-----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, HnURtBiN+WSzKf6cNWeGqoZsEp4ktjFxM4bJIegBCkLpEwPFQKgbcA8FuTW86n8/ MAf0rGVHl2gQriJ8d2qJ+Q== 0000950135-98-001892.txt : 19980330 0000950135-98-001892.hdr.sgml : 19980330 ACCESSION NUMBER: 0000950135-98-001892 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980327 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: SEC FILE NUMBER: 000-28062 FILM NUMBER: 98575460 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, INC. 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, 1997 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 March 9, 1998, the aggregate market value of the voting stock held by nonaffiliates totaled approximately $14,729,300 based on the closing stock price as reported by The Nasdaq Stock Market. On March 9, 1998, there were 7,034,051 shares of common stock, $.01 par value, of the registrant issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the 1997 Annual Report to Shareholders are incorporated by reference herein and filed as Exhibits hereto. ================================================================================ 2 CERION TECHNOLOGIES INC. 1997 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........................................... 11 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....................................... 12 Item 6. Selected Financial Data..................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 13 Item 8. Financial Statements and Supplementary Data................. 18 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 18 PART III Item 10. Directors and Executive Officers of the Registrant.......... 18 Item 11. Executive Compensation...................................... 21 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................ 26 Item 13. Certain Relationships and Related Transactions.............. 27 PART IV Item 14. Exhibits, Financial Statements Schedules and Reports on Form 8-K....................................................... 28 Signatures............................................................ 31
This Report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 as discussed in greater detail in Item 7 below. Such statements are inherently uncertain and actual results could differ materially from the Company's expectations. Specifically, such results are subject to certain risks and uncertainties, including without limitation those discussed in "Matters Affecting Future Results" in Item 7 below and those discussed in the Company's 1997 Annual Report to Shareholders in the section titled "Management's Discussion and Analysis of Financial Condition and Results of Operations" (which section is filed as Exhibit 99.1 hereto and 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. See "Matters Affecting Future Results" in Item 7 below 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 but fluctuating growth in demand over the last five years, but increased demand also has generated a rapid growth in production capacity. Periods of shortage have alternated recently with periods of oversupply. During the latter half of 1996 and throughout 1997 and continuing since then, the market appears to have been dominated by oversupply and consequently, pricing pressures. Although the Company's strategy during 1996 and 1997 was to compete on quality more than on price, during the latter half of 1996 and throughout 1997 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. 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 1997, an industry publication, the number of thin-film disks produced worldwide in 1993, 1994, 1995, 1996 and 1997 was 134 million, 186 million, 256 million, 344 million and 417 million, respectively, and projected at 450 million in 1998, which would represent a compound annual growth rate of approximately 28 percent over this six-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 independent producers, including the Company and Kobe Steel, Ltd. ("Kobe") through its subsidiaries and by vertically integrated thin-film disk manufacturers including Seagate Technologies, Inc. ("Seagate"), Komag, Inc. ("Komag"), StorMedia Incorporated ("StorMedia") and HMT Technology Corporation ("HMT"). During 1996 and 1997, StorMedia and HMT began to move towards vertically integrated production. In 1996, HMT acquired a facility in Oregon for aluminum disk substrate production. StorMedia announced in 1996 it would produce aluminum disk substrates at a new manufacturing facility in Singapore and in December 1997 acquired Akashic Memories Corporation ("Akashic"), which had significant production capacity to produce substrates. HMT and StorMedia represented 2 percent and 43 percent, respectively, of the Company's revenue in 1997 and 44 percent and 29 percent, respectively, in 1996. While Cerion has been able to sell substrates to 3 4 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 increased substantially during the latter half of 1996 through 1997 and are expected to continue into 1998, 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 the memory disk substrate 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 aluminum disk substrates of consistent, high quality at competitive prices. In the latter half of 1996 and throughout 1997, market conditions, dominated by oversupply and growth in vertical integration by thin-film disk manufacturers, forced the Company to pursue "commodity" products with less stringent tolerances for a significant portion of its aluminum disk substrate production to maintain market share. The Company believes that similar market conditions will exist into the foreseeable future. Differentiation in the areas of service, and responsiveness to short-term demand swings will be required to maintain the Company's current market share. The Company will continue a long-term focus on continual improvement by striving to provide products meeting more demanding specifications for flatness, smoothness and uniformity. These products will be focused on meeting the typically more stringent demands of "high-end" drive applications. In addition, the Company expects that market conditions will require it to offer customized products to meet each customer's specific product parameters. The Company's continued strategic focus will be to maintain and grow relative market share through an emphasis on continual product improvement. 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 -- 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. Although, providing the best product may not result in higher market prices, it may prove to cushion sporadic swings in market demand as the Company's customers may choose to maintain a constant supply of the highest quality substrate. 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, cancellation of orders by its second largest customer and a general oversupply of capacity throughout 4 5 the industry, required the Company to shift from supplying primarily "high-end" products to providing the market customized products that are categorized by both "high-end" and "low-end" to maintain market share in 1997. The Company expects that its 1998 revenue will be from products that vary in product parameters that could be categorized by both "low-end" and "high-end." 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 additional processing steps, which currently is 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 not currently being sold to any customers but is an example of the Company's focus 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 to reduce 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 production yields of Cerion's customers 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 one category, aluminum disk substrates, which represented at least 95 percent of net sales for the last three years, and historically (prior to 1997) a second category, 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), 84 mm (3 inch) and 65mm (2 1/2 inch) diameter disks. The 95mm product, which accounts for substantially all 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 not produced any OPC drums for sale since the latter part of 1996. 5 6 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 Raw Material Preparation 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. Very fine abrasive grinding stones are applied to Grinding the disk to produce the final surface finish, thickness and flatness either in a one-step or two-step process.
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, substantially all 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, that the Company believes provide it with both a cost advantage and a 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 distributed 4 percent of its pre-tax operating 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 is successful, a change notification document is issued. Upon approval of key areas, the change is implemented system-wide. The Company assigns a training instructor 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 that contribute to higher product quality and manufacturing yields. CUSTOMERS AND MARKETING Aluminum disk substrates represented over 95 percent of the Company's sales in 1996 and 100 percent in 1997. During 1997, Cerion shipped the majority of its aluminum disk substrates to two companies, StorMedia Incorporated ("StorMedia") and Trace Storage Technologies Inc. ("Trace"), representing approximately 41 percent and 43 percent, respectively, of the Company's net sales. During the fourth quarter of 1997, the Company shipped substantially all its aluminum disk substrates to two companies, Trace and StorMedia representing approximately 59 percent and 41 percent, respectively. 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 that are subject to cancellation, modification or rescheduling generally without penalties. In the past, certain orders have been canceled or deferred. 7 8 The Company, which has produced aluminum disk substrates since 1982, emerged in 1994 from a primarily captive supplier relationship with Nashua Corporation's ("Nashua") 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 in the aluminum disk substrate market. 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. ("Alcoa") as its primary source of supply for the aluminum disk blanks used in producing 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 or any of its other suppliers. The Company's reliance on Alcoa 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 disk industry is characterized by intense competition. The Company believes that the principal competitive factors affecting its business are product availability, quality and price. The Company believes that a majority of the machined aluminum disk substrates are supplied by vertically integrated thin-film media and disk drive manufacturers, such as Seagate, Komag, StorMedia 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. Cerion's direct competitors include both independent aluminum disk substrate manufacturers such as Kobe (which is much larger and has substantially greater production capacity than the Company), and vertically integrated companies that perform additional manufacturing processes on the substrates. These 8 9 vertically integrated companies include manufacturers of hard disk drives. These competitors operate in both the United States and overseas. The Company believes that all its competitors have significantly greater financial, technical, and marketing resources. Furthermore, certain of these competitors have the advantage of being supplied by affiliated companies with the aluminum blanks used for their aluminum disk substrates. Intense competition by companies otherwise focused on other segments of the hard disk drive industry began in 1996 and continued throughout 1997 because of these companies adding or growing internal aluminum disk substrate manufacturing capacity that exceeded internal usage requirements, as the hard disk drive industry experienced a slowdown in growth in the latter half of 1996 which is expected to continue throughout at least the first half of 1998. The following specific actions by the Company's customers in 1996 and 1997 illustrates the impact backwards integration has had on the Company. In the first half of 1996, StorMedia, the Company's largest customer in 1997, 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. Furthermore, StorMedia completed in December 1997 its acquisition of Akashic, which has significant production capacity to produce substrates. 