<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JANUARY 16, 1998
REGISTRATION NO. 333-41939
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 1
TO
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
STELLEX INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 13-3971931
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)
</TABLE>
and subsidiary guarantors
TSMD ACQUISITION CORP.
STELLEX MICROWAVE SYSTEMS, INC.
KII HOLDING CORP.
KII ACQUISITION CORP.
STELLEX AEROSPACE
BANDY MACHINING INTERNATIONAL
PARAGON PRECISION PRODUCTS
SCANNING ELECTRON ANALYSIS LABORATORIES, INC.
GENERAL INSPECTION LABORATORIES, INC.
(Exact name of registrants as specified in their respective charters)
<TABLE>
<S> <C>
DELAWARE 13-3964808
CALIFORNIA 77-0465876
DELAWARE 13-3954446
DELAWARE 13-3954445
CALIFORNIA 95-4172476
CALIFORNIA 95-4294446
CALIFORNIA 95-2882883
CALIFORNIA 95-4172314
CALIFORNIA 95-3972454
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
</TABLE>
3559
(PRIMARY STANDARD INDUSTRIAL CLASSIFICATION CODE NUMBER)
------------------------
<TABLE>
<S> <C>
WILLIAM L. REMLEY
PRESIDENT AND CHIEF EXECUTIVE OFFICER
STELLEX INDUSTRIES, INC.
3333 HILLVIEW AVE. 3333 HILLVIEW AVE.
PALO ALTO, CALIFORNIA 94304-1223 PALO ALTO, CALIFORNIA 94304-1223
(650) 493-4141 (650) 493-4141
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE
INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL NUMBER,
EXECUTIVE OFFICE) INCLUDING AREA CODE, OF AGENT FOR SERVICE)
</TABLE>
COPY TO:
ROBERT W. ERICSON
DANIEL A. NINIVAGGI
WINSTON & STRAWN
200 PARK AVENUE
NEW YORK, NEW YORK 10166
(212) 294-6885
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If the Securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. / /
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE AS MAY
BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A
FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
STELLEX INDUSTRIES, INC.
CROSS-REFERENCE SHEET
PURSUANT TO ITEM 501(B) OF REGULATION S-K
<TABLE>
<CAPTION>
ITEM
NUMBER ITEM LOCATION IN PROSPECTUS
- ------ ------------------------------------------ --------------------------------------------------------------
<S> <C> <C>
1. Forepart of Registration Statement and
Outside Front Cover Page of
Prospectus.............................. Outside Front Cover Page
2. Inside Front and Outside Back Cover
Pages of Prospectus..................... Inside Front Cover Page; Outside Back
Cover Page
3. Risk Factors, Ratio of Earnings to Fixed
Charges and Other
Information............................. Summary; Risk Factors; Selected Historical Financial Data; Pro
Forma Consolidated Financial Data
4. Terms of the Transaction.................. Outside Front Cover Page; Summary; Description of Notes; The
Exchange Offer; Certain U.S. Federal Income Tax
Considerations
5. Pro Forma Financial Information........... Pro Forma Consolidated Financial Data
6. Material Contracts with the Company Being
Acquired................................ Inapplicable
7. Additional Information Required........... Inapplicable
8. Interests of Named Experts and
Counsel................................. Legal Matters; Experts
9. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................. Inapplicable
10. Information with Respect to S-3
Registrants............................. Inapplicable
11. Incorporation of Certain Information by
Reference............................... Inapplicable
12. Information with Respect to S-3 or S-2
Registrants............................. Inapplicable
13. Incorporation of Certain Information by
Reference............................... Inapplicable
14. Information with Respect to Registrants
other than S-3 or S-2 Registrants....... Outside Front Cover Page; Summary; Risk Factors;
Capitalization; Pro Forma Consolidated Financial Data;
Selected Historical Financial Data; Management's Discussion
and Analysis of Financial Condition and Results of
Operations; Business; Management; Certain Transactions;
Principal Stockholders; Description of Certain Indebtedness;
Description of Notes
15. Information with Respect to S-3
Companies............................... Inapplicable
16. Information with Respect to S-3 or S-2
Companies............................... Inapplicable
17. Information with Respect to Companies
Other than S-3 or S-2 Companies......... Inapplicable
18. Information if Proxies, Consents or
Authorizations are to be Solicited...... Inapplicable
19. Information if Proxies, Consents or
Authorizations are not to be Solicited
or in an Exchange Offer................. Management; Principal Stockholders; Certain Transactions
</TABLE>
<PAGE>
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH
STATE.
SUBJECT TO COMPLETION, DATED JANUARY 16, 1998.
PROSPECTUS
STELLEX INDUSTRIES, INC.
OFFER TO EXCHANGE $1,000 IN PRINCIPAL AMOUNT OF ITS
SERIES B 9 1/2% SENIOR SUBORDINATED NOTES DUE 2007
WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT FOR
EACH $1,000 IN PRINCIPAL AMOUNT OF ITS OUTSTANDING
9 1/2% SENIOR SUBORDINATED NOTES DUE 2007,
OF WHICH $100,000,000 PRINCIPAL AMOUNT IS OUTSTANDING
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M., NEW YORK CITY TIME,
ON , 1998, UNLESS EXTENDED.
------------------------
Stellex Industries, Inc., a Delaware corporation ('Stellex,' and together
with its direct and indirect subsidiaries, the 'Company'), hereby offers (the
'Exchange Offer'), upon the terms and conditions set forth in this Prospectus
(the 'Prospectus') and the accompanying Letter of Transmittal (the 'Letter of
Transmittal'), to exchange $1,000 principal amount of its Series B 9 1/2% Senior
Subordinated Notes due 2007 (the 'New Notes'), registered under the Securities
Act of 1933, as amended (the 'Securities Act'), pursuant to a Registration
Statement of which this Prospectus is a part, for each $1,000 principal amount
of its outstanding 9 1/2% Senior Subordinated Notes due 2007 (the 'Old Notes'),
of which $100,000,000 principal amount is outstanding. The form and terms of the
New Notes are the same as the form and terms of the Old Notes (which they
replace), except that the New Notes will bear a Series B designation and will
have been registered under the Securities Act and, therefore, will not bear
legends restricting their transfer and will not contain certain provisions
relating to the payment of Liquidated Damages (as defined herein) which were
included in the terms of the Old Notes in certain circumstances relating to the
timing of the Exchange Offer. The New Notes will evidence the same debt as the
Old Notes (which they replace) and will be issued under and be entitled to the
benefits of the Indenture, dated as of October 31, 1997 (the 'Indenture'), among
Stellex, the Subsidiary Guarantors (as defined herein) and Marine Midland Bank,
as trustee (the 'Trustee'). The Old Notes and the New Notes are sometimes
referred to herein collectively as the 'Notes.' See 'The Exchange Offer' and
'Description of Notes.'
Interest on the New Notes will be paid semi-annually on May 1 and November 1
of each year, commencing on May 1, 1998. The New Notes will mature on November
1, 2007 unless previously redeemed. The New Notes will be redeemable, in whole
or in part, at the option of Stellex, at any time on or after November 1, 2002,
at the redemption prices set forth herein, plus accrued and unpaid interest, if
any, thereon, to the date of redemption. In addition, on or prior to November 1,
2000, Stellex may redeem, at any time and from time to time, up to 35% of the
aggregate principal amount of the Notes at a redemption price of 109.50% of the
principal amount thereof, plus accrued and unpaid interest and Liquidated
Damages, if any, thereon, to the date of redemption, with the net cash proceeds
from one or more Public Equity Offerings (as defined herein); provided, however,
that at least 65% of the aggregate principal amount of the Notes originally
issued remains outstanding following each such redemption. In addition, at any
time prior to November 1, 2002, Stellex may, at its option, redeem the Notes, in
whole but not in part, at a redemption price equal to 100% of the principal
amount thereof plus the applicable Make-Whole Premium (as defined herein). Upon
the occurrence of a Change of Control (as defined herein), each holder of Notes
may require Stellex to repurchase such holder's Notes, in whole or in part, at a
repurchase price of 101% of the principal amount thereof, plus accrued and
unpaid interest and Liquidated Damages, if any, thereon, to the repurchase date.
See 'Description of Notes.' There can be no assurance that the Company will have
funds available to repurchase the Notes upon the occurrence of a Change of
Control. See 'Risk Factors--Limitation on Change of Control.'
The New Notes will be unsecured and will be subordinated in right of payment
to all existing and future senior indebtedness of Stellex. The New Notes will
rank pari passu with any future senior subordinated indebtedness of Stellex and
will rank senior to all other subordinated indebtedness of Stellex. The New
Notes will be fully and unconditionally guaranteed, jointly and severally, on an
unsecured, senior subordinated basis, by the Subsidiary Guarantors. The
Subsidiary Guarantees (as defined herein) will be general, unsecured obligations
of the Subsidiary Guarantors, subordinated in right of payment to all existing
and future senior indebtedness of the Subsidiary Guarantors. The New Credit
Facilities (as defined herein) are secured by substantially all of the Company's
assets. See 'Description of Certain Indebtedness--New Credit
Facilities--Security.' As of September 30, 1997, on a pro forma basis after
giving effect to the Transactions (as defined herein), the aggregate principal
amount of Stellex's outstanding senior indebtedness would have been
approximately $2.1 million (excluding unused commitments of approximately $47.9
million under the New Credit Facilities) and Stellex would have had no senior
subordinated indebtedness outstanding other than the Notes. As of the same date,
the aggregate principal amount of senior indebtedness of the Subsidiary
Guarantors outstanding would have been approximately $2.6 million (exclusive of
guarantees under the New Credit Facilities). As of September 30, 1997, on a pro
forma basis after giving effect to the Transactions, Stellex's total
consolidated indebtedness would have been approximately $106.5 million and its
ratio of total indebtedness to total capitalization would have been 91.4%. The
Indenture pursuant to which the New Notes will be issued permits Stellex and the
Subsidiary Guarantors to incur additional indebtedness, including senior
indebtedness, subject to certain limitations. See 'Description of Notes.'
(Continued on Next Page)
------------------------
SEE 'RISK FACTORS' BEGINNING ON PAGE 13 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED BY INVESTORS IN CONNECTION WITH THE EXCHANGE OFFER AND
AN INVESTMENT IN THE NEW NOTES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION OR REGULATORY
AUTHORITY, NOR HAS ANY SUCH COMMISSION OR REGULATORY AUTHORITY
REVIEWED 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 , 1998.
<PAGE>
(Continued from Cover Page)
Stellex will accept for exchange any and all Old Notes validly tendered and
not withdrawn prior to 5:00 p.m., New York City time on , 1998,
unless extended by Stellex in its sole discretion (the 'Expiration Date'). See
'The Exchange Offer--Expiration Date; Extensions; Amendments.' Tenders of Old
Notes may be withdrawn at any time prior to 5:00 p.m. on the Expiration Date.
The Exchange Offer is subject to certain customary conditions.
The Old Notes were sold in an aggregate principal amount of $100.0 million
by Stellex on October 31, 1997 to Societe Generale Securities Corporation, BT
Alex. Brown Incorporated and Jefferies & Company, Inc. (the 'Initial
Purchasers') in a transaction not registered under the Securities Act in
reliance upon the private offering exemption under Section 4(2) of the
Securities Act (the 'Initial Offering'). The Initial Purchasers subsequently
placed the Old Notes with qualified institutional buyers in reliance upon Rule
144A under the Securities Act and with a limited number of accredited investors
(as defined in Rule 501(A)(1), (2), (3) or (7) under the Securities Act).
Accordingly, the Old Notes may not be reoffered, resold or otherwise transferred
in the United States unless registered under the Securities Act or unless an
applicable exemption from the registration requirements of the Securities Act is
available. The New Notes are being offered hereunder in order to satisfy the
obligations of Stellex and the Subsidiary Guarantors under the Registration
Rights Agreement (as defined herein) entered into by Stellex and the Subsidiary
Guarantors in connection with the Initial Offering. See 'The Exchange Offer.'
Based on no-action letters issued by the staff of the Securities and
Exchange Commission (the 'Commission') to third parties, Stellex believes the
New Notes issued pursuant to the Exchange Offer may be offered for resale,
resold and otherwise transferred by any holder thereof (other than any such
holder that is an 'affiliate' of Stellex within the meaning of Rule 405 under
the Securities Act) without compliance with the registration and prospectus
delivery provisions of the Securities Act, provided that such New Notes are
acquired in the ordinary course of such holder's business and such holder has no
arrangement or understanding with any person to participate in the distribution
of such New Notes. See 'The Exchange Offer--Resale of the New Notes.' Each
broker-dealer (a 'Participating Broker-Dealer') that receives New Notes for its
own account pursuant to the Exchange Offer must acknowledge that it will deliver
a prospectus in connection with any resale of such New Notes, and in connection
with any such resale may be deemed to be an 'underwriter' within the meaning of
the Securities Act. The Letter of Transmittal states that by so acknowledging
and by delivering a prospectus, a Participating Broker-Dealer will not be deemed
to admit that it is an 'underwriter' within the meaning of the Securities Act.
This Prospectus, as it may be amended or supplemented from time to time, may be
used by a Participating Broker-Dealer in connection with resales of New Notes
received in exchange for Old Notes where such Old Notes were acquired by such
Participating Broker-Dealer as a result of marketmaking activities or other
trading activities. The Company has agreed that, for a period of 90 days after
the Expiration Date, it will make this Prospectus available to any Participating
Broker-Dealer for use in connection with any such resale. See 'Plan of
Distribution.'
Holders of Old Notes not tendered and accepted in the Exchange Offer will
continue to hold such Old Notes and will be entitled to all the rights and
benefits and will be subject to the limitations applicable thereto under the
Indenture and with respect to transfer under the Securities Act. Stellex will
pay all the expenses incurred by it incident to the Exchange Offer. See 'The
Exchange Offer.'
There has not previously been any public market for the Old Notes or the New
Notes. Stellex does not intend to list the New Notes on any securities exchange
or to seek approval for quotation through any automated quotation system. There
can be no assurance that an active market for the New Notes will develop. See
'Risk Factors--Lack of Public Market; Restrictions on Transferability.'
Moreover, to the extent that Old Notes are tendered and accepted in the Exchange
Offer, the trading market for untendered and tendered but unaccepted Old Notes
could be adversely affected.
The New Notes will be available initially only in book-entry form and
Stellex expects that the New Notes issued pursuant to the Exchange Offer will be
issued in the form of a Global Note (as defined herein), which will be deposited
with, or on behalf of, The Depository Trust Company ('DTC') and registered in
its name or in the name of Cede & Co., its nominee. Beneficial interests in the
Global Note representing the New Notes will be shown on, and transfers thereof
will be effected through, records maintained by DTC and its participants. After
the initial issuance of the Global Note, New Notes in certificated form will be
issued in exchange for the Global Note only under the limited circumstances set
forth in the Indenture. See 'Description of Notes--Book-Entry, Delivery and
Form.'
<PAGE>
AVAILABLE INFORMATION
Stellex and the Subsidiary Guarantors have filed with the Commission a
Registration Statement on Form S-4 (the 'Exchange Offer Registration Statement,'
which term shall encompass all amendments, exhibits, annexes and schedules
thereto) pursuant to the Securities Act, and the rules and regulations
promulgated thereunder, covering the New Notes being offered hereby. This
Prospectus does not contain all the information set forth in the Exchange Offer
Registration Statement. For further information with respect to the Company and
the Exchange Offer, reference is made to the Exchange Offer Registration
Statement. Statements made in this Prospectus as to the contents of any
contract, agreement or other document referred to are not necessarily complete.
With respect to each such contract, agreement or other document filed as an
exhibit to the Exchange Offer Registration Statement, reference is made to the
exhibit for a more complete description of the document or matter involved, and
each such statement shall be deemed qualified in its entirety by such reference.
The Exchange Offer Registration Statement, including the exhibits thereto, can
be inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, at the
Regional Offices of the Commission at 7 World Trade Center, 13th Floor, New
York, New York 10048 and at Citicorp Center, 500 West Madison Street, Suite
1400, Chicago, Illinois 60661. Copies of such materials can be obtained from the
Public Reference Section of the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission maintains a World
Wide Web site that contains reports, proxy and information statements and other
information regarding registrants that file electronically with the Commission.
The address of such site is http://www.sec.gov.
As a result of the filing of the Exchange Offer Registration Statement with
the Commission, Stellex and the Subsidiary Guarantors will become subject to the
informational requirements of the Securities Exchange Act of 1934, as amended
(the 'Exchange Act'), and in accordance therewith will be required to file
periodic reports and other information with the Commission. The obligation of
Stellex and the Subsidiary Guarantors to file periodic reports and other
information with the Commission will be suspended if the Notes are held of
record by fewer than 300 holders as of the beginning of any fiscal year of
Stellex and the Subsidiary Guarantors other than the fiscal year in which the
Exchange Offer Registration Statement is declared effective. Stellex has agreed
that, whether or not it is required to do so by the rules and regulations of the
Commission, for so long as any of the Notes remain outstanding, it will furnish
to the holders of the Notes and file with the Commission (unless the Commission
will not accept such a filing) (i) all quarterly and annual financial
information that would be required to be contained in a filing with the
Commission on Forms 10-Q and 10-K if Stellex 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 Stellex's independent auditors and (ii) all current reports
that would be required to be filed with the Commission on Form 8-K if Stellex
were required to file such reports.
FORWARD-LOOKING STATEMENTS
THIS PROSPECTUS CONTAINS CERTAIN 'FORWARD-LOOKING STATEMENTS' CONCERNING
THE COMPANY'S OPERATIONS, OPERATING PERFORMANCE AND FINANCIAL CONDITION, WHICH
ARE SUBJECT TO INHERENT UNCERTAINTIES AND RISKS, INCLUDING THOSE IDENTIFIED
UNDER 'RISK FACTORS.' ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE
ANTICIPATED IN THIS PROSPECTUS. WHEN USED IN THIS PROSPECTUS, THE WORDS
'ESTIMATE,' 'PROJECT,' 'ANTICIPATE,' 'EXPECT,' 'INTEND,' 'BELIEVE' AND SIMILAR
EXPRESSIONS ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
i
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified by, and should be read in conjunction
with, the more detailed information and consolidated financial statements,
including the notes thereto, appearing elsewhere in this Prospectus. As used in
this Prospectus, unless the context otherwise requires, 'Stellex' refers to
Stellex Industries, Inc. (successor to Kleinert Industries, Inc.), the issuer of
the Notes, and the 'Company' refers to Stellex and its direct and indirect
subsidiaries. On October 31, 1997, Stellex acquired the tactical subsystems and
microwave devices businesses of Watkins-Johnson Company (the 'W-J Acquisition').
The W-J Acquisition, the Kleinert Acquisition (as defined), the Initial Offering
and the application of the net proceeds therefrom, and the consummation of the
New Credit Facilities (as defined) and the incurrence of $2.1 million of
indebtedness thereunder to partially fund the transactions described under
'--The Initial Offering--Notes,' are hereinafter referred to as the
'Transactions.' Stellex is a holding company, all of whose operations are
conducted through its operating subsidiaries. All references to historical
financial information contained herein are references to financial information
as reported in the historical financial statements of TSMD (as defined) and
Kleinert (as defined), as the case may be. Unless otherwise specified, pro forma
financial information and references to the Company's business or operations
contained in this Prospectus give effect to the Transactions. See Appendix I for
a glossary of definitions of certain technical or industry terms used herein.
THE COMPANY
The Company, through its subsidiaries Stellex Microwave Systems, Inc.
('Stellex Microwave') and Stellex Aerospace ('Stellex Aerospace'), is a leading
provider of highly engineered subsystems and components for the aerospace,
defense and space industries. Stellex Microwave is a worldwide leader in the
design, manufacture and marketing of fully integrated and proprietary microwave
electronic subsystems for radar-guided tactical missile systems and a broad line
of high radio frequency and microwave frequency single function modules. Stellex
Microwave products are used in the generation, reception and translation of
communication, data and radar signals. Stellex Aerospace is a leader in the
machining of turbomachinery, aircraft hinges and other structural components for
the aerospace and space industries. For the year ended December 31, 1996 and the
nine months ended September 30, 1997, after giving pro forma effect to the
Transactions, the Company would have had sales of $113.5 million and $91.1
million, respectively, net income (loss) of ($9.4) million and $1.4 million,
respectively, and Adjusted EBITDA (as defined) of $15.2 million and $16.9
million, respectively. See Note (a) to 'Selected Historical Financial
Data--Stellex' for further information regarding EBITDA. For the year ended
December 31, 1996, after giving pro forma effect to the Transactions, the
Company's earnings would have been insufficient to cover fixed charges by
approximately $10.6 million; for the nine months ended September 30, 1997, after
giving pro forma effect to the Transactions, the Company's ratio of earnings to
fixed charges would have been 1.1x. As of September 30, 1997, after giving pro
forma effect to the Transactions, the Company would have had $99.8 million in
order backlog. A substantial amount of the Company's order backlog can be
canceled at any time without penalty, except, in some cases, the recovery of the
Company's actual committed costs and profit on work performed up until the date
of cancellation. See 'Risk Factors--Backlog.'
The Company's objective is to provide extensive engineering, low cost
manufacturing and systems integration to the consolidated base of original
equipment manufacturers ('OEMs') within its industries. The Company believes
that it is well positioned to benefit from certain trends in its markets
including increases in the production of high-priority platforms, airframes and
spare parts, the use of sophisticated electronics, the consolidation of OEM
suppliers, and the outsourcing of subsystems.
STELLEX MICROWAVE
Stellex Microwave is a worldwide leader in the design, manufacture and
marketing of proprietary microwave electronic subsystems for use in radar-guided
munitions and signal intelligence equipment. As the largest independent supplier
of microwave subsystems for tactical missiles, Stellex Microwave's products are
critical to the onboard navigation, communications and target location systems
of many of the highest priority missile systems developed by the United States
Department of Defense (the 'DoD'). The Company's proprietary products, low cost
manufacturing and extensive engineering capabilities have enabled it to become
the sole or primary source for the principal programs it supplies. These
programs include the Advanced Medium Range Air-to-Air Missile ('AMRAAM'), the
Patriot missile and the Standard Missile, the most widely used radar-guided
missiles of their type in the U.S. armed forces. In addition, the Company is
currently participating in
1
<PAGE>
production programs for the AEGIS radar system and the TARTAR fire control
system, and has been recently selected to participate in the program to produce
the Longbow Hellfire missile, one of the U.S. Army's most significant new
missile systems.
Stellex Microwave is also a leading manufacturer of multi-function modules
('MFMs') and of single function modules ('SFMs'), such as high radio frequency
mixers, amplifiers, tuners, converters, filters and oscillators, which are sold
to system designers and manufacturers. Stellex Microwave has provided the
intelligence, electronic warfare, space and communication markets with a broad
assortment of such devices since 1957. For the year ended December 31, 1996 and
the nine months ended September 30, 1997, Stellex Microwave had sales of $89.2
million and $67.9 million, respectively.
STELLEX AEROSPACE
Stellex Aerospace is a leading provider of high precision products and
services to certain niche markets within the aerospace and space industries.
Through Bandy Machining International ('Bandy'), Stellex Aerospace is the
world's leading contract manufacturer of commercial and military precision
aircraft hinges. Hinges manufactured by Bandy, some types of which are produced
exclusively by Bandy, are installed on every type of aircraft currently produced
by the leading aircraft OEMs, including The Boeing Company ('Boeing'), McDonnell
Douglas Corporation ('McDonnell Douglas'), Airbus Industrie ('Airbus'), Lockheed
Martin Corporation ('Lockheed Martin'), and Northrop Grumman Corporation
('Northrop Grumman'). Through Paragon Precision Products ('Paragon'), Stellex
Aerospace is a leader in the machining of complex turbomachinery. Paragon's
flexible manufacturing operations permit the production of both (i) highly
engineered, close tolerance prototype components, which are generally
manufactured from expensive, exotic alloys and are found in high performance gas
turbine engines and liquid fuel rocket engines, and (ii) higher volume standard
components used in aircraft and industrial power actuation systems and high
performance turbine engines. Through Scanning Electron Analysis Laboratories,
Inc. ('SEAL') and General Inspection Laboratories, Inc. ('GIL'), Stellex
Aerospace also provides a comprehensive range of services for testing of
sophisticated manufactured aerospace components. For the year ended December 31,
1996 and the nine months ended September 30, 1997 (collectively comprised of
Kleinert (predecessor) sales for the six months ended June 30, 1997 and Stellex
(successor) for the three months ended September 30, 1997), Stellex Aerospace
had sales of $24.3 million and $23.2 million, respectively.
COMPETITIVE STRENGTHS
The Company believes that its competitive position in the markets it serves
is based on superior product design and performance and a consistent record of
meeting rigorous DoD and OEM contract performance criteria. Specifically, the
Company believes that its position is primarily attributable to the following
competitive strengths:
Strong Partnering Relationships with Major OEMs. As an incumbent preferred
supplier on high-priority, long-term programs, the Company has over many years
solidified its relationships with major OEMs. The Company participates in
concurrent design, engineering and development of new programs and provides cost
and performance enhancement for existing programs. Stellex Microwave often
serves as the sole source supplier of mission-critical subsystems to Hughes
Missile Systems Company ('Hughes'), Raytheon Company ('Raytheon'), Rockwell
International Corporation ('Rockwell'), Boeing and Lockheed Martin. Stellex
Microwave was selected by Hughes as subcontractor of the year for each of 1994,
1995 and 1996. Paragon is a preferred supplier, often as a sole or primary
source, of a variety of turbomachinery and turbine engine components to such
OEMs as AlliedSignal, Inc. ('AlliedSignal'), Aerojet General Corporation
('Aerojet') (a subsidiary of GenCorp, Inc.) and the Rocketdyne division of
Boeing ('Rocketdyne'). Bandy also has received the highest quality awards from,
and is a preferred supplier to, many of its customers, including Boeing,
McDonnell Douglas, Airbus, Lockheed Martin, and Northrop Grumman.
Integration Leadership. Stellex Microwave has developed proprietary
technology, products and manufacturing processes which integrate the electronic
functions as well as the mechanical and packaging requirements of microwave
subsystems into 'snap-together' designs that eliminate the need for expensive
and less reliable external cables and connectors. The Company's proprietary
packaging and substrate materials and manufacturing processes were developed
over a period of many years and are instrumental in the superior
2
<PAGE>
performance of its integrated microwave subsystems. The Company believes that
the leading edge technology and manufacturing processes which it has developed
for high production volume missile subsystems will provide a significant
competitive advantage in developing integrated products for certain commercial
markets.
Low Cost Manufacturing. By following systematic design parameters that
balance the need for multi-functionality, cost reduction and reliability and by
using a modularized automated manufacturing process, the Company is able to
manufacture subsystems in high volume and achieve the highest percentage of
usable product in its industry. The Company believes that its manufacturing
processes enable it to reduce unit costs and shorten development and production
cycles, thereby providing the Company with a significant cost advantage in
competing for high volume subsystem programs.
Reputation for High Quality. The Company's individual microwave devices
are well known among designers of high performance electronic equipment, and the
catalogs used by Stellex Microwave have been standard reference materials since
1978. Paragon is one of five companies in the United States which competes for
and produces sophisticated, close tolerance machined prototypes of rotating
turbine components for use in aircraft jet engines and other components for use
in spacecraft rocket engines. Management believes that the 'Bandy' name is the
most recognized name in precision aircraft hinges in the world. GIL is one of
the leading independent, full-service non-destructive testing ('NDT')
laboratories in the United States. SEAL is one of three companies in the United
States approved by the National Aeronautics and Space Administration ('NASA') to
perform destructive physical analysis on high-reliability space electronic
components.
INDUSTRY TRENDS
United States defense budget appropriations are forecasted to remain
relatively constant or increase slightly in the near term, reversing the recent
decline in spending which precipitated the dramatic consolidation among prime
contractors. In order to enhance readiness and modernize their forces, military
agencies are expected to continue to maximize resources by modifying and
upgrading existing systems and platforms and relying upon sophisticated
electronic equipment for existing and new systems. In furtherance of their
objectives, agencies are expected to require enhanced performance and cost
reductions from their prime contractors. The Company believes that this cost and
technology pressure will cause continued consolidation of the defense industry's
supply base and cause prime contractors to (i) focus on the design and
manufacture of overall weapon systems and (ii) outsource the manufacture and
integration of subsystems to independent commercially-oriented suppliers. The
Company believes that the current procurement environment favors the Company's
proprietary design and manufacturing processes, which are characterized by
limited reliance on government funded research and development.
The Company believes that current trends in the aerospace industry are
favorable for both the consolidated OEMs and their preferred suppliers.
According to the Boeing Commercial Airplane Group 1997 Current Market Outlook
(the 'Boeing Report'), expenditures on new aircraft production, revenue
passenger miles and the worldwide fleet of aircraft have all increased in recent
years and are projected to grow further over the next five years. In addition,
military procurements for aircraft replacement parts and components are expected
to increase as a result of an aging fleet of aircraft and generally low
inventory levels. Management believes that these factors will benefit aerospace
industry preferred suppliers, such as the Company, that were able to withstand
the difficult operating environment of the early 1990s.
BUSINESS STRATEGY
The Company's objective is to strengthen its position as a leading supplier
of highly engineered subsystems and components to its customers in the
aerospace, defense and space industries and to expand its business to contiguous
commercial markets. The following are the key strategies the Company intends to
employ to achieve this objective:
Exploit Outsourcing Trend. The Company estimates that approximately 50% of
the subsystems used on all types of radar-guided missiles are still produced
internally by OEMs. The Company believes it is well positioned to compete
effectively for this remaining in-house production by capitalizing on its
proprietary products and low cost manufacturing processes. For example, Stellex
Microwave has increased its share of the individual microwave subsystems onboard
the AMRAAM from approximately 50% in 1992 to over 90% in 1997. Many of these
AMRAAM subsystems had previously been produced by the in-house microwave
component groups of
3
<PAGE>
Hughes and Raytheon. In addition, the design of one of the Company's subsystems
produced for the Standard Missile was incorporated in the 1997 Raytheon design
of the Advanced Sea Sparrow missile. Overall program costs of these missiles
were substantially reduced as a result of this outsourcing. The Company also
believes that it has opportunities to capture new business in the commercial
aerospace industry as a result of additional outsourcing.
Capture Share in Commercial Markets. The Company believes that its
experience and expertise in high frequency microwave subsystem integration
provide it with significant opportunities to develop integrated products for
commercial applications. The Company's current defense and aerospace customers
are also the world's largest manufacturers of satellites. These manufacturers
currently purchase subsystems for their defense platforms but only purchase SFMs
for space applications. Using its existing technologies, the Company intends to
modify and market MFMs and, eventually, entire microwave subsystems for space
applications to supplement or replace such SFM sales.
Leverage Prototype Expertise. The Company will seek to gain a larger share
of the production volume for turbomachinery parts for which it develops the
prototype. In response to customer requests, the Company has, and plans to
continue to, selectively increase its production capacity such that it can
manufacture efficiently at higher volumes.
Acquire Selected Businesses. The Company anticipates that the
consolidation of the historically fragmented aerospace component manufacturing
industry will provide opportunities for selective acquisitions. In addition, in
response to growing demand for microwave products, the Company will pursue
selective acquisitions that can broaden its microwave product offering or
provide it with enhanced technological or strategic capabilities. Such
acquisitions offer the opportunity to broaden the Company's product lines and
manufacturing capabilities, diversify its customer base, improve its absorption
of corporate overhead and enhance its attractiveness as a leading supplier to
OEMs in the aerospace, defense and space industries.
THE TRANSACTIONS
On July 1, 1997, KII Holding Corp. ('KII Holding'), through a wholly-owned
subsidiary, acquired (the 'Kleinert Acquisition') all of the issued and
outstanding capital stock of Kleinert Industries, Inc. ('Kleinert') (currently
Stellex Aerospace) for approximately $26.5 million (including the assumption of
$2.6 million of indebtedness and the issuance to the seller of a note for
approximately $1.75 million). The Company, which was formed in September 1997,
currently owns approximately 80% of the issued and outstanding common stock of
KII Holding, with Stellex Aerospace's management holding the remainder of its
outstanding common stock. See 'Certain Transactions--The Kleinert Acquisition.'
On October 31, 1997, the Company, through a wholly-owned subsidiary,
acquired (the 'W-J Acquisition' and, together with the Kleinert Acquisition, the
'Acquisitions') the tactical subsystems and microwave devices businesses of
Watkins-Johnson ('TSMD') for a net purchase price of approximately $82.2 million
(after giving effect to estimated purchase price adjustments). The W-J
Acquisition was consummated simultaneously with the consummation of the Initial
Offering. See 'Certain Transactions--The W-J Acquisition.'
In connection with the consummation of the Initial Offering, the Company
entered into the New Credit Facilities, which provide for borrowing
availability, subject to certain conditions, in an outstanding principal amount
of up to $50 million. A substantial portion of the net proceeds to the Company
from the Initial Offering, together with borrowings under the New Credit
Facilities, was used to fund the W-J Acquisition and refinance indebtedness
incurred in connection with the Kleinert Acquisition.
Mentmore Holdings Corporation ('Mentmore'), a privately-held investment and
management company, currently provides management services to the Company. See
'Certain Transactions.'
------------------
The Company's principal executive offices are located at 3333 Hillview
Avenue, Palo Alto, California 94304-1223. Its telephone number at that location
is (650) 493-4141. Stellex was incorporated in Delaware on September 5, 1997.
4
<PAGE>
THE INITIAL OFFERING
Notes
Pursuant to a Purchase Agreement dated as of October 23, 1997 (the
'Purchase Agreement'), the Company sold Old Notes in an aggregate principal
amount of $100.0 million to the Initial Purchasers on October 31, 1997. The
Initial Purchasers subsequently resold the Old Notes purchased from the Company
to qualified institutional buyers pursuant to Rule 144A under the Securities Act
and to certain accredited investors (as defined in Rule 501(A)(1), (2), (3) or
(7) under the Securities Act). A substantial portion of the net proceeds from
the Initial Offering, estimated to have been approximately $92.3 million after
deducting discounts to the Initial Purchasers and estimated expenses relating to
the consummation of the Transactions, together with initial borrowings under the
New Credit Facilities, were used to repay certain indebtedness incurred in
connection with the Kleinert Acquisition and to finance the W-J Acquisition.
Specifically, the Company used a portion of the net proceeds of the Initial
Offering to (i) repay $17.2 million of principal and $42,000 of accrued interest
under that certain Credit Agreement dated as of July 1, 1997 (the 'Prior Credit
Agreement') between KII Holding (as defined) and Societe Generale, under which
borrowings bore interest at an average rate of 7.7% per annum as of October 31,
1997; (ii) repay $2.5 million of principal and $20,000 of accrued interest under
the Trinity Note (as defined), under which borrowings bore interest at an
average rate of 10% per annum as of October 31, 1997; and (iii) finance the W-J
Acquisition for a net purchase price of approximately $82.2 million.
Registration Rights Agreement
Pursuant to the Purchase Agreement, the Company, the Subsidiary Guarantors
and the Initial Purchasers entered into a Registration Rights Agreement dated as
of October 31, 1997 (the 'Registration Rights Agreement'), which grants the
holders of the Old Notes certain exchange and registration rights. The Exchange
Offer is intended to satisfy such exchange rights which terminate upon the
consummation of the Exchange Offer.
THE EXCHANGE OFFER
<TABLE>
<S> <C>
Securities Offered........................ $100,000,000 aggregate principal amount of 9 1/2% Senior Subordinated
Notes due 2007 of the Company.
The Exchange Offer........................ $1,000 principal amount of New Notes in exchange for each $1,000
principal amount of Old Notes. As of the date hereof, $100,000,000
aggregate principal amount of Old Notes are outstanding. The Company
will issue the New Notes to holders on or promptly after the
Expiration Date.
Based on an interpretation by the staff of the Commission set forth
in no-action letters issued to third parties, the Company believes
that New Notes issued pursuant to the Exchange Offer in exchange for
Old Notes may be offered for resale, resold and otherwise transferred
by any holder thereof (other than any such holder which is an
'affiliate' of the Company within the meaning of Rule 405 under the
Securities Act) without compliance with the registration and
prospectus delivery provisions of the Securities Act, provided that
such New Notes are acquired in the ordinary course of such holder's
business and that such holder does not intend to participate and has
no arrangement or understanding with any person to participate in the
distribution of such New Notes. Each holder accepting the Exchange
Offer is required to represent to the Company in the Letter of
Transmittal that, among other things, the New Notes will be acquired
by the holder in the ordinary course of business and the holder does
not intend to participate and has no arrangement or understanding
with any person to participate in the distribution of such New Notes.
Any Participating Broker-Dealer that acquired Old Notes for its own
account as a result of market-making activities or other trading
</TABLE>
5
<PAGE>
<TABLE>
<S> <C>
activities may be a statutory underwriter. Each Participating Broker-
Dealer that receives New Notes for its own account pursuant to the
Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes, and in connection with
any such resale may be deemed to be an 'underwriter' within the
meaning of the Securities Act. The Letter of Transmittal states that
by so acknowledging and by delivering a prospectus, a Participating
Broker-Dealer will not be deemed to admit that it is an 'underwriter'
within the meaning of the Securities Act. This Prospectus, as it may
be amended or supplemented from time to time, may be used by a
Participating Broker-Dealer in connection with resale of New Notes
received in exchange for Old Notes where such Old Notes were acquired
by such Participating Broker-Dealer as a result of market-making
activities or other trading activities. The Company has agreed that,
for a period of 90 days after the Expiration Date, it will make this
Prospectus available to any Participating Broker-Dealer for use in
connection with any such resale. See 'Plan of Distribution.'
Any holder who tenders in the Exchange Offer with the intention to
participate, or for the purpose of participating, in a distribution
of the New Notes could not rely on the position of the staff of the
Commission enunciated in no-action letters and, in the absence of an
exemption therefrom, must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with any
resale transaction Failure to comply with such requirements in such
instance may result in such holder incurring liability under the
Securities Act for which the holder is not indemnified by the
Company.
Minimum Condition......................... The Exchange Offer is not conditioned upon any minimum aggregate
principal amount of Old Notes being tendered or accepted for
exchange.
Expiration Date........................... 5:00 p.m., New York City time, on , 1998 unless the
Exchange Offer is extended, in which case the term 'Expiration Date'
means the latest date and time to which the Exchange Offer is
extended. See 'The Exchange Offer--Expiration Date; Extensions;
Amendments.'
Conditions to the Exchange Offer.......... The Exchange Offer is subject to certain customary conditions, which
may be waived by the Company. See 'The Exchange Offer--Conditions.'
The Company reserves the right to terminate or amend the Exchange
Offer at any time prior to the Expiration Date upon the occurrence of
any such condition.
Procedures for Tendering Old Notes........ Each holder of Old Notes wishing to accept the Exchange Offer must
complete, sign and date the accompanying Letter of Transmittal, or a
facsimile thereof, in accordance with the instructions contained
herein and therein, and mail or otherwise deliver such Letter of
Transmittal, or such facsimile, or an Agent's Message (as defined) in
connection with a book entry transfer together with the Old Notes and
other required documentation to the Exchange Agent (as defined) at
the addresss set forth herein. By executing the Letter of
Transmittal, each holder will represent to the Company that, among
other things, the New Notes acquired pursuant to the Exchange Offer
are being obtained in the ordinary course of business of the person
receiving such New Notes, whether
</TABLE>
6
<PAGE>
<TABLE>
<S> <C>
or not such person is the holder, and that neither the holder nor any
such other person (i) has any arrangement or understanding with any
person to participate in the distribution of such New Notes, (ii) is
engaging or intends to engage in the distribution of such New Notes,
or (iii) is an 'affiliate,' as defined under Rule 405 of the
Securities Act, of the Company. See 'The Exchange Offer--Purpose and
Effect of the Exchange Offer' and '--Procedures for Tendering.'
Untendered Old Notes...................... Following the consummation of the Exchange Offer, holders of Old
Notes eligible to participate but who do not tender their Old Notes
will not have any further exchange rights and such Old Notes will
continue to be subject to certain restrictions on transfer.
Accordingly, the liquidity of the market for such Old Notes could be
adversely affected.
Consequences of Failure
to Exchange............................. The Old Notes that are not exchanged pursuant to the Exchange Offer
will remain restricted securities. Accordingly, such Old Notes may be
resold only (i) to the Company, (ii) pursuant to Rule 144A or Rule
144 under the Securities Act or pursuant to some other exemption
under the Securities Act, (iii) outside the United States to a
non-U.S. person pursuant to the requirements of Rule 904 under the
Securities Act, or (iv) pursuant to an effective registration
statement under the Securities Act. See 'The Exchange Offer--
Consequences of Failure to Exchange.'
Shelf Registration Statement.............. If (i) changes in the law or the applicable interpretations of the
staff of the Commission do not permit the Company to effect the
Exchange Offer or (ii) any holder (A) is not eligible to participate
in the Exchange Offer, (B) participates in the Exchange Offer and
does not receive freely transferable New Notes in exchange for
tendered Old Notes or (C) is a broker-dealer that holds Notes
acquired directly from the Company or one of its affiliates, the
Company and the Subsidiary Guarantors will (i) file a shelf
registration statement (the 'Shelf Registration Statement') on or
prior to the 30th day after such filing obligation arises to cover
resales of Transfer Restricted Securities (as defined) covering
resales of the Old Notes, (ii) use their respective reasonable best
efforts to cause the Shelf Registration Statement to be declared
effective under the Securities Act on or prior to 60 days after such
obligation arises and (iii) use their respective reasonable best
efforts to keep effective the Shelf Registration Statement until two
years after its effective date, subject to certain exceptions,
including suspending the effectiveness thereof for certain valid
business reasons. For purposes of the foregoing, 'Transfer Restricted
Securities' means each Note until the earliest to occur of (i) the
date on which such Note has been exchanged for a freely tradeable New
Note in the Exchange Offer, (ii) the date on which such Note has been
effectively registered under the Securities Act and disposed of in
accordance with the Shelf Registration Statement or (iii) the date on
which such Note is distributed to the public pursuant to Rule 144
under the Securities Act or is saleable pursuant to Rule 144(k) under
the Securities Act. A holder of the Old Notes that sells such Old
Notes pursuant to the Shelf Registration Statement generally would be
required to be named as a selling security holder in the related
prospectus and to deliver a prospectus to purchasers, will be subject
to certain of the
</TABLE>
7
<PAGE>
<TABLE>
<S> <C>
civil liability provisions under the Securities Act in connection
with such sales and will be bound by the provisions of the
Registration Rights Agreement which are applicable to such a holder
(including certain indemnification obligations).
Special Procedures for Beneficial
Owners.................................. Any beneficial owner whose Old Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and
who wishes to tender should contact such registered holder promptly
and instruct such registered holder to tender on such beneficial
owner's behalf. If such beneficial owner wishes to tender on such
owner's own behalf, such owner must, prior to completing and
executing the Letter of Transmittal and delivering its Old Notes,
either make appropriate arrangements to register ownership of the Old
Notes in such owner's name or obtain a properly completed bond power
from the registered holder. The transfer of registered ownership may
take considerable time. The Company will keep the Exchange Offer open
for not less than twenty business days in order to provide for the
transfer of registered ownership.
Guaranteed Delivery Procedures............ Holders of Old Notes who wish to tender their Old Notes and whose Old
Notes are not immediately available or who cannot deliver their Old
Notes, the Letter of Transmittal or any other documents required by
the Letter of Transmittal to the Exchange Agent (or comply with the
procedures for book-entry transfer) prior to the Expiration Date must
tender their Old Notes according to the guaranteed delivery
procedures set forth in 'The Exchange Offer--Guaranteed Delivery
Procedures.'
Withdrawal Rights......................... Tenders may be withdrawn at any time prior to 5:00 p.m., New York
City time, on the Expiration Date.
Acceptance of Old Notes and Delivery of
New Notes............................... The Company will accept for exchange any and all Old Notes which are
properly tendered in the Exchange Offer prior to 5:00 p.m., New York
City time, on the Expiration Date. The New Notes issued pursuant to
the Exchange Offer will be delivered promptly following the
Expiration Date. See 'The Exchange Offer--Terms of the Exchange
Offer.'
Use of Proceeds........................... There will be no cash proceeds to the Company from the exchange
pursuant to the Exchange Offer.
Exchange Agent............................ Marine Midland Bank.
</TABLE>
8
<PAGE>
THE NEW NOTES
<TABLE>
<S> <C>
General................................... The form and terms of the New Notes are the same as the form and
terms of the Old Notes (which they replace) except that (i) the New
Notes bear a Series B designation, (ii) the New Notes have been
registered under the Securities Act and, therefore, will not bear
legends restricting the transfer thereof, and (iii) the holders of
New Notes will not be entitled to certain rights under the
Registration Rights Agreement, including the provisions providing for
an increase in the interest rate on the Old Notes in certain
circumstances relating to the timing of the Exchange Offer, which
rights will terminate when the Exchange Offer is consummated. See
'The Exchange Offer--Purpose and Effect of the Exchange Offer.' The
New Notes will evidence the same debt as the Old Notes and will be
entitled to the benefits of the Indenture. See 'Description of
Notes.' The Old Notes and the New Notes are referred to collectively
herein as the 'Notes.'
Issuers................................... Stellex Industries, Inc., the issuer of the Notes, and TSMD
Acquisition Corp., Stellex Microwave Systems, Inc., KII Holding
Corp., KII Acquisition Corp., Stellex Aerospace, Bandy Machining
International, Paragon Precision Products, Scanning Electron Analysis
Laboratories, Inc. and General Inspection Laboratories, Inc., as
guarantors of the Notes. See 'Description of Notes--Guarantees.'
Securities Offered........................ $100,000,000 principal amount of Series B 9 1/2% Senior Subordinated
Notes due 2007.
Maturity Date............................. November 1, 2007.
Interest Payment Dates.................... Interest will accrue on the New Notes from the most recent date to
which interest on the Notes has been paid or, if no interest has been
paid, from October 31, 1997, and will be payable semi-annually on
each May 1 and November 1, commencing May 1, 1998.
Optional Redemption....................... The New Notes will be redeemable, in whole or in part, at the option
of Stellex, at any time on or after November 1, 2002, at the
redemption prices set forth herein, plus accrued and unpaid interest,
if any, thereon, to the date of redemption. In addition, on or prior
to November 1, 2000, Stellex may redeem, at any time and from time to
time, up to 35% of the aggregate principal amount of the Notes at a
redemption price of 109.50% of the principal amount thereof, plus
accrued and unpaid interest and Liquidated Damages, if any, thereon,
to the date of redemption, with the net cash proceeds of one or more
Public Equity Offerings (as defined); provided, however, that at
least 65% of the aggregate principal amount of the Notes originally
issued remains outstanding following each such redemption. In
addition, at any time prior to November 1, 2002, Stellex may, at its
option, redeem the Notes, in whole but not in part, at a redemption
price equal to 100% of the principal amount thereof plus the
applicable Make-Whole Premium (as defined). See 'Description of
Notes--Optional Redemption.'
Subsidiary Guarantees..................... The New Notes will be fully and unconditionally guaranteed, jointly
and severally (the 'Subsidiary Guarantees'), on an unsecured, senior
subordinated basis, by each of Stellex's Subsidiaries existing on the
date of issuance of the New Notes and by each Subsidiary of Stellex
(other than Unrestricted Subsidiaries and Foreign Subsidiaries (as
defined)) created or acquired thereafter (collectively, the
'Subsidiary Guarantors'). See 'Description of Notes--Guarantees.'
</TABLE>
9
<PAGE>
<TABLE>
<S> <C>
Ranking................................... The New Notes will be unsecured and will be subordinated in right of
payment to all existing and future senior indebtedness of Stellex.
The New Notes will rank pari passu with any future senior
subordinated indebtedness of Stellex and will rank senior to all
other subordinated indebtedness of Stellex. The Subsidiary Guarantees
will be general, unsecured obligations of the Subsidiary Guarantors,
subordinated in right of payment to all existing and future senior
indebtedness of the Subsidiary Guarantors. As of September 30, 1997,
on a pro forma basis after giving effect to the Transactions, the
aggregate principal amount of Stellex's outstanding senior
indebtedness would have been approximately $2.1 million (excluding
unused commitments) and Stellex would have had no senior subordinated
indebtedness outstanding other than the Notes. As of the same date,
on a pro forma basis after giving effect to the Transactions, the
aggregate principal amount of senior indebtedness of the Subsidiary
Guarantors outstanding would have been approximately $2.6 million
(exclusive of guarantees of the New Credit Facilities, under which
the Company would have had approximately $47.9 million of total
borrowing availability and approximately $2.1 million outstanding).
See 'Description of Notes--Ranking and Subordination.'
Restrictive Covenants..................... The Indenture contains certain covenants pertaining to Stellex and
its Restricted Subsidiaries (as defined), including, but not limited
to, covenants with respect to the following matters: (i) limitations
on indebtedness and preferred stock; (ii) limitations on restricted
payments such as dividends, repurchases of Stellex's or subsidiaries'
stock, repurchases of subordinated obligations, and investments;
(iii) limitations on restrictions on distributions from subsidiaries;
(iv) limitations on sales of assets and of stock of subsidiaries; (v)
limitations on transactions with affiliates; (vi) limitations on
liens; and (vii) limitations on mergers, consolidations and transfers
of all or substantially all assets. However, all of these covenants
are subject to a number of important qualifications and exceptions.
See 'Description of Notes--Certain Covenants.'
Change of Control......................... Upon a Change of Control (as defined), each holder of New Notes may
require Stellex to repurchase any or all outstanding New Notes owned
by such holder at 101% of the principal amount thereof, plus accrued
and unpaid interest, if any, thereon, to the date of repurchase. See
'Description of Notes--Change of Control.' There can be no assurance
that the Company will have funds available to repurchase the Notes
upon the occurrence of a Change of Control. See 'Risk
Factors--Limitation on Change of Control.'
Registration Rights....................... Pursuant to the Registration Rights Agreement, Stellex and the
Subsidiary Guarantors agreed to (i) file, within 45 days of the
closing date of the Initial Offering, a registration statement (the
'Exchange Offer Registration Statement' and, together with the Shelf
Registration Statement, the 'Registration Statements') with respect
to an offer to exchange the Old Notes for New Notes of Stellex with
terms substantially identical to the Old Notes, (ii) cause such
Exchange Offer Registration Statement to be declared effective within
120 days after the closing date of the Initial Offering and (iii)
consummate the Exchange Offer within 165 days after the closing date
of the Initial Offering. In addition, under certain circumstances the
Company may be required to file a Shelf Registration Statement. In
the event that (i) the applicable
</TABLE>
10
<PAGE>
<TABLE>
<S> <C>
Registration Statement is not filed with the Commission on or prior
to the specified date, (ii) the Exchange Offer Registration Statement
is not declared effective within 120 days after the closing date of
the Initial Offering or the Shelf Registration Statement is not
declared effective on or prior to the 60th day after the shelf filing
deadline, (iii) the Exchange Offer is not consummated on or prior to
165 days after the closing date of the Initial Offering, or (iv) the
Shelf Registration Statement is filed and declared effective on or
prior to the date specified for such effectiveness, but shall
thereafter cease to be effective (at any time that the Company is
obligated to maintain the effectiveness thereof) without being
succeeded within 45 days by an additional Registration Statement
filed and declared effective (each such event referred to in clauses
(i) through (iv), a 'Registration Default'), the Company will
generally be obligated to pay liquidated damages ('Liquidated
Damages') to each holder of Transfer Restricted Securities, with
respect to the first 90-day period immediately following the
occurrence of the first Registration Default, in an amount equal to
$0.05 per week per $1,000 principal amount of the Notes constituting
Transfer Restricted Securities held by such holder until the
applicable Registration Statement is filed or declared effective, the
Exchange Offer is consummated or the Shelf Registration Statement
again becomes effective, as the case may be. The amount of Liquidated
Damages will increase by an additional $0.05 per week per $1,000
principal amount of Notes with respect to each subsequent 90-day
period until all Registration Defaults have been cured, up to a
maximum amount of Liquidated Damages of $0.20 per week per $1,000
principal amount of Notes. All accrued Liquidated Damages shall be
paid to holders in the same manner as interest payments on the Notes
on semi-annual payment dates which correspond to interest payment
dates for the Notes. Following the cure of all Registration Defaults,
the accrual of Liquidated Damages will cease.
Transfer Restrictions; Absence of a
Public Market for the Notes............. The Notes have not been registered under the Securities Act and are
subject to restrictions on transferability and resale. In addition,
there is currently no established market for the Notes. If issued,
the New Notes will generally be freely transferable (subject to the
restrictions discussed elsewhere herein) but will be new securities
for which there will not initially be a market. Accordingly, there
can be no assurance as to the development or liquidity of any market
for the Notes or, if issued, the New Notes. The Notes have been
designated eligible for trading in the PORTAL market. The Initial
Purchasers have advised Stellex that they currently intend to make a
market in the Notes. However, the Initial Purchasers are not
obligated to do so, and any market making with respect to the Notes
may be discontinued at any time without notice. Stellex does not
intend to apply for a listing of the Notes, or, if issued, the New
Notes, on any securities exchange or on any automated dealer
quotation system.
</TABLE>
RISK FACTORS
Before investing in the New Notes offered hereby, investors should
carefully consider the information set forth under the caption 'Risk Factors'
and all other information set forth in this Prospectus.
11
<PAGE>
SUMMARY PRO FORMA FINANCIAL DATA
The following table sets forth the consolidated statements of operations
and other financial data of the Company on a pro forma basis for the year ended
December 31, 1996 and the nine months ended September 30, 1997. The pro forma
statements of operations data give effect to the Transactions as if they
occurred on January 1, 1996. The pro forma balance sheet data give effect to the
Transactions as if they had occurred on September 30, 1997. The pro forma
financial data are provided for informational purposes only, are unaudited and
are not necessarily indicative of future results or what the operating results
or financial condition of the Company would have been had the Transactions
actually been consummated on the dates assumed. The following table should be
read in conjunction with 'Capitalization,' 'Pro Forma Consolidated Financial
Data,' 'Selected Historical Financial Data,' 'Management's Discussion and
Analysis of Financial Condition and Results of Operations' and the historical
financial statements of Stellex (formerly Kleinert) and TSMD (Stellex
Microwave), and the accompanying notes thereto, included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
PRO FORMA CONSOLIDATED
----------------------------------------------
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1996 SEPTEMBER 30, 1997
------------------ ---------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales............................................ $ 113,507 $ 91,086
Cost of goods sold(a)............................ 89,617 67,297
-------- --------
Gross profit..................................... 23,890 23,789
Selling, general and administrative(a)(b)........ 18,809 11,894
Amortization of intangibles...................... 3,496 1,760
-------- --------
Income from operations........................... 1,585 10,135
Interest expense(c).............................. 10,984 8,527
Other expense, net............................... 40 73
-------- --------
Income (loss) before income taxes................ (9,439) 1,535
Income tax provision............................. -- 150
-------- --------
Net income (loss)................................ $ (9,439) $ 1,385
-------- --------
-------- --------
OTHER FINANCIAL DATA:
EBITDA(d)........................................ $ 12,259 $ 16,923
Adjusted EBITDA(d)............................... 15,220 16,940
Depreciation and amortization.................... 10,725 6,868
Capital expenditures............................. 2,753 2,007
Ratio of Adjusted EBITDA to cash interest
expense(e)..................................... -- 2.1x
Ratio of total debt to Adjusted EBITDA(f)........ -- 4.7x
Ratio of earnings to fixed charges............... --(g) 1.1x
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
1997
-------------------
<S> <C>
COMBINED BALANCE SHEET DATA (AT END OF PERIOD):
Working capital.................................. $ 18,980
Total assets..................................... 133,445
Long-term debt, including current maturities..... 106,519
Minority interest................................ 778
Stockholders' equity............................. 10,012
</TABLE>
- ------------------
(a) In connection with the W-J Acquisition, Stellex Microwave entered into a
sublease with Watkins-Johnson of the facilities used by TSMD at a rent
higher than the historical amounts charged to TSMD. Accordingly, for the
year ended December 31, 1996 and the nine months ended September 30, 1997,
cost of goods sold has been increased by $1.1 million and $810,000,
respectively, and selling, general and administrative expense has been
increased by $120,000 and $90,000, respectively.
(b) Selling, general and administrative expense for the year ended December 31,
1996 and the nine months ended September 30, 1997 includes $750,000 and
$563,000, respectively, of management fees that would have been paid to
Mentmore pursuant to the Management Agreement (as defined). Excludes
non-recurring charges of $450,000 of investment banking and financial
advisory fees that were paid to Mentmore in connection with the Kleinert
Acquisition and $1,000,000 of investment banking and financial advisory fees
paid to Mentmore in connection with the W-J Acquisition and the Initial
Offering. See 'Certain Transactions--Management Agreement with Mentmore.'
(c) Interest expense reflects an interest rate of 9.5% on the Notes and related
amortization of the estimated debt issuance costs of $5.0 million over the
ten year term of the Notes. Interest expense also reflects charges of
$580,000 and $347,000 for the year ended December 31, 1996 and the nine
months ended September 30, 1997, respectively, related to the ongoing
working capital requirements of Stellex Microwave that are expected to be
funded through borrowings under the New Credit Facilities assuming a 7.75%
interest rate on the balance of working capital items not acquired as part
of the W-J Acquisition.
(d) EBITDA represents income (loss) before income taxes plus interest expense,
depreciation and amortization less interest income of $11,600 and $6,500 for
the year ended December 31, 1996 and the nine months ended September 30,
1997. Adjusted EBITDA ('Adjusted EBITDA') for the year ended December 31,
1996 excludes a $1.5 million charge included in cost of goods sold for the
write-off of slow moving and excess inventory, a $700,000 charge included in
cost of goods sold for severance costs relating to a reduction in force of
operational and manufacturing employees at Stellex Microwave and the Stellex
Aerospace management stock compensation adjustment totaling $761,000.
Adjusted EBITDA for the nine months ended September 30, 1997 excludes the
Stellex Aerospace management stock compensation adjustment totaling $17,000.
EBITDA is presented because it is a widely accepted financial indicator of a
company's ability to service indebtedness. However, EBITDA should not be
considered an alternative to operating income or cash flows from operating
activities (as determined in accordance with generally accepted accounting
principles) and should not be construed as an indication of a company's
operating performance or as a measure of liquidity. Since all companies and
analysts do not necessarily calculate EBITDA in the same fashion, EBITDA as
presented in this Prospectus may not be comparable to similarly titled
measures reported by other companies. Funds depicted by EBITDA are generally
not presently available for management's discretionary use due primarily to
legal and functional requirements to conserve funds for capital replacement
and expansion, debt service and other commitments and uncertainties.
(e) Cash interest expense excludes $500,000 of annual expense relating to the
amortization of debt issuance costs.
(f) For purposes of this calculation, an annualized EBITDA was utilized, which
was derived by multiplying EBITDA for the nine months ended September 30,
1997 times 1.333.
(g) In calculating the ratio of earnings to fixed charges, earnings consist of
income before taxes plus fixed charges. Fixed charges consist of interest
expense and amortization of deferred financing costs, whether expensed or
capitalized. Earnings were inadequate to cover fixed charges by $10,584,000
for the year ended December 31, 1996.
12
<PAGE>
RISK FACTORS
In addition to the other information set forth in this Prospectus, before
tendering their Old Notes for the New Notes offered hereby, holders of the Old
Notes should carefully consider the following risk factors, which may be
generally applicable to the Old Notes as well as the New Notes.
SUBSTANTIAL LEVERAGE
The Company is highly leveraged. At September 30, 1997, after giving pro
forma effect to the Transactions, the Company's total consolidated indebtedness
would have been $106.5 million, the Company's ratio of total indebtedness to
total capitalization would have been 91.4% and the Company would have had up to
an additional $47.9 million available to be borrowed under the New Credit
Facilities. In addition, subject to certain restrictions set forth in the New
Credit Facilities and the Indenture, the Company may incur additional
indebtedness, including Senior Indebtedness (as defined), in the future for
acquisitions, capital expenditures and other corporate purposes. For the year
ended December 31, 1996, the Company's pro forma earnings would have been
insufficient to cover fixed charges by approximately $10.6 million.
The Company's ability to make scheduled payments of the principal of, or
interest on, or to refinance its indebtedness (including the Notes) depends on
its future operating performance, which to a certain extent is subject to
economic, financial, competitive and other factors beyond its control. The
Company believes that, based on its current level of operations and anticipated
growth, its cash flow from operations, together with borrowings under the New
Credit Facilities, will be adequate to meet its anticipated requirements for
working capital, capital expenditures, interest payments and scheduled principal
payments over the next several years. See 'Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources.' There can be no assurance, however, that the Company's business will
generate cash flow at or above expected levels. If the Company is unable to
generate sufficient cash flow from operations in the future to service its debt
fund working capital requirements and make necessary capital expenditures, or if
its future earnings are insufficient to make all required principal payments out
of internally generated funds, the Company may be required to refinance all or a
portion of its existing debt, sell assets or obtain additional financing. There
can be no assurance that any such refinancing or asset sales would be possible
or that any additional financing could be obtained on terms acceptable to the
Company or at all, particularly in view of the Company's high level of debt.
The Company's high level of debt will have several important effects on its
future operations, including the following: (a) the Company will have
significant cash requirements to service debt (which, under current
circumstances, are projected to be approximately $11.0 million during the first
year following the Initial Offering and may be even greater depending on the
Company's results of operations, capital expenditure requirements and a variety
of other factors), reducing funds available for working capital, acquisitions,
capital expenditures and other corporate purposes and increasing the Company's
vulnerability to adverse general economic and industry conditions and (b) the
financial covenants and other restrictions contained in the New Credit
Facilities, the Indenture and other agreements relating to the Company's
indebtedness require the Company to meet certain financial tests, restrict its
ability to borrow additional funds and impose limitations on the disposition of
assets. In addition, although management believes that capital expenditures
above maintenance levels can be deferred to address cash flow or other
constraints, such initiatives cannot be deferred for extended periods without
adverse effects on the Company's business, results of operations and financial
position. The Company's continued growth depends, in part, on its ability to
maintain its facilities and technological capabilities, and, therefore, to the
extent it is unable to do so with internally generated cash, its inability to
finance capital expenditures through borrowed funds could have a material
adverse effect on the Company's financial position and results of operations.
13
<PAGE>
SUBORDINATION OF THE NOTES AND SUBSIDIARY GUARANTEES; UNSECURED STATUS OF THE
NOTES
Subordination
The payment of principal of, premium and interest on, and any other amounts
owing in respect of, the Notes is subordinated to the prior payment in full of
all existing and future Senior Indebtedness of the Company, including
indebtedness under the New Credit Facilities. Similarly, the Subsidiary
Guarantees of the Subsidiary Guarantors will be subordinated in right of payment
to all Guarantor Senior Indebtedness of the respective Subsidiary Guarantors. At
September 30, 1997, after giving pro forma effect to the Transactions, the
Company and the Subsidiary Guarantors would have had an aggregate of $4.8
million of Senior Indebtedness and Guarantor Senior Indebtedness outstanding and
up to $47.9 million of undrawn commitments available under the New Credit
Facilities. The Indenture limits, but does not prohibit, the incurrence by the
Company and the Subsidiary Guarantors of additional indebtedness which may
constitute Senior Indebtedness and Guarantor Senior Indebtedness. In the event
of the bankruptcy, liquidation, dissolution, reorganization or other winding up
of the Company, the assets of the Company will be available to pay obligations
on the Notes only after all Senior Indebtedness has been paid in full in cash,
and there may not be sufficient assets remaining to pay amounts due on any or
all of the Notes. In addition, under certain circumstances, the Company may not
pay principal of, premium or interest on, or any other amounts owing in respect
of, the Notes, or purchase, redeem or otherwise retire the Notes, if a payment
default or a non-payment default exists with respect to certain Senior
Indebtedness, and, in the case of a non-payment default, a payment blockage
notice has been received by the Trustee (as defined). See 'Description of
Notes--Ranking and Subordination.'
Unsecured Status of the Notes and Subsidiary Guarantees
The Notes and Subsidiary Guarantees are unsecured obligations of the
Company and the Subsidiary Guarantors, respectively. The Indenture permits the
Company to incur certain secured indebtedness, including indebtedness under the
New Credit Facilities, which is secured by a lien on substantially all of the
assets of the Company and the Subsidiary Guarantors. The holders of any secured
indebtedness will have a claim prior to the holders of the Notes with respect to
any assets pledged by the Company and the Subsidiary Guarantors as security for
such indebtedness. Upon an event of default under the New Credit Facilities, the
lenders thereunder would be entitled to foreclose on the assets of the Company
and the Subsidiary Guarantors. In such event, the assets of the Company and the
Subsidiary Guarantors remaining after repayment of such secured indebtedness may
be insufficient to satisfy the obligations of the Company and the Subsidiary
Guarantors with respect to the Notes and the Subsidiary Guarantees.
HOLDING COMPANY STRUCTURE
Stellex is a holding company with no independent operations. Stellex is
dependent on the earnings and cash flow of, and dividends and distributions or
advances from, its subsidiaries to provide the funds necessary to meet its debt
service obligations, including the payment of principal and interest on the
Notes. In particular, Stellex is heavily dependent on the earnings of Stellex
Microwave, which, on a pro forma basis, would have accounted for approximately
74.6% of the Company's sales for the nine months ended September 30, 1997. There
can be no assurance that Stellex's subsidiaries will generate sufficient cash
flow to dividend, distribute or advance funds to Stellex.
ABILITY TO SERVICE DEBT
The Company's ability to make scheduled payments or to refinance its
obligations with respect to its indebtedness will depend on its financial and
operating performance which in turn will be subject to prevailing economic
conditions and to certain financial, business and other factors beyond its
control. If the Company's cash flow and capital resources are insufficient to
fund its debt service obligations, the Company may be forced to reduce or delay
planned expansion and capital expenditures, sell assets, obtain additional
equity capital or restructure its debt. There can be no assurance that the
Company's operating results, cash flow and capital resources will be sufficient
for payment of its indebtedness in the future. In the absence of such operating
results and resources, the Company could face substantial liquidity problems and
might be required to dispose of material assets or operations to meet its debt
service and other obligations, and there can be no assurance as to the
14
<PAGE>
timing of such sales or the proceeds that the Company could realize therefrom.
In addition, because the Company's obligations under the New Credit Facilities
bear interest at floating rates, an increase in interest rates could adversely
affect, among other things, the Company's ability to meet its debt service
obligations. As of the date of this Prospectus, the Company has not entered into
interest rate swaps or other derivative arrangements but may consider doing so
in the future. See 'Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources' and 'Description of
Certain Indebtedness--New Credit Facilities.'
