31,110
Selling, general and administrative
expense.................................. 19,267 4,449 1,391 (476) 24,631
Amortization and write-downs of intangible
assets................................... 28,656 -- -- -- 28,656
Purchased in-process research and
development expense...................... 13,935 -- -- -- 13,935
-------- ------- ------- -------- --------
Income (loss) from operations............ (24,098) 13,449 298 (1,069) (11,420)
Interest expense........................... 8,408 38 2 -- 8,448
Other (income) expense -- net.............. (22) (5) 1 -- (26)
-------- ------- ------- -------- --------
Income (loss) before equity in
subsidiaries, taxes and extraordinary
items................................. (32,484) 13,416 295 (1,069) (19,842)
Equity in net income of subsidiaries....... 6,219 -- -- (6,219) --
Income tax expense (benefit)............... (15,397) 6,305 118 -- (8,974)
-------- ------- ------- -------- --------
Net income (loss) before extraordinary
items................................. (10,868) 7,111 177 (7,288) (10,868)
Extraordinary loss, net of income taxes.... (1,122) -- -- -- (1,122)
-------- ------- ------- -------- --------
Net income (loss).......................... $(11,990) $ 7,111 $ 177 $ (7,288) $(11,990)
======== ======= ======= ======== ========
</TABLE>
F-22
<PAGE> 149
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net income (loss).......................... $(11,990) $ 7,111 $ 177 $(7,288) $(11,990)
Depreciation, amortization and
write-downs of intangible assets...... 32,511 347 95 -- 32,953
Equity in net income of subsidiaries..... (6,219) -- -- 6,219 --
Other non-cash adjustments............... 3,044 -- -- -- 3,044
Purchased in-process research and
development........................... 13,935 -- -- -- 13,935
Extraordinary items...................... 1,122 -- -- -- 1,122
Changes in working capital............... (60,782) 1,521 (2,274) 1,069 (60,466)
-------- ------- ------- ------- --------
Net cash provided by (used for)
operating activities............. (28,379) 8,979 (2,002) -- (21,402)
-------- ------- ------- ------- --------
Investing activities:
Acquisition of property, plant and
equipment............................. (23,519) (627) (418) -- (24,564)
Acquisitions, net of cash acquired of
$1,597................................ (20,752) -- -- -- (20,752)
-------- ------- ------- ------- --------
Net cash used for investing
activities....................... (44,271) (627) (418) -- (45,316)
-------- ------- ------- ------- --------
Financing activities:
Revolving loans -- net................... (300) (300)
Proceeds from term notes................. 145,000 -- -- -- 145,000
Repayment of debt........................ (80,429) (17) -- -- (80,446)
Intercompany balances and other.......... 4,478 (7,213) 2,920 -- 185
-------- ------- ------- ------- --------
Net cash provided by (used for)
financing activities............. 68,749 (7,230) 2,920 -- 64,439
-------- ------- ------- ------- --------
Net increase (decrease) in cash and cash
equivalents.............................. (3,901) 1,122 500 -- (2,279)
Cash and cash equivalents, beginning of
period................................... 5,016 -- -- -- 5,016
-------- ------- ------- ------- --------
Cash and cash equivalents, end of period... $ 1,115 $ 1,122 $ 500 $ -- $ 2,737
======== ======= ======= ======= ========
</TABLE>
F-23
<PAGE> 150
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
DECEMBER 31, 1997
ASSETS
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Accounts receivable -- net................. $ 27,693 $ 470 $ 567 $ -- $ 28,730
Inventories................................ 48,255 5,624 5,844 (4,138) 55,585
Other current assets....................... 17,672 786 602 -- 19,060
Property, plant and equipment, net......... 35,510 2,194 319 -- 38,023
Intercompany balances...................... (4,308) 11,589 (7,281) -- --
Investment in subsidiaries................. 13,247 -- -- (13,247) --
Other...................................... 12,800 48 484 -- 13,332
-------- ------- ------- -------- --------
Total assets.......................... $150,869 $20,711 $ 535 $(17,385) $154,730
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current liabilities.................. $ 32,241 $ 3,079 $ 195 $ -- $ 35,515
Current portion of debt.................... 1,785 -- -- -- 1,785
Long-term debt............................. 119,272 -- -- -- 119,272
Redeemable preferred stock................. 9,237 -- -- -- 9,237
Other...................................... 6,207 -- 587 -- 6,794
Stockholders' equity (deficit)............. (17,873) 17,632 (247) (17,385) (17,873)
-------- ------- ------- -------- --------
Total liabilities, redeemable
preferred stock and stockholders'
equity (deficit).................... $150,869 $20,711 $ 535 $(17,385) $154,730
======== ======= ======= ======== ========
</TABLE>
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales.................................. $165,724 $38,995 $12,631 $(32,690) $184,660
Cost of sales.............................. 102,461 16,098 11,069 (28,334) 101,294
-------- ------- ------- -------- --------
Gross profit............................. 63,263 22,897 1,562 (4,356) 83,366
Research and development expense........... 40,412 3,004 156 -- 43,572
Selling, general and administrative
expense.................................. 18,559 3,556 2,140 (1,287) 22,968
Amortization and write-downs of intangible
assets................................... 14,591 -- -- -- 14,591
-------- ------- ------- -------- --------
Income (loss) from operations............ (10,299) 16,337 (734) (3,069) 2,235
Interest expense........................... 11,566 -- 7 -- 11,573
Other (income) expense -- net.............. 278 (53) 249 -- 474
-------- ------- ------- -------- --------
Income (loss) before equity in
subsidiaries and taxes................ (22,143) 16,390 (990) (3,069) (9,812)
Equity in net income of subsidiaries....... 5,631 -- -- (5,631) --
Income tax expense (benefit)............... (10,968) 7,130 (430) -- (4,268)
-------- ------- ------- -------- --------
Net income (loss).......................... $ (5,544) $ 9,260 $ (560) $ (8,700) $ (5,544)
======== ======= ======= ======== ========
</TABLE>
F-24
<PAGE> 151
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
<S> <C> <C> <C> <C> <C>
Net income (loss).......................... $(5,544) $ 9,260 $ (560) $(8,700) $ (5,544)
Depreciation, amortization and
write-downs of intangible assets...... 21,119 487 266 -- 21,872
Equity in net income of subsidiaries..... (5,631) -- -- 5,631 --
Other non-cash adjustments............... 3,548 -- -- -- 3,548
Changes in working capital............... (21,090) (4,154) (4,093) 3,069 (26,268)
-------- ------- ------- ------- --------
Net cash provided by (used for)
operating activities................ (7,598) 5,593 (4,387) -- (6,392)
-------- ------- ------- ------- --------
Investing activities:
Acquisition of property, plant and
equipment............................. (15,442) (1,404) (245) -- (17,091)
Increase in patent costs................. (78) (78)
-------- ------- ------- ------- --------
Net cash used for investing
activities.......................... (15,520) (1,404) (245) -- (17,169)
-------- ------- ------- ------- --------
Financing activities:
Proceeds from debt....................... 26,900 26,900
Repayment of debt........................ (1,776) -- (24) (1,800)
Other.................................... (1,364) (4,531) 4,678 -- (1,217)
-------- ------- ------- ------- --------
Net cash provided by (used for)
financing activities................ 23,760 (4,531) 4,654 -- 23,883
-------- ------- ------- ------- --------
Effect of exchange rate on cash............ -- -- (82) -- (82)
Net increase (decrease) in cash and cash
equivalents.............................. 642 (342) (60) -- 240
Cash and cash equivalents, beginning of
period................................... 1,115 1,122 500 2,737
-------- ------- ------- ------- --------
Cash and cash equivalents, end of period... $ 1,757 $ 780 $ 440 $ -- $ 2,977
======== ======= ======= ======= ========
</TABLE>
F-25
<PAGE> 152
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales................................... $48,443 $9,560 $4,696 $(11,096) $51,603
Cost of sales............................... 28,872 4,358 3,831 (9,147) 27,914
------- ------ ------ -------- -------
Gross profit.............................. 19,571 5,202 865 (1,949) 23,689
Research and development expense............ 9,767 608 55 -- 10,430
Selling, general and administrative
expense................................... 5,059 966 408 (270) 6,163
Amortization and write-downs of intangible
assets.................................... 3,363 -- -- -- 3,363
------- ------ ------ -------- -------
Income from operations.................... 1,382 3,628 402 (1,679) 3,733
Interest expense............................ 2,565 -- 1 -- 2,566
Other (income) expense -- net............... 81 (5) -- -- 76
------- ------ ------ -------- -------
Income (loss) before equity in
