<PAGE>
As filed with the Securities and Exchange Commission on , 1999
Registration No. 333-
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM S-1
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 3829 33-0328048
(State or Other Jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Incorporation or Organization) Classification Code Number) Identification Number)
</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 any of the securities being registered on this form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities
Act, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------
Proposed Proposed Amount of
Title of Each Class of Amount to be Maximum Offering Maximum Aggregate Registration
Securities To Be Registered Registered Price Per Note Offering Price Fee
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
10 3/4% Senior Notes due 2005.......... $3,000,000(1) 100% $3,000,000 $834
- -------------------------------------------------------------------------------------------------------
Note Guarantees for the 10 3/4% Senior
Notes due 2005(2)..................... $0 0% $0 $0
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</TABLE>
(1) Includes Note Guarantees of the Senior Notes due 2005 by Applied Robotic
Technologies, Inc., Helios, Incorporated, Santa Barbara Metric, Inc. and
Air Bearings, Incorporated, each a guarantor of the Notes to be registered
and a wholly-owned subsidiary of the Registrant.
(2) Pursuant to Rule 457(n) of the Securities Act, no registration fee is
required with respect to the Note Guarantees.
---------------
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 an amendment which specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act or until the Registration Statement shall become effective
on such date as the Commission, acting pursuant to said Section 8(a), may
determine.
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- -------------------------------------------------------------------------------
<PAGE>
*TABLE OF ADDITIONAL REGISTRANTS
<TABLE>
<CAPTION>
State or other
Jurisdiction of Primary Standard
Name, Address and Incorporation or Industrial Classification I.R.S. Employer
Telephone Number(1) Organization Code Number Identification No.
- ------------------------ ---------------- ------------------------- ------------------
<S> <C> <C> <C>
Air Bearings,
Incorporated........... California 3829 94-3092378
Applied Robotic
Technologies, Inc. .... California 3829 68-0022756
Helios, Incorporated.... California 3829 77-0077044
Santa Barbara Metric,
Inc. .................. California 3829 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>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this preliminary prospectus is not complete and may be +
+changed. These securities may not be sold until the registration statement +
+filed with the Securities and Exchange Commission is effective. This +
+preliminary prospectus is not an offer to sell nor does it seek an offer to +
+buy these securities in any jurisdiction where the offer or sale is not +
+permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion, Dated , 1999
, 1999
Prospectus
10 3/4% SENIOR NOTES DUE 2005
($3,000,000 principal amount)
[LOGO OF PHASE METRICS APPEARS HERE]
Donaldson, Lufkin & Jenrette Securities Corporation, a noteholder of Phase
Metrics, Inc., a Delaware corporation, may offer and sell up to an aggregate
principal amount of $3,000,000 of our 10 3/4% Senior Notes due 2005, the
"Notes," in integral multiples of $1,000 from time to time under this
prospectus. This selling noteholder will receive all of the net proceeds from
the sale of these Notes, although we will bear the expenses related to offering
these Notes.
The Notes are senior unsecured obligations of the Company. Applied Robotic
Technologies, Inc., Helios, Incorporated, Air Bearings, Incorporated and Santa
Barbara Metric, Inc., each a wholly-owned subsidiary of the Company, have
agreed to guarantee our obligations under the Notes. The Notes are issued under
an Indenture dated as of January 30, 1998 among the Company, our subsidiary
guarantors and State Street Bank and Trust Company, the trustee of the Notes.
See "Description of Notes."
---------------
See "Risk Factors" beginning on page 9 to read about certain factors you should
consider before buying the Notes.
---------------
Neither the Securities and Exchange Commission nor any other regulatory body
has approved or disapproved of these securities or passed upon the accuracy or
adequacy of this prospectus. Any representation to the contrary is a criminal
offense.
---------------
The date of this prospectus is , 1999.
<PAGE>
SUMMARY
You should read the following summary together with the more detailed
information and consolidated financial statements and the notes to those
statements appearing elsewhere in this prospectus.
This prospectus contains forward-looking statements based on our current
expectations, assumptions, estimates and projections about our company and our
industry. These forward-looking statements involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these forward-
looking statements as a result of certain factors, as more fully described in
the "Risk Factors" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" sections and elsewhere in this prospectus.
We undertake no obligation to update publicly any forward-looking statements
for any reason, even if new information becomes available or other events occur
in the future.
Unless the context otherwise requires, all references to the "Company,"
"Phase Metrics," "we" and "us" refer to Phase Metrics, Inc. and its
consolidated subsidiaries. The definition of certain technical terms may be
found in the Glossary beginning on page A-1.
Phase Metrics
We are a leading supplier of technologically advanced process and production-
test equipment for the data storage industry. Our systems are used primarily by
manufacturers of disk drives, thin-film disks and read/write heads to manage
and improve their 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 important in the highly competitive disk
drive and disk drive component industries. We were formed in 1989 as a single
product supplier to the data storage industry. From late 1994 through 1997, we
expanded our product line through the acquisition of seven specialized
suppliers of complementary systems for the disk drive and disk drive component
industries. These acquisitions and our internal research and development
program have provided us with (1) a significant research and development effort
focused exclusively on the process and production-test equipment market, (2) a
broad technological base and product line with applications throughout the disk
drive and disk drive component production chains and (3) a global
infrastructure capable of providing world-wide customer service and support.
Demand for our products is driven by demand for disk drives and disk drive
components, rapid advances in data storage technology, and yield management
challenges and margin pressure facing data storage manufacturers. The
increasing need for greater data storage capacity is driven mostly by the
development of software that requires more storage space, the increased use of
computer networks 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.
Our 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. These products are used by 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.
Our process systems include servowriters and disk burnishers which perform
manufacturing process functions. We also provide integrated automation systems
for the disk drive, disk and read/write head certification and manufacturing
processes. Our products are highly complex and use extensive proprietary
software and electronic hardware, optical and laser systems, and mechanical
componentry.
1
<PAGE>
We sell our systems throughout the world primarily through our direct sales
force. We sell most of our systems to domestic data storage companies with
production facilities in the United States as well as Singapore, Malaysia and
other parts of Southeast Asia. We believe that over 70% of the purchasing
decisions for our products are made by individuals based in the United States.
Our customers include substantially all of the world's leading data storage
manufacturers, including Fujitsu, HMT, IBM, Iomega, Komag, Read-Rite, Samsung,
Seagate and Trace.
For a discussion of certain factors that should be considered by prospective
investors in connection with an investment in the Notes, see "Risk Factors."
The Notes
We initially sold the Notes offered hereby as part of an offering of an
aggregate of $110,000,000 principal amount of notes on January 30, 1998 (the
"Original Note Offering"). We did not register this transaction under the
Securities Act because there was an exemption under Section 4(2). After the
Original Note Offering we were required to exchange the Notes issued in the
Original Note Offering for notes that were publicly registered. In November
1998, we completed the exchange of $107,000,000 of the $110,000,000 of the
originally issued Notes. The remaining $3,000,000 principal amount of
originally issued Notes was held by the selling noteholder who was not allowed
to participate in the exchange due to regulations of the Securities and
Exchange Commission. As a result, we are required to register the Notes for
sale by the selling noteholder. Depending on the context herein, the term
"Notes" refers to either the $3,000,000 of principal amount offered under this
Prospectus or the $110,000,000 of principal amount previously issued in the
Original Note Offering.
The Notes bear interest from January 30, 1998, at a rate equal to 10 3/4% per
annum. Interest on the Notes is payable semiannually on February 1 and August 1
of each year, commencing August 1, 1998. The Notes are redeemable at our
option, 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 Notes."
Prior to February 1, 2001, we have the option to redeem up to 33% of the
initially outstanding aggregate principal amount of the Notes from the net
proceeds of a public sale of our Common Stock ("Common Stock") at a price of
110.75% of the principal amount of the Notes, 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
the Notes remains outstanding immediately after such redemption. Upon the
occurrence of a Change of Control (as defined herein), each Holder (as defined
herein) of the Notes may require us to repurchase all or a portion of such
Holder's Notes at 101% of the aggregate principal amount of the Notes, together
with accrued and unpaid interest and Liquidated Damages, if any, to the date of
repurchase. We cannot be certain that sufficient funds will be available at the
time of any Change of Control to make any required repurchase of the Notes. See
"Risk Factors -- We May Not Be Able to Make Required Payments Upon a Change of
Control" and "Description of Notes -- Repurchase at the Option of Holders --
Change of Control."
The Notes are senior unsecured obligations and rank pari passu in right of
payment to all of our existing and future senior indebtedness and senior in
right of payment to all of our existing and future subordinated indebtedness.
The Notes are effectively subordinated, however, to all of our secured
obligations, to the extent of the assets securing such obligations. The Notes
are fully and unconditionally guaranteed on a joint and several basis (the
"Notes Guarantees") by Applied Robotic Technologies, Inc., Helios,
Incorporated, Air Bearings, Incorporated and Santa Barbara Metric, Inc. (the
"Subsidiary Guarantors"). The 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 Note
Guarantees are effectively subordinated, however, to all secured obligations of
the Subsidiary Guarantors, to the extent of the assets securing such
obligations. As of December 31, 1998, the Notes and the Note Guarantees were
effectively subordinated to
2
<PAGE>
approximately $3.1 million of secured indebtedness under our capital lease
obligations. In addition, the Notes are structurally subordinated to all
indebtedness and other obligations of the Non-Guarantor Subsidiaries, including
all accounts payable and debt for borrowed money. As of December 31, 1998, the
Non-Guarantor Subsidiaries had an aggregate of $0.5 million of such
indebtedness and other obligations outstanding, all of which ranked effectively
senior to the Notes in right of payment. The Subsidiary Guarantors did not, as
of December 31, 1998, have any material amount of indebtedness outstanding.
Our subsidiaries in Japan, Korea, Thailand, Malaysia, Singapore and Barbados
(collectively, the "Non-Guarantor Subsidiaries") have not guaranteed our
obligations under the Notes. As of and for the years ended December 31, 1997
and 1998, the operating results and assets of the Non-Guarantor Subsidiaries,
individually and in the aggregate, were not material to our results of
operations and assets on a consolidated basis, net of intercompany
eliminations. See Note 14 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 our 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 year ended December 31, 1998, were 6.7%, 0.5%, 11.1% and 0.0%,
respectively.
We do not intend to list the 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"), one of our significant stockholders, has advised us that they intend
to make a market in the Notes; however, DLJ is not obligated to do so and any
market-making may be discontinued at any time at DLJ's election. 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 with such activities must
be updated for any reason. As a result, we cannot determine whether an active
trading market will develop for the Notes. To the extent that a market for the
Notes develops, their market value will depend on market conditions (such as
yields on alternative investments), general economic conditions, our financial
condition and other conditions. Such conditions might cause the Notes, to the
extent that they are traded, to trade at a significant discount from their face
value. See "Risk Factors -- There is No Active Trading Market for the Notes."
No dealer, salesperson or other person has been authorized to give any
information or to represent anything not contained in this prospectus. You must
not rely on any unauthorized information or representations. This prospectus is
an offer to sell only the Notes offered hereby, but only under circumstances
and in jurisdictions where it is lawful to do so. The information contained in
this prospectus is current only as of its date.
The January 1998 Refinancing
In connection with the Original Note Offering in January 1998, we refinanced
(the "Refinancing") all of our then-existing term loan and revolving credit
indebtedness under our then-existing credit facility (the "Former Credit
Facility"). The net proceeds from the Original Note Offering, together with
existing cash and $1.6 million in initial borrowings (the "Initial Draw") under
the credit facility that we entered into in January 1998 to replace the Former
Credit Facility (the "New Credit Facility") were used to repay all outstanding
indebtedness under the Former Credit Facility as well as the expenses related
to the Original Note Offering and the Refinancing.
June and November Restructurings and Recent Operating Results
Our business, operating results and financial condition have been adversely
affected by a significant downturn in the data storage industry and reduced,
delayed or canceled capital equipment expenditures by our customers. In light
of these circumstances, and our expectation that the data storage industry's
adverse market conditions will extend for the foreseeable future, on June 18,
1998, we announced to employees and implemented
3
<PAGE>
the June restructuring (the "June Restructuring"). The June Restructuring
included a workforce reduction of approximately 115 employees (15% of our
workforce at the time), relocation and consolidation of much of our Concord,
California operation to our Fremont, California facility, and the sale and
partial leaseback of our San Diego, California facility and real property. Due
to the continued downturn in the data storage industry, on November 2, 1998, we
announced to employees and implemented the November restructuring (the
"November Restructuring"). The November Restructuring included a workforce
reduction of approximately 60 employees (10% of our workforce at the time), and
a reduction and consolidation of facilities at our Fremont, California
location. While we believe our cost-cutting measures are appropriate given our
current and anticipated levels of net sales, we cannot be sure that such
measures will be sufficient. We may have to carry out additional cost-cutting
measures in the future. Moreover, these current or future cost-cutting measures
may have a material adverse effect on our ability to increase our net sales or
pay our debts.
As a result of the significant downturn in the data storage industry, we
experienced a net loss of $76.9 million for 1998. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations." In 1998, we
recorded a $19.8 million charge to cost of sales to write-off excess and
obsolete inventory, $4.2 million in restructuring charges, as well as
$9.0 million of tax expense related to the recording of a valuation allowance
against our entire net deferred tax asset balance.
August/September 1998 Series C Preferred Stock Financing
In August and September 1998, we issued and sold 7,610,000 shares of our
Series C Preferred Stock for $4.00 per share to a group of investors, which
included a number of our current stockholders and two members of our Board of
Directors (the "Series C Financing"). We received approximately $30.4 million
in the Series C Financing and we used $7.1 million of those proceeds to repay
the outstanding indebtedness under the New Credit Facility. See "Description of
Capital Stock -- Series C Preferred Stock."
4
<PAGE>
Our principal executive offices are located at 10260 Sorrento Valley Road,
San Diego, California 92121. Our telephone number is (619) 646-4800.
Summary of Terms of Notes
Securities Offered.......... $3.0 million in aggregate principal amount of
our 10 3/4% Senior Notes due 2005.
Maturity Date............... February 1, 2005.
Interest Rate and Payment The Notes bear interest at the rate of 10
Dates....................... 3/4% per annum, payable semiannually in
arrears on February 1 and August 1 of each
year, commencing August 1, 1998.
Optional Redemption......... The Notes are redeemable at our option, in
whole or in part, at any time on or after
February 1, 2002, in cash at the redemption
prices set forth in this prospectus, 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, we may redeem up to 33% of
the initially outstanding aggregate principal
amount of 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 Notes remains
outstanding immediately after the occurrence
of such redemption. See "Description of Notes
-- Optional Redemption."
Change of Control........... Upon the occurrence of a Change of Control,
each holder of Notes will have the right to
require us to repurchase all or any part of
such holder's 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 Notes -- Repurchase at the
Option of Holders -- Change of Control." We
cannot be certain that, in the event of a
Change of Control, we would have sufficient
funds to repurchase all Notes tendered. See
"Risk Factors -- We May Not Be Able to Make
Required Payments Upon a Change of Control."
Ranking..................... The Notes are senior to our unsecured
obligations and rank pari passu in right of
payment with all of our existing and future
senior indebtedness and senior in right of
payment to all of our existing and future
subordinated indebtedness. The Notes are
effectively subordinated, however, to all of
our secured obligations, to the extent of the
assets securing such obligations. As of
December 31, 1998, the Notes and the Note
Guarantees were effectively subordinated to
approximately $3.1 million of secured
indebtedness under our capital lease
obligations. See "Risk Factors -- The Rights
of the Holders of the Notes to Receive
Payments is Junior to Certain Other Existing
and Future Indebtedness."
5
<PAGE>
Note Guarantees............. The Notes are fully and unconditionally
guaranteed on a joint and several basis by
all Subsidiary Guarantors. The 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 Note Guarantees are
effectively subordinated to all secured
obligations of the Subsidiary Guarantors, to
the extent of the assets securing such
obligations.
Certain Covenants........... The Notes are issued under an indenture dated
January 30, 1998 (the "Indenture") which
contains certain covenants that limit, among
other things, our ability to (1) pay
dividends, redeem capital stock or make
certain other restricted payments or
investments; (2) incur additional
indebtedness or issue preferred equity
interests; (3) merge, consolidate or sell all
or substantially all of our assets; (4)
create liens on assets and (5) enter into
certain transactions with affiliates or
related persons. See "Description of Notes --
Certain Covenants."
Form and Denomination....... The Notes are 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 are shown
on, and transfers thereof will be effected
through, records maintained by the Depositary
and its Participants. The Regulation S
Permanent Global Notes have been deposited
with State Street Bank and Trust Company (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
Notes -- Book-Entry; Delivery; Form and
Transfer."
Non-Guarantor Our Non-Guarantor Subsidiaries have not
Subsidiaries................ guaranteed our obligations under the Notes.
As of and for the years ended December 31,
1997 and 1998, the operating results and
assets of the Non-Guarantor Subsidiaries,
individually and in the aggregate, were not
material to our results of operations and
assets on a consolidated basis, net of
intercompany eliminations. See Note 14 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 our
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 year ended December 31, 1998,
were 6.7%, 0.5%, 11.1% and 0.0%,
respectively.
6
<PAGE>
Summary Selected Consolidated Financial Data
The following table presents our summary selected consolidated financial data
for the periods indicated. The summary selected consolidated statement of
operations data for the years ended December 31, 1996, 1997 and 1998 is derived
from our audited Consolidated Financial Statements included elsewhere in this
prospectus. The following selected consolidated financial data should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," our Consolidated Financial Statements and
related Notes thereto included elsewhere herein and the other information
contained in this prospectus.
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996(1) 1997 1998
(in thousands, except ratios)
<S> <C> <C> <C>
Consolidated Statement of
Operations Data:
Net sales....................... $190,773 $184,660 $104,994
Gross profit(2)................. 86,912 83,366 11,826
Operating expenses(3)........... 98,332 81,131 64,215
Income (loss) from operations... (11,420) 2,235 (52,389)
Net loss(4)..................... (11,990) (5,544) (76,851)
Other Data:
Cash used for operating
activities..................... $(21,402) $ (6,392) $(11,962)
Cash provided by (used for)
investing activities........... (40,885) (17,169) 10,156
Cash provided by financing
activities..................... 60,008 23,883 23,478
EBITDA(5)....................... 21,533 24,107 (40,333)
Depreciation and amortization
and write-downs of
intangibles.................... 32,953 21,872 12,056
Acquisition of property, plant
and equipment.................. 24,564 17,091 1,492
Ratio of earnings to fixed
charges(6)..................... -- -- --
</TABLE>
<TABLE>
<CAPTION>
December 31,
1998
------------
<S> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents......................................... $ 24,714
Working capital................................................... 45,883
Total assets...................................................... 96,115
Long-term debt, including current portion......................... 116,631
Redeemable preferred stock........................................ 42,543
Stockholders' deficit............................................. (97,157)
</TABLE>
- --------
(1) The Company completed the acquisitions of 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 Note 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 ABI, SBM and a portion of
the business of Kirell from their respective acquisition dates.
(2) In connection with the negative impact on the Company's operations of the
significant data storage industry downturn, for the year ended December 31,
1998, the Company recorded $19.8 million in charges to cost of sales to
write down excess and obsolete inventory.
(3) The Company incurred $4.2 million of restructuring costs in 1998, primarily
related to severance costs and asset impairment resulting from workforce
reductions and facility consolidations.
(4) In connection with the negative impact on the Company's operations of the
significant data storage industry downturn, for the year ended December 31,
1998, the Company recorded $9.0 million of tax expense related to recording
a valuation allowance against its entire net deferred tax asset balance.
(5) 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.
7
<PAGE>
(6) 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 for
redemption value and dividends on preferred stock. For the years ended
December 31, 1996, 1997 and 1998, earnings were inadequate to cover fixed
charges by $24.8 million, $14.7 million and $69.8 million, respectively.
8
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RISK FACTORS
You should consider carefully the following risks in your evaluation of us
and the Notes. The risks and uncertainties described below are not the only
ones facing our company. Additional risks and uncertainties may also adversely
impact and impair our business. If any of the following risks actually occurs,
our business, operating results or financial condition would likely suffer. In
such case, the value of the Notes could decline, and you may lose all or part
of the money you paid to buy the Notes.
This prospectus contains forward-looking statements based on our current
expectations, assumptions, estimates and projections about our company and our
industry. These forward-looking statements involve risks and uncertainties.
Our actual results could differ materially from those anticipated in such
forward-looking statements as a result of certain factors, as more fully
described in this section and elsewhere in this prospectus. We undertake no
obligation to update publicly any forward-looking statements for any reason,
even if new information becomes available or other events occur in the future.
We Have a Substantial Amount of Indebtedness
In connection with the Original Note Offering, we incurred a significant
amount of indebtedness. At December 31, 1998, we had indebtedness of $116.6
million. Subject to certain limitations, we may also incur additional
indebtedness in the future under the terms of the Indenture related to the
Notes. See "Capitalization."
Our ability to make scheduled payments of principal and interest on, or to
refinance, our indebtedness (including the Notes), and to fund our operations,
including planned capital expenditures and research and development expenses,
depends on our 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
our control. For the years ended December 31, 1996, 1997 and 1998, earnings
were inadequate to cover fixed charges by $24.8 million, $14.7 million, and
$69.8 million, respectively.
Over the past several quarters, the data storage industry and the production
and process-test equipment industry have been experiencing significant
weakness in demand for products, intense competition and pricing erosion, and
overcapacity. Such adverse market conditions have resulted, and may continue
to result in, the deferral or cancellation of orders for our products. Delays
or declines in product orders have had a material adverse effect on our
operating results and financial condition over the last several quarters and
fluctuations in demand for our products are expected to continue for the
foreseeable future. As a result of the outgoing significant downturn in the
data storage industry, we experienced a net loss of $76.9 million for 1998. We
cannot be certain that our business will generate adequate cash flow or that
any growth can be achieved under current or future market conditions. If we
are unable to generate sufficient cash flow from operations to pay our debts
and operate our business, including making necessary capital expenditures, we
may be required to refinance all or a portion of our existing debt, including
the Notes, to sell assets or to obtain additional financing. We cannot be
certain that any such action would be accomplished on acceptable terms.
Our high level of debt will have several important effects on our future
operations, including, but not limited to:
. making it more difficult for us to satisfy our obligations with respect
to the Notes;
. increasing our vulnerability to general adverse economic and industry
conditions;
. limiting our ability to obtain additional financing to fund future
working capital, capital expenditures, research and development and other
general corporate requirements;
. requiring a substantial portion of our cash flow from operations to pay
the principal of, and interest on, our 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
. limiting our flexibility in planning for, or reacting to, changes in our
business.
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See "Management's Discussion and Analysis of Financial Condition and Results
of Operations -- Liquidity and Capital Resources."
Existing Financing Covenants Restrict our Operations
The Indenture related to the Notes contains a number of covenants that
significantly restrict our operations, such as our ability 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.
We cannot be certain that we will be able to comply with such covenants or
restrictions in the future. Our ability to comply with such covenants and
restrictions may be affected by events beyond our control, including
prevailing economic and financial conditions and general conditions in the
data storage industry.
The Right of the Holders of the Notes to Receive Payments is Junior to Certain
Other Existing and Future Indebtedness
As of December 31, 1998, the Notes and the Note Guarantees were effectively
subordinated to approximately $3.1 million of secured indebtedness under our
capital lease obligations.
If we incur any additional senior indebtedness in the future that is not
subordinated to the indebtedness outstanding under the Notes, even if such
indebtedness were not secured, the holder of such debt would be entitled to
share ratably with the holders of the Notes in any proceeds distributed in
connection with any insolvency, liquidation, reorganization, dissolution or
other winding-up of our business. This may have the effect of reducing the
amount of proceeds available to pay to holders of the Notes upon the
occurrence of any such events.
Our Non-Guarantor Subsidiaries have not guaranteed our obligations under the
Notes. As of and for the years ended December 31, 1997 and 1998, the operating
results and assets of the Non-Guarantor Subsidiaries, individually and in the
aggregate, were not material to our results of operations and assets on a
consolidated basis, net of intercompany eliminations. See Note 14 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 our 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 year ended December 31, 1998,
were 6.7%, 0.5%, 11.1% and 0.0%, respectively.
