-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, N5WrBClS2vaSslot+hCbW0Bg4e7e75pNqtaeC2H9+ruSyqVLgWXla7l8/W/EjiKz xmAmE+/MezUfiM2TITyL4A== 0000950135-97-001547.txt : 19970401 0000950135-97-001547.hdr.sgml : 19970401 ACCESSION NUMBER: 0000950135-97-001547 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CERION TECHNOLOGIES INC CENTRAL INDEX KEY: 0001011067 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER STORAGE DEVICES [3572] IRS NUMBER: 020485458 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 000-28062 FILM NUMBER: 97569867 BUSINESS ADDRESS: STREET 1: 1401 INTERSTATE DR CITY: CHAMPAIGN STATE: IL ZIP: 61821 BUSINESS PHONE: 2173593700 MAIL ADDRESS: STREET 1: 1401 INTERSTATE DRIVE CITY: CHAMPAIGN STATE: IL ZIP: 61821 10-K405 1 CERION TECHNOLOGIES FORM 10-K405 1 ================================================================================ UNITED STATES 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, 1996 COMMISSION FILE NUMBER 1-5492-1 CERION TECHNOLOGIES INC. (Exact name of registrant as specified in its Charter) DELAWARE 02-0485458 (State of or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization)
1401 INTERSTATE DRIVE CHAMPAIGN, ILLINOIS 61821 (217) 359-3700 (Address, including zip code, and telephone number, including area code, of registrant's principal executive offices) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share 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 and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ 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) On February 28, 1997, the aggregate market value of the voting stock held by nonaffiliates totaled approximately $29,828,000 based on the closing stock price as reported by The Nasdaq Stock Market. On February 28, 1997, there were 7,018,406 shares of common stock, $.01 par value, of the registrant issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the definitive Proxy Statement to be delivered to Shareholders in connection with the Annual Meeting of Shareholders to be held May 7, 1997 are incorporated by reference herein. 2. Portions of the 1996 Annual Report to Shareholders are incorporated by reference herein. 3. Portions of the registrant's Registration Statement on Form S-1 (Registration No. 333-2590) are incorporated by reference herein. ================================================================================ 2 CERION TECHNOLOGIES INC. 1996 FORM 10-K ANNUAL REPORT TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business..................................................................... 3 Item 2. Facilities and Properties.................................................... 10 Item 3. Legal Proceedings............................................................ 10 Item 4. Submission of Matters to a Vote of Security Holders.......................... 11 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........ 11 Item 6. Selected Financial Data...................................................... 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................... 12 Item 8. Financial Statements and Supplementary Data.................................. 16 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................................... 16 PART III Item 10. Directors and Executive Officers of the Registrant........................... 16 Item 11. Executive Compensation....................................................... 18 Item 12. Security Ownership of Certain Beneficial Owners and Management............... 18 Item 13. Certain Relationships and Related Transactions............................... 18 PART IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K............. 18 Signatures.............................................................................. 21
This Report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including without limitation those discussed in the Company's 1996 Annual Report to Shareholders in the section titled "Outlook" (which section is hereby incorporated by reference herein). Such forward-looking statements speak only as of the date on which they are made, and the Company cautions not to place undue reliance on such statements. The Company disclaims any duty to update any such statements. 2 3 PART I ITEM 1. BUSINESS GENERAL Cerion Technologies Inc. ("Cerion" or "the Company") manufactures precision-machined aluminum disk substrates, which are the metallic platforms of magnetic thin film disks used in the hard disk drives of portable and desktop computers, network servers, add-on storage devices and storage upgrades. The Company's manufacturing and engineering expertise, together with its proprietary manufacturing processes and equipment, enable it to supply customers with high product volumes and consistent quality while meeting increasingly stringent product tolerances. The Company believes that its ability to develop and manufacture high quality aluminum substrates helps thin film disk manufacturers meet the rapidly evolving technological requirements of the hard disk drive market. The Company has used its core competencies in precision machining to produce aluminum organic photo conductor ("OPC") drum substrates for laser printer cartridges and maintains this manufacturing capability. See "Factors That Affect Future Results" hereunder for discussion regarding matters that may affect the Company's future performance. INDUSTRY BACKGROUND Fluctuating Market Conditions. The markets in which the Company sells its aluminum disk substrates have shown rapid growth in demand, but increased demand has also generated a rapid growth in production. Periods of shortage have alternated recently with periods of oversupply. During the latter half of 1996, and continuing since then, the market appears to have been dominated by oversupply, and consequently, pricing pressures. Although the Company's strategy during 1996 was to compete on quality more than on price, during the latter half of 1996 the Company was nevertheless forced to compete increasingly on price, even on those products meeting the tightest specifications. These changing market forces had a significant impact on the Company's sales and margins. Growth in Demand. The introduction of increasingly powerful microprocessors and more memory intensive software, combined with the development and growth of multimedia computing applications and Internet usage, have stimulated demand for PCs in both the home and business markets. In addition, the applications currently being developed for PCs require greater storage capacity, sharply increasing the demand for high-capacity disk drives. According to International Data Corporation, mean storage capacity per desktop disk drive has increased from 170 megabytes in 1993 to 540 megabytes in 1995. The market demand for aluminum substrates used for thin film disks in disk drives has been growing rapidly, stimulated by demand for PCs, storage upgrades and add-ons to existing computers and the growing use of sophisticated network servers. According to TrendFOCUS in 1996, an industry publication, the number of thin film disks produced worldwide in 1993, 1994, 1995, and 1996 was 134 million, 186 million, 256 million, and 344 million, respectively, and projected at 426 million in 1997, which would represent a compound annual growth rate of approximately 34 percent over this five-year period. Although the average storage capacity per disk drive has increased significantly, the average number of disks per drive has remained relatively constant, primarily as a result of significant advances in technology and in the storage capacity of thin film disks. The Company believes that success in the disk drive industry will continue to depend on the ability of the disk drive manufacturers, together with their suppliers of critical components, such as thin film disks and disk substrates, to keep pace with these advances. As a result, thin film disk manufacturers are likely to continue to require more stringent smoothness and flatness tolerances and higher quality levels from their aluminum disk substrate suppliers. Growth in Supply. Aluminum disk substrates are produced by vertically integrated thin-film disk manufacturers and by independent producers, including the Company and Kobe Steel, Ltd. ("Kobe") through its subsidiaries. Cerion's primary independent aluminum disk substrate competitor is Kobe, which the Company believes has production capacity that is substantially greater than that of the Company. In addition, vertically integrated companies produce substrates, such as Seagate Technologies, Inc. ("Seagate"), Akashic Memories Corporation ("Akashic") and Komag, Inc. ("Komag"). In addition, during 1996, two other major 3 4 companies began to move towards vertically-integrated production, as StorMedia Incorporated ("StorMedia") announced that it will produce aluminum disk substrates at a new manufacturing facility in Singapore, and HMT Technology Corporation ("HMT") acquired a facility in Oregon for aluminum disk substrate production. While Cerion has been able to sell substrates to certain of these vertically integrated companies, it has lost revenues from others, including a significant amount of revenues lost from one vertically integrated company, HMT. Even as the demand has increased for smoothness, flatness and uniformity, pricing pressures have also increased substantially during the latter half of 1996, even for disks meeting the most stringent specifications. Changes in Aluminum Disk Substrate Performance Characteristics. A thin film disk is composed of a substrate, generally aluminum, which must be flat, smooth and free of surface defects. This base substrate is then coated with very thin layers of nickel and magnetic material, which create the disk's magnetic properties. Minor deviations in the tolerance or qualities of the aluminum substrate can cause significant numbers of disks to be rejected, creating significant yield loss to thin film disk manufacturers. The increased demand for high-performance disk drives has resulted in increased pressures for aluminum substrate manufacturers to tighten their specifications for smoothness, flatness and uniformity. These qualities contribute to improved disk performance in the following ways: (i) the flatter the disk, the less risk that the recording head will "crash" against the surface of the disk, thus increasing the performance and reliability of the finished product; (ii) with a smoother original substrate, thin film disk manufacturers are able to spend less time and use less material on the smoothing of the nickel plating layer that is applied on the aluminum substrate, resulting in cost efficiencies; and (iii) a smoother disk facilitates storage of information at higher densities, thus increasing the disk's memory capability. THE CERION STRATEGY Cerion focuses on providing value-added engineering and technological solutions that meet the demands of markets requiring precision finishing of aluminum. The Company's strategy is to combine engineering expertise, innovative manufacturing techniques and proprietary equipment to provide a high volume of advanced, precision-machined products of consistent, high quality at competitive prices. This strategy has been heavily influenced by the teachings of Dr. W. Edwards Deming, a consultant to the Company from 1986 until his death in 1993. The Company adopted many of his management principles. In the latter half of 1996, market conditions forced the Company to pursue "commodity," or "low-end" products for most of its aluminum disk substrate production to maintain market share, and the Company expects that a dominant portion of its 1997 revenue will also be derived from the low-end of this market. Nevertheless, the Company believes that if it is to be successful over the longer term it must shift the dominant portion of its sales to the "high end" of the market, in which products must meet more demanding specifications of flatness, smoothness and uniformity. The Company succeeded in achieving this goal during the latter half of 1995 and the first half of 1996. Despite the quality of the Company's products, it was unable to sustain this sales mix during the latter half of 1996 because it was faced with backwards integration by its largest customer and cancellation of orders by its second largest customer due to excess supply. As noted above, the Company expects the impact of these developments to make it unlikely that it will be able to shift sales back to the "high end" of its market during 1997. The Company has sought to be a supplier to the "high end" of the disk market for the following reasons: (i) those customers that demand the highest quality and most stringent tolerances have the greatest ability to benefit from the value added by the Company's core competencies -- its engineering skills, proprietary manufacturing processes and proprietary equipment; and (ii) the Company believes that, unlike the "lower end", less exacting segment of the disk market, suppliers in the "high end" of the market compete substantially on quality as well as on price, thereby permitting higher average selling prices. The key elements of the Company's strategy are as follows: - Focus on Manufacturing Cost Improvement. The reduction in market demand for the Company's products in the second half of 1996, driven by backwards integration by its largest customer, and 4 5 cancellation of orders by its second largest customer, required the Company to pursue "commodity", "low-end" products to maintain market share. The Company expects that a dominant portion of its 1997 revenue will be derived from this "low-end" substrate. Thus, Cerion is focused on bringing manufacturing costs in line with new pricing standards in the industry. This focus requires innovative manufacturing process changes designed to increase output from existing labor and equipment resources. One element of the strategy is the automation of processing steps which is currently under evaluation. - Development of "High-End" Products. The Company believes it is a leader in developing new products exceeding current industry requirements. For example, the Company's innovations in proprietary processes, such as chemical etching, resulted in the manufacture of substrates capable of meeting increasingly stringent tolerance requirements. In addition, Cerion's proprietary grinding technology has led to the development of the Company's newest product, its FFX Super Smooth ("FFX") disk, which is substantially smoother than aluminum disk substrates commercially available. The FFX disk is being sold to one customer in small quantities. The Company focuses on developing products ahead of market requirements, increasing the likelihood that the Company's products will be designed into new disk media for higher-capacity disk drives. - Continue to Improve Proprietary Manufacturing Processes and Production Equipment. The Company seeks to continue to improve its manufacturing processes and equipment to increase efficiency and production capacity and to improve product quality. The Company believes its proprietary equipment enables Cerion to achieve significant cost savings and reduces the capital required to expand capacity. In addition, the Company believes that continuing advances in these areas have helped Cerion to develop manufacturing expertise that may give it a competitive advantage. - Maintain Strict Control of Manufacturing Process. The Company's real-time statistical monitoring of its manufacturing processes results in greater product uniformity and higher production yields, and provides its customers with more detailed statistical information regarding product consistency, which can improve Cerion's customers' production yields relative to competing substrates. In addition, product uniformity is an essential factor in the supplier qualification process of disk drive manufacturers. The Company's quality system is ISO 9001 registered. PRODUCTS The Company currently manufactures products within two categories: aluminum disk substrates, which represented at least 95 percent of net sales for the last three years, and OPC drum substrates. Cerion's aluminum disks are the base, or substrate, for the memory disk in a hard disk drive. The Company's current aluminum disk substrate products consist of 130mm (5 1/4 inch), 95mm (3 1/2 inch) and 65mm (2 1/2 inch) diameter disks. The 95mm product, which accounts for the large majority of the Company's current disk substrate sales, is used primarily in the hard disk drives of desktop computers, network servers and add-on storage devices. The 65mm diameter product is used primarily in laptop computers. The Company's aluminum disk substrates have evolved significantly over time. For example, the Company's 95mm product, which the Company has been selling since 1987 for thin film disk applications, has been enhanced over time to incorporate greatly improved characteristics for smoothness, flatness, and dimensional variations. Most laser printers and certain office copiers contain an organic photoconductor ("OPC") imaging drum which accepts an electric charge that attracts toner for transfer to paper. These OPC drums use a precision-machined aluminum substrate onto which a photo-reactive coating is applied. OPC drums are incorporated into laser printer cartridges that are consumed during operation and replaced on a regular basis. The Company has produced and maintains manufacturing capabilities for OPC drum substrates in 30mm and 40mm diameters for use in desktop laser printer cartridges. The Company also is developing OPC drum substrates and magnetic roller substrates for use in office copiers and laser printer cartridges, respectively. The Company currently is exploring other offerings to expand on its core product lines. The Company has developed its FFX disk, which is designed to be a "high-end" 95mm product and which has only one-quarter of the surface roughness of the Company's standard product. Cerion's FFX disk is being sold to one customer 5 6 in small quantities. In addition, the Company is investigating the application of its precision-machining capabilities for other products, materials and industries. MANUFACTURING PROCESSES AND PROPRIETARY EQUIPMENT The Company's manufacturing methods are derived from careful attention to the practice of continuous improvement and statistical methods of data analysis. Together with its engineering expertise and internally developed proprietary equipment, the Company believes its manufacturing and processing methods provide it with lower capital equipment costs relative to certain of its competitors, as well as superior yields and product quality. In the application of these processes, the Company has arranged its manufacturing operation in a cellular manner. The Company staffs each cell with a team of cross-trained employees. These teams monitor the productivity of their individual cells and are trained to prevent and, if necessary, correct quality problems within their cells. In addition, teams are encouraged to suggest process improvements. These individual manufacturing cells are built around equipment necessary for most process steps, thus allowing each cell to operate, in many respects, as a mini-factory. This cellular approach substantially reduces in-process inventory, facilitates more effective communication, and improves both quality and productivity. The following diagram summarizes the stages in the Company's aluminum disk substrate manufacturing process:
STAGE DESCRIPTION - ------------------------------------- --------------------------------------------------- - ------------------------------------- Raw aluminum blanks are received by the Company and Thickness Sorting sorted by individual thickness to a resolution of - ------------------------------------- .0001 of an inch. - ------------------------------------- Blanks are chemically etched to reduce thickness Chemical Etching variation and remove the hard oxide layer on the - ------------------------------------- surface, making the disks easier to grind. - ------------------------------------- The inner and outer diameters of the disks are Edge and Chamfer Machining machined to exacting tolerances and are finished to - ------------------------------------- specific chamfer angles. - ------------------------------------- The disks are subjected to high temperatures to Annealing release stresses built up during the preceding - ------------------------------------- machining step. - ------------------------------------- A very fine abrasive grinding stone is applied to Grinding the disk to produce the final surface finish, - ------------------------------------- thickness and flatness.
Even though there are extensive quality checks throughout the process, some parameters can be checked only after the grinding stage. Those parameters include visual quality, surface finish, thickness and flatness. The Company's real-time statistical monitoring of its processes results in greater product uniformity and higher production yields, and provides its customers with more detailed statistical information regarding product consistency. The greater uniformity of the Company's products can improve the customers' individual production yields relative to competing aluminum disk substrates. Proprietary real-time tracking systems allow the Company to pinpoint where in the manufacturing process a defect may have occurred, so that any disks affected may be isolated and removed. It also provides for feedback to the operators in order to eliminate the source of the defect immediately. The Company's study of its customers' manufacturing processes has led to the adoption of certain manufacturing and processing methods that the Company believes to be unique. For instance, Cerion has pioneered the use of chemical etching in the manufacture of aluminum disk substrates. This process was developed in collaboration with the University of Illinois chemical engineering department and certain of the Company's suppliers. Today, the majority of the aluminum disk substrates produced by the Company are chemically etched. 6 7 Proprietary Equipment and Processes The Company has developed proprietary equipment and processes that allow it to produce aluminum disk substrates within narrow specifications of smoothness, flatness and uniformity. For example, the Company has internally developed and built proprietary grinding machines for its own use, which the Company believes provide it with both a cost advantage and superior substrate over that produced by commercially available grinders. The capital cost of the Company's custom-built proprietary grinding machine is less than 25 percent of the list price of comparable grinders from a leading manufacturer. The Company's internally developed and manufactured proprietary abrasive stones used in the grinding process are significantly less expensive than typical commercially available alternatives. In-house control of grinding stone fabrication enables the Company to produce superior products with less machining time and allows for the custom fabrication of grinding stones for specific products. Custom fabrication of grinding stones has enabled Cerion to pioneer its new FFX product, which has a mirror-like surface with an average surface roughness of less than 20 angstroms (a unit of length equal to one ten-millionth of a millimeter), as opposed to the 80 angstrom average of the current disk substrates sold by the Company. Employee Participation Cerion believes that a critical component of its program of continuous process improvements and quality control is the active participation of its employees in these efforts. Employee teams are aware of production targets and meet regularly to discuss and evaluate process improvements. As incentive to such involvement, the Company in the first half of 1996 distributed 4 percent of its pretax earnings to its employees (other than executive officers) as profit sharing when the Company had positive operating performance. To facilitate process improvements, the Company encourages employees to pursue their own ideas by providing a procedure in which an employee writes a detailed description of a process improvement that is then reviewed by key engineering, manufacturing, training, maintenance and safety personnel. If approved, the Company provides support, such as process or safety engineering, to the employee, who is then responsible for implementation of his or her suggestion on a trial basis. At the end of the trial period, the employee prepares a report, including results and recommendations, and, if the trial has been successful, a change notification document is issued. Upon approval of key areas, the change is implemented system-wide. The Company assigns a process engineer full time to facilitate employee team meetings to review process improvement issues. The Company places significant emphasis on training and education. Cerion provides a tuition payment benefit available to all employees. In addition, the Company's hourly pay system works on a pay-for-skills basis. Employees are certified to pre-set standards in various skills relating to their job assignments. As the employees earn additional certifications, their pay increases. Classroom training in statistics, decision-making, business basics, teamwork and systems-thinking are being added to this skill certification system. The Company believes these practices foster a Company-wide dedication, sense of common ownership and increased skills which contribute to higher product quality and manufacturing yields. CUSTOMERS AND MARKETING Aluminum disk substrates represented over 95% of the Company's sales in 1995 and 1996. During 1996, Cerion shipped the majority of its aluminum disk substrates to four companies, HMT, StorMedia, Trace Storage Technologies Inc. ("Trace") and Seagate, representing approximately 45%, 30%, 11%, and 6%, respectively, of the Company's net sales of disk substrates. During the fourth quarter of 1996, the Company shipped its aluminum disk substrates to six companies, Trace, StorMedia, Akashic, Seagate, HMT, and International Business Machines ("IBM"), representing approximately 20%, 19%, 18%, 17%, 13%, and 12%, respectively. In its OPC drum substrate product line, the Company primarily shipped products in 1995 and 1996 to two companies, Nashua Corporation ("Nashua") and Xerox Corporation ("Xerox"). Cerion's customer base, and each customer's relative importance, has fluctuated significantly and the Company believes it will continue to do so. In addition, as is customary in the industry, Cerion's sales generally are made pursuant to purchase orders which are subject to cancellation, modification or rescheduling generally without 7 8 penalties and, in the past, certain orders have been canceled or deferred, as evidenced by the cancellation of all orders by StorMedia in the third quarter of 1996 and a reduction in orders to zero by HMT in the fourth quarter of 1996. The Company, which has produced aluminum disk substrates since 1982, emerged in 1994 from a primarily captive supplier relationship with Nashua's Computer Products Divisions. Since the sale by Nashua of that division in 1994, Cerion has expanded its customer and product base in response to growth in market demand for substrates, and it continues its efforts to broaden this customer base, both in the aluminum disk substrate and OPC drum substrate markets. Nevertheless, the Company believes that its dependence on a small number of customers will continue. Consequently, the loss of, or reduction in demand from, one or more aluminum disk substrate customers through backwards integration, consolidation, adverse financial circumstances, production disruptions or otherwise does from time to time have a material adverse effect on the Company's business, results of operations and financial condition. Cerion, like other suppliers to the thin film disk industry, is required to work closely with thin film disk manufacturers in order to meet their specifications and to become qualified as a supplier. Qualifying aluminum disk substrates requires the Company to work extensively with the customer to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations as well as substantial interaction with the Company's senior management before making a purchasing decision. Accordingly, Cerion's products typically have a lengthy sales cycle during which the Company may expend substantial financial resources and management time and effort with no assurance that a sale will result. To meet these demands, the Company uses a system of multi-tiered communication for sales, marketing and customer service. Senior management of the Company, as well as production, operation and engineering personnel, directly market and interact with their counterparts at the Company's customers. The Company believes that this multi-tiered approach has resulted in strong, active relationships with both customers and suppliers and has helped Cerion pursue close technical collaboration with its customers during the design phase of new products and throughout the products' subsequent life cycle. SOURCES OF SUPPLY The Company relies on Alcoa Memory Products, Inc., a subsidiary of Aluminum Company of America, Incorporated ("Alcoa") as its sole source of supply for the aluminum disk blanks used in producing substrates. The Company also relies on VAW of America, Inc. ("VAW") as its sole source of supply for the aluminum drum blanks used in producing OPC drum substrates. A limited number of suppliers provide certain chemicals used in the Company's manufacturing processes. These chemicals often are customized to meet the Company's needs. Cerion has no long-term supply agreement with Alcoa, VAW or any of its other suppliers. The Company's reliance on Alcoa, VAW and its chemical suppliers therefore entails risk. If their products were to become unavailable or available in significantly reduced quantities or increased prices, it would have a significant impact on the Company's operating results. Locating and qualifying a substitute supplier could be a time-consuming and uncertain process. Changing suppliers for certain materials could require that the product be requalified with the customer. Moreover, a substitute supplier might be reluctant to undertake such a project without a significant commitment by the Company to higher prices or future purchases. Cerion believes, however, that the advantage of working closely with these suppliers may offset the foregoing risks. For example, Alcoa works closely with the Company to optimize Alcoa's production processes to meet Cerion's specifications. COMPETITION The aluminum disk substrate industry and the OPC drum substrate industry are both characterized by intense competition. The Company believes that the principal competitive factors affecting these industries are product availability, quality, and price. Cerion's primary independent aluminum disk substrate competitor is Kobe, which the Company believes has production capacity that is substantially greater than that of the 8 9 Company's. The Company further believes that Kobe has significantly greater financial, technical and marketing resources. In addition, Kobe has the advantage of being supplied by an affiliated company with the aluminum blanks used for its aluminum disk substrates. In 1996, StorMedia announced that it would produce aluminum disk substrates, as part of the production of nickel plated and polished substrates, at a new manufacturing facility in Singapore. In addition, HMT acquired a facility in 1996 in Oregon for aluminum disk substrate production, as well as for nickel plating and polishing. HMT expanded the capacity of this facility and as a result regular shipments to HMT were reduced to zero in December 1996. Several other disk drive and thin film disk manufacturers, including Seagate, Akashic and Komag produce aluminum disk substrates internally for their own use. Moreover, backwards integrated companies could make their aluminum disk substrates available for distribution in the market as direct competitors of the Company. Any of these changes would reduce the already small number of current and potential customers and increase competition for the remaining market. Such competition could materially adversely affect the Company's business, results of operations and financial condition. In addition, because of the limited number of potential customers in the disk drive industry, the loss of one or more of its customers through backwards integration, consolidations, adverse financial circumstances or otherwise, has during 1996 and could again have a material adverse effect on the Company's business, results of operations and financial condition. The Company believes that Kobe and certain vertically-integrated disk drive manufacturers currently are attempting to increase aluminum disk substrate manufacturing capacity. These efforts, together with the Company's own efforts in 1996 to increase production, have resulted in significant additional capacity in the aluminum disk substrate industry. This additional capacity has resulted in industry capacity in excess of demand, and Cerion has experienced increased competition which has materially adversely affected the Company's business, results of operations and financial condition. The Company believes that a majority of the machined aluminum disk substrates in the U.S. market is supplied by vertically integrated thin film media and disk drive manufacturers, such as Seagate, Komag, and HMT, and that the balance is supplied by independent aluminum disk substrate manufacturers such as Cerion. Shortage of supply in the past has influenced disk drive manufacturers and thin film disk manufacturers to vertically integrate substrate manufacturing into their own operations. BACKLOG Cerion's sales generally are made pursuant to supply agreements, purchase orders and releases which are subject to cancellation, modification or rescheduling, generally without penalty. The Company's backlog of supply agreements and purchase orders requesting delivery in the following quarter was approximately $3.7 million as of December 31, 1996, $7.9 million as of December 31, 1995, and $2.5 million as of December 31, 1994. Because these purchase orders may be canceled, modified or rescheduled by customers on short notice and generally without penalty, the Company does not believe that its backlog as of any particular date should be considered indicative of sales for any future period. INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS The Company regards elements of its manufacturing processes, product designs and internally developed equipment as proprietary and seeks to protect its proprietary rights through a combination of employee and third-party non-disclosure agreements, internal security procedures and trade secret laws. Because patent protection requires public disclosure of a process or design, which gives potentially valuable knowledge to a competitor even if the patent is issued, Cerion evaluates the advantages and disadvantages of seeking patent protection for its proprietary processes and designs versus continuing to rely on trade secret protections. To date, the Company has generally opted to protect its proprietary rights as trade secrets but may file patent applications in the future. Although Cerion intends to defend its proprietary interests, there can be no assurance that these measures will be successful. The Company believes, however, that because of the rapid pace of change in manufacturing processes and product design in the aluminum disk substrate and OPC drum substrate industries, legal protections of its proprietary rights are less significant factors in the Company's success than the innovative skills, experience and technical competence of its employees. 9 10 The Company attempts to ensure that its products and processes do not infringe patents and other proprietary rights of third parties. Nevertheless, there can be no assurance that such a claim will not arise at some future date. If a patent claim were to arise, the Company may be required to seek a patent license from a third party. Although patent holders commonly offer such licenses, no assurance can be given that licenses would be offered or that the terms of any offered licenses would be acceptable to the Company. If a patent license were to become necessary, the failure to obtain such a license could cause Cerion to incur substantial liabilities and possibly suspend use of the process or equipment utilizing the patented invention. EMPLOYEES As of February 12, 1997, Cerion had 418 full-time employees located at its facility in Champaign, Illinois, with approximately 391 in manufacturing and research, development and engineering, and the remainder in administration and marketing. None of Cerion's employees is represented by a labor union. The Company believes that attracting and motivating skilled technical talent, and managing turnover, is vital to its success. ENVIRONMENTAL REGULATION The Company's operations and manufacturing processes are subject to certain federal, state and local environmental protection laws and regulations relating to Cerion's use, handling, storage, discharge and disposal of certain hazardous materials and hazardous and non-hazardous wastes. The Company has not suffered any material adverse effect in complying with applicable environmental regulations. However, environmental laws and regulations, especially those relating to the use of hazardous materials or generation of hazardous wastes, may become more stringent over time. There can be no assurance that Cerion has complied or will comply in all respects with environmental laws and regulations, nor can there be any assurance that the Company will be able to obtain all necessary permits that will be required under such laws and regulations. Any modified environmental regulations, and any failure by the Company with respect to any of the other matters described above, might subject Cerion to significant penalties, compliance expenses, or production suspensions or delays, and might require the Company to acquire costly equipment. ITEM 2. FACILITIES AND PROPERTIES The Company's headquarters and manufacturing facility are located in one 49,000 square foot building in Champaign, Illinois. At this Company-owned facility, Cerion operates twenty manufacturing cells for aluminum disk substrates and four for OPC drum substrates. Cerion also has an option to purchase 3.1 acres of land adjacent to its headquarters. In addition, the Company leases 12,000 square feet in Urbana, Illinois for cleaning shipping containers and for storage of finished goods and raw materials. The Company's existing facility is operating three shifts per day, five days per week and is using all remaining manufacturing space at this facility. Any significant expansion of capacity would require Cerion to return to a seven days per week manufacturing schedule, or if that was insufficient, to build, purchase or lease a new facility. ITEM 3. LEGAL PROCEEDINGS On August 8, 1996, an individual plaintiff, Joshua Tietelbaum, initiated a lawsuit against the Company, Nashua, William Blair & Co., David A. Peterson, Paul A. Harter, Richard A. Clark and Gerald G. Garbacz in the Circuit Court of Cook County, Illinois. The action purports to be on behalf of a class consisting of all persons (other than the defendants) who purchased the common stock of Cerion between May 24, 1996 and July 9, 1996. The complaint alleges that, in connection with the Cerion initial public offering, the defendants issued certain materially false and misleading statements and omitted the disclosure of material facts regarding, in particular, certain significant customer relationships. The complaint alleges that the defendants violated sections 11, 12, and 15 of the 1993 Securities Act and sections 12 and 13 of the Illinois Blue Sky Law. The complaint seeks a declaration that the case may proceed as a class action, damages, rescission of the sale of Cerion common stock by Cerion and Nashua, costs, attorneys fees, and other relief on behalf of the 10 11 individual plaintiff and the class. The Company believes the lawsuit to be without merit and intends to vigorously defend against this action. On September 4, 1996, an individual plaintiff, Philippe Olczyk, initiated a lawsuit against the Company, Nashua, William Blair & Co., David A. Peterson, Daniel M. Junius and Gerald G. Garbacz in the Circuit Court of Cook County, Illinois. The action purports to be on behalf of a class consisting of all persons (other than the defendants) who purchased the common stock of Cerion between May 24, 1996 and July 9, 1996. The complaint alleges that, in connection with the Cerion initial public offering, the defendants issued certain materially false and misleading statements and omitted the disclosure of material facts regarding, in particular, certain significant customer relationships. The complaint alleges that the defendants violated the Illinois Blue Sky Law and the Illinois Consumer Fraud and Deceptive Practices Act. The complaint seeks declarations that the case may be maintained as a class action and that the defendants violated the Illinois Consumer Fraud Act, actual and punitive damages, costs, attorneys fees, appointment of a trustee, and other relief. The Company believes the lawsuit to be without merit and intends to vigorously defend against this action. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter of the year ended December 31, 1996 to a vote of the Company's security holders. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded in the over-the-counter market and prices are quoted on The Nasdaq National Stock Market under the symbol "CEON". The following table sets forth the high and low bid prices as reported by The Nasdaq Stock Market for the periods indicated beginning on May 24, 1996, the first day of trading, after the Company completed its initial public offering:
HIGH LOW ------ ----- 1996 Second Quarter............................................. $19.50 $8.00 Third Quarter.............................................. 11.25 2.25 Fourth Quarter............................................. 9.19 2.75
On March 24, 1997, the closing price of the Company's common stock as reported by The Nasdaq National Stock Market was $3.63 per share. There were approximately 3,800 shareholders of the common stock of the Company as of such date. Cerion has not paid cash dividends on its Common Stock and does not intend to do so in the foreseeable future. 11 12 ITEM 6. SELECTED FINANCIAL DATA The following table summarizes certain selected financial data for each of the five years in the period ended December 31, 1996. The information presented should be read in conjunction with the financial statements included elsewhere in this report.