FRAUDULENT CONVEYANCE
The incurrence of indebtedness (such as the Notes) in connection with the
W-J Acquisition and the application of the proceeds thereof to consummate the
W-J Acquisition are subject to review under relevant federal and state
fraudulent conveyance statutes in a bankruptcy or reorganization case or a
lawsuit by or on behalf of creditors of the Company. Under these statutes, if a
court were to find that obligations (such as the Notes) were incurred with the
intent of hindering, delaying or defrauding present or future creditors or that
the Company received less than a reasonably equivalent value or fair
consideration for those obligations and, at the time of the occurrence of the
obligations, the obligor either (i) was insolvent or rendered insolvent by
reason thereof, (ii) was engaged or was about to engage in a business or
transaction for which its remaining unencumbered assets constituted unreasonably
small capital or (iii) intended to or believed that it would incur debts beyond
its ability to pay such debts as they matured or became due, such court could
void the Company's obligations under the Notes, subordinate the Notes to other
indebtedness of the Company or take other action detrimental to the holders of
the Notes.
The measure of insolvency for purposes of a fraudulent conveyance claim
will vary depending upon the law of the jurisdiction being applied. Generally,
however, a company will be considered insolvent at a particular time if the sum
of its debts at that time is greater than the then fair value of its assets or
if the fair saleable value of its assets at that time is less than the amount
that would be required to pay its probable liability on its existing debts as
they became absolute and mature. The Company believes that, after giving effect
to the Transactions, the Company was (i) neither insolvent nor rendered
insolvent by the incurrence of indebtedness in connection with the W-J
Acquisition and the Initial Offering, (ii) in possession of sufficient capital
to run its business effectively and (iii) incurring debts within its ability to
pay as the same mature or become due.
There can be no assurance, however, as to what standard a court would apply
to evaluate the parties' intent or to determine whether the Company was
insolvent at the time of, or rendered insolvent upon consummation of, the
Transactions or that, regardless of the standard, a court would not determine
that the Company was insolvent at the time of, or rendered insolvent upon
consummation of, the Transactions.
In addition, the Subsidiary Guarantees may be subject to review under
relevant federal and state fraudulent conveyance and similar statutes in a
bankruptcy or reorganization case or in a lawsuit by or on behalf of creditors
of any of the Subsidiary Guarantors. In such a case, the analysis set forth
above would generally apply, except that the Subsidiary Guarantees could also be
subject to the claim that, since the Subsidiary Guarantees were incurred for the
benefit of the Company (and only indirectly for the benefit of the Subsidiary
Guarantors), the obligations of the Subsidiary Guarantors thereunder were
incurred for less than reasonably equivalent value or fair consideration. A
court could avoid a Subsidiary Guarantor's obligation under its Subsidiary
Guarantee, subordinate the Subsidiary Guarantee to other indebtedness of such
Subsidiary Guarantor or take other action detrimental to the holders of the
Notes.
RESTRICTIONS UNDER DEBT AGREEMENTS
The Indenture contains covenants that, among other things, limit the
ability of the Company and its Restricted Subsidiaries to incur additional
indebtedness, incur liens, pay dividends and make certain other restricted
payments, make investments, consummate certain asset sales, enter into certain
transactions with affiliates, sell stock of Restricted Subsidiaries, consolidate
or merge with any other person or transfer all or substantially all of the
assets of the Company. In addition, the New Credit Facilities contain
restrictive covenants which, generally, are more restrictive than those
contained in the Indenture, and limit the Company's ability to prepay its
subordinated indebtedness (including the Notes). The New Credit Facilities also
require the Company
15
<PAGE>
to maintain specified consolidated financial ratios and satisfy certain
consolidated financial tests. The Company's ability to meet those financial
ratios and financial tests can be affected by events beyond its control, and
there can be no assurance that the Company will meet those ratios and tests. See
'Description of Certain Indebtedness--New Credit Facilities.'
Upon consummation of the Initial Offering and the W-J Acquisition, the
Company was in compliance with the covenants and restrictions contained in the
New Credit Facilities and in the Indenture. However, its ability to continue to
comply with such agreements may be affected by events beyond its control,
including prevailing economic, financial and industry conditions. The breach of
any of such covenants or restrictions could result in a default under the New
Credit Facilities and/or the Indenture, which would permit the senior lenders or
the holders of the Notes, as the case may be, to declare all amounts borrowed
thereunder to be due and payable, together with accrued and unpaid interest, and
the commitments of the senior lenders to make further extensions of credit under
the New Credit Facilities could be terminated. If the Company were unable to
repay its indebtedness to its senior lenders, such lenders could proceed against
the collateral securing such indebtedness as described under 'Description of
Certain Indebtedness--New Credit Facilities.'
LIMITATION ON CHANGE OF CONTROL
Upon a Change of Control (as defined under 'Description of Notes--Change of
Control'), the Company will be required to offer to purchase all of the
outstanding Notes at a price equal to 101% of the principal amount thereof to
the date of repurchase plus accrued and unpaid interest and Liquidated Damages,
if any, thereon to the date of repurchase. The Change of Control purchase
feature of the Notes may in certain circumstances discourage or make more
difficult a sale or takeover of the Company. In particular, a Change of Control
may cause an acceleration of, or require an offer to repurchase under, the New
Credit Facilities and certain other indebtedness, if any, of the Company and its
subsidiaries, in which case such indebtedness would be required to be repaid in
full before repurchase of the Notes. See 'Description of Certain
Indebtedness--New Credit Facilities' and 'Description of Notes--Change of
Control.' The inability to repay such indebtedness, if accelerated, and to
purchase all of the tendered Notes would constitute an event of default under
the Indenture. There can be no assurance that the Company will have funds
available to repurchase the Notes upon the occurrence of a Change of Control.
LACK OF PUBLIC MARKET; RESTRICTIONS ON TRANSFERABILITY
The Old Notes were issued to, and the Company believes are currently owned
by, a relatively small number of beneficial owners. Prior to the Exchange Offer,
there has not been any public market for the Old Notes. The Old Notes have not
been registered under the Securities Act and will be subject to restrictions on
transferability to the extent that they are not exchanged for New Notes by
holders who are entitled to participate in the Exchange Offer. The holders of
Old Notes (other than any such holder that is an 'affiliate' of the Company
within the meaning of Rule 405 under the Securities Act) who are not eligible to
participate in the Exchange Offer are entitled to certain registration rights,
and the Company and the Subsidiary Guarantors are required to file a Shelf
Registration Statement with respect to such Old Notes. The New Notes will
constitute a new issue of securities with no established trading market. The
Company does not intend to list the New Notes on any national securities
exchange or seek the admission thereof to trading in the National Association of
Securities Dealers Automated Quotation System. The Initial Purchasers have
advised the Company that they currently intend to make a market in the New
Notes, but they are not obligated to do so and may discontinue such market
making at any time. In addition, such market making activity will be subject to
the limits imposed by the Securities Act and the Exchange Act and may be limited
during the Exchange Offer and the pendency of the Shelf Registration Statement.
Accordingly, no assurance can be given that an active public or other market
will develop for the New Notes or as to the liquidity of the trading market for
the New Notes. If a trading market does not develop or is not maintained,
holders of the New Notes may experience difficulty in reselling the New Notes or
may be unable to sell them at all. If a market for the New Notes develops, any
such market may be discontinued at any time.
If a public trading market develops for the New Notes, future trading
prices of such securities will depend on many factors including, among other
things, prevailing interest rates, the Company's results of operations and the
market for similar securities. Depending on prevailing interest rates, the
market for similar securities and
16
<PAGE>
other factors, including the financial condition of the Company, the New Notes
may trade at a discount from their principal amount.
LACK OF STAND-ALONE OPERATING HISTORY
Prior to the consummation of the W-J Acquisition, Stellex Microwave
constituted an operating division of Watkins-Johnson. Throughout its history,
the business of Stellex Microwave benefited from its association with
Watkins-Johnson. Although pursuant to the terms of the W-J Acquisition Stellex
Microwave retained the right to sell its products through the 1997-98 device
catalog produced by Watkins-Johnson and to identify its products as 'formerly
made by Watkins-Johnson' until the expiration of Watkins-Johnson's 1999-2000
catalog, the ability of the Company to function as a stand-alone entity,
including its ability to develop name recognition for its products independent
of the 'Watkins-Johnson' name, is unproven. See 'Certain Transactions--The W-J
Acquisition' and 'Business--Sales and Marketing--Stellex Microwave--Microwave
Devices.' In addition, Watkins-Johnson corporate personnel formerly provided
management information, financial, treasury, tax, legal, cash management,
payroll processing and employee benefits assistance to the Stellex Microwave
business. Although the costs of these services were allocated to the business by
Watkins-Johnson for internal corporate accounting purposes, these costs may not
necessarily reflect accurately the costs that the business would have incurred
for those services as a stand-alone entity. Because these services are essential
to the effective operation of the Company's business, the failure by the Company
to establish and maintain its own capacity to provide these services, or to
obtain them from outside contractors, could have a material adverse effect on
the Company's financial condition and results of operations.
DEPENDENCE ON DEFENSE MARKET
A substantial portion of the Company's pro forma sales (approximately 62%
in 1996) would have been to the defense market. As a result, the Company's sales
could be materially adversely impacted by a decrease in defense spending by the
United States government because of defense spending cuts, general budgetary
constraints or otherwise. The United States defense budget declined
significantly in the early 1990s and, while appropriations are forecasted to
remain relatively constant during the next five years, there can be no assurance
that there will not be further reductions in defense spending generally or in
the procurement of weapon systems utilizing the Company's products. Fewer
available defense industry production programs, coupled with continued pricing
pressure on follow-on orders for programs in which the Company participates and
other factors, caused Stellex Microwave's defense-related sales, primarily
microwave subsystems and components, to decline from approximately $72.2 million
for the year ended December 31, 1995 to $62.4 million for the year ended
December 31, 1996. The Company expects to continue to derive a substantial
portion of its sales from these business segments and develop microwave products
for defense applications. Failure of the Company to replace sales attributable
to a significant defense program or contract at the end of that program or
contract, whether due to cancellation, spending cuts, budgetary constraints or
otherwise, could have a material adverse effect upon the Company's financial
position and results of operations. In addition, a large portion of the
Company's expenses are fixed and difficult to reduce, thus magnifying the
material adverse effect of any revenue shortfall. See 'Management's Discussion
and Analysis of Financial Condition and Results of Operations.'
DEPENDENCE ON CERTAIN CUSTOMERS
In December 1997, Raytheon, the Company's second largest customer based on
1996 pro forma sales, completed its acquisition of the defense business of
Hughes Aircraft Company, the Company's largest customer
based on 1996 pro forma sales. Combined pro forma sales to Raytheon and Hughes
in 1996 and the nine months ended September 30, 1997 accounted for approximately
34% and 37%, respectively, of the Company's total pro forma sales in such
periods.
DEPENDENCE ON PROPRIETARY TECHNOLOGY
The Company's future success is dependent in part upon its proprietary
technology and trade secrets, including manufacturing and scientific know-how.
There can be no assurance that other parties will not develop technologies that
are similar or superior to the Company's technology, duplicate the Company's
technology or design around the patents and other intellectual property owned by
the Company. There also can be no assurance
17
<PAGE>
that the steps taken by the Company to protect its proprietary technology and
trade secrets will prevent misappropriation of its technology, including its
manufacturing know-how. See 'Business--Technology' and '--Intellectual
Property.'
The Company must also continually engage in effective research and
development efforts in order to provide innovative new products for
technologically-sophisticated customers and markets. There is an inherent risk
that advances in existing technology could have a material adverse impact on its
financial condition and results of operations. See 'Business--Competition.'
COMPETITION
Declining defense budgets in the early 1990s and increasing pressures for
cost reductions have precipitated a major consolidation in the defense industry.
In recent years, this consolidation has resulted in program cancellations, scope
reductions and delays in contract funding or awards. While it appears that the
rapid decline in U.S. defense spending has ceased, reduced funding has
contributed to significant price competition throughout the industry. In
addition, while Stellex Microwave faces competition in the subsystems markets in
which it competes from independent microwave equipment manufacturers which have
integration capabilities, management believes that its primary competition is
from the in-house manufacturing operations of OEMs and prime contractors, most
of whom have greater financial and technical resources than the Company. The
future success of Stellex Microwave, and the Company, is dependent on the extent
to which OEMs and prime contractors elect to purchase from outside sources
rather than manufacture and integrate their own MFMs and components. These
in-house manufacturers could also elect to enter the non-captive market for
microwave products and compete directly with Stellex Microwave's microwave
components. See 'Business--Competition.'
Approximately 62% of the Company's 1996 pro forma sales were derived from
contracts with the U.S. government and its prime contractors. The Company
encounters significant competition for a number of these contracts in most of
its business segments from other companies, some of which have financial,
technical, marketing, manufacturing, distribution and other resources
substantially greater than those of the Company. The Company's ability to
compete for these contracts depends to a large extent on the effectiveness and
innovativeness of its research and development programs, its ability to offer
better program performance than its competitors at a lower cost to the U.S.
government customer, and its readiness in facilities, equipment and personnel to
undertake the programs for which it competes.
Many of the markets in which the Company competes or intends to compete are
highly competitive and require a high level of service, extremely reliable
products and cost competitiveness. There can be no assurance that the Company
will continue to compete successfully for new program opportunities or otherwise
secure new business, or that new programs, if awarded, and other new business
will be profitable. In addition, even as to those defense programs which the
U.S. government or a prime contractor have historically awarded to the Company
on a sole-source basis, the U.S. government or prime contractor may in the
future determine to shift to a competitive bidding process. There can be no
assurance that the Company will continue to be successful in remaining the
sole-source contractor on various programs or, in competitive situations, in
having its bids accepted or, if accepted, that awarded contracts will generate
sufficient sales to result in profitability for the Company.
UNCERTAINTY ASSOCIATED WITH GOVERNMENT CONTRACTS
The Company's contracts with the U.S. government and its prime contractors
are subject to termination either upon default by the Company or at the
convenience of the U.S. government. Termination for convenience provisions
generally entitle the Company to recover costs incurred, settlement expenses and
profit on work completed prior to termination. In addition to the right of the
U.S. government to terminate U.S. government contracts, such contracts are
conditioned upon the continuing availability of congressional appropriations.
Congress usually appropriates funds for a given program on a fiscal year basis
even though contract performance may take more than one year. Consequently, at
the outset of a major program, the contract is usually partially funded, and
additional monies are normally, incrementally, committed to the contract by the
procuring agency
18
<PAGE>
from appropriations made by Congress for future fiscal years. See
'Business--Government Contracts and Regulation.'
Because the Company contracts to supply goods and services to the U.S.
government and its prime contractors, it is also subject to other risks,
including contract suspensions, protests by disappointed bidders of contract
awards, which can result in the reopening of the bidding process, and changes in
government policies or regulations. In addition, licenses are required from U.S.
government agencies to export many of the weapon systems and other products for
which the Company supplies microwave subsystems and other components. See
'Business--Government Contracts and Regulation' and '--Sales to Foreign
Customers.'
Due to its business with the U.S. government and its prime contractors, the
Company may also be subject to 'whistle blower' suits brought by private
plaintiffs in the name of the U.S. government upon the allegation that the
Company submitted a false claim to the U.S. government, as well as to false
claim suits brought by the U.S. government. A judgment against the Company in a
'whistle blower' or false claim suit could cause the Company to be liable for
substantial damages and could carry penalties of suspension or debarment which
would make the Company ineligible to be awarded any U.S. government contracts
for a period of up to three years and, thereby, could potentially have a
material adverse effect on the Company's financial condition and results of
operations. See 'Business--Government Contracts and Regulation.'
U.S. GOVERNMENT CONTRACT CONSENTS AND NOVATIONS
Watkins-Johnson was a party to several contracts with various agencies of
the U.S. government which were transferred to the Company in connection with the
W-J Acquisition. These contracts generate a relatively small portion of the
Company's consolidated pro forma sales. The U.S. government may assert that, as
a result of the W-J Acquisition, the Company must enter into a novation
agreement with the U.S. government and Watkins-Johnson in order to continue to
be recognized as the contractor under its U.S. government contracts. A novation
agreement is typically entered between the U.S. government, a contractor who
transfers its assets (including its contracts) to a successor-in-interest, and
that successor-in-interest. If required, the novation process typically takes a
matter of weeks or months, and can require up to or more than a year, to
complete and in any event was not completed prior to the consummation of the W-J
Acquisition. Although the Company knows of no reason why it cannot successfully
complete the negotiation and execution of the novation agreements that may be
required, there can be no assurance that such agreements will ultimately be
obtained. Failure to obtain any novation agreement deemed to be required could
have a material adverse effect on the Company's financial condition and results
of operations.
A substantial portion of the Company's consolidated pro forma sales would
have been generated under subcontracts between Watkins-Johnson and prime
contractors of U.S. government agencies. The subcontracts cannot be transferred
to a successor-in-interest without the consent of the prime contractor. While
prime contractor approval has been obtained for the transfer of a substantial
number of material subcontracts, approval remains outstanding for a number of
material contracts with key prime contractors, representing expected revenues of
approximately $9.3 million through 1998 and $2.4 million thereafter through
1999, or approximately 8.2% and 2.1%, respectively, of the Company's total pro
forma sales in 1996. The U.S. government may assert that it also has the right
to approve the transfer of subcontracts. Such approval, if required, will be
sought. Although the Company knows of no reason why any required consent or
approval from U.S. government agencies and its prime contractors would not be
granted, there can be no assurance that any such consent or approval will
ultimately be obtained. Failure to obtain consent to the transfer of the
subcontracts from prime contractors or, if required, from the U.S. government
could have a material adverse effect on the Company's financial condition and
results of operation.
CONTRACT PROFIT EXPOSURES
The Company's products are provided primarily through two types of
contracts: fixed-price and cost-reimbursable contracts. The Company would have
derived approximately 6% of its total pro forma sales during 1996 from
cost-reimbursable contracts under which the Company is reimbursed for all actual
costs incurred in performing the contract to the extent that such costs are
within the contract ceiling and allowable under the terms of the contract, plus
a fee or profit. A significant portion of the balance of the Company's total pro
forma sales in
19
<PAGE>
1996 would have been attributable to fixed-price contracts with durations
typically ranging from several months to several years, which require the
Company to perform services under a contract at a stipulated price, subject to
periodic adjustments in some cases.
The Company assumes greater financial risk on fixed-price type contracts
than on cost-reimbursable contracts. The Company believes that an increasing
percentage of its contracts will be entered into on a fixed-price basis. Failure
to anticipate technical problems, estimate costs accurately or control costs
during performance of a fixed-price contract may reduce the Company's profit or
cause a loss.
CONTROLLING STOCKHOLDERS
The outstanding capital stock of Stellex is beneficially owned by two
trusts, the pool of contingent beneficiaries of which are (i) Richard L. Kramer
and certain members of his family and (ii) William L. Remley and certain members
of his family. As a result of their relationships with such trusts, Messrs.
Kramer and Remley may be deemed to beneficially own 90% and 100%, respectively,
of the outstanding capital stock of Stellex. Messrs. Kramer and Remley are
executive officers and directors of Mentmore and Stellex. The interests of
Mentmore, Mr. Kramer, Mr. Remley and their affiliates may differ from the
interests of holders of the Notes. See 'Principal Stockholders.'
DEPENDENCE ON KEY PERSONNEL
The success of the Company is largely dependent on the personal efforts and
abilities of senior management. The loss of services of key management
personnel, particularly the personnel identified in 'Management--Directors,
Executive Officers and Key Employees,' could have a material adverse effect on
the Company. The Company's continued success also depends in large part on its
ability to recruit and retain the professional and technical personnel necessary
in connection with its operations. Competition for skilled personnel in the
electronics and aerospace industries is intense and increasing, and companies
often experience high attrition among their skilled employees. Excessive
attrition among its professional and technical personnel could increase the
Company's costs of performing its contractual obligations, reduce the Company's
ability to efficiently satisfy its clients' needs and seriously constrain the
Company's future growth potential. In addition, the Company must often comply
with provisions in government contracts that require employment of persons with
specified levels of education, work experience and security clearances. The loss
of any significant number of the Company's existing key professional and
technical personnel or the inability to attract and retain key employees in the
future could have a material adverse effect on the Company's financial condition
and results of operations. See 'Business--Employees' and 'Management.'
ENVIRONMENTAL MATTERS
The Company and its operations are subject to extensive federal, state, and
local environmental laws and regulations that may change frequently and that (i)
impose limitations and prohibitions on the discharge of, and establish standards
for the use, disposal, and management of, certain materials, substances and
waste, and (ii) impose liability for the costs of investigating and cleaning up,
and certain damages resulting from, past spills, disposals or other releases of
hazardous substances or materials (together, 'Environmental Laws'). Management
cannot predict with any certainty whether and to what extent future events, such
as changes in existing laws and regulations or the discovery of conditions not
currently known to the Company, or contractual indemnification not providing the
Company with the protection it anticipates for certain known environmental
conditions, may affect the Company. Furthermore, actions by federal, state, and
local governments concerning environmental matters could result in laws or
regulations that could increase the costs of producing the Company's products or
otherwise adversely affect the demand for its products. Any such development
could result in a material adverse impact on the Company. See 'Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Environmental Matters' and 'Business--Government Contracts and
Regulation.'
20
<PAGE>
NATURAL DISASTERS
The geology and other natural conditions of the California area, in which
all of the Company's facilities are located, present particular risks of natural
disasters, including the risk of seismic activity. Future seismic activity in
California could cause significant damage to these facilities and could have a
material adverse effect on the Company's financial condition and results of
operations.
COMPANY GROWTH AND RISKS RELATED TO FUTURE ACQUISITIONS
A key element of the Company's business strategy is to selectively pursue
acquisitions of other companies in the aerospace and defense industries. There
can be no assurance that acquisition opportunities will continue to be available
or that if available, such acquisitions could be consummated on terms acceptable
to the Company, or that the Company, particularly in view of its high level of
debt, would be able to obtain financing on terms that it deems acceptable to
consummate any potential acquisition. See 'Risk Factors--Substantial Leverage'
and '--Ability to Service Debt.' In addition, the Company's future performance
will depend, in part, on its ability to manage expanding operations and to adapt
its operational systems to such expansions. The failure of the Company to
effectively manage its growth or successfully integrate acquired companies or
assets into the Company's operations could have a material adverse effect on the
Company's financial condition and results of operations.
BACKLOG
The Company's order backlog is subject to fluctuations and is not
necessarily indicative of future sales. There can be no assurance that current
order backlog will necessarily lead to sales in any future period. The Company's
order backlog as of September 30, 1997 was approximately $99.8 million,
approximately 29.7% of which was attributable to commercial customers and
approximately 70.3% of which was attributable to defense customers. A
substantial amount (approximately $22.3 million as of September 30, 1997) of the
Company's order backlog can be canceled at any time without penalty, except, in
some cases, the recovery of the Company's actual committed costs and profit on
work performed up to the date of cancellation. Cancellations of pending purchase
orders or termination or reductions of purchase orders in progress from
customers of the Company could have a material adverse effect on the Company's
financial position and results of operations. See 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--Backlog.'
CONSEQUENCES OF FAILURE TO EXCHANGE OLD NOTES
Holders of the Old Notes who do not exchange their Old Notes for New Notes
pursuant to the Exchange Offer will continue to be subject to the restrictions
on transfer of such Old Notes, as set forth in the legend thereon, as a
consequence of the issuance of the Old Notes pursuant to exemptions from, or in
transactions not subject to, the registration requirements of the Securities Act
and applicable state securities laws. In general, the Old Notes may not be
offered or sold, unless registered under the Securities Act and applicable state
securities laws, or pursuant to an exemption therefrom. Except under certain
limited circumstances, the Company does not intend to register the Old Notes
under the Securities Act. In addition, any holder of Old Notes who tenders in
the Exchange Offer for the purpose of participating in a distribution of the New
Notes may be deemed to have received restricted securities and, if so, will be
required to comply with the registration and propectus delivery requirements of
the Securities Act in connection with any resale transaction. To the extent Old
Notes are tendered and accepted in the Exchange Offer, the trading market, if
any, for the Old Notes not so tendered could be adversely affected. See 'The
Exchange Offer.'
21
<PAGE>
CAPITALIZATION
The following table sets forth the cash and cash equivalents and the
capitalization of the Company at September 30, 1997, and as adjusted to give
effect to the Transactions, and should be read in conjunction with 'Pro Forma
Consolidated Financial Data,' 'Management's Discussion and Analysis of Financial
Condition and Results of Operations,' and the historical consolidated financial
statements of Stellex (successor to Kleinert), and the accompanying notes
thereto, included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
--------------------------
HISTORICAL PRO FORMA
---------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents........................................ $ 730 $ 730
---------- -----------
---------- -----------
Short-term note payable(a)....................................... 4,000 --
---------- -----------
Long-term debt, including current maturities:
Prior Credit Facility.......................................... $ 17,250 $ --(b)
New Credit Facilities(c)....................................... -- 2,130
The Notes...................................................... -- 100,000
Trinity Note................................................... 2,500 --(d)
Other long-term debt, including current maturities(e).......... 4,369 4,389
---------- -----------
Total long-term debt, including current maturities........ 24,119 106,519
---------- -----------
Minority interest(f)............................................. 778 778
---------- -----------
Stockholders' equity:
Preferred Stock(g)............................................. -- 11,450
Common Stock(h)................................................ 50 50
Retained earnings.............................................. (256) (1,488)
---------- -----------
Total stockholders' equity.................................. (206) 10,012
---------- -----------
Total capitalization...................................... $ 28,691 $ 117,309
---------- -----------
---------- -----------
</TABLE>
- ------------------
(a) Consists of indebtedness outstanding under the Sunderland Note (as defined).
See 'Certain Transactions--Relationship with Equity Investors.'
(b) Reflects the repayment of $17.2 million of principal and $42,000 of accrued
interest outstanding as of September 30, 1997 under the Prior Credit
Agreement. Substantially all of these borrowings were incurred to finance
the Kleinert Acquisition. Borrowings under the Prior Credit Agreement bore
interest at an average rate of 7.7% per annum as of September 30, 1997.
(c) In connection with the consummation of the Initial Offering, the Company
entered into the New Credit Facilities. As of September 30, 1997, on a pro
forma basis, the Company would have had up to $47.9 million of borrowing
availability under the New Credit Facilities, subject to the satisfaction of
certain conditions. See 'Description of Certain Indebtedness--New Credit
Facilities.'
(d) Reflects the repayment of $2.5 million of principal and $20,000 of accrued
interest outstanding as of September 30, 1997 under the Trinity Note (as
defined). See 'Certain Transactions--Trinity Note.' Borrowings under the
Trinity Note bore interest at a rate of 10% per annum as of September 30,
1997.
(e) Consists of indebtedness outstanding under the Paragon Note (as defined) and
the Kleinert Seller Note (as defined). See 'Description of Certain
Indebtedness--Paragon Note' and '--Kleinert Seller Note,' and Note 5 to the
consolidated financial statements of Stellex (successor to Kleinert)
included elsewhere in this Prospectus.
(f) Consists of 19.9% of the issued and outstanding common stock of KII Holding
which is held by its management, who have rights to sell such shares to KII
Holding under certain circumstances.
(g) Consists of Series A Preferred Stock with an aggregate stated value of
$11.45 million issued in connection with the consummation of the W-J
Acquisition and the Initial Offering to certain trusts and other entities
owned by such trusts and certain other trusts, the beneficiaries of which
are certain relatives of Richard L. Kramer and William L. Remley. See
'Certain Transactions--Relationship with Equity Investors.'
(h) Consists of Common Stock, without par value, of which 1,000 shares are
authorized and 1,000 shares are issued and outstanding.
22
<PAGE>
PRO FORMA CONSOLIDATED FINANCIAL DATA
On July 1, 1997, KII Holding, through a wholly-owned subsidiary, acquired
all of the issued and outstanding capital stock of Kleinert for approximately
$26.5 million (including the assumption of $2.6 million of indebtedness and the
issuance to the seller of a note for approximately $1.75 million). Stellex was
formed on September 5, 1997 and, as a result of an equity exchange transaction
between Stellex and KII Holding on September 12, 1997, owns approximately 80% of
the outstanding common stock of KII Holding, with Stellex Aerospace's management
holding the remainder.
On October 31, 1997, concurrently with the consummation of the Initial
Offering, Stellex, through a wholly-owned subsidiary, acquired the tactical
subsystems and microwave devices businesses of Watkins-Johnson for a net
purchase price of approximately $82.2 million (after giving effect to estimated
purchase price adjustments). In addition, on the same date the Company entered
into the New Credit Facilities to provide working capital and
acquisition-related borrowing availability of $25 million and $25 million,
respectively.
The unaudited pro forma consolidated financial statements have been
prepared to give effect to the application of the purchase method of accounting
for the Kleinert Acquisition and the W-J Acquisition, as well as the application
of proceeds from the Initial Offering and New Credit Facilities. The allocation
of the purchase price to the tangible and intangible assets and liabilities
acquired in connection with the Acquisitions reflected in these pro forma
consolidated financial statements are based on preliminary estimates of their
fair market values. The Company expects to finalize the allocation of the
purchase price in conjunction with the year-end closing and audit for 1997.
However, the Company does not expect that the effects of the final allocation
will differ materially from those set forth herein.
The unaudited pro forma consolidated balance sheet as of September 30, 1997
gives effect to the W-J Acquisition, the Initial Offering and the New Credit
Facilities as if they had occurred as of September 30, 1997.
The unaudited pro forma consolidated statements of operations for the year
ended December 31, 1996 and the nine months ended September 30, 1997 give effect
to the Transactions as if they had occurred as of January 1, 1996, and include
estimated amounts for interest required to fund the working capital requirements
of Stellex Microwave during such periods. The pro forma consolidated statements
of operations exclude non-recurring charges directly related to the
Acquisitions, including (i) investment banking and financial advisory fees paid
and payable to Mentmore, (ii) increases in cost of sales arising from the
write-up of inventories at the date of the consummation of the Acquisitions to
fair market value and (iii) retention bonuses to be paid to certain employees of
TSMD; these amounts are estimated to be $1.5 million, $1.2 million, and $2.3
million, respectively, which are anticipated to be included in expenses in the
three months ended December 31, 1997.
The unaudited pro forma consolidated financial statements have been
prepared by management of the Company and do not necessarily represent the
results of the Company's operations which would have occurred if the
Transactions had actually taken place on the dates indicated, and may not be
indicative of the results of operations which may be obtainable in the future.
The unaudited pro forma consolidated financial statements should be read in
conjunction with the historical consolidated financial statements of Stellex
(successor to Kleinert) and TSMD (Stellex Microwave) and the accompanying notes
thereto, 'Summary Pro Forma Financial Data,' 'Capitalization,' 'Selected
Historical Financial Data' and 'Management's Discussion and Analysis of
Financial Condition and Results of Operations,' which information is included
elsewhere in this Prospectus.
23
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED BALANCE SHEET
AS OF SEPTEMBER 30, 1997
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
OFFERING
AND
W-J NEW CREDIT STELLEX
STELLEX TSMD ACQUISITION FACILITIES CONSOLIDATED
HISTORICAL HISTORICAL ADJUSTMENTS ADJUSTMENTS PRO FORMA
---------- ---------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
ASSETS
Cash and equivalents.............................. $ 730 $ -- $ 730
Receivables....................................... 5,803 15,500 (15,200)(a) (50)(g) 6,053
Inventories....................................... 13,211 15,100 1,000(b) 29,311
Prepaid and other................................. 815 300 (300)(a) 815
Deferred taxes.................................... 486 3,000 (3,000)(a) 486
---------- ---------- ----------- ----------- ------------
Total current assets............................ 21,045 33,900 (17,500) (50) 37,395
Property and equipment............................ 13,767 4,300 17,600(b) 35,667
Favorable lease................................... -- -- 4,500(c) 4,500
Goodwill.......................................... -- -- 49,900(d) 49,900
Other assets...................................... 1,215 -- 5,000(f) 5,983
(232)(h)
---------- ---------- ----------- ----------- ------------
Total Assets.................................... $ 36,027 $ 38,200 $ 54,500 $ 4,718 $133,445
---------- ---------- ----------- ----------- ------------
---------- ---------- ----------- ----------- ------------
LIABILITIES AND EQUITY
Bank line of credit............................... $ 1,230 $ -- 2,130(f) 2,130
(1,230)(g)
Notes payable..................................... 4,058 -- -- (4,000)(j) 58
Accounts payable.................................. 1,536 2,400 (2,400)(a) (2,700)(g) 1,536
2,700(e)
Accrued liabilities............................... 2,158 7,500 (4,000)(a) 5,658
Payable for W-J Acquisition....................... 82,200 (82,200)(g) --
Customer deposits................................. 233 4,800 5,033
---------- ---------- ----------- ----------- ------------
Total current liabilities....................... 9,215 14,700 78,500 (84,000) 18,415
Notes payable..................................... 18,581 -- (16,000)(g) 2,581
The Notes......................................... 100,000(f) 100,000
Other subordinated debt........................... 4,250 -- (2,500)(g) 1,750
Deferred compensation and pension liabilities..... 1,672 500 2,172
Deferred income taxes............................. 1,737 500 (500)(a) 1,737
---------- ---------- ----------- ----------- ------------
Total liabilities............................... 35,455 15,700 78,000 (6,500) 122,655
---------- ---------- ----------- ----------- ------------
Minority interest................................. 778 778
---------- ---------- ----------- ----------- ------------
Preferred stock................................... 4,000(j) 11,450
7,450(i)
Common stock...................................... 50 -- 50
Additional paid in capital........................ -- -- --
Invested equity................................... -- 22,500 (22,500)(a) --
Retained earnings................................. (256) -- (1,000)(e) (232)(h) (1,488)
---------- ---------- ----------- ----------- ------------
Total Shareholders' Equity...................... (206) 22,500 (23,500) 11,218 10,012
---------- ---------- ----------- ----------- ------------
Total............................................. $ 36,027 $ 38,200 $ 54,500 $ 4,718 $133,445
---------- ---------- ----------- ----------- ------------
---------- ---------- ----------- ----------- ------------
</TABLE>
See notes to pro forma consolidated balance sheet.
24
<PAGE>
NOTES TO PRO FORMA CONSOLIDATED BALANCE SHEET
The accompanying unaudited pro forma consolidated balance sheet as of September
30, 1997 gives effect to the W-J Acquisition, the Initial Offering and the New
Credit Facilities as if they had occurred as of September 30, 1997. Pro forma
adjustments are as follows:
<TABLE>
<S> <C>
As to the W-J Acquisition:
(a) Pursuant to the W-J Acquisition, the Company only purchased certain assets and assumed certain liabilities of
TSMD. Reflects an adjustment to eliminate those assets not purchased and liabilities not assumed as part of
the W-J Acquisition, and the related invested equity account.
(b) Reflects an adjustment to increase the carrying values of property and inventory acquired in connection with
the W-J Acquisition to their estimated fair market values (based on preliminary estimates).
(c) Reflects an adjustment to record the difference in contractual lease costs on the Stellex Microwave leased
facilities compared to estimated fair market lease costs, to be amortized over three years.
(d) Reflects an adjustment to reflect the excess purchase price paid over the fair value of the tangible and
identified intangible assets purchased and liabilities assumed (goodwill) in connection with the W-J
Acquisition.
(e) Reflects an adjustment to record the investment banking and financial advisory fees paid to Mentmore in
connection with the W-J Acquisition and the Initial Offering, and to accrue additional acquisition-related
expenses. See 'Certain Transactions--Management Agreement with Mentmore.'
As to the Initial Offering and the New Credit Facilities:
(f) Reflects adjustments to record the proceeds of the Initial Offering, estimated debt issuance costs of
$5,000,000 and the incurrence of $2,130,000 of borrowings under the New Credit Facilities.
(g) Reflects the payment of the W-J Acquisition purchase price of $82,200,000 (after giving effect to estimated
purchase price adjustments), payment of related accrued costs for the W-J Acquisition, and the repayment of
$17,230,000 of debt under the Prior Credit Facility and $2,500,000 of debt under the Trinity Note.
(h) Reflects an adjustment to write-off debt issuance costs recorded in connection with the Kleinert Acquisition,
as such debt was repaid with the proceeds of the Initial Offering.
(i) Reflects the sale of preferred stock for an aggregate of $7,450,000.
(j) Reflects the exchange of a note payable to an affiliated company for preferred stock of Stellex.
</TABLE>
25
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
(UNAUDITED, DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
W-J
ACQUISITION
AND
KLEINERT OFFERING COMPANY
KLEINERT ADJUST- TSMD ADJUST- CONSOLIDATED
HISTORICAL MENTS HISTORICAL MENTS PRO FORMA
------------- ----------- ------- ----------- ------------
(PREDECESSOR)
<S> <C> <C> <C> <C> <C> <C> <C>
Sales......................... $24,307 $89,200 $113,507
Cost of sales................. 17,367 $ (204) (a) 65,900 $ 3,274 (i) 87,417
1,080 (j)
Inventory writedowns and staff
reductions.................. -- 2,200 2,200
------------- ----------- ------- ----------- ------------
Gross profit.................. 6,940 204 21,100 (4,354) 23,890
Selling, general and
administrative.............. 3,629 (47) (a) 14,600 246 (i) 18,809
761 (c) 120 (j)
(500) (k)
Amortization of intangibles... 31 (31) (a) -- 3,496 (i) 3,496
------------- ----------- ------- ----------- ------------
Income from operations........ 3,280 (479) 6,500 (7,716) 1,585
Interest expense.............. 856 140 (e) -- 10,000 (l) 10,984
(592) (f) 580 (m)
Other expense, net............ 47 (7) (g) -- 40
------------- ----------- ------- ----------- ------------
Income (loss) before taxes.... 2,377 (20) 6,500 (18,296) (9,439)
Provision (benefit) for income
taxes....................... 945 (8) (h) 2,500 (3,437) (n) --
------------- ----------- ------- ----------- ------------
Net income (loss)............. 1,432 (12) 4,000 (14,859) (9,439)
Preferred stock dividends..... -- -- (1,145) (o) (1,145)
------------- ----------- ------- ----------- ------------
Income (loss) applicable to
common stockholders......... $ 1,432 $ (12) $ 4,000 $ (16,004) $(10,584)
------------- ----------- ------- ----------- ------------
------------- ----------- ------- ----------- ------------
</TABLE>
See notes to pro forma consolidated statements of operations.
26
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED, DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS W-J
ENDED THREE MONTHS ACQUISITION
JUNE 30, ENDED KLEINERT/ AND
1997 SEPTEMBER 30, 1997 STELLEX OFFERING COMPANY
KLEINERT STELLEX ADJUST- TSMD ADJUST- CONSOLIDATED
HISTORICAL HISTORICAL MENTS HISTORICAL MENTS PRO FORMA
------------- ------------------ -------- ---------- ----------- ------------
(PREDECESSOR) (SUCCESSOR)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales......................... $14,296 $ 8,890 $ 67,900 $ 91,086
Cost of sales................. 10,140 6,747 $ (131) (a) 47,900 $ 2,455 (i) 67,297
(624) (b) 810 (j)
------------- -------- -------- ---------- ----------- ------------
Gross profit.................. 4,156 2,143 755 20,000 (3,265) 23,789
Selling, general and
administrative.............. 1,783 1,571 (27) (a) 9,100 185 (i) 11,894
17 (c) 90 (j)
(450) (d) (375) (k)
Amortization of intangibles... 15 12 (15) (a) -- 1,748 (i) 1,760
------------- -------- -------- ---------- ----------- ------------
Income from operations........ 2,358 560 1,230 10,900 (4,913) 10,135
Interest expense.............. 376 508 70 (e) -- 7,500 (l) 8,527
(274) (f) 347 (m)
Other expense, net............ 98 20 (45) (g) -- 73
------------- -------- -------- ---------- ----------- ------------
Income before taxes........... 1,884 32 1,479 10,900 (12,760) 1,535
Provision (benefit) for income
taxes....................... 754 288 592 (h) 4,200 (5,684) (n) 150
------------- -------- -------- ---------- ----------- ------------
Net income.................... 1,130 (256) 887 6,700 (7,076) 1,385
Preferred stock dividends..... -- -- -- (859) (o) (859)
------------- -------- -------- ---------- ----------- ------------
Income applicable to common
stockholders................ $ 1,130 $ (256) $ 887 $ 6,700 $ (7,935) $ 526
------------- -------- -------- ---------- ----------- ------------
------------- -------- -------- ---------- ----------- ------------
</TABLE>
See notes to pro forma consolidated statements of operations.
27
<PAGE>
NOTES TO PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
The accompanying pro forma consolidated statements of operations for the year
ended December 31, 1996 and the nine months ended September 30, 1997 give effect
to the Transactions as if they had occurred as of January 1, 1996. Pro forma
adjustments are as follows:
As to the Kleinert Acquisition:
(a) Reflects an adjustment to record the decrease in depreciation and
amortization expense as a result of the allocation of the purchase price to
the net assets of Kleinert (based on estimated lives of four to eight years
for equipment and 32.5 years for the buildings at Kleinert). These amounts
are based on appraised values of the tangible assets. No amounts were
ascribed to intangible assets or goodwill as the purchase price did not
exceed the fair value of the net tangible assets acquired.
(b) Reflects an adjustment to eliminate non-recurring expenses associated with
the writeoff of inventory fair value adjustments directly connected with
the Kleinert Acquisition.
(c) Reflects an adjustment to record the estimated increase in the value of the
shares of common stock of KII Holding held by management which may be sold
to KII Holding under certain circumstances, as well as the estimated value
of stock appreciation rights (SARs) held by Stellex Aerospace management.
(d) Reflects an adjustment to eliminate non-recurring investment banking and
financial advisory fees paid to Mentmore directly connected with the
Kleinert Acquisition.
(e) Reflects an adjustment to record interest expense on indebtedness under the
Kleinert Seller Note incurred in connection with the Kleinert Acquisition
and not repaid in connection with the Initial Offering.
(f) Reflects an adjustment to eliminate interest expense on indebtedness
refinanced in the Transactions.
(g) Reflects an adjustment to eliminate non-recurring expenses directly
connected with the Kleinert Acquisition.
(h) Reflects an adjustment to record the estimated tax effect of entries (a)
through (g) above.
As to the W-J Acquisition and the Initial Offering:
(i) Reflects an adjustment to record the increase in depreciation and
amortization expense as a result of the allocation of the purchase price to
net assets of TSMD (based on estimated lives of five years for equipment,
three years for a favorable rent agreement and 25 years for goodwill, and
straight-line depreciation and amortization). These amounts are based on
preliminary estimates of fair market values of the tangible assets
acquired.
(j) Reflects an adjustment for additional cash to be paid for facilities rent
based on agreements between the Company and Watkins-Johnson entered into in
connection with the W-J Acquisition.
(k) Reflects an adjustment to eliminate the Watkins-Johnson corporate expense
allocation to TSMD ($2,800,000 and $2,100,000 for the year ended December
31, 1996 and nine months ended September 30, 1997, respectively) and to
record the Company's estimated costs of corporate services on a separate
company basis, as well as the Mentmore management fees payable pursuant to
the Management Agreement.
(l) Reflects an adjustment to record interest on the Notes at an interest rate
of 9.5% per annum, and related amortization of the estimated debt issuance
costs of $5,000,000 over the ten-year expected term of the Notes.
(m) Reflects an adjustment to impute interest expense on the net working capital
requirements of TSMD. As business units of Watkins-Johnson, no interest
expense was allocated to TSMD for the invested equity of their operations.
The ongoing working capital requirements of TSMD are expected to be funded
through cash flow from operations and borrowings under the New Credit
Facilities. Interest was calculated at 7.75% per annum based on the balance
of working capital items which will require funding by the Company on an
ongoing basis and TSMD's cash flows subsequent to January 1, 1996.
(n) Reflects an adjustment to record the estimated tax effect of entries (i)
through (m). The goodwill incurred on the acquisition is expected to be
deductible under Section 197 of the Internal Revenue Code. The 1996 tax
benefit is limited due to limitations on the recognizability of a deferred
tax asset on the pro forma net loss of the combined companies.
(o) Reflects an adjustment to record the dividends relating to the $11,450,000
preferred stock issued by the Company in connection with the Initial
Offering and the W-J Acquisition.
28
<PAGE>
SELECTED HISTORICAL FINANCIAL DATA
STELLEX
The selected historical financial data of Stellex as of and for each of the
five years in the period ended December 31, 1996 have been derived from the
audited financial statements of its predecessor, Kleinert; such audited
financial statements for the years ended December 31, 1994, 1995 and 1996 are
included elsewhere in this Prospectus. The selected financial data for Stellex
as of and for the nine, six and three months ended September 30, 1996, June 30,
1997 and September 30, 1997, respectively, are unaudited and, with the exception
of the financial data for the three months ended September 30, 1997, have been
prepared on the same basis as the audited financial data and, in the opinion of
management of Stellex, contain all adjustments necessary for a fair presentation
of the results of operations for such periods. The selected historical financial
data for the successor company as of and for the three months ended September
30, 1997 reflect adjustments resulting from the application of the purchase
method of accounting in conjunction with the Kleinert Acquisition. The purchase
accounting adjustments relate primarily to the impact of write-ups of
inventories and property and equipment to their fair values and the addition of
acquisition debt. The results of operations for the 1997 interim periods
presented are not necessarily indicative of the results to be expected for the
full year. The data presented below should be read in conjunction with the
historical financial statements of Stellex (successor to Kleinert) and related
footnotes, 'Pro Forma Consolidated Financial Data,' and 'Management's Discussion
and Analysis of Financial Condition and Results of Operations' contained
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS SIX MONTHS
ENDED ENDED THREE MONTHS
YEAR ENDED DECEMBER 31, SEPTEMBER 30, JUNE 30, ENDED
------------------------------------------- ------------- ---------- SEPTEMBER 30,
1992 1993 1994 1995 1996 1996 1997 -------------
------- ------- ------- ------- ------- ------------- ---------- 1997
-------------
(DOLLARS IN THOUSANDS) (SUCCESSOR)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Sales................................ $25,620 $21,664 $17,808 $21,049 $24,307 $17,967 $ 14,296 $ 8,890
Cost of goods sold................... 18,220 16,239 13,121 15,083 17,367 12,872 10,140 6,747
------- ------- ------- ------- ------- ------------- ---------- -------------
Gross profit......................... 7,400 5,425 4,687 5,966 6,940 5,095 4,156 2,143
Selling, general and
administrative..................... 4,133 3,514 3,110 3,299 3,629 2,747 1,783 1,571
Amortization of intangibles.......... 629 533 416 282 31 23 15 12
------- ------- ------- ------- ------- ------------- ---------- -------------
Operating income..................... 2,638 1,378 1,161 2,385 3,280 2,325 2,358 560
Interest expense..................... 1,386 1,078 979 1,034 856 660 376 508
Interest income...................... (93) (73) (44) (5) (11) (7) (5) (2)
Other expense (income)............... 317 273 145 44 58 39 103 22
------- ------- ------- ------- ------- ------------- ---------- -------------
Income before income taxes........... 1,028 100 81 1,312 2,377 1,633 1,884 32
Income tax provision................. 377 42 50 525 945 657 754 288
------- ------- ------- ------- ------- ------------- ---------- -------------
Net income (loss).................... $ 651 $ 58 $ 31 $ 787 $ 1,432 $ 976 $ 1,130 $ (256)
------- ------- ------- ------- ------- ------------- ---------- -------------
------- ------- ------- ------- ------- ------------- ---------- -------------
OTHER FINANCIAL DATA:
Cash flows from operating
activities......................... $ 2,717 $ 3,172 $ 2,130 $ 1,866 $ 2,657 $ 1,571 $ 479 $ (56)
Cash flows from investing
activities......................... (245) (372) 285 (643) (1,048) (623) (835) (15,338)
Cash flows from financing
activities......................... (2,466) (2,858) (2,360) (1,432) (1,407) (695) 272 15,802
EBITDA(a)............................ $ 5,127 $ 3,831 $ 3,440 $ 4,291 $ 4,913 $ 3,539 $ 3,133 $ 1,987
Depreciation and amortization........ 2,806 2,726 2,424 1,950 1,691 1,253 878 375
Capital expenditures................. 542 389 288 657 1,053 623 868 539
Ratio of earnings to fixed
charges(b)......................... 1.74x 1.09x 1.08x 2.27x 3.78x 3.47x 6.01x 1.06x
BALANCE SHEET DATA (AT END OF PERIOD):
Working capital...................... $ 7,043 $ 6,751 $ 6,621 $ 6,802 $ 7,735 $ 21,600 $ 11,829
Total assets......................... 33,694 30,065 28,029 28,180 29,614 42,700 36,027
Long-term debt, including current
maturities......................... 15,237 12,650 10,021 7,824 5,682 -- 22,889
Stockholders' equity................. 12,652 11,927 11,958 12,745 14,178 25,100 (206)
</TABLE>
- ------------------
(a) EBITDA represents income (loss) before income taxes plus interest expense,
depreciation and amortization less interest income. EBITDA for the three
months ended September 30, 1997 excludes certain non-recurring costs
directly related to the Kleinert Acquisition which included investment
banking fees paid to Mentmore totaling $450,000 and non-cash amortization of
an acquisition accounting adjustment to fair value inventory totaling
$624,000. The definition of EBITDA as used herein differs in certain
respects from the definition of such term in the Indenture. See 'Description
of Notes--Certain Definitions.' EBITDA is presented because it is a widely
accepted financial indicator of a company's ability to service indebtedness.
However, EBITDA should not be considered an alternative to operating income
or cash flows from operating activities (as determined in accordance with
generally accepted accounting principles) and should not be construed as an
indication of a company's operating performance or as a measure of
liquidity. Since all companies and analysts do not necessarily calculate
EBITDA in the same fashion, EBITDA as presented in this Prospectus may not
be comparable to similarly titled measures reported by other companies.
Funds depicted by EBITDA are generally not presently available for
management's discretionary use due primarily to legal and functional
requirements to conserve funds for capital replacement and expansion, debt
service and other commitments and uncertainties.
(b) In calculating the ratio of earnings to fixed charges, earnings consist of
income before taxes plus fixed charges. Fixed charges consist of interest
expense and amortization of deferred financing costs, whether expensed or
capitalized.
29
<PAGE>
STELLEX MICROWAVE
The selected financial data of Stellex Microwave as of and for the years
ended December 31, 1995 and 1996 and as of September 30, 1997 and for the nine
month period then ended have been derived from the audited financial statements
of the tactical systems and microwave devices business ('TSMD') of
Watkins-Johnson Company included elsewhere in this Prospectus. Certain assets
and liabilities held by TSMD were acquired by the Company in connection with the
W-J Acquisition. The selected financial data for TSMD as of and for the year
ended December 31, 1994 and as of the nine months ended September 30, 1996 are
unaudited but have been prepared on the same basis as the audited financial data
of TSMD and, in the opinion of management of Stellex Microwave, contain all
adjustments necessary for a fair presentation of the results of operations for
such periods. TSMD was a division of Watkins-Johnson, and its results may not be
reflective of those that would have resulted had it operated as an independent
entity. The results of operations for the nine months ended September 30, 1997
are not necessarily indicative of the results to be expected for the full year.
The data presented below should be read in conjunction with the historical
financial statements and related footnotes, 'Pro Forma Consolidated Financial
Data,' and 'Management's Discussion and Analysis of Financial Condition and
Results of Operations' contained elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ ------------------
1994 1995 1996 1996 1997
-------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Sales................................................... $101,300 $97,600 $89,200 $61,300 $67,900
Cost of goods sold...................................... 72,300 65,200 68,100 45,400 47,900
-------- ------- ------- ------- -------
Gross profit............................................ 29,000 32,400 21,100 15,900 20,000
Selling, general and administrative..................... 22,400 17,300 14,600 11,000 9,100
-------- ------- ------- ------- -------
Income before income taxes.............................. 6,600 15,100 6,500 4,900 10,900
Income tax provision.................................... 2,600 5,900 2,500 1,900 4,200
-------- ------- ------- ------- -------
Net income.............................................. $ 4,000 $ 9,200 $ 4,000 $ 3,000 $ 6,700
-------- ------- ------- ------- -------
-------- ------- ------- ------- -------
OTHER FINANCIAL DATA:
Cash flows from operating activities.................... N/A $ 21 $ (3) $ 15
Cash flows from investing activities.................... N/A (2) (2) (1)
Cash flows from financing activities.................... N/A (19) 5 (14)
EBITDA(a)............................................... $ 9,300 $17,700 $ 8,800 $12,300
Adjusted EBITDA(a)...................................... 9,300 18,100 11,000 12,300
Depreciation and amortization........................... 2,700 2,600 2,300 1,400
Capital expenditures.................................... 3,000 2,200 1,700 600
BALANCE SHEET DATA (AT END OF PERIOD)(B):
Working capital......................................... $ 25,800 $16,900 $25,800 $19,200
Total assets............................................ 46,600 39,200 50,200 38,200
Long-term debt.......................................... -- -- -- --
Stockholders' equity.................................... 31,000 21,400 29,900 22,500
</TABLE>
- ------------------
(a) EBITDA represents income (loss) before income taxes, depreciation and
amortization. TSMD's historical results do not include interest expense or
interest income. Adjusted EBITDA for the year ended December 31, 1996
excludes a $1.5 million charge included in cost of goods sold for the
write-off of slow moving and excess inventory, and a $700,000 charge
included in cost of goods sold for severance costs relating to a reduction
in force of operational and manufacturing employees, of which $300,000 was
recorded in the nine months ended September 30, 1996. Adjusted EBITDA for
the year ended December 31, 1995 excludes a $400,000 charge included in
selling, general and administrative expenses for severance costs relating to
a reduction in force of operational and manufacturing employees. The
definition of EBITDA as used herein differs in certain respects from the
definition of such term in the Indenture. See 'Description of Notes--Certain
Definitions.' EBITDA is presented because it is a widely accepted financial
indicator of a company's ability to service indebtedness. However, EBITDA
should not be considered an alternative to operating income or cash flows
from operating activities (as determined in accordance with generally
accepted accounting principles) and should not be construed as an indication
of a company's operating performance or as a measure of liquidity. Since all
companies and analysts do not necessarily calculate EBITDA in the same
fashion, EBITDA as presented in this Prospectus may not be comparable to
similarly titled measures reported by other companies. Funds depicted by
EBITDA are generally not presently available for management's discretionary
use due primarily to legal and functional requirements to conserve funds for
capital replacement and expansion, debt service and other commitments and
uncertainties.
(b) Represents the historical assets of TSMD. In connection with the W-J
Acquisition, a subsidiary of the Company acquired only certain operating
assets and liabilities of TSMD. See 'Certain Transactions--The W-J
Acquisition.'
30
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company, through its subsidiaries, Stellex Microwave and Stellex
Aerospace, is a leading provider of highly engineered subsystems and components
for the aerospace, defense and space industries. Stellex Microwave is a
worldwide leader in the design, manufacture and marketing of fully integrated
and proprietary microwave electronic subsystems for radar-guided tactical
missile systems and a broad line of high radio frequency and microwave frequency
single function modules. Stellex Microwave products are used in the generation,
reception and translation of communication, data and radar signals. Stellex
Aerospace is a leader in the machining of turbomachinery, aircraft hinges and
other structural components for the aerospace and space industries.
On July 1, 1997, KII Holding acquired Stellex Aerospace (formerly Kleinert
Industries, Inc.) from Kleinert Industrie Holding A.G. Stellex Aerospace
conducts its business through four operating subsidiaries--Paragon, Bandy, SEAL
and GIL. On September 5, 1997 Stellex was formed and thereafter acquired
approximately 80% of the common stock of KII Holding. The results of operations
of Stellex for the periods presented herein represent the results of operations
of Kleinert for such periods. See 'Certain Transactions--Kleinert Acquisition.'
In connection with the W-J Acquisition, the Company acquired the tactical
subsystems and microwave devices businesses ('TSMD') of Watkins-Johnson, which
was operated as a division of Watkins-Johnson and was not a separate legal
entity. The Company operates the TSMD business through Stellex Microwave. The
results of operations of Stellex Microwave for the periods presented herein
represent the results of operations of TSMD for such periods and its results may
not be reflective of those that would have resulted had it operated as an
independent entity. The income tax expense and other tax-related information of
Stellex Microwave for the periods presented (i) are presented as if TSMD had not
been eligible to be included in the consolidated tax returns of Watkins-Johnson
and (ii) have required certain assumptions, allocations and significant
estimates that management believes are reasonable in measuring the tax
consequences to TSMD as if it had been a stand-alone taxpayer separate from
Watkins-Johnson.
STELLEX AEROSPACE
The Company's sales to the aerospace industry are conducted primarily by
Stellex Aerospace. Stellex Aerospace's historical financial results have been
significantly influenced by both the cyclicality of the commercial aerospace
industry and the increased outsourcing of the production of components by OEMs
to outside suppliers. During the period from 1992 to 1994, the commercial
aerospace industry experienced a significant reduction in orders for new
aircraft and engines. In response, Stellex Aerospace significantly reduced its
costs by reducing its work force and rationalizing its production capacity. In
addition, Stellex Aerospace took steps to expand its business activity
throughout this period by increasing the number of customers for whom it
manufactured prototypes and by seeking contracts to produce higher volumes of
turbomachinery components. Since 1994, primarily as a result of the recovery in
overall aircraft orders and its success in gaining additional prototype and
production-oriented supply contracts, Stellex Aerospace has significantly
increased sales and profitability.
The Company believes that the recent increases in expenditures on new
aircraft production and revenue passenger miles will benefit aerospace industry
suppliers, such as the Company, that were able to withstand the difficult
operating environment and consolidation among suppliers of the early 1990's. See
'Business--Industry Overview.'
31
<PAGE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 (COLLECTIVELY COMPRISED OF KLEINERT
(PREDECESSOR) FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND STELLEX (SUCCESSOR) FOR
THE THREE MONTHS ENDED SEPTEMBER 30, 1997) COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1996
Sales. Stellex Aerospace's sales increased by $5,218,900, or 29.0%, in the
nine months ended September 30, 1997 over the comparable period in the prior
year. The increase in sales was primarily attributable to increases in
commercial aircraft production by Boeing, strong spare parts demand and the
acceleration of the production schedule for the C-17 program which impacted
Bandy's business. In addition, Paragon experienced increases in spacecraft and
prototype work due to continuing strong demand for space shuttle parts.
Gross profit. Gross profit increased by $1,204,400, or 23.6%, in the nine
months ended September 30, 1997 over the comparable period in the prior year,
and gross profit margin decreased to 27.2% in the nine months ended September
30, 1997 from 28.4% in the comparable period in the prior year. Gross profit was
impacted during the three month period ended September 30, 1997 by the
amortization of a non-recurring purchase accounting adjustment totaling
approximately $624,000, resulting from the write-up of inventories to their fair
market value on the date of the Kleinert Acquisition. Ignoring the impact of
this write-up on gross profit margin would result in a 29.9% comparable amount.
Gross margin benefitted from an improvement in plant utilization and production
efficiencies at Bandy due to the installation of new Fadal milling machines.
These benefits were partially offset by increased outsourcing necessitated by
capacity constraints and raw material price increases on aluminum extrusions.
Additional milling capacity will be added at Bandy during the fourth quarter of
1997 to accommodate increasing demand.
Selling, general and administrative. Selling, general and administrative
expenses increased $606,700, or 22.1%, in the nine months ended September 30,
1997 over the comparable period in the prior year. The increase in selling,
general and administrative expenses was primarily due to a non-recurring charge
totaling $450,000 for investment banking and financial advisory fees related to
the Kleinert Acquisition. Excluding this non-recurring charge, selling, general
and administrative expenses as a percentage of sales decreased from 15.3% in the
nine months ended September 30, 1996 to 12.5% in the comparable period in 1997,
primarily because the increased sales volume and improved plant utilization
required a relatively small increase in selling, general and administrative
expenses. Additionally, employee benefit costs were reduced in the 1997 period
over the levels in the comparable period in the prior year when two deferred
compensation plans were established.
Amortization of intangible assets. Amortization expense relating to
intangible assets increased by $4,400, or 18.8%, in the nine months ended
September 30, 1997 over the comparable period in the prior year. The increase
was due to increased amortization of intangibles relating to the Kleinert
Acquisition.
Operating income. Operating income increased by $593,300, or 25.5%, in the
nine months ended September 30, 1997 over the comparable period in the prior
year. Operating income as a percentage of net sales decreased to 12.6% in the
nine months ended September 30, 1997 from 12.9% in the comparable period.
However, excluding non-recurring adjustments related to the Kleinert
Acquisition, operating income as a percentage of net sales would have increased
to 17.2%, primarily due to the factors outlined above.
Interest expense. Interest expense increased by $224,200, or 34.0%, in the
nine months ended September 30, 1997 over the comparable period in the prior
year. The increase in interest expense resulted from a net increase in total
outstanding debt of approximately $18,000,000, primarily to finance the Kleinert
Acquisition, offset partially by an interest rate reduction from 10.125% to
7.875% on a building mortgage, and lower outstanding debt during the first six
months of 1997.
Other expense (income). Other expense (income) increased by $86,300 in the
nine months ended September 30, 1997, over the comparable period in the prior
year. The increase in other (income) expense was primarily due to expenses
related to the Kleinert Acquisition and a vending machine contract dispute
settlement.
Income tax provision. The effective income tax rates for the nine months
ended September 30, 1997 and 1996 were 54.4% and 40.2%, respectively. The higher
effective income tax rate for 1997 was primarily due to the non-deductibility
for income tax purposes of certain purchase accounting adjustments relating to
the Kleinert Acquisition.
Net income. As a result of the factors described above, net income
decreased by $101,700, or 10.4%, during the period ended September 30, 1997 over
the comparable period in the prior year.
32
<PAGE>
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Sales. Stellex Aerospace's sales increased by $3,257,800, or 15.5%, in
1996 over 1995. The increase in sales was primarily attributable to the
resurgence of new orders as a result of increases in aircraft production in
commercial and military aircraft markets, offset partially by $1.0 million in
lower sales resulting from a reduction in volume in Paragon's Titan program,
which is in the latter stages of its product life cycle.
Gross profit. Stellex Aerospace's gross profit increased by $974,500, or
16.3%, in 1996 over 1995. Gross profit margin increased to 28.6% in 1996 from
28.3% in 1995. The increase in gross profit was primarily the result of
increased sales. The slight improvement in gross margin was due primarily to
longer production runs and improved plant capacity utilization, which was almost
entirely offset by lower margins on a new power actuation contract,
industry-wide pricing pressures and lower volume on Paragon's higher margin
Titan program.
Selling, general and administrative. Selling, general and administrative
expenses increased by $330,700, or 10.0%, in 1996 over 1995. As a percentage of
sales, selling, general and administrative expenses decreased from 15.7% in
1995, to 14.9% in 1996 because the increased sales volume and improved plant
utilization did not require a comparable increase in selling or administrative
expenses. Additional administrative costs, however, were incurred in
establishing two deferred compensation plans.
Amortization of intangible assets. Amortization expense relating to
intangible assets decreased by $251,000, or 88.9%, in 1996 from 1995. The
decrease in amortization expense relating to intangible assets was due to the
expiration of a non-compete agreement during 1995.
Operating income. Operating income increased by $894,800, or 37.5%, in
1996 over 1995. Operating income as a percentage of net sales increased to 13.5%
in 1996 from 11.3% in 1995 primarily due to the factors outlined above.
Interest expense. Interest expense decreased by $178,600, or 17.3%, in
1996 from 1995. The decrease in interest expense resulted primarily from a
reduction of the mortgage interest rate on a building and lower outstanding
debt.
Other expense (income). Other expense (income) increased by $7,900, or
20.5%, in 1996 over 1995. The increase in other (income) expense was primarily
due to lower levels of gains on sale of fixed assets and expenses related to the
Kleinert Acquisition.
Income tax provision. The effective income tax rate was 39.7% and 40.0%,
in 1996 and 1995, respectively.
Net income. As a result of the factors described above, net income
increased by $645,400, or 82.0%, for the year ended December 31, 1996 over 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Sales. Stellex Aerospace's sales increased by $3,240,700, or 18.2%, in
1995 over 1994. The increase in sales was primarily attributable to production
orders from a new program for AlliedSignal for machine blades and vanes for a
new jet engine totaling approximately $2,500,000 and general improving strength
in the aerospace industry.
Gross profit. Stellex Aerospace's gross profit increased by $1,278,800, or
27.3%, in 1995 over 1994. Gross profit margin increased to 28.3% in 1995 from
26.3% in 1994. The increase in gross profit and gross profit margin was
primarily the result of higher margin orders, lower depreciation expense, longer
production runs and improved plant capacity utilization.
Selling, general and administrative. Selling, general and administrative
expenses increased by $189,300, or 6.1%, in 1995 over 1994. As a percentage of
sales, selling, general and administrative expenses decreased as a percentage of
sales from 17.5% in 1994 to 15.7% in 1995 because increased sales volume and
improved plant utilization did not require comparable increases in selling and
administrative expenses.
Amortization of intangible assets. Amortization expense relating to
intangible assets decreased by $133,900, or 32.2%, in 1995 over 1994. The
decrease in amortization expense related to the expiration of a non-compete
agreement established in conjunction with the Bandy acquisition in 1990.
Operating income. Operating income increased by $1,223,400, or 105.3%, in
1995 over 1994. Operating income as a percentage of net sales increased to 11.3%
in 1995 from 6.5% in 1994 primarily due to factors outlined above.
33
<PAGE>
Interest expense. Interest expense increased by $55,600, or 5.7%, in 1995
over 1994. The increase in interest expense resulted from greater working
capital needs and capital spending offset partially by lower interest rates
during the latter period.
Other expense (income). Other expense (income) decreased by $62,600, or
61.9%, in 1995 over 1994. The decrease in other expense (income) was primarily
due to lower severance costs, non-repeat of 1994 earthquake expenses, and lower
interest income.
Income tax provision. The effective income tax rate was 40.0% and 61.3%,
in 1995 and 1994, respectively.
Net income. As a result of the factors described above, net income
increased by $755,600 for the year ended December 31, 1995 over 1994.
STELLEX MICROWAVE
Since the consummation of the W-J Acquisition, the Company's sales to the
DoD and other government agencies and their prime contractors have been
conducted, in large part, by Stellex Microwave. Stellex Microwave's historical
financial results have been affected by a variety of factors which influence the
defense industry in general and Stellex Microwave in particular. Significant
factors include DoD budget appropriations, the level of production of high
priority platforms, the use of sophisticated electronics, the level of new
weapon development and procurement, the competition among OEM suppliers, and the
outsourcing of the manufacture and integration of subsystems to independent
commercially-oriented suppliers. United States defense budget appropriations are
forecasted to remain relatively constant or increase slightly in the near term,
reversing the recent decline in spending which precipitated the dramatic
consolidation among prime contractors. See 'Business--Industry Overview.'
Between 1994 and 1996, the number of AMRAAM missiles purchased by the DoD
decreased significantly and the number of sophisticated tuners purchased by the
DoD and various intelligence agencies also decreased significantly. This decline
was due primarily to reduced military force structures and signals intelligence
activity. In response to the decline of AMRAAM sales, management implemented
various initiatives to gain market share in the AMRAAM program and to support
other key tactical missile programs and thereby diversify and grow Stellex
Microwave's subsystem revenue base. As a result, the Company is the dominant
supplier of microwave subsystems for the AMRAAM program and is currently
supporting several key missile programs including Standard Missile, Longbow
Hellfire, Patriot PAC-3 and Sea Sparrow. As the majority of these programs have
been in initial development or low rate production, management expects to
further diversify Stellex Microwave's program revenues as these programs move to
high rate production.