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 and Komag, Inc., 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 1997 and could again have a material adverse effect on the Company's business, results of operations and financial condition. The Asian economic conditions that occurred in 1997 have impacted the Company's competitive position in primarily two ways. First, certain of the Company's competitors have experienced a reduction in cost of raw materials and labor costs that are obtained from Asian economies. The Company has not realized any benefit from the reduction in such raw material costs because the Company's primary suppliers are located in the United States. Additionally, the Asian domestic markets have softened in terms of demand which has resulted in under-utilized capacity of aluminum disk substrate production being made available to export to the United States. These factors have created new entrants to the competitive United States market and have increased the ability of these new entrants to drive pricing downward to gain market share. The Company believes that both the independent aluminum disk substrate producers and certain vertically integrated disk drive manufacturers have been attempting to increase aluminum disk substrate manufacturing capacity. These efforts, together with the Company's own efforts in 1996 and 1997 to increase production, have resulted in significant additional capacity for the aluminum disk substrates. This additional capacity has resulted in industry capacity in excess of demand. In addition, Cerion has experienced increased competition, which has materially adversely affected the Company's business, results of operations and financial condition. BACKLOG Cerion's sales generally are made pursuant to supply agreements, purchase orders and releases that 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 $2.7 million as of December 31, 1997, $3.7 million as of December 31, 1996, and $7.9 million as of December 31, 1995. 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. 9 10 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 industry, 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. 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 On March 5, 1998 the Company reduced its workforce by 110 employees representing approximately 30 percent of the Company's full-time workforce. The workforce reduction was necessitated to align production capacity with expected future order volume. As of March 13, 1998, Cerion had 255 full-time employees located at its facility in Champaign, Illinois, with approximately 228 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 20 manufacturing cells for aluminum disk substrates. 10 11 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 and storage of 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 this 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 Corporation ("Nashua"), William Blair & Co. ("Blair") and certain Cerion directors and officers in the Circuit Court of Cook County, Illinois. On September 4, 1996, a second individual plaintiff, Philippe Olczyk, initiated a similar lawsuit against the Company, Nashua, Blair and certain Cerion directors in the Circuit Court of Cook County, Illinois. Both lawsuits purport to be brought 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. These two cases were consolidated before the same judge. On March 24, 1997, Teitelbaum and Olcyzk, joined by a third plaintiff, Robert K. Pickup, filed a Consolidated Amended Class Action Complaint ("Consolidated Complaint") against the Company, Nashua, Blair, and certain Cerion directors and officers. The Consolidated Complaint supersedes the prior complaints and also 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 Consolidated 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 Consolidated Complaint alleges that the defendants violated sections 11, 12(a)(2), and 15 of the 1933 Securities Act, section 13 of the Illinois Blue Sky Law, and the Illinois Consumer Fraud and Deceptive Practices Act. The Consolidated Complaint seeks a declaration that the case may proceed as a class action, damages and rescission of the sale of Cerion common stock by Cerion and Nashua, to the extent purchasers still hold Cerion shares, or rescissory damages, if they sold their Cerion stock; attorneys fees and costs; and other relief. On October 9, 1997, the Circuit Court of Cook County, Illinois dismissed the class action lawsuit filed against all defendants providing the Plaintiffs with the option to file an amended complaint in which they may attempt to state a claim against the Company and the other defendants. On December 5, 1997, the Plaintiffs filed an amended complaint against the same defendants with substantially similar alleged claims. The Company believes the Amended Consolidated Complaint to be without merit and is defending vigorously against the amended case. 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, 1997 to a vote of the Company's security holders. 11 12 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 National 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 ---- --- 1997 First Quarter.......................................... $ 6.88 $3.63 Second Quarter......................................... 4.38 2.63 Third Quarter.......................................... 3.00 1.94 Fourth Quarter......................................... 3.44 1.97 1996 Second Quarter......................................... $19.50 $8.00 Third Quarter.......................................... 11.25 2.25 Fourth Quarter......................................... 9.19 2.75
On March 9, 1998, the closing price of the Company's Common Stock as reported by The Nasdaq National Stock Market was $2.094 per share. There were approximately 2,500 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. There has been no change in the information required by paragraphs (f)(2) through (f)(4) of Item 701 of Regulation S-K from that previously reported by the Company on Form S-R, except as follows with respect to the Company's use of net offering proceeds to the Company from its initial public offering after deducting previously reported expenses, as of December 31, 1997. The proceeds of $19,525,350 from the initial public offering were utilized as follows as of December 31, 1997: Construction of plant, building and facilities.............. $ 1,163,208 Purchase and installation of machinery and equipment........ 4,426,290 Purchase of real estate..................................... 75,000 Repayment of indebtedness -- First Nashua Note.............. 1,156,429 Repayment of indebtedness -- Second Nashua Note............. 10,184,973 Working capital, including cash and cash equivalents........ 2,519,450
Cash and cash equivalents included in working capital will continue to be used for general corporate purposes. In the Company's Prospectus, dated May 24, 1996, the Company stated that it planned to use approximately $9.0 to $12.0 million of the proceeds of the offering to build, purchase or lease a new facility and related equipment. As a result of a change in market conditions during the second half of 1996 and throughout 1997, the Company canceled its capacity expansion plans, which included the new facility. 12 13 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, 1997. The information presented should be read in conjunction with the financial statements included elsewhere in this report.
YEARS ENDED DECEMBER 31, ------------------------------------------------------------ PRO FORMA 1993 1994 1995 1995(1) 1996 1997 ---- ---- ---- ------- ---- ---- STATEMENTS OF OPERATIONS DATA: Net sales............................ $14,612 $14,553 $28,175 $28,175 $36,540 $31,810 Cost of sales........................ 12,306 12,995 19,668 19,668 26,729 26,606 ------- ------- ------- ------- ------- ------- Gross profit....................... 2,306 1,558 8,507 8,507 9,811 5,204 Selling, general & administrative expenses........................... 1,651 1,731 2,537 3,510 5,561 4,405 ------- ------- ------- ------- ------- ------- Operating income (loss)............ 655 (173) 5,970 4,997 4,250 799 Interest income (expense)............ (94) (115) (316) (1,129) 169 366 ------- ------- ------- ------- ------- ------- Income (loss) before provision (benefit) for income taxes...... 561 (288) 5,654 3,868 4,419 1,165 Provision (benefit) for income taxes.............................. 222 (105) 2,210 1,512 1,914 338 ------- ------- ------- ------- ------- ------- Net income (loss).................... $ 339 $ (183) $ 3,444 $ 2,356 $ 2,505 $ 827 ======= ======= ======= ======= ======= ======= Net income per share, basic and diluted............................ $ .06 $ (.03) $ .64 $ .44 $ .39 $ .12 Average common shares outstanding.... 5,400 5,400 5,400 5,400(2) 6,379 7,024
1993 1994 1995 1996 1997 ---- ---- ---- ---- ---- BALANCE SHEET DATA: Working capital........................ $ (27) $2,645 $ 3,436 $10,248 $11,764 Total assets........................... 4,629 7,546 11,874 23,333 25,265 Short-term debt........................ 23 26 -- -- -- Long-term debt......................... 342 316 -- -- -- Stockholders' equity(3)................ 3,182 6,121 8,458 19,366 20,233
- --------------- (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, 1993, 1994 and 1995 and stockholders' equity at December 31, 1996 and 1997. 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 1997 Annual Report to Shareholders, and is incorporated herein by reference. (1) 13 14 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 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 the Company'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 towards 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 and the Company's largest customer in 1997, 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. Dependence on a Small Number of Customers. Aluminum disk substrates, all sales of which were to thin-film disk manufacturers, represented over 95 percent of the Company's sales in 1997 and 1996. The Company's aluminum disk substrate customers in 1997 were primarily Trace, StorMedia, Seagate and HMT, which represented approximately 43%, 41%, 11% and 2%, 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 1997 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. The Company's customers and the overall disk drive and component market has experienced a prolonged period of volatility and oversupply during the past 18 months beginning in the second quarter of 1996. A chronology of market events that have impacted the Company highlights the impact that changes in market conditions and customer manufacturing strategies have on the Company's operating performance. In the first half of 1996, the Company's largest customer in 1997, 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 of 1996 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. However, in 1997 StorMedia made the Company its sole external source of aluminum disk substrates, allowing StorMedia to become the Company's largest customer. Furthermore, StorMedia completed in December 1997 its acquisition of Akashic, which has significant production capacity to produce substrates. 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 in 1996 by the Company's principal customers resulted in the reduction or elimination of purchases from the Company and could result 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. 14 15 There also has been a trend toward consolidation in the disk drive industry, which the Company expects may continue. 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 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 28 percent for the Company's aluminum disk substrates in the 18 months ended December 1997. 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. As announced by several of the hard drive and thin-film media manufacturers in the fourth quarter of 1997 and first quarter of 1998, the market is changing with a period of over-production causing a supply/demand imbalance within the industry. Although the media segment of the disk drive industry experienced in excess of 20 percent annual growth in 1997, several disk drive manufacturers initiated cutbacks in production plans for 1998 in response to supply/demand imbalances within the industry which has reduced demand in the first quarter of 1998 and possibly for a longer period. 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 further reduce the Company's sales of its 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 that 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 in the past; prior to the third quarter of 1996, and submit purchase orders or releases 14 to 60 days in advance of shipment dates. However, beginning in late 1996, customers began only forecasting four to six weeks in advance. 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 both independent aluminum disk substrate manufacturers and vertically integrated companies are attempting to increase aluminum substrate manufacturing capacity. The Company increased its own manufacturing capacity in 1996 and 1997, through equipment expansion and manufacturing process changes that improved the output capacity of existing equipment and some or most of the vertically integrated, thin-film disk or hard drive manufacturers did the same in 1996 and 1997 and are expected to continue in the future, including the Company's largest customer 15 16 in 1996; HMT and largest customer in 1997; StorMedia. These efforts may result in significant additional capacity in the industry. The Company has faced increased pricing pressures since the latter half of 1996, with price reductions that averaged 28 percent in the eighteen months ending December 1997 for the Company's products. To the extent the efforts described above result in industry capacity in excess of levels of demand, the Company has experienced and will continue to experience increased levels of competition and increased pricing pressures, which are likely to have a material adverse effect on the Company's business, results of operations and financial condition. Intense Competition Among Manufacturers of Aluminum Disk Substrates. Cerion's direct competitors include both independent aluminum disk substrate manufacturers such as Kobe (which is much larger and has substantially greater production capacity than the Company) and vertically integrated companies that perform additional manufacturing processes on the substrates. These vertically integrated companies include manufacturers of hard disk drives. These competitors operate in both the United States and overseas. The Company believes that all its competitors have significantly greater financial, technical, and marketing resources. Furthermore, certain of these competitors have the advantage of being supplied by affiliated companies with the aluminum blanks used for their aluminum disk substrates. Intense competition by companies otherwise focused on other segments of the hard disk drive industry began in 1996 and continued throughout 1997 because of these companies adding or growing internal aluminum disk substrate manufacturing that exceeded internal usage requirements, as the hard disk drive industry experienced a slowdown in growth in the latter half of 1996 which is expected to continue throughout at least the first half of 1998. The following specific actions by the Company's customers in 1996 and 1997 illustrates the impact backwards integration has had on the Company. In the first half of 1996, StorMedia, the Company's largest customer in 1997, 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. Furthermore, StorMedia completed in December 1997 its acquisition of Akashic, which has significant production capacity to produce substrates. 