subsidiaries and taxes................. (1,264) 3,633 401 (1,679) 1,091
Equity in net income of subsidiaries........ 1,145 -- -- (1,145) --
Income tax expense (benefit)................ (883) 1,090 120 -- 327
------- ------ ------ -------- -------
Net income.................................. $ 764 $2,543 $ 281 $ (2,824) $ 764
======= ====== ====== ======== =======
</TABLE>
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net income.................................. $ 764 $ 2,543 $ 281 $(2,824) $ 764
Depreciation, amortization and write-downs
of intangible assets................... 4,780 125 45 -- 4,950
Equity in net income of subsidiaries...... (1,145) -- -- 1,145 --
Other non-cash adjustments................ 726 -- -- -- 726
Changes in working capital................ (7,242) (927) (344) 1,679 (6,834)
------- ------- ----- ------- -------
Net cash provided by (used for)
operating activities................. (2,117) 1,741 (18) -- (394)
------- ------- ----- ------- -------
Investing activities:
Acquisition of property, plant and
equipment.............................. (2,774) (129) (84) -- (2,987)
------- ------- ----- ------- -------
Net cash used for investing
activities........................... (2,774) (129) (84) -- (2,987)
------- ------- ----- ------- -------
Financing activities:
Revolving loans -- net.................... 3,700 -- -- -- 3,700
Other..................................... 1,668 (1,974) 121 -- (185)
------- ------- ----- ------- -------
Net cash provided by (used for)
financing activities................. 5,368 (1,974) 121 -- 3,515
------- ------- ----- ------- -------
Effect of exchange rate on cash............. -- -- (24) -- (24)
Net increase (decrease) in cash and cash
equivalents............................... 477 (362) (5) -- 110
Cash and cash equivalents, beginning of
period.................................... 1,115 1,122 500 -- 2,737
------- ------- ----- ------- -------
Cash and cash equivalents, end of period.... $ 1,592 $ 760 $ 495 $ -- $ 2,847
======= ======= ===== ======= =======
</TABLE>
F-26
<PAGE> 153
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
ASSETS
Accounts receivable -- net................. $ 30,973 $ 550 $ 600 $ -- $ 32,123
Inventories................................ 45,590 4,752 5,689 (4,003) 52,028
Other current assets....................... 16,690 75 1,146 -- 17,911
Property, plant and equipment, net......... 33,949 2,156 291 -- 36,396
Intercompany balances...................... (4,789) 12,196 (7,407) -- --
Investment in subsidiaries................. 13,702 -- -- (13,702) --
Other...................................... 10,319 315 473 -- 11,107
-------- ------- ------- -------- --------
Total assets.......................... $146,434 $20,044 $ 792 $(17,705) $149,565
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current liabilities.................. $ 28,138 $ 2,044 $ 540 $ -- $ 30,722
Current portion of debt.................... 961 -- -- -- 961
Long-term debt............................. 123,938 -- -- -- 123,938
Redeemable preferred stock................. 9,793 -- -- -- 9,793
Other...................................... 6,398 -- 547 -- 6,945
Stockholders' equity (deficit)............. (22,794) 18,000 (295) (17,705) (22,794)
-------- ------- ------- -------- --------
Total liabilities, redeemable
preferred stock and stockholders'
equity (deficit).................... $146,434 $20,044 $ 792 $(17,705) $149,565
======== ======= ======= ======== ========
</TABLE>
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net sales................................... $29,410 $4,495 $2,908 $(4,311) $32,502
Cost of sales............................... 19,003 2,401 2,650 (4,437) 19,617
------- ------ ------ ------- -------
Gross profit.............................. 10,407 2,094 258 126 12,885
Research and development expense............ 8,650 819 -- -- 9,469
Selling, general and administrative
expense................................... 3,502 607 362 (9) 4,462
Amortization and write-downs of intangible
assets.................................... 1,638 -- -- -- 1,638
------- ------ ------ ------- -------
Income (loss) from operations............. (3,383) 668 (104) 135 (2,684)
Interest expense............................ 3,432 (4) 3 -- 3,431
Other (income) expense -- net............... 103 14 (22) -- 95
------- ------ ------ ------- -------
Income (loss) before equity in
subsidiaries, taxes and extraordinary
items.................................. (6,918) 658 (85) 135 (6,210)
Equity in net income of subsidiaries........ 455 -- -- (455) --
Income tax expense (benefit)................ (2,986) 290 (37) -- (2,733)
------- ------ ------ ------- -------
Net income (loss) before extraordinary
items.................................. (3,477) 368 (48) (320) (3,477)
Extraordinary loss, net of income taxes..... (941) -- -- -- (941)
------- ------ ------ ------- -------
Net income (loss)........................... $(4,418) $ 368 $ (48) $ (320) $(4,418)
======= ====== ====== ======= =======
</TABLE>
F-27
<PAGE> 154
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(INFORMATION PERTAINING TO MARCH 31, 1998 AND THE
THREE MONTHS ENDED MARCH 31, 1997 AND 1998 IS UNAUDITED)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
FOREIGN
PARENT GUARANTOR NON-GUARANTOR ELIMINATING
COMPANY SUBSIDIARIES SUBSIDIARIES ENTRIES CONSOLIDATED
-------- ------------ ------------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Net income (loss).......................... $ (4,418) $ 368 $ (48) $(320) $ (4,418)
Depreciation, amortization and
write-downs of intangible assets...... 3,577 200 21 -- 3,798
Equity in net income of subsidiaries..... (455) -- -- 455 --
Other non-cash adjustments............... 726 -- -- -- 726
Extraordinary item....................... 941 -- -- -- 941
Changes in working capital............... (5,015) 3,879 (4,446) (135) (5,717)
-------- ------- ------- ----- --------
Net cash provided by (used for)
operating activities................ (4,644) 4,447 (4,473) -- (4,670)
Investing activities:
Acquisition of property, plant and
equipment............................. (710) (39) (1) -- (750)
-------- ------- ------- ----- --------
Net cash used for investing
activities.......................... (710) (39) (1) -- (750)
-------- ------- ------- ----- --------
Financing activities:
Proceeds from senior notes............... 110,000 -- -- -- 110,000
Repayment of term and subordinated
notes................................. (79,200) -- -- -- (79,200)
Revolving loans -- net................... (22,400) -- -- -- (22,400)
Payment of debt issuance costs........... (4,820) -- (4,820)
Other.................................... 85 (5,138) 4,804 -- (249)
-------- ------- ------- ----- --------
Net cash provided by (used for)
financing activities................ 3,665 (5,138) 4,804 -- 3,331
-------- ------- ------- ----- --------
Effect of change rate on cash.............. -- -- 32 -- 32
Net increase (decrease) in cash and cash
equivalents.............................. (1,689) (730) 362 -- (2,057)
Cash and cash equivalents, beginning of
period................................... 1,757 780 440 -- 2,977
-------- ------- ------- ----- --------
Cash and cash equivalents, end of period... $ 68 $ 50 $ 802 $ -- $ 920
======== ======= ======= ===== ========
</TABLE>
F-28
<PAGE> 155
INDEPENDENT AUDITORS' REPORT
Air Bearings, Incorporated:
We have audited the accompanying statements of income and retained earnings
and of cash flows of Air Bearings, Incorporated for the year ended December 31,
1995. 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 financial statements present fairly, in all material
respects the results of operations and cash flows of Air Bearings, Incorporated
for the year ended December 31, 1995 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
San Jose, California
September 6, 1996
F-29
<PAGE> 156
AIR BEARINGS, INCORPORATED
STATEMENT OF INCOME AND RETAINED EARNINGS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1995
------------
<S> <C>
Sales....................................................... $7,924
Cost of sales............................................... 1,621
------
Gross profit.............................................. 6,303
------
Operating expenses:
Selling, general and administrative....................... 372
Research and development.................................. 92
------
Total operating expenses.......................... 464
------
Income from operations...................................... 5,839
Other income -- net......................................... (9)
------
Income before income taxes.................................. 5,848
Income tax expense.......................................... 88
------
Net income.................................................. 5,760
Distributions to stockholders............................... (1,818)
Retained earnings, beginning of year........................ 718
------
Retained earnings, end of year.............................. $4,660
======
</TABLE>
See notes to financial statements.