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------- PRO FORMA 1992 1993 1994 1995 1995(1) 1996 ------- ------- ------- ------- --------- ------- STATEMENTS OF OPERATIONS DATA: Net sales.......................... $16,542 $14,612 $14,553 $28,175 $28,175 $36,540 Cost of sales...................... 13,544 12,306 12,995 19,668 19,668 26,729 ------- ------- ------- ------- ------- ------- Gross profit.................. 2,998 2,306 1,558 8,507 8,507 9,811 Selling, general & administrative expenses......................... 1,321 1,651 1,731 2,537 3,510 5,561 ------- ------- ------- ------- ------- ------- Operating income (loss)....... 1,677 655 (173) 5,970 4,997 4,250 Interest income (expense).......... (89) (94) (115) (316) (1,129) 169 ------- ------- ------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes....................... 1,588 561 (288) 5,654 3,868 4,419 Provision (benefit) for income taxes............................ 612 222 (105) 2,210 1,512 1,914 ------- ------- ------- ------- ------- ------- Net income (loss).................. $ 976 $ 339 $ (183) $ 3,444 $ 2,356 $ 2,505 ======= ======= ======= ======= ======= ======= Net income per share............... $ .44 $ .39 Average common shares outstanding...................... 5,400(2) 6,379
1992 1993 1994 1995 1996 ------- ------- ------- ------- ------- BALANCE SHEET DATA: Working capital.................... $ (139) $ (27) $ 2,645 $ 3,436 $10,248 Total assets....................... 3,428 4,629 7,546 11,874 23,333 Short-term debt.................... 21 23 26 -- -- Long-term debt..................... 365 342 316 -- -- Stockholders' equity(3)............ 1,987 3,182 6,121 8,458 19,366
- --------------- (1) The pro forma statement of operations data presents the results of the Company after giving effect to the following, as if each had occurred as of January 1, 1995: (i) interest expense of $1.1 million (less $304,000 allocated interest expense to the Company) related to dividends to Nashua in the form of certain promissory notes payable to Nashua in the aggregate original principal amount of approximately $11.1 million; (ii) the elimination of a $227,000 corporate charge paid to Nashua; and (iii) the inclusion of $1.2 million in estimated selling, general and administrative expenses that would have been incurred if the Company were an independent public company during 1995. (2) Reflects shares outstanding as of December 31, 1995, giving effect to a stock split. See Stockholders' Equity and Parent Company Investment Notes to the Financial Statements. (3) Represents parent company investment at December 31, 1992, 1993, 1994 and 1995 and stockholders' equity at December 31, 1996. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Information required not included hereunder by this item may be found in the section captioned "Management's Discussion and Analysis of Financial Condition and Results of Operations" appearing in the 1996 Annual Report to Shareholders, and is incorporated herein by reference. (1) MATTERS AFFECTING FUTURE RESULTS This Report contains certain forward-looking statements, including the statement below regarding the possible impact of cancellation of orders by a major customer and backwards integration within the industry towards the manufacture of aluminum disk substrates. Moreover, from time to time in both written releases and reports and oral statements, the Company and its Senior Management may express expectations regarding 12 13 future performance of the Company. All of these "forward-looking statements" are inherently uncertain, and investors must recognize that actual events could cause actual results to differ materially from Senior Management's expectations. Key risk factors that could, in particular, have an adverse impact on current and future performance include the Company's dependence on a small number of customers, as witnessed by the cancellation of orders in July 1996 by one of the Company's two largest customers, a trend toward vertical integration among thin-film disk manufacturers that may reduce demand for the Company's products, as evidenced by the Company's largest customer in 1996, dependence on the intensely competitive and cyclical hard-disk drive industry, absence of long-term purchase commitments from the Company's customers and risk of excess industry capacity. With respect to forward-looking statements contained herein, we urge our shareholders to read Cerion's Annual Report and other reports filed with the Securities and Exchange Commission, including forms 10-Q and the Company's Prospectus dated May 24, 1996. FACTORS THAT AFFECT FUTURE RESULTS Dependence on a Small Number of Customers. Aluminum disk substrates, all sales of which were to thin film disk manufacturers, represented over 95% of the Company's sales in 1996 and 1995. The Company's aluminum disk substrate customers in 1996 were primarily HMT, StorMedia, Trace and Seagate which represented approximately 45%, 30%, 11% and 6%, respectively, of the Company's aluminum disk substrate sales. There are a relatively small number of thin film disk manufacturers worldwide. Because many of these thin film disk manufacturers supply all or part of their aluminum disk substrate needs either through captive suppliers or vertically integrated operations, the Company believes that its dependence in this business on a few customers will continue in the future. The Company's customer base, and each customer's relative importance, fluctuated significantly during 1996 and may continue to fluctuate. The loss of one or more of the Company's customers or potential customers through consolidations, adverse financial circumstances or otherwise, could have a material adverse effect on the Company's business, results of operations and financial condition. In 1996, StorMedia announced that it would produce aluminum disk substrates, as part of the production of nickel plated and polished substrates, at a new manufacturing facility in Singapore. Subsequent to this announcement, in July the Company announced the cancellation of subsequent orders from StorMedia because of a loss of orders from StorMedia's largest customer, not because of StorMedia's internal capability to manufacture aluminum disk substrates in Singapore. In addition, HMT acquired a facility in Oregon for aluminum disk substrate production, as well as for nickel plating and polishing. HMT expanded the capacity of this facility and regular shipments to HMT ceased in December 1996. The internal production of aluminum disk substrates by the Company's principal customers resulted in 1996 in the reduction or elimination of purchases from the Company and could result in the future in further reduction or elimination of purchases from the Company or the sale by such customers of aluminum disk substrates in competition with the Company. Moreover, the decision by one or more of the Company's customers to move to a single supply source could materially adversely affect the Company if the Company were not chosen as the single supply source. Similarly, a decision by one or more of the Company's customers to expand its base of suppliers could result in that customer reducing its purchases from the Company and materially adversely affect the Company's business, results of operations and financial condition. For example, in 1994 StorMedia shifted a significant portion of its demand to a competitor of the Company to eliminate the Company's sole-supplier status, which significantly affected the Company's results of operations. There also has been a trend toward consolidation in the disk drive industry, which the Company expects to continue. For example, in 1995 two leading disk drive manufacturers, Seagate and Conner, merged to form the world's largest disk drive manufacturing company. If any of the Company's customers or competitors were to combine, it would result, among other things, in a reduction of the number of their suppliers or increased pricing pressures, which could materially adversely affect the Company's business, operating results and financial condition. There can be no assurance that the Company's current customers will continue to place orders with the Company, that orders by existing customers will continue at the levels of previous periods or that customers will not cancel existing orders (which they did in 1996 and may generally do without penalty), nor can there be any assurance that the Company will be able to obtain orders from new customers. The level of orders for 13 14 aluminum disk substrates also depends on the production levels of thin film disk manufacturers, which may be subject to disruptions and delays as well as fluctuations in market demand. The loss of one or more of the Company's current customers or a significant reduction in the level of their orders could materially adversely affect the Company's business, operating results and financial condition. Dependence on Intensely Competitive and Cyclical Hard Disk Drive Industry; Price Reductions. The demand for the Company's aluminum substrates for thin film disks depends solely upon the demand for hard disk drives, which in turn depends on the demand for new personal computers, storage upgrades and add-ons to existing computers and the growing use of sophisticated network servers. The disk drive industry is cyclical and historically has experienced periods of oversupply and reduced production levels, resulting in significantly reduced demand for thin film disks, as well as pricing pressures, as evidenced by recent market price reductions as much as 20 percent in the third and fourth quarters of 1996. The effect of these cycles on suppliers, including manufacturers of thin film disks and aluminum disk substrates, has been magnified by the hard disk manufacturers' practice of ordering components, including thin film disks, in excess of their current needs during periods of rapid growth. In recent years, the disk drive industry has experienced significant growth, and the Company has expanded its capacity. There can be no assurance that growth in the disk industry will continue at recent rates or at all, that the level of demand for disk drives will not decline, or that future demand will be sufficient to support existing and future capacity. In addition, the growth rate of personal computer unit sales may decline, which may adversely affect the demand for hard disk drives. A decline in demand for hard disk drives could reduce the Company's sales of its primary product line and have a material adverse effect on the Company's business, operating results and financial condition. Absence of Long-Term Purchase Commitments. As is customary in this industry, the Company's sales are usually made pursuant to purchase orders which are subject to cancellation, modification or rescheduling generally without penalties. Customers typically provide the Company with forecasts of expected requirements for the next three- to six-month period and submit purchase orders or releases 14 to 60 days in advance of shipment dates. In the past, certain forecasts of the Company's customers have failed to materialize or have been altered and delivery schedules have been deferred. For instance, in 1994 and 1996, sharp reductions in two large customers' orders adversely affected the Company's results of operations. Changes in forecasts, rescheduling and quantity reductions may result in inventory losses and under-utilization of production capacity. From time to time, customers have changed certain specifications or standards for their products, resulting in lower production yields, higher manufacturing costs and lower productivity and margins than anticipated by the Company. Risk of Excess Industry Capacity. The Company believes that Kobe Precision, Inc., a subsidiary of Kobe Steel, Ltd., is attempting to increase aluminum substrate manufacturing capacity. Kobe is the Company's primary competitor among independent aluminum disk substrate manufacturers. The Company increased its own manufacturing capacity in 1996, and some or most of the vertically integrated, thin film disk or hard drive manufacturers did the same in 1996 and are expected to continue in the future, including the Company's two largest customers in 1996: HMT and StorMedia. These efforts may result in significant additional capacity in the industry within the next one to two years. The Company has already faced increased pricing pressures in the latter half of 1996, with price reductions as much as 20 percent. To the extent the efforts described above result in industry capacity in excess of levels of demand, the Company could experience increased levels of competition and increased pricing pressures, which could have a material adverse effect on the Company's business, results of operations and financial condition. Intense Competition Among Manufacturers of Aluminum Disk Substrates. The Company believes that Kobe is its primary competitor among independent aluminum disk substrate manufacturers. Kobe has significantly greater financial, technical and marketing resources than the Company. In addition, Kobe has an advantage in that it is supplied by an affiliated company with the aluminum blanks from which its aluminum disk substrates are manufactured. Moreover, Seagate, HMT and several other industry participants currently produce aluminum disk substrates internally for their own use, and the Company believes that a majority of the thin film disk market currently is supplied by such vertically integrated manufacturers. These companies could make their products available for distribution into the market as direct competitors of the Company. Additionally, the Company's principal current aluminum disk substrate customer announced in 1996 that they 14 15 will produce aluminum disk substrates for internal use. Any of these changes could reduce the already small number of current and potential customers for the Company's products and increase competition for the remaining market. Moreover, the aluminum disk substrate industry is characterized by intense price competition. Although the Company's products compete on the basis of availability and quality, price also is an important competitive factor as evidenced by recent market price reductions as much as 20 percent in the second half of 1996. Any increase in price competition will have a material adverse effect on the Company's gross margins and on its business, operating results and financial condition. There can be no assurance that the Company will be able to continue to compete successfully with existing or new competitors. Although the Company believes its products are competitive, the Company also believes that certain factors have had a negative impact on its products' competitiveness. The Company currently lacks the capability to nickel plate and polish its substrates, a capability considered important by certain customers. Moreover, the Company's manufacturing facility in Illinois is a significant distance from its principal customers. The Company's manufacturing process also is more labor intensive than a number of its competitors and, as a result, may be more adversely affected by rising labor costs. Lengthy Qualification Process for New Products and Changes in Manufacturing Processes. The Company is required to work closely with manufacturers in the thin film disk industry in order to become qualified as a supplier. In addition, changes in products or, in certain cases, manufacturing processes, also may require additional customer qualification. Qualifying aluminum disk substrates requires the Company to work extensively with the customer to meet product specifications. Therefore, customers often require a significant number of product presentations and demonstrations as well as substantial interaction with the Company's senior management before making a purchasing decision. Accordingly, the Company's products typically have a lengthy sales cycle during which the Company may expend substantial financial resources and management time and effort with no assurance that a sale will result. In the event the Company's products do not become qualified for a particular product development program on a timely basis, the Company could be excluded as a supplier of aluminum disk substrates for such program entirely or could become a secondary source of supply for such program, which typically results in lower sales. In addition, the Company may be prevented or delayed from making certain manufacturing process improvements due to the qualification process. Such failure to become qualified or timely qualified could have a material adverse effect on the Company's business, operating results and financial condition. Dependence on Suppliers. The Company relies on Alcoa as its sole supplier of the aluminum blanks used by it for producing aluminum disk substrates. It also relies on a sole supplier for the aluminum drum blanks used for its OPC drum substrates, and on a limited number of suppliers for certain materials used in its aluminum disk and OPC drum substrate manufacturing processes, including etching chemicals and coolants. The Company does not have any long-term supply contracts with Alcoa or any of its other major suppliers. Changing suppliers for certain materials would be expensive and require long lead times. For certain materials, a change in supplier could result in the Company being required to requalify its products with certain of its customers. Any significant limitations on the supply of raw materials could disrupt, limit or halt the Company's production of aluminum disk substrates or OPC drum substrates and could have a material adverse effect on the Company's business, operating results and financial condition. Further, a significant increase in the price of one or more of these components also could materially adversely affect the Company's business, results of operations and financial condition. Future Capital Needs. Based upon anticipated cash flows from operating activities, remaining proceeds from the initial public offering completed in 1996 and credit availability, the Company believes that it has the liquidity and capital resources needed to meet its financial commitments through 1997. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions beyond year end levels, the Company expects it will continue to incur net losses and negative cash flows from operating activities. Without such cost improvements and increased demand, at present cost levels and planned capital expenditures of approximately $4.0 million annually, the Company over an extended period of time will exhaust all or substantially all of its cash resources and borrowing availability under its credit facility. In such 15 16 event, the Company would be required to pursue other alternatives to improve liquidity, including further cost reductions, sales of assets, the deferral of certain capital expenditures and obtaining additional sources of funds. No assurance can be given that the Company will be able to successfully pursue such alternatives. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this item may be found in the Financial section of the 1996 Annual Report to Shareholders on pages 7 through 23, and is incorporated herein by reference. (1) ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None - --------------- (1) The Company's 1996 Annual Report to Shareholders is not to be deemed filed as part of this report except for those parts thereof specifically incorporated by reference. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required not included hereunder with respect to Directors and compliance with Section 16(a) of the Securities Exchange Act may be found in the sections captioned "Proposal No. 1 -- Election of Directors" and "Executive Compensation and Other Information Concerning Directors and Executive Officers" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 7, 1997. Such information is incorporated herein by reference. The executive officers and directors of the Company are as follows:
NAME AGE POSITIONS - ------------------------------------- --- ------------------------------------------------- David A. Peterson.................... 57 Chief Executive Officer, President and Director Michael F. Brown..................... 38 Vice President-Marketing Richard A. Clark..................... 32 Chief Financial Officer, Vice President-Finance and Treasurer Paul A. Harter....................... 31 Vice President-Operations William A. Hughes.................... 34 Vice President-Product Development Gerald G. Garbacz (2)................ 59 Chairman of the Board of Directors Joseph A. Baute (2).................. 69 Director Sheldon A. Buckler (1)............... 66 Director Daniel M. Junius (1)................. 44 Director Ross W. Manire (2)................... 45 Director
- --------------- (1) Member of the Compensation Committee (2) Member of the Audit Committee The following is a biographical summary of the experience of the executive officers, key employees and existing directors of the Company. David A. Peterson is a co-founder of the original operations of the Company and has served as Chief Executive Officer, President and a director of the Company since its incorporation on December 31, 1995. From December 1991 through December 1995, Mr. Peterson served as General Manager of the Precision Technologies division of Nashua, the predecessor of the Company. From April 1991 until December 1991 he served as Vice President-Operations of the Thin Film unit of the Computer Products Division of Nashua. From July 1986 until April 1991, Mr. Peterson served as Vice President-Manufacturing of Disk-Tec (acquired 16 17 by Nashua in July 1986 and became the Precision Technologies division of Nashua). From June 1982 until July 1986 he served as Director of Operations of Disk-Tec. Michael F. Brown has served as Vice President-Marketing of the Company since February 1996. From December 1995 until February 1996, Mr. Brown served as Market Development Manager of the Company. From September 1991 to December 1995, Mr. Brown was the Director of Sales and Marketing for Frisby Manufacturing Co., a precision-component manufacturer for the automotive and home appliance industries. From January 1986 to August 1991, Mr. Brown served as Manufacturer's Representative of J.A. Shoemaker & Associates, a manufacturing company. Richard A. Clark has served as Chief Financial Officer, Vice President-Finance and Treasurer of the Company since March 1996. From May 1995 through March 1996, Mr. Clark served as Director of Internal Audit of Nashua. From January 1992 to May 1995, Mr. Clark served as Manager within the Business Assurance practice of the accounting firm of Coopers & Lybrand L.L.P. From July 1988 to January 1992, Mr. Clark was a Senior Associate with Coopers and Lybrand L.L.P. Mr. Clark is a certified public accountant. Paul A. Harter has served as Vice President-Operations of the Company since February 1996. From August 1994 until February 1996 Mr. Harter served as Director of Operations of the Company. From July 1987 to August 1994, Mr. Harter served the Company in various management and staff positions. William A. Hughes has served as Vice President-Product Development of the Company since February 1996. Mr. Hughes has served the Company as Director of Product Development from September 1995 until February 1996, Product Development Manager from December 1993 to September 1995, Technical Supervisor from June 1989 until December 1993, and in a variety of other management and staff positions from June 1983 until June 1989. Gerald G. Garbacz has served as director of the Company since January 1996, and has been President and Chief Executive Officer since January 1996 and became Chairman in March 1996 of Nashua Corporation. From 1994 through 1995, Mr. Garbacz was a private investor. He was Chairman and Chief Executive Officer of Baker & Taylor Inc., an information distribution company from 1992 to 1994 and Executive Vice President of W.R. Grace & Co. from 1990 to 1992. He is also a Director of Handy & Harman Inc. Joseph A. Baute has served as a director of the Company since March 1996. Mr. Baute served as a Director of Nashua from 1984 through June 1996, as Chairman of its Board of Directors from April 1995 through June 1996, and in an interim capacity as its President and Chief Executive Officer from November 1995 through December 1995. From 1979 until his retirement in 1993, Mr. Baute served as Chairman and Chief Executive Officer of Markem Corporation, an information application systems company. Mr. Baute is director of Houghton Mifflin Company, State Street Boston Corporation, INSO Corporation and several private corporations. He also is a former director and Chairman of the Federal Reserve Bank of Boston and a former director and past Chairman of the Board of Directors of the The New England Council for Economic Development. Sheldon A. Buckler has served as a director of the Company since March 1996. Mr. Buckler has been Chairman of the Board of Commonwealth Energy System since May 1995. He was Vice Chairman of the Board of Polaroid Corporation from 1990 until his retirement in 1994. He is also a Director of Nashua Corporation, ASECO Corporation, PARLEX Corporation and Spectrum Information Technologies, Inc. Daniel M. Junius has served as a director of the Company since January 1996. Mr. Junius has served as Vice President-Finance and Treasurer of Nashua since September 1995 and as Treasurer of Nashua since 1985. Ross W. Manire has served as a director since February 1997. Mr. Manire has served as Senior Vice President and General Manager of the Networks Products Division of U.S. Robotics, Inc. since May 1995 and served as its Senior Vice President-Operations and Chief Financial Officer from early 1993 through May 1995. 17 18 U.S. Robotics, Inc. is an international designer, manufacturer and marketer of high performance information access products. Mr. Manire is a director of Seaton Corporation and the Machaira Group. The executive officers of the Company are Messrs. Peterson, Harter, Clark, Hughes and Brown. Officers are elected on an annual basis to serve at the discretion of the Board of Directors. ITEM 11. EXECUTIVE COMPENSATION The information required with respect to this item may be found in the sections captioned "Executive Compensation and Other Information Concerning Directors and Executive Officers" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of the Stockholders to be held on May 7, 1997. Such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required with respect to this item may be found in the section captioned "Security Ownership of Management and Directors" and "Security Ownership of Certain Beneficial Owners and Management" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 7, 1997. Such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required with respect to this item may be found in the section captioned "Certain Transactions" appearing in the definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on May 7, 1997. Such information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) DOCUMENTS FILED AS PART OF FORM 10-K 1. FINANCIAL STATEMENTS. The following financial statements and supplementary data are included in Part II Item 8 filed as part of this report: - Balance Sheets as of December 31, 1996 and 1995 - Statements of Operations for the years ended December 31, 1996, 1995 and 1994 - Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 - Notes to Financial Statements - Quarterly Financial Information (unaudited) - Report of Independent Accountants 2. FINANCIAL STATEMENT SCHEDULE. - Schedule II - Valuation and Qualifying Accounts Schedules not listed above have been omitted because they are not applicable, not required or the information required is shown in the financial statements or the notes thereto. 18 19 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE -------------------------------- To the Board of Directors of Cerion Technologies Inc. Our audits of the financial statements referred to in our report dated February 3, 1997 (except as to the "Revolving Credit Facility" note, which is as of March 7, 1997) appearing in the 1996 Annual Report to Shareholders of Cerion Technologies Inc. (which report and financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related financial statements. PRICE WATERHOUSE LLP Chicago, Illinois February 3, 1997, except as to the "Revolving Credit Facility" note, which is as of March 7, 1997 19 20 3. LIST OF EXHIBITS.