We Have Experienced Significant Losses
We had net losses of approximately $12.0 million, $5.5 million and $76.9
million for 1996, 1997 and 1998, respectively. Such losses and accrual of
certain preferred stock dividends and accretion for the redemption value and
dividends of such preferred stock have contributed to a retained deficit of
approximately $103.3 million as of December 31, 1998. In addition, we used
cash for operating activities of approximately $21.4 million, $6.4 million and
$12.0 million for 1996, 1997 and 1998, respectively. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
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Our Operating Results are Subject to Wide Variations
In the past, we have experienced wide fluctuations in our quarterly and
annual operating results and have experienced net losses for the past several
quarters. We may continue to experience net losses and fluctuations in our
business due to a number of factors, not all of which are in our control.
These factors include, without limitation, the following:
. the continuing downturn in the data storage industry;
. the size, timing and rescheduling or cancellation of orders from, and
shipments to, major customers;
. the timing of introductions of our new products and product enhancements
or our competitors' introduction of such products;
. our ability to develop, introduce and market new, technologically
advanced products;
. the cyclicality of the data storage industry;
. the rescheduling or cancellation of capital expenditures by our
customers;
. variations in our customer base and product mix;
. the level of any of our significant volume pricing discounts;
. the availability and cost of key production materials and components;
. our ability to effectively manage our inventory and control costs;
. the financial stability of our major customers;
. personnel changes;
. expenses associated with acquisitions;
. restructurings;
. fluctuations in amortization and write-downs of intangible assets; and
. 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 is currently experiencing a significant weakness
in demand for data storage products, intense competition and pricing erosion,
and overcapacity in manufacturing operations. Such adverse market conditions
have existed for numerous quarters and have resulted in the rescheduling or
cancellation of specific orders by several of our major customers and has had
a material adverse effect on our business, operating results and financial
condition. This downturn in the data storage industry will likely continue for
several quarters, and, as a result, we expect order delays and reschedulings
to occur in the future.
Our business, operating results and financial condition have been adversely
and materially affected by a significant downturn in the data storage industry
and reduced or delayed capital equipment expenditures by data storage
companies. In light of these circumstances, and our expectation that the data
storage industry's adverse market conditions will extend for the foreseeable
future, on June 18, 1998, we implemented the June Restructuring, which
included a workforce reduction of approximately 115 employees (15% of our
workforce at the time), relocation and consolidation of much of our Concord,
California operation to the Fremont, California facility, and the sale and
partial leaseback of our San Diego, California facility and real property. On
November 2, 1998, due to the continued weakness in the data storage industry,
we implemented the November Restructuring, which included a workforce
reduction of approximately 60 employees (10% of our workforce at that time),
and a reduction and consolidation of facilities at our Fremont, California
location. While we believe our cost-cutting measures are appropriate given our
current and anticipated levels of net sales, we cannot be
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certain that such measures will be sufficient or that additional cost-cutting
measures will not be necessary in the future. Moreover, the June and November
Restructurings or future cost-cutting measures may have a material adverse
effect on our ability to increase our net sales or service our debt.
In connection with the negative impact that the downturn in the data storage
industry had on our operations, in 1998, we recorded a $19.8 million charge to
cost of sales to write down excess and obsolete inventory, $4.2 million in
restructuring charges related to the June and November Restructurings, as well
as $9.0 million of tax expense related to recording a valuation allowance
against our entire net deferred tax asset balance.
Quarterly results in the future may fluctuate due to the factors discussed
above or other factors. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
Dependence on and Cyclicality of Data Storage Industry
Our business depends almost entirely upon capital expenditures by our
customers, which in turn depend upon market demand for their products. Our
industry is cyclical and historically has experienced varying growth rates and
periods of oversupply like the one currently being experienced causing higher
than anticipated inventory levels and intense price competition. The data
storage industry is currently experiencing one of its most severe and
prolonged downturns with continuing weakness in demand for products, intense
competition, significant price erosion and overcapacity. As a result of this
downturn, there is significantly reduced demand for our products. The current
downturn in the disk storage industry generally, and the slowdown in our
customers' orders in the last several quarters has had a material adverse
effect on our business, operating results and financial condition. It is
likely that this downturn in our market will continue for the foreseeable
future, and, as a result, our customers will likely continue to delay or
cancel orders for our products and our business, operating results and
financial condition will be materially adversely affected. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
We Have Had to Restructure Operations and May Have to Again in the Future
In light of the continued downturn in the data storage industry, and our
expectation that the data storage industry's adverse market conditions will
extend for the foreseeable future, on June 18, 1998, we announced the June
Restructuring, which included a workforce reduction of approximately 115
employees (15% of our workforce at the time), relocation and consolidation of
much of our Concord, California operation to our Fremont, California facility,
and the sale and partial leaseback of our San Diego, California facility and
real property. In the second quarter of 1998, we recorded a charge of $3.0
million related to the June Restructuring. The significant components of the
restructuring charge were $0.9 million for employee severance costs, and
$2.0 million for asset impairment related to assets obsoleted due to
restructuring activities. As of December 31, 1998, all termination benefits
had been paid to affected employees. Relocation of the Concord operation was
complete at December 31, 1998. Period costs incurred in connection with these
activities were not significant.
In connection with the impact of the industry downturn on our operations in
1998 we recorded a $19.8 million charge to cost of sales to write-off excess
and obsolete inventory. Also in 1998, we recorded $9.0 million of income tax
expense related to the recording of a valuation allowance against our entire
deferred tax asset balance. Such charge was taken due to factors which give
rise to uncertainty as to whether the deferred tax asset is realizable,
including the lack of history of consistent earnings and the significant
losses in 1998.
Due to the continued downturn in the data storage industry, on November 2,
1998, we announced the November Restructuring, which included a workforce
reduction of approximately 60 employees (10% of our workforce at the time),
and a reduction and consolidation of facilities at our Fremont, California
location. In the fourth quarter of 1998, we recorded a charge of $1.1 million
related to the November Restructuring. The significant components of the
restructuring charge were $0.3 million for employee severance costs and
$0.6 million for asset impairment related to assets obsoleted due to the
restructuring activities. While the Company believes its cost-cutting measures
are appropriate given the Company's current and anticipated levels
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of net sales, there can be no assurance that such measure will be sufficient
and that additional cost-cutting measures will not be necessary, or that the
June Restructuring, the November Restructuring or future cost-cutting measures
will not have a material adverse effect on the Company's ability to increase
its net sales.
We May Not Be Able to Adapt to Rapid Technological Change
Rapid technological changes and evolving industry standards characterize the
data storage industry. Our customers frequently introduce new products and
enhancements, with relatively short product life cycles, typically between
nine and 18 months. In addition, our customers often develop multiple products
simultaneously, such that new products could be introduced as frequently as
every three months. Our customers' new product introductions typically result
in new technological challenges for us, both with respect to our installed
base and with respect to our next generation products. As a result, we must
continue to enhance our existing products and develop and manufacture new
products with improved capabilities. These technological changes require us to
make substantial investments in research and development. Although we
continually develop new products, there can be no assurance that we 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.
Our failure to develop, manufacture and market new or enhanced products, would
have a material adverse effect on our business, operating results and
financial condition. In addition, we are highly dependent on our close working
relationships with our key customers to advance our technologies. The
termination of any one of these key relationships could have a material
adverse effect on our ability to anticipate and develop necessary
technological changes to our products.
Our 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. If our customers modify their own design and internal production
processes without our products, demand for our equipment would likely decline.
Further, unless we are 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 our business, operating results
and financial condition.
Future technological innovations may reduce demand for disk drives.
Competing technologies to disk drive based data storage 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. Our products may not be adaptable to any
successor technology. Our business, operating results and financial condition
could be materially adversely affected by any significant migration toward
technology that would replace disk drives as a computer data storage medium.
We Depend on a Small Number of Customers
There are a relatively small number of data storage manufacturers throughout
the world and we derive a significant portion of our net sales from a
relatively small number of customers. We expect that our dependence on
relatively few key customers will continue in the future. Approximately 45.0%,
51.0% and 50.0% of our net sales in 1996, 1997 and 1998, respectively, were
derived from sales to our three largest customers in each of those periods.
Even though our customer mix will likely change from period to period in the
future, Seagate Technology, Inc. ("Seagate"), Komag, Incorporated ("Komag"),
HMT Technology Corporation ("HMT") and Trace Storage Technology USA
Corporation ("Trace") have historically accounted for a significant portion of
our net sales. For 1996, 1997 and 1998, Seagate accounted for 19.0%, 18.0% and
17.1%, respectively, of net sales; Komag accounted for 14.5%, 15.9% and 4.8%,
respectively, of net sales; HMT accounted for 5.2%, 17.1% and 16.3%,
respectively, of net sales; and Trace accounted for 11.5%, 4.4% and 1.2%,
respectively, of net sales. For 1998, Western Digital Corporation accounted
for 16.6% of net sales. If net sales to these or any of our other significant
customers were to decrease in any material amount in the future, our business,
operating results and financial condition would be materially adversely
affected.
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In general, we do not enter into long-term purchase agreements with our
customers. If completed orders are not replaced on a timely basis by new
orders from the same or other customers, our net sales would be materially
adversely affected. In addition, the following could have a material adverse
effect on our business, operating results and financial condition:
. the loss of a key customer;
. any reduction, cancellation or rescheduling of an order from any key
customer, including reductions, delays or cancellations due to customer
departures from recent buying patterns; and
. economic or competitive conditions in our industry.
Any failure to collect or delay in collecting receivables could have a
material adverse effect on our 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
we expect this trend to continue. Some of our customers have been, and may
continue to be acquired by competitors, causing further consolidation.
Previous acquisitions in the disk drive industry have often caused the
purchasing departments of the combined companies to reevaluate their
purchasing decisions. Such acquisitions may 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 our customer revenues to increase
thereby increasing our dependence on fewer customers.
We Have a High Risk of Inventory Obsolescence
Due to the cyclical nature of and rapid technological change in our
industry, our inventory is subject to substantial risk of obsolescence. To
address these risks, we monitor our inventories on a periodic basis and
provide inventory write-downs intended to cover these risks. Despite our
precautions, we may be required to take significant inventory charges which,
in turn, could materially and adversely affect our business, operating results
and financial condition due to the following:
. our dependence on a few customers and a limited number of product
programs for each customer;
. the magnitude of our commitment to support our customers' programs;
. our limited remedies in the event a customer cancels or materially
reduces one or more product orders; and
. the possibility that a customer may experience financial difficulties.
The significant downturn in the data storage industry negatively impacted
our operations, and in 1998, we recorded a $19.8 million charge to cost of
sales to write down excess and obsolete inventory. We may be required to take
additional inventory write-downs in the future due to our inability to obtain
necessary product acceptance, or due to further cancellations by customers.
Our Industry is Highly Competitive
The disk drive process and production-test equipment industry is highly
competitive. In each of our product lines, we face 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. For example, we face competition from
Zyratex, General Disk and Hitachi DECO for servowriters; Hitachi DECO and Sony
Techtronics for disk certifiers; Integral Solutions International for quasi-
static MR head testers; Koyo Precision Instruments, Inc. and Zygo Corporation
for flying height testers, and Technistar for automation technology.
Historically, there has also been competition from entrepreneurs with
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focused market knowledge and new technology. We experience intense competition
world-wide from Hitachi DECO, a large, full-line manufacturer of process and
production-test equipment. Hitachi DECO has substantially greater financial,
technical, marketing, manufacturing, research and development and other
resources. We also experience competition from other full-line and partial-
line manufacturers of process and production-test equipment. Our competitors
may develop enhancements to, or future generations of, competitive products
that will offer price or performance features superior to our products, or new
competitors may enter our markets. Finally, as many of our competitors are
based in foreign countries, they have cost structures and equipment prices
based on foreign currencies. Accordingly, currency fluctuations could cause
our dollar-priced products to be less competitive than our competitors'
products priced in other currencies.
Many of our competitors are investing heavily in the development of new and
enhanced products aimed at applications currently addressed by our products.
We expect our 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. We will be
required to make significant investments in product development and research,
sales and marketing and ongoing customer service and support to remain
competitive. We cannot be certain that we will have sufficient resources to
continue to make such investments or that we will be able to achieve the
technological advances necessary to maintain our competitive position.
We believe that our future success will be dependent, in part, upon our
ability to compete successfully in the Japanese, South Korean and Southeast
Asian markets. Our largest competitor, Hitachi DECO, is headquartered in Japan
which gives it a competitive advantage in that market to the extent buying
decisions are influenced by Hitachi DECO's local presence. In addition, our
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, our continuing ability to develop in a timely manner products that
meet the technical requirements of our foreign customers and our continuing
ability to develop and maintain satisfactory relationships with leading
companies in our industry in these areas. Moreover, our sales in these areas
will be affected by the overall economies of Japan, South Korea and Southeast
Asia. To the extent that recent economic troubles in Asian markets have
negatively impacted the capacity expansion and upgrade plans of our customers
or potential customers in affected regions, then such economic troubles have
also negatively impacted our operations. With respect to existing customers,
we do not believe that such Asian economic troubles have had a significant
impact on our operations. With respect to potential customers, we are unable
to quantify the impact that such Asian economic troubles will have on our
operations.
In addition to the competition from our competitors, most of our 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, we 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, rapid changes in data storage
technology, and the development of new process and production-test equipment
may be so closely linked to our 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 us at a competitive disadvantage.
Because of the foregoing competitive factors, we may not be able to compete
successfully in the future. Increased competitive pressure could cause us to
lower our prices which would have an adverse effect on our business, financial
condition and results of operations.
We Sell a Small Number of Products
We derive revenues primarily from sales of our process and production-test
systems and parts for such systems. Our products can generally be categorized
into four principal areas:
. disk (media) testing and processing;
. read/write head testing;
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. disk drive processing; and
. automation.
We derive a significant portion of our net sales from a relatively small
number of products. In 1996, 1997 and 1998, we derived approximately 47.0%,
58.9% and 54.1% of our net sales, respectively, from sales of our media
certifier products (excluding parts and service), with the MG250 series
constituting a majority of our media certifier sales over each of these
periods. Although we expect that net sales from our media certifier products,
including our MG series and our MC series, will continue to account for a
substantial portion of our total net sales in the foreseeable future, we
realize that the downturn in the data storage industry is caused, in part, by
the overcapacity of media certifiers in the market today. Any material
reduction in demand for our media certifier products would have a material
adverse effect on our business, operating results and financial condition.
We Depend on Proprietary Technology
Our success is heavily dependent upon the establishment and maintenance of
proprietary technologies. We currently attempt to protect our intellectual
property rights through patents, copyrights, trade secrets and other measures.
These efforts may not be adequate to prevent misappropriation by third parties
and may not be adequate under the laws of some foreign countries which may not
protect our proprietary rights to the same extent as do laws of the United
States. Our competitors may be able to independently develop products that are
substantially equivalent or superior to our products, or design around our
patents. Any such adverse circumstances could have a material adverse effect
on our business, operating results and financial condition.
Although we do not believe any of our products or proprietary rights
infringe the rights of third parties, infringement claims may be asserted
against us 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 us to enter into royalty or licensing agreements.
Such royalty or licensing agreements, if required, may not be available on
acceptable terms, or at all. If infringement were established, we could be
required to pay damages or be enjoined from making, using or selling the
infringing product. Likewise, a third party's product, if infringing on our
proprietary rights, may not be prevented from doing so without litigation. Any
of the foregoing could have a material adverse effect on our business,
operating results and financial condition.
We cannot be certain that the claims allowed on any of our patents will be
sufficiently broad to protect our technology. Moreover, any patent we own
could be invalidated, deemed unenforceable, circumvented or challenged. Also,
we cannot be certain that our patent rights will provide us competitive
advantages or that any of our pending or future patent applications will be
issued with claims of the scope that we desire, if at all. Furthermore, others
may develop similar products, duplicate our products or design around the
patents we own. In addition, foreign intellectual property laws or our
agreements may not protect our intellectual property rights in any foreign
country. Any failure to protect our intellectual property rights could have a
material adverse effect on our business, operating results and financial
condition.
We require each of our employees to enter into a proprietary rights and non-
disclosure agreement in which the employee agrees to maintain the
confidentiality of all of our proprietary information and, subject to certain
exceptions, to assign to us all rights in any proprietary information or
technology made or contributed by the employee during his or her employment.
In addition, we regularly enter 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 our proprietary technology without
authorization or to develop similar technology independently.
Manufacturing Risks
Our products have a large number of components and are highly complex. We
have experienced and may continue to experience manufacturing delays due to
technical difficulties. In addition, many of our products must be semi-
customized to meet individual product specification requirements. The
customization of a customer order
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may require new technical capabilities not previously incorporated
successfully into our products. As a result, we may be unable to complete our
customers' customized development or technical specifications in a timely
manner. Any significant failure in this regard would have a material adverse
effect on our business, operating results and financial condition as well as
our customer relationships. In addition, due to the semi-customized nature of
many of our products, we have incurred and may continue to incur substantial
unanticipated costs in a product's development and production which cannot be
passed on to the customer. Such unanticipated costs include the increased cost
of components due to expediting charges, other purchasing inefficiencies and
greater than expected engineering, quality control, installation, upgrade,
post-installation service and support and warranty costs. The occurrence of
any of these events could materially adversely affect our business, operating
results and financial condition.
In certain instances we rely on a single source or a limited group of
suppliers for certain components and subassemblies used in our products. The
partial or complete loss of these sources could have at least a temporary
material adverse effect on our 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 our products from these and other suppliers
which could impede our ability to quickly respond to changes in demand and
product specifications.
Shortages of critical components and subassemblies used in our products have
occurred in the past and may occur in the future. Also, the availability of
materials may have longer lead times. In addition, our manufacture and timely
delivery of products 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 our
product delivery until alternative sourcing may be developed. Alternative
sources may not be located in time to avoid penalties or cancellation of our
product orders. If a significant order or orders were cancelled for this
reason it could have a material adverse effect on our business, operating
results and financial condition. Further, a significant increase in the price
of one or more components used to produce our products would increase our
production costs. See "Business -- Manufacturing."
Risk of Natural Disasters
We conduct our manufacturing activities at our facilities in San Diego,
Fremont and Hayward, California. Our 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 our manufacturing
activities could result in a prolonged interruption of our business. See
"Business -- Manufacturing."
Risks Associated with Acquisitions
While we currently have no commitments, agreements or understandings with
respect to any future acquisitions, our business strategy includes the
expansion of our business, products lines and technology through acquisitions.
We regularly review various acquisition prospects, including companies,
technologies or products complementary to our business and periodically engage
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;
. the risks of entering markets in which we have limited or no direct
experience;
. the potential loss of key employees of the acquired companies;
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. dilutive issuances of equity securities;
. the incurrence of additional debt;
. reduction of existing cash balances; and
. amortization expenses related to goodwill and other intangible assets and
other charges to operations that may materially adversely affect our
results of operations.
Moreover, any equity or debt financings proposed in connection with any
acquisition may not be available to us on acceptable terms or at all, when,
and if, suitable strategic acquisition opportunities arise. Although
management expects to carefully analyze any opportunity before committing our
resources, there can be no assurance that any completed acquisition will
result in long-term benefits or that our management will be able to manage
effectively the resulting business. See "Business -- Competition."
We 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 connection with our
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 independently of purchased technologies, causing a decline
in the carrying values of such purchased technologies. Such impairments may
occur in the future and future acquisitions may 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.
We May Require Additional Capital to Fund Our Operations
To achieve our long-term strategic objectives and maintain our competitive
position, we 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. We are continually
investing in new technologies and our international infrastructure and, as a
result, our fixed costs may increase in the foreseeable future, depending on
the timing of any recovery in demand for our products. Our fixed costs may
also increase if we expand our infrastructure in South Korea, Japan, other
parts of Asia, or other locations. Any liquidity deficiency in the future
could delay or change our management's plans, including curtailing our
acquisition strategy, capital expenditures, facilities expansion and research
and development expenditures, which could materially adversely affect our
ability to pay our debts (including indebtedness and interest under the Notes)
and our business, operating results and financial condition.
We continue to have limited cash resources and significant future
obligations. The precise amount and timing of our capital needs will depend
upon a number of factors, including:
. the market demand for our products;
. the availability of strategic opportunities;
. the progress of our product development efforts;
. technological challenges in connection with existing and future products;
and
. the success of our aggressive working capital and inventory management.
We may not be able to obtain additional financing as needed on acceptable
terms or at all. If we are unable to obtain sufficient capital, our
acquisition strategy, capital expenditures, facilities expansion and research
and development expenditures would be materially and adversely affected. See
"Capitalization" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
18
<PAGE>
In August 1998, we issued and sold an aggregate of 6,360,000 shares of our
Series C Preferred Stock in our Series C Financing for $25.4 million in
proceeds. Immediately following the consummation of the Series C Financing, we
used $7.1 million of the proceeds from the offering to repay all outstanding
indebtedness under the New Credit Facility and subsequently terminated such
facility. As of the date of this prospectus, we have no revolving or other
type of working capital credit facility for working capital. In September
1998, one of the investors in the Series C Financing purchased an additional
1,250,000 shares of Series C Preferred Stock for an aggregate of $5.0 million.
See "Description of Capital Stock-- Series C Preferred Stock."
Based on currently available information, and subject to the success of our
aggressive working capital and inventory management efforts, we believe our
available cash and cash generated from operations will be adequate to fund our
operations for the foreseeable future, and for no less than the next 12
months. While operating activities may provide cash in certain periods
depending on the timing of any recovery in demand for our products we may
require additional sources of financing. We 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. However, we
continue to have limited capital resources and significant future obligations,
including our future principal and interest payments under the Notes. The
existence of certain restrictive covenants in the Indenture for the Notes may
inhibit our ability to raise additional financing. There can be no assurance
that we will be able to obtain additional sources of financing on favorable
terms, if at all, at such time or times as we may require such capital. See
"Risk Factors -- We Have a Substantial Amount of Indebtedness."
We Depend on Key Personnel
Our future performance depends in significant part upon the continued
service of our chief executive officer, other senior management personnel and
our key technical personnel. We are dependent on our 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 our products and introduce new and enhanced future products and
applications. Our industry is characterized by a high level of employee
mobility and aggressive recruiting of skilled personnel. Our employees may
terminate their employment at any time. Accordingly, there can be no assurance
that any of our current employees will continue to work for us. The loss of
key employees could have a material adverse effect on our business, operating
results and financial condition. We have an employment agreement with our
chief executive officer, but we do 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."
Our International Operations are Subject to Inherent Risks
Our 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.
19
<PAGE>
These factors could have a material adverse effect on our business,
operating results or financial condition. In addition, although substantially
all of our 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 we conduct business
could have a material adverse effect on our business, operating results and
financial condition. 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, some of our customers may delay,
reschedule or cancel significant current or future product orders. If any such
orders are delayed, rescheduled or cancelled, our business, operating results
and financial condition would be adversely affected. To the extent that recent
economic troubles in Asian markets have negatively impacted the capacity
expansion and upgrade plans of our customers or potential customers in
affected regions, then such economic troubles have also negatively impacted
our operations. With respect to existing customers, we do not believe that
such Asian economic troubles have had a significant impact on our operations.
With respect to potential customers, we are unable to quantify the impact that
such Asian economic troubles will have on our operations.
We are Subject to Many Environmental Regulations
We are 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. We believe that we are 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 upon us, or
our officers, directors or employees, suspension of production, alteration of
our manufacturing process or cessation of operations. Such regulations could
require expensive remediation or abatement actions to comply with
environmental regulations. Any failure to properly manage the use, disposal or
storage of, or adequately restrict the release of, hazardous or toxic
substances could subject us to significant liabilities.
We Will Be Substantially Influenced by Officers and Directors
Our directors and officers and their respective affiliates beneficially own
approximately 89.4% of our capital stock as of December 31, 1998. As a result,
these stockholders, acting together, would be able to effectively control all
matters requiring approval by the stockholders, including the election of
directors and approval of significant corporate transactions. These
stockholders are parties to an agreement which, in part, requires them to vote
their shares of capital stock for certain nominee directors. See "Management,"
"Certain Transactions" and "Principal Stockholders."