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 and Komag, produce aluminum disk substrates internally for their own use. Moreover, Seagate, StorMedia, HMT, Komag 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, one of the Company's principal current aluminum disk substrate customers announced in 1996 that they will produce aluminum disk substrates for internal use and achieved this internal capability through the purchase of Akashic in December 1997. 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. The Asian economic conditions that occurred in 1997 have impacted the Company's competitive position in primarily two ways. First, certain of the Company's competitors have experienced a reduction in cost of raw materials and labor costs that are obtained from Asian economies. The Company has not realized any benefit from the reduction in such raw material costs because the Company's primary suppliers are located in the United States. Additionally, the Asian domestic markets have softened in terms of demand which has resulted in under-utilized capacity of aluminum disk substrate production being made available to export to the United States. These factors have created new entrants to the competitive United States market and have increased the ability of these new entrants to drive pricing downward to gain market share. The Company believes that both the independent aluminum disk substrate producers and certain vertically integrated disk drive manufacturers have been attempting to increase aluminum disk substrate manufacturing capacity. These efforts, together with the Company's own efforts in 1996 and 1997 to increase production, have resulted in significant additional capacity for the aluminum disk substrates. This additional capacity has resulted in industry capacity in excess of demand. In addition, Cerion has experienced increased 16 17 competition, which has materially adversely affected the Company's business, results of operations and financial condition. Moreover, the disk 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 market price reductions as much as 28 percent for the Company's products in the 18 months ended December 1997. 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 Memory Products, Inc. a subsidiary of Aluminum Company of America, Incorporated ("Alcoa"), as its primary supplier of the aluminum blanks used by it for producing aluminum disk substrates. It also relies on a limited number of suppliers for certain materials used in its aluminum disk 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 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 1998. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions beyond the cost reductions achieved in the future, the Company may 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 $3.0 million annually, the Company over an extended period of time could 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 17 18 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. During the first quarter of 1998, one of the Company's significant customers became delinquent in the payment of outstanding accounts receivable totaling $4.1 million. This delinquency occurred because of the customer experiencing significant operating losses and negative cash flow from operations that strained the customers liquidity. This customer's outstanding balance due to the Company exceeds an average of approximately 110 days compared to normal trade terms provided to this customer of 60 days. Future payment of this amount by the customer is expected to be structured payments over a time frame not to exceed one year. This anticipated structuring of future payments will reduce the Company's liquidity and financial flexibility. Furthermore, in the event that this customer's financial position worsens during the payment period, the risk of default increases. Thus, any significant default by customers on the payment of outstanding amounts due to the Company could cause a significant reduction in liquidity and may exhaust the Company's cash resources. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Information with respect to this item may be found in the Financial section of the 1997 Annual Report to Shareholders on pages 12 through 23, and is incorporated herein by reference.(1) - --------------- (1) The Company's 1997 Annual Report to Shareholders is not to be deemed filed as part of this report except for those parts thereof specifically incorporated by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers and directors of the Company are as follows:
NAME AGE POSITIONS ---- --- --------- David A. Peterson(3)......................... 58 Chief Executive Officer, President and Director Michael F. Brown............................. 39 Vice President-Marketing Richard A. Clark(3).......................... 33 Chief Financial Officer, Vice President-Finance and Treasurer Paul A. Harter(3)............................ 32 Vice President-Operations William A. Hughes............................ 35 Vice President-Product Development Gerald G. Garbacz(2)(3)...................... 61 Chairman of the Board of Directors Joseph A. Baute(2)........................... 70 Director Sheldon A. Buckler(1)........................ 66 Director Osmund M. Fundingsland(1).................... 54 Director Daniel M. Junius(1)(3)....................... 46 Director Ross W. Manire(2)............................ 46 Director Gerard V. Schenkkan.......................... 42 Director Ronald D. Verdoorn........................... 48 Director
- --------------- (1) Member of the Compensation Committee (2) Member of the Audit Committee (3) Individual is named as a defendant in the Consolidated Amended Class Action Complaint as discussed in Item 3 of this document 18 19 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 President and 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 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 January 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 & 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 February 1996, 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. Mr. Garbacz has been President , Chief Executive Officer and the Chairman of the Board of Nashua Corporation since January 1996. 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. 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 a director of Houghton Mifflin Company, State Street Boston Corporation, INSO Corporation, Metrika Systems 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 also is a Director of Nashua Corporation, ASECO Corporation, PARLEX Corporation, Commonwealth Energy Corporation and Spectrum Information Technologies, Inc. 19 20 Osmund M. Fundingsland has served as a director of the Company since February 1997 and has been the Chief Executive Officer of OSF International, a sales marketing consulting company, since its inception in 1995. From 1983 through 1994, Mr. Fundingsland was an Executive Vice-President of Applied Magnetics Corporation, an independent manufacturer of magnetic recording heads and head stack assemblies for disk drives. Mr. Fundingsland is a director of the ISERA group, a software company. He also serves on the board of directors for the International Disk Drive Equipment and Materials Association (IDEMA). Daniel M. Junius has served as a director of the Company since January 1996. Mr. Junius has served as Vice President-Finance and Chief Financial Officer of Nashua Corporation since 1995 and as Treasurer of Nashua since 1985. Ross W. Manire has served as a director since February 1997. Mr. Manire has been a Senior Vice President of the Carrier Systems Business Unit at 3Com since the merger of 3Com Corporation and U.S. Robotics Corporation in June 1997. Mr. Manire served as Senior Vice President and General Manager of the Networks Systems Division of U.S. Robotics, Inc. from May 1995 through June 1997 and served as its Senior Vice President-Operations and Chief Financial Officer from early 1993 through May 1995. U.S. Robotics, Inc. was an international designer, manufacturer and marketer of high-performance information access products. 3Com is a supplier of local area network and wide area network systems for the large enterprise, small business, home and service provider markets. Mr. Manire also is a director of AT Financial Corp. and EA Industries, Inc. Gerard V. Schenkkan has served as a director of the Company since March 1998. Mr. Schenkkan has been Vice President and General Manager of the Optical Storage Business Unit of Quantum Corporation since November 1997. He also served as Vice President of Corporate Development at Quantum Corporation from July 1996 until late 1997. From 1993 through 1996, Mr. Schenkkan was Marketing Manager of the Storage Systems Division of Hewlett-Packard Company. Quantum Corporation designs and manufactures storage products and is one of the largest global suppliers of hard disk drives. Ronald D. Verdoorn has served as a director of the Company since March 1998. Mr. Verdoorn has been a consultant since 1997. Mr. Verdoorn served as Executive Vice President and Chief Operating Officer of the Storage Products Group Media and LSI at Seagate Technologies, Inc. from 1995 through 1997. Mr. Verdoorn was Senior Vice President of Worldwide Manufacturing Operations at Seagate Technologies, Inc. from 1992 through 1995. Seagate Technologies, Inc. develops and manufacturers advanced information technology, including disk and tape storage devices, magnetic recording heads and media, precision motors, microelectronics, and data access and management software. Mr. Verdoorn is also a director of EA Industries, Inc. and Marvell. The executive officers of the Company are Messrs. Peterson, Brown, Clark, Harter and Hughes. Officers are elected on an annual basis to serve at the discretion of the Board of Directors. BOARD OF DIRECTORS STRUCTURE INTO CLASSES The Board of Directors of Cerion Technologies Inc. is divided into three classes. The Class II Directors' term will expire at the Meeting and the Class III and Class I Directors' terms will expire in 1999 and 2000, respectively. All Directors elected at this and future Annual Meetings of Stockholders will be elected for three-year terms. All directors will hold office until their successors have been duly elected and qualified. Prior to the Meeting, Ross W. Manire, David A. Peterson and Gerard V. Schenkkan were the Class I Directors; Sheldon A. Buckler, Osmund M. Fundingsland and Joseph A. Baute were the Class II Directors; and Gerald G. Garbacz, Daniel M. Junius and Ronald D. Verdoorn were the Class III Directors. Mr. Baute's term as director will expire at the Annual Meeting. The nominees for Class II Directors are Sheldon A. Buckler and Osmund M. Fundingsland. Mr. Buckler and Mr. Fundingsland currently are serving as Class II Directors of the Company. Shares represented by all proxies received by the Board of Directors and not so marked as to withhold authority to vote for Mr. Buckler and Mr. Fundingsland will be voted FOR the election of both nominees. Messrs. Buckler and Fundingsland would be elected to hold office until the Annual Meeting of Shareholders to be held in 2001 and until their 20 21 respective successors are duly elected and qualified. Both of these nominees have indicated their willingness to serve, if elected; however, if either should be unable or unwilling to serve, the proxies will be voted for the election of a substitute nominee designated by the Board of Directors or for fixing the number of directors at a lesser number. The following table sets forth for each nominee to be elected at the Meeting and for each director whose term of office will extend beyond the Meeting, his age, the position(s) currently held by each nominee or director with the Company, the year such nominee or director was first elected a director, the year each nominee's or director's term will expire and the class of director of each nominee or director.