In addition, during the past five years, significant management attention
and corporate resources of Watkins-Johnson were devoted to growing its
semiconductor equipment and low frequency telecommunications equipment
businesses. Also, in early 1995, Watkins-Johnson sold a business that shared
facilities and personnel with the businesses now conducted by Stellex Microwave.
In response to these factors, Stellex Microwave management initiated a program
to reduce its operations to a level more appropriate for the requirements of the
reduced military force structures and to increase its share of microwave
subsystems on those high priority military weapons systems on which the DoD is
expected to rely to equip its modernized force structure.
Beginning in 1994, Watkins-Johnson (i) divested a non-core business line
which shared production facilities with TSMD, (ii) consolidated manufacturing
operations into its Palo Alto facility, (iii) reduced and reconfigured its sales
force, and (iv) reduced its work force from approximately 900 to 560 people, a
38% reduction. As a result, in 1995 selling, general and administrative expenses
decreased by $5,100,000, or 22.8%, as compared to 1994. In conjunction with this
ongoing restructuring, severance costs were incurred in varying amounts in each
of the years from 1994 through 1996 and during the six months ended June 30,
1997. Management believes Stellex Microwave derived significant benefits from
its rationalization efforts throughout 1995 and 1996, and that its production
capacity and work force are of sufficient size to efficiently conduct its
current level of operations.
As part of its arrangements with certain OEMs, Stellex Microwave has from
time to time agreed to reduce prices in conjunction with receiving Value
Engineering ('VE') payments from such OEMs in advance of the ordering of single
or multiple year production requirements. This practice is designed to allow
Stellex Microwave to invest in process changes that result in lower production
costs. Beginning in 1995, in an attempt to improve operating efficiency by
increasing production volume, Stellex Microwave aggressively pursued VE payments
and
34
<PAGE>
increased volume from Raytheon, who at that time produced most of its microwave
subsystem requirements in-house. Stellex Microwave received a material VE
payment in December 1995. To win the production order, Stellex Microwave
redesigned the subsystem, reduced its average ship-set price, and gained the
sole source supplier position on three microwave subsystems previously produced
by Raytheon. This new supply contract was signed in June 1996 and Stellex
Microwave began shipping subsystems under the terms of the contract during the
fourth quarter of 1996. The contract was anticipated to cover shipments of
subsystems through the third quarter of 1997.
In addition to the effect of trends within the defense industry, operating
results of Stellex Microwave were materially impacted in 1996 and to a lesser
degree in the six months ended June 30, 1997 by operating difficulties
associated with the installation of a new materials and manufacturing management
software ('MRP') system. As a result of such difficulties, Stellex Microwave
failed to deliver a significant number of microwave component parts within time
frames specified by purchase orders and incurred significant additional labor
inefficiencies. In the third quarter of 1996, Stellex Microwave installed a new
manager for its higher volume microwave components business, retrained its
employees in the operation of the MRP system and aggressively monitored the
delivery status of its microwave components. As a result of such efforts, on
time delivery results began to improve in the six months ended June 30, 1997 and
management now believes that its materials management system is effective.
Nonetheless, management expects that the MRP difficulties experienced in 1996
will negatively impact sales of microwave component parts in the current year.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1996
Sales. Sales increased by $6,600,000, or 10.8%, in the nine months ended
September 30, 1997 over the nine months ended September 30, 1996. The increase
in sales was primarily attributable to an increase in sales of integrated
subsystems. The increase in sales of integrated subsystems was primarily the
result of higher shipments of subsystems for the AMRAAM program to Raytheon,
partially offset by lower pricing on such subsystems.
Gross profit. Gross profit increased by $4,100,000, or 25.8%, for the nine
months ended September 30, 1997 over the comparable period in the prior year.
Gross profit margin increased to 29.5% for the nine months ended September 30,
1997 from 25.9% for the comparable period in the prior year. The increase in
gross profit and gross profit margin was primarily attributable to the increase
in sales and the improved manufacturing efficiencies in the current period
resulting from the resolution of operating difficulties associated with the MRP
system and higher production volumes. These positive factors were partially
offset by the price declines on AMRAAM as a result of the new contract with
Raytheon.
Selling, general and administrative expenses. Selling, general and
administrative expenses (which includes independent research and development
costs) decreased by $1,900,000, or 17.3%, during the nine months ended September
30, 1997 over the comparable period in the prior year. This decrease resulted
from a reduction in research and development costs of $500,000 and a reduction
in selling, general and administrative expenses of $800,000. The reduction in
research and development costs was a result of a decrease in the number of
projects authorized. The reduction in selling, general and administrative
expenses was primarily attributable to headcount reductions implemented as part
of Stellex Microwave's continuing effort to streamline its administrative
operations.
Income before income taxes. Income before income taxes increased by
$6,000,000, or 122%, for the nine months ended September 30, 1997 over the
comparable period in the prior year. The increase in income before income taxes
was primarily attributed to the factors outlined above.
Income tax provision. The effective income tax rate was 38.5% for both the
nine months ended September 30, 1997 and 1996, respectively.
Net income. As a result of the factors described above, net income
increased to $6,700,000 for the nine months ended September 30, 1997, an
increase of $3,700,000, or 108.8%, over the comparable period in the prior year.
35
<PAGE>
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Sales. Stellex Microwave's sales decreased by $8,400,000, or 8.6%, in 1996
over 1995. The decrease in sales was primarily due to lower sales volume on
integrated subsystems and, to a lesser extent, microwave devices. The decrease
in sales of integrated subsystems was due to an $8,000,000 decrease in product
sales related to the AMRAAM program, partially offset by increased sales of
subsystems for other missile programs. The decrease in sales for the AMRAAM was
primarily attributable to $4,700,000 of VE payments which were made in the
second half of 1995 relating to engineering design changes made that year for
production scheduled to begin in 1996. In addition, there was a reduction in the
number of AMRAAMs purchased by the DoD in 1996 and an even greater decrease in
the number purchased from Hughes, which is Stellex Microwave's primary subsystem
customer. Sales were also impacted by lower selling prices for Stellex
Microwave's AMRAAM-related products. These decreases were partially offset by
increased sales volume on AMRAAM subsystems to Raytheon under a supply contract
signed in June 1996. In addition, Stellex Microwave began shipping subsystems
for the upgraded Standard Missile-2, increased the production of the MFE, and
had an end-of-life sale of HARM subsystems. The decrease in sales of microwave
devices was caused by declines in the market for signals intelligence equipment
made for various intelligence agencies, partially offset by increased sales of
space-qualified and electronic warfare SFMs.
Gross profit. Gross profit decreased by $11,300,000, or 34.9%, in 1996
over 1995, and gross profit margin decreased to 23.7% in 1996 from 33.2% in
1995. The decrease in gross profit and gross profit margin resulted primarily
from the receipt of a substantial VE payment in December 1995 that related to
1996 and 1997 production, together with price reductions on AMRAAM-related
products. Additionally, (i) contract losses totaling $2,200,000 incurred on two
microwave tuner fixed price programs, (ii) obsolescence reserves on component
inventory totaling $1,500,000, (iii) severance costs aggregating $700,000
relating to purchasing, material handling and production labor reductions and
other labor inefficiencies, resulting primarily from the introduction of Stellex
Microwave's new MRP system and the continued automation and outsourcing of
production functions and (iv) continued focus on manufacturing process controls
and manufacturing inefficiencies resulting from implementation difficulties with
the new MRP system, all led to additional reductions in gross margins.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $2,700,000, or 15.6%, in 1996 over 1995.
This decrease resulted from a reduction of research and development costs of
$1,300,000 and a reduction in selling, general and administrative expenses of
approximately $1,400,000. The reduction in research and development spending
resulted from selective focus on higher probability production-worthy projects.
The reduction in selling, general and administrative costs represented a
continuation of a corporate strategy to streamline operations in response to the
contraction in defense spending as well as the significant level of
consolidation in its defense-related customer base.
Income before income taxes. Income before income taxes decreased by
$8,600,000, or 57.0%, in 1996 over 1995. The decrease in income before income
taxes resulted primarily from manufacturing inefficiencies resulting from the
implementation of the new MRP system, the receipt of a significant VE payment in
1995, a decrease in volume and pricing on the AMRAAM contract and non-recurring
losses incurred regarding certain loss contracts and inventory obsolescence
reserves. These costs were partially offset by reductions in selling, general
and administrative expenses.
Income tax provision. The effective tax rate for 1996 was 38.5%, while the
effective tax rate for 1995 was 39.1%.
Net income. As a result of the factors described above, net income
decreased to $4,000,000 in 1996, a decrease of $5,200,000, or 56.5%, over 1995.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Sales. Sales decreased by $3,700,000, or 3.7%, in 1995 over 1994. The
decrease in sales was primarily attributable to a reduction in the sales of an
end-of-life product line and reduction in sales volume on certain missile
programs. Revenues from guided munitions programs remained constant as increases
in sales associated with the AMRAAM and other programs were offset by reduced
sales associated with the older HARM program.
Gross profit. Gross profit increased $3,400,000, or 11.7%, in 1995 over
1994, and gross profit margin increased to 33.2% in 1995 from 28.6% in 1994. The
increase in gross profit and gross profit margin was primarily due to a
reduction in direct labor and overhead expenses as a result of the consolidation
of plant
36
<PAGE>
facilities during April 1995. Successful development of a 'snap together' type
of subassembly fabrication technique was initiated during 1995 which, together
with the plant consolidation effort, reduced direct labor costs.
Selling, general and administrative expenses. Selling, general and
administrative expenses decreased by $5,100,000, or 22.8%, in 1995 from 1994.
The decrease in selling, general and administrative expenses consisted of a
reduction in selling, general and administrative expenses of $4,400,000 and a
reduction of research and development costs totaling $700,000. The reduction of
the above costs resulted from headcount reductions and consolidation of Stellex
Microwave's plant facilities in Palo Alto.
Income before income taxes. Income before income taxes increased
$8,500,000, or 128.8%, in 1995 over 1994. The increase in income before income
taxes resulted primarily from reductions in production costs due to development
of less labor intensive fabrication techniques, reductions in headcount and
consolidation of plant facilities.
Income tax provision. The effective tax rate for 1995 was 39.1%, while the
effective tax rate for 1994 was 39.4%.
Net income. As a result of the foregoing, net income increased to
$9,200,000 in 1995, an increase of $5,200,000, or 130.0%, over 1994.
LIQUIDITY AND CAPITAL RESOURCES
Historical
Stellex generated (used) cash flows from operations of $2,130,400,
$1,866,100 and $2,657,000 for 1994, 1995 and 1996, respectively, and $1,570,700
and $423,400 for the nine months ended September 30, 1996 and September 30,
1997, respectively. Cash flows over the periods presented reflect a consistent
increase in earnings offset, in part, by a gradual buildup of inventories
supporting the growing level of sales.
Stellex used (provided) cash flows in investing activities, excluding cash
flows used in connection with the Kleinert Acquisition of ($285,100), $643,100
and $1,048,000 during 1994, 1995 and 1996, respectively, and $622,500 and
$1,374,000 for the nine months ended September 30, 1996 and September 30, 1997,
respectively. During 1994, cash flows were generated from collection of a note
receivable totaling $548,000. During 1995, 1996 and the nine months ended
September 30, 1997, investments in machinery were made in order to accommodate a
rising level of production orders resulting from increasing levels of aircraft
manufacturing activity.
Stellex used (provided) cash flows in financing activities, excluding net
cash provided in connection with the Kleinert Acquisition, of $2,359,800,
$1,431,900 and $1,406,600 in 1994, 1995 and 1996, respectively, and $695,000 and
($687,000) for the nine months ended September 30, 1996 and September 30, 1997,
respectively. For the three years 1994 through 1996, Stellex repaid outstanding
long term indebtedness in excess of $2,000,000 in each of these three years. Net
borrowings on a line of credit totaling $169,300, $765,000 and $735,000 for
1994, 1995 and 1996, respectively, and $730,000 for the nine months ended
September 30, 1997 provided working capital primarily used to build inventories
to support the growing level of business.
On July 1, 1997, KII Holding, through a wholly-owned subsidiary, acquired
all of the issued and outstanding capital stock of Kleinert for approximately
$26.5 million (including the assumption of $2.6 million of indebtedness and the
issuance to the seller of a note for approximately $1.75 million). The Company
also entered into the Prior Credit Facility in connection with the Kleinert
Acquisition. In connection with the Initial Offering, the Company repaid all
indebtedness outstanding under the Prior Credit Facility, together with $2.5
million of other indebtedness incurred in connection with the Kleinert
Acquisition.
Stellex Microwave generated (required) cash flows from operations of
$21,000,000 and ($2,800,000) in 1995 and 1996, respectively, and $14,700,000 in
the nine months ended September 30, 1997. Cash flows for 1995 were impacted
primarily by favorable earnings and a significant reduction in inventories
representing final shipments on Lot 8 of the AMRAAM contract. Cash flows for
1996 were impacted primarily by the buildup of Lots 9 and 10 of the AMRAAM
contract and an increase in trade receivables resulting from system conversion
inefficiencies, offset partially by contract advances on the AMRAAM. Cash flows
for the nine months ended September 30, 1997 were favorably impacted by
increased collections on trade receivables primarily due to a more focused
effort on collections. This came in response to an unusually high level of
delinquent accounts which resulted from MRP system conversion inefficiencies
during 1996.
37
<PAGE>
Stellex Microwave used cash flows for property additions of $2,200,000 and
$1,700,000 in 1995 and 1996, respectively, and $600,000 in the nine months ended
September 30, 1997. Stellex Microwave is an engineering, design and assembly
oriented business which does not require significant capital expenditures on an
ongoing basis.
Following the Initial Offering
Upon the consummation of the Initial Offering and the W-J Acquisition, the
Company entered into the New Credit Facilities, which provide for borrowings in
a principal amount at any one time outstanding of up to $25.0 million under the
Revolving Credit Facility (as defined) and $25.0 million under the Acquisition
Facility (as defined), with initial available borrowing rates equal to (i) the
Eurodollar Rate (as defined therein) plus 2% or Societe Generale's base rate
plus 1% in the case of borrowings under the Revolving Credit Facility and (ii)
the Eurodollar Rate plus 2.25% or Societe Generale's base rate plus 1.25% in the
case of borrowings under the Acquisition Facility. See 'Description of Certain
Indebtedness--New Credit Facilities--Interest.'. The Company borrowed $2.5
million under the Revolving Credit Facility upon consummation of the W-J
Acquisition and the Initial Offering. Included in the initial borrowing under
the Revolving Credit Facility was a working capital advance totaling $370,000
for Stellex Microwave. The Company's borrowings under the Revolving Credit
Facility are subject to a borrowing base consisting of the aggregate sum of 85%
of eligible accounts receivable and 50% of eligible inventories, each as defined
in the Revolving Credit Facility. The computed borrowing base upon the
consummation of the Initial Offering and the W-J Acquisition totaled
approximately $16.0 million. Borrowings under the Acquisition Facility are
available to the Company to fund future acquisitions, subject to certain
specified conditions. The New Credit Facilities require prepayments in the
amount of 50% of Excess Cash Flow (as defined therein), 100% of net cash
proceeds from certain asset sales, and 100% of net cash proceeds from the
issuance of debt and/or equity securities. The New Credit Facilities mature in
2003. See 'Description of Certain Indebtedness--New Credit Facilities.'
Interest payments on the Notes together with interest and principal
payments on other existing indebtedness, including indebtedness under the New
Credit Facilities, represent significant cash requirements for the Company. The
Notes require semiannual interest payments of $4,750,000 commencing in May 1998.
Existing indebtedness consists of (i) the Kleinert Seller Note in the amount of
$1,750,000 bearing interest at 8% per annum and maturing in July 1999 and (ii)
the Paragon Note in the amount of $2,639,000 as of September 30, 1997 bearing
interest at 7.875% per annum and maturing in December 2001. See 'Description of
Certain Indebtedness.'
The Company's remaining liquidity demands will be for capital expenditures
and working capital needs. In connection with the W-J Acquisition, the Company
purchased certain assets exclusive of certain working capital accounts such as
trade receivables and trade payables. As a result, the Company has required
significant amounts of working capital particularly since the consummation of
the Initial Offering and additional amounts may be required to be borrowed under
the New Credit Facilities. For 1998, based on the Company's existing operations,
the Company expects to spend approximately $3,300,000 on capital projects
primarily to maintain its facilities and expand its production capacity in order
to take advantage of profitable market opportunities. Based on its existing
operations, the Company anticipates capital expenditures for the foreseeable
future to remain consistent with the level of capital expenditures projected for
1998, in order to continue to support facilities maintenance, production
capacity expansion and existing equipment upgrade programs. In connection with
the W-J Acquisition, Stellex Microwave entered into a Gallium Arsenide and Thin
Film Supply and Services Agreement, pursuant to which Stellex Microwave will
purchase gallium arsenide and thin film parts used in the manufacture of
microwave subsystems and modules. Pursuant to this agreement, Stellex Microwave
is responsible for certain product development and process costs associated with
the maintenance of Watkins-Johnson's gallium arsenide and thin film fabrication
facility. For 1998, the Company's total costs for parts, product development and
processes under such agreement will equal a minimum of approximately $5.8
million. See 'Business--Supply Contracts.' To the extent cash flow from
operations is insufficient to cover the Company's capital expenditure, debt
service, working capital and other capital requirements, it expects to utilize
its borrowing availability under the New Credit Facilities.
The Company believes that, based on its current level of operations and
anticipated growth, its cash flow from operations, together with borrowings
available under the New Credit Facilities, will be adequate to meet its
anticipated requirements for working capital, capital expenditures, interest
payments and any scheduled principal payments in the foreseeable future.
38
<PAGE>
INFLATION AND CHANGING PRICES
Inflation has not been material to the Company's operations for the periods
presented.
BACKLOG
The Company's pro forma backlog of orders as of September 30, 1997 and
December 31, 1996 was $99.8 million ($70.1 million of which was related to
products for the defense industry) and $89.8 million ($72.8 million of which was
related to products for the defense industry), respectively. The Company
includes in its backlog only those orders for which it has accepted purchase
orders. However, backlog is not necessarily indicative of future sales. A
substantial amount of the Company's backlog can be canceled at any time without
penalty, except, in most cases, for the recovery of the Company's actual
committed costs and profit on work performed up to the date of cancellation. A
substantial portion of the purchase orders comprising backlog at September 30,
1997 include product specifications not yet achieved by the Company. A failure
to develop products meeting such specifications could lead to a cancellation of
the related purchase orders. See 'Risk Factors--Backlog.'
ENVIRONMENTAL MATTERS
The Company and its operations are subject to extensive federal, state, and
local Environmental Laws that may change frequently. See 'Risk
Factors--Environmental Matters.' The Company can be expected to incur capital
and operating expenses to maintain compliance with and to meet new applicable
Environmental Laws. Based upon the underlying facts giving rise to its
environmental regulatory obligations and technical reports prepared on the
Company's facilities, the Company does not anticipate that any such capital or
operating expenses will have a material adverse effect on the Company's results
of operations. There can be no assurance, however, that unanticipated, future
Environmental Laws or previously unidentified environmental conditions will not
result in the Company having to incur material capital or operating expenses.
In connection with the W-J Acquisition, the Company entered into a
three-year sublease agreement with Watkins-Johnson for two buildings and a
portion of a third building located at the Stanford Research Park in Palo Alto,
California. Groundwater contamination was discovered in or about 1982 at the
real property upon which these buildings are located. Watkins-Johnson has been
remediating the groundwater under a portion of the property subleased by the
Company pursuant to an order issued in 1990 by the California Department of
Toxic Substances Control of the California Environmental Protection Agency (the
'DTSC'). Furthermore, Watkins-Johnson and other potentially responsible parties
have entered into another order with the DTSC pursuant to which they are
remediating a regional groundwater contamination problem on the Palo Alto
property (the 'Hillview-Porter Site') that also underlies a portion of the
property that the Company subleases. Under the terms of the W-J Stock Purchase
Agreement (as defined) and the sublease agreement, Watkins-Johnson has generally
retained liability for contamination at the property that (i) occurred on or
prior to the consummation of the W-J Acquisition and (ii) occurs during the term
of the sublease agreement which is not caused primarily by the Company, and has
agreed to indemnify the Company in connection therewith. While management
believes the Company will not incur material costs or liability in connection
with such contamination, there can be no assurance that it will not.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ('FASB') issued
Statement of Financial Accounting Standards ('SFAS') No. 130, 'Reporting
Comprehensive Income'. The standard establishes guidelines for the reporting and
display of comprehensive income and its components in financial statements.
Disclosure of comprehensive income and its components will be required beginning
with the Company's fiscal year ending 1998.
Also in June 1997, the FASB issued SFAS No. 131, 'Disclosures About
Segments of an Enterprise and Related Information'. The standard requires that
companies disclose 'operating segments' based on the way management
disaggregates the company for making internal operating decisions. The new rules
will be effective for the Company's 1998 fiscal year end. The Company has not
evaluated the impact, if any, of the new standard.
39
<PAGE>
BUSINESS
OVERVIEW
The Company, through its subsidiaries Stellex Microwave and Stellex
Aerospace, is a leading provider of highly engineered subsystems and components
for the aerospace, defense and space industries. Stellex Microwave is a
worldwide leader in the design, manufacture and marketing of fully integrated
and proprietary microwave electronic subsystems for radar-guided tactical
missile systems and a broad line of high radio frequency and microwave frequency
single function modules. Stellex Microwave products are used in the generation,
reception and translation of communication, data and radar signals. Stellex
Aerospace is a leader in the machining of turbomachinery, aircraft hinges and
other structural components for the aerospace and space industries. For the year
ended December 31, 1996 and the nine months ended September 30, 1997, after
giving pro forma effect to the Transactions, the Company would have had sales of
$113.5 million and $91.1 million, respectively, net income (loss) of ($9.4)
million and $1.4 million, respectively, and Adjusted EBITDA of $15.2 million and
$16.9 million, respectively. See Note (a) to 'Selected Historical Financial
Data--Stellex' for further information regarding EBITDA. For the year ended
December 31, 1996, after giving pro forma effect to the Transactions, the
Company's earnings would have been insufficient to cover fixed charges by
approximately $10.6 million; for the nine months ended September 30, 1997, after
giving pro forma effect to the Transactions, the Company's ratio of earnings to
fixed charges would have been 1.1x. As of September 30, 1997, after giving pro
forma effect to the Transactions, the Company would have had $99.8 million in
order backlog. A substantial amount of the Company's order backlog can be
canceled at any time without penalty, except, in some cases, the recovery of the
Company's actual committed costs and profit on work performed up until the date
of cancellation. See 'Risk Factors--Backlog' and 'Management's Discussion and
Analysis of Financial Condition and Results of Operations--Backlog.'
The Company's objective is to provide extensive engineering, low cost
manufacturing and systems integration to the consolidated base of OEMs within
its industries. The Company believes that it is well positioned to benefit from
certain trends in its markets including increases in the production of
high-priority platforms, airframes and spare parts, the use of sophisticated
electronics, the consolidation of OEM suppliers, and the outsourcing of
subsystems.
Stellex Microwave
Stellex Microwave is a worldwide leader in the design, manufacture and
marketing of proprietary microwave electronic subsystems for use in radar-guided
munitions and signal intelligence equipment. As the largest independent supplier
of microwave subsystems for tactical missiles, Stellex Microwave's products are
critical to the onboard navigation, communications and target location systems
of many of the highest priority missile systems developed by the DoD. The
Company's proprietary products, low cost manufacturing and extensive engineering
capabilities have enabled it to become the sole or primary source for the
principal programs it supplies. These programs include the AMRAAM, the Patriot
missile and the Standard Missile, the most widely used radar-guided missiles of
their type in the U.S. armed forces. In addition, the Company is currently
participating in production programs for the AEGIS radar system and the TARTAR
fire control system, and has been recently selected to participate in the
program to produce the Longbow Hellfire missile, one of the U.S. Army's most
significant new missile systems.
Stellex Microwave is also a leading manufacturer of MFMs and SFMs, such as
high radio frequency mixers, amplifiers, tuners, converters, filters and
oscillators, which are sold to system designers and manufacturers. Stellex
Microwave has provided the intelligence, electronic warfare, space and
communication markets with a broad assortment of such devices since 1957. For
the year ended December 31, 1996 and the nine months ended September 30, 1997,
Stellex Microwave had sales of $89.2 million and $67.9 million, respectively.
Stellex Aerospace
Stellex Aerospace is a leading provider of high precision products and
services to certain niche markets within the aerospace and space industries.
Through Bandy, Stellex Aerospace is the world's leading contract manufacturer of
commercial and military precision aircraft hinges. Hinges manufactured by Bandy,
some of which are produced exclusively by Bandy, are installed on every type of
aircraft currently produced by the leading aircraft OEMs, including Boeing,
McDonnell Douglas, Airbus, Lockheed Martin, and Northrop Grumman. Through
Paragon, Stellex Aerospace is a leader in the machining of complex
turbomachinery. Paragon's flexible manufacturing operations permit the
production of both (i) highly engineered, close tolerance
40
<PAGE>
prototype components, which are generally manufactured from expensive, exotic
alloys and are found in high performance gas turbine engines and liquid fuel
rocket engines, and (ii) higher volume standard components used in aircraft and
industrial power actuation systems and high performance turbine engines. Through
SEAL and GIL, Stellex Aerospace also provides a comprehensive range of services
for testing of sophisticated manufactured aerospace components. For the year
ended December 31, 1996 and the nine months ended September 30, 1997
(collectively comprised of Kleinert (predecessor) sales for the six months ended
June 30, 1997 and Stellex (successor) for the three months ended September 30,
1997), Stellex Aerospace had sales of $24.3 million and $23.2 million,
respectively.
COMPETITIVE STRENGTHS
The Company believes that its competitive position in the markets it serves
is based on superior product design and performance and a consistent record of
meeting rigorous DoD and OEM contract performance criteria. Specifically, the
Company believes that its position is primarily attributable to the following
competitive strengths:
Strong Partnering Relationships with Major OEMs. As an incumbent preferred
supplier on high-priority, long-term programs, the Company has over many years
solidified its relationships with major OEMs. The Company participates in
concurrent design, engineering and development of new programs and provides cost
and performance enhancement for existing programs. Stellex Microwave often
serves as the sole source supplier of mission-critical subsystems to Hughes,
Raytheon, Rockwell, Boeing and Lockheed Martin. Stellex Microwave was selected
by Hughes as subcontractor of the year for each of 1994, 1995 and 1996. Paragon
is a preferred supplier, often as a sole or primary source, of a variety of
turbomachinery and turbine engine components to such OEMs as AlliedSignal,
Aerojet and Rocketdyne. Bandy also has received the highest quality awards from,
and is a preferred supplier to, many of its customers, including Boeing,
McDonnell Douglas, Airbus, Lockheed Martin, and Northrop Grumman.
Integration Leadership. Stellex Microwave has developed proprietary
technology, products and manufacturing processes which integrate the electronic
functions as well as the mechanical and packaging requirements of microwave
subsystems into 'snap-together' designs that eliminate the need for expensive
and less reliable external cables and connectors. The Company's proprietary
packaging and substrate materials and manufacturing processes were developed
over a period of many years and are instrumental in the superior performance of
its integrated microwave subsystems. The Company believes that the leading edge
technology and manufacturing processes which it has developed for high
production volume missile subsystems will provide a significant competitive
advantage in developing integrated products for certain commercial markets.
Low Cost Manufacturing. By following systematic design parameters that
balance the need for multi-functionality, cost reduction and reliability and by
using a modularized automated manufacturing process, the Company is able to
manufacture subsystems in high volume and achieve the highest percentage of
usable product in its industry. The Company believes that its manufacturing
processes enable it to reduce unit costs and shorten development and production
cycles, thereby providing the Company with a significant cost advantage in
competing for high volume subsystem programs.
Reputation for High Quality. The Company's individual microwave devices
are well known among designers of high performance electronic equipment, and the
catalogs used by Stellex Microwave have been standard reference materials since
1978. Paragon is one of five companies in the United States which competes for
and produces sophisticated, close tolerance machined prototypes of rotating
turbine components for use in aircraft jet engines and other components for use
in spacecraft rocket engines. Management believes that the 'Bandy' name is the
most recognized name in precision aircraft hinges in the world. GIL is one of
the leading independent, full-service NDT laboratories in the United States.
SEAL is one of three companies in the United States approved by NASA to perform
destructive physical analysis on high-reliability space electronic components.
INDUSTRY OVERVIEW
Defense Industry
United States defense budget appropriations are forecasted to remain
relatively constant or increase slightly in the near term, reversing the recent
decline in spending which precipitated the dramatic consolidation among prime
contractors. In order to enhance readiness and modernize their forces, military
agencies are expected to continue to maximize resources by modifying and
upgrading existing systems and platforms and relying upon
41
<PAGE>
sophisticated electronic equipment for existing and new systems. In furtherance
of their objectives, agencies are expected to require enhanced performance and
cost reductions from their prime contractors. The Company believes that this
cost and technology pressure will cause continued consolidation of the defense
industry's supply base and cause prime contractors to (i) focus on the design
and manufacture of overall weapon systems and (ii) outsource the manufacture and
integration of subsystems to independent commercially-oriented suppliers. The
Company believes that the current procurement environment favors the Company's
proprietary design and manufacturing processes, which are characterized by
limited reliance on government funded research and development.
Historically, many microwave systems for defense, intelligence and space
applications were assembled on a component by component basis. Prime contractors
integrated these components with cables, connectors and older packaging
technologies. The inherent manufacturing inefficiencies and reliability issues
of this process have led OEMs and prime contractors to require increased
integration and functionality from their suppliers. In addition to improved
reliability, such integration has reduced the cost of microwave subsystems to
the prime contractor and of the overall program to the DoD. Management believes
that the benefits made apparent by the trend toward subsystem integration in the
defense market will lead to a similar trend in a variety of commercial
applications.
Aerospace Industry
The commercial aircraft industry experienced severe difficulties in the
early 1990s. Airplane deliveries as a percentage of the world airline fleet
peaked at 9% in 1991 and fell to 4.7% by 1994. However, since 1994, the
commercial aerospace market has shown significant signs of recovery. According
to the Boeing Report, annual deliveries of commercial aircraft will increase
from approximately 400 in 1996 to more than 600 in 1997 and will be between 700
and 800 in 1998. In addition, for the period from 1996 through 2000, revenue
passenger miles are expected to increase from 1.6 trillion to 2.1 trillion and
the worldwide fleet of aircraft are expected to increase from 11,500 at the end
of 1996 to approximately 14,000 at the end of 2001 (net of approximately 1,375
retirements). The Company believes that the following factors, among others, are
causing this increase in new aircraft orders: (i) projected worldwide airline
traffic growth of 5.5% per year over the next decade (including growth of 6.7%
per year in the Southeast Asia region and 11.8% per year in China); (ii)
projected cargo traffic growth of 6.6% per year; (iii) projected increase in the
load factor of aircraft currently in service; (iv) the aging of the current
commercial aircraft fleet; (v) the cost effectiveness of using new aircraft; and
(vi) the improved operating performance of airlines worldwide.
In the military segment of the aerospace market, demand for aircraft
components declined significantly in the early 1990's, largely as a result of
reductions in defense budgets. The DoD and other government agencies responded
to decreases in their budgets by utilizing substantial built-up inventories of
replacement parts, which in many cases satisfied existing demand for several
years. The Company believes that current inventories of military aircraft
replacement parts and components are at the lowest levels in several decades and
that increased purchasing is likely over the next several years.
BUSINESS STRATEGY
The Company's objective is to strengthen its position as a leading supplier
of highly engineered subsystems and components to its customers in the
aerospace, defense and space industries and to expand its business to contiguous
commercial markets. The following are the key strategies the Company intends to
employ to achieve this objective:
Exploit Outsourcing Trend. The Company estimates that approximately 50% of
the subsystems used on all types of radar-guided missiles are still produced
internally by OEMs. The Company believes it is well positioned to compete
effectively for this remaining in-house production by capitalizing on its
proprietary products and low cost manufacturing processes. For example, Stellex
Microwave has increased its share of the individual microwave subsystems onboard
the AMRAAM from approximately 50% in 1992 to over 90% in 1997. Many of these
AMRAAM subsystems had previously been produced by the in-house microwave
component groups of Hughes and Raytheon. In addition, the design of one of the
Company's subsystems produced for the Standard Missile was incorporated in the
1997 Raytheon design of the Advanced Sea Sparrow missile. Overall program costs
of these missiles were substantially reduced as a result of this outsourcing.
The Company also believes that it has opportunities to capture new business in
the commercial aerospace industry as a result of additional outsourcing.
42
<PAGE>
Capture Share in Commercial Markets. The Company believes that its
experience and expertise in high frequency microwave subsystem integration
provide it with significant opportunities to develop integrated products for
commercial applications. The Company's current defense and aerospace customers
are also the world's largest manufacturers of satellites. These manufacturers
currently purchase subsystems for their defense platforms but only purchase SFMs
for space applications. Using its existing technologies, the Company intends to
modify and market MFMs and, eventually, entire microwave subsystems for space
applications to supplement or replace such SFM sales.
Leverage Prototype Expertise. The Company will seek to gain a larger share
of the production volume for turbomachinery parts for which it develops the
prototype. In response to customer requests, the Company has, and plans to
continue to, selectively increase its production capacity such that it can
manufacture efficiently at higher volumes. The Company is a member of the
Strategic Advisory Council of the Satellite Communications Division of Motorola,
Inc. ('Motorola').
Acquire Selected Businesses. The Company anticipates that the
consolidation of the historically fragmented aerospace component manufacturing
industry will provide opportunities for selective acquisitions. In addition, in
response to growing demand for microwave products, the Company will pursue
selective acquisitions that can broaden its microwave product offering or
provide it with enhanced technological or strategic capabilities. Such
acquisitions offer the opportunity to broaden the Company's product lines and
manufacturing capabilities, diversify its customer base, improve its absorption
of corporate overhead and enhance its attractiveness as a leading supplier to
OEMs in the aerospace, defense and space industries.
MARKETS, PRODUCTS AND SERVICES
The following is a description of the principal markets served by the
Company as well as the products and services the Company delivers for those
markets.
Markets
Guided Munitions. With advances in radar technology increasing the
likelihood that launching platforms will be detected and destroyed, military
forces are demanding that future missiles be longer-range than present models
and contain more sophisticated guidance systems. Because radar-guided missiles
are able to engage targets at a greater distance than other tactical weapons,
the radar-guided missile has become the tactical weapon of choice of the world's
military forces. The Electronic Industries Association estimates that the value
of guided missiles manufactured in the U.S. for sale throughout the world, as
well as the electronic content of such missiles, will increase from 1996 to
2001. This increase in value is expected to result from sales to the governments
of the U.S. and foreign nations. Sales to foreign governments are primarily
driven by the sales of U.S. manufactured warplanes and the increased willingness
of the U.S. government to permit the foreign sale of more sophisticated
weaponry. As the world's largest merchant supplier of integrated microwave
subsystems for radar-guided tactical missiles, Stellex Microwave has been
recognized as a leader in designing and manufacturing high-performance,
fully-integrated guidance, communications and fusing subsystems for defense
applications which strive to meet these evolving requirements. Subsystems such
as these are produced in high volume, since combat aircraft carry eight to ten
missiles each, and are continually upgraded, since guided missiles act as
cost-effective force multipliers by defending significantly more expensive
aircraft and ships. Approximately 50% of the $450 million guided munitions
microwave electronics market is held captive at the large missile prime
contractors, and in light of the industry trend toward outsourcing and Stellex
Microwave's competitive position, the Company believes it can significantly
increase its estimated current 25-30% market share.
Electronic Warfare and Radar. Military forces worldwide are dependent on
sophisticated electronic equipment. Military aircraft and naval vessels
generally contain extensive electronic countermeasure equipment for defense
against enemy missile and radar systems. These systems typically provide
protection for the aircraft or the ship from incoming enemy missiles by jamming
the missiles' tracking systems through various high radio frequency and
microwave signal processing techniques. According to industry sources,
electronic warfare spending will increase both domestically and internationally
as forces seek greater protection for their smaller fleets of combat systems
from the proliferation of increasingly lethal threat systems. The Company
addresses the electronic warfare and radar market through a combination of
catalog microwave devices and electronic equipment in which these devices are
integrated.
Space Applications. Commercial revenues in the global space industry
exceeded government expenditures for the first time in 1996. For the period from
1996 to 2000, Via Satellite, an industry publication, estimates that
43
<PAGE>
the value of the launched satellites will increase from approximately $9 billion
to $14.5 billion and that revenues generated by the manufacture and operation of
ground equipment, including receivers and transmitters, will increase from
approximately $22 billion to $27 billion. The largest commercial space
companies, including Hughes Aircraft Company, Lockheed Martin, and Loral Space
Systems, are expanding their commercial space activities to take advantage of
this anticipated growth.
The Company is currently a preferred supplier to Hughes and Lockheed
Martin's space businesses as well as their defense businesses. The Company is
also a member of the Strategic Advisory Council of Motorola's Satellite
division. Management believes that major space system integrators, which
currently purchase the majority of their microwave equipment on a component by
component basis from a fragmented supply base, will seek lower costs by moving
from the purchase of individual components to integrated subsystems. The Company
believes that it can develop MFMs and, eventually, entire subsystems for space
applications similar to those for its guided munitions markets and use these
products to increase its space-related market share.
The Company presently addresses the space market with products from its
microwave devices product line, principally amplifiers and mixers for use in
military and commercial satellites. Most of its products currently sold in this
market are customized, space-level quality adaptions of the Company's standard
microwave devices.
Commercial Applications. The global subscriber base of wireless telephony
users is expected to continue its rapid growth, having increased due primarily
to increasing competition among service providers, decreasing prices for
handsets, a more favorable regulatory environment and greater availability of
services and radio frequency spectrum. The growth in wireless communications has
required substantial investment by service providers in infrastructure
equipment. According to industry sources, spending by wireless service providers
on infrastructure equipment was approximately $26 billion in 1996 and will
increase to approximately $42 billion in 2001.
The Company believes that the superior transmission capacity of high
frequency microwave equipment and the lower cost of integrated systems can
facilitate the large increases in wireless and PCS transmission volume and the
cost effective construction of communication infrastructures. The Company
therefore expects increased use of integrated microwave technology for many
infrastructure applications.
The Company's current commercial products include a combination of catalog
microwave devices and electronic equipment in which these devices are
integrated. The Company's components are used in commercial products such as
microwave frequency test equipment, communications equipment such as amplifiers
in fiber-optic transmission systems, and avionics products.
Intelligence Applications. The Company's broadband microwave tuners and
signal-analysis equipment are used by military and other governmental agencies
to perform range-monitoring, frequency-measurement, signal localization and
interference-analysis functions, often in complex, high-signal-density
environments. Stellex Microwave continues to sustain its technological and
marketing leadership in this market through Company-funded design and
development efforts producing advanced receivers and related equipment featuring
the small-size, light-weight and low-power-consumption characteristics demanded
by its customers at competitive prices.
Niche Aerospace Manufacturing. Stellex Aerospace's niche manufacturing
operations have focused on discrete, growth-oriented markets in the aerospace
industry having limited competition and which utilize the Company's
sophisticated machining capabilities. Over the past two decades, Paragon has
applied its machining and production expertise to three distinct business
segments: spacecraft and prototype components, engine airfoil components and
engine and power actuation components. Bandy markets standard hinges, custom
hinges, and access doors and panels to four main business segments in the
aircraft market, commercial OEM production, commercial spare parts, military OEM
production and military spare parts.
Testing and Engineering Services. Through GIL and SEAL the Company
performs a broad range of material defect testing and analysis on a variety of
materials used in the aerospace, plastics and other industries. The Company is
actively involved in research and development and general engineering services
for new product development, the improvement of existing products and
value-added engineering services. The Company's services to the aerospace
industry include destructive physical analysis for the space station, the
testing of space shuttle components and space satellites and non-destructive
testing of materials used in commercial and military aircraft.
44
<PAGE>
Products and Services
The following chart provides summary information regarding the Company's
principal product and service lines, the markets which these products and
services serve, and the Company's principal programs and customers by product
and service line.
<TABLE>
<CAPTION>
PRINCIPAL
PRODUCT/SERVICE LINE* PRINCIPAL MARKETS PROGRAMS/CUSTOMERS
- ------------------------------------ ------------------------------------ ------------------------------------
<S> <C> <C>
INTEGRATED SUBSYSTEMS
(38% OF PRO FORMA SALES)
Missile Subsystems Guided munitions AMRAAM/Hughes and Raytheon
Standard Missile/Hughes and
Raytheon
Longbow Hellfire/Lockheed Martin
Patriot PAC-3/Boeing
Intelligence Subsystems Intelligence applications JASA tuner/TRW, Inc.
Multi-Function Modules** Space applications Potential to integrate components in
('MFMs') space and other applications/
Motorola, Hughes and Boeing
MICROWAVE DEVICES
(36% OF PRO FORMA SALES)
Modular Components Space applications, electronic ICO/Hughes
warfare and radar, commercial Transmission amplifiers/Northern
applications Telecom Limited
Single Function Modules Electronic warfare and radar, guided F/A-18 radar/Hughes
('SFMs') munitions, commercial applications AEGIS/Raytheon
Test equipment/Marconi Instruments,
Ltd.
Electronic Equipment Intelligence applications, Intelligence tuners/U.S. and
electronic warfare and radar foreign government agencies
TARTAR/Raytheon
TURBOMACHINERY AND ENGINE COMPONENTS Commercial and military aviation, X-33 Space Plane/Rocketdyne
(9% OF PRO FORMA SALES) satellite and space station Space Shuttle/Rocketdyne
Titan/Aerojet
Atlas/Pratt & Whitney
TFE-1042/AlliedSignal
Delta/Aerojet and Rocketdyne
STRUCTURAL AEROSPACE PARTS Niche aerospace manufacturing, 737, 747, 757, 767 and 777/Boeing
(10% OF PRO FORMA SALES) including hinges and door assemblies A300 and A310/Airbus
F-15, F-18, C-17, MD-80, MD-90 and
MD-11/McDonnell Douglas
F-16 and C-130/Lockheed Martin
TESTING AND ENGINEERING SERVICES Aerospace, plastics, medical devices Space station/NASA
(7% OF PRO FORMA SALES) Testing/All major OEMs
</TABLE>
- ------------------
* All pro forma sales information is for the nine months ended September 30,
1997.
** Not currently sold as a separate product.
Integrated Subsystems
Missile Subsystems. The Company's core business is the manufacture and
marketing of fully operational and proprietary integrated microwave subsystems
for tactical radar guided missiles. In recent years the microwave content of
complete missile systems has remained fairly stable at approximately 10% even as
microwave subsystems have continued to become more integrated to achieve higher
performance. Representative programs for which the Company produces missile
subsystems include:
45
<PAGE>
o AMRAAM. The AMRAAM is an air-to-air missile for which the Company
produces the operational signal generator, target detection devices and
pilot/missile data link. AMRAAM is a next-generation weapon for fighter
aircraft, capable of being launched from beyond visual range, in day or
at night and in all weather. The most significant difference between
AMRAAM and earlier radar-guided missiles is that earlier missiles homed
to the radar emissions sent from the launching aircraft and reflected by
the target, whereas AMRAAM has an active radar of its own and can guide
itself to the target during the terminal phase of flight. This
'fire-and-forget' radar guidance system allows the pilot to break away
immediately after launch, enhancing survivability and acting as a force
multiplier by permitting engagement of other targets. AMRAAM is
operational with the U.S. military's front-line fighters and has been
procured by fourteen countries. To date more than 8,000 AMRAAMs have been
produced, and production is expected to continue at 500-1,000 systems per
year for the next five to seven years.
The AMRAAM is currently produced by Hughes and Raytheon. Stellex
Microwave has been involved with the AMRAAM since its inception in 1978,
when it was invited to become a member of the Hughes AMRAAM development
team based on its pioneering development of integrated microwave
subsystem technology. Stellex Microwave initially developed and produced
two of the AMRAAM's four microwave subsystems for Hughes. In 1985,
Stellex Microwave partnered with Hughes on an Air Force-funded value
engineering program which resulted in the capture by Stellex Microwave of
the remaining two subsystems for Hughes. In 1996 Raytheon, the AMRAAM
second source, elected to reduce costs by outsourcing the manufacture of
all but one of the AMRAAM's microwave subsystems to Stellex Microwave.
Today Stellex Microwave produces more than 90% of the microwave
subsystems onboard the AMRAAM.
o Standard Missile. Standard Missile is a ship-launched missile for which
the Company produces the antenna receiver assembly, the rear receiver and
the data link. Standard Missile, an all-weather, medium-to long-range
missile, is the primary surface-launched, area air-defense weapon for the
U.S. Navy and many allied countries, offering protection from airborne
threats for an entire fleet area at a range of nearly 80 miles. The
next-generation Standard Missile, the SM-2 Block IV, is now entering
low-rate initial production, with full production typically running
between 200 and 300 units per year.
Stellex Microwave has been active on the Standard Missile program since
the 1970s, when it began supplying the prime contractor with SFMs. When
Raytheon was selected as an alternate source for the Block IV version of
the Standard Missile in 1986, it chose Stellex Microwave to develop the
missile's complex antenna receiver assembly. The prime contractor
unsuccessfully attempted to produce this subsystem in-house, and Stellex
Microwave is now the sole source supplier of this subsystem.
o Longbow Hellfire. Longbow Hellfire is an air-to-ground missile for which
the Company produces the GaAs MIMIC millimeter wave transmitter. Longbow
Hellfire provides an autonomous 'fire-and-forget' capability in
adverse-weather and high obscurant environments and features a
state-of-the-art tandem shaped-charge warhead, providing highly effective
lethality against current and projected reactive tank armors. Longbow
Hellfire, the first 'fire-and-forget' missile mounted on a helicopter, is
the principal air-to-ground weapon for the Apache helicopter, is
qualified on the Kiowa Warrior and Cobra helicopters and is cleared for
flight on the Blackhawk helicopter. Longbow Hellfire is entering low-rate
production, with over 13,000 U.S. Army units planned.
Lockheed Martin initially selected TRW, Inc. ('TRW') as vendor for the
Longbow Hellfire transmitter assembly, largely based on TRW's GaAs chip
manufacturing capability. Based on its ability to manufacture reliably
the volumes required by the procurement contract, Stellex Microwave was
selected as the new vendor in July 1997 as the program moved to low-rate
production. Today, Stellex Microwave is moving into a dominant position
as the only qualified vendor for the transmitter subsystem, with a firm
backlog of more than $8.8 million as of September 30, 1997. As the
program enters full production, the Company anticipates material
increases in production rates.
o Patriot PAC-3. Patriot is the cornerstone of the U.S. Army's integrated
air defense system, for which the Company produces the Ka band down
converter. The Patriot surface-launched air defense missile system is a
long range, all altitude, all weather system which recorded an historic
first wartime intercept of a tactical ballistic missile during Operation
Desert Storm. The new Patriot Advanced Capability (PAC-3) kinetic energy,
high-altitude anti-missile missile has no warhead and uses 'hit-to-kill'
technology to
46
<PAGE>
destroy incoming advanced aircraft, tactical ballistic missiles and
cruise missiles. To date, approximately 9,000 Patriot missiles have been
delivered.
At the outset of the Patriot missile program, the prime contractor
initially selected a subsidiary of another major prime contractor as
vendor for the Ka band down converter. After this manufacturer failed to
produce the converter after a development period of several years,
Stellex Microwave, at the invitation of the prime contractor, produced a
working prototype in six months. Stellex Microwave is now the sole source
supplier of the Ka band converter for the Patriot missile.
Intelligence Subsystems. The Company builds miniature broadband microwave
tuners with high quality phase noise performance to pick up signals that are
transmitted with more advanced, high-data modulation techniques. The Company's
intelligence subsystems, which feature Stellex Microwave's unique MFM and
subsystem manufacturing technologies, employ highly integrated 'snap-together'
packaging to create size and weight advantages over competitors. These products
are used in intelligence applications requiring sophisticated technology, such
as the Joint Airborne SIGINT Architecture program which monitors electronic
transmission over a wide range of frequency.
Multi-Function Modules ('MFMs'). MFMs combine mixers, amplifiers,
limiters, switches, and oscillators in a single hermetic package. In their
manufacture the Company uses patented packaging technology to optimize its
time-to-market and manufacturing cost advantages. Although MFMs are not
currently marketed as stand-alone products, the Company integrates multiple MFMs
with control circuiting and mechanical interface housings to produce subsystems.
In addition, the Company is developing plans to configure MFMs for specific
space satellite applications. Management believes that Stellex Microwave's
record of high-reliability and first pass qualification testing of its MFM
design methodology provides the Company with significant opportunities to
satisfy the requirements of its targeted space customers.
Microwave Devices
Modular Components. The Company's modular components, produced for a
variety of microwave applications, consist primarily of single function mixers,
amplifiers and frequency doublers, as well as custom designs, operating in a
frequency range from DC to 44 Ghz. These products are built to inventory with
published specifications and sell for prices ranging from approximately $20 to
several hundred dollars each. Because of the inherent high levels of quality of
these products, they are often used for high-reliability and space-qualified
applications such as satellites. For these applications, requirements for parts
traceability and extensive screening result in superior product quality and
reliability, often at a premium price when compared to the standard catalog
version of the same part.
Single Function Modules ('SFMs'). The Company's SFMs consist primarily of
connectorized components such as frequency converters, VCOs, YIG devices and
microwave amplifiers for use in older applications or where minimized size and
weight are not critical. Representative programs for which the Company produces
SFMs include:
o APG-73 Radar System. The APG-73, utilized in the F/A-18 Hornet, is a
pulse-doppler radar for which the Company produces the frequency
converter used in the radar receiver. The APG-73 is an all-weather
search-and-track sensor that uses programmable digital processors to
provide the features and flexibility needed for both air-to-air and
air-to-surface missions. Doppler radar permits a pilot to identify
targets against the ground clutter to intercept low flying targets. The
APG-73 radar supports multi-target tracking which enables the launch and
support of several AMRAAM missiles simultaneously.
o AEGIS SPY Radar System. The AEGIS SPY is an automatic detect and track,
multi-function phased-array radar system for which the Company produces a
frequency converter. This high powered (four megawatt) radar is able to
protect an entire aircraft carrier group by performing search, track and
missile guidance functions simultaneously with a track capacity of over
100 targets. Its computer-based command and decision interface makes the
AEGIS combat system capable of simultaneous operation against a multi-
mission threat involving anti-air, anti-surface and anti-submarine
warfare. The combat-proven, shock-capable, and reliable SPY missile
protection radar is operational aboard all 27 cruisers and 16 destroyers
in the U.S. Navy's AEGIS fleet.
47
<PAGE>
Electronic Equipment
Electronic equipment combines the Company's microwave devices with operator
interface, digital commands and control electronics. Because the devices are
typically interconnected using cables, these products are larger in size and
weight than those built using modular subsystem technology. These larger
products continue to be used for many older systems, especially those based on
land and ships. Management believes that over time the Company's electronic
equipment products will incorporate more sophisticated MFM and subsystem design
technology. Representative programs for which the Company produces electronic
equipment include:
o Microwave Receivers. The W-J8969 2-18 GHz microwave receiver has been
selected by several U.S. and international intelligence agencies to
monitor both communications and electronic intelligence signals. In
production since 1989, this receiver features high sensitivity and low
phase distortion.
o TARTAR. The MK-74 TARTAR, the U.S. Navy's first line of defense against
anti-ship cruise missiles, is a fire control system for which the Company
produces the mast-mounted phase coherent five-channel receiver assembly.
There are over 70 MK-74 systems operational around the world.
Turbomachinery and Engine Components
The Company, through Paragon, specializes in sophisticated five-axis
machining of turbomachinery components. Paragon's flexible manufacturing
operations permit the production of both (i) highly engineered, close tolerance
prototype components which are generally manufactured from expensive, exotic
alloys and are found in high performance gas turbine engines and liquid fuel
rocket engines and (ii) higher volume standard components used in aircraft and
industrial power actuation systems and high performance turbine engines.
Paragon's turbomachinery components include engine rotors, impellers, stators,
valve bodies, actuator housings and intricate blades and vanes used in jet
engines. Paragon currently produces eight different part numbers for the
TFE-1042 turbofan engine manufactured by AlliedSignal and is the sole source
provider of twelve parts for Aerojet's Titan engines. Paragon is also a primary
source supplier for Rocketdyne on several projects including six parts for its
first stage Delta rocket engine and numerous turbomachinery components for the
space shuttle's main engine.
Structural Aerospace Parts
The Company, through Bandy, manufactures precision hinges, access doors and
panels, specialty machined structural and interior aircraft components, and
other custom machined parts. Bandy produces more than 20,000 different hinge
designs ranging from one inch to more than 40 feet in length for such
applications as aircraft galleys, access, cargo and passenger doors, flaps,
racks, ramps, cases, landing gear, seats and lavatories. Bandy's 'special' or
'custom' hinges are used extensively on aircraft, helicopters, jet engine
systems, missiles and many other commercial, industrial and military
applications ranging from the space shuttle to nuclear submarines. Bandy's door
products range in size from two inches up to 36 inches in length and are made
for the F-16 airplane, among others, as well as missiles, unmanned aerial
vehicles, torpedoes, precision instrument housings and many other applications
to provide inspection visibility and servicing access. Bandy's specialty
machined components include spars, stringers, support rails, posts and related
items for aircraft.
Testing and Engineering Services
Stellex Aerospace performs testing and engineering services through SEAL
and GIL. SEAL offers a comprehensive range of material defect testing and
analysis, utilizing electron microscopy, residual gas analysis and other highly
sophisticated processes, on a variety of materials used in the aerospace,
plastics, medical device and other industries. In addition, SEAL is actively
involved in research and development and general engineering services for new
product development, the improvement of existing products and value-added
engineering services. SEAL is one of only three engineering companies approved
by NASA to conduct destructive physical analysis for the space station and has
been actively involved in the testing of space shuttle components, commercial
and military satellites and liquid fuel tanks on several NASA rocket booster
programs. SEAL provides services through a staff of over 50 employees, which
includes experts in the fields of materials and metallurgical science,
electronic components, failure analysis, analytical techniques and related
sciences.
48
<PAGE>
GIL is a full-service inspection and metal treatment laboratory,
specializing in non-destructive testing and inspection of materials and
manufactured components using advanced analytical techniques and
state-of-the-art equipment. GIL's testing processes, including radiography,
ultrasound, liquid and magnetic particle penetrant and pressure testing, assist
in determining internal or external flaws, fractures, material containments or
manufacturing defects in materials and/or component parts to ensure component
quality. GIL, which primarily services the aerospace industry, is one of the
leading independent, full-service NDT laboratories in the United States.
TECHNOLOGY
Microwaves are electromagnetic waves with wavelengths in the centimeter
range and frequencies ranging from 300 MHz to 40 Ghz. The high frequency nature
of microwaves is preferred in many electronic equipment applications because it
permits the design of smaller equipment, provides for high-speed data
transmission and accurate positioning information, and operates under all
weather conditions. As a result, microwave transmission technology has been used
for many years in the defense, space, intelligence and telecommunications
markets for various purposes, including missile guidance, identification of
targets or other aircraft, navigation, radar, electronic countermeasures and
high volume point to point communications.
A representative example of the application of microwave technology is the
microwave assembly subsystem of the AMRAAM. The microwave assembly's function is
to generate the microwave signals that are used by the missile's onboard
navigation, communications and target location microwave subsystems. The
individual components of the microwave assembly which permit it to perform its
signal generation function include the oscillators, which create the signals,
the amplifiers which set the proper power level, switches for channeling the
signals and mixers which are used for frequency conversion. The microwave
assembly is typical of a high-performance subsystem, in that it includes many of
the typical building blocks for a microwave system. In addition to those found
within the microwave assembly, individual components used in a system might
include filters, couplers and isolators. These types of components are the
building blocks of complex MFMs and subsystems used in a variety of
applications.
Historically, many microwave systems were assembled on a component by
component basis. Prime contractors integrated these components with cables,
connectors and older packaging techniques. The resulting inefficiencies and
reliability issues of this process led to increased integration in certain
applications. A fully integrated subsystem refers to a collection of MFMs
packaged together on a mechanical mounting structure and integrated with control
and power conditioning electronics. Each MFM is a hermetically sealed structure
containing a custom substrate base, which is used as a transmission medium,
along with active chips such as diodes and transistors. The single integrated
subsystem performs all of the functions otherwise performed by up to 20
individual electronic components. The development of integrated subsystems has
resulted in microwave systems which, relative to assembled components, provide
the OEM with a product which is:
o Physically smaller and lighter. The elimination of connectors, cables and
extraneous packaging allows the size and weight of the system to be
significantly reduced.
o More reliable during operation. Subsystem packaging is better suited for
heat dissipation and meeting shock and vibration requirements. In
addition, because fewer individual packages and components are used, the
number of interconnects and hermetic seals are greatly reduced.
Connectors and seals are the source of a large percentage of performance
failures in microwave subsystems.
o Easier for the OEM to test and assemble. Because the system is fully
functional when received from the supplier, the OEM only needs to test
one system instead of a series of components, and because the system is
fully assembled and a single system performs many functions, the OEM only
needs to fit it into the application instead of assembling a series of
packages with fewer functions.
o Less expensive. More reliable manufacturing processes produce greater
yields, which reduce costs for the manufacturer.
o More functional. The elimination of cables and connectors directly
results in the improvement of key performance parameters such as phase
and amplitude stability.
49
<PAGE>
The manufacture of integrated subsystems affords the supplier several
advantages when competing for high volume, high performance microwave subsystem
supply contracts. Strict adherence to a rigorous set of proven design rules
results in faster product development times and greater yields when programs
move from the development phase into high volume production. Because this design
methodology has been proven in many applications, a high rate of first-pass
qualification testing is often achieved. In addition, technologies developed
during the design of a particular system are often useful in follow-on
applications.
The level of integration in certain applications, particularly in the space
segment of the aerospace industry, remains relatively low. Management believes
that the same benefits which led to the integration of microwave products for
the guided munitions market are achievable in other commercial markets such as
space satellites and certain high-frequency microwave equipment used for
telecommunications infrastructures. See '--Markets, Products and Services.'
Stellex Microwave had company-sponsored research and development expenses
of $5.5 million, $4.8 million and $3.5 million for the years ended December 31,
1994, 1995 and 1996, respectively; customer-sponsored research and development
at Stellex Microwave was estimated to be approximately $7.6 million, $10.4
million and $8.0 million, respectively, for such periods. Research and
development expenses at Stellex Aerospace for such periods were not significant.
MANUFACTURING
Stellex Microwave
Stellex Microwave designs, manufactures and tests microwave subsystems and
components at its manufacturing facilities located in Palo Alto, California.
Stellex Microwave's integrated subsystem factory consists of a 6,000 square foot
modern 'clean room' facility which contains highly automated manufacturing and
testing equipment. This facility currently produces 400 complex microwave
subsystems per week, employs a flexible manufacturing line process capable of
thin-film and solder assembly as well as full microwave testing and data
analysis. High reliability and space qualified microwave components are also
produced at the Company's Palo Alto facility. In addition, Stellex Microwave
utilizes contract manufacturers in the Philippines, Thailand and China for high
volume, labor intensive microwave components such as cascadable amplifiers and
mixers.
The subsystem approach to microwave system design seeks improved
performance at lower cost by transferring to the microwave supplier the
responsibility for the inter-operability of the individual microwave components.
Beginning in the mid-1970's, numerous suppliers have claimed this capability.
However, the design and manufacture of subsystems has posed several key
challenges to suppliers. For example, a broad range of microwave component
capabilities is required to address subsystem engineering requirements. Most
suppliers lack extensive component expertise, especially in the area of
frequency converters. In addition, while many suppliers have solved electrical
problems associated with subsystem development and production, few have been
effective in addressing mechanical issues such as substrate attachment. Finally,
many suppliers have focused on satisfying subsystem functional requirements
without adequate attention to manufacturing requirements, leading to a lack of
manufacturing standardization, costly design changes and high manufacturing
costs.
Stellex Microwave has successfully addressed many of the problems facing
microwave subsystem suppliers. Stellex Microwave has maintained a broad
capability of microwave component design. The technology leadership of Stellex
Microwave mixers is particularly important, as the components are vital to
low-distortion frequency conversion. In addition, Stellex Microwave's Mechanical
Design Department has created a uniform packaging methodology that solved
mechanical issues and led to high-yield manufacturing. The management of Stellex
Microwave enforces the use of this design methodology. All new product designs
utilize qualified design techniques and can be manufactured in a
highly-automated factory. For example, despite their different geometric shapes
and electronic designs, modules for AMRAAM, Standard Missile and Longbow
Hellfire are all assembled on the same line, using common processes.
An example of the successful implementation of the Company's integrated
design methodology and advanced manufacturing techniques can be seen in Stellex
Microwave's experience in supplying the microwave
50
<PAGE>
subsystems for the AMRAAM missile. The AMRAAM missile program began in 1980,
with Stellex Microwave working in close technical partnership with Hughes, the
primary supplier of the missile to the DoD. Since 1992, the Company has been the
sole source supplier to Hughes of four parts for the AMRAAM. Since the inception
of the program, Stellex Microwave has been able to integrate various functions
into increasingly smaller modules. For example, the missile's radio frequency
processor, which was originally comprised of 11 separate modules, is now
contained in one fully-integrated subsystem. This one subsystem provides
significant benefits to the missile's performance due to its increased
functionality, smaller size and greater reliability. Moreover, while increasing
functionality, Stellex Microwave has also been able to significantly reduce
costs through the use of a variety of proprietary processes. For example,
Stellex Microwave has developed a metal injection molding process for the
production of microwave subassembly housings used in the AMRAAM microwave
subsystem. Housings can require dimensional tolerances of less than a thousandth
of an inch and, therefore, constitute one of the largest cost components of the
subsystem. Traditionally, the housing had been manufactured by machine cutting,
which was expensive and time-consuming. The metal injection molding process has
dramatically reduced the cost of manufacturing the housing and shortened
production cycles. Raytheon, which is the second source supplier of the AMRAAM
and which originally had manufactured the missile's microwave assemblies
internally, now outsources most of its microwave requirements for the missile to
Stellex Microwave.
As a result of the Company's integrated design approach and manufacturing
capabilities, management believes that Stellex Microwave is well-positioned to
participate in the further integration of microwave components and modules both
in existing and future programs and in various commercial applications. Further,
because the Company's processes have been developed over a number of years and
are generally proprietary, management believes that they would be relatively
difficult to replicate by competitors.
Stellex Microwave produces its microwave devices in a separate facility
that is configured to support the wide variety of microwave components that it
manufactures. It is staffed by experienced manufacturing personnel, many of whom
are certified in multiple processes. The factory has been qualified to meet
rigorous reliability requirements imposed by the Company's customers and
government agencies, including requirements relating to satellite applications.
In an effort to increase the profitability of the microwave devices business,
the Company intends to increase its use of offshore independent contractors to
manufacture and test microwave components. Management believes that the
outsourcing of these responsibilities will significantly reduce labor costs and
increase production capabilities, without negatively affecting the quality of
its products or delivery requirements. In addition, by utilizing multiple
sources the Company can be assured of competitive rates and sufficient capacity.
For microwave devices that are required to meet high-reliability or
space-qualified standards, the Company intends to continue to conduct testing to
ensure compliance with these standards at its facilities in the United States.
In 1996, Stellex Microwave received ISO-9001 certification for its
microwave products manufacturing facilities. The Company's offshore independent
contractors have also received ISO-9001 certification. ISO-9001 is a standard
established by the International Organization for Standardization that provides
a methodology by which manufacturers can obtain quality certification. Although
this certification is not currently required by any of its customers, the
Company believes that it will be beneficial to the acquisition of future
business, particularly as the consolidation and outsourcing trends in the
defense industry continue. To help ensure the highest product quality and
reliability and to maximize control over the complete manufacturing cycle and
costs, the Company seeks to achieve vertical integration in the manufacturing
process wherever appropriate.
Stellex Aerospace
Stellex Aerospace manufactures turbomachinery components for rocket booster
engines, precision aircraft hinges, structural and interior aircraft components,
access door assemblies, door panels and hinges for special industrial
applications. Stellex Aerospace's manufacturing facilities are highly automated
and incorporate a variety of quality control systems.
Paragon manufactures both highly sophisticated, close tolerance prototype
components, often machined from expensive metal alloys, as well as higher volume
standard components. As a result of the variety of products it manufactures,
Paragon's manufacturing operations are flexible and generally adaptable to a
variety of applications. It employs advanced machinery, including four and five
axis machining centers, multiple spindle
51
<PAGE>
high volume production machining centers, wire electrical discharge machining
('EDM') machines and computer numerical control ('CNC') turning centers.
Paragon's computerized CNC machines interface with a sophisticated
computer-aided-design/computer-aided-manufacturing ('CAD/CAM') network. As a
contract manufacturer, Paragon does not typically design or own the products it
manufacturers.
Bandy's manufacturing facility is geared toward high volume, low cost
production. Bandy has developed a high level of proprietary equipment and
automated manufacturing systems. A substantial portion of its equipment has been
redesigned, customized and/or upgraded in recent years to meet exacting
manufacturing requirements and to reduce production costs. Bandy combines the
use of numerical control equipment, vertical and universal milling machines and
custom-designed hinge equipment with other advanced, high production
manufacturing methods to produce standard or customized precision hinges and
machined parts. Bandy owns all of its own tooling, which historically has given
it a competitive advantage in obtaining spare and replacement part business.
Certain customers of Stellex Aerospace have developed their own design,
product performance, manufacturing process and quality standards and require
their suppliers, including Stellex Aerospace, to comply with such standards. As
a result, Stellex Aerospace has developed and implemented comprehensive quality
system policies and procedures which meet or exceed the requirements of its
customers. In addition, the Company is currently seeking ISO-9000 certification
for Stellex Aerospace's manufacturing facilities. In recognition of its high
quality standards, Stellex Aerospace has received numerous quality awards from
its customers, including Boeing and McDonnell Douglas, and the highest quality
designations from Lockheed Martin, Teledyne and Rohr.
SALES AND MARKETING
The Company employs distinctly different sales and marketing approaches in
each of its businesses, which are tailored to the needs of its customers. The
Company markets its products through its own sales force and a network of
independent sales representatives and distributors in the United States and
certain foreign countries. The Company's sales managers are responsible for
coordinating the efforts of the independent sales representatives and for
staying abreast of government and commercial programs in their respective
regions. They also keep the Company's engineering, manufacturing and management
personnel advised of possible future trends and requirements of customers.