EXHIBIT NUMBER DESCRIPTION - ------ ---------------------------------------------------------------------------------- 2.1(a) Capital Contribution Agreement. 3.1(a) Amended and Restated Certificate of Incorporation of the Registrant. 3.2(a) Amended and Restated By-Laws of Cerion Technologies Inc. 4.1(a) Specimen Certificate for shares of Cerion Technologies Inc.'s Common Stock. 10.1(a) Form of Tax Allocation Agreement between Cerion Technologies Inc. and Nashua Corporation. 10.2(a) Form of Registration Rights Agreement between Cerion Technologies Inc. and Nashua Corporation. 10.3(a) Form of Intercompany Agreement between Cerion Technologies Inc. and Nashua Corporation. 10.4(a) 1996 Stock Incentive Plan. 10.5(a) Form of One-Year Vesting Option Agreement. 10.6(a) Form of Performance-Accelerated Option Agreement. 10.7 Financing Agreement, dated as of March 7, 1997 between Cerion Technologies Inc., and The CIT Group/Business Credit, Inc. 10.8 Mortgage, Security Agreement, Financing Statement and Assignment of Rents and Leases by and between Cerion Technologies Inc. and The CIT Group/Business Credit, Inc.. 10.9(b) Employment Contract between Cerion Technologies Inc. and David Peterson as President and Chief Executive Officer. 10.10(b) Form of Employment Contract between Cerion Technologies Inc. and the four remaining executive officers of the Company. 11.1 Computation of net income per common share. 27. Financial Data Schedule (EDGAR version only). 99.1 Financial Section of the 1996 Annual Report to Shareholders, pages 11 through 23.
- --------------- (a) Incorporated by Reference to Form S-1 filed on March 21, 1996 amended on April 25, 1996, File No. 333-2590. (b) Incorporated by Reference to Form 10-Q filed for the quarter ended September 27, 1996 (Exhibits 10.9, and 10.10 originally filed as Exhibits 10.1 and 10.2, respectively). (B) REPORTS ON FORM 8-K The Company filed no reports on Form 8-K during the quarter ended December 31, 1996. 20 21 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CERION TECHNOLOGIES INC. By: /s/ RICHARD A. CLARK ---------------------------------- RICHARD A. CLARK VICE PRESIDENT-FINANCE, CHIEF FINANCIAL OFFICER AND TREASURER Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE CAPACITY DATE - ------------------------------------------ --------------------------------- --------------- /s/ DAVID A. PETERSON President and Chief Executive March 24, 1997 - ------------------------------------------ Officer (Principal Executive DAVID A. PETERSON Officer) and Director /s/ RICHARD A. CLARK Chief Financial Officer, Vice March 24, 1997 - ------------------------------------------ President-Finance, and Treasurer RICHARD A. CLARK (Principal Financial and Accounting Officer) /s/ JOSEPH A. BAUTE* Director - ------------------------------------------ JOSEPH A. BAUTE /s/ SHELDON A. BUCKLER* Director - ------------------------------------------ SHELDON A. BUCKLER /s/ GERALD G. GARBACZ* Director - ------------------------------------------ GERALD G. GARBACZ /s/ DANIEL M. JUNIUS* Director - ------------------------------------------ DANIEL M. JUNIUS /s/ ROSS W. MANIRE* Director - ------------------------------------------ ROSS W. MANIRE By /s/ RICHARD A. CLARK March 24, 1997 - ------------------------------------------ *RICHARD A. CLARK AS ATTORNEY-IN-FACT
21 22 SCHEDULE II CERION TECHNOLOGIES, INC. VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
COLUMN C - ADDITIONS COLUMN B ----------------------------- ------------ PROVISION COLUMN D COLUMN A BALANCE AT FOR RECOVERIES FOR ------------- COLUMN E - ----------------------------------- BENGINNING BAD DEBTS ACCOUNTS UNCOLLECTIBLE ------------- ALLOWANCE FOR DOUBTFUL ACCOUNTS OF AND CUSTOMER PREVIOUSLY ACCOUNTS BALANCE AT AND CUSTOMER RETURNS PERIOD RETURNS WRITTEN-OFF WRITTEN-OFF END OF PERIOD - ----------------------------------- ------------ ------------ -------------- ------------- ------------- Year ended December 31, 1996....... $ 51 $187 0 $ 4 $ 234 Year ended December 31, 1995....... 36 21 0 6 51 Year ended December 31, 1994....... 15 21 0 0 36
BALANCE AT PROVISION RECOVERIES FOR BENGINNING FOR INVENTORY UNCOLLECTIBLE OF INVENTORY PREVIOUSLY INVENTORY BALANCE AT INVENTORY VALUATION RESERVE PERIOD VALUATION WRITTEN-OFF WRITTEN-OFF END OF PERIOD - ----------------------------------- ------------ ------------ -------------- ------------- ------------- Year ended December 31, 1996....... $ 50 $419 0 0 $ 469 Year ended December 31, 1995....... 19 31 0 0 50 Year ended December 31, 1994....... 50 0 0 31 19
RECOVERIES FOR BALANCE AT PROVISION DEFERRED TAX BENGINNING FOR ASSET DEFERRED TAX DEFERRED TAX ASSET OF DEFERRED PREVIOUSLY ASSET BALANCE AT VALUATION ALLOWANCE PERIOD TAX ASSET WRITTEN-OFF WRITTEN-OFF END OF PERIOD - ----------------------------------- ------------ ------------ -------------- ------------- ------------- Year ended December 31, 1996....... 0 $147 0 0 $ 147 Year ended December 31, 1995....... 0 0 0 0 0 Year ended December 31, 1994....... 0 0 0 0 0
22 EX-10.7 2 FINANCING AGREEMENT DATED MARCH 7, 1997 1 Exhibit 10.7 FINANCING AGREEMENT ------------------- THE CIT GROUP/BUSINESS CREDIT, INC. (AS LENDER) AND CERION TECHNOLOGIES INC. (AS BORROWER) DATED: MARCH 7, 1997 2 TABLE OF CONTENTS
PAGE ---- SECTION 1. Definitions . . . . . . . . . . . . . . . . . . 2 SECTION 2. Conditions Precedent . . . . . . . . . . . . . 8 SECTION 3. Revolving Loans . . . . . . . . . . . . . . . . 12 SECTION 4. [Reserved] . . . . . . . . . . . . . . . . . . . 15 SECTION 5. Letters of Credit . . . . . . . . . . . . . . . 15 SECTION 6. Collateral . . . . . . . . . . . . . . . . . . . 18 SECTION 7. Representations, Warranties and Covenants . . . 21 SECTION 8. Interest, Fees and Expenses . .. . . . . . . . . 28 SECTION 9. Powers. . . .. .. .. . . . . . . . . . . . . . . 29 SECTION 10. Events of Default and Remedies. . . . . . . . . 30 SECTION 11. Termination . . . . . . . . . . . . . . . . . 32 SECTION 12. Miscellaneous . . . . . . . . . . . . . . . . . 35
EXHIBITS - -------- NONE 3 THE CIT GROUP/BUSINESS CREDIT, INC., a New York corporation, (hereinafter, "CITBC") with offices located at 10 South LaSalle Street, 22nd Floor, Chicago, Illinois 60603, is pleased to confirm the terms and conditions under which CITBC shall make revolving loans, advances and other financial accommodations to CERION TECHNOLOGIES INC. (hereinafter, the "Company"), a Delaware corporation with a principal place of business at 1401 Interstate Drive, Champaign, Illinois 61821. SECTION 1. DEFINITIONS ----------- ACCOUNTS shall mean all of the Company's now existing and future: (A) accounts receivable, (whether or not specifically listed on schedules furnished to CITBC), and any and all instruments, documents, contract rights, chattel paper, general intangibles, including, without limitation, all accounts created by or arising from all of the Company's sales of goods or rendition of services to its customers, and all accounts arising from sales or rendition of services made under any of the Company's trade names or styles, or through any of the Company's divisions; (B) unpaid seller's rights (including rescission, replevin, reclamation and stoppage in transit) relating to the foregoing or arising therefrom; (C) rights to any goods represented by any of the foregoing, including rights to returned or repossessed goods; (D) reserves and credit balances arising hereunder; (E) guarantees or collateral for any of the foregoing; (F) insurance policies or rights relating to any of the foregoing; and (G) cash and non-cash proceeds of any and all the foregoing. ANNIVERSARY DATE shall mean the date occurring one year from the date hereof and the same date in every year thereafter. AVAILABILITY shall mean at any time of determination, the excess of (A) the Borrowing Base at such time, over (B) the sum at such time of I) the outstanding aggregate amount of all Obligations, II) the Availability Reserve and III) after the occurrence of an Event of Default, all payments of the Company to CITBC coming due within sixty (60) days from the date of computation. AVAILABILITY RESERVE shall mean, at any time of determination, the sum of (A) the then outstanding amount of all Letters of Credit, (B) unless and until the Company provides CITBC with evidence of credit insurance covering the Trace Receivable in form and substance satisfactory to CITBC and the Company assigns to CITBC the Company's right to receive the proceeds of such credit insurance, an amount equal to $500,000.00, (C) the sum of three (3) months rental payments on all of the Company's leased premises for which the Company has not delivered to CITBC a landlord's waiver in form and substance satisfactory to CITBC, and (D) such other reserves as CITBC, in its sole discretion, deems necessary from time to time. BORROWING BASE shall mean the lesser of (A) the Line of Credit or (B) the sum of I) Eligible Accounts Receivable multiplied by 4 eighty-five percent (85%), and II) the lesser of x) Eligible Inventory multiplied by fifty percent (50%) or y) $500,000. BUSINESS DAY shall mean any day on which both CITBC and Chase Manhattan Bank are open for business. CAPITAL EXPENDITURES for any period shall mean the aggregate of all expenditures of the Company during such period that in conformity with GAAP are required to be included in or reflected by the property, plant or equipment or similar fixed asset account reflected in the consolidated balance sheet of the Company. CAPITAL LEASE shall mean any lease of property (whether real, personal or mixed) which, in conformity with GAAP, is accounted for as a capital lease or a Capital Expenditure on the balance sheet of the Company. CHASE MANHATTAN RATE shall mean the rate of interest per annum announced by Chase Manhattan Bank from time to time as its prime rate in effect at its principal office in the City of New York. (The prime rate is not intended to be the lowest rate of interest charged by Chase Manhattan Bank to its borrowers). COLLATERAL shall mean all real and personal property in which the Company has or obtains rights, wherever located, including, without limitation, present and future Accounts, Equipment, Inventory, Documents of Title, General Intangibles, Investment Property, Other Collateral and Real Estate of the Company. COLLATERAL MANAGEMENT FEE shall mean the sum of $10,000.00 per annum which shall be paid to CITBC in accordance with paragraph 8 of Section 8 hereof to offset the expenses and costs of CITBC in connection with record keeping, periodic examinations and analyzing and evaluating the Collateral. COMMITMENT LETTER shall have the meaning provided for in paragraph (l) of Section 2 of this Financing Agreement. CONSOLIDATED BALANCE SHEET shall mean a consolidated balance sheet for the Company and the consolidated subsidiaries of the Company, if any, eliminating all inter-company transactions and prepared in accordance with GAAP. CUSTOMARILY PERMITTED LIENS shall mean: (A) liens of local or state authorities for franchise or other like taxes provided the aggregate amount of such liens shall not exceed $100,000.00 at any one time; (B) statutory liens of landlords and liens of carriers, warehousemen, mechanics, materialmen and other like liens imposed by law, created in the ordinary course of business and for amounts not yet due (or which are being contested in good faith by appropriate proceedings or other appropriate actions which are sufficient to prevent imminent foreclosure of such liens) and with 2 5 respect to which adequate reserves or other appropriate provisions are being maintained in accordance with GAAP; (C) deposits made (and the liens thereon) in the ordinary course of business (including, without limitation, security deposits for leases, surety bonds and appeal bonds) in connection with workers' compensation, unemployment insurance and other types of social security benefits or to secure the performance of tenders, bids, contracts (other than for the repayment or guarantee of borrowed money or purchase money obligations), statutory obligations and other similar obligations arising as a result of progress payments under government contracts; and (D) easements (including, without limitation, reciprocal easement agreements and utility agreements), encroachments, minor defects or irregularities in title, variation and other restrictions, charges or encumbrances (whether or not recorded) affecting the Real Estate and which are listed in Schedule B of the title insurance policy delivered to CITBC herewith; and DEFAULT shall mean any event specified in Section 10 hereof, whether or not any requirement for the giving of notice, the lapse of time, or both, or any other condition, event or act, has been satisfied. DEFAULT RATE OF INTEREST shall mean a rate of interest per annum equal to the sum of: (A) two and one-quarter percent (2.25%) and (B) the Chase Manhattan Rate, which CITBC shall be entitled to charge the Company on all Obligations due CITBC by the Company to the extent provided in paragraph 2 of Section 10 of this Financing Agreement. DEPOSITORY ACCOUNT shall mean those accounts owned by CITBC and designated for the deposit of proceeds of Collateral. DOCUMENTATION FEE shall mean CITBC's standard fees relating to any and all modifications, waivers, releases, amendments or additional collateral with respect to this Financing Agreement, the Collateral and/or the Obligations. DOCUMENTS OF TITLE shall mean all present and future warehouse receipts, bills of lading, shipping documents, chattel paper, instruments and similar documents, all whether negotiable or not and all goods and inventory relating thereto and all cash and non-cash proceeds of the foregoing. EARLY TERMINATION DATE shall mean the date on which the Company terminates this Financing Agreement or the Line of Credit which date is prior to the third (3rd) Anniversary Date. EARLY TERMINATION FEE shall: (A) mean the fee CITBC is entitled to charge the Company in the event the Company terminates the Line of Credit or this Financing Agreement on a date prior to the third Anniversary Date; and (B) be the product obtained by multiplying I) 3 6 the lesser of x) $7,500,000 or y) the Borrowing Base as of the Early Termination Date, times II) either x) two percent (2%), if the Early Termination Date occurs on or prior to the first Anniversary Date, or y) one percent (1%), if the Early Termination Date occurs after the first Anniversary Date but prior to the third Anniversary Date. ELIGIBLE ACCOUNTS RECEIVABLE shall mean the gross amount of the Company's accounts receivable that conform to the warranties contained herein and at all times continue to be acceptable to CITBC in its sole discretion, LESS, without duplication, the sum of (A) any returns, discounts, claims, credits and allowances of any nature (whether issued, owing, granted or outstanding) and (B) reserves for: I) sales to the United States of America or to any agency, department or division thereof; II) foreign sales, other than that portion of foreign sales not exceeding $2,500,000 in the aggregate at any one time x) secured by stand-by letters of credit (in form and substance satisfactory to CITBC) issued or confirmed by, and payable at, banks having a place of business in the United States of America and payable in United States currency, and which sales otherwise comply with all other criteria for eligibility hereunder or y) for which the Company has procured credit insurance in form and substance satisfactory to CITBC and has assigned to CITBC the Company's right to receive the proceeds of such credit insurance; III) accounts that remain unpaid more than ninety (90) days from invoice date; IV) contras; V) sales to any subsidiary of the Company, or to any other company affiliated with the Company in any way; VI) bill and hold (deferred shipment) or consignment sales; VII) sales to any customer which is w) insolvent, x) the debtor in any bankruptcy, insolvency, arrangement, reorganization, receivership or similar proceedings under any federal or state law, y) negotiating, or has called a meeting of its creditors for purposes of negotiating, a compromise of its debts or z) financially unacceptable to CITBC or has a credit rating unacceptable to CITBC; VIII) all sales to any customer if fifty percent (50%) or more of either x) all outstanding invoices or y) the aggregate dollar amount of all outstanding invoices, are unpaid more than ninety (90) days from invoice date; IX) any other reason deemed necessary by CITBC in its sole discretion. ELIGIBLE INVENTORY shall mean the gross amount of the Company's inventory of raw materials, valued at the lower of cost or market on a first-in, first-out ("FIFO") basis in accordance with GAAP, which (A) conform to the warranties contained herein and (B) at all times continue to be acceptable to CITBC in its sole discretion, LESS the value of goods not present in the United States of America, goods to be returned to the Company's suppliers and goods in transit to third parties (other than the Company's agents or warehouses), and LESS the value of any reserves with respect to the Inventory deemed necessary by CITBC in its sole discretion. 4 7 EQUIPMENT shall mean all present and hereafter acquired machinery, equipment, furnishings and fixtures, and all additions, substitutions and replacements thereof, wherever located, together with all attachments, components, parts, equipment and accessories installed thereon or affixed thereto and all proceeds of whatever sort. ERISA shall mean the Employee Retirement Income Security Act or 1974, as amended from time to time and the rules and regulations promulgated thereunder from time to time. EVENT(S) OF DEFAULT shall have the meaning provided for in Section 10 of this Financing Agreement. GAAP shall mean generally accepted accounting principles in the United States of America as in effect from time to time and for the period as to which such accounting principles are to apply. GENERAL INTANGIBLES shall have the meaning set forth in the Uniform Commercial Code as in effect in the State of Illinois and shall include, without limitation, all present and future right, title and interest in and to all tradenames, trademarks (together with the goodwill associated therewith), patents, licenses, customer lists, distribution agreements, supply agreements and tax refunds, together with all monies and claims for monies now or hereafter due and payable in connection with any of the foregoing or otherwise, and all cash and non-cash proceeds thereof. INDEBTEDNESS shall mean, without duplication, all liabilities, contingent or otherwise, which are any of the following: (A) obligations in respect of borrowed money or for the deferred purchase price of property, services or assets (other than Inventory), or (B) lease obligations which, in accordance with GAAP, have been, or which should be capitalized. INVENTORY shall mean all of the Company's present and hereafter acquired merchandise, inventory and goods, and all additions, substitutions and replacements thereof, wherever located, together with all goods and materials used or usable in manufacturing, processing, packaging or shipping same; in all stages of production - from raw materials through work-in-process to finished goods and all proceeds thereof of whatever sort. INVESTMENT PROPERTY shall mean all of the Company's present and hereafter acquired securities, securities entitlements, securities accounts and other investment property, as such terms are defined in the Uniform Commercial Code as in effect in the State of Illinois. ISSUING BANK shall mean the bank issuing Letters of Credit for the Company. 5 8 LETTERS OF CREDIT shall mean all letters of credit issued with the assistance of CITBC by the Issuing Bank for or on behalf of the Company. LETTER OF CREDIT GUARANTY shall mean the guaranty delivered by CITBC to the Issuing Bank of the Company's reimbursement obligation under the Issuing Bank's Reimbursement Agreement, Application for Letter of Credit or other like document. LETTER OF CREDIT GUARANTY FEE shall mean the fee CITBC may charge the Company under paragraph 3 of Section 8 of this Financing Agreement for (A) issuing the Letter of Credit Guaranty or (B) otherwise aiding the Company in obtaining Letters of Credit. LINE OF CREDIT shall mean the commitment of CITBC to make loans and advances pursuant to Section 3 of this Financing Agreement and to assist the Company in obtaining Letters of Credit under Section 5 of this Financing Agreement in the aggregate amount equal to $7,500,000. LINE OF CREDIT FEE shall: (A) mean the fee due CITBC at the end of each month for the Line of Credit, and (B) be determined by multiplying the difference between I) the Line of Credit and II) the average daily amount of Revolving Loans and Letters of Credit outstanding for said month, by three-eighths of one percent (0.375%) per annum for the number of days in said month. LOAN FACILITY FEE shall mean the fee payable to CITBC in accordance with, and pursuant to, the provisions of paragraph 7 of Section 8 of this Financing Agreement. OBLIGATIONS shall mean all loans and advances made or to be made by CITBC to the Company or to others for the Company's account; any and all indebtedness and obligations which may at any time be owing by the Company to CITBC howsoever arising, whether now in existence or incurred by the Company from time to time hereafter; whether secured by pledge, lien upon or security interest in any of the Company's assets or property or the assets or property of any other person, firm, entity or corporation; whether such indebtedness is absolute or contingent, joint or several, matured or unmatured, direct or indirect and whether the Company is liable to CITBC for such indebtedness as principal, surety, endorser, guarantor or otherwise. Obligations shall also include indebtedness owing to CITBC by the Company under this Financing Agreement or under any other agreement or arrangement now or hereafter entered into between the Company and CITBC; indebtedness or obligations incurred by, or imposed on, CITBC as a result of environmental claims arising out of the Company's operation, premises or waste disposal practices or sites; the Company's liability to CITBC as maker or endorser on any promissory note or other instrument for the payment of money; the Company's liability to CITBC under any instrument of guaranty or indemnity, or arising under any guaranty, endorsement 6 9 or undertaking which CITBC may make or issue to others for the Company's account, including any accommodation extended with respect to applications for Letters of Credit, CITBC's acceptance of drafts or CITBC's endorsement of notes or other instruments for the Company's account and benefit. OPERATING LEASES shall mean all leases of property (whether real, personal or mixed) other than Capital Leases. OTHER COLLATERAL shall mean: (A) all now owned and hereafter acquired deposit accounts maintained by or on behalf of the Company with any bank or financial institution; (B) all of the Company's cash and other monies and property in the possession or control of CITBC; (C) all of the Company's book's, ledger cards, disks and related data processing software at any time evidencing or containing information relating to any of the Collateral described herein or otherwise necessary or helpful in the collection thereof or realization thereon, and all cash and non-cash proceeds of the foregoing. OUT-OF-POCKET EXPENSES shall mean all of CITBC's present and future expenses incurred relative to this Financing Agreement, whether incurred heretofore or hereafter, which expenses shall include, without being limited to, the cost of record searches, all costs and expenses incurred by CITBC in opening bank accounts, depositing checks, receiving and transferring funds, and any charges imposed on CITBC due to "insufficient funds" of deposited checks and CITBC's standard fees relating thereto, any amounts paid by, incurred by or charged to, CITBC by the Issuing Bank under the Letter of Credit Guaranty or the Company's Reimbursement Agreement, Application for Letter of Credit or other like document which pertain either directly or indirectly to such Letters of Credit, and CITBC's standard fees relating to the Letters of Credit and any drafts thereunder, local counsel fees, title insurance premiums, real estate survey costs, the Georgia General Intangible Tax, fees and taxes relative to the filing of financing statements, costs of preparing and recording mortgages/deeds of trust against the Real Estate and all expenses, costs and fees set forth in paragraph 3 of Section 10 of this Financing Agreement. PERMITTED ENCUMBRANCES shall mean: (A) liens expressly permitted, or consented to, by CITBC; (B) Purchase Money Liens; (C) Customarily Permitted Liens; (D) liens granted CITBC by the Company; (E) liens of judgment creditors provided such liens do not exceed, in the aggregate, at any time, $50,000.00 (other than liens bonded or insured to the reasonable satisfaction of CITBC); and (F) liens for taxes not yet due and payable or which are being diligently contested in good faith by the Company by appropriate proceedings and which liens are not I) other than with respect to Real Estate, senior to the liens of CITBC or II) for taxes due the United States of America. 7 10 PERMITTED INDEBTEDNESS shall mean: (A) current indebtedness maturing in less than one year and incurred in the ordinary course of business for raw materials, supplies, equipment, services, taxes or labor; (B) the indebtedness secured by the Purchase Money Liens; (C) indebtedness arising under the Letters of Credit and this Financing Agreement; (D) deferred taxes and other expenses incurred in the ordinary course of business; and (E) other indebtedness existing on the date of execution of this Financing Agreement and listed in the most recent financial statement delivered to CITBC or otherwise disclosed to CITBC in writing. PURCHASE MONEY LIENS shall mean liens on any item of Equipment acquired after the date of this Financing Agreement provided that (A) each such lien shall attach only to the property to be acquired, (B) a description of the property so acquired is furnished to CITBC, and (C) the debt incurred in connection with such acquisitions shall not exceed in the aggregate $10,000 in any fiscal year. REAL ESTATE shall mean the Company's fee and/or leasehold interests in the real property which has been, or will be, encumbered, mortgaged, pledged or assigned to CITBC or its designee. REVOLVING LOANS shall mean the loans and advances made, from time to time, to or for the account of the Company by CITBC pursuant to Section 3 of this Financing Agreement. TANGIBLE NET WORTH shall mean the the excess of (A) total assets less intangible assets, over (B) total liabilities net of subordinated debt, all determined in accordance with GAAP on a basis consistent with the latest audited statements. TRACE RECEIVABLE shall mean any and all existing and future Accounts from Trace Storage Technologies Inc. or any affiliate thereof. SECTION 2. CONDITIONS PRECEDENT -------------------- The obligation of CITBC to execute this Financing Agreement and to make loans hereunder is subject to the satisfaction of, or waiver of, immediately prior to or concurrently with the making of such loans, the following conditions precedent: (A) LIEN SEARCHES - CITBC shall have received tax, judgment and Uniform Commercial Code searches satisfactory to CITBC for all locations presently occupied or used by the Company. (B) CASUALTY INSURANCE - The Company shall have delivered to CITBC evidence satisfactory to CITBC that casualty insurance policies listing CITBC as loss payee or mortgagee, as the case may be, are in full force and effect, all as set forth in Section 7, paragraph 5 of this Financing Agreement. 