F-30
<PAGE> 157
AIR BEARINGS, INCORPORATED
STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1995
------------
<S> <C>
Operating activities:
Net income................................................ $5,760
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation........................................... 72
Changes in assets and liabilities:
Accounts receivable.................................. (1,743)
Inventory............................................ (494)
Prepaid expenses and other........................... (2)
Accounts payable..................................... 35
Accrued expenses and other liabilities............... 129
------
Net cash provided by operating activities......... 3,757
------
Investing activities -- Acquisition of property............. (536)
------
Financing activities:
Distributions to stockholders............................. (1,818)
Repayments of notes payable............................... --
------
Net cash used for financing activities............ (1,818)
------
Net increase in cash and cash equivalents................... 1,403
Cash and cash equivalents, beginning of year................ --
------
Cash and cash equivalents, end of year...................... $1,403
======
</TABLE>
See notes to financial statements.
F-31
<PAGE> 158
AIR BEARINGS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
YEAR ENDED DECEMBER 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
General -- The Company develops and manufactures air bearing spindles and
other components used in production test equipment for the data storage
industry.
Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions. Assets, liabilities, revenues and expenses, and
disclosure of contingent assets and liabilities are affected by such estimates
and assumptions. Actual results could differ from those estimates.
Cash and Cash Equivalents -- Cash equivalents consist of money market
accounts. The Company has not experienced any losses on its cash accounts.
Inventory -- Inventory is stated at the lower of cost (first-in, first-out)
or market.
Property -- Property is stated at cost. Depreciation is provided using the
straight-line method over the estimated useful lives of the property (generally
5 years).
Revenue -- Revenue from product sales is recognized upon shipment.
Concentrations of Credit Risk -- The Company markets and sells its products
domestically and internationally without collateral. Export sales, primarily to
companies in Asia, accounted for 17% of 1995 sales. Three customers individually
accounted for 43%, 22% and 17% of 1995 sales and the related accounts receivable
from these customers aggregated approximately $1.5 million at December 31, 1995.
2. LEASE COMMITMENTS
The Company has month-to-month operating leases for its facilities. Rental
expense under these leases was $34,000 for the year ended December 31, 1995.
3. INCOME TAXES
The Company is an S Corporation for federal tax and California franchise
tax reporting purposes. S Corporation status requires the pass-through of income
and losses to the shareholders of the Company. The tax payable and related
provision by the Company consists of a 1 1/2% statutory California franchise
tax. Distributions of earnings are made periodically during the year to the
stockholders in an amount estimated to cover the tax on the earnings of the S
Corporation.
4. EMPLOYEE BENEFIT PLAN
The Company maintains a Simplified Employee Pension Plan ("SEP IRA Plan")
for the benefit of all qualifying employees. The SEP IRA Plan provides for
employer contributions up to 15% of each participant's compensation (as defined)
with an individual yearly maximum employer contribution (as defined).
Contributions of $66,000 were declared by the Company's Board of Directors in
1995.
5. SUBSEQUENT EVENT
On January 18, 1996, all of the Company's outstanding stock was acquired by
Phase Metrics, Inc. for total consideration of approximately $21 million.
* * * * * *
F-32
<PAGE> 159
======================================================
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR DLJ. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY, TO
ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE
UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME
SUBSEQUENT TO THE DATE HEREOF.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Available Information................. iv
Summary............................... 1
Risk Factors.......................... 12
The Exchange Offer.................... 25
The Refinancing....................... 32
Use of Proceeds....................... 32
Capitalization........................ 33
Selected Consolidated Financial
Data................................ 34
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 36
Business.............................. 47
Management............................ 64
Certain Transactions.................. 72
Principal Stockholders................ 74
Description of Indebtedness........... 76
Description of New Notes.............. 78
Certain United States Federal Tax
Considerations...................... 108
Notice to Investors................... 111
Plan of Distribution.................. 112
Description of Capital Stock.......... 114
Legal Matters......................... 116
Experts............................... 116
Glossary.............................. A-1
Index to Financial Statements......... F-1
</TABLE>
======================================================
======================================================
$110,000,000
LOGO
NEW 10 3/4% SENIOR NOTES DUE 2005
--------------------
PROSPECTUS
--------------------
, 1998
======================================================
<PAGE> 160
ALTERNATE PAGES TO BE USED IN MARKET-MAKING
PROSPECTUS FOLLOW
<PAGE> 161
PROSPECTUS [ALTERNATIVE COVER PAGE FOR MARKET-MAKING PROSPECTUS]
NEW 10 3/4% SENIOR NOTES DUE 2005
($110,000,000 PRINCIPAL AMOUNT)
OF
[PHASE METRICS LOGO]
------------------------
Phase Metrics, Inc., a Delaware corporation (the "Company"), exchanged (the
"Exchange Offer"), upon the terms and subject to the conditions set forth in a
prospectus related thereto, up to an aggregate principal amount of $110,000,000
of its new 10 3/4% Senior Notes due 2005 (the "New Notes") and the guarantees
related thereto for an equal principal amount of its outstanding 10 3/4% Senior
Notes due 2005 (the "Notes") and the guarantees related thereto. The New Notes
are senior unsecured obligations of the Company and are substantially identical
(including principal amount, interest rate, maturity and redemption rights) to
the Notes for which they were exchanged pursuant to the Exchange Offer, except
that (i) the offering and sale of the New Notes was registered under the
Securities Act of 1933, as amended (the "Securities Act") and (ii) holders of
New Notes are not entitled to certain rights under the Registration Rights
Agreement of the Company and Applied Robotic Technologies, Inc., Helios,
Incorporated, Air Bearings, Incorporated and Santa Barbara Metric, Inc., all of
which are California corporations and wholly-owned subsidiaries of the Company
(together with any future other subsidiary of the Company that executes a New
Note Guarantee, the "Subsidiary Guarantors") dated as of January 30, 1998 (the
"Registration Rights Agreement"). The New Notes are fully and unconditionally
guaranteed on a senior unsecured basis (the "New Note Guarantees") by, and are
joint and several obligations of the Subsidiary Guarantors. The New Notes are
issued under an Indenture dated as of January 30, 1998 (the "Indenture"), among
the Company, the Subsidiary Guarantors and State Street Bank and Trust Company,
as trustee (the "Trustee"). See "Description of New Notes."
