-----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, Pfp+7XaX0X8ZCRuKJQrd+4xeYqQbYg0gDuA/oiWbjgqkbmwMzokA0W4Ivi2llpVz VcERgPDZ5no5dr09AK64Hw== 0000893877-99-000583.txt : 19990831 0000893877-99-000583.hdr.sgml : 19990831 ACCESSION NUMBER: 0000893877-99-000583 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19990531 FILED AS OF DATE: 19990830 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFIC AEROSPACE & ELECTRONICS INC CENTRAL INDEX KEY: 0000790023 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC LIGHTING & WIRING EQUIPMENT [3640] IRS NUMBER: 911744587 STATE OF INCORPORATION: WA FISCAL YEAR END: 0531 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-26088 FILM NUMBER: 99702629 BUSINESS ADDRESS: STREET 1: 430 OLDS STATION RD CITY: WENATCHEE STATE: WA ZIP: 98801 BUSINESS PHONE: 5096679600 MAIL ADDRESS: STREET 1: 430 OLDS STATION ROAD CITY: WENATCHEE STATE: WA ZIP: 98801 FORMER COMPANY: FORMER CONFORMED NAME: PCT HOLDINGS INC /NV/ DATE OF NAME CHANGE: 19950223 FORMER COMPANY: FORMER CONFORMED NAME: VERAZZANA VENTURES LTD DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: VERAZZANA VENTURES SYSTEMS LTD DATE OF NAME CHANGE: 19890618 10-K405 1 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended May 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ Commission file number 0-26088 PACIFIC AEROSPACE & ELECTRONICS, INC. (Exact name of registrant as specified in its charter) Washington 91-1744587 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 430 Olds Station Road, Third Floor Wenatchee, Washington 98801 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (509) 667-9600 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered ------------------- --------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value (Title of class) Common Stock Purchase Warrants (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [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] State the aggregate market value of the voting stock held by non-affiliates, based on the closing price for the registrant's Common Stock on the Nasdaq National Market System, as of August 24, 1999: approximately $28,879,996.50. Indicate the number of shares outstanding of each of the registrant's classes of common equity, as of August 24, 1999: Common Stock, $.001 par value ("Common Stock"): 19,253,331 shares. Documents Incorporated by Reference: None, except certain Exhibits referred to on the list of Exhibits, contained in Item 14 of this report. TABLE OF CONTENTS Item of Form 10-K Page - -------------------------------------------------------------------------------- PART I Item 1 - Description of Business........................................... 1 Item 2 - Description of Property........................................... 22 Item 3 - Legal Proceedings................................................. 23 Item 4 - Submission of Matters to a Vote of Security Holders............... 23 PART II Item 5 - Market for Common Equity and Related Shareholder Matters.......... 24 Item 6 - Selected Financial Data .......................................... 28 Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations.................... 29 Item 7A - Quantitative and Qualitative Disclosures About Market Risk........ 40 Item 8 - Financial Statements.............................................. 41 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................... 81 PART III Item 10 - Directors and Executive Officers of the Company................... 82 Item 11 - Executive Compensation............................................ 85 Item 12 - Security Ownership of Certain Beneficial Owners and Management............................................. 91 Item 13 - Certain Relationships and Related Transactions...................................................... 93 Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K... 94 SIGNATURES................................................................... 99 i PART I ITEM 1. DESCRIPTION OF BUSINESS Overview Pacific Aerospace & Electronics, Inc. is an international engineering and manufacturing company that develops, manufactures and markets high-performance, technically demanding electronic and metal components and assemblies for the aerospace, defense, electronics, medical, energy and transportation industries. The Company is organized into three operational groups: U.S. Aerospace, U.S. Electronics, and European Aerospace. During the Company's 1999 fiscal year, the Company acquired Aeromet International PLC ("Aeromet"). Immediately following the end of the fiscal year, the Company acquired Skagit Engineering & Manufacturing, Inc. ("Skagit"). Aeromet, which forms the basis of the Company's European Aerospace Group, supplies magnesium and aluminum precision sand and investment castings and titanium and aluminum formed sheet products to the aerospace, defense and motorsport industries in Europe. The Aeromet acquisition nearly doubled the Company's size, and significantly expanded the Company's customer base and product offerings. The Skagit acquisition, although smaller in scope than the Aeromet acquisition, was important to the Company because it significantly expanded the capabilities of the Company's U.S. Aerospace Group in the area of metals fabrication. See "- Products, Processes and Markets - U.S. Aerospace Group - Fabrication Division." The Company is continuing its consolidation strategy of identifying and acquiring companies that (i) provide the opportunity for increased sales penetration with the Company's existing customers and new sales to the Company's potential customers and (ii) extend and vertically integrate the manufacturing capabilities of the Company's operational groups. References in this Form 10-K to the "Company" include Pacific Aerospace & Electronics, Inc. and its subsidiaries. The Company's headquarters are located at 430 Olds Station Road, Wenatchee, Washington 98801, and its telephone number is (509) 667-9600. 1 Corporate History The Company has acquired its various divisions in a series of transactions since 1990. Each acquisition was accounted for as a purchase. The following chart identifies the Company's three operational groups, the operating divisions and companies that comprise those groups, the year of each acquisition, and the current locations of the Company's operations.
Year of Acquisition Current Location ------------ ---------------- U.S. AEROSPACE GROUP Casting Division: Aeromet America, Inc. 1995 Entiat, Washington Lyden Castparts, Inc. 1998 Tacoma, Washington Machining Division: Cashmere Manufacturing Co. 1994 Wenatchee, Washington Seismic Safety Products, Inc. 1995 Wenatchee, Washington Fabrication Division: Skagit Engineering & Manufacturing, Inc. 1999 Sedro-Woolley, Washington Engineering Division: Nova-Tech Engineering, Inc. * Edmonds, Washington EUROPEAN AEROSPACE GROUP Casting Division: Aeromet International PLC 1998 Sittingbourne, England Rochester, England Worcester, England Forming Division: Aeromet International PLC 1998 Welwyn Garden City, England Birmingham, England U.S. ELECTRONICS GROUP Interconnect Division: Pacific Coast Technologies, Inc. 1990 Wenatchee, Washington Balo Precision Parts, Inc. 1998 Wenatchee, Washington Filter Division: Ceramic Devices, Inc. 1995 Wenatchee, Washington Bonded Metals Division: Northwest Technical Industries, Inc. 1997 Sequim, Washington Display Technology Division: Electronic Specialty Corporation and 1998 Vancouver, Washington Displays & Technologies, Inc. * The Company does not currently own Nova-Tech Engineering, Inc. ("Nova-Tech"). However, the Company has signed a letter of intent to acquire Nova-Tech, and the Company is negotiating the terms of a definitive stock purchase agreement with Nova-Tech's shareholders. The Company expects that the definitive stock purchase agreement will contain conditions to closing, including receipt of a letter ruling from the Internal Revenue Service that is necessary to permit Nova-Tech's Employee Stock Ownership Plan to sell its Nova-Tech stock on the terms anticipated. The Company is providing services to Nova-Tech under the terms of an Operating Agreement dated April 23, 1999. See "- U.S. Aerospace Group - Engineering Division" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources."
Aeromet Acquisition On July 30, 1998, the Company acquired Aeromet International PLC ("Aeromet") through the Company's indirect wholly owned subsidiary, Pacific Aerospace & Electronics (UK) Limited, for (pound)42 million (approximately $69 million) in cash. Aeromet is the largest company acquired by the Company to date, and the acquisition nearly doubled the Company's workforce, facilities and 2 revenues and significantly expanded the Company's customer base and product offerings. The acquisition also significantly enhanced the Company's commercial aerospace and defense industry presence and provided the Company with a solid platform from which to access major European commercial aircraft and aircraft engine programs as well as markets within the European defense and transportation industries. See " - Products, Processes and Markets - European Aerospace Group." In order to fund the Aeromet acquisition and provide working capital, the Company issued $75 million of 11 1/4% Senior Subordinated Notes due 2005 (the "Old Notes") in a private placement under Rule 144A of the Securities Act of 1933, as amended ("Securities Act") that closed simultaneously with the Aeromet acquisition (the "Offering"). The Old Notes were purchased by qualified institutional buyers and were issued pursuant to an Indenture (the "Indenture"), dated July 30, 1998, between the Company, the Company's U.S. operating subsidiaries (the "Subsidiaries") and IBJ Schroder Bank & Trust Company (now known as IBJ Whitehall Bank & Trust Company), as trustee (the "Trustee"). In February 1999, the Company exchanged the Old Notes for new senior subordinated notes (the "Notes") of an equal principal amount and registered the Notes on a Form S-4 Registration Statement (No. 333-68023), which was declared effective on January 22, 1999. The terms of the Notes are substantially identical to the terms of the Old Notes, except that they are not subject to transfer restrictions or registration rights, unless held by certain broker-dealers, affiliates or certain other persons. The Notes (i) are senior subordinated, unsecured, general obligations of the Company, (ii) will mature on August 1, 2005, unless previously redeemed pursuant to the Indenture, and (iii) are jointly and severally guaranteed on a senior subordinated basis by each of the Subsidiaries. Business Strengths Significant Customer Base The Company has a strong international customer base, which includes many of the world's leading companies, such as: Aeronautical Macchi Manufacturing Corporation ("Aermacchi"), AlliedSignal Inc., BF Goodrich Company, The Boeing Company ("Boeing"), Bombardier Inc., British Aerospace plc ("British Aerospace"), DaimlerChrysler AG, Deere & Company, Marconi Actuation Systems, Inc. (d/b/a GEC Marconi Avionics), GKN Westland Aerospace, Inc., Honeywell Inc. ("Honeywell"), Litton Marine Systems, Inc., Lockheed Martin Corporation, Lucas Aerospace (a division of Lucas Varity plc), Northern Telecom Ltd. ("Northern Telecom"), Northrop Grumman Corporation ("Northrop Grumman"), Paccar Inc. ("PACCAR"), Parker Hannifan Corporation, Raytheon Company ("Raytheon"), Rolls-Royce plc ("Rolls-Royce"), and Schlumberger Ltd. The Company believes that one of the key advantages of the Aeromet acquisition was the addition of a significant base of additional customers, primarily in Europe, to the Company's already blue-chip customer base. Strong Position in Major Aerospace and Defense Programs The Company supplies components and parts to Boeing for each of Boeing's 737, 747, 757, 767 and 777 commercial aircraft construction programs. Aeromet participates in the Airbus A300/310, A320 and A330/340 commercial aircraft construction programs. In addition, both the Company and Aeromet participate in major defense and military aircraft programs. 3 Diversity of Product Offerings and Capabilities The Company designs and manufactures a broad range of precision cast, formed, machined and fabricated metal products, as well as a broad range of electronics components and sub-assemblies. The Company collaborates with many of its customers to develop products that meet specific design or customization requests. The Company believes that one of its key strengths is its ability to provide total solutions to its customers. The Company also believes that its experience and capabilities in working with the changing needs of its customers will allow it to continue to respond to changing market trends in its industries. Strong Technology Position The Company utilizes specialized manufacturing techniques, advanced materials science, integrated design, process engineering and proprietary technologies or processes in the manufacture of its products. In particular, the U.S. Aerospace Group owns four U.S. patents and has a broad base of expertise in the manufacture of cast aluminum products using lost foam, sand and permanent mold casting technologies. The European Aerospace Group possesses specialized expertise in casting aluminum and magnesium products using sand casting and investment casting techniques and its licensed "Sophia Process" technology, and in super-plastic forming of titanium sheet and stretch forming of aluminum sheet. The U.S. Electronics Group owns 28 U.S. patents and uses a combination of patented technology, trade secrets and other proprietary technology in the manufacture of its electronics products. The Company has a number of patents pending and maintains an ongoing program of evaluating and protecting its proprietary rights and processes. Strategies The Company's objective is to be a world class manufacturer that generates profitable growth by taking advantage of available opportunities in its industries. The Company believes that pursuing the following business strategies will enable the Company to increase market penetration, create operating efficiencies, and enhance its competitive position in its core markets. Integrate and Consolidate Operations During the 1999 fiscal year, the Company has focused on streamlining and centralizing the operations and administration of its operating groups in order to reduce costs, increase operating efficiencies, and allow the Company to provide more complete and faster solutions to its customers. The Company's U.S. accounting, human resources, and information services functions have been consolidated at the corporate level. In March 1999, the Company hired Werner Hafelfinger as Vice President Operations and Chief Operating Officer to assist with the consolidation of operations and to capitalize on the synergies of the Company's groups and divisions. In the U.S. Electronics Group, the operations of the Interconnect Division have been combined by moving its New Jersey operations to Wenatchee, Washington to share the facilities, employees and management of its Wenatchee counterpart, and unprofitable or obsolete lines of business in the Display Technology Division have been discontinued. In the U.S. and European Aerospace Groups, the Company has reorganized operations to adopt a cellular manufacturing process to improve work flow, reduce cycle time, inventories and scrap levels, improve flexibility, and increase employee interest in projects. The U.S. and European Aerospace Groups have also begun to focus on standardizing manufacturing processes, leveraging engineering expertise, and obtaining globally recognized quality certifications. 4 Enhance Sales and Marketing Functions The Company is also focused on strengthening its sales and marketing functions to continue the Company's revenue growth. The Company is currently consolidating marketing efforts within its operating groups and expanding its direct sales forces. The Company believes that it has the opportunity to leverage customer relationships to supply more complete systems by providing products that combine the technologies and manufacturing abilities of its different groups. Consequently, the Company is emphasizing cross-selling efforts between its operating groups. The Aeromet acquisition has also provided the Company with a strong European base, which the Company intends to use to expand its international marketing efforts. Offer Complete Solutions The Company is continuing to vertically integrate its manufacturing processes in order to improve operating efficiencies and increase profit margins. A key component of this strategy is to use the Company's expertise in advanced materials science and in the manufacture and assembly of precision products to identify new products, services, technologies and markets and to provide customers with total solutions, from design to assembly. Commercial aircraft manufacturers and defense contractors are continuing to move toward purchasing from a smaller number of suppliers that can supply more complete systems and pre-assembled parts, and the Company is positioning itself to be one of those suppliers. By producing products that integrate the Company's metals casting, forming, machining and fabrication expertise with the Company's expertise in the manufacture of higher-margin connectors, seals, filters, relays, and electronic packages, the Company expects to improve its profit margins and position itself to capture a larger share of its customers' total product requirements. Pursue Strategic Acquisitions The Company believes that there are and will continue to be opportunities to grow the Company and enhance its profitability through acquisition. The Company intends to continue to pursue strategic acquisitions of companies and technologies that it believes will provide the opportunity for increased sales penetration with existing customers and new sales to potential customers, and that will extend and vertically integrate the Company's products and technologies. Industry Overview The aerospace supply industry has been enjoying favorable trends driven by strong growth in commercial aircraft fundamentals. Industry sources have estimated that the worldwide market for aircraft, including components, will be approximately $520 billion over the ten-year period of 1997 through 2007. In 1998 and 1999, the favorable trends have been somewhat tempered by the Asian financial downturn, but industry analysts and aircraft manufacturers still expect overall growth in air traffic patterns and the demand for new aircraft. Demand for aerospace components is closely related to delivery and use rates for commercial aircraft. Delivery and use rates are in turn directly related to the actual and projected volume of passenger and freight traffic, average aircraft age, and global fleet size. According to the Boeing 1998 Current Market Outlook, world air traffic grew 6% from 1996 to 1997, following a 7% increase in the previous year. However, the Boeing 1999 Current Market Outlook reported that air travel in 1998 varied from the trend, particularly because of decreases in Asian air traffic. Boeing has revised its estimate for the growth rate of world air travel over the next ten years to a rate of approximately 4.7% per year. Boeing also projects that during this same period the world jet fleet 5 will grow from an operating fleet of 12,600 commercial aircraft at the end of 1998 to approximately 19,100 aircraft (net of retirements) at the end of 2008. In 1998, Boeing delivered 559 new commercial aircraft, compared to 320 new commercial aircraft in 1997 and 220 in 1996. In 1998, Airbus delivered 229 new commercial aircraft, compared to 182 in 1997 and 126 in 1996. In December 1998, Boeing announced plans to produce 620 aircraft in 1999. In July 1999, Boeing announced that it had delivered 313 commercial aircraft in the first half of 1999, putting it on track for its 1999 goal. However, deliveries are expected to decline to 480 in 2000 and 420 in 2001. At the end of July 1999, Airbus had delivered 167 commercial aircraft for the year. Industry reports indicate that the total number of all commercial aircraft ordered in the first half of 1999 has decreased to 324, compared to 569 in the first half of 1998. Of these orders, 120 were for Boeing aircraft and 204 were for Airbus aircraft. In 1998, 1,212 commercial aircraft were ordered - 656 from Boeing and 557 from Airbus. According to the U.S. Department of Defense, defense procurement funding is expected to continue to grow. Some estimates say that this growth will be at approximately 6% per year, from approximately $43 billion in 1998 to approximately $60 billion in 2001. The Company believes that both its electronics and aerospace business segments will benefit from this trend. As in other transportation segments, aircraft manufacturers and defense contractors have been aggressively searching for ways to improve the quality and reduce the cost of their manufactured products. One major area of focus has been the manner in which they work with their supply base. Similar to automotive manufacturers, aircraft manufacturers and defense contractors have increasingly become product designers and assemblers rather than vertically integrated manufacturers. As a result, these manufacturers are outsourcing component manufacturing to independent suppliers, seeking to benefit from an independent supplier's lower cost structure and specialized manufacturing knowledge. Suppliers that demonstrate an ability to effectively deliver a high quality product on the required delivery schedule at a reasonable cost will benefit from this shift. In addition, commercial aircraft manufacturers are tending, and defense contractors are being strongly encouraged by the U.S. Department of Defense, to purchase from suppliers that can supply more complete systems and pre-assembled parts. These shifts are leading to a consolidation in the supply base. Certain segments of the aerospace supply base are already consolidated, such as engines, avionics and landing gears. Other segments, however, including structural components and electronics, remain fragmented. The Company believes that this trend toward consolidation presents an opportunity for suppliers with the financial and management resources to complete acquisitions and expand their operations. The electronics industry is enjoying growth in the Company's specific sector as well. According to Fleck Research, a division of Global Connector Research Group, Inc., the top ten manufacturers of connectors, cable assemblies, backplane and interconnect devices combined produced over $11 billion worth of product in 1997, and growth is forecasted at a rate of 4.3% through year 2002. The Company believes that the portion of this market pertaining to hermetic connectors can be estimated at 1%, or $112 million total available market. Additionally, the Company estimates the size of the hermetic electronics packaging market to be approximately $250 million. Growth in the high reliability electronics industry has been fueled by several factors, including the rapid pace of technological advancement and development of new satellite products. The growth in demand by these sophisticated customers has induced manufacturers to create more complex designs of lighter, more efficient configurations and higher levels of performance. Additionally, international demand for advanced electronics components is growing rapidly as these new developments enter the arena of available solutions. 6 Products, Processes and Markets The products, manufacturing processes and markets of the Company in fiscal 1999, and the industry segments in which the Company operates, are summarized below. For financial information about operational segments and geographic areas, see "Notes to Consolidated Financial Statements -- Note 3" in the Company's financial statements for May 31, 1999.
- ------------------------------------------------------------------------------------------------------- Manufacturing Segment Group Division Processes Sample Products - ------------------------------------------------------------------------------------------------------- U.S. Casting Sand; lost foam; and Aircraft and truck parts A Aerospace permanent mold casting E --------------------------------------------------------------------------- R Machining Precision machining of Aircraft parts O bonded and cast metals S --------------------------------------------------------------------------- P Fabrication Metal fabrication Tooling and structures for A aircraft manufacture C --------------------------------------------------------------------------- E Engineering Design Aviation tool design ------------------------------------------------------------------------------------------- European Forming Hot and super-plastic Jet engine bulkhead components; Aerospace titanium forming; cold airframe and engine details; stretch aluminum forming aircraft skin panels; leading edges --------------------------------------------------------------------------- Casting Sand casting; investment Aircraft parts; aircraft engine casting; Sophia casting; parts; motorsport engine parts machining - ------------------------------------------------------------------------------------------------------- - ------------------------------------------------------------------------------------------------------- U.S. Interconnect Design and manufacture Electronic connectors, packages E Electronics and assemblies with ceramic and L glass hermetic seals E --------------------------------------------------------------------------- C Filter Design and manufacture Ceramic discoidal T electromagnetic filters and R capacitors O --------------------------------------------------------------------------- N Bonded Metals Explosive bonding and Metallurgically welded metals I forming of dissimilar for use in electronic C metals connectors and assemblies S --------------------------------------------------------------------------- Display Design and manufacture Relays and solenoids; Technology ruggedized flat panel displays - -------------------------------------------------------------------------------------------------------
U.S. Aerospace Group Casting Division At its facility in Entiat, Washington, the U.S. Aerospace Group's Casting Division designs and manufactures precision cast aluminum parts using permanent mold, sand, and lost foam casting technologies. At its facility in Tacoma, Washington, the division designs and manufactures aluminum, bronze, iron, and steel parts using sand casting technology. The division's cast parts are sold principally to the transportation and aerospace industries. Permanent Mold Casting. The permanent mold process is well-suited for high strength, long production life parts that do not require frequent changes in design and can be made in high volume. The division uses this process primarily to produce components used in diesel engines and 7 other structural parts for the transportation industry. The permanent mold process uses a cast iron mold to shape the part to be cast. Molten aluminum is ladled into the heated mold and, once cooled, the casting is removed from the mold. As the mold is not destroyed in the production process, it can be reused. As an example of the Company's focus on vertically integrating to produce more complete solutions, the acquisition of the division's Tacoma facility has permitted the division to produce its own molds, which had previously been subcontracted. This has provided the division with more control, lower costs, and the ability to more quickly respond to customers' needs. Sand Casting. The sand casting process is more appropriate for lower volume parts. It is also appropriate for parts produced in iron and steel, which have high melting temperatures, prohibiting the use of many other casting processes. The division uses this process to produce parts for the aerospace industry, such as housings. This process uses a wood, plastic, or aluminum pattern of the part to be cast. An automatic molding machine hydraulically squeezes molding sand to accurately reproduce the pattern. After the molten aluminum is poured into the mold, the sand is removed, leaving the casting. The sand mold is destroyed in the process, but the sand may be recycled for future moldings. The division has recently added an SO2 core making process, which produces sand cores and molds without the use of heat, providing for more dimensional accuracy and increased productivity. Lost Foam Casting. The lost foam process is well-suited for producing parts with complex patterns, because it reduces the amount of machining that would be required if the parts had been made with sand or permanent mold castings. The U.S. Aerospace Group's Casting Division uses this process to produce support brackets and housings primarily for the transportation industry. In the lost foam process, the pattern is created from expanded polystyrene beads. The foam pattern is then suspended in a large metal flask and surrounded with dry sand. Molten aluminum is poured directly on the pattern, which vaporizes as the aluminum replaces every detail of the pattern. The lost foam process allows for complex details of a part to be cast with little or no touch-up, and the tooling used to create the polystyrene patterns has an unlimited life because the tooling only comes in contact with the polystyrene beads. Machining Division At its facility in Wenatchee, Washington, the U.S. Aerospace Group's Machining Division operates a precision machine shop that produces precision machined components, structural parts and assemblies principally from aluminum, titanium, stainless steel and explosively bonded metals for the commercial aerospace and defense industries. These products range from small connectors to complex assemblies for use in commercial and military aircraft, heavy trucks and seismic safety gas shutoff valves. The division uses computerized numerical control ("CNC") machining cells to manufacture particularly complex components and assembly housings. The division builds its machined products either to customer specifications or according to an engineering and tooling design developed by the Company to suit a customer's particular need. The division has a direct computer link to Boeing that allows immediate access to the drawings for Boeing parts. The division inspects and tests its machined products at various stages of production using non-destructive methods such as X-ray, ultra-sound, manual and computerized measuring instruments, eddy current, and dyes before the products are passed for shipment to the customer. In response to changes in its customers' manufacturing processes, the division often supplies its precision machined parts on a "just in time to point of use" basis. As a result of these processes and the high quality of its machined parts, the U.S. Aerospace Group has won numerous awards for supplier excellence from customers such as Boeing, Northrop Grumman and Kawasaki. The group's machining operations are ISO 9002 compliant and DI-9000A Boeing approved, qualifying it to perform work for most aerospace, medical equipment and general electronics companies. The U.S. 8 Aerospace Group also has machining capabilities at its Entiat and Tacoma, Washington facilities to support its Casting Division. Fabrication Division At its Sedro-Woolley, Washington facility, the U.S. Aerospace Group's Fabrication Division fabricates component parts, completed assemblies and tooling, and fully manufactured industrial products, such as heavy duty mobile transporters for use by aircraft manufacturers in moving large sections during the manufacturing process. The acquisition of this division, which occurred as of June 1, 1999, has provided the U.S. Aerospace Group with the capacity to produce both large-sized and heavy-gauge sheet metal components for the aerospace industry and other industries. Engineering Division The U.S. Aerospace Group's Engineering Division provides comprehensive aerospace design and related engineering services primarily for the commercial and defense aerospace industries. These services include aircraft tool design, manufacturing systems, machine design, systems engineering, and technical supervision. The division also provides tools and machines for non-aerospace industries. The Company has a number of engineers employed at its various facilities. When and if the Company acquires Nova-Tech, the Company expects Nova-Tech to form the core of this division. The Company has signed a letter of intent to acquire Nova-Tech, and the Company is negotiating the terms of a definitive stock purchase agreement with Nova-Tech's shareholders. The Company expects that the definitive stock purchase agreement will contain conditions to closing, including receipt of a letter ruling from the Internal Revenue Service that is necessary to permit Nova-Tech's Employee Stock Ownership Plan to sell its Nova-Tech stock on the terms anticipated. The Company is providing services to Nova-Tech under the terms of an Operating Agreement dated April 23, 1999. Nova-Tech is a full service engineering firm of licensed professional engineers, who specialize in turn-key design and build, machine designs, engineering research and development, and total system engineering. Nova-Tech designs and builds high productivity tools, fixtures, and machines for the aerospace industry. European Aerospace Group Forming Division At its Welwyn Garden City and Birmingham facilities in England, the European Aerospace Group's Forming Division uses hot and cold metal forming technologies to manufacture titanium and aluminum assemblies and details for the commercial aerospace and defense industries. The division also performs finishing, welding, brazing and riveting processes on these parts. Testing of products is done using non-destructive techniques and in-house X-ray facilities. Interactive discussions with customers enable the division to closely match component design to the most suitable forming process. Hot Forming of Titanium. The division's Welwyn Garden City facility specializes in hot and super-plastic forming of titanium, and the Company believes it has the largest independent capability in the European Union for that process. Unlike most sheet metal materials, titanium and its alloys are extremely difficult to form in a cold condition. To overcome this, the division has developed a variety of hot forming processes, including hot die forming, hot brake press forming, super-plastic forming, gas blow forming, and hot stretch-forming. These processes maximize weight savings, maintain structural integrity, minimize cost, and enable the designer to manipulate the developing alloys into complex shapes. The forming equipment consists of air circulating, low thermal mass heat treatment furnaces with temperatures up to 1,100 degrees centigrade and related quenching facilities. The division designs the necessary tooling using its in-house pattern facility. 