The Notes Could Be Voided or Subordinated if Certain Circumstances Existed at
the Time We Incurred Such Indebtedness
Under applicable provisions of federal bankruptcy law or comparable
provisions of state fraudulent transfer laws, if, among other things, we or
any Subsidiary Guarantor, at the time we incurred the indebtedness evidenced
by the Notes or the Note Guarantees, as the case may be, (1) (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 us or
such Subsidiary Guarantor constituted unreasonably small capital or (c)
intended or intends to incur, or believed or believes that we would incur,
debts beyond our ability to pay such debts as they mature and (2) we 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 Notes and the Note Guarantees could be
voided or claims in respect of the Notes or the Note Guarantees could be
subordinated to all other debts of ours or such Subsidiary Guarantor, as the
case may be. In addition, our payment of interest and principal pursuant to
the Notes or the payment of amounts by a Subsidiary Guarantor pursuant to a
Note Guarantee could be voided and required to be returned to the person
making such payment, or to a fund for the credit of our creditors 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, we or a Subsidiary Guarantor would
20
<PAGE>
be considered insolvent if (1) the sum of our debts, including contingent
liabilities, were greater than the saleable value of all our assets at a fair
valuation or if the present fair saleable value of our assets were less than
the amount that would be required to pay our probable liabilities on our
existing debts, including contingent liabilities, as they become absolute and
mature or (2) we could not pay our 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, we and each Subsidiary Guarantor
believe that, after giving effect to the indebtedness incurred in connection
with the Original Note Offering, we were not insolvent, did not have
unreasonably small capital for the business in which we were engaged and had
not incurred debts beyond our 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 our or such Subsidiary
Guarantor's conclusions.
We May Not Be Able to Make Required Payments Upon a Change of Control
The Indenture provides that, upon the occurrence of a Change of Control, we
will be required to make an offer to repurchase all of the Notes issued and
then outstanding under the Indenture at a purchase price equal to 101% of
their principal amount plus any accrued and unpaid interest and Liquidated
Damages, to the date of repurchase. See "Description of Notes -- Repurchase at
the Option of Holders -- Change of Control." If a Change of Control were to
occur, it is unlikely that we would be able to repay all of our obligations,
the Notes and any other indebtedness that may become payable in such event
without refinancing our obligations. We may not be able to obtain any such
financing on commercially reasonable terms, or at all, and consequently we
cannot give any assurance that we would be able to repurchase any of the Notes
upon a Change of Control.
There Is No Active Trading Market for the Notes
No established trading market exists for the Notes. We do not intend to list
the 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 us that it currently intends to make a market in the
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 Notes may experience difficulty in reselling
the Notes or may be unable to sell them at all. If a market for the 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
Notes.
Risks Related to the "Year 2000" Issue
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. We are in the
process of assessing the readiness of our internal systems and our products
for handling the Year 2000 issue. Our ongoing assessment includes
identification of exposures, repair or replacement of deficient systems,
testing, implementation and contingency planning. Based on the assessments
performed to date, we believe that all of our critical internal systems are
Year 2000 ready. We are continuing to monitor the Year 2000 readiness of our
products, including our installed base of products. If it is ultimately
determined that any of our installed base of products have Year 2000 readiness
issues, we currently plan to offer to our customers upgrades for certain of
such products. We are continuing to monitor our internal operations for Year
2000 readiness, including developing our contingency plan. To date, we have
not incurred any material costs in connection with our assessment of our Year
2000 readiness. We do not believe that the costs of any actions required as a
result of our assessment to date will have a material adverse effect on our
business, operating results or financial condition. There can be no assurance,
however, that we will successfully implement the correct solutions or that
there will be no delay in or increased costs associated with our Year 2000
readiness. Our inability to successfully implement such changes could have a
material adverse effect on our business, operating results or financial
condition. In addition, there can be no
21
<PAGE>
assurance that our critical product and service providers, and their critical
providers and so on, are or will become Year 2000 ready on a timely basis. The
failure of such critical product and service providers and integrated
information systems to be or become Year 2000 ready could have a material
adverse effect on our business, operating results or financial condition. In
addition, it is possible that our revenue may be adversely affected if current
and prospective customers direct their spending resources away from purchasing
our products over the next two years in order to correct or replace
information systems which are not Year 2000 ready.
22
<PAGE>
USE OF PROCEEDS
DLJ will receive all of the net proceeds from the sales of the Notes offered
by this prospectus. Accordingly, we will not receive any proceeds from sales
of these Notes offered hereby.
23
<PAGE>
CAPITALIZATION
The following table sets forth the capitalization of Phase Metrics as of
December 31, 1998 (in thousands, except share data).
<TABLE>
<CAPTION>
December 31, 1998
-----------------
<S> <C>
Cash and cash equivalents.................................... $ 24,714
=========
Debt (including current portion):
Senior Notes due 2005 ($110,000 principal amount)........... 105,487
Convertible Subordinated Notes.............................. 8,000
Capital lease obligations................................... 3,144
---------
Total debt (including current portion)................... 116,631
Series B redeemable preferred stock, $.0001 par value,
3,857,280 shares authorized, issued and outstanding
(liquidation preference of $11,328)......................... 11,331
Series C redeemable preferred stock, $.0001 par value,
7,610,000 shares authorized, issued and outstanding
(liquidation preference of $38,050)......................... 31,212
Stockholders' deficit:
Series A preferred stock, $.0001 par value, 8,250,000 shares
authorized, issued and outstanding (liquidation preference
of $9,000)................................................. 3
Common stock, $.0001 par value, 70,000,000 shares
authorized; 5,622,309 shares issued and outstanding........ 6,498
Retained deficit............................................ (103,298)
Accumulated translation adjustments......................... (360)
---------
Total stockholders' deficit.............................. (97,157)
---------
Total capitalization................................... $ 62,017
=========
</TABLE>
24
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated statement of operations data for the
years ended December 31, 1996, 1997 and 1998, and the selected consolidated
balance sheet data as of December 31, 1997 and 1998, are derived from Phase
Metrics' audited Consolidated Financial Statements included elsewhere in this
prospectus. The selected consolidated statement of operations data for the
years ended December 31, 1994 and 1995, and the selected consolidated balance
sheet data as of December 31, 1994, 1995 and 1996 are derived from Phase
Metrics' audited Consolidated Financial Statements not included in this
prospectus. 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 Phase Metrics' Consolidated
Financial Statements and related Notes thereto included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------
1994(1) 1995(1) 1996(1) 1997 1998
(in thousands, except ratios)
<S> <C> <C> <C> <C> <C>
Consolidated Statement
of Operations Data:
Net sales.............. $ 20,064 $116,894 $190,773 $184,660 $104,994
Gross profit(2)........ 10,099 52,128 86,912 83,366 11,826
Operating expenses(3).. 8,530 40,161 98,332 81,131 64,215
Income (loss) from
operations............ 1,569 11,967 (11,420) 2,235 (52,389)
Interest expense....... 651 5,625 8,448 11,573 14,456
Income (loss) before
income taxes and
extraordinary items... 943 6,193 (19,842) (9,812) (66,506)
Income tax expense
(benefit)(4).......... (611) 1,524 (8,974) (4,268) 9,000
Income (loss) before
extraordinary items... 1,554 4,669 (10,868) (5,544) (75,506)
Extraordinary loss, net
of income taxes....... -- -- (1,122) -- (1,345)
Net income (loss)...... 1,554 4,669 (11,990) (5,544) (76,851)
Other Data:
Cash provided by (used
for) operating
activities............ (1,994) 18,300 (21,402) (6,392) (11,962)
Cash provided by (used
for) investing
activities............ (22,266) (11,102) (40,885) (17,169) 10,156
Cash provided by (used
for) financing
activities............ 24,455 (3,099) 60,008 23,883 23,478
EBITDA(5).............. 2,782 27,864 21,533 24,107 (40,333)
Depreciation,
amortization and
write-downs of
intangible assets..... 1,213 15,897 32,953 21,872 12,056
Acquisition of
property, plant and
equipment............. 293 9,135 24,564 17,091 1,492
Ratio of earnings to
fixed charges(6)...... 1.0x 1.2x -- -- --
</TABLE>
<TABLE>
<CAPTION>
December 31,
------------------------------------------------
1994 1995 1996 1997 1998
(in thousands)
<S> <C> <C> <C> <C> <C>
Consolidated Balance
Sheet Data:
Cash and cash
equivalents............ $ 917 $ 5,016 $ 2,737 $ 2,977 $ 24,714
Working capital......... (15,616) (5,774) 42,681 66,075 45,883
Total assets............ 49,609 119,896 154,013 154,730 96,115
Long-term debt,
including current
portion................ 28,200 30,239 96,020 121,057 116,631
Redeemable preferred
stock.................. 314 3,314 6,314 9,237 42,543
Stockholders' equity
(deficit)(2)(3)(4)..... (310) 3,592 (9,031) (17,873) (97,157)
</TABLE>
- --------
(1) In November 1994, Phase Metrics acquired ProQuip and certain net assets of
Cambrian. Between June 1995 and December 1996, Phase Metrics 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 Note 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, Phase Metrics' consolidated statements of
operations 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.
25
<PAGE>
(2) In connection with the negative impact on Phase Metrics' operations of the
significant data storage industry downturn, for the year ended December
31, 1998, the Company recorded $19.8 million in charges to cost of sales
to write down excess and obsolete inventory.
(3) Phase Metrics incurred $1.0 million of restructuring costs in 1994 in
connection with the acquisitions of ProQuip and Cambrian, primarily
related to the elimination of duplicate facilities and information
systems. Phase Metrics incurred $4.2 million of restructuring costs in
1998, primarily related to employee severance costs and asset impairment
resulting from workforce reductions and facility consolidations.
(4) In connection with the negative impact on Phase Metrics' operations of the
significant data storage industry downturn, for the year ended December
31, 1998, Phase Metrics recorded $9.0 million of tax expense relating to
the recording of a valuation allowance against its entire deferred tax
asset balance. Prior to the Recapitalization (See "Certain Transactions--
Recapitalization"), Phase Metrics was an S Corporation for 1994 income tax
purposes and, as such, taxable income and losses were passed on to the
sole stockholder of Phase Metrics as cash distributions. Had Phase Metrics
been a C corporation, assuming a combined statutory income tax rate of
41%, income tax expense would have been approximately $0.4 million for
1994. Phase Metrics 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."
(5) 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. Phase Metrics 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.
(6) 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 for
redemption value and dividends on preferred stock. For the years ended
December 31, 1996, 1997 and 1998, earnings were inadequate to cover fixed
charges by $24.8 million, $14.7 million and $69.8 million, respectively.
26
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company was incorporated 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 process
and production-test equipment for disks and read/write heads. In June 1995,
the Company acquired Helios, a supplier of servowriter and other related
equipment used in the production of disk drives. In July 1995, the Company
acquired both ART, a supplier of integrated automation systems for process and
production-test equipment, and Tahoe, a developer of quasi-static MR head
testers used for testing MR read/write heads. In January 1996, the Company
acquired ABI, a supplier of air bearing spindles and other related components
used in the Company's products and by others. In December 1996, the Company
acquired SBM, a developer of spinstands and micropositioner equipment and
technology used by data storage manufacturers, and in December 1996, the
Company acquired a portion of the business of Kirell, a supplier of 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. At December 31, 1998, future potential combined
maximum earn-out payments in connection with such acquisitions are not
expected to be material. Also, in connection with the acquisitions, the
Company recorded capitalized intangible assets totaling $61.2 million. At
December 31, 1998, 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 $1.4 million as of December 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 45.0%, 51.0% and 50.0% of its net sales in 1996, 1997 and 1998,
respectively, were derived from sales to its 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, Komag, HMT, and Trace have
historically accounted for a significant portion of its net sales. For 1996,
1997 and 1998, Seagate accounted for 19.0%, 18.0% and 17.1%, respectively, of
net sales; Komag accounted for 14.5%, 15.9% and 4.8%, respectively, of net
sales; HMT accounted for 5.2%, 17.1% and 16.3%, respectively, of net sales;
and Trace accounted for 11.5%, 4.4% and 1.2%, respectively, of net sales. For
1998, Western Digital accounted for 16.6% of net sales. If net sales to these
or any of its other significant customers were to decrease in any material
amount in the future, the Company's business, operating results 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 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, operating
results and financial condition. Each of the Company's customers has 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
27
<PAGE>
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, operating results and financial condition.
The Company derives its revenues primarily from sales of its process and
production-test systems and upgrades and parts for such systems. The Company's
products can generally be categorized into four principal areas: (1) disk
(media) testing and processing, (2) read/write head testing, (3) disk drive
processing and (4) automation. The Company derives a significant portion of
its net sales from a relatively small number of products. In 1996, 1997 and
1998, the Company derived approximately 47.0%, 58.9% and 54.1% 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 MG series and its MC 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, operating results and financial condition.
The data storage industry in general has recently experienced significant
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 through 1999. 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.
As indicated above, the Company's business, operating results and financial
condition have been adversely and materially affected by a downturn in the
data storage industry and reduced or delayed capital equipment expenditures by
data storage companies. In light of the continued downturn in the data storage
industry, and the Company's expectation that the data storage industry's
adverse market conditions will extend for the foreseeable future, on June 18,
1998, the Company implemented the June Restructuring which included a
workforce reduction of approximately 115 employees, relocation and
consolidation of much of its Concord, California operation to the Company's
Fremont, California facility, and consolidation of its San Diego, California
facility. In connection with the consolidation of the San Diego, California
facility, the Company sold the real property, improvements, fixtures and
office buildings (collectively, the "Property") for aggregate net proceeds of
$11.9 million. In connection with the sale of the Property, the Company
entered into a lease with the purchaser to lease back a portion of the
Property. Due to the continued downturn in the data storage industry, the
Company implemented the November Restructuring which included a workforce
reduction of approximately 60 employees and a consolidation of facilities at
the Company's Fremont, California location. While the Company believes its
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 the June Restructuring, the November Restructuring or
future cost-cutting measures will not have a material adverse effect on the
Company's ability to increase its net sales.
In connection with the negative impact on the Company's operations of the
significant data storage industry downturn, in 1998, the Company recorded
$19.8 million in charges to cost of sales to write-off excess and
28
<PAGE>
obsolete inventory, $4.2 million in restructuring charges related to the June
and November Restructurings, as well as $9.0 million of tax expense related to
the recording of a valuation allowance against its entire net deferred tax
asset balance.
In August and September 1998 the Company sold 7,610,000 shares of Series C
Preferred Stock for $4 per share. The proceeds of approximately $30.4 million
were used to repay in full the Company's New Credit Facility and accrued
interest totaling $7.1 million, with the remaining proceeds used for general
operating purposes. The New Credit Facility was then terminated. As of the
date of this prospectus, the Company has no revolving or other type of credit
facility for working capital. See "Description of Capital Stock -- Series C
Preferred Stock."
The Company had net sales of $184.7 million for 1997 compared to $105.0
million for 1998. The Company had EBITDA (as described in Footnote 5 in
"Selected Consolidated Financial Data") of $24.1 million for 1997 compared to
$(40.3) million for 1998. Cash used for operating activities was $6.4 million
for 1997 and $12.0 million for 1998. Period to period fluctuations in
operations impacting these amounts were the net losses for 1997 and 1998, a
decrease in amortization and write downs of intangible assets, a decrease in
deferred income tax assets, a smaller increase period to period in accounts
receivable, a decrease in 1998 inventories compared to an increase in 1997 and
increases in 1998 income taxes receivable and accrued expenses compared to
decreases in 1997. 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 write-downs 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. 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, partially offset by
increases in research and development and interest expense.
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.
Year 2000 Readiness
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. We are in the
process of assessing the readiness of our internal systems and our products
for handling the Year 2000 issue. Our ongoing assessment includes
identification of exposures, repair or replacement of deficient systems,
testing, implementation and contingency planning. Based on the assessments
performed to date, we believe that all of our critical internal systems are
Year 2000 ready. We are continuing to monitor the Year 2000 readiness of our
products, including our installed base of products. If it is ultimately
determined that any of our installed base of products have Year 2000 readiness
issues, we currently plan to offer to our customers upgrades for certain of
such products. We are continuing to monitor our internal operations for Year
2000 readiness, including developing our contingency plan. To date, we have
not incurred any material costs in connection with our assessment of our Year
2000 readiness. We do not believe that the costs of any actions required as a
result of our assessment to date will have a material adverse effect on our
business, operating results or financial condition. There can be no assurance,
however, that we will successfully implement the correct solutions or that
there will be no delay in or increased costs associated with our Year 2000
readiness. Our inability to successfully implement such changes could have a
material adverse effect on our business, operating results or financial
condition. In addition, there can be no assurance that our critical product
and service providers, and their critical providers and so on, are or will
become Year 2000 ready on a timely basis. The failure of such critical product
and service providers and integrated information systems to be or become Year
2000 ready could have a material adverse effect on our business,
29
<PAGE>
operating results or financial condition. In addition, it is possible that our
revenue may be adversely affected if current and prospective customers direct
their spending resources away from purchasing our products over the next two
years in order to correct or replace information systems which are not Year
2000 ready.
30
<PAGE>
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>
Year Ended December 31,
------------------------------
1996 1997 1998
(in thousands)
<S> <C> <C> <C>
Consolidated Statement of Operations Data:
Net sales.................................... $190,773 $184,660 $104,994
Cost of sales................................ 103,861 101,294 93,168
-------- -------- --------
Gross profit................................ 86,912 83,366 11,826
Operating expenses:
Research and development.................... 31,110 43,572 33,329
Selling, general and administrative......... 24,631 22,968 17,370
Amortization and write-downs of
intangibles................................ 28,656 14,591 3,460
Settlement charge........................... -- -- 5,872
Restructuring charge........................ -- -- 4,184
Purchased in-process research and
development................................ 13,935 -- --
-------- -------- --------
Income (loss) from operations................ (11,420) 2,235 (52,389)
Interest expense............................. 8,448 11,573 14,456
Other (income) expense -- net................ (26) 474 (339)
-------- -------- --------
Loss before income taxes and extraordinary
items....................................... (19,842) (9,812) (66,506)
Income tax (benefit) expense................. (8,974) (4,268) 9,000
-------- -------- --------
Loss before extraordinary items.............. (10,868) (5,544) (75,506)
Extraordinary loss, net of income taxes...... (1,122) -- (1,345)
-------- -------- --------
Net loss..................................... $(11,990) $ (5,544) $(76,851)
======== ======== ========
Other Data:
Cash used for operating activities........... $(21,402) $ (6,392) $(11,962)
Cash provided by (used for) investing
activities.................................. (40,885) (17,169) 10,156
Cash provided by financing activities........ 60,008 23,883 23,478
EBITDA(1).................................... 21,533 24,107 (40,333)
<CAPTION>
Year Ended December 31,
------------------------------
1996 1997 1998
<S> <C> <C> <C>
Consolidated Statement of Operations Data:
Net sales.................................... 100.0 % 100.0 % 100.0 %
Cost of sales................................ 54.4 54.9 88.7
-------- -------- --------
Gross profit................................ 45.6 45.1 11.3
Operating expenses:
Research and development.................... 16.3 23.6 31.7
Selling, general and administrative......... 12.9 12.4 16.5
Amortization and write-downs of
intangibles................................ 15.0 7.9 3.3
Settlement charge........................... -- -- 5.6
Restructuring charge........................ -- -- 4.0
Purchased in-process research and
development................................ 7.3 -- --
-------- -------- --------
Income (loss) from operations................ (5.9) 1.2 (49.8)
Interest expense............................. 4.4 6.3 13.8
Other (income) expense -- net................ -- 0.3 (0.3)
-------- -------- --------
Loss before income taxes and extraordinary
items....................................... (10.3) (5.4) (63.3)
Income tax (benefit) expense................. (4.7) (2.3) 8.6
-------- -------- --------
Loss before extraordinary items.............. (5.6) (3.1) (71.9)
Extraordinary loss, net of income taxes...... (0.6) -- (1.3)
-------- -------- --------
Net loss..................................... (6.2) (3.1) (73.2)
======== ======== ========
Other Data:
Cash used for operating activities........... (11.2)% (3.5)% (11.4)%
Cash provided by (used for) investing
activities.................................. (21.4) (9.3) 9.7
Cash provided by financing activities........ 31.5 12.9 22.4
EBITDA(1).................................... 11.3 13.1 (38.4)
</TABLE>
- ----------
(1) See "Selected Consolidated Financial Data" for definition of and caveats
EBITDA.
31
<PAGE>
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 43.2% from $184.7 million for 1997 to $105.0
million for 1998. This decrease was primarily due to decreased unit sales of
the Company's products due to the adverse market conditions previously
mentioned.
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.
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 $83.4 million
for 1997 to $11.8 million for 1998. Gross profit as a percentage of net sales
("gross margin") decreased from 45.1% for 1997 to 11.3% for 1998. The decrease
was primarily due to (1) lower gross profit on products shipped in connection
with the Settlement Agreement discussed below, (2) two other customer
contracts involving lower than average sales prices which also negatively
impacted the Company's gross profit, (3) underutilization of manufacturing
capacity, (4) higher costs resulting from lower production volumes, and (5)
$19.8 million of inventory write-offs recorded in 1998 as a result of the
downturn in the data storage industry and its impact on the Company's
operations, partially offset by decreases in personnel costs as a result of
workforce reductions in August 1997, and January, June and November 1998. See
"Restructuring Charge" below.
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.
In April 1998, the Company entered into an agreement (the "Settlement
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 concluded that such
actions were necessary in order to discourage further unauthorized use of its
intellectual property in the future by this or other third parties. The
Company recorded a $5.9 million charge to earnings in the second quarter of
1998 in connection with the Settlement Agreement. The Company is making the
reimbursement provided for under the Settlement Agreement by providing a
credit to the customer for products purchased by the customer. Products
purchased under the Settlement Agreement are at favorable pricing which
negatively impacted the Company's gross profit margin in 1998. Such negative
impact is expected to continue in 1999.
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.
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 $43.6 million for 1997 to
$33.3 million for 1998. Research and development expense as a percentage of
net sales increased from 23.6% for 1997 to 31.7% for 1998. The percentage
increase was primarily due to the decrease in net sales, partially offset by a
decrease in personnel costs as a result of workforce reductions in August
1997, and January, June and November 1998. The Company anticipates that it
will continue to devote a significant amount of financial resources to
research and development for the foreseeable future.
32
<PAGE>
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.
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 11 of Notes to Consolidated Financial Statements. Selling, general and
administrative expense decreased from $23.0 million for 1997 to $17.4 million
for 1998. Selling, general and administrative expense as a percentage of net
sales increased from 12.4% for 1997 to 16.5% for 1998. The percentage increase
was primarily due to a decrease in net sales, partially offset by a decrease
in personnel costs as a result of workforce reductions in August 1997, and
January, June and November, 1998.
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 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.
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 and write downs of intangible assets decreased from $14.6
million for 1997 to $3.5 million for 1998. This decrease was due to more
intangible assets becoming fully amortized prior to or during 1998 as well as
a write down to fair value of $2.0 million in 1997 related to impairment of
certain intangible assets recorded in connection with one of the Company's
acquisitions.
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.
Settlement Charge
In connection with the Settlement Agreement, discussed under "Results of
Operations -- Gross Profit," the Company recorded a $5.9 million charge to
earnings in the second quarter of 1998.
33
<PAGE>
Restructuring Charge
In 1998, the data storage industry in general, including many of the
Company's customers, experienced significant weakness in demand for data
storage products, intense competition, pricing erosion and overcapacity in
manufacturing operations. Such adverse market conditions resulted in the
rescheduling or cancellation of orders by several of the Company's major
customers and had a material adverse effect on the Company's business,
operating results and financial condition. In light of these circumstances,
and the Company's expectation that the data storage industry's adverse market
conditions will extend for the foreseeable future, on June 18, 1998, the
Company implemented the June Restructuring, which included a workforce
reduction of approximately 115 employees, relocation and consolidation of much
of its Concord, California operation to the Company's Fremont, California
facility, and consolidation of its San Diego, California facility.
In the second quarter of 1998, the Company recorded a charge of $3.0 million
related to the June Restructuring. The significant components of the
restructuring charge were $0.9 million for employee severance costs, $2.0
million in impairment costs related to property, plant and equipment obsoleted
due to restructuring activities, and $0.1 million of other costs.
Due to the continued downturn in the data storage industry, the Company
implemented the November Restructuring in November 1998, which included a
workforce reduction of approximately 60 employees, and a consolidation of
facilities at the Company's Fremont, California location.
In the fourth quarter of 1998, the Company recorded a charge of $1.1 million
related to the November Restructuring. The significant components of the
restructuring charge were $0.3 million for employee severance costs and $0.6
million in impairment costs related to property, plant and equipment obsoleted
due to restructuring activities and $0.2 million of other costs.