The New Notes will bear interest from January 30, 1998, the date of
issuance of the Notes, at a rate equal to 10 3/4% per annum. Interest on the New
Notes will be payable semiannually on February 1 and August 1 of each year,
commencing August 1, 1998. The New Notes are redeemable at the option of the
Company, in whole or in part, at any time on or after February 1, 2002, at the
redemption prices set forth herein, plus accrued and unpaid interest and
Liquidated Damages (as defined herein), if any, thereon to the date of
redemption.
Prior to February 1, 2001, up to 33% of the initially outstanding aggregate
principal amount of New Notes (and any Notes which remain outstanding after the
Exchange Offer) will be redeemable at the option of the Company from the net
proceeds of a public sale of the Company's Common Stock ("Common Stock") at a
price of 110.75% of the principal amount of the New Notes (and any Notes which
remain outstanding after the Exchange Offer), together with accrued and unpaid
interest and Liquidated Damages, if any, to the date of redemption; provided,
that at least 67% of the initially outstanding aggregate principal amount of New
Notes (and any Notes which remain outstanding after the Exchange Offer) remains
outstanding immediately after such redemption. Upon the occurrence of a Change
of Control (as defined herein), each Holder (as defined herein) of New Notes may
require the Company to repurchase all or a portion of such Holder's New Notes at
101% of the aggregate principal amount of the New Notes, together with accrued
and unpaid interest and Liquidated Damages, if any, to the date of repurchase.
There can be no assurance that sufficient funds will be available at the time of
any Change of Control to make any required repurchase of New Notes. See "Risk
Factors -- Payment Upon a Change of Control" and "Description of New
Notes -- Repurchase at the Option of Holders -- Change of Control."
------------------------
SEE "RISK FACTORS" COMMENCING ON PAGE 12 FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY HOLDERS WHO TENDER NOTES
IN THE EXCHANGE OFFER.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is , 1998.
B-1
<PAGE> 162
The New Notes are senior unsecured obligations of the Company and rank pari
passu in right of payment to all existing and future senior indebtedness of the
Company and senior in right of payment to all existing and future subordinated
indebtedness of the Company. The New Notes are effectively subordinated,
however, to all secured obligations of the Company, including any borrowings
under the New Credit Facility (as defined herein) to the extent of the assets
securing such obligations. The New Notes are fully and unconditionally
guaranteed under the New Note Guarantees on a joint and several basis by the
Subsidiary Guarantors. The New Note Guarantees are senior unsecured obligations
of the Subsidiary Guarantors and rank pari passu in right of payment to all
existing and future senior indebtedness of the Subsidiary Guarantors. The New
Note Guarantees are effectively subordinated, however, to all secured
obligations of the Subsidiary Guarantors, including the guarantees of the
Subsidiary Guarantors in favor of the lenders under the New Credit Facility, to
the extent of the assets securing such obligations. As of March 31, 1998, all of
the Company's indebtedness under its current revolving credit facility (the "New
Credit Facility") was secured by the assets of the Company and the Subsidiary
Guarantors, and, accordingly, the New Notes and the New Note Guarantees were
effectively subordinated to approximately $11.2 million of obligations of the
Company and the Subsidiary Guarantors as of such date, which amount is inclusive
of indebtedness under capital lease obligations. In addition, the Notes are and
the New Notes will be structurally subordinated to all indebtedness and other
obligations of the Non-Guarantor Subsidiaries, including all accounts payable,
and debt for borrowed money. As of March 31, 1998, the Non-Guarantor
Subsidiaries had an aggregate of $0.5 million of such indebtedness and other
obligations outstanding, all of which ranked or will rank effectively senior to
the Notes and New Notes in right of payment. Other than the guarantees of the
Subsidiary Guarantors in favor of the lenders under the New Credit Facility, the
Subsidiary Guarantors did not, as of March 31, 1998, have any material amount of
indebtedness outstanding.
This Prospectus is to be used by Donaldson, Lufkin & Jenrette Securities
Corporation ("DLJ"), a significant stockholder of the Company, in connection
with its offers and sales of the New Notes (and related guarantees) from
time-to-time in market-making transactions at negotiated prices related to
prevailing market prices at the time of sale. DLJ may act as principal or agent
in such transactions. The Company does not intend to list the New Notes on any
securities exchange or to seek admission thereof to trading in the National
Association of Securities Dealers Automated Quotation System. DLJ has advised
the Company that it intends to make a market in the New Notes; however, DLJ is
not obligated to do so and any market-making may be discontinued at any time.
DLJ may be required to discontinue its market-making activities when this
Prospectus must be updated for any reason. The Company will receive no portion
of the proceeds of the sale of any New Notes by DLJ and will bear expenses
incident to the registration thereof. See "Plan of Distribution."
The Company's Japanese, Korean and Singapore subsidiaries, Phase Metrics
Japan Co. Ltd., Phase Metrics Korea Co. Ltd. and Phase Metrics Pacific PTE,
Ltd., respectively, and Phase Metrics International Incorporated, the Company's
foreign sales corporation based in Barbados (collectively, the "Non-Guarantor
Subsidiaries") have not guaranteed the Company's obligations under the Notes and
will not guarantee the Company's obligations under the New Notes. As of and for
the year ended December 31, 1997, and the three-month period ended March 31,
1998, the operating results and assets of the Non-Guarantor Subsidiaries,
individually and in the aggregate, were not material to the results of
operations and assets of the Company on a consolidated basis, net of
intercompany eliminations. See Note 12 of Notes to Consolidated Financial
Statements. The total assets, total liabilities, net sales and net income (loss)
of the Non-Guarantor Subsidiaries as a percentage of the Company's consolidated
total assets, total liabilities, net sales and net income (loss) as of and for
the year ended December 31, 1997 were 3.1%, 0.4%, 1.6% and 10.1%, respectively,
and as of and for the three-month period ended March 31, 1998, were 3.5%, 0.6%,
5.5% and 1.1%, respectively.
The Notes were initially sold by the Company on January 30, 1998 (the "Note
Closing") in transactions not registered under the Securities Act of 1933, as
amended (the "Securities Act") in reliance upon the exemption provided in
Section 4(2) thereof (the "Note Offering").
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PRO-
[Alternative Cover Continued]
B-2
<PAGE> 163
SPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY ANY SECURITY
OTHER THAN THE NEW NOTES OFFERED HEREBY, NOR DOES IT CONSTITUTE AN OFFER TO SELL
OR THE SOLICITATION OF AN OFFER TO BUY ANY OF THE NEW NOTES TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO
SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION
CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
[End of Alternative Cover]
B-3
<PAGE> 164
ABSENCE OF ACTIVE TRADING MARKET
The New Notes constitute a new issue of securities with no established
trading market. Although the New Notes will generally be permitted to be resold
or otherwise transferred by holders who are not affiliates of the Company
without compliance with the registration requirements under the Securities Act,
the Company does not intend to list the New Notes on any securities exchange or
to seek admission thereof to trading in the National Association of Securities
Dealers Automated Quotation System. Although DLJ has advised the Company that it
currently intends to make a market in the New Notes, DLJ is not obligated to do
so and may discontinue such market making at any time without notice. In
addition, such market making activity will be subject to the limits imposed by
law. If a trading market does not develop or is not maintained, holders of the
New Notes may experience difficulty in reselling the New Notes or may be unable
to sell them at all. If a market for the New Notes develops, any such market may
be discontinued at any time. Accordingly, there can be no assurance as to the
development or liquidity of any market for the New Notes.