Stellex Microwave--Tactical Subsystems
The Company's tactical subsystems are sold to a limited number of prime
contractors based on anticipated program funding of identified tactical missile
and intelligence systems. Marketing for tactical subsystems relies on extensive
direct interaction between Company personnel and their counterparts at prime
contractors and government agencies which comprise the tactical missile and
intelligence markets. Stellex Microwave uses a team-based sales approach to
facilitate close management by Company personnel of relationships at multiple
levels of the customer's organization, including management, engineering and
purchasing personnel. Trade shows and advertising are oriented to positioning
Stellex Microwave as the premier supplier of advanced microwave technology for
production volume tactical missiles and intelligence systems.
Sales of tactical subsystems begin with the identification of tactical
missile and intelligence programs that are expected to require medium to high
volume production of integrated microwave subassemblies. Stellex Microwave
focuses on those programs with a high probability of obtaining production
funding as targets for new business. Stellex Microwave avoids contracts for
one-of-a-kind products and limited production programs.
Once a program is identified as a target, Stellex Microwave typically works
closely with the customer during the product design and qualification phase.
Stellex Microwave also regularly becomes involved after initial product design
and development when a customer has encountered pre-production problems. Each
program is bid with a price proposal. New programs then enter a developmental
phase where Stellex Microwave's subassemblies are developed and tested and then
integrated into the missile system for further evaluation and testing. Upon
completion of the development phase, Stellex Microwave develops a proposal for
the production phase of the program. Existing production programs, such as
AMRAAM, frequently move through product update cycles which are rapidly
engineered and moved into production.
52
<PAGE>
Stellex Microwave--Microwave Devices
The Company's microwave devices are sold to a broad range of government
agencies and civilian contractors worldwide. Stellex Microwave sells and
distributes microwave devices worldwide using an internal sales force, sales
representatives and independent distributors. Stellex Microwave typically
processes more than 5,000 purchase orders a year from more than 400 different
customers. Marketing for microwave devices includes trade shows and advertising
focused on positioning Stellex Microwave as the highest quality supplier with
the broadest selection of microwave components. The Company uses a 500-page
parts catalog which is revised every two years. Catalog sales accounted for a
significant portion of the Company's microwave device pro forma sales for the
year ended December 31, 1996 and the nine months ended September 30, 1997. In
order to capitalize on its reputation developed under the Watkins-Johnson name,
pursuant to the terms of the W-J Acquisition, Stellex Microwave will retain the
right to sell its products through the 1997-98 device catalog produced by
Watkins-Johnson and will also have the right to identify its products as
'formerly made by Watkins-Johnson' until the expiration of the 1999-2000
catalog.
Stellex Aerospace
The Company believes that Paragon is one of only five companies in the
United States with the expertise to compete for and produce highly
sophisticated, close tolerance prototype component parts. As a result of recent
marketing efforts to broaden its customer base, Paragon now has approximately 20
active prototype customers. Although prototype work is normally associated with
short-term, low-volume work, Paragon is often able to secure a preferred
position for future production requirements by establishing a strong
relationship with the customer during the early prototype development stage.
Paragon intends to maximize these opportunities to become a competitive and
cost-effective producer of longer-term, higher-volume orders.
Bandy's sales effort was recently reorganized into a dedicated,
single-contact sales representative system. Previously, Bandy operated a pool
system whereby a customer's call to place an order or obtain information was
referred to the first available salesperson. The new system provides Bandy's
sales representatives with the opportunity to become more familiar with the
special and unique requirements of their particular accounts as well as ensure
that orders are properly processed and schedules maintained. Additional benefits
of the new system include a more even distribution of salesperson workload as
well as a reduction in the time required to process orders and respond to
requests. Bandy employs four persons in-house to answer sales questions and
process orders and uses outside sales agents to serve its international
customers.
CUSTOMERS
The Company's customers include many of the world's largest defense
contractors, aircraft OEMs and aircraft component manufacturers. The Company's
largest customers in 1996 based on sales were Hughes and Raytheon, which
together accounted for approximately 34% of the Company's total pro forma sales.
In December 1997, Raytheon completed its acquisition of the defense business of
Hughes. See 'Risk Factors--Dependence on Certain Customers.'
The vast majority of the Company's tactical subsystem sales, which
accounted for 39% of the Company's total pro forma sales in 1996, are derived
from contracts with a limited number of tactical missile and
intelligence/reconnaissance prime contractors, such as Raytheon, Hughes, Litton,
Lockheed Martin, Rockwell-Boeing and TRW. Microwave component sales, which
accounted for approximately 40% of the Company's total pro forma sales in 1996,
are made to a broad range of government agencies and civilian contractors.
Stellex Aerospace, whose sales accounted for approximately 21% of the Company's
total pro forma sales in 1996, sells primarily to aircraft OEMs, aircraft and
rocket engine manufacturers and government agencies. In 1996, approximately 62%
of the Company's pro forma sales were to government agencies and their prime
contractors. Such sales are subject to unique conditions and terms. See 'Risk
Factors--Uncertainty Associated with Government Contracts.'
53
<PAGE>
COMPETITION
Stellex Microwave
The markets for Stellex Microwave's microwave subsystems are characterized
by rapid technological change, new product development, product obsolescence and
evolving industry standards. In addition, as a result of significant development
costs associated with integration techniques and designs, these markets have
significant barriers to entry. Management believes that competition within the
microwave subsystem market is driven primarily by the ability to design and
deliver high performance and price competitive products in sufficient quantities
in a timely manner. Competition is also affected by the quality of technical
support and the ability to design customized products that address each
customer's particular requirements. Stellex Microwave faces competition in the
subsystems markets in which it competes from independent microwave equipment
manufacturers which have integration capabilities, but management believes that
its primary competition is from in-house manufacturing operations of OEMs and
prime contractors, many of whom are customers of the Company. Management
believes that Stellex Microwave's proprietary materials and manufacturing
techniques allow it to produce highly sophisticated, cost-effective and reliable
microwave subsystems that are not easily replicated. However, Stellex
Microwave's future success is dependent upon the extent to which OEMs and prime
contractors, many of which have greater financial and technical resources than
the Company, elect to purchase from outside sources rather than manufacture and
integrate their own subsystems, MFMs and components. See 'Risk
Factors--Competition.'
Stellex Aerospace
The narrowly defined niche markets within the aircraft industry served by
Stellex Aerospace are relatively fragmented, with few competitors for each of
the products provided by Stellex Aerospace. In the markets for the spacecraft
and prototype components which it produces, Paragon's competition is generally
limited to only two or three companies, due primarily to high entry costs and
significant technical requirements. In the markets for engine airfoil components
and power actuation components, Paragon faces numerous competitors including, in
many cases, the in-house manufacturing operations of its customers. In addition,
as airfoils represent a substantial cost component of aerospace engines,
customers are increasingly focused on reducing costs and increasing competition.
Paragon's major customers are intensely price competitive with each other, and
this price competition increases their incentives to reduce costs from their
suppliers.
Bandy faces competition in its hinge market business from a limited number
of international independent manufacturers and the in-house operations of
aircraft OEMs. Bandy also competes with small machine shops for specialty
machined components. As a result of recent economic and structural contraction
in the commercial and military hinge markets, the number of direct machine shops
dedicated to the production of hinges has been significantly reduced. The
Company believes that the key competitive factors in this changed market include
not only product quality and machining tolerance requirements, but also customer
relationships established over many years. The Company believes that Bandy's
reputation for high quality products and superior manufacturing capabilities
have made it the market share leader of the worldwide aircraft hinge market.
54
<PAGE>
PROPERTIES
The Company and its subsidiaries have an aggregate of six principal
operating facilities, all of which are located in California. Stellex
Microwave's facility is leased under a sub-lease from Watkins-Johnson entered
into in connection with the W-J Acquisition. Stellex Aerospace has five
facilities located in southern California. The following table sets forth
certain information relating to the Company's principal operating facilities.
<TABLE>
<CAPTION>
SQUARE
LOCATION DESCRIPTION FOOTAGE OWNED/LEASED
- --------------------------- ------------------------------------------------- ------- ------------------------
<S> <C> <C> <C>
Palo Alto, California Stellex Microwave's manufacturing, engineering 120,000 Leased
and testing facility and office
Woodland Hills, California Stellex Aerospace's office 1,475 Leased
Valencia, California Paragon's manufacturing facility, machine shop 54,000 Owned
and warehouse
Burbank, California Bandy's manufacturing facility, warehouse and 48,000 Leased
office
El Segundo, California SEAL's laboratory, testing facility and office 20,600 Leased
Cudahy, California GIL's laboratory, testing facility and office 32,400 Leased
</TABLE>
The Company believes that its properties are adequate to support its
operations for the foreseeable future. In connection with the W-J Acquisition,
Stellex Microwave entered into a sub-lease with Watkins-Johnson for its facility
in Palo Alto, California. Upon the termination of such sub-lease in October,
2000, Stellex Microwave will be required to relocate. The Company is in the
process of reviewing alternate sites for Stellex Microwave, and intends to
minimize any disruption caused by such relocation. All of the Company's other
leases, other than the lease relating to the Woodland Hills facility, which is
month-to-month, have remaining terms generally ranging from one to six years.
Substantially all of such leases contain renewal options pursuant to which the
Company may extend the lease terms in increments of five to ten years. The
Company does not anticipate any difficulties in renewing any of these leases as
they expire.
EMPLOYEES
As of September 30, 1997, the Company employed approximately 825 persons.
Virtually all of the Company's employees reside in the United States and none
are covered by collective bargaining agreements. The Company considers its
relations with its employees to be good.
GOVERNMENT CONTRACTS AND REGULATION
A substantial portion of the Company's sales result from contracts with the
U.S. government and its prime contractors. These contracts are generally
cost-reimbursement or fixed-price type contracts. Cost-reimbursement type
contracts provide for the payment of actual allowable costs, plus a fee. Under
fixed-price type contracts, the contractor benefits from or shares in cost
savings but generally bears or shares the risk of cost overruns. Cost-
reimbursement type contracts are normally priced to realize lower margins than
fixed-price type contracts. For the year ended December 31, 1996, approximately
6.3% of the Company's pro forma sales were derived from cost-reimbursement
contracts. A significant portion of the balance of the Company's pro forma sales
for the year ended December 31, 1996 were derived from fixed-price type
contracts.
Contracts with the U.S. government and its prime contractors contain
standard provisions for termination at the convenience of the U.S. government or
such prime contractor, pursuant to which the Company is generally entitled to
recover costs incurred, settlement expenses and profit on work completed prior
to termination. Contracts with the U.S. government do not provide for
renegotiation of profits.
Companies supplying products and services directly or indirectly to the
U.S. government are subject to other risks such as contract suspensions, changes
in policies or regulations and availability of funds. Any of these factors could
adversely affect the Company's business with the U.S. government in the future.
See 'Risk Factors--Uncertainty Associated with Government Contracts.'
55
<PAGE>
All of the Company's operations are subject to compliance with regulatory
requirements of federal, state and municipal authorities, including regulations
concerning employment obligations and affirmative action, workplace safety and
protection of the environment. While compliance with applicable regulations has
not adversely affected the Company's operations in the past, there can be no
assurance that the Company will continue to be in compliance in the future or
that these regulations will not change. See 'Risk Factors--Environmental
Matters,' and 'Management's Discussion and Analysis of Financial Condition and
Results of Operations--Environmental Matters.'
In particular, the Company must comply with detailed government procurement
and contracting regulations and with United States government security
regulations, certain of which carry substantial penalty provisions for
nonperformance or misrepresentation in the course of negotiations. Failure of
the Company to comply with its government procurement, contracting or security
obligations could result in penalties or suspension of the Company from
government contracting, which could have a material adverse effect on the
Company's financial position and results of operations.
The Company is required to maintain a United States government facility
clearance at certain of its locations. This clearance could be suspended or
revoked if the Company were found not to be in compliance with applicable
security regulations. Any such revocation or suspension would delay the
Company's delivery of its products to customers. Although the Company has
adopted policies directed at ensuring its compliance with applicable
regulations, there can be no assurance that the approved status of the Company
facilities will continue without interruption. United States government
regulations require a license for the export of advanced weapons systems.
Changes in United States government policies towards the export of these systems
may impact the Company's international business.
SALES TO FOREIGN CUSTOMERS
For the year ended December 31, 1996, approximately $18.0 million, or 16%,
of the pro forma sales of the Company were attributable to sales where the
end-user was a foreign customer. The principal customers are governments of
those countries in Western Europe, the Middle East and the Pacific Rim region
which are generally deemed to be friendly to the government of the United States
and to have relatively stable governments. A substantial portion of the
Company's sales where the end-user is a foreign government involve weapon and
intelligence systems. These sales are generally subject to U.S. government
regulation and licensing. A change in U.S. government policy toward foreign
governments with whom the Company, directly or indirectly, conducts business
could affect the Company's sales. Although the loss of all of the Company's
foreign business could have a materially adverse impact on the Company's results
of operations and financial condition, it is management's opinion that this risk
is remote and that the loss of any single contract involving a foreign
government would not be material.
SOURCES AND AVAILABILITY OF RAW MATERIALS
The Company's manufacturing operations require a wide variety of electronic
and mechanical components for which the Company has multiple commercial sources.
The Company's manufacturing operations also require raw materials which are
purchased in the open market and are normally available from a number of
suppliers. The Company has not experienced any significant delays in obtaining
timely deliveries of essential materials.
SUPPLY CONTRACTS
In connection with the W-J Acquisition, the Company and Watkins-Johnson
entered into a Gallium Arsenide and Thin Film Supply and Services Agreement (the
'GaAs Agreement'). Stellex Microwave depends on a steady supply of gallium
arsenide and thin film parts. These parts, and the technology associated with
these parts, are used in the manufacture of microwave subsystems and modules for
a variety of applications, including virtually every integrated subsystem
manufactured by Stellex Microwave. A gallium arsenide part is a wafer, die or
dice comprising one or more layers of gallium arsenide, on which is implemented
one or more transistors or diodes. A thin-film part is a part component,
interconnect, wafer, substrate, die or dice comprising one or more layers of
thin-film material such as tantalum nitride or gold deposited on a ceramic.
In the GaAs Agreement, Watkins-Johnson agreed to sell, and the Company
agreed to buy, parts manufactured in Watkins-Johnson's gallium arsenide and thin
film fabrication facility (the 'GaAs Facility').
56
<PAGE>
The GaAs Agreement will expire on December 31, 2000, unless earlier terminated
by the Company on one year's notice by the Company.
Under the GaAs Agreement, prices for parts are guaranteed through January
1, 1999. Thereafter, prices may be adjusted by no more than 10 percent. The
Company must also pay certain research and development and process costs
associated with the maintenance of the GaAs Facility. The Company must make
quarterly payments for research and developmment totalling at least $800,000 in
1998, $400,000 in 1999, and $300,000 in 2000. The share of process costs is
determined by a formula that measures the Company's use of the GaAs Facility.
For 1998, the Company will pay at least $2.2 million in process costs. For each
six month period thereafter, the Company's share will be recalculated based on
actual usage rates, but the Company's share of process costs will not change by
more than 10 percent from the Company's share six months before the
recalculation. For 1998, the Company's total payments for parts, research and
development, and process costs must equal at least $5.8 million.
In connection with the W-J Acquisition, Watkins-Johnson transferred to the
Company a Metal Injection Molding, Glass Seal and Hybrid Assembly facility (the
'MIM Facility'). The Company agreed to supply Watkins-Johnson with products and
services from the MIM Facility at prices specified in a supply agreement. This
supply agreement will run until December 31, 2000, unless earlier terminated on
one year's notice by Watkins-Johnson.
INTELLECTUAL PROPERTY
The Company owns patents on packaging and substrate materials,
manufacturing processes and other microwave technology which are significant in
the performance of its integrated microwave subsystems. The Company's
significant patents have terms expiring from 2000 to 2014. In addition, the
Company is a party to patent and other intellectual property licensing
agreements with various parties, including Watkins-Johnson.
In addition to the Company's patented and licensed technology, management
believes that the Company's research, development and engineering skills, as
well as its scientific and technical know-how, are instrumental to the Company's
business. The U.S. government typically receives royalty-free licenses on
inventions arising from government contracts, with each contractor retaining all
commercial rights with respect to such inventions.
In connection with the W-J Acquisition, the Company entered into a patent
cross license with Watkins-Johnson whereby patents transferred in connection
with the W-J Acquisition are licensed, on a royalty-free basis, to
Watkins-Johnson. In addition, pursuant to this cross license, Watkins-Johnson
licenses the patents it retains, other than specifically excluded patents, on a
royalty-free basis to the Company. Watkins-Johnson does not have license rights
relating to the Company's patents for microwave devices and electronic equipment
for the defense and space industries. The Company is not licensed to
Watkins-Johnson's patents to manufacture gallium arsenide parts for third
parties.
Intellectual property rights, including trade secrets and know how,
associated with the business of Stellex Microwave, were transferred or licensed
to the Company in connection with the consummation of the W-J Acquisition. These
intellectual property rights include the rights associated with gallium arsenide
and thin film parts and the MIM Facility.
Stellex Microwave is party to approximately 95 separate nondisclosure
agreements. Each of these agreements was entered into to restrict or prohibit
the disclosure of proprietary information shared with Stellex Microwave by other
companies in connection with certain proposed business relationships.
LEGAL PROCEEDINGS
The Company is involved in lawsuits and is subject to certain contingencies
incidental to its business. While the ultimate results of these matters cannot
be predicated with certainty, management does not expect them to have a material
adverse effect on the consolidated financial position or results of operations
of the Company.
57
<PAGE>
MANAGEMENT
DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES
The following table sets forth information with respect to the directors,
executive officers and other key employees of the Company. All directors and
officers of the Company hold office until the annual meeting of stockholders
next following their election, or until their successors are elected and
qualified.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
Richard L. Kramer.................................... 48 Chairman of the Board of Directors and Director of
Stellex Industries, Inc.
William L. Remley.................................... 47 Vice Chairman, President, Chief Executive Officer,
Treasurer and Director of Stellex Industries, Inc.
P. Roger Byer........................................ 52 Chief Financial Officer of Stellex Industries, Inc.
Keith D. Gilbert..................................... 55 President and Chief Executive Officer of Stellex
Microwave Systems, Inc.
Bradley C. Call...................................... 54 President and Chief Executive Officer of Stellex
Aerospace
Timothy L. Boland.................................... 59 Vice President, Tactical Subsystems of Stellex
Microwave Systems, Inc.
John L. Martin....................................... 58 Vice President, Microwave Devices of Stellex
Microwave Systems, Inc.
Kevin R. Hunter...................................... 37 Vice President, Systems Engineering of Stellex
Microwave Systems, Inc.
Eric F. Richardson................................... 36 Vice President, Design Engineering of Stellex
Microwave Systems, Inc.
Julius E. Hodge...................................... 46 Chief Financial Officer of Stellex Aerospace
Lawrence R. Smith.................................... 52 President of Paragon Precision Products
John Barriatua....................................... 62 President of General Inspection Laboratories, Inc.
Roland H. Marti...................................... 52 President of Scanning Electron Analysis Laboratories,
Inc.
Thomas B. Fulton..................................... 49 President of Bandy Machining International
</TABLE>
- ------------------
Richard L. Kramer became the Chairman of the Board of Directors and a
director of the Company in September 1997, shortly after its formation. Mr.
Kramer is also Chairman and a director of Mentmore Holdings Corporation, Texfi
Industries Inc., a textile and apparel manufacturing firm, CPT Holdings. Inc., a
manufacturer of specialty structural steel profiles, Weldotron Corporation, a
packaging equipment manufacturer, Orion Acquisition Corp. II, an investment
company, MC Equities, Inc., an insurance holding company, Precise Technology,
Inc., a full-service, custom injection molder of precision plastic products, and
Republic Properties Corporation. Mr. Kramer is a director of J&L Structural,
Inc., Precise Holding Corporation, Trinity Investment Corp. and Sunderland
Industrial Holdings Corporation.
William L. Remley became the Vice Chairman, Chief Executive Officer and a
director of the Company in September 1997, shortly after its formation. Mr.
Remley is also President, Chief Executive Officer and a director of Mentmore
Holdings Corporation and Weldotron Corporation, Vice-Chairman, Chief Executive
Officer and a director of Texfi Industries Inc., President and a director of CPT
Holdings Inc., Orion Acquisition Corp. II and MC Equities, Inc. and Vice
Chairman, Treasurer and a director of Precise Technology, Inc., a full-service,
custom injection molder of precision plastic products. Mr. Remley is a director
of J&L Structural, Inc., Republic Properties Corporation, Precise Holding
Corporation, Trinity Investment Corp. and Sunderland Industrial Holdings
Corporation.
P. Roger Byer became the Chief Financial Officer of the Company in
September 1997, shortly after its formation. Prior to joining the Company, Mr.
Byer was employed by General Aquatics Corporation, and its predecessor, KDI
Corporation, as Chief Financial Officer from June 1986 until May 1997. Mr. Byer
is also Chief Operating Officer of Mentmore Holdings Corporation.
58
<PAGE>
Keith D. Gilbert became the President and Chief Executive Officer of
Stellex Microwave in October 1997 upon consummation of the W-J Acquisition.
Prior to joining Stellex Microwave, Mr. Gilbert held the positions of Executive
Vice President of Watkins-Johnson from November 1995 and acting President of
TSMD from April 1997, respectively, until the consummation of the W-J
Acquisition. Prior to this time, Mr. Gilbert was employed by Watkins-Johnson for
31 years in a variety of positions, including President of the Electronics Group
from March 1993 until February 1995 and Vice President of the Defense Group from
1990 until March 1993. Mr. Gilbert currently provides consulting services to
Watkins-Johnson.
Bradley C. Call became the President, Chief Executive Officer of Stellex
Aerospace in July 1997. Prior to joining Stellex Aerospace, Mr. Call was
employed by Kleinert as Chairman, President and Chief Executive Officer from
September 1988 until the consummation of the Kleinert Acquisition in July 1997.
Mr. Call has also held the position of President of Bandy from January 1994
until November 1997. Mr. Call is a director of Unihealth Pacificare Health
Systems.
Timothy L. Boland became the Vice President, Tactical Subsystems of Stellex
Microwave in October 1997 upon consummation of the W-J Acquisition. Prior to
joining Stellex Microwave, Mr. Boland held the position of Vice President,
Tactical Subsystems Sector of Watkins-Johnson from October 1993 until the
consummation of the W-J Acquisition. Prior to this time, Mr. Boland was employed
by Hughes Aircraft Company for 24 years in a variety of positions, including
Manager of AMRAAM Advanced Programs from January 1990 until October 1993.
John L. Martin became the Vice President, Microwave Devices of Stellex
Microwave in October 1997 upon consummation of the W-J Acquisition. Prior to
joining Stellex Microwave, Mr. Martin had been employed by Watkins-Johnson as
Vice President, Microwave Devices Sector and Acting Sales Director from October
1996 and June 1997, respectively, until the consummation of the W-J Acquisition.
In addition, Mr. Martin had been employed by Watkins-Johnson as Manager of
Product Assurance, Manager of Safety and Security and Department Manager of the
Integrated Assemblies Department from January 1992 until the consummation of the
W-J Acquisition.
Kevin R. Hunter became the Vice President, Systems Engineering of Stellex
Microwave in October 1997 upon consummation of the W-J Acquisition. Prior to
joining Stellex Microwave, Mr. Hunter held the position of Director, Tactical
Subsystems Engineering of Watkins-Johnson from July 1997 until the consummation
of the W-J Acquisition. Prior to this time, Mr. Hunter was employed by
Watkins-Johnson in a variety of positions, including Manager of the Tactical
Engineering Department from March 1995 until July 1997, Section Head of the
Subsystems Design Section from September 1993 until March 1995, Head of Missile
Subsystems Design from January 1993 until September 1993, and Head of Product
Development from March 1992 until January 1993.
Eric F. Richardson became the Vice President, Design Engineering of Stellex
Microwave in October 1997 upon consummation of the W-J Acquisition. Prior to
joining Stellex Microwave, Mr. Richardson held the position of Director,
Engineering of Watkins-Johnson from September 1995 until the consummation of the
W-J Acquisition. Prior to this time, Mr. Richardson was employed by
Watkins-Johnson in a variety of positions, including Manager of the Mechanical
Engineering Department from March 1992 until September 1995.
Julius E. Hodge became the Chief Financial Officer of Stellex Aerospace in
July 1997. Prior to joining Stellex Aerospace, Mr. Hodge was employed by
Kleinert as Chief Financial Officer from May 1989 until the consummation of the
Kleinert Acquisition in July 1997.
Lawrence R. Smith has held the position of President of Paragon since
November 1990. Prior to this time, Mr. Smith was employed by Rogerson Kratos,
Inc. as President from April 1985 until June 1990.
John Barriatua has held the position of President of GIL since June 1985.
Prior to this time, Mr. Barriatua was employed by GIL for 26 years in a variety
of positions.
Roland H. Marti has held the position of President of SEAL since February
1989. Prior to this time, Mr. Marti was employed by Kevex Instruments as
Director of Sales from 1984 until 1989, Director, Western Area for Princeton
Gamma-Tech from 1983 until 1984 and Worldwide Sales Manager for Bausch & Lomb
from 1980 until 1983.
Thomas B. Fulton has held the position of President of Bandy since November
1997. Prior to joining Bandy, Mr. Fulton was employed by Kaiser Compositek as
President from April 1995 until November 1997. Prior to this time, Mr. Fulton
was employed by Kade Composites as President from July 1986 until April 1997.
59
<PAGE>
DIRECTORS
Messrs. Kramer and Remley are non-employee directors of Stellex and do not
receive compensation for acting in such capacity other than reimbursement for
out-of-pocket expenses incurred to attend meetings of the Board of Directors and
visit the Company's offices or other locations on behalf of the Company for any
special purpose. Messrs. Kramer and Remley are the sole executive officers and
directors of Mentmore Holdings Corporation, which provides management services
to the Company. See 'Certain Transactions--Management Agreement with Mentmore.'
EXECUTIVE COMPENSATION
The following table sets forth the compensation paid by the Company's
predecessor and/or Watkins-Johnson to (i) the Company's current Chief Executive
Officer and (ii) each of the individuals currently serving as executive officers
of the Company whose annual compensation exceeded $100,000 in 1996.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
ANNUAL COMPENSATION
---------------------------------
OTHER ANNUAL ALL OTHER
NAME AND SALARY BONUS COMPENSATION COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($) ($)
- ----------------------------------------------------------- ---- ------- ------ ------------ ------------
<S> <C> <C> <C> <C> <C>
William L. Remley,
Chief Executive
Officer of Stellex....................................... 1996 0 0 0 0
Keith D. Gilbert,
President and Chief
Executive Officer of
Stellex Microwave (a).................................... 1996 209,150 12,732 0 17,156(c)
Bradley C. Call,
President and Chief
Executive Officer of
Stellex Aerospace (b).................................... 1996 217,530 66,680 0 0
</TABLE>
- ------------------
(a) Mr. Gilbert was employed during 1996 as Executive Vice President of
Watkins-Johnson and acting President of TSMD, and the compensation presented
relates to such employment. For information regarding Mr. Gilbert's future
compensation as President and Chief Executive Officer of Stellex Microwave,
see 'Management--Employment and Other Agreements.'
(b) Mr. Call was employed during 1996 as Chairman, President and Chief Executive
Officer of Kleinert (predecessor to Stellex), and the compensation presented
relates to such employment.
(c) Consists of a 401(k) matching contribution of $4,500, an employee stock
ownership plan contribution of $1,500 and an unvested, deferred management
incentive bonus plan award of $11,156.
EMPLOYEE BENEFIT ARRANGEMENTS
The Company has retained the firm of McDaniel & Associates, an employee
benefit consulting firm, to advise it in structuring an appropriate employee
compensation program for the officers and employees of Stellex Microwave and
Stellex Aerospace. The Company anticipates adopting a formal program in the near
future. In addition, the Company will seek to enter into employment agreements
with certain of its executive officers and key employees. The Company expects
that the terms of such employment agreements, as well as the terms of the
overall compensation program adopted by the Board of Directors of Stellex, will
be comparable to the compensation packages offered to officers and employees of
the Company under prior ownership and will be competitive with compensation
programs offered by other companies in the Company's industry.
Pursuant to the Stellex Aerospace Investor Agreement (as defined), certain
Management Members (as defined) were granted stock appreciation rights ('SARs')
by KII Holding. A portion of the SARs vest over a five year period. The vesting
of the remaining SARs is generally conditioned upon Stellex Aerospace meeting
certain targeted levels of annual and cumulative EBITDA (as defined therein)
over a five year period. See 'Certain Transactions--The Kleinert Acquisition.'
60
<PAGE>
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company's compensation policies are determined and executive officer
compensation decisions are made by the Board of Directors of Stellex.
EMPLOYMENT AND OTHER AGREEMENTS
Stellex Microwave is a party to an employment agreement with Keith D.
Gilbert, President and Chief Executive Officer of Stellex Microwave. Mr.
Gilbert's employment agreement commenced as of November 1, 1997 and will expire
on December 31, 2000, unless sooner terminated. Under such agreement, Mr.
Gilbert receives a base salary of $250,000 per annum, subject to annual
increases at the discretion of Stellex Microwave's board of directors. Beginning
with Stellex Microwave's fiscal year 1998, Mr. Gilbert will also be entitled to
receive an annual incentive bonus of up to 75% of his base salary based upon
Stellex Microwave's attainment of certain targeted levels of annual EBITDA (as
defined in his agreement). Under the terms of his employment agreement, Mr.
Gilbert is eligible to participate in all incentive, deferred compensation,
savings and retirement, welfare benefit and fringe benefit plans, practices,
policies and programs to the extent applicable generally to other peer
executives of Stellex Microwave. In addition, Mr. Gilbert is entitled to four
weeks paid vacation per year and reimbursement for all reasonable expenses
incurred by him in the discharge of his duties.
Mr. Gilbert's employment agreement may be terminated by Stellex Microwave
at any time, with or without cause, upon 120 days' written notice, and upon his
death or disability. In the event Mr. Gilbert's employment agreement is
terminated for cause or Mr. Gilbert terminates his own employment, Stellex
Microwave will pay Mr. Gilbert his base salary through the date of termination
to the extent not theretofore paid plus any compensation previously deferred by
him (the 'Accrued Obligations'). In the event of Mr. Gilbert's death or
disability, Stellex Microwave will pay Mr. Gilbert, or his estate, as the case
may be, the Accrued Obligations plus any amounts due pursuant to the terms of
any applicable welfare benefit plans. In the event Mr. Gilbert's employment
agreement is terminated other than for cause or death or disability, Stellex
Microwave will pay Mr. Gilbert the Accrued Obligations plus his base salary for
the lesser of the remainder of the term of his employment agreement or one year.
For a period of two years following the termination of his employment, Mr.
Gilbert will be subject to provisions prohibiting his employment with certain
significant employees of Stellex Microwave and solicitation of such employees or
Stellex Microwave's customers. Mr. Gilbert's employment agreement also contains
provisions relating to non-disclosure of Stellex Microwave's proprietary
information and the assignment to Stellex Microwave of ownership of certain
intellectual property conceived by Mr Gilbert during his employment.
RETENTION PLANS
In anticipation of the divestiture of its tactical subsystems and microwave
devices business units, Watkins-Johnson implemented an enhanced profit sharing
program designed to foster retention of employees of the business pending and
following the W-J Acquisition. This program provides for the doubling of
benefits payable under Watkins-Johnson's pre-existing profit sharing bonus plan
to all employees of the business who remain employed by Watkins-Johnson or are
employed by Stellex Microwave at the end of 1997 (the additional bonus amounts
being payable in March of 1998). Watkins-Johnson has estimated that the total
amount that will be payable to employees under this plan is approximately
$800,000.
Certain key employees of the business are also eligible for additional
individual retention bonuses, some of which are fixed dollar amounts and others
of which are based on the financial results of the business during 1997.
Watkins-Johnson has estimated that the total amount that will be payable to
these employees under these plans is approximately $1.5 million.
Pursuant to the W-J Stock Purchase Agreement, Stellex Microwave agreed to
assume Watkins-Johnson's obligation to make retention payments to employees of
the business and deposited into an escrow account an amount projected to be
sufficient to defray the costs of all such payments and related payroll taxes
and such amount was credited against the purchase price paid at the closing of
the W-J Acquisition.
EMPLOYEE LOANS
Stellex Microwave is the holder of a promissory note made by Timothy L.
Boland, Stellex Microwave's Vice President, Tactical Subsystems, which was in
the original principal amount of $100,000 (of which $58,654 has been forgiven
and $41,346 remains outstanding). This note was made in connection with loans
for relocation assistance.
61
<PAGE>
CERTAIN TRANSACTIONS
THE W-J ACQUISITION
On August 29, 1997, a wholly owned subsidiary of Stellex, TSMD Acquisition
Corp. (the 'Buyer'), entered into a Stock Purchase Agreement (the 'W-J Stock
Purchase Agreement') with Watkins-Johnson and W-J TSMD Inc. ('W-J TSMD'),
pursuant to which Watkins-Johnson agreed to contribute certain assets and
liabilities relating to its tactical subsystems and microwave devices businesses
(collectively the 'Business') to W-J TSMD, and the Buyer agreed to purchase all
of the issued and outstanding capital stock of W-J TSMD (the 'Stellex Microwave
Stock') for a net purchase price of approximately $82.2 million (after giving
effect to estimated purchase price adjustments). The closing of the W-J
Acquisition occurred on October 31, 1997 concurrently with the consummation of
the Initial Offering. In connection with the consummation of the W-J
Acquisition, the corporate name of W-J TSMD was changed to Stellex Microwave
Systems, Inc.
The W-J Stock Purchase Agreement contains representations and warranties
typical of agreements of like nature, including, without limitation, those
relating to corporate organization and capitalization, the valid authorization,
execution, delivery and enforceability of all transaction documents, the
financial statements, the absence of material adverse changes in the Business,
the absence of material undisclosed liabilities, tax matters, material
contracts, the quality and title of the property comprising the Business,
litigation and employee matters, governmental authorizations, licenses and
permits, insurance, compliance with laws, employee benefit plans, customers and
suppliers, compliance with environmental and other laws, and compliance with the
terms of government contracts. Generally, the representations and warranties of
Watkins-Johnson expire on the second anniversary of the closing date except that
(i) those relating to the corporate organization and capitalization of Stellex
Microwave, title to the Stellex Microwave Stock and its assets and the absence
of brokers remain in full force and effect indefinitely, (ii) those concerning
environmental matters generally survive until the tenth anniversary of the
closing date, (iii) certain representations regarding the good repair and
adequacy of the material tangible properties of the Business terminate on the
date which is six months following the closing date, (iv) certain
representations and warranties regarding the merchantability and quality of
inventory included in the Business terminate upon the final determination of the
Adjustment Amount (as defined in the W-J Stock Purchase Agreement) and (v) those
relating to tax matters generally survive until the expiration of the applicable
statute of limitations.
Pursuant to the W-J Stock Purchase Agreement, Watkins-Johnson agreed to
indemnify the Buyer and Stellex Microwave for all liabilities and other losses
arising from, among other things, any breach of its representations, warranties
or covenants contained in the W-J Stock Purchase Agreement, the Excluded
Liabilities (as defined in the W-J Stock Purchase Agreement), third party claims
or demands regarding conduct of the Business prior to the closing date,
violations of law that occur prior to the closing date and certain environmental
conditions. The Buyer agreed to indemnify Watkins-Johnson for all liabilities
and other losses arising from, among other things, any breach of its
representations, warranties or covenants contained in the W-J Stock Purchase
Agreement, the Assumed Obligations (as defined in the W-J Stock Purchase
Agreement), third party claims or demands regarding conduct of the Business
following the closing date and violations of law that occur after the closing
date. With certain exceptions, neither Watkins-Johnson nor the Buyer is required
to indemnify any other person for breaches of certain representations and
warranties unless the aggregate of all amounts for which indemnity would
otherwise be payable exceeds $500,000 and, in such event, the indemnifying party
will be responsible only for the amount in excess of $500,000. In addition, the
indemnification obligations for breaches of representations and warranties of
each of Watkins-Johnson and the Buyer are generally limited to a maximum of $20
million, except that there is no limit on Watkins-Johnson's obligations with
respect to breaches of certain representations and warranties, including those
relating to the corporate organization and capitalization of Stellex Microwave,
certain tax matters, title to the Stellex Microwave Stock and its assets, the
absence brokers and certain environmental matters. There is also no limit on
indemnification by Watkins-Johnson for specified pending claims and litigation.
The W-J Stock Purchase Agreement also contains non-competition and
non-solicitation agreements binding on Watkins-Johnson, the Buyer and Stellex
Microwave. Watkins-Johnson, on behalf of itself and its Affiliates (as defined
in the W-J Stock Purchase Agreement), agreed for a period of four years after
the date of such agreement that it will not, directly or indirectly participate
in the ownership, management or control of, or the financing of, or be employed
by, or consult for or otherwise render services to, or allow its name or
reputation to be used in or by any other present or future business enterprise
in the defense or space industries or that otherwise compete with the Business
or its products in each state of the United States and in each foreign
jurisdiction in which the
62
<PAGE>
Business is conducted or its products are sold as of the closing date; provided
that the foregoing provision expressly does not apply to certain intelligence
systems manufactured by Watkins-Johnson that are designed to monitor or
intercept communication signals, products for the telecommunications market
currently manufactured or in development by Watkins-Johnson and
Watkins-Johnson's ability to act as an outside GaAs foundry for third parties.
In addition, Watkins-Johnson generally agreed to refrain from soliciting
employees of Stellex Microwave for a period of four years from the closing date.
Similarly, the Buyer, on behalf of itself and its Affiliates, agreed for a
period of four years after the date of the W-J Stock Purchase Agreement that it
will not (i) manufacture Gallium Arsenide parts for third parties, (ii) disclose
to third parties confidential process and design rule information related to the
manufacture of Gallium Arsenide parts except as necessary for the manufacture of
parts solely for the Buyer and its Affiliates and (iii) manufacture for the
telecommunications market products that duplicate, in whole or with minor
modifications, the proprietary designs of products currently manufactured or in
development by Watkins-Johnson, including, without limitation, cellular and PCS
base station subsystems, wireless local loop customer premise equipment,
repeater subsystems for point to multi-point and medium power amplifiers. In
addition, the Buyer and Stellex Microwave generally agreed to refrain from
soliciting employees of Watkins-Johnson for a period of four years from the
closing date.
In connection with the W-J Acquisition, Watkins-Johnson and the Company
entered into a variety of ancillary agreements to accommodate the separation of
the Business from the businesses retained by Watkins-Johnson. Stellex Microwave
entered into a sub-lease with Watkins-Johnson for the facilities currently used
by the Business that allows the Company to continue to conduct the Business at
its existing site for a maximum of three years. In addition, Watkins-Johnson and
Stellex Microwave entered into a supply agreement that allows Stellex Microwave
to purchase from Watkins-Johnson, at agreed upon rates, products used in
connection with the Business from Watkins-Johnson's gallium arsenide foundry and
thin-film production substrate facility. Stellex Microwave also entered into an
agreement to furnish Watkins-Johnson, at agreed upon rates, with metal injection
molding services through a facility purchased from Watkins-Johnson in connection
with the W-J Acquisition. Finally, Watkins-Johnson and Stellex Microwave entered
into a license agreement covering certain common technology used in the
operation of the Business and the businesses being retained by Watkins-Johnson.
See 'Business--Properties,' '--Supply Agreements' and '--Intellectual Property.'
The foregoing summary of the material terms of the W-J Stock Purchase
Agreement and related matters does not purport to be complete and is subject to,
and is qualified in its entirety by reference to, all of the provisions of the
W-J Stock Purchase Agreement, including the definitions of certain terms therein
and the exhibits and schedules thereto.
THE KLEINERT ACQUISITION
On July 1, 1997, KII Acquisition Corp. ('Acquisition Corp.'), approximately
80% of the common stock of which is indirectly owned by Stellex, acquired all of
the issued and outstanding capital stock of Kleinert (currently known as Stellex
Aerospace) from Kleinert Industries Holding AG (the 'Seller'), for a purchase
price of approximately $26.5 million (including the assumption of $2.6 million
of indebtedness and the issuance by Acquisition Corp. to the Seller of a
promissory note (the 'Kleinert Seller Note') in the principal amount of
$1,750,000). The Kleinert Seller Note matures on July 1, 1999 and bears interest
at a rate of 8%. The Kleinert Seller Note is guaranteed by Stellex Aerospace and
each of its subsidiaries.
The Stock Purchase Agreement entered into in connection with the Kleinert
Acquisition (the 'Kleinert Stock Purchase Agreement') contains representations
and warranties typical of agreements of like nature, including, without
limitation, those relating to corporate organization and authorization, good
title to Kleinert's capital stock, violations of law and defaults under material
contracts, third party consents, Kleinert's financial statements, tax,
environmental and intellectual property matters, the absence of undisclosed
liabilities, title to and condition of assets, litigation, compliance with laws,
insurance, employee benefit plans, inventory and required permits and licenses.
Pursuant to the Kleinert Stock Purchase Agreement, the Seller agreed to
indemnify Acquisition Corp. for all liabilities and other losses arising from,
among other things, any breach of the representations, warranties or covenants
of the Seller or Kleinert contained in the Kleinert Stock Purchase Agreement.
Indemnification claims must be brought by Acquisition Corp. prior to June 30,
1999, except with respect to breaches of certain representations relating to tax
matters, which may be brought any time prior to the applicable statute of
limitations. Acquisition Corp. has agreed to indemnify the Seller for all
liabilities (including without limitation liabilities for Taxes), and other
losses arising from, among other things, the operation or conduct of Stellex
63
<PAGE>
Aerospace's business after the Closing Date and the breach of any
representation, warranty or covenant of Acquisition Corp. contained in the
Kleinert Stock Purchase Agreement. Indemnification claims brought by the Seller
generally must be made prior to June 30, 1999. With certain limited exceptions
(e.g., fraud), neither the Seller nor Acquisition Corp. is required to indemnify
any other person unless the aggregate of all amounts for which indemnity would
otherwise be payable exceeds $100,000 (the 'Basket Amount') and, in such event,
the indemnifying party shall be responsible for all Indemnified Losses,
including those comprising the Basket Amount. In addition, the indemnification
obligations of each Acquisition Corp. and the Seller are generally limited to a
maximum of $1,750,000. Pursuant to the Kleinert Seller Note, and subject to
certain conditions and procedures, Acquisition Corp. may offset amounts due
under the Kleinert Seller Note by indemnification claims and other amounts owing
by the Seller to Acquisition Corp. under the Kleinert Stock Purchase Agreement.
Pursuant to an Agreement entered into in connection with the Kleinert
Acquisition (the 'Stellex Aerospace Investor Agreement'), six senior members of
Stellex Aerospace's management team (the 'Buyers,' and together with a member of
management who received SARs as described below, the 'Management Members')
purchased 19.9% of the issued and outstanding shares of KII Holding Corp. ('KII
Holding'), the parent holding company of Stellex Aerospace, for approximately
$800,000. In addition, an entity beneficially owned by trusts established for
the benefit of Messrs. Kramer and Remley and certain members of their families
purchased KII Holding's remaining common stock for approximately $3.1 million
and 84 shares of KII Holding's Series A Preferred Stock, having a stated value
of $10,000 per share (the 'Series A Preferred Stock'), for $840,000. Pursuant to
the Stellex Aerospace Investor Agreement, the Buyers also agreed to purchase
shares of KII Holding's Series B Preferred Stock with the net bonus payments
received by the Buyers under their respective participation plan agreements with
the Seller.
Pursuant to the Stellex Aerospace Investor Agreement, KII Holding granted
SARs to certain Management Members. KII Holding has the right to redeem (the
'Redemption Right') all, but not less than all, of any common stock held by any
Management Member and to cause a liquidation and termination of any SAR held by
him to KII Holding upon the occurrence of certain events, including the death,
disability or termination of the Management Member, and for any reason after
July 1, 2002. Moreover, the Stellex Aerospace Investor Agreement gives each
Management Member the right to cause KII Holding to purchase all, but not less
than all, of any common stock of KII Holding held by him and/or to cause KII
Holding to liquidate and terminate any SARs held by him (hereinafter referred to
as the 'Put Right') upon the occurrence of certain events, including such
Management Member's death, disability, termination Without Cause (as defined in
the Stellex Aerospace Investor Agreement) or scheduled retirement, and for any
reason after July 1, 2002. The applicable purchase price to be received by a
Management Member upon the exercise of a Redemption Right or Put Right is based
upon a formula set forth in the Stellex Aerospace Investor Agreement. To the
extent KII Holding is prohibited under the terms of its existing indebtedness
from making payment to any Management Member for any shares of its common stock
or vested SARs purchased or liquidated pursuant to the Stellex Aerospace
Investor Agreement, then it is required to issue a promissory note to such
Management Member for the amount owing. Such note shall be payable when and to
the extent KII Holding is permitted to make such payment and bear interest at a
rate of 10% per annum. Such note shall also be unsecured and subordinated to all
other indebtedness of KII Holding, including KII Holding's Guarantee of the
Notes.
The Stellex Aerospace Investor Agreement further provides that subsequent
to the closing of the Kleinert Acquisition, each Management Member will enter
into a five year employment agreement with KII Holding or one of its
subsidiaries. The Company has engaged an employee benefits firm to advise it in
structuring its overall compensation program and anticipates implementing such
program and entering into the employment agreements with the Management Members
at its earliest opportunity.
The foregoing summary of the material terms of the Kleinert Stock Purchase
Agreement, the Stellex Aerospace Investor Agreement and related matters does not
purport to be complete and is subject to, and is qualified in its entirety by
reference to, all of the provisions of the Kleinert Stock Purchase Agreement and
the Stellex Aerospace Investor Agreement, including the definitions of certain
terms therein and exhibits and schedules thereto.
TRINITY NOTE
In connection with the Kleinert Acquisition, KII Holding issued a
promissory note (the 'Trinity Note') in the principal amount of $2,500,000 to
Trinity Investment Corp. ('Trinity'). Richard L. Kramer and William L. Remley
are executive officers and directors of Trinity, which is a subsidiary of
entities owned by trusts
64
<PAGE>
established for the benefit of certain relatives of Messrs. Kramer and Remley.
The outstanding principal and accrued interest on the Trinity Note was repaid
with a portion of the proceeds of the Initial Offering.
MANAGEMENT AGREEMENT WITH MENTMORE
Mentmore provides management services to Stellex and the Subsidiary
Guarantors pursuant to the Amended and Restated Management Advisory Services
Agreement effective as of November 1, 1997 (the 'Management Agreement'), between
Stellex, the Subsidiary Guarantors and Mentmore. Pursuant to the Management
Agreement, Mentmore provides Stellex and the Subsidiary Guarantors with general
management, advisory, consulting and other services with respect to the
Company's business, including, without limitation, strategic planning, financial
planning, accounting and financial reporting, consulting and assistance with
respect to traditional treasury functions, general business development
services, and oversight and review of tax preparation, planning and audits.
Under the terms of the Management Agreement, Mentmore receives customary
indemnification, reimbursement of certain costs and an annual management fee of
$750,000, which is payable monthly, plus, after the first anniversary of the
consummation of the Initial Offering, the amount by which 1% of the Company's
total consolidated sales in any fiscal year exceeds such fee. The Management
Agreement has a term of 10 years and is automatically extended for one
additional year as of December 31 of each year during the term of the agreement
unless either party shall have previously notified the other in writing on or
before September 30 of its desire not to further extend the term. In addition,
Mentmore may terminate the Management Agreement at any time upon 90 days prior
written notice to the other parties thereto, and such parties may terminate the
Management Agreement 'for cause' (as defined in the Management Agreement). The
sole executive officers and directors of Mentmore are Richard L. Kramer and
William L. Remley.
In connection with the Kleinert Acquisition, Mentmore received investment
banking fees of $450,000, and reimbursement for certain expenses. Mentmore
received total fees of $1,000,000 and the reimbursement of certain expenses in
connection with financial advisory and other services rendered to the Company in
connection with the W-J Acquisition and the Initial Offering. In addition,
Michael D. Schenker Co. L.P.A., whose principal is an officer of Mentmore,
received customary fees in connection with services rendered in connection with
the Transactions.
TAX SHARING AGREEMENT
The Company's liability for taxes will be determined based upon a tax
sharing agreement (the 'Tax Sharing Agreement') entered into among Stellex and
the Subsidiary Guarantors. Under the Tax Sharing Agreement, Stellex and its
subsidiaries will generally be responsible for federal taxes based upon the
amount that would be due if Stellex and its subsidiaries filed federal tax
returns as a separate affiliated group of corporations rather than as part of
Stellex's consolidated federal tax returns. The combined state tax liabilities
will be allocated to Stellex and its subsidiaries based on similar principles.
RELATIONSHIP WITH EQUITY INVESTORS
In connection with the consummation of the Transactions, certain equity
investments in the Company were made by trusts or other entities owned by
trusts, the beneficiaries of which are relatives of Richard L. Kramer and
William L. Remley. Such investments consisted of the purchase for cash of shares
of the Company's Series A Preferred Stock for an aggregate consideration of
$7,450,000 and its Common Stock for an aggregate consideration of $50,000. In
addition, a $4,000,000 promissory note (the 'Sunderland Note') issued to
Sunderland Industrial Holdings Corporation ('Sunderland') in connection with the
Kleinert Acquisition was exchanged, in connection with the consummation of the
Transactions, for shares of the Company's Series A Preferred Stock having an
aggregate stated value of $4,000,000. The Company's Series A Preferred Stock is
not mandatorily redeemable at the option of the holder, and dividends thereunder
are payable in cash or in kind at the option of the Company's Board of
Directors, subject to restrictions under the Indenture. Richard L. Kramer and
William L. Remley are the principal executive officers and directors of
Sunderland, whose outstanding capital stock is held by trusts, the beneficiaries
of which are certain relatives of Messrs. Kramer and Remley.
65
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information concerning the beneficial
ownership of Stellex's Common Stock as of December 1, 1997 by (i) each person
known to the Company to own beneficially more than 5% of Stellex's outstanding
Common Stock, (ii) by each director, executive officer and key employee of the
Company and (iii) all such directors, executive officers and key employees as a
group. All shares are owned with sole voting and investment power, unless
otherwise indicated.
<TABLE>
<CAPTION>
COMMON STOCK
BENEFICIALLY
OWNED
-------------
BENEFICIAL OWNER SHARES %
- ------------------------------------------------------------------------------- ------ ---
<S> <C> <C>
Cottingham Trust (1996)(a)..................................................... 900 90
Askrigg Trust (1996)(b)........................................................ 100 10
Richard L. Kramer.............................................................. 900 (c) 90
William L. Remley.............................................................. 1,000 (d) 100
P. Roger Byer.................................................................. -- --
Keith D. Gilbert............................................................... -- --
Bradley C. Call................................................................ -- --
Timothy L. Boland.............................................................. -- --
John L. Martin................................................................. -- --
Kevin R. Hunter................................................................ -- --
Eric F. Richardson............................................................. -- --
Julius E. Hodge................................................................ -- --
Total Executive Officers and Directors as a Group.............................. 1,000 100
</TABLE>
- ------------------
(a) The pool of contingent beneficiaries of Cottingham Trust (1996)
('Cottingham') is comprised of Richard L. Kramer and certain members of his
family. The trustees of Cottingham are Alhambra Holdings (Trustees) Inc.
('Alhambra') and William L. Remley. All powers with respect to investment or
voting of securities owned by Cottingham are exercisable by Mr. Remley. All
powers with respect to selection and removal of the beneficiaries of
Cottingham are exercisable by Alhambra. The administrative office address of
Cottingham and Alhambra is 2 Alhambra Plaza, Suite 1202, Coral Gables, FL
33134. Mr. Kramer, the Chairman of the Board of Directors and a director of
Stellex and the Subsidiary Guarantors, and Mr. Remley, Vice Chairman, Chief
Executive Officer and a director of Stellex and Vice Chairman and a director
of the Subsidiary Guarantors, are the sole executive officers and directors
of Mentmore, which provides management services to the Company.
(b) The pool of contingent beneficiaries of Askrigg Trust (1996) ('Askrigg') is
comprised of William L. Remley and certain members of his family. The
trustees of Askrigg are Richard L. Kramer and Gary R. Siegel. All powers
with respect to investment or voting of securities owned by Askrigg are
exercisable by Mr. Siegel. All powers with respect to selection and removal
of the beneficiaries of Askrigg are exercisable by Mr. Kramer. The
administrative office address of Askrigg is 201 Crandon Blvd., Apt. 643, Key
Biscayne, FL 33149, and an address of Mr. Siegel is c/o Mentmore Holdings
Corporation, 1430 Broadway, 13th Floor, New York, NY 10018-3308. Mr. Kramer,
the Chairman of the Board of Directors and a director of Stellex and the
Subsidiary Guarantors, and Mr. Remley, Vice Chairman, Chief Executive
Officer and a director of Stellex and Vice Chairman and a director of the
Subsidiary Guarantors, are the sole executive officers and directors of
Mentmore, which provides management services to the Company.
(c) Comprised of 900 shares of Stellex's Common Stock held of record by
Cottingham, as to which Mr. Kramer disclaims beneficial ownership. See
footnote (a) above.
(d) Comprised of 900 and 100 shares of Stellex's Common Stock held of record by
Cottingham and Askrigg, respectively, as to which Mr. Remley disclaims
beneficial ownership. See footnotes (a) and (b) above.
66
<PAGE>
DESCRIPTION OF CERTAIN INDEBTEDNESS
NEW CREDIT FACILITIES
Upon consummation of the Initial Offering, Stellex and its direct and
indirect subsidiaries (each a 'Borrower' and collectively, the 'Borrowers')
entered into a credit agreement (the 'New Credit Facilities') with Societe
Generale, as administrative agent (the 'Agent') for a syndicate of financial
institutions (the 'Lenders'). The following summary, which sets forth the
expected material terms of the New Credit Facilities, does not purport to be
complete and is subject to, and qualified by reference to, all of the provisions
of the New Credit Facilities, including all of the definitions therein of terms
not defined in this Prospectus.
General. The New Credit Facilities provide for borrowings in a principal
amount at any one time outstanding of up to $25.0 million under a revolving
credit facility (the 'Revolving Credit Facility') and $25.0 million under an
acquisition facility (the 'Acquisition Facility'). Borrowings under the
Revolving Credit Facility may be used to provide for working capital and other
general corporate purposes. Borrowings under the Acquisition Facility may be
used to fund future acquisitions on terms and conditions satisfactory to the
Lenders. Borrowings under the New Credit Facilities are collectively referred to
herein as the 'Loans.' See 'Capitalization' and 'Management's Discussion and
Analysis of Financial Condition and Results of Operations.'
Interest. For purposes of calculating interest, the Loans can be, at the
election of the relevant Borrower, Base Rate Loans or Eurodollar Rate Loans or a
combination thereof. Base Rate Loans under the Revolving Credit Facility bear
interest at Societe Generale's base rate plus 1%, and Eurodollar Rate Loans
under the Revolving Credit Facility bear interest at Societe Generale's
Eurodollar Rate plus 2%. Base Rate Loans under the Acquisition Facility bear
interest at Societe Generale's base rate plus 1.25%, and Eurodollar Rate Loans
under the Acquisition Facility bear interest at Societe Generale's Eurodollar
Rate plus 2.25%. The foregoing interest rates are effective through June 30,
1998, and thereafter are subject to adjustment based upon the Leverage Ratio (as
defined in the New Credit Facilities). Interest is payable monthly for Base Rate
Loans and at the end of each interest payment period, but not less frequently
than quarterly, for Eurodollar Rate Loans.
Availability and Repayment. Subject to the provisions of the New Credit
Facilities, the Borrowers may, from time to time, borrow, repay and reborrow
under the Revolving Credit Facility, subject to a borrowing base consisting of
the aggregate sum of 85% of eligible accounts receivable and 50% of eligible
inventories. Subject to the provisions of the New Credit Facilities, borrowings
under the Acquisition Facility may be made up to the full amount available
thereunder until the second anniversary of the closing of the New Credit
Facilities, subject to certain financial and non-financial conditions
satisfactory to the Lenders. At the second anniversary of the Closing Date (as
defined in the New Credit Facilities), all amounts borrowed under the
Acquisition Facility will convert to a term loan which will be repayable in 15
substantially equal quarterly installments of 4.17% of the outstanding Term Loan
Amount (as defined in the New Credit Facilities) commencing on February 1, 1999
and continuing through and including August 1, 2003, followed by a final payment
of all remaining unpaid amounts on the Maturity Date (as defined in the New
Credit Facilities). Borrowings under the Acquisition Facility will permanently
reduce by such amount the availability for further borrowings under the
Acquisition Facility, and amounts repaid under the Acquisition Facility may not
be reborrowed. The New Credit Facilities require, subject to certain exceptions,
prepayments in the amount of 50% of Excess Cash Flow (as defined in the New
Credit Facilities), 100% of net cash proceeds from certain asset sales, and 100%
of net cash proceeds from offerings of debt and/or equity securities, with such
prepayments to be applied pro rata to the remaining maturities of acquisition
loans. The entire unpaid balance under the New Credit Facilities is payable on
the sixth anniversary of the closing thereof.
Security. Borrowings under the New Credit Facilities are secured, for the
ratable benefit of the Lenders, by (i) a first priority perfected security
interest in favor of First Union Commercial Corporation, as collateral agent
(the 'Collateral Agent'), in (a) all of the capital stock of the Company's
direct and indirect subsidiaries owned by the Company and (b) all present and
future tangible and intangible property and interests in property of the Company
and its direct and indirect subsidiaries (other than certain real property owned
by Paragon (the 'Paragon Real Estate')) and (ii) a second priority perfected
mortgage on the Paragon Real Estate in favor of the Collateral Agent.
67
<PAGE>
Guarantees. Each Borrower's payment obligations under the New Credit
Facilities is jointly and severally guaranteed, on a senior secured basis, by
each other Borrower and Stellex's future direct and indirect subsidiaries.
Covenants. The New Credit Facilities contain financial covenants pursuant
to which the Company and its direct and indirect subsidiaries must, on a
consolidated basis, maintain (i) a Minimum Fixed Charge Coverage Ratio (as
defined in the New Credit Facilities); (ii) a Minimum Interest Coverage Ratio
(as defined in the New Credit Facilities); (iii) a Minimum Net Worth (as defined
in the New Credit Facilities) and (iv) a Maximum Leverage Ratio (as defined in
the New Credit Facilities).
In addition, the New Credit Facilities contain covenants pertaining to the
management and operation of the Company and its subsidiaries. These covenants
include, among others, requirements that each of the Company and its
subsidiaries (i) preserve its corporate existence and not amend its charter or
by-laws; (ii) maintain adequate insurance coverage; (iii) maintain its
properties and all necessary licenses, permits and intellectual property; (iv)
perform its obligations under leases, related documents, material contracts and
other agreements; and (v) comply with applicable laws and regulations, including
those related to tax, employee, pension and environmental matters.
The New Credit Facilities also subject the Company and its subsidiaries to
significant limitations on indebtedness, guarantees, capital expenditures, liens
or encumbrances, mergers, consolidations, divestitures, acquisitions,
investments, capital contributions, joint ventures, partnerships, creation of
new subsidiaries, changes of business, loans and advances, dividends and other
stock payments, repurchases or redemptions of equity, asset sales or transfers,
leases, voluntary prepayments or repurchases or redemptions of debt,
transactions with affiliates, management fees, and changes in accounting
treatment.
Events of Default. The New Credit Facilities provide for events of default
customarily found in facilities of this type, including: (i) failure to pay
principal or interest or fees when due; (ii) any representation or warranty
proving to have been materially incorrect when made; (iii) failure to perform or
observe covenants after any applicable grace period; (iv) cross-defaults to
other material indebtedness; (v) bankruptcy defaults; (vi) material judgment
defaults; (vii) change of control; (viii) ERISA defaults; (ix) any loan document
ceasing to be in full force and effect and (x) any interest created by the
related security documents ceasing to be enforceable and of the same effect and
priority purported to be created thereby.
KLEINERT SELLER NOTE
In connection with the Kleinert Acquisition, KII Acquisition Corp.
('Acquisition Corp.'), an indirect 80% owned subsidiary of Stellex, issued the
Kleinert Seller Note to Kleinert Industrie Holding AG, the former owner of
Stellex Aerospace. The principal amount of the Kleinert Seller Note is
$1,750,000, it matures on July 1, 1999 and it bears interest at a rate of 8%.
The Kleinert Seller Note is guaranteed by Stellex Aerospace and each of its
subsidiaries. Subject to certain conditions, Acquisition Corp. may offset
amounts due under the Kleinert Seller Note by indemnification claims and other
amounts owing by the Seller to Acquisition Corp. under the Kleinert Stock
Purchase Agreement. Interest on the principal amount of the Kleinert Seller
Note, as adjusted by any offset permitted thereunder, is payable annually in
arrears.
PARAGON NOTE
Paragon is the obligor under a promissory note (the 'Paragon Note') payable
to Farm Bureau Life Insurance Company in the original principal amount of
$2,850,000. The Paragon Note matures on December 1, 2001 and bears interest at a
rate of 7.875% per annum. The Paragon Note is secured by a security interest in
certain real property, and related fixtures and personal property, located at
Paragon's facility in Valencia, California. The Paragon Note is guaranteed on a
secured basis by Stellex Aerospace.
68
<PAGE>
THE EXCHANGE OFFER
PURPOSE AND EFFECT OF THE EXCHANGE OFFER
The Old Notes were originally sold by the Company to the Initial Purchasers
pursuant to the Purchase Agreement. The Initial Purchasers subsequently resold
the Old Notes to qualified institutional buyers in reliance on Rule 144A under
the Securities Act and to a limited number of accredited investors (as defined
in Rule 501(A)(1), (2), (3) or (7) under the Securities Act). As a condition to
the Purchase Agreement, the Company and the Subsidiary Guarantors entered into
the Registration Rights Agreement with the Initial Purchasers pursuant to which
the Company and the Subsidiary Guarantors have agreed, for the benefit of the
holders of the Old Notes, at the Company's cost, to (i) file the Exchange Offer
Registration Statement within 45 days after the date of the original issue of
the Old Notes with the Commission with respect to the Exchange Offer for the New
Notes; (ii) use their reasonable best efforts to cause the Exchange Offer
Registration Statement to be declared effective under the Securities Act within
120 days after the date of the original issuance of the Old Notes and (iii)
unless the Exchange Offer would not be permitted by applicable law or Commission
policy, commence the Exchange Offer and use their reasonable best efforts to
issue as soon as practicable, but in any event prior to 165 days after the date
of the original issue of the Old Notes, New Notes in exchange for all Old Notes
tendered prior thereto in the Exchange Offer. Upon the Exchange Offer
Registration Statement being declared effective, the Company will offer the New
Notes in exchange for surrender of the Old Notes. The Company will keep the
Exchange Offer open for not less than 20 business days (or longer if required by
applicable law) after the date on which notice of the Exchange Offer is mailed
to the holders of the Old Notes. For each Old Note surrendered to the Company
pursuant to the Exchange Offer, the holder of such Old Note will receive a New
Note having a principal amount equal to that of the surrendered Old Note. Each
New Note will bear interest from its issuance date. Holders of Old Notes that
are accepted for exchange will receive, in cash, accrued interest thereon to,
but not including, the issuance date of the New Notes. Such interest will be
paid with the first interest payment on the New Notes. Interest on the Old Notes
accepted for exchange will cease to accrue upon issuance of the New Notes.
Under existing interpretations of the staff of the Commission contained in
the 'Exxon Capital Holdings Corporation' line of no-action letters to third
parties, the New Notes will in general be freely tradeable after the Exchange
Offer without further registration under the Securities Act. However, any
purchaser of Old Notes who is an 'affiliate' of the Company or who intends to
participate in the Exchange Offer for the purpose of distributing the New Notes
(i) will not be able to rely on the interpretation of the staff of the
Commission, (ii) will not be able to tender its Old Notes in the Exchange Offer
and (iii) must comply with the registration and prospectus delivery requirements
of the Securities Act in connection with any sale or transfer of the Old Notes,
unless such sale or transfer is made pursuant to an exemption from such
requirements.
As contemplated by these no-action letters and the Registration Rights
Agreement, each holder accepting the Exchange Offer is required to represent to
the Company in the Letter of Transmittal that (i) the New Notes are to be
acquired by the holder or the person receiving such New Notes, whether or not
such person is the holder, in the ordinary course of business, (ii) the holder
or any such other person (other than a broker-dealer referred to in the next
sentence) is not engaging, and does not intend to engage, in a distribution of
the New Notes, (iii) the holder or any such other person has no arrangement or
understanding with any person to participate in the distribution of the New
Notes, (iv) neither the holder nor any such other person is an 'affiliate' of
the Company within the meaning of Rule 405 under the Securities Act, and (v) the
holder or any such other person acknowledges that if such holder or any other
person participates in the Exchange Offer for the purpose of distributing the
New Notes it must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with any resale of the New
Notes and cannot rely on those no-action letters. Each Participating
Broker-Dealer that receives New Notes for its own account in exchange for Old
Notes, where such Old Notes were acquired by such Participating Broker-Dealer as
a result of market-making activities or other trading activities, must
acknowledge that it will deliver a prospectus in connection with any resale of
such New Notes. See 'Plan of Distribution.'
Upon the effectiveness of the Exchange Offer Registration Statement, the
Company will offer to the holders of Transfer Restricted Securities who are able
to make certain representations the opportunity pursuant to the Exchange Offer
to exchange their Transfer Restricted Securities for New Notes. If (i) any
change in law or
69
<PAGE>
applicable interpretations of the staff of the Commission do not permit the
Company to effect the Exchange Offer or (ii) any Holder (A) is not eligible to
participate in the Exchange Offer, (B) participates in the Exchange Offer and
does not receive freely tradeable New Notes in exchange for tendered Old Notes
or (C) is a broker-dealer and owns Old Notes acquired directly from the Company
or an affiliate of the Company, the Company will file with the Commission a
Shelf Registration Statement on or prior to the 30th day after such filing
obligation arises to cover resales of Transfer Restricted Securities by the
Holders thereof who satisfy certain conditions relating to, among other things,
the provision of information in connection with the Shelf Registration
Statement. The Company will use its reasonable best efforts to cause the
applicable registration statement to be declared effective as promptly as
possible by the Commission. For purposes of the foregoing, 'Transfer Restricted
Securities' means each Note until the earliest to occur of (i) the date on which
such Note has been exchanged by a person other than a broker-dealer for a New
Note in the Exchange Offer, (ii) the date on which such Note has been
effectively registered under the Securities Act and disposed of in accordance
with the Shelf Registration Statement or (iii) the date on which such Note is
distributed to the public pursuant to Rule 144 under the Securities Act or is
saleable pursuant to Rule 144(k) under the Securities Act.
The Company will, in the event of the filing of the Shelf Registration
Statement, provide to each holder of Old Notes covered thereby copies of the
prospectus which is a part of the Shelf Registration Statement, notify each such
holder when the Shelf Registration Statement has become effective and take
certain other actions as are required to permit unrestricted resale of the Old
Notes. A holder of the Old Notes that sells such Old Notes pursuant to the Shelf
Registration Statement generally would be required to be named as a selling
security holder in the related prospectus and to deliver a prospectus to
purchasers, will be subject to certain of the civil liability provisions under
the Securities Act in connection with such sales and will be bound by the
provisions of the Registration Rights Agreement which are applicable to such a
holder (including certain indemnification obligations).