8 11 (C) MORTGAGES/DEEDS OF TRUST - The Company shall have executed and delivered to either CITBC or an agent of CITBC or of a title insurance company acceptable to CITBC such mortgages and deeds of trust as CITBC may reasonably require to obtain first liens on the Real Estate. (D) UCC FILINGS - Any documents (including without limitation, financing statements) required to be filed in order to create, in favor of CITBC, a first and exclusive perfected security interest in the Collateral with respect to which a security interest may be perfected by a filing under the Uniform Commercial Code shall have been properly filed in each office in each jurisdiction required in order to create in favor of CITBC a perfected lien on the Collateral. CITBC shall have received acknowledgement copies of all such filings (or, in lieu thereof, CITBC shall have received other evidence satisfactory to CITBC that all such filings have been made); and CITBC shall have received evidence that all necessary filing fees and all taxes or other expenses related to such filings have been paid in full. (E) TITLE INSURANCE POLICIES - CITBC shall have received, in respect of each mortgage or deed of trust, a mortgagee's title policy or marked-up unconditional binder for such insurance. Each such policy shall (I) be in an amount satisfactory to CITBC; (II) insure that the mortgage or deed of trust insured thereby creates a valid first lien on the property covered by such mortgage or deed of trust, free and clear of all defects and encumbrances except those acceptable to CITBC; (III) name CITBC as the insured thereunder; and (IV) contain such endorsements and effective coverage as CITBC may reasonably request, including without limitation the revolving line of credit endorsement. CITBC shall also have received evidence that all premiums in respect of such policies have been paid and that all charges for mortgage recording taxes, if any, shall have been paid. (F) SURVEYS - CITBC and the title insurance company issuing each policy referred to in the immediately preceding paragraph (each, a "TITLE INSURANCE COMPANY") shall have received maps or plats of a perimeter or boundary of the site of each of the properties covered by the mortgages or deeds of trust, dated a date satisfactory to CITBC and the relevant Title Insurance Company prepared by an independent professional licensed land surveyor satisfactory to CITBC and the relevant Title Insurance Company, which maps or plats and the surveys on which they are based shall be made in accordance with the Minimum Standard Detail Requirements for Land Title Surveys jointly established and adopted by the American Land Title Association and the American Congress on Surveying and Mapping; and, without limiting the generality of the foregoing, there shall be surveyed and shown on the maps or plats or surveys the following: I) the locations on such sites of all the buildings, structures and other improvements and the established building setback lines insofar as the foregoing affect the perimeter or 9 12 boundary of such property; II) the lines of streets abutting the sites and width thereof; III) all access and other easements appurtenant to the sites or necessary or desirable to use the sites; IV) all roadways, paths, driveways, easements, encroachments and overhanging projections and similar encumbrances affecting the sites, whether recorded, apparent from a physical inspection of the sites or otherwise known to the surveyor; V) any encroachments on any adjoining property by the building structures and improvements on the sites; and VI) if the site is designated as being on a filed map, a legend relating the survey to said map. Further, the survey shall be certified to CITBC and the Title Insurance Company and contain a legend reciting as to whether or not the site is located in a flood zone. (G) EXAMINATION & VERIFICATION- CITBC shall have completed to the satisfaction of CITBC an examination and verification of the Accounts, Inventory, books and records of the Company. (H) OPINIONS - Counsel for the Company shall have delivered to CITBC opinions satisfactory to CITBC opining, inter alia, that, subject to I) the filing, priority and remedies provisions of the Uniform Commercial Code, II) the provisions of the Bankruptcy Code, insolvency statutes or other like laws, III) the equity powers of a court of law and IV) such other matters as may be agreed upon with CITBC, all documents of the Company are x) valid, binding and enforceable according to their terms, y) are duly authorized and z) do not violate any terms, provisions, representations or covenants in the charter or by-laws of the Company or, to the best knowledge of such counsel, of any loan agreement, mortgage, deed of trust, note, security or pledge agreement or indenture to which the Company is a signatory or by which the Company or its assets are bound. (I) ADDITIONAL DOCUMENTS - The Company shall have executed and delivered to CITBC all loan documents necessary to consummate the lending arrangement contemplated between the Company and CITBC. (J) MINIMUM AVAILABILITY AND CASH BALANCE - The Company shall provide CITBC with documentation evidencing that, as of the date hereof, I) the Company has not less than $5,000,000 in cash (or cash equivalents) on its consolidated balance sheet, and II) the Availability is not less than the greater of x) $3,000,000.00 less 85% of the face amount of the Trace Receivable then outstanding or y) $2,100,000. (K) CONTROL AGREEMENT WITH BROKER - The Company, CITBC and the Company's stockbroker shall have entered into an agreement, in form and substance satisfactory to CITBC, regarding the control of the Company's investment account(s). (L) CITBC COMMITMENT LETTER - The Company has fully complied, to the satisfaction of CITBC, with all of the terms and conditions of 10 13 the commitment letter, dated February 5, 1997 (the "Commitment Letter"), issued by CITBC to, and accepted by, the Company. (M) ENVIRONMENTAL REPORT - CITBC shall have received environmental audit reports on I) all of the Company's fee interests, and II) the Company's waste disposal practices. The reports must be satisfactory to CITBC and not disclose or indicate any liability (real or potential) stemming from the Company's premises, its operations, its waste disposal practices or waste disposal sites used by Company. (N) BOARD RESOLUTION - CITBC shall have received a copy of the resolutions of the Board of Directors of the Company authorizing the execution, delivery and performance of I) this Financing Agreement, and II) any related agreements, in each case certified by the Secretary or Assistant Secretary of the Company as of the date hereof, together with a certificate of the Secretary or Assistant Secretary of the Company as to the incumbency and signature of the officers of the Company executing this Financing Agreement and any certificate or other documents to be delivered by it pursuant hereto, together with evidence of the incumbency of such Secretary or Assistant Secretary. (O) CORPORATE ORGANIZATION - CITBC shall have received I) a copy of the Certificate of Incorporation of the Company certified by the Secretary of State of its incorporation, II) a copy of the By-Laws (as amended through the date hereof) of the Company and certified by the Secretary or Assistant Secretary of the Company, and III) an original good standing certificate (or equivalent document) issued by the Secretary of State of Illinois. (P) OFFICER'S CERTIFICATE - CITBC shall have received an executed Officer's Certificate of the Company, satisfactory in form and substance to CITBC, certifying that I) the representations and warranties contained herein are true and correct in all material respects on and as of the date hereof, II) the Company is in compliance with all of the terms and provisions set forth herein, and (III) no Event of Default or Default has occurred. (Q) ABSENCE OF DEFAULT - No Default, Event of Default or material adverse change in the financial condition, business, prospects, profits, operations or assets of the Company shall have occurred. (R) LEGAL RESTRAINTS/LITIGATION - At the date of execution of this Financing Agreement, there shall be no I) litigation, investigation or proceeding (judicial or administrative) pending or threatened against the Company or its assets, by any agency, division or department of any county, city, state or federal government, II) injunction, writ or restraining order restraining or prohibiting the consummation of the financing arrangements contemplated under this Financing Agreement, or III) suit, action, investigation or proceeding (judicial or administrative) pending or threatened 11 14 against the Company or its assets, which, in the opinion of CITBC, if adversely determined could have a material adverse effect on the business, operation, assets, or financial condition of the Company or any of the Collateral. (S) DISBURSEMENT AUTHORIZATION - The Company shall have delivered to CITBC all information necessary for CITBC to issue wire transfer instructions on behalf of the Company for the initial and subsequent loans and/or advances to be made under this Agreement including, but not limited to, disbursement authorizations in form acceptable to CITBC. (T) COLLECTION ACCOUNTS; PAYMENT DIRECTION - CITBC shall have established a lockbox and opened a bank account in its name for the collection of the Company's Accounts and the deposit of the proceeds of the Collateral, and CITBC, the Company and the depository bank shall have entered into an agreement in form and substance satisfactory to CITBC regarding the administration and control of such lockbox and bank account. In addition, the Company shall have provided CITBC with satisfactory evidence that the Company has directed its account debtors to send payments on all Accounts directly to such lockbox. (U) CREDIT INSURANCE FOR TRACE RECEIVABLE - As a condition precedent to the making of any Revolving Loan or the issuance of any Letter of Credit Guaranty by CITBC under this Financing Agreement (but not the execution of this Financing Agreement by CITBC), the Company shall obtain credit insurance covering the Trace Receivable in form and substance satisfactory to CITBC, and all proceeds thereof shall be assigned to CITBC. Upon the execution of this Financing Agreement and the initial disbursement of loans hereunder, all of the above Conditions Precedent shall have been deemed satisfied except as the Company and CITBC shall otherwise agree herein or in a separate writing. SECTION 3. REVOLVING LOANS --------------- 1. Subject to the terms and conditions of this Financing Agreement, and subject to CITBC's right to make "overadvances", CIT agrees to make loans and advances to the Company on a revolving basis from time to time (i.e. subject to the limitations set forth herein, the Company may borrow, repay and re-borrow Revolving Loans) in the aggregate principal amount not exceeding at any one time the Borrowing Base. All requests for loans and advances must be received by an officer of CITBC no later than 1:00 p.m., New York time, of the Business Day on which such loans and advances are required. In no event shall CITBC have an obligation to make any loans or advances to the Company which would exceed the Availability as of the date such request is made. Should CITBC for any reason honor requests for advances in excess of the limitations set forth herein, such advances shall be considered "overadvances" and shall 12 15 be made in CITBC's sole discretion, subject to any additional terms CITBC deems necessary. 2. In furtherance of the continuing assignment and security interest in the Company's Accounts, the Company will, upon the creation of Accounts, execute and deliver to CITBC in such form and manner as CITBC may reasonably require, solely for CITBC's convenience in maintaining records of collateral, such confirmatory schedules of Accounts as CITBC may reasonably request, and such other appropriate reports designating, identifying and describing the Accounts as CITBC may reasonably require. In addition, upon CITBC's request the Company shall provide CITBC with copies of agreements with, or purchase orders from, the Company's customers, and copies of invoices to customers, proof of shipment or delivery and such other documentation and information relating to said Accounts and other collateral as CITBC may reasonably require. Failure to provide CITBC with any of the foregoing shall in no way affect, diminish, modify or otherwise limit the security interests granted herein. The Company hereby authorizes CITBC to regard the Company's printed name or rubber stamp signature on assignment schedules or invoices as the equivalent of a manual signature by one of the Company's authorized officers or agents. 3. The Company hereby represents and warrants that: (A) each Account is based on an actual and bona fide sale and delivery of goods or rendition of services to customers, made by the Company in the ordinary course of its business; (B) the Inventory being sold and the Accounts created are the exclusive property of the Company and are not and shall not be subject to any lien, consignment arrangement, encumbrance, security interest or financing statement whatsoever, other than the Permitted Encumbrances; (C) the invoices evidencing such Accounts are in the name of the Company; and (D) the customers of the Company have accepted the goods or services, owe and are obligated to pay the full amounts stated in the invoices according to their terms, without dispute, offset, defense, counterclaim or contra, except for disputes and other matters arising in the ordinary course of business of which the Company has advised CITBC pursuant to paragraph 5 of this Section 3. The Company confirms to CITBC that any and all taxes or fees relating to its business, its sales, the Accounts or goods relating thereto, are its sole responsibility and that same will be paid by the Company when due and that none of said taxes or fees represent a lien on or claim against the Accounts. The Company also warrants and represents that it is a duly and validly existing corporation and is qualified in all states where the failure to so qualify would have an adverse effect on the business of the Company or the ability of the Company to enforce collection of Accounts due from customers residing in that state. The Company agrees to maintain such books and records regarding Accounts as CITBC may reasonably require and agrees that the books and records of the Company will reflect CITBC's interest in the Accounts. All of the books and records of the Company will be available to CITBC at normal 13 16 business hours, including any records handled or maintained for the Company by any other company or entity. 4. The Company may and will enforce, collect and receive all amounts owing on the Accounts for CITBC's benefit and on CITBC's behalf, but at the Company's expense, however, such privilege shall (A) terminate automatically upon the institution by or against the Company of any proceeding under any bankruptcy or insolvency law or, (B) at the election of CITBC, terminate upon written notice from CITBC to the Company. Any checks, cash, notes or other instruments or property received by the Company with respect to any Accounts shall be held by the Company in trust for CITBC, separate from the Company's own property and funds, and immediately turned over to CITBC with proper assignments or endorsements by deposit to the Depository Accounts. All amounts received by CITBC in payment of Accounts will be credited to the Company's accounts upon CITBC's receipt of "collected funds" at CITBC's bank account in New York, New York on the Business Day of receipt if received no later than 1:00 pm or on the next succeeding Business Day if received after 1:00 pm. No checks, drafts or other instrument received by CITBC shall constitute final payment to CITBC unless and until such instruments have actually been collected. 5. The Company agrees to notify CITBC promptly of any matters materially affecting the value, enforceability or collectibility of any Account and of all material customer disputes, offsets, defenses, counterclaims, returns, rejections and all reclaimed or repossessed merchandise or goods. The Company agrees to issue credit memoranda promptly (with duplicates to CITBC upon request after the occurrence of an Event of Default) upon accepting returns or granting allowances, and may continue to do so until CITBC has notified the Company that (A) an Event of Default has occurred, (B) CITBC has declared all outstanding Obligations immediately due and payable and (C) all future credits or allowances are to be made only after CITBC's prior written approval. Upon the occurrence of an Event of Default and until such time as such Event of Default is waived and on notice from CITBC, the Company agrees that all returned, reclaimed or repossessed merchandise or goods shall be set aside by the Company, marked with CITBC's name and held by the Company for CITBC's account as owner and assignee. 6. CITBC shall maintain a separate account on its books in the Company's name in which the Company will be charged with loans and advances made by CITBC to it or for its account, and with any other Obligations, including any and all costs, expenses and reasonable attorney's fees which CITBC may incur in connection with the exercise by or for CITBC of any of the rights or powers herein conferred upon CITBC, or in the prosecution or defense of any action or proceeding to enforce or protect any rights of CITBC in connection with this Financing Agreement or the Collateral assigned hereunder, or any Obligations owing to CITBC by the Company. The Company will be credited with all amounts received by CITBC from 14 17 the Company or from others for the Company's account, including, as above set forth, all amounts received by CITBC in payment of assigned Accounts and such amounts will be applied to payment of the Obligations. In no event shall prior recourse to any Accounts or other security granted to or by the Company be a prerequisite to CITBC's right to demand payment of any Obligation. Further, it is understood that CITBC shall have no obligation whatsoever to perform in any respect any of the Company's contracts or obligations relating to the Accounts. 7. After the end of each month, CITBC shall promptly send the Company a statement showing the accounting for the charges, loans, advances and other transactions occurring between CITBC and the Company during that month. The monthly statements shall be deemed correct and binding upon the Company and shall constitute an account stated between the Company and CITBC unless CITBC receives a written statement of the exceptions within thirty (30) days of the date of the monthly statement. 8. In the event that either (A) the aggregate amount of all Obligations and Letters of Credit outstanding at any time exceeds the Borrowing Base, or (B) the Availability is ever less than zero, the Company shall immediately prepay the Revolving Loans by an amount equal to such excess, in the case of (A), or by an amount sufficient to cause the Availability to exceed zero, in the case of (B). SECTION 4. [RESERVED] SECTION 5. LETTERS OF CREDIT ----------------- In order to assist the Company in establishing or opening Letters of Credit with an Issuing Bank to cover the purchase of imported Inventory, Equipment or for any other reason acceptable to CITBC, the Company has requested CITBC to join in the applications for such Letters of Credit, and/or guarantee payment or performance of such Letters of Credit and any drafts or acceptances thereunder through the issuance of the Letters of Credit Guaranty, thereby lending CITBC's credit to the Company and CITBC has agreed to do so. These arrangements shall be handled by CITBC subject to the terms and conditions set forth below. 1. The amount, purpose and extent of the Letters of Credit and changes or modifications thereof by the Company and/or the Issuing Bank of the terms and conditions thereof shall in all respects be subject to the prior approval of CITBC, PROVIDED, HOWEVER, that (A) in no event may the aggregate amount of all such outstanding Letters of Credit exceed, in the aggregate, at any one time $1,000,000, (B) the amount of any Letter of Credit to be issued shall not exceed the Availability as of the date of the issuance thereof, (C) the Letter of Credit and all documentation in connection therewith shall be in form and substance satisfactory to 15 18 the Company, CITBC and the Issuing Bank, and (D) the initial expiration date of any Letter of Credit shall not be more than one year from the date of the issuance thereof. 2. CITBC shall have the right, without notice to the Company, to charge the Company's account on CITBC's books with the amount of any and all indebtedness, liability or obligation of any kind incurred by CITBC under the Letters of Credit Guaranty at the earlier of (A) payment by CITBC under the Letters of Credit Guaranty, or (B) the declaration by CITBC, after the occurrence of an Event of Default, that all outstanding Obligations are immediately due and payable. Any amount charged to Company's loan account shall be deemed a Revolving Loan hereunder and shall incur interest at the rate provided in Section 8, paragraph 1 of this Financing Agreement. 3. The Company unconditionally indemnifies CITBC and holds CITBC harmless from any and all loss, claim or liability incurred by CITBC arising from any transactions or occurrences relating to Letters of Credit established or opened for the Company's account, the collateral relating thereto and any drafts or acceptances thereunder, and all Obligations thereunder, including any such loss or claim due to any action taken by any Issuing Bank, other than for any such loss, claim or liability arising out of the gross negligence or willful misconduct by CITBC under the Letters of Credit Guaranty. The Company further agrees to hold CITBC harmless from any errors or omission, negligence or misconduct by the Issuing Bank. The Company's unconditional obligation to CITBC hereunder shall not be modified or diminished for any reason or in any manner whatsoever, other than as a result of CITBC's gross negligence or willful misconduct. The Company agrees that any charges incurred by CITBC for the Company's account by the Issuing Bank shall be conclusive on CITBC and may be charged to the Company's account. 4. CITBC shall not be responsible for: (A) the existence, character, quality, quantity, condition, packing, value or delivery of the goods purporting to be represented by any documents; (B) any difference or variation in the character, quality, quantity, condition, packing, value or delivery of the goods from that expressed in the documents; (C) the validity, sufficiency or genuineness of any documents or of any endorsements thereon, even if such documents should in fact prove to be in any or all respects invalid, insufficient, fraudulent or forged; (D) the time, place, manner or order in which shipment is made; (E) partial or incomplete shipment, or failure or omission to ship any or all of the goods referred to in the Letters of Credit or documents; (F) any deviation from instructions; (G) delay, default, or fraud by the shipper and/or anyone else in connection with the Collateral or the shipping thereof; or (H) any breach of contract between the shipper or vendors and the Company. Furthermore, without being limited by the foregoing, CITBC shall not be responsible for any 16 19 act or omission with respect to or in connection with any Collateral. 5. The Company agrees that any action taken by CITBC, if taken in good faith, or any action taken by any Issuing Bank, under or in connection with the Letters of Credit, the guarantees, the drafts or acceptances, or the Collateral, shall be binding on the Company and shall not put CITBC in any resulting liability to the Company. In furtherance thereof but subject to paragraph 6 below, CITBC shall have the full right and authority to clear and resolve any questions of non-compliance of documents; to give any instructions as to acceptance or rejection of any documents or goods; to execute any and all steamship or airways guaranties (and applications therefore), indemnities or delivery orders; to grant any extensions of the maturity of, time of payment for, or time of presentation of, any drafts, acceptances, or documents; and to agree to any amendments, renewals, extensions, modifications, changes or cancellations of any of the terms or conditions of any of the applications, Letters of Credit, drafts or acceptances; all in CITBC's sole name, and the Issuing Bank shall be entitled to comply with and honor any and all such documents or instruments executed by or received solely from CITBC, all without any notice to or any consent from the Company. 6. Without CITBC's express consent and endorsement in writing, the Company agrees: (A) not to execute any and all applications for steamship or airway guaranties, indemnities or delivery orders; to grant any extensions of the maturity of, time of payment for, or time of presentation of, any drafts, acceptances or documents; or to agree to any amendments, renewals, extensions, modifications, changes or cancellations of any of the terms or conditions of any of the applications, Letters of Credit, drafts or acceptances; and (B) after the occurrence of an Event of Default which is not waived by CITBC, not to I) clear and resolve any questions of non-compliance of documents, or II) give any instructions as to acceptances or rejection of any documents or goods. 7. The Company agrees that any necessary import, export or other licenses or certificates for the import or handling of the Collateral will have been promptly procured; all foreign and domestic governmental laws and regulations in regard to the shipment and importation of the Collateral, or the financing thereof will have been promptly and full complied with; and any certificates in that regard that CITBC may at any time request will be promptly furnished. In this connection, the Company warrants and represents that all shipments made under any such Letters of Credit are in accordance with the laws and regulations of the countries in which the shipments originate and terminate, and are not prohibited by any such laws and regulations. The Company assumes all risk, liability and responsibility for, and agrees to pay and discharge, all present and future local, state, federal or foreign taxes, duties, or levies. Any embargo, restriction, laws, 17 20 customs or regulations of any country, state, city, or other political subdivision, where the Collateral is or may be located, or wherein payments are to be made, or wherein drafts may be drawn, negotiated, accepted, or paid, shall be solely the Company's risk, liability and responsibility. 8. Upon any payments made to the Issuing Bank under the Letter of Credit Guaranty, CITBC shall acquire by subrogation, any rights, remedies, duties or obligations granted or undertaken by the Company to the Issuing Bank in any application for Letters of Credit, any standing agreement relating to Letters of Credit or otherwise, all of which shall be deemed to have been granted to CITBC and apply in all respects to CITBC and shall be in addition to any rights, remedies, duties or obligations contained herein. SECTION 6. COLLATERAL ---------- 1. As security for the prompt payment in full of all loans and advances made and to be made to the Company from time to time by CITBC pursuant hereto, as well as to secure the payment in full of the other Obligations, the Company hereby pledges and grants to CITBC a continuing general lien upon and security interest in all of the Collateral, including, without limitation, all of its: (A) present and hereafter acquired Inventory; (B) present and hereafter acquired Equipment; (C) present and future Accounts; (D) present and future Documents of Title; (E) present and future General Intangibles; (F) present and future Investment Property; (G) present and future Other Collateral; and (H) Real Estate. 2. The security interests granted hereunder shall extend and attach to: (A) All Collateral which is presently in existence and which is owned by the Company or in which the Company has any interest, whether held by the Company or others for its account, and, if any Collateral is Equipment, whether the Company's interest in such Equipment is as owner or lessee or conditional vendee; (B) All Equipment whether the same constitutes personal property or fixtures, including, but without limiting the generality of the foregoing, all dies, jigs, tools, benches, tables, accretions, 18 21 component parts thereof and additions thereto, as well as all accessories, motors, engines and auxiliary parts used in connection with or attached to the Equipment; and (C) All Inventory and any portion thereof which may be returned, rejected, reclaimed or repossessed by either CITBC or the Company from the Company's customers, as well as to all supplies, goods, incidentals, packaging materials, labels and any other items which contribute to the finished goods or products manufactured or processed by the Company, or to the sale, promotion or shipment thereof. 3. The Company agrees to safeguard, protect and hold all Inventory for CITBC's account and make no disposition thereof except in the regular course of the business of the Company as herein provided. Inventory may only be sold and shipped by the Company to its customers in the ordinary course of the Company's business, on open account and on terms currently being extended by the Company to its customers, provided that all proceeds of all sales (including cash, accounts receivable, checks, notes, instruments for the payment of money and similar proceeds) are forthwith transferred, endorsed, and turned over and delivered to CITBC by deposit in the Depository Accounts. Cash sales or sales of Inventory in which a lien upon, or security interest in, Inventory is retained by the Company shall be made by the Company only with the approval of CITBC, and the proceeds of such sales or sales of Inventory for cash shall not be commingled with the Company's other property, but shall be segregated, held by the Company in trust for CITBC as CITBC's exclusive property, and shall be delivered immediately by the Company to CITBC in the identical form received by the Company by deposit to the Depository Accounts. Upon the sale, exchange, or other disposition of Inventory, as herein provided, the security interest in the Company's Inventory provided for herein shall, without break in continuity and without further formality or act, continue in, and attach to, all proceeds, including any instruments for the payment of money, accounts receivable, contract rights, documents of title, shipping documents, chattel paper and all other cash and non-cash proceeds of such sale, exchange or disposition. As to any such sale, exchange or other disposition, CITBC shall have all of the rights of an unpaid seller, including stoppage in transit, replevin, rescission and reclamation. 4. The Company agrees at its own cost and expense to keep the Equipment in as good and substantial repair and condition as the same is now or at the time the lien and security interest granted herein shall attach thereto, reasonable wear and tear excepted, making any and all repairs and replacements when and where necessary. The Company also agrees to safeguard, protect and hold all Equipment for CITBC's account and make no disposition thereof unless the Company first obtains the prior written approval of CITBC. Any sale, exchange or other disposition of any Equipment 19 22 shall only be made by the Company with the prior written approval of CITBC, and the proceeds of any such sales shall not be commingled with the Company's other property, but shall be segregated, held by the Company in trust for CITBC as CITBC's exclusive property, and shall be delivered immediately by the Company to CITBC in the identical form received by the Company by deposit to the Depository Accounts. Upon the sale, exchange, or other disposition of the Equipment, as herein provided, the security interest provided for herein shall, without break in continuity and without further formality or act, continue in, and attach to, all proceeds, including any instruments for the payment of money, accounts receivable, contract rights, documents of title, shipping documents, chattel paper and all other cash and non-cash proceeds of such sales, exchange or disposition. As to any such sale, exchange or other disposition, CITBC shall have all of the rights of an unpaid seller, including stoppage in transit, replevin, rescission and reclamation. Notwithstanding anything hereinabove contained to the contrary, the Company may sell, exchange or otherwise dispose of obsolete Equipment or Equipment no longer needed in the Company's operations, PROVIDED, HOWEVER, that (A) the then book value of the Equipment so disposed of does not exceed $250,000 in the aggregate in any fiscal year and $500,000 in the aggregate during the term of this Financing Agreement, (B) the proceeds of such sales or dispositions are delivered to CITBC in accordance with the foregoing provisions of this paragraph, except that the Company may retain and use such proceeds to purchase forthwith replacement Equipment which the Company determines in its reasonable business judgment to have a collateral value at least equal to the Equipment so disposed of or sold, PROVIDED, HOWEVER, that the aforesaid right shall automatically cease upon the occurrence of an Event of Default which is not waived. 5. The rights and security interests granted to CITBC hereunder are to continue in full force and effect, notwithstanding the termination of this Financing Agreement or the fact that the account maintained in the Company's name on the books of CITBC may from time to time be temporarily in a credit position, until the final payment in full to CITBC of all Obligations and the termination of this Financing Agreement. Any delay, or omission by CITBC to exercise any right hereunder, shall not be deemed a waiver thereof, or be deemed a waiver of any other right, unless such waiver be in writing and signed by CITBC. A waiver on any one occasion shall not be construed as a bar to or waiver of any right or remedy on any future occasion. 6. To the extent that the Obligations are now or hereafter secured by any assets or property other than the Collateral or by the guarantee, endorsement, assets or property of any other person, then CITBC shall have the right in its sole discretion to determine which rights, security, liens, security interests or remedies CITBC shall at any time pursue, foreclose upon, relinquish, subordinate, modify or take any other action with respect to, without in any way 20 23 modifying or affecting any of them, or any of CITBC's rights hereunder. 7. Any reserves or balances to the credit of the Company and any other property or assets of the Company in the possession of CITBC may be held by CITBC as security for any Obligations and applied in whole or partial satisfaction of such Obligations when due. The liens and security interests granted herein and any other lien or security interest CITBC may have in any other assets of the Company, shall secure payment and performance of all now existing and future Obligations. CITBC may in its discretion charge any or all of the Obligations to the account of the Company when due. 8. This Financing Agreement and the obligation of the Company to perform all of its covenants and obligations hereunder are further secured by a mortgage, deed of trust or assignment on the Real Estate. 