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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED
DECEMBER 31, 1997 OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM __________ TO __________
COMMISSION FILE NUMBER: 333-41939
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STELLEX INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3971931
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
1430 Broadway, 13th Floor
New York, New York 10018
(212) 391-1392
(Address, including zip code and telephone number,
including area code, of registrant's principal executive offices)
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Securities registered pursuant to Section 12(b)
of the Act:
None.
Securities registered pursuant to Section 12(g)
of the Act:
None.
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes / / No /X/
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
As of March 1, 1998, the number of shares outstanding of the
registrant's Common Stock, no par value, was 1,000 shares. There is no trading
market for the Common Stock. Accordingly, the aggregate market value of the
Common Stock held by non-affiliates of the registrant is not determinable. See
Part II, Item 5 of this Report.
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CROSS REFERENCE SHEET
AND
TABLE OF CONTENTS
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Page Number
or Reference
PART I
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ITEM 1. Business................................................................................... 1
ITEM 2. Properties................................................................................. 16
ITEM 3. Legal Proceedings.......................................................................... 17
ITEM 4. Submission of Matters to a Vote of Security Holders........................................ 17
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PART II
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ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters...................... 17
ITEM 6. Selected Financial Data.................................................................... 18
ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................. 19
ITEM 8. Financial Statements and Supplementary Data................................................ 30
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure................................................................................. 31
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PART III
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ITEM 10. Directors and Executive Officers of the Registrant......................................... 31
ITEM 11. Executive Compensation..................................................................... 33
ITEM 12. Security Ownership of Certain Beneficial Owners and Management............................. 37
ITEM 13. Certain Relationships and Related Transactions............................................. 38
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PART IV
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ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................... 42
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PART I
As used in this Report, unless the context otherwise requires,
"Stellex" refers to Stellex Industries, Inc. (successor to Kleinert Industries,
Inc.) and the "Company" refers to Stellex and its direct and indirect
subsidiaries. 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 Industries, Inc. ("Kleinert"), as the case may be. 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 offering of Stellex's 9 1/2% Senior
Subordinated Notes due 2007, which was consummated on October 31, 1997 (the
"Offering"), and the consummation of the New Credit Facilities (as defined) and
the incurrence of indebtedness thereunder to partially fund the W-J Acquisition
are hereafter collectively referred to as the "Transactions".
ITEM 1. BUSINESS
Overview
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, 1997, after
giving pro forma effect to the Transactions, the Company would have had sales of
$120.5 million and net income of approximately $1.5 million. As of December 31,
1997, the Company had $92.6 million in order 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 ("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 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,
1997, Stellex Microwave had sales of $88.7 million.
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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 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"), 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, 1997 (collectively comprised of
Kleinert (predecessor) sales for the six months ended June 30, 1997 and Stellex
(successor) for the six months ended December 31, 1997), Stellex Aerospace had
sales of $31.9 million.
Industry
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 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 Commercial Airplane Group 1997 Current Market Outlook (the "Boeing
Report"), annual deliveries of commercial aircraft are expected to increase from
approximately 400 in 1996 to 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; (ii)
projected cargo traffic growth; (iii) projected increase in the load factor of
aircraft currently in service; (iv) the
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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.
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. 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.
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. 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. 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 the Satellite division of Motorola, Inc. ("Motorola"). 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
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spectrum. The growth in wireless communications has required substantial
investment by service providers in infrastructure equipment.
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.
Products and Services
The following describes the Company's principal product and service
lines, the markets which these products and services serve, and the Company's
principal programs by product and service line.
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:
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
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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 Missile Systems Company
("Hughes") and Raytheon Company ("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 approximately 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. 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 destroy incoming
advanced aircraft, tactical ballistic missiles and cruise missiles.
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
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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.
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:
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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, Inc. ("AlliedSignal") and
is the sole source provider of twelve parts for the Titan engines produced by
Aerojet General Corporation ("Aerojet") (a subsidiary of GenCorp, Inc.). Paragon
is also a primary source supplier for the Rocketdyne division of Boeing
("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 National Aeronautics and Space Administration ("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. 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 non-destructive
testing ("NDT") laboratories in the United States.
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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. 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.
9
<PAGE>
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 Part I, Item 1.
"Business--Markets, Products and Services."
Stellex Microwave had company-sponsored research and development expenses
of $4.8 million, $3.5 million and $2.4 million for the years ended December 31,
1995, 1996 and 1997, respectively; customer-sponsored research and development
at Stellex Microwave totaled approximately $10.4 million, $8.0 million and $7.9
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.
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.
The Company also uses offshore independent contractors to manufacture and test
microwave components.
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
10
<PAGE>
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 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. Paragon received ISO-9002 certification in
November 1997, while Bandy is currently seeking ISO- 9000 certification. Stellex
Aerospace has received numerous quality awards from its customers, including
Boeing and McDonnell Douglas Corporation ("McDonnell Douglas"), and the highest
quality designations from Lockheed Martin, Allegheny Teledyne Incorporated
("Teledyne") and Rohr Inc.
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
11
<PAGE>
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.
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, 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.
12
<PAGE>
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 1997 based on sales were Hughes and Raytheon, which
together accounted for approximately 36.8% of the Company's total pro forma
sales. In December 1997, Raytheon completed its acquisition of the defense
business of Hughes.
The vast majority of the Company's tactical subsystem sales, which
accounted for 37.8% of the Company's total pro forma sales in 1997, were derived
from contracts with a limited number of tactical missile and
intelligence/reconnaissance prime contractors, such as Raytheon, Hughes, Litton
Industries, Inc. ("Litton"), Lockheed Martin, Rockwell-Boeing and TRW. Microwave
component sales, which accounted for approximately 35.7% of the Company's total
pro forma sales in 1997, were made to a broad range of government agencies and
civilian contractors. Stellex Aerospace, whose sales accounted for approximately
26.5% of the Company's total pro forma sales in 1997, sells primarily to
aircraft OEMs, aircraft and rocket engine manufacturers and government agencies.
In 1997, approximately 62.9% of the Company's pro forma sales were to government
agencies and their prime contractors. Such sales are subject to unique
conditions and terms.
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.
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
13
<PAGE>
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.
Employees
As of March 1, 1998, the Company employed approximately 841 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
fixed-price type contracts. Under fixed-price type contracts, the contractor
benefits from or shares in cost savings but generally bears or shares the risk
of cost overruns.
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.
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 Part II, Item 7. "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, 1997, approximately $20.5 million, or
17.0%, 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
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<PAGE>
U.S. government policy toward foreign governments with whom the Company,
directly or indirectly, conducts business could adversely affect the
Company's sales.
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"). 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 development totaling 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.
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<PAGE>
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.
ITEM 2. 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>
Location Description Square Footage Owned/Leased
-------- ----------- -------------- ------------
<S> <C> <C> <C>
Palo Alto, California Stellex Microwave's manufacturing, 120,000 Leased
engineering and testing facility and
administrative office
Woodland Hills, California Stellex Aerospace's administrative 1,475 Leased
office
Valencia, California Paragon's manufacturing facility, 54,000 Owned
machine shop and warehouse
Burbank, California Bandy's manufacturing facility, 48,000 Leased
warehouse and office
El Segundo, California SEAL's laboratory, testing facility 20,600 Leased
and office
Cudahy, California GIL's laboratory, testing facility 32,400 Leased
and office
</TABLE>
16
<PAGE>
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. On or prior to 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.
ITEM 3. 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 predicted 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.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
There is no established trading market for any class of equity securities
of the Company.
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ITEM 6. SELECTED FINANCIAL DATA
The selected historical financial data of the Company as of and for each
of the five years in the period ended December 31, 1997 have been derived from
the audited financial statements of its predecessor, Kleinert, through June 30,
1997, and of the Company, as of and for the six months ended December 31, 1997.
The selected historical financial data for the Company as of and for the six
months ended December 31, 1997 reflect adjustments resulting from the
application of the purchase method of accounting in conjunction with the
Kleinert and W-J acquisitions. 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 data presented
below should be read in conjunction with the historical financial statements of
the Company and related footnotes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" contained elsewhere in this
filing.
<TABLE>
<CAPTION>
Six Months Six Months
Ended Ended
Year Ended December 31, June 30, December 31,
------------------------- ---------- -------------
1993 1994 1995 1996 1997 1997
---------- ---------- ---------- ----------- ------ -----
(Successor)
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C>
Income Statement Data:
Sales................................... $21,664 $17,808 $21,049 $24,307 $14,296 $ 30,536
Costs of goods sold..................... 16,239 13,121 15,083 17,367 10,140 24,732
------- ------- ------- ------- ------ --------
Gross profit............................ 5,425 4,687 5,966 6,940 4,156 5,804
Selling, general and administrative..... 3,514 3,110 3,299 3,629 1,783 5,669
Amortization of intangibles............. 533 416 282 31 15 716
------ ------ ------ ------ ------- --------
Operating income (loss)................. 1,378 1,161 2,385 3,280 2,358 (581)
Interest expense........................ 1,078 979 1,034 856 376 2,578
Interest income......................... (73) (44) (5) (11) (5) (26)
Other expense (income).................. 273 145 44 58 103 14
--------- -------- -------- --------- --------- ---------
Income (loss) before income taxes....... 100 81 1,312 2,377 1,884 (3,147)
Income tax provision (benefit).......... 42 50 525 945 754 (1,170)
--------- --------- -------- ------- --------- --------
Net income (loss) before
extraordinary item.................... $ 58 $ 31 $ 787 $ 1,432 $ 1,130 (1,977)
Extraordinary loss on early
extinguishment of debt................ -- -- -- -- -- 448
--------- ----------- ----------- ------------ ------------- --------
Net income (loss)....................... $ 58 $ 31 $ 787 $ 1,432 $ 1,130 $ (2,425)
========== ========== ========== ============ ============ ==========
Other Financial Data:
Cash flows from operating activities.... $ 3,172 $ 2,130 $ 1,866 $ 2,657 $ 479 $ (4,548)
Cash flows from investing activities.... (372) 285 (643) (1,048) (835) (99,195)
Cash flows from financing activities.... (2,858) (2,360) (1,432) (1,407) 272 106,725
EBITDA(a)............................... 3,831 3,440 4,291 4,913 3,133 6,238
Depreciation and amortization........... 2,726 2,424 1,950 1,691 878 2,132
Capital expenditures.................... 389 288 657 1,053 868 1,289
Ratio of earnings to fixed charges(b)... 1.09x 1.08x 2.27x 3.78x 6.01x --
Balance Sheet Data (at end of period):
Working capital......................... $ 6,751 $ 6,621 $ 6,802 $ 7,735 $ 8,975 $ 32,858
Total assets............................ 30,065 28,029 28,180 29,614 31,675 145,782
Long-term debt, including
current maturities.................... 12,650 10,021 7,824 5,682 5,654 112,322
Stockholders' equity.................... 11,927 11,958 12,745 14,178 15,308 8,884
</TABLE>
- ---------------------
(a) EBITDA represents income (loss) before income taxes plus interest
expense, depreciation and amortization less interest income. EBITDA for
the six months ended December 31, 1997 excludes certain non-recurring
costs directly related to the Kleinert and W-J acquisitions which
included investment banking fees paid to Mentmore Holdings Corporation
("Mentmore") totaling $1,450,000 and non-cash amortization of acquisition
accounting adjustments to the fair value inventory totaling $2,951,000.