The Registration Rights Agreement provides that (i) the Company will file
an Exchange Offer Registration Statement with the Commission on or prior to 45
days after the closing date of the Initial Offering (the 'Closing Date'), (ii)
the Company will use its reasonable best efforts to have the Exchange Offer
Registration Statement declared effective by the Commission on or prior to 120
days after the Closing Date, (iii) unless the Exchange Offer would not be
permitted by applicable law or Commission policy, the Company will commence the
Exchange Offer and use its reasonable best efforts to issue as soon as
practicable, but in any event prior to 165 days after the Closing Date, New
Notes in exchange for all Old Notes tendered prior thereto in the Exchange Offer
and (iv) if obligated to file the Shelf Registration Statement, the Company will
use its reasonable best efforts to file the Shelf Registration Statement with
the Commission on or prior to 30 days after such filing obligation arises and to
cause the Shelf Registration Statement to be declared effective by the
Commission on or prior to 60 days after such obligation arises. If (a) the
Company fails to file any of the Registration Statements required by the
Registration Rights Agreement on or before the date specified for such filing,
(b) the Exchange Offer Registration Statement is not declared effective within
120 days after the Closing Date or the Shelf Registration Statement is not
declared effective on or prior to the 60th day after the shelf filing deadline,
(c) the Exchange Offer is not consummated on or prior to 165 days after the
Closing Date or (d) the Shelf Registration Statement is filed and declared
effective on or prior to the date specified for such effectiveness, but shall
thereafter cease to be effective (at any time that the Company is obligated to
maintain the effectiveness thereof) without being succeeded within 45 days by an
additional Registration Statement filed and declared effective (each such event
referred to in clauses (a) through (d) above, a 'Registration Default'), then
the Company will pay liquidated damages ('Liquidated Damages') to each Holder of
Transfer Restricted Securities, with respect to the first 90-day period
immediately following the occurrence of the first Registration Default in an
amount equal to $.05 per week per $1,000 principal amount of Notes that
constitute Transfer Restricted Securities held by such holder until the
applicable Registration Statement is filed or declared effective, the Exchange
Offer is consummated or the Shelf Registration Statement again becomes
effective. The amount of the Liquidated Damages will increase by an additional
$.05 per week per $1,000 principal amount of Notes with respect to each
subsequent 90-day period until all Registration Defaults have been cured, up to
a maximum amount of Liquidated Damages of $.20 per week per $1,000 principal
amount of Notes. All accrued Liquidated Damages will be paid by the Company in
the same manner as interest payments on the Notes on semi-annual payment dates
which correspond to interest payment dates for the Notes. Following the cure of
all Registration Defaults, the accrual of Liquidated Damages will cease.
Notwithstanding the foregoing, the Company may issue a notice that the Shelf
70
<PAGE>
Registration Statement is no longer effective or that the Prospectus included
therein is unusable pending the announcement of a material corporate transaction
and, in the event that the aggregate number of days in any consecutive
twelve-month period for which all such notices are issued and effective does not
exceed 45 days in the aggregate, then Liquidated Damages will not be payable as
described above as a result of such suspension.
Holders of Old Notes will be required to make certain representations (as
described in the Registration Rights Agreement) in order to participate in the
Exchange Offer and will be required to deliver information to be used in
connection with the Shelf Registration Statement within the time periods set
forth in the Registration Rights Agreement in order to have their Old Notes
included in the Shelf Registration Statement and benefit from the provisions
regarding Liquidated Damages set forth above.
The summary herein of certain provisions of the Registration Rights
Agreement, which contains the material terms relating to the registration rights
and related obligations of Holders of Old Notes, does not purport to be complete
and is subject to, and is qualified in its entirety by, all the provisions of
the Registration Rights Agreement, a copy of which is filed as an exhibit to the
Exchange Offer Registration Statement of which this Prospectus is a part.
Following the consummation of the Exchange Offer, holders of the Old Notes
who were eligible to participate in the Exchange Offer but who did not tender
their Old Notes will not have any further registration rights and such Old Notes
will continue to be subject to certain restrictions on transfer. Accordingly,
the liquidity of the market for such Old Notes could be adversely affected.
TERMS OF THE EXCHANGE OFFER
Upon the terms and subject to the conditions set forth in this Prospectus
and in the Letter of Transmittal, the Company will accept any and all Old Notes
validly tendered and not withdrawn prior to 5:00 p.m., New York City time, on
the Expiration Date. The Company will issue $1,000 principal amount of New Notes
in exchange for each $1,000 principal amount of Old Notes accepted in the
Exchange Offer. Holders may tender some or all of their Old Notes pursuant to
the Exchange Offer. However, Old Notes may be tendered only in integral
multiples of $1,000.
The form and terms of the New Notes are the same as the form and terms of
the Old Notes except that (i) the New Notes bear a Series B designation and a
different CUSIP number from the Old Notes, (ii) the New Notes have been
registered under the Securities Act and hence will not bear legends restricting
the transfer thereof and (iii) the holders of the New Notes will not be entitled
to certain rights under the Registration Rights Agreement, including the
provisions providing for the payment of Liquidated Damages in certain
circumstances relating to the timing of the Exchange Offer, all of which rights
will terminate when the Exchange Offer is terminated. The New Notes will
evidence the same debt as the Old Notes and will be entitled to the benefits of
the Indenture.
As of the date of this Prospectus, $100,000,000 aggregate principal amount
of Old Notes were outstanding. The Company has fixed the close of business on
, 1998 as the record date for the Exchange Offer for purposes of
determining the persons to whom this Prospectus and the Letter of Transmittal
will be mailed initially.
Holders of Old Notes do not have any appraisal or dissenters' rights under
the General Corporation Law of Delaware or the Indenture in connection with the
Exchange Offer. The Company intends to conduct the Exchange Offer in accordance
with the applicable requirements of the Exchange Act and the rules and
regulations of the Commission thereunder.
The Company shall be deemed to have accepted validly tendered Old Notes
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering holders
for the purpose of receiving the New Notes from the Company.
If any tendered Old Notes are not accepted for exchange because of an
invalid tender, the occurrence of certain other events set forth herein or
otherwise, the certificates for any such unaccepted Old Notes will be returned,
without expense, to the tendering holder thereof as promptly as practicable
after the Expiration Date.
Holders who tender Old Notes in the Exchange Offer will not be required to
pay brokerage commissions or fees or, subject to the instructions in the Letter
of Transmittal, transfer taxes with respect to the exchange of Old Notes
pursuant to the Exchange Offer. The Company will pay all charges and expenses,
other than transfer taxes in certain circumstances, in connection with the
Exchange Offer. See '--Fees and Expenses.'
71
<PAGE>
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term 'Expiration Date' shall mean 5:00 p.m., New York City time, on
, 1998, unless the Company in its sole discretion extends the
Exchange Offer, in which case the term 'Expiration Date' shall mean the latest
date and time to which the Exchange Offer is extended, which in no event shall
be more than days after the date of this Prospectus.
In order to extend the Exchange Offer, the Company will issue a notice of
such extension by press release or other public announcement prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
Expiration Date.
The Company reserves the right, in its sole discretion, prior to the
Expiration Date (i) to delay accepting any Old Notes, to extend the Exchange
Offer or to terminate the Exchange Offer if any of the conditions set forth
below under 'Conditions' shall not have been satisfied, by giving oral or
written notice of such delay, extension or termination to the Exchange Agent or
(ii) to amend the terms of the Exchange Offer in any manner. Any such delay in
acceptance, extension, termination or amendment will be followed as promptly as
practicable by oral or written notice thereof to the registered holders.
PROCEDURES FOR TENDERING
Only a holder of Old Notes may tender such Old Notes in the Exchange Offer.
To tender in the Exchange Offer, a holder must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, have the signatures thereon
guaranteed if required by the Letter of Transmittal, and mail or otherwise
deliver such Letter of Transmittal or such facsimile, together with the Old
Notes and any other required documents, to the Exchange Agent prior to 5:00
p.m., New York City time, on the Expiration Date. To be tendered effectively,
the Old Notes, Letter of Transmittal or an Agent's Message in connection with a
book-entry transfer and other required documents must be completed and received
by the Exchange Agent at the address set forth below under 'Exchange Agent'
prior to 5:00 p.m., New York City time, on the Expiration Date. Delivery of the
Old Notes may be made by book-entry transfer in accordance with the procedures
described below. Confirmation of such book-entry transfer must be received by
the Exchange Agent prior to the Expiration Date.
The term 'Agent's Message' means a message, transmitted by a book-entry
transfer facility to, and received by, the Exchange Agent forming a part of a
confirmation of a book-entry transfer, which states that such book-entry
transfer facility has received an express acknowledgment from the participant in
such book-entry transfer facility tendering the Notes that such participant has
received and agrees to be bound by the terms of the Letter of Transmittal and
that the Company may enforce such agreement against such participant.
By executing the Letter of Transmittal, each holder will make the
representations set forth above in the third paragraph under the heading
'--Purpose and Effect of the Exchange Offer.'
Each Participating Broker-Dealer that receives New Notes for its own
account in exchange for Old Notes, where such Old Notes were acquired by such
Participating Broker-Dealer as a result of market-making activities or other
trading activities, must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. See 'Plan of Distribution.'
The tender by a holder and the acceptance thereof by the Company will
constitute agreement between such holder and the Company in accordance with the
terms and subject to the conditions set forth herein and in the Letter of
Transmittal.
THE METHOD OF DELIVERY OF OLD NOTES AND THE LETTER OF TRANSMITTAL AND ALL
OTHER REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND SOLE RISK
OF THE HOLDER. AS AN ALTERNATIVE TO DELIVERY BY MAIL, HOLDERS MAY WISH TO
CONSIDER OVERNIGHT OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME
SHOULD BE ALLOWED TO ASSURE DELIVERY TO THE EXCHANGE AGENT BEFORE THE EXPIRATION
DATE. NO LETTER OF TRANSMITTAL OR OLD NOTES SHOULD BE SENT TO THE COMPANY.
HOLDERS MAY REQUEST THEIR RESPECTIVE BROKERS, DEALER, COMMERCIAL BANKS, TRUST
COMPANIES OR NOMINEES TO EFFECT THE ABOVE TRANSACTIONS.
Any beneficial owner whose Old Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee and who wishes
to tender should contact the registered holder promptly and instruct such
72
<PAGE>
registered holder to tender on such beneficial owner's behalf. See 'Instructions
to Registered Holder and/or Book-Entry Transfer Facility Participant from
Beneficial Owner' included with the Letter of Transmittal.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed by an Eligible Institution (as defined) unless
the Old Notes tendered pursuant thereto are tendered (i) by a registered holder
who has not completed the box entitled 'Special Registration Instructions' or
'Special Delivery Instructions' on the Letter of Transmittal or (ii) for the
account of an Eligible Institution. In the event that signatures on a Letter of
Transmittal or a notice of withdrawal, as the case may be, are required to be
guaranteed, such guarantee must be by a member firm of the Medallion System (an
'Eligible Institution').
If the Letter of Transmittal is signed by a person other than the
registered holder of any Old Notes listed therein, such Old Notes must be
endorsed or accompanied by a properly completed bond power, signed by such
registered holder as such registered holder's name appears on such Old Notes
with the signature thereon guaranteed by an Eligible Institution.
If the Letter of Transmittal or any Old Notes or bond powers are signed by
trustees, executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and evidence satisfactory to the
Company of their authority to so act must be submitted with the Letter of
Transmittal.
The Company understands that the Exchange Agent will make a request
promptly after the date of this Prospectus to establish accounts with respect to
the Old Notes at DTC for the purpose of facilitating the Exchange Offer, and
subject to the establishment thereof, any financial institution that is a
participant in DTC's system may make book-entry delivery of Old Notes by causing
DTC to transfer such Old Notes into the Exchange Agent's account with respect to
the Old Notes in accordance with DTC's procedures for such transfer. Although
delivery of the Old Notes may be effected through book-entry transfer into the
Exchange Agent's account at DTC, an appropriate Letter of Transmittal properly
completed and duly executed with any required signature guarantee and all other
required documents must in each case be transmitted to and received or confirmed
by the Exchange Agent at its address set forth below on or prior to the
Expiration Date, or, if the guaranteed delivery procedures described below are
complied with, within the time period provided under such procedures. Delivery
of documents to DTC does not constitute delivery to the Exchange Agent.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance of tendered Old Notes and withdrawal of tendered Old Notes
will be determined by the Company in its sole discretion, which determination
will be final and binding. The Company reserves the absolute right to reject any
and all Old Notes not properly tendered or any Old Notes the Company's
acceptance of which would, in the opinion of counsel for the Company, be
unlawful. The Company also reserves the right in its sole discretion to waive
any defects, irregularities or conditions of tender as to particular Old Notes.
The Company's interpretation of the terms and conditions of the Exchange Offer
(including the instructions in the Letter of Transmittal) will be final and
binding on all parties. Unless waived, any defects or irregularities in
connection with tenders of Old Notes must be cured within such time as the
Company shall determine. Although the Company intends to notify holders of
defects or irregularities with respect to tenders of Old Notes, neither the
Company, the Exchange Agent nor any other person shall incur any liability for
failure to give such notification. Tenders of Old Notes will not be deemed to
have been made until such defects or irregularities have been cured or waived.
Any Old Notes received by the Exchange Agent that are not properly tendered and
as to which the defects or irregularities have not been cured or waived will be
returned by the Exchange Agent to the tendering holders, unless otherwise
provided in the Letter of Transmittal, as soon as practicable following the
Expiration Date.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and (i) whose Old Notes are not
immediately available, (ii) who cannot deliver their Old Notes, the Letter of
Transmittal or any other required documents to the Exchange Agent or (iii) who
cannot complete the procedures for book-entry transfer, prior to the Expiration
Date, may effect a tender if:
(a) the tender is made through an Eligible Institution,
(b) prior to the Expiration Date, the Exchange Agent receives from
such Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand
73
<PAGE>
delivery) setting forth the name and address of the holder, the certificate
number(s) of such Old Notes and the principal amount of Old Notes tendered,
stating that the tender is being made thereby and guaranteeing that, within
three New York Stock Exchange trading days after the Expiration Date, the
Letter of Transmittal (or facsimile thereof) together with the
certificate(s) representing the Old Notes (or a confirmation of book-entry
transfer of such Notes into the Exchange Agent's account at DTC), and any
other documents required by the Letter of Transmittal will be deposited by
the Eligible Institution with the Exchange Agent; and
(c) such properly completed and executed Letter of Transmittal (or
facsimile thereof), as well as the certificate(s) representing all tendered
Old Notes in proper form for transfer (or a confirmation of book-entry
transfer of such Old Notes into the Exchange Agent's account at DTC), and
all other documents required by the Letter of Transmittal are received by
the Exchange Agent upon three New York Stock Exchange trading days after
the Expiration Date.
Upon request to the Exchange Agent, a Notice of Guaranteed Delivery will be
sent to holders who wish to tender their Old Notes according to the guaranteed
delivery procedures set forth above.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the Expiration Date.
To withdraw a tender of Old Notes in the Exchange Offer, a telegram, telex,
letter or facsimile transmission notice of withdrawal must be received by the
Exchange Agent at its address set forth herein prior to 5:00 p.m., New York City
time, on the Expiration Date. Any such notice of withdrawal must (i) specify the
name of the person having deposited the Old Notes to be withdrawn (the
'Depositor'); (ii) identify the Old Notes to be withdrawn (including the
certificate number(s) and principal amount of such Old Notes, or, in the case of
Old Notes transferred by book-entry transfer, the name and number of the account
at the DTC to be credited); (iii) be signed by the holder in the same manner as
the original signature on the Letter of Transmittal by which such Old Notes were
tendered (including any required signature guarantees) or be accompanied by
documents of transfer sufficient to have the Trustee with respect to the Old
Notes register the transfer of such Old Notes into the name of the person
withdrawing the tender and (iv) specify the name in which any such Old Notes are
to be registered, if different from that of the Depositor. All questions as to
the validity, form and eligibility (including time of receipt) of such notices
will be determined by the Company, whose determination shall be final and
binding on all parties. Any Old Notes so withdrawn will be deemed not to have
been validly tendered for purposes of the Exchange Offer and no New Notes will
be issued with respect thereto unless the Old Notes so withdrawn are validly
retendered. Any Old Notes which have been tendered but which are not accepted
for exchange will be returned to the holder thereof without cost to such holder
as soon as practicable after withdrawal, rejection of tender or termination of
the Exchange Offer. Properly withdrawn Old Notes may be retendered by following
one of the procedures described above under '--Procedures for Tendering' at any
time prior to the Expiration Date.
CONDITIONS
Notwithstanding any other term of the Exchange Offer, the Company shall not
be required to accept for exchange, or exchange New Notes for, any Old Notes,
and may terminate or amend the Exchange Offer as provided herein prior to the
Expiration Date, if:
(a) any action or proceeding is instituted or threatened in any court
or by or before any governmental agency with respect to the Exchange Offer
which, in the reasonable judgment of the Company, might materially impair
the ability of the Company to proceed with the Exchange Offer or any
material adverse development has occurred in any existing action or
proceeding with respect to the Company or any of its subsidiaries; or
(b) any law, statute, rule, regulation or interpretation by the staff
of the Commission is proposed, adopted or enacted, which, in the reasonable
judgment of the Company, might materially impair the ability of the Company
to proceed with the Exchange Offer or materially impair the contemplated
benefits of the Exchange Offer to the Company; or
74
<PAGE>
(c) any governmental approval has not been obtained, which approval
the Company shall, in its reasonable discretion, deem necessary for the
consummation of the Exchange Offer as contemplated hereby.
If the Company determines in its reasonable discretion that any of the
above conditions are not satisfied, the Company may (i) refuse to accept any Old
Notes and return all tendered Old Notes to the tendering holders, (ii) extend
the Exchange Offer and retain all Old Notes tendered prior to the expiration of
the Exchange Offer, subject, however, to the rights of holders to withdraw such
Old Notes (see '--Withdrawal of Tenders') or (iii) waive such unsatisfied
conditions with respect to the Exchange Offer and accept all properly tendered
Old Notes which have not been withdrawn.
EXCHANGE AGENT
Marine Midland Bank has been appointed as Exchange Agent for the Exchange
Offer. Questions and requests for assistance, requests for additional copies of
this Prospectus or of the Letter of Transmittal and requests for Notice of
Guaranteed Delivery should be directed to the Exchange Agent addressed as
follows:
<TABLE>
<S> <C>
By Mail: By Overnight Courier:
MARINE MIDLAND BANK MARINE MIDLAND BANK
140 Broadway--Level A 140 Broadway--Level A
New York, New York 10005-1180 New York, New York 10005-1180
Attention: Corporate Trust Services Attention: Corporate Trust Services
(registered or certified mail recommended)
By Hand: Facsimile Transmission:
MARINE MIDLAND BANK (212) 658-2292
140 Broadway--Level A Confirm by Telephone:
New York, New York 10005-1180 (212) 658-5931
Attention: Corporate Trust Services
</TABLE>
DELIVERY TO AN ADDRESS OTHER THAN SET FORTH ABOVE WILL NOT CONSTITUTE A
VALID DELIVERY.
FEES AND EXPENSES
The expenses of soliciting tenders will be borne by the Company. The
principal solicitation is being made by mail; however, additional solicitation
may be made by telegraph, telecopy, telephone or in person by officers and
regular employees of the Company and its affiliates.
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers, or others
soliciting acceptances of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable out-of-pocket expenses in connection therewith.
The cash expenses to be incurred in connection with the Exchange Offer will
be paid by the Company. Such expenses include fees and expenses of the Exchange
Agent and Trustee, accounting and legal fees and printing costs, among others.
ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Old Notes,
which is face value, as reflected in the Company's accounting records on the
date of exchange. Accordingly, no gain or loss for accounting purposes will be
recognized by the Company. The expenses of the Exchange Offer will be expensed
over the term of the New Notes.
75
<PAGE>
CONSEQUENCES OF FAILURE TO EXCHANGE
The Old Notes that are not exchanged for New Notes pursuant to the Exchange
Offer will remain restricted securities. Accordingly, such Old Notes may be
resold only (i) to the Company (upon redemption thereof or otherwise), (ii) so
long as the Old Notes are eligible for resale pursuant to Rule 144A, to a person
inside the United States whom the seller reasonably believes is a qualified
institutional buyer within the meaning of Rule 144A under the Securities Act in
a transaction meeting the requirements of Rule 144A, (iii) in accordance with
Rule 144 under the Securities Act, or pursuant to another exemption from the
registration requirements of the Securities Act (and based upon an opinion of
counsel reasonably acceptable to the Company), (iv) outside the United States to
a foreign person in a transaction meeting the requirements of Rule 904 under the
Securities Act, or (v) pursuant to an effective registration under the
Securities Act, in each case in accordance with any applicable securities laws
of any state of the United States.
RESALE OF THE NEW NOTES
With respect to resales of New Notes, based on interpretations by the staff
of the Commission set forth in no-action letters issued to third parties, the
Company believes that a holder or other person who receives New Notes, whether
or not such person is the holder (other than a person that is an 'affiliate' of
the Company within the meaning of Rule 405 under the Securities Act) who
receives New Notes in exchange for Old Notes in the ordinary course of business
and who is not participating, does not intend to participate, and has no
arrangement or understanding with any person to participate, in the distribution
of the New Notes, will be allowed to resell the New Notes to the public without
further registration under the Securities Act and without delivering to the
purchasers of the New Notes a prospectus that satisfies the requirements of
Section 10 of the Securities Act. However, if any holder acquires New Notes in
the Exchange Offer for the purpose of distributing or participating in a
distribution of the New Notes, such holder cannot rely on the position of the
staff of the Commission enunciated in such no-action letters or any similar
interpretive letters, and must comply with the registration and prospectus
delivery requirements of the Securities Act in connection with any resale
transaction, unless an exemption from registration is otherwise available.
Further, each Participating Broker-Dealer that receives New Notes for its own
account in exchange for Old Notes, where such Old Notes were acquired by such
Participating Broker-Dealer as a result of market-making activities or other
trading activities, must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes.
As contemplated by these no-action letters and the Registration Rights
Agreement, each holder accepting the Exchange Offer is required to represent to
the Company in the Letter of Transmittal that (i) the New Notes are to be
acquired by the holder or the person receiving such New Notes, whether or not
such person is the holder, in the ordinary course of business, (ii) the holder
or any such other person (other than a broker-dealer referred to in the next
sentence) is not engaging, and does not intend to engage, in the distribution of
the New Notes, (iii) the holder of any such other person has no arrangement or
understanding with any person to participate in the distribution of the New
Notes, (iv) neither the holder nor any such other person is an 'affiliate' of
the Company within the meaning of Rule 405 under the Securities Act, and (v) the
holder of any such other person acknowledges that if such holder or other person
participates in the Exchange Offer for the purpose of distributing the New Notes
it most comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale of the New Notes and cannot rely on
those no-action letters. As indicated above, each Participating Broker-Dealer
that receives a New Note for its own account in exchange for Old Notes must
acknowledge that it will deliver a prospectus in connection with any resale of
such New Notes. For a description of the procedures for such resales by
Participating Broker-Dealers, see 'Plan of Distribution.'
76
<PAGE>
DESCRIPTION OF NOTES
GENERAL
The New Notes are to be issued under an Indenture, dated as of October 31,
1997 (the 'Indenture'), between the Company, the Subsidiary Guarantors and
Marine Midland Bank, as Trustee (the 'Trustee').
The form and terms of the New Notes are the same as the form and terms of
the Old Notes (which they replace) except that (i) the New Notes bear a Series B
designation, (ii) the New Notes have been registered under the Securities Act
and, therefore, will not bear legends restricting the transfer thereof, and
(iii) the holders of New Notes will not be entitled to certain rights under the
Registration Rights Agreement, including the provisions providing for an
increase in the interest rate on the Old Notes in certain circumstances relating
to the timing of the Exchange Offer, which rights will terminate when the
Exchange Offer is consummated.
The following summary of the material provisions of the Indenture and the
New Notes does not purport to be complete and is subject to, and is qualified in
its entirety by reference to, all the provisions of the Indenture, including the
definitions of certain terms therein and those terms made a part thereof by the
TIA. The New Notes are subject to all such terms, and holders of the New Notes
are referred to the Indenture and the TIA for a statement of them. A copy of the
Indenture has been filed as an exhibit to the Exchange Offer Registration
Statement of which this Prospectus is a part. See 'Available Information.'
Capitalized terms used herein and not otherwise defined have the meanings set
forth under '--Certain Definitions.' For purposes of this summary, the term
'Company' refers only to Stellex Industries, Inc. and not to any of its
Subsidiaries. The Old Notes and the New Notes are sometimes referred to herein
collectively as the 'Notes.'
Principal of, premium, if any, and interest and Liquidated Damages, if any,
on the Notes will be payable, and the Notes may be exchanged or transferred, at
the office or agency of the Company in the Borough of Manhattan, The City of New
York (which initially shall be the corporate trust office of the Trustee, at 140
Broadway--Level A, New York, New York 10005-1180), except that, at the option of
the Company, payment of interest and Liquidated Damages, if any, may be made by
check mailed to the registered holders of the Notes at their registered
addresses.
The Notes will be issued only in fully registered form, without coupons, in
denominations of $1,000 and any integral multiple of $1,000. No service charge
will be made for any registration of transfer or exchange of Notes, but the
Company may require payment of a sum sufficient to cover any transfer tax or
other similar governmental charge payable in connection therewith.
The definition of 'Restricted Subsidiary' in the Indenture excludes any
'Unrestricted Subsidiary' and, as a result, Unrestricted Subsidiaries generally
will not be bound by the restrictive provisions of the Indenture and will not be
Subsidiary Guarantors. As of the Issue Date, all of the Company's Subsidiaries
were Restricted Subsidiaries.
TERMS OF THE NOTES
The Notes will be unsecured, senior subordinated obligations of the
Company, will be guaranteed on a senior subordinated basis by the Subsidiary
Guarantors, will be limited to $100 million aggregate principal amount and will
mature on November 1, 2007. Each Note will bear interest at a rate of 9 1/2% per
annum from the most recent date to which interest has been paid or provided for
or, if no interest has been paid or provided for, from the date of original
issuance. Interest is payable semi-annually in arrears on May 1 and November 1,
commencing May 1, 1998, to holders of record of the Notes at the close of
business on the immediately preceding April 15 and October 15, respectively.
Interest on the Notes will be computed on the basis of a 360-day year of twelve
30-day months.
OPTIONAL REDEMPTION
The Notes will be redeemable, at the Company's option, in whole or in part,
at any time on or after November 1, 2002, and prior to maturity, upon not less
than 30 nor more than 60 days' prior notice mailed by first-class mail to each
Holder's registered address, at the following redemption prices (expressed as a
percentage of principal amount), plus accrued and unpaid interest and Liquidated
Damages, if any, to the redemption date (subject to the right of Holders of
record on the relevant record date to receive interest due on the relevant
interest payment date), if redeemed during the 12-month period commencing on
November 1 of the years set forth below:
<TABLE>
<CAPTION>
REDEMPTION
PERIOD PRICE
- ----------------------------------------------------------------------- ----------
<S> <C>
2002................................................................... 104.750%
2003................................................................... 103.167%
2004................................................................... 101.583%
2005 and thereafter.................................................... 100.000%
</TABLE>
77
<PAGE>
In addition, at any time and from time to time prior to November 1, 2000,
the Company may redeem in the aggregate up to 35% of the aggregate principal
amount of the Notes originally issued, with the proceeds of one or more Public
Equity Offerings at a redemption price (expressed as a percentage of principal
amount thereof) of 109.50% of the aggregate principal amount thereof plus
accrued and unpaid interest and Liquidated Damages, if any, to the redemption
date (subject to the right of Holders of record on the relevant record date to
receive interest due on the relevant interest payment date); provided, however,
that at least 65% of the aggregate principal amount of the Notes originally
issued remains outstanding after each such redemption.
In addition, at any time prior to November 1, 2002, the Company may, at its
option, redeem the Notes, in whole but not in part, at a redemption price equal
to 100% of the principal amount thereof plus the applicable Make-Whole Premium.
In the case of any partial redemption, selection of the Notes for
redemption will be made by the Trustee on a pro rata basis, by lot or by such
other method as the Trustee in its sole discretion shall deem to be fair and
appropriate, although no Note of $1,000 in original principal amount will be
redeemed in part. If any Note is to be redeemed in part only, the notice of
redemption relating 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.
GUARANTEES
Each Subsidiary Guarantor fully and unconditionally guarantees, jointly and
severally, to each Holder and the Trustee, on a senior subordinated basis, the
full and prompt payment of principal of and interest on the Notes, and of all
other obligations of the Company under the Indenture.
The Indebtedness evidenced by each Subsidiary Guarantee (including the
payment of principal of, premium, if any, and interest on the Notes) will be
subordinated to Guarantor Senior Indebtedness on the same basis as the Notes are
subordinated to Senior Indebtedness. As of September 30, 1997, on a pro forma
basis after giving effect to the Transactions, there would have been
approximately $2.6 million of Guarantor Senior Indebtedness (exclusive of the
guarantees of the New Credit Facility). Although the Indenture contains
limitations on the amount of additional Indebtedness that the Company's
Restricted Subsidiaries, including the Subsidiary Guarantors, may incur, under
certain circumstances the amount of such Indebtedness could be substantial and,
in any case, such Indebtedness may be Guarantor Senior Indebtedness. See
'--Ranking and Subordination' and 'Certain Covenants--Limitation on Indebtedness
and Preferred Stock' below.
The obligations of each Subsidiary Guarantor are limited to the maximum
amount as will, after giving effect to all other contingent and fixed
liabilities of such Subsidiary Guarantor (including, without limitation, any
guarantees under the New Credit Facility) and after giving effect to any
collections from or payments made by or on behalf of any other Subsidiary
Guarantor in respect of the obligations of such other Subsidiary Guarantor under
its Subsidiary Guarantee or pursuant to its contribution obligations under the
Indenture, result in the obligations of such Subsidiary Guarantor under the
Subsidiary Guarantee not constituting a fraudulent conveyance or fraudulent
transfer under federal or state law.
No Subsidiary Guarantor may consolidate with or merge with or into any
Person other than the Company or any other Subsidiary Guarantor or sell
substantially all of its assets unless: (i) subject to the provisions of the
following paragraph, the entity formed by or surviving any such consolidation or
merger (if other than the Subsidiary Guarantor) or to which such sale, lease,
conveyance or other disposition shall have been made is a corporation organized
and existing under the laws of the United States or any State thereof or the
District of Columbia; (ii) subject to the provisions of the following paragraph,
such entity assumes by supplemental indenture all of the obligations of the
Subsidiary Guarantor under the Indenture and the Subsidiary Guarantee; (iii)
immediately after giving effect to such transaction, no Default or Event of
Default shall have occurred and be continuing; and (iv) immediately after giving
pro forma effect to such transaction either (A) the Company would have been able
to incur $1.00 of additional Indebtedness pursuant to paragraph (a) of the
covenant 'Limitation on Indebtedness and Preferred Stock' or (B) the Company's
Consolidated Coverage Ratio would be no less than such Consolidated Coverage
Ratio immediately prior to such transaction. Notwithstanding the foregoing, each
Subsidiary Guarantor may consolidate with or merge into or sell its assets to
the Company or another Subsidiary Guarantor.
78
<PAGE>
Upon (i) the release by the lenders under the New Credit Facility, related
documents and future refinancings thereof of all guarantees of a Subsidiary
Guarantor and all Liens on the property and assets of such Subsidiary Guarantor
relating to such guarantees, or (ii) the 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, in each case in accordance with the terms of the
Indenture, then such Subsidiary Guarantor (in the event of a sale or other
disposition, by way of such a merger, consolidation or otherwise, of all the
Capital Stock of such Subsidiary Guarantor) or the corporation acquiring the
property (in the event of a sale or other disposition of all or substantially
all of the assets of such Subsidiary Guarantor) shall be deemed released from
all of its obligations under the Indenture and the Subsidiary Guarantee;
provided that the Net Available Cash from such sale or other disposition is
applied in accordance with the applicable provisions of the Indenture. See
'--Certain Covenants--Limitation on Sales of Assets and Subsidiary Stock.'
RANKING AND SUBORDINATION
The payment of the principal of, premium (if any), and interest and
Liquidated Damages, if any, on the Notes is subordinated in right of payment, as
set forth in the Indenture, to the prior payment in full in cash of all Senior
Indebtedness of the Company, whether outstanding on the Issue Date or thereafter
incurred. However, payment from the money or the proceeds of U.S. Government
Obligations held in any defeasance trust described under 'Defeasance' below is
not subordinate to any Senior Indebtedness or subject to the restrictions
described herein. As of September 30, 1997, on a pro forma basis after giving
effect to the Transactions, the outstanding Senior Indebtedness of the Company
would have been approximately $2.1 million (exclusive of unused commitments).
Although the Indenture contains limitations on the amount of additional
Indebtedness that the Company may incur, under certain circumstances the amount
of such Indebtedness could be substantial and, in any case, such Indebtedness
may constitute Senior Indebtedness. See 'Certain Covenants--Limitation on
Indebtedness and Preferred Stock' below.
'Senior Indebtedness' is defined, whether outstanding on the Issue Date or
thereafter incurred, as (i) all Indebtedness of the Company under the New Credit
Facility, including, without limitation, obligations to pay principal and
interest (including any interest accruing subsequent to the filing of a petition
of bankruptcy at the rate provided for in the documentation with respect
thereto, whether or not such interest is an allowed claim under applicable law),
reimbursement obligations under letters of credit, fees, expenses and
indemnities, and all Hedging Obligations with respect to Indebtedness under the
New Credit Facility, including, without limitation, Hedging Obligations entered
into with any lender under the New Credit Facility, whether outstanding on the
date of the Indenture or thereafter incurred, (ii) the principal of, premium, if
any, and interest (including any interest accruing subsequent to the filing of a
petition of bankruptcy at the rate provided for in the documentation with
respect thereto, whether or not such interest is an allowed claim under
applicable law) on, and all other Obligations with respect to, any other
Indebtedness of the Company permitted to be incurred by the Company under the
terms of the Indenture, whether outstanding on the date of the Indenture or
thereafter incurred, unless the instrument under which such Indebtedness is
incurred expressly provides that it is on a parity with, or subordinated in
right of payment to, the Notes and (iii) all Obligations of the Company with
respect to the foregoing; provided, however, that Senior Indebtedness will not
include (1) any obligation of the Company to any Subsidiary, (2) any liability
for Federal, state, foreign, local or other taxes owed or owing by the Company,
(3) any accounts payable or other liability to trade creditors arising in the
ordinary course of business (including Guarantees thereof or instruments
evidencing such liabilities) or (4) any Indebtedness, Guarantee or obligation of
the Company that is expressly subordinate or junior in right of payment to any
other Indebtedness, Guarantee or obligation of the Company, including any Senior
Subordinated Indebtedness and any Subordinated Obligations.
Only Indebtedness of the Company that is Senior Indebtedness will rank
senior to the Notes in accordance with the provisions of the Indenture. The
Notes will in all respects rank pari passu with all other Senior Subordinated
Indebtedness of the Company. The Company has agreed in the Indenture that it
will not incur, directly or indirectly, any Indebtedness that is subordinate or
junior in ranking in any respect to Senior Indebtedness unless such Indebtedness
is Senior Subordinated Indebtedness or is contractually subordinated in right of
payment to Senior Subordinated Indebtedness. In addition, no Subsidiary
Guarantor shall incur any Indebtedness if such Indebtedness is subordinate or
junior in ranking in any respect to any Guarantor Senior Indebtedness of such
Subsidiary Guarantor unless such Indebtedness is Guarantor Senior Subordinated
79
<PAGE>
Indebtedness of such Subsidiary Guarantor or is contractually subordinated in
right of payment to Guarantor Senior Subordinated Indebtedness of such
Subsidiary Guarantor. Unsecured Indebtedness is not deemed to be subordinate or
junior to Secured Indebtedness merely because it is unsecured.
The Company and the Subsidiary Guarantors may not make any payment upon or
in respect of the Notes (except in Permitted Junior Securities or from the trust
described under 'Defeasance' below) and may not make any deposit pursuant to the
provisions described under 'Defeasance' below or otherwise purchase or retire
any Notes for cash or property (collectively, 'pay the Notes') if (i) a default
in the payment when due of Designated Senior Indebtedness occurs and is
continuing beyond any applicable period of grace or (ii) any other default on
Designated Senior Indebtedness occurs and is continuing with respect to
Designated Senior Indebtedness that permits the holders of the Designated Senior
Indebtedness as to which such default relates to accelerate its maturity and the
Trustee receives a notice of such default (a 'Payment Blockage Notice') from the
holders of any Designated Senior Indebtedness unless the default has been cured
or waived and any such Payment Blockage Notice has been rescinded or such Senior
Indebtedness has been paid in full in cash. Payments on the Notes may and shall
be resumed (a) in the case of a payment default, upon the date on which such
default is cured or waived in writing and (b) in the case of a nonpayment
default, the earlier of the date on which such nonpayment default is cured or
waived in writing and 179 days after the date on which the applicable Payment
Blockage Notice is received, unless the maturity of any Designated Senior
Indebtedness has been accelerated. No new Payment Blockage Notice may be sent
(irrespective of the number of defaults with respect to Designated Senior
Indebtedness at such time) unless and until 360 days have elapsed since the
effectiveness of the immediately prior Payment Blockage Notice. No nonpayment
default that existed or was continuing on the date of delivery of any Payment
Blockage Notice to the Trustee shall be, or be made, the basis for a subsequent
Payment Blockage Notice unless such nonpayment default shall have been waived
for a period of not less than 90 days (it being acknowledged that any subsequent
action, or any breach of any financial covenants for a period commencing after
the date of delivery of any Payment Blockage Notice, which, in either case,
would give rise to a default pursuant to any provision under which a default
previously existed or was continuing shall constitute a new default for this
purpose). Each Holder by his acceptance of a Note irrevocably agrees that if any
payment or payments shall be made pursuant to the Indenture and the amount or
total amount of such payment or payments exceeds the amount, if any, that such
Holder would be entitled to receive upon the proper application of the
subordination provisions of the Indenture, the payment of such excess amount
shall be deemed null and void, and the Holder agrees that it will be obliged to
turnover the amount of the excess payment to the holders of such Senior
Indebtedness.
Upon any payment or distribution of the assets of the Company upon a total
or partial liquidation or dissolution or reorganization or bankruptcy of or
similar proceeding relating to the Company or the Subsidiary Guarantors or their
respective property, the holders of Senior Indebtedness will be entitled to
receive payment in full in cash of the Senior Indebtedness before the holders of
the Notes are entitled to receive any payment of any kind or character with
respect to the Notes, and until the Senior Indebtedness is paid in full in cash
or cash equivalents, any payment or distribution to which holders of the Notes
would be entitled but for the subordination provisions of the Indenture will be
made to holders of the Senior Indebtedness as their interests may appear (except
that Holders of Notes may receive Permitted Junior Securities and payments made
from the trust described under '--Defeasance' below). If a distribution is made
to holders of the Notes that, due to the subordination provisions, should not
have been made to them, such holders are required to turnover such amount to the
holders of Senior Indebtedness as their interests may appear.
If payment of the Notes is accelerated because of an Event of Default, the
Company and the Trustee shall promptly notify the holders of the Designated
Senior Indebtedness or the Representative of such holders of the acceleration.
The Company may not pay the Notes until five Business Days after such holders or
the Representative of the Designated Senior Indebtedness receive notice of such
acceleration and, thereafter, may pay the Notes only if the subordination
provisions of the Indenture otherwise permit payment at that time.
By reason of such subordination provisions contained in the Indenture, in
the event of insolvency, creditors of the Company and the Subsidiary Guarantors
who are holders of Senior Indebtedness may recover more, ratably, than the
Noteholders, and creditors of the Company and the Subsidiary Guarantors who are
not holders of Senior Indebtedness or of Senior Subordinated Indebtedness
(including the Notes) may recover less, ratably, than holders of Senior
Indebtedness.
80
<PAGE>
CHANGE OF CONTROL
Upon the occurrence of any of the following events (each a 'Change of
Control') with respect to the Company, each Holder will have the right to
require the Company to repurchase all or any part (equal to $1,000 or an
integral multiple thereof) of such Holder's Notes at a purchase price in cash
equal to 101% of the principal amount thereof, plus accrued and unpaid interest,
if any, to the date of repurchase (subject to the right of Holders of record on
the relevant record date to receive interest due on the related interest payment
date):
(i)(A) the consummation of any transaction (including, without
limitation, any merger or consolidation) the result of which is that any
'person' (as such term is used in Sections 13(d) and 14(d) of the Exchange
Act), other than one or more Permitted Holders, is or becomes the
beneficial owner (as defined in Rules 13d-3 and 13d-5 under the Exchange
Act), directly or indirectly, of more than 35% of the total voting power of
the Voting Stock of the Company and (B) the Permitted Holders 'beneficially
own' (as defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly
or indirectly, in the aggregate a lesser percentage of the total voting
power of the Voting Stock of the Company than such other person and do not
have the right or ability by voting power, contract or otherwise to elect
or designate for election a majority of the Board of Directors of the
Company;
(ii) the first day on which a majority of the members of the Board of
Directors of the Company are not Continuing Directors;
(iii) any sale, lease, exchange or other transfer (in one transaction
or a series of related transactions) of all, or substantially all, the
assets of the Company and its Restricted Subsidiaries taken as a whole to
any 'person' or group of 'persons' for purposes of Section 13(d) of the
Exchange Act (other than to any Wholly Owned Subsidiary of the Company or
to one or more Permitted Holders); or
(iv) the adoption of a plan of liquidation of the Company.
Within 30 days following any Change of Control, the Company shall mail a
notice to each Holder with a copy to the Trustee stating: (1) that a Change of
Control has occurred and that such Holder has the right to require the Company
to purchase any or all of such Holder's Notes at a purchase price in cash equal
to 101% of the principal amount thereof, plus accrued and unpaid interest, if
any, to the date of repurchase (subject to the right of Holders of record on a
record date to receive interest on the relevant interest payment date); (2) the
circumstances and relevant facts regarding such Change of Control; (3) the
repurchase date (which shall be no earlier than 30 days nor later than 60 days
from the date such notice is mailed); and (4) the instructions determined by the
Company, consistent with this covenant, that a Holder must follow in order to
have its Notes purchased by the Company. Notwithstanding the occurrence of a
Change of Control, the Company shall not be obligated to repurchase the Notes
upon a Change of Control if the Company has irrevocably elected to redeem all of
the Notes under the provisions described under '--Optional Redemption' above,
provided that the Company does not default in its redemption obligations
pursuant to such election.
The phrase 'all or substantially all,' as used with respect to a sale of
assets in the definition in the Indenture of 'Change of Control,' varies
according to the facts and circumstances of the subject transaction, has no
clearly established meaning under New York law (the law governing the Indenture)
and is subject to judicial interpretation. Accordingly, in certain
circumstances, there may be a degree of uncertainty in ascertaining whether a
particular transaction would involve a disposition of 'all or substantially all'
of the assets of a Person and therefore it may be unclear whether a Change of
Control has occurred.
The Company will comply, to the extent applicable, with the requirements of
Section 14(e) of the Exchange Act and any other securities laws or regulations
in connection with the repurchase of Notes pursuant to this covenant. To the
extent that the provisions of any securities laws or regulations conflict with
provisions of this covenant, the Company will comply with the applicable
securities laws and regulations and will not be deemed to have breached its
obligations under this paragraph by virtue thereof.
The Change of Control purchase feature is a result of negotiations between
the Company and the Initial Purchasers. Management has no present intention to
engage in a transaction involving a Change of Control, although it is possible
that the Company could decide to do so in the future. Subject to the limitations
discussed below, the Company could, in the future, enter into certain
transactions, including acquisitions, refinancings or other recapitalizations,
that would not constitute a Change of Control under the Indenture, but that
could increase
81
<PAGE>
the amount of indebtedness outstanding at such time or otherwise affect the
Company's capital structure or credit rating.
The New Credit Facility prohibits the Company from repurchasing any Notes
and also provides that change of control events with respect to the Company
would constitute a default thereunder. Any future credit agreements or other
agreements relating to Senior Indebtedness to which the Company becomes a party
may contain similar restrictions and provisions. In the event a Change of
Control occurs at a time when the Company is prohibited from repurchasing Notes,
the Company could seek the consent of its lenders to the repurchase of Notes or
could attempt to refinance or repay the borrowings that contain such
prohibition. If the Company does not obtain such a consent or repay such
borrowings, the Company will remain prohibited from repurchasing Notes. In such
case, the Company's failure to repurchase tendered Notes would constitute an
Event of Default under the Indenture which would, in turn, constitute a default
under the New Credit Facility. In such circumstances, the subordination
provisions in the Indenture would likely restrict payments to the Holders of
Notes. Moreover, the exercise by the Holders of their right to require the
Company to repurchase the Notes could cause a default under such Indebtedness,
even if the Change of Control itself does not, due to the financial effect of
such repurchase on the Company. Finally, the Company's ability to pay cash to
the Holders upon a repurchase may be limited by the Company's then existing
financial resources. There can be no assurance that sufficient funds will be
available when necessary to make any required repurchases.
CERTAIN COVENANTS
The Indenture contains covenants including, among others, the following:
Limitation on Indebtedness and Preferred Stock. (a) (i) The Company
will not Incur, and will not permit any Restricted Subsidiary to Incur, any
Indebtedness (including Acquired Indebtedness) or issue Disqualified Stock
and (ii) the Company will not permit any of its Restricted Subsidiaries
that are not Subsidiary Guarantors to issue any shares of Preferred Stock;
provided, however, that the Company or any Subsidiary Guarantor may Incur
Indebtedness (including Acquired Indebtedness) or issue Disqualified Stock
if on the date thereof (and after giving effect to the application of
proceeds therefrom) the Consolidated Coverage Ratio would be greater than
1.85:1 if such Incurrence shall occur on or prior to December 31, 1998 and
greater than 2.0:1 if such Incurrence shall occur thereafter.
(b) Notwithstanding the foregoing paragraph (a), the Company and its
Restricted Subsidiaries may Incur the following Indebtedness and issue the
following Disqualified Stock: (i) Indebtedness (including, without
limitation, letters of credit and Guarantees) of the Company or any
Subsidiary Guarantor under the New Credit Facility with respect thereto in
an aggregate principal amount outstanding at any time not to exceed $50
million, less the aggregate amount of all proceeds from all Asset
Dispositions that have been applied since the Issue Date to permanently
reduce the outstanding amount of such Indebtedness pursuant to the covenant
'Limitation on Sale of Assets and Subsidiary Stock'; (ii) Indebtedness of
the Company owing to and held by any Subsidiary Guarantor or Indebtedness
of a Restricted Subsidiary owing to and held by the Company or any
Subsidiary Guarantor; provided, however, that any subsequent issuance or
transfer of any Capital Stock or any other event which results in any such
Subsidiary Guarantor ceasing to be a Subsidiary Guarantor or any subsequent
transfer of any such Indebtedness (except to the Company or a Subsidiary
Guarantor or a pledge or other transfer thereof intended to create a
security interest therein) will be deemed to constitute the Incurrence of
such Indebtedness by the issuer thereof; (iii) Indebtedness represented by
the Notes (including the Subsidiary Guarantees) and any Indebtedness or
Disqualified Stock of the Company or any Restricted Subsidiary (other than
the Indebtedness described in clauses (i) and (ii) above) outstanding on
the Issue Date; (iv) Indebtedness of a Subsidiary Guarantor outstanding on
or prior to the date on which such Subsidiary Guarantor was acquired by the
Company or a Subsidiary Guarantor (other than Indebtedness Incurred in
connection with, or in contemplation of, the transaction or series of
related transactions pursuant to which such Subsidiary Guarantor became a
Subsidiary Guarantor or was otherwise acquired by the Company or a
Subsidiary Guarantor); provided, however, that the aggregate principal
amount, accreted value or liquidation preference, as applicable, of such
Indebtedness does not exceed $5 million at any one time outstanding; (v)
Indebtedness (A) in respect of performance bonds, bankers' acceptances,
workers' compensation claims, surety or appeal bonds, payment obligations
in connection with self-insurance or similar obligations, and bank
overdrafts (and letters of credit in respect thereof) provided
82
<PAGE>
by the Company or any Subsidiary Guarantor in the ordinary course of its
business and which do not secure other Indebtedness and (B) under Currency
Agreements and Interest Rate Agreements Incurred which, at the time of
Incurrence, is in the ordinary course of business; provided that such
agreements are entered into for bona fide hedging purposes, are not for
speculation or trading purposes and are designed to protect against
fluctuations in interest rates or currency exchange rates, as the case may
be, and, in the case of Interest Rate Agreements, any such Interest Rate
Agreement has a notional amount corresponding to the Indebtedness being
hedged thereby; (vi) Indebtedness represented by Guarantees by the Company
of Indebtedness otherwise permitted to be Incurred pursuant to this
covenant and Indebtedness represented by Guarantees by a Subsidiary
Guarantor of Indebtedness of the Company or of another Restricted
Subsidiary otherwise permitted to be Incurred pursuant to this covenant;
(vii) Indebtedness incurred by the Company or any Subsidiary Guarantor and
arising from agreements providing for indemnification, adjustment of
purchase price or similar obligations, from guarantees or letters of
credit, surety bonds or performance bonds securing any obligations of the
Company or any Restricted Subsidiary pursuant to such agreements, in each
case incurred in connection with the purchase or sale of a business or
assets otherwise permitted by the Indenture; (viii) Indebtedness of the
Company or any Subsidiary Guarantor in an aggregate principal amount not to
exceed $5 million at any time outstanding incurred in connection with the
purchase, redemption, acquisition, cancellation or other retirement for
value of Subsidiary Management Equity Interests; (ix) the incurrence by the
Company or any Subsidiary Guarantor of Indebtedness represented by
Capitalized 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
Subsidiary Guarantor, in an aggregate principal amount not to exceed the
principal amount of such Capitalized Lease Obligations outstanding on the
date hereof plus $10 million at any time outstanding; (x) the issuance by
KII Holding of Series B Preferred Stock having an aggregate liquidation
preference not to exceed $200,000 at any one time outstanding to its
officers and employees; (xi) (A) Indebtedness of the Company or a
Subsidiary Guarantor represented by Put/Call Promissory Notes and (B)
Disqualified Stock of the Company or a Subsidiary Guarantor represented by
Put/Call Preferred Stock, in each case incurred or issued in exchange for
Management Equity Interests, in an aggregate amount not to exceed the value
(calculated in accordance with the respective agreements pursuant to which
such Management Equity Interests were issued or exchanged) of the
Management Equity Interests so exchanged; (xii) the issuance by the Company
or any Subsidiary Guarantor of Refinancing Indebtedness in exchange for, or
the net proceeds which are used to refund, refinance or replace,
Indebtedness that was permitted by paragraph (a) or by clauses (iii), (iv)
and (viii) of this paragraph (b) to be incurred; and (xiii) other
Indebtedness of the Company or any Subsidiary Guarantor in an aggregate
principal amount at any one time outstanding not to exceed $12.5 million.
(c) Notwithstanding the foregoing, neither the Company nor any
Restricted Subsidiary shall Incur any Indebtedness pursuant to the
foregoing paragraph (b) if the proceeds thereof are used, directly or
indirectly, to Refinance any Subordinated Obligations of the Company unless
such new Indebtedness shall be subordinated to the Notes to at least the
same extent as such Subordinated Obligations being Refinanced. No
Subsidiary Guarantor shall incur any Indebtedness pursuant to the foregoing
paragraph (b) if the proceeds thereof are used, directly or indirectly, to
Refinance any Guarantor Subordinated Obligation of such Subsidiary
Guarantor unless such Indebtedness shall be subordinated to the obligations
of such Subsidiary Guarantor under the Subsidiary Guarantee to at least the
same extent as such Guarantor Subordinated Obligation of such Subsidiary
Guarantor.
(d) The Company will not permit any Unrestricted Subsidiary to Incur
any Indebtedness other than Non-Recourse Debt, provided, however, if any
such Indebtedness ceases to be Non-Recourse Debt, such event shall be
deemed to constitute an Incurrence of Indebtedness by the Company or a
Restricted Subsidiary.
(e) For purposes of determining compliance with the foregoing
covenant, (i) in the event that an item of Indebtedness meets the criteria
of more than one of the types of Indebtedness described above, the Company
will classify (and may reclassify from time to time) such item of
Indebtedness and only be required to include the amount and type of such
Indebtedness in one of the above clauses and (ii) an item of Indebtedness
may be divided and classified in more than one of the types of Indebtedness
described above.
83
<PAGE>
Limitation on Liens. The Indenture provides that the Company will not, and
will not permit any of its Restricted Subsidiaries to, directly or indirectly,
create, incur, assume or suffer to exist any Lien (other than Permitted Liens)
securing Indebtedness or trade payables on any asset now owned or hereafter
acquired, or any income or profits therefrom or assign or convey any right to
receive income therefrom, unless contemporaneously therewith effective provision
is made to secure the Notes equally and ratably with such Indebtedness or trade
payable for so long as such Indebtedness or trade payable is secured by a Lien.
Limitation on Layering. The Company shall not Incur any Indebtedness if
such Indebtedness is by its terms contractually subordinate or junior in ranking
in any respect to any Senior Indebtedness unless such Indebtedness is Senior
Subordinated Indebtedness or is contractually subordinated in right of payment
to Senior Subordinated Indebtedness. No Subsidiary Guarantor shall Incur any
Indebtedness if such Indebtedness is by its terms subordinate or junior in
ranking in any respect to any Guarantor Senior Indebtedness of such Subsidiary
Guarantor unless such Indebtedness is Guarantor Senior Subordinated Indebtedness
of such Subsidiary Guarantor or is contractually subordinated in right of
payment to Guarantor Senior Subordinated Indebtedness of such Subsidiary
Guarantor.
Limitation on Restricted Payments. (a) The Company will not, and will not
permit any Restricted Subsidiary to, directly or indirectly, (i) declare or pay
any dividend or make any distribution on or in respect of its Capital Stock
(including any payment in connection with any merger or consolidation involving
the Company) except dividends or distributions payable solely in its Capital
Stock (other than Disqualified Stock) or in options, warrants or other rights to
purchase such Capital Stock and except dividends or distributions payable to the
Company or another Restricted Subsidiary (and, if such Restricted Subsidiary
making such dividend or distribution is not wholly owned, to its other
shareholders on a pro rata basis), (ii) purchase, repurchase, redeem, retire or
otherwise acquire or retire for value any Capital Stock of the Company or any
Restricted Subsidiary held by Persons other than the Company or another
Restricted Subsidiary, (iii) purchase, repurchase, redeem, defease or otherwise
acquire or retire for value, prior to scheduled maturity, scheduled repayment or
scheduled sinking fund payment any Subordinated Obligations (other than regular
scheduled payments of interest and the purchase, repurchase or other acquisition
of Subordinated Obligations in anticipation of satisfying a sinking fund
obligation, principal installment or final maturity, in each case due within one
year of the date of such purchase, repurchase or acquisition) or (iv) make any
Investment (other than a Permitted Investment) in any Person (any such dividend,
distribution, purchase, redemption, repurchase, defeasance, other acquisition,
retirement, payment or Investment being herein referred to as a 'Restricted
Payment') if at the time the Company or such Restricted Subsidiary makes such
Restricted Payment: (1) a Default or Event of Default shall have occurred and be
continuing (or would result therefrom); (2) the Company and its Restricted
Subsidiaries could not Incur at least $1.00 of additional Indebtedness under
paragraph (a) of the covenant described under '--Limitation on Indebtedness and
Preferred Stock;' or (3) the aggregate amount of such Restricted Payment and all
other Restricted Payments (the amount so expended, if other than in cash, to be
determined in good faith by the Board of Directors of the Company) made
subsequent to the Issue Date (excluding Restricted Payments permitted by clauses
(i), (ii), (iv) and (vii) of the following paragraph), would exceed the sum of:
(A) 50% of the Consolidated Net Income with respect to the period (treated as
one accounting period) from the beginning of the fiscal quarter in which the
Issue Date occurs) to the end of the most recent fiscal quarter for which
internal financial statements are available ending at least 30 days prior to the
date of such Restricted Payment (or, in case such Consolidated Net Income is a
deficit, minus 100% of such deficit); (B) the aggregate Net Cash Proceeds
received by the Company from the issue or sale of Capital Stock (other than
Disqualified Stock) subsequent to the Issue Date (other than an issuance or sale
to a Subsidiary) and, without duplication, the aggregate amount of any other
capital contributions received by the Company in cash subsequent to the Issue
Date and on or prior to the date the Restricted Payment occurs; (C) the amount
by which Indebtedness of the Company is reduced on the Company's balance sheet
upon the conversion or exchange (other than by a Restricted Subsidiary)
subsequent to the Issue Date of any Indebtedness of the Company convertible or
exchangeable for Capital Stock (other than Disqualified Stock) of the Company
(less the amount of any cash or other property distributed by the Company upon
such conversion or exchange); and (D) the amount equal to the net reduction in
Investments in Unrestricted Subsidiaries resulting from (i) repayments of the
principal of loans or advances or other transfers of assets to the Company or
any Restricted Subsidiary from Unrestricted Subsidiaries or (ii) the
redesignation of Unrestricted Subsidiaries as Restricted Subsidiaries or (iii)
the sale or liquidation of any Unrestricted Subsidiaries (valued in each case as
provided in the definition of 'Investment') not to exceed, in the case of any
Unrestricted
84
<PAGE>
Subsidiary, the amount of Investments previously made by the Company or any
Restricted Subsidiary in such Unrestricted Subsidiary, which amount was
previously included in the calculation of the amount of Restricted Payments.
(b) The provisions of the foregoing paragraph (a) will not prohibit: (i)
any purchase, redemption, defeasance or other acquisition of Capital Stock of
the Company or Subordinated Obligations made by exchange for, or out of the net
proceeds of the substantially concurrent sale of, Capital Stock of the Company
(other than Disqualified Stock and other than Capital Stock issued or sold to a
Subsidiary); provided, however, that (A) such purchase, redemption, defeasance
or other acquisition will be excluded in the calculation of the amount of
Restricted Payments pursuant to clause (3) of paragraph (a) above and (B) the
Net Cash Proceeds from such sale will be excluded from clause (3)(B) of
paragraph (a) above; (ii) any purchase, redemption, defeasance or other
acquisition of Subordinated Obligations made by exchange for, or out of the net
proceeds of the substantially concurrent sale of, Subordinated Obligations of
the Company; provided, however, that (A) the principal amount of such new
Indebtedness does not exceed the principal amount (or accreted value, if
applicable) of the Subordinated Obligations being so redeemed, repurchased,
defeased, acquired or retired for value (plus the amount of any premium required
to be paid under the terms of the instrument governing the Subordinated
Obligations being so redeemed, repurchased, defeased, acquired or retired and
related fees and expenses) (except to the extent such excess is a result of a
simultaneous incurrence of additional Indebtedness permitted to be incurred
under the Indenture), (B) such new Indebtedness is subordinated to the Notes on
terms substantially the same as those contained in the instrument or agreement
governing or evidencing such Subordinated Obligations so purchased, exchanged,
redeemed, repurchased, defeased, acquired or retired for value, (C) such new
Indebtedness has a final scheduled maturity date no earlier than the final
scheduled maturity date of such Subordinated Obligations (or, if earlier, the
Notes) purchased, exchanged, redeemed, repurchased, defeased, acquired or
retired for value and (D) such new Indebtedness has an Average Life equal to or
greater than the Average Life of such Subordinated Obligations purchased,
exchanged, redeemed, repurchased, defeased, acquired or retired for value;
provided further, however, that such purchase, redemption, defeasance or other
acquisition will be excluded in the calculation of the amount of Restricted
Payments pursuant to clause (3) of paragraph (a) above; (iii) dividends paid
within 60 days after the date of declaration thereof if at such date of
declaration such dividend would have complied with this covenant; provided,
however, that the amount of such dividend will be included in the calculation of
the amount of Restricted Payments pursuant to clause (3) of paragraph (a) above;
(iv) Investments in securities not constituting cash or Temporary Cash
Investments received in connection with an Asset Disposition made pursuant to
the provisions of the covenant described under '--Certain Covenants--Limitation
on Sales of Assets and Subsidiary Stock' below; provided that such amounts will
be excluded in the calculation of the amount of Restricted Payments pursuant to
clause (3) of paragraph (a) above; (v) the payment of scheduled dividends on, or
the scheduled or mandatory redemption, repurchase or retirement of, any
Disqualified Stock (other than Put/Call Preferred Stock) issued after the date
hereof in compliance with the provisions of the Indenture; provided that such
amounts will be included in the calculation of the amount of Restricted Payments
pursuant to clause (3) of paragraph (a) above; (vi) payments made with respect
to the repurchase, redemption or other acquisition or retirement for value of
Management Equity Interests (A) prior to the third anniversary of the Issue Date
in an aggregate principal amount not to exceed $500,000 in any twelve-month
period and (B) subsequent to the third anniversary of the Issue Date in an
aggregate principal amount not to exceed $2 million in any twelve month period;
provided that (1) subsequent to the third anniversary of the Issue Date, the
Company may make an additional $2 million of such payments in any such
twelve-month period if, after giving pro forma effect to all such payments, the
Consolidated Coverage Ratio would be greater than 2.5:1, and (2) to the extent
such Management Equity Interests have been exchanged for Put/Call Promissory
Notes or Put/Call Preferred Stock incurred or issued in accordance with clause
(xi) under 'Limitation on Indebtedness and Preferred Stock,' such amounts may be
applied toward the repurchase of or payment on such Put/Call Promissory Notes
and Put/Call Preferred Stock; and provided further that such amounts will be
included in the calculation of the amount of Restricted Payments pursuant to
clause (3) of paragraph (a) above; (vii) the repurchase of Management Equity
Interests in exchange for Put/Call Promissory Notes and Put/Call Preferred Stock
incurred or issued in accordance with clause (xi) under 'Limitation on
Indebtedness and Preferred Stock'; provided that such repurchase will be
excluded in the calculation of the amount of Restricted Payments pursuant to
clause (3) of paragraph (a) above; and (viii) other Restricted Payments in an
aggregate amount not to exceed $5 million; provided that such amounts will be
included in the
85
<PAGE>
calculation of the amount of Restricted Payments pursuant to clause (3) of
paragraph (a) above; provided, however, that at the time of, and after giving
effect to, any Restricted Payment permitted by clauses (v), (vi), and (viii) no
Default or Event of Default shall have occurred and be continuing. In addition,
payments and transactions permitted pursuant to clauses (v), (vi), (vii),
(viii), (ix) and (x) of paragraph (b) under 'Certain Covenants--Limitation on
Transactions with Affiliates' below shall not be deemed to be Restricted
Payments.
Limitation on Restrictions on Distributions from Restricted
Subsidiaries. The Company will not, and will not permit any Restricted
Subsidiary to, create or otherwise cause or permit to exist or become effective
any consensual encumbrance or restriction on the ability of any Restricted
Subsidiary to (i) pay dividends or make any other distributions on its Capital
Stock or pay any Indebtedness or other obligation owed to the Company, (ii) make
any loans or advances to the Company or (iii) transfer any of its property or
assets to the Company or any Restricted Subsidiary, except: (1) any encumbrance
or restriction pursuant to an agreement in effect at or entered into on the
Issue Date (including pursuant to the New Credit Facility); (2) any encumbrance
or restriction with respect to a Restricted Subsidiary pursuant to an agreement
relating to any Capital Stock of such Restricted Subsidiary or Indebtedness
Incurred by such Restricted Subsidiary on or prior to the date on which such
Restricted Subsidiary was acquired by the Company or a Restricted Subsidiary and
outstanding on such date (other than Indebtedness Incurred in connection with,
or in contemplation of, the transaction or series of related transactions
pursuant to which such Restricted Subsidiary became a Restricted Subsidiary or
was acquired by the Company or a Restricted Subsidiary); (3) any encumbrance or
restriction contained in agreements or instruments with respect to 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; (4) any encumbrance or restriction pursuant to an
agreement effecting a Refinancing of Indebtedness Incurred pursuant to an
agreement referred to in clause (1), (2) or (3) of this covenant or contained in
any amendment to an agreement referred to in clause (1), (2) or (3) of this
covenant; provided, however, that the encumbrances and restrictions contained in
any such refinancing agreement or amendment are not, taken as a whole,
materially less favorable to the Noteholders than the encumbrances and
restrictions contained in any such agreement as determined in good faith by the
Company; (5) in the case of clause (iii), any encumbrance or restriction (A)
that restricts in a customary manner the subletting, assignment or transfer of
any property or asset that is subject to a lease, license or similar contract,
(B) by virtue of any transfer of, agreement to transfer, option or right with
respect to, or Lien on, any property or assets of the Company or any Restricted
Subsidiary not otherwise prohibited by the Indenture or (C) contained in
security agreements, mortgages or Capitalized Lease Obligations securing
Indebtedness of a Restricted Subsidiary to the extent such encumbrance or
restrictions restrict the transfer of the property subject to such security
agreements, mortgages or Capitalized Lease Obligations; (6) any restriction with
respect to a Restricted Subsidiary imposed pursuant to an agreement entered into
for the sale or disposition of Capital Stock or assets of such Restricted
Subsidiary pending the closing of such sale or disposition; (7) any encumbrance
or restriction arising under or by reason of applicable law; (8) any encumbrance
or restriction contained in the Indenture; and (9) customary net worth
provisions contained in leases and other agreements entered into by a Restricted
Subsidiary in the ordinary course of business; and (10) customary restrictions
contained in any agreements or documentation governing Indebtedness issued
pursuant to clause (xiii) of paragraph (b) of the covenant described above under
the caption '--Certain Covenants--Limitation on Indebtedness and Preferred
Stock'; provided that such restrictions are no more restrictive, taken as a
whole, than those pursuant to the New Credit Facility.