9 The division also has the capability to chemically mill three-dimensional components in titanium. The division markets its hot-formed titanium products primarily to the commercial aircraft, helicopter and military aircraft markets. The division's titanium products include jet engine Nacelle bulkhead components, airframe and engine details, and erosion shields for helicopters. The division's titanium products are included on the Airbus model 320, 321, 330 and 340 aircraft, the Boeing model 717 and 737 aircraft, and the Dash 8-400 aircraft. Cold Forming of Aluminum Alloys. At its Birmingham facility, the European Aerospace Group's Forming Division specializes in the pressing and cold forming of aluminum alloys used for aircraft skin panels, leading edges and acoustic panel liners. Stretch forming is a process well suited to producing aircraft skin panels and leading edges. Specialized equipment in the Birmingham facility has the capability to form sheets up to 8 feet wide and up to 13 feet long, with stretching loads of up to 700 tons being applied. Most tools are machined from oxidation-resistant stainless steel castings, and forming dies up to four tons can be handled. Together with specialist gripper jaws and rotational platen, this enables the division to stretch-form aluminum alloys into a wide variety of shapes and sizes. The division's capabilities extend from design to completion, including tooling design and manufacture, forming, chemical milling, trimming, assembly, and quality control. The division markets its formed aluminum alloy products primarily to the aerospace market. Casting Division At its Rochester, Worcester and Sittingbourne, England facilities, the European Aerospace Group's Casting Division manufactures aluminum investment castings and aluminum and magnesium precision sand castings. The division is a European leader in the production of light alloy sand and investment castings for the commercial aerospace and defense sectors. Precision Investment Casting. At its Worcester, England facility, the European Aerospace Group's Casting Division manufactures aluminum investment casting products, including aircraft and defense system components such as electronic enclosures, aircraft engine outer guide vanes, navigation lights, wing tip fences, winglet components, duct stators, and heads up display units. At its Rochester, England facility, the division manufactures aircraft components such as pressure tight fuel connectors. The versatility, accuracy and replicability of the investment casting process provides many advantages over more traditional methods of machining and fabricating metal products from solid components. The investment casting process uses a metal die manufactured to required specifications. The division's precision tooling capabilities permit production of metal dies that incorporate a variety of details and features. A die can be reused to produce the required number of parts without degradation to the original die. The division's production of the die gives the customer an incentive to order additional units of the part from the Company. Sophia Process Investment Casting. At its Worcester, England facility, the European Aerospace Group's Casting Division uses the computerized "Sophia Process" to manufacture significantly larger, more complex castings than can be made as a single part using more traditional investment casting processes. Using this technology, the division can produce components up to 1.3 cubic meters in one piece. The European Aerospace Group is one of only four licensees of the Sophia Process, and is licensed to make and sell metal castings in the United Kingdom, Ireland, Australia, New Zealand and certain African and Asian countries. Parts made with the Sophia Process have relatively thin wall thickness but have strength and ductility values comparable to fabricated, forged and machined solid components. The Sophia Process stringently controls the heat level and process parameters to make lighter but stronger components that resist fracture and fatigue. The process reduces machining, fabrication and assembly costs by eliminating both doublers at material interfaces and the weakness and stress associated with riveted assemblies. The division uses high strength alloys with good castability to ensure that the integrity and enhanced properties from one casting are identical to the next, and to achieve the desired combination of tensile strength, ductility 10 and elongation. Parts made with the Sophia Process are used for the commercial aerospace, defense and transportation industries. Such applications include civil aircraft, military aircraft, missiles and underwater weapons applications and applications for the motorsport industry. The European Aerospace Group is using the Sophia Process to produce components for the Airbus A320, A330 and A340 aircraft, such as navigation light housings and wing tip fences, as a single part. Sand Casting. At its Sittingbourne, England facility, the European Aerospace Group's Casting Division manufactures aluminum and magnesium alloy precision sand castings, including machined and finished parts for the commercial aerospace, defense and motorsport industries. Sand casting is suitable for products that are larger than typical investment casting parts. It is also suitable for products that require heavy wall sections. These products include aircraft engine heat exchangers and air intakes, aircraft engine fuel pump housings, aircraft windscreen canopies, and high performance motorsport engine components and gearboxes. For such customer requirements, sand casting provides an effective method of producing components with strength and uniformity. The division has made significant advances in both the process and materials technology for magnesium and aluminum sand castings. The division engineers patterns utilizing computer assisted design technologies to achieve repeatable high casting integrity and enhanced mechanical properties. The division has complete non-destructive testing and inspection facilities, such as dye penetrant flaw detection and X-ray testing of components, as required by the rigorous standards of the aerospace industry. Machining. The European Aerospace Group also has a sophisticated machining center that supports the group's casting and forming operations. The group's machining facility has the technical capabilities to provide the range of machining services for complete production and finishing of components, including design, pattern production, casting and final machining of a component. The machining facility also performs specialized machining of small detail components in steel and titanium. U.S. Electronics Group The Company's U.S. Electronics Group develops, manufactures and markets a wide array of complex hermetically-sealed electronic connectors and assemblies, ceramic capacitors and filters, relays and solenoids, and flat panel display units. These products are used for specialized applications in the aerospace, defense, telecommunications, energy, medical, and electronics industries. Many of these products involve sealing and encapsulation of electronic components and are specifically engineered to withstand degradation or destruction in harsh environments, such as the ocean, space and the human body. These environments experience extremes in temperature, pressure, corrosiveness and impact that can make product repair or replacement difficult or impossible. To meet the demands of these challenging applications, the Company has developed or acquired numerous patents and many proprietary processes. Interconnect Division At its facility in Wenatchee, Washington, the U.S. Electronics Group's Interconnect Division designs and manufactures hermetically sealed electronic connectors, feedthroughs, assemblies and instrument packages. Electronics must be hermetically sealed when used in locations where the external environment can penetrate the unit. One of the division's product lines, which until July 1999 was manufactured in Butler, New Jersey, uses a cost-effective, traditional glass-to-metal seal, which provides an effective seal in less demanding environments. This technology is used for products such as waveguide windows and certain types of electronic feedthroughs. The division's second line of hermetically sealed products use a more expensive, proprietary ceramic sealant, called Kryoflex(R). The Kryoflex sealant is used in products that must withstand extremely invasive environments, such as satellite and weapons systems, implantable medical devices, down-hole oil 11 drilling tools, and the fiber optic connectors used on the International Space Station. Kryoflex has several formula variations, which make it compatible with many different metal alloys. Both the glass seal and the ceramic seal products are manufactured to customer specifications using the division's engineering and design expertise, metallurgical and ceramic analysis capabilities, ceramics formulation, laser welding, and production processes. The connectors' packages and assemblies are formed on the division's machining centers, CNC lathes, Swiss screw machines, vacuum brazing furnaces, and CNC-controlled laser welding machines. The division also has the capacity to electroplate and chemically film its products. The division also manufactures hermetically bonded products using the Company's proprietary ceramic adhesive. This ceramic adhesive bonds metals that will not normally bond, such as copper and stainless steel. When combined with the U.S. Electronics Group's explosive bonding technology, the resulting component is nearly as light as aluminum, making it the preferred product where weight minimization is important, such as in space applications. The Company also holds patents in metal matrix composite technology, which the Company believes will allow it to produce even lighter, more durable electronics packages in the future. Filter Division At its facility in Wenatchee, Washington, the U.S. Electronics Group's Filter Division designs and manufactures very small, specialized multilayer discoidal (round) ceramic capacitors and filters. These products are advanced electronic circuit filtering devices designed to filter out electromagnetic interference ("EMI") and other undesirable electrical signals that pose significant problems for the manufacturers and users of high-performance, high-reliability electronic systems operating in harsh environments. The division's products include mini screw-in filters for telecommunications, aerospace and defense applications, ring laser gyros, commercial eyelets for IFF (identification friend or foe) systems and satellite amplifiers, high reliability bolt configurations for the space shuttle's main engine controllers, filter pins, custom filter assemblies, and broad band filters for military display systems. The division produces the smallest discoidal filter in the industry. The division is an approved supplier of EMI devices to most aerospace and defense contractors, and the U.S. Electronics Group uses these filters in its own hermetically sealed electronic products. The division has a self-contained facility with plating, Swiss turning, assembly, and product testing capabilities, and has received a number of military and industry qualification ratings. Bonded Metals Division At its facility in Sequim, Washington, the U.S. Electronics Group's Bonded Metals Division bonds similar and dissimilar metals, using an explosive metallurgical welding technology. Using this technology, an explosive charge permanently fuses metals, many of which would otherwise be incompatible, such as aluminum and stainless steel. The result is a strong but lightweight metal that can be machined and welded into complex assemblies. The division finishes the metals to the customer's specifications using milling, welding, lathe and rolling techniques, and tests the finished products in its metallurgical lab using non-destructive testing such as dye penetration and ultrasonic scanning. The division also uses its explosive technology to shock-harden metals for use in applications where extremely high tensile strength is required, such as rail track intersections and switch components, and to pressure form complex metal parts. The division's explosively bonded metals are used by the U.S. Electronics Group and other customers in the aerospace, defense, energy, medical, and marine industries. Explosively bonded metals are used to fabricate products for highly specialized applications such as satellites, aircraft and missiles, where weight minimization is a critical factor. The metals are also used for products such as oil drill heads, aircraft engine heat exchange tubes, flanges, and feedthroughs for nuclear particle accelerators, where strength at high temperature and heat dissipation are critical, and for products such as naval interfaces and structures, where galvanic corrosion resistance is a requirement. 12 Display Technology Division Relays and Solenoids. At its facility in Vancouver, Washington, the U.S. Electronics Group's Display Technology Division designs, manufactures and markets electromechanical devices, such as relays, solenoids, sensors, electronic assemblies, actuators, and time delays used in a wide variety of satellite, aircraft and military hardware applications. These high reliability but low power switches use only one to ten amperes, making them suitable for applications such as satellite power bus controllers and aircraft fuel control valves, and they have been used in many space vehicles launched by the United States and European countries. The division has specialized equipment for CNC milling, turning and welding that is used for producing these products. Flat Panel Displays. The division also designs and manufactures ruggedized, optically enhanced liquid crystal displays and optical filters. These displays allow users to view the image at a much higher resolution than standard commercial units. The division's flat panel display product is an extended temperature commercial liquid crystal display sandwiched between specialized layers of glass and optical filters in the front, heating and cooling units, and a computerized optical enhancer, in the back. The entire unit is mounted in a heavy-duty housing. The flat panel display is used for high ambient light commercial applications that range from GPS displays and light control filters used on private and commercial aircraft to ground vehicle displays and automatic teller machine displays. Sales and Marketing; Distribution The Company markets its products using a combination of direct sales and outside sales representatives. In addition, the Company maintains internal customer service staff and engineering capabilities to provide technical support to customers. The Company is consolidating marketing efforts within its operating groups and expanding its direct sales forces. Currently, the U.S. Aerospace Group relies primarily on its direct sales force, but the group also maintains a sales representative network for sales in specific markets and geographic areas. The European Aerospace Group utilizes its own employee sales force for sales of its products to customers in the United Kingdom. This internal sales force is organized into two groups, one group responsible for sales of precision castings and one group responsible for metal formed products. The European Aerospace Group also uses independent agents to market its products to customers in countries other than the United Kingdom. The U.S. Electronics Group markets its products in the United States, Europe and Asia through a network of manufacturer representatives and resellers, generally established on a geographic basis. The Company believes that it has the opportunity to leverage customer relationships to supply more complete systems by providing products that combine the technologies and manufacturing abilities of its different groups. Consequently, the Company is emphasizing cross-selling efforts between its operating groups. Customers The Company's top ten customers in terms of revenues during fiscal 1999 were Boeing, PACCAR, Rolls-Royce, British Aerospace, Aermacchi, Lucas Aerospace, Northrop Grumman, Raytheon, Honeywell, and Northern Telecom. Only the first four of the top ten customers accounted for 5% or more of the Company's revenues, with Boeing at approximately 13%, PACCAR at approximately 8%, Rolls-Royce at approximately 7%, and British Aerospace at approximately 5%. Together, the top ten customers accounted for approximately 47% of the Company's sales during fiscal 1999, and no other customer accounted for more than 2% of the Company's revenues. Because of the relatively small number of customers for most of the Company's products, the Company's largest customers can influence product pricing and other terms of trade. The loss of 13 any of the Company's largest customers or reduced or canceled orders from those customers could have a material adverse effect on the Company and its financial performance. The Company's U.S. Aerospace and European Aerospace Groups currently serve substantially different customer bases in similar markets. For example, the U.S. Aerospace Group supplies components and parts to Boeing for each of Boeing's 737, 747, 757, 767 and 777 commercial aircraft construction programs. The European Aerospace Group supplies components and parts for each of Airbus' A300/310, A320 and A330/340 commercial aircraft construction programs. The Company's sales are currently divided approximately equally between the United States and Europe. One of the Company's goals is to take advantage of its position in both the United States and European markets to provide access for its U.S. groups to customers in Europe, and access for its European group to customers in the U.S., which they might not otherwise be able to serve. Consequently, the Company is emphasizing cross-marketing efforts between its European and U.S. groups. Backlog The majority of the Company's sales are made pursuant to individual purchase orders and are subject to termination by the customer upon payment of the cost of work in process plus a related profit factor. Historically, the Company has experienced no significant order cancellations. As of May 31, 1999, the Company had purchase orders and contractual arrangements evidencing anticipated future deliveries ("backlog") through fiscal year 2001 of approximately $100 million, of which approximately $80 million is expected to be delivered in fiscal year 2000. As of May 31, 1998, the Company had backlog through fiscal year 2000 of approximately $100 million. There is no assurance that backlog will be completed and booked as net sales. Cancellations of pending contracts or terminations or reductions of contracts in progress could have a material adverse effect on the Company and its financial performance. Competition The Company is subject to substantial competition in many of the markets that it serves. In the hot forming market, the Company's competitors include Die Barnes Group Inc. and GKN Westland Aerospace (North America). In the cold forming market, the Company competes with companies such as AHF and Pendle, as well as the in-house cold forming capabilities of certain of its customers, including British Aerospace. In the sand casting market, the Company competes with a number of West Coast and Midwest foundries, including ConMetco in Oregon and North Carolina, Production Pattern in California, Progress Foundry in Minnesota, and Wellman Dynamics in Iowa. The Company's competitors in the European sand casting market include SFU, Stones, Haleys, Hitchcock, and Teledyne. In the investment casting market, the Company's competitors include the Cercast Group, Tital and Tritech. In the precision machining market, the Company competes with a number of regional machine shops. In the electronics markets, the Company's competitors include Amphenol Corporation, Hermetic Seal Corporation, AVX Corporation, Spectrum Control, Inc., and Electronics Design and Communications Instruments. Many of these competitors have greater financial resources, broader experience, better name recognition and more substantial marketing operations than the Company, and represent substantial long-term competition for the Company. Components and products similar to those made by the Company can be made by competitors using a number of different manufacturing processes. The Company believes that its manufacturing processes, proprietary technologies, and experience provide significant advantages to the Company's customers, such as high quality, more complete solutions, competitive prices, and physical properties that must meet stringent demands. However, alternative forms of manufacturing can be used to produce many of the components and products made by the 14 Company. In addition, new developments by competitors are expected to continue, and the Company's competitors could develop products that are viewed by customers as more effective or more economical than the Company's product lines. The Company may not be able to compete successfully against current and future competitors, and the competitive pressures faced by the Company could have a material adverse effect on the Company and its financial performance. Raw Materials The European Aerospace Group obtains approximately 70% of its titanium from one supplier and is subject to a lead time of approximately 65 weeks in ordering and obtaining titanium. While the European Aerospace Group generally has managed the ordering process to obtain titanium when needed, a labor strike at the supplier negatively affected the group's ability to obtain timely deliveries of titanium during fiscal 1999. Although the shortage of titanium did not have a material adverse effect on the European Aerospace Group's business or on the financial condition of the Company, some business was lost due to customers' dual sourcing contracts, and some customer orders that were expected to be delivered in fiscal 1999 were delayed into fiscal 2000. The effect of the strike emphasizes the fact that a failure of the Company to obtain titanium or other raw materials when needed, or significant cost increases imposed by suppliers of raw materials such as titanium or aluminum, could have a material adverse effect on the Company and its financial performance. The Company generally has readily available sources of all raw materials and supplies it needs to manufacture its products and, where possible, the Company maintains alternate sources of supply. However, the Company does not have fixed price contracts or arrangements for all of the raw materials and other supplies it purchases. Shortages of, or price increases for, certain raw materials and supplies used by the Company have occurred in the past and may occur in the future. Future shortages or price fluctuations could have a material adverse effect on the Company's ability to manufacture and sell its products in a timely and cost-effective manner. Proprietary Rights Significant aspects of the Company's business depend on proprietary processes, know-how and other technology that are not subject to patent protection. The Company relies on a combination of trade secret, copyright and trademark laws, confidentiality procedures, and other intellectual property protection to protect its proprietary technology. However, there is no assurance that the Company's competitors may not develop or utilize technology that is the same as or similar to such technology of the Company. The Company has 32 U.S. patents, eight U.S. patent applications pending, two PCT International patent applications pending, one Canadian patent application pending, and one European patent enforceable in the U.K., most of which pertain to the U.S. Electronics Group. In addition, the European Aerospace Group has one patent application pending in several jurisdictions. There is no assurance that any of the patent applications will result in issued patents, that existing patents or any future patents will give the Company any competitive advantages for its products or technology, or that, if challenged, these patents will be held valid and enforceable. Most of the Company's issued patents expire at various times over the next 15 years, with 16 patents expiring over the next five years. Although the Company believes that the manufacturing processes of much of its patented technology are sufficiently complex that competing products made with the same technology are unlikely, there is no assurance that the Company's competitors will not design competing products using the same or similar technology after these patents have expired. Despite the precautions taken by the Company, unauthorized parties may attempt to copy aspects of the Company's products or obtain and use information that the Company regards as proprietary. Existing intellectual property laws give only limited protection with respect to such actions, and policing violations of such laws is difficult. The laws of certain countries in which the Company's 15 products are or may be distributed do not protect products and intellectual property rights to the same extent as do the laws of the United States. The Company could be required to enter into costly litigation to enforce its intellectual property rights or to defend infringement claims by others. Such infringement claims could require the Company to license the intellectual property rights of third parties. There is no assurance that such licenses would be available on reasonable terms, or at all. Environmental Matters The Company's facilities are subject to governmental laws and regulations concerning solid waste disposal, hazardous materials generation, storage, use and disposal, air emissions, waste water discharge, employee health and other environmental matters (together, "Environmental Laws"). Proper waste disposal and environmental regulation are major considerations for the Company because a number of the metals, chemicals and other materials used in and resulting from its manufacturing processes are classified as hazardous substances and hazardous wastes. If permitting and other requirements of applicable Environmental Laws are not met, the Company could be liable for damages and for the costs of remedial actions and could also be subject to fines or other penalties, including revocation of permits needed to conduct its business. Any permit revocation could require the Company to cease or limit production at one or more of its facilities, which could have a material adverse effect on the Company and its financial performance. The Company has an ongoing program of monitoring and addressing environmental matters, and from time to time in the ordinary course of business is required to address minor issues of noncompliance at its operating sites. Recently, the Company identified certain operations or processes that lacked required permits or otherwise are not in full compliance with applicable Environmental Laws. Although the Company believes these items are not material, the Company is taking steps to remedy any noncompliance. Environmental Laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with any violations. As a generator of hazardous materials, the Company is subject to financial exposure with regard to its properties even if it fully complies with these laws. In addition, certain of the Company's facilities are located in industrial areas and have lengthy operating histories. As a consequence, it is possible that historical or neighboring activities have affected properties currently owned by the Company and that, as a result, additional environmental issues may arise in the future, the precise nature of which the Company cannot now predict. There is no assurance that any present or future noncompliance with Environmental Laws or future discovery of contamination will not have a material adverse effect on the Company's results of operations or financial condition. Government Regulation Certain of the Company's products are manufactured and sold under United States government contracts or subcontracts. As with all companies that provide products or services to the United States government, the Company is directly and indirectly subject to various federal rules, regulations and orders applicable to government contractors. Some of these regulations relate specifically to the vendor-vendee relationship with the government, such as the bidding and pricing rules. Under regulations of this type, the Company must observe certain pricing restrictions, produce and maintain detailed accounting data, and meet various other requirements. The Company is also subject to many regulations affecting the conduct of its business generally. For example, in the United States the Company must adhere to federal acquisition requirements and standards established by the Occupational Safety and Health Act relating to labor practices and occupational safety standards. The Company is currently updating and implementing written policies and training programs relating to employee health and safety matters at several of its facilities. Violation of applicable government rules and regulations could result in civil liability, in 16 cancellation or suspension of existing contracts, or in ineligibility for future contracts or subcontracts funded in whole or in part with federal funds. In addition, some of the Company's customers are in the defense industry, and loss of governmental certification by such customers could have a material adverse effect on their purchases from the Company and the Company's business and financial performance. Employees As of May 31, 1999, the Company had approximately 1,157 employees, of whom approximately 1,035 were engaged in manufacturing functions, 38 in sales and marketing functions, 74 in administrative functions, and 10 in executive functions. Of the employees, approximately 283 were employed by the U.S. Aerospace Group, 573 by the European Aerospace Group, 289 by the U.S. Electronics Group, and 12 by Corporate. None of the Company's workforce in the United States is unionized. In March 1999, employees at the U.S. Aerospace Group's Casting Division voted against representation by the Teamsters Union. Certain of the European Aerospace Group's manufacturing and engineering employees are represented by labor unions, although all negotiations are carried out through employee work committees. The Company has not experienced any work stoppages, and it believes that its relationships with its employees are good. Risk Factors Acquisition Risks. The Company has pursued an aggressive growth strategy and expects to continue to evaluate and pursue potential strategic acquisitions. The success of this strategy depends upon the Company's ability to manage the risks associated with acquisitions. These risks include: o the ability of the Company to assess the value, strengths and weaknesses of acquisition candidates accurately, o the Company's effectiveness in implementing necessary changes at newly acquired subsidiaries, o possible diversion of management attention from the Company's operations, and o possible increased borrowings, disruption of product development cycles and dilution of earnings per share. The Company has recently incurred substantial losses in connection with its acquisition of Electronic Specialty Corporation, and its investment in Orca Technologies, Inc. The size of the Company's European Aerospace Group, which was acquired in July 1998, will cause it to have a significant impact on the Company's future financial results. If the Company fails to manage these or other acquisition risks, there could be a material adverse effect on the Company and its financial performance. See "- Strategies - Pursue Strategic Acquisitions," and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events Electronic Specialty Corporation Settlement" and "- Orca Technologies, Inc." Management of Growth. The Company has experienced rapid growth from both operations and acquisitions. This growth has placed and will continue to place significant demands on the Company's managerial, administrative, financial and operational resources. For example, both the Company's total number of employees and the number of its operating sites nearly doubled as a result of the Aeromet acquisition. The Company's operating divisions have had different accounting systems, which the Company has integrated or has plans to integrate. As the Company grows and becomes more complex, an increasing level of diligence in its business decisions will be necessary to comply with regulatory and accounting requirements. To manage its growth effectively, the Company must continue to improve its operational, accounting, financial and other 17 management processes and systems, and must continue to attract and retain highly skilled management and technical personnel. See "- Strategies." Significant Debt. The Company incurred substantial debt and payment obligations in order to finance the Aeromet acquisition and ongoing operations. This debt could have important consequences, such as: o making the Company unable to obtain additional financing in the future, o diverting a significant portion of the Company's cash flow to principal and interest payments and away from operations, acquisitions and capital expenditures, o increasing the Company's interest expense, and decreasing the Company's net income, o putting the Company at a competitive disadvantage in relation to competitors with less debt, or o limiting the Company's flexibility in adjusting to downturns in its business or market conditions. Ability to Make Debt Payments. The Company's future financial and operating performance will affect its ability to make payments on its debt. Since the Company's performance is affected by many factors, some of which are beyond its control, there is no assurance that the Company will have sufficient cash flow to make its debt payments when scheduled, or at all. If the Company did not have sufficient cash flow to make its debt payments, the Company could be forced to: o reduce or delay capital expenditures, o dispose of material assets or operations, potentially at a loss, o restructure or refinance its debt at potentially higher rates of interest, or o seek additional equity capital, which could dilute the value of the shares held by the Company's existing shareholders. There is no assurance that the Company would be able to achieve any of these actions on satisfactory terms or at all. In addition, if the Company were unable to repay its secured debt, the Company's secured lenders could proceed against any collateral securing that debt. Restrictive Debt Covenants. The Company is subject to a number of significant covenants under some of the agreements governing its debt. Those covenants restrict a number of corporate activities, including the ability of the Company to: o dispose of or create liens on assets, o incur additional indebtedness, o prepay or amend certain debt, o pay dividends or repurchase stock, o enter into sale and leaseback transactions, o make investments, loans or advances, o engage in acquisitions, mergers or consolidations, o make capital expenditures, o change the business conducted by the Company or its subsidiaries, or o engage in certain transactions with affiliates. The breach of any of these covenants could result in a default that would permit the lenders to declare all amounts owed by the Company to be immediately due and payable. As a result, the Company's lenders might terminate their commitments to extend further credit to the Company. In addition, if there is a change of control of the Company, the Company may be required to repay its 18 debt. Any of these events could have a material adverse effect on the Company and its financial performance. Possible Need for Additional Capital. The Company believes that its existing cash and credit facilities will be sufficient to meet the Company's currently budgeted working capital requirements for at least the next 12 months. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources." The Company's actual capital needs, however, will depend on many unpredictable factors, including: o actual revenue generated from operations, o interest due on the Company's variable rate debt, o capital expenditures required to remain competitive, and o cash required for acquired companies, future acquisitions, and financing transaction costs. As a result of these factors, the Company is unable to predict accurately the amount or timing of its future capital needs, if any. The Company's inability to obtain additional capital if and when needed could have a material adverse effect on its financial performance. Year 2000. The Company is developing and carrying out a comprehensive strategy for updating its information management and manufacturing systems for Year 2000 ("Y2K") compliance. The Company's information technology ("IT") systems include customized and standard software purchased from outside vendors. All software has been identified and is being assessed to determine the extent of renovations required in order to be Y2K compliant. The Company has identified significant non-IT systems which may be impacted by the Y2K problem, including those relating to production, processing and communication equipment and is in the process of determining through inquiries of equipment suppliers, as well as testing of such equipment, the extent of renovations required, if any. The Company believes that required renovations, validation and implementations will be completed by September 30, 1999. The Company is continuing to identify third parties with which it has a significant relationship that, in the event of a Y2K failure, could have a material impact on the Company's financial position or operating results. The Company is continuing to make inquiries of these third parties to assess their Y2K readiness. The Company expects that this process will continue throughout the remainder of calendar 1999. Worst case Y2K scenarios could be as insignificant as a minor interruption in production or shipping resulting from unanticipated problems encountered in the IT systems of the Company or any of the significant third parties with whom the Company does business. The pervasiveness of the Y2K issue makes it likely that previously unidentified issues will require remediation during the normal course of business. In such a case, the Company anticipates that transactions could be processed manually while IT and other systems are repaired and that such interruptions would have a minor effect on the Company's operations. On the other hand, a worst case Y2K scenario could be as catastrophic as an extended loss of utility service resulting from interruptions at the point of power generation, long-line transmission, or local distribution to the Company's production facilities. Such an interruption could result in an inability to provide products to the Company's customers, resulting in a material adverse effect on the Company's operating results and financial position. The Company is in the process of developing a contingency plan in the event of a catastrophic Y2K problem and expects to have a plan in place by September 30, 1999. Foreign Operations. Maintaining its European Aerospace Group subjects the Company to the risks of foreign operations. These risks include: o the Company's ability to manage operations in the United Kingdom effectively from its Wenatchee, Washington headquarters, 19 o unfavorable changes in foreign government policies, regulations, tariffs, taxes and other trade barriers, o exchange controls and limitations on dividends or other payments, and o devaluations and fluctuations in currency exchange rates. Exchange Rates. Because of its European Aerospace Group, the Company may decide to engage in hedging transactions in order to protect the Company from losses if the exchange rate between the U.S. dollar and the British pound sterling changes. However, hedging transactions may not completely offset such losses. The European Aerospace Group has a few contracts that are in European currencies other than British pounds sterling, or in U.S. dollars. The Company believes that the conversion of such currencies to the Euro will not have a material adverse effect on the European Aerospace Group's business or financial condition. Aerospace Industry Risks; Cyclicality. The Company operates in historically cyclical industries. The aerospace, defense and transportation industries are sensitive to general economic conditions and have been adversely affected by past recessions. In past years, the aerospace industry has been adversely affected by a number of factors, including increased fuel and labor costs, and intense price competition. Recently, the commercial aircraft industry has experienced a downturn in the rate of its growth due to changing economic conditions and as a result of the ongoing financial crisis in Asia, which has caused reduction in production rates for some commercial airline programs. Additional cancellations or delays in aircraft orders from Asian customers of Boeing or Airbus could reduce demand for the Company's products and could have a material adverse effect on the Company's business and financial performance. There is no assurance that this trend will not continue or that general economic conditions will not lead to a downturn in demand for core products of the Company. See "- Industry Overview." Dependence on Key Management and Technical Personnel. The Company believes that its ability to successfully implement its business strategy and to operate profitably depends significantly on the continued employment of its senior management team, led by its president, Donald A. Wright, and its significant technical personnel. The Company has key man life insurance policies on the life of Mr. Wright totaling $8 million. The Company's business and financial results could be materially adversely affected if Mr. Wright, other members of the senior management team, or significant technical personnel become unable or unwilling to continue in their present employment. In addition, the Company's growth and future success will depend in large part on its ability to retain and attract additional board members, senior managers and highly skilled technical personnel. Competition for such individuals is intense, and there is no assurance that the Company will be successful in attracting and retaining them. The Company's failure to do so could have a material adverse effect on the Company's business and financial performance. Technological Change; Development of New Products. The market for the Company's products is characterized by evolving technology and industry standards, changes in customer needs, adaptation of products to customer needs, and new product introductions. The Company's competitors from time to time may announce new products, enhancements, or technologies that have the potential to replace or render the Company's existing products obsolete. The Company's success will depend on its ability to: o enhance its current products and develop new products to meet changing customer needs, and achieve market acceptance of such products, and o anticipate or respond to evolving industry standards and other technological changes on a timely and cost-effective basis. 20 The Company's failure to do so, or any significant delay, could have a material adverse effect on the Company's business and financial performance. Product Liability. The Company is subject to the risk of product liability claims and lawsuits for harm caused by its products. The Company maintains product liability insurance with a maximum coverage of $2 million. However, there is no assurance that this insurance will be sufficient to cover any claims that may arise. A successful product liability claim in excess of the Company's insurance coverage could have a material adverse effect on the Company's business and financial performance. 21 ITEM 2. DESCRIPTION OF PROPERTY The principal executive and administrative offices of the Company are located at 430 Olds Station Road, Wenatchee, Washington. The Company's headquarters building provides approximately 18,000 square feet of office space, and is owned by the Company. The Company also leases office facilities in (a) Edmonds, Washington, for administrative offices of approximately 1,800 square feet, for a base rent of $3,187 per month, subject to annual adjustment, under a lease that expires in 2001, and (b) Bothell, Washington, of approximately 21,390 square feet, for base rent of $295,000 per year, subject to annual adjustment, under a lease that expires in 2003. The Company subleases the Bothell facility to a third party and guarantees payment of the sublease. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events - Orca Technologies, Inc." The location, use and approximate size of the Company's principal owned and leased manufacturing properties are as follows:
Approx. Own/ Annual Lease Mortgage Group Location Area Lease Rent Expiration Balance - ------------------------------------------------------------------------------------------------------------ U.S. Wenatchee, Washington 42,000 Lease $ 199,000 2007 N/A Aerospace --------------------------------------------------------------------------------------------- Entiat, Washington 84,000 Own N/A N/A $1,108,000 --------------------------------------------------------------------------------------------- Tacoma, Washington 21,700 Lease $ 78,000 2008 N/A --------------------------------------------------------------------------------------------- Sedro-Woolley, Washington 94,600 Lease $ 374,000 2003 N/A --------------------------------------------------------------------------------------------- Wenatchee, Washington 41,400 Lease $ 147,000 2001 N/A - ------------------------------------------------------------------------------------------------------------ European Sittingbourne, Welwyn Aerospace Garden City and Worcester 157,000 Lease (pound)751,000 2018 N/A --------------------------------------------------------------------------------------------- Worcester 15,000 Lease (pound) 45,000 2003 N/A --------------------------------------------------------------------------------------------- Rochester 34,000 Lease (pound)180,000 2001 N/A --------------------------------------------------------------------------------------------- Birmingham 59,000 Lease (pound)236,000 2008 N/A --------------------------------------------------------------------------------------------- Sittingbourne 7,000 Lease (pound) 45,000 2005 N/A - ------------------------------------------------------------------------------------------------------------ U.S. Wenatchee, Washington 49,000 Lease $ 240,000 2007 N/A Electronics --------------------------------------------------------------------------------------------- Sequim, Washington 18,355 Own N/A N/A None --------------------------------------------------------------------------------------------- Butler, New Jersey 30,000 Own N/A N/A None --------------------------------------------------------------------------------------------- Vancouver, Washington 50,000 Lease $ 336,000 2009 N/A - ------------------------------------------------------------------------------------------------------------
In July 1999, the Company moved the New Jersey operations of its Interconnect Division to Wenatchee, Washington. The Company has engaged a real estate broker to sell or lease the Butler, New Jersey property listed above. In connection with the Aeromet acquisition, the Company entered into a 12-month option to purchase the Sittingbourne, Worcester and Welwyn Garden City facilities that are being leased by Aeromet, for a purchase price of approximately $12.5 million in cash. The Company did not elect to exercise this option. In January 1999, the Company executed an agreement with the Port of Chelan County, Washington, giving the Company an option to purchase three parcels of land at or adjacent to its Wenatchee campus for a total of $5.4 million. The Company purchased the first parcel, for property adjacent to its Wenatchee campus, for $853,000 in cash, on February 2, 1999. If the Company exercises its options to purchase both of the remaining two parcels, the purchase of the second parcel would be expected to close in December 2000 and the third would be expected to close in August 2001. 22 ITEM 3. LEGAL PROCEEDINGS From time to time the Company is involved in legal proceedings relating to claims arising out of operations in the normal course of business. The Company is not aware of any material legal proceedings pending or threatened against the Company or any of its properties. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. 23 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED SHAREHOLDER MATTERS Market Information, Shareholders, and Dividends Until March 13, 1995, there was no public market for the Company's Common Stock. From that date through September 14, 1995, the Common Stock was listed on the Nasdaq Electronic Bulletin Board. From September 15, 1995 through July 15, 1996, the Common Stock was traded on the Nasdaq Small Cap Market System under the symbol "PCTH." Since July 16, 1996, the Company's Common Stock and Common Stock Purchase Warrants ("Warrants") have been traded on the Nasdaq National Market System under the symbols "PCTH" for the Common Stock and "PCTHW" for the Warrants. Each Warrant entitles the holder to purchase one share of Common Stock at an exercise price of $4.6875 per share. The Nasdaq National Market System reported the following range of high and low sales prices for the Common Stock and the Warrants for each calendar quarter during the period from January 1, 1997 through May 31, 1999, which covers all of the calendar quarters within the Company's 1998 and 1999 fiscal years:
Common Stock Warrants Calendar Period High Low High Low 1997 First Quarter $ 4.7500 $ 2.7500 $ 1.4063 $ .5000 Second Quarter 4.0625 2.6875 1.1875 .7188 Third Quarter 5.0625 3.7188 2.2500 1.2500 Fourth Quarter 6.8750 4.0000 2.7500 1.5000 1998 First Quarter 7.0313 4.1875 3.1250 1.1250 Second Quarter 6.9375 5.3125 3.0000 2.3750 Third Quarter 7.0000 2.7813 3.0000 1.0000 Fourth Quarter 3.0000 1.4375 1.0625 0.5000 1999 First Quarter 2.9688 1.6875 0.8750 0.3438 Second Quarter (April 1 - May 31, 1999) 2.1875 1.5000 0.5625 0.3750
As of August 24, 1999, the closing sales price on the Nasdaq National Market System for the Common Stock was $1.50 per share, and the closing sales price on the Nasdaq National Market System for the Warrants was $0.50 per Warrant. The Company has never declared or paid cash dividends on the Common Stock. The Company currently anticipates that it will retain all future earnings to fund the operation of its business and does not anticipate paying dividends on the Common Stock in the foreseeable future. The Company's agreements with its principal lender and the Indenture restrict the Company's ability to pay dividends. Common Stock As of August 24, 1999, there were 1,013 holders of record of 19,253,331 shares of fully paid and nonassessable Common Stock outstanding. The number of holders is based on the Common Stock records maintained by the Company's transfer agent. Each share of outstanding Common Stock is entitled to participate equally in dividends as and when declared by the Board of Directors of the Company, out of funds legally available therefor, and is entitled to participate equally in any distribution of net assets made to the Company's common shareholders in the event of liquidation of 24 the Company after payment to all creditors thereof. There are no preemptive rights or rights to convert Common Stock into any other securities. The holders of the Common Stock are entitled to one vote for each share held of record on all matters voted upon by the Company's shareholders and may not cumulate votes for the election of directors. Thus, the owners of a majority of the shares of the Common Stock outstanding may elect all of the directors of the Company and the owners of the balance of the shares of the Common Stock would not be able to elect any directors of the Company. Preferred Stock The Company's Board of Directors has the authority to issue shares of Preferred Stock in one or more series and to fix the powers, designations, preferences and relative, participating, optional or other rights of any series of preferred stock, including dividend rights, conversion rights, voting rights, redemption terms, liquidation preferences, sinking fund terms and the number of shares constituting any series, without shareholder approval, unless such approval is required by applicable law or by the rules of any stock exchange or automated quotation system on which securities of the Company may be listed or traded. Series A Convertible Preferred Stock In February 1997, the Board of Directors authorized the issuance of 50,000 shares of the Company's Series A Convertible Preferred Stock, which were sold to a limited number of institutional investors under Rule 506 of the Securities Act. Effective as of June 11, 1997, the Company registered for resale up to 1,948,541 shares of Common Stock underlying the Series A Convertible Preferred Stock on a Form S-3 registration statement. As of May 14, 1998, all of the Series A Convertible Preferred Stock had been converted into 1,494,593 shares of Common Stock. Series B Convertible Preferred Stock Preferred Stock Offering. In May and August 1998, the Company issued a total of 170,000 shares of Series B Convertible Preferred Stock ("Preferred Stock") and related warrants (the "Preferred Stock Warrants") to purchase 236,109 shares of Common Stock, for a total price of $17 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events - Preferred Stock Offering." Redemption. The Company may redeem the Preferred Stock at a redemption price of $115 per share upon 20-days notice to the holder if the holder does not elect to convert within 15 days of receiving a redemption notice. The Company must either redeem any Preferred Stock that it is not permitted to convert without shareholder approval under Nasdaq requirements or obtain shareholder approval for such conversion. If the Company's senior lender requires, any redemption price, or other cash payments due to the holders, must be converted into promissory notes in favor of the holder until conversion or redemption is allowed to occur. The Indenture restricts the ability of the Company to repurchase its capital stock. Conversion Shares. Upon conversion of a share of Preferred Stock, the holder will receive the number of shares of Common Stock equal to $100 divided by the then-applicable conversion price of the Preferred Stock. See "- Conversion Price", below. However, no holder of Preferred Stock is entitled to voluntarily convert Preferred Stock that would cause the holder to own more than 9.9% of the Company's outstanding Common Stock at any time. Conversion Price. The conversion price of the Preferred Stock is the lower of (a) $7.20 per share, or (b) the average of the three lowest closing bid prices per share of the Common Stock over the 22 trading days before conversion. The Company cannot issue more than 3,000,000 shares of Common Stock pursuant to conversion notices unless (1) the Company's shareholders approve the issuance of additional shares of Common Stock over the 3,000,000 shares already reserved for issuance (the 25 "Additional Shares"), or (2) the Company redeems any Preferred Stock whose conversion would cause the issuance of Additional Shares. The average conversion price that would result in the issuance of 3,000,000 shares of Common Stock is $5.67. As of August 24, 1999, 13,684 shares of Preferred Stock had been converted into 849,614 shares of Common Stock. The Indenture restricts the Company's ability to redeem its capital stock unless it meets certain conditions, and the Company expects that it would request shareholder approval to issue Additional Shares if 3,000,000 shares of Common Stock are not sufficient to cover all of the Preferred Stock to be converted. If the Company's shareholders approve the issuance of Additional Shares, the number of Additional Shares actually issued would depend on the market price of the Company's Common Stock at the time Preferred Stock is converted, and could result in the issuance of a substantial number of Additional Shares. If (a) the Company does not redeem the Preferred Stock whose conversion would cause the issuance of the Additional Shares, or (b) the Company's shareholders do not approve the issuance of Additional Shares and the Company is therefore unable to convert any of the Preferred Stock, then the Company will incur a monthly penalty of 2% of the Preferred Stock's liquidation preference until the Company redeems the Preferred Stock or obtains shareholder approval to issue the Additional Shares. Any Preferred Stock outstanding on May 15, 2003 will automatically convert into Common Stock at the then-applicable conversion price. Sale of Shares Issued Upon Conversion. Up to 3,000,000 shares of Common Stock issued upon conversion of the Preferred Stock, and the 236,109 shares issuable upon exercise of the Preferred Stock Warrants, may be sold by the holders pursuant to a registration statement on Form S-1 that was declared effective by the SEC on December 23, 1998, or under any applicable exemption from registration. The Company would also register any Additional Shares for resale. Exercise of the Preferred Stock Warrants. The Preferred Stock Warrants may be exercised after May 15, 1999 and before their expiration on May 15, 2001. The exercise price of the Preferred Stock Warrants is $7.20 per share of Common Stock. The Company intends to use the proceeds from exercise of these warrants, when and if they are exercised, primarily for working capital or other corporate purposes. Indemnification. The Company has agreed to indemnify the holders of the Preferred Stock, and those holders have agreed to indemnify the Company, against certain liabilities under the Securities Act. Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Company pursuant to the foregoing provisions, or otherwise, the Company has been advised that, in the opinion of the SEC, such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. Warrants As of August 24, 1999, the Company had outstanding warrants to purchase Common Stock as follows: o warrants to purchase 236,109 shares that (a) were issued in connection with the Preferred Stock Offering, (b) have an exercise price of $7.20 per share, and (c) expire on May 15, 2001; o publicly traded warrants to purchase 2,295,000 shares of Common Stock, that (a) were issued as part of the units sold in the Company's July 1996 registered public offering ("Units"), (b) have an exercise price of $4.6875 per share, and (c) expire in July 2001; o warrants to purchase Units consisting of 180,000 shares of registered Common Stock and publicly traded warrants to purchase 180,000 shares of Common Stock, that (a) were issued to underwriters in the July 1996 public offering, (b) have an exercise price of $3.75 per Unit, and (c) expire in July 2001; and 26 o warrants to purchase a total of 247,500 shares of Common Stock issued to several employees and consultants of the Company, that (a) have exercise prices ranging from $2.00 to $4.80 per share, and (b) expiration dates that range from May 2001 to February 2005. No holder of warrants possesses any rights as a shareholder under such warrants until exercise of such warrants. Of the shares issuable upon exercise of the employee and consultant warrants, 160,000 shares are registered under a Form S-8 registration statement, and 87,500 shares are registered for resale under a Form S-3 registration statement. Registration Rights Liviakis. 590,000 shares of restricted Common Stock held by Liviakis Financial Communications, Inc. and Robert B. Prag have certain piggyback registration rights that took effect in February 1999 after expiration of a lock-up period. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events - Issuance of Common Stock to Liviakis." These piggyback registration rights are subject to certain conditions, including the right of the Company's underwriters, if any, to limit the number of such shares included in the registration. Preferred Stock Offering. The Company would be obligated to register for resale any shares of Common Stock issuable upon conversion of Preferred Stock that would exceed 3,000,000 shares of Common Stock, if the Company's shareholders approve such issuance. Fall 1998 Common Stock Offering. The Company has agreed to register for resale the 2,585,000 shares of Common Stock sold in its Fall 1998 Common Stock Offering. However, the Company has offered to file a registration statement with respect to those shares, and, as of August 24, 1999, the holders have not elected to exercise their registration rights. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events - Fall 1998 Common Stock Offering." Anti-Takeover Laws The Company, as a Washington corporation, is subject to certain provisions of Washington law regarding significant business transactions and fair price restrictions. These provisions may have the effect of delaying or deterring a hostile takeover of the Company. Washington's "Significant Business Transactions" statute (Chapter 23B.19 of the Washington Business Corporation Act) applies to public companies that are incorporated under Washington law. The statute prohibits, subject to certain exceptions, a corporation from entering into any "significant business transactions" with an "Acquiring Person" (defined generally as a person who or an affiliated group that beneficially owns 10% or more of the outstanding voting securities of a corporation) for a period of five years after such person or affiliated group becomes an Acquiring Person unless the transaction or share acquisition made by the Acquiring Person is approved prior to the share acquisition by a majority of the target corporation's directors. In addition, this statute prohibits a corporation subject thereto from entering into a significant business transaction with an Acquiring Person unless the consideration to be received by the corporation's shareholders in connection with the proposed transaction satisfies the "fair price" provisions set forth in the statute. Transfer Agent and Registrar The Transfer Agent and Registrar for the Company's Common Stock and publicly traded Warrants is Interwest Transfer Co., Inc. 27 ITEM 6. SELECTED FINANCIAL DATA The following selected financial data presents selected historical financial data of the Company as of and for the years ended May 31, 1995, 1996, 1997, 1998, and 1999, and is derived from the Company's audited financial statements. This data should be read in conjunction with the Company's Financial Statements and Notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations.
Years Ended May 31, ------------------------------------------------------------- (in thousands, except percentage and per share data) 1995 1996 1997 1998 1999 --------- --------- --------- --------- --------- Statement of Operations Data: Net sales(1)....................... $ 11,035 $ 20,725 $ 34,175 $ 54,099 $ 107,366 Cost of sales...................... 9,092 16,439 25,969 39,487 86,094 --------- --------- --------- --------- --------- Gross profit....................... 1,943 4,286 8,206 14,612 21,272 Operating expenses................. 3,327 4,869 6,259 9,872 17,308 --------- --------- --------- --------- --------- Income (loss) from operations...... (1,384) (583) 1,947 4,740 3,964 Net interest (expense)............. (282) (498) (384) (755) (8,140) Other income (expense)............. 14 15 169 (853) (11,332) --------- --------- --------- --------- --------- Income (loss) before taxes......... (1,652) (1,066) 1,732 3,132 (15,508) Income taxes benefit (expense)..... 241 67 (50) 482 2,639 --------- --------- --------- --------- --------- Net income (loss).................. $ (1,411) $ (999) $ 1,682 $ 3,614 $ (12,869) --------- --------- --------- --------- --------- Net income (loss) per share: Basic........................... (.41) (.16) .18 .29 (.74) Diluted......................... (.41) (.16) .17 .27 (.74) Shares used in computation of income (loss) per share: Basic........................... 3,469 6,209 9,500 12,486 17,359 Diluted......................... 3,469 6,209 10,036 13,606 17,359 Other Financial Data: EBITDA(2).......................... $ (976) $ 288 $ 3,305 $ 6,944 $ 10,669 EBITDA margin(3)................... -- 1.4% 9.7% 12.8% 9.9% Depreciation and amortization...... $ 409 $ 871 $ 1,358 $ 2,204 $ 6,705 Capital expenditures............... 959 1,293 2,739 10,290 8,281 At May 31, ------------------------------------------------------------- (in thousands) 1995 1996 1997 1998 1999 --------- --------- --------- --------- --------- Balance Sheet Data: Cash and cash equivalents.......... $ 1,079 $ 725 $ 3,048 $ 11,461 $ 8,134 Working capital.................... 1,758 952 13,090 25,599 38,329 Total assets....................... 11,630 27,649 35,752 78,580 158,727 Long-term debt (including current portion)........................ 3,902 6,404 4,233 11,233 83,410 Shareholders' equity............... 5,454 12,539 25,619 56,142 54,019 - -------------- (1) The increases in net sales are attributable to acquisitions by the Company and internal growth. See "Description of Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." (2) "EBITDA" represents income (loss) from operations plus depreciation and amortization expense. EBITDA should not be construed as an alternative to (i) net income, as defined by generally accepted accounting principles, as an indicator of the Company's operating performance or (ii) cash flow, as defined by generally accepted accounting principles, as a measure of liquidity. (3) "EBITDA margin" represents EBITDA as a percent of net sales.
28 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- This section and the "Description of Business" section of this Form 10-K contain "forward-looking statements." These forward-looking statements are not guarantees of the Company's future performance. They are subject to risks and uncertainties related to business operations, some of which are beyond the Company's control. Any of these risks or uncertainties may cause actual results or future circumstances to differ materially from the forward-looking statements set forth in this section under the captions "Overview" and "Liquidity and Capital Resources," and in "Description of Business" under each of the captions in that section. - -------------------------------------------------------------------------------- Overview The Company has been an active consolidator of companies, and its results of operations have been substantially affected by acquisitions. The Company has acquired and integrated eleven companies since 1990. See "Description of Business - Corporate History." These acquisitions, as well as internal growth in the Company's existing and acquired businesses, have resulted in substantial increases in net sales. The Company's operating expenses and margins and other expenses also have been affected by certain expenses directly associated with the acquisitions and related capital raising transactions. The Company has experienced substantial increases in all other expense categories as a result of the increases in its operations. A portion of these expenses is attributable to the assimilation of acquired operations into the Company's existing businesses. In July 1998, the Company acquired Aeromet International PLC ("Aeromet"). Aeromet is a manufacturer of magnesium and aluminum precision sand and investment castings, and of titanium and aluminum formed sheet products, with five locations in England. The Aeromet acquisition has had a significant effect on the Company's operations and on comparisons of income, expense, and balance sheet items in periods after July 1998. The Company's financial results for fiscal 1999 include ten months of operations of Aeromet. Substantially all of the Company's revenues are generated by sales to customers in the commercial aerospace, defense, electronics, and transportation industries, with commercial aerospace and defense industry sales being the most significant. The commercial aerospace and defense industries are cyclical in nature and subject to changes based on general economic conditions, and on commercial airline industry, defense and government spending. See "Description of Business - Industry Overview" and " - Risk Factors - Aerospace Industry Risks; Cyclicality." The Company's operations focus on developing, manufacturing and marketing high performance electronics and metal components and assemblies. The Company's electronics products are characterized by relatively low volumes and high margins. In comparison, volumes have historically been higher and margins lower for the Company's metals products. The Company believes that margins will remain higher for electronic and assembled products than for its metals products. Products incorporating both electronics and metal parts are expected to generate margins closer to electronics product margins. As a result of margin differences, changes in product mix among its electronics, assembled and metals products can be expected to affect overall margins for the Company. The Company's sales are not subject to significant seasonal fluctuations. However, production and resulting sales are subject to the number of working days in any given period. Results for various periods may vary materially due to the number of working days available in any period. Management believes that the Company's operations for the periods discussed have not been adversely affected by inflation. 29 Results of Operations For an understanding of the significant factors that influenced the Company's performance during the past three fiscal years, the following discussion should be read in conjunction with the consolidated financial statements of the Company presented in this Form 10-K. The following table sets forth for the periods indicated certain historical statement of operations data of the Company expressed in dollars (in thousands) and as a percentage of net sales.
Years Ended May 31, ------------------------------------------------------------------------------------------------------ 1995 1996 1997 1998 1999 ------------------ ------------------ ------------------ ------------------ ------------------ Net sales.................. $ 11,035 100.0% $ 20,725 100.0% $ 34,175 100.0% $ 54,099 100.0% $ 107,366 100.0% Cost of sales.............. 9,092 82.4 16,439 79.3 25,969 76.0 39,487 73.0 86,094 80.2 ------------------ ------------------ ------------------ ------------------ ------------------ Gross profit............... 1,943 17.6 4,286 20.7 8,206 24.0 14,612 27.0 21,272 19.8 Operating expenses......... 3,327 30.1 4,869 23.5 6,259 18.3 9,872 18.2 17,308 16.1 ------------------ ------------------ ------------------ ------------------ ------------------ Income (loss) from operations............... (1,384) (12.5) (583) (2.8) 1,947 5.7 4,740 8.8 3,964 3.7 Net interest expense....... (282) (2.6) (498) (2.4) (384) (1.1) (755) (1.4) (8,140) (7.6) Other income (expense)..... 14 0.1 15 - 169 0.5 (853) (1.6) (11,332) (10.6) Income tax benefit (expense)................ 241 2.2 67 0.3 (50) (0.1) 482 0.9 2,639 2.5 ------------------ ------------------ ------------------ ------------------ ------------------ Net income (loss).......... $ (1,411) (12.8)% $ (999) (4.9)% $ 1,682 5.0% $ 3,614 6.7% $ (12,869) (12.0) ================== ================== ================== ================== ================== EBITDA..................... $ (976) (8.8)% $ 288 1.4% $ 3,305 9.7% $ 6,944 12.8% $ 10,669 9.9% ================== ================== ================== ================== ==================
Year Ended May 31, 1999 Compared to Year Ended May 31, 1998 Net Sales. Net sales increased by $53.3 million, or 98.5%, to $107.4 million for fiscal 1999 from $54.1 million in fiscal 1998. The significant increase in net sales for fiscal 1999 from fiscal 1998 included a significant net sales contribution from Aeromet ($52.8 million), and an increase in sales of electronic products for aerospace, satellite and weapons systems (a $3.5 million increase), offset by a decrease in commercial aerospace and transportation net sales (a $3.0 million decrease). The commercial aerospace industry net sales decrease was primarily attributable to decreases in production of certain aircraft models and inventory minimization initiatives at Boeing. The Company completed the Aeromet acquisition in July 1998. This acquisition expanded the Company's operations to the European aerospace and defense markets, as well as adding to the Company's core competencies in casting and forming. See "Description of Business - Corporate History" and "- Products, Processes and Markets - European Aerospace Group." Accordingly, net sales for fiscal 1999 included ten months of operations of Aeromet, contributing $52.8 million in net sales. Gross Profit. Gross profit increased by $6.7 million, or 45.9%, to $21.3 million for fiscal 1999 from $14.6 million in fiscal 1998. As a percentage of net sales, gross profit decreased to 19.8% in fiscal 1999 from 27.0% in fiscal 1998. This percentage decrease was primarily attributable to three factors. First, the addition of Aeromet has caused consolidated average margins to be lower because casting segment gross profits have been historically lower, generally in the 18% to 22% range (gross profits on Aeromet net sales for fiscal 1999 were 20%). Second, commercial aerospace net sales decreased during fiscal 1999. Third, the Company recorded approximately $2.2 million in non-recurring adjustments to inventories, which reduced gross profits 2.1% for fiscal 1999. Operating Expenses. Operating expenses increased by $7.4 million, or 75.3%, to $17.3 million for fiscal 1999 from $9.9 million in fiscal 1998. The Aeromet acquisition added $3.6 million, corporate operational costs added $2.0 million, and the remainder of $2.2 million was attributable to general cost increases in operating businesses. As a percentage of net sales, operating expenses decreased from 18.2% to 16.1%. 30 EBITDA. EBITDA, as defined, increased by $3.7 million, or 53.6%, to $10.7 million for fiscal 1999 from $6.9 million in fiscal 1998. As a percentage of net sales, EBITDA decreased to 9.9% in fiscal 1999 from 12.8% in fiscal 1998. The decrease in EBITDA as a percentage of net sales during this period was primarily attributable to $2.2 million in non-recurring adjustments to inventories recorded during the year and the decreased gross profit due to the decline in commercial aerospace net sales and Aeromet's lower margins. Net Interest Expense. Net interest expense increased $7.4 million, or 980.1%, to $8.1 million for fiscal 1999 from $755,000 in fiscal 1998. This increase was primarily due to the Company's financing of the Aeromet acquisition in July 1998 with the issuance of $75.0 million of 11 1/4% senior subordinated notes (a $7.7 million increase in interest expense and the associated amortization of issuance costs). Other Income (Expense). Other income (expense) represents non-recurring and non-operational income and expense for the period. Other expense increased to $11.3 million in fiscal 1999 from $853,000 in fiscal 1998. This increase of $10.5 million was due principally to a $7.8 million write-down of the Company's investment in Orca Technologies, Inc., a write-off of $2.0 million of goodwill, net, associated with the acquisition of Electronic Specialty Corporation ("ESC") in April 1998, and a $1.1 million write-down for long-lived asset impairment at ESC. Net Income. Net income decreased $16.5 million, to a $12.9 million loss for fiscal 1999 from a $3.6 million income in fiscal 1998, primarily as a result of the factors discussed above. Income tax benefit increased $2.1 million, to $2.6 million for fiscal 1999 from $482,000 in fiscal 1998, primarily as a result of the net operating losses incurred in fiscal 1999. Year Ended May 31, 1998 Compared to Year Ended May 31, 1997 Net Sales. Net sales increased by $19.9 million, or 58%, to $54.1 million for fiscal 1998 from $34.2 million in fiscal 1997. The significant increase in net sales for fiscal 1998 from fiscal 1997 included increases in both commercial aerospace industry net sales (an $11.3 million increase) and defense industry net sales (a $3.5 million increase). The commercial aerospace industry net sales increase was primarily attributable to increases in production at Boeing and the related increase in demand from that customer for the Company's precision cast and machined products. The defense industry net sales increase was primarily attributable to an increase in orders of aerospace, satellite and weapons systems electronics products. Commercial aerospace industry net sales comprised 42.6% of total net sales in fiscal 1998, up from 34.5% of net sales in fiscal 1997. Defense industry sales comprised 19.9% of total net sales in fiscal 1998, down from 21.3% of net sales in fiscal 1997. The Company completed its acquisition of Balo Precision Parts, Inc. ("Balo") in February 1998 and its ESC acquisition effective as of March 1998. These acquisitions expanded production of hermetically sealed product offerings and added relay, solenoid and flat panel display product lines. See "Description of Business - Corporate History" and "- Products, Processes and Markets - U.S. Electronics Group." Accordingly, net sales for fiscal 1998 also included approximately four months of operations of Balo and three months of operations for ESC, contributing approximately $4.3 million to net sales in fiscal 1998. 31 Gross Profit. Gross profit increased by $6.4 million, or 78.0%, to $14.6 million for fiscal 1998 from $8.2 million in fiscal 1997. As a percentage of net sales, gross profit increased to 27.0% in fiscal 1998 from 24.0% in fiscal 1997, which was primarily attributable to increased efficiencies gained in manufacturing processes and in-house production of processes that had previously been purchased from outside vendors. The Company also believes that capital investments in equipment and production processes contributed to the improvement in gross profit margins. Operating Expenses. Operating expenses increased by $3.6 million, or 57.1%, to $9.9 million for fiscal 1998 from $6.3 million in fiscal 1997, partially due to the Balo and ESC acquisitions and increased levels of operations in fiscal 1998. As a percentage of net sales, operating expenses remained essentially unchanged. EBITDA. EBITDA increased by $3.6 million, or 109.1%, to $6.9 million for fiscal 1998 from $3.3 million in fiscal 1997. As a percentage of net sales, EBITDA increased to 12.8% in fiscal 1998 from 9.7% in fiscal 1997. The increase in EBITDA as a percentage of net sales during this period was primarily attributable to production efficiencies and improved capacity utilization. Net Interest Expense. Net interest expense increased $371,000, or 96.6%, to $755,000 for fiscal 1998 from $384,000 in fiscal 1997. This increase was primarily due to the Company's financing of capital equipment purchases and debt incurred to finance the expansion of its Wenatchee facilities to support growth in net sales. Other Income (Expense). Other income (expense) represents non-recurring and non-operational income and expense for the period. Other expense increased to $853,000 in fiscal 1998 from income of $169,000 in fiscal 1997. This increase of $1,022,000 was due principally to a $1.0 million write-off of portions of notes receivable and associated debt restructuring and related expenses in connection with the termination of the Company's efforts during the third quarter of fiscal 1998 to form an information technology group. Net Income. Net income increased $1.9 million, or 111.8% to $3.6 million for fiscal 1998 from $1.7 million in 1997, primarily as a result of the factors discussed above. Year Ended May 31, 1997 Compared to Year Ended May 31, 1996 Net Sales. Net sales increased by $13.5 million, or 65.2%, to $34.2 million for fiscal 1997 from $20.7 million in fiscal 1996. This increase was primarily attributable to larger order sizes for electronics products, due to broader market acceptance of the Company's electronics products and technologies, which increased sales of higher priced products and added new customers. The Company acquired Northwest Technical Industries, Inc. ("NTI") in April 1997, which added capabilities for explosive bonding of specialty metals. See "Description of Business - Corporate History" and "- Products, Processes and Markets - U.S. Electronics Group." Accordingly, net sales for fiscal 1997 included one month of operations of NTI, which contributed $183,000 to total net sales for that year. Gross Profit. Gross profit increased by $3.9 million, or 90.7%, to $8.2 million for fiscal 1997, up from $4.3 million in fiscal 1996. As a percentage of net sales, gross profit increased to 24.0% in fiscal 1997 from 20.7% in fiscal 1996. The increase in gross profit as a percentage of net sales was primarily attributable to achieving revenue levels which allowed for production efficiencies and increased capacity utilization. The Company also believes that its investments in manufacturing equipment contributed to improvements in gross profit margins. Operating Expenses. Operating expenses increased by $1.4 million, or 28.6%, to $6.3 million for fiscal 1997, from $4.9 million for fiscal 1996. As a percentage of net sales, operating expenses 32 decreased to 18.3% in fiscal 1997 from 23.5% in fiscal 1996. The substantial decrease in operating expenses as a percentage of net sales was primarily attributable to the Company's improved ability to leverage its operating costs and the consolidation of certain operations to the Company's Wenatchee manufacturing campus. Specifically, both Ceramic Devices, Inc. in the U.S. Electronics Group and Cashmere Manufacturing Co., Inc. in the U.S. Aerospace Group were consolidated into the Company's Wenatchee manufacturing campus. See "Description of Business - Products, Processes and Markets - U.S. Electronics Group" and "- U.S. Aerospace Group." EBITDA. EBITDA increased by $3.0 million, or 1,000.0%, to $3.3 million for fiscal 1997, up from $300,000 for fiscal 1996. As a percentage of net sales, EBITDA increased to 9.7% in fiscal 1997, from 1.4% in fiscal 1996. The substantial increase in EBITDA as a percentage of net sales was primarily attributable to efficiencies gained in manufacturing processes, consolidation of certain operations to the Company's Wenatchee campus allowing for overhead efficiencies, and increases in net sales not requiring incremental increases in operating expenses. Net Interest Expense. Net interest expense decreased $114,000, or 22.9%, to $384,000 for fiscal 1997 from $498,000 in fiscal 1996, primarily as a result of the repayment of debt that was funded by proceeds from a July 1996 public and a February 1997 private offering of equity securities, and the reduction of bank line of credit balances throughout the year. Other Income (Expense). Other income increased to $169,000 in fiscal 1997 from income of $15,000 in fiscal 1996, primarily as a result of sale of scrap and recycling of excess materials in the manufacturing process. Net Income. Net income increased $2.7 million to $1.7 million for fiscal 1997 from a loss of $999,000 in fiscal 1996, primarily as a result of factors discussed above. Liquidity and Capital Resources Cash used in operating activities was $372,000 for fiscal 1999 compared to cash provided by operating activities of $1.6 million in fiscal 1998. The change in net cash from operations was primarily a result of the net loss for the year and decreases in accounts payable, accrued liabilities and other liabilities, partially offset by decreases in inventories. Cash used in investing activities increased from $16.7 million in fiscal 1998 to $79.3 million in fiscal 1999, an increase of $62.6 million. The change results primarily from the Company's