As of December 31, 1998, $1.1 million had been paid and $0.4 million was
recorded as an accrued liability for remaining severance and other costs
related to the June and November restructurings. Relocation of the Concord
operation, and consolidation of facilities at the Fremont and San Diego
locations were complete as of December 31, 1998.
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 and 1998, the Company
incurred costs of approximately $1.6 million and $0.5 million, respectively,
in connection with development of spinstand technology which comprised the
purchased in-process research and development projects acquired in the SBM
acquisitions. In 1997, the Company incurred costs of approximately $1.0
million in connection with development of laser texturizer technology which
comprised the purchased in-process research and development project acquired
in the Kirell acquisition. The in-process research and development projects
acquired in connection with the ABI and Kirell acquisitions were completed in
1997 and the in-process research and development project acquired in
connection with the SBM acquisition was completed in 1998.
34
<PAGE>
Interest Expense
Interest expense increased from $8.4 million for 1996 to $11.6 million for
1997 and to $14.5 million for 1998. These increases primarily reflect the
increased debt levels outstanding and higher interest rates during the
respective periods.
Income Taxes
Income tax expense (benefit) was $(9.0) million for 1996, $(4.3) million for
1997 and $9.0 million for 1998.
For 1996 and 1997, the effective income tax rates differed from the
applicable statutory rates due primarily to state income taxes and utilization
of income tax credits available for research and development expenses. For
1998, the effective income tax rate differed from the applicable statutory
rate due primarily to the valuation allowance against the Company's entire
deferred tax asset balance. Such charge was taken due to uncertainty regarding
realization of the deferred tax asset due to the significant loss incurred in
1998 and uncertainty regarding future taxable income.
Extraordinary Items
Extraordinary loss, net of income taxes, was $1.3 million for 1998, and
consisted of the write-off of unamortized debt issuance costs in connection
with the January and August 1998 repayments of debt outstanding under the
Company's then-existing credit agreements.
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.
Cash Flow from Operating Activities
Cash flow from operating activities is computed based on net income (loss)
plus depreciation, amortization and write-downs of intangible 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 was $6.4 million for 1997 and
$12.0 million for 1998. Period to period fluctuations in operations impacting
these amounts were the net losses for 1997 and 1998, a decrease in
amortization and write downs of intangible assets, a decrease in deferred
income tax assets, a smaller increase period to period in accounts receivable,
a decrease in 1998 inventories compared to an increase in 1997 and increases
in 1998 income taxes receivable and accrued expenses compared to decreases in
1997.
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 write-downs 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.
EBITDA
EBITDA represents income (loss) from operations before depreciation and
amortization and write-downs of intangible assets. 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.
35
<PAGE>
The Company had EBITDA of $24.1 million for 1997 compared to $(40.3) million
for 1998. This decrease was primarily due to decreased net sales, lower gross
margins, the settlement charge and the restructuring charges, 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.
Liquidity and Capital Resources
The Company has financed its capital requirements through sales of Common
and Preferred Stock, and borrowings under the Notes and subordinated, term and
revolving credit facilities. The Company's principal sources of liquidity have
been cash flow from operations and borrowing. The Company's principal
requirements for cash are debt service requirements, capital expenditures and
working capital.
As of December 31, 1998, the Company's outstanding indebtedness included
$105.5 million under the Notes, $8.0 million under its Convertible
Subordinated Notes and $3.1 million of capital lease obligations. At December
31, 1998, the Company had $7.1 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. As of the date of this prospectus, the Company
does not have a working capital credit facility in place. See "Description of
Notes" and "Description of Indebtedness -- Convertible Subordinated Notes."
The Notes 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.
Cash provided by (used for) investing activities was $(17.2) million for
1997 and $10.2 million for 1998. In 1997, the amount consisted primarily of
cash used in connection with purchases of property and equipment. In 1998, the
amount consisted of proceeds from the sale of property, plant and equipment
partially offset by cash used in connection with purchases of property, plant
and equipment. Cash provided by financing activities was $23.9 million for
1997 and $23.5 million for 1998, and consisted primarily of revolving loan
activity in 1997, while 1998 included the net proceeds from issuance of the
Notes, net of repayment of borrowings under the Company's previous term notes
and revolving loans, as well as the issuance of the Series C Preferred Stock.
See "Description of Capital Stock--Series C Preferred Stock."
The Company plans approximately $1.3 million in capital expenditures during
the next 12 months. The Company has no material outstanding commitments with
respect to such planned expenditures as of the date of this filing.
The Non-Guarantor Subsidiaries have not guaranteed the Company's obligations
under the Notes. As of and for the years ended December 31, 1997 and 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 14 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 year ended December 31, 1998, were 6.7%, 0.5%, 11.1% and
0.0%, 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 exchange rate fluctuations.
36
<PAGE>
Based on currently available information, and subject to the success of the
Company's aggressive working capital and inventory management efforts, the
Company believes that its available cash and cash generated from operations
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, depending on the timing of any recovery in demand for the
Company's products, the Company 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. However, the Company continues to have limited
capital resources and significant future obligations, including the Company's
future principal and interest payments under the Notes. The existence of
certain restrictive covenants in the Indenture for the Notes may inhibit the
Company's ability to raise additional financing. There can be no assurance 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 -- We Have a Substantial Amount of Indebtedness"
and "Risk Factors -- We May Require Additional Capital to Fund Our
Operations."
37
<PAGE>
BUSINESS
The Company is a 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 (1)
media certifiers, burnishers, glide height testers and optical scanners which
are used in the production of thin-film disks (media), (2) servowriters used
in the production of disk drives and high capacity disk cartridges, (3) flying
height testers and quasi-static magnetoresistive ("MR") head testers used in
the production of read/write heads and (4) 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 at critical steps in 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 and disk
burnishers) 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: (1) the overall demand
for disk drives and disk drive components; (2) rapid advances in data storage
technology and (3) yield management challenges and margin pressure facing data
storage manufacturers.
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 and burnishers for removing bumps
from 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.
38
<PAGE>
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
incorporating numerous important new technologies, including (1) in 1993, the
first testing system capable of accurately measuring the flying height of a
read/write head below one microinch; (2) in 1995, the first disk (media)
certifier with integrated optical defect scanning and also the first certifier
with digital glide certification; (3) in 1996, the first family of quasi-
static MR head testers to address each stage of the manufacturing process for
the rapidly growing MR head market; and (4) in 1997, the first disk drive
servowriter to incorporate non-contact, laser positioning technology. The
Company currently holds 48 patents in the United States, with an additional 62
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 believes it will be able to leverage this installed base when a
turnaround in the data storage industry occurs 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
140 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
1998, the Company invested approximately $33.3 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 Malaysia. The
Company believes that 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 approximately
30 dedicated customer service and support engineers and technicians in 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.
39
<PAGE>
Experienced Management Team With Significant Ownership. The Company's
chairman and chief executive officer, John F. Schaefer 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. The Company's
directors and officers and their respective affiliates beneficially owned
approximately 89.4% of the Company's capital stock as of December 31, 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.
Strategy
The key elements of the Company's 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 marketing 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 an 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. 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 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
40
<PAGE>
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: (1) disk
(media) process and production-test equipment; (2) read/write head production-
test equipment; (3) disk drive process and production-test equipment; and (4)
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 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 six months of 1999.
Disk (Media) Process and Production-Test Equipment
<TABLE>
<CAPTION>
Product Introduction Date Applications
-------------------------- ----------------- ------------------------------
<C> <C> <S>
Media Certifiers
- -----------------------------------------------------------------------------
MG250 February 1995 Burnishing (removes bumps and
MC950 June 1997 particles from the surface
MG3500 October 1998 of a finished disk)
MG250APS January 1996
MG250EPS January 1998 Optical Scanning ("APS" and
MC950EPS September 1998 "EPS" Options optically scan
MSA950 September 1997 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
PS5100 June 1998 defects on disk substrates
and/or finished disks)
Media Balance Tester
- -----------------------------------------------------------------------------
MB1000 November 1996 Media Balancing (verifies that
disk substrates or finished
disks are in balance within
required specifications)
</TABLE>
41
<PAGE>
Head Production-Test Equipment
<TABLE>
<CAPTION>
Product Introduction Date Applications
------------------------ ----------------- --------------------------------
<C> <C> <S>
Quasi-static MR Head
Testers
- -----------------------------------------------------------------------------
MRH(HGA-level Tester) September 1995 Quasi-static MR Testing
MRW(Wafer-level Tester) September 1996 (conducts critical tests at the
MRS(Slider-level Tester) June 1997 wafer, bar, slider or HGA level
MRB(Bar-level Tester) September 1997 of MR head production, including
MRH-200 September 1998 resistance, amplitude, asymmetry
MRS-200 September 1998 and stability tests)
HGA Resonance Tester
- -----------------------------------------------------------------------------
HRT-1 June 1994 Mechanical Resonance Testing
HRT-2 April 1999 (tests HGA for mechanical
resonance characteristics within
required specifications)
Flying Height Testers
- -----------------------------------------------------------------------------
DFHT II September 1995 Flying Height Testing (measures
DFHT III January 1998 head to disk spacing ("flying
DFHT IV January 1999 height") under various dynamic
FH3000 June 1996 test conditions)
FH4000 September 1996
</TABLE>
Disk Drive Process and Production-Test Equipment
<TABLE>
<CAPTION>
Product Introduction Date Applications
------------ ----------------- --------------------------------------------
<C> <C> <S>
Servowriters
- -----------------------------------------------------------------------------
HS5100 March 1997 Servowriting Drives (establishes reference
HS6100 September 1997 tracks on hard disk drives to provide
HS7000 September 1997 track/head position information essential to
HS7500 September 1998 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)
</TABLE>
Production Automation Equipment
<TABLE>
<CAPTION>
Product Introduction Date Applications
--------------------------- ----------------- -------------------------------
<C> <C> <S>
Automation
- -------------------------------------------------------------------------------
Media Certifier Workcell August 1995 Production Media Handling
Optical Inspection Workcell October 1997 (provides automated handling of
Distributed Automation November 1998 disks with certifiers, and
sorts disks into grades
according to test results)
</TABLE>
42
<PAGE>
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 405 million disks
produced worldwide in 1998. 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: (1) burnishing -- removing bumps and
particles from the surface of a finished disk; (2) optical scanning --
optically scanning the surface of a finished disk for defects that could
damage the glide head; (3) glide certification -- verifying that the surface
of a finished disk does not have protrusions in excess of certain specified
limits; and (4) 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 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.
MG3500, MG250 and MG250EPS Media Certifiers. The MG 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 MG certifier incorporates the following functions: burnishing,
optical scanning (optional), glide testing, and certifying finished disks. The
MG3500 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 100 MHz with low-glide technology to accommodate high areal
density media. The MG3500 features a user-friendly interface, a fully
programmable analog channel, and automatic internal calibration algorithm. The
MG3500 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.
PS5100 Disk Inspection System. The PS5100 is an optical scanning system that
scans for defects on disk substrates and/or finished disks. The PS5100 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 PS5100 has industry leading submicron-level defect
detection capability and features a spiral scanning technique for high
throughput.
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, provides rapid pass/fail testing
for adjustable balance criteria. Testing may be performed at both substrate as
well as finished disk levels.
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<PAGE>
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 776 million HGAs (head
gimbal assemblies) were shipped in 1998, 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 growing market by providing the following head
production-test equipment: (1) flying height testers -- which measure head
flying heights under various dynamic test conditions; (2) quasi-static MR
testers -- which conduct critical tests at the wafer, bar, slider or HGA level
of MR head production, including resistance, amplitude, asymmetry and
stability tests; and (3) 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.
Quasi-static MR and MR-200 Series Head Testers. The Company's quasi-static
MR 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 new
product 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, quasi-static MR 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 IV and FH3000 Flying Height Testers. The DFHT IV 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 IV 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 DFHT IV 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.
FH4000 Flying Height Tester. The FH4000 flying height tester utilizes the
same technology as the DFHT IV 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.
44
<PAGE>
Disk Drive Process and Production-Test Equipment
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 disk 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 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 growing segment of the data storage market.
HS7000 and HS7500 Servowriters. 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.
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 MG3500 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 MG3500
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.
45
<PAGE>
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>
Fuji Photo Film HMT Technology Corporation Applied Magnetics Corporation HMT Technology
Company, Ltd. HOYA Corporation DAS Devices Corporation
Iomega Corporation Komag, Incorporated Fujitsu Limited HOYA Corporation
Sony Corporation MaxMedia Division, Headway Seagate Technology, Inc.
NEC Corporation Hyundai Electronics America International Business Trace Storage Technology
Samsung Electronics Seagate Technology, Inc. Machines Corporation USA Corporation
Company, Ltd. Trace Storage Technology Mitsumi Electronic Co., Ltd. Western Digital Corporation
USA Corporation Quantum Corporation
Western Digital Corporation Read-Rite Corporation
SAE Magnetics (H.K.) Ltd.
</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 45.0%, 51.0% and 50.0% of the Company's net sales in 1996, 1997
and 1998, respectively, were derived from sales to its 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, Komag, HMT and Trace have
historically accounted for a significant portion of its net sales. For 1996,
1997 and 1998, Seagate accounted for 19.0%, 18.0% and 17.1%, respectively, of
net sales; Komag accounted for 14.5%, 15.9% and 4.8%, respectively, of net
sales; HMT accounted for 5.2%, 17.1% and 16.3%, respectively, of net sales;
and Trace accounted for 11.5%, 4.4% and 1.2%, respectively, of net sales. For
1998, Western Digital Corporation accounted for 16.6% of net sales. If net
sales to these or any of its other significant customers were to decrease in
any material amount in the future, the Company's business, operating results
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 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 any of 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, operating results 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, operating results and
financial condition.
46
<PAGE>
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 1996, 1997 and 1998, the Company's export sales to unaffiliated customers
constituted approximately 57.0%, 49.0% and 49.0%, 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, Southeast Asia, China and South Korea, the Company
sells its products directly through its wholly-owned subsidiaries. The Company
expects that export sales will continue to represent a significant portion of
its net sales in the foreseeable future. See "Risk Factors -- Our
International Operations are Subject to Inherent Risks."
Customer Service and Support
As of February 28, 1999, the Company had a world-wide customer service and
support staff of 54 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
and Thailand.
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 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 $4.6 million as of February 28, 1999. 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 Zyratex, General Disk and Hitachi
DECO for servowriters; Hitachi DECO and Sony Techtronics for disk certifiers;
Integral Solutions International for quasi-static MR head testers; Koyo
Precision Instruments, Inc. and Zygo Corporation for flying height testers
47
<PAGE>
and Technistar for automation technology. 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 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 (1) identify
emerging data storage technology trends early in the development process, (2)
identify and develop new core technologies for the Company's systems and (3)
contribute to the
48
<PAGE>
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, 1999 the Company employed a total
of approximately 140 degreed engineers focused on product development and
research. Research and development expenses were approximately $31.1 million,
$43.6 million and $33.3 million for 1996, 1997 and 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 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 Company's ability to quickly increase its
manufacturing capacity could be limited given (1) the complexity of the
manufacturing process, especially if the Company is partially customizing its
products to its customers' specifications; (2) the lengthy lead times
necessary to obtain critical components and (3) 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 48 United States patents and has applied for 62
additional patents in the United States. The Company also holds a number of
foreign patents and has filed a number of foreign patent
49
<PAGE>
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, operating
results and financial condition.
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, operating results and
financial condition.
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.
Employees
As of February 28, 1999, the Company had 397 full-time employees, including
141 in product development and research, 123 in manufacturing, 29 in sales and
marketing, 54 in service and support, and 50 in finance, information systems
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 leases buildings with a total of approximately 41,000 square
feet in San Diego, California under a lease expiring in December, 2001; three
buildings with a total of 175,000 square feet under leases expiring in
November and December 2000 and August 2003 in Fremont, California; one
building with a total of 16,000 square feet under a lease expiring in May 1999
in Concord, California; and 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 except Concord (research and
development only), 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 and San Diego facilities. For its
Pacific Rim operations, the Company
50
<PAGE>
also leases 1,900 square feet in Tokyo, Japan; 2,700 square feet in AnSen
City, South Korea; 5,000 square feet in Singapore; 800 square feet in Thailand
and 500 square feet in Malaysia. 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
On May 4, 1998, the Company filed suit against Vlad Pogrebinsky, Igor
Iosilevsky, Thomas Tucker, Jonathan Nguyen and Magnetic Recording Solutions,
Inc. alleging misappropriation of trade secrets, breach of contract, copyright
infringement, interference with prospective advantage and unfair competition.
(Phase Metrics, Inc. v. Magnetic Recording Solutions et. al.) The case was
filed in the U.S. District Court in the Northern District of California. The
individual defendants are former employees of the Company. Among other things,
the Company seeks damages and injunctive relief for the misappropriation and
use of its trade secrets and confidential information and for unauthorized
copying and use of its copyrighted computer software. On July 29, 1998, the
defendants in the case filed counterclaims against the Company and its
president and chief executive officer alleging intentional and negligent
interference with contractual relations, intentional and negligent
interference with prospective business advantage, trade libel, slander per se,
intentional and negligent infliction of emotional distress, unfair
competition, attempted monopolization, monopolization, and unfair practices in
violation of California Business and Professions Code Section 17000, et. seq.
The counterclaim seeks injunctive relief and damages in an unspecified amount.
The court has stayed the claims in the counterclaim which allege antitrust
violations, in response to a motion to bifurcate and stay brought by the
Company. The Company believes it has valid defenses to the counterclaims
brought by the defendants in this case and intends to vigorously defend such
counterclaims.
On March 16, 1999, the court granted the Company's motion for a preliminary
injunction and enjoined the defendants from further marketing or selling the
infringing products and any derivative products thereof and from continuing to
use the Company's copyrighted and trade secret technology. On March 22, 1999,
the court held a hearing regarding the precise terms of the injunction and the
appropriate level of a bond.
The Company is also subject to various other legal matters in the normal
course of its business. While the results of litigation and claims cannot be
predicted with certainty, the Company believes that the final outcome of these
other matters will not have a material adverse effect on its business,
operating results or financial condition.
51
<PAGE>
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, 1999.
<TABLE>
<CAPTION>
Name Age Position
<S> <C> <C>
John F. Schaefer............56 Chairman of the Board, President and Chief
Executive Officer
David L. Bultman............51 Executive Vice President, General Manager,
Disk Drive and Media Products
Wayne G. Erickson...........41 Vice President, Sales and Marketing, Head
Products and Vice President,
Corporate Business Development
Dr. Michael R. Madden.......56 Vice President, Operations, Head Products
Ronald Y. Miyahara..........49 Vice President and General Manager, Asia
Operations
Albertus H. Munnikhuis......47 Vice President, Sales and Marketing, Disk Drive
and Media Products
Dr. Jun Zhu.................32 Vice President, Head Product Development
Michael G. Rogowski.........45 Vice President, Operations, Disk Drive and
Media Products
Brad LaLuzerne..............38 Vice President, Finance, Chief Financial Officer
and Assistant Secretary
Arthur J. Cormier(1)........41 Director
Thompson Dean(1)(2).........40 Director
Robert Finzi(1)(2)..........45 Director
Dr. Gilbert F. Amelio(1)....55 Director
William E. Terry(2).........65 Director
Andrew T. Sheehan...........40 Director
</TABLE>
- --------
(1) Member of Audit Committee
(2) 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, General Manager, 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, Engineering at DKI. Prior to
joining DKI, Mr. Bultman was Vice President, Engineering at Ministor
Peripherals.
52
<PAGE>
Wayne G. Erickson became Vice President, Sales and Marketing, Head Products
and Vice President, Corporate Business Development 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.
Dr. Michael R. Madden has been Vice President, Operations, Head Products
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 1986 to 1994.
Brad LaLuzerne became Vice President, Finance and Chief Financial Officer in
June 1998. Prior to that, Mr. LaLuzerne held the Controller and other
positions in the Fremont operation from March 1996 to June 1998. Between June
1984 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, Operations, Disk Drive and
Media Products since June 1998 and was Vice President of Customer Engineering
from November 1994 to June 1998. 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 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.
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 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.
53
<PAGE>
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 of the Company 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.
Andrew T. Sheehan has been a Director of the Company since August 1998. Mr.
Sheehan joined ABS Capital Partners II, L.P. ("ABS") in April 1998 as a
General Partner. Prior to joining ABS, Mr. Sheehan was a Managing Director in
the technology group of BT Alex. Brown and the co-head of West Coast
investment banking in San Francisco. Mr. Sheehan joined Alex. Brown in 1985.
Mr. Sheehan holds board membership on other privately held companies.
The Board of Directors has a 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 Messrs. Dean, Finzi and Terry. None of these individuals were at
any time during 1998 an officer or employee of the Company.
The Board of Directors also has an 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 Messrs.
Cormier, Dean, Finzi, Terry 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
54
<PAGE>
common stock under the 1995 Option Plan at an exercise price of $8.75 per
share when he joined the Board in August 1997. In 1998, Mr. Terry was granted
an option to purchase an additional 50,000 shares of common stock at an
exercise price of $3.75 per share. 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, 1999, Dr. Amelio had vested in
73,333 option shares and Mr. Terry had vested in 15,833 option shares. Dr.
Amelio and Mr. Terry will vest in their remaining option shares, as long as
they remain members 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 when 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.
Executive Compensation
The following table sets forth certain summary information concerning the
compensation earned in 1997 and 1998 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 1998 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 1998 has resigned or otherwise terminated
employment during 1998.
<TABLE>
<CAPTION>
Long Term
Compensation
Awards
------------
Annual Compensation Securities
Name and ------------------------------ Underlying All Other
Principal Position(s) Year Salary Bonus Other(1) Options Compensation(2)
<S> <C> <C> <C> <C> <C> <C>
John F. Schaefer........ 1997 $325,000 $105,000 $ -- -- $6,658
Chairman and Chief
Executive Officer 1998 314,615 -- -- -- 5,000
David L. Bultman........ 1997 230,000 190,000 (3) 3,256 -- 2,569
Vice President, General
Manager, Product
Development 1998 250,962 201,708 3,818 3,358
Disk Drive and Media
Products
Wayne G. Erickson....... 1997 -- -- -- -- --
Vice President, Sales
and Marketing 1998 207,692 11,200 1,921 -- 2,762
Head Products and Vice
President,
Corporate Business
Development
Albert H. Munnikhuis.... 1997 -- -- -- -- --
Vice President, Sales
and Marketing 1998 166,346 39,545 6,900 -- 4,003
Disk Drive and Media
Products
Neil A. Brumberger(4)... 1997 200,000 75,000 2,483 -- 4,904
Vice President and
President, Phase 1998 153,287 75,000 1,177 -- 4,115
Metrics Automation
</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.
(4) The Company reached an agreement for the termination of Mr. Brumberger's
full-time employment with the Company effective July 1998.
55
<PAGE>
Stock Options and Stock Appreciation Rights
The following table contains information concerning the stock options
granted during 1997 and 1998 to the Named Executive Officers. 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
or 1998.
<TABLE>
<CAPTION>
Individual Grants(1)
---------------------------------------------------------
Potential
Realization Value
Market at Assumed Annual
Price of Rates of Stock
Number of Percent Securities Price
Securities of Total Exercise Underlying Appreciation For
Underlying Options Granted Price Options on Option Term(3)
Options to Employees in Per Date of Expiration -----------------
Name Year Granted 1997 and 1998 Share(2) Grant(2) Date 5% 10%
---- ---- ---------- --------------- -------- ---------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
John F.
Schaefer....... 1997 -- -- -- -- -- -- --
1998 -- -- -- -- -- -- --
David L.
Bultman........ 1997 25,000 2.3% $8.75 $8.75 8/01/07 $137,571 $348,631
1998 125,000 10.6 3.75 3.75 7/30/08 294,794 747,067
Wayne G.
Erikson........ 1997 -- -- -- -- -- -- --
1998 -- -- -- -- -- -- --
Albert H.
Munnikhuis..... 1997 -- -- -- -- -- -- --
1998 40,000 3.4 3.75 3.75 7/30/08 94,334 239,061
Neil A.
Brumberger(4).. 1997 -- -- -- -- -- -- --
1998 -- -- -- -- -- -- --
</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, 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.
(4) The Company reached an agreement for the termination of Mr. Brumberger's
full-time employment with the Company effective July 1998.