9. The Company shall give to CITBC from time to time such mortgage, deed of trust or assignment on the Real Estate or real estate acquired after the date hereof as CITBC shall require to obtain a valid first lien thereon subject only to those exceptions of title as set forth in future title insurance policies that are satisfactory to CITBC. 10. The Company shall give to CITBC from time to time such pledge or security agreements with respect to General Intangibles and capital stock of any subsidiary of the Company as CITBC shall require to obtain valid first liens thereon. SECTION 7. REPRESENTATIONS, WARRANTIES AND COVENANTS ----------------------------------------- 1. The Company hereby warrants and represents and/or covenants that: (A) the fair value of the Company's assets exceeds the book value of the Company's liabilities; (B) the Company is generally able to pay its debts as they become due and payable; and (C) the Company does not have unreasonably small capital to carry on its business as it is currently conducted absent extraordinary and unforeseen circumstances. The Company further warrants and represents that except for the Permitted Encumbrances, the security interests granted herein constitute and shall at all times constitute the first and only liens on the Collateral; that, except for the Permitted Encumbrances, the Company is or will be at the time additional Collateral is acquired by it, the absolute owner of the Collateral with full right to pledge, sell, consign, transfer and create a security interest therein, free and clear of any and all claims or liens in favor of others; that the Company will at its expense forever warrant and, at CITBC's request, defend the same from any and all claims and demands of any other person other than the Permitted Encumbrances; that the Company will not grant, create or permit to exist, any lien upon or security interest in the Collateral, or any proceeds thereof, in favor of any other 21 24 person other than the holders of the Permitted Encumbrances; and that the Equipment does not comprise a part of the Inventory of the Company and that the Equipment is and will only be used by the Company in its business and will not be held for sale or lease, or removed from its premises, or otherwise disposed of by the Company without the prior written approval of CITBC except as otherwise permitted in paragraph 4 of Section 6 of this Financing Agreement. 2. The Company agrees to maintain books and records pertaining to the Collateral in such detail, form and scope as CITBC shall reasonably require. The Company agrees that CITBC or its agents may enter upon the Company's premises at any time during normal business hours, and from time to time, for the purpose of inspecting the Collateral, and any and all records pertaining thereto. The Company agrees to afford CITBC prior written notice of any change in the location of any Collateral, other than to locations, that as of the date hereof, are known to CITBC and at which CITBC has filed financing statements and otherwise fully perfected its liens thereon. The Company is also to advise CITBC promptly, in sufficient detail, of any material adverse change relating to the type, quantity or quality of the Collateral or on the security interests granted to CITBC therein. 3. The Company agrees to execute and deliver to CITBC, from time to time, solely for CITBC's convenience in maintaining a record of the Collateral, such written statements, and schedules as CITBC may reasonably require, designating, identifying or describing the Collateral pledged to CITBC hereunder. The Company's failure, however, to promptly give CITBC such statements or schedules shall not affect, diminish, modify or otherwise limit CITBC's security interests in the Collateral. 4. The Company agrees to comply with the requirements of all state and federal laws in order to grant to CITBC valid and perfected first security interests in the Collateral, subject only to the Permitted Encumbrances. CITBC is hereby authorized by the Company to file any financing statements covering the Collateral whether or not the Company's signature appears thereon. The Company agrees to do whatever CITBC may reasonably request, from time to time, by way of: (A) filing notices of liens, financing statements, amendments, renewals and continuations thereof; (B) cooperating with CITBC's agents and employees; (C) keeping Collateral records; (D) transferring proceeds of Collateral to CITBC's possession; and (E) performing such further acts as CITBC may reasonably require in order to effect the purposes of this Financing Agreement. 5. (A) The Company agrees to maintain insurance on the Real Estate, Equipment and Inventory under such policies of insurance, with such insurance companies, in such reasonable amounts and covering such insurable risks as are at all times reasonably satisfactory to CITBC. All policies covering the Real Estate, 22 25 Equipment and Inventory are, subject to the rights of any holders of Permitted Encumbrances holding claims senior to CITBC, to be made payable to CITBC, in case of loss, under a standard non-contributory "mortgagee", "lender" or "secured party" clause and are to contain such other provisions as CITBC may require to fully protect CITBC's interest in the Real Estate, Inventory and Equipment and to any payments to be made under such policies. All original policies or true copies thereof are to be delivered to CITBC with the loss payable endorsement in CITBC's favor, and shall provide for not less than thirty (30) days prior written notice to CITBC of the exercise of any right of cancellation. At the Company's request, or if the Company fails to maintain such insurance, CITBC may arrange for such insurance, but at the Company's expense and without any responsibility on CITBC's part for: obtaining the insurance, the solvency of the insurance companies, the adequacy of the coverage, or the collection of claims. Upon the occurrence of an Event of Default which is not waived, CITBC shall, subject to the rights of any holders of Permitted Encumbrances holding claims senior to CITBC, have the sole right, in the name of CITBC or the Company, to file claims under any insurance policies, to receive, receipt and give acquittance for any payments that may be payable thereunder, and to execute any and all endorsements, receipts, releases, assignments, reassignments or other documents that may be necessary to effect the collection, compromise or settlement of any claims under any such insurance policies. (B) I) In the event of any loss or damage by fire or other casualty, insurance proceeds relating to Inventory shall first reduce the Company's Revolving Loan and then reduce any of the other Obligations. II) In the event any part of the Company's Real Estate or Equipment is damaged by fire or other casualty and the insurance proceeds for such damage or other casualty (the "Proceeds") is less than or equal to $250,000.00, CITBC shall promptly apply such Proceeds to reduce the Company's outstanding balances under the Revolving Loan account. III) As long as an Event of Default has not occurred (which is not waived), the Company has sufficient business interruption insurance to replace the lost profits of any of the Company's facilities, and the Proceeds are in excess of $250,000.00, the Company may elect (by delivering written notice to CITBC) to replace, repair or restore such Real Estate or Equipment to substantially the equivalent condition prior to such fire or other casualty as set forth herein. If the Company does not, or cannot, elect to use the Proceeds as set forth above, CITBC may, subject to the rights of any holders of Permitted Encumbrances holding claims senior to CITBC, apply the Proceeds to the payment of the Obligations in such manner and in such order as CITBC may reasonably elect. 23 26 IV) If the Company elects to use the Proceeds for the repair, replacement or restoration of any Real Estate or Equipment, and there is then no Event of Default, x) proceeds of insurance on Equipment and Real Estate in excess of $250,000.00 will be applied to the reduction of the Revolving Loans of the Company and y) CITBC may set up a reserve against Availability for an amount equal to the proceeds referred to in clause x) hereof. The reserve will be reduced dollar-for-dollar upon receipt of non-cancelable executed purchase orders, delivery receipts or contracts for the replacement, repair or restoration of Equipment or the Real Estate and disbursements in connection therewith. Prior to the commencement of any restoration, repair or replacement of Real Estate, the Company shall provide CITBC with a restoration plan and a total budget certified by an independent third party experienced in construction costing. If there are insufficient Proceeds to cover the cost of restoration as so determined, the Company shall be responsible for the amount of any such insufficiency, prior to the commencement of restoration and shall demonstrate evidence of such before the reserve will be reduced. Completion of restoration shall be evidenced by a final, unqualified certification of the design architect employed, if any; an unconditional Certificate of Occupancy, if applicable; such other certification as may be required by law; or if none of the above is applicable, a written good faith determination of completion by the Company (herein collectively the "Completion"). Upon Completion, any remaining reserve as established hereunder will be automatically released. 6. The Company agrees to pay, when due, all taxes, assessments, claims and other charges (herein "taxes") lawfully levied or assessed upon the Company or the Collateral and if such taxes remain unpaid after the date fixed for the payment thereof unless such taxes are being diligently contested in good faith by the Company by appropriate proceedings or if any lien shall be claimed thereunder (A) for taxes due the United States of America or (B) which in CITBC's opinion might create a valid obligation having priority over the rights granted to CITBC herein, CITBC may, on the Company's behalf, pay such taxes, and the amount thereof shall be an Obligation secured hereby and due to CITBC on demand. 7. The Company: (A) agrees to comply with all acts, rules, regulations and orders of any legislative, administrative or judicial body or official, which the failure to comply with would have a material and adverse impact on the Collateral, or any material part thereof, or on the operation of the Company's business, provided that the Company may contest any acts, rules, regulations, orders and directions of such bodies or officials in any reasonable manner which will not, in CITBC's reasonable opinion, materially and adversely effect CITBC's rights or priority in the Collateral; and (B) agrees to comply with all environmental statutes, acts, rules, regulations or orders as presently existing or as adopted or amended in the future, applicable to the ownership and/or use of its real property and operation of its business, 24 27 which the failure to comply with would have a material and adverse impact on the Collateral, or any material part thereof, or on the operation of the business of the Company. The Company hereby indemnifies CITBC and agrees to defend and hold CITBC harmless from and against any and all loss, damage, claim, liability, injury or expense which CITBC may sustain or incur in connection with: any claim or expense asserted against CITBC as a result of any environmental pollution, hazardous material or environmental clean-up of the Company's real property; or any claim or expense which results from the Company's operations (including, but not limited to, the Company's off-site disposal practices) and the Company further agrees that this indemnification shall survive termination of this Financing Agreement as well as the payment of all Obligations or amounts payable hereunder. The Company shall not be deemed to have breached any provision of this paragraph 7 if I) the failure to comply with the requirements of this paragraph 7 resulted from good faith error or innocent omission, II) the Company promptly commences and diligently pursues a cure of such breach and III) such failure is cured within ten (10) Business Days following the Company's receipt of notice of such failure. 8. Until termination of the Financing Agreement and payment and satisfaction of all Obligations due hereunder, the Company agrees that, unless CITBC shall have otherwise consented in writing, the Company will furnish to CITBC: (A) within ninety (90) days after the end of each fiscal year of the Company, I) a Consolidated Balance Sheet as at the close of such year, and statements of profit and loss, cash flow and reconciliation of surplus of the Company and all subsidiaries of the Company (if any) for such year, audited by independent public accountants selected by the Company and satisfactory to CITBC, and II) a copy of the Company's Form 10- K annual report for such fiscal year which the Company files with the Securities Exchange Commission; (B) within sixty (60) days after the end of each fiscal quarter, I) a Consolidated Balance Sheet as at the end of such period and statements of profit and loss, cash flow and surplus of the Company and all subsidiaries of the Company (if any) for such period, certified by an authorized financial or accounting officer of the Company, and II) a copy of the Company's Form 10-Q quarterly report for such period which the Company files with the Securities Exchange Commission; (C) within thirty (30) days after the end of each month, a Consolidated Balance Sheet as at the end of such period and statements of profit and loss, cash flow and surplus of the Company and all subsidiaries of the Company (if any) for such period, certified by an authorized financial or accounting officer of the Company; and (D) from time to time, such further information regarding the business affairs and financial condition of the Company as CITBC may reasonably request, including without limitation annual cash flow projections in form satisfactory to CITBC. Each financial statement which the Company is required to submit hereunder must be accompanied by an officer's certificate, signed by the President, Vice President, Controller, or Treasurer, pursuant to which any one such officer 25 28 must certify that: (A) the financial statement(s) fairly and accurately represent(s) the Company's financial condition at the end of the particular accounting period, as well as the Company's operating results during such accounting period, subject to year-end audit adjustments; (B) during the particular accounting period I) there has been no default or condition which, with the passage of time or notice, or both, would constitute a Default or Event of Default under this Financing Agreement (PROVIDED, HOWEVER, that if any such officer has knowledge that any such Default or Event of Default has occurred during such period, the existence of and a detailed description of same shall be set forth in such officer's certificate), and II) the Company has not received any notice of cancellation with respect to its property insurance policies; and (C) the exhibits attached to such financial statement(s) constitute detailed calculations showing compliance with all financial covenants contained in this Financing Agreement. 9. The Company shall maintain at all times during the periods below, determined as of the end of each calendar month during such period, a Tangible Net Worth of not less than: APPLICABLE PERIOD MINIMUM NET WORTH ----------------- ----------------- From the date hereof through March 31, 1997 $15,000,000.00 For the month of April, 1997 $14,500,000.00 For the month of May, 1997 $14,250,000.00 For the month of June, 1997 $14,000,000.00 From July 1, 1997 though August 31, 1997 $13,500,000.00 For the month of September, 1997 $13,000,000.00 For the month of October, 1997 $12,500,000.00 For the month of November, 1997 $12,250,000.00 For the month of December, 1997 and each calendar month thereafter $12,000,000.00 10. Until termination of the Financing Agreement and payment and satisfaction of all Obligations due hereunder, the Company agrees that, without the prior written consent of CITBC, except as otherwise herein provided, the Company will not: (A) Mortgage, assign, pledge, transfer or otherwise permit any lien, charge, security interest, encumbrance or judgment, (whether as a result of a purchase money or title retention transaction, or other security interest, or otherwise) to exist on any of its assets or goods, whether real, personal or mixed, whether now owned or hereafter acquired, except for the Permitted Encumbrances; (B) Incur or create any Indebtedness other than the Permitted Indebtedness; 26 29 (C) Borrow any money on the security of the Company's Collateral from sources other than CITBC; (D) Sell, lease, assign, transfer or otherwise dispose of I) Collateral, except in the ordinary course of the Company's business and as otherwise specifically permitted by this Financing Agreement, or II) either all or substantially all of the Company's assets, which do not constitute Collateral; (E) Merge, consolidate or otherwise alter or modify its corporate name, principal place of business, structure, status or existence, or enter into or engage in any operation or activity materially different from that presently being conducted by the Company; (F) Assume, guarantee, endorse, or otherwise become liable upon the obligations of any person, firm, entity or corporation, except by the endorsement of negotiable instruments for deposit or collection or similar transactions in the ordinary course of business; (G) Declare or pay any dividend of any kind on, or purchase, acquire, redeem or retire, any of the capital stock or equity interest of the Company, of any class whatsoever, whether now or hereafter outstanding; or (H) Make advances or loans to, or investments in, any firm, entity, person or corporation in excess of $20,000 in the aggregate outstanding at any time. 11. Without the prior written consent of CITBC, the Company will not: (A) enter into any Operating Lease if after giving effect thereto the aggregate obligations with respect to Operating Leases of the Company during any fiscal year would exceed $80,000; or (B) contract for, purchase, make expenditures for, lease pursuant to a Capital Lease or otherwise incur obligations with respect to Capital Expenditures (whether subject to a security interest or otherwise) during any fiscal year in the aggregate amount in excess of: (A) $5,285,000.00 for the fiscal year ending December 31, 1997; (B) $4,000,000.00 for the fiscal year ending December 31, 1998; and (C) $3,600,000.00 for the fiscal year ending December 31, 1999 and for each fiscal year thereafter. 12. The Company agrees to advise CITBC in writing of: (A) all expenditures (actual or anticipated) in excess of $25,000.00 for I) environmental clean-up, II) environmental compliance or III) environmental testing and the impact of said expenses on the Company's Working Capital; and B) any notices the Company receives 27 30 from any local, state or federal authority advising the Company of any environmental liability (real or potential) stemming from the Company's operations, its premises, its waste disposal practices, or waste disposal sites used by the Company and to provide CITBC with copies of all such notices if so required. 13. Without the prior written consent of CITBC, the Company agrees that it will not enter into any transaction, including, without limitation, any purchase, sale, lease, loan or exchange of property with any subsidiary or affiliate of the Company. SECTION 8. INTEREST, FEES AND EXPENSES --------------------------- 1. Interest on the Revolving Loan shall be payable monthly as of the end of each month and shall be an amount equal to eight and one-half percent (8.50%) per annum on the average of the net balances owing by the Company to CITBC in the Company's account at the close of each day during such month. This rate of interest is based on the eight and one-quarter percent (8.25%) per annum Chase Manhattan Rate as of March 6, 1997. In the event of any change in said Chase Manhattan Rate, the rate hereunder shall change, as of the first of the month following any change, so as to remain one-quarter of one percent (0.25%) above the Chase Manhattan Rate. The rate hereunder shall be calculated based on a 360-day year. CITBC shall be entitled to charge the Company's account at the rate provided for herein when due until all Obligations have been paid in full. 2. [RESERVED] 3. In consideration of the Letter of Credit Guaranty of CITBC, the Company shall pay CITBC the Letter of Credit Guaranty Fee which shall be an amount equal to one and one-half percent (1.50%) per annum, payable monthly, on the face amount of each Letter of Credit less the amount of any and all amounts previously drawn under the Letter of Credit. The rate hereunder shall be calculated based on a 360-day year. 4. Any charges, fees, commissions, costs and expenses charged to CITBC for the Company's account by any Issuing Bank in connection with or arising out of Letters of Credit issued pursuant to this Financing Agreement or out of transactions relating thereto will be charged to the Company's account in full when charged to or paid by CITBC and when made by any such Issuing Bank shall be conclusive on CITBC. 5. The Company shall reimburse or pay CITBC, as the case may be, for (A) all Out-of-Pocket Expenses of CITBC and (B) any applicable Documentation Fee. 6. Upon the last Business Day of each month, commencing with March 31, 1997, the Company shall pay CITBC the Line of Credit Fee. 28 31 7. To induce CITBC to enter into this Financing Agreement and to extend to the Company the Revolving Loan, the Company shall pay to CITBC a Loan Facility Fee in the amount of $75,000, $37,500 of which was paid to CITBC by the Company in connection with the Company's acceptance of the Commitment Letter and the balance of which is due and payable upon execution of this Financing Agreement. 8. Upon the execution of this Financing Agreement and on each Anniversary Date thereafter, the Company shall pay to CITBC the Collateral Management Fee. 9. Upon the occurrence of an Event of Default, the Company shall pay CITBC's standard charges for, and the fees and expenses of, the CITBC personnel used by CITBC for reviewing the books and records of the Company and for verifying, testing, protecting, safeguarding, preserving or disposing of all or any part of the Collateral which shall be in addition to the Collateral Management Fee. 10. The Company hereby authorizes CITBC to charge the Company's accounts with CITBC with the amount of all payments due hereunder as such payments become due. The Company confirms that any charges which CITBC may so make to the Company's account as herein provided will be made as an accommodation to the Company and solely at CITBC's discretion. SECTION 9. POWERS ------ The Company hereby constitutes CITBC or any person or agent CITBC may designate as its attorney-in-fact, at the Company's cost and expense, to exercise all of the following powers, which being coupled with an interest, shall be irrevocable until all of the Company's Obligations to CITBC have been paid in full: (A) To receive, take, endorse, sign, assign and deliver, all in the name of CITBC or the Company, any and all checks, notes, drafts, and other documents or instruments relating to the Collateral; (B) To receive, open and dispose of all mail addressed to the Company and to notify postal authorities to change the address for delivery thereof to such address as CITBC may designate; (C) To request from customers indebted on Accounts at any time, in the name of CITBC or the Company or that of CITBC's designee, information concerning the amounts owing on the Accounts; (D) To transmit to customers indebted on Accounts notice of CITBC's interest therein and to notify customers indebted on Accounts to make payment directly to CITBC for the Company's account; and 29 32 (E) To take or bring, in the name of CITBC or the Company, all steps, actions, suits or proceedings deemed by CITBC necessary or desirable to enforce or effect collection of the Accounts. Notwithstanding anything hereinabove contained to the contrary, the powers set forth in (B), (D) and (E) above may only be exercised after the occurrence of an Event of Default and until such time as such Event of Default is waived. SECTION 10. EVENTS OF DEFAULT AND REMEDIES ------------------------------ 1. Notwithstanding anything hereinabove to the contrary, CITBC may terminate this Financing Agreement immediately upon the occurrence of any of the following (herein "Events of Default"): (A) cessation of the business of the Company or the calling of a meeting of the creditors of the Company for purposes of compromising the debts and obligations of the Company; (B) the failure of the Company to generally meet debts as they mature; (C) the commencement by or against the Company of any bankruptcy, insolvency, arrangement, reorganization, receivership or similar proceedings under any federal or state law; (D) breach by the Company of any warranty, representation or covenant contained herein (other than those referred to in sub-paragraph (e) below) or in any other written agreement between the Company or CITBC, provided that such Default by the Company of any of the warranties, representations or covenants referred in this sub-paragraph (d) shall not be deemed to be an Event of Default unless and until such Default shall remain unremedied to CITBC's satisfaction for a period of ten (10) Business Days from the date of such Default; (E) breach by the Company of any warranty, representation or covenant of Section 3, Paragraphs 3 (other than the third sentence of paragraph 3) and 4; Section 6, Paragraphs 3 and 4 (other than the first sentence of paragraph 4); Section 7, Paragraphs 1,5,6, 9, 10, 11 and 13; (F) failure of the Company to pay any of the Obligations on the due date thereof, provided that nothing contained herein shall prohibit CITBC from charging such amounts to the Company's account on the due date thereof; or (G) the Company shall I) engage in any "prohibited transaction" as defined in ERISA, II) have any "accumulated funding deficiency" as defined in ERISA, III) have any "reportable event" enumerated in subsection c(1), c(5), c(6) or c(13) of Section 4303 of ERISA, or have any other "reportable event" and fail to give CITBC prompt 30 33 written notice thereof, IV) terminate any Plan, as defined in ERISA or V) be engaged in any proceeding in which the Pension Benefit Guaranty Corporation shall seek appointment, or is appointed, as trustee or administrator of any Plan, as defined in ERISA; and with respect to this sub-paragraph (g) such event or condition x) remains uncured for a period of thirty (30) Business Days from date of occurrence and y) could, in the reasonable opinion of CITBC, subject the Company to any tax, penalty or other liability material to the business, operations or financial condition of the Company. 2. Upon the occurrence of a Default and/or an Event of Default, at the option of CITBC, all loans and advances provided for in paragraph 1 of Section 3 of this Financing Agreement shall be thereafter in CITBC's sole discretion and the obligation of CITBC to make revolving loans and/or open Letters of Credit shall cease unless such Default is cured to CITBC's reasonable satisfaction within the applicable grace period or Event of Default is waived by CITBC and at the option of CITBC upon the occurrence of an Event of Default: (A) all Obligations shall become immediately due and payable; (B) CITBC may charge the Company the Default Rate of Interest on all then outstanding or thereafter incurred Obligations in lieu of the interest provided for in paragraphs one and two of Section 8 of this Financing Agreement provided I) CITBC has given the Company written notice of the Event of Default, provided, however, that no notice is required if the Event of Default is the Event listed in paragraph 1(c) of this Section 10 and II) the Company has failed to cure the Event of Default within ten (10) Business Days after x) CITBC deposited such notice in the United States mail or y) the occurrence of the Event of Default listed in paragraph 1(c) of this Section 10; and (C) CITBC may immediately terminate this Financing Agreement upon notice to the Company, PROVIDED, HOWEVER, that no notice of termination is required if the Event of Default is the Event listed in paragraph 1(c) of this Section 10. The exercise of any option is not exclusive of any other option which may be exercised at any time by CITBC. 