DLJ may be deemed to be an "affiliate" of the Company and, as such, may be
required to deliver a prospectus in connection with its market-making activities
in the New Notes.
B-4
<PAGE> 165
USE OF PROCEEDS
There will be no proceeds to the Company from the Exchange Offer. The net
proceeds to the Company from the sale of the Notes were approximately $105.9
million (after deducting discounts and commissions and Note Offering expenses
payable by the Company). The Company used all of such net proceeds, together
with the Initial Draw of approximately $1.6 million under the New Credit
Facility, to repay in full its then-existing term loan and revolving credit
indebtedness under the Former Credit Facility, including all accrued interest
thereunder to the date of repayment, and all expenses related to the
Refinancing. The term loan portion of the Former Credit Facility bore interest
at the Company's option of prime plus 2% to 2.5% or LIBOR plus 3% to 3.5% and
the revolver portion of the Former Credit Facility bore interest at the
Company's option of prime plus 0.5% to 2% or LIBOR plus 1.5% to 3%, based on the
Company's consolidated leverage ratio as defined in the Former Credit Agreement.
The term loans and revolver matured in December 2002 and December 1999,
respectively. The Company used proceeds from the term loans and revolver to
refinance its then existing credit facility, fund capital expenditures, working
capital and certain acquisitions.
This Prospectus is delivered in connection with the sale of the New Notes
(and the related guarantees) by DLJ in market-making transactions. The Company
will not receive any of the proceeds from such transactions.
B-5
<PAGE> 166
PLAN OF DISTRIBUTION
This Prospectus has been prepared for use by DLJ in connection with offers
and sales from time-to-time of the New Notes (and related guarantees) in
market-making transactions at negotiated prices relating to prevailing market
prices at the time of sale. DLJ may act as principal or agent in such
transactions. DLJ has advised the Company that it currently intends to make a
market in the New Notes, but it is not obligated to do so and may discontinue or
suspend any such market-making activities at any time without notice.
There is no existing market for the New Notes and there can be no assurance
as to the liquidity of any market that may develop for the New Notes, the
ability of Holders of the New Notes to sell their New Notes or the price at
which Holders would be able to sell their New Notes. Future trading prices of
the New Notes will depend on many factors, including, among other things,
prevailing interest rates, the Company's operating results, the market for
similar securities and general economic conditions. The Company does not
currently intend to list the New Notes on any securities exchange or the
National Association of Securities Dealers Automated Quotation System.
Therefore, no assurance can be given as to the liquidity of any trading market
for the New Notes. See "Risk Factors -- Absence of Active Trading Market."
DLJ served as the initial purchaser in the Note Offering and received total
underwriting discounts and commissions of $3.575 million in connection
therewith.
DLJ and the Company entered into the Registration Rights Agreement with
respect to the use by DLJ of this Prospectus. Pursuant to the Registration
Rights Agreement, the Company agreed to bear all registration expenses incurred
under such agreement, and the Company agreed to indemnify DLJ against certain
liabilities, including liabilities under the Securities Act.
Entities affiliated with DLJ (i) hold 11,800,000 shares of Common Stock of
the Company, including shares of the Company's Series A Preferred Stock and
Series B Preferred Stock which are convertible into an aggregate of 2,000,000
shares and 3,857,280 shares of the Company's Common Stock, respectively,
Convertible Subordinated Notes which are convertible into an aggregate of
5,142,720 shares of the Company's Common Stock, and Bridge Financing Warrants
which are exercisable for an aggregate of 800,000 shares of the Company's Common
Stock and (ii) pursuant to the Securityholders Agreement, are entitled to elect
two members to the Company's Board of Directors.
Under the Securityholders Agreement, the Company is obligated until
November 23, 1998, to use DLJ as its exclusive financial advisor and investment
banker. In consideration for DLJ's services, the Company has agreed to pay DLJ
an annual retainer of $200,000. In each of 1995, 1996 and 1997, the Company paid
DLJ $200,000 in fees for financial advisory and certain investment banking
services provided to the Company.
In connection with the refinancing of its then-outstanding indebtedness in
December of 1996, the Company paid fees of $1.2 million in the aggregate for
debt issuance costs to DLJCF. DLJCF is an affiliate of DLJ.
B-6
<PAGE> 167
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under Section 145 of the Delaware General Corporation Law the Company has
broad powers to indemnify its directors and officers against liabilities they
may incur in such capacities, including liabilities under the Securities Act of
1933, as amended (the "Securities Act"). The Company's Bylaws (the "Bylaws")
(Exhibit 3.2 hereto) provide that the Company shall indemnify its directors and
officers to the fullest extent permitted by Delaware law. The Bylaws authorize
the Company, to the fullest extent permitted by law, to advance litigation
expenses to its directors and officers in defending any proceeding.
In addition, the Company's Certificate of Incorporation (the "Certificate")
(Exhibit 3.1 hereto) provides that, pursuant to Delaware law, its directors
shall not be liable for monetary damages for breach of the directors' fiduciary
duty of care to the Company and its stockholders. This provision in the
Certificate does not eliminate the duty of care, and in appropriate
circumstances equitable remedies such as injunctive or other forms of
non-monetary relief will remain available under Delaware law. In addition, each
director will continue to be subject to liability for breach of the director's
duty of loyalty to the Company, for acts or omissions not in good faith or
involving intentional misconduct, for knowing violations of law, for actions
leading to improper personal benefit to the director and for payment of
dividends or approval of stock repurchases or redemptions that are unlawful
under Delaware law. The provision also does not affect a director's
responsibilities under any other law, such as the federal securities laws or
state or federal environmental laws. The Certificate further provides that the
Company shall indemnify (and advance expenses to) its directors and also is
authorized to indemnify its officers (and any other person to which Delaware law
permits) to the fullest extent permitted by law.
The Company has entered into agreements to indemnify its directors and
certain of its officers and employees in addition to the indemnification
provided for in the Bylaws and under Delaware law. These agreements will, among
other things, indemnify the Company's directors and certain of its officers and
employees for certain expenses (including attorneys fees), judgments, fines and
settlement amounts incurred by such person in any action or proceeding,
including any action by or in the right of the Company, on account of services
by that person as a director or officer of the Company or as a director or
officer of any subsidiary of the Company, or as a director or officer of any
other company or enterprise that the person provides services to at the request
of the Company. The agreements also require the Company to advance all
reasonable expenses incurred by or on behalf of the indemnified director or
officer in connection with any proceeding by reason of the director or officer's
corporate status subject to an undertaking by the indemnified director or
officer to repay any expenses advanced that have been ultimately determined not
to be indemnifiable. These indemnification agreements further provide that the
conferred indemnification rights and remedies are to be nonexclusive of any
other rights and remedies granted under law, the Certificate, any other
agreement, or otherwise and that no change to these agreements shall limit or
restrict any right under these agreements with respect to any action taken or
omitted by such director or officer in his corporate status prior to such change
and to the extent any such change in the law permits greater indemnification
than would be currently provided under the Certificate and these agreements, the
parties' intent is that these agreements provide the greater benefits so
afforded by such change. The Company has also obtained directors' and officers'
liability insurance.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(A) EXHIBITS
The following Exhibits are attached hereto and incorporated herein by
reference.
<TABLE>
<C> <S>
3.1** Certificate of Incorporation of the Company, as amended.
3.2** Bylaws of the Company.
4.1** Purchase Agreement dated as of January 23, 1998 by and among
the Company, Helios, Incorporated, Applied Robotic
Technologies, Inc., Air Bearings, Incorporated, Santa
Barbara Metric, Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation.