56
<PAGE>
Aggregate Option Exercises in 1997 and 1998 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 1998
and unexercised options held by them at the end of each of those fiscal years.
None of the Named Executive Officers exercised any options during 1997 or
1998.
<TABLE>
<CAPTION>
Value of Unexercised In-the
Number of Unexercised Options Money Options at
at December 31, 1997 and 1998(#) December 31, 1997 and 1998($)(1)
---------------------------------------- ----------------------------------------
Name Year Exercisable(2) Unexercisable Exercisable(2) Unexercisable
---- ---- ---------------- ------------------ ---------------- ------------------
<S> <C> <C> <C> <C> <C>
John F. Schaefer........ 1997 -- -- -- --
1998
David L. Bultman........ 1997 125,000(2) -- -- --
1998 250,000 -- --
Wayne G. Erikson........ 1997 -- -- -- --
1998 -- -- -- --
Albert H. Munnikhuis.... 1997 -- -- -- --
1998 60,000(3) -- $55,000(3) --
Neil A. Brumberger(4)... 1997 -- -- -- --
1998 -- -- -- --
</TABLE>
- --------
(1) Based upon the fair market values of $8.75 and $3.75 per share determined
by the Board of Directors at December 31, 1997 and 1998, respectively,
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 28,333 and 54,118 options
had vested as of December 31, 1997 and 1998, respectively. 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 13,333 options had vested
as of December 31, 1998. The option shares issuable upon exercise of such
options are, prior to vesting, subject to a right of repurchase in favor
of the Company.
(4) The Company reached an agreement for the termination of Mr. Brumberger's
full-time employment with the Company effective July 1998.
Compensation Committee Interlocks and Insider Participation
The members of the Compensation Committee are Messrs. Dean, Finzi and Terry,
none of whom has been an officer or employee of the Company at any time since
the Company's inception. 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. Prior to the formation of the
Compensation Committee, the Board of Directors as a whole made decisions
relating to compensation of the Company's executive officers.
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 1996, 1997
and 1998, 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 Original Note Offering and received an underwriting
discount of $3.575 million in connection therewith. See "Principal
Stockholders" and "Certain Transactions."
57
<PAGE>
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 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 $300,000. 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 for any reason 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
Company reached an agreement for the termination of Mr. Brumberger's full-time
employment with the Company, effective July 1998.
In connection with any change of control of the Company, subject to certain
limitations, outstanding options held by Mr. Bultman (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 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 Option 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
58
<PAGE>
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 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 December 31, 1998, options to purchase up to 2,404,009 shares of
common stock were outstanding under the 1995 Plan, options for 1,468,309
shares had been exercised, net of repurchases, and 2,527,682 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 a 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.
59
<PAGE>
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 F. Schaefer. In connection with the Recapitalization, the Company also
(1) entered into a Securityholders Agreement with DLJ and the Sprout Entities,
Mr. Cormier and Mr. Schaefer (the "Securityholders Agreement"), (2) exchanged
its existing capital stock for shares of its Series A and B Preferred Stock,
(3) issued and sold shares of its Common Stock and (4) 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 3,238,400 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 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.
Series C Preferred Stock Financing
In August and September 1998, the Company issued and sold an aggregate of
7,610,000 shares of its Series C Preferred Stock for $4.00 per share to a
group of investors, which included a number of its current
60
<PAGE>
stockholders and two members of the Company's Board of Directors. The Company
received aggregate proceeds of approximately $30.4 million in connection with
the Series C Financing. Immediately following the consummation of the Series C
Financing, the Company used $7.1 million of the net proceeds therefrom to
repay the indebtedness and accrued interest outstanding under the New Credit
Facility. See "Description of Capital Stock -- Series C Preferred Stock."
Securityholders Agreement
The Amended and Restated Securityholders Agreement (the "Securityholders
Agreement") provides that each of Messrs. Schaefer and Cormier, DLJMBP, Sprout
II and ABS, 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 sixth director and DLJ
and the Sprout Entities shall have the right to designate the seventh director
to the Company's Board. The Securityholders Agreement also contains 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 stockholders 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 was 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, 1997 and 1998, 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 Original 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
under the Former Credit Facility in December 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.
61
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information with respect to the
beneficial ownership of the Company's capital stock as of December 31, 1998,
by (1) each person (or group of affiliated persons) known by the Company to
beneficially own more than five percent of Phase Metrics' common stock, (2)
each of the Company's directors, (3) each of the Named Executive Officers and
(4) 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>
Common Series A Series B Series C
Stock(2) Preferred(3) Preferred(4) Preferred(5) Total(6)
----------------- ----------------- ----------------- ----------------- ------------------
Beneficial Owner(1) Number Percent Number Percent Number Percent Number Percent Number Percent
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
DLJ and the Sprout
Entities (7)........... 5,942,720 51.4% 2,000,000 24.2% 3,857,280 100.0% 2,500,000 32.9% 14,300,000 36.1%
Arthur J. Cormier (8)... -- -- 4,500,000 54.5 -- -- -- -- 4,500,000 13.4
John F. Schaefer (9).... 2,750,000 48.9 1,750,000 21.2 -- -- -- -- 4,500,000 13.4
ABS Capital Partners II,
L.P.(10)............... -- -- -- -- 5,000,000 65.7 3,750,000 14.8
Neil A. Brumberger(11).. 450,000 7.3 -- -- -- -- -- -- 450,000 1.2
Wayne G. Erickson(12)... 300,000 5.3 -- -- -- -- -- -- 300,000 *
David L. Bultman(13).... 250,000 4.3 -- -- -- -- -- -- 250,000 *
Dr. Gilbert F.
Amelio(14)............. 100,000 1.7 -- -- -- -- 100,000 1.3 200,000 *
William E. Terry(15).... 100,000 1.7 -- -- -- -- 10,000 * 60,000 *
Albert H.
Munnikhuis(16)......... 90,000 1.6 -- -- -- -- -- -- 30,000 *
Thompson Dean(7)........ -- -- -- -- -- -- -- -- -- --
Robert Finzi(7)......... -- -- -- -- -- -- -- -- -- --
Andrew T. Sheehan(10)... -- -- -- -- -- -- -- -- -- --
All directors and
executive officers as a
group (12 persons)
(17)................... 4,060,000 63.2 6,250,000 75.8 -- -- 110,000 1.4 10,420,000 30.2
</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 December
31, 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 5,622,309 shares of common stock outstanding as of
December 31, 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 one share 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 one share of common stock. See "Description of Capital
Stock -- Series B Preferred Stock."
(5) The number of shares reflects the number of shares of common stock in the
aggregate issuable upon the conversion of the Series C Preferred Stock
held by each person. Each share of Series C Preferred Stock is
convertible into one share of common stock. See "Description of Capital
Stock -- Series C Preferred Stock."
(6) 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 December
31, 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.
62
<PAGE>
(7) 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.
(8) Includes 130,000 shares held by Mr. Cormier's children and other
relatives for which Mr. Cormier maintains voting control.
(9) 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.
(10) Mr. Sheehan, as a General Partner of ABS, may be deemed to share voting
and investment power over such shares. Mr. Sheehan disclaims beneficial
interest in such shares, except to the extent of his interests in ABS.
The address of ABS is 101 California Street, 47th Floor, San Francisco,
California 94111.
(11) The Company reached an agreement for the termination of Mr. Brumberger's
full-time employment with the Company, effective July 1998. As of July
1998, Mr. Brumberger had exercised and vested in approximately 60,000
options.
(12) Includes 19,736 shares held in trust for Mr. Erickson's children for
which Mr. Erickson maintains voting control. Includes 45,000 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.
(13) Includes immediately exercisable options to purchase 250,000 shares.
Because of limitations under the federal tax laws for Incentive Stock
Options, only options to purchase 222,888 shares are currently
exercisable or exercisable within 60 days of December 31, 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 2003.
(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 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 annual and monthly installments ending in July 2003.
(16) Includes immediately exercisable options to purchase 60,000 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 annual and monthly installments ending in July 2003.
(17) See Footnotes 8, 9, 10, 11, 12, 13, 14, 15 and 16 above. Includes options
exercisable for 800,000 shares of common stock under the 1995 Plan of
which options to purchase 637,403 shares are currently exercisable or
exercisable within 60 days of December 31, 1998, because of limitations
under the Federal tax laws for Incentive Stock Options. Also includes
510,000 shares of common stock of which 82,167 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 and ABS. See Footnotes 7 and 10 above.
63
<PAGE>
DESCRIPTION OF INDEBTEDNESS
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 (1) 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;
(2) voluntarily liquidate, dissolve or wind up the Company or any of its
subsidiaries; (3) voluntarily convey, exchange or transfer all or
substantially all of the Company's assets; (4) other than indebtedness
outstanding under the 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, (5) pay dividends or make distributions on capital stock of the
Company and its subsidiaries and (6) except as required under the terms of the
Indenture related to the 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, (1) a default continuing in payment of all or any part of the
principal or interest payable thereunder when due; (2) 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 (3) 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 Notes.
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.
64
<PAGE>
DESCRIPTION OF NOTES
General
The Notes are issued pursuant to the Indenture dated as of January 30, 1998,
among the Company, Subsidiary Guarantors and State Street Bank and Trust
Company of California, N.A., as trustee (the "Trustee"). The terms of the
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 Notes are subject to all such terms, and Holders
of Notes are referred to the Indenture and the Trust Indenture Act for a
statement thereof. 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 Notes are general unsecured obligations of the Company and rank pari
passu in right of payment with all current and future unsecured senior
Indebtedness of the Company. The Company's obligations under the Notes are
fully and unconditionally guaranteed on an unsecured senior basis by, and are
joint and several obligations of, the Subsidiary Guarantors. See "-- Note
Guarantees." As of September 30, 1998, the Notes and the Note Guarantees were
effectively subordinated to approximately $2.6 million of secured obligations
of the Company and the Subsidiary Guarantors. The Indenture permits the
incurrence of additional secured Indebtedness in the future. A copy of the
Indenture has been filed as an exhibit to the Registration Statement (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 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 were 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 Notes are limited in aggregate principal amount to $110.0 million
($107.0 million previously sold and $3.0 million hereunder) and will mature on
February 1, 2005. Interest on the Notes accrues at the rate of 10 3/4% per
annum and is 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 Notes accrues
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 is 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 Notes is 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 Notes at their respective addresses set forth in the register of Holders
of Notes; provided that all payments of principal, premium and Liquidated
Damages, if any, and interest with respect to Notes the Holders of which have
given wire transfer instructions to the Company are required to be made by
wire transfer of immediately available funds to the accounts specified by the
Holders thereof. Until otherwise designated by the Company, the Company's
office or agency in New York is the office of the Trustee maintained for such
purpose. The Notes are issued in denominations of $1,000 and integral
multiples thereof.
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Note Guarantees
The Company's payment obligations under the Notes are fully and
unconditionally guaranteed by the Subsidiary Guarantors on a joint and several
basis. The Note Guarantees are general unsecured obligations of the Subsidiary
Guarantors, 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 Note Guarantee are
limited so as not to constitute a fraudulent conveyance under applicable law.
The Indenture provides 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, (1) 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 Notes and the
Indenture; (2) immediately after giving effect to such transaction, no Default
or Event of Default exists; (3) 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 (4) 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 (1), (3) and (4) 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 provides that (1) 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 (2) 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 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.
Optional Redemption
The Notes are not redeemable at the Company's option prior to February 1,
2002. Thereafter, the Notes are 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>
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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
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
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 Notes are to be redeemed at any time, selection of
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 Notes are listed, or, if the 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 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 Notes to be redeemed
at its registered address. Notices of redemption may not be conditional. If
any Note is to be redeemed in part only, the notice of redemption that relates
to such 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 Note. Any Notes called for redemption become due on the date
fixed for redemption. On and after the redemption date, interest ceases to
accrue on the 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 Notes.
Repurchase at the Option of Holders
Change of Control
Upon the occurrence of a Change of Control, each Holder of Notes has 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 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 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 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 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 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 Notes or
portions thereof so tendered and (3) deliver or cause to be delivered to the
Trustee the Notes so accepted together with an Officers' Certificate stating
the aggregate principal amount of Notes or portions thereof being purchased by
the Company. The Paying Agent will promptly mail to each Holder of Notes so
tendered the Change of Control Payment for such 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 Notes surrendered, if any; provided, that each such new note will be in a
principal amount of $1,000 or an integral multiple thereof.
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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 Notes to require that the
Company repurchase or redeem the 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 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 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 (1) 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 (2) 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 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.
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 Notes if the Notes are then redeemable or, if
the 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
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
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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 Notes (an "Asset Sale Offer") to purchase the maximum
principal amount of 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 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 Notes surrendered by Holders thereof exceeds the
amount of Excess Proceeds, the Trustee shall select the 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 regulations thereunder to
the extent such laws and regulations are applicable in connection with the
repurchase of the Notes as a result of an Asset Sale Offer.
Certain Covenants
Restricted Payments
The Indenture provides 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: (1) 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); (2) 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; (3) 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 Notes,
except scheduled payments of interest or principal at Stated Maturity of such
Indebtedness or (4) make any Restricted Investment (all such payments and
other actions set forth in clauses (1) through (4) 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
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 (2) of the next succeeding paragraph), is less than the sum of (1)
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
(2) 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
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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 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 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 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.
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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"):
(1) 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;
(2) the incurrence by the Company and its Restricted Subsidiaries of the
Existing Indebtedness;
(3) the incurrence by the Company and the Subsidiary Guarantors of
Indebtedness represented by the Notes and the Note Guarantees,
respectively;
(4) 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 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;
(5) 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 (5), does
not exceed $5.0 million;
(6) 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;
(7) 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
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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 (7);
(8) 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;
(9) 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;
(10) 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;
(11) 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;
(12) 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 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;
(13) 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;
(14) 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 (14) 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
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(15) 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 (15), 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 (1) through (15) 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
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
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substantially all of its properties or assets in one or more related
transactions, to another Person unless (1) 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; (2) 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; (3) immediately after such
transaction no Default or Event of Default exists; (4) 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 (5) each
Subsidiary Guarantor, unless it is the other party to the transactions
described above, shall have by supplemental indenture confirmed that its Note
Guarantee shall apply to such Person's obligations under the Indenture and the
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 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 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 (1) 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
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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 (2) 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 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 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 (1) 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 to any
Restricted Subsidiary that is neither a Subsidiary Guarantor nor a Foreign
Subsidiary, (2) 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 (3) 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, (a) cause such transferee, acquired Restricted
Subsidiary or Restricted Subsidiary incurring Acquired Debt (if not then a
Subsidiary Guarantor) to execute a Note Guarantee of the Obligations of the
Company under the Notes in the form set forth in the Indenture and (b) deliver
to the Trustee an Opinion of Counsel, in form reasonably satisfactory to the
Trustee, that such 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 Securities and Exchange Commission (the "SEC" or
"Commission"), so long as any Notes are outstanding, the Company
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will furnish to the Holders of Notes (1) 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 (2) 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 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: (1) default for 30 days in the payment when due of interest on, or
Liquidated Damages, if any, with respect to, the Notes; (2) default in payment
when due of the principal of or premium, if any, on the Notes; (3) 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"; (4) failure by the Company for 30 days
after notice from the Trustee or at least 25% in principal amount of the Notes
then outstanding to comply with the provisions described under the captions
"-- Restricted Payments" or "-- Incurrence of Indebtedness and Issuance of
Preferred Stock"; (5) failure by the Company for 60 days after notice from the
Trustee or at least 25% in principal amount of the Notes then outstanding to
comply with any of its other agreements in the Indenture or the Notes; (6)
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 been so accelerated, aggregates $5.0 million or more; (7) 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 (8) 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 Notes may declare
all the 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 Notes will become due and payable without further
action or notice. Holders of the Notes may not enforce the Indenture or the
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 Notes may direct the Trustee in its
exercise of any trust or power. The Trustee may withhold from Holders of the
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 Notes pursuant to the
optional redemption provisions of the Indenture, an equivalent premium shall
also become and be immediately due and payable to
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the extent permitted by law upon the acceleration of the 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 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 Notes.
The Holders of a majority in aggregate principal amount of the Notes then
outstanding by notice to the Trustee may on behalf of the Holders of all of
the 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 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 Notes, the
Indenture, the Note Guarantees or for any claim based on, in respect of, or by
reason of, such obligations or their creation. Each Holder of Notes, by
accepting a Note, waives and releases all such liability. The waiver and
release are part of the consideration for issuance of the 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 Notes and all
obligations of the Subsidiary Guarantors under the Note Guarantees ("Legal
Defeasance") except for (1) the rights of Holders of outstanding Notes to
receive payments in respect of the principal of, premium and Liquidated
Damages, if any, and interest on such Notes when such payments are due from
the trust referred to below, (2) the Company's obligations with respect to the
Notes concerning issuing temporary Notes, registration of Notes, mutilated,
destroyed, lost or stolen Notes and the maintenance of an office or agency for
payment and money for security payments held in trust, (3) the rights, powers,
trusts, duties and immunities of the Trustee, and the Company's obligations in
connection therewith and (4) 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 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 Notes.
In order to exercise either Legal Defeasance or Covenant Defeasance, (1) the
Company must irrevocably deposit with the Trustee, in trust, for the benefit
of the Holders of the 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 Notes on the stated maturity or on the
applicable redemption date, as the case may be, and the Company must specify
whether the Notes are being defeased to maturity or to a particular redemption
date; (2) 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
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effect that, and based thereon such opinion of counsel shall confirm that, the
Holders of the outstanding 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; (3) 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 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; (4) 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; (5) 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; (6) 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; (7) 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 Notes over the other
creditors of the Company with the intent of defeating, hindering, delaying or
defrauding creditors of the Company or others and (8) 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 the 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 Note selected for redemption. Also, the Company is not required
to transfer or exchange any Note for a period of 15 days before a selection of
Notes to be redeemed.
The registered Holder of a Note will be treated as the owner of it for all
purposes.
Amendment, Supplement and Waiver
Except as provided in the next two succeeding paragraphs, the Indenture, the
Notes or the Note Guarantees may be amended or supplemented with the consent
of the Holders of at least a majority in principal amount of the Notes then
outstanding (including, without limitation, consents obtained in connection
with a purchase of, or tender offer or exchange offer for, Notes), and any
existing default or compliance with any provision of the Indenture, the Notes
or the Note Guarantees may be waived with the consent of the Holders of a
majority in principal amount of the then outstanding Notes (including consents
obtained in connection with a tender offer or exchange offer for Notes).
Without the consent of each Holder affected, an amendment or waiver may not
(with respect to any Notes held by a non-consenting Holder): (1) reduce the
principal amount of Notes whose Holders must consent to an amendment,
supplement or waiver, (2) reduce the principal of or change the fixed maturity
of any Note or alter the provisions with respect to the redemption of the
Notes (other than provisions relating to the covenants described above under
the caption "-- Repurchase at the Option of Holders"); (3) reduce the rate of
or change the time for payment of interest on any Note; (4) waive a Default or
Event of Default in the payment of principal of or premium or Liquidated
Damages, if any, or interest on the Notes (except a rescission of acceleration
of the Notes by the Holders of at least a majority in aggregate principal
amount of the Notes and a waiver of the payment default that resulted from
such acceleration); (5) make any Note payable in money other than that stated
in the Notes; (6) make any change in the provisions of the Indenture relating
to waivers of past Defaults or the
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rights of Holders of Notes to receive payments of principal of or premium, if
any, or interest on the Notes; (7) waive a redemption payment with respect to
any Note (other than a payment required by one of the covenants described
above under the caption "-- Repurchase at the Option of Holders") or (8) make
any change in the foregoing amendment and waiver provisions.
Notwithstanding the foregoing, without the consent of any Holder of Notes,
the Company, the Subsidiary Guarantors and the Trustee may amend or supplement
the Indenture, the Notes or the Note Guarantees to cure any ambiguity, defect
or inconsistency, to provide for uncertificated Notes in addition to or in
place of certificated Notes, to provide for the assumption of the Company's
and the Subsidiary Guarantors' obligations to Holders of 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 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 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 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 Notes, unless such Holder shall have
offered to the Trustee security and indemnity satisfactory to it against any
loss, liability or expense.
Additional Information
Anyone who receives this prospectus may obtain a copy of the Indenture
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 Notes held by QIBs initially are in the form of one or more registered
global notes without interest coupons (collectively, the "U.S. Global Notes").
The U.S. Global Notes have been 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 Notes that were
offered and sold in offshore transactions in reliance on Regulation S, if any,
are 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."
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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 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 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 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
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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 Notes registered in their names, will not receive physical delivery
of 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 Notes are registered
(including 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 is
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
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 Notes are governed by standing instructions and
customary practices between them and are not 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 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 Notes for all purposes.
The Global Notes trade in DTC's Same-Day Funds Settlement System and,
therefore, transfers between Direct Participants in DTC are effected in
accordance with DTC's procedures, and are settled in immediately available
funds. Transfers between Indirect Participants (other than Indirect
Participants who hold an interest in the Notes through Euroclear or Cedel
Bank) who hold an interest through a Direct Participant are effected in
accordance with the procedures of such Direct Participant but generally settle
in immediately available funds. Transfers between and among Indirect
Participants who hold interests in the Notes through Euroclear and Cedel Bank
are effected in the ordinary way in accordance with their respective rules and
operating procedures.
Subject to compliance with the transfer restrictions applicable to the Notes
described herein, cross-market transfers between Direct Participants in DTC,
on the one hand, and Indirect Participants who hold interests in the Notes
through Euroclear or Cedel Bank, on the other hand, are 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 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.
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Because of time zone differences, the securities accounts of an Indirect
Participant who holds an interest in the 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 do 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 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 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 Notes, DTC
reserves the right to exchange Global Notes (without the direction of one or
more of its Direct Participants) for Notes in certificated form, and to
distribute such certificated forms of 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 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 (1) any individual resident in the United States, (2)
any partnership or corporation organized or incorporated under the laws of the
United States, (3) 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
executor or administrator is a non-U.S. Person who has sole or shared
investment discretion with respect to its assets), (4) 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), (5) any agency or branch of a foreign entity
located in the United States, (6) 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, (7) 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), or (8)
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.
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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 Notes in registered,
certificated form without interest coupons ("Certificated Notes") if (1) 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, (2) the Company, at its option, notifies
the Trustee in writing that it elects to cause the issuance of Certificated
Notes or (3) 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 Related Notes.
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 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 requires that payments in respect of the Notes represented by
the Global Notes (including principal, premium, if any, interest and
Liquidated Damages, if any) be made by wire transfer of immediately
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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.
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, (1)
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 (2) 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 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 (1) 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 (2) 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 (1) or (2), 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.
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"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 consolidation) 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
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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 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
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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 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.
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"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 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).
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"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 (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 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 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.
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"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 (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 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 Notes on
terms at least as favorable to the Holders of Notes as those
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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.
"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 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
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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.
"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 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.
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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 Notes by the original holders of the 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.
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 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 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
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 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
Stated Interest. Stated interest on a Note is 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 Notes
will not be considered to be issued with original issue discount for federal
income tax purposes.
Bond Premium on the Notes. If a United States Holder of a 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
(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 is 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 rather than as a separate deduction
item.
Market Discount on the Notes. The tax consequences of a disposition of the
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) at a market discount which equals or exceeds
1% of the stated redemption price of the Notes at maturity multiplied by the
number of remaining complete years to maturity and
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thereafter recognizes gain upon a disposition (or makes a gift) of the 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 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 Notes may elect to include any market discount in
income currently rather than upon disposition of the 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 Note who acquired a Note at a market discount
generally is required to defer the deduction of a portion of the interest on
any indebtedness incurred or maintained to purchase or carry such Note until
the market discount is recognized upon a subsequent disposition of the 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 Notes. Upon the sale, exchange,
redemption, retirement, maturity or other disposition of a 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 Note. Gain or loss
recognized on the disposition of a 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 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
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 Note will be subject to backup withholding at the rate of 31% with
respect to interest, principal and premium, if any, paid on a 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
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
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
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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 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 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 Notes is exempt from withholding of
United States federal income tax under clause (a) of the rules described under
"Stated Interest," the 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 Notes and the IRS the amount of any
interest paid on the 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
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 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 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
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.