acquisition of Aeromet in July 1998 ($69.4 million) and increased investment in property and equipment of $8.0 million in fiscal 1999 compared to $6.5 million in fiscal 1998, partially offset by a $4.8 million decrease in issuance of notes receivable. Cash generated from financing activities increased by $52.9 million, to $76.4 million in fiscal 1999, from $23.5 million in fiscal 1998. During fiscal 1999, the Company completed several financing transactions. As a result, the Company received net proceeds of: (i) $71.7 million from the issuance of senior subordinated notes to support the Aeromet acquisition; (ii) $4.9 million from the sale of Common Stock; and (iii) $6.6 million from the sale of Series B Convertible Preferred Stock. Cash generated by the debt and equity financing transactions was offset to a certain degree by payments on long-term debt and capital leases of $5.8 million and financing costs of $1.0 million during fiscal 1999. At May 31, 1999, the Company's primary banking relationships include a revolving line of credit of up to $6.3 million for the Company's U.S. operations, which expires in September 1999, and a revolving line of credit up to approximately $7.2 million (4.5 million pounds sterling) for the Company's U.K. operations, which expired in July 1999. The Company is currently negotiating with 33 its lenders to renew these lines of credit. As of May 31, 1999, both revolving lines of credit were unused. Capital expenditures, other than for the Aeromet acquisition, were approximately $8.1 million in fiscal 1999. Of this amount, $2.7 million was for a building and land and approximately $5.4 million was for equipment. Included in the amount spent for capital equipment was the purchase of substantially all the assets of Lyden Castparts, Inc. ("Lyden") from a related party by the Company's Aeromet America, Inc. subsidiary. The purchase price consisted of approximately $642,000 of Lyden's liabilities, which the Company paid, plus approximately $300,000 in assumed liabilities consisting primarily of trade payables. On June 1, 1999, the Company acquired all of the stock of Skagit Engineering & Manufacturing, Inc. for $1.3 million in cash. The Company has also entered into a letter of intent to acquire Nova-Tech Engineering, Inc. ("Nova-Tech"). The Company is negotiating the terms of a stock purchase agreement with Nova-Tech's shareholders and expects that the purchase price will consist of approximately $2.7 million in cash and $250,000 in stock. The Company expects that the definitive stock purchase agreement will contain conditions to closing, including receipt of a letter ruling from the Internal Revenue Service that is necessary to permit Nova-Tech's Employee Stock Ownership Plan to sell its Nova-Tech stock on the terms anticipated. The Company is providing services to Nova-Tech under an Operating Agreement dated April 23, 1999. As of May 31, 1999, the Company had loaned $735,000 to Nova-Tech for working capital. As of August 19, 1999, the Company had loaned Nova-Tech an additional $1,365,000. These loans have been made under the terms of two demand notes dated April 26, 1999 and August 5, 1999, each of which is secured by substantially all of the assets of Nova-Tech. As of May 31, 1999, the Company had no other material commitments outstanding for purchases of additional capital assets. In December 1998, the Company entered into an agreement giving it the option to purchase three parcels of land that make up its Wenatchee campus from the Port of Chelan County for $5.4 million. The purchase of the first parcel was completed in early February 1999. If the Company exercises its options to purchase both of the remaining two parcels, the purchase of the second parcel is expected to close in December 2000 and the third is expected to close in August 2001. The Company's working capital, as of May 31, 1999 and 1998 was $38.3 million and $25.6 million, respectively. The increase in working capital in fiscal 1999 over fiscal 1998 was primarily the result of debt and equity financing activities. In July 1998, the Company completed an offering of $75.0 million of 11 1/4% senior subordinated notes (the "Old Notes") to qualified institutional buyers to finance the Aeromet acquisition. In February 1999, the Company exchanged the Old Notes for new senior subordinated notes (the "Notes") of an equal principal amount. The Notes will mature on August 1, 2005, unless previously redeemed. The Notes will be redeemable at the option of the Company on or after August 1, 2003. In addition, on or before August 1, 2001, the Company may redeem up to 20% of the original aggregate principal amount of the Notes, subject to certain conditions. See "- Significant Events - Aeromet Acquisition." The Company believes that the current cash balances and credit facilities, plus cash from future operations, will be sufficient to meet the Company's operating cash requirements and to fund budgeted capital expenditures. The Company may, however, need to issue more equity in the future to fund possible acquisition opportunities, or to fund the eventual redemption or repayment of the Notes used to finance the Aeromet acquisition. With the acquisition of Aeromet, whose functional currency is the British pound sterling, the Company translates the activity of Aeromet into U.S. dollars on a monthly basis. The balance sheet of Aeromet is translated using the exchange rate as of the date of the balance sheet, and for purposes of the statement of operations and statement of cash flows the Company uses the weighted average exchange rate for the period. The value of the Company's assets, liabilities, revenue, and expenses may vary materially from one reporting period to the next solely as a result of varying exchange rates. The 34 Company is in the process of developing a comprehensive foreign currency hedging policy but has not entered into any hedging activity as of May 31, 1999. The Company does not expect any material changes in the results of operations or in operating procedures due to the conversion to the "Euro" by eleven countries in the European Union on January 1, 1999. The Company expects to continue to transact business using primarily the U.S. dollar and the British pound sterling. At May 31, 1999, the Company had net operating loss (NOLs) carryforwards for federal income tax purposes of approximately $14.0 million, the benefits of which expire in the tax year 2001 through the tax year 2019. The NOLs created by the Company's subsidiaries prior to their acquisition, and the NOLs created as a consolidated group or groups subsequent to a qualifying tax free merger or acquisition, have limitations related to the amount of usage by each subsidiary or consolidated group as described in the Internal Revenue Code. As a result of these limitations, approximately $1.0 million of the $14.0 million of NOLs will never become available. At May 31, 1999, the Company recorded a valuation allowance of $2.2 million because management believed that it was uncertain that some portion or all of the deferred tax assets would be realized. At May 31, 1999, the Company had net deferred tax assets of $4.3 million, the realization of which is dependent on material increases over present levels of pre-tax income, primarily in the United States. The Company expects to achieve these increases through continued integration, cross selling, and operational efficiencies of its businesses. The Company anticipates that its effective income tax rate will continue to approach the statutory rate in the future. In addition, undistributed earnings of the Company's foreign subsidiaries, for which no U.S. income taxes have been provided, aggregated approximately $3.7 million at May 31, 1999. No provision for foreign withholding or U.S. federal income taxes was made for the undistributed earnings, as it is management's intention that earnings will be reinvested indefinitely in foreign operations or will be remitted substantially free of additional taxes. Significant Events Aeromet Acquisition Acquisition Transaction. On July 30, 1998, Pacific Aerospace & Electronics (UK) Limited ("PA&E-UK"), a company organized under the laws of the United Kingdom and an indirect wholly-owned subsidiary of the Company, purchased all of Aeromet's issued and outstanding capital stock. The Aeromet acquisition was made pursuant to a Share Acquisition Agreement dated July 1, 1998, between Charles Baynes plc, Westpark Limited (an affiliate of Charles Baynes plc), PA&E-UK, and the Company. In consideration for PA&E-UK's acquisition of all of Aeromet's issued and outstanding capital stock, the Company delivered to Westpark Limited (pound)42 million (or approximately $69 million) in cash. The purchase price was determined in arms-length negotiations between Charles Baynes plc and the Company. See "Description of Business - Risk Factors - Acquisition Risks." Rule 144A Offering. The Company funded the Aeromet acquisition from the net proceeds of the sale of the Old Notes. Subject to the terms and conditions of a Purchase Agreement (the "Purchase Agreement"), dated July 23, 1998, between the Company, the Company's U.S. subsidiaries, and the initial purchasers, the initial purchasers agreed to purchase, and the Company agreed to sell, the Old Notes in the aggregate principal amount of $75 million. The Old Notes were issued pursuant to an Indenture, dated July 30, 1998 (the "Indenture") between the Company, its U.S. subsidiaries and IBJ Schroder Bank & Trust Company (now known as IBJ Whitehall Bank & Trust Company), as trustee (the "Trustee"). In February 1999, the Company exchanged the Old Notes for new senior subordinated notes (the "Notes") of an equal principal amount and registered the Notes on a Form S-4 Registration Statement, which was declared effective on January 22, 1999. The terms of the Notes are substantially identical to the terms of the Old Notes, except that they are not subject to transfer restrictions or registration rights, unless held by certain broker-dealers, affiliates or certain other persons. The Notes (a) are senior subordinated, unsecured, general obligations of the Company, (b) 35 will mature on August 1, 2005, unless previously redeemed pursuant to the Indenture, and (c) are jointly and severally guaranteed on a senior subordinated basis by each of the Company's U.S. operating subsidiaries. The Company is subject to a number of restrictive covenants under the Indenture. In addition, if there is a change of control of the Company's Common Stock, the Company may be required to repay the Notes. See "Description of Business - Risk Factors - Restrictive Debt Covenants." Issuance of Common Stock to Liviakis In February 1998, the Company entered into a financial services agreement with Liviakis Financial Communications, Inc. ("Liviakis") to provide financial and public relations services to the Company. In connection with that consulting agreement, the Company issued to Liviakis and Robert B. Prag, one of its principals, warrants to purchase an aggregate of 1,290,000 shares of Common Stock for $4.62 per share. In August 1998, the Company, Liviakis and Mr. Prag entered into an agreement in which (a) a finder's fee claim by Liviakis against the Company was resolved in exchange for the Company's issuance of an aggregate of 590,000 shares of Common Stock to Liviakis and Mr. Prag under the exemption from registration provided in Section 4(2) of the Securities Act, and (b) Liviakis and Mr. Prag transferred the warrants previously issued to them to the Company for cancellation. No commissions were paid in connection with issuance of the shares to Liviakis and Mr. Prag. Reduction of Long-Term Debt During September 1998, the Company paid off a note in the amount of $4.0 million. In connection with the payoff, the Company accelerated recognition of $160,000 of related loan fees, which is included in interest expense for fiscal 1999. Preferred Stock Offering In August 1998, the Company completed an offering (the "Preferred Stock Offering") of its Series B Convertible Preferred Stock (the "Preferred Stock") and related warrants by issuing (a) an additional 70,000 shares of Preferred Stock, and (b) additional related warrants to purchase 97,221 shares of Common Stock, in exchange for a purchase price of $7,000,000, which had been held in escrow pending completion of the Aeromet acquisition. When combined with the first Preferred Stock Offering closing in May 1998, the Company issued a total of 170,000 shares of Preferred Stock and related warrants to purchase 236,109 shares of Common Stock, for a total gross purchase price of $17 million. See "Market for Common Equity and Related Shareholder Matters - Preferred Stock - Series B Convertible Preferred Stock." On October 30, 1998, the Company filed a Form S-1 Registration Statement covering resale of up to 3,000,000 shares of Common Stock issuable upon conversion of the Preferred Stock and 236,109 shares issuable upon exercise of the related warrants. The Registration Statement was declared effective on December 23, 1998. Fall 1998 Common Stock Offering In November 1998, the Company issued an aggregate of 2,585,000 shares of Common Stock to accredited investors under Rule 506 of Regulation D, in exchange for aggregate cash consideration of $5,170,000. The Company paid $310,200 in commissions to the placement agent in connection with the offering. The Company agreed to file a registration statement registering these shares for resale during April 1999. The Company offered to file such a registration statement prior to that date, but as of August 24, 1999, the investors have not elected to have the Company proceed with the registration. Electronic Specialty Corporation Settlement In April 1999, the Company reached a settlement with Deltec Holdings, Inc. ("Deltec Holdings") and certain parties related to Deltec Holdings, with respect to the purchase of the Company's wholly- 36 owned subsidiary, ESC. As of March 1, 1998, a wholly-owned subsidiary of the Company purchased substantially all of the assets of Deltec Holdings, which had been known as Electronic Specialty Corporation (the "ESC Acquisition"). In consideration for the purchase, the Company delivered to Deltec Holdings $2 million in cash and 923,304 shares of restricted Common Stock. The number of shares issued was determined based on a per share value of $6.4984, which was the average closing price of the Company's Common Stock on the Nasdaq National Market System for the 20 consecutive trading days preceding the closing date. In June 1998, the Company terminated ESC's president. The Company subsequently became aware of certain differences between ESC's actual financial condition and the financial condition represented by Deltec Holdings in the closing documents. The Company took a number of actions, including reducing ESC's workforce, appointing a new general manager, and reassessing ESC's business opportunities and relationships with customers and suppliers. During the first quarter of fiscal 1999, the Company wrote off its goodwill in ESC in the amount of $3,581,000, and during the second quarter of fiscal 1999, the Company recorded a $1.6 million non-recurring inventory write-down due to the discontinuation of an unprofitable product line. In the fourth quarter of fiscal 1999, the Company recorded a $1.1 million non-recurring charge for the impairment of long-lived assets at ESC. The Company made claims against Deltec Holdings based on Deltec Holdings' representations and warranties in the Asset Purchase Agreement related to the ESC acquisition. The parties settled those claims on April 2, 1999, and Deltec Holdings agreed to return to the Company for cancellation 225,000 of the shares of Common Stock that it received as part of the purchase price. The settlement resulted in the Company recognizing a non-recurring gain of $1.4 million during the fourth quarter of fiscal 1999. Orca Technologies, Inc. At May 31, 1999, the Company held 2,289,309 shares (the "Orca Shares") of common stock of Orca Technologies, Inc. ("Orca"), which, to the Company's knowledge, constituted approximately 14% of Orca's issued and outstanding common stock. The Company acquired 179,600 of the Orca Shares in a market transaction, and acquired the other 2,109,709 of the Orca Shares pursuant to an April 1998 restructuring agreement between Orca and the Company. In the restructuring agreement, the Company (a) canceled certain loans owed it by Orca in exchange for the 2,109,709 shares of Orca's common stock, (b) agreed to continue guaranteeing Orca's credit facility of $1.3 million and an equipment lease of $373,000 for equipment used by Orca's then-subsidiary, Televar, Inc., and (c) accepted a $950,000 promissory note from Orca (the "Orca Note") as payment for certain third-party notes then owned by the Company. See "Notes to Consolidated Financial Statements - Note 8" in the Company's financial statements for May 31, 1999. The Orca Note accrues interest at 8% per annum, requires interest-only payments for the first year, and requires fully amortizing monthly payments of principal plus interest for the final four years of the note. The Company also sublets its Bothell, Washington office space to Orca for a base rent of approximately $32,000 per month. As of May 31, 1998, the Company recorded a temporary unrealized loss, included in stockholders' equity, on the Orca Shares of $436,000. During the year ended May 31, 1999, the Company determined that the decline of the stock price was other than a temporary decline in the fair value and recorded a loss of $4.9 million, which included the previous temporary unrealized loss and is included in other expense. At May 31, 1999, the carrying value of the Company's investment in the Orca Shares was $72,000. In addition, the Company recorded an allowance for certain expenses and the guarantee of Orca's line of credit totaling approximately $2.0 million, which has been included in other expense. On June 29, 1999, the Company, as guarantor of Orca's line of credit, advanced $300,000 for a partial repayment of the line of credit required by the lender. As of May 31, 1999, Orca was ten months delinquent in its interest payments, and the Company had not received the scheduled principal payments as outlined in the Orca Note. The Company had reserved $250,000 of 37 the Orca Note in the fourth quarter of fiscal 1998, and during fiscal 1999, the Company reserved the remaining balance of $700,000, which has been included in other expense. As of May 31, 1999, Orca was also ten months delinquent on its lease payments to the Company. The Company has retained a real estate broker and is negotiating to sublease the Bothell space to a third party. Year 2000 The Company is developing and carrying out a comprehensive strategy for updating its information management and manufacturing systems for Year 2000 compliance. The Company's information technology ("IT") systems include customized and standard software purchased from outside vendors. All software has been identified and is being assessed to determine the extent of renovations required in order to be Y2K compliant. The Company believes that all software has been made Y2K compliant through vendor-provided updates or replacement with other Y2K compliant hardware and software. The Company has identified significant non-IT systems which may be impacted by the Y2K problem, including those relating to production, processing and communication equipment and is in the process of determining through inquiries of equipment suppliers, as well as testing of such equipment, the extent of renovations required, if any. The Company believes that required renovations, validation and implementations will be completed by September 30, 1999. The Company is continuing to identify third parties with which it has a significant relationship that, in the event of a Y2K failure, could have a material impact on the Company's financial position or operating results. The third parties include energy and utility suppliers, creditors, material and product suppliers, communication vendors and the Company's significant customers. These relationships, especially those associated with certain suppliers and customers, are material to the Company and a Y2K failure by one or more of these parties could result in a material adverse effect on the Company's operating results and financial position. The Company is continuing to make inquiries of these third parties to assess their Y2K readiness. The Company expects that this process will continue throughout the remainder of calendar 1999. The Company expects that costs to address Y2K issues will total approximately $250,000, of which approximately $125,000 was spent in fiscal 1999, with the remainder being spent during fiscal 2000. Costs include salary and fringe benefits for personnel, hardware and software costs, and consulting and travel expenses associated, directly or indirectly, with addressing Y2K issues. Y2K issues have received a high priority within the Company and, as a result, certain other IT projects have been delayed. While such non-Y2K projects are expected to enhance operational efficiencies and improve the quality of information available to management, the delay of such projects is not expected to have a material adverse impact on the Company's operations. Worst case Y2K scenarios could be as insignificant as a minor interruption in production or shipping resulting from unanticipated problems encountered in the IT systems of the Company or any of the significant third parties with whom the Company does business. The pervasiveness of the Y2K issue makes it likely that previously unidentified issues will require remediation during the normal course of business. In such a case, the Company anticipates that transactions could be processed manually while IT and other systems are repaired and that such interruptions would have a minor effect on the Company's operations. On the other hand, a worst case Y2K scenario could be as catastrophic as an extended loss of utility service resulting from interruptions at the point of power generation, long-line transmission, or local distribution to the Company's production facilities. Such an interruption could result in an inability to provide products to the Company's customers, resulting in a material adverse effect on the Company's operating results and financial position. The Company is in the process of developing a contingency plan in the event of a catastrophic Y2K problem and expects to have a plan in place by September 30, 1999. 38 New Accounting Pronouncements In April 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. This accounting standard, which is effective for fiscal years beginning after December 15, 1998, requires that certain costs of start-up activities and organization costs be expensed as incurred. The adoption of SOP 98-5 is not expected to have a material effect on the Company's financial position or results of operations. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires the recognition of all derivatives in the consolidated balance sheet as either assets or liabilities measured at fair value. SFAS No. 133 was effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137, which delays implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations. 39 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has financial instruments that are subject to interest rate risk, primarily debt obligations issued at a fixed rate. However, fixed-rate debt obligations issued by the Company are generally not callable until maturity. The fair value of such instruments approximates their face value except for the Notes which, as of May 31, 1999, were trading on the open market for approximately 75% of face value. The Company does not consider the market risk exposure for interest rates to be material. The Company is subject to foreign currency exchange rate risk relating to receipts from and payments to suppliers in foreign currencies. Since approximately 50% of the Company transactions are conducted in foreign currency, the exchange rate risk could be material. The Company is in the process of developing a comprehensive foreign currency hedging policy but had not entered into any hedging activity as of May 31, 1999. The Company is exposed to commodity price fluctuations through purchases of aluminum and other raw materials. The Company enters into certain supplier agreements that guarantee quantity and price of the applicable commodity to limit the exposure to commodity price fluctuations and availability concerns. At May 31, 1999, the Company had purchase commitments for raw materials aggregating $4,414,000. The Company holds an investment in the common stock of a public company. The Company is exposed to risks associated with the quoted equity price of the common stock. At May 31, 1999, the carrying value of the investment was $72,000. 40 ITEM 8. FINANCIAL STATEMENTS INDEPENDENT AUDITORS' REPORT The Board of Directors Pacific Aerospace & Electronics, Inc.: We have audited the accompanying consolidated balance sheets of Pacific Aerospace & Electronics, Inc. and subsidiaries as of May 31, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. The accompanying consolidated statements of operations, stockholders' equity, and cash flows of Pacific Aerospace & Electronics, Inc. for the year ended May 31, 1997 were audited by other auditors whose report thereon dated July 2, 1997, expressed an unqualified opinion on those statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pacific Aerospace & Electronics, Inc. and subsidiaries as of May 31, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity, and cash flows for the years then ended in conformity with generally accepted accounting principles. /s/ KPMG LLP Seattle, Washington July 16, 1999, except as to note 24 which is as of August 19, 1999 41 INDEPENDENT AUDITORS' REPORT The Board of Directors Pacific Aerospace & Electronics, Inc.: We have audited the accompanying consolidated statements of operations, stockholders' equity, and cash flows of Pacific Aerospace & Electronics, Inc. and subsidiaries for the year ended May 31, 1997. This consolidated financial statement is the responsibility of the Company's management. Our responsibility is to express an opinion on this consolidated financial statement based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statement referred to above presents fairly, in all material respects, the results of operations and cash flows of Pacific Aerospace & Electronics, Inc. and subsidiaries for the year ended May 31, 1997 in conformity with generally accepted accounting principles. /s/ MOSS ADAMS LLP Everett, Washington July 2, 1997 42
PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Consolidated Balance Sheets May 31, 1998 and 1999 Assets 1998 1999 -------------- -------------- Current assets: Cash and cash equivalents $ 11,461,000 8,134,000 Accounts receivable, net of allowance for doubtful accounts of $130,000 in 1998 and $355,000 in 1999 9,375,000 24,992,000 Inventories 16,184,000 24,616,000 Deferred income taxes 386,000 880,000 Prepaid expenses and other 272,000 2,316,000 -------------- -------------- Total current assets 37,678,000 60,938,000 -------------- -------------- Property, plant and equipment, net 26,335,000 45,279,000 -------------- -------------- Other assets: Notes receivable from related parties 700,000 1,458,000 Investment 4,579,000 72,000 Costs in excess of net book value of acquired subsidiaries, net of accumulated amortization of $439,000 in 1998 and $1,430,000 in 1999 6,515,000 41,052,000 Patents, net of accumulated amortization of $307,000 in 1998 and $407,000 in 1999 1,229,000 1,255,000 Deferred financing costs, net of accumulated amortization of $664,000 in 1999 -- 5,029,000 Deferred income taxes 222,000 3,395,000 Other 1,322,000 249,000 -------------- -------------- Total other assets 14,567,000 52,510,000 -------------- -------------- $ 78,580,000 158,727,000 ============== ============== Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 6,748,000 10,484,000 Accrued liabilities 2,370,000 5,615,000 Accrued interest 217,000 2,813,000 Current portion of long-term debt 1,027,000 1,278,000 Current portion of capital lease obligations 206,000 297,000 Line of credit 1,511,000 -- Other current liabilities -- 2,122,000 -------------- -------------- Total current liabilities 12,079,000 22,609,000 Long-term liabilities: Long-term debt, net of current portion 9,059,000 5,220,000 Capital lease obligations, net of current portion 941,000 1,615,000 Senior subordinated notes payable -- 75,000,000 Deferred rent and other 359,000 264,000 -------------- -------------- Total liabilities 22,438,000 104,708,000 -------------- -------------- Stockholders' equity: Series B convertible preferred stock, $0.001 par value, 5,000,000 shares authorized, 100,000 shares issued and outstanding at May 31, 1998 and 161,035 shares issued and outstanding at May 31, 1999 -- -- Common stock, $0.001 par value, 100,000,000 shares authorized, 15,395,723 and 18,932,779 shares issued and outstanding at May 31, 1998 and 1999, respectively 15,000 19,000 Additional paid-in capital 57,830,000 69,276,000 Cumulative other comprehensive loss (436,000) (1,140,000) Accumulated deficit (1,267,000) (14,136,000) -------------- -------------- Total stockholders' equity 56,142,000 54,019,000 Commitments, contingencies and subsequent events -- -- -------------- -------------- $ 78,580,000 158,727,000 ============== ============== See accompanying notes to consolidated financial statements.
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PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended May 31, 1997, 1998 and 1999 1997 1998 1999 -------------- -------------- -------------- Net sales $ 34,175,000 54,099,000 107,366,000 Cost of sales 25,969,000 39,487,000 86,094,000 -------------- -------------- -------------- Gross profit 8,206,000 14,612,000 21,272,000 Operating expenses 6,259,000 9,872,000 17,308,000 -------------- -------------- -------------- Income from operations 1,947,000 4,740,000 3,964,000 -------------- -------------- -------------- Other income (expense): Interest income 126,000 110,000 532,000 Interest expense (510,000) (865,000) (8,672,000) Other 169,000 (853,000) (11,332,000) -------------- -------------- -------------- (215,000) (1,608,000) (19,472,000) -------------- -------------- -------------- Income (loss) before income tax benefit (expense) 1,732,000 3,132,000 (15,508,000) Income tax benefit (expense) (50,000) 482,000 2,639,000 -------------- -------------- -------------- Net income (loss) 1,682,000 3,614,000 (12,869,000) -------------- -------------- -------------- Other comprehensive income (loss): Foreign currency translation -- -- (1,727,000) Income tax benefit -- -- 587,000 Valuation of available for sale securities -- (436,000) 436,000 -------------- -------------- -------------- Total other comprehensive loss -- (436,000) (704,000) -------------- -------------- -------------- Comprehensive income (loss) $ 1,682,000 3,178,000 (13,573,000) ============== ============== ============== Net income (loss) per share: Basic $ 0.18 0.29 (0.74) Diluted 0.17 0.27 (0.74) Shares used in computation of net income (loss) per share: Basic 9,499,980 12,486,077 17,359,491 Diluted 10,035,846 13,606,061 17,359,491 See accompanying notes to consolidated financial statements.
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PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended May 31, 1997, 1998 and 1999 Acc- Series A Series B umulated convertible convertible other Total preferred stock preferred stock Common stock Additional compre- Acc- stock --------------- --------------- ------------------- paid-in hensive umulated holders' Shares Amount Shares Amount Shares Amount capital loss deficit equity ------- ------- ------- ------- ---------- -------- ---------- ---------- ---------- ---------- Balance at May 31, 1996 -- $ -- -- $ -- 7,478,309 $ 8,000 19,094,000 -- (6,563,000) 12,539,000 Sale of common stock -- -- -- -- 2,264,400 2,000 5,347,000 -- -- 5,349,000 Issuance of warrants -- -- -- -- -- -- 16,000 -- -- 16,000 Issuance of common stock in connection with an acquisition -- -- -- -- 477,540 -- 1,552,000 -- -- 1,552,000 Sale of preferred stock for cash 50,000 -- -- -- -- -- 4,481,000 -- -- 4,481,000 Net income -- -- -- -- -- -- -- -- 1,682,000 1,682,000 ------- ------- ------- ------- ---------- -------- ---------- ---------- ---------- ---------- Balance at May 31, 1997 50,000 -- -- -- 10,220,249 10,000 30,490,000 -- (4,881,000) 25,619,000 Issuance of common stock -- -- -- -- 8,559 -- 13,000 -- -- 13,000 Sale of common stock for cash -- -- -- -- 524,000 1,000 2,222,000 -- -- 2,223,000 Increase in preferred stock, net of issuance costs -- -- 100,000 -- -- -- 9,260,000 -- -- 9,260,000 Issuance of warrants -- -- -- -- -- -- 444,000 -- -- 444,000 Exercise of warrants for cash, net of tax effects of $99,000 -- -- -- -- 795,000 1,000 3,723,000 -- -- 3,724,000 Issuance of common stock on conversion of convertible notes and accrued interest of $154,000 -- -- -- -- 1,405,018 1,000 5,518,000 -- -- 5,519,000 Exercise of options for cash -- -- -- -- 25,000 -- 53,000 -- -- 53,000 Issuance of common stock on conversion of preferred stock (50,000) -- -- -- 1,494,593 1,000 (1,000) -- -- -- Unrealized losses on available for sale securities -- -- -- -- -- -- -- (436,000) -- (436,000) Issuance of common stock in connection with acquisition -- -- -- -- 923,304 1,000 6,108,000 -- -- 6,109,000 Net income -- -- -- -- -- -- -- -- 3,614,000 3,614,000 ------- ------- ------- ------- ---------- -------- ---------- ---------- ---------- ---------- Balance at May 31, 1998 -- -- 100,000 -- 15,395,723 15,000 57,830,000 (436,000) (1,267,000) 56,142,000 Issuance of preferred stock, net of issuance costs of $370,000 -- -- 70,000 -- -- -- 6,630,000 -- -- 6,630,000 Issuance of common stock for services -- -- -- -- 590,000 1,000 1,769,000 -- -- 1,770,000 Cancellation of warrants -- -- -- -- -- -- (360,000) -- -- (360,000) Valuation of available for sale securities -- -- -- -- -- -- -- 436,000 -- 436,000 Foreign currency translation adjustment, net of tax effect of $587,000 -- -- -- -- -- -- -- (1,140,000) -- (1,140,000) Issuance of common stock on conversion of Series B preferred stock -- -- (8,965) -- 545,114 -- -- -- -- -- Issuance of common stock under employee stock purchase plan, net of related expenses of $4,000 -- -- -- -- 41,942 -- 72,000 -- -- 72,000 Sale of common stock for cash, net of issuance costs of $344,000 -- -- -- -- 2,585,000 3,000 4,823,000 -- -- 4,826,000 Common shares redeemed in connection with a prior acquisition -- -- -- -- (225,000) -- (1,488,000) -- -- (1,488,000) Net loss -- -- -- -- -- -- -- -- (12,869,000)(12,869,000) ------- ------ ------- ------- ---------- -------- ---------- ---------- ---------- ---------- Balance at May 31, 1999 -- $ -- 161,035 $ -- 18,932,779 $ 19,000 69,276,000 (1,140,000)(14,136,000) 54,019,000 ======= ====== ======= ======= ========== ======== ========== ========== ========== ========== See accompanying notes to consolidated financial statements.
45
PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended May 31, 1997, 1998 and 1999 1997 1998 1999 ------------- ------------- ------------- Cash flow from operating activities: Net income (loss) $ 1,682,000 3,614,000 (12,869,000) Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,358,000 2,204,000 6,705,000 Amortization of deferred finance costs -- -- 664,000 Allowance on note receivable and guarantees -- 250,000 2,884,000 Unrealized loss on investment -- -- 4,943,000 Loss on restructuring of note receivable -- 1,038,000 -- Loss recorded on impairment of long lived assets -- -- 3,275,000 Loss on sale of property, plant and equipment -- -- 86,000 Director compensation paid in common stock 44,000 13,000 -- Consulting services paid through issuance of stock options and warrants 6,000 139,000 -- Federal income tax benefit -- (1,200,000) (4,287,000) Changes in operating assets and liabilities: Accounts receivable (1,774,000) (2,286,000) (121,000) Inventories (1,951,000) (3,387,000) 2,751,000 Prepaid expenses and other current assets (178,000) 474,000 (421,000) Other assets 44,000 (1,176,000) 1,077,000 Accounts payable, accrued liabilities and other liabilities 557,000 1,911,000 (5,059,000) ------------- ------------- ------------- Net cash provided by (used in) operating activities (212,000) 1,594,000 (372,000) ------------- ------------- ------------- Cash flow from investing activities: Sale (purchase) of certificate of deposit (1,000,000) 1,000,000 -- Proceeds from stock subscription receivable 1,030,000 -- -- Acquisition of property, plant and equipment (2,100,000) (6,509,000) (8,040,000) Proceeds from sale of property, plant and equipment -- -- 104,000 Acquisition of subsidiaries -- (4,318,000) (69,752,000) Acquisition of patents -- -- (128,000) Acquisition of investment -- (742,000) -- Issuance of notes receivable -- (6,261,000) (1,458,000) Payments received on note receivable from related party 58,000 125,000 -- ------------- ------------- ------------- Net cash used in investing activities (2,012,000) (16,705,000) (79,274,000) ------------- ------------- ------------- Cash flow from financing activities: Net repayments under line of credit (1,224,000) (358,000) (1,511,000) Decrease in restricted cash 1,000,000 -- -- Proceeds from long-term debt and convertible notes 237,000 10,125,000 1,442,000 Payments on long-term debt and capital leases (5,686,000) (1,503,000) (5,752,000) Proceeds from sale of common stock, net 5,739,000 2,223,000 4,898,000 Proceeds from sale of preferred stock, net 4,481,000 9,260,000 6,630,000 Proceeds from issuance of senior subordinated notes, net -- -- 71,731,000 Proceeds from exercise of stock options and warrants -- 3,777,000 -- Payment of financing costs -- -- (1,013,000) ------------- ------------- ------------- Net cash provided by financing activities 4,547,000 23,524,000 76,425,000 ------------- ------------- ------------- Effect of exchange rates on cash -- -- (106,000) ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents 2,323,000 8,413,000 (3,327,000) Cash and cash equivalents at beginning of year 725,000 3,048,000 11,461,000 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 3,048,000 11,461,000 8,134,000 ============= ============= ============= See accompanying notes to consolidated financial statements.
46
PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued Years ended May 31, 1997, 1998 and 1999 1997 1998 1999 ------------- ------------- ------------- Supplemental cash flow: Cash paid during the year for: Interest $ 613,000 712,000 5,296,000 Federal income taxes 18,000 521,000 411,000 Acquisition of subsidiaries: Fair value of assets acquired and resulting goodwill, excluding cash 1,928,000 10,034,000 86,593,000 Liabilities assumed 482,000 3,925,000 16,811,000 Common stock issued 1,446,000 6,109,000 -- Noncash investing and financing activities: Seller financed acquisition of property, plant and equipment 639,000 3,336,000 241,000 Seller financed acquisition of patents 35,000 -- -- Conversion of notes and accrued interest to common stock -- 5,519,000 -- Restructuring of certain notes receivable for an investment in common stock -- 6,053,000 -- Property, plant, and equipment included in accounts payable -- 445,000 -- Deferred portion of common stock issued for consulting services -- 305,000 -- Long-term debt retired through acquisition of subsidiary -- 139,000 -- Reclassification of property, plant and equipment to other assets -- -- 1,217,000 ============= ============= ============= See accompanying notes to consolidated financial statements.