</TABLE>
II-1
<PAGE> 168
<TABLE>
<C> <S>
4.2** Indenture dated as of January 30, 1998 by and among the Company, the Subsidiary Guarantors and
State Street Bank and Trust Company of California, N.A. as Trustee.
4.3** Form of 10 3/4% Senior Notes Due 2005 dated as of January 30, 1998 (incorporated by reference to
Exhibit 4.2).
4.4** Registration Rights Agreement dated as of January 30, 1998 by and among the Company, Helios,
Incorporated, Applied Robotics Technologies, Inc., Air Bearings, Incorporated, Santa Barbara
Metric, Inc. and Donaldson, Lufkin & Jenrette Securities Corporation.
5.1 Opinion of Brobeck, Phleger & Harrison LLP.
10.1** Lease Agreement dated June 5, 1995 by and between the Company and Security Capital Industrial
Trust.
10.2** Sublease Agreement dated April 1, 1997 by and between the Company and Hitachi America Ltd.
10.3** Master Security Agreement dated as of May 5, 1995 between the Company and Komag Incorporated, a
Delaware corporation.
10.4** Employment Agreement dated November 23, 1994 by and between the Company and John F. Schaefer.
10.5** Komag Intercreditor Agreement dated May 5, 1995.
10.6** Form of Indemnification Agreement.
10.7** 1995 Stock Option/Stock Issuance Plan.
10.8** Form of Notice of Grant of Stock Option with respect to holders of stock options granted under the
1995 Stock Option/Stock Issuance Plan.
10.9** Form of Stock Option Agreement and Addendum generally used in connection with the 1995 Stock
Option/Stock Issuance Plan.
10.10** Form of Stock Purchase Agreement and Addendum generally used in connection with the 1995 Stock
Option/ Stock Issuance Plan.
10.11** Securityholders Agreement dated November 23, 1994, as amended, between DLJ Merchant Banking
Partners, L.P., DLJ International Partners, C.V., DLJ Offshore Partners, C.V., DLJ Merchant Banking
Funding, Inc., DLJ Capital Corporation, Sprout Growth II, L.P., Sprout Capital VI, L.P., DLJ First
ESC L.L.C., Arthur J. Cormier, John F. Schaefer and the Company.
10.12** Master Capital Lease Agreement dated as of January 13, 1996 by and between the Company and NTFC
Capital Corporation.
10.13** Form of Convertible Subordinated Note Due 2005 dated as of November 23, 1994 including all
amendments thereto.
10.14** Amended and Restated Credit Facility dated as of January 30, 1998 by and among the Company, as
Borrower, Fleet National Bank, Imperial Bank and the other lenders named therein.
12.1** Statement Regarding Computation of Ratios.
21.1 List of Subsidiaries.
23.1 Independent Auditors' Consent and Report on Schedule.
23.2 Consent of Brobeck, Phleger & Harrison LLP (contained in Exhibit 5.1).
24.1** Powers of Attorney (contained on signature page on page II-4, II-5, II-6, II-7 and II-8).
25.1** Form T-1 Statement of Eligibility and Qualification of State Street Bank and Trust Company of
California, N.A. as Trustee.
27.1** Financial Data Schedule.
99.1** Form of Letter of Transmittal for the 10 3/4% Senior Notes due 2005.
</TABLE>
II-2
<PAGE> 169
<TABLE>
<C> <S>
99.2** Guidelines for Certification of Taxpayer Identification Number on Substitute Form W-9.
99.3** Form of Notice of Guaranteed Delivery.
</TABLE>
- ---------------
** Previously filed.
(b) FINANCIAL STATEMENT SCHEDULES
Schedule II -- Valuation and Qualifying Accounts -- Phase Metrics, Inc.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the financial
statements or notes thereto.
ITEM 22. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(a)(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to tis Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or most recent
post-effective amendment thereof) which, individually or in the aggregate,
represent a fundamental change in the information set forth in the
registration statement. Notwithstanding the foregoing, any increase or
decrease in volume of securities offered (if the total dollar value of
securities offered would not exceed that which was registered) and any
deviation from the low or high and of the estimated maximum offering range
may be reflected in the form of prospectus filed with the Commission
pursuant to Rule 424(b) if, in the aggregate, the changes in volume and
price represent no more than 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement.
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Company pursuant to the foregoing provisions, or otherwise, the Registrant has
been advised that in the opinion of the Securities and Exchange Commission such
indemnification is against public policy as expressed in the Securities Act and
is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrant of expenses
incurred or paid by a director, officer or controlling person of the Registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of the counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(c) To respond to requests for information that is incorporated by
reference into the Prospectus that is a part of this Registration Statement
pursuant to Item 4, 10(b), 11, or 13 of this Form, within one business day of
receipt of such request, and to send the incorporated documents by first class
mail or other equally prompt means. This includes information contained in
documents filed subsequent to the effective date of this Registration Statement
through the date of responding to the request.
II-3
<PAGE> 170
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on the 4th day of June, 1998.
PHASE METRICS, INC.
By: /s/ JOHN F. SCHAEFER
------------------------------------
John F. Schaefer
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN F. SCHAEFER Chairman of the Board, Chief June 4, 1998
- ----------------------------------------------------- Executive Officer and President
John F. Schaefer (Principal Executive Officer)
/s/ R. JOSEPH SAUNDERS Vice President, Chief Financial June 4, 1998
- ----------------------------------------------------- Officer and Assistant Secretary
R. Joseph Saunders (Principal Accounting and
Financial Officer)
* Director June 4, 1998
- -----------------------------------------------------
Arthur J. Cormier
* Director June 4, 1998
- -----------------------------------------------------
Thompson Dean
* Director June 4, 1998
- -----------------------------------------------------
Robert Finzi
* Director June 4, 1998
- -----------------------------------------------------
Dr. Gilbert F. Amelio
* Director June 4, 1998
- -----------------------------------------------------
William E. Terry
</TABLE>
* By: /s/ R. JOSEPH SAUNDERS
-------------------------------
R. Joseph Saunders
(Attorney-in-fact)
II-4
<PAGE> 171
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on the 4th day of June, 1998.
AIR BEARINGS, INCORPORATED
By: /s/ JOHN F. SCHAEFER
------------------------------------
John F. Schaefer
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN F. SCHAEFER Chairman of the Board and Chief June 4, 1998
- ----------------------------------------------------- Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ R. JOSEPH SAUNDERS Chief Financial Officer, June 4, 1998
- ----------------------------------------------------- Assistant Secretary and Director
R. Joseph Saunders (Principal Accounting and
Financial Officer)
</TABLE>
II-5
<PAGE> 172
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on the 4th day of June, 1998.
APPLIED ROBOTIC TECHNOLOGIES, INC.
By: /s/ JOHN F. SCHAEFER
------------------------------------
John F. Schaefer
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN F. SCHAEFER Chairman of the Board and Chief June 4, 1998
- ----------------------------------------------------- Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ R. JOSEPH SAUNDERS Vice President, Assistant June 4, 1998
- ----------------------------------------------------- Secretary and Director (Principal
R. Joseph Saunders Accounting and Financial Officer)
</TABLE>
II-6
<PAGE> 173
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on the 4th day of June, 1998.
HELIOS, INCORPORATED
By: /s/ JOHN F. SCHAEFER
------------------------------------
John F. Schaefer
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN F. SCHAEFER Chairman of the Board and Chief June 4, 1998
- ----------------------------------------------------- Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ R. JOSEPH SAUNDERS Vice President, Assistant June 4, 1998
- ----------------------------------------------------- Secretary and Director (Principal
R. Joseph Saunders Accounting and Financial Officer)
</TABLE>
II-7
<PAGE> 174
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of San Diego,
State of California, on the 4th day of June, 1998.
SANTA BARBARA METRIC, INC.