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
18
<PAGE>
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 filing 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. Earnings of the Company were inadequate to cover
fixed charges by $3,147,000 for the six months ended December 31, 1997.
ITEM 7. 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 is a holding company
and has no independent operations. 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 Corp. ("KII Holding"), an 80% owned
consolidated subsidiary of the Company, through a wholly-owned subsidiary, KII
Acquisition Corp., acquired Stellex Aerospace (formerly Kleinert Industries,
Inc.) from Kleinert Industrie Holding A.G. (the "Kleinert Acquisition"). The
remaining 19.9% is held by Stellex Aerospace management. Stellex Aerospace
conducts its business through four operating subsidiaries--Paragon, Bandy, SEAL
and GIL. The results of operations of Stellex Aerospace for the periods
presented herein represent the results of operations of Kleinert (predecessor)
for such periods prior to and including June 30, 1997, and those of Stellex
Aerospace thereafter. See Part II, Item 6. "Selected Financial Data."
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
Company's results of operations include the results of Stellex Microwave
following its acquisition on October 31, 1997. The results of operations of TSMD
for the periods presented herein represent the results of operations of TSMD
prior to the acquisition, while operating as a division of Watkins-Johnson, and
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. See Part II, Item 6. "Selected Financial Data."
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.
19
<PAGE>
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.
Results of Operations
Historical - Company
The Company commenced operations when it acquired Kleinert on July 1,
1997, and subsequently acquired TSMD on October 31, 1997. Both acquisitions are
included in the results of operations of the Company from their respective
purchase dates and accounted for using the purchase method.
Results for the Six Months Ended December 31, 1997 of the Company.
Sales. Stellex Aerospace's sales totaled approximately $17.6 million for the six
months ended December 31, 1997. Continuing increases in demand for new aircraft
production for both commercial and military markets, as well as increased orders
for aircraft replacement parts in these markets, translates to an opportunity
for improved performance during 1998.
Stellex Microwave's sales totaled approximately $13.0 million for the two
months ended December 31, 1997, representing the period from its acquisition by
Stellex on October 31, 1997. AMRAAM sales were negatively impacted by lower
pricing; however, future growth is anticipated in subsystems business as a
result of follow-on AMRAAM orders and a recently awarded transmitter assembly
program for the Longbow missile, along with an increased emphasis being placed
on marketing and engineering as it relates to growing the microwave components
business.
Gross profit. Gross profit totaled approximately $3.9 million, or 22.4% as a
percentage of sales, for Stellex Aerospace for the six months ended December 31,
1997. During the six month period a non-recurring charge to cost of sales
totaled approximately $1.5 million resulting from the amortization of a purchase
accounting adjustment revaluing inventory coincident with the Kleinert
Acquisition. Ignoring the impact of this non-recurring charge, gross margins
would have totaled 30.6%. Stellex Aerospace has experienced an improvement in
gross margins during this recent period as a result of increased manufacturing
and laboratory operating efficiencies. These efficiencies are due primarily to
overall increased volume and the expansion of manufacturing capacities and
capabilities through the purchase of additional machinery and equipment at both
Paragon and Bandy.
Stellex Microwave's gross profit totaled approximately $1.9 million or
14.4% as a percentage of sales for the two month period ended December 31, 1997.
During this two month period a non-recurring charge to cost of sales totaled
$1.5 million resulting from the amortization of a purchase accounting adjustment
revaluing inventory coincident with the W-J Acquisition. Ignoring the impact of
this non-recurring charge, gross margins would have totaled 26.0%. Gross margins
during the period were primarily impacted by lower pricing on AMRAAM deliveries.
Selling, general and administrative. Selling, general and administrative
expenses for Stellex Aerospace totaled $2.8 million for the six months ended
December 31, 1997. Significant items impacting selling, general and
administrative expenses included a non-recurring charge totaling $450,000 for
investment banking and financial advisory fees to Mentmore as a result of the
Kleinert Acquisition, $150,000 in management fees paid to Mentmore in
conjunction with a management services agreement which became effective
subsequent to the Kleinert Acquisition. In addition to the forementioned items,
the significance of the revenue growth currently experienced has led to
adminstrative support cost increases. These additional costs were not
unanticipated and provide the added infrastructure necessary to continue to grow
profitably.
Selling, general and administrative expenses for Stellex Microwave
totaled $2.6 million for the two months ended December 31, 1997. Significant
items impacting selling, general and administrative expenses included a
non-recurring charge totaling $1.0 million for investment banking and financial
advisory fees of Mentmore and $75,000 in management fees paid to Mentmore in
conjunction with a management services agreement which became effective
20
<PAGE>
subsequent to the W-J Acquisition. In addition, Stellex Microwave continues to
realize additional general and administrative cost savings primarily through
headcount reduction as part of its continuing effort to streamline its
administrative operations.
Selling, generally and administrative expenses for Stellex totaled
$300,000 for the six months ended December 31, 1997. This represented a
compensation charge incurred as a result of a put right associated with the
ownership of common stock in KII Holdings Corp. by members of management of
Stellex Aerospace.
Amortization of intangibles. Amortization of intangibles includes amortization
of goodwill over 25 years and other identified intangibles such as favorable
lease arrangements, patents, technology and assembled workforce over their
estimated lives ranging from one to twenty years.
Interest expense. The Company's interest expense of $2.6 million for the six
months ended December 31, 1997 reflects primarily the sum of two months of
interest on the $100.0 million of 9.5% Senior Subordinated Notes, four months of
interest on a $16.0 million variable rate senior credit facility with a bank and
a $2.5 million 10% note payable to an affiliate (both refinanced upon closing
the Offering), and six months of interest on a $2.6 million 7.875% mortgage note
and a $1.75 million 8% Seller note which originated upon closing the Kleinert
Acquisition.
Extraordinary loss. An extraordinary loss from the early extinguishment of
senior debt associated with the Kleinert Acquisition occurred as a result of the
Offering. This loss totaled $747,200 and is shown net of the effect of income
taxes.
Pro Forma Results for the Years Ended December 31, 1997 and 1996 of the Company
The unaudited pro forma consolidated results for the years ended December 31,
1997 and 1996 give effect to the Transactions as if they had occurred as of
January 1, 1996, and include estimated amounts for interest required to fund
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 to Mentmore ($1.5 million), (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 ($3.0 million) and (iii)
extraordinary losses due to early retirement of debt.
The unaudited pro forma consolidated results 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.
1997 1996
---- ----
Statement of Operations Data:
- -----------------------------
Net sales $120,532 $113,507
Cost of sales 87,576 87,977
-------- ---------
Gross profit 32,956 25,530
Selling, general and administrative 16,568 18,817
Amortization of intangibles 3,875 3,875
-------- ---------
Operating income 12,513 2,838
Interest expense 10,896 10,774
Other 35 40
-------- ----------
Income (loss) before taxes 1,582 (7,976)
Provision for taxes 100 --
-------- ----------
Net income (loss) $ 1,482 $ (7,976)
======== ==========
Other Data:
- -----------
EBITDA $ 22,945 $ 13,459
======== ==========
21
<PAGE>
Sales. Stellex Aerospace's pro forma sales would have increased by $7.6 million,
or 31.1%, in the pro forma year ended December 31, 1997 over the pro forma year
ended December 31, 1996. 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.
Stellex Microwave's pro forma sales would have decreased by $500,000,
or 1.0%, in the pro forma year ended December 31, 1997 over the pro forma year
ended December 31, 1996. The slight decrease in sales was primarily attributable
to a decrease in microwave component part sales due to the effects of delinquent
shipments during late 1996 and early 1997 resulting from start-up problems
experienced as part of the Oracle system conversion, coupled with the planned
deemphasis of the low margin receiver/synthesizer product lines. These decreases
were almost completely offset by 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. Stellex Aerospace's pro forma gross profit would have increased by
$2.5 million, or 35.4%, in the pro forma year ended December 31, 1997 over the
pro forma year ended December 31, 1996. Pro forma gross profit margin would have
increased to 30.4% in the year pro forma year ended December 31, 1997 from 29.4%
in the pro forma year ended December 31, 1996. Pro forma gross profit and pro
forma gross profit margin benefited from increased manufacturing and laboratory
operating efficiencies due to the overall increased volume and the expansion of
manufacturing capacities and capabilities through the purchase of additional
machinery and equipment at both Paragon and Bandy. These benefits were partially
offset by increased outsourcing necessitated by capacity constraints and raw
material price increases on aluminum extrusions at Bandy.
Stellex Microwave's pro forma gross profit would have increased by $4.9
million, or 26.6%, in the pro forma year ended December 31, 1997 over the pro
forma year ended December 31, 1996. Pro forma gross profit margin would have
increased to 26.3% in the pro forma year ended December 31, 1997 from 20.6% in
the pro forma year ended December 31, 1996. Pro forma gross profit and pro forma
gross profit margin benefited primarily from improved manufacturing efficiencies
resulting from the resolution of operating difficulties associated with the
startup of the new MRP system coupled with higher production volumes. These
improvements were partially offset by lower pricing on AMRAAM subsystems as a
result of a new contract.
Selling, general and administrative expenses. Pro forma selling, general and
administrative expenses for Stellex Aerospace would have increased $544,000, or
15.2%, in the pro forma year ended December 31, 1997 over the pro forma year
ended December 31, 1996. As a percentage of sales, these expenses decreased to
13.0% from 14.7% during the same respective periods. The increase in pro forma
selling, general and administrative expenses is due primarily to providing
additional administrative personnel to support the increased sales volume offset
partially by lower employee benefit costs in 1997 over 1996 when two deferred
compensation plans were established.
Pro forma selling, general and administrative expenses for Stellex
Microwave would have decreased $2.3 million, or 16.1%, in the pro forma year
ended December 31, 1997 over the pro forma year ended December 31, 1996. As a
percentage of sales, these expenses decreased to 13.7% from 16.2 % during the
same respective periods. The decrease in pro forma selling, general and
administrative expenses is due to a reduction in research and development costs
resulting from a decrease in the number of projects authorized, as well as
certain headcount reductions as part of management's continuing effort to
streamline its administrative operations.
Pro forma selling, general and administrative expenses for Stellex
totaled $300,000 and $761,000 for the pro forma years ended December 31, 1997
and 1996, respectively. These expenses represented compensation charges incurred
as a result of put rights associated with the ownership of common stock in KII
Holdings Corp. by members of management of Stellex Aerospace.