47 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (1) Description of Business and Basis of Presentation (a) Description of Business Pacific Aerospace & Electronics, Inc., headquartered in Wenatchee, Washington, is an international engineering and manufacturing company which develops, manufactures and markets high performance electronic and metal components and assemblies for the aerospace, defense, electronics and transportation industries. The consolidated financial statements include the accounts of Pacific Aerospace & Electronics, Inc. and its wholly-owned subsidiaries (collectively, the "Company"). (b) Basis of Presentation These consolidated financial statements are prepared in accordance with generally accepted accounting principles (GAAP) in the United States (U.S.) and present the financial position, results of operations and changes in financial position of the Company and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Certain 1997 and 1998 amounts have been reclassified to conform with the 1999 presentation. (2) Summary of Significant Accounting Principles (a) Cash and Cash Equivalents Cash and cash equivalents consist of cash, demand deposits with banks and highly liquid investments with maturity dates at purchase of three months or less. (b) Inventories Inventories are stated at the lower of cost, primarily determined by the first-in, first-out method, or market (replacement cost for raw materials and net realizable value for work in progress and finished goods). (c) Property, Plant and Equipment Property, plant and equipment are stated at cost. Property, plant and equipment under capital leases are stated at the lower of the fair market value of the assets or the present value of minimum lease payments at the inception of the leases. Depreciation and amortization are calculated using the straight-line method over the estimated useful lives of the owned assets ranging from 5 years for certain machinery and equipment to 40 years for certain buildings. Property, plant and equipment held under capital leases are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease terms, ranging from 7 to 10 years. 48 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) Expenditures for maintenance and repairs are charged to expense as incurred. Upon sale or retirement, the cost and related accumulated depreciation or amortization are removed from the accounts and any resulting gain or loss is reflected in other income or expense. (d) Investment At May 31, 1998 and 1999, the Company had an investment in the common stock, registered and unregistered shares, of a public company of less than 20%. The investment is classified as an available-for-sale security in accordance with Statements of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, and is reported at fair value, with temporary unrealized gains and losses excluded from the statements of operations and reported as a separate component of stockholders' equity. Unrealized losses which are determined to be other-than-temporary are included in other income or expense in the statements of operations. Fair value of the registered shares of common stock at May 31, 1998 and 1999, and unregistered shares at May 31, 1998 is determined as the quoted value of the stock in the over-the-counter market, without any discounts for large blocks or unregistered shares. Fair value of the unregistered shares at May 31, 1999 is determined based on expected net realizable value. There is no assurance that such values will be realizable upon liquidation or sale. (e) Intangible Assets Costs in excess of net book value of acquired subsidiaries are amortized using the straight-line method over a period ranging from 15 to 40 years from the date of acquisition. Purchased patents are recorded at cost. Developed patents are recorded at the value of the related compensation awarded. Patents are amortized using the straight-line method over the estimated useful lives of the patents ranging from 10 to 17 years. Deferred financing costs were incurred in connection with the Senior Subordinated Note offering and are being amortized using the straight-line method over the seven year life of the notes. (f) Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. 49 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (g) Revenue Recognition Revenue is recognized when products are shipped to customers and when services are earned. (h) Research and Development Research and development costs are expensed as incurred and are included in cost of sales. (i) Income Taxes The Company follows the asset and liability method of accounting for income taxes. Under the asset and liability method of accounting for income taxes, deferred tax assets and liabilities are recognized based on the estimated future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. (j) Stock-Based Compensation The Company follows the provisions of SFAS No. 123, Accounting for Stock-Based Compensation. This statement permits a company to choose either a new fair-value method or the Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, intrinsic-value based method of accounting for stock-based compensation arrangements. SFAS No. 123 requires pro forma disclosure of net income (loss) and earnings (loss) per share computed as if the fair-value based method had been applied in financial statements of companies that continue to account for such arrangements under APB Opinion No. 25. The Company has elected to continue to record stock-based compensation using the APB Opinion No. 25 intrinsic-value-based method and, therefore, the adoption of SFAS No. 123 has not impacted the Company's financial positions, results of operations, or liquidity. (k) Net Income (Loss) Per Share Basic income (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted income (loss) per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period using the treasury stock method. As the Company had a net loss for the year ended May 31, 1999, basic and diluted net loss per share are the same. 50 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (l) Foreign Currency The functional currency of the Company's foreign subsidiaries is the local currency of the country in which the subsidiary is incorporated. Assets and liabilities of foreign operations are translated into U.S. dollars using rates of exchange in effect at the end of the reporting period. Income and expense accounts are translated into U.S. dollars using average rates of exchange during the reporting period. The net gain or loss resulting from translation is shown as a foreign currency translation adjustment and is included in accumulated other comprehensive income (loss) in stockholders' equity. Gains and losses from foreign currency transactions are included in other income or expense in the consolidated statements of operations. There were no significant foreign currency transaction gains or losses for the years ended May 31, 1997, 1998 and 1999. (m) Comprehensive Income (Loss) On June 1, 1998, the Company adopted the provisions of SFAS No. 130, Reporting Comprehensive Income, which establishes standards for the reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of consolidated financial statements. The Company's comprehensive income (loss) primarily consists of the valuation of available-for-sale securities and foreign currency translation adjustments. (n) Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (o) New Accounting Pronouncements In April 1998, the Accounting Standards Executive Committee issued Statement of Position 98-5, Reporting on the Costs of Start-Up Activities. This accounting standard, which is effective for fiscal years beginning after December 15, 1998, requires that certain costs of start-up activities and organization costs be expensed as incurred. The adoption of SOP 98-5 is not expected to have a material effect on the Company's financial position or results of operations. 51 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires the recognition of all derivatives in the consolidated balance sheet as either assets or liabilities measured at fair value. SFAS No. 133 was effective for fiscal years beginning after June 15, 1999. In June 1999, the FASB issued SFAS No. 137 which delays implementation of SFAS No. 133 until fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 is not expected to have a material effect on the Company's financial position or results of operations. (3) Segment Information and Concentration of Risk The Company is organized into three operational segments, "U.S. Aerospace," "European Aerospace," and "U.S. Electronics." The Aerospace segments are primarily comprised of machined and cast metal product operations. Net sales of the Aerospace segments include sales to customers in the aerospace, defense and transportation industries. Net sales of the Electronics segment also include sales to customers in the aerospace and defense industries. Historically, these segments have been cyclical and sensitive to general economic and industry specific conditions. In particular, the aerospace industry, in recent years, has been adversely affected by a number of factors, including reduced demand for commercial aircraft, a decline in military spending, postponement of overhaul and maintenance of aircraft, increased fuel and labor costs, increased regulations, intense price competition, among other factors. In addition, there is no assurance that general economic conditions will not lead to a downturn in demand for core components and products of the Company, in each of its operational segments. Presented below is the Company's operational segment information. In addition, all operational segments identified as "U.S." and the Corporate are located within the U.S. while the operations and assets of the "European Aerospace" segment are located within the United Kingdom. Identifiable assets are those assets used in the Company's operations in each segment, and do not include advances or loans between the business segments. Corporate assets are identified below, and no allocations were necessary for assets used jointly by the segments. 52 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) Year ended May 31, 1997:
Corporate, U.S. European U.S. other and Aerospace Aerospace Electronics eliminations Total -------------- -------------- -------------- -------------- -------------- Net sales to customers $ 22,949,000 -- 11,226,000 -- 34,175,000 Net sales between segments 151,000 -- -- (151,000) -- Income (loss) from operations 1,043,000 -- 2,203,000 (1,299,000) 1,947,000 Identifiable assets 21,011,000 -- 11,419,000 3,322,000 35,752,000 Capital expenditures 1,961,000 -- 778,000 -- 2,739,000 Depreciation and amortization 897,000 -- 461,000 -- 1,358,000 Interest income 13,000 -- -- 113,000 126,000 Interest expense 297,000 -- 131,000 82,000 510,000
Year ended May 31, 1998: Corporate, U.S. European U.S. other and Aerospace Aerospace Electronics eliminations Total -------------- -------------- -------------- -------------- -------------- Net sales to customers $ 34,146,000 -- 19,953,000 -- 54,099,000 Net sales between segments 162,000 -- 5,000 (167,000) -- Income (loss) from operations 4,665,000 -- 2,454,000 (2,379,000) 4,740,000 Identifiable assets 29,761,000 -- 28,943,000 19,876,000 78,580,000 Capital expenditures 4,212,000 -- 1,333,000 4,745,000 10,290,000 Depreciation and amortization 1,301,000 -- 855,000 48,000 2,204,000 Interest income -- -- 46,000 64,000 110,000 Interest expense 381,000 -- 104,000 380,000 865,000
53 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued)
Year ended May 31, 1999: Corporate, U.S. European U.S. other and Aerospace Aerospace Electronics eliminations Total -------------- -------------- -------------- -------------- -------------- Net sales to customers $ 31,096,000 52,814,000 23,456,000 -- 107,366,000 Net sales between segments 239,000 -- -- (239,000) -- Income (loss) from operations 2,148,000 6,983,000 (1,281,000) (3,886,000) 3,964,000 Identifiable assets 26,655,000 90,125,000 21,735,000 20,212,000 158,727,000 Capital expenditures 1,681,000 1,556,000 2,332,000 2,712,000 8,281,000 Depreciation and amortization 1,659,000 3,170,000 1,684,000 192,000 6,705,000 Interest income -- 17,000 19,000 496,000 532,000 Interest expense 419,000 3,516,000 202,000 4,535,000 8,672,000
The Company had net sales to two customers, each comprising greater than 10% of net sales, aggregating 43% and 45% in the years ended May 31, 1997 and 1998, respectively. The Company had net sales to one customer comprising greater than 10% of net sales, aggregating 13% in the year ended May 31, 1999. The Company had accounts receivable from two customers, each comprising greater than 10% of accounts receivable, aggregating 25% in the year ended May 31, 1998. The Company had accounts receivable from one customer comprising greater than 10% of accounts receivable, aggregating 11% in the year ended May 31, 1999. Credit is extended to customers based on an evaluation of their financial condition and collateral is generally not required. The Company currently purchases aluminum and other raw materials from a limited number of suppliers. Although there are a limited number of potential suppliers of such raw materials, management believes that other suppliers could provide these raw materials on comparable terms. A change in suppliers, however, could cause a delay in manufacturing, increased costs, and a possible loss of sales, which could have a material adverse effect on the manufacturing and delivery of the Company's products. The Company purchased $2,570,000, $2,723,000 and $6,570,245 from one supplier during the years ended May 31, 1997, 1998 and 1999, respectively. The Company purchases other raw materials, of lesser significance, which are available from a limited number of suppliers. At May 31, 1999, the Company had purchase commitments for raw materials aggregating $4,414,000 and equipment aggregating $881,000. 54 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (4) Business Acquisitions In April 1997, the Company acquired all of the assets and assumed certain liabilities of Northwest Technical Industries, Inc. The asset purchase price consisted of 477,540 shares of the Company's common stock valued at $1,552,000. Costs in excess of net book value of $270,000 were recorded as a result of this acquisition. Effective for accounting purposes in February 1998, the Company acquired substantially all of the assets and assumed certain liabilities of PCC Composites, Inc.'s operating unit, Balo Precision Parts. The purchase price consisted of $2.25 million in cash and resulted in costs in excess of net book value of $1,029,000. Effective for accounting purposes in March 1998, the Company acquired substantially all assets and certain liabilities of Electronic Specialty Corporation and its wholly-owned subsidiary, Displays & Technologies, Inc. (collectively "ESC"). The purchase price consisted of $2.0 million in cash, 923,304 shares of the Company's common stock valued at $6,109,000, and acquisition costs of $77,000 for a total of $8,186,000. The purchase price and related acquisition costs were allocated as follows: Current assets $ 4,066,000 Equipment 4,364,000 Other non-current assets 50,000 Cost in excess of net book value 3,631,000 Liabilities assumed (3,925,000) ------------ Total $ 8,186,000 ============ During the year ended May 31, 1999, the Company made claims against the previous owner of ESC based on certain representations and warranties in the purchase agreement. In April 1999, the previous owner of ESC agreed to return 225,000 of the Company's common shares previously received in the acquisition. In July 1998, the Company purchased all of the outstanding stock of Aeromet International PLC (Aeromet). The purchase price consisted of (pound)42,000,000 (approximately $68,875,000) in cash and acquisition costs of $542,000 for a total of $69,417,000. The purchase price and related acquisition costs were allocated as follows: Current assets $ 27,529,000 Equipment 18,177,000 Cost in excess of net book value 39,884,000 Liabilities assumed (16,173,000) ------------ Total $ 69,417,000 ============ 55 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) The business combinations described above have been accounted for using the purchase method. Accordingly, assets and liabilities have been recorded at their fair value at acquisition date. Operating results of these acquired companies are included in the Company's consolidated statements of operations from the respective acquisition dates. The following summary, prepared on a pro forma basis, presents the unaudited consolidated condensed results of operations of the Company, as if the aforementioned business acquisitions were made as of the first day of the immediately preceding fiscal year in which the entity was acquired. There are no material adjustments which impact the summary.
Year ended May 31 (unaudited) --------------------------------- 1998 1999 --------------- --------------- Net sales $ 119,798,000 117,368,000 Income from operations 6,278,000 4,096,000 Net income (loss) 1,118,000 (14,286,000) Net income (loss) per share: Basic 0.08 (0.82) Diluted 0.08 (0.82) Shares used in computation of net income (loss) per share: Basic 13,287,961 17,359,491 Diluted 14,407,945 17,359,491
The pro forma results are not necessarily indicative of the actual results of operations that would have occurred had the transactions been consummated as of the date indicated nor are they intended to indicate results that may occur in the future. (5) Inventories Inventories at May 31 consist of the following:
1998 1999 --------------- --------------- Raw materials $ 5,789,000 7,374,000 Work in progress 5,683,000 11,478,000 Finished goods 4,712,000 5,764,000 --------------- -------------- $ 16,184,000 24,616,000 =============== ==============
56 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (6) Property, Plant and Equipment Property, plant and equipment, including assets under capital lease arrangements, at May 31 consist of the following:
1998 1999 --------------- --------------- Land $ 1,171,000 2,028,000 Buildings 4,380,000 8,765,000 Leasehold improvements 1,738,000 2,285,000 Machinery and equipment 18,331,000 38,687,000 Furniture and fixtures 2,494,000 3,099,000 --------------- -------------- 28,114,000 54,864,000 Less accumulated depreciation and amortization 5,108,000 10,295,000 --------------- -------------- 23,006,000 44,569,000 Construction and purchases in progress 3,329,000 710,000 --------------- -------------- $ 26,335,000 45,279,000 =============== ==============
The Company recognized depreciation of property, plant and equipment of $1,103,000, $1,851,000 and $5,448,000 during the years ended May 31, 1997, 1998 and 1999, respectively. Included in property, plant and equipment are costs of $1,402,000 and $3,244,000 and related accumulated amortization of $208,000 and $893,000 recorded under capital leases at May 31, 1998 and 1999, respectively. (7) Notes Receivable from Related Parties At May 31, 1999, the Company had notes receivable from two individual entities in which the Company has entered into signed letters of intent to purchase. The first, which is due on demand subsequent to December 15, 1999, allows for a maximum draw of $1.5 million and bears interest at a fixed rate of 7.5%. The note had an outstanding balance of $735,000 at May 31, 1999. The second note, which is due on demand, allows for a maximum draw of $750,000 and bears interest at a fixed rate of 7.5%. The note had an outstanding balance of $723,000 at May 31, 1999. The Company to which the second note relates was acquired subsequent to year-end (see note 24). Each note is secured by substantially all of the assets of the respective entity. The Company has classified these notes as noncurrent at May 31, 1999. See note 8 for a discussion of the related party note receivable at May 31, 1998. 57 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (8) Investments At May 31, 1998 and 1999, the Company held an interest in the common stock, registered and unregistered shares of a public company of less than 20%. The investment consists of shares which were purchased on the open market and shares which were obtained in conjunction with the settlement of certain outstanding notes receivable from the public company under an April 1998 restructuring agreement. Under the restructuring agreement, the public company agreed to convert notes, previously issued to the Company by the public company and its subsidiaries, into shares of the public company stock at $2.00 per share. In addition, the public company agreed to grant the Company demand registration rights for those shares and, in the event of an underwritten public offering, piggyback registration rights, which will be effective after the earliest of (a) the closing of the public company's third round of financing, or (b) the first anniversary of the closing of the restructuring agreement. The Company also agreed to continue guaranteeing the public company's credit facility of $1.3 million and an equipment lease of $373,000. As of May 31, 1998, the Company recorded a temporary unrealized loss, included in stockholders' equity, on the shares of $436,000. During the year ended May 31, 1999, the Company determined that the decline of the stock price was other than a temporary decline in the fair value and recorded a loss of $4,943,000 which included the previous temporary unrealized loss and is included in other expense. At May 31, 1999, the registered shares are valued at the quoted market price while the unregistered shares are valued at expected net realizable value. In addition, the Company recorded an allowance for certain expenses and the guarantee of the public company's line of credit totaling approximately $2 million which has been included in other expense. In the restructuring agreement, the public company also agreed to purchase certain other notes and interests of the Company (including warrants and interests in a lawsuit and bankruptcy action) for a $950,000 promissory note from the public company. The note accrues interest at 8% per annum, requires interest-only payments for the first year, and requires fully amortizing monthly payments of principal plus interest for the final four years of the note. As of May 31, 1999, the Company has not received the scheduled principal or interest payments as outlined in the note. As a result, the Company has fully reserved the note and related interest receivable as of May 31, 1999. Certain of the Company's officers were directors of the public company through June 1997, and certain of the Company's former directors were also directors of the public company through January 1998. In addition, certain officers of the Company were individual shareholders of the public company until such shares were sold in May 1998. Certain directors and officers of the Company personally guaranteed certain debt of the public company until July 1997. (9) Credit Facility The Company has a credit facility with a bank consisting of (a) a revolving working capital line of credit of up to $6,300,000 which expires in September 1999 (the "Line of Credit"), (b) a capital equipment acquisition credit facility of up to $2,000,000 which expires in June 2008 (the "Equipment Line"), and (c) a term loan of approximately $700,000 which expires in March 2008 (the "Construction Loan"). As of May 31, 1999, the Equipment Line had an outstanding balance of $1,184,000 and the Line of Credit and Construction Loan had an outstanding balance of $685,000. Borrowings under the credit facilities bear interest at variable rates 58 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) ranging from 6.94% to 7.19% at May 31, 1999, and are secured by inventories, accounts receivable, and certain equipment and building improvements. The agreement contains restrictive covenants related to working capital, net worth and debt service coverage. Management believes the Company is in compliance with these covenants at May 31, 1999. The Company also has a (pound)4,500,000 line of credit with a bank in the U.K. which expires in July 1999. Borrowings under the line of credit bear interest at variable rates (7% at May 31, 1999). At May 31, 1999, there were no borrowings outstanding on the line of credit. In connection with the acquisition of ESC, the Company assumed a revolving working capital line of credit. The outstanding balance at May 31, 1998 was $1,511,000. Subsequent to May 31, 1998, the line of credit balance was repaid in full and was not renewed. (10) Long-Term Debt Long-term debt at May 31 consists of the following:
1998 1999 ------------- ------------- Industrial revenue bond payable to a bank in monthly installments of $19,200, including interest at 8.12%, through July 2004 $ 1,108,000 961,000 Note payable to a bank in monthly installments of $7,000, including interest at LIBOR plus 2% (6.94% at May 31, 1999), with the remaining principal balance due in full in March 2008 712,000 685,000 Subordinated note payable to the City of Entiat in monthly installments of $7,300, including interest at 8%, with the principal balance due in full in May 2001 505,000 457,000 Note payable to bank in monthly principal installments of $5,000 plus interest at the 30-day commercial paper rate plus 3.25% (8.75% at May 31, 1999) through March 31, 2003 265,000 205,000 Notes payable to a pension fund and others, with interest at 6.75%, repaid in full during the year ended May 31, 1999 4,050,000 -- Notes payable to a financing company for certain equipment in aggregate monthly installments of $58,000, including interest at 9% to 10.9%, with maturity dates through 2004 2,685,000 2,220,000 Other notes payable for vehicles and certain equipment in aggregate monthly installments of $30,000, including interest at 7.9% to 10.9% with maturity dates through December 2003 761,000 786,000 Note payable to a bank in monthly installments of $10,127, including interest at LIBOR plus 2.25% (7.19% at May 31, 1999) through June 2008 -- 1,184,000 ------------- ------------- 10,086,000 6,498,000 Less current portion 1,027,000 1,278,000 -------------- ------------- Long-term debt, net of current portion $ 9,059,000 5,220,000 ============== =============
59 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) The industrial revenue bond agreement and a certain note payable to a bank require, among other items, that the Company maintain minimum working capital, tangible net worth and debt to tangible net worth ratios. Management believes the Company is in compliance with these covenants at May 31, 1999. Scheduled principal maturities of long-term debt at May 31, 1999 are as follows for each of the following fiscal year-ends: 2000 $ 1,278,000 2001 1,083,000 2002 981,000 2003 861,000 2004 601,000 Thereafter 1,694,000 ------------- $ 6,498,000 ============= Long-term debt is secured by substantially all assets of the Company and, in certain circumstances, through personal guarantees of certain stockholders. (11) Senior Subordinated Notes Payable In July 1998, the Company completed a $75 million debt offering of 11 1/4% Senior Subordinated Notes (the Notes) due in August 2005 (the Offering). The Notes are unconditionally guaranteed on a senior subordinated basis by the Company's U.S. subsidiaries. The net proceeds from the Offering were used to finance the acquisition of Aeromet. Interest on the Notes is payable semiannually on February 1 and August 1 of each year, commencing February 1, 1999. The Notes may be redeemable at the option of the Company, in whole or in part, on or after August 1, 2003 at the redemption price as defined in the agreement. In addition, on or before August 1, 2001, the Company may redeem up to 20% of the Notes at a redemption price of 111.25% of the principal amount plus accrued and unpaid interest. Under provisions of the indenture applicable to the Notes, the Company is limited in its ability to incur additional indebtedness or issue Disqualified Capital Stock, pay dividends or make other distributions, create certain liens on assets, sell certain assets and stock of subsidiaries, enter into certain transactions with affiliates, and effect certain mergers and consolidations. The Company is also subject to certain restrictive covenants and is required to maintain certain financial ratios in connection with the Notes. Management believes the Company is in compliance with these covenants at May 31, 1999. 60 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (12) Leasing Arrangements (a) Capital Leases The Company leases certain property, plant and equipment under capital lease agreements that expire at various dates through 2008. Capital lease obligations are secured by the underlying leased assets. Aggregate minimum payments to be made under these agreements at May 31, 1999 are as follows for each of the following fiscal year-ends: 2000 $ 475,000 2001 484,000 2002 374,000 2003 316,000 2004 290,000 Thereafter 444,000 ------------- 2,383,000 Less amounts representing interest ranging from 6% to 16% 471,000 ------------- Present value of net minimum capital lease obligations 1,912,000 Less current portion 297,000 ------------- Capital lease obligations, less current portion $ 1,615,000 ============= (b) Operating Leases The Company leases certain property, plant and equipment under operating lease agreements that expire at various dates through June 2026. Aggregate minimum rental payments to be made under these agreements at May 31, 1999 are as follows for each of the following fiscal year-ends: 2000 $ 3,417,000 2001 3,329,000 2002 2,922,000 2003 2,896,000 2004 2,669,000 Thereafter 26,134,000 ------------- $ 41,367,000 ============= 61 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) Total rent expense during the years ended May 31, 1997, 1998 and 1999 amounted to $475,000, $788,000 and $3,356,000, respectively. (13) Convertible Notes In August 1997, the Company closed a private offering of $5,800,000, before expenses of $435,000, in convertible promissory notes (the "Convertible Notes") to two accredited investors. The Company subsequently filed a registration statement, which was declared effective, registering for resale up to 1,720,690 shares of common stock issuable upon conversion of the Convertible Notes. As of May 31, 1998, all of the Convertible Notes had been converted into 1,405,018 shares of common stock. (14) Common Stock In July 1996, the Company conducted a public offering of 2,250,000 units at a price of $3.125 per unit. At May 31, 1997, 1998 and 1999, all of these warrants were outstanding. In addition, the Company issued warrants to two underwriters for the purchase of an additional 225,000 units at $3.75 per unit. Each unit is composed of one share of the Company's common stock and a warrant to purchase one share of the Company's common stock. The warrants entitled the holder to purchase one share of common stock at $4.6875 per share, exercisable any time through July 2001. The Company incurred a total of $1,726,000 in costs related to the offering. The costs incurred were charged against the proceeds of the stock offering in the year ended May 31, 1997. During the year ended May 31, 1998, 45,000 of the underwriter's warrants were exercised for 45,000 units. No warrants were exercised during the year ended May 31, 1999. In November 1997, the Company closed a private offering of $6,408,000, before expenses of $320,000, in common stock and notes payable to three accredited investors. The Company subsequently filed a registration statement, which was declared effective, registering for resale the 524,000 shares of common stock sold in the offering. The outstanding balance of the notes payable was repaid in full during the year ended May 31, 1999. In November 1998, the Company sold 2,585,000 shares of its common stock at $2.00 per share, in a private offering to institutional investors. Proceeds from the offering totaled $5,170,000 before expenses of $341,000. (15) Convertible Preferred Stock (a) Series A Convertible Preferred Stock In February 1997, the Company sold 50,000 shares of Series A convertible preferred stock (Series A) in a private placement for $5,000,000, and incurred related offering costs of $519,000, resulting in net proceeds of $4,481,000. At May 31, 1998, all of the shares of Series A had been converted into 1,494,593 shares of common stock. 62 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (b) Series B Convertible Preferred Stock In May 1998, the Company sold 100,000 shares of Series B convertible preferred stock (Series B) for $100 per share, and issued warrants to purchase 138,888 shares of common stock, in a private offering, which resulted in gross proceeds of $10.0 million, less related offering costs of $740,000 for net proceeds of $9,260,000. In addition, the purchasers deposited $7.0 million in an escrow account which, subsequent to the closing of the purchase of Aeromet, was exchanged by the Company for 70,000 additional shares of Series B and additional warrants to purchase 97,221 shares of common stock. Net proceeds to the Company, subsequent to offering costs of $369,000, were $6,631,000. Upon conversion of shares of Series B, the holder will receive the number of shares of common stock equal to $100 divided by the then applicable conversion price of the Series B. The conversion price of the Series B at May 31, 1999 is equal to the lower of (a) $7.20 per share, or (b) the average of the three lowest closing bid prices per share of the common stock over the 22 trading days before conversion. No holder of Series B is entitled to voluntarily convert Series B that would cause the holder to own more than 9.9% of the Company's total outstanding common stock at any one time. Any Series B outstanding on May 2003 will be automatically converted into common stock at the then-applicable conversion price. Series B has a liquidation preference equal to the greater of the sum of $100 per Series B share and any declared but unpaid dividends or the amount the holder would be entitled to if the Series B were converted to common stock at the then applicable conversion rate. Dividends on Series B are based on the discretion of the board of directors and no dividends on the Series B have been declared or paid as of May 31, 1999. If a dividend is declared or paid on common stock, other than in shares of common stock, Series B holders are entitled to a dividend per share of Series B equal to the amount which would be received as if the Series B were converted to common stock at the then applicable conversion rate. The Company may redeem the Series B at a redemption price of $115 per share under certain circusmtances. As of May 31, 1999, 8,965 shares of Series B have been converted into 545,114 shares of common stock. 63 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (16) Warrants The Company periodically issues warrants to purchase common shares in connection with preferred stock, debt and certain consulting services. A summary of the Company's warrants, excluding warrants issued in connection with the public offering in July 1996, is as follows:
Weighted average price Warrants of shares ------------- ------------- Balance at May 31, 1996 and 1997 497,500 $ 4.34 Granted 1,928,888 4.74 Exercised (750,000) 4.61 ------------- ------------- Balance at May 31, 1998 1,676,388 4.36 Granted 97,221 7.20 Canceled (1,290,000) 4.62 ------------- ------------- Balance at May 31, 1999 483,609 4.24 ============= =============
The following summarizes warrants outstanding, excluding warrants issued in connection with the public offering in July 1996, at May 31, 1999:
Weighted average Weighted Range of remaining average exercise Number contractual exercise Number prices outstanding life price exercisable -------------- -------------- -------------- -------------- -------------- $ 2.00 - 4.00 210,000 3.69 years 2.35 210,000 4.01 - 6.00 37,500 2.00 years 4.80 37,500 6.01 - 8.00 236,109 4.00 years 7.20 236,109 -------------- 483,609 ==============