3. Immediately upon the occurrence of any Event of Default, CITBC may to the extent permitted by law: (A) remove from any premises where same may be located any and all documents, instruments, files and records, and any receptacles or cabinets containing same, relating to the Accounts, or CITBC may use, at the Company's expense, such of the Company's personnel, supplies or space at the Company's places of business or otherwise, as may be necessary to properly administer and control the Accounts or the handling of collections and realizations thereon; (B) bring suit, in the name of the Company or CITBC, and generally shall have all other rights respecting said Accounts, including without limitation the right to I) accelerate or extend the time of payment, II) settle, compromise, release in whole or in part any amounts owing on any Accounts and III) issue credits in the name of the Company or CITBC; (C) sell, assign and deliver the Collateral and any returned, reclaimed or repossessed merchandise, with or without 31 34 advertisement, at public or private sale, for cash, on credit or otherwise, at CITBC's sole option and discretion, and CITBC may bid or become a purchaser at any such sale, free from any right of redemption, which right is hereby expressly waived by the Company; (D) foreclose the security interests created herein by any available judicial procedure, or to take possession of any or all of the Inventory and Equipment without judicial process, and to enter any premises where any Inventory and Equipment may be located for the purpose of taking possession of or removing the same and (E) exercise any other rights and remedies provided in law, in equity, by contract or otherwise. CITBC shall have the right, without notice or advertisement, to sell, lease, or otherwise dispose of all or any part of the Collateral whether in its then condition or after further preparation or processing, in the name of the Company or CITBC, or in the name of such other party as CITBC may designate, either at public or private sale or at any broker's board, in lots or in bulk, for cash or for credit, with or without warranties or representations, and upon such other terms and conditions as CITBC in its sole discretion may deem advisable, and CITBC shall have the right to purchase at any such sale. If any Inventory and Equipment shall require rebuilding, repairing, maintenance or preparation, CITBC shall have the right, at its option, to do such of the aforesaid as is necessary, for the purpose of putting the Inventory and Equipment in such saleable form as CITBC shall deem appropriate. The Company agrees, at the request of CITBC, to assemble the Inventory and Equipment and to make it available to CITBC at premises of the Company or elsewhere and to make available to CITBC the premises and facilities of the Company for the purpose of CITBC's taking possession of, removing or putting the Inventory and Equipment in saleable form. However, if notice of intended disposition of any Collateral is required by law, it is agreed that ten (10) Business Days notice shall constitute reasonable notification and full compliance with the law. The net cash proceeds resulting from CITBC's exercise of any of the foregoing rights, (after deducting all charges, costs and expenses, including reasonable attorneys' fees) shall be applied by CITBC to the payment of the Company's Obligations, whether due or to become due, in such order as CITBC may elect, and the Company shall remain liable to CITBC for any deficiencies, and CITBC in turn agrees to remit to the Company or its successors or assigns, any surplus resulting therefrom. The enumeration of the foregoing rights is not intended to be exhaustive and the exercise of any right shall not preclude the exercise of any other rights, all of which shall be cumulative. The mortgage, deed of trust or assignment on the Real Estate shall govern the rights and remedies of CITBC thereto. SECTION 11. TERMINATION ----------- Except as otherwise permitted herein, CITBC may terminate this Financing Agreement and the Line of Credit only as of the third or any subsequent Anniversary Date and then only by giving the Company 32 35 at least sixty (60) days prior written notice of termination. Notwithstanding the foregoing CITBC may terminate the Financing Agreement immediately upon the occurrence of an Event of Default, PROVIDED, HOWEVER, that if the Event of Default is an event listed in paragraph 1(c) of Section 10 of this Financing Agreement, CITBC may regard the Financing Agreement as terminated and notice to that effect is not required. This Financing Agreement, unless terminated as herein provided, shall automatically continue from Anniversary Date to Anniversary Date. The Company may terminate this Financing Agreement and the Line of Credit at any time upon at least sixty (60) days' prior written notice to CITBC; PROVIDED, HOWEVER, that if such termination is on a date other than the third Anniversary Date or any subsequent Anniversary Date, the Company shall pay to CITBC, immediately on demand, the Early Termination Fee, unless such termination occurs in connection with a sale of all or substantially all of the capital stock or assets of the Company which results in the repayment in full of all Obligations, in which case no Early Termination Fee shall be owed by the Company to CITBC. All Obligations shall become due and payable as of any termination hereunder or under Section 10 hereof and, pending a final accounting, CITBC may withhold any balances in the Company's account (unless supplied with an indemnity satisfactory to CITBC) to cover all of the Company's Obligations, whether absolute or contingent, including contingent Obligations with respect to Letters of Credit outstanding at the time of termination. All of CITBC's rights, liens and security interests shall continue after any termination until all Obligations have been paid and satisfied in full. SECTION 12. MISCELLANEOUS ------------- 1. The Company hereby waives diligence, demand, presentment and protest and any notices thereof as well as notice of nonpayment. No delay or omission of CITBC or the Company to exercise any right or remedy hereunder, whether before or after the happening of any Event of Default, shall impair any such right or shall operate as a waiver thereof or as a waiver of any such Event of Default. No single or partial exercise by CITBC of any right or remedy precludes any other or further exercise thereof, or precludes any other right or remedy. 2. This Financing Agreement and the documents executed and delivered in connection therewith constitute the entire agreement between the Company and CITBC; supersede any prior agreements; can be changed only by a writing signed by both the Company and CITBC; and shall bind and benefit the Company and CITBC and their respective successors and assigns. 3. In no event shall the Company, upon demand by CITBC for payment of any indebtedness relating hereto, by acceleration of the maturity thereof, or otherwise, be obligated to pay interest and fees in excess of the amount permitted by law. Regardless of any 33 36 provision herein or in any agreement made in connection herewith, CITBC shall never be entitled to receive, charge or apply, as interest on any indebtedness relating hereto, any amount in excess of the maximum amount of interest permissible under applicable law. If CITBC ever receives, collects or applies any such excess, it shall be deemed a partial repayment of principal and treated as such; and if principal is paid in full, any remaining excess shall be refunded to the Company. This paragraph shall control every other provision hereof and of any other agreement made in connection herewith. 4. If any provision hereof or of any other agreement made in connection herewith is held to be illegal or unenforceable, such provision shall be fully severable, and the remaining provisions of the applicable agreement shall remain in full force and effect and shall not be affected by such provision's severance. Furthermore, in lieu of any such provision, there shall be added automatically as a part of the applicable agreement a legal and enforceable provision as similar in terms to the severed provision as may be possible. 5. THE COMPANY AND CITBC EACH HEREBY WAIVE ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING ARISING OUT OF THIS FINANCING AGREEMENT. THE COMPANY HEREBY IRREVOCABLY WAIVES PERSONAL SERVICE OF PROCESS AND CONSENTS TO SERVICE OF PROCESS BY CERTIFIED OR REGISTERED MAIL, RETURN RECEIPT REQUESTED. 6. Except as otherwise herein provided, any notice or other communication required hereunder shall be in writing, and shall be deemed to have been validly served, given or delivered when hand delivered or sent by facsimile, or three Business Days after deposit in the United State mails, with proper first class postage prepaid and addressed to the party to be notified as follows: (A) if to CITBC, at: The CIT Group/Business Credit, Inc. 10 South LaSalle Street, 22nd Floor Chicago, Illinois 60603 Attn: Regional Manager Telecopier No. (312) 443-0139 (B) if to the Company at: 1401 Interstate Drive Champaign, Illinois 61821 Attn: Richard A. Clark, Vice President-Finance and CFO Telecopier No. (217) 359-3702 with a copy to: 34 37 Erwin, Martinkus, Cole & Ansel 411 W. University Avenue Champaign, Illinois 61820 Attn: Sam Erwin, Esq. Telecopier No. (217) 351-4314 or to such other address as any party may designate for itself by like notice. 7. THE VALIDITY, INTERPRETATION AND ENFORCEMENT OF THIS FINANCING AGREEMENT SHALL BE GOVERNED BY THE LAWS OF THE STATE OF ILLINOIS. IN WITNESS WHEREOF, the parties hereto have caused this Financing Agreement to be executed, agreed to, accepted and delivered in Chicago, Illinois by their proper and duly authorized officers as of the date set forth above. THE CIT GROUP/BUSINESS CREDIT, INC. By:/s/ Jim Anderson ------------------------------- Title: Vice President CERION TECHNOLOGIES INC. By:/s/Richard A. Clark ------------------------------- Title: Vice President/Finance 35 EX-10.8 3 MORTGAGE SECURITY AGREEMENT 1 Exhibit 10.8 Illinois MORTGAGE, SECURITY AGREEMENT, FINANCING STATEMENT AND ASSIGNMENT OF RENTS AND LEASES ------------------------------ THIS MORTGAGE, SECURITY AGREEMENT, FINANCING STATEMENT AND ASSIGNMENT OF RENTS AND LEASES ("Mortgage") entered into as of the 7th day of March, 1997 by CERION TECHNOLOGIES INC., a Delaware corporation ("Mortgagor"), having its principal place of business at 1401 Interstate Drive, Champaign, Illinois 61821 to THE CIT GROUP/BUSINESS CREDIT, INC., a New York corporation with an office located at 10 South LaSalle Street, Chicago, Illinois 60603 ("Mortgagee"). Except as otherwise provided herein, all capitalized terms used but not defined herein shall have the respective meanings given to them in the Loan Agreement (as hereinafter defined). WITNESSETH: WHEREAS, pursuant to and upon satisfaction of the conditions set forth in that certain Financing Agreement, dated March 7, 1997, between Mortgagor and Mortgagee (the Financing Agreement and any and all renewals, extensions for any period, increases or rearrangements thereof is referred to as the "Loan Agreement"), Mortgagee has agreed to make certain Revolving Loans and Mortgagee has also agreed to guaranty the Mortgagor's reimbursement obligations to the Issuing Bank for its issuance of Letters of Credit and Mortgagee has further agreed to extend certain other financial accommodations from time to time to Mortgagor, all in an aggregate principal amount not to exceed Seven Million Five Hundred Thousand and no/100 Dollars ($7,500,000.00); and 2 WHEREAS, as a condition to Mortgagee's extension of certain financial accommodations to Mortgagor including, without limitation, the extension of credit pursuant to the Loan Agreement, Mortgagee has required that Mortgagor enter into this Mortgage and grant to Mortgagee the liens and security interests referred to herein to secure (i) payment of the principal amount, together with interest thereon, of all present and future advances of money made by Mortgagee to Mortgagor, including without limitation, the reborrowing of principal previously repaid pursuant to the Loan Agreement, as well as all other Obligations (all as defined and provided in the Loan Agreement) of Mortgagor to Mortgagee; (ii) repayment of all reimbursement obligations due the Issuing Bank from time to time, (iii) other payment and performance obligations related to this Mortgage (the aforesaid Obligations of Mortgagor to Mortgagee, together with the other payment and performance obligations being hereinafter referred to collectively as the "Liabilities"); and WHEREAS, the Liabilities secured hereby shall not exceed an aggregate principal amount, at any one time outstanding of Twenty Five Million and no/100 Dollars ($25,000,000.00), PROVIDED, that the foregoing limitation shall apply only to the lien upon the real property created by this Mortgage, and it shall not in any manner limit, affect or impair any grant of a security interest or other right in favor of the Mortgagee under the provisions of the Loan Agreement or under any other security agreement at any time executed by Mortgagor; NOW, THEREFORE, in consideration of the premises contained herein and to secure payment of the Liabilities and in consideration of One Dollar ($1.00) in hand paid, the receipt and sufficiency whereof are hereby acknowledged, Mortgagor does hereby grant, remise, release, alien, convey, mortgage and warrant to Mortgagee, its successors and assigns, the following described real estate (the "Land") in Champaign County, Illinois, and does further grant a security interest to Mortgagee in all Personal Property (as defined below) as well as all Mortgaged Property (as defined below) as may be secured under the Uniform Commercial Code (the "Code") in effect in the State of Illinois (the "State"): See Exhibit A attached hereto and by this reference made a part hereof for the legal description of the Land which Land, together with all right, title and interest, if any, which Mortgagor may now have or hereafter acquire in and to all improvements, buildings and structures now or hereafter located -2- 3 thereon of every nature whatsoever, is herein called the "Premises". TOGETHER WITH all right, title and interest, if any, including any after-acquired right, title and interest, and including any right of use or occupancy, which Mortgagor may now have or hereafter acquire in and to (a) all easements, rights of way, gores of land or any lands occupied by streets, ways, alleys, passages, sewer rights, water courses, water rights and powers, and public places adjoining said Land, and any other interests in property constituting appurtenances to the Premises, or which hereafter shall in any way belong, relate or be appurtenant thereto, and (b) all hereditaments, gas, oil, minerals (with the right to extract, sever and remove such gas, oil and minerals), and easements, of every nature whatsoever, located in or on the Premises and all other rights and privileges thereunto belonging or appertaining and all extensions, additions, improvements, betterments, renewals, substitutions and replacements to or of any of the rights and interests described in subparagraphs (a) and (b) above (hereinafter the "Property Rights"). TOGETHER WITH all right, title and interest, if any, including any after-acquired right, title and interest, and including any right of use or occupancy, which Mortgagor may now or hereafter acquire in and to all fixtures and appurtenances of every nature whatsoever now or hereafter located in, on or attached to, and used or intended to be used in connection with, or with the operation of, the Premises, including, but not limited to (a) all apparatus, machinery and equipment of Mortgagor and (b) all extensions, additions, improvements, betterments, renewals, substitutions and replacements to or of any of the foregoing (the items described in the foregoing clauses (a) and (b) being the "Fixtures"); as well as all personal property and equipment of every nature whatsoever now or hereafter located in or on the Premises, including but not limited to (c) accounts, contract rights, general intangibles, tax refunds, chattel paper, instruments, notes, letters of credit, documents, documents of title; (d) inventory; (e) equipment; (f) all of Mortgagor's deposit accounts (general or special) with and credits and other claims against Mortgagee, or any other financial institution with which Mortgagor maintains deposits; (g) all of Mortgagor's now owned or hereafter acquired monies, and any and all other property and interests in property of Mortgagor now or hereafter coming into the actual possession, custody or control of Mortgagee or any agent or affiliate of Mortgagee in any way or for any purpose (whether for safekeeping, deposit, custody, pledge, transmission, collection or otherwise); -3- 4 (h) all insurance proceeds of or relating to any of the foregoing; (i) all insurance proceeds relating to any key man life insurance policy covering the life of any officer or director of Mortgagor; (j) all of Mortgagor's books and records relating to any of the foregoing; and (k) all accessions and additions to, substitutions for, and replacements, products and proceeds of any of the foregoing clauses (c) through (j) (the items described in the foregoing clauses (c) through (k) and any other personal property referred to in this paragraph being the "Personal Property"). It is mutually agreed, intended and declared that the Premises and all of the Property Rights and Fixtures owned by Mortgagor (referred to collectively herein as the "Real Property") shall, so far as permitted by law, be deemed to form a part and parcel of the Land and for the purpose of this Mortgage to be real estate and covered by this Mortgage. It is also agreed that if any of the property herein mortgaged is of a nature so that a security interest therein can be perfected under the Code in effect in the State, this instrument shall constitute a security agreement, fixture filing and financing statement, and Mortgagor agrees to execute, deliver and file or refile any financing statement, continuation statement, or other instruments Mortgagee may reasonably require from time to time to perfect or renew such security interest under the Code. To the extent permitted by law, (i) all of the Fixtures are or are to become fixtures on the Land and (ii) this instrument, upon recording or registration in the real estate records of the proper office, shall constitute a "fixture-filing" within the meaning of Sections 9-313 and 9-402 of the Code. Subject to the terms and conditions of the Loan Agreement, the remedies for any violation of the covenants, terms and conditions of the agreements herein contained shall be as prescribed herein or by general law, or, as to that part of the security in which a security interest may be perfected under the Code, by the specific statutory consequences now or hereafter enacted and specified in the Code, all at Mortgagee's sole election. TOGETHER WITH all the estate, right, title and interest of the Mortgagor in and to (i) all judgments, insurance proceeds, awards of damages and settlements resulting from condemnation proceedings or the taking of the Real Property, or any part thereof, under the power of eminent domain or for any damage (whether caused by such taking or otherwise) to the Real Property, or any part thereof, or to any rights appurtenant thereto, and all proceeds of any sales or other dispositions of the Real Property or any part thereof; and (except as otherwise provided herein or in the Loan Agreement) the Mortgagee is hereby authorized to collect and receive said awards and proceeds and to give proper receipts and acquittances therefor, and to apply the -4- 5 same as provided in the Loan Agreement; and (ii) all contract rights, general intangibles, actions and rights in action relating to the Real Property or the Personal Property including, without limitation, all rights to insurance proceeds and unearned premiums arising from or relating to damage to the Real Property or the Personal Property; and (iii) all proceeds, products, replacements, additions, substitutions, renewals and accessions of and to the Real Property and the Personal Property. (The rights and interests described in this paragraph shall hereinafter be called the "Intangibles".) As additional security for the Liabilities secured hereby, Mortgagor (i) does hereby pledge and assign to Mortgagee from and after the date hereof (including any period of redemption), primarily and on a parity with the Real Property, and not secondarily, all the rents, issues and profits of the Real Property and all rents, issues, profits, revenues, royalties, bonuses, rights and benefits due, payable or accruing (including all deposits of money as advance rent, for security or as earnest money or as down payment for the purchase of all or any part of the Real Property) (the "Rents") under any and all present and future leases, contracts or other agreements relative to the ownership or occupancy of all or any portion of the Real Property, and (ii) except to the extent such a transfer or assignment is not permitted by the terms thereof, does hereby transfer and assign to Mortgagee all such leases and agreements (including all Mortgagor's rights under any contracts for the sale of any portion of the Mortgaged Property and all revenues and royalties under any oil, gas and mineral leases relating to the Real Property) (the "Leases"). Mortgagee hereby grants to Mortgagor the right to collect and use the Rents as they become due and payable under the Leases, but not more than one (1) month in advance thereof, unless an Event of Default shall have occurred PROVIDED that the existence of such right shall not operate to subordinate this assignment to any subsequent assignment, in whole or in part, by Mortgagor, and any such subsequent assignment shall be subject to the rights of the Mortgagee under this Mortgage. Mortgagor further agrees to execute and deliver such assignments of leases or assignments of land sale contracts as Mortgagee may from time to time request. In the event of an Event of Default (1) the Mortgagor agrees, upon demand, to deliver to the Mortgagee all of the Leases with such additional assignments thereof as the Mortgagee may request and agrees that the Mortgagee may assume the management of the Real Property and collect the Rents, applying the same upon the Liabilities in the manner provided in the Loan Agreement, and (2) the Mortgagor hereby authorizes and directs all tenants, purchasers or other persons occupying or otherwise acquiring any -5- 6 interest in any part of the Real Property to pay the Rents due under the Leases to the Mortgagee upon request of the Mortgagee. Mortgagor hereby appoints Mortgagee as its true and lawful attorney in fact to manage said property and collect the Rents, with full power to bring suit for collection of the Rents and possession of the Real Property, giving and granting unto said Mortgagee and unto its agent or attorney full power and authority to do and perform all and every act and thing whatsoever requisite and necessary to be done in the protection of the security hereby conveyed; PROVIDED, HOWEVER, that (i) this power of attorney and assignment of rents shall not be construed as an obligation upon said Mortgagee to make or cause to be made any repairs that may be needful or necessary and (ii) Mortgagee agrees that until such Event of Default as aforesaid, Mortgagee shall permit Mortgagor to perform the aforementioned management responsibilities. Upon Mortgagee's receipt of the Rents, at Mortgagee's option, it may use the proceeds of the Rents to pay: (1) reasonable charges for collection thereof, costs of necessary repairs and other costs requisite and necessary during the continuance of this power of attorney and assignment of rents, (2) general and special taxes, insurance premiums, and (3) any or all of the Liabilities pursuant to the provisions of the Loan Agreement. This power of attorney and assignment of rents shall be irrevocable until this Mortgage shall have been satisfied and released of record and the releasing of this Mortgage shall act as a revocation of this power of attorney and assignment of rents. Mortgagee shall have and hereby expressly reserves the right and privilege (but assumes no obligation) to demand, collect, sue for, receive and recover the Rents, or any part thereof, now existing or hereafter made, and apply the same in accordance with the provisions of the Loan Agreement. All of the property described above, and each item of property therein described, not limited to but including the Land, the Premises, the Property Rights, the Fixtures, the Personal Property, the Real Property, the Intangibles, the Rents and the Leases, is herein referred to as the "Mortgaged Property." Nothing herein contained shall be construed as constituting the Mortgagee a mortgagee-in-possession in the absence of the taking of actual possession of the Mortgaged Property by the Mortgagee. Nothing contained in this Mortgage shall be construed as imposing on Mortgagee any of the obligations of the lessor under any Lease of the Mortgaged Property in the absence of an explicit assumption thereof by Mortgagee. In the exercise of the powers herein granted the Mortgagee, except as provided in the Loan Agreement, no liability -6- 7 shall be asserted or enforced against the Mortgagee, all such liability being expressly waived and released by Mortgagor. TO HAVE AND TO HOLD the Mortgaged Property, properties, rights and privileges hereby conveyed or assigned, or intended so to be, unto Mortgagee, its beneficiaries, successors and assigns, forever for the uses and purposes herein set forth. Mortgagor hereby releases and waives all rights under and by virtue of the Homestead Exemption Laws, if any, of the State and Mortgagor hereby covenants, represents and warrants that, at the time of the ensealing and delivery of these presents, Mortgagor is well seised of the Mortgaged Property in fee simple and with lawful authority to sell, assign, convey and mortgage the Mortgaged Property, and that the title to the Mortgaged Property is free and clear of all encumbrances, except as described on Exhibit B attached hereto and made a part hereof, and that, except for the encumbrances set forth on Exhibit B, Mortgagor will forever defend the same against all lawful claims. The following provisions shall also constitute an integral part of this Mortgage: 1. PAYMENT OF TAXES ON THE MORTGAGE. Without limiting any of the provisions of the Loan Agreement, Mortgagor agrees that, if the United States or any department, agency or bureau thereof or if the State or any of its subdivisions having jurisdiction shall at any time require documentary stamps to be affixed to this Mortgage or shall levy, assess, or charge any tax, assessment or imposition upon this Mortgage or the credit or indebtedness secured hereby or the interest of Mortgagee in the Premises or upon Mortgagee by reason of or as holder of any of the foregoing then, Mortgagor shall pay for such documentary stamps in the required amount and deliver them to Mortgagee or pay (or reimburse Mortgagee for) such taxes, assessments or impositions. Mortgagor agrees to exhibit to Mortgagee, at any time upon request, official receipts showing payment of all taxes, assessments and charges which Mortgagor is required or elects to pay under this paragraph. Mortgagor agrees to indemnify Mortgagee against liability on account of such documentary stamps, taxes, assessments or impositions, whether such liability arises before or after payment of the Liabilities and regardless of whether this Mortgage shall have been released. 2. LEASES AFFECTING THE REAL PROPERTY. Mortgagor agrees faithfully to perform all of its obligations under all present and future Leases at any time assigned to Mortgagee as additional security, and to refrain from any action or inaction which would result in termination of any such Leases or in the -7- 8 diminution of the value thereof or of the Rents due thereunder. All future lessees under any Lease made after the date of recording of this Mortgage shall, at Mortgagee's option and without any further documentation, attorn to Mortgagee as lessor if for any reason Mortgagee becomes lessor thereunder, and, upon demand, pay rent to Mortgagee, and Mortgagee shall not be responsible under such Lease for matters arising prior to Mortgagee becoming lessor thereunder. 3. USE OF THE REAL PROPERTY. Mortgagor agrees that it shall not permit the public to use the Real Property in any manner that might tend, in Mortgagee's reasonable judgment, to impair Mortgagor's title to such property or any portion thereof, or to make possible any claim or claims of easement by prescription or of implied dedication to public use. 4. INDEMNIFICATION. Mortgagor shall not use or permit the use of any part of the Real Property for an illegal purpose, including, without limitation, the violation of any environmental laws, statutes, codes, regulations or practices. Without limiting any indemnification Mortgagor has granted in the Loan Agreement, Mortgagor agrees to indemnify and hold harmless Mortgagee from and against any and all losses, suits, liabilities, fines, damages, judgments, penalties, claims, charges, costs and expenses (including reasonable attorneys' and paralegals' fees, court costs and disbursements) which may be imposed on, incurred or paid by or asserted against the Real Property by reason or on account of or in connection with (i) the construction, reconstruction or alteration of the Real Property, (ii) any negligence or misconduct of Mortgagor, any lessee of the Real Property, or any of their respective agents, contractors, subcontractors, servants, employees, licensees or invitees, (iii) any accident, injury, death or damage to any person or property occurring in, on or about the Real Property or any street, drive, sidewalk, curb or passageway adjacent thereto, or (iv) any other transaction arising out of or in any way connected with the Mortgaged Property. 5. INSURANCE. Mortgagor shall, at its sole expense, obtain for, deliver to, assign and maintain for the benefit of Mortgagee, until the Liabilities are paid in full, insurance policies as specified in the Loan Agreement. In the event of a casualty loss, the net insurance proceeds from such insurance policies shall be paid and applied as specified in the Loan Agreement. 6. CONDEMNATION AWARDS. Mortgagor hereby assigns to Mortgagee, as additional security, all awards of damage resulting -8- 9 from condemnation proceedings or the taking of or injury to the Real Property for public use, and Mortgagor agrees that the proceeds of all such awards shall be paid and applied as specified in the Loan Agreement. 7. REMEDIES. Subject to the provisions of the Loan Agreement, upon the occurrence of an Event of Default under the terms of the Loan Agreement, in addition to any rights and remedies provided for in the Loan Agreement, and to the extent permitted by applicable law, the following provisions shall apply: (a) MORTGAGEE'S POWER OF ENFORCEMENT. It shall be lawful for Mortgagee to (i) immediately sell the Mortgaged Property either in whole or in separate parcels, as prescribed by the State law, under power of sale, which power is hereby granted to Mortgagee to the full extent permitted by the State law, and thereupon, to make and execute to any purchaser(s) thereof deeds of conveyance pursuant to applicable law or (ii) immediately foreclose this Mortgage by judicial action. The court in which any proceeding is pending for the purpose of foreclosure of this Mortgage may, at once or at any time thereafter, either before or after sale, without notice and without requiring bond, and without regard to the solvency or insolvency of any person liable for payment of the Liabilities secured hereby, and without regard to the then value of the Mortgaged Property or the occupancy thereof as a homestead, appoint a receiver (the provisions for the appointment of a receiver and assignment of rents being an express condition upon which the Loan hereby secured is made) for the benefit of Mortgagee, with power to collect the Rents, due and to become due, during such foreclosure suit and the full statutory period of redemption notwithstanding any redemption. The receiver, out of the Rents when collected, may pay costs incurred in the management and operation of the Real Property, prior and subordinate liens, if any, and taxes, assessments, water and other utilities and insurance, then due or thereafter accruing, and may make and pay for any necessary repairs to the Real Property, and may pay all or any part of the Liabilities or other sums secured hereby or any deficiency decree entered in such foreclosure proceedings. Upon or at any time after the filing of a suit to foreclose this Mortgage, the court in which such suit is filed shall have full power to enter an order placing Mortgagee in possession of the Real Property with the same power granted to a receiver pursuant to this subparagraph and with all other rights and privileges of a mortgagee-in- possession under applicable law. -9- 10 (b) MORTGAGEE'S RIGHT TO ENTER AND TAKE POSSESSION, OPERATE AND APPLY INCOME. Mortgagee shall, at its option, have the right, acting through its agents or attorneys, either with or without process of law, forcibly or otherwise, to enter upon and take possession of the Real Property, expel and remove any persons, goods, or chattels occupying or upon the same, to collect or receive all the Rents, and to manage and control the same, and to lease the same or any part thereof, from time to time, and, after deducting all reasonable attorneys' fees and expenses, and all reasonable expenses incurred in the protection, care, maintenance, management and operation of the Real Property, distribute and apply the remaining net income in accordance with the terms of the Loan Agreement or upon any deficiency decree entered in any foreclosure proceedings. 