Limitation on Sales of Assets and Subsidiary Stock. (a) The Company will
not, and will not permit any Restricted Subsidiary to, make any Asset
Disposition unless (i) the Company or such Restricted Subsidiary receives
consideration at the time of such Asset Disposition at least equal to the fair
market value, as determined in good faith by the Board of Directors of the
Company (including as to the value of all non cash consideration), of the shares
and assets subject to such Asset Disposition, (ii) at least 75% of the
consideration thereof received by the Company or such Restricted Subsidiary is
in the form of cash or Temporary Cash Investments and (iii) an amount equal to
100% of the Net Available Cash from such Asset Disposition is applied by the
Company or such Restricted Subsidiary, as the case may be, within 365 days from
the later of the date of such Asset Disposition or the receipt of such Net
Available Cash (A) first, to the extent the Company or any Restricted
Subsidiary, as the case may be, elects (or is required by the terms of the New
Credit Facility or any Senior Indebtedness), to prepay, repay or purchase
Indebtedness under the New Credit Facility or other Senior Indebtedness or
Indebtedness (other than Disqualified Stock) of a Wholly Owned Subsidiary (in
each case other than Indebtedness owed to the Company or an Affiliate of the
Company); (B) second to the extent of any remaining balance of Net Available
86
<PAGE>
Cash after any election in accordance with clause (A) (or in any combination
with clause (A)), to the extent the Company or such Restricted Subsidiary, as
the case may be, elects, to the investment by the Company or any Wholly Owned
Subsidiary in Additional Assets; (C) third to the extent of any remaining
balance of such Net Available Cash after any election in accordance with clauses
(A) and (B), to make an Offer (as defined below) to purchase Notes pursuant to
and subject to the conditions set forth in paragraph (b) of this covenant within
45 days from the 365th day after the later of the date of such Asset Disposition
and the receipt of such Net Available Cash; and (D) fourth to the extent of any
remaining balance of such Net Available Cash after election or application in
accordance with clauses (A), (B) and (C), to general corporate purposes;
provided, however, that in connection with any prepayment, repayment, purchase
or other acquisition of Indebtedness pursuant to clause (A) above, the Company
or such Restricted Subsidiary will retire such Indebtedness and will cause any
related loan commitment or availability (if any) to be permanently reduced in an
amount equal to the principal amount so prepaid, repaid or purchased.
Notwithstanding the foregoing provisions, the Company and its Restricted
Subsidiaries shall not be required to apply any Net Available Cash in accordance
herewith except to the extent that the aggregate Net Available Cash from all
Asset Dispositions exceeds $2,000,000. The Company shall not be required to make
an Offer for Notes pursuant to this covenant if the Net Available Cash available
therefor (after application of the proceeds as provided in clauses (A) and (B))
is less than $5,000,000 (which lesser amounts shall be carried forward for
purposes of determining whether an Offer is required with respect to the Net
Available Cash from subsequent Asset Dispositions).
For the purposes of this covenant, the following are deemed to be cash: (x)
the assumption by the transferee of Indebtedness of the Company or any
Restricted Subsidiary (other than Indebtedness that is subordinated to the Notes
or the Subsidiary Guarantees) and the release of the Company or such Restricted
Subsidiary from all liability on such Indebtedness in connection with such Asset
Disposition, and (y) securities received by the Company or any Restricted
Subsidiary from the transferee that are promptly converted by the Company or
such Restricted Subsidiary into cash or Temporary Cash Investments.
(b) In the event of an Asset Disposition that requires the purchase of
Notes pursuant to clause (a)(iii)(C) of this covenant, the Company will be
required to purchase Notes tendered pursuant to an offer by the Company for the
Notes (the 'Offer') at a purchase price of 100% of their principal amount plus
accrued interest and Liquidated Damages, if any, to the date of purchase in
accordance with the procedures (including prorating in the event of
oversubscription) set forth in the Indenture. If the aggregate purchase price of
Notes tendered pursuant to the Offer is less than the Net Available Cash
allotted to the purchase of the Notes, the Company will apply the remaining Net
Available Cash in accordance with clause (a)(iii)(D) above.
(c) The Company will comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations in connection with the repurchase of Notes pursuant to this
covenant. To the extent that the provisions of any securities laws or
regulations conflict with provisions of this covenant, the Company will comply
with the applicable securities laws and regulations and will not be deemed to
have breached its obligations under this covenant by virtue thereof.
Limitation on Transactions with Affiliates. (a) The Company will not, and
will not permit any Restricted Subsidiary to, directly or indirectly, enter into
or conduct any transaction or series of transactions (including the purchase,
sale, lease or exchange of any property, or rendering of any service) with any
Affiliate of the Company or a Restricted Subsidiary (an 'Affiliate Transaction')
unless (i) the terms of such transaction are no less favorable to the Company or
such Restricted Subsidiary, as the case may be, than those that could be
obtained at the time of such transaction in arm's-length dealings with a Person
who is not such an Affiliate; (ii) in the event such Affiliate Transaction
involves an aggregate amount in excess of $1,000,000, the terms of such
transaction shall have been approved by a majority of the members of the Board
of Directors of the Company (and such majority determines that such Affiliate
Transaction satisfies the criteria in clause (i) above) and (iii) in the event
such Affiliate Transaction involves an aggregate amount in excess of $5,000,000,
the Company has received a written opinion from a nationally recognized
independent investment banking, accounting or appraisal firm that such Affiliate
Transaction is fair to the Company or such Restricted Subsidiary from a
financial point of view.
(b) The foregoing shall not apply to (i) any Restricted Payment permitted
to be made pursuant to 'Limitation on Restricted Payments,' (ii) any issuance of
securities, or other payments, awards or grants in cash, securities or otherwise
pursuant to, or the funding of, employment arrangements, stock options and stock
87
<PAGE>
ownership plans approved by the Board of Directors of the Company, (iii) any
fees, indemnities, loans or advances to employees in the ordinary course of
business, (iv) any transaction between the Company and a Restricted Subsidiary
or between Restricted Subsidiaries, (v) any agreement in effect on the Issue
Date or any amendment thereto or transaction contemplated thereby (and any
replacement or amendment of any such agreement so long as any such amendment or
replacement thereof is not materially less favorable to the Holders than the
original agreement in effect on the Issue Date), (vi) payments by the Company or
any of its Restricted Subsidiaries to Mentmore and/or its Affiliates made for
any financial advisory, financing, underwriting or placement services or in
respect of other investment banking activities, including, without limitation,
in connection with acquisitions or divestitures, which payments are approved a
majority of the members of the Board of Directors of the Company in good faith;
(vii) payments under any tax sharing agreement to the extent such payments do
not otherwise exceed the tax liability the Company would have had were it not
party to such tax sharing agreement; (viii) any other payment or reimbursement
of reasonable and customary fees and expenses incurred by an Affiliate for
services rendered to the Company or any of its Restricted Subsidiaries not to
exceed $250,000 in any twelve-month period (without duplication for any amounts
paid pursuant to any other clause of this covenant); (ix) the application of the
proceeds of the Initial Offering and the transactions entered into in connection
therewith in the manner contemplated thereby; and (x) (A) payments under the
Management Agreement in an amount not to exceed $750,000 in any fiscal year and
(B) after the first anniversary of the Issue Date, additional payments under the
Management Agreement in an amount not to exceed 1% of the Company's total
consolidated sales in any fiscal year less any amount paid pursuant to the
preceding clause (A), provided, in the case of clause (B) above, that the
Company's Consolidated Coverage Ratio, after giving pro forma effect to such
payment, is equal to or greater than 2.25 to 1, in each case plus reasonable
expenses incurred in connection with and reimbursable under the Management
Agreement.
Limitation on Sales of Subsidiary Capital Stock. The Company (i) will not,
and will not permit any Restricted Subsidiary of the Company to, transfer,
convey, sell, lease or otherwise dispose of any Capital Stock of any Restricted
Subsidiary to any Person (other than to the Company or a Wholly Owned
Subsidiary) and (ii) will not permit any Restricted Subsidiary to issue any of
its Capital Stock (other than to management of such Restricted Subsidiary and,
if necessary, shares of its Capital Stock constituting directors' qualifying
shares) to any Person other than to the Company or a Wholly Owned Subsidiary,
unless (a) after any such transfer, conveyance, sale, lease, disposition or
issuance, such Restricted Subsidiary continues to be a Restricted Subsidiary and
(b) the net cash proceeds from such transfer, conveyance, sale, lease,
disposition or issuance are applied in accordance with the covenant described
above under 'Limitation on Sales of Assets and Subsidiary Stock'; provided,
however, that this provision shall not prohibit the transfer, conveyance, sale,
lease or other disposition of all of the Capital Stock of any Restricted
Subsidiary or the retention of Preferred Stock which is not Disqualified Stock
in connection with any such transfer, conveyance, sale, lease or other
disposition.
SEC Reports. Notwithstanding that the Company may not be required to
remain subject to the reporting requirements of Section 13 or 15(d) of the
Exchange Act, the Company will file with the SEC (unless the SEC will not accept
such a filing) and provide the Trustee and Noteholders with the annual reports
and such information, documents and other reports which are specified in
Sections 13 and 15(d) of the Exchange Act. The Company also will comply with the
other provisions of TIA Section 314(a). Notwithstanding the foregoing, the
Company shall not be required to make any such filings prior to the date on
which the Company's annual report on Form 10-K for the fiscal year ended
December 31, 1997 would have been required to be filed if, at the time such
filings would have been required to be made with the Commission, either (i) the
Company shall have provided to each Holder the information that would have been
required to be filed or (ii) the Exchange Offer Registration Statement has been
filed with the Commission but has not yet been declared effective and copies of
the Exchange Offer Registration Statement and any amendments thereto (to the
extent such registration statement and/or amendments contain additional
information not disclosed in the Offering Memorandum that would have been the
subject of a filing required to be made under Section 13 or 15(d) of the
Exchange Act) have been provided to each Holder, provided that any exhibits to
the Exchange Offer Registration Statement (or any amendments thereto) need not
be delivered to any Holder of the Notes, but sufficient copies thereto shall be
furnished to the Trustee as reasonably requested to permit the Trustee to
deliver any such exhibits to any Holder upon request. In addition, the Company
and the Subsidiary Guarantors have agreed that, for so long as any Notes remain
outstanding, they will furnish to the Holders and to securities analysts and
prospective investors, upon their request, the information required to be
delivered pursuant to Rule 144(d)(4) under the Securities Act.
88
<PAGE>
Future Guarantors. The Company shall cause each new Subsidiary having
either net assets or stockholders' equity in excess of $50,000 (other than (i) a
new Subsidiary designated as an Unrestricted Subsidiary and (ii) Foreign
Subsidiaries) to become a Subsidiary Guarantor under the Indenture and thereby
Guarantee the Notes on the terms and conditions set forth in the Indenture.
MERGER AND CONSOLIDATION
The Company will not consolidate with or merge with or into, or convey,
transfer or lease all or substantially all its consolidated assets to, any
Person, unless: (i) the resulting, surviving or transferee Person (the
'Successor Company') will be a corporation organized and existing under the laws
of the United States of America, any State thereof or the District of Columbia
and the Successor Company (if not the Company) will expressly assume, by
supplemental indenture, executed and delivered to the Trustee, in form
satisfactory to the Trustee, all the obligations of the Company under the Notes
and the Indenture; (ii) immediately after giving pro forma effect to such
transaction (and treating any Indebtedness which becomes an obligation of the
Successor Company or any Restricted Subsidiary as a result of such transaction
as having been Incurred by the Successor Company or such Restricted Subsidiary
at the time of such transaction), no Default or Event of Default will have
occurred and be continuing; (iii) immediately after giving pro forma effect to
such transaction, the Successor Company would be able to Incur an additional
$1.00 of Indebtedness under paragraph (a) of the covenant described under
'--Limitation on Indebtedness and Preferred Stock;' (iv) immediately after
giving effect to such transaction, the Successor Company will have a
Consolidated Net Worth in an amount which is not less than the Consolidated Net
Worth of the Company immediately prior to such transaction; and (v) the Company
will have delivered to the Trustee an Officers' Certificate and an Opinion of
Counsel, each stating that such consolidation, merger or transfer and such
supplemental indenture (if any) comply with the Indenture, as set forth in the
Indenture.
The Successor Company will succeed to, and be substituted for, and may
exercise every right and power of, the Company under the Indenture, but the
predecessor Company in the case of a lease of all or substantially all its
assets will not be released from the obligation to pay the principal of and
interest on the Notes.
DEFAULTS
An Event of Default is defined in the Indenture as (i) a default in any
payment of interest on or Liquidated Damages, if any, with respect to, any Note
when due, and continuance of such default for a period of 30 days, whether or
not such payment is prohibited by the provisions described under 'Ranking and
Subordination' above (ii) a default in the payment of principal of any Note when
due at its Stated Maturity, upon optional redemption, upon required repurchase,
upon declaration or otherwise, whether or not such payment is prohibited by the
provisions described under 'Ranking and Subordination' above (iii) the failure
by the Company to comply with its obligations under '--Merger and
Consolidation,' (iv) the failure by the Company to comply for 30 days after
notice with any of its obligations under the covenants described under '--Change
of Control' or '--Certain Covenants' (in each case, other than a failure to
purchase Notes), (v) the failure by the Company to comply for 60 days after
notice with its other agreements contained in the Indenture, (vi) the failure by
the Company or any Significant Subsidiary of the Company to pay any interest or
principal of or premium on Indebtedness within any applicable grace period
provided in such Indebtedness after final maturity or the acceleration of any
such Indebtedness by the holders thereof because of a default and the total
amount of such Indebtedness unpaid or accelerated exceeds $10 million or its
foreign currency equivalent (the 'cross acceleration provision'), (vii) certain
events of bankruptcy, insolvency or reorganization of the Company or any
Significant Subsidiary of the Company (the 'bankruptcy provisions'), (viii) any
final, non-appealable judgment or decree by a court of competent jurisdiction
for the payment of money in excess of $10 million is rendered against the
Company or any Significant Subsidiary of the Company and such judgment or decree
remains outstanding for a period of 60 day following such judgment and is not
discharged, waived or stayed (the 'judgment default provision') or (ix) except
as permitted by the Indenture, a Subsidiary Guarantee ceases to be in full force
and effect or a Subsidiary Guarantor denies or disaffirms its obligations under
its Subsidiary Guarantee.
The foregoing will constitute Events of Default whatever the reason for any
such Event of Default and whether it is voluntary or involuntary or is effected
by operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body.
89
<PAGE>
However, a default under clauses (iv) or (v) of the first paragraph above
will not constitute an Event of Default until the Trustee or the Holders of 25%
in aggregate principal amount of the outstanding Notes notify the Company as
provided in the Indenture of the default and the Company does not cure such
default within the time specified in clauses (iv) and (v) hereof after receipt
of such notice.
If an Event of Default occurs and is continuing, the Trustee or the Holders
of at least 25% in aggregate principal amount of the outstanding Notes by notice
in writing to the Company and the Trustee specifying the respective Event of
Default and that it is a notice of acceleration may declare the principal of and
accrued but unpaid interest on all the Notes to be due and payable; provided
that, so long as any Designated Senior Indebtedness shall be outstanding, such
acceleration shall not be effective until the earlier of (i) an acceleration of
any such Designated Senior Indebtedness and (ii) five Business Days after
receipt by the Company and the Representative of written notice of such
acceleration. Upon such a declaration, such principal and interest will be due
and payable immediately. If an Event of Default relating to certain events of
bankruptcy, insolvency or reorganization of the Company occurs and is
continuing, the principal of and accrued interest on all the Notes will become
immediately due and payable without any declaration or other act on the part of
the Trustee or any Holders. Under certain circumstances, the Holders of a
majority in aggregate principal amount of the outstanding Notes may rescind any
such acceleration with respect to the Notes and its consequences.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the Holders unless such Holders
shall have offered to the Trustee reasonable indemnity or security against any
loss, liability or expense. Except to enforce the right to receive payment of
principal, premium (if any) or interest when due, no Holder may pursue any
remedy with respect to the Indenture or the Notes unless (i) such Holder shall
have previously given the Trustee notice that an Event of Default is continuing,
(ii) Holders of at least 25% in aggregate principal amount of the outstanding
Notes shall have requested the Trustee to pursue the remedy, (iii) such Holders
shall have offered the Trustee reasonable security or indemnity against any
loss, liability or expense, (iv) the Trustee shall not have complied with such
request within 60 days after the receipt of the request and the offer of
security or indemnity and (v) the Holders of a majority in principal amount of
the outstanding Notes shall not have given the Trustee a direction inconsistent
with such request within such 60-day period. Subject to certain restrictions,
the Holders of a majority in principal amount of the outstanding Notes are given
the right to direct the time, method and place of conducting any proceeding for
any remedy available to the Trustee or of exercising any trust or power
conferred on the Trustee. The Trustee, however, may refuse to follow any
direction that conflicts with law or the Indenture or that the Trustee
determines is unduly prejudicial to the rights of any other Holder or that would
involve the Trustee in personal liability. Prior to taking any action under the
Indenture, the Trustee will be entitled to indemnification satisfactory to it in
its sole discretion against all losses and expenses caused by taking or not
taking such action.
The Indenture provides that if a Default occurs and is continuing and is
known to the Trustee, the Trustee must mail to each Holder notice of the Default
within the earlier of 90 days after it occurs or 30 days after it is known to a
Trust Officer or written notice of it is received by the Trustee. Except in the
case of a Default in the payment of principal of, premium (if any) or interest
on any Note, the Trustee may withhold notice if and so long as a committee of
its Trust Officers in good faith determines that withholding notice is in the
interests of the Noteholders. In addition, the Company is required to deliver to
the Trustee, within 120 days after the end of each fiscal year, a certificate
indicating whether the signers thereof know of any Default that occurred during
the previous year. The Company also is required to deliver to the Trustee,
within 30 days after the occurrence thereof, written notice of any event which
would constitute certain Defaults, their status and what action the Company is
taking or proposes to take in respect thereof.
AMENDMENTS AND WAIVERS
Subject to certain exceptions, the Indenture may be amended with the
consent of the Holders of a majority in principal amount of the Notes then
outstanding (including, without limitation, consents obtained in connection with
the purchase of, or tender offer or exchange offer for, Notes) and any past
default or compliance with any provisions may be waived with the consent of the
Holders of a majority in principal amount of the Notes then outstanding
(including, without limitation, consents obtained in connection with the
purchase of, or tender offer or exchange offer for, Notes). However, without the
consent of each Holder of an outstanding Note affected, no
90
<PAGE>
amendment may (with respect to any Notes held by a nonconsenting holder) (i)
reduce the amount of Notes whose Holders must consent to an amendment,
supplement or waiver, (ii) reduce the rate of or extend the time for payment of
interest on any Note, (iii) reduce the principal of or extend the Stated
Maturity of any Note, (iv) reduce the premium payable upon the redemption of any
Note or change the time at which any Note may be redeemed as described under
'--Optional Redemption,' (v) make any Note payable in money other than that
stated in the Note, (vi) impair the right of any Holder to receive payment of
principal of and interest on such Holder's Notes on or after the due dates
therefor or to institute suit for the enforcement of any payment on or with
respect to such Holder's Notes or (vii) make any change in the foregoing
amendment provisions which require each Holder's consent.
Without the consent of any Holder, the Company and the Trustee may amend
the Indenture to cure any ambiguity, omission, defect or inconsistency, to
provide for the assumption by a successor corporation of the obligations of the
Company under the Indenture, to provide for uncertificated Notes in addition to
or in place of certificated Notes (provided that the uncertificated Notes are
issued in registered form for purposes of Section 163(f) of the Code, or in a
manner such that the uncertificated Notes are as described in Section
163(f)(2)(B) of the Code), to add additional Guarantees with respect to the
Notes, to secure the Notes, to add to the covenants of the Company for the
benefit of the Noteholders or to surrender any right or power conferred upon the
Company, to make any change that does not adversely affect the rights of any
Holder and to comply with any requirement of the SEC in connection with the
qualification of the Indenture under the TIA. However, no amendment may be made
to the subordination provisions of the Indenture that adversely affects the
rights of any holder of Senior Indebtedness then outstanding unless the holders
of such Senior Indebtedness (or any group or representative thereof authorized
to give a consent) consent to such change.
The consent of the Noteholders is not necessary under the Indenture to
approve the particular form of any proposed amendment. It is sufficient if such
consent approves the substance of the proposed amendment.
After an amendment under the Indenture becomes effective, the Company is
required to mail to Noteholders a notice briefly describing such amendment.
However, the failure to give such notice to all Noteholders, or any defect
therein, will not impair or affect the validity of the amendment.
TRANSFER AND EXCHANGE
A Noteholder may transfer or exchange Notes in accordance with the
Indenture. Upon any transfer or exchange, the registrar and the Trustee may
require a Noteholder, among other things, to furnish appropriate endorsements
and transfer documents and the Company may require a Noteholder to pay any taxes
required by law or permitted by the Indenture, including any transfer tax or
other similar governmental charge payable in connection therewith. The Company
is not required to transfer or exchange any Note selected for redemption or to
transfer or exchange any Note for a period of 15 days prior to a selection of
Notes to be redeemed. The Notes will be issued in registered form and the
registered holder of a Note will be treated as the owner of such Note for all
purposes.
DEFEASANCE
The Company at any time may terminate all its obligations under the Notes
and the Indenture ('legal defeasance'), except for certain obligations,
including those with respect to the defeasance trust and obligations to register
the transfer or exchange of the Notes, to replace mutilated, destroyed, lost or
stolen Notes and to maintain a registrar and paying agent in respect of the
Notes. The Company at any time may terminate its obligations under the covenants
described under 'Certain Covenants' and 'Change of Control' and thereafter any
omission to comply with such obligations shall not constitute a Default or an
Event of Default with respect to the Notes. In addition, the operation of the
cross acceleration provision, the bankruptcy provisions with respect to
Significant Subsidiaries and the judgment default provision described under
'--Defaults' and the limitations contained in clauses (iii) and (iv) under
'--Merger and Consolidation' will not be applicable ('covenant defeasance').
The Company may exercise its legal defeasance option notwithstanding its
prior exercise of its covenant defeasance option. If the Company exercises its
legal defeasance option, payment of the Notes may not be accelerated because of
an Event of Default with respect thereto. If the Company exercises its covenant
defeasance option, payment of the Notes may not be accelerated because of an
Event of Default specified in
91
<PAGE>
clause (iv), (v), (vi), (vii) (with respect only to Significant Subsidiaries) or
(viii) under '--Defaults' above or because of the failure of the Company to
comply with clause (iii) or (iv) under '--Merger and Consolidation.'
In order to exercise either defeasance option, the Company must irrevocably
deposit or cause to be deposited in trust (the 'defeasance trust') with the
Trustee money or U.S. Government Obligations which through the scheduled payment
of principal and interest in respect thereof in accordance with their terms will
provide cash at such times and in such amounts as will be sufficient to pay
principal and interest and Liquidated Damages, if any, when due on all the Notes
(except lost, stolen or destroyed Notes which have been replaced or repaid) to
maturity or redemption, as the case may be, and must comply with certain other
conditions, including delivery to the Trustee of an Opinion of Counsel to the
effect that holders of the Notes will not recognize income, gain or loss for
federal income tax purposes as a result of such deposit and defeasance and will
be subject to federal income tax on the same amount and in the same manner and
at the same times as would have been the case if such deposit and defeasance had
not occurred (and, in the case of legal defeasance only, such Opinion of Counsel
must be based on a ruling of the Internal Revenue Service or other change in
applicable federal income tax law).
CONCERNING THE TRUSTEE
Marine Midland Bank is the Trustee under the Indenture and has been
appointed by the Company as Registrar and Paying Agent with regard to the Notes.
GOVERNING LAW
The Indenture provides that it and the Notes will be governed by, and
construed in accordance with, the laws of the State of New York without giving
effect to applicable principles of conflicts of law to the extent that the
application of the law of another jurisdiction would be required thereby.
CERTAIN DEFINITIONS
'Acquired Indebtedness' of any specified Person means Indebtedness of any
other Person existing at the time such other Person is merged with or into or
becomes a Restricted Subsidiary of such specified Person, including Indebtedness
Incurred in connection with, or in contemplation of, such other Person's
becoming a Restricted Subsidiary of such specified Person.
'Additional Assets' means (i) any property or assets (other than
Indebtedness and Capital Stock) used in connection with the business of the
Company or any of its Restricted Subsidiaries on the Issue Date or in a Related
Business or (ii) the Capital Stock of a Person that is a Restricted Subsidiary
prior to the acquisition of such Capital Stock or becomes a Restricted
Subsidiary as a result of the acquisition of such Capital Stock by the Company
or another Restricted Subsidiary; provided, however, that, in the case of clause
(ii), such Restricted Subsidiary is primarily engaged in a Related Business.
'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 the purposes of this definition,
'control' when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise; and the terms
'controlling' and 'controlled' have meanings correlative to the foregoing;
provided that the beneficial ownership of 10% or more of the Voting Stock of a
Person shall be deemed to be control.
'Asset Disposition' means any sale, lease, transfer or other disposition
(or series of related sales, leases, transfers or dispositions) of shares of
Capital Stock of a Restricted Subsidiary (other than directors' qualifying
shares), property or other assets, including by way of a Sale/Leaseback
Transaction (each referred to for the purposes of this definition as a
'disposition'), by the Company or any of its Restricted Subsidiaries, in each
case resulting in Net Available Cash of $1,000,000 or more (including any
disposition by means of a merger, consolidation or similar transaction, except
that the sale, lease, conveyance or other disposition of all or substantially
all of the assets of the Company and its Subsidiaries taken as a whole will be
governed by the provisions of the Indenture described above under the caption
'--Change of Control' and/or the provisions described above under the caption
'--Merger and Consolidation' and not by the provisions of the covenant
'Limitation on Sales of Assets and Subsidiary Stock') other than (i) a
disposition by a Restricted Subsidiary to the Company or by the Company or a
Restricted Subsidiary to a Restricted Subsidiary, (ii) a disposition of property
or assets in the ordinary course of business, (iii) dispositions of inventory in
the ordinary course of
92
<PAGE>
business, (iv) for purposes of the 'Limitation on Sales of Assets and Subsidiary
Stock' covenant only, a disposition that constitutes a Restricted Payment
permitted by the 'Limitation on Restricted Payments' covenant and (v)
dispositions of obsolete or worn-out equipment.
'Average Life' means, as of the date of determination, with respect to any
Indebtedness or Preferred Stock, the quotient obtained by dividing (i) the sum
of the product of the numbers of years from the date of determination to the
dates of each successive scheduled principal payment of such Indebtedness or
redemption or similar payment with respect to such Preferred Stock multiplied by
the amount of such payment by (ii) the sum of all such payments.
'Bank Indebtedness' means any and all Obligations, whether outstanding on
the Issue Date or thereafter incurred, payable by the Company or its
Subsidiaries under or in respect of the New Credit Facility and any related
notes, collateral documents, letters of credit and guarantees, including,
without limitation, principal, premium (if any), interest (including interest
accruing on or after the filing of any petition in bankruptcy or for
reorganization relating to the Company whether or not a claim for post filing
interest is allowed in such proceedings), fees, charges, expenses, reimbursement
obligations, guarantees, indemnities and all other amounts payable thereunder or
in respect thereof.
'Board of Directors' means the Board of Directors or equivalent governing
body of a Person (or the general partner of such Person, as the case may be) or
any committee thereof duly authorized to act on behalf of such Board of
Directors or equivalent governing body.
'Business Day' means a day other than a Saturday, Sunday or other day on
which banking institutions in New York State are authorized or required by law
to close.
'Capitalized Lease Obligation' of a Person means an obligation of such
Person that is required to be classified and accounted for on the balance sheet
of such Person as a capitalized lease for financial reporting purposes in
accordance with GAAP, and the amount of Indebtedness represented by such
obligation shall be the capitalized amount of such obligation determined in
accordance with GAAP; and the Stated Maturity thereof shall be the date of the
last payment of rent or any other amount due under such lease.
'Capital Stock' of any Person 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, in each case, including Preferred Stock.
'Code' means the Internal Revenue Code of 1986, as amended.
'Consolidated Coverage Ratio' as of any date of determination means the
ratio of (i) the aggregate amount of EBITDA for the period of the most recent
four consecutive fiscal quarters for which internal financial information is
available ending at least 30 days prior to the date of such determination to
(ii) Consolidated Interest Expense for such four fiscal quarters; provided,
however, that, without duplication, (1) if the Company or any Restricted
Subsidiary has Incurred any Indebtedness (other than in the case of Indebtedness
arising under revolving credit borrowings, in which case Consolidated Interest
Expense shall be computed based upon the average daily balance of such
Indebtedness during the period) since the beginning of such period that remains
outstanding or if the transaction giving rise to the need to calculate the
Consolidated Coverage Ratio is an Incurrence of Indebtedness, or both, EBITDA
and Consolidated Interest Expense for such period shall be calculated after
giving effect on a pro forma basis to such Indebtedness as if such Indebtedness
had been Incurred on the first day of such period and the discharge of any other
Indebtedness repaid, repurchased, defeased or otherwise discharged with the
proceeds of such new Indebtedness as if such discharge had occurred on the first
day of such period, (2) if since the beginning of such period the Company or any
Restricted Subsidiary shall have made any Asset Disposition or if the
transaction giving rise to the need to calculate the Consolidated Coverage Ratio
is an Asset Disposition, the EBITDA for such period shall be reduced by an
amount equal to the EBITDA (if positive) directly attributable to the assets
which are the subject of such Asset Disposition for such period, or increased by
an amount equal to the EBITDA (if negative) directly attributable thereto for
such period and Consolidated Interest Expense for such period shall be reduced
by an amount equal to the Consolidated Interest Expense directly attributable to
any Indebtedness of the Company or any Restricted Subsidiary repaid,
93
<PAGE>
repurchased, defeased or otherwise discharged with respect to the Company and
its continuing Restricted Subsidiaries in connection with such Asset Disposition
for such period (and, if the Capital Stock of any Restricted Subsidiary is sold,
the Consolidated Interest Expense for such period directly attributable to the
Indebtedness of such Restricted Subsidiary to the extent the Company and its
continuing Restricted Subsidiaries are no longer liable for such Indebtedness
after such sale), (3) if since the beginning of such period the Company or any
Restricted Subsidiary (by merger or otherwise) shall have made an Investment in
any Restricted Subsidiary (or any Person which becomes a Restricted Subsidiary)
or an acquisition of assets, including any acquisition of assets occurring in
connection with a transaction causing a calculation to be made hereunder, which
constitutes all or substantially all of an operating unit of a business, EBITDA
and Consolidated Interest Expense for such period shall be calculated after
giving pro forma effect thereto (including the Incurrence or retirement of any
Indebtedness) as if such Investment or acquisition occurred on the first day of
such period and EBITDA for such period shall be calculated without giving effect
to clause (ii) set forth in the definition of Consolidated Net Income and (4) if
since the beginning of such period any Person (that subsequently became a
Restricted Subsidiary or was merged with or into the Company or any Restricted
Subsidiary since the beginning of such period) shall have made any Asset
Disposition or any Investment that would have required an adjustment pursuant to
clause (2) or (3) above if made by the Company or a Restricted Subsidiary during
such period, EBITDA and Consolidated Interest Expense for such period shall be
calculated after giving pro forma effect thereto as if such Asset Disposition or
Investment occurred on the first day of such period. For purposes of this
definition, whenever pro forma effect is to be given to an acquisition of
assets, the amount of income or earnings relating thereto and the amount of
Consolidated Interest Expense associated with any Indebtedness Incurred in
connection therewith, the pro forma calculations shall be determined in good
faith by a responsible financial or accounting officer of the Company. If any
Indebtedness bears a floating rate of interest and is being given pro forma
effect, the interest expense on such Indebtedness shall be calculated as if the
rate in effect on the date of determination had been the applicable rate for the
entire period (taking into account any Interest Rate Agreement applicable to
such Indebtedness).
'Consolidated Interest Expense' means, for any period, the total interest
expense of the Company and its consolidated Restricted Subsidiaries, plus, to
the extent not included in such interest expense, (i) interest expense
attributable to capital leases, (ii) amortization of debt discount and debt
issuance cost (excluding the amortization of deferred financing fees), (iii)
capitalized interest, (iv) non-cash interest expense, (v) commissions, discounts
and other fees and charges owed with respect to letters of credit and bankers'
acceptance financing, (vi) interest actually paid by the Company or any such
Restricted Subsidiary under any Guarantee of Indebtedness or other obligation of
any other Person, (vii) net costs associated with Hedging Obligations (including
amortization of fees), (viii) (A) Disqualified Stock dividends and (B) Preferred
Stock dividends of a Restricted Subsidiary that is not a Subsidiary Guarantor,
in each case other than dividends paid in Capital Stock (except Disqualified
Stock) and only in respect of such Disqualified Stock or Preferred Stock held by
Persons other than the Company or a Wholly Owned Subsidiary and (ix) the cash
contributions to any employee stock ownership plan or similar trust to the
extent such contributions are used by such plan or trust to pay interest or fees
to any Person (other than the Company) in connection with Indebtedness Incurred
by such plan or trust; provided, however, that there shall be excluded therefrom
(A) any such interest expense of any Unrestricted Subsidiary to the extent the
related Indebtedness is not Guaranteed or paid by the Company or any Restricted
Subsidiary, (B) interest on Put/Call Promissory Notes and (C) dividends on
Put/Call Preferred Stock.
'Consolidated Net Income' means, for any period, the net income (loss) of
the Company and its consolidated Subsidiaries; provided, however, that there
shall not be included in such Consolidated Net Income:
(i) any net income (loss) of any Person (other than the Company) if
such Person is not a Restricted Subsidiary, except that (A), subject to the
limitations contained in clause (iv) below, the Company's equity in the net
income of any such Person for such period shall be included in such
Consolidated Net Income up to the aggregate amount of cash actually
distributed by such Person during such period to the Company or a
Restricted Subsidiary as a dividend or other distribution (subject, in the
case of a dividend or other distribution paid to a Restricted Subsidiary,
to the limitations contained in clause (iii) below) and (B) the Company's
equity in a net loss of any such Person (other than an Unrestricted
Subsidiary) for such period shall be included in determining such
Consolidated Net Income,
(ii) any net income (loss) of any Person acquired by the Company or a
Subsidiary in a pooling of interests transaction for any period prior to
the date of such acquisition,
94
<PAGE>
(iii) any net income of any Restricted Subsidiary to the extent such
Restricted Subsidiary is prohibited, directly or indirectly, from paying
dividends or distributions, directly or indirectly, to the Company or any
other Restricted Subsidiary, except that (A), subject to the exclusion
contained in clause (iv) below, the Company's equity in the net income of
any such Restricted Subsidiary for such period shall be included in such
Consolidated Net Income up to the aggregate amount of cash actually
distributed by such Restricted Subsidiary during such period to the Company
or another Restricted Subsidiary as a dividend or other distribution
(subject, in the case of a dividend paid to another Restricted Subsidiary,
to the limitation contained in this clause) and (B) the Company's equity in
a net loss of any such Restricted Subsidiary for such period shall be
included in determining such Consolidated Net Income,
(iv) any gain or loss realized upon the sale or other disposition of
any property, plant or equipment of the Company or its consolidated
Subsidiaries (including pursuant to any Sale/Leaseback Transaction) which
is not sold or otherwise disposed of in the ordinary course of business and
any gain or loss realized upon the sale or other disposition of any Capital
Stock of any Person,
(v) any extraordinary gain or loss,
(vi) the cumulative effect of a change in accounting principles,
(vii) foreign currency exchange gains and losses, and
(viii) any income (loss) from discontinued operations.
Notwithstanding the foregoing, for the purpose of the covenant described
under 'Certain Covenants--Limitation on Restricted Payments' only, there shall
be excluded from Consolidated Net Income any dividends, repayments of loans or
advances or other transfers of assets from Unrestricted Subsidiaries to the
Company or a Restricted Subsidiary to the extent such dividends, repayments or
transfers increase the amount of Restricted Payments permitted under such
covenant pursuant to clause (a)(3)(D) thereof.
'Consolidated Net Worth' means the total of the amounts shown on the
balance sheet of the Company and its Restricted Subsidiaries, determined on a
consolidated basis in accordance with GAAP, as of the end of the most recent
fiscal quarter of the Company ending at least 30 days prior to the taking of any
action for the purpose of which the determination is being made, as (i) the par
or stated value of all outstanding Capital Stock of the Company plus (ii)
paid-in capital or capital surplus relating to such Capital Stock plus (iii) any
retained earnings or earned surplus less (A) any accumulated deficit and (B) any
amounts attributable to Disqualified Stock.
'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 Issue Date or (ii) was nominated by either of the Principals to
serve on such Board of Directors.
'Currency Agreement' means in respect of a Person any foreign exchange
contract, currency swap agreement or other similar agreement or arrangement as
to which such Person is a party or a beneficiary.
'Default' means any event which is, or after notice or passage of time or
both would be, an Event of Default.
'Designated Senior Indebtedness' means (i) the Bank Indebtedness in the
case of the Company, (ii) any Guarantee by a Subsidiary Guarantor of the Bank
Indebtedness in the case of such Subsidiary Guarantor and (iii) any other Senior
Indebtedness in the case of the Company or Guarantor Senior Indebtedness in the
case of such Subsidiary Guarantor which, at the date of determination, has an
aggregate principal amount outstanding of, or under which, at the date of
determination, the holders thereof are committed to lend up to, at least $10
million and is specifically designated by the Company or such Subsidiary
Guarantor as 'Designated Senior Indebtedness' for purposes of the Indenture.
'Disqualified Stock' means, with respect to any Person, any Capital Stock
which 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 (i) matures
or is mandatorily redeemable pursuant to a sinking fund obligation or otherwise,
(ii) is convertible or exchangeable automatically or at the option of the holder
thereof for Indebtedness or other Disqualified Stock or (iii) is redeemable at
the option of the holder thereof, in whole or in part, in each case on or prior
to the 91st day following the Stated Maturity of the Notes.
95
<PAGE>
'EBITDA' for any period means the Consolidated Net Income for such period,
plus the following (without duplication) to the extent deducted in calculating
such Consolidated Net Income: (i) income tax expense, (ii) Consolidated Interest
Expense, (iii) depreciation expense, (iv) amortization expense (including
amortization of goodwill and other intangibles), (v) non-cash management
compensation expense, (vi) any increase in cost of sales resulting from the
write-up of inventory in accordance with Accounting Principles Board Opinion No.
16 (or a successor provision) and (vii) all other non-cash items reducing
Consolidated Net Income (excluding any non-cash item to the extent it requires
an accrual of or reserve for cash disbursements for any future period), in each
case for such period, (viii) any extraordinary, non-recurring or unusual loss
plus any net loss realized in connection with an asset disposition and (ix) all
premiums or prepayments of Indebtedness and minus (x) all non-cash items
increasing Consolidated Net Income.
'Exchange Act' means the Securities Exchange Act of 1934, as amended.
'Foreign Subsidiary' means any Subsidiary which is incorporated or
otherwise organized under the laws of any jurisdiction other than the United
States of America, any state thereof or the District of Columbia.
'GAAP' means generally accepted accounting principles in the United States
of America as in effect as of the date of the Indenture, including those 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 approved by a significant segment of the
accounting profession. All ratios and computations based on GAAP contained in
the Indenture shall be computed in conformity with GAAP.
'Guarantee' means a guarantee, 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; provided, however,
that the term 'Guarantee' shall not include endorsements for collection or
deposit in the ordinary course of business. The term 'Guarantee' used as a verb
has a corresponding meaning.
'Guarantor Senior Indebtedness' means, with respect to a Subsidiary
Guarantor, whether outstanding on the Issue Date or thereafter incurred, (i) any
Guarantee of Indebtedness of the Company and its Subsidiaries under the New
Credit Facility, including, without limitation, obligations of the Company to
pay principal and interest (including any interest accruing subsequent to the
filing of a petition of bankruptcy at the rate provided for in the documentation
with respect thereto, whether or not such interest is an allowed claim under
applicable law), reimbursement obligations under letters of credit, fees,
expenses and indemnities, and all Hedging Obligations entered into with any
lender under the New Credit Facility, whether outstanding on the date of the
Indenture or thereafter incurred, (ii) the principal of, premium, if any, and
interest (including any interest accruing subsequent to the filing of a petition
of bankruptcy at the rate provided for in the documentation with respect
thereto, whether or not such interest is an allowed claim under applicable law)
on, and all other Obligations with respect to, any other Indebtedness of such
Subsidiary Guarantor permitted to be incurred by such Subsidiary Guarantor under
the terms of the Indenture, whether outstanding on the date of the Indenture or
thereafter incurred, unless the instrument under which such Indebtedness is
incurred expressly provides that it is on a parity with or subordinated in right
of payment to the obligations of such Subsidiary Guarantor under its Subsidiary
Guarantee and (iii) all Obligations of the Subsidiary Guarantor with respect to
the foregoing; provided, however, that Guarantor Senior Indebtedness shall not
include (1) any obligations of such Subsidiary Guarantor to the Company or any
other Subsidiary of the Company, (2) any liability for Federal, state, local or
other taxes owed or owing by such Subsidiary Guarantor, (3) any accounts payable
or other liability to trade creditors arising in the ordinary course of business
(including Guarantees thereof or instruments evidencing such liabilities) or (4)
any Indebtedness, Guarantee or obligation of such Subsidiary Guarantor that is
expressly subordinate or junior in right of payment to any other Indebtedness,
Guarantee or obligation of such Subsidiary Guarantor, including any Guarantor
Senior Subordinated Indebtedness and Guarantor Subordinated Obligations of such
Subsidiary Guarantor.
'Guarantor Senior Subordinated Indebtedness' means, with respect to a
Subsidiary Guarantor, the obligations of such Subsidiary Guarantor under the
Subsidiary Guarantee and any other Indebtedness of such Subsidiary Guarantor,
whether outstanding on the Issue Date or thereafter incurred, that specifically
provides that such Indebtedness is to rank pari passu in right of payment with
the obligations of such Subsidiary Guarantor under the Subsidiary Guarantee and
is not subordinated by its terms in right of payment to any Indebtedness or
96
<PAGE>
other obligation of such Subsidiary Guarantor which is not Guarantor Senior
Indebtedness of such Subsidiary Guarantor.
'Guarantor Subordinated Obligation' means, with respect to a Subsidiary
Guarantor, any Indebtedness of such Subsidiary Guarantor (whether outstanding on
the Issue Date or thereafter incurred) which is subordinate or junior in right
of payment to the obligations of such Subsidiary Guarantor under the Subsidiary
Guarantee pursuant to a written agreement.
'Hedging Obligations' of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement or Currency Agreement.
'Holder' or 'Noteholder' means the Person in whose name a Note is
registered on the Registrar's books.
'Incur' means issue, assume, Guarantee, incur or otherwise become liable
for; provided, however, that any Indebtedness or Disqualified Stock of a Person
existing at the time such Person becomes a Subsidiary (whether by merger,
consolidation, acquisition or otherwise) shall be deemed to be incurred by such
Subsidiary at the time it becomes a Subsidiary.
'Indebtedness' means, with respect to any Person on any date of
determination (without duplication),
(i) the principal of and, if any is due and payable at such time,
premium in respect of indebtedness of such Person for borrowed money,
(ii) the principal of and, if any is due and payable at such time,
premium in respect of obligations of such Person evidenced by bonds,
debentures, notes or other similar instruments,
(iii) all obligations of such Person in respect of unreimbursed
drawings under letters of credit or other similar instruments (including
reimbursement obligations with respect thereto) (other than letters of
credit securing obligations entered into in the ordinary course of business
to the extent any drawings thereunder are reimbursed no later than the
fifth Business Day following receipt by such Person of a demand for
reimbursement following payment on the letter of credit),
(iv) all obligations of such Person to pay the deferred and unpaid
purchase price of property or services (except Trade Payables), which
purchase price is due more than six months after the date of placing such
property in service or taking delivery and title thereto or the completion
of such services,
(v) all Capitalized Lease Obligations of such Person,
(vi) the amount of all obligations of such Person with respect to the
redemption, repayment or other repurchase of any Disqualified Stock or,
with respect to any Restricted Subsidiary that is not a Subsidiary
Guarantor, the aggregate liquidation preference of any Preferred Stock (but
excluding, in each case, any accrued dividends),
(vii) all Indebtedness of other Persons secured by a Lien on any asset
of such Person, whether or not such Indebtedness is assumed by such Person;
provided, however, that the amount of such Indebtedness shall be the lesser
of (A) the fair market value of such asset at such date of determination
and (B) the amount of such Indebtedness of such other Person,
(viii) all Indebtedness of other Persons to the extent Guaranteed by
such Person,
(ix) to the extent not otherwise included in this definition, Hedging
Obligations and,
(x) Acquired Indebtedness.
The amount of Indebtedness of any Person at any date shall be the outstanding
balance at such date of all unconditional obligations as described above (or the
accreted value thereof, in the case of Indebtedness that does not require
current payments of interest) and the maximum liability, upon the occurrence of
the contingency giving rise to the obligation, of any contingent obligations at
such date. Indebtedness shall not include interest or commitment or other fees.
'Interest Rate Agreement' means with respect to any Person any interest
rate protection agreement, interest rate future agreement, interest rate option
agreement, interest rate swap agreement, interest rate cap agreement, interest
rate collar agreement, interest rate hedge agreement or other similar agreement
or arrangement as to which such Person is party or a beneficiary.
97
<PAGE>
'Investment' in any Person means any direct or indirect advance, loan
(other than advances to customers in the ordinary course of business that are
recorded as accounts receivable on the balance sheet of such Person and advances
to employees of such Person and its Restricted Subsidiaries made in the ordinary
course of business) or other extension of credit (including by way of Guarantee
or similar arrangement) or capital contribution to (by means of any transfer of
cash or other property to others or any payment for property or services for the
account or use of others), or any purchase or acquisition for consideration of
Capital Stock, Indebtedness or other similar instruments issued by such Person;
provided that if the sole consideration for any such investment is Capital Stock
of such Person or its Subsidiaries that is not Disqualified Stock, then such
investment shall not be deemed an Investment for purposes of the Indenture.
'Investment' shall exclude extensions of trade credit by the Company and its
Restricted Subsidiaries on commercially reasonable terms in accordance with such
Person's normal trade practices. For purposes of the definition of 'Unrestricted
Subsidiary' and the 'Limitation on Restricted Payments' covenant, (i)
'Investment' shall include the portion (proportionate to the Company's equity
interest in such Subsidiary) of the fair market value of the net assets of any
Subsidiary of the Company at the time that such Subsidiary is designated an
Unrestricted Subsidiary; provided, however, that upon a redesignation of such
Subsidiary as a Restricted Subsidiary, the Company shall be deemed to continue
to have a permanent 'Investment' in an Unrestricted Subsidiary in an amount (if
positive) equal to (x) the Company's 'Investment' in such Subsidiary at the time
of such original designation less (y) the portion (proportionate to the
Company's equity interest in such Subsidiary) of the fair market value of the
net assets of such Subsidiary at the time that such Subsidiary is so
re-designated a Restricted Subsidiary; and (ii) any property transferred to or
from an Unrestricted Subsidiary shall be valued at its fair market value at the
time of such transfer, in each case as determined in good faith by the Board of
Directors. For the purposes of calculating the amount of other 'Investments,'
including Permitted Investments, the amount of any Investment shall be the
original cost of such Investment plus the cost of all additional Investments by
the Company or any of its Restricted Subsidiaries, without any adjustments for
increases or decreases in value, or write-ups, write-downs or write-offs with
respect to such Investment, reduced by the payment of dividends or distributions
in connection with such Investment or any other amounts received in respect of
such Investment; provided that no such payment of dividends or distributions or
receipt of any such other amounts shall reduce the amount of any Investment if
such payment of dividends or distributions or receipt of any such amounts would
be included in Consolidated Net Income.
'Issue Date' means the date on which the Notes are originally issued.
'KII Holding' means KII Holding Corp., a Restricted Subsidiary of the
Company on the Issue Date, and its successors and assigns.
'Kleinert' means Kleinert Industries, Inc., the predecessor to Stellex
Aerospace, Inc. and a Restricted Subsidiary of the Company on the Issue Date.
'Lien' means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
'Make-Whole Premium' means, with respect to a Note, an amount equal to the
greater of (i) 4.75% of the outstanding principal amount of such Note and (ii)
the excess of (a) the present value of the remaining interest, premium and
principal payments due on such Note as if such Note were redeemed on November 1,
2002, computed using a discount rate equal to the Treasury Rate plus 75 basis
points, over (b) the outstanding principal amount of such Note.
'Management Agreement' means the Management Advisory Services Agreement,
dated as of July 1, 1997, between the Company, certain of its Subsidiaries and
Mentmore, as it may be amended, modified, supplemented or restated from time to
time.
'Management Equity Interests' means shares of Capital Stock of the Company
or of a Subsidiary Guarantor, options, warrants or stock appreciation or similar
rights, in each case held by any current or former officer, employee or other
member of management (or their estates or beneficiaries under their estates) of
the Company or of such Subsidiary Guarantor pursuant to any management equity
subscription agreement, employment agreement, employee benefit plan, stockholder
agreement, stock option agreement or similar management investor agreement and
which may be required to be repurchased by the Company or such Subsidiary
Guarantor, or which may be repurchased at the option of the Company or such
Subsidiary Guarantor, in each case pursuant to the terms of any such agreement
under which such equity interests were issued.
98
<PAGE>
'Mentmore' means Mentmore Holdings Corporation and its successors.
'Net Available Cash' from an Asset Disposition means cash payments received
(including any cash payments received by way of deferred payment of principal
pursuant to a Note or installment receivable or otherwise, but only as and when
received, but excluding any other consideration received in the form of
assumption by the acquiring Person of Indebtedness or other obligations relating
to such properties or assets or received in any other non-cash form) therefrom,
in each case net of (i) all legal, accounting, investment banking, financial
advisory, brokerage, consultant, title and recording tax expenses, commissions
and other fees and expenses incurred, and all Federal, state, provincial,
foreign and local taxes required to be paid or accrued as a liability under
GAAP, as a consequence of such Asset Disposition, (ii) all payments made on any
Indebtedness which is secured by any assets subject to such Asset Disposition,
in accordance with the terms of any Lien upon such assets, or which must by its
terms, or in order to obtain a necessary consent to such Asset Disposition, or
by applicable law be repaid out of the proceeds from such Asset Disposition,
(iii) all distributions and other payments required to be made to minority
interest holders in Subsidiaries or joint ventures as a result of such Asset
Disposition and (iv) the deduction of appropriate amounts to be provided by the
seller as a reserve, in accordance with GAAP, against any liabilities associated
with the assets disposed of in such Asset Disposition and retained by the
Company or any Restricted Subsidiary after such Asset Disposition, including,
without limitation, in respect of sales price adjustments, pension and other
post-employment benefit liabilities and liabilities related to indemnification
obligations associated with the assets sold or disposed of in such Asset
Disposition.
'Net Cash Proceeds', with respect to any issuance or sale of Capital Stock,
means the cash proceeds of such issuance or sale net of attorneys' fees,
accountants' fees, underwriters' or placement agents' fees, discounts or
commissions and brokerage, consultant and other fees actually incurred in
connection with such issuance or sale and net of taxes paid or payable as a
result thereof.
'New Credit Facility' means that certain credit facility entered into on
the Issue Date among the Company, the Subsidiary Guarantors, Societe Generale,
and the lenders from time to time party thereto, including all collateral
documents, instruments and agreements executed in connection therewith, and the
term New Credit Facility shall also include any amendments, supplements,
modifications, extensions, renewals, restatements or refundings thereof and any
credit facilities or agreements that replace, refund or refinance any part of
the loans, other credit facilities or commitments thereunder, including any such
replacement, refunding or refinancing facility that increases the amount
borrowable thereunder or alters the maturity thereof.
'Non-Recourse Debt' means Indebtedness (i) as to which neither the Company
nor any Restricted Subsidiary (a) provides any Guarantee or credit support of
any kind (including any undertaking, Guarantee, indemnity, agreement or
instrument that would constitute Indebtedness) or (b) is directly or indirectly
liable (as a guarantor or otherwise) and (ii) 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 of the Company or any
Restricted Subsidiary to declare a default under such other Indebtedness or
cause the payment thereof to be accelerated or payable prior to its stated
maturity.
'Obligations' means any principal, interest, penalties, fees, indemnities,
damages and other liabilities payable under the instruments governing, or under
agreements entered into in connection with, any Indebtedness.
'Permitted Holders' means (i) Richard L. Kramer and William L. Remley (the
'Principals'), (ii) any spouse or immediate family member of a Principal and any
child or spouse of any spouse or immediate family member of a Principal, (iii) a
trust, corporation, partnership or other entity, the beneficiaries,
stockholders, partners, owners or Persons beneficially holding, directly or
indirectly, a controlling interest of which consists of a Principal and/or such
other Persons referred to in the immediately preceding clause (ii) or (iv) the
trustees of any trust referred to in clause (iii).
'Permitted Investment' means an Investment by the Company or any Restricted
Subsidiary in (i) the Company or in a Restricted Subsidiary or a Person which
will, upon the making of such Investment, become a Restricted Subsidiary;
provided, however, that the primary business of such Restricted Subsidiary is a
Related Business; (ii) another Person if as a result of such Investment such
other Person is merged or consolidated with or into, or transfers or conveys all
or substantially all its assets to, the Company or a Restricted Subsidiary;
99
<PAGE>
provided, however, that such Person's primary business is a Related Business;
(iii) Temporary Cash Investments; (iv) receivables owing to the Company or any
Restricted Subsidiary, if created or acquired in the ordinary course of business
and payable or dischargeable in accordance with customary trade terms; provided,
however, that such trade terms may include such concessionary trade terms as the
Company or any such Restricted Subsidiary deems reasonable under the
circumstances; (v) payroll, travel, relocation and similar advances to cover
matters that are expected at the time of such advances ultimately to be treated
as expenses for accounting purposes and that are made in the ordinary course of
business; (vi) loans or advances to employees made in the ordinary course of
business of the Company or such Restricted Subsidiary; (vii) stock, obligations
or securities received in settlement of debts created in the ordinary course of
business and owing to the Company or any Restricted Subsidiary or in
satisfaction of judgments; (viii) Guarantees permitted to be made pursuant to
the covenant 'Limitation on Indebtedness and Preferred Stock'; (ix) Investments
in securities of trade creditors received in settlement of obligations or
pursuant to any plan of reorganization or similar arrangement upon the
bankruptcy or insolvency of any trade creditors of customers, (x) Currency
Agreements and Interest Rate Agreements entered into in the ordinary course of
business; provided that such agreements are entered into for bona fide hedging
purposes, are not for speculation or trading purposes and are designed to
protect against fluctuations in interest rates, currency exchange rates or
commodity prices, as the case may be, and, in the case of Interest Rate
Agreements, any such Interest Rate Agreement has a notional amount corresponding
to the Indebtedness being hedged thereby, (xi) Investments made by the Company
or a Restricted Subsidiary in connection with an Asset Disposition made in
compliance with the covenant 'Limitation on Sales of Assets and Subsidiary
Stock,' (xii) any acquisition of assets solely in exchange for the issuance of
Capital Stock (other than Disqualified Stock) of the Company; (xiii) any
Investment existing on the date of the Indenture; and (xiv) other Investments in
any Person having an aggregate fair market value, when taken together with all
other Investments made pursuant to this clause (xiv) that are at the time
outstanding, not to exceed $5 million.
'Permitted Junior Securities' means (A) Capital Stock of the Company or (B)
debt securities that (i) are subordinated to all Senior Indebtedness (and any
debt securities issued in exchange for Senior Indebtedness) to substantially the
same extent as, or to a greater extent than, the Notes are subordinated to
Senior Indebtedness and (ii) have a Stated Maturity no earlier than one year
after the Stated Maturity of the New Credit Facility (or, if earlier, the
Notes).
'Permitted Liens' means (i) Liens securing Senior Indebtedness and
Guarantor Senior Indebtedness that was permitted by the terms of the Indenture
to be incurred; (ii) Liens in favor of the Company or any Restricted Subsidiary;
(iii) Liens on property of a Person existing at the time such Person becomes a
Subsidiary of the Company or is merged into or consolidated with the Company or
any Subsidiary of the Company; provided that such Liens were in existence prior
to the time such Person becomes a Subsidiary or 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 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 to secure Indebtedness
(including Capital Lease Obligations) permitted by clause (ix) of the second
paragraph of the covenant entitle '--Limitation on Indebtedness and Preferred
Stock' covering only the assets acquired with such Indebtedness; (vii) Liens
existing on the date of the Indenture; (viii) 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; (ix)
statutory Liens or landlords', carriers', warehousemens', mechanics', suppliers'
or similar Liens incurred in the ordinary course of business of the Company or
any Subsidiary of the Company; (x) easements, minor title defects,
irregularities in title or other charges or encumbrances on property not
interfering in any material respect with the use of such property by the Company
or a Subsidiary of the Company; (xi) Liens incurred or deposits made in the
ordinary course of business in connection with workers' compensation,
unemployment insurance and other types of social security; (xii) liens securing
industrial revenue bonds or other tax-favored financing; (xiii) deposit
arrangements entered into in connection with acquisitions or in the ordinary
course of business; (xiv) other Liens securing obligations incurred in the
ordinary course of business which obligations do not exceed $2 million at any
one time outstanding; and (xv) any extensions, substitutions, replacements or
renewals of the foregoing.
100
<PAGE>
'Person' means any individual, corporation, partnership joint venture,
association, joint-stock company, trust, unincorporated organization, government
or any agency or political subdivision thereof or any other entity.
'Preferred Stock', as applied to the Capital Stock of any corporation,
means Capital Stock of any class or classes (however designated) which is
preferred as to the payment of dividends, or as to the distribution of assets
upon any voluntary or involuntary liquidation or dissolution of such
corporation, over shares of Capital Stock of any other class of such
corporation.
'Public Equity Offering' means an underwritten primary public offering of
common stock of the Company pursuant to an effective registration statement
under the Securities Act.
'Put/Call Preferred Stock' means preferred stock which may be issued by the
Company or a Subsidiary Guarantor to the holders of any Management Equity
Interests of the Company or such Subsidiary Guarantor in exchange for such
Management Equity Interests held by such holders; provided that (a) payments on
such preferred stock, including pursuant to any redemption, repurchase or
default provision, and payments of dividends on such preferred stock, in each
case in cash, may be made only to the extent Restricted Payments would then be
permitted to be made in accordance with the covenant 'Limitations on Restricted
Payments,' with any such payment being included in the calculation of the amount
of Restricted Payments pursuant to clause (3) of paragraph (a) of such covenant
and (b) no failure to pay such preferred stock or failure to comply with any
other provision of such preferred stock or of the instrument governing such
preferred stock shall cause a default or event of default under any Indebtedness
of the Company and its Restricted Subsidiaries.
'Put/Call Promissory Notes' means promissory notes which may be issued by
the Company or a Subsidiary Guarantor to the holders of any Management Equity
Interests of the Company or such Subsidiary Guarantor in exchange for such
Management Equity Interests held by such holders; provided that (a) such notes
and any guarantees thereof are expressly subordinated to the Notes or the
applicable Subsidiary Guarantee pursuant to the terms of the instrument
governing such notes, (b) such notes are not secured by any Lien or any property
or assets of the Company or any of its Restricted Subsidiaries, (c) payments of
principal on such notes, including pursuant to any guarantee, redemption,
repurchase or default provision, and payments of interest on such notes,
including pursuant to any guarantee, in each case in cash, may be made only to
the extent Restricted Payments would then be permitted to be made in accordance
with the covenant 'Limitation on Restricted Payments,' with any such payment
being included in the calculation of the amount of Restricted Payments pursuant
to clause (3) of paragraph (a) of such covenant and (d) no failure to pay such
notes or failure to comply with any other provision of such notes or of the
instrument governing such notes shall cause a default or event of default under
any Indebtedness of the Company and its Restricted Subsidiaries.
'Refinancing Indebtedness' means Indebtedness issued in exchange for, or
that refunds, refinances, replaces, renews, repays or extends (including
pursuant to any defeasance or discharge mechanism) (collectively, 'refinances,'
and 'refinanced' shall have a correlative meaning) any Indebtedness existing on
the date of the Indenture or Incurred in compliance with the Indenture
(including Indebtedness of the Company that refinances Indebtedness of any
Restricted Subsidiary and Indebtedness of any Restricted Subsidiary that
refinances Indebtedness of another Restricted Subsidiary) including Indebtedness
that refinances other Refinancing Indebtedness; provided, however, that (i) the
Refinancing Indebtedness has a Stated Maturity no earlier than the Stated
Maturity of the Indebtedness being refinanced (or, if earlier, the Notes), (ii)
the Refinancing Indebtedness has an Average Life at the time such Refinancing
Indebtedness is Incurred that is equal to or greater than the Average Life of
the Indebtedness being refinanced and (iii) such Refinancing Indebtedness is
Incurred in an aggregate principal amount (or if issued with original issue
discount, an aggregate issue price) that is equal to or less than the sum of the
aggregate principal amount (or if issued with original issue discount, the
aggregate accreted value) then outstanding of the Indebtedness being refinanced
plus the amount of reasonable fees and expenses and prepayment premiums incurred
in connection with such refinancing; provided further, however, that Refinancing
Indebtedness shall not include (x) Indebtedness of a Restricted Subsidiary which
is not a Subsidiary Guarantor that refinances Indebtedness of the Company or (y)
Indebtedness of the Company or a Restricted Subsidiary that refinances
Indebtedness of an Unrestricted Subsidiary (unless such Unrestricted Subsidiary
is concurrently redesignated a Restricted Subsidiary).
101
<PAGE>
'Related Business' means the businesses of the Company and the Restricted
Subsidiaries on the date of the Indenture and any business related, ancillary or
complementary thereto, or which is an extension thereof, in each case as
determined by the Company in good faith.
'Representative' means any trustee, agent or representative (if any) of an
issue of Designated Senior Indebtedness.
'Restricted Subsidiary' means any Subsidiary of the Company other than an
Unrestricted Subsidiary.
'Sale/Leaseback Transaction' means an arrangement relating to property now
owned or hereafter acquired whereby the Company or a Restricted Subsidiary
transfers such property to a Person (other than to the Company or a Restricted
Subsidiary) and the Company or a Restricted Subsidiary leases it from such
Person.
'SEC' means the U.S. Securities and Exchange Commission.
'Secured Indebtedness' means any Indebtedness of the Company or a
Subsidiary Guarantor secured by a Lien.
'Senior Subordinated Indebtedness' means the Notes and any other
Indebtedness of the Company that specifically provides that such Indebtedness is
to rank pari passu with the Notes in right of payment and is not subordinated by
its terms in right of payment to any Indebtedness or other obligation of the
Company which is not Senior Indebtedness.
'Series B Preferred Stock' means Series B Preferred Stock of KII Holding
required to be issued to its officers and employees pursuant to the Agreement,
dated as of July 1, 1997, among KII Holding and the other parties thereto.
'Significant Subsidiary' means any Restricted Subsidiary that would be a
'Significant Subsidiary' of the Company within the meaning of Rule 1-02 under
Regulation S-X promulgated by the SEC.
'Stated Maturity' means, with respect to any security, the date specified
in such security as the fixed date on which the payment of principal of such
security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred).
'Subordinated Obligation' means any Indebtedness of the Company (whether
outstanding on the Issue Date or thereafter Incurred) which is subordinate or
junior in right of payment to the Notes pursuant to a written agreement.
'Subsidiary' of any Person means any corporation, association, partnership
or other business entity of which more than 50% of the total voting power of
shares of Capital Stock or other interests (including partnership interests)
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 (i) such Person, (ii) such Person and one
or more Subsidiaries of such Person or (iii) one or more Subsidiaries of such
Person.
'Subsidiary Guarantee' means the Guarantee by a Subsidiary Guarantor of the
Company's obligations with respect to the Notes.
'Subsidiary Guarantor' means each Subsidiary of the Company existing on the
Issue Date and each new Subsidiary (other than Foreign Subsidiaries and
Unrestricted Subsidiaries) that guarantees the Company's obligations with
respect to the Notes.
'Temporary Cash Investments' means any of the following: (i) any investment
in direct obligations of the United States of America or any agency thereof or
obligations Guaranteed by the United States of America or any agency thereof,
(ii) investments in time deposit accounts, certificates of deposit, eurodollar
time deposits, bankers' acceptances and money market deposits maturing within
360 days of the date of acquisition thereof issued by a bank or trust company
which is organized under the laws of the United States of America, any state
thereof or any foreign country recognized by the United States of America having
capital, surplus and undivided profits aggregating in excess of $250,000,000 (or
the foreign currency equivalent thereof) and whose long-term debt is rated 'A'
(or such similar equivalent rating) or higher by at least one nationally
recognized statistical rating organization (as defined in Rule 436 under the
Securities Act), (iii) repurchase obligations with a term of not more than 30
days for underlying securities of the types described in clause (i) above
entered into with a bank
102
<PAGE>
meeting the qualifications described in clause (ii) above, (iv) investments in
commercial paper, maturing not more than 180 days after the date of acquisition,
issued by a corporation (other than an Affiliate of the Company) organized and
in existence under the laws of the United States of America or any foreign
country recognized by the United States of America with a rating at the time as
of which any investment therein is made of 'P-1' (or higher) according to
Moody's Investors Service, Inc. or 'A-1' (or higher) according to Standard &
Poor's Ratings Group, (v) investments in securities with maturities of six
months or less from the date of acquisition issued or fully guaranteed by any
state, commonwealth or territory of the United States of America, or by any
political subdivision or taxing authority thereof, and rated at least 'A' by
Standard & Poor's Ratings Group or 'A' by Moody's Investors Service, Inc. and
(vi) investment funds registered under the Investment Company Act of 1940, as
amended, investing at least 95% of their assets in securities of any of the
types described in clauses (i) through (v) above.
'TIA' means the Trust Indenture Act of 1939 (15 U.S.C. Sections 77aaa-
77bbbb) as in effect on the date of the Indenture.
'Trade Payables' means, with respect to any Person, any accounts payable or
any indebtedness or monetary obligation to trade creditors created, assumed or
Guaranteed by such Person arising in the ordinary course of business in
connection with the acquisition of goods or services.
'Unrestricted Subsidiary' means (i) any Subsidiary of the Company that at
the time of determination shall be designated an Unrestricted Subsidiary by the
Board of Directors in the manner provided below and (ii) any Subsidiary of an
Unrestricted Subsidiary. The Board of Directors may designate any Subsidiary of
the Company (including any newly acquired or newly formed Subsidiary of the
Company) to be an Unrestricted Subsidiary unless such Subsidiary or any of its
Subsidiaries owns any Capital Stock or Indebtedness of, or owns or holds any
Lien on any property of, the Company or any other Subsidiary of the Company that
is not a Subsidiary of the Subsidiary to be so designated; provided, however,
that either (A) the Subsidiary to be so designated has total consolidated assets
of $10,000 or less or (B) if such Subsidiary has consolidated assets greater
than $10,000, then such designation would be permitted under 'Limitation on
Restricted Payments.' The Board of Directors may designate any Unrestricted
Subsidiary to be a Restricted Subsidiary; provided, however, that immediately
after giving effect to such designation (x) the Company could Incur $1.00 of
additional Indebtedness under clause (a) of 'Limitation on Indebtedness and
Preferred Stock' and (y) no Default shall have occurred and be continuing. Any
such designation by the Board of Directors shall be evidenced to the Trustee by
promptly filing with the Trustee a copy of the Board Resolution giving effect to
such designation and an Officers' Certificate certifying that such designation
complied with the foregoing provisions.
'U.S. Government Obligations' means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable or redeemable at the issuer's option.
'Voting Stock' of a corporation means all classes of Capital Stock of such
corporation then outstanding and normally entitled to vote in the election of
directors.