64 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (17) Compensation Plans (a) Long-Term Investment and Incentive Plan The Company has a long-term stock investment and incentive plan (Option Plan) under which directors, officers, key employees and other key individuals may be awarded stock options, stock appreciation rights, stock and cash bonuses, restricted stock, or performance units. Under the Option Plan, the exercise price of options issued is not less than fair-market value at the date of grant. Options expire ten years from the grant date. As of May 31, 1997, 1998 and 1999, the Company had not issued any stock appreciation rights, stock and cash bonuses, restricted stock, or performance units under the Option Plan. As the Company applies APB Opinion No. 25 and related interpretations in accounting for its Option Plan, no compensation costs have been recognized for stock options issued to employees. Had compensation costs for stock options been determined consistent with SFAS No. 123, the results of the Company would have been adjusted to the pro forma amounts indicated below:
1997 1998 1999 ------------ ------------ ------------ Net income (loss): As reported $ 1,682,000 3,614,000 (12,869,000) Pro forma 75,000 2,478,000 (14,962,000) Net income (loss) per share: As reported: Basic 0.18 0.29 (0.74) Diluted 0.17 0.27 (0.74) Pro forma: Basic 0.01 0.20 (0.86) Diluted 0.01 0.18 (0.86) Shares used in computation of net income (loss) per share: Basic 9,499,980 12,486,077 17,359,491 Diluted 10,035,846 13,606,061 17,359,491
The fair value of the options granted during 1997, 1998 and 1999 is estimated as $1,853,000, $3,007,000 and $474,340, respectively, using the Black-Scholes option-pricing model with the following assumptions on the date of grant: zero percent dividend yield, expected volatility from 24% to 73%, risk-free interest rate from 5.55% to 6.59%, and expected lives ranging from 5 to 10 years. 65 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) In December 1998, the Company repriced certain options to purchase 1,466,056 shares to a lower exercise price. The repricing resulted in additional compensation costs under SFAS No. 123 of $352,000, which are included in the pro forma amounts disclosed above. A summary of the Company's Stock Option Plan is as follows:
Shares of common stock ----------------------------- Weighted Available Options average price options under plan of shares ------------- ------------- ------------- Balance at June 1, 1996 854,717 145,283 $ 5.09 Authorized 1,000,000 -- -- Granted (998,333) 998,333 4.53 ------------- ------------- ------------- Balance at May 31, 1997 856,384 1,143,616 4.61 Authorized 1,000,000 -- -- Granted (1,112,500) 1,112,500 5.49 Exercised -- (25,000) 2.11 ------------- ------------- ------------- Balance at May 31, 1998 743,884 2,231,116 5.09 Granted (1,804,388) 1,804,388 2.51 Expired 30,000 (30,000) 2.00 Canceled 1,466,056 (1,466,056) (3.70) Terminations 72,500 (72,500) 6.13 ------------- ------------- ------------- Balance at May 31, 1999 508,052 2,466,948 $ 3.32 ============= ============= =============
No options were exercised during the years ended May 31, 1997 and 1999. The following summarizes options outstanding at May 31, 1999:
Options outstanding Options exercisable --------------------------------------------------- --------------------------------- Weighted average Weighted Weighted Range of remaining average average exercise Number contractual exercise Number exercise prices outstanding life price exercisable price --------------- --------------- --------------- --------------- --------------- --------------- $ 2.00 - $4.00 1,859,388 8.42 $ 2.51 1,653,583 $ 2.53 $ 4.01 - $6.00 607,560 7.21 4.69 607,560 4.69 --------------- --------------- 2,466,948 2,261,143 =============== ===============
66 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (b) Independent Director Stock Plan The Company has an Independent Director Stock Plan under which nonemployee directors of the Company are awarded common stock and stock options of the Company for serving on its board of directors. The plan authorizes and reserves for issuance a maximum of 500,000 common shares. At May 31, 1999, 420,804 shares were available for future issuance. During the years ended May 31, 1997 and 1998, 14,400 and 8,559 shares of the Company's common stock, respectively, were issued under the plan, of which all were vested at May 31, 1999. During the year ended May 31, 1999, 600 shares and 56,637 options were issued under the plan. Included in compensation expense are $44,000, $13,000, and $89,000 for the years ended May 31, 1997, 1998, and 1999, respectively, resulting from the shares and options issued. (c) Retirement Plan The Company maintains a 401(k) plan covering all eligible employees who meet service requirements as provided in the plan. Company contributions to the profit-sharing plan are determined annually by the Board of Directors. No contributions were made by the Company to the plan during the year ended May 31, 1997. The Company contributed $27,000 and $48,000 to the plan during the years ended May 31, 1998 and 1999, respectively. (d) Employee Stock Purchase Plan The Company has an Employee Stock Purchase Plan under which employees are eligible to purchase shares of the Company's common stock, through payroll deductions, at the lower of 85% of the Company's stock price on the first day of an offering period or 100% of the Company's stock price on the last day of an offering period. The first offering period began in November 1998. During the year ended May 31, 1999, 41,942 shares were purchased by employees under the plan. (18) Other Income and Expense Included in other income and expense during the year ended May 31, 1999 are other than temporary unrealized losses related to the Company's investment in shares of a public company of $4,943,000 as well as allowances totaling $2,884,000 related to the Company's guarantees of certain debt, a reserve for the outstanding note receivable and other expenses of the public company expected to be incurred by the Company. Other income and expense also includes a net amount of $2,033,000 resulting from the write-off of costs in excess of net book value of acquired subsidiaries recorded in conjunction with the acquisition of ESC, and a long-lived asset impairment charge of $1,150,000 related to certain of ESC's fixed assets. 67 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (19) Income Taxes Total income tax benefit (expense) is as follows:
1997 1998 1999 ------------- ------------- ------------- Current: Federal $ (50,000) (593,000) 262,000 Foreign -- -- (1,422,000) Deferred: Federal -- 1,075,000 3,799,000 ------------- ------------- ------------- Total $ (50,000) 482,000 2,639,000 ============= ============= =============
The domestic and foreign components of income (loss) before income tax benefit (expense) were as follows:
1997 1998 1999 ------------- ------------- ------------- Domestic $ 1,732,000 3,132,000 (18,992,000) Foreign -- -- 3,484,000 ------------- ------------- ------------- Income (loss) before income tax benefit (expense) $ 1,732,000 3,132,000 (15,508,000) ============= ============= =============
Undistributed earnings of the Company's foreign subsidiaries for which no U.S. income taxes have been provided aggregates approximately $3,700,000 at May 31, 1999. No provision for foreign withholding or United States Federal income taxes was made for the undistributed earnings, as it is management's intention that earnings will be reinvested indefinitely in foreign operations or will be remitted substantially free of additional taxes. 68 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) A reconciliation of the United States Federal statutory tax rate of 34% and the Company's effective tax rates of 3%, 15% and 17% in the years ended May 31, 1997, 1998 and 1999, respectively, is as follows:
1997 1998 1999 ------------- ------------- ------------- Computed expected income tax benefit (expense) $ (588,000) (1,065,000) 5,273,000 Change in valuation allowance 558,000 1,717,000 (2,200,000) Other (20,000) (170,000) (434,000) ------------- ------------- ------------- $ (50,000) 482,000 2,639,000 ============= ============= =============
Significant components of the Company's deferred tax assets (liabilities) at May 31 are as follows:
1998 1999 -------------- -------------- Deferred tax assets: NOL carryforward $ 1,387,000 4,427,000 Unrealized capital loss -- 1,532,000 Other 641,000 1,550,000 Valuation allowances -- (2,200,000) -------------- -------------- 2,028,000 5,309,000 Deferred tax liabilities - depreciation (1,420,000) (1,034,000) -------------- -------------- Net deferred tax asset $ 608,000 4,275,000 ============== ==============
The Company has net operating loss (NOLs) carryforwards for U.S. Federal income tax purposes of approximately $14,000,000, the benefits of which expire in the tax year 2001 through the tax year 2019. The NOLs created by the Company's subsidiaries prior to their acquisition and the NOLs created as a consolidated group or groups subsequent to a qualifying tax free merger or acquisition, have limitations related to the amount of usage by each subsidiary or consolidated group as described in the Internal Revenue Code. As a result of these limitations, approximately $1,000,000 of the $14,000,000 total NOLs at May 31, 1999 will never become available. (20) Earnings Per Share Basic earnings per share is computed on the basis of the weighted average number of common shares outstanding. Diluted earnings per share is computed on the basis of the weighted average number of common shares outstanding, using the "if-converted" method, and outstanding stock options, using the "treasury stock" method. 69 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) The components of basic and diluted earnings per share at May 31 were as follows:
1997 1998 1999 --------------- --------------- --------------- Net income (loss) available for common shareholders $ 1,682,000 3,614,000 (12,869,000) =============== =============== =============== Average outstanding shares of common stock 9,499,980 12,486,077 17,359,491 Dilutive effect of: Warrants 273,564 853,470 -- Employee stock options 262,302 266,514 -- --------------- --------------- --------------- Common stock and common stock equivalents 10,035,846 13,606,061 17,359,491 =============== =============== =============== Earnings (loss) per share: Basic $ 0.18 0.29 (0.74) Diluted 0.17 0.27 (0.74)
(21) Fair Value of Financial Instruments The Company's financial instruments include cash, receivables, investment, accounts payable and short and long-term borrowings. The fair value of these financial instruments approximates their carrying amounts based on current market indicators, such as prevailing interest rates, with the exception of the senior subordinated notes payable, which are currently trading at approximately 75% of face value. (22) Contingencies (a) Legal The Company is currently subject and party to various legal actions arising in the normal course of business. Management believes the ultimate liability, if any, arising from such claims or contingencies is not likely to have a material adverse effect on the Company's results of operations or financial condition. In the normal course of business, the Company disposes of potentially hazardous material which could result in claims related to environmental cleanup. The Company has not been notified of any related claims. The Company is subject to various other environmental and governmental regulations. Although the extent of any noncompliance with those regulations, if any, is not completely ascertainable, management believes the ultimate liability is not likely to have a material adverse effect on the Company's results of operations or financial condition. 70 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (b) Year 2000 Like most other companies, the Year 2000 computer issue creates risks for the Company. The Year 2000 issue exists because many computer programs use two digit rather than four digit date fields to define the applicable year. As a result, computer equipment and software and devices with imbedded technology that are time-sensitive may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, production delays and a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Incomplete or untimely resolution of the Year 2000 issue by the Company or critically important suppliers or customers of the Company could have a materially adverse effect on the Company's business, financial condition, or results of operations. (23) Consolidating Condensed Financial Statements The following statements present consolidating condensed financial information of the Company for the indicated periods. The Company's senior subordinated notes, which were used to finance the Aeromet acquisition in July 1998, have been guaranteed by all of the Company's U.S. wholly owned subsidiaries. The guarantor subsidiaries have fully and unconditionally guaranteed this debt on a joint and several basis. This debt is not guaranteed by the Company's foreign subsidiaries, which consist of Aeromet and two related holding companies. There are no significant contractual restrictions on the distribution of funds from the guarantor subsidiaries to the parent corporation. The consolidating condensed financial information is presented in lieu of separate financial statements and other disclosures of the guarantor subsidiaries, as management has determined that such information is not material to investors. 71 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (a) Consolidating condensed balance sheet information at May 31, 1999 is as follows:
Guarantor Non-guarantor Assets Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Current assets: Cash and cash equivalents $ 1,798,000 39,000 6,297,000 -- 8,134,000 Accounts receivable, net -- 8,723,000 16,661,000 (392,000) 24,992,000 Inventories -- 13,564,000 11,052,000 -- 24,616,000 Other 4,535,000 1,517,000 660,000 (3,516,000) 3,196,000 ------------ ------------ ------------- ------------ ------------ Total current assets 6,333,000 23,843,000 34,670,000 (3,908,000) 60,938,000 ------------ ------------ ------------- ------------ ------------ Property, plant and equipment, net 6,151,000 21,930,000 17,198,000 -- 45,279,000 ------------ ------------ ------------- ------------ ------------ Other assets: Investment 72,000 -- -- -- 72,000 Costs in excess of net book value of acquired subsidiaries, net -- 2,717,000 38,335,000 -- 41,052,000 Investment in and loans to subsidiaries 115,099,000 75,000,000 85,000 (190,184,000) -- Other 8,254,000 3,295,000 (163,000) -- 11,386,000 ------------ ------------ ------------- ------------ ------------ Total other assets 123,425,000 81,012,000 38,257,000 (190,184,000) 52,510,000 ------------ ------------ ------------- ------------ ------------ Total assets $135,909,000 126,785,000 90,125,000 (194,092,000) 158,727,000 ============ ============ ============= ============ ============ Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 180,000 2,542,000 8,154,000 (392,000) 10,484,000 Current portion of long-term debt 138,000 1,140,000 -- -- 1,278,000 Other 5,084,000 1,597,000 7,682,000 (3,516,000) 10,847,000 ------------ ------------ ------------- ------------ ------------ Total current liabilities 5,402,000 5,279,000 15,836,000 (3,908,000) 22,609,000 Long-term liabilities: Long-term debt, net of current portion 76,375,000 3,845,000 -- -- 80,220,000 Intercompany note and loan payable 85,000 61,869,000 37,500,000 (99,454,000) -- Other 28,000 1,105,000 746,000 -- 1,879,000 ------------ ------------ ------------- ------------ ------------ Total liabilities 81,890,000 72,098,000 54,082,000 (103,362,000) 104,708,000 ------------ ------------ ------------- ------------ ------------ Stockholders' equity: Convertible preferred stock -- -- -- -- -- Common stock 19,000 58,641,000 35,117,000 (93,758,000) 19,000 Additional paid-in capital 69,276,000 -- -- -- 69,276,000 Accumulated other comprehensive loss (1,140,000) -- (1,136,000) 1,136,000 (1,140,000) Retained earnings (accumulated deficit) (14,136,000) (3,954,000) 2,062,000 1,892,000 (14,136,000) ------------ ------------ ------------- ------------ ------------ Total stockholders' equity 54,019,000 54,687,000 36,043,000 (90,730,000) 54,019,000 ------------ ------------ ------------- ------------ ------------ Total liabilities and stockholders' equity $135,909,000 126,785,000 90,125,000 (194,092,000) 158,727,000 ============ ============ ============= ============ ============
72 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (b) Consolidating condensed balance sheet information at May 31, 1998 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Current assets: Cash and cash equivalents $ 9,398,000 2,063,000 -- -- 11,461,000 Accounts receivable, net -- 9,608,000 -- (233,000) 9,375,000 Inventories -- 16,184,000 -- -- 16,184,000 Other 12,000 646,000 -- -- 658,000 ------------ ------------ ------------- ------------ ------------ Total current assets 9,410,000 28,501,000 -- (233,000) 37,678,000 ------------ ------------ ------------- ------------ ------------ Property, plant and equipment, net 3,464,000 22,871,000 -- -- 26,335,000 ------------ ------------ ------------- ------------ ------------ Other assets: Investment 4,579,000 -- -- -- 4,579,000 Costs in excess of net book value of acquired subsidiaries, net -- 6,515,000 -- -- 6,515,000 Investment in subsidiaries 21,452,000 -- -- (21,452,000) -- Intercompany note and loan receivable 19,764,000 -- -- (19,764,000) -- Other 3,186,000 287,000 -- -- 3,473,000 ------------ ------------ ------------- ------------ ------------ Total other assets 48,981,000 6,802,000 -- (41,216,000) 14,567,000 ------------ ------------ ------------- ------------ ------------ Total assets $ 61,855,000 58,174,000 -- (41,449,000) 78,580,000 ============ ============ ============= ============ ============ Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 927,000 6,054,000 -- (233,000) 6,748,000 Current portion of long-term debt 24,000 1,003,000 -- -- 1,027,000 Other 635,000 3,669,000 -- -- 4,304,000 ------------ ------------ ------------- ------------ ------------ Total current liabilities 1,586,000 10,726,000 -- (233,000) 12,079,000 Long-term liabilities: Long-term debt, net of current portion 4,127,000 4,932,000 -- -- 9,059,000 Intercompany note and loan payable -- 19,764,000 -- (19,764,000) -- Other -- 1,300,000 -- -- 1,300,000 ------------ ------------ ------------- ------------ ------------ Total liabilities 5,713,000 36,722,000 -- (19,997,000) 22,438,000 ------------ ------------ ------------- ------------ ------------ Stockholders' equity: Convertible preferred stock -- -- -- -- -- Common stock 15,000 -- -- -- 15,000 Additional paid-in capital 57,830,000 21,546,000 -- (21,546,000) 57,830,000 Accumulated other comprehensive loss (436,000) -- -- -- (436,000) Retained earnings (accumulated deficit) (1,267,000) (94,000) -- 94,000 (1,267,000) ------------ ------------ ------------- ------------ ------------ Total stockholders' equity 56,142,000 21,452,000 -- (21,452,000) 56,142,000 ------------ ------------ ------------- ------------ ------------ Total liabilities and stockholders' equity $ 61,855,000 58,174,000 -- (41,449,000) 78,580,000 ============ ============ ============= ============ ============
73 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (c) Consolidating condensed statement of operations information for the year ended May 31, 1999 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Net sales $ -- 56,675,000 52,814,000 (2,123,000) 107,366,000 Cost of sales -- 45,942,000 42,275,000 (2,123,000) 86,094,000 ------------ ------------ ------------- ------------ ------------ Gross profit -- 10,733,000 10,539,000 -- 21,272,000 Operating expenses 4,367,000 11,463,000 3,556,000 (2,078,000) 17,308,000 ------------ ------------ ------------- ------------ ------------ Income (loss) from operations (4,367,000) (730,000) 6,983,000 2,078,000 3,964,000 Other income (expense): Parent's share of subsidiaries net loss (1,800,000) -- -- 1,800,000 -- Interest expense (8,050,000) (622,000) (3,516,000) 3,516,000 (8,672,000) Other (727,000) (4,496,000) 17,000 (5,594,000) (10,800,000) ------------ ------------ ------------- ------------ ------------ Total other expense (10,577,000) (5,118,000) (3,499,000) (278,000) (19,472,000) ------------ ------------ ------------- ------------ ------------ Income (loss) before income taxes (14,944,000) (5,848,000) 3,484,000 1,800,000 (15,508,000) Income tax benefit (expense) 2,075,000 1,986,000 (1,422,000) -- 2,639,000 ------------ ------------ ------------- ------------ ------------ Net income (loss) (12,869,000) (3,862,000) 2,062,000 1,800,000 (12,869,000) Other comprehensive income (loss): Foreign currency translation, net of tax (4,000) -- (1,136,000) -- (1,140,000) Valuation of available for sale securities 436,000 -- -- -- 436,000 ------------ ------------ ------------- ------------ ------------ Total other comprehensive income (loss) 432,000 -- (1,136,000) -- (704,000) ------------ ------------ ------------- ------------ ------------ Comprehensive income (loss) $(12,437,000) (3,862,000) 926,000 1,800,000 (13,573,000) ============ ============ ============= ============ ============
74 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (d) Consolidating condensed statement of operations information for the year ended May 31, 1998 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Net sales $ -- 54,968,000 -- (869,000) 54,099,000 Cost of sales -- 40,356,000 -- (869,000) 39,487,000 ------------ ------------ ------------- ------------ ------------ Gross profit -- 14,612,000 -- -- 14,612,000 Operating expenses 2,378,000 9,373,000 -- (1,879,000) 9,872,000 ------------ ------------ ------------- ------------ ------------ Income (loss) from operations (2,378,000) 5,239,000 -- 1,879,000 4,740,000 Other income (expense): Parent's share of subsidiaries net income 4,778,000 -- -- (4,778,000) -- Interest expense (380,000) (485,000) -- -- (865,000) Other 995,000 141,000 -- (1,879,000) (743,000) ------------ ------------ ------------- ------------ ------------ Total other income (expense) 5,393,000 (344,000) -- (6,657,000) (1,608,000) ------------ ------------ ------------- ------------ ------------ Income before income taxes 3,015,000 4,895,000 -- (4,778,000) 3,132,000 Income tax benefit (expense) 599,000 (117,000) -- -- 482,000 ------------ ------------ ------------- ------------ ------------ Net income 3,614,000 4,778,000 -- (4,778,000) 3,614,000 Other comprehensive loss - valuation of available-for-sale securities (436,000) -- -- -- (436,000) ------------ ------------ ------------- ------------ ------------ Comprehensive income $ 3,178,000 4,778,000 -- (4,778,000) 3,178,000 ============ ============ ============= ============ ============
75 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (e) Consolidating condensed statement of operations information for the year ended May 31, 1997 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Net sales $ -- 34,774,000 -- (599,000) 34,175,000 Cost of sales -- 26,615,000 -- (646,000) 25,969,000 ------------ ------------ ------------- ------------ ------------ Gross profit -- 8,159,000 -- 47,000 8,206,000 Operating expenses 1,346,000 6,216,000 -- (1,303,000) 6,259,000 ------------ ------------ ------------- ------------ ------------ Income (loss) from operations (1,346,000) 1,943,000 -- 1,350,000 1,947,000 Other income (expense): Parent's share of subsidiaries net income 1,691,000 -- -- (1,691,000) -- Interest expense (82,000) (428,000) -- -- (510,000) Other 1,415,000 230,000 -- (1,350,000) 295,000 ------------ ------------ ------------- ------------ ------------ Total other income (expense) 3,024,000 (198,000) -- (3,041,000) (215,000) ------------ ------------ ------------- ------------ ------------ Income before income taxes 1,678,000 1,745,000 -- (1,691,000) 1,732,000 Income tax benefit (expense) 4,000 (54,000) -- -- (50,000) ------------ ------------ ------------- ------------ ------------ Net income 1,682,000 1,691,000 -- (1,691,000) 1,682,000 Other comprehensive income -- -- -- -- -- ------------ ------------ ------------- ------------ ------------ Comprehensive income $ 1,682,000 1,691,000 -- (1,691,000) 1,682,000 ============ ============ ============= ============ ============
76 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (f) Consolidating condensed statement of cash flows information for the year ended May 31, 1999 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Cash flow from operating activities - net cash provided by (used in) operating activities $ (6,795,000) 696,000 3,927,000 1,800,000 (372,000) ------------ ------------ ------------- ------------ ------------ Cash flow from investing activities: Acquisition of property, plant and equipment (2,471,000) (4,013,000) (1,556,000) -- (8,040,000) Investment in and loans to subsidiaries (69,752,000) (75,000,000) (75,000,000) 150,000,000 (69,752,000) Other changes, net (6,401,000) 76,000 (85,000) 4,928,000 (1,482,000) ------------ ------------ ------------- ------------ ------------ Net cash used in investing activities (78,624,000) (78,937,000) (76,641,000) 154,928,000 (79,274,000) ------------ ------------ ------------- ------------ ------------ Cash flow from financing activities: Proceeds from long-term debt, senior subordinated notes and convertible notes, net 72,160,000 37,500,000 37,500,000 (75,000,000) 72,160,000 Payments on long-term debt and capital leases (4,154,000) (1,548,000) (50,000) -- (5,752,000) Proceeds from sale of common stock, net 4,898,000 37,500,000 37,500,000 (75,000,000) 4,898,000 Proceeds from sale of preferred stock, net 6,630,000 -- -- -- 6,630,000 Other changes, net (1,715,000) 2,765,000 4,167,000 (6,728,000) (1,511,000) ------------ ------------ ------------- ------------ ------------ Net cash provided by financing activities 77,819,000 76,217,000 79,117,000 (156,728,000) 76,425,000 ------------ ------------ ------------- ------------ ------------ Net change in cash and cash equivalents (7,600,000) (2,024,000) 6,403,000 -- (3,221,000) Cash and cash equivalents at beginning of year 9,398,000 2,063,000 -- -- 11,461,000 Effect of exchange rates on cash -- -- (106,000) -- (106,000) ------------ ------------ ------------- ------------ ------------ Cash and cash equivalents at end of year $ 1,798,000 39,000 6,297,000 -- 8,134,000 ============ ============ ============= ============ ============ Supplemental cash flow: Noncash operating expenses related to: Depreciation $ 192,000 2,951,000 2,326,000 -- 5,469,000 Amortization -- 392,000 844,000 -- 1,236,000 Cash paid during the year for: Interest 4,870,000 413,000 13,000 -- 5,296,000 Federal income taxes 100,000 -- 311,000 -- 411,000 Acquisition of subsidiaries: Fair value of assets acquired and resulting goodwill, excluding cash 86,593,000 -- -- -- 86,593,000 Liabilities assumed 16,811,000 -- -- -- 16,811,000 Noncash investing and financing activities: Seller financed acquisition of property, plant and equipment 241,000 -- -- -- 241,000 Reclassification of property, plant and equipment to other assets -- 1,217,000 -- -- 1,217,000 ============ ============ ============= ============ ============
77 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (g) Consolidating condensed statement of cash flows information for the year ended May 31, 1998 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Cash flow from operating activities - net cash provided by operating activities $ 4,023,000 2,349,000 -- (4,778,000) 1,594,000 ------------ ------------ ------------- ------------ ------------ Cash flow from investing activities: Acquisition of property, plant and equipment (3,010,000) (3,499,000) -- -- (6,509,000) Acquisition of subsidiaries (4,318,000) -- -- -- (4,318,000) Other changes, net (14,085,000) 125,000 -- 8,082,000 (5,878,000) ------------ ------------ ------------- ------------ ------------ Net cash used in investing activities (21,413,000) (3,374,000) -- 8,082,000 (16,705,000) ------------ ------------ ------------- ------------ ------------ Cash flow from financing activities: Proceeds from long-term debt and convertible notes 9,590,000 535,000 -- -- 10,125,000 Payments on long-term debt and capital leases (125,000) (1,378,000) -- -- (1,503,000) Proceeds from sale of common stock, net 2,223,000 -- -- -- 2,223,000 Proceeds from sale of preferred stock, net 9,260,000 -- -- -- 9,260,000 Other changes, net 3,777,000 2,946,000 -- (3,304,000) 3,419,000 ------------ ------------ ------------- ------------ ------------ Net cash provided by financing activities 24,725,000 2,103,000 -- (3,304,000) 23,524,000 ------------ ------------ ------------- ------------ ------------ Net change in cash and cash equivalents 7,335,000 1,078,000 -- -- 8,413,000 Cash and cash equivalents at beginning of year 2,063,000 985,000 -- -- 3,048,000 ------------ ------------ ------------- ------------ ------------ Cash and cash equivalents at end of year $ 9,398,000 2,063,000 -- -- 11,461,000 ============ ============ ============= ============ ============ Supplemental cash flow: Noncash operating expenses related to: Depreciation $ 34,000 1,874,000 -- -- 1,908,000 Amortization -- 296,000 -- -- 296,000 Cash paid during the year for: Interest 17,000 695,000 -- -- 712,000 Federal income taxes 521,000 -- -- -- 521,000 Acquisition of subsidiaries: Fair value of assets acquired and resulting goodwill, excluding cash 10,034,000 -- -- -- 10,034,000 Liabilities assumed 3,925,000 -- -- -- 3,925,000 Common stock issued 6,109,000 -- -- -- 6,109,000 Noncash investing and financing activities: Seller financed acquisition of property, plant and equipment -- 3,336,000 -- -- 3,336,000 Conversion of notes and accrued interest to common stock 5,519,000 -- -- -- 5,519,000 Restructuring of certain notes receivable for an investment in common stock 6,053,000 -- -- -- 6,053,000 Other noncash investing and financing activities, net 750,000 139,000 -- -- 889,000 ============ ============ ============= ============ ============
78 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (h) Consolidating condensed statement of cash flows information for the year ended May 31, 1997 is as follows:
Guarantor Non-guarantor Parent subsidiaries subsidiaries Eliminations Consolidated ------------ ------------ ------------- ------------ ------------ Cash flow from operating activities - net cash provided by operating activities $ 1,474,000 5,000 -- (1,691,000) (212,000) ------------ ------------ ------------- ------------ ------------ Cash flow from investing activities: Acquisition of property, plant and equipment (9,000) (2,091,000) -- -- (2,100,000) Other changes, net (9,622,000) 58,000 -- 9,652,000 88,000 ------------ ------------ ------------- ------------ ------------ Net cash used in investing activities (9,631,000) (2,033,000) -- 9,652,000 (2,012,000) ------------ ------------ ------------- ------------ ------------ Cash flow from financing activities: Proceeds from long-term debt and convertible notes -- 237,000 -- -- 237,000 Payments on long-term debt and capital leases (94,000) (5,592,000) -- -- (5,686,000) Proceeds from sale of common stock, net 5,739,000 -- -- -- 5,739,000 Proceeds from sale of preferred stock, net 4,481,000 -- -- -- 4,481,000 Other changes, net (224,000) 7,961,000 -- (7,961,000) (224,000) ------------ ------------ ------------- ------------ ------------ Net cash provided by financing activities 9,902,000 2,606,000 -- (7,961,000) 4,547,000 ------------ ------------ ------------- ------------ ------------ Net change in cash and cash equivalents 1,745,000 578,000 -- -- 2,323,000 Cash and cash equivalents at beginning of year 318,000 407,000 -- -- 725,000 ------------ ------------ ------------- ------------ ------------ Cash and cash equivalents at end of year $ 2,063,000 985,000 -- -- 3,048,000 ============ ============ ============= ============ ============ Supplemental cash flow: Noncash operating expenses related to: Depreciation $ -- 1,290,000 -- -- 1,290,000 Amortization -- 68,000 -- -- 68,000 Cash paid during the year for: Interest 70,000 543,000 -- -- 613,000 Federal income taxes -- 18,000 -- -- 18,000 Acquisition of subsidiaries: Fair value of assets acquired and resulting goodwill, excluding cash 1,928,000 -- -- -- 1,928,000 Liabilities assumed 482,000 -- -- -- 482,000 Common stock issued 1,446,000 -- -- -- 1,446,000 Noncash investing and financing activities: Seller financed acquisition of property, plant and equipment -- 639,000 -- -- 639,000 Other noncash investing and financing activities, net -- 35,000 -- -- 35,000 ============ ============ ============= ============ ============
79 PACIFIC AEROSPACE & ELECTRONICS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements May 31, 1998 and 1999 (continued) (i) Inventory Information at May 31 is as follows:
1998 1999 -------------- -------------- Guarantor subsidiaries Raw materials $ 5,789,000 5,074,000 Work in progress 5,683,000 3,788,000 Finished goods 4,712,000 4,702,000 -------------- -------------- 16,184,000 13,564,000 -------------- -------------- Non-guarantor subsidiaries: Raw materials -- 2,300,000 Work in progress -- 7,690,000 Finished goods -- 1,062,000 -------------- -------------- -- 11,052,000 -------------- -------------- Total inventory $ 16,184,000 24,616,000 ============== ==============
(24) Subsequent Events On June 1, 1999, the Company acquired all of the stock of Skagit Engineering & Manufacturing, Inc. for $1.3 million in cash. The Company also entered into a letter of intent to acquire Nova-Tech Engineering, Inc. (Nova-Tech) and expects that the purchase price will consist of approximately $2.7 million in cash and $250,000 in stock. The Company expects that the definitive stock purchase agreement will contain conditions to closing, including receipt of a letter ruling from the Internal Revenue Service that is necessary to permit Nova-Tech's Employee Stock Ownership Plan to sell its Nova-Tech stock on the terms anticipated. The Company is providing services to Nova-Tech under an Operating Agreement dated April 23, 1999. As of May 31, 1999, the Company had loaned $735,000 to Nova-Tech for working capital. As of August 19, 1999, the Company had loaned Nova-Tech an additional $1,365,000. These loans have been made under the terms of two demand notes dated April 26, 1999 and August 5, 1999, each of which is secured by substantially all of the assets of Nova-Tech. 80 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 17, 1998, the appointment of Moss Adams LLP, the Company's previous principal independent accountant, was terminated, and KPMG LLP was engaged, as the Company's principal independent accountant. The decision to change principal independent accountants was approved by the Finance and Audit Committee of the Company's Board of Directors. In connection with the audit for the fiscal year ended May 31, 1997, and the subsequent interim period through April 17, 1998: (a) the report of Moss Adams LLP contained no adverse opinion or disclaimer of opinion, or modification as to uncertainty, audit scope or accounting principles; and (b) there were no disagreements with Moss Adams LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which, if not resolved to the satisfaction of Moss Adams LLP, would have caused it to make reference to the subject matter of the disagreement in connection with its reports. 81 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY Directors and Executive Officers The following table sets forth information as of August 24, 1999, regarding the directors and executive officers of the Company.