Amortization of intangibles. Pro forma amortization expense relating to
intangible assets would have increased primarily as a result of the amortization
of intangibles relating primarily to the goodwill associated with the W-J
22
<PAGE>
Acquisition amortized over estimated lives ranging from 1 to 25 years dependent
on the character of the identified intangibles.
Interest expense. The Company's pro forma interest expense for the comparable
periods reflects primarily the sum of annual interest on the $100.0 million of
9.5% Senior Subordinated Notes, a $2.6 million 7.9% mortgage note, a $1.75
million 8% Seller note which originated upon closing the Kleinert Acquisition,
an average working capital line of credit balance of approximately $5.0 million
at an 8% rate of interest and approximately $500,000 of amortization of deferred
financing costs relating to the financing transactions occurring with the W-J
Acquisition.
Provision for taxes. The provision for taxes was primarily impacted by
utilization of net operating loss carry forwards during 1997.
Historical - Predecessor
Six Months Ended June 30, 1997 Compared to Six Months Ended June 30,
1996.
The following table summarizes Stellex Aerospace's unaudited historical
results of operations for the six months ended June 30, 1997 and 1996.
Six Months Ended
Statement of Operations Data: June 30,
- ----------------------------- ----------------
1997 1996
------ -----
Sales $ 14,296 $ 11,650
Cost of Sales 10,140 8,291
----------- ------------
Gross Profit 4,156 3,359
Selling, general and administrative 1,783 1,788
Amortization of intangibles 15 15
----------- ------------
Operating income 2,358 1,556
Interest expense 376 442
Other expense 98 24
----------- ------------
Income before taxes 1,884 1,090
Provision for taxes 754 436
----------- ------------
Net income $ 1,130 $ 654
=========== ============
Other Data:
- ----------
EBITDA $ 3,133 $ 2, 354
=========== ============
Sales. Stellex Aerospace's sales increased by $2,646,000, or 22.7%, in
the six months ended June 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 $797,400, or 23.7%, in the six
months ended June 30, 1997 over the comparable period in the prior year, and
gross profit margin increased to 29.1% in the six months ended June 30, 1997
from 28.8% in the comparable period in the prior year. The increase in gross
profit was primarily due to the increase in Stellex Aerospace's sales. 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 almost entirely offset by increased outsourcing necessitated
by capacity constraints and raw material price increases on aluminum extrusions.
23
<PAGE>
Selling, general and administrative. Selling, general and administrative
expenses decreased by $4,600, or 0.2%, in the six months ended June 30, 1997
over the comparable period in the prior year. As a percentage of sales, selling,
general and administrative expenses decreased from 15.5% in the six months ended
June 30, 1996 to 12.6% in the comparable period in 1997 because the increased
sales volume and improved plant utilization required no corresponding increase
in selling or administrative expenses. Additionally, employee benefit costs were
reduced over the levels in the comparable period in the prior year when two
deferred compensation plans were established.
Interest expense. Interest expense decreased by $66,700, or 15.1%, in the
six months ended June 30, 1997, over the comparable period in the prior year.
The decrease in interest expense resulted primarily from an interest rate
reduction from 10.125% to 7.875% on a building mortgage and lower outstanding
debt during the current period.
Other expense (income). Other expense (income) increased by $75,000 in
the six months ended June 30, 1997, over the comparable period in the prior
year. The increase in other expense (income) was primarily due to expenses
related to the Kleinert Acquisition and a vending machine contract dispute
settlement.
Provision for Taxes. The effective income tax rate was 40.0% for both the
six months ended June 30, 1997 and 1996, respectively.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Sales. Stellex Aerospace's sales increased by $3.3 million, 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.
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.
Historical - Stellex Microwave
24
<PAGE>
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.
Between 1994 and 1997, 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. In conjunction with this ongoing restructuring, severance costs
were incurred in varying amounts in each of the years from 1994 through 1997.
Management believes Stellex Microwave derived significant benefits from its
rationalization efforts throughout 1995, 1996 and 1997, 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 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.
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 nine months ended September 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
25
<PAGE>
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 improved in the nine
months ended September 30, 1997 and management now believes that its materials
management system is effective. Nonetheless, sales of microwave component parts
in 1997 were negatively impacted due to the MRP difficulties experienced in
1996.
Stellex Microwave was acquired by a wholly-owned subsidiary of the
Company on October 31, 1997, and its results of operations have been included in
the Company's consolidated results of operations since such date. The following
review of the historical performance of Stellex Microwave is for the years ended
December 31, 1996 and 1995, and for the nine month periods ended September 30,
1997 and 1996.
The table below summarizes the historical financial data of Stellex
Microwave as of and for the years ended December 31, 1996 and 1995 and the nine
months ended September 30, 1997 have been derived from the audited financial
statements of TSMD. The financial data of TSMD for the nine month period ended
September 30, 1996 is unaudited but has been prepared on the same basis as the
1995 and 1996 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 period. Certain assets and liabilities held by
TSMD were acquired by the Company in connection with the W-J Acquisition. 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.
<TABLE>
<CAPTION>
Nine Months Nine Months
Ended Ended
Year Ended December 31, September 30, September 30,
----------------------- ------------- -------------
1995 1996 1996 1997
---------- ----------- ------ -----
<S> <C> <C> <C> <C>
Income Statement Data:
Sales.................................. $97,600 $89,200 $61,300 $67,900
Costs of goods sold.................... 65,200 68,100 45,400 47,900
-------- -------- ------- --------
Gross profit........................... 32,400 21,100 15,900 20,000
Amortization........................... -- -- -- --
Selling, general and administrative.... 17,300 14,600 11,000 9,100
-------- -------- ------- --------
Income before income taxes............. 15,100 6,500 4,900 10,900
Income tax provision (tax benefit)..... 5,900 2,500 1,900 4,200
-------- -------- ------- --------
Net income (loss)...................... $ 9,200 $ 4,000 $ 3,000 $ 6,700
======== ======== ======= ========
</TABLE>
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
26
<PAGE>
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.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Sales. Stellex Microwave's sales decreased by $8.4 million, 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 $8.0 million 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 $4.7 million 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 $11.3 million, 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 $2.2 million incurred on
two microwave tuner fixed price programs, (ii) obsolescence reserves on
component inventory totaling $1.5 million, (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
$1.3 million and a reduction in selling, general and administrative expenses of
approximately $1.4 million. 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 tax provision. The effective tax rate for 1996 was 38.5%, while
the effective tax rate for 1995 was 39.1%.
27
<PAGE>
Liquidity and Capital Resources
The Company provided (used) cash flows from operations of ($4,547,600),
$479,000, $2,657,000 and $1,866,000 for the six month periods ended December 31,
1997 (successor period) and June 30, 1997 and for the years ended December 31,
1996 and 1995, respectively. Cash flows from operations for the six months ended
December 31, 1997 were primarily impacted by the build-up in trade receivables
for Stellex Microwave following its acquisition due to the exclusion of existing
trade receivables from the purchase transaction. Cash flows from operations from
1995 until June 30, 1997 reflect consistent earnings offset, in part, by a
build-up of inventories supporting the growing level of sales.
The Company used cash flows from investing activities, excluding cash
flows used in connection with the Kleinert Acquisition and the W-J Acquisition
of $1,289,100, $835,000, $1,048,000 and $643,000 for the six month periods ended
December 31, 1997 (successor period) and June 30, 1997 and for the years ended
December 31, 1996 and 1995, respectively. Cash flows utilized over the periods
presented were primarily supporting investments in machinery to accommodate a
rising level of production orders resulting from increasing levels of aircraft
manufacturing activity.
The Company used (provided) cash flows from financing activities,
excluding cash flows used in connection with the Kleinert Acquisition and the
W-J Acquisition of ($5,424,300), ($272,000), $1,407,000 and $1,432,000 for the
six month periods ended December 31, 1997 (successor period) and June 30, 1997
and for the years ended December 31, 1996 and 1995, respectively. During 1997,
cash flows from financing activities was primarily impacted by borrowings of
$5,000,000 under the Revolving Credit Facility to fund working capital at
Stellex Microwave. During 1996 and 1995, the Company repaid outstanding long
term indebtedness in excess of $2,000,000 per annum, offset by a consistent
level of borrowings approximating $750,000 per annum under existing lines of
credit primarily for the purpose of building inventories to support the growing
levels of new aircraft production and replacement parts requirements.
Upon consummation of the 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 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. The Company borrowed $2.5
million under the Revolving Credit Facility upon consummation of the W-J
Acquisition and the Offering. Outstanding borrowings under the Revolving Credit
Facility as of December 31, 1997 totaled $7.5 million. The increase in
borrowings under the Revolving Credit Facility subsequent to the W-J Acquisition
was primarily due to the fact that trade receivables were not purchased as part
of the W-J Acquisition. 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 as of December 31,
1997, totaled approximately $19.4 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.
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 $2,624,000 as of the year ended December 31,
1997 bearing interest at 7.875% per annum and maturing in December 2001.
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 Offering and additional amounts may be required to be
28
<PAGE>
borrowed under the New Credit Facilities. For 1998, based on the Company's
existing operations, the Company expects to spend approximately $3,500,000 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 Part I, Item 1. "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.
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 December 31, 1997 and
December 31, 1996 was $92.6 million ($72.5 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 December 31,
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.
Environmental Matters
The Company and its operations are subject to extensive federal, state,
and local Environmental Laws that may change frequently. 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
29
<PAGE>
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.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," which standardizes the
disclosure requirement for pensions and other postretirement benefits. The
implementation of SFAS No. 132 is not expected to have an impact on the
Company's financial statements. The standard will be effective for the Company
for the year ended December 31, 1998.
The Year 2000 Issue
The Company has made an assessment of the impact of the Year 2000 issue
on its internal operations and has developed a plan to bring all of its computer
systems into compliance before the end of 1998. Based on the assessment of the
Company's computer systems software, it has been determined that certain of the
Company's hardware and software systems are either currently Year 2000 compliant
or have an existing upgrade available from the software vendor that is Year 2000
compliant. It is management's intention that all systems that are not currently
Year 2000 compliant will either be upgraded to be Year 2000 compliant or
replaced with alternative systems that are Year 2000 compliant by the end of the
third quarter in 1998.
While achieving Year 2000 compliance is a major task, the costs to be
incurred in addressing the Year 2000 issues are not expected to have a material
impact on the Company's future financial results.
Forward-Looking Statements
This report contains forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Investors are cautioned that
any forward-looking statements, including statements regarding the intent,
belief, or current expectations of the Company or its management, are not
guarantees of future performance and involve risks and uncertainties, and that
actual results may differ materially from those in forward-looking statements as
a result of various factors including, but not limited to: (i) general economic
conditions in the markets in which the Company operates, (ii) cancellation of
specific aircraft or missile programs due to defense spending or general
budgetary constraints or poor customer demand, (iii) development of competing
technology and scientific know-how similar or superior to that of the Company's
and (iv) success in hiring and retaining key management and technical personnel.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary financial information that are
required to be included pursuant to this Item 8 are listed in Item 14 of this
Report under the caption "(a)1." and follow Item 14. The financial statements
and supplementary financial information specifically referenced in such list are
incorporated in this Item 8 by reference.