DIRECTOR YEAR TERM CLASS OF NOMINEE OR DIRECTOR'S NAME AGE POSITION(S) HELD SINCE WILL EXPIRE DIRECTOR -------------------------- --- ---------------- -------- ----------- -------- Gerald G. Garbacz..................... 61 Chairman of the Board 1996 1999 III of Directors Daniel M. Junius...................... 45 Director 1996 1999 III Ronald D. Verdoorn.................... 42 Director 1998 1999 III Sheldon A. Buckler.................... 66 Director 1996 1998 II Osmund M. Fundingsland................ 54 Director 1997 1998 II Ross W. Manire........................ 46 Director 1997 2000 I David A. Peterson..................... 58 President, Chief 1996 2000 I Executive Officer and Director Gerard V. Schenkkan................... 48 Director 1998 2000 I
COMPLIANCE WITH SECTION 16(a) of the Securities and Exchange Act The Company is not aware of any failure to file on a timely basis the forms required by Section 16(a) of the Exchange Act during the most recent fiscal year. ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth the annual and long-term compensation paid to the person who served as Cerion's Chief Executive Officer during 1997 and Cerion's other executive officers who earned a salary and bonus in excess of $100,000 in 1997 and 1996:
ANNUAL COMPENSATION ------------------------------------------- LONG-TERM NAME AND OTHER ANNUAL COMPENSATION ALL OTHER PRINCIPAL POSITION YEAR SALARY $ BONUS $ COMPENSATION $ OPTIONS # COMPENSATION(1) ------------------ ---- -------- ------- -------------- ------------ --------------- David A. Peterson.......... 1997 $163,070 $144,193 $ -- 128,390 $7,736 President & Chief 1996 160,611 -- -- 136,780 5,340 Executive Officer 1995 148,874 83,567 -- 11,500(2) 4,285 Michael F. Brown........... 1997 112,127 66,095 -- 51,300 3,413 Vice President-Marketing 1996 110,434(3) -- 56,636(4) 52,600 2,884 Richard A. Clark........... 1997 112,127(3) 66,095 -- 51,300 3,372 Vice President-Finance 1996 85,567 -- 117,427(5) 52,600 1,280 Paul A. Harter............. 1997 91,732(3) 54,074 -- 56,550 1,574 Vice President-Operations 1996 91,318 -- -- 63,100 3,334 William A. Hughes.......... 1997 92,771(3) 54,074 -- 56,550 3,488 Vice President-Product 1996 99,972 -- -- 63,100 5,446 Development
- --------------- (1) In 1997, Messrs. Peterson, Brown, Clark, Harter and Hughes earned (i) $4,575, $2,988, $2,988, $1,434 and $2,470, respectively, as contributions to the Company's Employees' Saving Plan; (ii) $2,430, $225, 21 22 $184, $140, and $143, respectively, as life insurance premiums and income; (iii) $731, $200, $200, $0, and $0, respectively, as taxable club membership dues; and (iv) $0, $0, $0, $0 and $875 as a car allowance. In 1996, Messrs. Peterson, Brown, Clark, Harter and Hughes earned (i) $2,660, $2,660, $1,234, $3,194 and $3,360, respectively, as contributions to the Company's Employees' Savings Plan; (ii) $2,430, $224, $46, $140 and $140, respectively, as life insurance premiums and income; (iii) $250, $0, $0, $0 and $0, respectively, as taxable club membership dues; and (iv) $0, $0, $0, $0 and $1,946, respectively, as a car allowance. (2) In 1995, Nashua (the then-parent of the Company) granted Mr. Peterson options to purchase common stock of Nashua under Nashua's incentive plan. The options terminated unexercised six months following the Company's initial public offering. (3) Messrs. Brown, Clark, Harter and Hughes first became executive officers in 1996. (4) Includes moving expense reimbursements of $35,893 and tax equalization payments of $20,743. (5) Includes moving expense reimbursements of $70,550 and tax equalization payments of $46,877. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information as to options granted during fiscal 1997 to the individuals listed in the Summary Compensation Table.
VALUE AT ASSUMED % OF TOTAL ANNUAL RATES OF STOCK SHARES OPTIONS PRICE APPRECIATION FOR UNDERLYING GRANTED TO EXERCISE OR OPTION TERM (5) OPTIONS EMPLOYEES BASE PRICE EXPIRATION ----------------------- GRANTED IN 1997 ($/SHARE)(4) DATE 5% 10% ---------- ---------- ------------ ---------------- ---------- ---------- David A. Peterson........... 128,390(1) 33.0% $2.25 - 4.13 2/3/07 & 7/22/07 $252,613 $640,170 Michael F. Brown............ 51,300(2) 13.2% 2.25 - 4.13 2/3/07 & 7/22/07 102,148 258,864 Richard A. Clark............ 51,300(2) 13.2% 2.25 - 4.13 2/3/07 & 7/22/07 102,148 258,864 Paul A. Harter.............. 56,550(3) 14.5% 2.25 - 4.13 2/3/07 & 7/22/07 109,577 277,690 William A. Hughes........... 56,550(3) 14.5% 2.25 - 4.13 2/3/07 & 7/22/07 109,577 277,690
- --------------- (1) Options to purchase 60,000 and 26,300 shares will become exercisable on February 3, 1998 and July 22, 1998, respectively, if Mr. Peterson remains in the employ of the Company. Options to purchase 42,090 shares are "performance-accelerated" options. These options will become exercisable in tranches of 25% each based upon the Common Stock trading, for a period of 20 consecutive trading days, at an average premium of 25%, 50%, 75% and 100%, respectively, above the exercise price, if the optionee remains an employee of the Company on such date. However, if 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. (2) Options to purchase 25,000 and 15,775 shares each will become exercisable on February 3, 1998 and July 22, 1998, respectively, if Messrs. Brown and Clark remain in the employ of the Company. Options to purchase 10,525 shares are "performance-accelerated" options subject to the conditions described in footnote (1). (3) Options to purchase 25,000 and 15,775 shares each will become exercisable on February 3, 1998 and July 22, 1998 respectively if Messrs. Harter and Hughes remain in the employ of the Company. Options to purchase 15,775 shares are "performance-accelerated" options subject to the conditions described in footnote (1). (4) The one year vesting options granted on February 3, 1997 were granted at $4.13. The one year vesting options and performance-accelerated options granted on July 22, 1997 were granted at $2.25. (5) In accordance with SEC rules, also shown are the hypothetical gains or "option spreads," on the pre-tax basis, that would exist for the respective options. These gains are based on assumed rates of annual 22 23 compound stock price appreciation of 5% and 10% from the date the options were granted over the full option term. To put this data into perspective, the resulting Cerion stock prices for the grants expiring on February 3, 2007 and July 22, 2007 would be $6.73 and $3.67, respectively, at a 5% rate of appreciation and $10.71 and $5.84, respectively, at a 10% rate of appreciation. The amounts reflected in the table may not accurately reflect or predict the actual value of the stock options. OPTION EXERCISES IN FISCAL YEAR 1997 AND VALUE OF OPTIONS AT END OF FISCAL 1997
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED, OPTIONS HELD AT IN-THE-MONEY, OPTIONS SHARES ACQUIRED VALUE FISCAL YEAR END AT FISCAL YEAR END NAME ON EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE(#) EXERCISABLE/UNEXERCISABLE($) ---- --------------- ----------- ---------------------------- ---------------------------- David A. Peterson.... 0 $0 0/128,390 $0/$0 Michael F. Brown..... 0 $0 0/ 51,300 $0/$0 Richard A. Clark..... 0 $0 0/ 51,300 $0/$0 Paul A. Harter....... 0 $0 0/ 56,550 $0/$0 William A. Hughes.... 0 $0 0/ 56,550 $0/$0
SEVERANCE BENEFITS The Company has entered into employment agreements with executive officers Messrs. Peterson, Brown, Clark, Harter and Hughes in order to ensure their continued service to Cerion in the event of an attempt by a person or group of persons to gain control of Cerion. Such employment agreements provide that upon termination of employment under certain circumstances within three years of a "change in control" as defined in these agreements, the employee would receive severance pay equal to three times the sum of his annual salary and bonus for Messrs. Peterson, Brown, Clark, Harter and Hughes. In addition, if within three years following the "change in control", Messrs. Peterson, Brown, Clark, Harter or Hughes elect to terminate employment for "good reason" (as defined), he would receive the above described severance pay. These severance payments are subject to reduction to the extent necessary to avoid excise taxes under Section 280G of the Internal Revenue Code. COMPENSATION OF DIRECTORS Directors who are not employees of the Company, Nashua or of any affiliated company ("Non-Employee Directors") will receive a fee of $750 per meeting of the Board of Directors or any committee thereof. All directors are reimbursed for their out-of-pocket expenses incurred in attending such meetings. The Company, under its 1996 Stock Incentive Plan, also grants each Non-Employee Director, on the election or re-election date of each such director, that number of shares of Common Stock which is equal in value to $10,000 (subject to adjustment annually), calculated with reference to the closing price of the Common Stock on the trading day immediately prior to the date of grant, and an option to purchase 1,000 shares of Common Stock exercisable at the same price. COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION The Company's executive compensation program is administered by the Compensation Committee of the Board of Directors (the "Committee"). The Committee, which is composed of three independent directors, establishes and administers the Company's executive compensation policies and plans, and administers the Company's stock option plan. The Committee considers internal and external information in determining officers' compensation, including input from independent compensation consultants and outside survey data. 23 24 Compensation Philosophy The Company's compensation policies for executive officers are based on the belief that the interests of executives should be closely aligned with those of the Company's shareholders. The Compensation policies are designed to achieve the following objectives: - Offer compensation opportunities that attract highly qualified executives, reward outstanding initiative and achievement, and retain the leadership and skills necessary to build long-term shareholder value. - Maintain a significant portion of executives' total compensation at risk, tied to both the annual and long-term financial performance of the Company and the creation of shareholder value. - Further the Company's short and long-term strategic goals and values by aligning compensation with business objectives and individual performance. Compensation Program The Company's executive compensation program has three major integrated components: base salary, annual incentive awards, and long-term incentives. Base Salary. Base salary levels for executive officers are determined annually by reviewing the competitive pay practices of companies of similar size and market capitalization, the skills, performance level, and contribution to the business of individual executives, and the needs of the Company. Overall, the Company believes that base salaries for executive officers are approximately competitive with median base salary levels for similar positions in similar companies, but the Committee has not attempted to aim for any specific range of any particular group of companies. Annual Incentive Awards. The Company's executive officers are eligible to receive annual cash bonus awards designed to motivate executives to attain short-term and longer-term corporate and individual management goals. The Committee establishes the annual incentive opportunity for each executive officer in relation to his or her base salary. Awards under this program are based on the attainment of specific Company performance measures established by the Committee early in the fiscal year. For 1997 and 1998, the formula for these bonuses was determined as a function of net income and cash flow objectives, thus establishing a direct link between executive pay and Company profitability. The Company's financial performance in 1997 met the objectives set by the Committee, as such, awards were earned. Long-Term Incentives. The Committee believes that stock options are an excellent vehicle for compensating its officers and employees. The Company provides long-term incentives through its 1996 Stock Incentive Plan, the purpose of which is to create a direct link between executive compensation and increases in shareholder value. Stock options are granted at fair market value and vest in installments, generally over two years. When determining option awards for an executive officer, the Committee considers the executive's current contribution to Company performance, the anticipated contribution to meeting the Company's long-term strategic performance goals, and industry practices and norms, but without using any specific targets or criteria. Long-term incentives granted in prior years and existing levels of stock ownership also are taken into consideration, but the Committee has no specific ownership target. Because the receipt of value by an executive officer under a stock option is dependent upon an increase in the price of the Company's Common Stock, this portion of the executives' compensation is directly aligned with an increase in shareholder value. Chief Executive Officer Compensation Mr. Peterson's base salary, annual incentive award and long-term incentive compensation are determined by the Committee based upon the same factors as those employed by the Committee for executive officers generally. Mr. Peterson's current annual base salary is $168,000 subject to annual review and adjustment by the Board of Directors of the Company. Mr. Peterson also may be entitled to an annual cash bonus depending on the Company's achievement of certain performance objectives, including certain milestones in earnings and cash flows during a fiscal year, as compared to the preceding fiscal year. Any such cash bonus shall be 24 25 computed on a formula basis established by the Committee. For the year ending December 31, 1997, Mr. Peterson was paid a cash bonus totaling $144,188, or 88.4 percent of his 1997 base salary. Section 162(m) of the Internal Revenue Code limits the tax deduction to $1 million for compensation paid to certain executives of public companies. Having considered the requirements of Section 162(m), the Committee believes that grants made pursuant to the Company's Stock Incentive Plan meet the requirement that such grants be "performance based" and are, therefore, exempt from the limitations on deductibility. Historically, the combined salary and bonus of each executive officer has been well below the $1 million limit. The Committee's present intention is to comply with Section 162(m) unless the Committee feels that required changes would not be in the best interest of the Company or its shareholders. Respectfully Submitted by the Compensation Committee Sheldon A. Buckler, Chairman Daniel M. Junius Osmund M. Fundingsland COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The members of the Compensation Committee are Sheldon A. Buckler, Daniel M. Junius and Osmund M. Fundingsland. No member of the Compensation Committee was or is an officer or employee of the Company. 25 26 PERFORMANCE GRAPHS The following graph compares the cumulative total returns for Cerion's Common Stock with the comparable returns for Standard and Poor's SmallCap 600 Index and the Standard and Poor's Computers (Hardware) Index for the period beginning May 24, 1996 and ending December 31, 1997. [GRAPHIC OMITTED]
CERION S&P COMPUTERS Measurement Period TECHNOLOGIES SMALLCAP (HARDWARE)- PEER (Fiscal Year Covered) INC 500 INDEX 500 GROUP May 96 100 100 100 100 1996 34.21 104.12 115.00 182.54 1997 10.36 130.76 168.33 112.50
Standard & Poor's Compustat-1-15-98 This graph assumes the investment of $100 in Cerion's Stock, the Standard and Poor's SmallCap 600 Index and the Standard and Poor's Computers (Hardware) Index and a Peer Group of eight companies within the data storage segment of the computer industry as of May 24, 1996 (the date on which Cerion's Common Stock was first registered with the SEC and began trading) and assumes dividends were reinvested. Additional measurement points are at the remaining fiscal quarter ends for the year ended December 31, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS The following table shows the number of shares and percentage of Cerion's common stock beneficially owned by all persons known to Cerion to be the beneficial owners of more than 5% of its common stock, as of March 9, 1998.
PERCENT OF AMOUNT AND NATURE COMMON STOCK NAME OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP OUTSTANDING ------------------------ ----------------------- ------------ Nashua Corporation......................................... 2,599,000(b) 37.0% State of Wisconsin Investment Board........................ 686,200(a) 9.8%
- --------------- (a) Based on information reported in a Schedule 13G filed with the Securities and Exchange Commission dated January 20, 1998. (b) Based on information reported in a Schedule 13G filed with the Securities and Exchange Commission dated February 13, 1998. Shares are owned by a wholly owned subsidiary of Nashua. 26 27 SECURITY OWNERSHIP OF MANAGEMENT AND DIRECTORS The following table shows the number of shares and percentage of Cerion's Common Stock deemed to be beneficially owned by each director and nominee for director, each executive officer named in the Summary Compensation Table above and by all directors and officers of Cerion as a group, as of March 27, 1998.
AMOUNT AND NATURE OF PERCENT OF SHARES NAME BENEFICIAL OWNERSHIP(A) OUTSTANDING ---- ----------------------- ----------------- David A. Peterson(e)...................................... 62,000 0.9% Michael F. Brown(f)....................................... 25,100 0.3% Richard A. Clark(f)....................................... 27,650 0.4% Paul A. Harter(f)......................................... 25,000 0.3% William A. Hughes(f)...................................... 25,300 0.3% Gerald G. Garbacz......................................... 4,000 0.1% Joseph A. Baute(c)........................................ 5,925 0.1% Sheldon A. Buckler(c)..................................... 9,925 0.1% Osmund M. Fundingsland(b)................................. 4,265 0.1% Daniel M. Junius(d)....................................... 2,500 * Ross W. Manire(b)......................................... 8,936 0.1% Gerard V. Schenkkan....................................... 4,848 0.1% Ronald D. Verdoorn........................................ 4,848 0.1% Directors and Officers as a group (13 persons(g).......... 210,297 2.9%
- --------------- (a) Information as to the interests of the respective nominees has been furnished in part by them. The inclusion of information concerning shares held by or for their spouses or children or by corporations in which they have an interest does not constitute an admission by such nominees of beneficial ownership thereof. Unless otherwise indicated, all persons have sole voting and dispositive power as to all shares they are shown as owning. (b) Includes 1,000 shares each Non-Employee Director (Directors who are not employees of the Company, Nashua or of any affiliated company) has a right to acquire within 60 days of April 6, 1998 through the exercise of stock options. (c) Includes 2,000 shares each Non-Employee Director has a right to acquire within 60 days of April 6, 1998 through the exercise of stock options. (d) Includes 1,500 shares held in a retirement account of Mr. Junius's spouse. Mr. Junius disclaims beneficial ownership of these shares. (e) Includes 60,000 shares Mr. Peterson has a right to acquire within 60 days of April 6, 1998 through the exercise of stock options. (f) Includes 25,000 shares each Executive officer has a right to acquire within 60 days of April 6, 1998 through the exercise of stock options. (g) Includes 166,000 shares which the directors and officers of Cerion have the right to acquire within 60 days of April 6, 1998 through exercises of stock options. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS No information is required with respect to this item because no such relationships or related transactions existed in 1997. 27 28 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, 1997 and 1996 - Statements of Operations for the years ended December 31, 1997, 1996 and 1995 - Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995 - 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. 28 29 REPORT OF INDEPENDENT ACCOUNTANT 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 2, 1998 appearing in the 1997 Annual Report to Stockholders 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 2, 1998 29 30 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(c) Financing Agreement, dated as of March 7, 1997 between Cerion Technologies Inc., and The CIT Group/Business Credit, Inc. 10.8(c) 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 indicated therein. 24 Powers of Attorney 27 Financial Data Schedule (EDGAR version only). 99.1 Financial Section of the 1997 Annual Report to Shareholders, pages 12 through 23. 99.2 Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 1997 Annual Report to Shareholders, pages 8 through 11.