'Wholly Owned Subsidiary' means a Restricted Subsidiary of the Company all
the Capital Stock of which (other than directors' qualifying shares) is owned by
the Company or another Wholly Owned Subsidiary.
BOOK-ENTRY; DELIVERY AND FORM
Except as set forth below, the New Notes will initially be issued in the
form of one or more registered Notes in global form without coupons (each a
'Global Note'). Each Global Note will be deposited upon issuance with, or on
behalf of, The Depository Trust Company (the 'Depository') and registered in the
name of Cede & Co., as nominee of the Depository, or will remain in the custody
of the Trustee pursuant to the FAST Balance Certificate Agreement between the
Depository and the Trustee.
New Notes that are issued in respect of Notes that were (i) originally
issued to or transferred to institutional 'accredited investors,' as defined in
Rule 501(a) (1), (3) or (7) under the Securities Act ('Institutional Accredited
Investors'), who are not QIBs or to any other persons who are not QIBs or (ii)
issued as described below under 'Certificated Securities,' will be issued in
registered definitive form without coupons (the 'Certificated Securities'). Upon
the transfer to a QIB of Certificated Securities, such Certificated Securities
103
<PAGE>
may, unless the Global Note has previously been exchanged for Certificated
Securities, be exchanged for an interest in the Global Note representing the
principal amount of Notes being transferred.
The Depository has advised the Company that it is (i) a limited purpose
trust company organized under the laws of the State of New York, (ii) a member
of the Federal Reserve System, (iii) a 'clearing corporation' with the meaning
of the Uniform Commercial Code, as amended, and (iv) a 'Clearing Agency'
registered pursuant to Section 17A of the Exchange Act. The Depository was
created to hold securities for its participants (collectively, the
'Participants') and facilitates the clearance and settlement of securities
transactions between Participants through electronic book-entry changes to the
accounts of its Participants, thereby eliminating the need for physical transfer
and delivery of certificates. The Depository's Participants include securities
brokers and dealers (including the Initial Purchasers), banks and trust
companies, clearing corporations and certain other organizations. Access to the
Depository's system is also available to other entities such as banks, brokers,
dealers and trust companies (collectively, the 'Indirect Participants') that
clear through or maintain a custodial relationship with a Participant, either
directly or indirectly. QIBs may elect to hold Notes purchased by them through
the Depository. QIBs who are not Participants may beneficially own securities
held by or on behalf of the Depository only through Participants or Indirect
Participants. Persons that are not QIBs may not hold Notes through the
Depository.
The Company expects that pursuant to procedures established by the
Depository (i) upon deposit of the Global Note, the Depository will credit the
accounts of Participants designated by the Exchange Agent with an interest in
the Global Note and (ii) ownership of such interests in the Global Note will be
shown on, and the transfer of ownership thereof will be effected only through,
records maintained by the Depository (with respect to the interest of
Participants), the Participants and the Indirect Participants. The laws of some
states require that certain persons take physical delivery in definitive form of
securities that they own and that security interests in negotiable instruments
can only be perfected by delivery of certificates representing the instruments.
Consequently, the ability to transfer Notes or to pledge the Notes as collateral
will be limited to such extent.
So long as the Depository or its nominee is the registered owner of the
Global Note, the Depository or such nominee, as the case may be, will be
considered the sole owner or Holder of the Notes represented by the Global Note
for all purposes under the Indenture. Except as provided below, owners of
beneficial interests in a Global Note will not be entitled to have Notes
represented by such Global Note registered in their names, will not receive or
be entitled to receive physical delivery of Certificated Securities, and will
not be considered the owners or holders thereof under the Indenture for any
purpose, including with respect to giving of any directions, instruction or
approval to the Trustee thereunder. As a result, the ability of a person having
a beneficial interest in Notes represented by a Global Note to pledge such
interest to persons or entities that do not participate in the Depository's
system or to otherwise take action with respect to such interest, may be
affected by the lack of a physical certificate evidencing such interest.
Accordingly, each QIB owning a beneficial interest in a Global Note must
rely on the procedures of the Depository and, if such QIB is not a Participant
or an Indirect Participant, on the procedures of the Participant through which
such QIB owns its interest, to exercise any rights of a Holder under the
Indenture or such Global Note. The Company understands that under existing
industry practice, in the event the Company requests any action of holders or a
QIB that is an owner of a beneficial interest in a Global Note desires to take
any action that the Depository, as the Holder of such Global Note, is entitled
to take, the Depository would authorize the Participants to take such action and
the Participant would authorize QIBs owning through such Participants to take
such action or would otherwise act upon the instruction of such QIBs. Neither
the Company nor the Trustee will have any responsibility or liability for any
aspect of the records relating to or payments made on account of Notes by the
Depository, or for maintaining, supervising or reviewing any records of the
Depository relating to such Notes.
Payments with respect to the principal of, premium, if any, and interest on
any Notes represented by a Global Note registered in the name of the Depository
or its nominee on the applicable record date will be payable by the Trustee to
or at the direction of the Depository or its nominee in its capacity as the
registered Holder of the Global Note representing such Notes under the
Indenture. Under the terms of the Indenture, the Company and the Trustee may
treat the persons in whose names the Notes, including the Global Note, are
registered as the owners thereof for the purpose of receiving such payment and
for any and all other purposes whatsoever. Consequently, neither the Company nor
the Trustee has or will have any responsibility or liability for the payment of
such
104
<PAGE>
amounts to beneficial owners of Notes (including principal, premium, if any, and
interest), or to immediately credit the accounts of the relevant Participants
with such payment, in amounts proportionate to their respective holdings in
principal amount of beneficial interest in the Global Note as shown on the
records of the Depository. Payments by the Participants and the Indirect
Participants to the beneficial owners of Notes will be governed by standing
instructions and customary practice and will be the responsibility of the
Participants or the Indirect Participants.
CERTIFICATED SECURITIES
If (i) the Company notifies the Trustee in writing that the Depository is
no longer willing or able to act as a depository and the Company is unable to
locate a qualified successor within 90 days, (ii) the Company, at its option,
notifies the Trustee in writing that it elects to cause the issuance of Notes in
definitive form under the Indenture or (iii) upon the occurrence of certain
other events, then, upon surrender by the Depository of its Global Notes,
Certificated Securities will be issued to each person that the Depository
identifies as the beneficial owner of the Notes represented by the Global Note.
Upon any such issuance, the Trustee is required to register such Certificated
Securities in the name of such person or persons (or the nominee of any
thereof), and cause the same to be delivered thereto.
Neither the Company nor the Trustee shall be liable for any delay by the
Depository or any Participant or Indirect Participant in identifying the
beneficial owners of the related Notes and each such person may conclusively
rely on, and shall be protected in relying on, instructions from the Depository
for all purposes (including with respect to the registration and delivery, and
the respective principal amounts, of the Notes to be issued).
105
<PAGE>
CERTAIN U.S. FEDERAL INCOME TAX CONSIDERATIONS
The Company recommends that each holder consult such holder's own tax
adviser as to the particular tax consequences of exchanging such holder's Old
Notes for New Notes, including the applicability and effect of any state, local
or foreign tax laws.
PLAN OF DISTRIBUTION
Each Participating Broker-Dealer that receives New Notes for its own
account pursuant to the Exchange Offer must acknowledge that it will deliver a
prospectus in connection with any resale of such New Notes. This Prospectus, as
it may be amended or supplemented from time to time, may be used by a
Participating Broker-Dealer in connection with resales of New Notes received in
exchange for Old Notes where such Old Notes were acquired as a result of
market-making activities or other trading activities. The Company has agreed
that, for a period of 90 days after the Expiration Date, it will make this
Prospectus available to any Participating Broker-Dealer for use in connection
with any such resale. Until , 1998 (90 days after the commencement of
the Exchange Offer), all dealers effecting transactions in the New Notes,
whether or not participating in this distribution, may be required to deliver a
prospectus.
The Company will not receive any proceeds from any sales of the New Notes
by Participating Broker-Dealers. New Notes received by Participating
Broker-Dealers for their own account pursuant to the Exchange Offer may be sold
from time to time in one or more transactions in the over-the-counter market, in
negotiated transactions, through the writing of options on the New Notes or a
combination of such methods of resale, at market prices prevailing at the time
of resale, at prices related to such prevailing market prices or negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such Participating Broker-Dealer and/or the purchasers of
any such New Notes. Any Participating Broker-Dealer that resells the New Notes
that were received by it for its own account pursuant to the Exchange Offer and
any broker or dealer that participates in a distribution of such New Notes may
be deemed to be an 'underwriter' within the meaning of the Securities Act and
any profit on any such resale of New Notes and any commissions or concessions
received by any such persons may be deemed to be underwriting compensation under
the Securities Act. The Letter of Transmittal states that by acknowledging that
it will deliver and by delivering a prospectus, a Participating Broker-Dealer
will not be deemed to admit that it is an 'underwriter' within the meaning of
the Securities Act.
For a period of 90 days after the Expiration Date the Company will promptly
send additional copies of this Prospectus and any amendment or supplement to
this Prospectus to any broker-dealer that requests such documents in the Letter
of Transmittal. The Company has agreed to pay all expenses incident to the
Exchange Offer other than commissions or concessions of any broker-dealers and
will indemnify Holders of the Notes (including any broker-dealers) against
certain liabilities, including liabilities under the Securities Act.
LEGAL MATTERS
The validity of the issuance of the New Notes and the Subsidiary Guarantees
being offered hereby will be passed upon for the Company and the Subsidiary
Guarantors by Winston & Strawn, New York, New York.
EXPERTS
The consolidated balance sheets as of December 31, 1995 and 1996 and the
consolidated statements of income, shareholder's equity, and cash flows for each
of the three years in the period ended December 31, 1996 of Kleinert Industries,
Inc. and its subsidiaries, the predecessor of Stellex and Subsidiaries, in this
Prospectus, have been included herein in reliance on the report of Coopers &
Lybrand L.L.P., independent accountants, given on the authority of that firm as
experts in accounting and auditing. The combined balance sheets as of December
31, 1995 and 1996 and September 30, 1997 and the combined statements of
operations and invested equity and of cash flows for the years ended December
31, 1995 and 1996 and the nine months ended September 30, 1997 of the Tactical
Systems and Microwave Devices Sectors of Watkins-Johnson Company included in
this Prospectus, have been included herein in reliance on the report of Deloitte
& Touche, LLP, independent accountants, given on the authority of that firm as
experts in accounting and auditing. The balance sheet of Stellex as of September
5, 1997 included in this Prospectus has been included herein in reliance on the
report of Deloitte & Touche, LLP, independent accountants, given on the
authority of that firm as experts in accounting and auditing.
106
<PAGE>
INDEX TO FINANCIAL STATEMENTS*
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
STELLEX INDUSTRIES, INC.
Independent Auditors' Report............................................................................... F-2
Balance Sheet at September 5, 1997......................................................................... F-3
Notes to Balance Sheet..................................................................................... F-4
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES (FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
FINANCIAL STATEMENTS:
Report of Independent Accountants.......................................................................... F-5
Consolidated Balance Sheets at December 31, 1995 and 1996 and September 30, 1997 (unaudited)............... F-6
Consolidated Statements of Income for the years ended December 31, 1994, 1995 and 1996
and the nine months ended September 30, 1996 and six months ended June 30, 1997 (predecessor)(unaudited)
and the three months ended September 30, 1997 (successor) (unaudited).................................... F-7
Consolidated Statements of Shareholder's Equity for the years ended December 31, 1994, 1995
and 1996 and the six months ended June 30, 1997 (predecessor)(unaudited) and the three months ended
September 30, 1997 (successor)(unaudited)................................................................ F-8
Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996
and the nine months ended September 30, 1996 and six months ended June 30, 1997 (predecessor)(unaudited)
and the three months ended September 30, 1997 (predecessor)(unaudited)................................... F-9
Notes to Consolidated Financial Statements................................................................. F-10
FINANCIAL STATEMENT SCHEDULE:
Schedule II--Valuation and Qualifying Accounts and Reserves................................................ S-1
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES SECTORS OF
WATKINS-JOHNSON COMPANY
Independent Auditors' Report............................................................................... F-18
Combined Balance Sheets as of December 31, 1995 and 1996 and September 30, 1997............................ F-19
Combined Statements of Operations and Invested Equity for the years ended December 31, 1995 and 1996 and
the nine months ended September 30, 1997................................................................. F-20
Combined Statements of Cash Flows for the years ended December 31, 1995 and 1996 and the nine months ended
September 30, 1997....................................................................................... F-21
Notes to Combined Financial Statements..................................................................... F-22
</TABLE>
- ------------------
* The New Notes are guaranteed by all direct and indirect subsidiaries of
Stellex, Stellex has no operations or assets separate from its investments in
its subsidiaries and the New Notes are guaranteed on a full and unconditional
and joint and several basis by the Subsidiary Guarantors. Accordingly, Stellex
has not presented separate financial statements and other disclosures
concerning each Subsidiary Guarantor because management has determined that
such information is not material to investors.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Stellex Industries, Inc.:
We have audited the accompanying balance sheet of Stellex Industries, Inc.
('Stellex') as of September 5, 1997. This balance sheet is the responsibility of
the management of Stellex. Our responsibility is to express an opinion on this
financial statement based on our audit.
We conducted our audit 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 statement is free from material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statement. 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 audit provides a reasonable basis for our opinion.
In our opinion, such balance sheet presents fairly, in all material respects,
the financial position of Stellex as of September 5, 1997 in conformity with
generally accepted accounting principles.
DELOITTE & TOUCHE LLP
San Jose, California
December 5, 1997
F-2
<PAGE>
STELLEX INDUSTRIES, INC.
BALANCE SHEET
SEPTEMBER 5, 1997
<TABLE>
<S> <C>
ASSETS............................................................. $ 0
----
----
Liabilities and Equity:
Total liabilities................................................ $ 0
----
Preferred stock; stated value $10,000 per share; 500 shares
authorized and 0 shares issued................................ 0
Common stock; no par value; 1,000 shares authorized and 0 shares
issued........................................................ 0
----
Total Liabilities and Equity..................................... $ 0
----
----
</TABLE>
See notes to balance sheet.
F-3
<PAGE>
STELLEX INDUSTRIES, INC.
NOTES TO BALANCE SHEET
SEPTEMBER 5, 1997
NOTE 1--FORMATION
On September 5, 1997, Stellex Holdings Corp. was incorporated as a Delaware
corporation which subsequently on October 23, 1997 amended its articles of
incorporation to change its corporate name to Stellex Industries, Inc.
('Stellex').
NOTE 2--SUBSEQUENT EVENTS
On September 12, 1997, Stellex issued 1,000 shares of its no par common
stock to Greystoke Capital Management Limited LDC ('Greystoke') in exchange for
(i) 8,010 shares of common stock of KII Holding Corp., (ii) 84 shares of Series
A Cumulative Preferred Stock of KII Holding Corp., (iii) $50,000 cash and (iv)
the assumption of a $4,000,000 promissory note. As a result, Stellex acquired an
80.1% interest in KII Holding Corp.
On October 31, 1997, Stellex, through a wholly-owned subsidiary, TSMD
Acquisition Corp., purchased 100% of the outstanding common stock of Stellex
Microwave Systems, Inc., representing the operations of the Tactical Subsystems
and Microwave Devices Sectors ('TSMD') of the Watkins-Johnson Company for a net
purchase price of approximately $82.2 million (after giving effect to estimated
purchase price adjustments). The purchase was financed with the net proceeds
from a simultaneous offering of senior subordinated notes totaling $92.3
million, borrowings of $2.5 million under a newly established $25.0 million
revolving credit facility and the sale of Series A Preferred Stock for an
aggregate consideration of $7,450,000. Existing indebtedness at certain of
Stellex's subsidiaries totaling $19.7 million plus accrued interest was also
repaid concurrently.
F-4
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder of
Kleinert Industries, Inc.
We have audited the accompanying consolidated financial statements and the
financial statement schedule of Kleinert Industries, Inc. and Subsidiaries,
listed in the Index on page F-1 of this Registration Statement on Form S-4.
These financial statements and financial statement schedule 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, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Kleinert
Industries, Inc. and Subsidiaries as of December 31, 1995 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996 in conformity with generally
accepted accounting principles. In addition, in our opinion, the financial
statement schedule referred to above, when considered in relation to the basic
financial statements as a whole, present fairly, in all material respects, the
information required to be included therein.
COOPERS & LYBRAND L.L.P.
Los Angeles, California
April 11, 1997, except for Note 10 as to which the date is July 1, 1997
F-5
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
-------------------------- -------------
1995 1996 1997
----------- ----------- -------------
(PREDECESSOR) (UNAUDITED)
(SUCCESSOR)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.......................................... $ 203,600 $ 406,000 $ 729,800
Trade accounts receivable, less allowance for doubtful
accounts ($61,300 in 1995 and $112,300 in 1996).................... 3,487,400 3,876,000 5,803,200
Inventories (Note 2)............................................... 10,473,600 11,547,700 13,210,800
Due from Parent.................................................... -- 55,600 --
Income taxes receivable............................................ -- -- 466,900
Prepaid and other assets........................................... 188,800 225,700 347,900
Deferred income taxes (Note 6)..................................... 351,000 486,000 486,000
----------- ----------- -------------
Total current assets............................................. 14,704,400 16,597,000 21,044,600
Property, plant and equipment, net (Note 3).......................... 11,775,400 11,165,400 13,766,900
Goodwill, net of accumulated amortization of $231,500 in 1995 and
$262,700 in 1996................................................... 1,017,300 986,100 --
Deferred financing cost.............................................. -- -- 232,200
Other assets......................................................... 683,200 865,900 983,700
----------- ----------- -------------
Total assets..................................................... $28,180,300 $29,614,400 $36,027,400
----------- ----------- -------------
----------- ----------- -------------
</TABLE>
<TABLE>
<S> <C> <C> <C>
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities:
Bank line of credit (Note 4)........................................ $ 3,565,000 $ 4,300,000 $ 1,230,000
Short term notes payable............................................ -- -- 4,000,000
Accounts payable.................................................... 1,167,300 1,525,000 1,536,100
Accrued liabilities................................................. 943,300 1,261,400 2,158,300
Customer deposits................................................... 43,500 177,900 233,100
Income taxes payable................................................ 43,000 39,600 --
Notes payable, current (Note 5)..................................... 2,140,500 1,558,000 58,000
------------ ------------ -------------
Total current liabilities......................................... 7,902,600 8,861,900 9,215,500
Notes payable, less current portion (Note 5).......................... 5,683,000 4,123,900 22,830,900
Unfunded pension benefits (Note 7).................................... 305,000 307,800 307,800
Deferred compensation liability (Note 7).............................. 1,082,400 1,291,900 1,364,000
Deferred income taxes (Note 6)........................................ 462,200 851,300 1,737,000
------------ ------------ -------------
Total liabilities................................................. 15,435,200 15,436,800 35,455,200
------------ ------------ -------------
Minority interest..................................................... -- -- 778,100
Commitments and contingencies (Note 8)
Shareholder's equity:
Common stock, $1,000 par value; 1,000,000 shares authorized, 10,000
shares issued and outstanding at December 31, 1995 and 1996: no
par value; 1,000 shares authorized, issued and outstanding at
September 30, 1997................................................ 10,000,000 10,000,000 50,000
Preferred stock, no par value; 500 shares authorized, none issued
and outstanding at September 30, 1997............................. -- -- --
Additional paid-in capital.......................................... 1,952,700 1,952,700 --
Retained earnings (Accumulated deficit)............................. 792,400 2,224,900 (255,900)
------------ ------------ -------------
Total shareholder's equity (Accumulated deficit).................. 12,745,100 14,177,600 (205,900)
------------ ------------ -------------
Total liabilities and shareholder's equity........................ $ 28,180,300 $ 29,614,400 $36,027,400
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
(PREDECESSOR) FOR THE SIX
----------------------------------------- FOR THE NINE MONTHS FOR THE THREE
MONTHS ENDED ENDED JUNE MONTHS ENDED
FOR THE YEARS ENDED DECEMBER 31, SEPTEMBER 30, 30, SEPTEMBER 30,
----------------------------------------- ------------- ----------- -------------
1994 1995 1996 1996 1997 1997
----------- ----------- ----------- ------------- ----------- -------------
(UNAUDITED) (UNAUDITED)
(SUCCESSOR)
(PREDECESSOR)
<S> <C> <C> <C> <C> <C> <C>
Sales...................... $17,808,400 $21,049,100 $24,306,900 $17,966,900 $14,296,000 $ 8,889,800
Cost of sales.............. 13,121,600 15,083,500 17,366,800 12,872,000 10,139,600 6,746,900
----------- ----------- ----------- ------------- ----------- ------------
Gross profit........... 4,686,800 5,965,600 6,940,100 5,094,900 4,156,400 2,142,900
----------- ----------- ----------- ------------ ----------- ------------
Operating expenses:
Selling and marketing.... 628,600 744,300 836,300 622,900 429,800 251,800
General and
administrative......... 2,480,600 2,554,200 2,792,900 2,124,100 1,353,300 1,318,800
Amortization of
noncompete covenants,
goodwill and
organization costs..... 416,100 282,200 31,200 23,400 15,600 12,200
----------- ----------- ----------- ------------ ----------- ------------
Total operating costs.. 3,525,300 3,580,700 3,660,400 2,770,400 1,798,700 1,582,800
----------- ----------- ----------- ------------ ----------- ------------
Income from
operations........... 1,161,500 2,384,900 3,279,700 2,324,500 2,357,700 560,100
----------- ----------- ----------- ------------ ----------- ------------
Other (income) expense:
Interest income.......... (43,500) (5,500) (11,600) (6,700) (4,500) (2,000)
Interest expense......... 978,800 1,034,400 855,800 659,500 375,700 508,000
Other.................... 144,700 44,100 58,100 39,000 102,900 22,400
----------- ----------- ----------- ------------ ----------- ------------
Total other expense.... 1,080,000 1,073,000 902,300 691,800 474,100 528,400
----------- ----------- ----------- ------------ ----------- ------------
Income before provision
for income taxes..... 81,500 1,311,900 2,377,400 1,632,700 1,883,600 31,700
----------- ----------- ----------- ------------ ----------- ------------
Provision for income taxes
(Note 6)................. 50,000 524,800 944,900 656,700 753,400 287,600
----------- ----------- ----------- ------------ ----------- ------------
Net income (loss)...... $ 31,500 $ 787,100 $ 1,432,500 $ 976,000 $ 1,130,200 $ (255,900)
----------- ----------- ----------- ------------ ----------- ------------
----------- ----------- ----------- ------------ ----------- ------------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-7
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
<TABLE>
<CAPTION>
COMMON STOCK PREFERRED STOCK ADDITIONAL
---------------------- -------------------- PAID-IN RETAINED TOTAL
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS AMOUNT
------- ------------ ------ ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993...... 10,000 $ 10,000,000 -- -- $1,952,700 $ (26,200) $11,926,500
Net income (predecessor)........ -- -- -- -- -- 31,500 31,500
------- ------------ ------ ----------- ---------- ---------- -----------
Balance at December 31, 1994...... 10,000 10,000,000 -- -- 1,952,700 5,300 11,958,000
Net income (predecessor)........ -- -- -- -- -- 787,100 787,100
------- ------------ ------ ----------- ---------- ---------- -----------
Balance at December 31, 1995...... 10,000 10,000,000 -- -- 1,952,700 792,400 12,745,100
Net income (predecessor)........ -- -- -- -- -- 1,432,500 1,432,500
------- ------------ ------ ----------- ---------- ---------- -----------
Balance at December 31, 1996...... 10,000 10,000,000 -- -- 1,952,700 2,224,900 14,177,600
------- ------------ ------ ----------- ---------- ---------- -----------
Net income (unaudited)
(predecessor) for the six
months ended June 30, 1997.... -- -- -- -- -- 1,130,200 1,130,200
------- ------------ ------ ----------- ---------- ---------- -----------
Balance at June 30, 1997
(unaudited)..................... 10,000 $ 10,000,000 -- -- $1,952,700 $3,355,100 $15,307,800
------- ------------ ------ ----------- ---------- ---------- -----------
Stock sale in connection with
the Kleinert Acquisition...... (10,000) (10,000,000) -- -- (1,952,700) (3,355,100) --
Issuance of Stock............... 1,000 50,000 -- -- -- -- 50,000
Net loss (unaudited) (successor)
for the three months ended
September 30, 1997............ -- -- -- -- -- (255,900) (255,900)
------- ------------ ------ ----------- ---------- ---------- -----------
Balance at September 30, 1997
(unaudited)..................... 1,010 $ 50,000 -- $ -- -- ($ 255,900) ($ 205,900)
------- ------------ ------ ----------- ---------- ---------- -----------
------- ------------ ------ ----------- ---------- ---------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE SIX
FOR THE NINE MONTHS
MONTHS ENDED ENDED JUNE FOR THE THREE
FOR THE YEARS ENDED DECEMBER 31, SEPTEMBER 30, 30, MONTHS ENDED
-------------------------------------- ------------- ----------- SEPTEMBER 30,
1994 1995 1996 1996 1997 1997
----------- ----------- ---------- ------------- ----------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
(PREDECESSOR) (SUCCESSOR)
Cash flows from operating activities:
Net income (loss).................... $ 31,500 $ 787,100 $1,432,500 $ 976,000 $1,130,200 ($ 255,900)
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation....................... 2,008,400 1,668,100 1,660,200 1,229,200 862,600 363,400
Amortization....................... 416,100 282,200 31,200 23,400 15,600 12,200
Gain on sale of property........... (11,000) (10,600) (2,200) -- (4,000)
Deferred income taxes.............. 45,200 165,800 254,100 174,400 125,100 51,500
Changes in assets and liabilities:
Trade accounts receivable........ (11,800) (299,000) (388,600) (445,000) (978,200) (899,000)
Inventories...................... (841,400) (1,058,200) (1,074,100) (777,300) (1,078,300) 502,700
Income taxes receivable.......... -- -- -- -- -- 109,800
Prepaid and other assets......... 317,700 (8,400) (36,900) (99,400) (51,244) (91,400)
Due from Parent.................. -- -- (55,600) -- (2,100) --
Other assets..................... (160,800) (146,000) (182,700) (108,000) (74,500) (43,300)
Accounts payable................. 185,700 127,500 357,700 (32,900) 559,000 (549,000)
Accrued liabilities.............. 118,700 329,400 530,400 571,100 17,944 684,700
Customer deposits................ 9,100 8,200 134,400 13,000 (3,100) 58,300
Income taxes payable............. 23,000 20,000 (3,400) (19,600) (39,600) --
----------- ----------- ---------- ------------ ---------- -------------
Net cash provided by (used in)
operating activities......... 2,130,400 1,866,100 2,657,000 1,570,700 479,400 (56,000)
----------- ----------- ---------- ------------ ---------- ------------
Cash flows from investing activities:
Additions to fixed assets............ (288,000) (656,700) (1,052,500) (622,500) (868,500) (539,000)
Collections on notes receivable...... 548,000 1,600 -- -- -- --
Proceeds from sale of fixed assets... 25,100 12,000 4,500 -- 33,500 --
Net cash paid to the Seller for
acquisition of Kleinert............ -- -- -- -- -- (14,799,300)
----------- ----------- ---------- ------------ ---------- ------------
Net cash (used in) provided by
investing activities......... 285,100 (643,100) (1,048,000) (622,500) (835,000) (15,338,300)
----------- ----------- ---------- ------------ --------- ------------
Cash flows from financing activities:
Net borrowings on line of credit..... 169,300 765,000 735,000 (35,000) 300,000 430,000
Repayment on notes payable........... (2,529,100) (2,196,900) (2,141,600) (730,000) (28,400) (14,600)
Proceeds from borrowings in
connection with Kleinert
Acquisition........................ -- -- -- -- -- 23,300,000
Repayment of debt in connection with
Kleinert Acquisition............... -- -- -- -- -- (7,600,000)
Acquisition related costs............ -- -- -- -- -- (313,300)
----------- ----------- ---------- ------------ --------- ------------
Net cash used in financing
activities................... (2,359,800) (1,431,900) (1,406,600) (695,000) 271,600 15,802,100
----------- ----------- ---------- ------------ ---------- ------------
Net increase (decrease) in cash
and cash equivalents......... 55,700 (208,900) 202,400 353,200 (84,000) 407,800
Cash and cash equivalents, beginning of
year................................. 356,800 412,500 203,600 203,600 406,000 322,000
----------- ----------- ---------- ------------ --------- ------------
Cash and cash equivalents, end of
year................................. $ 412,500 $ 203,600 $ 406,000 $ 456,800 $ 322,000 $ 729,800
----------- ----------- ---------- ------------ ---------- ------------
----------- ----------- ---------- ------------ ---------- ------------
Supplemental disclosure of cash flow
information:
Cash paid during the year for:
Interest........................... $ 976,500 $ 1,032,800 $ 863,900
Income taxes--net.................. $ (39,400) $ 339,000 $ 694,200
Note issued to seller in connection
with the accquisition of
Kleinert......................... 1,750,000
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-9
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
General/Basis of Presentation
Kleinert Industries, Inc., a wholly owned subsidiary of Kleinert Industrie
Holding A.G., a Swiss company (the 'Parent') as of December 31, 1995 and 1996
and for the years ended December 31, 1994, 1995 and 1996, was organized under
the laws of the State of California on July 1, 1988, commenced operations on
September 1, 1988, and provides management services for its wholly owned
subsidiaries--Paragon Precision Products ('PPP'), General Inspection
Laboratories, Inc. ('GIL'), Scanning Electron Analysis Laboratories, Inc.
('SEAL'), and Bandy Machining International ('BMI').
Kleinert Acquisition (unaudited) -- On July 1, 1997, KII Holding Corp., a
Delaware company ('KII Holding'), through a wholly-owned subsidiary (KII
Acquisition Corp., a Delaware company), acquired all of the issued and
outstanding capital stock of Kleinert Industries, Inc. and Subsidiaries, a
California company (predecessor company and currently known as Stellex Aerospace
and Subsidiaries) from Kleinert Industries Holding AG. The acquisition has been
accounted for using the purchase method of accounting, and, accordingly, the net
purchase price of approximately $26.5 million (including the assumption of $2.6
million of indebtedness and the issuance to the seller of a note for
approximately $1.75 million) has been allocated to the assets purchased and the
liabilities assumed based upon the fair values at the date of acquisition. There
was no excess purchase price over the fair values on the net assets acquired in
connection with the acquisition. The acquisition was financed with a portion of
the proceeds from new borrowings totaling approximately $23.3 million. KII
Holding is owned by Stellex Industries, Inc., a Delaware company, which owns
approximately 80% of the issued and outstanding common stock of KII Holding,
with Stellex Aerospace's management holding the remainder of its outstanding
common stock. Stellex Industries, Inc., a holding company whose operations are
conducted through its operating subsidiaries, was formed and incorporated on
September 5, 1997. On September 12, 1997, Stellex Industries, Inc. ('Stellex')
sold 1,000 shares of its no par common stock to Greystoke Capital Management
Limited LDC ('Greystoke') for (i) 8,010 shares of common stock of KII Holding
Corp., (ii) 84 shares of Series A Cumulative Preferred Stock of KII Holding
Corp., (iii) $50,000 cash and (iv) assumption of a $4 million promissory note.
This transaction had the effect of exchanging stock for an 80.1% interest in KII
Holding Corp.
The accompanying consolidated financial statements for the years ended
1994, 1995, 1996 and through the acquisition on July 1, 1997 consist of Kleinert
Industries, Inc. and its wholly-owned subsidiaries. Subsequent to the
acquisition, the resultant entity consists of Stellex and its majority owned
subsidiaries: KII Holding, KII Acquisition Corp.; Kleinert Industries, Inc.
(renamed Stellex Aerospace); PPP; GIL; SEAL; and BMI. Prior to the acquisition,
the predecessor company is referred to as the 'Company' for the years ended
1994, 1995, 1996 and through June 30, 1997.
PPP specializes in the manufacture of precision aerospace components. GIL
provides a complete array of non-destructive testing services for inspecting
critical parts and manufactured components. SEAL specializes in materials
analysis and problem-solving for government and industry. BMI manufactures
precision hinges, door panels and hinged assemblies for both aerospace and
industrial applications.
TSMD Acquisition (unaudited) -- On October 31, 1997, Stellex, through a
wholly-owned subsidiary, TSMD Acquisition Corp., purchased 100% of the
outstanding common stock of Stellex Microwave Systems, Inc., representing the
operations of the Tactical Subsystems and Microwave Devices Sectors ('TSMD') of
the Watkins-Johnson Company, for a net purchase price of approximately $82.2
million (after giving effect to estimated purchase price adjustments). The
purchase was financed primarily with the net proceeds from a simultaneous
offering of senior subordinated notes totaling $92.3 million. The accompanying
consolidated financial statements as of September 30, 1997 do not include the
consolidated accounts of TSMD as this acquisition occurred subsequent to
September 30, 1997 (unaudited).
F-10
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--(CONTINUED)
Principles Of Consolidation
As of December 31, 1995 and 1996 and for the years ended December 31, 1994,
1995 and 1996, the consolidated financial statements include the accounts of
Kleinert Industries, Inc. and its wholly owned subsidiaries (the 'Company'). All
significant intercompany transactions have been eliminated in consolidation.
The accompanying consolidated financial statements include the accounts of
Stellex and its majority owned subsidiaries for the period July 1, 1997 through
September 30, 1997 and the consolidated accounts of the predecessor company
prior to the acquisition. All significant intercompany transactions have been
eliminated in consolidation.
Use Of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash And Cash Equivalents
Cash and cash equivalents include all highly liquid investment instruments
purchased with a maturity of three months or less. The carrying amount
approximates fair value because of the short maturity of these instruments.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or
market.
Property, Plant And Equipment
Property, plant and equipment are stated at the Company's allocated
acquisition cost for assets acquired through purchase acquisitions and at cost
for all new additions, and are being depreciated over the estimated useful lives
of the assets, using the straight-line method of depreciation. Estimated useful
lives are as follows:
<TABLE>
<S> <C>
Building and improvements..................... 40 years
Leasehold improvements........................ 3-10 years (based on the lesser of the useful
life of the assets or the remaining life of
the lease)
Machinery and equipment....................... 10 years
Office furniture and fixtures................. 10 years
Office equipment and computers................ 5 years
Autos and trucks.............................. 5 years
</TABLE>
Expenditures for maintenance and repairs are charged to expense as
incurred. Major renewals or betterments which substantially extend the useful
life of the assets are capitalized. Upon sale or disposition of assets, the cost
and related accumulated depreciation are removed from the accounts and any
resulting gain or loss is reflected in income.
Goodwill
Goodwill is amortized over a period of 40 years on a straight-line basis.
F-11
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:--(CONTINUED)
Long-Lived Assets
In fiscal year 1996, the Company adopted Statement of Financial Accounting
Standard No. 121, 'Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of' ('SFAS'). The adoption of SFAS No. 121 had
no impact on the Company's financial position or on its results of operations.
In accordance with SFAS No. 121, long-lived assets held and used by the
Company are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. For
purposes of evaluating the recoverability of long-lived assets, the Company
evaluates the carrying value of its goodwill and property, plant and equipment
on an ongoing basis and recognizes an impairment when the estimated future
undiscounted cash flows from operations are less than the carrying value of the
related long-lived asset.
Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards ('SFAS') No.109, 'Accounting for Income Taxes,'
which prescribes an asset and liability approach. The asset and liability method
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between tax bases and financial
reporting bases of assets and liabilities, using enacted tax rates in effect for
the year in which the differences are expected to reverse.
The provision for income taxes includes federal and state income taxes
currently payable and those deferred because of temporary differences between
the financial statement and tax bases of assets and liabilities. Such temporary
differences primarily result from state franchise taxes, allowance for doubtful
accounts, and differences between the book and tax bases of property and
equipment. If necessary, valuation allowances are established to reduce deferred
tax assets to the amount expected to be realized.
Revenue Recognition
Sales and cost of the products sold are recorded at the time of shipment.
Interim Financial Information
The financial information as of September 30, 1997 and for the nine months
ended September 30, 1996, the six months ended June 30, 1997 and the three
months ended September 30, 1997 is unaudited but, in the opinion of management
of the Company, contains all adjustments (consisting of normal recurring
accruals) necessary for a fair presentation of financial position, results of
operations and cash flows.
2. INVENTORIES:
Inventories consist of the following:
<TABLE>
<CAPTION>
(PREDECESSOR) (SUCCESSOR)
DECEMBER 31, SEPTEMBER
-------------------------- 30,
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Raw materials............................. $ 984,000 $ 1,151,500 $ 1,245,400
Work-in-process........................... 4,089,700 4,634,900 6,400,800
Finished goods............................ 5,399,900 5,761,300 5,564,600
----------- ----------- -----------
Total..................................... $10,473,600 $11,547,700 $13,210,800
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
F-12
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
3. PROPERTY, PLANT AND EQUIPMENT:
Property, plant and equipment consists of the following:
<TABLE>
<CAPTION>
(SUCCESSOR)
(PREDECESSOR) SEPTEMBER
DECEMBER 31, 30,
-------------------------- -----------
1995 1996 1997
----------- ----------- -----------
<S> <C> <C> <C>
Land...................................................... $ 1,230,200 $ 1,230,200 $ 1,000,000
Building and improvements................................. 3,423,800 3,451,900 2,100,000
Leasehold improvements.................................... 203,200 209,700 94,900
Machinery and equipment................................... 19,851,700 20,556,200 10,356,800
Office furniture and fixtures............................. 571,000 574,300 52,400
Office equipment and computers............................ 1,164,700 1,344,000 229,800
Autos and trucks.......................................... 130,200 130,500 46,500
Projects in progress...................................... 254,500 317,800 250,400
----------- ----------- -----------
26,829,300 27,814,600 14,130,300
Less accumulated depreciation............................. (15,053,900) (16,649,200) (363,400)
----------- ----------- -----------
Total................................................ $11,775,400 $11,165,400 $13,766,900
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
4. BANK LINE OF CREDIT:
The Company has a $6,550,000 revolving line of credit with a California
commercial bank. The bank has a first priority security interest in
substantially all assets of the Company, except land and buildings. The line of
credit is scheduled for renewal on August 1, 1997. The line bears interest at
either .25% over the bank's prime rate or 1.5% over the London Interbank Offered
Rate ('LIBOR') or the Offshore Interbank Offered Rate ('IBOR'). At December 31,
1996, the effective interest rate was 7.165% (1995--7.1875%). The credit
agreement contains restrictive covenants on additional borrowings, capital
expenditures, acquisitions and dividend payments and requires that the Company
meet certain specified financial ratios. As of December 31, 1996, the Company
was in compliance with all of the covenants and financial ratios under its
credit agreement. Amounts outstanding under the facility at December 31, 1995
and 1996 were $3,565,000 and $4,300,000, respectively. The carrying amount
approximates fair value because of the short maturity of this instrument.
5. NOTES PAYABLE:
The balance of notes payable consists of the following:
<TABLE>
<CAPTION>
(PREDECESSOR) (SUCCESSOR)
DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1995 1996 1997
---------- ---------- -------------
<S> <C> <C> <C>
Note payable to the Parent with interest at 7.5% payable
trimesterly. The principal balance of $600,000 was paid on
August 31, 1996. Interest expense incurred was $77,900 and
$30,000 in 1995 and 1996, respectively.................... $ 600,000 -- --
</TABLE>
F-13
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
5. NOTES PAYABLE:--(CONTINUED)
<TABLE>
<CAPTION>
(PREDECESSOR) (SUCCESSOR)
DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
1995 1996 1997
---------- ---------- -------------
<S> <C> <C> <C>
Note payable, first deed of trust on PPP land and building
in Valencia, California as collateral, with a net book
value of $4,037,700 (1995--$4,122,900), with interest at
7.875%; principal and interest payments of $22,264 are due
monthly with the unpaid balance of $2,362,700 due December
1, 2001................................................... $2,723,000 $2,681,900 $ 2,638,900
Uncollateralized note payable issued in connection with
acquisition of BMI payable to Credit Suisse, which
provides for interest at the borrower's preference of
either the bank's base prime rate, payable monthly or 1.5%
over LIBOR, payable the earlier of the maturity of the
borrowings for LIBOR or quarterly; the Company exercised
the later option. At December 31, 1996, effective interest
was 7.102% (1995--7.25%); annual principal payments of
$1,500,000 are due through September 1998; the note
becomes due upon a change in ownership of the Company..... 4,500,000 3,000,000 --
Various notes and contracts payable, relating to equipment
and other assets with varying rates of interest and
maturities................................................ 500 -- --
Term note payable issued in connection with acquisition of
Kleinert payable to Societe Generale, which provides for
interest at the borrower's preference of either the banks
prime rate plus 1%, payable on the first day of each
calendar month or 2% over LIBOR, payable at maturity of
the term note; principal amounts shall be payable in
eleven substantially equal semi-annual installments in the
principal amount of $1,300,000 on the second day of
January and July in each year commencing on January 2,
1999 through and including January 2, 2004 and one
installment in the principal amount of $1,700,000 on the
maturing date of June 30, 2004............................ -- -- 16,000,000
Promissory note issued in connection with the acquisition of
Kleinert with interest rate of 10% per annum due along
with the principal amount on June 30, 2005................ -- -- 2,500,000
Note payable to Kleinert Industrie Holding AG in connection
with the Kleinert acquisition with interest rate of 8%
payable annually and principal amount due at maturity,
July 1, 1999; the note is guaranteed by Stellex Aerospace
and each of its subsidiaries.............................. -- -- 1,750,000
---------- ---------- -------------
Total.................................................. 7,823,500 5,681,900 22,888,900
Less current portion...................................... 2,140,500 1,558,000 58,000
---------- ---------- -------------
Long-term portion...................................... $5,683,000 $4,123,900 $ 22,830,900
---------- ---------- -------------
---------- ---------- -------------
</TABLE>
F-14
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
5. NOTES PAYABLE:--(CONTINUED)
Maturities of long-term debt as of December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997........................................................ $1,558,000
1998........................................................ 1,562,800
1999........................................................ 67,900
2000........................................................ 73,400
2001........................................................ 2,419,800
----------
Total.................................................. $5,681,900
----------
----------
</TABLE>
The fair value of the Company's long-term notes payable is based on either
quoted market prices or current rates for similar issues for debt of the same
remaining maturities. At December 31, 1996 and 1995, the fair value of the
Company's long-term notes payable approximated carrying value based on their
effective interest rates compared to current market rates.
6. INCOME TAXES:
The provision for income taxes consists of the following:
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal.......................................................... $ 24,000 $281,400 $514,800
State............................................................ (19,200) 77,600 176,000
-------- -------- --------
4,800 359,000 690,800
-------- -------- --------
Deferred:
Federal.......................................................... (2,800) 121,300 202,700
State............................................................ 48,000 44,500 51,400
-------- -------- --------
45,200 165,800 254,100
-------- -------- --------
Total......................................................... $ 50,000 $524,800 $944,900
-------- -------- --------
-------- -------- --------
</TABLE>
Deferred taxes are primarily the result of the use of accelerated
depreciation for tax purposes, the deferral of gain on property sold following a
tax-free exchange, accrued expenses not currently deductible, and net operating
loss and alternative minimum tax credit carryforwards.
The difference between the actual tax provision and the amount obtained by
applying the statutory federal income tax rate of 34% to the income before
income taxes is primarily attributable to the effect of state income taxes
(state tax rate of 9.3%) and nondeductible expenses relating to goodwill and
officers' life insurance.
The effective tax rate of 40% for the six months ended June 30, 1997
(unaudited) represents the Company's estimate of the annual tax rate. For the
three months ended September 30, 1997 (unaudited), the difference between the
actual tax provision and the amount obtained by applying the statutory federal
income tax rate of 34% to the income before income taxes is primarily
attributable to the effect of nondeductible expense relating to inventory
resulting from the acquisition of Kleinert.
At December 31, 1996, the Company's alternative minimum tax credits for
federal and state purposes are estimated to be $279,200 and $119,700,
respectively, which are available to reduce income taxes on an indefinite
carryforward basis.
F-15
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
6. INCOME TAXES:--(CONTINUED)
The net deferred tax assets and liabilities at December 31, consist of the
following:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Deferred tax assets--current.............................................. $ 376,000 $ 519,300
Deferred tax liabilities--current......................................... (25,000) (33,300)
----------- -----------
Net deferred tax asset--current......................................... $ 351,000 $ 486,000
----------- -----------
----------- -----------
Deferred tax liabilities--long-term....................................... ($1,998,900) ($2,006,000)
Deferred tax assets--long-term............................................ 1,536,700 1,154,700
----------- -----------
Net deferred tax liability--long-term................................... ($ 462,200) ($ 851,300)
----------- -----------
----------- -----------
</TABLE>
7. EMPLOYEE BENEFIT PLANS:
Defined Contribution Plan
The Company sponsors a defined contribution pension plan which covers
substantially all employees. Company contributions are determined at 1.5% of the
employees' gross compensation, plus an additional matching of 50% of the
employees' voluntary contribution. The maximum Company contribution is limited
to 3% of the employees' gross compensation. Total Company contributions were
$192,100, $200,500 and $223,300 in 1994, 1995 and 1996, respectively.
Unfunded Pension Benefits
The Company also sponsors a defined benefit plan which covers four
employees of a subsidiary of the Company. The balance of unfunded pension
benefits represents the net present value of estimated future payments based on
actuarially determined life expectancies and an 8% discount rate. No assets have
currently been provided for the plan.
Deferred Compensation Agreements
The Company has individual deferred compensation agreements with eight
management employees. These agreements provide for monthly payments to be made
to the individuals commencing upon their retirement and continuing for an
agreed-upon term as set forth in the agreements, generally fifteen years. The
amount of the payments is specified by each contract and is generally equal to
forty percent of the employee's average compensation for the last five years of
his employment as reduced by the amount of any company--provided benefits to
which the employee is entitled from any other Kleinert pension benefit plan. The
agreements also contain other provisions entitling the employees to
pre-retirement death benefits, disability benefits and survivor benefits.
The Company has in place individual life insurance policies on each of the
covered employees and intends to use the insurance benefits (accumulated cash
surrender value of the policies and the post-retirement death benefits) to fund
the benefit payments required under the agreements. The insurance policies are
designed such that the insurance benefits under the policies are expected, over
time, to be sufficient to pay all of the required benefits and reimburse the
Company for its costs of providing the insurance.
At December 31, 1995 and 1996, the deferred compensation liability was
$1,082,400 and $1,291,900, respectively. The estimated liability was calculated
based on actuarially determined estimates of compensation, mortality, retirement
dates and other relevant factors pertaining to the participants and a discount
rate of 8% per annum. The related expense for the years ended December 31, 1994,
1995 and 1996 was 77,200, $71,800 and $209,500, respectively. The expense for
1996 included the nonrecurring step-up of the liability for the implementation
of two additional agreements effective January 1, 1996.
F-16
<PAGE>
STELLEX INDUSTRIES, INC., AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF SEPTEMBER 30, 1997 AND FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1996, THE SIX MONTHS ENDED JUNE 30, 1997
AND THE THREE MONTHS ENDED SEPTEMBER 30, 1997 IS UNAUDITED)
8. LEASE COMMITMENTS:
The Company leases office facilities and equipment under operating lease
agreements which expire at various dates through 2004. The facility leases have
renewal options. Certain leases provide for annual increases, at various dates,
based upon percentage changes in the Consumer Price Index.
Minimum annual rentals and sublease income on facility and equipment leases
are as follows:
<TABLE>
<CAPTION>
MINIMUM
ANNUAL
RENTALS
----------
<S> <C>
1997........................................................ $ 703,400
1998........................................................ 710,300
1999........................................................ 596,900
2000........................................................ 339,600
2001........................................................ 18,300
Thereafter.................................................. 26,300
----------
Total....................................................... $2,394,800
----------
----------
</TABLE>
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Rent expense(a).................................................... $725,300 $740,200 $723,300
Sublease income.................................................... $ 24,000 $ 26,400 $ --
</TABLE>
- ------------------
(a) Includes $292,100, $309,500 and $290,000 in 1994, 1995 and 1996,
respectively, for facility rent paid to the former owner of BMI.
9. FINANCIAL INSTRUMENTS:
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of trade accounts receivable.
The Company's customer base principally includes the commercial aviation,
aerospace and defense industries. The Company is directly affected by national
and international economic conditions in the aerospace and defense industries.
Management believes that such factors are mitigated by the longevity of the
Company's relationships with its customers. For the year ended December 31,
1996, the Company derived approximately 53% of its sales from ten (10) customers
consisting of nineteen (19) separate operating divisions.
It is the policy of the Company to deposit its cash in federally insured
financial institutions. From time to time, deposits exceed Federal Deposit
Insurance Corporation limits.
10. SUBSEQUENT EVENTS:
On July 1, 1997, the Company's prior owner sold 100% of the outstanding
stock of the Company to KII Acquisition Corp., a subsidiary of KII Holding. In
connection with such sale, all indebtedness of the Company other than the
Company's building mortgage was repaid. As part of the closing of the sale,
certain members of management of the Company were paid a bonus totaling
approximately $1,460,000 as part of a management participation agreement with
the prior owner. Management is entitled to receive additional compensation from
the prior owner based on a percentage of the amount repaid under the $1,750,000
Kleinert Seller Note issued in connection with the sale.
F-17
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of Watkins-Johnson Company:
We have audited the accompanying combined balance sheets of the Tactical
Subsystems and Microwave Devices Sectors of Watkins-Johnson Company (the
'Sectors'), as of December 31, 1995 and 1996 and September 30, 1997 and the
related combined statements of operations and invested equity and of cash flows
for the years ended December 31, 1995 and 1996 and the nine months ended
September 30, 1997. These combined financial statements are the responsibility
of the management of Watkins-Johnson Company. 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 from
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, the financial statements referred to above present fairly, in
all material respects, the combined financial position of the Sectors as of
December 31, 1995 and 1996 and September 30, 1997 and the combined results of
their operations and their combined cash flows for the periods stated above in
conformity with generally accepted accounting principles.
The Sectors are business units of Watkins-Johnson Company; consequently, as
indicated in Note 1, these financial statements have been derived from the
consolidated financial statements and accounting records of Watkins-Johnson
Company, and reflect significant assumptions and allocations. Moreover, as
indicated in Note 1, the Sectors rely on Watkins-Johnson Company for
administrative, management and other services. The reported financial position,
results of operations and cash flows of the Sectors could differ from those that
would have resulted had the Sectors operated autonomously or as an entity
independent of Watkins-Johnson Company.
DELOITTE & TOUCHE LLP
San Jose, California
November 4, 1997
F-18
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
<S> <C> <C> <C>
ASSETS
Current Assets:
Receivables, net........................................................... $16,800 $18,200 $15,200
Unbilled receivables....................................................... 800 4,300 300
Inventories................................................................ 12,700 18,900 15,100
Deferred tax asset......................................................... 2,900 3,400 3,000
Other...................................................................... 300 300 300
------- ------- -------------
Total current assets......................................................... 33,500 45,100 33,900
Property Plant and Equipment:
Machinery and equipment.................................................... 42,800 44,500 45,100
Accumulated depreciation and amortization.................................. (37,100) (39,400) (40,800)
------- ------- -------------
Property, plant and equipment, net........................................... 5,700 5,100 4,300
------- ------- -------------
Total Assets................................................................. $39,200 $50,200 $38,200
------- ------- -------------
------- ------- -------------
LIABILITIES AND INVESTED EQUITY
Current liabilities:
Accounts payable........................................................... $ 5,800 $ 2,400 $ 2,400
Advances on contracts...................................................... 1,900 7,500 4,800
Accrued salaries and profit sharing........................................ 1,900 2,100 1,500
Accrued vacation........................................................... 2,300 2,300 2,000
Provision for losses on contracts.......................................... 2,700 2,900 3,000
Accrued expenses--other.................................................... 2,000 2,100 1,000
------- ------- -------------
Total current liabilities.................................................... 16,600 19,300 14,700
Deferred tax liability....................................................... 200 500 500
Deferred compensation........................................................ 1,000 500 500
Commitments and contingencies (Note 4)
Invested equity.............................................................. 21,400 29,900 22,500
------- ------- -------------
Total liabilities and invested equity........................................ $39,200 $50,200 $38,200
------- ------- -------------
------- ------- -------------
</TABLE>
See notes to combined financial statements.
F-19
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
COMBINED STATEMENTS OF OPERATIONS AND INVESTED EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------------------- -----------------
1995 1996 1997
------------ ------------ -----------------
<S> <C> <C> <C>
Sales................................................................... $ 97,600 $ 89,200 $ 67,900
Cost of goods sold...................................................... 65,200 68,100 47,900
------------ ------------ -----------------
Gross profit....................................................... 32,400 21,100 20,000
Operating expenses:
Research and development.............................................. 4,800 3,500 1,600
Selling and administrative............................................ 10,000 8,300 5,600
Corporate allocations................................................. 2,500 2,800 1,900
------------ ------------ -----------------
Total operating expenses........................................... 17,300 14,600 9,100
------------ ------------ -----------------
Income before income taxes.............................................. 15,100 6,500 10,900
Income tax provision.................................................... 5,900 2,500 4,200
------------ ------------ -----------------
Net income......................................................... 9,200 4,000 6,700
Invested equity, beginning of period.................................... 31,000 21,400 29,900
Net advances to (from) the sectors...................................... (18,800) 4,500 (14,100)
------------ ------------ -----------------
Invested equity, end of period.......................................... $ 21,400 $ 29,900 $ 22,500
------------ ------------ -----------------
------------ ------------ -----------------
</TABLE>
See notes to combined financial statements.
F-20
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------- -----------------
1995 1996 1997
-------- ------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income........................................................... $ 9,200 $ 4,000 $ 6,700
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Depreciation and amortization of property, plant and
equipment.................................................... 2,600 2,300 1,400
Deferred taxes.................................................. (200) (200) 400
Net changes in operating assets and liabilities:
Receivables, net................................................ 2,500 (4,900) 7,000
Inventories..................................................... 5,000 (6,200) 3,800
Other current assets............................................ (100) -- --
Accrued expenses and payables................................... 2,300 (3,100) (2,000)
Advances on contracts........................................... (1,200) 5,600 (2,700)
Provisions for losses on contracts.............................. 800 200 100
Deferred compensation........................................... 100 (500) --
-------- ------- -----------------
Net cash provided by (used in) operating activities.................... 21,000 (2,800) 14,700
-------- ------- -----------------
Cash flows from investing activities:
Additions to property, plant and equipment........................... (2,200) (1,700) (600)
-------- ------- -----------------
Cash flows from financing activities:
Net advances to (from) the Sectors................................... (18,800) 4,500 (14,100)
-------- ------- -----------------
Net increase in cash................................................... -- -- --
Cash, beginning of period.............................................. -- -- --
-------- ------- -----------------
Cash, end of period.................................................... $ -- $ -- $ --
-------- ------- -----------------
-------- ------- -----------------
</TABLE>
See notes to combined financial statements.
F-21
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and Description of Business
The Tactical Subsystems and Microwave Devices Sectors ('TSMD' or the
'Sectors') are business units within the Microwave Products Group (the 'Group')
of Watkins-Johnson Company ('Watkins-Johnson' or the 'Company'). The Sectors
design, market and manufacture a broad range of microwave devices, modular
subsystems and electronic equipment operating over the RF and microwave
frequency bands for sale primarily for military and aerospace applications.
Basis of Presentation
As business units of Watkins-Johnson, the Company does not prepare separate
financial statements for the Sectors in accordance with generally accepted
accounting principles ('GAAP') in the normal course of operations. Accordingly,
the accompanying combined financial statements have been derived from the
consolidated assets, liabilities, revenues and expenses, and the accounting
records of Watkins-Johnson. The accompanying combined financial statements
reflect the assets, liabilities, revenue and expenses directly attributable to
the Sectors as well as allocations deemed reasonable by management to present
the financial position, results of operations and cash flows of the Sectors on a
stand-alone basis. Although management is unable to estimate the actual costs
that would have been incurred if the services performed by Watkins-Johnson had
been purchased from independent third parties, the allocation methodologies have
been described within the respective footnotes, where applicable, and management
considers the allocations to be reasonable. However, the financial position,
results of operations and cash flows of the Sectors may differ from those that
would have been achieved had the Sectors operated autonomously or as a combined
entity independent of Watkins-Johnson.
Revenue Recognition and Receivables
Revenues, other than long-term contracts, are recorded upon shipment or
completion of tasks as specified in the contract. Estimated product warranty
costs are accrued at the time of shipment; actual warranty costs have not
differed materially from these accrued estimates. Sales and allowable fees under
cost-reimbursement contracts are recorded as costs are incurred. Long-term
contract sales and cost of goods sold are recognized using the
percentage-of-completion method based on the actual physical completion of work
performed and the ratio of costs incurred to total estimated costs to complete
the contract. Any anticipated losses on contracts are charged to earnings when
identified.
Unbilled receivables represent revenue recognized for long-term contracts
not yet billable based on the terms of the contract. These amounts are billable
upon shipment of the product, achievement of milestones, or completion of the
contract. Unbilled receivables are expected to be billed and collected within
one year. Receivables representing retainage not collectible within one year are
not material. There are no significant billed or unbilled receivables subject to
future negotiation.
Government contracts have provisions for audit, price redetermination and
other profit and cost limitations. Contracts may be terminated without prior
notice at the government's convenience. In the event of such termination, the
Company may be compensated for the work performed, a reasonable allowance for
profit, and commitments at the time of termination. The right to terminate for
convenience has not had any significant effect on the Company's financial
position or results of operations.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of trade receivables.
Concentration of credit risk with respect to trade receivables is limited due to
the nature of the customers to which the Company's products are sold.
F-22
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Inventories
Inventories are stated at the lower of cost, using first-in, first-out and
average-cost basis, or market. Cost of inventory items is based on purchase and
production cost. Long-term contract costs and selling and administrative
expenses are excluded from inventory. Progress payments are not netted against
inventory.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Leases which at inception
assure the lessor full recovery of the fair market value of the property over
the lease term are capitalized. Provision for depreciation and amortization is
primarily based on the sum-of-the-years'-digits and straight-line methods.
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standard No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of, which established the accounting
and reporting requirements for recognizing and measuring impairment of
long-lived assets. The effect of adopting this standard did not have a material
effect on fiscal 1996 or the nine months ended September 30, 1997.
Accounts Payable and Accrued Expenses
Accounts payable and accrued liabilities records are maintained at the
Group level. For determining balance sheet amounts, accounts payable and other
accrued expenses have been allocated to the Sectors based on the ratio that the
total sales of the Sectors bears to the total sales of the Group. In the opinion
of management, the liabilities allocated to the Sectors as of December 31, 1995
and 1996 and September 30, 1997 are reasonable.
Deferred Compensation
The Company has deferred compensation plans covering selected members of
management and key technical employees. The purpose is to reward and encourage
talented employees to remain with the Company. Such amounts are payable in
accordance with various fixed payment schedules.
Stock-Based Compensation
The Sectors account for stock-based compensation under the intrinsic value
method as defined in Accounting Principles Board Opinion No. 25, 'Accounting for
Stock Issued to Employees,' (APB 25).
Research and Development
Research and development (R&D) costs incurred by the Sectors are
accumulated on an identified project basis. Costs associated with
customer-funded R&D are included in cost of sales. Company-sponsored R&D
projects related to the Sectors is included in expense in the period incurred.
Allocated Expenses
Certain overhead, selling, administrative and corporate expenses represent
an allocation of the Group's operating expenses and include payroll and charges
for office space which the Sector shares with Watkins-Johnson. These costs have
been allocated to the Sectors based primarily on the allocation methodology
prescribed by government regulations pertaining to government contractors, which
management believes to be a reasonable allocation method.
Corporate support costs such as treasury, cash management, accounting,
financial management, legal, public relations, information systems, human
resources, telecommunications, and support services are allocated to the Group
based primarily on the ratio that the total cost of sales of the Group bears to
the total cost of sales of the Company, which management believes to be a
reasonable allocation method. However, such amounts may not be the same as would
have been incurred had the Sectors operated autonomously or as a combined entity
independent of Watkins-Johnson.
F-23
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
In 1995, the Sectors incurred a charge of approximately $400,000, included
in sales and administrative expense, for a reduction in force of sales
employees. In 1996, the Sectors incurred a charge of approximately $700,000,
included in cost of sales, for a reduction in force of operational and
manufacturing employees.
Interest Expense
No interest expense has been charged to the Sectors on their invested
equity by Watkins-Johnson.
Income Taxes
The Sectors' results are included in the consolidated federal and state tax
returns of Watkins-Johnson and its affiliates. The Sectors have provided for
income taxes as if they were a separate taxpayer utilizing federal and state
statutory tax rates. The combined financial statements include provisions for
deferred income taxes using the liability method for transactions that are
reported in one period for financial accounting purposes and in another for
income tax purposes. Deferred tax assets have been recognized based on the
realizability determination of Watkins-Johnson.
Cash Flows
The Company does not maintain separate cash accounts for its Sectors, and
all cash receipts and disbursements are made at the Group level. For the
purposes of the statements of cash flows, the allocated assets and liabilities
of the Sectors have been used to calculate the cash flow statements.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. In addition to the allocation of corporate
and Group expenses described above, the most significant assumptions and
estimates relate to allowance for bad debts, inventory obsolescence, percentage
of completion on long-term contracts and warranty provisions. Actual results
could differ from those estimates.
2. RECEIVABLES
Receivables consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------ -------------
1995 1996 1997
------- ------- -------------
<S> <C> <C> <C>
Trade.................................................... $16,300 $17,300 $15,100
Long-term contracts:
Billed................................................. 900 1,400 600
Unbilled............................................... 800 4,300 300
------- ------- -------------
Total.................................................... 1,700 5,700 900
------- ------- -------------
18,000 23,000 16,000
Less: allowance for doubtful accounts.................... 400 500 500
------- ------- -------------
Receivables, net......................................... $17,600 $22,500 $15,500
------- ------- -------------
------- ------- -------------
</TABLE>
F-24
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
------------------ -------------
1995 1996 1997
------- ------- -------------
<S> <C> <C> <C>
Finished goods........................................... $ 800 $ 900 $ 1,200
Work-in-progress......................................... 8,200 11,000 6,800
Raw materials............................................ 3,700 7,000 7,100
------- ------- -------------
$12,700 $18,900 $15,100
------- ------- -------------
------- ------- -------------
</TABLE>
In the fourth quarter of 1996, the Sectors incurred a charge of
approximately $1,500,000, included in cost of sales, for the writeoff of slow
moving and excess inventories.
4. FACILITIES
The Sectors operate in facilities owned or leased by Watkins-Johnson, and
are not included in the combined balance sheets of the Sectors. The Sectors are
allocated depreciation and lease costs based on an estimate of occupancy.
Such facilities are subject to an environmental remediation plan being
monitored by various regulatory agencies. Watkins-Johnson recorded a provision
for estimated remediation actions and cleanup costs related to these facilities
in 1991, and no additional provisions have been made by the Company, nor is any
charges relating to such remediation included in the Sectors' combined
statements of operations for the years ended 1995 and 1996 or the nine months
ended September 30, 1997. Management of Watkins-Johnson believes the accrual of
$8 million as of December 31, 1996 and $7 million as of September 30, 1997 (not
included in the accompanying combined balance sheets of the Sectors) remains
adequate based on facts known at that time. However, changes in environmental
regulations, improvements in cleanup technology and discovery of additional
information concerning this site could affect estimated costs in the future.
5. SHAREOWNERS' EQUITY
Stock Option Plans
Employees of the Sectors participate in the stock option plans of the
Company. The employee stock option plan provides for grants of nonqualifying and
incentive stock options to certain key employees and officers. Watkins-Johnson
may grant options to purchase up to 3,900,000 shares of common stock. The
options are granted at the market price on date of grant and expire on the tenth
anniversary date. One-third of the options granted are exercisable in each of
the third, fourth and fifth succeeding years. The plan allows those employees
who are subject to the insider trading restrictions certain limited rights to
receive cash in the event of a change in control.
As discussed in Note 1, the Company applies Accounting Principles Board
Opinion No. 25, 'Accounting for Stock Issued to Employees,' and related
interpretations in accounting for its plans. Accordingly, no compensation
expense has been recognized for its stock-based compensation plans. Had
compensation cost for the Company's stock option plans been determined based
upon the fair value at the grant date for awards under these plans, and
amortized over the vesting period of the awards consistent with the methodology
prescribed under Statement of Financial Accounting Standards No. 123,
'Accounting for Stock-Based Compensation,' the Sectors' pro forma combined net
income for the years ended December 31, 1995 and 1996 and nine months ended
September 30, 1997 would have been $9,000,000, $3,800,000 and $6,600,000,
respectively. However, the impact of outstanding nonvested stock options granted
prior to 1995 has been excluded from the pro forma calculation; accordingly, the
1995, 1996 and 1997 pro forma adjustments are not indicative of future period
pro
F-25
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. SHAREOWNERS' EQUITY--(CONTINUED)
forma adjustments, when the calculation will apply to all applicable stock
options. The weighted average fair value of options granted during 1995, 1996
and 1997 is calculated as $13.58, $5.94 and $6.81, respectively, on the date of
grant using the Black-Scholes option-pricing model with the following weighted
average assumptions for the stock of Watkins-Johnson: dividend yield of 1.7% for
1995 grants, 1.5% for 1996 grants and 1.28% for 1997 grants; volatility, 37.5%
for 1995 and 1996 and 38% for 1997; risk-free interest rate at the time of grant
of 7.1% for 1995, 6.2% for 1996 and 6.0% for 1997; and an expected term to
exercise of approximately 3.5 months from the vest date for 1996 and 1995 and
4.5 months from the vest date for 1997. The Company's calculations are based on
a multiple option valuation approach, and forfeitures are recognized as they
occur.
6. INCOME TAXES
The provision for taxes on income from operations consists of the following
(in thousands):
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Current:
Federal........................................................ $4,900 $2,300 $3,100
State.......................................................... 1,200 400 800
------ ------ ------
Total current.................................................... 6,100 2,700 3,900
Deferred
Federal........................................................ (200) (200) 300
State.......................................................... -- -- --
------ ------ ------
Total deferred................................................... (200) (200) 300
------ ------ ------
Total............................................................ $5,900 $2,500 $4,200
------ ------ ------
------ ------ ------
</TABLE>
Deferred tax assets (liabilities) consist of the following at December 31,
1995 and 1996 and September 30, 1997 (in thousands):
<TABLE>
<S> <C> <C> <C>
Program accruals................................................. $1,000 $1,000 $1,000
Inventory reserves............................................... 800 1,500 1,100
Bad debt reserves................................................ 100 200 200
Compensation..................................................... 600 400 300
Uniform capitalization........................................... 100 200 200
State taxes...................................................... 200 -- 100
Worker's compensation reserve.................................... 100 100 100
------ ------ ------
Gross deferred tax assets........................................ 2,900 3,400 3,000
Deferred tax liabilities-depreciation............................ (200) (500) (500)
------ ------ ------
Net deferred tax assets.......................................... $2,700 $2,900 $2,500
------ ------ ------
------ ------ ------
</TABLE>
The differences between the effective income tax rate and the statutory
federal income tax rate are as follows:
<TABLE>
<S> <C> <C> <C>
Statutory federal tax rate....................................... 35.0% 35.0% 35.0%
Export sales benefit............................................. (1.0) (0.8) (1.2)
State taxes, net of federal benefit.............................. 5.1 4.3 4.7
------ ------ ------
Effective rate................................................... 39.1% 38.5% 38.5%
------ ------ ------
------ ------ ------
</TABLE>
The effective tax rate of 38.5% for the nine months ended September 30,
1997 represents the Company's estimate of the 1997 annual tax rate for the
Sectors.