30
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
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.
Paul Dudek............................. 47 Chief Financial Officer of Stellex Microwave
Julius E. Hodge........................ 47 Chief Financial Officer of Stellex Aerospace
Lawrence R. Smith...................... 52 President of Paragon Precision Products
John Barriatua......................... 62 President of General Inspection Laboratories, Inc.
</TABLE>
31
<PAGE>
<TABLE>
<S> <C> <C>
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 Vice President of Finance at General Aquatics (successor to KDI
Corporation) since its formation in 1995. Prior to General Aquatics Mr. Byer
held the position of Vice President of Finance with KDI Corporation from 1987 to
1995. Mr. Byer spent nine years in the New York office of Arthur Andersen, where
he functioned as an Audit Manager. After leaving Arthur Andersen, Mr. Byer
worked at various firms in the capacity of Assistant Controller and Director of
Auditing until 1976 when he joined the Keene Corporation, initially as Assistant
Controller and later as Vice President of Finance.
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 and 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 and 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
32
<PAGE>
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.
Paul Dudek became Chief Financial Officer of Stellex Microwave in January
1998. Prior to joining Stellex Microwave, Mr. Dudek was employed by AlliedSignal
Aerospace as Vice President, Finance of Aerospace Equipment Systems from
November 1994 until December 1997. Prior to this time, Mr. Dudek was employed by
General Electric Capital Corporation from November 1991 until November 1994 as
the Senior Vice President and Chief Financial Officer for the Modular Space and
Transportation Equipment Financing divisions.
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 from April 1995 until November 1997, and served as its President
since January 1996. Prior to this time, Mr. Fulton was employed by Kade
Composites from July 1986 until April 1995, and served as its President from
February 1988 until April 1995.
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 Part III, Item 13. "Certain Relationships and
Related Transactions--Management Agreement with Mentmore."
ITEM 11. EXECUTIVE COMPENSATION
Compensation of Executive Officers
33
<PAGE>
The following table sets forth the compensation paid by the Company, its
predecessor and/or Watkins-Johnson to (i) the Company's current Chief Executive
Officer and (ii) the four next most highly compensated individuals serving as
executive officers of the Company whose annual compensation exceeded $100,000 in
1997.
SUMMARY COMPENSATION TABLE
Annual Compensation
<TABLE>
<CAPTION>
Other All
Annual Other
Compen- Compen-
Name and Principal Salary Bonus sation sation
Position Year ($) ($) ($) ($)
<S> <C> <C> <C> <C> <C>
William L. Remley, 1997 --- --- --- ---
Chief Executive
Officer of Stellex (a)
Keith D. Gilbert, 1997 213,644 63,898 --- 1,575(c)
President and
Chief Executive
Officer of Stellex
Microwave (b)
Bradley C. Call, 1997 222,784 80,000 --- 739,276(e)
President and
Chief Executive
Officer of Stellex
Aerospace (d)
Roland H. Marti, 1997 124,538 14,797 --- 93,280(g)
President of
Scanning Electron
Analysis
Laboratories, Inc. (f)
Lawrence R. Smith, 1997 114,950 19,862 --- 239,306(i)
President of
Paragon Precision
Products (h)
</TABLE>
- -------------------
(a) Mr. Remley is an executive officer and director of Mentmore, which,
pursuant to the Management Agreement (as defined), provides the Company
with general management, advisory, consulting and other services in
exchange for an annual management fee. See Part III, Item 13. "Certain
Relationships and Related Transactions--Management Agreement with
Mentmore."
(b) Mr. Gilbert was employed from January 1, 1997 to October 31, 1997 as
Executive Vice President of Watkins-Johnson and acting President of TSMD,
and $188,684 of the salary and all of the bonus and all other
compensation presented relates to such employment. Mr. Gilbert was
employed from November 1, 1997 to December 31, 1997 as President and
Chief Executive Officer of Stellex Microwave, and $24,960 of the salary
presented relates to such employment.
34
<PAGE>
(c) Consists of a management incentive bonus plan award.
(d) Mr. Call was employed from January 1, 1997 to July 1, 1997 as Chairman,
President and Chief Executive Officer of Kleinert (predecessor to
Stellex), and $108,675 of the salary presented relates to such
employment. Mr. Call was employed from July 1, 1997 to December 31, 1997
as President and Chief Executive Officer of Stellex Aerospace, and
$114,109 of the salary presented relates to such employment.
(e) Mr. Call received $730,132 from Kleinert Industries, Inc. in connection
with the consummation of the Kleinert Acquisition. See Part III, Item 13.
"Certain Relationships and Related Transactions--The Kleinert
Acquisition." All other compensation also includes 401(k) employer
contributions of $4,800 and term life insurance premiums of $4,344. Fifty
percent of each of such amounts relate on a pro rata basis to each of the
periods of Mr. Call's employment described in footnote (d) above.
(f) Mr. Marti was employed from January 1, 1997 to July 1, 1997 as President
of Scanning Electron Analysis Laboratories, Inc. (a wholly owned
subsidiary of Kleinert Industries, Inc.) and $60,750 of the salary
presented relates to such employment. Mr. Marti was employed from July 1,
1997 to December 31, 1997 as President of Scanning Electron Analysis
Laboratories, Inc. (a wholly owned subsidiary of Stellex Aerospace) and
$63,788 of the salary presented relates to such employment.
(g) Mr. Marti received $87,616 from Kleinert Industries, Inc. in connection
with the consummation of the Kleinert Acquisition. See Part III, Item 13.
"Certain Relationships and Related Transactions -- The Kleinert
Acquisition." All other compensation also includes 401(k) employer
contribution of $4,800 and term life insurance premiums of $864. Fifty
percent of each of such amounts relate on a pro rata basis to each of the
periods of Mr. Marti's employment described in footnote (f) above.
(h) Mr. Smith was employed from January 1, 1997 to July 1, 1997 as President
of Paragon Precision Products (a wholly owned subsidiary of Kleinert
Industries, Inc.) and $55,000 of the salary presented relates to such
employment. Mr. Smith was employed from July 1, 1997 to December 31, 1997
as President of Paragon Precision Products (a wholly owned subsidiary of
Stellex Aerospace) and $59,950 of the salary presented relates to such
employment.
(i) Mr. Smith received $233,642 from Kleinert Industries, Inc. in connection
with the consummation of the Kleinert Acquisition. See Part III, Item 13.
"Certain Relationships and Related Transactions -- The Kleinert
Acquisition." All other compensation also includes 401(k) employer
contribution of $4,800 and term life insurance premiums of $864. Fifty
percent of each of such amounts relate on a pro rata basis to each of the
periods of Mr. Smith's employment described in footnote (h) above.
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 Part III, Item 13. "Certain Relationships
and Related Transactions--The Kleinert Acquisition."
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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 provided for the
doubling of benefits payable under Watkins-Johnson's pre-existing profit sharing
bonus plan to all employees of the business who remained employed by
Watkins-Johnson or Stellex Microwave at the end of 1997. The total bonus
payments under this plan approximated $700,000 with the final disbursements
occurring in March 1998.
Certain key employees of the business were also eligible for additional
individual retention bonuses, some of which were fixed dollar amounts and others
of which were based on the financial results of the business during 1997. The
total bonus payments under these plans approximated $1.1 million with the final
disbursements occurring in March 1998.
Pursuant to the W-J Stock Purchase Agreement, Stellex Microwave placed
funds to defray the costs of all such retention payments and related payroll
taxes into an escrow account. The amount placed in the escrow account that was
used to pay such retention amounts and related taxes was credited against the
purchase price paid at the closing of the W-J Acquisition.
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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 $75,000 has been forgiven
and $25,000 remained outstanding as of December 31, 1997). The balance of this
note shall be forgiven in the event Mr. Boland remains in the employ of Stellex
Microwave through 1998. This note was made in connection with loans for
relocation assistance.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth information concerning the beneficial
ownership of Stellex's Common Stock as of March 1, 1998 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.
Common Stock
Beneficially Owned
------------------
Beneficial Owner Shares %
- ---------------- ------ -
Cottingham Trust (1996)(a)......... 892 89.2
Askrigg Trust (1996)(b)............ 99 9.9
Richard L. Kramer.................. 892(c) 89.2
William L. Remley.................. 991(d) 99.1
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.......... 991 99.1
- -------------------
(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, with the exception of Stellex Microwave of which Mr. Kramer
is the Vice Chairman, and Mr. Remley, Vice Chairman, Chief Executive
Officer and a director of Stellex and Vice Chairman and a director of the
Subsidiary Guarantors, with the exception of Stellex Microwave of which
Mr. Remley is the Chairman, 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, with the exception of Stellex
Microwave of which Mr. Kramer is the Vice Chairman, and Mr. Remley, Vice
Chairman, Chief Executive Officer and a director of Stellex and Vice
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Chairman and a director of the Subsidiary Guarantors, with the exception
of Stellex Microwave of which Mr. Remley is the Chairman, are the sole
executive officers and directors of Mentmore, which provides management
services to the Company.
(c) Comprised of 892 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 892 and 99 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.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED 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 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
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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 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 Part I,
Item 1. "--Supply Agreements" and "--Intellectual Property" and Part I, Item 2.
"Business--Properties."
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
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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
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
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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 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 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 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 Offering. For the year ended
December 31, 1997, the Company paid an additional $225,000 of fees to Mentmore
under the Management Agreement. 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
its subsidiaries. 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.
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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.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) List of documents filed as part of this Report:
1. The financial statements listed on page F-1 are
filed as part of this Report.
2. Financial Statement Schedules:
All schedules are omitted because they are not applicable, not
required or the information is included elsewhere in the Consolidated
Financial Statements or Notes thereto.
3. List of Exhibits:
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------ -----------
<S> <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 Certificate 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.
</TABLE>
42
<PAGE>
<TABLE>
<S> <C>
*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.
*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.
**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.
*10.3 Stock Purchase Agreement dated as of May 23, 1997, by and among KII Acquisition Corp.
and Kleinert Industrie Holding AG.
*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.
*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.
*12.1 Subsidiaries of the Registrants.
27.1 Financial Data Schedule
</TABLE>
- ----------------
43
<PAGE>
* Filed with Registration Statement No. 333-41939 and incorporated
herein by reference.
** Confidential treatment requested for a portion of this exhibit
previously filed with Registration Statement No. 333-41939 and
incorporated herein by reference.
(b) Reports on Form 8-K:
None.
(c) Exhibits:
See (a)(3) above for a listing of Exhibits filed as a part of this
Report.
(d) Additional Financial Statement Schedules:
None.