- --------------- (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). (c) Incorporated by Reference to Form 10-K filed for the year ended December 31, 1996 (Exhibits 10.7 and 10.8 originally filed as Exhibits 10.7 and 10.8, respectively.) (b) Reports on Form 8-K The Company filed no reports on Form 8-K during the quarter ended December 31, 1997. 30 31 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 27, 1998 - --------------------------------------------------- Officer (Principal Executive DAVID A. PETERSON Officer) and Director /s/ RICHARD A. CLARK Chief Financial Officer, Vice March 27, 1998 - --------------------------------------------------- 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/ OSMUND M. FUNDINGSLAND* Director - --------------------------------------------------- OSMUND M. FUNDINGSLAND /s/ GERALD G. GARBACZ* Director - --------------------------------------------------- GERALD G. GARBACZ /s/ DANIEL M. JUNIUS* Director - --------------------------------------------------- DANIEL M. JUNIUS /s/ ROSS W. MANIRE* Director - --------------------------------------------------- ROSS W. MANIRE /s/ GERARD SCHENKKAN* Director - --------------------------------------------------- GERARD SCHENKKAN /s/ RONALD VERDOORN* Director - --------------------------------------------------- RONALD VERDOORN By /s/ RICHARD A. CLARK March 27, 1998 ---------------------------------------------- *RICHARD A. CLARK AS ATTORNEY-IN-FACT
31 32 SCHEDULE II CERION TECHNOLOGIES INC. VALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C - ADDITIONS COLUMN D COLUMN E -------- -------- -------------------- -------- -------- CHARGED TO BALANCE AT CHARGED TO OTHER BEGINNING OF COSTS AND ACCOUNTS- DEDUCTIONS- BALANCE AT DESCRIPTION PERIOD EXPENSES DESCRIBE DESCRIBE END OF PERIOD - -------------------------------------- ---- ---- -- ----- ---- ALLOWANCE FOR DOUBTFUL ACCOUNTS AND CUSTOMER RETURNS Year ended December 31, 1997.......... $234 $151 $0 $ 0 $385 Year ended December 31, 1996.......... 51 187 0 4 234 Year ended December 31, 1995.......... 36 21 0 6 51 INVENTORY VALUATION RESERVE Year ended December 31, 1997.......... $469 $ 0 $0 $(244)(1) $225 Year ended December 31, 1996.......... 50 419 0 0 469 Year ended December 31, 1995.......... 19 31 0 0 50 DEFERRED TAX ASSET VALUATION ALLOWANCE Year ended December 31, 1997.......... $147 $ 0 $0 $(147)(2) $ 0 Year ended December 31, 1996.......... 0 147 0 0 147 Year ended December 31, 1995.......... 0 0 0 0 0
- --------------- (1) Adjustment due to sale of previously reserved inventory. (2) Adjustment due to revaluation of realizable tax benefit. 32 EX-24 2 POWER OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ DAVID A. PETERSON Director February 12, 1998 - --------------------------- ----------------------- ----------------- David A. Peterson 2 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ DANIEL M. JUNIUS Director February 1, 1998 - --------------------------- ----------------------- ---------------- Daniel M. Junius 3 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ SHELDON A. BUCKLER Director February 2, 1998 - --------------------------- ----------------------- ---------------- Sheldon A. Buckler 4 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ ROSS W. MANIRE Director February 1, 1998 - --------------------------- ----------------------- ---------------- Ross W. Manire 5 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ JOSEPH A. BAUTE Director February 2, 1998 - --------------------------- ----------------------- ----------------- Joseph A. Baute 6 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ RONALD D. VERDOORN Director March 16, 1998 - --------------------------- ----------------------- -------------- Ronald D. Verdoorn 7 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ GERARD V. SCHENKKAN Director March 20, 1998 - --------------------------- ----------------------- ---------------- Gerard V. Schenkkan 8 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ OSMUND M. FUNDINGSLAND Director March 20, 1998 - ------------------------------ --------------------- -------------- Osmund M. Fundingsland 9 EXHIBIT 24 POWER OF ATTORNEY ----------------- I, the undersigned Director and/or Officer of Cerion Technologies Inc. (the "Company"), hereby severally constitute and appoint Richard A. Clark, Vice President-Finance, Chief Financial Officer and Treasurer, my true and lawful attorney and agent to sign for me, and in my name and in the capacity or capacities indicated below (A) the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. Signature Title Date --------- ----- ---- /s/ GERALD G. GARBACZ Director March 20, 1998 - --------------------------- ----------------------- -------------- Gerald G. Garbacz EX-27 3 FINANCIAL DATA SCHEDULE
5 1,000 U.S. DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 4,588 0 10,656 385 726 16,430 15,275 6,506 25,265 4,666 0 0 0 70 20,163 25,265 31,810 31,810 26,606 26,606 4,405 0 366 1,165 338 827 0 0 0 827 0.12 0.12
EX-99.1 4 FINANCIAL SECTION OF 1997 ANNUAL REPORT 1 Exhibit 99.1 Statements of Operations
Years ended December 31, ------------------------------------------------- (In thousands, except per share data) 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------- Net sales $31,810 $36,540 $28,175 Cost of sales 26,606 26,729 19,668 ------------------------------------------------- Gross profit 5,204 9,811 8,507 Selling, general and administrative expenses 4,405 5,561 2,537 ------------------------------------------------- Operating income 799 4,250 5,970 Interest income (expense) 366 169 (316) ------------------------------------------------- Income before provision for income taxes 1,165 4,419 5,654 Provision for income taxes 338 1,914 2,210 ------------------------------------------------- Net income $ 827 $ 2,505 $ 3,444 ================================================= Net income per share, basic and diluted $ .12 $ .39 $ .64 Average shares outstanding 7,024 6,379 5,400 -------------------------------------------------
The notes are an integral part of the financial statements. 12 2 Balance Sheets
December 31, -------------------------- (In thousands, except share and per share data) 1997 1996 - ---------------------------------------------------------------------------------------------------------------- Assets Current Assets: Cash and cash equivalents $ 4,588 $ 9,300 Accounts receivable, net of allowances for doubtful accounts and customer returns of $385 and $234, respectively 10,271 2,928 Inventories 726 1,046 Prepaid expenses and other assets 208 395 Deferred income taxes 637 273 -------------------------- Total current assets 16,430 13,942 Property, plant and equipment, net 8,769 9,391 Other assets 66 - -------------------------- $25,265 $23,333 ========================== Liabilities and Stockholders' Equity Current Liabilities: Accounts payable and accrued expenses $ 4,666 $ 3,694 -------------------------- Total current liabilities 4,666 3,694 Deferred income taxes 366 273 Commitments and contingencies 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; 7,028,337 and 7,016,184 shares issued and outstanding, respectively 70 70 Additional paid-in capital 18,679 18,639 Retained earnings 1,484 657 -------------------------- Total stockholders' equity 20,233 19,366 -------------------------- $25,265 $23,333 ==========================
The notes are an integral part of the financial statements. 13 3 Statements of Cash Flows
Years ended December 31, ------------------------------------------------ (In thousands) 1997 1996 1995 - -------------------------------------------------------------------------------------------------------------------- Cash flows provided by (used in) operating activities: Net income $ 827 $ 2,505 $ 3,444 Adjustments to reconcile net income to cash provided by (used in) operating activities: Depreciation 2,466 2,099 1,035 Loss on disposal of property, plant and equipment 201 - - Deferred income taxes (271) (249) 158 Changes in operating assets and liabilities: Accounts receivable (7,343) 3,002 (2,956) Inventories 320 (734) 109 Accounts payable and accrued expenses 972 621 2,152 Prepaid expenses and other assets 187 (413) 31 ------------------------------------------------ Net cash provided by (used in) operating activities (2,641) 6,831 3,973 ------------------------------------------------ Cash flows provided by (used in) investing activities: Additions to property, plant and equipment (2,164) (6,107) (2,564) Proceeds from sale of property, plant and equipment 153 - 114 Purchase of short-term investments (6,750) (4,496) - Proceeds from redemption of short-term investments 6,750 4,496 - ------------------------------------------------ Cash flows used in investing activities (2,011) (6,107) (2,450) ------------------------------------------------ Cash flows provided by (used in) financing activities: Payments to parent company - - (1,107) Debt issuance costs (100) - - Repayment of borrowings - (11,142) (342) Proceeds from shares issued 40 19,545 - ------------------------------------------------ Cash flows provided by (used in) financing activities (60) 8,403 (1,449) ================================================ Increase (decrease) in cash (4,712) 9,127 74 Cash at beginning of year 9,300 173 99 ------------------------------------------------ Cash at end of year $ 4,588 $ 9,300 $ 173 ================================================ Supplemental disclosure of cash flow information: Interest paid $ - $ 14 $ 316 Income taxes paid 236 226 - ------------------------------------------------
14 4 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 hard disk drives of portable and desktop computers, network servers, add-on storage devices and storage upgrades. The Company operates in one business segment. All sales are denominated in U.S. dollars. Basis of Presentation: The accompanying financial statements for the year ended December 31, 1995 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. 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. Beginning on 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 Revenue Recognition: Sales of products are recorded based on product shipment to customers. 15 5 Research, Development and Engineering: Included in selling, general and administrative expenses are research, development and engineering expenditures of $567,000, $1,071,000 and $648,000 for the years ended December 31, 1997, 1996 and 1995, 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 year ended December 31, 1995 and the provision for income taxes has been calculated as if the Company was 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, 1997 and 1996 and the reported amounts of net sales and expenses during the three years in the period ended December 31, 1997. 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, 1997 and 1996, the Company held $4.6 million and $7.4 million, respectively, 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 adopted 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 initial adoption of SFAS 121 had no impact on the Company's financial statements. Net Income Per Share: In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). The adoption of SFAS 128 had no impact on the calculation of net income per share for the periods presented. Net income per share for the periods presented is determined by dividing the applicable net income by the weighted average number of common shares outstanding during the period. For periods prior to the initial public offering, the weighted average number of common shares outstanding was assumed to be the number of shares issued to Nashua on December 31, 1995. Options to purchase shares were outstanding during the years ended December 31, 1997 and 1996 but were not included in the diluted earnings per share computation because the exercise price exceeded the average market price for the period. Reclassifications: Certain amounts within the footnotes related to the classification of Research, Development and Engineering Expenses and Accounts Payable and Accrued Expenses in the prior years' consolidated financial statements have been reclassified to conform with the current year presentation. These reclassifications had no effect on previously reported net income. 