F-26
<PAGE>
TACTICAL SUBSYSTEMS AND MICROWAVE DEVICES
SECTORS OF WATKINS-JOHNSON COMPANY
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
7. EMPLOYEE BENEFIT PLANS
The Watkins-Johnson Employees' Investment Plan conforms to the requirements
of the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal
Revenue Code as a qualified defined contribution plan. The Plan covers
substantially all employees of the Sectors and for 1995, 1996 and 1997 provided
that the Company match employees' 401(k) salary deferrals up to 3% of eligible
employee compensation. The amount charged to income was $897,000 in 1995,
$804,000 in 1996 and $528,000 for the nine months ended September 30, 1997.
The Employee Stock Ownership Plan (ESOP) was established to encourage
employee participation and long-term ownership of Company stock and covers
substantially all employees of the Sectors. The Board determines each year's
contribution depending on the performance and financial condition for the
Company. The Board approved a contribution equal to 1% of eligible employee
compensation for 1995, 1996 and the nine months ended September 30, 1997, which
resulted in charges to income of $244,000, $286,000 and $192,000, respectively.
The ESOP is a qualified defined contribution plan under ERISA.
8. SIGNIFICANT CUSTOMERS
The Sectors sell primarily to the defense market, and had sales of
$72,200,000 in 1995, $62,400,000 in 1996 and $47,200,000 in the nine months
ended September 30, 1997 to the U.S. government and its prime contractors.
Export sales were $15,000,000 in 1995, $13,700,000 in 1996 and $13,900,000 in
the nine months ended September 30, 1997.
Sales to individual customers representing greater than 10% of company
sales are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
<S> <C> <C> <C>
Hughes Aircraft Company.................................. $40,000 $30,000 $20,000
Raytheon Company......................................... 8,300 8,000 14,000
United States government................................. 13,000 4,000 3,000
</TABLE>
In October 1997, Raytheon Co. obtained government approval to acquire the
defense holdings of Hughes Aircraft Company in a merger. It is unknown what
effect, if any, such a merger may have on the Sectors at this time.
9. SALE OF TSMD OPERATIONS
On or prior to October 31, 1997, the Company contributed the operations of
TSMD, along with certain of the Sectors' assets and the transfer of certain
liabilities to its subsidiary, W-J TSMD, Inc., which was renamed Stellex
Microwave Systems, Inc. (Stellex Microwave). The stock of Stellex Microwave was
sold to TSMD Acquisition Corp. on October 31, 1997. The transaction was
completed under a previously announced Stock Purchase Agreement dated as of
August 29, 1997 (Stock Purchase Agreement).
Watkins-Johnson has agreed to sublease space to Stellex Microwave in Palo
Alto, California for three years. Under the terms of the Stock Purchase
Agreement and the sublease agreement, Watkins-Johnson has generally retained
liability for contamination of the property that (i) occurred on or prior to the
consummation of the sale and (ii) occurs during the term of the sublease
agreement not caused primarily by Stellex Microwave, and has agreed to indemnify
Stellex Microwave in connection therewith.
F-27
<PAGE>
APPENDIX I
GLOSSARY
Amplifier: A device which is used in a transmitter or receiver to increase the
power level of the signal to a useful range.
CNC: Computer Numerical Control. A manufacturing system which allows machinists
to use menu prompts on a computer screen to quickly program a machine tool to
produce complex parts.
Converter: A circuit that changes radio frequency signals from one frequency to
another.
Device: An electrical component or integrated circuit.
EDM: Electrical Discharge Machining. A cutting method by which materials are
machined without physical contact using an electrically charged wire that melts
a small portion of the work piece. Since no cutting forces are present, EDM is
ideal for delicate parts.
Filter: A circuit which selectively allows signals of desired frequencies to
pass while simultaneously rejecting signals of undesired frequencies.
Four and five axis machining: A machining method by which a CNC machine can
independently move four or five machine axes to generate taper cuts.
Frequency: The number of complete oscillations per second in an electromagnetic
wave.
GaAs: Gallium Arsenide. Substrate material used in the fabrication of high
frequency diodes, transistors, and integrated circuits.
High Radio Frequency: Nomenclature used to describe frequency ranges from 3
megahertz to 300 gigahertz.
High Reliability: See Space Qualified.
Integrated Subsystem: A collection of MFMs packaged together on a mechanical
mounting structure and integrated with control and power conditioning
electronics.
MFM: Multi-function module. A hermetically sealed structure containing a custom
substrate base, which is used as a transmission medium, along with active chips
such as diodes and transistors.
Microwave: Frequency band nomenclature used to characterize signals with a
wavelength between 30 and 1 centimeters in length.
Millimeter wave: Frequency band nomenclature used to characterize signals with a
wavelength below 1 centimeter in length.
Mixer: A device which converts radio frequency power at one frequency into power
at another frequency to facilitate signal processing.
Oscillator: A component that oscillates at a set frequency, thereby generating a
signal.
Output Transducer: A device which converts an electrical message signal to its
desired output form. For example, the output transducer for a voice
communication system can be a loudspeaker.
Processor: An electronic device that operates on data.
Receiver: A device which operates on the output signal from a transmission
channel in preparation for delivery to the output transducer.
SFM: Single Function Module. An enclosure which contains circuitry intended to
realize a single electrical function. These functions include amplifiers,
filters, oscillators and frequency converters.
Space Qualified: Electrical components which have been environmentally tested,
screened and documented to a level suitable for delivery and use in space based
applications. Also referred to as high reliability.
Substrate: The physical material on which a thin film or integrated circuit is
fabricated.
I-1
<PAGE>
Thin Film: A photolithography process used to deposit high definition metallized
traces on substrate materials.
Transceiver: An integrated device which incorporates the functions of a
transmitter and receiver in one package. Typically used in a communication
system in which the transmitter and receiver share a common antenna.
Transmitter: A device which processes an input signal to produce a transmitted
signal suited to the characteristics of the transmission channel.
Transmission Channel: The electrical medium that bridges the distance from
source to destination. The transmission channel can be a pair of wires, a
coaxial cable or a radio wave.
Tuner: A microwave device designed to search and collect communication and
non-communication signals, while maintaining all of the received signal's
characteristics.
VCO: Voltage Controlled Oscillator. A device which generates an output signal
whose operating frequency is determined and adjusted by a variable input direct
current (DC) voltage.
Wavelength: The distance between the peak cycles of a periodic electromagnetic
wave.
YIG: Yttrium-Iron Garnet. Magnetic insulators which resonate at a microwave
frequency when magnetized by a suitable direct magnetic field. Typically used in
tunable microwave filters and oscillators.
I-2
<PAGE>
------------------------------------------------------
------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR ANY OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE
HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE AN IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information.......................... i
Prospectus Summary............................. 1
Risk Factors................................... 13
Capitalization................................. 22
Pro Forma Consolidated Financial Data.......... 23
Selected Historical Financial Data............. 29
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 31
Business....................................... 40
Management..................................... 58
Certain Transactions........................... 62
Principal Stockholders......................... 66
Description of Certain Indebtedness............ 67
The Exchange Offer............................. 69
Description of Notes........................... 77
Certain U.S. Federal Income Tax
Considerations............................... 106
Plan of Distribution........................... 106
Legal Matters.................................. 106
Experts........................................ 106
Index to Financial Statements.................. F-1
Glossary....................................... I-1
</TABLE>
Until , 1998 (90 days after the commencement of the Exchange Offer),
all dealers effecting transactions in the registered securities, whether or not
participating in the distribution, may be required to deliver a prospectus. This
delivery requirement is in addition to the obligation of dealers to deliver a
prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
------------------------------------------------------
$100,000,000
[LOGO]
OFFER TO EXCHANGE $1,000 IN PRINCIPAL AMOUNT OF ITS SERIES B 9 1/2% SENIOR
SUBORDINATED NOTES DUE 2007 WHICH HAVE BEEN REGISTERED UNDER THE SECURITIES ACT
FOR EACH $1,000 IN PRINCIPAL AMOUNT OF ITS 9 1/2% SENIOR SUBORDINATED NOTES DUE
2007.
THE EXCHANGE AGENT FOR THE
EXCHANGE OFFER IS:
MARINE MIDLAND BANK
By Facsimile:
(212) 658-2292
Confirmation by Telephone:
(212) 658-5931
By Mail, Overnight Courier or Hand Delivery
140 Broadway -- Level A
New York, New York 10005-1180
Attention: Corporate Trust Services
------------------------
PROSPECTUS
------------------------
, 1998
------------------------------------------------------
------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Capitalized terms used but not defined in Part II have the meanings
ascribed to them in the Prospectus contained in this Registration Statement.
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Stellex Industries, Inc. and its subsidiaries, TSMD Acquisition Corp., KII
Holding Corp. and KII Acquisition Corp. (collectively, the 'Delaware
Subsidiaries'), are Delaware corporations. Section 145 ('Section 145') of the
General Corporation Law of the State of Delaware (the 'DGCL') provides that a
Delaware corporation may indemnify any persons who were, are or are threatened
to be made, parties to any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative (other than
an action by or in the right of such corporation), by reason of the fact that
such person is or was an officer, director, employee or agent of such
corporation, or is or was serving at the request of such corporation as a
director, officer, employee or agent of another corporation or enterprise. The
indemnity may include expenses (including attorneys' fees), judgments, fines and
amounts paid in settlement actually and reasonably incurred by such person in
connection with such action, suit or proceeding provided such person acted in
good faith and in a manner he reasonably believed to be in or not opposed to the
corporation's best interests and, with respect to any criminal action or
proceeding, had no reasonable cause to believe that his conduct was illegal. A
Delaware corporation may indemnify any persons who are, were or are threatened
to be made, a party to any threatened, pending or completed action or suit by or
in the right of the corporation by reasons of the fact that such person was a
director, officer, employee or agent of such corporation, or is or was serving
at the request of such corporation as a director, officer, employee or agent of
another corporation or enterprise. The indemnity may include expenses (including
attorneys' fees) actually and reasonably incurred by such person in connection
with the defense or settlement of such action or suit, provided such person
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the corporation's best interests, provided that no indemnification is
permitted without judicial approval if the officer, director, employee or agent
is adjudged to be liable to the corporation. Where an officer, director,
employee or agent is successful on the merits or otherwise in the defense of any
action referred to above, the corporation must indemnify him against the
expenses which such officer or director has actually and reasonably incurred.
The Certificate of Incorporation and/or Bylaws of each of Stellex and the
Delaware Subsidiaries provide for the indemnification of persons under the
circumstances described in Section 145 of the DGCL.
Stellex Microwave Systems, Inc., Stellex Aerospace, Bandy Machining
International, Paragon Precision Products, Scanning Electron Analysis
Laboratories, Inc. and General Inspection Laboratories, Inc. are California
corporations and their Articles of Incorporation and Bylaws provide for
indemnification of their officers and directors to the fullest extent permitted
by law. Section 204(10) of the California General Corporation Law (the 'CGCL')
eliminates the liability of a corporation's directors for monetary damages to
the fullest extent permissible under California law. Pursuant to Section 204(11)
of the CGCL, a California corporation may idemnify Agents (as defined in Section
317 of the CGCL), subject only to the applicable limits set forth in Section 204
of the CGCL with respect to actions for breach of duty to the corporation and
its shareholders.
As permitted by Section 317 of the CGCL, indemnification may be provided by
a California corporation of its Agents (as defined in Section 317 of the CGCL),
to the maximum extent permitted by the CGCL, in connection with any proceeding
arising by reason of the fact that such person is or was such a director or
officer, against expenses, judgments, fines, settlements and other amounts
actually and reasonably incurred in any such proceeding.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits:
<TABLE>
<S> <C> <C>
*3.1 -- Certificate of Incorporation of Stellex Industries, Inc.
*3.2 -- Bylaws of Stellex Industries, Inc.
*3.3 -- Certificate of Incorporation of TSMD Acquisition Corp.
*3.4 -- Bylaws of TSMD Acquisition Corp.
</TABLE>
II-1
<PAGE>
<TABLE>
<S> <C> <C>
*3.5 -- Articles of Incorporation of Stellex Microwave Systems, Inc.
*3.6 -- Bylaws of Stellex Microwave Systems, Inc.
*3.7 -- Certificate of Incorporation of KII Holding Corp.
*3.8 -- Bylaws of KII Holding Corp.
*3.9 -- Certificate of Incorporation of KII Acquisition Corp.
*3.10 -- Bylaws of KII Acquisition Corp.
*3.11 -- Articles of Incorporation of Stellex Aerospace.
*3.12 -- Bylaws of Stellex Aerospace.
*3.13 -- Articles of Incorporation of Bandy Machining International.
*3.14 -- Bylaws of Bandy Machining International.
*3.15 -- Articles of Incorporation of Paragon Precision Products.
*3.16 -- Bylaws of Paragon Precision Products.
*3.17 -- Articles of Incorporation of Scanning Electron Analysis Laboratories, Inc.
*3.18 -- Bylaws of Scanning Electron Analysis Laboratories, Inc.
*3.19 -- Articles of Incorporation of General Inspection Laboratories, Inc.
*3.20 -- Bylaws of General Inspection Laboratories, Inc.
*4.1 -- Purchase Agreement dated as of October 23, 1997, by and among Stellex Industries, Inc., TSMD
Acquisition Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex
Aerospace, Bandy Machining International, Paragon Precision Products, Scanning Electron Analysis
Laboratories, Inc. and General Inspection Laboratories, Inc. and Societe Generale Securities
Corporation, BT Alex. Brown Incorporated and Jefferies & Company, Inc.
*4.2 -- Indenture dated as of October 31, 1997 by and among Stellex Industries, Inc., TSMD Acquisition Corp.,
Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy
Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc.
and General Inspection Laboratories, Inc. and Marine Midland Bank, as trustee.
*4.3 -- Registration Rights Agreement dated as of October 31, 1997 by and among Stellex Industries, Inc.,
TSMD Acquisition Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp.,
Stellex Aerospace, Bandy Machining International, Paragon Precision Products, Scanning Electron
Analysis Laboratories, Inc. and General Inspection Laboratories, Inc. and Societe Generale Securities
Corporation, BT Alex. Brown Incorporated and Jefferies & Company, Inc.
5.1 -- Opinion of Winston & Strawn.
*10.1 -- Credit Agreement dated as of October 31, 1997 by and among Stellex Industries, Inc., TSMD Acquisition
Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace,
Bandy Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories,
Inc. and General Inspection Laboratories, Inc. and Societe Generale, as Agent.
</TABLE>
II-2
<PAGE>
<TABLE>
<S> <C> <C>
+10.2 -- Stock Purchase Agreement dated as of August 29, 1997 by and among TSMD Acquisition Corp.,
Watkins-Johnson Company and W-J TSMD Inc.
</TABLE>
<TABLE>
<CAPTION>
The following schedules to the Stock Purchase Agreement have been omitted. The Company hereby
undertakes to furnish supplementally a copy of any such omitted schedules to the Commission upon
request.
SCHEDULE TITLE
----------------- -----------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 2.4 -- Status of Tax Audits
Schedule 2.5(a) -- Customer Contracts
Schedule 2.5(b) -- Certain Supplier Contracts
Schedule 2.5(c) -- Government Contracts
Schedule 2.5(d) -- Certain Contracts over $250,000
Schedule 2.5(e) -- Certain Contracts in Excess of Three Years
Schedule 2.5(f) -- Substantially Dependent/Material Adverse Contracts
Schedule 2.5(m) -- Material Losses
Schedule 2.5(n) -- Offshore Production Contracts
Schedule 2.6(d) -- Government Furnished Items
Schedule 2.16 -- Employee Benefit Plan
Schedule 2.21 -- Key Customer/Supplier
Schedule 2.23(c) -- Government Contract Audit
Schedule 2.24 -- Backlog
Schedule 2.25 -- Clearances
Schedule 5.7 -- Warranty Principles
Schedule 5.10 -- Proration
Schedule 9.15 -- Knowledge
</TABLE>
<TABLE>
<S> <C> <C>
*10.3 -- Stock Purchase Agreement dated as of May 23, 1997, by and among KII Acquisition Corp. and Kleinert
Industrie Holding AG.
</TABLE>
<TABLE>
<CAPTION>
The following schedules to the Stock Purchase Agreement have been omitted. The Company hereby
undertakes to furnish supplementally a copy of any such omitted schedules to the Commission
upon request.
SCHEDULE TITLE
------------------- --------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 3.1.5 -- No Violation (Seller)
Schedule 3.1.6 -- Third Party Consents (Seller)
Schedule 3.1.7 -- No Litigation (Seller)
Schedule 3.2.2(a) -- Organization and Good Standing (Company)
Schedule 3.2.2(b) -- Organization and Good Standing (Subsidiaries)
Schedule 3.2.3(b) -- Outstanding Stock of Subsidiaries
Schedule 3.2.5 -- Title to Assets
Schedule 3.2.6(b) -- Absence of Certain Changes
Schedule 3.2.6(c) -- Undisclosed Liabilities
Schedule 3.2.8 -- Compliance with Laws
Schedule 3.2.11 -- No Violation (Company/Subsidiaries)
Schedule 3.2. -- Third Party Consents (Company/Subsidiaries)
Schedule 3.2.13 -- No Litigation
Schedule 3.2.14(a) -- Plans
Schedule 3.2.14(b) -- Health Benefits
Schedule 3.2.14(c) -- Claims Related to Plans
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE TITLE
------------------- --------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 3.2.14(e) -- Plans in Compliance
Schedule 3.2.14(h) -- Plan Administration
Schedule 3.2.14(i) -- Funding
Schedule 3.2.14(j) -- Funding of Deferred Compensation Plans
Schedule 3.2.15A -- Owned and Leased Real Property
Schedule 3.2.15B -- Encumbrances, etc.
Schedule 3.2.16 -- Accounts Receivable
Schedule 3.2.17 -- Inventory
Schedule 3.2.18 -- Customers
Schedule 3.2.19 -- Product Warranty and Product Liability
Schedule 3.2.20 -- Insurance
Schedule 3.2.21 -- Machinery and Equipment
Schedule 3.2.22 -- Intellectual Properties
Schedule 3.2.23 -- Capital Projects and Expenditures
Schedule 3.2.24 -- Subsidiaries
Schedule 3.2.25(a) -- Hazardous Substances--Use, Storage & Disposal
Schedule 3.2.25(b) -- Hazardous Substances--Asbestos, etc.
Schedule 3.2.25(c) -- Hazardous Substances--Environmental Litigation
Schedule 3.2.25(d) -- Hazardous Substances--Compliance
Schedule 3.2.25(e) -- Hazardous Substances--Underground Storage Tanks
Schedule 3.2.26(b) -- Taxes--Returns Filed, Taxes Paid
Schedule 3.2.26(c) -- Taxes--Tax Reserves
Schedule 3.2.26(d) -- Taxes--Returns Furnished
Schedule 3.2.26(e) -- Taxes--Deficiencies, Audits, etc.
Schedule 3.2.27 -- Compensation, Vacation Time, etc.
Schedule 3.2.29 -- Bank Accounts, Investments
Schedule 3.2.30 -- Contracts, Other Agreements
Schedule 3.2.31 -- Permits and Licenses
Schedule 3.2.32 -- Indebtedness
Schedule 5.2.2 -- Capital Transactions
Schedule 5.2.3 -- Personal Property
Schedule 5.2.9 -- Noncompliance with Existing Indebtedness
Schedule 6.2.1 -- Elimination of Intercompany Accounts
Schedule 6.2.2 -- Intercompany Agreements
Schedule 7.1.6 -- Compliance with Law
Schedule 9.2 -- Inventory Reserve Amount
</TABLE>
<TABLE>
<S> <C> <C>
*10.4 -- Stellex Aerospace Investor Agreement dated as of July 1, 1997, by and among KII Holding Corp. and
Greystoke Capital Management Limited LDC, and Bradley C. Call, Julius E. Hodge, Lawrence R. Smith,
John Barriatua, Roland H. Marti, Arun Kumar and Louis A. Brown.
*10.5 -- Promissory Note dated as of July 1, 1997 by KII Acquisition Corp. to Kleinert Industrie Holding AG.
*10.6 -- Promissory Note dated September 6, 1991 by Paragon Precision Products to Farm Bureau Life Insurance
Company.
</TABLE>
II-4
<PAGE>
<TABLE>
<S> <C> <C>
*10.7 -- Amended and Restated Management Advisory Services Agreement, effective as of November 1, 1997, by and
between Mentmore Holdings Corporation, Stellex Industries, Inc., TSMD Acquisition Corp., Stellex
Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy Machining
International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc. and General
Inspection Laboratories, Inc.
*10.8 -- Tax Allocation and Indemnity Agreement dated as of October 31, 1997, and retroactively applied to the
calendar year ended December 31, 1997, by and among Stellex Industries, Inc., TSMD Acquisition Corp.,
Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy
Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc.
and General Inspection Laboratories, Inc.
+10.9 -- Gallium Arsenide and Thin Film Supply and Services Agreement dated as of October 31, 1997 between
Stellex Industries, Inc. and Watkins-Johnson Company.
+10.10 -- Metal Injection Molding, Glass Seal and Hybrid Assembly Facility Agreement dated as of October 31,
1997 between Stellex Industries, Inc. and Watkins-Johnson Company.
+10.11 -- Cross License Agreement dated as of October 31, 1997 between Watkins-Johnson Company, Stellex
Microwave Systems, Inc. and TSMD Acquisition Corp.
10.12 -- Employment Agreement dated as of November 1, 1997 between Stellex Microwave Systems, Inc. and Keith
Gilbert.
*12.1 -- Statement Regarding Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Subsidiaries of the Registrants.
23.1 -- Consent of Coopers & Lybrand L.L.P.
23.2 -- Consent of Deloitte & Touche LLP.
23.3 -- Consent of Winston & Strawn (included in Exhibit 5.1).
*24.1 -- Powers of Attorney.
*25.1 -- Statement of Eligibility of Trustee.
*27.1 -- Financial Data Schedule.
*99.1 -- Form of Letter of Transmittal.
*99.2 -- Form of Notice of Guaranteed Delivery.
*99.3 -- Form of Tender Instructions.
</TABLE>
- ------------------
* Previously filed.
+ Confidential treatment requested for a portion of this exhibit previously
filed.
(B) FINANCIAL STATEMENT SCHEDULES:
Schedule II--Valuation and Qualifying Accounts and Reserves
ITEM 22. UNDERTAKINGS.
Each undersigned registrant hereby undertakes:
(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;
(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. 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
II-5
<PAGE>
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% change in the maximum aggregate
offering price set forth in the 'Calculation of Registration
Fee' table in the effective 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
the 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;
(4) Each undersigned registrant hereby undertakes as follows: that
prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this
registration statement, by any person or party who is deemed to be
an underwriter within the meaning of Rule 145(c), the registrant
undertakes that such reoffering prospectus will contain the
information called for by the applicable registration form with
respect to reofferings by persons who may be deemed underwriters,
in addition to the information called for by the other items of
the applicable form;
(5) Each registrant undertakes that every prospectus: (i) that is
filed pursuant to paragraph (1) immediately preceding, or (ii)
that purports to meet the requirements of Section 10(a)(3) of the
Act and is used in connection with an offering of securities
subject to Rule 415, will be filed as a part of an amendment to
the registration statement and will not be used until such
amendment is effective, and that, for purposes 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;
(6) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 may be permitted to directors, officers and
controlling persons of the registrants pursuant to the provisions
described under Item 20 or otherwise, the registrants have been
advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as
expressed in the 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
registrants 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, each
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 Act and will be
governed by the final adjudication of such issue;
(7) Each undersigned registrant hereby undertakes to respond to
requests for information that is incorporated by reference into
the prospectus pursuant to Item 4, 10(b), 11 or 13 of this form,
within one business day of receipt of such request, and to send
the incorporated documents by first class mail or other equally
prompt means. This includes information contained in documents
filed subsequent to the effective date of the registration
statement through the date of responding to the request; and
(8) Each undersigned registrant hereby undertakes to supply by means
of a post-effective amendment all information concerning a
transaction, and the company being acquired involved therein, that
was not the subject of and included in the registration statement
when it became effective.
II-6
<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 New York,
State of New York, as of January 16, 1998.
STELLEX INDUSTRIES, INC.
By: /s/ William L. Remley
----------------------------------
William L. Remley
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman, President, Chief Executive January 16, 1998
- ------------------------------------------ Officer and Treasurer
William L. Remley
*P. Roger Byer Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
P. Roger Byer officer)
*By /s/ William L. Remley
---------------------------------------
William L. Remley
(Attorney-in-Fact)
</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 New York,
State of New York, as of January 16, 1998.
TSMD ACQUISITION CORP.
By: /s/ William L. Remley
----------------------------------
William L. Remley
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley President and Treasurer January 16, 1998
- ------------------------------------------ (principal financial and accounting
William L. Remley officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</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 Palo Alto,
State of California, as of January 16, 1998.
STELLEX MICROWAVE SYSTEMS, INC.
By: /s/ Keith D. Gilbert
----------------------------------
Keith D. Gilbert
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
/s/ William L. Remley Chairman of the Board of Directors and January 16, 1998
- ------------------------------------------ Treasurer
William L. Remley
*Richard L. Kramer Vice Chairman January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ Keith D. Gilbert President and Chief Executive Officer and January 16, 1998
- ------------------------------------------ Director
Keith D. Gilbert
*P. Roger Byer Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
P. Roger Byer officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</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 Woodland
Hills, State of California, as of January 16, 1998.
KII HOLDING CORP.
By: /s/ Bradley C. Call
----------------------------------
Bradley C. Call
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
/s/ Bradley C. Call President and Director January 16, 1998
- ------------------------------------------
Bradley C. Call
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</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 Woodland
Hills, State of California, as of January 16, 1998.
KII ACQUISITION CORP.
By: /s/ Bradley C. Call
----------------------------------
Bradley C. Call
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
/s/ Bradley C. Call President and Director January 16, 1998
- ------------------------------------------
Bradley C. Call
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-11
<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 Woodland
Hills, State of California, as of January 16, 1998.
STELLEX AEROSPACE
By: /s/ Bradley C. Call
----------------------------------
Bradley C. Call
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, as amended,
this Registration Statement has been signed by the following persons in the
capacities and as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Assistant Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
/s/ Bradley C. Call President, Chief Executive Officer and January 16, 1998
- ------------------------------------------ Director
Bradley C. Call
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-12
<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 Burbank,
State of California, as of January 16, 1998.
BANDY MACHINING INTERNATIONAL
By: /s/ Thomas B. Fulton
----------------------------------
Thomas B. Fulton
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Assistant Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
/s/ Thomas B. Fulton President January 16, 1998
- ------------------------------------------
Thomas B. Fulton
*Bradley C. Call Director January 16, 1998
- ------------------------------------------
Bradley C. Call
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-13
<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 Woodland
Hills, State of California, as of January 16, 1998.
PARAGON PRECISION PRODUCTS
By: /s/ Lawrence Smith
----------------------------------
Lawrence Smith
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Assistant Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
*Bradley C. Call Director January 16, 1998
- ------------------------------------------
Bradley C. Call
/s/ Lawrence Smith President January 16, 1998
- ------------------------------------------
Lawrence Smith
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-14
<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 El Segundo,
State of California, as of January 16, 1998.
SCANNING ELECTRON
ANALYSIS LABORATORIES, INC.
By: /s/ Roland H. Marti
----------------------------------
Roland H. Marti
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Assistant Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
*Bradley C. Call Director January 16, 1998
- ------------------------------------------
Bradley C. Call
/s/ Roland H. Marti President January 16, 1998
- ------------------------------------------
Roland H. Marti
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-15
<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 Cudahy,
State of California, as of January 16, 1998.
GENERAL INSPECTION LABORATORIES, INC.
By: /s/ John Barriatua
----------------------------------
John Barriatua
President
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 as of the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------------------ ------------------------------------------- -------------------
<S> <C> <C>
*Richard L. Kramer Chairman of the Board of Directors January 16, 1998
- ------------------------------------------
Richard L. Kramer
/s/ William L. Remley Vice Chairman and Assistant Treasurer January 16, 1998
- ------------------------------------------
William L. Remley
*Bradley C. Call Director January 16, 1998
- ------------------------------------------
Bradley C. Call
/s/ John Barriatua President January 16, 1998
- ------------------------------------------
John Barriatua
*Julius E. Hodge Chief Financial Officer January 16, 1998
- ------------------------------------------ (principal financial and accounting
Julius E. Hodge officer)
*By /s/ William L. Remley
-------------------------------------
William L. Remley
(Attorney-in-Fact)
</TABLE>
II-16
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
(FORMERLY KLEINERT INDUSTRIES, INC. AND SUBSIDIARIES)
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
<TABLE>
<CAPTION>
DEDUCTIONS--
UNCOLLECTIBLE
ADDITIONS ACCOUNTS
------------------------ WRITES OFF
BALANCE CHARGED NET OF RECOVERY
AT TO COSTS OF PREVIOUSLY BALANCE
BEGINNING AND FROM WRITTEN-OFF AT END
OF YEAR EXPENSES ACQUISITIONS ITEMS OF YEAR
--------- -------- ------------ ---------------- --------
<S> <C> <C> <C> <C> <C>
1996
Allowance for doubtful accounts.............. $61,300 $ 39,200 $ -- $ 11,800 $112,300
--------- -------- ------ ---------------- --------
--------- -------- ------ ---------------- --------
1995
Allowance for doubtful accounts.............. $33,300 $ 30,100 $ -- $ (2,100) $ 61,300
--------- -------- ------ ---------------- --------
--------- -------- ------ ---------------- --------
1994
Allowance for doubtful accounts.............. $14,400 $ 13,500 $ -- $ 5,400 $ 33,300
--------- -------- ------ ---------------- --------
--------- -------- ------ ---------------- --------
</TABLE>
S-1
<PAGE>
EXHIBIT INDEX
<TABLE>
<S> <C> <C>
*3.1 -- Certificate of Incorporation of Stellex Industries, Inc.
*3.2 -- Bylaws of Stellex Industries, Inc.
*3.3 -- Certificate of Incorporation of TSMD Acquisition Corp.
*3.4 -- Bylaws of TSMD Acquisition Corp.
*3.5 -- Articles of Incorporation of Stellex Microwave Systems, Inc.
*3.6 -- Bylaws of Stellex Microwave Systems, Inc.
*3.7 -- Certificate of Incorporation of KII Holding Corp.
*3.8 -- Bylaws of KII Holding Corp.
*3.9 -- Certificate of Incorporation of KII Acquisition Corp.
*3.10 -- Bylaws of KII Acquisition Corp.
*3.11 -- Articles of Incorporation of Stellex Aerospace.
*3.12 -- Bylaws of Stellex Aerospace.
*3.13 -- Articles of Incorporation of Bandy Machining International.
*3.14 -- Bylaws of Bandy Machining International.
*3.15 -- Articles of Incorporation of Paragon Precision Products.
*3.16 -- Bylaws of Paragon Precision Products.
*3.17 -- Articles of Incorporation of Scanning Electron Analysis Laboratories, Inc.
*3.18 -- Bylaws of Scanning Electron Analysis Laboratories, Inc.
*3.19 -- Articles of Incorporation of General Inspection Laboratories, Inc.
*3.20 -- Bylaws of General Inspection Laboratories, Inc.
*4.1 -- Purchase Agreement dated as of October 23, 1997, by and among Stellex Industries, Inc., TSMD
Acquisition Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex
Aerospace, Bandy Machining International, Paragon Precision Products, Scanning Electron Analysis
Laboratories, Inc. and General Inspection Laboratories, Inc. and Societe Generale Securities
Corporation, BT Alex. Brown Incorporated and Jefferies & Company, Inc.
*4.2 -- Indenture dated as of October 31, 1997 by and among Stellex Industries, Inc., TSMD Acquisition Corp.,
Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy
Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc.
and General Inspection Laboratories, Inc. and Marine Midland Bank, as trustee.
*4.3 -- Registration Rights Agreement dated as of October 31, 1997 by and among Stellex Industries, Inc.,
TSMD Acquisition Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp.,
Stellex Aerospace, Bandy Machining International, Paragon Precision Products, Scanning Electron
Analysis Laboratories, Inc. and General Inspection Laboratories, Inc. and Societe Generale Securities
Corporation, BT Alex. Brown Incorporated and Jefferies & Company, Inc.
5.1 -- Opinion of Winston & Strawn.
*10.1 -- Credit Agreement dated as of October 31, 1997 by and among Stellex Industries, Inc., TSMD Acquisition
Corp., Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace,
Bandy Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories,
Inc. and General Inspection Laboratories, Inc. and Societe Generale, as Agent.
</TABLE>
<PAGE>
<TABLE>
<S> <C> <S>
+10.2 -- Stock Purchase Agreement dated as of August 29, 1997 by and among TSMD Acquisition Corp.,
Watkins-Johnson Company and W-J TSMD Inc.
</TABLE>
<TABLE>
<CAPTION>
The following schedules to the Stock Purchase Agreement have been omitted. The Company hereby
undertakes to furnish supplementally a copy of any such omitted schedules to the Commission upon
request.
SCHEDULE TITLE
----------------- -----------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 2.4 -- Status of Tax Audits
Schedule 2.5(a) -- Customer Contracts
Schedule 2.5(b) -- Certain Supplier Contracts
Schedule 2.5(c) -- Government Contracts
Schedule 2.5(d) -- Certain Contracts over $250,000
Schedule 2.5(e) -- Certain Contracts in Excess of Three Years
Schedule 2.5(f) -- Substantially Dependent/Material Adverse Contracts
Schedule 2.5(m) -- Material Losses
Schedule 2.5(n) -- Offshore Production Contracts
Schedule 2.6(d) -- Government Furnished Items
Schedule 2.16 -- Employee Benefit Plan
Schedule 2.21 -- Key Customer/Supplier
Schedule 2.23(c) -- Government Contract Audit
Schedule 2.24 -- Backlog
Schedule 2.25 -- Clearances
Schedule 5.7 -- Warranty Principles
Schedule 5.10 -- Proration
Schedule 9.15 -- Knowledge
</TABLE>
<TABLE>
<S> <C> <C>
*10.3 -- Stock Purchase Agreement dated as of May 23, 1997, by and among KII Acquisition Corp. and Kleinert
Industrie Holding AG.
</TABLE>
<TABLE>
<CAPTION>
The following schedules to the Stock Purchase Agreement have been omitted. The Company hereby
undertakes to furnish supplementally a copy of any such omitted schedules to the Commission
upon request.
SCHEDULE TITLE
------------------- --------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 3.1.5 -- No Violation (Seller)
Schedule 3.1.6 -- Third Party Consents (Seller)
Schedule 3.1.7 -- No Litigation (Seller)
Schedule 3.2.2(a) -- Organization and Good Standing (Company)
Schedule 3.2.2(b) -- Organization and Good Standing (Subsidiaries)
Schedule 3.2.3(b) -- Outstanding Stock of Subsidiaries
Schedule 3.2.5 -- Title to Assets
Schedule 3.2.6(b) -- Absence of Certain Changes
Schedule 3.2.6(c) -- Undisclosed Liabilities
Schedule 3.2.8 -- Compliance with Laws
Schedule 3.2.11 -- No Violation (Company/Subsidiaries)
Schedule 3.2.12 -- Third Party Consents (Company/Subsidiaries)
Schedule 3.2.13 -- No Litigation
Schedule 3.2.14(a) -- Plans
Schedule 3.2.14(b) -- Health Benefits
Schedule 3.2.14(c) -- Claims Related to Plans
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SCHEDULE TITLE
------------------- --------------------------------------------------------------------
<S> <C> <C> <C>
Schedule 3.2.14(e) -- Plans in Compliance
Schedule 3.2.14(h) -- Plan Administration
Schedule 3.2.14(i) -- Funding
Schedule 3.2.14(j) -- Funding of Deferred Compensation Plans
Schedule 3.2.15A -- Owned and Leased Real Property
Schedule 3.2.15B -- Encumbrances, etc.
Schedule 3.2.16 -- Accounts Receivable
Schedule 3.2.17 -- Inventory
Schedule 3.2.18 -- Customers
Schedule 3.2.19 -- Product Warranty and Product Liability
Schedule 3.2.20 -- Insurance
Schedule 3.2.21 -- Machinery and Equipment
Schedule 3.2.22 -- Intellectual Properties
Schedule 3.2.23 -- Capital Projects and Expenditures
Schedule 3.2.24 -- Subsidiaries
Schedule 3.2.25(a) -- Hazardous Substances--Use, Storage & Disposal
Schedule 3.2.25(b) -- Hazardous Substances--Asbestos, etc.
Schedule 3.2.25(c) -- Hazardous Substances--Environmental Litigation
Schedule 3.2.25(d) -- Hazardous Substances--Compliance
Schedule 3.2.25(e) -- Hazardous Substances--Underground Storage Tanks
Schedule 3.2.26(b) -- Taxes--Returns Filed, Taxes Paid
Schedule 3.2.26(c) -- Taxes--Tax Reserves
Schedule 3.2.26(d) -- Taxes--Returns Furnished
Schedule 3.2.26(e) -- Taxes--Deficiencies, Audits, etc.
Schedule 3.2.27 -- Compensation, Vacation Time, etc.
Schedule 3.2.29 -- Bank Accounts, Investments
Schedule 3.2.30 -- Contracts, Other Agreements
Schedule 3.2.31 -- Permits and Licenses
Schedule 3.2.32 -- Indebtedness
Schedule 5.2.2 -- Capital Transactions
Schedule 5.2.3 -- Personal Property
Schedule 5.2.9 -- Noncompliance with Existing Indebtedness
Schedule 6.2.1 -- Elimination of Intercompany Accounts
Schedule 6.2.2 -- Intercompany Agreements
Schedule 7.1.6 -- Compliance with Law
Schedule 9.2 -- Inventory Reserve Amount
</TABLE>
<TABLE>
<S> <C> <C>
*10.4 -- Stellex Aerospace Investor Agreement dated as of July 1, 1997, by and among KII Holding Corp. and
Greystoke Capital Management Limited LDC, and Bradley C. Call, Julius E. Hodge, Lawrence R. Smith,
John Barriatua, Roland H. Marti, Arun Kumar and Louis A. Brown.
*10.5 -- Promissory Note dated as of July 1, 1997 by KII Acquisition Corp. to Kleinert Industrie Holding AG.
*10.6 -- Promissory Note dated September 6, 1991 by Paragon Precision Products to Farm Bureau Life Insurance
Company.
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
*10.7 -- Amended and Restated Management Advisory Services Agreement, effective as of November 1, 1997, by and
between Mentmore Holdings Corporation, Stellex Industries, Inc., TSMD Acquisition Corp., Stellex
Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy Machining
International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc. and General
Inspection Laboratories, Inc.
*10.8 -- Tax Allocation and Indemnity Agreement dated as of October 31, 1997, and retroactively applied to the
calendar year ended December 31, 1997, by and among Stellex Industries, Inc., TSMD Acquisition Corp.,
Stellex Microwave Systems, Inc., KII Holding Corp., KII Acquisition Corp., Stellex Aerospace, Bandy
Machining International, Paragon Precision Products, Scanning Electron Analysis Laboratories, Inc.
and General Inspection Laboratories, Inc.
+10.9 -- Gallium Arsenide and Thin Film Supply and Services Agreement dated as of October 31, 1997 between
Stellex Industries, Inc. and Watkins-Johnson Company.
+10.10 -- Metal Injection Molding, Glass Seal and Hybrid Assembly Facility Agreement dated as of October 31,
1997 between Stellex Industries, Inc. and Watkins-Johnson Company.
+10.11 -- Cross License Agreement dated as of October 31, 1997 between Watkins-Johnson Company, Stellex
Microwave Systems, Inc. and TSMD Acquisition Corp.
10.12 -- Employment Agreement dated as of November 1, 1997 between Stellex Microwave Systems, Inc. and Keith
Gilbert.
*12.1 -- Statement Regarding Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Subsidiaries of the Registrants.
23.1 -- Consent of Coopers & Lybrand L.L.P.
23.2 -- Consent of Deloitte & Touche LLP.
23.3 -- Consent of Winston & Strawn (included in Exhibit 5.1).
*24.1 -- Powers of Attorney.
*25.1 -- Statement of Eligibility of Trustee.
*27.1 -- Financial Data Schedule.
*99.1 -- Form of Letter of Transmittal.
*99.2 -- Form of Notice of Guaranteed Delivery.
*99.3 -- Form of Tender Instructions.
</TABLE>
- ------------------
* Previously filed.
+ Confidential treatment requested for a portion of this exhibit previously
filed.
<PAGE>
[Letterhead of Winston & Strawn]
January 15, 1998
Stellex Industries, Inc.
TSMD Acquisition Corp.
Stellex Microwave Systems, Inc.
KII Holding Corp.
KII Acquisition Corp.
Stellex Aerospace
Bandy Machining International
Paragon Precision Products
Scanning Electron Analysis Laboratories, Inc.
General Inspection Laboratories, Inc.
3333 Hillview Ave.
Palo Alto, California 94304-1223
Re: Registration Statement on Form S-4
of Stellex Industries, Inc. and the
Guarantors (as defined below)
File No. 333-41939
Ladies and Gentlemen:
We have acted as special counsel to Stellex Industries, Inc., a
Delaware corporation (the "Company"), and certain of its subsidiaries (the
"Guarantors") in connection with the preparation of the Registration Statement
on Form S-4 (the "Registration Statement") filed on behalf of the Company and
the Guarantors with the Securities and Exchange Commission (the "Commission")
relating to the registration of $100,000,000 aggregate principal amount of the
Company's Series B 9-1/2% Senior Subordinated Notes due 2007 (the "New Notes")
and the Guarantees thereof by the Guarantors, which are to be offered in
exchange for an equivalent principal amount of the Company's currently
outstanding 9-1/2% Senior Subordinated Notes due 2007 (the "Old Notes"), all as
more fully described in the Registration Statement. The New Notes will be issued
under that certain Indenture dated as of October 31, 1997 (the "Indenture")
among the Company, the Guarantors and Marine Midland Bank, as trustee.
Capitalized terms used herein and not otherwise defined shall have the meanings
assigned to such terms in the prospectus (the "Prospectus") contained in the
Registration Statement.
<PAGE>
January 15, 1998
Page 2
This opinion letter is delivered in accordance with the requirements
of Item 601(b)(5) of Regulation S-K under the Securities Act of 1933, as amended
(the "Securities Act").
In connection with this opinion letter, we have examined and are
familiar with originals or copies, certified or otherwise identified to our
satisfaction, of (i) the Registration Statement, in the form filed with the
Commission and as amended through the date hereof; (ii) the Certificates of
Incorporation of the Company and each of the Guarantors, as currently in effect;
(iii) the By-laws of the Company and each of the Guarantors, as currently in
effect; (iv) the Indenture; (v) the form of the New Notes; and (vi) resolutions
of the Boards of Directors of the Company and each of the Guarantors relating
to, among other things, the issuance and exchange of the New Notes for the Old
Notes, the issuance of the Guarantees and the filing of the Registration
Statement. We also have examined such other documents as we have deemed
necessary or appropriate as a basis for the opinions set forth below.
In our examination, we have assumed the legal capacity of all natural
persons, the genuineness of all signatures, the authenticity of all documents
submitted to us as originals, the conformity to original documents of all
documents submitted to us as certified or photostatic copies, and the
authenticity of the originals of such latter documents. As to certain facts
material to this opinion letter, we have relied without independent verification
upon oral or written statements and representations of officers and other
representatives of the Company, the Guarantors and others.
Based upon and subject to the foregoing, we are of the opinion that:
1. The issuance and exchange of the New Notes for the Old Notes and
the issuance of the Guarantees have been duly authorized by requisite corporate
action on the part of the Company and the Guarantors, respectively.
2. The New Notes and the Guarantees will be valid and binding
obligations of the Company and the Guarantors, respectively, entitled to the
benefits of the Indenture and enforceable against the Company and the
Guarantors, respectively, in accordance with their terms, except to the extent
that the enforceability thereof may be limited by (x) bankruptcy, insolvency,
fraudulent conveyance, reorganization, moratorium or other similar laws now or
hereafter in effect relating to creditors' rights generally and (y) general
principles of equity (regardless of whether enforceability is considered in a
proceeding at law or in equity) when (i) the Registration Statement, as
<PAGE>
January 15, 1998
Page 3
finally amended (including all necessary post-effective amendments), shall have
become effective under the Securities Act; (ii) the New Notes are duly executed
and authenticated in accordance with the provisions of the Indenture; and (iii)
the New Notes shall have been issued and delivered in exchange for the Old Notes
pursuant to the terms set forth in the Prospectus.
The foregoing opinions are limited to the laws of the United States,
the State of New York and the General Corporation Law of the State of Delaware.
We express no opinion as to the application of the securities or blue sky laws
of the various states to the issuance or exchange of the New Notes.
We hereby consent to the reference to our firm under the heading
"Legal Matters" in the Prospectus and to the filing of this opinion with the
Commission as an exhibit to the Registration Statement. In giving such consent,
we do not concede that we are experts within the meaning of the Securities Act
or the rules and regulations thereunder or that this consent is required by
Section 7 of the Securities Act.
Very truly yours,
/s/ WINSTON & STRAWN
---------------------
WINSTON & STRAWN
<PAGE>
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is entered into by and
between Stellex Microwave Systems, Inc. (the "Company") and Keith Gilbert
("Employee"), as of the 1st day of November 1997.
I. EMPLOYMENT.
The Company hereby employs Employee and Employee hereby accepts such
employment, upon the terms and conditions hereinafter set forth, from November
1, 1997, to and including December 31, 2000.
II. DUTIES.
A. Employee shall serve during the course of his employment as
President and Chief Executive Officer of the Company, and shall have such other
duties and responsibilities as the Board of Directors of the Company shall
determine from time to time. In the event that at any time during the term of
this Agreement Employee serves as a Director of the Company, Employee shall not
participate as a Director in any actions taken, determinations made, or
instructions given by the Board of Directors that relate to Employee's
employment with the Company or any aspect of this Agreement.
B. Employee shall perform all duties incident to the position of
President and Chief Executive Officer as may from time to time be requested by
the Board of Directors. At all times, Employee shall devote his full time and
best efforts,
1
<PAGE>
knowledge and experience to performing his duties hereunder, shall perform such
duties in a diligent and competent manner and shall act in conformity with the
written and oral policies of the Company and within the limits, budgets and
business plans set by the Company. Employee will at all times during the term of
his employment with the Company strictly adhere to and obey all of the rules and
regulations in effect from time to time relating to the conduct of employees of
the Company. Employee further agrees that to the best of his ability and
experience he will at all times loyally and conscientiously perform all duties
and obligations whether expressly or implicitly required of him by the terms of
this Agreement.
C. For the term of this Agreement, Employee shall report to the Board
of Directors of the Company.
III. COMPENSATION.
A. The Company will pay to Employee a base salary at the rate of
$250,000.00 per year. Such salary shall be earned monthly and shall be payable
in periodic installments no less frequently than bi-weekly in accordance with
the Company's customary payroll practices. Amounts payable shall be reduced by
standard withholding and other authorized deductions. The Board of Directors
will review Employee's base salary annually and, in their sole discretion, may
increase such base salary.
B. Annual Incentive Bonus. Employee shall be eligible for an annual
incentive bonus, beginning with the Company's 1998 fiscal year, pursuant to the
terms set forth on Exhibit A hereto.
C. Incentive, Deferred Compensation, Savings and Retirement Plans.
During the term of this Agreement, Employee shall be entitled to participate in
all
2
<PAGE>
incentive, deferred compensation, savings and retirement plans, practices,
policies and programs applicable generally to other peer executives of the
Company.
D. Welfare Benefit Plans. Employee and/or his family, as the case may
be, shall be eligible for participation in and shall receive all benefits under
welfare benefit plans, practices, policies and programs provided by the Company
(including, without limitation, medical, prescription, dental, disability,
salary continuance, employee life, group life, accidental death and travel
accident insurance plans and programs) to the extent applicable generally to
other peer executives of the Company.
E. Expenses. Employee shall be entitled to receive prompt reimbursement
for all reasonable employment expenses incurred by him in accordance with the
policies, practices and procedures as in effect generally with respect to other
peer executives of the Company.
F. Fringe Benefits. Employee shall be entitled to fringe benefits in
accordance with the plans, practices, programs and policies as in effect
generally with respect to other peer executives of the Company.
G. Vacation. Employee shall be entitled to four (4) weeks paid vacation
per year, subject to a maximum vacation accrual at any time of four (4) weeks.
H. The Company reserves the right to modify, suspend or discontinue any
and all of the plans, practices, policies and programs referred to in Sections C
- - F above at any time without recourse by Employee so long as such action is
taken generally with respect to other similarly situated peer executives and
does not single out Employee.
3
<PAGE>
IV. TERMINATION.
A. Death or Disability. Employee's employment shall terminate
automatically upon Employee's death. If the Company determines that the
Disability of Employee has occurred (pursuant to the definition of Disability
set forth below), it may terminate Employee's employment by giving written
notice in accordance with Section XIX. For purposes of this Agreement,
"Disability" shall mean a physical or mental impairment which substantially
limits a major life activity of Employee and which renders Employee unable to
perform the essential functions of his position, with or without reasonable
accommodation, for a period of 120 days. The Company reserves the right to make
the determination of disability under this Agreement based upon information
supplied by Employee and/or his medical personnel, as well as information from
medical personnel (or others) selected by the Company or its insurers.
B. Cause. The Company may terminate Employee's employment for Cause.
For purposes of this Agreement, "Cause" shall be determined by the Board of
Directors based upon the information then known to the Company, and shall mean
any of the following: (i) Employee's material breach of any provision of this
Agreement; (ii) Employee's material or repeated failure or neglect to perform
the duties of his position with the Company including, but not limited to,
failure to implement or achieve the Company's business plan; (iii) Employee's
development or pursuit of interests adverse to the Company or any of its direct
or indirect subsidiaries or parent companies or their affiliates; (iv)
Employee's insubordination; (v) Employee's willful misconduct, dishonesty, gross
negligence, theft, fraud or other illegal conduct; (vi) Employee's
4
<PAGE>
conduct which reflects adversely upon, or remarks disparaging of, the Company,
its Board, officers, directors, advisors or employees or its affiliates or
subsidiaries; (vii) Employee's violation of any fiduciary duty or duty of
loyalty to the Company; or (viii) any other material reason which would justify
a reasonably prudent employer in terminating an employee's employment in similar
circumstances.
C. Other than Cause or Death or Disability. The Company may terminate
Employee's employment at any time, with or without cause, upon 120 days' written
notice.
D. Obligations of the Company Upon Termination.
1. Death or Disability. If Employee's employment is terminated
by reason of Employee's Death or Disability, this Agreement shall
terminate without further obligations to Employee or his legal
representatives under this Agreement, other than for (a) payment of the
sum of (i) Employee's annual base salary through the date of
termination to the extent not theretofore paid and (ii) any
compensation previously deferred by Employee (together with any accrued
interest or earnings thereon) and any accrued vacation pay, in each
case to the extent not theretofore paid (the sum of the amounts
described in clauses (i) and (ii) shall be hereinafter referred to as
the "Accrued Obligations"), which shall be paid to Employee or his
estate or beneficiary, as applicable, in a lump sum in cash within 30
days of the date of termination; and (b) payment to Employee or his
estate or beneficiary, as applicable, any amounts due pursuant to the
terms of any applicable welfare benefit plans.
5
<PAGE>
2. Cause. If Employee's employment is terminated by the
Company for Cause, this Agreement shall terminate without further
obligations to Employee other than for the timely payment of Accrued
Obligations. If it is subsequently determined that the Company did not
have Cause for termination under this Section IV-D-2, then the
Company's decision to terminate shall be deemed to have been made under
Section IV-D-3 and the amounts payable thereunder shall be the only
amounts Employee may receive for his termination.
3. Other than Cause or Death or Disability. If the Company
terminates Employee's employment other than for Cause or for Death or
Disability, this Agreement shall terminate without further obligations
to Employee other than (a) the timely payment of Accrued Obligations
and (b) continuation of Employee's base salary for the lesser of (i)
the remainder of the term of this Agreement or (ii) one (1) year. The
Company shall make any salary continuation payments to Employee in the
Company's normal payroll cycles and shall deduct standard withholdings
and other authorized deductions.
4. Termination By Employee. If Employee's employment is
terminated by Employee, this Agreement shall terminate without further
obligations to Employee other than for the timely payment of Accrued
Obligations.
5. Exclusive Remedy. Employee agrees that the payments
contemplated by this Agreement shall constitute the exclusive and sole
remedy for any termination of his employment and Employee covenants not
to assert or
6
<PAGE>
pursue any other remedies, at law or in equity, with respect to any
termination of employment.
V. CONFIDENTIAL AND PROPRIETARY INFORMATION.
A. Employee, in the performance of Employee's duties on behalf of the
Company, shall have access to, receive and be entrusted with confidential,
proprietary information, including but in no way limited to inventions,
improvements, technical developments, trademarks, designs, formulae, processes,
computer programs, know-how, techniques, data, trade secrets, discoveries,
copyrightable works, financial data, and other information or documents
regarding the business or technology of the Company, including but not limited
to drawings, computer programs or portions thereof, computer data, blueprints,
process specifications, customer lists, price data, relationships with
employees, manner of operations, business plans, and other Company documents
owned or at any time in the future developed, by the Company or its agents or
consultants, or used presently or at any time in the future in the course of its
business that is not otherwise part of the public domain (collectively, the
"Proprietary Information"). All such Proprietary Information is considered
secret and will be available to Employee in confidence. Except in the
performance of duties on behalf of the Company, Employee shall not, directly or
indirectly for any reason whatsoever, disclose or use any such Proprietary
Information, unless such Proprietary Information ceases (through no fault of
Employee's) to be confidential because it has become part of the public domain.
All records, files, drawings, documents, equipment and other tangible items,
wherever
7
<PAGE>
located, relating in any way to the Proprietary Information or otherwise to the
Company's business, which Employee prepares, uses or encounters, shall be and
remain the Company's sole and exclusive property and shall be included in the
Proprietary Information. Upon termination of this Agreement by any means, or
whenever requested by the Company, Employee shall promptly deliver to the
Company any and all of the Proprietary Information, not previously delivered to
the Company, that may be or at any previous time has been in Employee's
possession or under Employee's control.
B. Employee hereby acknowledges that the sale or unauthorized use or
disclosure of any of the Company's Proprietary Information by any means
whatsoever and any time before, during or after Employee's employment with the
Company shall constitute Unfair Competition. Employee agrees that Employee shall
not engage in Unfair Competition either during the time employed by the Company
or any time thereafter.
8
<PAGE>
VI. OWNERSHIP AND ASSIGNMENT OF PROPRIETARY INFORMATION.
A. Employee shall disclose to the Company all Proprietary Information
which he may conceive or make during his employment, either solely, jointly, or
in common with others, and which (1) are developed, either in whole or in part,
by use of the Company's equipment, supplies, facilities or Proprietary
Information, or (2) are related to the Company's business at the time of
conception or reduction to practice, or (3) are related to the Company's actual
or demonstrably anticipated research or development at the time of conception or
reduction to practice, or (4) result from any work Employee performs for the
Company.
B. Employee agrees to assign to the Company complete ownership of all
Proprietary Information which he conceives under the circumstances listed in
Section VI(A) above, and as well as complete ownership of all patent
applications, patents, trademarks, and copyrights (United States and foreign)
which the Company may desire to secure with respect to such Proprietary
Information. Employee further agrees, both during his employment and thereafter,
to cooperate with the Company in procuring such patents, trademarks, and
copyrights, including execution of all documents necessary or incidental to such
processes.
C. Employee acknowledges that he has read the California Goggin Act
attached hereto as Exhibit B and understands that under its provisions Employee
may retain ownership of inventions that he may make entirely on his own time and
in a manner not described in Section VI(A) above. Employee agrees, however, to
disclose to the Company all inventions that he conceives during his employment,
including any
9
<PAGE>
invention which he desires to retain as his own property, so that the Company
may determine if such invention qualifies under the law for retention as
Employee's property. The Company will treat any such disclosed information as
confidential unless such information (1) was previously known to the Company,
(2) is disclosed in patents or other publications, (3) has been imparted to the
Company by third parties, or (4) is well known to the trade to which it relates.
Employee understands that this paragraph applies even if he works outside of
California.
D. Employee agrees, during his employment and thereafter, to maintain
and make available to the Company, upon its request, complete and up-to-date
written records (including computer files, photographs, or drawings, where
appropriate) of all Proprietary Information which, during the course of his
employment with the Company, he has conceived or created, either in whole or in
part.
10
<PAGE>
VII. NON-COMPETITION.
Employee agrees that, during the term of this Agreement, he will not,
directly or indirectly, without the prior written consent of the Board of
Directors of the Company, provide consultative service with or without pay, own,
manage, operate, join, control, participate in, or be connected as a
stockholder, partner, or otherwise with, any business, individual, partner,
firm, corporation, or other entity which is then in competition with the
business of the Company or any present affiliate of the Company. Employee
further acknowledges and agrees that by virtue of his position and duties with
the Company, including his access to the Proprietary Information of the Company
in discharging such duties, Employee's employment or participation with any
entity in competition with the Company for a period of two (2) years after
termination of this Agreement would inevitably require Employee to use or
disclose the Company's Proprietary Information in violation of this Agreement.
VIII. ANTISOLICITATION.
Employee promises and agrees that during the term of this Agreement,
and for a period of two (2) years after the termination of this Agreement, he
will not solicit or attempt to solicit customers of the Company or any of its
present or future subsidiaries or affiliates, either directly or indirectly, to
divert their business to any individual, partnership, firm, corporation or other
entity then in competition with the business of the Company, or any subsidiary
or affiliate of the Company.
11
<PAGE>
IX. JOINING FORMER COMPANY EMPLOYEES.
Employee promises and agrees that for two (2) years following his
termination of employment other than pursuant to Section IV-C above or
Disability above or expiration of this Agreement, he will not enter business or
work with any person who was employed with the Company, and who earned annually
$25,000 or more as a Company employee during the last six months of his or her
own employment, in any business, partnership, firm, corporation or other entity
then in competition with the business of the Company or any subsidiary or
affiliate of the Company.
X. SOLICITING EMPLOYEES.
Employee promises and agrees that he will not, for a period of two (2)
years following termination of his employment or the expiration of this
Agreement, directly or indirectly solicit any of the Company employees who
earned annually $25,000 or more as a Company employee during the last six months
of his or her own employment to work for any business, individual, partnership,
firm, corporation, or other entity then in competition with the business of the
Company or any subsidiary or affiliate of the Company.
XI. REMEDIES.
It is expressly agreed that the Company will or would suffer
irreparable injury if Employee were to engage in any conduct or commit any act
in violation of Sections V - X above, and the Company would by reason of such
violation be entitled to injunctive
12
<PAGE>
relief in a court of appropriate jurisdiction. Employee consents and stipulates
to the entry of such injunctive relief in such a court prohibiting him from
engaging in any action in violation of this Agreement, which relief shall be
cumulative to other remedies at law or in equity and shall not be construed as
an exclusive remedy.
XII. SUCCESSORS.
A. This Agreement is personal to Employee and shall not, without the
prior written consent of the Company, be assignable by Employee.
B. This Agreement shall inure to the benefit of and be binding upon the
Company and its successors and assigns and any such successor or assignee shall
be deemed substituted for the Company under the terms of this Agreement for all
purposes. As used herein, "successor" and "assignee" shall include any person,
firm, corporation or other business entity which at any time, whether by
purchase, merger or otherwise, directly or indirectly acquires the stock of the
Company or to which the Company assigns this Agreement by operation of law or
otherwise.
XIII. WAIVER.
No waiver of any breach of any term or provision of this Agreement
shall be construed to be, nor shall be, a waiver of any other breach of this
Agreement. No waiver shall be binding unless in writing and signed by the party
waiving the breach.
13
<PAGE>
XIV. MODIFICATION.
This Agreement may not be amended or modified other than by a written
agreement executed by Employee and the Board of Directors.
XV. SAVINGS CLAUSE.
If any provision of this Agreement or the application thereof is held
invalid, the invalidity shall not affect other provisions or applications of the
Agreement which can be given effect without the invalid provisions or
applications and to this end the provisions of this Agreement are declared to be
severable. In the event that a court of competent jurisdiction determines that
any provision or portion of this Agreement is unreasonable, arbitrary, against
public policy or otherwise unenforceable, such court shall enforce such
provision to the extent the court determines reasonable or in accordance with
public policy and to the maximum extent enforceable by law.
14
<PAGE>
XVI. COMPLETE AGREEMENT.
This Agreement constitutes and contains the entire agreement and final
understanding concerning Employee's employment with the Company and the other
subject matters addressed herein between the parties. It is intended by the
parties as a complete and exclusive statement of the terms of their agreement.
It supersedes and replaces all prior negotiations and all agreements proposed or
otherwise, whether written or oral, concerning the subject matter hereof. Any
representation, promise or agreement not specifically included in this Agreement
shall not be binding upon or enforceable against either party. This is a fully
integrated agreement.
XVII. GOVERNING LAW.
This Agreement shall be deemed to have been executed and delivered
within the State of California, and the rights and obligations of the parties
hereunder shall be construed and enforced in accordance with, and governed by,
by the laws of the State of California without regard to principles of conflict
of laws.
XVIII. CONSTRUCTION.
Each party has cooperated in the drafting and preparation of this
Agreement. Hence, in any construction to be made of this Agreement, the same
shall not be construed against any party on the basis that the party was the
drafter. The captions of this Agreement are not part of the provisions hereof
and shall have no force or effect.
15
<PAGE>
XIX. COMMUNICATIONS.
All notices, requests, demands and other communications hereunder shall
be in writing and shall be deemed to have been duly given if delivered or if
mailed by registered or certified mail, postage prepaid, addressed to Employee
at Stellex Microwave Systems, Inc, Stanford Research Park, 3333 Hillview Avenue,
Palo Alto, CA 94304 or addressed to the Company at Stellex Microwave Systems,
Inc., c/o Stellex Industries, Inc., 1430 Broadway, 13th Floor, New York, NY
10018. Either party may change the address at which notice shall be given by
written notice given in the above manner.
XX. EXECUTION.
This Agreement is being executed in one or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument. Photographic copies of such signed counterparts may
be used in lieu of the originals for any purpose.
In witness whereof, the parties hereto have executed this Agreement as
of the date first above written.
"COMPANY" "EMPLOYEE"
STELLEX MICROWAVE SYSTEMS, INC.
/s/ Keith Gilbert
---------------------
By /s/ William L. Remley
--------------------------
Its _______________________
16
<PAGE>
EXHIBIT A
ANNUAL INCENTIVE BONUS
Employee shall be eligible for an annual incentive bonus, beginning
with fiscal year 1998, based upon the Company's attainment of targeted annual
EBITDA pursuant to the following schedule:
Actual EBITDA Bonus as a
divided by Targeted Percentage of
EBITDA Base Salary
Less than 95% 0.0%
95% 25.0%
100% 50.0%
125% or greater 75.0%
[Interpolate between levels]
The target EBITDA shall be established annually by the Board of Directors no
later than January 1 of each fiscal year. As used herein, "EBITDA" shall mean,
for any period, determined for the Company in conformity with generally accepted
accounting principles consistently applied (i) the sum of the amounts for such
period of (A) net income (i.e., the net earnings or loss after taxes), (B)
depreciation and amortization expense, (C) interest expense, and (D) federal,
state, local, and foreign income taxes, minus (ii) extraordinary or
non-recurring gains. The Board of Directors may, in its sole discretion,
consider other appropriate adjustments to EBITDA. Within thirty (30) days after
completion of the Company's audited financial statements for the fiscal year,
the Board of Directors shall determine the eligibility and amount of any
Incentive Bonus and shall pay such bonus to Employee in a lump sum, less
standard withholdings and authorized deductions.
A-1
<PAGE>
EXHIBIT B
THE GOGGIN ACT
Sections 2870, 2871 and 2872 of the California Labor Code
2870. (a) Any provision in an employment agreement which provides that an
employee shall assign, or offer to assign, any of his or her rights in an
invention to his or her employer shall not apply to an invention that the
employee developed entirely on his or her own time without using the employer's
equipment, supplies, facilities, or trade secret information except for those
inventions that either: (1) Relate at the time of conception or reduction to
practice of the invention to the employer's business, or actual or demonstrably
anticipated research or development of the employer; or (2) Result from any work
performed by the employee for the employer;
(b) To the extent a provision in an employment agreement purports to
require an employee to assign an invention otherwise excluded from being
required to be assigned under subdivision (a), the provision is against the
public policy of this state and is unenforceable.
2871. No employer shall require a provision made void and unenforceable by
Section 2870 as a condition of employment or continued employment. Nothing in
this article shall be construed to forbid or restrict the right of an employer
to provide in contracts of employment for disclosure, provided that any such
disclosures be received in confidence,
B-1
<PAGE>
of all of the employee's inventions made solely or jointly with others during
the term of his or her employment, a review process by the employer to determine
such issues as may arise, and for full title to certain patents and inventions
to be in the United States, as required by contracts between the employer and
the United States or any of its agencies.
2872. If an employment agreement entered into after January 1, 1980, contains a
provision requiring the employee to assign or offer to assign any of his or her
rights in any invention to his or her employer, the employer must also, at the
time the agreement is made, provide a written notification to the employee that
the agreement does not apply to an invention which qualifies fully under the
provisions of Section 2870. In any suit or action arising thereunder, the burden
of proof shall be on the employee claiming the benefits of its provisions.
B-2
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the inclusion in this Amendment No. 1 to Registration Statement
No. 333-41939 on Form S-4 of our report dated April 11, 1997 (except for Note
10, as to which the date is July 1, 1997), on our audits of the consolidated
financial statements and financial statement schedule of Kleinert Industries,
Inc. and Subsidiaries. We also consent to the reference to our firm under the
caption 'Experts'.
Coopers & Lybrand L.L.P.
/s/ Coopers & Lybrand L.L.P.
Los Angeles, California
January 15, 1998
<PAGE>
EXHIBIT 23.2
We consent to the use in this Amendment No. 1 to Registration Statement No,
333-41939 of Stellex Industries, Inc. on Form S-4 of our report dated December
5, 1997 relating to the balance sheet of Stellex Industries Inc. as of September
5, 1997; our report dated November 4, 1997 relating to the financial statements
of the Tactical Subsystems and Microwave Devices Sectors of the Watkins-Johnson
Company; and to the references to us under the heading 'Experts.'
/s/ Deloitte & Touche LLP
San Jose, California
January 15, 1998