Supplemental Information to be Furnished With Reports Filed Pursuant to Section
15(d) of the Act by Registrants Which Have Not Registered Securities Pursuant to
Section 12 of the Act
Neither an annual report covering the Registrant's last fiscal year nor
proxy materials with respect to any annual or other meeting of security holders
have been sent to security holders.
44
<PAGE>
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
Stellex Industries, Inc.:
We have audited the accompanying consolidated balance sheet of Stellex
Industries, Inc. and subsidiaries (the "Company") as of December 31, 1997 and
the related consolidated statements of operations, stockholders' equity and
cash flows for the six-month period then ended. We did not audit the financial
statements of KII Holding Corp. (a consolidated subsidiary) which statements
reflect total assets constituting 26% of consolidated total assets at December
31, 1997 and total revenues constituting 58% of consolidated total revenues
for the six-month period then ended. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for KII Holding Corp., is based solely on the
report of such other auditors. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements 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 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 audit and the report of the other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors, such
consolidated financial statements present fairly, in all material respects,
the financial position of Stellex Industries, Inc. and subsidiaries as of
December 31, 1997, and the results of their operations and their cash flows
for the six-month period then ended in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements, the Company
adopted a new accounting basis effective July 1, 1997 in connection with a
change of ownership and recorded net assets as of that date at the new owner's
acquisition cost. Accordingly, the book values of assets in the accompanying
consolidated financial statements as of December 31, 1997 are not comparable
to those of earlier periods.
DELOITTE & TOUCHE LLP
San Jose, California
March 13, 1998
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of
KII Holding Corp. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of KII Holding
Corp. and subsidiaries (formerly Kleinert Industries, Inc.) as of December 31,
1997 and 1996 and the related consolidated statements of operations,
stockholders' equity and cash flows for the six-month period ended December
31, 1997 (successor) and June 30, 1997 (predecessor) and the years ended
December 31, 1996 and 1995 (predecessor). These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated 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 present fairly, in all material
respects, the consolidated financial position of KII Holding Corp. and
subsidiaries (formerly Kleinert Industries, Inc. and subsidiaries) as of
December 31, 1997 and 1996, and the consolidated results of their operations
and their cash flows for the six months ended December 31, 1997 (successor)
and June 30, 1997 (predecessor) and the years ended December 31, 1996 and 1995
(predecessor) in conformity with generally accepted accounting principles.
COOPERS & LYBRAND LLP
Los Angeles, California
March 6, 1998
-2-
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
December 31,
1997 1996
ASSETS (Predecessor)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 3,304,200 $ 406,000
Accounts receivable, less allowance for doubtful accounts
($91,600 in 1997 and $112,300 in 1996) 15,232,200 3,876,000
Inventories 27,884,200 11,547,700
Prepaid and other assets 3,753,000 281,300
Deferred income taxes 2,172,400 486,000
------------- ------------
Total current assets 52,346,000 16,597,000
Property, plant and equipment, net 31,506,000 11,165,400
Goodwill, net of accumulated amortization of $252,400 in 1997 and $262,700 in 1996 42,919,700 986,100
Other intangible assets, net of accumulated amortization of $393,500 12,594,800
Deferred financing costs, net of accumulated amortization of $90,900 5,356,800 -
Other assets 1,059,100 865,900
------------- ------------
TOTAL ASSETS $ 145,782,400 $ 29,614,400
============= ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving line of credit $ - $ 4,300,000
Current portion of notes and capital lease obligations 139,700 1,558,000
Accounts payable 4,637,900 1,525,000
Accrued liabilities 12,031,100 1,301,000
Advance billings and customer deposits 2,678,900 177,900
------------- ------------
Total current liabilities 19,487,600 8,861,900
9-1/2% senior subordinated notes 100,000,000 -
Long-term obligations, less current portion 12,181,800 4,123,900
Deferred employee benefits 1,704,000 1,599,700
Deferred income taxes 2,446,700 851,300
Minority interest in KII Holdings Corp. 1,078,100 -
------------- ------------
Total liabilities and minority interest 136,898,200 15,436,800
------------- ------------
COMMITMENTS AND CONTINGENCIES (Notes 11, 14 and 15)
STOCKHOLDERS' EQUITY:
Common stock, no par value, 1,000 shares authorized and outstanding 50,000 -
Common stock - predecessor, $1,000 par value; 1,000,000 shares authorized,
10,000 shares issued and outstanding - 10,000,000
Preferred stock, no par value: 500 shares authorized, 229 shares issued and outstanding 11,450,000 -
Additional paid-in capital - 1,952,700
Retained earnings (accumulated deficit) (2,615,800) 2,224,900
------------- ------------
Total stockholders' equity 8,884,200 14,177,600
------------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 145,782,400 $ 29,614,400
============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
-3-
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------
Six Months Six Months
Ended Ended
December 31, June 30, Years Ended December 31,
-------------------------------
1997 1997 1996 1995
(Predecessor)
<S> <C> <C> <C> <C>
SALES $ 30,535,900 $ 14,296,000 $ 24,306,900 $ 21,049,100
COST OF SALES 24,731,900 10,139,600 17,366,800 15,083,500
------------ ------------ ------------ ------------
Gross profit 5,804,000 4,156,400 6,940,100 5,965,600
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Selling, general and administrative 5,080,600 1,783,100 3,629,200 3,298,500
Research and development 588,000 - - -
Amortization of noncompete covenants,
goodwill and other intangible costs 716,100 15,600 31,200 282,200
------------ ------------ ------------ ------------
Total operating costs 6,384,700 1,798,700 3,660,400 3,580,700
------------ ------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS (580,700) 2,357,700 3,279,700 2,384,900
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income 25,400 4,500 11,600 5,500
Interest expense (2,577,700) (375,700) (855,800) (1,034,400)
Other (14,000) (102,900) (58,100) (44,100)
------------ ------------ ------------ ------------
Total other expense (2,566,300) (474,100) (902,300) (1,073,000)
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE PROVISION FOR
INCOME TAXES AND EXTRAORDINARY LOSS (3,147,000) 1,883,600 2,377,400 1,311,900
------------ ------------ ------------ ------------
PROVISION (BENEFIT) FOR INCOME TAXES (1,170,300) 753,400 944,900 524,800
------------ ------------ ------------ ------------
INCOME (LOSS) BEFORE EXTRAORDINARY
LOSS (1,976,700) 1,130,200 1,432,500 787,100
EXTRAORDINARY LOSS ON EARLY EXTINGUISH-
MENT OF DEBT (Net of income tax benefit of $298,900) (448,300) - - -
------------ ------------ ------------ ------------
NET INCOME (LOSS) (2,425,000) 1,130,200 1,432,500 787,100
PREFERRED STOCK DIVIDENDS (190,800) - - -
------------ ------------ ------------ ------------
INCOME (LOSS) APPLICABLE TO COMMON
STOCKHOLDERS $ (2,615,800) $ 1,130,200 $ 1,432,500 $ 787,100
============ =========== =========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
-4-
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Retained
Common Stock Preferred Stock Additional Earnings
--------------------- -------------------- Paid-in (Accumulated
Predecessor: Shares Amount Shares Amount Capital Deficit) Total
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, January 1, 1995 10,000 $ 10,000,000 $ 1,952,700 $ 5,300 $ 11,958,000
Net income 787,100 787,100
------ ------------ ---- ------------ ----------- ------------ ------------
BALANCE, December 31, 1995 10,000 10,000,000 1,952,700 792,400 12,745,100
Net income 1,432,500 1,432,500
------ ------------ ---- ------------ ----------- ------------ ------------
BALANCE, December 31, 1996 10,000 10,000,000 1,952,700 2,224,900 14,177,600
------ ------------ ---- ------------ ----------- ------------ ------------
Net income 1,130,200 1,130,200
------ ------------ ---- ------------ ----------- ------------ ------------
BALANCE, June 30, 1997 10,000 $ 10,000,000 $ 1,952,700 $ 3,355,100 $ 15,307,800
====== ============ ==== ============ =========== ============ ============
The Company:
Issuance of stock 1,000 $ 50,000 229 $ 11,450,000 $ 11,500,000
Net loss for the six months ended
December 31, 1997 $ (2,425,000) (2,425,000)
Dividends declared on preferred stock (190,800) (190,800)
------ ------------ ---- ------------ ----------- ------------ ------------
BALANCE, December 31, 1997 1,000 $ 50,000 229 $ 11,450,000 $ - $ (2,615,800) $ 8,884,200
====== ============ ==== ============ =========== ============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
-5-
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------------------
Six Months Six Months
Ended Ended
December 31, June 30, Years Ended December 31,
-----------------------------
1997 1997 1996 1995
(Predecessor)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,425,000) $ 1,130,200 $ 1,432,500 $ 787,100
Reconciliation to net cash provided by operating activities:
Depreciation and amortization 2,132,300 878,200 1,691,400 1,950,300
Gain on sale of property (900) (4,000) (2,200) (10,600)
Deferred income taxes (1,170,300) 125,100 254,100 165,800
Stock compensation 300,000 - - -
Extraordinary loss on extinguishment of debt 448,300 - - -
Changes in assets and liabilities (net of acquisitions):
Accounts receivable (10,500,900) (978,200) (388,600) (299,000)
Inventories 3,007,200 (1,078,300) (1,074,100) (1,058,200)
Income taxes receivable (92,000) - - -
Prepaid and other assets (2,661,900) (105,300) (219,600) (8,400)
Due from Parent - (2,100) (55,600) (146,000)
Other assets - (74,500) (182,700) -
Accounts payable 2,554,200 559,000 357,700 127,500
Accrued liabilities 3,861,400 18,000 530,400 329,400
Customer deposits - (3,100) 134,400 8,200
Income taxes payable - (60,100) (3,400) 20,000
------------ ----------- ----------- -----------
Net cash provided by (used in) operating activities (4,547,600) 479,400 2,657,000 1,866,100
------------ ----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash paid for acquisition of Kleinert and TSMD (97,905,800) - - -
Additions to fixed assets (1,289,100) (868,500) (1,052,500) (656,700)
Proceeds from sale of fixed assets and other - 33,500 4,500 13,600
------------ ----------- ----------- -----------
Net cash (used in) investing activities (99,194,900) (835,000) (1,048,000) (643,100)
------------ ----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of senior subordinated notes, net of issuance costs 94,552,300 - - -
Net borrowings on line of credit 7,500,000 300,000 735,000 765,000
Net borrowings on notes payable 430,000 (28,400) (2,141,600) (2,196,900)
Proceeds from borrowings in connection with Kleinert Acquisition 19,300,000 - - -
Proceeds from sales of stock (including minority interest) 12,278,100 - - -
Repayments under capital lease obligations (5,700) - - -
Repayment of debt and notes payable in conjunction with
Kleinert acquisition (27,330,000) - - -
------------ ----------- ----------- -----------
Net cash used in (provided by) financing activities 106,724,700 271,600 (1,406,600) (1,431,900)
------------ ----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents 2,982,200 (84,000) 202,400 (208,900)
CASH AND CASH EQUIVALENTS, beginning of year 322,000 406,000 203,600 412,500
------------ ----------- ----------- -----------
CASH AND CASH EQUIVALENTS, end of year $ 3,304,200 $ 322,000 $ 406,000 $ 203,600
============ =========== =========== ===========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION-
Cash paid during the year for:
Interest $ 750,100 $ 377,800 $ 863,900 $ 1,032,800
Income taxes, net $ 369,000 $ 633,000 $ 694,200 $ 339,000
Transactions in connection with the acquisition of Kleinert:
Note issued to seller $ 1,750,000 $ - $ - $ -
Mortgage note assumed $ 2,600,000 $ - $ - $ -
</TABLE>
See accompanying notes to consolidated financial statements.