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PLAN OF DISTRIBUTION
This prospectus has been prepared for use by the selling noteholder in
connection with sales of Notes held by the selling noteholder and not tendered
in the Exchange Offer. It is expected that all or a substantial portion of the
Notes offered hereby may be sold by the selling noteholder to purchasers in
one or more transactions. The selling noteholder may effect such transactions
by selling the Notes offered hereby to or through dealers, and such dealers
may receive compensation in the form of discounts, concessions or commissions
from the selling noteholder and/or the purchasers of such Notes for whom they
may act as agents or to whom they may sell as principal.
The selling noteholder served as initial purchaser in the Original Note
Offering and received total discounts and commissions of $3.575 million in
connection therewith. The selling noteholder has advised the Company that it
currently intends to make a market in the Notes, including the Notes offered
hereby, but it is not obligated to do so and may discontinue or suspend any
such market-making activities at any time without notice.
There can be no assurance as to the continuing existence of the market for
the Notes, the liquidity of any market for the Notes, the ability of Holders
of the Notes offered hereby to sell their Notes or at the price at which
Holders of the Notes offered hereby would be able to sell their Notes. Future
trading prices of the Notes offered hereby 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 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 Notes. See "Risk Factors--There is No
Active Trading Market for the Notes."
The selling noteholder and the Company entered into the Registration Rights
Agreement with respect to the use by the selling noteholder of the Prospectus.
Pursuant to the Registration Rights Agreement, the Company agreed to bear all
registration expenses incurred under such agreement and the Company has agreed
to indemnify the selling noteholder against certain liabilities, including
liabilities under the Securities Act.
Entities affiliated with the selling noteholder (i) hold 14,300,000 shares
of Common Stock of the Company, including shares of the Company's Series A
Preferred Stock, Series B Preferred Stock and Series C Preferred Stock which
are convertible into an aggregate of 2,000,000 shares, 3,857,280 shares and
2,500,000 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.
In consideration for the selling noteholder's services, the Company paid to
the selling noteholder, in each of 1996, 1997 and 1998, $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 the selling noteholder.
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SELLING NOTEHOLDER
The following table sets forth certain information regarding the beneficial
ownership of our Notes by the selling Noteholder. All information contained in
the table below is based upon beneficial ownership as of December 31, 1998:
<TABLE>
<CAPTION>
Amount of Notes Amount of Notes
Beneficially Owned Amount of Beneficially Owned
Selling Noteholder Before Offering Notes Being Offered After Offering(1)
- ------------------ ------------------ ------------------- ------------------
<S> <C> <C> <C>
DLJ.................. $3,000,000 $3,000,000 $0.00
</TABLE>
- ----------
(1) This table assumes that all Notes owned by the selling Noteholder which
are offered by this prospectus are being sold. The selling Noteholder
reserves the right to accept or reject, in whole or in part, any proposed
sale of Notes. The selling Noteholder also may offer and sell less than
the number of Notes indicated. The selling Noteholder is not making any
representation that any Notes covered by this prospectus will or will not
be offered for sale.
Except as indicated in the "Plan of Distribution," we are not aware of any
material relationship between us and any selling Noteholder within the past
three years other than as a result of the ownership of the Notes.
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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 5,622,309 shares were
outstanding as of December 31, 1998, and 19,717,280 shares of Preferred Stock,
$.0001 par value per share, 8,250,000 of which have been designated Series A
Preferred Stock, 3,857,280 of which have been designated Series B Preferred
Stock and 7,610,000 of which have been designated Series C Preferred Stock,
all of which shares of Series A, B and C 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 and C Preferred Stock, but prior and in
preference to any distribution of assets of the Company to the holders of
Common Stock, the amount of $1.091 per share. Each share of Series A Preferred
Stock is convertible at any time into Common Stock on a one-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 $6.00 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 and/or shares of Series C 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 and
C Preferred Stock could be converted. 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 or Bylaws of the
Company 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 unless payments of liquidation
preferences are paid in accordance with the Company's Certificate of
Incorporation. Notwithstanding anything to the contrary contained above, no
payments of any kind payable on the Series A Preferred Stock shall be made
unless and until 95% of the Series C Preferred Stock shall have first been
redeemed or converted; provided, however, after August 3, 2000, the Company
may pay dividends on the Series A Preferred Stock in certain circumstances.
Series B Preferred Stock
Subject to the rights of the holders of Series C Preferred Stock, each share
of Series B Preferred Stock is entitled to receive cumulative dividends at (i)
a rate of 25% of $1.5555 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 $1.5555
per share per annum and (B) $1.5555 multiplied by the prime rate plus 2%,
thereafter. Subject to the rights of the holders of Series C Preferred Stock,
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) $1.5555 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. Subject to the rights of the holders of the Series C Preferred
Stock, the Company's Certificate of Incorporation requires the Company to
redeem the Series B
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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 $1.5555 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 one-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 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
$6.00 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, (x) 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 there remains
outstanding 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), (i) amend, alter or repeal the Certificate of
Incorporation of the Company or any significant subsidiary in any manner
adverse to the preferences, privileges, voting rights and powers of the
holders of the Series B Preferred Stock, (ii) voluntarily sell, convey,
exchange or transfer all or substantially all of the Company's property or
assets or merge or consolidate with any other corporation unless the holders
of Common Stock would receive in connection therewith at least $4.67 per
share, or (iii) create, authorize, or issue any class or series of stock
ranking prior to the Series B Preferred Stock or any securities on parity with
Series B 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
an obligation or security convertible into or evidencing the right to purchase
any such class or series of stock; and (y) 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 and Series C Preferred Stock
(so long as there remains outstanding at least 25% of the aggregate number of
shares of Common Stock issuable upon conversion of the Series B and C
Preferred Stock and the Convertible Subordinated Notes), (i) voluntarily
liquidate, dissolve, or wind up the Company or any significant subsidiary,
(ii) increase the size of the Board of Directors of the Company or any
significant subsidiary, (iii) other than indebtedness under the Notes, 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, (iv) except as expressly permitted or required in the
Certificate of Incorporation, pay dividends or distributions on capital stock
of the Company and its subsidiaries and (v) except as expressly permitted or
required in the Certificate of Incorporation, redeem or repurchase any shares
of capital stock of the Company. Notwithstanding anything to the contrary
contained above, no payments of any kind payable on the Series B Preferred
Stock shall be made unless and until 95% of the Series C Preferred Stock shall
have first been redeemed or converted; provided, however, after August 3,
2000, the Company may pay dividends on the Series B Preferred Stock in certain
circumstances.
Series C Preferred Stock
After August 3, 2000, each share of Series C Preferred Stock is entitled to
receive cumulative dividends at a rate per annum equal to the greater of (A)
$0.50 per share per annum and (B) $4.00 multiplied by the prime rate plus 2%.
In the event of any liquidation, dissolution or winding up of the Company, the
holders of Series C Preferred Stock shall be entitled to receive in preference
to the holders of Series A and B Preferred Stock and Common Stock an amount
equal to the greater of (A) $5.00 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 C Preferred Stock had such share been converted into Common
Stock. The Company's Certificate of Incorporation requires the Company to
redeem the Series C 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 $5.00 per share in cash, together with accrued and unpaid dividends.
Each share of Series C Preferred Stock is convertible into Common Stock at any
time on a one-for-one basis, subject to adjustment with respect to certain
dilutive issuances by the Company. In addition, all of the shares of Series C
Preferred Stock shall be converted 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 $6.00 and net
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proceeds to the Company of at least $15.0 million. The holders of Series C
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 C 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, (x) limit the Company's ability to, without the
affirmative vote of the holders of at least a majority of the outstanding
shares of Series C Preferred Stock (so long as there remains outstanding at
least 25% of the aggregate number of shares of Common Stock issuable upon
conversion of the Series C Preferred Stock), (i) amend, alter or repeal the
Certificate of Incorporation of the Company or any significant subsidiary in
any manner adverse to the preferences, privileges, voting rights and powers of
the holders of the Series C Preferred Stock and (ii) create, authorize, or
issue any class or series of stock ranking prior to the Series C Preferred
Stock or any securities on a parity with the Series C Preferred Stock, or
increase the authorized number of shares of any such class or series, 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;
and (y) limit the Company's ability to, without the affirmative vote of at
least 66 2/3% of the outstanding shares of Series B Preferred Stock and Series
C Preferred Stock (so long as there remains outstanding at least 25% of the
aggregate number of shares of Common Stock issuable upon conversion of the
Series B Preferred Stock, Series C Preferred Stock and Convertible
Subordinated Notes), (i) voluntarily liquidate, dissolve or wind up the
Company or any significant subsidiary, (ii) increase the size of the Board of
Directors of the Company or any significant subsidiary, (iii) other than
indebtedness under the Notes, 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, (iv) except as
expressly permitted or required in the Certificate of Incorporation, pay
dividends or distributions on capital stock of the Company and its
subsidiaries and (v) except as expressly permitted or required in the
Certificate of Incorporation, 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, B and C 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 22.7 million shares of Common Stock (including
Common Stock issuable upon the conversion of the Series A, B and C 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 four 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
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the Registration Rights Holders. The Company is generally obligated to bear
the expenses, other than underwriting discounts and sales commissions, of
these registrations.
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.
Inter-Securityholder Agreement
In connection with the Series C Financing, the Company entered into an
Inter-Securityholder Agreement in August 1998 (the "Inter-Securityholder
Agreement") with the holders (such holders, the "Series C Holders") of the
Company's Series C Preferred Stock and the holders (such holders, the
"Subordinated Holders") of the Company's Convertible Subordinated Notes.
Pursuant to the Inter-Securityholder Agreement, the Subordinated Holders
agreed, for the benefit of the Series C Holders, to among other things, (a)
subordinate any obligations (the "Junior Obligations") arising from or
relating to the Convertible Subordinated Notes to any obligations arising from
or relating to the Series C Preferred Stock, and (b) refrain from exercising
certain rights pertaining to, or receiving any payments on, the Junior
Obligations under certain circumstances, without the consent of the holders of
a majority of the shares of Series C Preferred Stock then outstanding.
ADDITIONAL INFORMATION
We have filed with the Commission a Registration Statement on Form S-1
(including the exhibits and schedules thereto) under the Securities Act with
respect to the Notes to be sold in the Offering. This prospectus does not
contain all the information set forth in the Registration Statement. For
further information with respect to Phase Metrics and the Notes to be sold in
the Offering, reference is made to the Registration Statement. Statements
contained in this prospectus as to the contents of any contract, agreement or
other document referred to are not necessarily complete, and in each instance
reference is made to the copy of such contract, agreement or other document
filed as an exhibit to the Registration Statement, each such statement being
qualified in all respects by such reference. In addition, we file annual,
quarterly and current reports, proxy statements and other information with the
Commission, or in the case of our Subsidiary Guarantors, by including
information regarding the Subsidiary Guarantors in our periodic reports under
the Exchange Act.
You may read and copy all or any portion of the Registration Statement or
any reports, statements or other information we file at the Commission's
public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You
can request copies of these documents, upon payment of a duplicating fee, by
writing to the Commission. Please call the Commission at 1-800-SEC-0330 for
further information on the operation of the public reference rooms. Phase
Metrics' Commission filings, including the Registration Statement, are also
available to you on the Commission internet site (http://www.sec.gov).
We have agreed that, whether or not we are required to do so by the rules
and regulations of the Commission, for so long as any of the Notes remain
outstanding, we will furnish to the holders of the Notes and to the extent
permitted by applicable law or regulation, file with the Commission (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 our 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 Notes
remain
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<PAGE>
outstanding, we have agreed to make available to any prospective purchaser of
the Notes or beneficial owner of the Notes, in connection with any sale
thereof, the information required by Rule 144A(d)(4) under the Securities Act.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the
Notes offered hereby will be passed upon for the Company by Brobeck, Phleger &
Harrison LLP, Irvine, 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 consolidated financial statements of the Company as of December 31, 1997
and 1998 and for each of the three years in the period ended December 31, 1998
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.
102
<PAGE>
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.
A-1
<PAGE>
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.
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>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Phase Metrics, Inc.:
Independent Auditors' Report............................................. F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998............. F-3
Consolidated Statements of Operations for the years ended December 31,
1996, 1997 and 1998..................................................... F-4
Consolidated Statements of Stockholders' Deficit for the years ended
December 31, 1996, 1997 and 1998........................................ F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1996, 1997 and 1998..................................................... F-6
Notes to Consolidated Financial Statements............................... F-7
</TABLE>
F-1
<PAGE>
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, 1997 and 1998, and the
related consolidated statements of operations, stockholders' deficit and cash
flows for each of the three years in the period ended December 31, 1998. 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, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1998 in conformity with generally accepted accounting
principles.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
February 5, 1999
F-2
<PAGE>
PHASE METRICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31,
------------------
1997 1998
-------- --------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents............................... $ 2,977 $ 24,714
Accounts receivable, net................................ 28,730 13,577
Inventories............................................. 55,585 25,222
Prepaid expenses and other.............................. 1,975 2,189
Income taxes receivable................................. 5,156 6,062
Deferred tax assets..................................... 8,952 --
-------- --------
Total current assets.................................. 103,375 71,764
Property, plant and equipment, net........................ 38,023 17,793
Intangible assets, net.................................... 4,966 1,782
Deferred tax assets....................................... 5,269 --
Other..................................................... 3,097 4,776
-------- --------
Total assets.............................................. $154,730 $ 96,115
======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' DEFICIT
Current liabilities:
Accounts payable........................................ $ 10,419 $ 6,682
Accrued expenses and other liabilities.................. 16,058 16,966
Customer deposits....................................... 9,038 859
Current portion of debt................................. 1,785 1,374
-------- --------
Total current liabilities............................. 37,300 25,881
Long-term liabilities:
Long-term debt.......................................... 111,272 107,257
Convertible subordinated notes.......................... 8,000 8,000
Accrued expenses and interest........................... 6,794 9,591
Series B redeemable preferred stock, $.0001 par value,
3,857,280 shares
authorized, issued and outstanding (liquidation
preference of $10,578 and
$11,328 at December 31, 1997 and 1998, respectively)..... 9,237 11,331
Series C redeemable preferred stock, $.0001 par value,
7,610,000 shares authorized, issued and outstanding
(liquidation preference of $38,050)...................... -- 31,212
Commitments and contingencies (Notes 6 and 11)
Stockholders' deficit:
Series A preferred stock, $.0001 par value, 8,250,000
shares authorized, issued and outstanding (liquidation
preference of $9,000).................................. 3 3
Common stock, $.0001 par value, 70,000,000 shares
authorized; 5,627,431 and 5,622,309 shares issued and
outstanding at December 31, 1997 and 1998,
respectively........................................... 6,090 6,498
Retained deficit........................................ (23,166) (103,298)
Accumulated other comprehensive loss.................... (800) (360)
-------- --------
Total stockholders' deficit........................... (17,873) (97,157)
-------- --------
Total liabilities, redeemable preferred stock and
stockholders' deficit.................................... $154,730 $ 96,115
======== ========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Net sales....................................... $190,773 $184,660 $104,994
Cost of sales................................... 103,861 101,294 93,168
-------- -------- --------
Gross profit................................ 86,912 83,366 11,826
Operating expenses:
Research and development...................... 31,110 43,572 33,329
Selling, general and administrative........... 24,631 22,968 17,370
Amortization and write-downs of intangibles... 28,656 14,591 3,460
Settlement charge............................. -- -- 5,872
Restructuring charges......................... -- -- 4,184
Purchased in-process research and
development.................................. 13,935 -- --
-------- -------- --------
Total operating expenses.................... 98,332 81,131 64,215
-------- -------- --------
Income (loss) from operations................... (11,420) 2,235 (52,389)
Interest expense................................ 8,448 11,573 14,456
Other (income) expense, net..................... (26) 474 (339)
-------- -------- --------
Loss before income taxes and extraordinary
items.......................................... (19,842) (9,812) (66,506)
Income tax expense (benefit).................... (8,974) (4,268) 9,000
-------- -------- --------
Loss before extraordinary items................. (10,868) (5,544) (75,506)
Extraordinary loss, net of income taxes......... (1,122) -- (1,345)
-------- -------- --------
Net loss........................................ $(11,990) $ (5,544) $(76,851)
======== ======== ========
Accretion for redemption value and dividends on
Series B and C redeemable preferred stock...... $ (3,000) $ (2,923) $ (3,281)
======== ======== ========
Net loss attributable to common stockholders.... $(14,990) $ (8,467) $(80,132)
======== ======== ========
Comprehensive Loss:
Net loss...................................... $(11,990) $ (5,544) $(76,851)
Other comprehensive income (loss):
Foreign currency translation adjustments...... -- (800) 440
-------- -------- --------
Comprehensive loss.............................. $(11,990) $ (6,344) $(76,411)
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT
(Dollars in thousands)
<TABLE>
<CAPTION>
Series A Accumulated
Preferred Stock Common Stock Retained Other
---------------- ----------------- Earnings Comprehensive
Shares Amount Shares Amount (Deficit) Loss Total
--------- ------ --------- ------ --------- ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1,
1996................... 8,250,000 $ 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................... 8,250,000 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................... 8,250,000 3 5,627,431 6,090 (23,166) (800) (17,873)
Exercise of options, net
of repurchases......... -- -- (5,122) 8 -- -- 8
Accrued dividends on
Series B redeemable
preferred stock........ -- -- -- -- (750) -- (750)
Accretion for redemption
value on Series B
redeemable preferred
stock.................. -- -- -- -- (1,337) -- (1,337)
Accretion for dividends
and redemption value on
Series C redeemable
preferred stock........ -- -- -- -- (1,194) -- (1,194)
Compensation expense on
option grants.......... -- -- -- 400 -- 400
Net loss................ -- -- -- -- (76,851) (76,851)
Accumulated translation
adjustments............ -- -- -- -- -- 440 440
--------- --- --------- ------ --------- ----- --------
Balance, December 31,
1998................... 8,250,000 $ 3 5,622,309 $6,498 $(103,298) $(360) $(97,157)
========= === ========= ====== ========= ===== ========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
PHASE METRICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Operating activities:
Net loss....................................... $(11,990) $ (5,544) $(76,851)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization and writedowns
of intangibles.............................. 32,953 21,872 12,056
Amortization of deferred financing costs..... 644 540 776
Loss on disposal of property, plant and
equipment................................... -- 714 163
Compensation expense on option grants........ 400 400 400
Deferred income taxes........................ (16,333) (1,353) 14,221
Interest on convertible subordinated notes... 2,000 1,894 1,000
Impairment of property, plant and equipment.. -- -- 2,519
Purchased in-process research and
development................................. 13,935 -- --
Extraordinary loss net of income taxes....... 1,122 -- 1,345
Changes in assets and liabilities:
Accounts receivable........................ 2,442 (3,688) 15,153
Inventories................................ (20,019) (4,508) 29,897
Prepaid expenses and other assets.......... (5,796) 3,732 (3,681)
Income taxes receivable.................... (5,000) (156) (168)
Accounts payable........................... (5,189) (7,769) (3,737)
Customer deposits, accrued expenses and
other liabilities......................... (10,571) (12,526) (5,055)
-------- -------- --------
Net cash used for operating activities... (21,402) (6,392) (11,962)
-------- -------- --------
Investing activities:
Acquisition of property, plant and equipment... (24,564) (17,091) (1,492)
Proceeds from sale of property, plant and
equipment..................................... 4,431 -- 11,926
Acquisitions, net of cash acquired of $1,595... (20,752) -- --
Other.......................................... -- (78) (278)
-------- -------- --------
Net cash provided by (used for) investing
activities.............................. (40,885) (17,169) 10,156
-------- -------- --------
Financing activities:
Proceeds from term notes....................... 145,000 -- --
Proceeds from senior notes..................... -- -- 110,000
Repayment of term and subordinated notes....... (80,446) (1,800) (79,200)
Revolving loans--net........................... (300) 26,900 (30,700)
Payment of debt issuance costs................. (3,872) (330) (5,560)
Payments on capital lease obligations.......... (436) (912) (1,090)
Proceeds from issuance of common stock, net of
repurchases................................... 62 25 8
Proceeds from issuance of preferred stock...... -- -- 30,020
-------- -------- --------
Net cash provided by financing
activities.............................. 60,008 23,883 23,478
-------- -------- --------
Effect of exchange rate changes on cash and cash
equivalents..................................... -- (82) 65
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents..................................... (2,279) 240 21,737
Cash and cash equivalents, beginning of period... 5,016 2,737 2,977
-------- -------- --------
Cash and cash equivalents, end of period......... $ 2,737 $ 2,977 $ 24,714
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid.................................. $ 5,277 $ 9,393 $ 7,760
======== ======== ========
Income taxes paid (net refunds)................ $ 21,857 $ (5,357) $ (5,103)
======== ======== ========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
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.
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.
Cash and Cash Equivalents--The Company invests its excess cash in money
market accounts, commercial paper 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.
Fair Value of Financial Instruments--As of December 31, 1997 and 1998, the
carrying amounts of cash and cash equivalents and borrowings outstanding under
the Company's credit agreements approximated their respective fair values.
Estimation of the fair value of the Senior notes and convertible subordinated
notes is not deemed practicable as there is no public market for these notes
and the Company is unable to determine the market interest rate at which
financing would have been available at December 31, 1998.
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 sells its products without collateral primarily to companies
located in the western 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.
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 were 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 $4.3 million, $7.3
million, and $8.6 million for the years ended December 31, 1996, 1997 and
1998, respectively.
Intangible Assets--Intangible assets consist primarily of purchased
technology and covenants not to compete recorded in connection with the
Company's acquisitions. Purchased technology was amortized using the straight-
line method over its expected useful life, 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.
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,
F-7
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 totaling $2.0 million related to an impairment
loss for Air Bearings, Inc. ("ABI") purchased technology. In 1998, the Company
recorded write-downs totaling $2.5 million related to impairment losses for
property, plant and equipment obsoleted due to restructuring activities.
Stock-Based Compensation--As permitted by SFAS 123, "Accounting for Stock-
Based Compensation," the Company has elected to account for stock-based awards
to employees using the intrinsic value method, in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees"
and related Interpretations in accounting for its stock-based awards to
employees.
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 resulting
translation adjustments are presented as a separate component of stockholders'
deficit.
Revenue and Related Cost 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.
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 its net assets during
the period from non-owner sources. Accumulated translation adjustments of
$(0.8) million and $0.4 million for the years ended December 31, 1997 and 1998
respectively, are the only other comprehensive income component for the
Company and have been reported as other comprehensive income in the
accompanying consolidated statements of operations.
Segment Reporting--As of January 1, 1998, the Company adopted SFAS No. 131,
"Disclosures About Segments of an Enterprise and Related Information." The
Company operates in one reportable segment. The adoption of SFAS No. 131 has
no impact on the earnings or statement of financial position of the Company.
(See Note 13)
Recent Accounting Pronouncements--In June 1998, the FASB issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 requires that all derivative instruments be recorded on the balance sheet
at their fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative is designated as part of a hedge transaction and, if it
is, the type of hedge transaction. The Company is required to adopt SFAS No.
133 for its fiscal year ending December 31, 1999. The Company has not yet
determined the impact, if any, that adoption of SFAS No. 133 will have on its
earnings or statement of financial position.
F-8
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Stock Split--Concurrent with the sale of the Series C Preferred, the Company
implemented a twenty-for-one stock split with respect to the Series A and
Series B Preferred Stock, with corresponding adjustments to related common
stock conversion factors and per share liquidation preferences, redemption
prices and dividend rates. Related share information has been restated
accordingly herein.
Reclassifications--Certain prior year amounts have been reclassified to
conform with the current year presentation.