By: /s/ JOHN F. SCHAEFER
------------------------------------
John F. Schaefer
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <C> <S>
/s/ JOHN F. SCHAEFER Chairman of the Board and Chief June 4, 1998
- ----------------------------------------------------- Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ R. JOSEPH SAUNDERS Chief Financial Officer, June 4, 1998
- ----------------------------------------------------- Assistant Secretary and Director
R. Joseph Saunders (Principal Accounting and
Financial Officer)
/s/ W. DEWEY HOCKEMEYER Director June 4, 1998
- -----------------------------------------------------
W. Dewey Hockemeyer
</TABLE>
II-8
<PAGE> 175
SCHEDULE II
PHASE METRICS, INC.
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONS
---------------------------
BALANCE AT CHARGES TO BALANCE AT
BEGINNING COSTS AND CHARGES TO END OF
DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS OF PERIOD
----------- ---------- ---------- -------------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1995
Allowance for doubtful accounts......... $154 $ 463 $-- $ 27 $ 590
Year ended December 31, 1996
Allowance for doubtful accounts......... 590 247 -- 91 746
Year ended December 31, 1997
Allowance for doubtful accounts......... 746 1,405 -- 488 1,663
</TABLE>
<PAGE> 176
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTIONS
------- ------------
<C> <S>
3.1** Certificate of Incorporation of the Company, as amended.
3.2** Bylaws of the Company.
4.1** Purchase Agreement dated as of January 23, 1998 by and among
the Company, Helios, Incorporated, Applied Robotic
Technologies, Inc., Air Bearings, Incorporated, Santa
Barbara Metric, Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation.
4.2** Indenture dated as of January 30, 1998 by and among the
Company, the Subsidiary Guarantors and State Street Bank and
Trust Company of California, N.A. as Trustee.
4.3** Form of 10 3/4% Senior Notes Due 2005 dated as of January
30, 1998 (incorporated by reference to Exhibit 4.2).
4.4** Registration Rights Agreement dated as of January 30, 1998
by and among the Company, Helios, Incorporated, Applied
Robotics Technologies, Inc., Air Bearings, Incorporated,
Santa Barbara Metric, Inc. and Donaldson, Lufkin & Jenrette
Securities Corporation.
5.1 Opinion of Brobeck, Phleger & Harrison LLP.
10.1** Lease Agreement dated June 5, 1995 by and between the
Company and Security Capital Industrial Trust.
10.2** Sublease Agreement dated April 1, 1997 by and between the
Company and Hitachi America Ltd.
10.3** Master Security Agreement dated as of May 5, 1995 between
the Company and Komag Incorporated, a Delaware corporation.
10.4** Employment Agreement dated November 23, 1994 by and between
the Company and John F. Schaefer.
10.5** Komag Intercreditor Agreement dated May 5, 1995.
10.6** Form of Indemnification Agreement.
10.7** 1995 Stock Option/Stock Issuance Plan.
10.8** Form of Notice of Grant of Stock Option with respect to
holders of stock options granted under the 1995 Stock
Option/Stock Issuance Plan.
10.9** Form of Stock Option Agreement and Addendum generally used
in connection with the 1995 Stock Option/Stock Issuance
Plan.
10.10** Form of Stock Purchase Agreement and Addendum generally used
in connection with the 1995 Stock Option/ Stock Issuance
Plan.
10.11** Securityholders Agreement dated November 23, 1994, as
amended, between DLJ Merchant Banking Partners, L.P., DLJ
International Partners, C.V., DLJ Offshore Partners, C.V.,
DLJ Merchant Banking Funding, Inc., DLJ Capital Corporation,
Sprout Growth II, L.P., Sprout Capital VI, L.P., DLJ First
ESC L.L.C., Arthur J. Cormier, John F. Schaefer and the
Company.
10.12** Master Capital Lease Agreement dated as of January 13, 1996
by and between the Company and NTFC Capital Corporation.
10.13** Form of Convertible Subordinated Note Due 2005 dated as of
November 23, 1994 including all amendments thereto.
10.14** Amended and Restated Credit Facility dated as of January 30,
1998 by and among the Company, as Borrower, Fleet National
Bank, Imperial Bank and the other lenders named therein.
12.1** Statement Regarding Computation of Ratios.
21.1 List of Subsidiaries.
</TABLE>
<PAGE> 177
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTIONS
------- ------------
<C> <S>
23.1 Independent Auditors' Consent and Report on Schedule.
23.2 Consent of Brobeck, Phleger & Harrison LLP (contained in
Exhibit 5.1).
24.1** Powers of Attorney (contained on signature page on page
II-4, II-5, II-6, II-7 and II-8).
25.1** Form T-1 Statement of Eligibility and Qualification of State
Street Bank and Trust Company of California, N.A. as
Trustee.
27.1** Financial Data Schedule.
99.1** Form of Letter of Transmittal for the 10 3/4% Senior Notes
due 2005.
99.2** Guidelines for Certification of Taxpayer Identification
Number on Substitute Form W-9.
99.3** Form of Notice of Guaranteed Delivery.
</TABLE>
- ---------------
** Previously filed.
<PAGE> 1
EXHIBIT 5.1
BROBECK, PHLEGER & HARRISON LLP
Phase Metrics, Inc.
10260 Sorrento Valley Road
San Diego, California 92121
Ladies and Gentlemen:
We have acted as counsel for Phase Metrics, Inc. (the "Company")
in connection with the proposed offering and issuance of $110.0 million of new
10 3/4% Senior Notes due 2005 (the "New Notes") of the Company, and related
guarantees (the "New Note Guarantees") of Applied Robotic Technologies, Inc.,
Helios Incorporated, Santa Barbara Metric, Inc. and Air Bearings, Incorporated,
each a California corporation and wholly-owned subsidiary of the Company (the
"Subsidiary Guarantors"), in exchange for a like amount of 10 3/4 Senior Notes
due 2005 (the "Notes") of the Company, as contemplated by the Prospectus (the
"Prospectus") included as part of the Registration Statement on Form S-4 with
respect to the New Notes and the New Note Guarantees originally filed with the
Securities and Exchange Commission (the "Commission") on March 27, 1998 under
the Securities Act of 1933 (the "Securities Act") (such Registration Statement,
as amended or supplemented, is hereinafter referred to as the "Registration
Statement").
In our capacity as counsel to the Company and the Subsidiary
Guarantors, we have examined, among other things, the following:
(i) The Registration Statement and Prospectus contained
therein;
(ii) The Indenture, dated January 30, 1998, by and between
the Company, the Subsidiary Guarantors, and State Street Bank and Trust Company
of California N.A. (the "Trustee") (the "Indenture");
(iii) The Registration Rights Agreement, dated January 30,
1998, by and between the Company, the Subsidiary Guarantors and Donaldson,
Lufkin & Jenrette Securities Corporation;
(iv) The Certificate of Incorporation of the Company and the
Subsidiary Guarantors, including all amendments thereto, as in effect on the
date hereof;
(v) The Bylaws of the Company and the Subsidiary Guarantors,
including all amendments thereto, as in effect on the date hereof;
(vi) Resolutions of the Board of Directors of the Company,
adopted by unanimous written consent as of January 1, 1998, authorizing the
issuance and offering of the New Notes and certain other actions with regard
thereto; and
<PAGE> 2
Phase Metrics, Inc. June 9, 1998
Page 2
(vii) Resolutions of the Board of Directors of the Subsidiary
Guarantors, adopted by unanimous written consent as of March 26, 1998,
authorizing the New Note Guarantees and certain other actions with regard
thereto.