Name Age Position with Company - -------------------------------------------------------------------------------- Donald A. Wright 47 Chairman of the Board, Chief Executive Officer and President Werner Hafelfinger 53 Chief Operating Officer, Vice President Operations, Director Nick A. Gerde 54 Chief Financial Officer, Vice President Finance, Treasurer and Assistant Secretary Sheryl A. Symonds 44 Vice President Administration, General Counsel and Secretary Allen W. Dahl, M.D. 71 Director Dale L. Rasmussen 49 Director Robert M. Stemmler 64 Director William A. Wheeler 65 Director
Donald A. Wright. Donald A. Wright has been the Chairman of the Board, Chief Executive Officer and President of the Company since February 1995, and of its predecessors since 1990. Mr. Wright is also an officer and director of each of the Company's operating subsidiaries. Werner Hafelfinger. Werner Hafelfinger has been a director of the Company since August 17, 1998. Mr. Hafelfinger has been Vice President Operations and Chief Operating Officer of the Company since March 1999. Mr. Hafelfinger was employed by St. Jude Medical (Cardiac Rhythm Management Division), a manufacturer of implantable medical devices, from 1984 until February 1999, where he served as Vice President of Global Manufacturing. Nick A. Gerde. Nick A. Gerde has been the Vice President Finance and Chief Financial Officer of the Company since February 1995. He has been the Treasurer of the Company since August 1996, and Assistant Secretary since November 1996. Mr. Gerde is also an officer and director of each of the Company's operating subsidiaries. Mr. Gerde served as a Business Development Specialist with the Economic Development Council of North Central Washington from July 1993 to June 1994, and as Vice President of Televar Northwest, Inc. (formerly a subsidiary of Orca Technologies, Inc.) from July 1994 to February 1995. Sheryl A. Symonds. Sheryl A. Symonds has been the Vice President Administration and General Counsel of the Company since September 1997. Prior to joining the Company, Ms. Symonds was a partner at Stoel Rives LLP, currently the Company's primary outside legal counsel. Ms. Symonds joined Stoel Rives LLP in 1985 and became a partner in 1992. Ms. Symonds has been Secretary of the Company since August 1996 and is also Secretary of each of the Company's operating subsidiaries. 82 Allen W. Dahl. Dr. Allen W. Dahl has been a director of the Company since February 1995, and of its predecessors since September 1994. Dr. Dahl is retired from practice as a physician in the Puget Sound region of Washington. Dale L. Rasmussen. Dale L. Rasmussen has been a director of the Company since June 1997. Mr. Rasmussen has been employed as the Senior Vice President and Secretary of IMPCO Technologies, Inc. since 1989. Robert M. Stemmler. Robert M. Stemmler has been a director of the Company since May 14, 1999. Mr. Stemmler has been the Chairman, CEO and President of IMPCO Technologies, Inc. since 1993. William A. Wheeler. William A. Wheeler has been a director of the Company since June 1997. Mr. Wheeler retired from Dowty Aerospace Yakima in May 1997, where he served as President, Chief Executive Officer and Chairman of the Board of Directors since 1979. Other Significant Employees Lewis L. Wear. Lewis L. Wear, 58, has been President of the U.S. Electronics Group since August 1996 and President of Pacific Coast Technologies, Inc. since February 1996. He also has been Vice President of Ceramic Devices since October 1997, President of NTI since April 1997, President of Balo since February 1998, and President of ESC since October 1998. Prior to November 1995, Mr. Wear was Vice President of Operations for Vacuum Atmospheres, a division of WEMS, Inc. Duncan Crighton. Duncan Crighton, 63, has been Chief Executive Officer of Aeromet since March 1997 and became President of the Company's European Aerospace Group upon closing of the Aeromet Acquisition. Mr. Crighton served as Managing Director of Aeromet's predecessor, Kent Aerospace Castings plc, from 1990 through 1995, and as a management consultant to Aeromet from 1995 to February 1997. Board of Directors Committees. The Board of Directors has a number of committees, as follows:
- ------------------------------------------------------------------------------------------------- Committee Function Current Members - --------------------------- ---------------------------------------------------- ---------------- Option Committee Administers the Company's Amended and Restated Dr. Dahl Stock Incentive Plan. Mr. Rasmussen Mr. Stemmler - --------------------------- ---------------------------------------------------- ---------------- Finance and Audit Reviews the Company's accounting policies, Mr. Rasmussen Committee practices, internal accounting controls and Mr. Hafelfinger financial reporting. Also oversees engagement Mr. Wheeler of the Company's independent auditors and monitors management implementation of the recommendations and findings of the Company's independent auditors. - --------------------------- ---------------------------------------------------- ---------------- Compensation Committee Establishes salaries, incentives and other Mr. Wheeler compensation for the chief executive officer, Dr. Dahl chief operating officer, chief financial Mr. Rasmussen officer, general counsel, subsidiary presidents and other key employees of the Company and its subsidiaries. Also administers policies relating to compensation and benefits, including the Amended and Restated Independent Director Stock Plan and the Employee Stock Purchase Plan. - --------------------------- ---------------------------------------------------- ---------------- Nominating Committee Recommends individuals to be presented to the Mr. Wright shareholders for election or reelection to the Mr. Rasmussen Board of Directors. Mr. Stemmler - -------------------------------------------------------------------------------------------------
83 Tenure. Directors of the Company hold office until the next annual meeting of the Company's shareholders and until their successors have been elected and duly qualified. The Board of Directors appoints the Company's executive officers at the first Board meeting after each annual meeting of shareholders. Executive officers hold office at the pleasure of the Board of Directors. Compensation. Under the Company's Amended and Restated Independent Director Stock Plan, each non-employee director of the Company receives an initial award of options to purchase 2,500 shares of Common Stock when that director is first elected and an annual award of options to purchase 10,000 shares of Common Stock. In addition, non-employee directors receive $1,000 in cash per year for each committee on which they serve, and an additional $500 in cash per year for serving as chairperson of a committee. The Board may elect to pay any of the cash fees in shares of Common Stock. See "Executive Compensation - Benefit Plans - - Independent Director Stock Plan." All directors are reimbursed for reasonable travel and other out-of-pocket expenses incurred in attending meetings of the Board of Directors. Section 16(a) Beneficial Ownership Reporting Compliance Based solely on a review of Forms 3, 4 and 5 and amendments thereto furnished to the Company pursuant to Rule 16a-3(e) during its most recent fiscal year, and on written representations of the Company's officers, directors, or principal shareholders ("Reporting Persons") that no other reports were required, the Company believes that, during the fiscal year ended May 31, 1999, the Reporting Persons complied in all material respects with all applicable filing requirements under Section 16(a) of the Exchange Act. 84 ITEM 11. EXECUTIVE COMPENSATION Summary Compensation Table The following table sets forth in summary form the compensation paid by the Company to the Chief Executive Officer and to the Company's three most highly compensated executive officers (the "Named Executives") for services in all capacities to the Company for the last three fiscal years:
Long-Term Compensation Annual ------------------ Compensation Securities Fiscal ------------ Underlying Other Annual Name and Principal Position Year Salary($) Options/SARs(#)(1) Compensation($) - --------------------------- ------ ------------ ------------------ --------------- Donald A. Wright 1999 247,551 1,000,000 (2) 5,547 (3) CEO and President 1998 192,000 650,000 (4) 4,800 (5) 1997 160,000 920,000 (6) 400 (5) Werner Hafelfinger 1999 (7) 33,654 50,000 (8) 600 (5) COO, VP Operations Nick A. Gerde 1999 130,000 116,056 (2) 2,400 (5) CFO, VP Finance, 1998 100,000 75,000 (4) 2,400 (5) Treasurer and 1997 84,160 38,333 (4) -- Assistant Secretary Sheryl A. Symonds 1999 160,973 160,000 (2) -- VP Administration, 1998 (9) 105,000 160,000 (4) -- General Counsel and Secretary - -------------- (1) Represents options to purchase shares of Common Stock. (2) Represents repricing of previously granted options. On December 4, 1998, the Board of Directors approved the repricing of outstanding options under the Company's Amended and Restated Stock Incentive Plan. See "- Ten-Year Option Repricings." For purposes of this table, repriced options are considered to be option grants and, therefore, are required to be included in the table as options granted in fiscal 1999. Other than repricing of options, no options were granted to Mr. Wright, Mr. Gerde, or Ms. Symonds during fiscal 1999. (3) Represents estimated value of the personal use of Company vehicles ($4,800) and premiums on $2 million of key-man life insurance denoting Mr. Wright's spouse as beneficiary. (4) These options were repriced in fiscal 1999, and the entire balance is also included in this table as options granted during fiscal 1999. See footnote (2) above. (5) Represents estimated value of the personal use of a Company vehicle. (6) 257,440 of these options were repriced in fiscal 1999 and are also included as part of the total shown in this table as options granted during fiscal 1999. See footnote (2) above. (7) Represents the compensation received by Mr. Hafelfinger during the three months he was employed by the Company in fiscal year 1999. (8) Does not include options to purchase 10,000 shares granted to Mr. Hafelfinger in October 1998 under the Amended and Restated Independent Director Stock Plan, when Mr. Hafelfinger was a non-employee director of the Company. (9) Represents the compensation received by Ms. Symonds during the nine months she was employed by the Company in fiscal year 1998.
85 Option Grants Table The following table sets forth information on grants of stock options by the Company during the year ended May 31, 1999 to the Named Executives:
Securities % of Total Underlying Options Granted Exercise or Grant Date Options Granted to Employees in Base Price Expiration Present Name (#) Fiscal Year(1) ($/Share) Date Value (2)($) ---- --------------- --------------- ------------ ---------- ------------ Donald A. Wright (3) 97,560 5.5% $ 2.5313 10/30/05 177,316 15,000 * $ 2.5313 11/28/05 27,404 237,440 13.4% $ 2.5313 07/15/06 450,520 275,000 15.5% $ 2.5313 02/09/08 554,142 375,000 21.2% $ 2.5313 05/28/08 760,472 Werner Hafelfinger (4) 50,000 2.8% $ 2.5313 3/1/09 85,796 Nick A. Gerde (3) 24,390 1.4% $ 2.5313 10/30/05 44,329 8,333 * $ 2.5313 11/28/05 15,224 8,333 * $ 2.5313 05/21/07 16,330 15,000 * $ 2.5313 06/02/07 29,396 25,000 1.4% $ 2.5313 02/09/08 50,377 35,000 2.0% $ 2.5313 05/28/08 70,977 Sheryl A. Symonds (3) 75,000 4.2% $ 2.5313 07/18/07 147,525 50,000 2.8% $ 2.5313 02/09/08 100,753 35,000 2.0% $ 2.5313 05/28/08 70,977 - -------------- * Less than 1% (1) The denominator includes (i) options to purchase a total of 1,466,056 shares of Common Stock that were granted prior to fiscal 1999 and repriced in fiscal 1999 (see "- Ten-Year Option Repricings"), plus (ii) new options to purchase an additional 303,332 shares of Common Stock that were granted during fiscal 1999. (2) Although the Company believes that it is not possible to place a value on an option, in accordance with the rules of the SEC, the Company has used a Black-Scholes model of option valuation to estimate grant date present value. The actual value realized, if any, may vary significantly from the values estimated by this model. Any future values realized will ultimately depend upon the excess of the stock price over the exercise price on the date the option is exercised. The assumptions used to estimate the grant date present value of this option were: volatility (71.86%); risk-free rate of return (6%); dividend yield (0%); and time of exercise (remaining life 6.8 to 10 years). (3) These options represent options that were granted in previous years and repriced in fiscal 1999. Other than repricing of options, no options were granted to Mr. Wright, Mr. Gerde, or Ms. Symonds during fiscal 1999. See "- Ten-Year Option Repricings." (4) Does not include options to purchase 10,000 shares granted to Mr. Hafelfinger in October 1998 under the Amended and Restated Independent Director Stock Plan, when Mr. Hafelfinger was a non-employee director of the Company.
86 Aggregated Options and Fiscal Year-End Option Values The following table summarizes the aggregate stock options and warrants, and their market values at May 31, 1999, held by the Named Executives:
Number of Securities Value of Unexercised Underlying Unexercised In-the-Money Options Options at FY-end(#) at FY-end($)(1) -------------------------- -------------------------- Name Exercisable Unexercisable Exercisable Unexercisable ---- ----------- ------------- ----------- ------------- Donald A. Wright 1,764,010 18,550 -- -- Werner Hafelfinger (2) 50,000 -- -- -- Nick A. Gerde 161,300 9,756 -- -- Sheryl A. Symonds 160,000 -- -- -- (1) No options or warrants held by the Named Executives had exercise prices of less than $1.6875 per share, the closing price of the Common Stock on May 28, 1999. (2) Does not include options to purchase 10,000 shares granted to Mr. Hafelfinger in October 1998 under the Amended and Restated Independent Director Stock Plan, when Mr. Hafelfinger was a non-employee director of the Company.
Ten-Year Option Repricings In December 1998, the Board of Directors made a determination that underwater stock options held by employees of the Company should be repriced to reflect the then-current market value of the Company's Common Stock. Consequently, on December 4, 1998, all outstanding stock options with exercise prices over $2.5313 per share held by employees of the Company were repriced to have an exercise price of $2.5313 per share, which was the closing sale price of the Common Stock on that date, except that the repricing of Mr. Wright's options was limited to options to purchase 1,000,000 shares. The following table sets forth information on repricing of stock options by the Company during the year ended May 31, 1999 to the Named Executives:
Market Length of Number of Price of Original Securities Common Exercise Option Term Underlying Stock at Price at New Remaining at Options Time of Time of Exercise Date of Name and Position Date Repriced Repricing Repricing Price Repricing - ----------------- ------- ----------- ----------- --------- -------- ------------ Donald A. Wright 12/4/98 97,560 $ 2.5313 $ 5.1250 $ 2.5313 7 years Chairman of the Board, 12/4/98 15,000 $ 2.5313 $ 4.8750 $ 2.5313 7 years Chief Executive Officer 12/4/98 237,440 $ 2.5313 $ 4.6875 $ 2.5313 8 years and President 12/4/98 275,000 $ 2.5313 $ 4.7200 $ 2.5313 10 years 12/4/98 375,000 $ 2.5313 $ 6.1300 $ 2.5313 10 years Nick A. Gerde 12/4/98 24,390 $ 2.5313 $ 5.1250 $ 2.5313 7 years Chief Financial Officer, 12/4/98 8,333 $ 2.5313 $ 4.8750 $ 2.5313 7 years Vice President Finance, 12/4/98 8,333 $ 2.5313 $ 2.8750 $ 2.5313 9 years Treasurer, and 12/4/98 15,000 $ 2.5313 $ 3.0000 $ 2.5313 9 years Assistant Secretary 12/4/98 25,000 $ 2.5313 $ 4.7200 $ 2.5313 10 years 12/4/98 35,000 $ 2.5313 $ 6.1300 $ 2.5313 10 years Sheryl A. Symonds 12/4/98 75,000 $ 2.5313 $ 4.000 $ 2.5313 9 years Vice President Administration, 12/4/98 50,000 $ 2.5313 $ 4.7200 $ 2.5313 10 years General Counsel and Secretary 12/4/98 35,000 $ 2.5313 $ 6.1300 $ 2.5313 10 years
87 Employment Agreements The Company has entered into employment agreements with each of the Named Executives. The employment agreements employ Mr. Wright through fiscal 2003, and employ Mr. Hafelfinger, Mr. Gerde, and Ms. Symonds through fiscal 2002. The employment agreements provide for an annual salary in fiscal 2000 of $292,008, $175,000, $140,000, and $176,364, for Mr. Wright, Mr. Hafelfinger, Mr. Gerde, and Ms. Symonds, respectively. The employment agreements also provide for the annual grant to each of the Named Executives of options to purchase up to 275,000 shares of Common Stock for Mr. Wright, and up to 50,000 shares of Common Stock for Mr. Hafelfinger, Mr. Gerde, and Ms. Symonds. Of these, 50,000 of Mr. Wright's options are fixed, 25,000 of the other Named Executive's options are fixed, and the remainder are discretionary. The exercise price of any such options is equal to the fair market value of the Common Stock on the date of grant. Each option may contain vesting and other terms as are approved by the Board of Directors, and will expire ten years after the date of grant. If a Named Executive's employment with the Company is terminated without cause, or if there is a change of control, as those terms are defined in their employment agreements, the Company will be required to make severance payments equal to, in the case of Mr. Wright, twice Mr. Wright's then-current annual base salary; in the case of Mr. Gerde, one times his then-current annual base salary; in the case of Ms. Symonds, one and one-half times her then-current annual base salary; and in the case of Mr. Hafelfinger, twice his then current base salary in the event of a change in control or one times his then-current base salary if he is terminated without cause. Under these employment agreements, Mr. Wright, Mr. Hafelfinger, and Mr. Gerde agree not to compete with the Company for two years following termination of employment. In May 1999, the Board of Directors adopted an incentive compensation program for fiscal 2000, which provides for the payment of cash bonuses to the Named Executives, the group presidents, and approximately 20 other senior managers, upon attainment of certain goals. Under this program, each of the Named Executives can earn a cash bonus of 10% of his or her annual salary if the Company achieves budgeted operating income levels for the year and an additional 5% if the Company exceeds budgeted operating income by 10%. In addition, each of the Named Executives can earn a cash bonus of up to 5% of his or her annual salary upon achieving personal goals and objectives. Certain Tax Considerations Related to Executive Compensation As a result of Section 162(m) of the Code, if the Company pays more that $1,000,000 in compensation to a "covered employee" (the chief executive officer and the next four highest paid employees) in a single year, then the Company's deduction for such compensation could be limited to $1,000,000. Benefit Plans Amended and Restated Stock Incentive Plan The Company's shareholders adopted the Company's Amended and Restated Stock Incentive Plan (the "Option Plan") in October 1996. The Company has reserved for issuance under the Option Plan a maximum of 3,000,000 shares of Common Stock, subject to certain adjustments. Under the Option Plan, the plan administrator may award incentive stock options ("ISOs") to key employees, and may award non-qualified stock options ("NSOs"), stock appreciation rights ("SARs"), stock and cash bonus awards, restricted stock, and performance units to employees and certain non-employees (other than non-employee directors) who have important relationships with the Company or its subsidiaries. However, no person may receive options to purchase more than 1,000,000 shares in any one year. As of May 31, 1999, options to purchase an aggregate of 2,664,448 shares of Common Stock had been granted under the Option Plan, of which options for 25,000 shares had been exercised, and options for 172,500 shares had been forfeited, leaving 508,052 shares available 88 as of May 31, 1999 for future grant under the Option Plan. No SARs, stock or cash bonus awards, restricted stock or performance units have been granted under the Option Plan. In June 1999, options to purchase an additional 450,000 shares were granted under the Option Plan, leaving 58,052 shares available for future grants. The Option Plan is administered by the Option Committee of the Board of Directors, which is comprised of disinterested directors in accordance with Rule 16b-3 under the Exchange Act, and of outside directors under Section 162(m) of the Internal Revenue Code. However, only the Board of Directors may amend or terminate the Option Plan. Unless terminated sooner by the Board of Directors, the Option Plan expires in October 2006. In general, vested options and any related rights may only be exercised when (a) the recipient is employed by or in the service of the Company, (b) within 12 months following termination of employment by reason of death or disability, or (c) within three months following termination for any other reason except for cause. Options, SARs, cash and stock bonus awards and performance units are nonassignable and nontransferable except by will or by the laws of descent and distribution at the time of the recipient's death. On the date an ISO is granted, the aggregate fair market value of the Common Stock issuable under ISOs available for exercise during any calendar year, may not exceed $100,000. ISOs must expire ten years from the date of grant, and the exercise price must equal the fair market value of the underlying shares of Common Stock at the date of grant. ISOs may not be granted to employees holding more than 10% of the Company's total voting power unless (a) the exercise price is at least 110% of the Common Stock's fair market value on the date of grant, and (b) the option is not exercisable until five years after the date of grant. In July 1999 the Board of Directors adopted the 1999 Stock Incentive Plan (the "New Plan"), subject to the approval of the New Plan by the Company's shareholders at the 1999 annual meeting. The New Plan will also be administered by the Option Committee, and its terms are substantially similar to those of the Option Plan. Under the New Plan, 4,000,000 shares of Common Stock would be reserved for issuance. The primary differences between the New Plan and the existing Option Plan relate to the termination provisions for options. Under the New Plan, options would not expire until (a) 24 months after an option holder's termination of employment because of disability or death, rather than 12 months, and (b) 24 months after the retirement of the option holder, rather than 3 months. Independent Director Stock Plan The Company's shareholders adopted the Company's original Independent Director Stock Plan in November 1995. Following approval by the shareholders at the Company's 1998 Annual Meeting, the plan was amended and restated. The Company has reserved for issuance under the Amended and Restated Independent Director Stock Plan (the "Director Plan") a maximum of 500,000 shares of Common Stock, subject to adjustments, issuable to directors who are not employees of the Company or any of its subsidiaries. The Director Plan is administered by the Compensation Committee of the Board of Directors in accordance with Rule 16b-3 adopted under the Exchange Act. No director may vote on any matter relating to an award held by such director. Only the Board of Directors may suspend, amend or terminate the Director Plan. Unless terminated sooner by the Board of Directors, the Director Plan expires on October 2005. Under the Director Plan, as amended in 1998, each Independent Director receives fully-vested, non-qualified options to purchase up to 2,500 shares of Common Stock upon election to the Board (the "Initial Award"). Each time an Independent Director is elected to the Board (or on the date of each annual shareholders' meeting during terms longer than one year), each Independent Director receives an option to purchase up to 10,000 shares of Common Stock (the "Annual Award"). Annual Awards vest in full on the first anniversary of grant (the "Vesting Period") if the 89 Independent Director has attended at least 75% of the regularly scheduled Board meetings during the Vesting Period. Otherwise the Annual Award is forfeited, unless the Board of Directors votes unanimously to waive or modify the vesting requirement. An unvested Annual Award will also be forfeited if the director ceases to be an Independent Director during the Vesting Period for any reason other than death or disability unless the Board votes unanimously to waive that requirement. However, unvested Annual Awards automatically vest (a) if the director is unable to continue due to disability or death, (b) upon the closing of any merger, consolidation or plan of exchange in which the Company does not survive, or (c) upon sale of all or substantially all of the Company's assets. The exercise price of options granted under the Director Plan is based on the fair market value of the Company's Common Stock for the five trading days prior to the date of determination. No Independent Director may transfer any interest in unvested Annual Awards to any person other than to the Company. At May 31, 1999, 32,559 shares of Common Stock had been issued under the Director Plan, and options to purchase an additional 56,637 shares of Common Stock had been granted, 10,000 of which were forfeited, leaving 420,804 shares available for issuance under the Director Plan. Employee Stock Purchase Plan The Company's shareholders adopted the Company's 1997 Employee Stock Purchase Plan in October 1997 (the "Employee Stock Plan"). The Company has reserved for issuance under the Employee Stock Plan a maximum of 1,000,000 shares of Common Stock, subject to certain adjustments, for issuance to eligible employees of the Company and its subsidiaries. The Company pays all expenses relating to the Employee Stock Plan except expenses related to the resale of shares acquired by employees under the plan. The Employee Stock Plan is administered by the Compensation Committee of the Board of Directors. The plan administrator has designated Salomon Smith Barney, Inc. as the plan's custodian to vote the shares pursuant to the participants' instructions, keep the plan records, and provide periodic statements to participants. Under the Employee Stock Plan, eligible employees may purchase shares of the Company's Common Stock through payroll deductions ranging from a minimum of $20 bi-weekly, to a maximum of 15% of the employee's annual gross pay or $25,000. The purchase price per share is the lower of (a) 85% of fair market value on the first day of the offering period, or (b) 100% of fair market value on the last day of the offering period. The first offering period began November 1, 1998, and offering periods are one month long. Plan participants may sell their shares through the plan custodian for a discounted brokage fee. If a participant's employment terminates before the end of any offering period, no shares are purchased for the participant during that period and the payroll deduction is returned to the participant. Between November 1, 1998 and May 31, 1999, between 113 and 140 employees participated in the Employee Stock Plan each month, purchasing stock at prices ranging between $1.4076 per share and $2.3375 per share. For the seven months between November 1, 1998 and May 31, 1999, a total of 41,942 shares of Common Stock were issued under the Employee Stock Plan. 90 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Principal Shareholders The following table shows, to the best of the Company's knowledge based on the records of the Company's transfer agent and the Company's records on issuances of shares, as adjusted to reflect changes in ownership documented in filings with the Securities and Exchange Commission made by certain shareholders and provided to the Company pursuant to Section 16 of the Exchange Act, and statements provided to the Company by certain shareholders, the Common Stock owned as of August 24, 1999, by (1) each person known by the Company to own beneficially more than 5% of the outstanding Common Stock (each a "Principal Shareholder"); (2) each of the Company's directors; (3) the Named Executives; and (4) all executive officers and directors of the Company as a group. Except as otherwise noted, the Company believes the persons listed below have sole investment and voting power with respect to the Common Stock owned by them.
Amount and Percentage Nature of of Beneficial Common Name and Address of Beneficial Owner: Ownership(1) Stock - ------------------------------------ ------------ ---------- Donald A. Wright (2) 2,343,960 10.85% c/o Pacific Aerospace & Electronics, Inc. 430 Olds Station Road, Third Floor Wenatchee, WA 98801 Allen W. Dahl, M.D. (3) 42,401 * 7300 Madrona Drive NE Bainbridge Island, WA 98110 Werner Hafelfinger(4) 165,220 * c/o Pacific Aerospace & Electronics, Inc. 430 Olds Station Road, Third Floor Wenatchee, WA 98801 Dale L. Rasmussen (3) 15,492 * c/o IMPCO Technologies, Inc. 708 Industrial Drive Tukwila, WA 98188 Robert M. Stemmler (3) 8,137 * c/o IMPCO Technologies, Inc. 16804 Gridley Place Cerritos, CA 90703 William A. Wheeler (3) 16,092 * 2011 Lombard Lane Yakima, WA 98902 Nick A. Gerde (5) 241,289 1.24% c/o Pacific Aerospace & Electronics, Inc. 430 Olds Station Road, Third Floor Wenatchee, WA 98801 Sheryl A. Symonds (6) 213,881 1.10% c/o Pacific Aerospace & Electronics, Inc. 430 Olds Station Road, Third Floor Wenatchee, WA 98801 91 Pension Fund of the Siemens Companies in Switzerland 2,440,000 11.25% Freilagerstrasse 40 CH-8047, Zurich, Switzerland All executive officers and directors as a group 3,046,472 13.66% (8 persons) (7) - ------------ * Less than 1%. (1) Shares that a person has the right to acquire within 60 days are treated as outstanding for determining the amount and percentage of Common Stock owned by such person but are not deemed to be outstanding as to any other person or group. (2) Includes (a) 4,000 shares issuable upon exercise of public warrants, (b) 100,000 shares issuable upon exercise of another warrant, and (c) 1,889,010 shares issuable upon exercise of vested stock options. Does not include 18,550 unvested stock options. (3) Includes 10,000 shares issuable upon exercise of vested stock options. (4) Includes 110,000 shares issuable upon exercise of vested stock options. (5) Includes (a) 4,000 shares issuable upon exercise of public warrants, (b) 25,000 shares issuable upon exercise of another warrant, and (c) 191,178 shares issuable upon exercise of vested stock options. Does not include 4,878 unvested stock options. (6) Includes (a) 500 shares issuable upon exercise of public warrants and (b) 210,000 shares issuable upon exercise of vested stock options. (7) Includes currently exercisable warrants and options to purchase up to 2,565,447 shares of Common Stock.