-6-
<PAGE>
STELLEX INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
Formation of Stellex Industries, Inc. - On September 5, 1997, Stellex
Holdings Corp. was incorporated as a Delaware corporation, which on
October 23, 1997 amended its article of incorporation to change its name
to Stellex Industries, Inc. ("Stellex"). On September 12, 1997, Stellex
issued 1,000 shares of its common stock to Greystoke Capital Management
Limited LDC in exchange for (i) 8,010 shares of common and 84 shares of
Series A preferred stock of KII Holding Corp. ("KII Holdings"), (ii)
$50,000 cash and (iii) the assumption of a $4,000,000 promissory note.
KII Holdings had previously been formed to effect the acquisition of
Kleinert Industries and subsidiaries ("Kleinert") on July 1, 1997, as
described more fully below. As a result of the September 12, 1997
transaction, Stellex acquired an 80.1% interest in KII Holdings; the
remaining equity interests are held by certain members of Kleinert
management. The transaction has been accounted for as a reincorporation
of KII Holdings; accordingly, the financial statements of Stellex reflect
the results of its operations commencing with the acquisition of Kleinert
on July 1, 1997. Kleinert is the predecessor of Stellex, and financial
information for Kleinert is presented as of December 31, 1996 and for the
six months ended June 30, 1997 and the years ended December 31, 1996 and
1995 in accordance with the rules and regulations of the Securities and
Exchange Commission. References to the "Company" include both Stellex and
its predecessor, Kleinert.
Kleinert Acquisition - On July 1, 1997, KII Holdings through a
wholly-owned subsidiary (KII Acquisition Corp., a Delaware company),
acquired all of the outstanding capital stock of Kleinert from Kleinert
Industries Holding AG. The acquisition was 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) was 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 of
the net assets acquired in connection with the acquisition. Kleinert's
corporate name was subsequently changed to Stellex Aerospace. Kleinert
commenced operations in 1988, and provided 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").
PPP specializes in the manufacture of precision aerospace components.
GIL provides 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 hinges assemblies for
both aerospace and industrial applications.
TSMD Acquisition - 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. ("Stellex Microwave"),
which comprised the operations of the Tactical Subsystems and Microwave
Devices Sectors ("TSMD") of the Watkins-Johnson Company
("Watkins-Johnson"), for a net purchase price of approximately $82.1
million. The acquisition was accounted for using the purchase method of
accounting with estimated fair value being assigned to the assets
acquired and liabilities assumed. The purchase was financed primarily
with the net proceeds from offering of senior subordinated notes
totaling $92.3 million (see Note 6). Stellex Microwave designs, markets
and manufactures a broad
-7-
<PAGE>
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. Stellex's consolidated financial
statements include the results of operations of Stellex Microwave from
the acquisition date.
Pro Forma Financial Information - The following unaudited pro forma
financial information presents the results of operations of Stellex as
if the Kleinert Acquisition and the TSMD Acquisition had taken place on
January 1, 1996, and is not necessarily indicative of future operating
results of Stellex (in thousands):
Years Ended
December 31,
--------------------------
1997 1996
Sales $ 120,532 $ 113,507
Income from operations 12,513 2,838
Net income (loss) 1,482 (7,796)
Income (loss) applicable to
common stockholders 337 (8,941)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - Stellex is a holding company, which has no
operations or assets separate from its investments in its subsidiaries.
The consolidated financial statements include the accounts of Stellex
Microwave and KII Holdings and its 80% subsidiary, Stellex Aerospace and
its wholly-owned subsidiaries. All significant intercompany transactions
have been eliminated in consolidation.
The financial statements of Kleinert (the predecessor of Stellex)
include the accounts of Kleinert Industries, Inc. and its wholly-owned
subsidiaries. All significant intercompany transactions have been
eliminated in consolidation.
The Company adopted a new accounting basis effective July 1, 1997 in
connection with the change in ownership of Kleinert described in Note 1
and recorded net assets as of that date at the new owner's acquisition
cost. Accordingly, the book value of assets in the consolidated financial
statements as of December 31, 1997 are not comparable to the earlier
periods presented.
Cash and Cash Equivalents - Cash and cash equivalents include all highly
liquid investment instruments purchased with a maturity of three months
or less.
Inventories - Inventories are stated at the lower of cost (first-in,
first-out) or market.
-8-
<PAGE>
Property, Plant and Equipment - Property, plant and equipment are stated
at cost, and are being depreciated over the estimated useful lives of
the assets, using the straight-line method of depreciation. Estimated
useful lives are a follows:
Building and improvements 32 years
Leasehold improvements (based on the lesser of the useful
life of the assets or the remaining
life of the lease)
Machinery and equipment 7 - 10 years
Office furniture and fixtures 8 - 10 years
Office equipment and computers 4 - 5 years
Autos and trucks 4 - 5 years
Expenditures for maintenance and repairs are charged to expense as
incurred. Major renewals or betterments which substantially extend the
useful live of the assets are capitalized.
Long-Lived Assets - 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 on-going 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 assets.
Goodwill and Other Intangible Assets - Other intangible assets represent
specifically identified intangible assets - favorable lease
arrangements, patents, technology and assembled workforce - associated
with the acquisition of Stellex Microwave. These assets are being
amortized over their estimated lives ranging from one to 20 years.
Goodwill associated with the Stellex Microwave acquisition is being
amortized over 25 years. Goodwill arising from a previous acquisition by
Kleinert was being amortized over 40 years.
Revenue Recognition and Receivables - Revenues, other than long-term
contracts, and the related cost of sales 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 ratio
of costs incurred to total estimated costs to complete the contract.
Any anticipated losses on contracts are charged to earnings when
identified.
Government contracts have provisions for audit, price redetermination
and other profit and cost limitations. Contract 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.
Research and Development (R&D) - Company sponsored R&D costs are
expensed as incurred and included in operating expenses. Cost associated
with customer-funded R&D are included in costs of sales.
-9-
<PAGE>
Minority Interest in KII Holdings - Management of Stellex Aerospace owns
19.9% of the outstanding stock of KII Holdings. The amount reported in
the December 31, 1997 balance sheet of Stellex as minority interests
reflects the redemption value of such shares based on certain redemption
and put rights associated with the stock. Changes in the value of the
minority interest from the original amounts paid by the minority
shareholders are recorded as an adjustment to compensation expense in the
period.
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.
Concentration of Credit Risk - Financial instruments which potentially
subject the Company to concentrations of credit risk consist primarily
of trade receivables. The Company's customer base principally includes
the commercial aviation, defense, and aerospace 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.
The Company participates in a dynamic high technology industry and
believes that changes in any of the following areas could have a
material adverse effect on the Company's future financial position or
results of operations: advances and trends in new technologies and
industry standards; competitive pressures in the form of new products or
price reductions on current products; changes in product mix; changes in
the overall demand for products and services offered by the Company;
changes in certain strategic partnerships or customer relationships;
litigation or claims against the Company based on intellectual property,
patent, product, regulatory or other factors; risk associated with
changes in domestic and international economic and/or political
conditions or regulations; availability of necessary components; risks
associated with Year 2000 compliance; and the Company's ability to
attract and retain employees necessary to support its growth.
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.
Significant assumptions and estimates include: allowance for bad debts,
inventory obsolescence, percentage of completion on long-term contracts
and warranty provisions. Actual results could differ from those
estimates.
Recently Issued Accounting Standard - In June 1997, the Financial
Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive
Income," which requires that an enterprise report, by major components
and as a single total, the change in its net assets during the period
from nonowner sources.
-10-
<PAGE>
Adoption of this statement will not impact the Company's financial
position, results of operations or cash flows. The statement is
effective for the Company's fiscal year 1998.
3. INVENTORIES
Inventories consist of the following at December 31:
1997 1996
(Predecessor)
Raw materials $ 8,088,400 $ 1,151,500
Work-in-process 12,957,300 4,634,900
Finished goods 6,838,500 5,761,300
------------ -----------
Total $ 27,884,200 $ 11,547,700
============ ============
4. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at December 31:
1997 1996
(Predecessor)
Land $ 1,000,000 $ 1,230,200
Building and improvements 2,100,000 3,451,900
Leasehold improvements 94,900 209,700
Machinery and equipment 28,080,000 20,556,200
Office furniture and fixtures 449,500 574,300
Office equipment and computers 816,900 1,474,500
Projects in progress 305,800 317,800
----------- -----------
32,847,100 27,814,600
Accumulated depreciation and
amortization (1,341,100) (16,649,200)
----------- -----------
Total $31,506,000 $ 11,165,400
=========== ============
5. ACCRUED LIABILITIES
Accrued liabilities as of December 31 consist of the following:
1997 1996
(Predecessor)
Bonuses payable $ 2,892,200 $ 510,400
Interest payable 1,762,100 2,900
Accrued workers' holiday and
vacation liability 1,672,000 430,800
Provision for losses on contracts 1,644,300 -
Dividends payable 190,800 -
Other 3,869,700 356,900
------------ -----------
Total $ 12,031,100 $ 1,301,000
============ ===========
-11-
<PAGE>
6. FINANCING ARRANGEMENTS
Lines of Credit
Stellex has a credit facility which provides for a $25 million revolving
line of credit and a $25 million term line of credit. Borrowings under
the revolving line of credit may be either base rate loans, which bear
interest at Societe Generale's base rate plus 1%, or Eurodollar rate
loans, which bear interest at the lender's Eurodollar rate plus 2%;
borrowings under the term line bear interest 0.25% higher than the
revolver. These rates are subject to adjustment beginning July 1998
based upon the leverage ratio of the Company, as defined. Borrowings
under the revolving line of credit are limited to 85% of eligible
accounts receivable and 50% of eligible inventories, and are available
through October 2003. Borrowings under the term line of credit may be
made only for acquisitions prior to November 1999, subject to approval
by the lender, and will be repayable in 15 quarterly installments. The
term facility requires prepayments in the amount of 50% of excess cash
flows, as defined, and 100% of the proceeds from the offering of any
debt or equity securities. Borrowings are collateralized by all of the
assets of the Company and are jointly and severally guaranteed by each
of Stellex's subsidiaries. The Credit Facility requires the Company to
maintain a minimum fixed charges coverage ratio and interest coverage
ratio, as defined, minimum net worth of $5,500,000 and a maximum
leverage ratio. The credit facility also restricts the Company's ability
to incur additional indebtedness, pay dividends or other significant
activities without approval of the lender. The Company was in compliance
with the covenants at December 31, 1997. At December 31, 1997,
$7,500,000 was outstanding under the revolving line of credit in the
form of base rate loans.