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. 16 6 Product Sales: During the years ended December 31, 1997, 1996 and 1995, the Company had sales of approximately $0, $208,000 and $645,000, respectively, to divisions of Nashua. There were no amounts due from these divisions at December 31, 1997 and 1996. The Company believes that the product prices for such sales were at market prices. Corporate Services: In accordance with SAB 55, Nashua has allocated a portion of its domestic corporate expenses and charges to its divisions, including the Company through May 24, 1996. These expenses 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 and $227,000 for the years ended December 31, 1996 and 1995, respectively. The allocation and charges ceased on May 24, 1996. Certain research and development expenses of the Parent related to the Company's business were allocated to the Company in accordance with SAB 55. These amounts totaled $70,000 and $69,000 for the years ended December 31, 1996 and 1995, respectively, and 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 and $290,000 for the years ended December 31, 1996 and 1995, 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, ----------------------- 1997 1996 - -------------------------------------------------------------------------------- Raw materials $454,000 $ 442,000 Work in progress 24,000 19,000 Finished goods 248,000 585,000 ----------------------- $726,000 $1,046,000 ======================= 17 7 Property, Plant and Equipment Property, plant and equipment consisted of the following: December 31, ------------------------- 1997 1996 - -------------------------------------------------------------------------------- Land $ 260,000 $ 260,000 Buildings and improvements 3,908,000 3,908,000 Machinery and equipment 8,594,000 7,571,000 Furniture and fixtures 310,000 302,000 Construction in progress 253,000 4,000 Containers 1,950,000 1,882,000 ------------------------- 15,275,000 13,927,000 Less: accumulated depreciation (6,506,000) (4,536,000) ------------------------- $ 8,769,000 $ 9,391,000 ========================= Accounts Payable and Accrued Expenses Accounts payable and accrued expenses consisted of the following: December 31, ------------------------ 1997 1996 - ------------------------------------------------------------------------------- Accounts payable - trade $2,839,000 $1,802,000 Container deposits 18,000 585,000 Accrued payroll and benefits 925,000 727,000 Income taxes payable 304,000 58,000 Other 580,000 522,000 ------------------------ $4,666,000 $3,694,000 ======================== Employee Retirement Plans The Company adopted a defined contribution plan, the Cerion Technologies Inc. Employees Savings Plan ("Savings Plan") as of May 24, 1996. The Savings Plan allows full-time employees to become eligible in the month following employment to make certain tax-deferred voluntary contributions that the Company generally matches with a 50 percent contribution, limited to three percent of an employee's base pay. The Company's expense for the defined contribution plan totaled $145,000 in 1997 and $79,000 from May 24, 1996 through December 31, 1996. 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: "Related Party Transactions and Allocations." 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. 18 8 Leases Lease agreements cover warehouse space and office equipment under operating lease arrangements. These leases have expiration dates through January 1, 2000. Rental expense was approximately $70,000 in 1997, $92,000 in 1996 and $78,000 in 1995. Future minimum rents payable under noncancelable leases with initial terms exceeding one year are as follows: $57,000 in 1998 and $54,000 in 1999. Income Taxes Years ended December 31, ------------------------------------- 1997 1996 1995 - ------------------------------------------------------------------------------- Current: Federal $ 493,000 $1,783,000 $1,736,000 State 116,000 380,000 316,000 ------------------------------------- Total current 609,000 2,163,000 2,052,000 Deferred: Federal (244,000) (171,000) 134,000 State (27,000) (78,000) 24,000 ------------------------------------- Total deferred (271,000) (249,000) 158,000 ------------------------------------- Provision for income taxes $ 338,000 $1,914,000 $2,210,000 ===================================== Deferred tax liabilities and assets are comprised of the following: December 31, ---------------------- 1997 1996 - ------------------------------------------------------------------------------- Deferred tax liabilities: Depreciation $366,000 $ 273,000 ====================== Deferred tax assets: Accrued vacation $ 49,000 $ 63,000 Inventory reserve 90,000 187,000 Bad debt reserve 154,000 54,000 Accrued bonus 135,000 80,000 Accrued fees 160,000 25,000 Other 49,000 11,000 ---------------------- 637,000 420,000 Deferred tax asset valuation allowance - (147,000) ---------------------- $637,000 $ 273,000 ====================== 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, - -------------------------------------------------------------------------------- 1997 1996 1995 -------------------------------------- Federal statutory rate 35.0% 35.0% 35.0% State and local income taxes, net of Federal tax benefit 5.0% 4.7% 3.9% Tax asset valuation reserve (12.6)% 3.3% - Other, net 1.6% 0.3% 0.2% -------------------------------------- Effective tax rate 29.0% 43.3% 39.1% ====================================== 19 9 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 Common Stock in lieu of cash payment of directors' fees - - 40,000 - Net income - - - 827,000 --------------------------------------------------------------- Balances, December 31, 1997 $ - $70,000 $18,679,000 $ 1,484,000 ===============================================================
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 was $19,525,350. Parent Company Investment 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. 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 - ------------------------------------------------------------------------------- Beginning balance $ 8,458,000 $ 6,121,000 Net income - 3,444,000 Issuance of Common Stock (8,458,000) - Payments to Parent, net - (1,107,000) ------------------------- Ending balance $ - $ 8,458,000 ========================= 20 10 Concentration of Business Activities Customer Concentration: During the years ended December 31, 1997 and 1996, the Company shipped the majority of its aluminum disk substrates to three customers. These three customers represented approximately 29 percent, 10 percent and 44 percent, in the year ended December 31, 1996 and approximately 41 percent, 43 percent and two percent in the year ended December 31, 1997, respectively, of net sales. Concentration of Credit Risk: The Company sells in excess of 50 percent of its production to customers in the U.S., with approximately 43 percent of 1997 and 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 $7,642,000, $8,536,000 and $5,729,000 for the years ended December 31, 1997, 1996 and 1995, 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. 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 exercise 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. Had compensation cost been determined on the basis of fair value pursuant to SFAS 123, net income and net income per share for 1997 would have been $73,000 and $.01, respectively. 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 77 percent, risk-free interest rate of 6.3 percent and expected life of 5.9 years. 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 Options granted 389,090 2.25- 4.13 None Options forfeited 374,180 4.13-13.00 None -------------------------------------------- December 31, 1997 385,090 $2.25- 4.13 None 21 11 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 certain of the Company's accounts receivable and inventories. Availability under the facility as of December 31, 1997 totaled $3.2 million. 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 per annum, payable monthly. The facility contains certain covenants including the maintenance of certain financial ratios. In connection with obtaining the facility, the Company paid a commitment fee equal to 100 basis points of the total facility and other costs totaling approximately $90,000 in 1997. These costs are being 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. In March 1997, the two individual plaintiffs, joined by a third plaintiff, initiated a consolidated complaint with substantially the same allegations. In October 1997, the court dismissed the complaint and provided for the plaintiffs to file an amended complaint. The plaintiffs filed an amended complaint in December 1997. The amended complaint alleges 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 this lawsuit is without merit and it has substantial defenses and intends to vigorously defend against this action. Liquidity Matters During the second half of 1996 and throughout 1997, industry market supply exceeded demand, resulting in significant pricing and volume reductions and net losses for each of the last two quarters of 1996 and close to break-even performance for the first three quarters of 1997. 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 and 1997. Additionally, the Company does not believe current market conditions will support substantial price increases in the foreseeable future. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions that exceed cost reductions beyond year-end levels, the Company could 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 $3.0 million annually, the Company over an extended period of time may exhaust all or substantially all of its cash resources and borrowing availability under its credit facility (See the "Revolving Credit Facility" note for a description of the borrowing limitations under the Company's 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. Furthermore, any significant default by customers on the payment of outstanding amounts due to the Company could cause a significant reduction in liquidity and may exhaust the Company's cash resources sooner than would otherwise happen. No assurances can be given that the Company will be able to pursue such alternatives successfully. During the first quarter of 1998, one of the Company's significant customers became delinquent in the payment of outstanding accounts receivable totaling $4.1 million. This delinquency occurred because of the customer experiencing significant operating losses and negative cash flow from operations that strained the customer's liquidity. This customer's outstanding balance due to the Company exceeds an average of approximately 110 days compared to normal trade terms provided to this customer of 60 days. Future payment of this amount by the customer is expected to be structured payments over a time frame not to exceed one year. This anticipated structuring of future payments will reduce the Company's liquidity and financial flexibility. Furthermore, in the event that this customer's financial position worsens during the payment period, the risk of default increases. 22 12 Quarterly Operating Results and Common Stock Information (Unaudited)
1st 2nd 3rd 4th (In thousands, except per share data) Quarter Quarter Quarter Quarter Year - ---------------------------------------------------------------------------------------------------------------- 1997 Net sales $ 8,266 $ 7,104 $6,701 $ 9,739 $31,810 Gross profit 1,004 947 839 2,414 5,204 Operating income (loss) 22 (87) (261) 1,125 799 Net income 66 9 45 707 827 Net income per common share .01 - .01 .10 .12 Market bid price: High 6.88 4.38 3.00 3.44 6.88 Low 3.63 2.63 1.94 1.97 1.94 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(1) .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 Net income per common share(1) .06 .12 .16 .30 .64