8. APPLICATION OF THE RENTS OR PROCEEDS FROM FORECLOSURE OR SALE. In any foreclosure of this Mortgage by judicial action, or any sale of the Mortgaged Property by advertisement, in addition to any of the terms and provisions of the Loan Agreement, there shall be allowed (and included in the decree for sale in the event of a foreclosure by judicial action) to be paid out of the Rents or the proceeds of such foreclosure proceeding and/or sale: (a) LIABILITIES. All of the Liabilities and other sums secured hereby which then remain unpaid; and (b) OTHER ADVANCES. All other items advanced or paid by Mortgagee pursuant to this Mortgage; and (c) COSTS, FEES AND OTHER EXPENSES. All court costs, reasonable attorneys' and paralegals' fees and expenses, appraiser's fees, advertising costs, filing fees and transfer taxes, notice expenses, expenditures for documentary and expert evidence, stenographer's charges, publication costs, and costs (which may be estimated as to items to be expended after entry of the decree) of procuring all abstracts of title, title searches and examinations, title guarantees, title insurance policies, Torrens certificates and similar data with respect to title which Mortgagee in the reasonable exercise of its judgment may deem necessary. All such expenses shall become additional Liabilities secured hereby when paid or incurred by Mortgagee in connection with any proceedings, including but not limited to probate and bankruptcy proceedings, to which Mortgagee shall be a party, either as plaintiff, claimant or defendant, by reason of this Mortgage or any indebtedness hereby secured or in connection with the preparations for the commencement of any suit for the fore closure, whether or not actually commenced, or sale by -10- 11 advertisement. The proceeds of any sale (whether through a foreclosure proceeding or Mortgagee's exercise of the power of sale) shall be distributed and applied in accordance with the terms of the Loan Agreement. 9. CUMULATIVE REMEDIES; DELAY OR OMISSION NOT A WAIVER. Each remedy or right of Mortgagee shall not be exclusive of but shall be in addition to every other remedy or right now or hereafter existing at law or in equity. No delay in the exercise or omission to exercise any remedy or right accruing on the occurrence or existence of any Event of Default shall impair any such remedy or right or be construed to be a waiver of any such Event of Default or acquiescence therein, nor shall it affect any subsequent Event of Default of the same or different nature. Every such remedy or right may be exercised concurrently or independently and when and as often as may be deemed expedient by Mortgagee. 10. MORTGAGEE'S REMEDIES AGAINST MULTIPLE PARCELS. If more than one property, lot or parcel is covered by this Mortgage, and if this Mortgage is foreclosed upon, or judgment is entered upon any Liabilities secured hereby, or if Mortgagee exercises its power of sale, execution may be made upon or Mortgagee may exercise its power of sale against any one or more of the properties, lots or parcels and not upon the others, or upon all of such properties or parcels, either together or separately, and at different times or at the same time, and execution sales or sales by advertisement may likewise be conducted separately or concurrently, in each case at Mortgagee's election. 11. NO MERGER. In the event of a foreclosure of this Mortgage or any other mortgage or deed of trust securing the Liabilities, the Liabilities then due the Mortgagee shall not be merged into any decree of foreclosure entered by the court, and Mortgagee may concurrently or subsequently seek to foreclose one or more mortgages or deeds of trust which also secure said Liabilities. 12. NOTICES. Except as otherwise provided herein, any notices, demands, consents, requests, approvals, undertakings or other instruments required or permitted to be given in connection with this Mortgage (and all copies of such notices or other instruments as set forth below) shall be in writing, and shall be deemed to have been validly served, given or delivered if hand-delivered, or if sent by facsimile, or if sent by a nationally recognized overnight delivery service, charges prepaid, or if mailed (effective three (3) business days following deposit -11- 12 thereof at any main or branch United States Post Office) by United States mail, postage prepaid, addressed to the party so notified as follows: if to Mortgagor: Cerion Technologies Inc. 1401 Interstate Drive Champaign, Illinois 61821 Attn: Richard A. Clark, Vice President-Finance and CFO Telecopier No.: (217) 359-3702 with a copy to: Erwin, Martinkus, Cole & Ansel 411 W. University Avenue Champaign, Illinois 61820 Attn: Sam Erwin Telecopier No.: (217) 351-4314 if to Mortgagee: The CIT Group/Business Credit, Inc. 10 South LaSalle Street, 22nd Floor Chicago, Illinois 60603 Attn: Regional Manager Telecopier No.: (312) 443-0139 with a copy to: Sidley & Austin One First National Plaza Chicago, Illinois 60603 Attn: James L. Marovitz Telecopier No.: (312) 853-7036 Mortgagor or Mortgagee shall, from time to time, have the right to specify as the proper addressee and/or address for the purposes of this Mortgage any other party or address in the United States upon giving five (5) days' written notice thereof. 13. EXTENSION OF PAYMENTS. Mortgagor agrees that, without affecting the liability of any person for payment of the Liabilities secured hereby or affecting the lien of this Mortgage upon the Mortgaged Property or any part thereof (other than persons or property explicitly released as a result of the exercise by Mortgagee of its rights and privileges hereunder), -12- 13 Mortgagee may at any time and from time to time, on request of the Mortgagor, without notice to any person liable for payment of any Liabilities secured hereby, but otherwise subject to the provisions of the Loan Agreement, extend the time, or agree to alter or amend the terms of payment of such Liabilities. Mortgagor further agrees that any part of the security herein described may be released with or without consideration without affecting the remainder of the Liabilities or the remainder of the security. 14. GOVERNING LAW. Mortgagor agrees that this Mortgage is to be construed, governed and enforced in accordance with the laws of the State. Wherever possible, each provision of this Mortgage shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Mortgage shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Mortgage. 15. SATISFACTION OF MORTGAGE. Upon full payment of all the Liabilities, at the time and in the manner provided in the Loan Agreement, or upon satisfaction of the conditions set forth in the Loan Agreement for release of the Mortgaged Property from this Mortgage, this conveyance or lien shall be null and void and, upon demand therefor following such payment or satisfaction of the conditions set forth in the Loan Agreement for release of the Mortgaged Property, as the case may be, a satisfaction of mortgage or reconveyance of the Mortgaged Property shall promptly be provided by Mortgagee to Mortgagor. 16. SUCCESSORS AND ASSIGNS INCLUDED IN PARTIES. This Mortgage shall be binding upon the Mortgagor and upon the successors, assigns and vendees of the Mortgagor and shall inure to the benefit of the Mortgagee's successors and assigns; all references herein to the Mortgagor and to the Mortgagee shall be deemed to include their respective successors and assigns. Mortgagor's successors and assigns shall include, without limitation, a receiver, trustee or debtor in possession of or for the Mortgagor. Wherever used, the singular number shall include the plural, the plural shall include the singular, and the use of any gender shall be applicable to all genders. 17. WAIVER OF APPRAISEMENT, VALUATION, STAY, EXTENSION AND REDEMPTION LAWS. Mortgagor agrees, to the full extent permitted by law, that at all times following an Event of Default, neither Mortgagor nor anyone claiming through or under -13- 14 it shall or will set up, claim or seek to take advantage of any appraisement, valuation, stay, or extension laws now or hereafter in force, in order to prevent or hinder the enforcement or foreclosure of this Mortgage or the absolute sale of the Mortgaged Property or the final and absolute putting into possession thereof, immediately after such sale, of the purchaser thereat; and Mortgagor, for itself and all who may at any time claim through or under it, hereby waives, to the full extent that it may lawfully so do, the benefit of all such laws and any and all right to have the assets comprising the Mortgaged Property marshaled upon any foreclosure of the lien hereof and agrees that Mortgagee or any court having jurisdiction to foreclose such lien may sell the Mortgaged Property in part or as an entirety. To the full extent permitted by law, Mortgagor hereby waives any and all statutory or other rights of redemption from sale under any order or decree of foreclosure of this Mortgage, on its own behalf and on behalf of each and every person acquiring any interest in or title to the Mortgaged Property subsequent to the date hereof. 18. INTERPRETATION WITH OTHER DOCUMENTS. Notwithstanding anything in this Mortgage to the contrary, in the event of a conflict or inconsistency between the Mortgage and the Loan Agreement, the provisions of the Loan Agreement shall govern. 19. FUTURE ADVANCES. This Mortgage is given for the purpose of securing loan advances which the Mortgagee may make to or for Mortgagor pursuant and subject to the terms and provisions of the Loan Agreement. The parties hereto intend that, in addition to any other debt or obligation secured hereby, this Mortgage shall secure unpaid balances of loan advances made after this Mortgage is delivered to the Recorder of Deeds, Champaign County, Illinois, whether made pursuant to an obligation of Mortgagee or otherwise, provided that such advances are within twenty (20) years from the date hereof and in such event, such advances shall be secured to the same extent as if such future advances were made on the date hereof, although there may be no advance made at the time of execution hereof and although there may be no indebtedness outstanding at the time any advance is made. Such loan advances may or may not be evidenced by notes executed pursuant to the Loan Agreement. 20. INVALID PROVISIONS TO AFFECT NO OTHERS. In the event that any of the covenants, agreements, terms or provisions contained in this Mortgage shall be invalid, illegal or unenforceable in any respect, the validity of the remaining covenants, agreements, terms or provisions contained herein or in the Loan Agreement shall not be in any way affected, prejudiced -14- 15 or disturbed thereby. In the event that the application of any of the covenants, agreements, terms or provisions of this Mortgage is held to be invalid, illegal or unenforceable, those covenants, agreements, terms and provisions shall not be in any way affected, prejudiced or disturbed when otherwise applied. 21. CHANGES. Neither this Mortgage nor any term hereof may be changed, waived, discharged or terminated orally, or by any action or inaction, but only by an instrument in writing signed by the party against which enforcement of the change, waiver, discharge or termination is sought. To the extent permitted by law, any agreement hereafter made by Mortgagor and Mortgagee relating to this Mortgage shall be superior to the rights of the holder of any intervening lien or encumbrance. 22. TIME OF ESSENCE. Time is of the essence with respect to the provisions of this Mortgage. 23. NO STRICT CONSTRUCTION. The parties hereto have participated jointly in the negotiation and drafting of this Mortgage. In the event an ambiguity or question of intent or interpretation arises, this Mortgage shall be construed as if drafted jointly by the parties hereto and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Mortgage. IN WITNESS WHEREOF, this instrument is executed as of the day and year first above written by the person or persons identified below on behalf of Mortgagor (and said person or persons hereby represent that they possess full power and authority to execute this instrument). THE MORTGAGOR HEREBY DECLARES AND ACKNOWLEDGES THAT THE MORTGAGOR HAS RECEIVED, WITHOUT CHARGE, A TRUE COPY OF THIS MORTGAGE. MORTGAGOR: CERION TECHNOLOGIES INC. By /s/Richard A. Clark ---------------------- Richard A. Clark Vice President-Finance -15- 16 STATE OF ILLINOIS ) ) SS. COUNTY OF Champaign ) I, the undersigned, a Notary Public in and for said County, in said State, hereby certify that Richard A. Clark, whose name as Vice President-Finance of Cerion Technologies Inc., a Delaware corporation, is signed to the foregoing instrument, and who is known to me, acknowledged before me on this day that, being informed of the contents of the instrument, he, as such officer and with full authority, executed the same voluntarily for and as the act of said corporation. Given under my hand and Official seal this 7th day of March, 1997. /s/ Cheri L. Baker ----------------------------- Notary Public (Seal) My Commission Expires: ______ 7-5-97 ------------------------------ Notary Public in and for the State of Illinois ------------------------------------- OFFICIAL SEAL Cheri L. Baker Notary Public, State of Illinois My Commission Expires 7/5/97 ------------------------------------- 17 EXHIBIT A LEGAL DESCRIPTION OF THE PREMISES --------------------------------- PARCEL 1: LOT 18 OF INTERSTATE RESEARCH PARK LOTS 17 AND 18 SUBDIVISION, AS PER PLAT RECORDED IN PLAT BOOK "Z" AT PAGE 229 AS DOCUMENT 82 R 13954, SITUATED IN THE CITY OF CHAMPAIGN, IN CHAMPAIGN COUNTY ILLINOIS. PARCEL 2: LOT 2 OF "REPLAT OF LOT 2 OF A REPLAT OF LOT 17 OF INTERSTATE RESEARCH PARK LOTS NO. 17 AND 18 SUBDIVISION" AS PER PLAT RECORDED IN PLAT BOOK "BB" AT PAGE 93 AS DOCUMENT 90 R 21180, SITUATED IN THE CITY OF CHAMPAIGN COUNTY, ILLINOIS. PARCEL 3: LOT 2 OF CERION REPLAT INTERSTATE RESEARCH PARK AS PER PLAT RECORDED IN PLAT BOOK "CC" AT PAGE 182 AS DOCUMENT 96 R 16342, IN CHAMPAIGN COUNTY, ILLINOIS; FORMERLY KNOWN AS: THE EAST 65 FEET OF LOT 1 OF "REPLAT OF LOT 2 OF A REPLAT OF LOT 17 OF INTERSTATE RESEARCH PARK LOTS NO. 17 AND 18 SUBDIVISION" AS PER PLAT RECORDED IN PLAT BOOK "BB" AT PAGE 93 AS DOCUMENT 90 R 21180, SITUATED IN THE CITY OF CHAMPAIGN, IN CHAMPAIGN COUNTY, ILLINOIS. 18 EXHIBIT B PERMITTED EXCEPTIONS TO TITLE ----------------------------- Those title exceptions listed on title commitment 01-01-158, dated March 7, 1997, issued by Chicago Title Insurance Company for the property described on Exhibit A hereto. EX-11.1 4 COMPUTATION OF NET INCOME PER COMMON SHARE 1 EXHIBIT 11.1 CERION TECHNOLOGIES INC. COMPUTATION OF NET INCOME PER COMMON SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 ---- Net income $2,505 ====== Shares: Weighted average common shares outstanding during the period 6,379 Common equivalent shares -- ------- 6,379 Net income per common share: $ .39 ------ 25 EX-27 5 FDS
5 1,000 U.S.DOLLARS YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 1 9,300 0 3,162 234 1,046 13,942 13,927 4,536 23,333 3,694 0 0 0 70 19,296 23,333 36,540 36,540 26,729 26,729 5,561 0 (169) 4,419 1,914 2,505 0 0 0 2,505 .39 .39
EX-99.1 6 FINANCIAL SECTION OF 1996 ANNUAL REPORT 1 EXHIBIT 99.1 Cerion Technologies Inc. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Nashua Corporation ("Nashua") operated the business from the time of its acquisition in 1986 either as a division or wholly owned subsidiary until May 24, 1996, the date of Cerion Technologies Inc.'s ("Cerion" or "the Company") initial public offering that reduced Nashua's ownership to approximately 37 percent. RESULTS OF OPERATIONS - 1996 COMPARED TO 1995 NET SALES: Net sales grew 29.4 percent to $36.5 million in 1996 compared to $28.2 million in 1995. The growth experienced during the first six months of 1996 was attributable primarily to growth in the market for aluminum substrates, growth of net sales to the Company's existing customers and the addition of a significant new customer in the beginning of 1996. The second half of 1996 demonstrated the volatility within the market when, in July, Cerion announced a major customer had canceled all of its outstanding purchase orders with the Company, following a significant loss of orders by that customer. Furthermore, the Company's largest customer gradually began decreasing orders to zero in the second half of 1996 as it expanded its internal manufacturing capacity for aluminum disk substrates. Revenue in the third and fourth quarters of 1996 equaled only 45 percent of revenue in the first and second quarters of 1996. Average sales prices decreased significantly during the second half of 1996 resulting in an average sales price that in the second half of 1996 was approximately 13 percent lower than the second haft of 1995. GROSS PROFIT: Gross profit increased 15.3 percent, or $1.3 million, to $9.8 million in 1996 from $8.5 million in 1995. The increase in gross profit was due to increases in volume, improved utilization of existing manufacturing capacity and the spreading of fixed costs over a substantially higher sales volume during the first six months of 1996, offset by a dramatic decrease in unit volume and average selling prices in the second half of 1996, from the comparable 1995 period. Gross profit as a percentage of sales decreased to 26.9 percent in 1996 compared to 30.2 percent in 1995. The decrease in gross margin was attributable to the under utilization of existing capacity that was expanded in the first half of 1996 and the spreading of higher fixed costs attributable to larger available production capacity over a substantially lower sales volume in the second half of 1996. Gross profit also decreased from lower average selling prices of the Company's products in the second half of 1996. SELLING, GENERAL & ADMINISTRATIVE EXPENSES: Selling, general and administrative expenses increased approximately $3.1 million in 1996 to $5.6 million, compared to $2.5 million in 1995, representing 15.2 percent and 9.0 percent of net sales in such years, respectively. This increase primarily was due to the costs of additional personnel to support the Company's growth experienced in the first six months of 1996 (including the addition of two executive officers), the costs associated with the Company becoming a stand-alone entity, increased profit-sharing and performance-based bonus expenses during the first six months of 1996. The increase in the percentage results from both growth in absolute spending and a lower revenue base during the third and fourth quarters of 1996. INTEREST (INCOME ) EXPENSE: Interest income consists of interest income from short-term investments. Interest expense consists primarily of interest expense allocated to the Company by Nashua through May 24, 1996 (at which time the Company was a division or subsidiary of Nashua). See Related Party Transactions and Allocations in the Notes to the Financial Statements. PROVISION FOR (INCOME) TAXES: Provision far income taxes was $1.9 million in 1996 compared to $2.2 million in 1995. The Company's effective tax rate was 43.3 percent in 1996 compared to 39.1 percent in 1995 primarily because of an increase in nondeductible items as a percentage of income before provision for income taxes and the establishment of a valuation reserve for the Company's deferred tax assets. 2 RESULTS OF OPERATIONS - 1995 COMPARED TO 1994 NET SALES: Net sales increased 93.6 percent, or $13.6 million, to $28.2 million in 1995 from $14.6 million in 1994. This growth was attributable to growth in the market for aluminum disk substrates, the Company's emergence in May 1994 from its primarily captive integrated supplier relationship with a unit of Nashua which Nashua said at that time, to become an independent supplier of aluminum disk substrates and the absence in 1995 of certain disruptions in the Company's business that occurred in 1994. As a result, the Company was able to grow its net sales significantly to other customers, such as HMT Technology Corporation ("HMT") and Conner Peripherals, Inc. The increase in net sales was primarily in the Company's disk substrate business, which represented approximately $13.1 million of the increase. This increase resulted primarily from growth in unit volume and, to a lesser extent, higher average selling prices. Improved utilization of existing production capacity, productivity gains and additional capacity from capital expenditures contributed to growth in unit production. The Company shifted its sales mix in 1995 away from commodity-level aluminum disk substrates with lower average selling prices to high-end products requiring more stringent product tolerances and higher average selling prices. The remainder of the net sales increase in 1995 resulted from increased sales of: the Company's aluminum drum substrates, which had higher unit volumes and higher average selling prices. GROSS PROFIT: Gross profit increased $6.9 million to $8.5 million in 1995 from $1.6 million in 1994. Gross profit as a percentage of net sales increased to 30.2 percent in 1995 compared to 10.7 percent in 1994. The increase in gross profit was due partly to higher net sales while the gross margin increase was due to higher volume, improved utilization of existing manufacturing capacity and the spreading of fixed costs over a substantially higher sales volume. Gross profit and gross margin also increased from higher average selling prices of the Company's products in 1995. SELLING, GENERAL & ADMINISTRATIVE EXPENSE: Selling, general and administrative expenses increased 46.6 percent, or $806,000, to $2.5 million in 1995 from $1.7 million in 1994. This increase primarily was due to increased profit-sharing and performance-based bonus expenses, associated costs of increased personnel to support the Company's growth, higher research, development and engineering costs, and an increase in the overhead allocated to the Company by Nashua relating in part to the higher sales of the Company. Selling, general and administrative expenses as a percentage of net sales decreased to 9.0 percent in 1995 compared to 11.9 percent in 1994. This decrease primarily was due to expenses being spread over a substantially higher sales volume. INTEREST EXPENSE: Interest expense in both years consisted primarily of interest expense allocated to the Company by Nashua. Interest expense increased $201,000 to $316,000 in 1995 from $115,000 in 1994. See Related Party Transactions and Allocations in the Notes to the Financial Statements. PROVISION (BENEFIT) FOR INCOME TAXES: Provision for income taxes increased to $2.2 million in 1995 from a benefit of $105,000 in 1994. The Company's effective tax rate was 39.1 percent in 1995 compared to 36.5 percent in 1994, primarily because of a decrease in nondeductible items as a percentage of income (loss) before provision (benefit} for income taxes. LIQUIDITY AND CAPITAL RESOURCES The Company's principal capital requirements in 1996 were to fund working capital needs, manufacturing capacity expansion, and capital expenditures related to manufacturing process automation. During the periods presented, these capital requirements generally were satisfied by cash flows from operations except in the last two quarters of 1996 during which the Company reported operating losses. These operating losses and capital expenditures were funded from proceeds from the Company's initial public offering. 3 Nashua Corporation (which previously owned 100 percent of Cerion until the initial public offering in May 1996 which reduced Nashua's ownership to approximately 37 percent) historically had performed cash management services for the Company. The Company's cash flow was directed to Nashua, and Nashua in turn provided cash to the Company to fund operating expenses and capital expenditures. On May 31, 1996, this arrangement ceased. Shortly thereafter, the Company and Nashua determined the respective cash flows from the Company to Nashua and from Nashua to the Company, during the period from January 1, 1996 through May 30, 1996, and settled a net amount due from Cerion to Nashua of approximately $200,000. Net cash provided by (used in) operating activities was $6.8 million, $4.0 million and $(2.0) million in 1996, 1995 and 1994, respectively. The increase in cash provided by operating activities from 1994 to 1996 primarily was due to increases in net income and accounts payable as the Company experienced strong growth in net sales. The continued increase from 1995 to 1996 was attributable to a reduction in accounts receivable offset by increased inventories due to significantly lower revenues in the last half of 1996 combined with increased depreciation from capital equipment additions in 1995 and 1996. The increase in accounts payable from December 31, 1994 to December 31, 1995 consisted of increased trade payables associated with the growth in the business and capital projects undertaken by the Company in connection with its expansion of available capacity. The increase in accounts payable from 1995 to 1996 consisted of trade payables associated with the overall growth in the business. Net cash used in investing activities was $6.1 million, $2.5 million and 1.1 million in 1996, 1995 and 1994, respectively. Cash used in investing activities was primarily for capital expenditures related to modifications of existing equipment and purchases of new equipment. The newly purchased equipment increased both manufacturing capacities and efficiencies. The Company's short-term investments are comprised of investment grade commercial paper. Net cash provided by (used in) financing activities was $8.4 million, $(1.4) million and $3.1 million in 1996, 1995 and 1994, respectively. Net cash provided by financing activities increased in 1996 due to proceeds from the initial public offering partially offset by the repayment of indebtedness. On May 30, 1996, the Company closed its initial public offering with the sale of 4,416,000 shares of its Common Stock. Of the 4,416,000 shares of Common Stock said, 1,615,000 shares were said by the Company and 2,801,000 were said by Nashua Corporation. Nashua Corporation continues to own approximately 37 percent of the Company's outstanding Common Stock. The shares were sold to the public at $13.00 per share. The net proceeds to the Company after the Underwriting Discount was $19,525,350. On May 31, 1996, the Company repaid the two outstanding Promissory Notes issued to Nashua Corporation in March 1996 having a combined principal sum of $11,142,000. The prepayments were made without penalty. Based upon anticipated cash flows from operating activities, remaining proceeds from the initial public offering completed in 1996 and credit availability, the Company believes that it has the liquidity and capital resources needed to meet its financial commitments through 1997. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions beyond year-end levels, the Company will continue to incur net losses and negative cash flows from operating activities. Without such cost improvements and increased demand, at present cost levels and planned capital expenditures of approximately $4.0 million annually, the Company over an extended period of time will exhaust all or substantially all of its cash resources and borrowing availability under its credit facility. In such event, the Company would be required to pursue other alternatives to improve liquidity, including further cost reductions, sales of assets, the deferral of certain capital expenditures and obtaining additional sources of funds. No assurance can be given that the Company will be able to pursue such alternatives successfully. INFLATION In the opinion of management, inflation has not had a material effect on the operations of the Company. 4 MATTERS AFFECTING FUTURE RESULTS This Report contains certain "forward-looking" statements, including, but not limited to the statements regarding the possible impact of cancellation of orders by a major customer and backwards integration within the industry towards the manufacture of aluminum disk substrates. Moreover, from time to time in both written releases and reports and oral statements, the Company and its senior management may express expectations regarding future performance of the Company. All of these forward-looking statements are inherently uncertain, and investors must recognize that actual events could cause actual results to differ materially from senior management's expectations. Key risk factors that could, in particular, have an adverse impact on current and future performance include the Company's dependence on a small number of customers, as witnessed by the cancellation of orders in July 1996 by one of the Company's two largest customers, and subsequent loss of orders from one of the Company's largest customers evidencing a trend toward backwards integration among thin-film disk manufacturers that may continue to reduce demand for the Company's products, dependence on the intensely competitive and cyclical hard disk drive industry, absence of long-term purchase commitments from the Company's customers and risk of excess industry capacity. See "Factors that Affect Future Results" included in the Company's Form 10-K dated March 31, 1997 for a more detailed discussion of factors that could affect the Company's performance and the value of its Common Stock. With respect to forward-looking statements contained herein, we urge our shareholders to read Cerion's Form 10-K filed with the Securities and Exchange Commission. OUTLOOK Cerion does not provide forecasts of future financial performance. The statements contained in this Outlook are based upon current expectations. These statements are forward-looking; actual events could cause actual results to differ materially. Adverse industry conditions during the second half of 1996, in which available market supply exceeded demand and significant pricing reductions caused the Company to incur net losses in each of the last two quarters of 1996, are continuing. The Company expects it will incur operating losses for at least each of the first two quarters of 1997. Such losses have and will impair the Company"s liquidity and available sources of liquidity and will continue to affect the Company adversely until significant product cost improvements are achieved combined with increased sales volumes to return to profitability. See "Liquidity and Capital Resources." The Company does not believe current market conditions will support substantial price increases. Thus, any improvement in operating performance will require cost improvements to occur. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions beyond year-end levels, the Company will continue to incur net operating losses and negative cash flows from operating activities. Without such cost improvements and increased demand, at present cost levels and planned capital expenditures of approximately $4.0 million annually, the Company over an extended period of time will exhaust all or substantially all of its cash resources and borrowing availability under its credit facility. In such event, the Company would be required to pursue other alternatives to improve liquidity, including further cost reductions, sales of assets, the deferral of certain capital expenditures and obtaining additional sources of funds. No assurances can be given that the Company will be able to pursue such alternatives successfully. The Company's gross margin percentage is largely a function of product mix sold in any period. Various other factors, including unit volumes, costs and yield issues associated with initiating production on new processes also will continue to affect the amount of cost of sales and the variability of the gross margin percentage in future quarters. Additionally, increased depreciation resulting from the significant capital spending in 1996 and 1995, and planned capital spending in 1997 will negatively impact gross margins in future periods. The planned 1997 capital spending is focused in the area of manufacturing process changes to reduce product cost. Reduction in demand from either a reduction in market demand, further backwards integration by thin-film media manufacturers or a sudden loss of one or more customers will significantly impact the Company's operating performance. Volatility in demand for the Company's products will have a substantial impact to the Company's operating performance because of the fixed cost element of the Company's product manufacturing relative to total costs. 5 CERION TECHNOLOGIES INC. STATEMENTS OF OPERATIONS