2. Balance Sheet Details
Accounts Receivable
Accounts receivable consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998
------- -------
<S> <C> <C>
Trade receivables........................................ $30,393 $15,938
Allowance for doubtful accounts.......................... (1,663) (2,361)
------- -------
$28,730 $13,577
======= =======
</TABLE>
Inventories
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998
------- -------
<S> <C> <C>
Raw materials and components.............................. $30,915 $ 7,277
Work-in-process........................................... 9,796 8,237
Finished goods............................................ 14,874 9,708
------- -------
$55,585 $25,222
======= =======
</TABLE>
Property, Plant and Equipment
Property, plant and equipment consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1997 1998
-------- --------
<S> <C> <C>
Land................................................... $ 2,400 $ --
Buildings and improvements............................. 9,147 --
Equipment and furniture................................ 30,944 32,753
Leasehold improvements................................. 5,514 5,500
Construction in progress............................... 1,098 171
-------- --------
49,103 38,424
Accumulated depreciation and amortization.............. (11,080) (20,631)
-------- --------
$ 38,023 $ 17,793
======== ========
</TABLE>
F-9
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Intangible Assets
Intangible assets consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1997 1998
-------- ------
<S> <C> <C>
Purchased technology..................................... $ 17,598 $ --
Covenants not to compete................................. 2,175 2,175
Patents.................................................. 131 409
-------- ------
19,904 2,584
Accumulated amortization and write-downs................. (14,938) (802)
-------- ------
$ 4,966 $1,782
======== ======
</TABLE>
Accrued Expenses and Other Liabilities
Accrued expenses and other liabilities consist of the following (in
thousands):
<TABLE>
<CAPTION>
December 31,
---------------
1997 1998
------- -------
<S> <C> <C>
Accrued warranty.......................................... $ 5,461 $ 3,625
Accrued compensation...................................... 6,271 2,173
Accrued interest on senior notes.......................... -- 5,012
Other..................................................... 4,326 6,156
------- -------
$16,058 $16,966
======= =======
</TABLE>
Accrued Expenses and Interest
Accrued expenses and interest consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------
1997 1998
------ ------
<S> <C> <C>
Accrued interest on convertible subordinated notes.......... $6,102 $7,102
Other accrued expenses...................................... 692 2,489
------ ------
$6,794 $9,591
====== ======
</TABLE>
3. Acquisitions
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 provided 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.
In connection with the Company's acquisitions of ABI, SBM and a portion of
the business of KDI in 1996, the Company acquired certain in-process 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.
F-10
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The fair value of significant assets acquired, liabilities assumed and
purchased in-process research and development is summarized as follows (in
millions):
<TABLE>
<CAPTION>
1996
------------
KDI &
ABI SBM
----- -----
<S> <C> <C>
Current assets............................................... $ 4.5 $ 0.5
Property and other assets.................................... 0.7 --
Covenant not to compete...................................... -- 1.8
Purchased technology and goodwill............................ 4.9 --
Liabilities.................................................. (0.1) (1.4)
Purchased in-process research and development................ 11.0 2.4
----- -----
Total purchase price......................................... $21.0 $ 3.3
===== =====
</TABLE>
The following summarizes the cash and noncash components of the Company's
acquisitions (in millions):
<TABLE>
<CAPTION>
1996
-----
<S> <C>
Total purchase price............................................ $24.3
Common stock issued............................................. (1.9)
Cash acquired................................................... (1.6)
-----
Cash used for acquisitions...................................... $20.8
=====
</TABLE>
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, 1996. 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>
Proforma
Year Ended
December 31,
1996
------------
<S> <C>
Net sales..................................................... $190,773
========
Income before extraordinary item.............................. $ 1,320
========
Net income.................................................... $ 198
========
</TABLE>
F-11
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
4. Debt
Debt Summary--Debt is summarized as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1997 1998
-------- --------
<S> <C> <C>
Senior notes........................................... $ -- $105,487
Credit agreements...................................... 109,900 --
Convertible subordinated notes......................... 8,000 8,000
Capital lease obligations with weighted average annual
interest rates of 9%.................................. 3,157 3,144
-------- --------
Total.................................................. 121,057 116,631
Less current portion................................... (1,785) (1,374)
-------- --------
Long-term debt......................................... $119,272 $115,257
======== ========
</TABLE>
Senior Notes--In January 1998, the Company sold $110.0 million of its 10.75%
Senior Notes due January 2005 (the "Notes"), in a private offering. The Notes
bear interest at 10.75% per annum, payable semiannually in arrears in February
and August. 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 February 1, 2002, in cash at redemption prices as defined. In
addition, at any time prior to February 1, 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. Issuance costs of the Notes offering
totaled $5.1 million, including $3.6 million of underwriting discount paid to
an affiliate of a number of major stockholders of the Company.
The Notes 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.
Effective in October 1998, the Company completed offers to exchange all of
the Notes with new notes with substantially identical terms that are
registered under the Securities Act of 1933, as amended.
The Company is accreting the carrying value of the senior notes payable to
their redemption value.
Credit Agreements--At December 31, 1997, the Company had a $120.0 million
credit agreement (the "Credit Agreement") with a group of financial
institutions (the "Lenders") which provided for five-year term loans (the
"Term Loans") in the principal amount of $80.0 million and a three-year
revolving credit facility (the "Revolver") of up to $40.0 million. In
connection with the Credit Agreement, the Company paid fees of $1.2 million,
for debt issuance costs to the syndication agent, who was an affiliate of a
number of the major stockholders of the Company.
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 Company used the net proceeds of the Notes of $104.9 million, together
with existing cash and an initial draw of $1.6 million under the New Credit
Facility to repay in full its then existing credit agreements and accrued
interest, as well as to pay fees of $0.3 million for the New Credit Facility.
In connection with the January 1998 repayment of its then existing credit
agreements and accrued interest, the related unamortized debt issuance costs
were written off. This write-off, net of related tax benefit of $0.7 million,
has been reported as an extraordinary loss in the accompanying consolidated
statements of operations.
F-12
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In August 1998, with the proceeds from the sale of its Series C Preferred
Stock (see Note 9), the Company repaid in full the New Credit Facility and
accrued interest, totaling $7.1 million, and terminated the New Credit
Facility. In connection with this repayment, in the third quarter of 1998 the
Company recorded a $0.4 million write-off of the related unamortized debt
issuance costs as an extraordinary loss in the accompanying consolidated
statements of operations.
In connection with the refinancing of certain credit facilities in January
and December 1996, the related unamortized debt issuance costs were written
off. These write-offs, net of related tax benefit, have been reported as
extraordinary items in the accompanying consolidated statements of operations.
In connection with the December 1996 refinancing, the Company paid fees of
$1.2 million to an affiliate of a number of major stockholders of the Company.
The Company also paid this same entity $200,000 in fees for financial advisory
services in each of 1996, 1997 and 1998.
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 mature in July 2005. Interest accrued at
$2 million per year from issuance through November 23, 1997, and thereafter at
a minimum of $1 million per year. The Convertible Subordinated Notes bore
interest at 12.5% as of December 31, 1998. Interest is payable at maturity.
The convertible subordinated notes, including accrued interest are: (i)
convertible into 5,142,720 shares of Common Stock at the option of the holder,
(ii) automatically converted into Common Stock upon effectiveness of a public
equity offering as defined, and (iii) entitled to anti-dilution rights.
5. Income Taxes
The components of income tax expense (benefit) are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------
1996 1997 1998
-------- ------- -------
<S> <C> <C> <C>
Current income taxes:
Federal...................................... $ 6,330 $(2,915) $(5,960)
State........................................ 590 -- --
-------- ------- -------
Total...................................... 6,920 (2,915) (5,960)
Deferred income taxes:
Federal...................................... (13,610) 386 17,782
State........................................ (3,211) (1,739) (3,561)
-------- ------- -------
Total...................................... (16,821) (1,353) 14,221
Income tax (benefit) expense before
extraordinary items........................... (9,901) (4,268) 8,261
Extraordinary items............................ 927 -- 739
-------- ------- -------
Income tax expense (benefit)................... $ (8,974) $(4,268) $ 9,000
======== ======= =======
</TABLE>
F-13
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
The reconciliations between the statutory federal income tax rate and the
effective income tax rate for the years ended December 31, 1996, 1997 and 1998
are as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Statutory tax rate--expense (benefit)... (35.0)% (34.0)% (34.0)%
Federal research and development
credits................................ (4.0) (8.2) (1.7)
State income taxes, net of federal
benefit................................ (6.6) (4.2) (3.3)
Foreign sales corporation, net of tax... (2.4) -- --
Purchased in-process research and
development............................ 1.8 -- --
Compensation on option grants........... 0.6 1.4 0.2
Valuation allowance..................... -- -- 50.7
Other................................... 0.4 1.5 0.6
-------- -------- --------
Effective tax rate--expense (benefit)... (45.2)% (43.5)% 12.5 %
======== ======== ========
</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,
-----------------
1997 1998
------- --------
<S> <C> <C>
Reserves not currently deductible..................... $ 5,492 $ 7,252
Customer deposits..................................... 1,469 539
Uniform capitalization adjustment..................... 707 282
State taxes........................................... (1,345) (2,635)
Purchased technology.................................. 6,540 6,228
Property and equipment................................ -- 2,218
Tax loss and credit carryforwards (expiring through
2018)................................................ 803 18,261
Other................................................. 555 1,419
Valuation Allowance................................... -- (33,564)
------- --------
Total................................................. $14,221 $ --
======= ========
</TABLE>
At December 31, 1998, the Company had available federal and California state
net operating loss carryforwards of approximately $36.4 million in the
aggregate, to offset future taxable income through 2013 and 2003,
respectively. Current tax laws impose substantial restrictions on the
utilization of net operating loss and credit carryforwards in the event of an
"ownership change," as defined by the Internal Revenue Code. If there should
be an ownership change, the Company's ability to utilize its carryforwards
could be limited.
In 1998, the Company recorded a $33.6 million valuation allowance against
its entire net deferred tax asset balance due to uncertainty regarding
realization of the deferred tax asset, due to the significant loss incurred in
1998 and uncertainty regarding future taxable income.
6. Leases
Sale/Leaseback--In December 1998, the Company disposed of the real property,
improvements, fixtures and office buildings (collectively, the "Property")
located at its San Diego facility for net proceeds of $11.9 million. The
purchaser of the Property included an entity which is affiliated with a number
of the Company's major stockholders. The property was listed and sold through
a national real estate broker and the
F-14
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Company believes the purchase price represented fair value for the property.
In connection with the sale of the Property, the Company entered into a lease
with the purchaser to leaseback a portion of the Property. The resulting gain
of $0.9 million from the sale of the Property has been deferred in the
accompanying financial statements, and will be amortized to income over the
three year term of the lease.
Capital Leases--The Company entered into capital lease obligations of $1.8
million, $0.8 million, and $1.1 million in connection with lease agreements
for equipment and furniture during the years ended December 31, 1996, 1997 and
1998, respectively. At December 31, 1997 and 1998, assets under capital leases
included in property, plant and equipment totaled $4.4 million and $3.2
million, respectively, with accumulated amortization of $1.3 million in each
year.
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 $3.4 million, $5.1 million and $4.8 million for the
years ended December 31, 1996, 1997 and 1998, respectively.
Future minimum lease payments under capital and operating leases as of
December 31, 1998 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
Capital Operating
Year Ending December 31: Leases Leases
------------------------ ------- ---------
<S> <C> <C>
1999.................................................... $ 1,595 $3,157
2000.................................................... 1,453 2,846
2001.................................................... 352 1,676
2002.................................................... 81 869
2003.................................................... -- 607
------- ------
Total................................................... 3,481 $9,155
======
Amount representing interest............................ (337)
-------
Present value of minimum lease payments................. 3,144
Current portion......................................... (1,374)
-------
Long-term portion....................................... $ 1,770
=======
</TABLE>
7. Settlement Charge
In April 1998, the Company entered into an agreement (the "Settlement
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 concluded that this
action was necessary in order to discourage further unauthorized use of its
intellectual property in the future by this or other third parties. The
Company recorded a $5.9 million charge to earnings in the second quarter of
1998 in connection with the Settlement Agreement. The Company is making the
reimbursement provided for under the Settlement Agreement by providing a
credit to the customer for products purchased by the customer. Products
purchased under the Settlement Agreement are at favorable pricing which
negatively impacted the Company's gross profit margin in 1998. Such negative
impact is expected to continue in 1999.
F-15
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
8. Restructuring and Valuation Charges
In 1998, the data storage industry in general, including many of the
Company's customers, experienced significant weakness in demand for data
storage products, intense competition, pricing erosion and overcapacity in
manufacturing operations. Such adverse market conditions resulted in the
rescheduling or cancellation of orders by several of the Company's major
customers and had a material adverse effect on the Company's business, results
of operations and financial condition. In light of these circumstances, and
the Company's expectation that the impact on its operations of the data
storage industry's adverse market conditions will extend for the foreseeable
future, the Company implemented a plan of restructuring in June 1998, (the
"June Restructuring"). The June Restructuring included a workforce reduction
of approximately 115 employees, relocation and consolidation of much of its
Concord, California operation to the Company's Fremont, California facility,
and consolidation of its San Diego, California facility.
In the second quarter of 1998, the Company recorded a charge of $3.0 million
related to the June Restructuring. The significant components of the
restructuring charge were $0.9 million for employee severance costs, $2.0
million in impairment costs related to property, plant and equipment obsoleted
due to restructuring activities, and $0.1 million of other costs.
Due to the continued downturn in the data storage industry, the Company
implemented a plan of restructuring in November 1998 (the "November
Restructuring"). The November Restructuring included a workforce reduction of
approximately 60 employees, and a consolidation of facilities at the Company's
Fremont, California location.
In the fourth quarter of 1998, the Company recorded a charge of $1.1 million
related to the November Restructuring. The significant components of the
restructuring charge were $0.3 million for employee severance costs and $0.6
million in impairment costs related to property, plant and equipment obsoleted
due to restructuring activities, and $0.2 million of other costs.
Also, in connection with the industry downturn and resultant decrease in
demand for the Company's products, in 1998 the Company recorded $19.8 million
in charges to cost of sales to write-off excess and obsolete inventory.
As of December 31, 1998, $1.1 million had been paid and $0.4 million was
recorded as an accrued liability for remaining severance and other costs
related to the June and November restructurings. Relocation of the Concord
operation, and consolidation of facilities at the Fremont and San Diego
locations were complete as of December 31, 1998.
9. Redeemable Preferred Stock
The Series B redeemable preferred stock ("Series B Preferred Stock") is: (i)
voting, (ii) convertible at the option of the holder into Common Stock on a
one-for-one basis, (iii) entitled to $1.56 per share preference to Common
Stockholders in the event of liquidation, after payment of dividends, (iv)
entitled to cumulative dividends at a minimum rate of $1.5 million per year
through November, 1997 and thereafter at a minimum rate of $0.8 million per
year, (v) automatically converted into Common Stock on a one-for-one basis
upon the effectiveness of a public equity offering as defined, (vi) entitled
to antidilution rights, (vii) to have approval rights on new issuances of
Preferred Stock and (viii) redeemable at $1.56 per share beginning July 2005,
subject to funds legally available, after payment of dividends.
The $6.0 million redemption value was accreted to retained earnings over the
original redemption period which ended November 23, 1998.
F-16
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
In August and September 1998, the Company sold 7,610,000 shares of Series C
redeemable preferred stock (the "Series C Preferred Stock") for $4 per share.
The proceeds of approximately $30.4 million were used to repay in full the
Company's then existing revolving line of credit and accrued interest totaling
$7.1 million, with the remainder for general operating purposes.
The Series C Preferred Stock is: (i) voting, (ii) convertible at the option
of the holder into Common Stock on a one-for-one basis, (iii) entitled to $5
per share preference to the holders of Common Stock, Series A Preferred Stock,
Series B Preferred Stock and the Convertible Subordinated Notes in the event
of liquidation, after payment of dividends, (iv) entitled to cumulative
dividends at a minimum rate of $3.8 million per year beginning August 2000,
(v) automatically converted into Common Stock on a one-for-one basis upon the
effectiveness of a public equity offering as defined, (vi) entitled to
antidilution rights, (vii) to have approval rights on new issuances of
Preferred Stock and (viii) redeemable at $5 per share beginning July 2005,
after payment of dividends.
The dividends and the excess of redemption price over sales price are being
accreted to retained earnings using the effective interest method over the
redemption period ending July 2005.
10. Stockholders' Deficit
Series A Preferred Stock--Series A Preferred Stock is: (i) voting, (ii)
convertible at the option of the holder into Common Stock on a one-for-one
basis, (iii) entitled to $1.09 per share preference to Common Stockholders in
the event of liquidation, after payment to Series B and C Preferred
Stockholders, (iv) entitled to dividends to the same extent as Common
Stockholders, (v) automatically converted into Common Stock on a one-for-one
basis upon the effectiveness of a public equity offering as defined and
(vi) entitled to anti-dilution rights.
Common Shares Reserved--As of December 31, 1998, the Company has reserved
the following number of shares of Common Stock for future issuance:
<TABLE>
<S> <C>
Conversion of Series A, B and C Preferred Stock................. 19,717,280
Conversion of subordinated notes................................ 5,142,720
Exercise and issuance of stock options.......................... 4,931,691
Exercise of warrants............................................ 800,000
----------
Total........................................................... 30,591,691
==========
</TABLE>
Registration Rights--Series A, B and C Preferred Stockholders, Convertible
Subordinated Noteholders 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, B or C Preferred Stock. The Securityholders have been granted a
right of first refusal to purchase any 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. The warrants expire on November 23, 2004.
Stock Option Plan--Under the 1995 Stock Option Plan (the "Plan"), 6,400,000
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
over three or five years. Options are
F-17
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
immediately exercisable and underlying shares are subject to the Company's
repurchase rights, which lapse over the original vesting period of the options
exercised. 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, 1998, 2,527,682 shares were
available for future option grants.
A summary of stock option transactions is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Price
Number of Per
Shares Share
---------- --------
<S> <C> <C>
Balance at January 1, 1996............................ 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
Granted............................................... 1,181,200 4.22
Exercised............................................. (32,365) 1.01
Canceled.............................................. (1,033,010) 7.07
----------
Balance at December 31, 1998.......................... 2,404,009 $5.20
==========
Vested at December 31, 1996........................... 202,600 $1.58
==========
Vested at December 31, 1997........................... 495,833 $4.32
==========
Vested at December 31, 1998........................... 656,319 $5.02
==========
Subject to repurchase at December 31, 1996............ 817,679 $0.58
==========
Subject to repurchase at December 31, 1997............ 493,063 $0.55
==========
Subject to repurchase at December 31, 1998............ 221,752 $0.56
==========
</TABLE>
The Company recognized compensation expense of $0.4 million during each of
the years ended December 31, 1996, 1997 and 1998 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 certain stock options granted in 1995. The
remaining unamortized compensation expense related to such options is $0.7
million at December 31, 1998, 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 minimum 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,
1996, 1997 and 1998, respectively: weighted average risk-free interest rates
of 5.84%, 6.04% and 5.26%; no dividend yield; and a weighted average expected
life of 3.5, 3.5 and 3.2 years. In management's opinion, the existing models
do not necessarily provide a reliable single measure of the fair value of its
employee stock awards.
F-18
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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,
------------------------
1996 1997 1998
------- ------ -------
<S> <C> <C> <C>
Pro forma net loss.................................. $12,487 $5,976 $76,742
======= ====== =======
</TABLE>
The following table summarizes information as of December 31, 1998
concerning options outstanding:
<TABLE>
<CAPTION>
Weighted Average Shares
Exercise Options Remaining Subject to
Prices Outstanding Contractual Life Vested Repurchase
-------- ----------- ---------------- ------- ----------
(years)
<S> <C> <C> <C> <C>
$0.37 100,500 6.33 78,733 197,252
1.00 234,867 6.57 161,750 20,450
3.75 943,200 9.68 533 --
5.00 87,600 6.85 60,917 --
5.50 32,000 9.31 -- --
7.50 577,908 7.67 240,948 4,050
8.75 427,934 8.61 113,438 --
--------- ------- -------
2,404,009 656,319 221,752
========= ======= =======
</TABLE>
The weighted average fair value of options granted during the years ended
December 31, 1996, 1997 and 1998 was $1.33, $1.53 and $0.64, respectively.
11. Commitments and Contingencies
Acquisition-Related Agreements--Concurrent with certain of its acquisitions,
the Company entered into earn-out agreements based on units produced or sold.
At December 31, 1998, future potential combined maximum earn-out payments in
connection with such acquisitions are not expected to be material. During the
years ended December 31, 1996, 1997 and 1998, $3.8 million, $2.0 million and
$1.1 million, respectively, of earn-outs have been paid and charged to
operations.
Letter of Credit--As of December 31, 1998, the Company had a letter of
credit outstanding to a third party beneficiary in the amount of $2.1 million.
The letter of credit is secured by a $2.1 million certificate of deposit which
is included in non-current assets on the accompanying balance sheet.
Legal Matters--The Company is also subject to various other legal matters in
the normal course of its business. While the results of litigation and claims
cannot be predicted with certainty, the Company believes that the final
outcome of these other matters will not have a material adverse effect on its
business, operating results or financial condition.
12. Employee Savings Plan
Under the Company's 401(k) plan (the "Plan"), eligible employees may defer
up to 15% of their pretax earnings, subject to the Internal Revenue Service
annual contribution limit. Company matching contributions to the Plan were
$0.4 million for 1996 and $0.6 million for each of 1997 and 1998.
F-19
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
13. Industry and Geographic Information
The Company operates in one reportable segment. Sales to customers outside
the United States (primarily Asia) totaled 57%, 49%, and 49% of net sales for
the years ended December 31, 1996, 1997 and 1998, respectively. As of December
31, 1997 and 1998, balances due from foreign customers (primarily located in
Asia) were $12.0 million and $4.0 million, respectively.
The Company had sales to individual customers in excess of 10% of net sales,
as follows:
<TABLE>
<CAPTION>
1996 1997 1998
Customer: ---- ---- ----
<S> <C> <C> <C>
A........................................................... 19% 18% 17%
B........................................................... -- -- 17%
C........................................................... -- 17% 16%
D........................................................... 15% 16% --
E........................................................... 12% -- --
</TABLE>
As of December 31, 1997 and 1998, accounts receivable from individual
customers with balances due in excess of 10% of total accounts receivable
totaled $17.6 million and $12.3 million, respectively.