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 9, 1998, there were approximately 2,500 record holders of Cerion's Common Stock. (1)Earnings per share data prior to May 30, 1996 assumes shares issued to Nashua on December 31, 1995 were outstanding. 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, 1997 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, 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 of the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ Price Waterhouse LLP Chicago, Illinois February 2, 1998 23 EX-99.2 5 MANAGEMENT'S DISCUSSION & ANALYSIS 1 EXHIBIT 99.2 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 -- 1997 Compared to 1996 Net Sales: Net sales decreased 12.9 percent, or $4.7 million, to $31.8 million in 1997 from $36.5 million in 1996. The decrease in net sales resulted from average sales prices decreasing significantly between 1996 and 1997, resulting in an average sales price in 1997 that was approximately 24 percent lower than 1996. The lower average sales price was offset by a 14 percent increase in unit volume shipped. Net sales for the Company was concentrated with four customers that represented 43 percent, 41 percent, 11 percent and 2 percent in 1997, respectively, and 10 percent, 29 percent, 6 percent and 44 percent in 1996, respectively. The reduction in unit volume to our largest customer in 1996 began gradually in the second half of 1996 as it expanded its internal manufacturing capacity for aluminum disk substrates. Gross Profit: Gross profit decreased $4.6 million to $5.2 million in 1997 from $9.8 million in 1996. Gross profit as a percentage of net sales decreased to 16.4 percent in 1997 compared to 26.9 percent in 1996. The decrease in gross profit in 1997 compared to 1996 was attributable to the 24 percent decrease in average sales price offset by higher unit volumes shipped and the spreading of fixed costs over a higher sales volume. Furthermore, the Company's continual efforts to reduce manufacturing costs through process automation, eliminating an entire step in our manufacturing process for approximately half of our products in the second half of 1997 and continuous process improvement efforts to reduce manufacturing time for the manufacturing steps for the remaining products have resulted in approximately four percent lower manufacturing costs. Selling, General & Administrative Expenses: Selling, general and administrative expenses decreased 20.8 percent, or $1.2 million, to $4.4 million in 1997 from $5.6 million in 1996, representing 13.8 percent and 15.2 percent of net sales, respectively. The decrease was due primarily to higher nonrecurring costs included in 1996 including the relocation costs for two executive officers and costs associated with transitioning the Company from a division within Nashua Corporation to a stand-alone company. Furthermore, lower spending associated with a decrease in the work force, reduced research and development spending and lower freight costs because of customer mix contributed to the reduction in costs. Selling, general and administrative expenses in 1997 included a $250,000 charge related to the write off of equipment no longer utilized to produce aluminum organic photoconductor drum substrates for laser printer cartridges, a product line the Company exited in 1997. 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 for income taxes was $338,000 in 1997 compared to $1.9 million in 1996. The Company's effective tax rate was 29.0 percent in 1997 compared to 43.3 percent in 1996, as a percentage of income before provision for income taxes. The establishment of a valuation reserve for the Company's deferred tax assets in 1996 increased the Company's effective tax rate in 1996. Uncertainty regarding the utilization of the net deferred tax asset resulted in the establishment of the valuation reserve. The reserve was reversed in 1997 after the uncertainty concerning the utilization of the net deferred tax asset was removed. The reserve reversal reduced the Company's effective tax rate. 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 8 2 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 to produce 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. Selling prices decreased significantly during the second half of 1996 contributing to an average sales price that in the second half of 1996 was approximately 13 percent lower than the second half 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 net sales 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 underutilization 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, 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 and 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 for 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. Liquidity and Capital Resources The Company's principal capital requirements in 1997 were to fund working capital needs 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 1997 when these requirements were supplemented from the proceeds of the Company's initial public offering. Nashua (which previously owned 100 percent of Cerion until the Company's 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 $(2.6) million, $6.8 million and $4.0 million in 1997, 1996 and 1995, respectively. The decrease in cash provided by operating activities from 1996 to 1997 was attributable to a reduction in net income and an increase in accounts receivable due to significantly higher revenues in the last half of 1997 compared to the last half of 1996. Furthermore, the Company's accounts receivable collection slowed in the fourth quarter of 1997 compared to 1996, contributing to the higher level of accounts receivable at December 31, 1997. The increase in cash provided by operating activities from 1995 to 1996 was attributable to a reduction in 9 3 accounts receivable offset by increased inventories due to significantly lower revenues in the last half of 1996 compared to the last half of 1995 combined with increased depreciation from capital equipment additions in 1995 and 1996. The increase in accounts payable from December 31, 1995 to December 31, 1996 was due to the growth in the business and capital projects undertaken by the Company in connection with its expansion of capacity. The increase in accounts payable from 1996 to 1997 was associated with the overall growth of the business in the second half of 1997. Net cash used in investing activities was $2.0 million, $6.1 million and $2.5 million in 1997, 1996 and 1995, 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 $(60,000), $8.4 million and $(1.4) million in 1997, 1996 and 1995, 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 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 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 1998. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions that exceed cost reductions beyond year-end levels, the Company could 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 $3.0 million annually, the Company over an extended period of time may 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. Furthermore, any significant default by customers on the payment of outstanding amounts due to the Company could cause a significant reduction in liquidity and may exhaust the Company's cash resources sooner than would otherwise happen. No assurance can be given that the Company will be able to pursue such alternatives successfully. During the first quarter of 1998, one of the Company's significant customers became delinquent in the payment of outstanding accounts receivable totaling $4.1 million. This delinquency occurred because of the customer experiencing significant operating losses and negative cash flow from operations that strained the customer's liquidity. This customer's outstanding balance due to the Company exceeds an average of approximately 110 days compared to normal trade terms provided to this customer of 60 days. Future payment of this amount by the customer is expected to be structured payments over a time frame not to exceed one year. This anticipated structuring of future payments will reduce the Company's liquidity and financial flexibility. Furthermore, in the event that this customer's financial position worsens during the payment period, the risk of default increases. Inflation In the opinion of management, inflation has not had a material effect on the operations of the Company. 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, a trend toward 10 4 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 "Matters Affecting Future Results" included in the Company's Form 10-K dated March 27, 1998 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 and throughout 1997, 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 and operate at essentially breakeven performance for the first three quarters of 1997, are worsening in 1998. Despite the Company's profitablity in the fourth quarter of 1997, Cerion expects that a combination of factors affecting the industry, including the acquisition of aluminum substrate capabilities by certain of the Company's customers and an oversupply of aluminum disk substrates in the market, could significantly and adversely affect the Company's performance in the first half of 1998. There can be no assurance that these or other factors will not continue to negatively impact the Company's performance in subsequent quarters. Such losses and breakeven performance have and will impair the Company's liquidity and available sources of liquidity and may continue to affect the Company adversely until significant product cost improvements are achieved, combined with increased sales volumes to return to sustainable 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 and/or order volume increases to occur. Unless the Company achieves substantial cost improvements, increased demand and no further price reductions that exceed cost reductions beyond year-end levels, the Company could 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 $3.0 million annually, the Company over an extended period of time may 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. Furthermore, any significant default by customers on the payment of outstanding amounts due to the Company could cause a significant reduction in liquidity and may exhaust the Company's cash resources sooner than would otherwise happen. No assurances can be given that the Company will be able to pursue such alternatives successfully. During the first quarter of 1998, one of the Company's significant customers became delinquent in the payment of outstanding accounts receivable totaling $4.1 million. This delinquency occurred because of the customer experiencing significant operating losses and negative cash flow from operations that strained the customer's liquidity. This customer's outstanding balance due to the Company exceeds an average of 110 days compared to normal trade terms provided to this customer of 60 days. Future payment of this amount by the customer is expected to be structured payments over a time frame not to exceed one year. This anticipated structuring of future payments will reduce the Company's liquidity and financial flexibility. Furthermore, in the event that this customer's financial position worsens during the payment period, the risk of default increases. 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 1995 through 1997 and planned capital spending in 1998, will negatively impact gross margins in future periods. The planned 1998 capital spending is focused in the area of manufacturing process changes to reduce product cost. Reduction in demand from either a reduction in market requirements, 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 on the Company's operating performance because of the fixed cost element of the Company's manufacturing costs relative to total costs. 11 -----END PRIVACY-ENHANCED MESSAGE-----