In addition, we have obtained from public officials, officers and
other representatives of the Company and the Subsidiary Guarantors, and others
such certificates, documents and assurances as we considered necessary or
appropriate for purposes of rendering this opinion letter. In our examination of
the documents listed in (i) -- (vii) above and the other certificates and
documents referred to herein, we have assumed the legal capacity of all natural
persons, the genuineness of all signatures, the authenticity of all documents
submitted to us as originals, the conformity to original documents of all
documents submitted to us as copies and the authenticity of the originals of
such documents. Regarding documents executed by parties other than the Company
or the Subsidiary Guarantors, we have assumed (i) that each such other party had
the power to enter into and perform all its obligations thereunder, (ii) the due
authorization, execution and delivery of such documents by each such party, and
(iii) that such documents constitute the legal, valid, binding and enforceable
obligations of each such party.
This opinion letter relates solely to the laws of the State of
New York, the General Corporation Law of the States of Delaware and California,
and the federal securities laws and we express no opinion as to the effect or
applicability of the laws of any other jurisdictions.
Based upon and subject to the foregoing and on our consideration
of such other matters of fact and questions of law as we considered relevant in
the circumstances, we are of the opinion that:
1. The New Notes have been duly authorized by the Company
and the New Note Guarantees have been duly authorized by each respective
Subsidiary Guarantor;
2. When (i) authenticated (in the case of the New Notes)
by the Trustee in accordance with the provisions of the Indenture, (ii) duly
executed by the Company and the Subsidiary Guarantors, respectively, and (iii)
issued and delivered in exchange for the Notes in accordance with the terms of
the Exchange Offer (as defined in the Registration Statement), (a) the New Notes
will constitute valid and legal binding obligations of the Company, enforceable
against the Company in accordance with their terms, and (b) the New Note
Guarantees will constitute valid and legally binding obligations of the
Subsidiary Guarantors, enforceable against each Subsidiary Guarantor in
accordance with their terms.
<PAGE> 3
Phase Metrics, Inc. June 9, 1998
Page 3
To the extent that the obligations of the Company or any
Subsidiary Guarantor under the Indenture may be dependent upon such matters, we
have assumed for purposes of this opinion that (i) the Trustee is duly
organized, validly existing and in good standing under the laws of its
jurisdiction of organization and is duly qualified to engage in the activities
contemplated by the Indenture, (ii) the Indenture has been duly authorized,
executed and delivered by and constitutes the legal, valid and binding
obligation of the Trustee, (iii) the Trustee is in compliance, generally and
with respect to acting as Trustee, under the Indenture, with all applicable laws
and regulations and (iv) the Trustee has the requisite organizational and legal
power and authority to perform its obligations under the Indenture.
The opinions set forth above are subject to the qualification
that the enforceability of the obligations of the Company may be subject to or
limited by (i) bankruptcy, insolvency, reorganization, arrangement, moratorium,
fraudulent transfer and other similar laws affecting the rights of creditors
generally; and (ii) general equitable principles (whether relief is sought in a
proceeding at law or in equity), including, without limitation, concepts of
materiality, reasonableness, good faith, and fair dealing.
We express no opinion as to the enforceability of provisions
relating to indemnification, contribution or exculpation, to the extent any such
provision is contrary to public policy or prohibited by law (including, without
limitation, federal and state securities laws).
You should also be aware that, under applicable New York law, a
number of statutory and common law rights and protections exist in favor of
guarantors, and we express no opinion herein as to any waivers and other
provisions of the New Note Guarantees which purport to waive or alter rights
provided the Subsidiary Guarantors as guarantors by statute or judicial
decision.
The opinions set forth above are also subject to the following
additional qualifications, assumptions, limitations and exceptions:
(a) We express no opinion as to provisions of the New Notes and
New Note Guarantees, if any, purporting to establish an evidentiary standard or
to authorize conclusive determinations by any party thereto or any other person
or allowing any party thereto or any other person to make determinations in its
sole discretion.
(b) We also express no opinion as to:
(1) the enforceability of provisions of the New Notes and
New Note Guarantees, if any, pursuant to which the Company agrees to make
payments without set-off, defense or counter-claim;
<PAGE> 4
Phase Metrics, Inc. June 9, 1998
Page 4
(2) remedial provisions of the New Notes and New Note
Guarantees, if any, including, without limitation, certain of the waivers
therein, which purport to permit any person to exercise remedies with respect to
the Company and the Guarantors other than in compliance with applicable laws;
(3) provisions, if any, providing for the exclusive
jurisdiction of a particular court or purporting to waive rights to trial by
jury, service of process or objections to the laying of venue or to forum on the
basis of forum non conveniens, in connection with any litigation arising out of
or pertaining to the New Notes and New Note Guarantees;
(4) provisions, if any, contained in the New Notes and New
Note Guarantees purporting to waive either illegality as a defense to the
performance of contract obligations or any other defense to such performance
which cannot, as a matter of law, be effectively waived;
(5) provisions of the New Notes and New Note Guarantees,
if any, permitting modification thereof only by means of an agreement in writing
signed by the parties thereto;
(6) provisions of the New Notes and New Note Guarantees,
if any, requiring payment of attorneys' fees, except to the extent a court
determines such fees to be reasonable;
(7) the effect of the law of any jurisdiction other than
the State of New York which limits the rates of interest legally chargeable or
collectible; and
(8) provisions of the New Notes and New Note Guarantees,
if any, to the extent that they purport to exclude conflict of law principles
under New York law.
We hereby consent to the filing of this opinion as Exhibit 5.1 to
the Registration Statement. We also consent to the reference to our firm under
the heading "Legal Matters" in the Registration Statement. In giving this
consent, we do not thereby admit that we are in the category of persons whose
consent is required under Section 7 of the Securities Act or the rules and
regulations of the Commission thereunder.
This opinion letter is expressly limited to the matters set forth
above and we render no other opinion and express no other belief whether by
implication or otherwise, as to any other matters. This opinion letter is
rendered as of the date hereof, and we assume no
<PAGE> 5
Phase Metrics, Inc. June 9, 1998
Page 5
obligation to advise you of any facts, circumstances, events or developments
that may be brought to ourattention in the future, which facts, circumstances,
events or developments may alter, affect or modify the opinions or beliefs
expressed herein.
Very truly yours,
BROBECK, PHLEGER & HARRISON LLP
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF PHASE METRICS, INC.
SUBSIDIARIES
Name of Entity Organized Under Laws of
-------------- -----------------------
Air Bearings, Incorporated California
Applied Robotic Technologies, Inc. California
Helios, Incorporated California
Santa Barbara Metric, Inc. California
Phase Metrics Japan Co. Ltd. Japan
Phase Metrics Korea Co. Ltd. Korea
Phase Metrics Pacific PTE, Ltd. Singapore
Phase Metrics International Incorporated Barbados
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE
To the Board of Directors and Stockholders
of Phase Metrics, Inc.
We consent to the use in this Amendment No. 2 to Registration Statement No.
333-48817 of Phase Metrics, Inc.; Air Bearings, Incorporated; Applied Robotic
Technologies, Inc.; Helios, Incorporated; and Santa Barbara Metric, Inc. on Form
S-4 of our reports dated January 30, 1998, with respect to the consolidated
financial statements of Phase Metrics, Inc. and September 6, 1996 with respect
to the financial statements of Air Bearings, Incorporated appearing in the
Prospectus, which is a part of this Registration Statement, and to the
references to us under the heading "Experts" in such Prospectus.
Our audits of the financial statements referred to in our aforementioned
report dated January 30, 1998 also included the consolidated financial statement
schedule of Phase Metrics, Inc., listed in Item 21(b). This financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, such financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
DELOITTE & TOUCHE LLP
San Jose, California
June 8, 1998