For the year ended December 31, 1998, the Company recorded revenue from
customers throughout the United States and Japan, Korea and Singapore
(collectively referred to as "Asia"). The following presents net sales for the
years ended December 31, 1996, 1997 and 1998 and long-lived assets as of
December 31, 1997 and 1998 by geographic territory:
<TABLE>
<CAPTION>
1996 1997 1998
-------- ------------------- -------------------
Net Net Long-Lived Net Long-Lived
Sales Sales Assets Sales Assets
-------- -------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C>
United States--Domestic.... $ 82,032 $ 94,177 $50,552 $ 53,547 $23,589
--Foreign..... 108,238 87,594 -- 39,758 --
Japan...................... 500 985 212 8,850 195
Singapore and other Asia... 3 1,904 591 2,839 567
-------- -------- ------- -------- -------
Total...................... $190,773 $184,660 $51,355 $104,994 $24,351
======== ======== ======= ======== =======
</TABLE>
14. 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 4). 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, 1996, 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>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 intangibles... 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-21
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 and
amortization and
write-downs of
intangibles........... 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 term and
subordinated notes.... (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-22
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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
======== ======= ======= ======== ========
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year Ended December 31, 1997
<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 intangibles... 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-23
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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 and
amortization and
write-downs of
intangibles.......... 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)
Other................. (78) -- -- -- (78)
-------- ------- ------- ------- --------
Net cash used for
investing
activities.......... (15,520) (1,404) (245) -- (17,169)
-------- ------- ------- ------- --------
Financing activities:
Revolving loans--net.. 26,900 -- -- -- 26,900
Repayment of term and
subordinated notes... (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
changes on cash and
cash equivalents...... -- -- (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-24
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 1998
ASSETS
<TABLE>
<CAPTION>
Foreign
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Cash and cash
equivalents............ $ 23,631 $ 13 $ 1,070 $ -- $ 24,714
Accounts receivable,
net.................... 11,001 315 2,261 -- 13,577
Inventories............. 23,346 614 5,110 (3,848) 25,222
Other current assets.... 8,084 5 162 -- 8,251
Property, plant and
equipment, net......... 16,814 701 278 -- 17,793
Intercompany balances... (809) 9,375 (8,566) -- --
Investment in
subsidiaries........... 6,655 -- -- (6,655) --
Other................... 6,073 1 484 -- 6,558
-------- ------- ------- -------- --------
Total assets.......... $ 94,795 $11,024 $ 799 $(10,503) $ 96,115
======== ======= ======= ======== ========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Other current
liabilities............ $ 23,768 $ 264 $ 475 $ -- $ 24,507
Current portion of
debt................... 1,374 -- -- -- 1,374
Long-term debt.......... 115,257 -- -- -- 115,257
Redeemable preferred
stock.................. 42,543 -- -- -- 42,543
Other................... 9,010 -- 581 -- 9,591
Stockholders' equity
(deficit).............. (97,157) 10,760 (257) (10,503) (97,157)
-------- ------- ------- -------- --------
Total liabilities,
redeemable preferred
stock and
stockholders' equity
(deficit)............ $ 94,795 $11,024 $ 799 $(10,503) $ 96,115
======== ======= ======= ======== ========
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 1998
<CAPTION>
Foreign
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
Net sales............... $ 97,969 $ 9,769 $15,086 $(17,830) $104,994
Cost of sales........... 95,224 2,494 13,532 (18,082) 93,168
-------- ------- ------- -------- --------
Gross profit........... 2,745 7,275 1,554 252 11,826
Research and development
expense................ 33,318 11 -- -- 33,329
Selling, general and
administrative
expense................ 14,106 1,528 1,774 (38) 17,370
Amortization and write-
downs of intangibles... 3,460 -- -- -- 3,460
Settlement charge....... 5,872 -- -- -- 5,872
Restructuring charges... 4,184 -- -- -- 4,184
-------- ------- ------- -------- --------
Income (loss) from
operations............. (58,195) 5,736 (220) 290 (52,389)
Interest expense........ 14,438 (4) 22 -- 14,456
Other (income) expense--
net.................... (109) -- (230) -- (339)
-------- ------- ------- -------- --------
Income (loss) before
equity in subsidiaries
and taxes.............. (72,524) 5,740 (12) 290 (66,506)
Equity in net income of
subsidiaries........... 5,245 -- -- (5,245) --
Income tax expense
(benefit).............. 8,227 775 (2) -- 9,000
-------- ------- ------- -------- --------
Net income (loss) before
extraordinary items.... (75,506) 4,965 (10) (4,955) (75,506)
Extraordinary items, net
of income taxes........ (1,345) -- -- -- (1,345)
-------- ------- ------- -------- --------
Net income (loss)....... $(76,851) $ 4,965 $ (10) $ (4,955) $(76,851)
======== ======= ======= ======== ========
</TABLE>
F-25
<PAGE>
PHASE METRICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 1998
<TABLE>
<CAPTION>
Foreign
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------- ------------ ------------- ----------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)....... $(76,851) $ 4,965 $ (10) $(4,955) $(76,851)
Depreciation and
amortization and
write-downs of
intangibles........... 11,741 215 100 -- 12,056
Equity in net income of
subsidiaries.......... (5,245) -- -- 5,245 --
Other non-cash
adjustments........... 4,858 -- -- -- 4,858
Extraordinary Item..... 1,345 -- -- -- 1,345
Changes in working
capital............... 55,786 (8,157) (709) (290) 46,630
-------- ------- ------ ------- --------
Net cash used for
operating activities... (8,366) (2,977) (619) -- (11,962)
-------- ------- ------ ------- --------
Investing activities:
Acquisition of
property, plant and
equipment............. (1,387) (4) (101) -- (1,492)
Proceeds from sale of
property, plant and
equipment............. 11,926 -- -- -- 11,926
Other.................. (278) -- -- -- (278)
-------- ------- ------ ------- --------
Net cash provided by
(used for) investing
activities............. 10,261 (4) (101) -- 10,156
-------- ------- ------ ------- --------
Financing activities:
Proceeds from senior
notes................. 110,000 -- -- -- 110,000
Repayment of term and
subordinated notes.... (79,200) -- -- -- (79,200)
Revolving loans--net... (30,700) -- -- -- (30,700)
Payment of debt
issuance costs........ (5,560) -- -- -- (5,560)
Proceeds from issuance
of preferred stock.... 30,020 -- -- -- 30,020
Other.................. (4,581) 2,214 1,285 -- (1,082)
-------- ------- ------ ------- --------
Net cash provided by
financing activities... 19,979 2,214 1,285 -- 23,478
-------- ------- ------ ------- --------
Effect of exchange rate
on cash and cash
equivalents............ -- -- 65 -- 65
Net increase (decrease)
in cash and cash
equivalents............ 21,874 (767) 630 -- 21,737
Cash and cash
equivalents at
beginning of year...... 1,757 780 440 -- 2,977
-------- ------- ------ ------- --------
Cash and cash
equivalents at end of
year................... $ 23,631 $ 13 $1,070 $ -- $ 24,714
======== ======= ====== ======= ========
</TABLE>
F-26
<PAGE>
INDEPENDENT AUDITORS' REPORT
Phase Metrics, Inc.:
We have audited the consolidated financial statements of Phase Metrics, Inc.
and its subsidiaries as of December 31, 1998 and 1997, and for each of the
three years in the period ended December 31, 1998, and have issued our report
thereon dated February 5, 1999; such financial statements and report have been
included in this Prospectus on Form S-1. Our audits also included the
consolidated financial statement schedule of Phase Metrics, Inc. and its
subsidiaries, listed in Item 14(a)2. 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 consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
February 5, 1999
F-27
<PAGE>
SCHEDULE II
PHASE METRICS, INC.
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Additions
-------------------
Balance at Charges to Charges Balance
beginning costs and to other at end
Description of period expenses accounts Deductions of period
----------- ---------- ---------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C>
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
Year ended December 31,
1998
Allowance for doubtful
accounts................. 1,663 787 -- 89 2,361
</TABLE>
F-28
<PAGE>
===============================================================================
No dealer, salesperson or other person has been authorized to give any infor-
mation or to represent anything not contained in this prospectus. You must not
rely on any unauthorized information or representations. This prospectus is an
offer to sell only the Notes offered hereby, but only under circumstances and
in jurisdictions where it is lawful to do so. The information contained in this
prospectus is current only as of its date.
------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary.................................................................. 1
Risk Factors............................................................. 9
Use of Proceeds.......................................................... 23
Capitalization........................................................... 24
Selected Consolidated Financial Data..................................... 25
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 27
Business................................................................. 38
Management............................................................... 52
Certain Transactions..................................................... 60
Principal Stockholders................................................... 62
Description of Indebtedness.............................................. 64
Description of Notes..................................................... 65
Certain United States Federal Tax Considerations......................... 93
Plan of Distribution..................................................... 96
Selling Noteholder....................................................... 97
Description of Capital Stock............................................. 98
Additional Information................................................... 101
Legal Matters............................................................ 102
Experts.................................................................. 102
Glossary................................................................. A-1
Index to Financial Statements............................................ F-1
</TABLE>
===============================================================================
===============================================================================
$3,000,000
[LOGO OF PHASE METRICS(TM) APPEARS HERE]
10 3/4% Senior Notes
due 2005
-------------
PROSPECTUS
-------------
, 1999
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable in connection with the sale
and distribution of the securities being registered. All amounts are estimated
except the Securities and Exchange Commission registration fees. All of the
expenses below will be paid by the Company.
<TABLE>
<CAPTION>
Item
----
<S> <C>
Registration fee................................................... $
Blue Sky fees and expenses.........................................
Printing and engraving expenses....................................
Legal fees and expenses............................................
Accounting fees and expenses.......................................
Transfer Agent and Registrar fees..................................
Miscellaneous......................................................
--------
Total............................................................ $
========
</TABLE>
Item 14. 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. The Company's Bylaws (the "Bylaws") 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")
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
II-1
<PAGE>
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 15. Recent Sales of Unregistered Securities
1. In November 1994 the Registrant sold unregistered Common Stock, Series A
Preferred Stock, Series B Preferred Stock and Convertible Promissory Notes to
Mr. Schaefer and to certain affiliates of Donaldson, Lufkin & Jenrette
Securities Corporation ("DLJ") in connection with a recapitalization of the
Registrant (the "Recapitalization") and the acquisition by the Registrant of
all of the stock of ProQuip, Inc. and certain assets and technologies of
Cambrian Systems, Inc., as described in the Prospectus under "Certain
Transactions." In the Recapitalization Mr. Schaefer was sold 2,750,000 shares
of Common Stocks and 1,375,000 shares of Series A Preferred Stock, and Mr.
Cormier was sold 2,750,000 shares of Series A Preferred Stock. The affiliates
of DLJ were sold Series B Preferred Stock and notes that are convertible into
1,928,640 shares and 5,142,720 shares of Common Stock, respectively. The
Registrant believes that such transactions were exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) thereof because
(i) the offerees were institutional investors (other than the private sales to
management), (ii) there were a limited number of offerees and (iii) the
Company did not engage in any general solicitation.
2. In June 1995 the Registrant issued 800,000 shares of Common Stock to the
former stockholders of Helios, Incorporated ("Helios"), in partial
consideration for the acquisition by the Registrant of all of the stock of
Helios. The Registrant believes that such transaction was exempt from the
registration requirements of the Securities Act pursuant to Section 4(2)
thereof.
3. In July 1995 the Registrant issued 350,000 shares of Common Stock to the
former stockholders of Applied Robotic Technology ("ART"), including to Mr.
Neil A. Brumberger, an executive officer of the Registrant, in partial
consideration for the acquisition by the Registrant of all of the stock of
ART. The Registrant believes that such transaction was exempt from the
registration requirements of the Securities Act pursuant to Section 4(2)
thereof.
4. In January 1996 the Registrant issued 120,000 shares of Common Stock to
the former stockholders of Air Bearing Technology, Inc. ("ABI"), in partial
consideration for the acquisition by the Registrant of all of the stock of
ABI. The Registrant believes that such transaction was exempt from the
registration requirements of the Securities Act pursuant to Section 4(2)
thereof.
5. In January 1997 the Registrant issued 133,998 shares of Common Stock to
the former shareholders of Santa Barbara Metric, Inc. ("SBM"), in partial
consideration for the acquisition by the Registrant of all of the stock of
SBM. The Registrant believes that such transaction was exempt from
registration requirements of the Securities Act pursuant to Section 3(a)(10)
thereof.
6. In January 1998 the Registrant issued and sold $107,000,000 in aggregate
principal amount of 10 3/4% Senior Notes due 2005. The Registrant believes
that such transaction was exempt from the registration requirements of the
Securities Act pursuant to Section 4(2) thereof.
7. In August 1998 and September 1998, the Registrant issued and sold an
aggregate of 7,610,000 shares of its Series C Preferred Stock. The Registrant
believes that such transactions were exempt from the registration requirements
of the Securities Act pursuant to Section 4(2) thereof.
II-2
<PAGE>
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
The following Exhibits are attached hereto and incorporated herein by
reference.
<TABLE>
<C> <S>
3.1** Amended and Restated Certificate of Incorporation of the Company.
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.
10.6** 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** Amended and Restated Securityholders Agreement dated as of August 3,
1998, among DLJ Merchant Banking Partners, L.P., DLJ International
Partners, C.V., DLJ Offshore Partners, C.V., DLJ Merchant Banking
Funding, Inc., DLJ First ESC, L.P., DLJ Capital Corporation, Sprout
Growth II, L.P., Sprout Capital VI, L.P., PM Funding, Inc.,
Donaldson, Lufkin & Jenrette Securities Corporation, ABS Capital
Partners II, L.P., Arthur J. Cormier, John F. Schaefer, The
Freedland 1994 Unitrust, The Moraru 1994 Unitrust, The Le 1994
Unitrust, The Najjor Unitrust, Neil H. Brumberger, Hart H.
Brumberger, Roger D. Peters and Mary Anne Christine Peters Living
Trust, Jeffrey K. Rhoton and Yvonne H. Rhoton Living Trust, Raymond
M. Karam, Randall E. Bye, Pedro A. Aylwin, Dr. Gilbert E. Amelio 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** Inter-Securityholder Agreement dated as of August 3, 1998 among DLJ
Merchant Banking Partners, L.P., DLJ International Partners, C.V.,
DLJ Offshore Partners, C.V., DLJ Merchant Banking Funding, Inc., DLJ
Capital Corporation, DLJ First ESC, L.P., Sprout Growth II, L.P.,
Sprout Capital VI, L.P., ABS Capital Partners II, L.P., Donaldson,
Lufkin & Jenrette Securities Corporation, William E. Terry, Dr.
Gilbert F. Amelio and the Company.
</TABLE>
II-3
<PAGE>
<TABLE>
<C> <S>
10.15** Securities Purchase Agreement, dated as of August 3, 1998 among ABS
Capital Partners II, L.P., DLJ Merchant Banking Partners, L.P., DLJ
International Partners, C.V., DLJ Offshore Partners, C.V., DLJ
Merchant Banking Funding, Inc., DLJ Capital Corporation, Donaldson,
Lufkin & Jenrette Securities Corporation, DLJ First ESC, L.P.,
Sprout Growth II, L.P., Sprout Capital VI, L.P., Dr. Gilbert F.
Amelio, William E. Terry and the Company.
10.16* Purchase and Sale Agreement, dated as of October 16, 1998, as
amended, by and between the Company and Legacy Partners Commercial,
Inc.
10.17* Lease Agreement, dated as of December 16, 1998, by and between the
Company and Legacy Partners Commercial, Inc.
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-6, II-7,
II-8, II-9, II-10 and II-11).
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.
</TABLE>
- --------
* Incorporated by reference to the exhibits filed with the Company's Current
Report on Form 8-K filed on January 13, 1999.
** Incorporated by reference to the Exhibit indicated in the Company's
Registration Statement on Form S-4 (File No. 333-48817).
(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 17. 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 this 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 the 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 end 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 a 20 percent change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table in
the effective registration statement; and
(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.
II-4
<PAGE>
(b) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrant 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 its 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.
II-5
<PAGE>
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 30th day of March, 1999.
PHASE METRICS, INC.
/s/ John F. Schaefer
By: _________________________________
John F. Schaefer
Chairman, Chief Executive Officer
and President
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint John F. Schaefer and Brad LaLuzerne, and each of them, his true and
lawful attorney-in-fact and agent, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments (including post-effective
amendments) to this Registration Statement, or any related registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and
to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement on Form S-1 has been signed by the following persons in
the capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ John F. Schaefer Chairman of the Board, Chief March 30, 1999
____________________________________ Executive Officer and
John F. Schaefer President (Principal
Executive Officer)
/s/ Brad LaLuzerne Vice President, Chief March 30, 1999
____________________________________ Financial Officer and
Brad LaLuzerne Assistant Secretary
(Principal Accounting and
Financial Officer)
/s/ Arthur J. Cormier Director March 30, 1999
____________________________________
Arthur J. Cormier
/s/ Thompson Dean Director March 30, 1999
____________________________________
Thompson Dean
/s/ Robert Finzi Director March 30, 1999
____________________________________
Robert Finzi
/s/ Dr. Gilbert F. Amelio Director March 30, 1999
____________________________________
Dr. Gilbert F. Amelio
</TABLE>
II-6
<PAGE>
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ William E. Terry Director March 30, 1999
____________________________________
William E. Terry
/s/ Andrew T. Sheehan Director March 30, 1999
____________________________________
Andrew T. Sheehan
</TABLE>
II-7
<PAGE>
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 30th day of March, 1999.
AIR BEARINGS, INCORPORATED
/s/ John F. Schaefer
By: _________________________________
John F. Schaefer
Chairman and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint John F. Schaefer and Brad LaLuzerne, and each of them, his true and
lawful attorney-in-fact and agent, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments (including post-effective
amendments) to this Registration Statement, or any related registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and
to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
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
--------- ----- ----
<S> <C> <C>
/s/ John F. Schaefer Chairman of the Board and March 30, 1999
____________________________________ Chief Executive Officer
John F. Schaefer (Principal Executive Officer)
/s/ Brad LaLuzerne Chief Financial Officer, March 30, 1999
____________________________________ Assistant Secretary and
Brad LaLuzerne Director (Principal
Accounting and Financial
Officer)
</TABLE>
II-8
<PAGE>
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 30th day of March, 1999.
APPLIED ROBOTIC TECHNOLOGIES, INC.
/s/ John F. Schaefer
By: _________________________________
John F. Schaefer
Chairman and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint John F. Schaefer and Brad LaLuzerne, and each of them, his true and
lawful attorney-in-fact and agent, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments (including post-effective
amendments) to this Registration Statement, or any related registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and
to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
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
--------- ----- ----
<S> <C> <C>
/s/ John F. Schaefer Chairman of the Board and Chief March 30, 1999
____________________________________ Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ Brad LaLuzerne Vice President, Assistant March 30, 1999
____________________________________ Secretary and Director
Brad LaLuzerne (Principal Accounting and
Financial Officer)
</TABLE>
II-9
<PAGE>
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 30th day of March, 1999.
HELIOS, INCORPORATED
/s/ John F. Schaefer
By: _________________________________
John F. Schaefer
Chairman and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint John F. Schaefer and Brad LaLuzerne, and each of them, his true and
lawful attorney-in-fact and agent, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments (including post-effective
amendments) to this Registration Statement, or any related registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and
to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
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
--------- ----- ----
<S> <C> <C>
/s/ John F. Schaefer Chairman of the Board and Chief March 30, 1999
____________________________________ Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ Brad LaLuzerne Vice President, Assistant March 30, 1999
____________________________________ Secretary and Director
Brad LaLuzerne (Principal Accounting and
Financial Officer)
</TABLE>
II-10
<PAGE>
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 30th day of March, 1999.
SANTA BARBARA METRIC, INC.
/s/ John F. Schaefer
By: _________________________________
John F. Schaefer
Chairman and Chief Executive
Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and
appoint John F. Schaefer and Brad LaLuzerne, and each of them, his true and
lawful attorney-in-fact and agent, each with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments (including post-effective
amendments) to this Registration Statement, or any related registration
statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and
to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite or necessary to be done in
connection therewith, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully
do or cause to be done by virtue hereof.
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
--------- ----- ----
<S> <C> <C>
/s/ John F. Schaefer Chairman of the Board and Chief March 30, 1999
____________________________________ Executive Officer (Principal
John F. Schaefer Executive Officer)
/s/ Brad LaLuzerne Chief Financial Officer, March 30, 1999
____________________________________ Assistant Secretary and
Brad LaLuzerne Director (Principal Accounting
and Financial Officer)
/s/ W. Dewey Hockemeyer Director March 30, 1999
____________________________________
W. Dewey Hockemeyer
</TABLE>
II-11
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Descriptions
------- ------------
<C> <S>
3.1** Amended and Restated Certificate of Incorporation of the Company.
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.
10.6** 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** Amended and Restated Securityholders Agreement dated as of August
3, 1998, among DLJ Merchant Banking Partners, L.P., DLJ
International Partners, C.V., DLJ Offshore Partners, C.V., DLJ
Merchant Banking Funding, Inc., DLJ First ESC, L.P., DLJ Capital
Corporation, Sprout Growth II, L.P., Sprout Capital VI, L.P., PM
Funding, Inc., Donaldson, Lufkin & Jenrette Securities Corporation,
ABS Capital Partners II, L.P., Arthur J. Cormier, John F. Schaefer,
The Freedland 1994 Unitrust, The Moraru 1994 Unitrust, The Le 1994
Unitrust, The Najjor Unitrust, Neil H. Brumberger, Hart H.
Brumberger, Roger D. Peters and Mary Anne Christine Peters Living
Trust, Jeffrey K. Rhoton and Yvonne H. Rhoton Living Trust,
Raymond M. Karam, Randall E. Bye, Pedro A. Aylwin, Dr. Gilbert E.
Amelio 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.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Descriptions
------- ------------
<C> <S>
10.14** Inter-Securityholder Agreement dated as of August 3, 1998 among DLJ
Merchant Banking Partners, L.P., DLJ International Partners, C.V.,
DLJ Offshore Partners, C.V., DLJ Merchant Banking Funding, Inc.,
DLJ Capital Corporation, DLJ First ESC, L.P., Sprout Growth II,
L.P., Sprout Capital VI, L.P., ABS Capital Partners II, L.P.,
Donaldson, Lufkin & Jenrette Securities Corporation, William E.
Terry, Dr. Gilbert F. Amelio and the Company.
10.15** Securities Purchase Agreement, dated as of August 3, 1998 among ABS
Capital Partners II, L.P., DLJ Merchant Banking Partners, L.P., DLJ
International Partners, C.V., DLJ Offshore Partners, C.V., DLJ
Merchant Banking Funding, Inc., DLJ Capital Corporation, Donaldson,
Lufkin & Jenrette Securities Corporation, DLJ First ESC, L.P.,
Sprout Growth II, L.P., Sprout Capital VI, L.P., Dr. Gilbert F.
Amelio, William E. Terry and the Company.
10.16* Purchase and Sale Agreement dated as of October 16, 1998, as
amended, by and between the Company and Legacy Partners Commercial,
Inc.
10.17* Lease Agreement, dated as of December 16, 1998, by and between the
Company and Legacy Partners Commercial, Inc.
12.1 Statement Regarding Computation of Ratios.
21.1** List of Subsidiaries.
23.1 Independent Auditors' Consent.
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-6, II-7,
II-8, II-9, II-10 and II-11).
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.
</TABLE>
- --------
* Incorporated by reference to the exhibits filed with the Company's Current
Report on Form 8-K filed on January 13, 1999.
** Incorporated by reference to the Exhibit indicated in the Company's
Registration Statement on Form S-4 (File No. 333-48817).
<PAGE>
EXHIBIT 12.1
PHASE METRICS, INC.
STATEMENT REGARDING COMPUTATION OF RATIOS
(IN THOUSANDS, EXCEPT RATIOS)
RATIO OF EARNINGS TO COMBINED FIXED CHARGES
AND PREFERRED STOCK DIVIDENDS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1994 1995 1996 1997 1998
---- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Earnings:
Income (loss) before income taxes and extraordinary items... $ 943 $ 6,193 $(19,842) $ (9,812) $(66,506)
Fixed charges:
Interest expense.......................................... 651 5,625 8,448 11,573 14,456
Rental expense interest factor(1)......................... 60 178 1,133 1,700 1,600
------ ------- -------- -------- --------
Total fixed charges.................................... 711 5,803 9,581 13,273 16,056
------ ------- -------- -------- --------
Earnings (loss) available to cover fixed charges.............. $1,654 $11,996 $(10,261) $ 3,461 $(50,450)
====== ======= ======== ======== ========
Combined fixed charges and preferred stock dividend
requirements................................................. $1,598 $10,390 $ 14,581 $ 18,145 $ 19,337
====== ======= ======== ======== ========
Ratio of earnings (loss) to fixed charges(2).................. 1.0x 1.2x -- -- --
====== ======= ======== ======== ========
</TABLE>
________________
(1) The portion of operating lease rental expense that is representative of the
interest factor is deemed to be one-third of total operating lease rental
expense.
(2) For the years ended December 31, 1996, 1997 and 1998, earnings were
inadequate to cover Fixed Charges by $24.8 million, $12.7 million and $69.8
million, respectively.
<PAGE>
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
To the Board of Directors and Stockholders of Phase Metrics, Inc.
We consent to the use in this Registration Statement of Phase Metrics, Inc. on
Form S-1 of our report dated February 5, 1999, appearing in the Prospectus,
which is part of this Registration Statement, and of our report dated February
5, 1999, relating to the financial statement schedule appearing elsewhere in
this Registration Statement. We also consent to the reference to us under the
heading, "Experts" in such Prospectus.
/s/ Deloitte & Touche LLP
San Jose, California
March 30, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0001061419
<NAME> PHASE METRICS, INC.
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1998
<PERIOD-START> JAN-01-1997 JAN-01-1998
<PERIOD-END> DEC-31-1997 DEC-31-1998
<CASH> 2,977 24,714
<SECURITIES> 0 0
<RECEIVABLES> 30,393 15,938
<ALLOWANCES> (1,663) (2,361)
<INVENTORY> 55,585 25,222
<CURRENT-ASSETS> 103,375 71,764
<PP&E> 49,103 38,424
<DEPRECIATION> (11,080) (20,631)
<TOTAL-ASSETS> 154,730 96,115
<CURRENT-LIABILITIES> 37,300 25,881
<BONDS> 119,272 115,257
9,237 42,543
3 3
<COMMON> 6,090 6,498
<OTHER-SE> (23,166) (103,658)
<TOTAL-LIABILITY-AND-EQUITY> 154,730 96,115
<SALES> 184,660 104,994
<TOTAL-REVENUES> 184,660 104,994
<CGS> 101,294 93,168
<TOTAL-COSTS> 101,294 93,168
<OTHER-EXPENSES> 81,131 64,215
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 11,573 14,456
<INCOME-PRETAX> (9,812) (66,506)
<INCOME-TAX> (4,268) 9,000
<INCOME-CONTINUING> (5,544) (75,506)
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 (1,345)
<CHANGES> 0 0
<NET-INCOME> (5,544) (76,851)
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