Years ended December 31, ------------------------------------ (In thousands, except per share data) 1996 1995 1994 - ------------------------------------------------------------------------------------ Net sales $36,540 $ 28,175 $ 14,553 Cost of sales 26,729 19,668 12,995 ------------------------------------ Gross profit 9,811 8,507 1,558 Selling, general & administrative expenses 5,561 2,537 1,731 ------------------------------------ Operating income (loss) 4,250 5,970 (173) Interest income (expense) 169 (316) (115) ------------------------------------ Income (loss) before provision (benefit) for income taxes 4,419 5,654 (288) Provision (benefit) for income taxes 1,914 2,210 (105) ------------------------------------ Net income (loss) $ 2,505 $ 3,444 $ (183) ------------------------------------ Net income per share $ .39 -- -- Average shares outstanding 6,379 -- -- ------------------------------------
The notes are an integral part of the financial statements. 11 6 CERION TECHNOLOGIES INC. BALANCE SHEETS
December 31, -------------------- (In thousands, except share and per share data) 1996 1995 - ------------------------------------------------------------------------------------------- Assets Current Assets: Cash and cash equivalents $ 9,300 $ 173 Accounts receivable, net of allowances for doubtful accounts and customer returns of $234 and $51, respectively 2,928 5,930 Inventories 1,046 312 Prepaid expenses and other assets 395 -- Deferred income taxes 273 94 -------------------- Total current assets 13,942 6,509 Property, plant and equipment, net 9,391 5,365 -------------------- $23,333 $11,874 ==================== Liabilities, Parent Company Investment and Stockholders' Equity Current Liabilities: Accounts payable and accrued expenses $ 3,694 $ 3,073 -------------------- Total current liabilities 3,694 3,073 Deferred income taxes 273 343 Commitments and contingencies (see notes) Parent company investment -- 8,458 Stockholders' equity: Preferred Stock, par value $.01 per share, 100,000 shares authorized, none issued Common Stock, par value $.01 per share, 20,000,000 shares authorized; 7,016,184 shares issued and outstanding 70 -- Additional paid-in capital 18,639 -- Retained earnings 657 -- -------------------- Total stockholders' equity 19,366 -- -------------------- $23,333 $11,874 ====================
The notes are an integral part of the financial statements. 12 7 CERION TECHNOLOGIES INC. STATEMENTS OF CASH FLOWS
Years ended December 31, ----------------------------------- (In thousands) 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------ Cash flows provided by (used in) operating activities: Net income (loss) $ 2,505 $ 3,444 $ (183) Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: Depreciation 2,099 1,035 876 Deferred income taxes (249) 158 55 Changes in operating assets and liabilities: Accounts receivable 3,002 (2,956) (2,867) Inventories (734) 109 163 Accounts payable and accrued expenses 621 2,152 (25) Prepaid expenses and other assets (413) 31 -- ----------------------------------- Cash flows provided by (used in) operating activities 6,831 3,973 (1,981) ----------------------------------- Cash flows provided by (used in) investing activities: Additions to property, plant and equipment (6,107) (2,564) (1,148) Proceeds from sale of assets -- 114 4 Purchase of short-term investments (4,496) -- -- Proceeds from redemption of short-term investments 4,496 -- -- ----------------------------------- Cash flows used in investing activities (6,107) (2,450) (1,144) ----------------------------------- Cash flows provided by (used in) financing activities: Investment by (payments to) parent company -- (1,107) 3,121 Repayment of borrowings (11,142) (342) (22) Proceeds from shares issued 19,545 -- -- ----------------------------------- Cash flows provided by (used in) financing activities 8,403 (1,449) 3,099 ----------------------------------- Increase (decrease) in cash 9,127 74 (26) Cash at beginning of year 173 99 125 ----------------------------------- Cash at end of year $ 9,300 $ 173 $ 99 =================================== Supplemental disclosure of cash flow information: Interest paid $ 14 $ 316 $ 115 Income taxes paid 226 -- -- -----------------------------------
The notes are an integral part of the financial statements. 13 8 CERION TECHNOLOGIES INC. NOTES TO THE FINANCIAL STATEMENTS DESCRIPTION OF BUSINESS Business Definition: Until its initial public offering in May 1996, the business of Cerion Technologies Inc. ("the Company") had been operated by Nashua Corporation ("Nashua" or "the Parent") since its acquisition in 1986 by Nashua. As of December 31, 1995, Nashua converted the Company into a wholly owned subsidiary of Nashua and contributed to it the business of the Nashua Precision Technologies Division in return for the Company's stock and its assumption of the liabilities of the business. The Company was renamed Cerion Technologies Inc. on March 4, 1996. The Company develops, manufactures and markets precision-machined aluminum disk substrates that are used in the production of magnetic thin-film disks for the hard disk drives of portable and desktop computers, network servers, add-on storage devices and storage upgrades. The Company also produces organic photoconductor drum substrates for laser printer cartridges. The Company operates in one business segment. All sales are denominated in U.S. dollars. Basis of Presentation: The accompanying financial statements for the years ended December 31, 1995 and 1994 and the period January 1, 1996 through May 24, 1996, have been prepared as if the Company had operated as an independent, stand-alone entity for all periods presented. Such financial statements have been prepared using the historical basis of accounting and include all of the assets, liabilities, revenues and expenses of the Company previously included in Nashua's consolidated financial statements; however, certain adjustments have been made to reflect the operations of the Company on a stand-alone basis. Consequently, these statements include balances for other assets and liabilities related to the Company that were previously included in Nashua's consolidated financial statements except that there is no allocation to the Company of Nashua's borrowings. However, an allocation of Nashua's interest expense has been recorded as determined based upon the Company's net assets as a proportion of Nashua's consolidated net assets. Management believes that the basis for such allocations is reasonable. The Company's results of operations were included in Nashua's Federal, state and local income tax returns through May 24, 1996. See "Parent Company Investment" in the following notes. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 55 ("SAB 55"), these statements have been adjusted to include certain corporate expenses incurred by the Parent on the Company's behalf. The financial statements may not necessarily present the Company's financial position and results of operations as if the Company were a stand-alone entity. As of May 24, 1996, the Company's financial statements have been presented on a stand-alone basis. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Inventories: The Company values all of its inventories at the lower of cost or market on a first-in, first-out basis (FIFO). Property, Plant and Equipment, Net: Property, plant and equipment is recorded at cost. Expenditures for maintenance and repairs are charged to expense while the costs of significant improvements are capitalized. Depreciation is provided using the straight-line method. Upon retirement or sale, the cost of assets disposed and the related accumulated depreciation are eliminated and related gains or losses reflected in the statement of operations. The estimated useful lives of the assets are as follows: Buildings and improvements 10 to 40 years Machinery and equipment 4 to 10 years Furniture and fixtures 3 to 10 years Shipping containers 2 years
14 9 Revenue Recognition: Sales of products are recognized based on product shipment to customers. Research, Development and Engineering: Included in selling, general and administrative expenses are research, development and engineering expenditures of $1,302,000, $809,000 and $787,000 for the years ended December 31, 1996, 1995 and 1994, respectively. Research, development and engineering expenditures are charged to operations as incurred. Income Taxes: The results of the Company's operations have been included in the Federal and state consolidated income tax returns of the Parent for the years ended December 31, 1995 and 1994. The provisions (benefit) for income taxes included in these financial statements have been calculated as if the Company were a stand-alone taxpayer. Prepaid or deferred income taxes result principally from the use of different methods of depreciation for income tax and financial reporting purposes, the recognition of expenses for financial reporting purposes in years different from those in which the expenses are deductible for income tax purposes and the recognition of the tax benefit of net operating losses. 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 amount of assets and liabilities and disclosure of contingent assets and liabilities at December 31, 1996 and 1995 and the reported amounts of net sales and expenses during the three years in the period ended December 31, 1996. Actual results could differ from those estimates. Cash Equivalents: The Company considers all highly liquid investment instruments purchased with an original maturity of three months or less to be cash equivalents. At December 31, 1996, the Company held $7.4 million of various commercial paper instruments carried at cost, which approximated market. Accounting for Stock-Based Compensation: In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has decided to adopt SFAS 123 through disclosure only. Impairment of Long-Lived Assets: In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" ("SFAS 121"). The adoption of SFAS 121 had no impact on the Company's financial statements. Net Income Per Share: Net income per share for the period presented is determined by dividing net income applicable to Common Stock by the weighted average number of common shares outstanding during the period. RELATED PARTY TRANSACTIONS AND ALLOCATIONS Cash: The Company utilized Nashua's centralized cash management services until May 30, 1996. Under arrangements with Nashua, excess cash generated by the Company was retained by Nashua until May 24, 1996. Product Sales: During the years ended December 31, 1996, 1995 and 1994, the Company had sales of approximately $208,000, $645,000 and $5,541,000, respectively, to divisions of Nashua. The amounts due from these divisions have been included in the Parent Company Investment and were approximately $643,000 at December 31, 1995. The Company believes that the product prices for such sales were substantially at market prices. 15 10 Corporate Services: In accordance with SAB 55, Nashua has allocated a portion of its domestic corporate expenses and charges to its divisions, including to the Company through May 24, 1996. These expenses have included management and corporate overhead; benefit administration; risk management/insurance administration; tax and treasury/cash management services; environmental services; litigation administration services; and other support and executive functions. Allocations and charges for services were based on either a direct cost pass-through or a percentage allocation based on factors such as net sales, management time or headcount. Such allocations and corporate charges totaled $147,000, $227,000 and $88,000 for the years ended December 31, 1996, 1995 and 1994, respectively. The allocation and charges ceased on May 24, 1996. Domestic research and development expenses of the Parent related to the Company's business and allocated to the Company in accordance with SAB 55 totaled $70,000, $69,000 and $48,000 for the years ended December 31, 1996, 1995 and 1994, respectively, which are included in selling, general and administrative expenses. Management believes that the basis used for allocating corporate services was reasonable. However, the terms of these transactions may have differed from those that would have resulted from transactions among unrelated parties. Management believes that related expenses that would have been incurred during the year ended December 31, 1995 had the Company operated on a stand-alone basis would have approximated $784,000 (unaudited). Employee fringe benefit expenses were allocated to the Company based on Nashua's total benefits costs and the proportion of Nashua's total salaries and wages represented by the Company's salaries and wages. Fringe benefit costs, which are reflected in cost of sales and selling, general and administrative expenses, include employer FICA and unemployment taxes, medical insurance and annual accruals or contributions made for the Nashua Corporation Retirement Plan for Salaried Employees, the Nashua Corporation Hourly Employees Retirement Plan and the Nashua Corporation Employees' Savings Plan. See "Employee Retirement Plans" in the following notes. The Company was allocated $168,000, $290,000 and $259,000 for the years ended December 31, 1996, 1995 and 1994, respectively, for these expenses. Management believes the allocation method for fringe benefit costs was reasonable. Such allocation ceased on May 24, 1996. INVENTORIES Inventories consisted of the following:
December 31, ----------------------------- 1996 1995 - ------------------------------------------------------------------------------ Raw materials $ 442,000 $258,000 Work in progress 19,000 6,000 Finished goods 585,000 48,000 ----------------------------- $1,046,000 $312,000 =============================
PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consisted of the following:
December 31, ----------------------------- 1996 1995 - ------------------------------------------------------------------------------ Land $ 260,000 $ 185,000 Buildings and improvements 3,908,000 2,629,000 Machinery and equipment 7,571,000 3,250,000 Furniture and fixtures 302,000 113,000 Construction in progress 4,000 888,000 Containers 1,882,000 730,000 ----------------------------- 13,927,000 7,795,000 Less: accumulated depreciation (4,536,000) (2,430,000) ----------------------------- $ 9,391,000 $ 5,365,000 -----------------------------
16 11 ACCOUNTS PAYABLE AND ACCRUED EXPENSES Accounts payable and accrued expenses consisted of the following:
December 31, ---------------------------- 1996 1995 - -------------------------------------------------------------------------------- Accounts payable - trade $1,802,000 $1,319,000 Container deposits 585,000 710,000 Accrued payroll and benefits 661,000 574,000 Bank overdraft - 380,000 Other 646,000 90,000 ---------------------------- $3,694,000 $3,073,000 ============================
EMPLOYEE RETIREMENT PLANS The Company has not adopted any defined benefit plans, but adopted the Cerion Technologies Inc. Employees Savings Plan ("Savings Plan") in 1996. The Savings Plan allows full-time employees to become eligible in the month following employment to make certain tax-deferred voluntary contributions which the Company generally matches with a 50 percent contribution, limited to three percent of an employee's base pay. Retirement benefits were provided to the Company's employees through the Nashua Corporation Employees' Savings Plan ("Nashua Savings Plan"), the Nashua Corporation Hourly Employees' Retirement Plan and the Nashua Corporation Retirement Plan for Salaried Employees ("Retirement Plans") until May 24, 1996. The Retirement Plans were defined benefit plans. Guaranteed retirement income levels were determined based on years of service and salary levels as integrated with Social Security benefits. Employees were eligible under the Retirement Plans after one year of continuous service and were 100 percent vested after five years of service. Nashua's Retirement Plans are subject to Internal Revenue Service and ERISA funding limitations. Assets of the plans were invested in interest-bearing cash equivalents, fixed-income securities and common stocks. Total expense under the Nashua Savings and Retirement Plans for the years presented through May 24, 1996 is included in the Company's financial statements through the fringe benefit allocations discussed in a prior note: "Summary of Significant Accounting Policies." Nashua has not performed a separate actuarial calculation of the status of the Retirement Plans for the Company and the Company's employees were terminated from future participation in the plan as of May 24, 1996. Nashua's Savings Plan had similar terms and limitations as Cerion's Savings Plan. LEASES Lease agreements cover warehouse space, office equipment and an automobile under operating lease arrangements. These leases have expiration dates through 1999. Rental expense was approximately $92,000 in 1996, $78,000 in 1995 and $72,000 in 1994. Future minimum rents payable under noncancelable leases with initial terms exceeding one year are as follows: $53,000 in 1997, $9,000 in 1998 and $6,000 in 1999. 17 12 INCOME TAXES
Years ended December 31, --------------------------------------------- 1996 1995 1994 - -------------------------------------------------------------------------------------------------- Current: Federal $1,783,000 $1,736,000 $(137,000) State 380,000 316,000 (23,000) --------------------------------------------- Total current 2,163,000 2,052,000 (160,000) Deferred: Federal (171,000) 134,000 47,000 State (78,000) 24,000 8,000 --------------------------------------------- Total deferred (249,000) 158,000 55,000 --------------------------------------------- Provision (benefit) for income taxes $1,914,000 $2,210,000 $(105,000) =============================================
Deferred tax liabilities and assets are comprised of the following:
December 31, --------------------------- 1996 1995 - -------------------------------------------------------------------------------------------------- Deferred tax liabilities: Depreciation $ 273,000 $ 343,000 --------------------------- Deferred tax assets: Accrued vacation $ 63,000 $ 36,000 Inventory reserve 187,000 20,000 Bad debt reserve 54,000 20,000 Other 116,000 18,000 --------------------------- 420,000 94,000 Deferred tax asset valuation allowance (147,000) - --------------------------- $ 273,000 $ 94,000 ===========================
Reconciliation between income taxes computed using the Federal statutory income tax rate and the Company's effective tax rate are as follows:
Years ended December 31, ---------------------------------------- 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------- Federal statutory rate 35.0% 35.0% (35.0)% State and local income taxes, net of Federal tax benefit 4.7% 3.9% (3.4)% Tax asset valuation reserve 3.3% - - Other, net 0.3% 0.2% 1.9 % ---------------------------------------- Effective tax rate 43.3% 39.1% (36.5)% ========================================
18 13 STOCKHOLDERS' EQUITY The Company, on December 31, 1995 initially issued 5,400,000 shares of Common Stock, $.01 par value per share, to Nashua. In exchange, Nashua contributed to the Company the business of the Nashua Precision Technologies Division, including the liabilities of the business.
Parent Company Common Paid-in Retained Investment Stock Capital Earnings - ------------------------------------------------------------------------------------------------------------------------- Balances, December 31, 1995 $ 8,458,000 $ - $ - $ - Issuance of Common Stock (8,458,000) 54,000 8,404,000 - Nashua Notes - - (9,294,000) (1,848,000) Proceeds from initial public offering and selling of 1,615,000 shares - 16,000 19,509,000 - Issuance of Common Stock in lieu of cash payment of directors' fees - - 20,000 - Net income - - - 2,505,000 ------------------------------------------------------------------- Balances, December 31, 1996 $ - $ 70,000 $ 18,639,000 $ 657,000 ===================================================================
Issuance of Notes Payable to the Parent: As of March 1, 1996, Cerion distributed a dividend to Nashua in the form of a Promissory Note (the "First Nashua Note") payable to Nashua in the principal sum of $10,000,000. The First Nashua Note had an annual interest rate of 7.32 percent from March 1, 1996 to September 30, 1996. As of March 29, 1996, the Company distributed a second dividend to Nashua in the form of a Promissory Note (the "Second Nashua Note") payable to Nashua in the principal amount of $1,142,000. The Second Nashua Note had an annual interest rate of 7.32 percent. On May 31, 1996, the Company repaid the two outstanding Promissory Notes having a combined principal sum of $11,142,000. Stock Split: During March 1996, the Company effected a 1,800-for-one stock split. All share data in the accompanying financial statements have been retroactively restated to reflect the stock split. On May 30, 1996, the Company closed its initial public offering of its stock with the sale of 4,416,000 shares of its Common Stock. Of the 4,416,000 shares of Common Stock sold, 1,615,000 shares were sold by the Company and 2,801,000 were sold by Nashua. Nashua continues to own approximately 37 percent of the Company's outstanding Common Stock. The shares were sold to the public at $13.00 per share. The net proceeds to the Company after the underwriting discount were $19,525,350. PARENT COMPANY INVESTMENTS Because the Company operated at various times as a division and as part of a wholly owned subsidiary of Nashua, its equity accounts have been combined and presented as Parent Company Investment as of December 31, 1995 and 1994. Parent Company Investment also includes balances related to intercompany transactions and other charges and credits as more fully described in a prior note: "Summary of Significant Accounting Policies." No interest has been charged on Parent Company Investment. A summary of changes in Parent Company Investment is as follows:
Years ended December 31, ------------------------------------------------ 1996 1995 1994 - ----------------------------------------------------------------------------------------------------------- Beginning balance $ 8,458,000 $ 6,121,000 $ 3,183,000 Net income (loss) -- 3,444,000 (183,000) Issuance of Common Stock (8,458,000) -- -- Advances from (payments to) Parent, net -- (1,107,000) 3,121,000 ------------------------------------------------ Ending balance $ -- $ 8,458,000 $ 6,121,000 ================================================
19 14 CONCENTRATION OF BUSINESS ACTIVITIES Customer Concentration: During the years ended December 31, 1996 and 1995, the Company shipped the majority of its aluminum disk substrates to two customers. These two customers represented approximately 45 percent and 41 percent, in the year ended December 31, 1995 and approximately 29 percent and 44 percent in the year ended December 31, 1996, respectively, of net sales. Concentration of Credit Risk: The Company sells substantially all of its production to customers in the U.S., with approximately 11 percent of 1996 sales being made to companies located in the Pacific Rim. The Company performs periodic credit evaluations of its customers. The Company does not require collateral for its receivables and maintains an allowance for potential credit losses. Dependence on Supplier: The Company relies solely on one supplier for aluminum blanks used in the manufacture of aluminum disk substrates. Aluminum blank purchases were approximately $8,536,000, $5,729,000 and $3,252,000 for the years ended December 31, 1996, 1995 and 1994, respectively. 1996 STOCK INCENTIVE PLAN In February 1996, the Board of Directors adopted the 1996 Stock Incentive Plan (the "Plan") and reserved 701,500 shares of Common Stock, of which options for 370,180 shares of Common Stock have been granted by the Company to certain employees and directors effective upon completion of the initial public offering and remain outstanding, and 1,184 shares have been granted to two directors. The Plan provides for grants of incentive stock options to employees and directors of the Company and grants of stock to non-employee directors of the Company. The options are separated into two categories with different vesting provisions. The first category, one-year vesting options, will become exercisable on the first anniversary date of the option grant if the optionee remains an employee or director of the Company on such date. The second category, performance-accelerated options, will become exercisable in tranches of 25 percent each based upon the Common Stock trading, for a period of 20 consecutive trading days, at an average premium of 25 percent, 50 percent, 75 percent and 100 percent, respectively, above the initial public offering price, if the optionee remains an employee of the Company on such date. However, if any such performance goals are met prior to the first anniversary of the grant date, the shares that would otherwise become exercisable thereby only become exercisable on the first anniversary date of the grant date, if the optionee remains an employee of the Company on such date. On the eighth anniversary of the grant date, any remaining shares subject to a "performance-accelerated" option will become exercisable, if the optionee remains an employee of the Company on such date. In the event of a merger, consolidation, reverse merger or reorganization, or certain other events constituting a "Change in Corporate Control" as defined in the Plan, options outstanding under the Plan automatically will become fully vested and will terminate if not exercised prior to such event. No option granted under the Plan may be exercised after the expiration of ten years from the date it was granted. The exercise price of options under the Plan will equal the fair market value of the Common Stock on the date prior to the grant. The Plan will terminate in January 2006, unless earlier terminated by the Board of Directors. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), by electing to continue to apply the intrinsic value-based method of accounting for stock-based compensation. Had compensation cost been determined on the basis of fair value pursuant to SFAS 123, net income and net income per share for 1996 would have been $1,139,000 and $0.18. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants: dividend yield of zero percent for all years, expected volatility of 64 percent, risk-free interest rate of 6.2 percent and expected lives of 5.8 years. 20 15 A summary of the status of the Company's stock options under the incentive plan follows:
Outstanding Options Price Exercisable Options per share Options - --------------------------------------------------------------------------------------------- December 31, 1995 0 - - Options granted 422,680 $13.00 None Options forfeited 52,500 $13.00 None ------------------------------------------- December 31, 1996 370,180 $13.00 None ===========================================
REVOLVING CREDIT FACILITY The Company secured on March 7, 1997 a $7.5 million revolving credit facility ("facility") that matures March 7, 2000. The facility is collateralized by all the Company's assets and the Company may borrow against the facility based upon prescribed advance rates applied to the Company's accounts receivable and inventories. The facility bears interest at the bank's prime rate plus 1/4 percent. The facility's terms include a fee for the unused portion of the credit facility equal to 3/8 percent, payable monthly. The facility contains certain covenants including the maintenance of certain financial ratios. In connection with the obtaining of the facility, the Company paid a commitment fee equal to 100 basis points of the total facility and other costs totaling approximately $100,000 in 1997. These costs will be amortized over the term of the facility. LEGAL PROCEEDINGS In August and September 1996, two individual plaintiffs initiated lawsuits against the Company, Nashua, certain directors and officers of the Company, and the Company's underwriter, on behalf of classes consisting of all persons who purchased the Common Stock of the Company between May 24, 1996 and July 9, 1996. The complaints allege that, in connection with the Company's initial public offering, the defendants issued certain materially false and misleading statements and omitted the disclosure of material facts, in particular, certain matters concerning significant customer relationships. The complaints seek damages and injunctive relief. The Company believes these lawsuits are without merit and it has substantial defenses and intends to defend vigorously against these actions. LIQUIDITY MATTERS During the second half of 1996, industry market supply exceeded demand resulting in significant pricing and volume reductions and net losses for each of the last two quarters of 1996. No assurance can be given that further backwards integration by thin-film media manufacturers or other industry factors will not result in canceled orders or further volume reductions beyond levels experienced in the second half of 1996. Additionally, the Company does not believe current market conditions will support price increases in the foreseeable future. Unless the Company achieves substantial cost improvements, experiences increased demand for its products and/or stabilizes pricing, the Company will continue to incur operating net losses and negative cash flows from operating activities. Without such cost improvements, increased demand and/or pricing stabilization, the Company could, over an extended period of time, exhaust substantially all of its cash resources and borrowing availability. In such event, the Company would be required to pursue other alternatives to improve liquidity, including initiating plans for further cost reductions, selling assets, deferring certain capital expenditures and obtaining additional funding sources. No assurance can be given that the Company will be able to successfully pursue such alternatives. 21 16 QUARTERLY OPERATING RESULTS AND COMMON STOCK INFORMATION (UNAUDITED)
1st 2nd 3rd 4th (In thousands, except per share data) Quarter Quarter Quarter Quarter Year - ------------------------------------------------------------------------------------------------------------------------- 1996 Net sales $11,774 $13,440 $5,521 $ 5,805 $36,540 Gross profit (loss) 4,676 4,984 560 (409) 9,811 Operating income (loss) 3,200 3,592 (879) (1,663) 4,250 Net income (loss) 1,848 2,204 (467) (1,080) 2,505 Net income (loss) per common share .34 .36 (.07) (.15) .39 Market bid price: High N/A 19.50 11.25 9.19 19.50 Low N/A 8.00 2.25 2.75 2.25 1995 Net sales $ 5,028 $ 5,890 $7,232 $ 10,025 $28,175 Gross profit 1,148 1,607 2,131 3,621 8,507 Operating income 640 1,123 1,478 2,729 5,970 Net income 338 636 854 1,616 3,444
N/A - information not applicable as the Company's stock began trading on NASDAQ on May 24, 1996. The Company's stock is traded on the Nasdaq National Market. At March 24, 1997, there were approximately 3,800 record holders of Cerion's Common Stock. 22 17 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Cerion Technologies Inc. In our opinion, the accompanying balance sheets and the related statements of operations and of cash flows present fairly, in all material respects, the financial position of Cerion Technologies Inc. at December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in the "Liquidity Matters" note to the financial statements, industry market supply exceeded demand during the second half of 1996 resulting in significant pricing and volume reductions and net losses for each of the last two quarters of 1996. Price Waterhouse LLP Chicago, Illinois February 3, 1997, except as to the "Revolving Credit Facility" note, which is as of March 7, 1997 23 -----END PRIVACY-ENHANCED MESSAGE-----