Kleinert previously had a $6,550,000 revolving line of credit with a
California commercial bank. The bank had a first priority security
interest in substantially all assets of the Company, except land and
buildings. The line bore interest at either .25% over the bank's prime
rate or 1.5% over the London Interbank Offered Rate ("LIBOR"). At
December 31, 1996, the effective interest rate was 7.65%. The line was
repaid in connection with the Kleinert acquisition.
9-1/2% Senior Subordinated Notes
On October 23, 1997, Stellex issued $100 million principal amount 9-1/2%
senior subordinated notes. The notes require semiannual interest
payments and are due November 1, 2007. The notes are unsecured and are
subordinated in right of payment to all existing and future indebtedness
of Stellex. The notes are guaranteed, jointly and severally, on an
unsecured, senior subordinated basis, by each of Stellex's subsidiaries
(see Note 16). The indenture under which the notes were issued contains
certain covenants which limit the ability of Stellex to incur additional
indebtedness, to issue preferred stock, to make dividend payment and
other distribution to stockholders, and to sell assets or stock of its
subsidiaries. At December 31, 1997 the Company was in compliance with
these covenants. Upon a change in control, as defined, the holders of the
notes have the right to require Stellex to repurchase the notes at 101%
of their principal amount, plus any accrued interest. Stellex may redeem
the notes prior to 2007 at a premium, which declines over time. Debt
issuance costs relating to the offering are included in long-term assets
and are amortized to interest expense over the life of the debt.
-12-
<PAGE>
Other Long-Term Obligations
Other long-term obligations consists of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
(Predecessor)
<S> <C> <C>
Revolving line of credit $ 7,500,000 $ -
7.785% Note payable, first deed of trust on PPP land and
building with a net book value of $2,968,000; principal
and interest payments of $22,000 due monthly with the
balance of $2,363,000 due December 2001 2,624,000 2,681,900
8% Note payable to Kleinert Industries Holding AG in
connection with the Kleinert acquisition, interest payable
annually and principal due July 1, 1999; guaranteed by
Stellex Aerospace and each of its subsidiaries 1,750,000 -
Obligations under capital leases 447,500 -
Uncollateralized note payable issued in connection with
acquisition of BMI, interest at LIBOR plus 1.5%
(7.1% at December 31, 1996); repaid in connection
with the Kleinert acquisition - 3,000,000
------------ -----------
Total 12,321,500 5,681,900
Less current portion 139,700 1,558,000
------------ -----------
Long-term portion $ 12,181,800 $ 4,123,900
============ ===========
</TABLE>
On October 31, 1997, Stellex paid off on behalf of KII Holdings with the
proceeds of the senior subordinated debt certain external debt consisting
of: $16,000,000 term note issued in connection with the acquisition of
Kleinert payable to Societe Generale and maturing in 2004; a $2,500,000
promissory note also issued in connection with the acquisition payable to
Trinity Investment Corp. maturing in 2005; and $1,230,000 of revolving
credit borrowings under a credit facility. As a result, the Company
recorded a loss comprised of unamortized debt issuance cost of $747,200
which has been reflected, net of income taxes, in the Company's
consolidated statement of operations as an extraordinary item.
Maturities of long-term debt and capital leases (excluding the revolving
line of credit) are as follows as of December 31, 1997:
Long-Term Capital
Debt Leases
1998 $ 62,800 $ 121,100
1999 1,817,900 121,100
2000 73,400 119,900
2001 2,419,900 110,900
2002 - 100,200
Thereafter 100,000,000 -
------------- ---------
Total $ 104,374,000 $ 573,200
=============
Less amount representing interest (125,700)
---------
Total $ 447,500
=========
-13-
<PAGE>
7. MINORITY INTEREST
Pursuant to an agreement entered into in connection with the Kleinert
acquisition certain members of Stellex Aerospace's management (the
"Buyer(s)") purchased 19.9% of the common and preferred shares of KII
Holdings for $778,100.
KII Holdings has the right to redeem (the "Redemption Right") all, but
not less than all, of any common stock held by the Buyers upon the
occurrence of certain events including the death, disability or
termination of the Buyer, and for any reason after July 1, 2002. In
addition, each Buyer has the right to cause KII Holdings to purchase
all, but not less than all, of any common stock held by him under
similar conditions (the "Put Right"). The applicable purchase price to
be received by a Buyer upon the exercise of a Redemption Right or Put
Right is based upon a formula set forth in the Stellex Investor
Agreement. In addition, KII Holdings granted the Buyers the right to
receive the net appreciation associated with an additional 10% of equity
ownership in KII Holdings. The value of these stock appreciation rights
("SARs") is computed under the same formula used for the Redemption and
Put Rights on the minority interests, and may be paid under similar
conditions. The minority interest is reported in the financial
statements at the amount paid by management as adjusted for changes in
value based on the underlying formulas for the minority interests and
SARs, with a corresponding charge to compensation expense. This resulted
in an expense of $300,000 for the six months ended December 31, 1997.
To the extent KII Holdings is prohibited under the terms of its existing
indebtedness from making payment to any Buyer for any shares of its
common stock purchased or liquidated pursuant to the Stellex Investor
Agreement, then it is required to issue a promissory note to such Buyer
for the amount owing. Such note shall be payable when and to the extent
KII Holdings 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 Holdings.
8. SHAREHOLDERS' EQUITY
Preferred Stock
In October 1997, the Company issued 229 shares of preferred stock for
total gross proceeds of $11,450,000. Each stockholder of preferred stock
is entitled to one vote for each share of preferred stock outstanding.
When declared by the Board of Directors, the preferred stock holders are
entitled to receive cumulative dividends at a rate of 10% per annum of
the sum of the liquidation preference and any dividends which may be in
arrears. At December 31, 1997, dividends of $190,800 had been declared
but not paid. In the event of liquidation, dissolution or winding up of
the Company, the preferred stockholders shall receive a liquidation
preference of $50,000 per share. The preferred stock is redeemable at
the election of the Company at a price equal to the liquidation
preference plus an amount equal to all dividends accrued and unpaid.
-14-
<PAGE>
9. INCOME TAXES
The provision (benefit) for income taxes consists of the following:
Six Months Ended Year Ended
--------------------------
December 31, June 30, December 31,
-------------------------
1997 1997 1996 1995
(Predecessor)
Current:
Federal $ - $ 492,300 $ 514,800 $ 281,400
State 12,000 135,900 176,000 77,600
----------- --------- --------- ---------
12,000 628,200 690,800 359,000
----------- --------- --------- ---------
Deferred:
Federal (1,163,000) 85,100 202,700 121,300
State (19,300) 40,100 51,400 44,500
----------- --------- --------- ---------
(1,182,300) 125,100 254,100 165,800
----------- --------- --------- --------
Total $(1,170,300) $ 753,400 $ 944,900 $ 524,800
=========== ========= ========= =========
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. At December 31, 1997 the amount of deferred tax assets and
liabilities was not significant.
At December 31, 1997, the Company's alternative minimum tax credits for
federal and state purposes were approximately $303,900 and $134,800,
respectively, which are available to reduce income taxes on an
indefinite carryforward basis.
At December 31, 1997 the Company had net operating losses of approximately
$1,257,000 and $590,831 for federal and California income tax purposes,
which will begin to expire in 2012 and 2002, respectively. The extent to
which the loss carryforwards can be used to offset future taxable income
may be limited if changes in the Company's stock ownership exceed certain
defined limits.
The net deferred tax assets and liabilities at December 31 consist of
the following:
1997 1996
(Predecessor)
Current:
Deferred tax assets $ 2,172,400 $ 519,300
Deferred tax liabilities - (33,300)
------------ ----------
Net deferred tax asset $ 2,172,400 $ 486,000
============ ==========
Long-term:
Deferred tax liabilities $(3,128,300) (2,006,000)
Deferred tax assets 681,600 1,154,700
----------- ----------
Net deferred tax liability $ 2,446,700 $ (851,300)
=========== ==========
-15-
<PAGE>
The differences between the effective income tax rates and the statutory
federal income tax rate are as follows:
<TABLE>
<CAPTION>
Six Months Ended Years Ended
----------------------------
December 31, June 30, December 31,
-----------------------
1997 1997 1996 1995
Predecessor Predecessor
<S> <C> <C> <C> <C>
Statutory federal tax rate (35.0)% 35.0 % 35.0 % 35.0 %
State taxes, net of federal benefit (6.0)% 6.1 % 6.3 % 6.1 %
Change in value of minority interest 2.3 % - - -
Other 1.6 % (1.1)% (1.6)% (1.1)%
------- ------ ------ ------
Effective rate (37.1)% 40.0 % 39.7 % 40.0 %
======= ====== ====== ======
</TABLE>
10. EMPLOYEE BENEFIT PLANS
Unfunded Pension Benefits - The Company sponsors a defined benefit plan
which covers four employees of Stellex Aerospace. The balance of
unfunded pension benefits ($298,300 and $307,800 at December 31, 1997
and 1996, respectively) represents the net present value of estimated
future payments based on actuarially determined life expectancies and an
7.75% discount rate.
Deferred Compensation Agreements - The Company has individual deferred
compensation agreements with certain members of management. 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, 1997 and 1996, the deferred compensation liability was
$1,405,700 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 7.75% per annum. The related expense
for the six months ended December 31, 1997 and June 30, 1997 and for the
years ended December 31, 1996 and 1995 was $56,400, $56,900, $209,500
and $71,800, respectively. The expense for 1996 included the
nonrecurring step-up of the liability for the implementation of two
additional agreements effective January 1, 1996.
Defined Contribution Plan - The Company sponsors multiple defined
contribution plans which conform to the requirements of the Employee
Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue
Code as qualified defined contribution plans. Under the Stellex
Microwave Plan, the Company matches employees 401(k) salary deferrals up
to 3% of eligible employee compensation. For employees eligible under
the Stellex Aerospace defined contribution plan, the Company matches up
to 3% of the employee's eligible compensation. Total Company
contributions were $228,500, $133,400,
-16-
<PAGE>
$223,300 and $200,500 for the six months ended December 31, 1997 and June
30, 1997 and for the years ended December 31, 1996 and 1995,
respectively.
11. 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.
Watkins-Johnson has agreed to sublease space to Stellex Microwave in
Palo Alto, California for three years. Such facilities are subject to an
environmental remediation plan being monitored by various regulatory
agencies. Under the terms of the Stellex Microwave 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 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.
Minimum annual rentals and sublease income on facility and equipment
leases are as follows:
Minimum
Annual
Rentals
1998 $ 3,649,200
1999 3,513,900
2000 2,769,800
2001 12,600
2002 12,600
Thereafter 13,600
-----------
Total $ 9,971,700
===========
Six Months Ended Years Ended
-----------------------------
December 31, June 30, December 31,
-------------------------
1997 1997 1996 1995
Predecessor
Rent expense $ 838,900 $ 349,700 $ 723,300 $ 740,200
Rent expense includes $152,200, $150,000, $290,000 and $309,500 for the
six months ended December 31, 1997 and June 30, 1997 and for the years
ended December 31, 1996 and 1995, respectively, for facility rent paid
to the former owner of BMI.
12. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments.
-17-
<PAGE>
Cash and Cash Equivalents, Accounts Receivable, and Revolving Line of
Credit - The carrying amount reported in the consolidated balance sheet
for Cash and Cash Equivalents, Trade Accounts Receivable, and amounts
borrowed under the Company's revolving line of credit approximate their
fair value.
Notes Payable - The fair value of notes payable was calculated based on
interest rates available for debt with terms and due dates similar to the
Company's existing debt arrangements. At December 31, 1997 the carrying
amount of the senior subordinated notes and notes payable approximated
their fair value.
13. SIGNIFICANT CUSTOMERS
For the six months ended December 31, 1997, sales to one customer account
for 10% of total revenues. At December 31, 1997, one customer balance
accounted for 20% of accounts receivable.
14. SUPPLY CONTRACTS
In connection with the TSMD 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 module for a variety of applications, including
virtually every integrated subsystem manufactured by Stellex Microwave.
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"). The GaAs
Agreement expires 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 fixed 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 development totaling 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. For the
six-month period ended December 31, 1997 such costs totaled $446,700. At
December 31, 1997, the Company owed Watkins-Johnson $263,300 related to
this agreement.
In connection with the TSMD 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
-18-
<PAGE>
terminated on one year's notice by Watkins-Johnson. Through December 31,
1997, there were no sales made under the agreement.
15. RELATED PARTY TRANSACTIONS
Stellex has entered into a Management Agreement with Mentmore Holdings.
Under the terms of the Agreement (as amended), Mentmore receives
reimbursement of certain costs and an annual management fee of $750,000,
plus the amount by which 1% of the Company's total consolidated sales in
any fiscal year exceeds such fee. For the six months ended December 31,
1997, the total management fee paid to Mentmore was $225,000. As of
December 31, 1997, accounts payable included amounts due to Mentmore of
$106,800.
In connection with the Kleinert and TSMD Acquisitions, Mentmore received
investment banking fees of $1,450,000 and reimbursement for certain
expenses. Such fees are included in selling, general and administrative
expenses for the six months ended December 31, 1997.
16. CONDENSED FINANCIAL INFORMATION OF STELLEX AND ITS SUBSIDIARIES
The $100 million principal amount 9 1/2% senior subordinated notes are
guaranteed by all subsidiaries of Stellex consisting of Stellex
Microwave, a wholly-owned subsidiary and KII Holdings, an 80.1% owned
subsidiary, which owns 100% of Stellex Aerospace. Condensed
consolidating financial information as of December 31, 1997 and the
six-month period then ended follows:
<TABLE>
<CAPTION>
Stellex Stellex Stellex
Condensed Consolidating Balance Sheet (Parent Only) Microwave KII Holdings Eliminations Consolidated
<S> <C> <C> <C> <C> <C>
Cash $ 956,600 $ 1,195,400 $ 1,152,200 $ - $ 3,304,200
Accounts receivable - 9,785,500 5,446,700 - 15,232,200
Inventories - 15,067,100 12,817,100 - 27,884,200
Other current assets 2,019,400 4,476,800 1,448,500 (2,019,300) 5,925,400
------------- ------------- ------------ -------------- -------------
Total current assets 2,975,000 30,524,800 20,864,500 (2,019,300) 52,346,000
Property, plant and equipment - 17,047,100 14,458,900 - 31,506,000
Goodwill and intangibles - 55,514,500 - - 55,514,500
Investment in and advances to
subsidiaries 117,885,000 - - (117,885,000) -
Other assets - 4,373,600 2,042,300 - 6,415,900
------------- ------------- ------------ -------------- -------------
Total assets $ 120,861,000 $ 107,460,000 $ 37,365,700 $ (119,904,300) $ 145,782,400
============= ============= ============ =============== =============
Current liabilities $ 2,008,800 $ 15,454,800 $ 4,085,600 $ (2,061,600) $ 19,487,600
9-1/2% senior subordinated
notes 100,000,000 - - - 100,000,000
Intercompany notes - 92,969,000 20,943,000 (113,912,100) -
Other long-term liabilities 7,500,000 753,400 8,079,200 1,078,100 17,410,600
Stockholders' equity 11,352,200 (1,717,200) 4,257,900 (5,008,700) 8,884,200
------------- ------------- ------------ --------------- -------------
Total liabilities and
stockholders' equity $ 120,861,000 $ 107,460,000 $ 37,365,700 $ (119,904,300) $ 145,782,400
============= ============= ============ ============== =============
</TABLE>
-19-
<PAGE>
<TABLE>
<CAPTION>
Condensed Consolidating Statement Stellex Stellex Stellex
of Operations (Parent Only) Microwave KII Holdings Eliminations Consolidated
<S> <C> <C> <C> <C> <C>
Sales $ - $ 12,959,100 $ 17,576,800 $ - $ 30,535,900
Cost of sales - 11,087,800 13,644,100 - 24,731,900
Operating expenses - 2,592,000 2,776,600 300,000 5,668,600
Amortization of intangibles - 645,900 70,200 - 716,100
------------- ------------- ------------ -------------- -------------
Operating income (loss) - (1,366,600) 1,085,900 (300,000) (580,700)
Interest expense (1,758,100) (1,547,500) (1,070,700) 1,798,600 (2,577,700)
Other income (expense) 1,801,100 26,700 (17,800) (1,798,600) 11,400
------------- ------------- ------------- -------------- -------------
Income (loss) before income
taxes and extraordinary item 43,000 2,887,400 (2,600) (300,000) (3,147,000)
Income tax benefit - (1,169,200) (1,100) - (1,170,300)
------------- ------------- ------------ -------------- -------------
Loss before extraordinary item 43,000 (1,718,200) (1,500) (300,000) (1,976,700)
Extraordinary item - - (448,300) - (448,300)
------------- ------------- ------------ -------------- -------------
Net loss 43,000 (1,718,200) (449,800) (300,000) (2,425,000)
Preferred stock dividend (190,800) - - - (190,800)
-------------- ------------- ------------ -------------- -------------
Loss applicable to common
shareholders $ (147,800) (1,718,200) $ (449,800) $ (300,000) $ (2,615,800)
============ ============= ============ ============== =============
<CAPTION>
Condensed Consolidating Statement Stellex Stellex Stellex
of Cash Flows (Parent Only) Microwave KII Holdings Eliminations Consolidated
<S> <C> <C> <C> <C> <C>
Net income (loss) $ 43,000 $ (1,718,200) $ (449,800) $ (300,000) $ (2,425,000)
Depreciation and amortization - 1,248,600 883,700 - 2,132,300
Extraordinary loss - - 448,300 - 448,300
Deferred taxes and other - (576,400) (594,800) 300,000 (871,200)
Changes in operating assets
and liabilities (201,400) (4,501,100) 870,500 - (3,832,000)
-------------- ------------- ----------- ------------- -------------
Net cash provided by
(used in) operations 158,400 (5,547,100) 1,157,900 - (4,547,600)
------------ ------------- ----------- ------------- -------------
Fixed asset additions - (56,400) (1,232,700) - (1,289,100)
Cash paid to seller - (81,753,000) (16,152,800) - (97,905,800)
Investment in and advances to
subsidiaries (112,437,300) - - (112,437,300) -
-------------- ------------- ------------- --------------- -------------
Cash used for investing
activities (112,437,300) (81,809,400) (17,385,500) (112,437,300) (99,194,900)
-------------- ------------- ------------- -------------- -------------
Sales of stock 11,500,000 1,000 4,750,000 (3,972,900) 12,278,100
Issuance of subordinated
debt, net 94,552,300 - - - 94,552,300
Borrowing in connection with
Kleinert acquisition - - 19,300,000 - 19,300,000
Kleinert debt repayments - - (27,330,000) - (27,330,000)
Intercompany loans - 88,521,300 19,943,100 (108,464,400) -
Other, net 7,500,000 29,600 394,700 - 7,924,300
-------------- ------------- ------------- -------------- ---------------
Cash provided by financing
activities 113,552,300 88,551,900 17,057,800 (112,437,300) 106,724,700
-------------- ------------- ------------- -------------- -------------
Net increase (decrease) in cash $ 956,600 $ 1,195,400 $ 830,200 $ - $ 2,982,200
============== ============= ============== ============== =============
</TABLE>
* * * * * *
-20-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this Report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of New York, State of New York, as of March 30, 1998.
STELLEX INDUSTRIES, INC.
By: /s/ William L. Remley
-------------------------------------
William L. Remley
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this Report 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/ Richard L. Kramer Chairman of the Board of Directors and Director of March 30, 1998
----------------------- Stellex Industries, Inc.
Richard L. Kramer
/s/ William L. Remley Vice Chairman, President, Chief Executive Officer, March 30, 1998
----------------------- Treasurer and Director of Stellex Industries, Inc.
William L. Remley
/s/ P. Roger Byer Chief Financial Officer of Stellex Industries, Inc. March 30, 1998
- ----------------------- (principal financial and accounting officer)
P. Roger Byer
</TABLE>
45
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 3,304
<SECURITIES> 0
<RECEIVABLES> 15,324
<ALLOWANCES> 92
<INVENTORY> 27,884
<CURRENT-ASSETS> 52,346
<PP&E> 32,847
<DEPRECIATION> 1,341
<TOTAL-ASSETS> 145,782
<CURRENT-LIABILITIES> 19,488
<BONDS> 100,000
<COMMON> 50
0
11,450
<OTHER-SE> (2,616)
<TOTAL-LIABILITY-AND-EQUITY> 145,782
<SALES> 30,536
<TOTAL-REVENUES> 30,536
<CGS> 24,732
<TOTAL-COSTS> 6,385
<OTHER-EXPENSES> (11)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,578
<INCOME-PRETAX> (3,147)
<INCOME-TAX> (1,170)
<INCOME-CONTINUING> (1,977)
<DISCONTINUED> 0
<EXTRAORDINARY> (488)
<CHANGES> 0
<NET-INCOME> (2,425)
<EPS-PRIMARY> 0.000
<EPS-DILUTED> 0.000
</TABLE>