92 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Employment Agreements. The Company has entered into employment agreements with Donald A. Wright, Werner Hafelfinger, Nick A. Gerde and Sheryl A. Symonds. See "Executive Compensation - Employment Agreements." Siemens. In November 1998, the Company sold 2,200,000 shares of restricted Common Stock to Pension Fund of the Siemens Companies in Switzerland ("Siemens"), which caused it to be a Principal Shareholder. Previous to that purchase, Siemens held 240,000 shares of Common Stock and a $4,000,000 promissory note that were issued to Siemens in the Company's Fall 1997 Common Stock and Notes Offering. The Company repaid that note in September 1998. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Significant Events - Reduction of Long-Term Debt." Condominium. In November 1998, the Company entered into a Condominium Purchase and Sale Agreement (the "Condominium Agreement") with Donald A. Wright, the Company's Chief Executive Officer, President, and Chairman of the Board. Pursuant to the Condominium Agreement, Mr. Wright agreed to purchase from the Company a residential condominium unit within the Company's headquarters building for a total purchase price of $175,000. At the time the Condominium Agreement was executed, the condominium had not been completed. Upon completion, the condominium had a value higher than Mr. Wright's purchase price. As a result, Mr. Wright requested that the purchase be rescinded. The Board of Directors agreed to rescind the purchase, but amended Mr. Wright's employment agreement to require Mr. Wright to reside in the condominium unit. Mr. Wright pays rent on the condominium unit of $750.00 per month. In addition, the Board approved an Option to Purchase, which grants to Mr. Wright the right to purchase the condominium unit. The option is exercisable upon the earlier of February 1, 2000 or the cessation of the employment relationship between Mr. Wright and the Company and would remain exercisable until ten business days after such cessation. The purchase price would be: (i) $350,000 if the option is exercised prior to February 1, 2001; (ii) $300,000 if the option is exercised on or after February 1, 2001, but prior to February 1, 2002; and (iii) $250,000 if the option is exercised on or after February 1, 2002. The option terminates ten business days after Mr. Wright's employment relationship with the Company ceases for any reason other than death. 93 ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements The following financial statements are included in this Annual Report on Form 10-K: Independent Auditors' Report dated July 16, 1999 Independent Auditors' Report dated July 2, 1997 Consolidated Balance Sheets as of May 31, 1998 and 1999 Consolidated Statements of Operations for the years ended May 31, 1997, 1998 and 1999 Consolidated Statements of Stockholders' Equity for the years ended May 31, 1997, 1998 and 1999 Consolidated Statements of Cash Flows for the years ended May 31, 1997, 1998 and 1999 Notes to Consolidated Financial Statements (a)(2) Financial Schedules All financial schedules are omitted because the required information is inapplicable or the information is presented in the consolidated financial statements or related notes. (a)(3) Exhibits Exhibit Number Description -------- ----------- 2.1 Share Acquisition Agreement dated July 1, 1998, by and between Charles Baynes plc, Westpark Limited, Pacific Aerospace and Electronics (U.K.) Limited, and Pacific Aerospace & Electronics, Inc.(18) 3.1 Articles of Incorporation of Pacific Aerospace & Electronics, Inc.(6) 3.2 Amendment to Articles of Incorporation containing Designation of Rights and Preferences of Series A Convertible Preferred Stock, as corrected. (8) 3.3 Amendment to Articles of Incorporation containing Designation of Rights and Preferences of Series B Convertible Preferred Stock. (20) 3.4 Bylaws of Pacific Aerospace & Electronics, Inc.(6) 4.1 Form of specimen certificate for Common Stock.(6) 4.2 Form of specimen certificate for public warrants.(6) 4.3 Form of specimen certificate for the Series A Convertible Preferred Stock.(8) 4.4 Form of specimen certificate for the Series B Convertible Preferred Stock.(20) 4.5 Form of Common Stock Purchase Warrant issued to holders of the Series B Convertible Preferred Stock on May 15, 1998.(20) 4.6 Registration Rights Agreement, dated May 15, 1998 between Pacific Aerospace & Electronics, Inc. and the holders of the Series B Convertible Preferred Stock.(20) 4.7 Warrant Agreement between Interwest Transfer Co., Inc. and PCT Holdings, Inc. dated July 1, 1996.(4) 4.8 Form of Stock Purchase Agreement used in the Fall 1997 Common Stock and Note Offering. (14) 4.9 Purchase Warrant from Pacific Aerospace & Electronics, Inc. to Paulson Investment Company, Inc., dated September 30, 1997.(20) 4.10 Purchase Warrant from Pacific Aerospace & Electronics, Inc. to Chester L. Paulson, dated September 30, 1997.(20) 4.11 Purchase Warrant from Pacific Aerospace & Electronics, Inc. to M. Lorraine Maxfield dated September 30, 1997.(20) 94 4.12 Common Stock Purchase Warrant No. 001 from Pacific Aerospace & Electronics, Inc. to Donald A. Wright dated as of November 30, 1996.(10) 4.13 Common Stock Purchase Warrant No. 002 from Pacific Aerospace & Electronics, Inc. to Nick A. Gerde dated as of November 30, 1996.(10) 4.14 Common Stock Purchase Warrant No. 003 from Pacific Aerospace & Electronics, Inc. to Edward A. Taylor dated as of November 30, 1996.(10) 4.15 Common Stock Purchase Warrant from Pacific Aerospace & Electronics, Inc. to Robert L. Smith Unified Credit Trust dated as of February 5, 1998.(20) 4.16 Common Stock Purchase Warrant from Pacific Aerospace & Electronics, Inc. to David A. Noyes & Company dated June 3, 1997. (9) 4.17 Common Stock Purchase Warrant from Pacific Aerospace & Electronics, Inc. to Gregory K. Smith dated June 3, 1997. (9) 4.18 Common Stock Purchase Warrant from Pacific Aerospace & Electronics, Inc. to Nestor Wiegand dated June 3, 1997. (9) 4.19 Securities Purchase Agreement, dated May 15, 1998, between Pacific Aerospace & Electronics, Inc. and the purchasers of the Company's Series B Convertible Preferred Stock. (20) 4.20 Purchase Agreement dated as of July 23, 1998, between Pacific Aerospace & Electronics, Inc., Balo Precision Parts, Inc., Cashmere Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty Corporation, Morel Industries, Inc., Northwest Technical Industries, Inc., Pacific Coast Technologies, Inc., Seismic Safety Products, Inc., PA&E International, Inc. and Friedman, Billings, Ramsey & Co., Inc. and BancBoston Securities Inc.(18) 4.21 Indenture dated as of July 30, 1998, between Pacific Aerospace & Electronics, Inc., Balo Precision Parts, Inc., Cashmere Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty Corporation, Morel Industries, Inc., Northwest Technical Industries, Inc., Pacific Coast Technologies, Inc., Seismic Safety Products, Inc., PA&E International, Inc. and IBJ Schroder Bank & Trust Company.(18) 4.22 Registration Rights Agreement, dated as of July 30, 1998, between Pacific Aerospace & Electronics, Inc., Balo Precision Parts, Inc., Cashmere Manufacturing Co., Inc., Ceramic Devices, Inc., Electronic Specialty Corporation, Morel Industries, Inc., Northwest Technical Industries, Inc., Pacific Coast Technologies, Inc., Seismic Safety Products, Inc., PA&E International, Inc. and Friedman, Billings, Ramsey & Co., Inc. and BancBoston Securities Inc.(18) 4.23 Form of Global Note by Pacific Aerospace & Electronics, Inc.(18) 4.24 Form of Subsidiary Guaranty from the U.S. subsidiaries of Pacific Aerospace & Electronics, Inc. (25) 4.25 Form of Stock Purchase Agreement used in Fall 1998 Common Stock Offering. (25) 10.1 Placement Agreement, dated October 21, 1997, between Pacific Aerospace & Electronics, Inc. and Lysys Ltd. (12) 10.2 Placement Agreement, dated March 25, 1998, as amended May 15, 1998, between Pacific Aerospace & Electronics, Inc. and Lysys Ltd. (20) 10.3 Amended and Restated Stock Incentive Plan.(5) 10.4 Amendment No. 1 to the Amended and Restated Stock Incentive Plan. (19) 10.5 Amended and Restated Independent Director Stock Plan.(21) 10.6 1997 Employee Stock Purchase Plan.(11) 10.7 Employment Agreement, dated June 1, 1997, between Pacific Aerospace & Electronics, Inc. and Donald A. Wright.(9) 10.8 Amendment No. 1 to Employment Agreement, dated January 29, 1999, between Pacific Aerospace & Electronics, Inc. and Donald A. Wright.(27) 95 10.9 Employment Agreement, dated March 1, 1999, between Pacific Aerospace & Electronics, Inc. and Werner Hafelfinger. (27) 10.10 Employment Agreement, dated June 1, 1997, between Pacific Aerospace & Electronics, Inc. and Nick A. Gerde.(9) 10.11 Employment Agreement, dated September 1, 1997, between Pacific Aerospace & Electronics, Inc. and Sheryl A. Symonds.(12) 10.12 Debt Restructuring Agreement, dated April 6, 1998, between Pacific Aerospace & Electronics, Inc., Orca Technologies, Inc., Televar, Inc. and MONITRx, Inc.(15) 10.13 Commercial Guaranty, dated July 16, 1997, from Pacific Aerospace & Electronics, Inc. to KeyBank National Association.(13) 10.14 Promissory Note, dated March 18, 1998, from Pacific Aerospace & Electronics, Inc. to KeyBank National Association.(15) 10.15 Security Agreement, dated March 18, 1998, from Pacific Aerospace & Electronics, Inc. to KeyBank National Association.(15) 10.16 Facility Letter, dated July 30, 1998, from Barclays Bank plc to Aeromet International plc.(20) 10.17 Loan Agreement, dated September 22, 1998, between Pacific Aerospace & Electronics, Inc. and KeyBank National Association. (22) 10.18 Promissory Note, dated September 22, 1998, from Pacific Aerospace & Electronics, Inc. to KeyBank National Association.(22) 10.19 Security Agreement, dated September 22, 1998, between Pacific Aerospace & Electronics, Inc. and KeyBank National Association.(22) 10.20 Promissory Note, dated September 30, 1998, from Pacific Aerospace & Electronics, Inc. to KeyBank National Association.(22) 10.21 Deed of Trust, dated September 30, 1998, between Pacific Aerospace & Electronics, Inc., KeyBank National Association and Land Title Company, Chelan-Douglas County, Inc.(22) 10.22 Agreement, dated as of August 27, 1998, between Pacific Aerospace & Electronics, Inc., Liviakis Financial Communications, Inc. and Robert B. Prag.(20) 10.23 Asset Purchase Agreement, dated April 13, 1998, between Pacific Aerospace & Electronics, Inc. and Electronic Specialty Corporation.(17) 10.24 Sublease between Pacific Aerospace & Electronics, Inc. and Orca Technologies, Inc. dated April 27, 1998.(20) 10.25 General Terms Agreement No. PLR-950 Relating to Boeing Model Aircraft between Cashmere Manufacturing Co., Inc. and Boeing Commercial Airplane Group, effective as of February 5, 1990, as amended.(3) 10.26 Special Business Provisions No. L-890821-8140N between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of December 18, 1992.(1)(3) 10.27 Special Business Provisions No. L-500660-8134N between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of December 31, 1991.(1)(3) 10.28 Special Business Provisions No. L-435579-8180N between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of August 11, 1994.(1)(3) 10.29 Special Business Provisions No. PLR-950A between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of February 5, 1990.(1)(3) 10.30 Administrative Agreement No. L-435579-8180N between Cashmere Manufacturing Co., Inc. and Boeing Commercial Airplane Group effective as of August 11, 1994.(3) 10.31 Special Business Provisions No. POP-65311-0047 between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of February 26, 1996.(1)(3) 10.32 General Terms Agreement No. BCA-65311-0044 between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of February 26, 1996.(3) 96 10.33 General Terms Agreement No. BCA-65311-0140 between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of June 11, 1997.(20) 10.34 Special Business Provisions No. POP-65311-0143 between The Boeing Company and Cashmere Manufacturing Co., Inc. effective as of June 11, 1997.(1)(20) 10.35 Long Term Agreement No. 0108098 between Northrop Grumman Corporation and Cashmere Manufacturing Co., Inc. effective as of April 6, 1998.(1)(20) 10.36 Condominium Purchase and Sale Agreement between Pacific Aerospace & Electronics, Inc. and Donald A. Wright effective as of November 7, 1998.(24) 10.37 Rescission Agreement, dated January 29, 1999 between Pacific Aerospace & Electronics, Inc. and Donald A. Wright.(27) 10.38 Option to Purchase, dated January 29, 199, between Pacific Aerospace & Electronics, Inc. and Donald A. Wright. (27) 10.39 Real Estate Agreement, dated January 15, 1999, between Pacific Aerospace & Electronics, Inc. and the Port of Chelan County. (27) 10.40 Operating Agreement, dated as of April 23, 1999, between Pacific Aerospace & Electronics, Inc. and Nova-Tech Engineering, Inc.(28) 10.41 Demand Promissory Note, dated April 26, 1999 from Nova-Tech Engineering, Inc. to Pacific Aerospace & Electronics, Inc. (28) 10.42 Demand Promissory Note, dated August 5, 1999, from Nova-Tech Engineering, Inc. to Pacific Aerospace & Electronics, Inc. (28) 10.43 Security Agreement, dated April 26, 1999, from Nova-Tech Engineering, Inc. to Pacific Aerospace & Electronics, Inc. (28) 16.1 Letter from accountant regarding a change of accountants.(16) 21.1 List of Subsidiaries.(28) 23.1 Consent of KPMG LLP.(28) 23.2 Consent of Moss Adams LLP. (28) 27.1 Financial Data Schedule. (28) - -------------- (1) Subject to confidential treatment. Omitted confidential information was filed separately with the Securities and Exchange Commission. (2) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended May 31, 1995. (3) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement on Form SB-2 filed on June 19, 1996. (4) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the year ended May 31, 1996. (5) Incorporated by reference to the Company's Current Report on Form 10-QSB for the quarterly period ended November 30, 1996. (6) Incorporated by reference to the Company's Current Report on Form 8-K filed on December 12, 1996, reporting the reincorporation merger. (7) Incorporated by reference to the Company's Registration Statement of Certain Successor Issuers on Form 8-B filed on February 6, 1997. (8) Incorporated by reference to the Company's Current Report on Form 8-K filed on March 12, 1997, reporting the Series A Preferred Stock offering. (9) Incorporated by reference to the Company's Annual Report on Form 10-KSB for the fiscal year ending May 31, 1997. (10) Incorporated by reference to the Company's Registration Statement on Form S-8 filed on June 11, 1997. 97 (11) Incorporated by reference to the Company's Definitive Proxy Statement for its 1997 Annual Shareholders Meeting, filed on August 28, 1997. (12) Incorporated by reference to the Post-Effective Amendment No. 1 to Form SB-2, filed on November 3, 1997. (13) Incorporated by reference to the Company's Quarterly Report on Form 10-QSB for the quarterly period ending November 30, 1997. (14) Incorporated by reference to the Company's Registration Statement on Form S-3 filed on December 3, 1997. (15) Incorporated by reference to the Company's Quarterly Report on Form 10-QSB for the quarterly period ending February 28, 1998. (16) Incorporated by reference to the Company's Current Report on Form 8-K/A, filed on May 1, 1998. (17) Incorporated by reference to the Company's Current Report on Form 8-K filed on July 10, 1998. (18) Incorporated by reference to the Company's Current Report on Form 8-K filed on August 14, 1998. (19) Incorporated by reference to the Company's Registration Statement on Form S-8 filed on November 7, 1997. (20) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ending May 31, 1998. (21) Incorporated by reference to the Company's Definitive Proxy Statement filed on September 1, 1998. (22) Incorporated by reference to the Company's Quarterly Report on Form 10-Q, and Form 10-Q/A, for the quarterly period ending August 31, 1998. (23) Incorporated by reference to the Company's Registration Statement on Form S-1 filed on October 30, 1998. (24) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ending November 30, 1998. (25) Incorporated by reference to Registration Statement on Form S-4 filed on November 25, 1998. (26) Incorporated by reference to Amendment No. 1 to Registration Statement on Form S-4 filed on January 20, 1999. (27) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ending February 28, 1999. (28) Filed with this report. (b) Reports on Form 8-K. (i) The Company filed a Current Report on Form 8-K on July 10, 1998 reporting the ESC acquisition. This Form 8-K was amended by Form 8-K/A (Amendment No. 1) filed on August 26, 1998 and Form 8-K/A (Amendment No. 2) filed on September 21, 1998, which included ESC financial statements for the year ended March 31, 1997 and the nine months ended December 31, 1997. (ii) The Company filed a Current Report on Form 8-K on August 14, 1998 reporting the Aeromet acquisition, which included Aeromet financial statements for the two years ended December 31, 1996 and 1997. 98 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. Date: August 27, 1999. PACIFIC AEROSPACE & ELECTRONICS, INC. By /s/ DONALD A. WRIGHT ------------------------------------- DONALD A. WRIGHT President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the following capacities on August 27, 1999. Signatures Title /s/ DONALD A. WRIGHT President, Chief Executive Officer, and - ----------------------------- Chairman of the Board DONALD A. WRIGHT (Principal Executive Officer) /s/ NICK A. GERDE Vice President Finance, Chief Financial - ----------------------------- Officer, Treasurer, and Assistant Secretary NICK A. GERDE (Principal Financial and Accounting Officer) /s/ WERNER HAFELFINGER Director, Vice President Operations and - ----------------------------- Chief Operating Officer WERNER HAFELFINGER /s/ ALLEN W. DAHL Director - ----------------------------- ALLEN W. DAHL /s/ DALE L. RASMUSSEN Director - ----------------------------- DALE L. RASMUSSEN /s/ WILLIAM A. WHEELER Director - ----------------------------- WILLIAM A. WHEELER /s/ ROBERT M. STEMMLER Director - ----------------------------- ROBERT M. STEMMLER 99 EX-10.40 2 OPERATING AGREEMENT - PAE/NOVA-TECH ENGINEERING OPERATING AGREEMENT THIS AGREEMENT is entered into as of April 23, 1999, by and between PACIFIC AEROSPACE & ELECTRONICS, INC., a Washington corporation ("PA&E) and NOVA-TECH ENGINEERING, INC. (the "Company"). RECITALS A. On November 18, 1998, PA&E, the Company, and Hans and Karl Herrmann entered into a non-binding letter of intent (the "Letter of Intent"), relating to the proposed acquisition of the Company by a wholly owned subsidiary of PA&E. The proposed purchase is subject to, among other things, the satisfactory completion of due diligence investigations, the preparation and signing of a definitive purchase agreement (the "Purchase Agreement"), and the application for and receipt of an IRS ruling regarding certain issues related to the Company's ESOP. B. Pending the closing of the proposed acquisition, PA&E and the Company have agreed that PA&E will assist in, consult with, and oversee the operations and management of the Company, which PA&E is willing to do on the terms set forth in this agreement. C. The parties wish to provide for a mechanism for adequately compensating PA&E for its assistance in the event that PA&E does not acquire the Company. AGREEMENT In consideration of the mutual promises and agreements contained in this Agreement, the parties agree as follows: 1. Consultation and Assistance. From the date of this Agreement through the Termination Date (as defined in Section 8 below), PA&E will consult with the Company's management and provide certain personnel who will assist and consult with the Company's management regarding the operations of the Company. As part of the services to be provided under this Agreement, PA&E agrees to make available to the Company personnel to be designated by PA&E, at reasonable times and upon reasonable notice. All such personnel will be employees or agents of PA&E throughout the term of this Agreement. The parties agree that, in carrying out its duties under this Agreement, PA&E, at its election, may do any of the following: (a) Operations. PA&E may review the Company's books and records and business operations and consult with the Company's management on the conduct of the Company's business, its operating plans and budgets, and its organizational structure; (b) Strategic Planning. PA&E may consult with the Company's management regarding strategic planning; (c) Sales. PA&E or its agent may participate in marketing planning and in the sales activities of the Company; 1 (d) Customers and Suppliers. PA&E may participate with the Company's management in meetings and other dealings with customers and suppliers, and may review and comment on communications, contracts and commitments with customers and suppliers; (e) Products. PA&E may assist in and comment on product and service development, pricing, and improvements; (f) Employees. PA&E may participate with the Company's management in meetings and other dealings with employees, review and comment on communications and contracts with and commitments to employees, and assist the Company with decisions related to employees, including decisions regarding hiring, firing, and compensation; (g) Accounting. PA&E may review and comment on the Company's accounting system and may review and comment on preparation of the Company's financial statements and reports; (h) Management Meetings. PA&E may appoint one or more persons to participate in management meetings of the Company; (i) Board Meetings. PA&E may appoint one or more persons to attend and participate in meetings of the Company's Board of Directors, but not to vote; and (j) PA&E Personnel. PA&E may locate personnel at the Company's facilities, either full-or part-time, to enable PA&E to perform its duties under this Agreement. 2. Retention of Authority by the Company. Throughout the term of this Agreement, the Board of Directors of the Company shall retain authority over the business, policies, operations and assets of the Company in accordance with the Company's Articles of Incorporation and Bylaws. By entering into this Agreement, the Company does not delegate to PA&E any powers, duties, and responsibilities vested in the Company's Board of Directors by law or by the Company's Articles of Incorporation or Bylaws. 3. Compliance with Recommendations. Notwithstanding Section 2, above, the Company agrees that it will not take any action or fail to take any action within its control that would cause it to deviate materially from advice or recommendations made by PA&E without the prior written consent of PA&E. If the Company deviates materially from such recommendations or advice, PA&E may terminate this Agreement upon giving written notice to the Company and five days to cure the deviation. 4. Prohibited Actions. Notwithstanding any other provision of this Agreement, PA&E may not do any of the following: (a) Borrowings and Encumbrances. PA&E may not borrow any money in the name of or on behalf of the Company, mortgage or encumber any assets of the Company, or in any way pledge the credit of the Company; (b) Expenditures. PA&E may not make expenditures of any kind on behalf of the Company; 2 (c) Contracts. PA&E may not execute any lease, contract or other agreement in the name of or on behalf of the Company; (d) Assets. PA&E may not sell any assets of the Company; and (e) Other Actions. PA&E may not otherwise act on behalf of or in the name of the Company, except as expressly authorized. 5. Duty to Cooperate. The parties acknowledge that their mutual cooperation is critical to the ability of PA&E to perform its duties hereunder successfully and efficiently. Accordingly, each party agrees to cooperate with the other fully in the performance of this Agreement. 6. Compensation. If this Agreement is terminated for any reason other than the acquisition of the Company by PA&E, the Company will pay PA&E on the Termination Date a consulting fee (the "Consulting Fee") of $10,000 for each calendar month from the date of this Agreement through the Termination Date. The Consulting Fee is intended to compensate PA&E for all direct and indirect costs incurred in carrying out its duties under this Agreement. The parties agree that the Consulting Fee fairly reflects the costs and expenses incurred and to be incurred by PA&E. 7. Discretionary Financing. PA&E may from time to time extend loans to the Company as PA&E, in the exercise of its sole discretion and with approval from its Board of Directors and the Board of Directors of the Company, determines may be necessary. (a) Terms. The Company understands and agrees that any loans that may be made by PA&E to the Company would be made on terms mutually acceptable to the parties at or about the time the loan is to be made. This may include, at PA&E's option, the ability to convert the outstanding principal and interest upon maturity or earlier termination to common stock of the Company. Any loans would be secured by all of the assets of the Company, subject to the security interest held by Sterling Savings Bank, and would be conditioned on execution of loan documentation in form and substance acceptable to PA&E. Any loans would be payable no later than the earlier of (i) the due date stated in the applicable loan documents or (ii) 120 days after the Termination Date. (b) Payment Due on Termination. Unless expressly provided otherwise in this Agreement, the applicable loan documents, or a written agreement signed by PA&E, any loans extended to the Company by PA&E shall become due and payable in full 120 days after termination of this Agreement for any reason. (c) No Commitment. The Company acknowledges and agrees that PA&E has made no agreement or commitment to provide any loans or extend any credit to the Company. (d) Statutory Notice. ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FOREBEAR FROM ENFORCING REPAYMENT OF DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW. 3 8. Termination Date. The "Termination Date" shall be the earliest of: (i) the date on which PA&E acquires the Company; (ii) the termination of the Letter of Intent prior to execution of a Purchase Agreement; (iii) the termination of the Purchase Agreement prior to closing of an acquisition; (iv) the date on which this Agreement is terminated by written agreement of PA&E and the Company; (v) the date on which this Agreement is terminated as the result of the Company's violation of Section 3, above; or (vi) December 31, 1999. 9. Representations of the Company. Each party represents and warrants to the other party that: (i) it is a corporation duly organized and validly existing under the laws of the State of Washington; (ii) it has full power, authority and legal right to enter into this Agreement and to perform its obligations hereunder; (iii) this Agreement is the valid and binding obligation of the party making the representation, enforceable in accordance with its terms, and does not breach or cause a default under any other agreement by which the party is bound or by which any of its assets are affected; and (iv) the execution and delivery of this Agreement by the party and performance of its obligations hereunder do not require the consent or authorization of any person or entity that has not been obtained and do not violate any obligations, regulations, or other restrictions by which the party or any of its assets is bound. 10. Indemnification. Except to the extent caused by PA&E's willful misconduct or recklessness, the Company shall indemnify and hold PA&E and its affiliates, shareholders, directors, officers, employees, agents, and consultants harmless against and from all claims, damages, obligations, liabilities, losses, and expenses, including without limitation attorneys' fees and costs (together, "Losses"), which may arise from or in connection with the provisions of this Agreement, the operation or management of the Company, or any act or omission by any employee, agent or other personnel of the Company. PA&E shall indemnify and hold the Company and its affiliates, shareholders, directors, officers, employees, agents, and consultants harmless against and from all Losses to the extent caused by PA&E's willful misconduct or recklessness in connection with the responsibilities of PA&E under this Agreement. The provisions of this Section 10 shall survive the termination of this Agreement if termination is for any reason other than PA&E's acquisition of the Company. 11. Governing Law. The construction and terms of this Agreement are governed by the laws of the State of Washington. 12. No Waiver of Breach. No failure of PA&E or the Company to insist upon the strict performance of any covenant, agreement, term or provision of this Agreement, or to exercise any right or remedy available upon a breach thereof, shall constitute a waiver of any such breach or any subsequent breach of such covenant, agreement, term or provision. No waiver of any breach shall affect or alter this Agreement, but each and every covenant, agreement, term and provision of this Agreement shall continue in full force and effect with respect to any other then existing or subsequent breach thereof. 13. Assignment; Benefit. No party may voluntarily or involuntarily assign its interest under this Agreement without the prior written consent of the other party. Subject to the foregoing, this Agreement shall be binding upon and shall inure to the benefit of the parties an their respective successors and assigns. 4 14. Amendment; Waiver. The provisions of this Agreement, or of any agreement or document executed in connection with this Agreement, may be amended or waived only in writing by the party against which enforcement of such amendment or waiver is sought. 15. Severability. If any portion of this Agreement is held to be invalid by a court of competent jurisdiction, the remaining terms of this Agreement shall remain in full force and effect to the extent possible. 16. No Partnership or Joint Venture. Nothing contained in this Agreement shall constitute or be construed to be or create a partnership, joint venture or similar relationship between the Parties. 17. Entire Agreement. This Agreement and the documents executed in connection with this Agreement contain the entire agreement of the parties, and supersede any and all prior agreements, written or oral, relating to their subject matter. 18. Attorneys' Fees. The prevailing party in any arbitration or litigation concerning the Agreement is entitled to reimbursement of its reasonable attorneys' fees and expenses from the non-prevailing party, including costs and expenses incurred on appeal or in bankruptcy proceedings. 19. Counterparts. This Agreement may be executed in one or more counterparts, each of which will be deemed an original but all of which together will constitute the same instrument. IN WITNESS WHEREOF, the Company and PA&E have executed this Agreement on the day and year first above written. NOVA-TECH ENGINEERING, INC. By /s/ HANS H. HERRMANN 4-23-99 -------------------------------------- Hans Herrmann, President PACIFIC AEROSPACE & ELECTRONICS, INC. By /s/ DONALD A. WRIGHT 4-23-99 -------------------------------------- Donald A. Wright, President & CEO 5 EX-10.41 3 DEMAND PROMISSORY NOTE - $1,500,000 DEMAND PROMISSORY NOTE Principal: $1,500,000.00 Edmonds, WA April 26, 1999 1. Promise to Pay. FOR VALUE RECEIVED, NOVA-TECH ENGINEERING, INC., a Washington corporation ("Borrower"), unconditionally promises to pay to the order of PACIFIC AEROSPACE & ELECTRONICS, INC., a Washington corporation ("Lender"), at 430 Olds Station Road, Wenatchee, Washington 98801, or at such other place as the holder hereof from time to time may designate in writing, the principal sum of ONE MILLION FIVE HUNDRED THOUSAND DOLLARS ($1,500,000.00), or so much thereof as may be advanced by Lender to Borrower and outstanding from time to time, plus interest on the unpaid outstanding principal balance of each advance and such other sums as are payable under the terms of this Note. 2. Payments. All unpaid outstanding principal, interest and other sums owing under this Note shall be due and payable on demand. Borrower may completely or partially prepay this Note at any time or from time to time without penalty. Payments shall be applied first to accrued interest, costs and expenses payable under this Note and then to principal. Demand will not be made before December 15, 1999. 3. Interest. Interest shall accrue on the unpaid principal balance of this Note from the date hereof at the rate of seven and one-half percent (7.5%) per annum until the date on which Lender demands payment ("Demand Date"). If Borrower fails to pay all amounts due under this Note on the Demand Date, then interest shall accrue thereafter on the unpaid principal balance at the rate of twelve percent (12%) per annum until this Note is paid in full. 4. Security. This Note is secured by a security interest in all Borrower's tangible and intangible assets, according to a security agreement (the "Security Agreement") of even date herewith, executed by Borrower in favor of Lender and a UCC-1 Financing Statement filed with the Secretary of State of the State of Washington in connection therewith. Additional rights and obligations of Lender and Borrower are set forth in the Security Agreement. 5. Default; Acceleration. Borrower shall be in default under this Note if (i) Borrower fails to pay all amounts due hereunder on the Demand Date or (ii) if an event of default occurs under the terms of the Security Agreement. Upon an event of default under the Security Agreement, unless and until cure has been accomplished within time allowed for cure (if any), at the option of the holder of this Note and without notice to the Borrowers of the default, the entire indebtedness represented by this Note shall become immediately due and payable and interest shall thereafter accrue on the unpaid balance of principal due under this Note at the rate of twelve percent (12%) per annum. Upon -1- default under this Note, Lender may exercise any rights available to it under the Security Agreements or by applicable law. 6. Attorneys' Fees. If any action, judicial or nonjudicial, is brought on this Note, or if it is placed in the hands of an attorney for collection or advice following the expiration of the cure period (if any) for any default, then Borrower promises to pay all of Lender's costs and expenses in connection therewith, including without limitation reasonable attorneys' fees incurred and paid by holder in connection herewith through any appeal or in bankruptcy. All such costs and attorneys' fees shall bear interest from the date incurred until paid at the default interest rate. 7. Waivers. Borrower, all endorsers, and all persons liable or to become liable on this Note hereby waive presentment, demand, protest and notice of demand, protest and nonpayment, and any defense or claim that resort must first be had to any security or to any other person, and authorize the holder of this Note, without affecting its liability hereunder, from time to time, to renew, extend, or change the time for payment or the other terms of this Note, to take and hold security for the payment of this Note, to release or exchange the security therefor, to apply any such security to such obligations as the holder may determine in its sole discretion, and to release, substitute, or add to those liable or to become liable on this Note. 8. Authorization. Borrower and the officer signing below on its behalf represent and warrant to Lender that: (a) Borrower is a corporation duly organized and validly existing under the laws of Washington; (b) Borrower has taken all corporate action necessary to authorize execution and delivery of this Note and performance of its obligations under this Note and the Security Agreement; (c) Borrower has duly executed and delivered this Note to Lender; and (d) this Note is the valid and binding obligation of Borrowers in accordance with its terms. 9. Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of Washington, United States of America, without regard to conflict of laws rules. 10. Successors and Assigns. The provisions of this Note shall inure to the benefit of and be binding on any successor to Borrower and shall extend to any holder hereof. BORROWER: NOVA-TECH ENGINEERING, INC. By /s/ HANS H. HERRMANN -------------------------------------- Its President ---------------------------------- -2- EX-10.42 4 DEMAND PROMISSORY NOTE - 1,000,000 DEMAND PROMISSORY NOTE Principal: $1,000,000.00 Edmonds, WA August 5, 1999 1. Promise to Pay. FOR VALUE RECEIVED, NOVA-TECH ENGINEERING, INC., a Washington corporation ("Borrower"), unconditionally promises to pay to the order of PACIFIC AEROSPACE & ELECTRONICS, INC., a Washington corporation ("Lender"), at 430 Olds Station Road, Wenatchee, Washington 98801, or at such other place as the holder hereof from time to time may designate in writing, the principal sum of ONE MILLION DOLLARS ($1,000,000.00), or so much thereof as may be advanced by Lender to Borrower and outstanding from time to time, plus interest on the unpaid outstanding principal balance of each advance and such other sums as are payable under the terms of this Note. 2. Payments. All unpaid outstanding principal, interest and other sums owing under this Note shall be due and payable on demand. Borrower may completely or partially prepay this Note at any time or from time to time without penalty. Payments shall be applied first to accrued interest, costs and expenses payable under this Note and then to principal. Demand will not be made before December 15, 1999. 3. Interest. Interest shall accrue on the unpaid principal balance of this Note from the date hereof at the rate of seven and one-half percent (7.5%) per annum until the date on which Lender demands payment ("Demand Date"). If Borrower fails to pay all amounts due under this Note on the Demand Date, then interest shall accrue thereafter on the unpaid principal balance at the rate of twelve percent (12%) per annum until this Note is paid in full. 4. Security. This Note is secured by a security interest in all Borrower's tangible and intangible assets, according to a security agreement (the "Security Agreement") dated April 26, 1999, executed by Borrower in favor of Lender and a UCC-1 Financing Statement filed with the Secretary of State of the State of Washington on May 11, 1999, in connection therewith. Additional rights and obligations of Lender and Borrower are set forth in the Security Agreement. 5. Default; Acceleration. Borrower shall be in default under this Note if (i) Borrower fails to pay all amounts due hereunder on the Demand Date or (ii) if an event of default occurs under the terms of the Security Agreement. Upon an event of default under the Security Agreement, unless and until cure has been accomplished within time allowed for cure (if any), at the option of the holder of this Note and without notice to the Borrowers of the default, the entire indebtedness represented by this Note shall become immediately due and payable and interest shall thereafter accrue on the unpaid balance of principal due under this Note at the rate of twelve percent (12%) per annum. Upon -1- default under this Note, Lender may exercise any rights available to it under the Security Agreements or by applicable law. 6. Attorneys' Fees. If any action, judicial or nonjudicial, is brought on this Note, or if it is placed in the hands of an attorney for collection or advice following the expiration of the cure period (if any) for any default, then Borrower promises to pay all of Lender's costs and expenses in connection therewith, including without limitation reasonable attorneys' fees incurred and paid by holder in connection herewith through any appeal or in bankruptcy. All such costs and attorneys' fees shall bear interest from the date incurred until paid at the default interest rate. 7. Waivers. Borrower, all endorsers, and all persons liable or to become liable on this Note hereby waive presentment, demand, protest and notice of demand, protest and nonpayment, and any defense or claim that resort must first be had to any security or to any other person, and authorize the holder of this Note, without affecting its liability hereunder, from time to time, to renew, extend, or change the time for payment or the other terms of this Note, to take and hold security for the payment of this Note, to release or exchange the security therefor, to apply any such security to such obligations as the holder may determine in its sole discretion, and to release, substitute, or add to those liable or to become liable on this Note. 8. Authorization. Borrower and the officer signing below on its behalf represent and warrant to Lender that: (a) Borrower is a corporation duly organized and validly existing under the laws of Washington; (b) Borrower has taken all corporate action necessary to authorize execution and delivery of this Note and performance of its obligations under this Note and the Security Agreement; (c) Borrower has duly executed and delivered this Note to Lender; and (d) this Note is the valid and binding obligation of Borrowers in accordance with its terms. 9. Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of Washington, United States of America, without regard to conflict of laws rules. 10. Successors and Assigns. The provisions of this Note shall inure to the benefit of and be binding on any successor to Borrower and shall extend to any holder hereof. BORROWER: NOVA-TECH ENGINEERING, INC. By /s/ HANS H. HERRMANN -------------------------------------- Its President ---------------------------------- -2- EX-10.43 5 SECURITY AGREEMENT - PAE/NOVA-TECH ENGINEERING SECURITY AGREEMENT DATED: April 26, 1999 FROM: NOVA-TECH ENGINEERING, INC. 115 Second Avenue North Edmonds, WA 98020 DEBTOR TO: PACIFIC AEROSPACE & ELECTRONICS, INC. 430 Olds Station Road Wenatchee, WA 98801 SECURED PARTY FOR VALUE RECEIVED, and to secure both the payment of the Indebtedness and the performance of the obligations owed to Secured Party under this Security Agreement and the Related Agreements, Debtor grants Secured Party a security interest in the Collateral, in accordance with the definitions and terms set forth below: 1. Definitions. 1.1 Indebtedness. "Indebtedness" shall mean all amounts now or hereafter owed by Debtor to Secured Party, whether or not evidenced by a promissory note or notes and whether direct, indirect, or contingent. 1.2 Related Agreements. The "Related Agreements" shall mean the promissory note of even date herewith, in the principal amount of $1,500,000.00, made by Debtor in favor of Secured Party, and any other present or future agreement between Debtor and Secured Party evidencing any part of the Indebtedness. 1.3 Collateral. The "Collateral" shall be all tangible and intangible property of Debtor, whether now owned or hereafter acquired, whether now existing or hereafter arising, or in which Debtor now has or hereafter acquires any rights, including without limitation: (1) All furniture, leasehold improvements, motor vehicles, appliances, fixtures, furnishings, tools, machinery and equipment and other goods of Debtor, now owned or hereafter acquired, and all additions and accessions thereto and replacements therefor; (2) All inventory, supplies and materials of Debtor now owned or hereafter acquired, together with all additions and accessions thereto and replacements therefor; (3) All accounts, accounts receivable, negotiable documents, notes, drafts, acceptances, claims, lease rights (to the extent they are assignable without consent of the lessor), securities, instruments, choses in action, whether in contract or in tort, proceeds of lawsuits, and general intangibles of Debtor (including, but not limited to goodwill, permits, licenses, trademarks, trade names and trade secrets), and all other rights of Debtor to the payment of money, now existing or hereafter arising; (4) All deposit accounts of Debtor maintained with any bank or other financial institution; (5) All records, papers and books of account or other documents or papers relating to, affecting or describing any of the foregoing Collateral, in whatever form, including without limitation all computerized records, diskettes, programs, etc. relating thereto; (6) All of Debtor?s contract rights and proceeds of insurance policies; (7) All of Debtor?s patents and patents pending; (8) All of Debtor?s stock in and to subsidiaries wholly owned by Debtor; and (9) All proceeds of the foregoing Collateral. For purposes of this Security Agreement, the term "proceeds" includes whatever is receivable or received when Collateral or proceeds is sold, collected, exchanged or otherwise disposed of, whether such disposition is voluntary or involuntary, and includes, without limitation, all rights to payment, including return premiums, with respect to any insurance relating thereto. 2. Obligations of Debtor. Debtor warrants and covenants: 2.1 Payment and Performance. Debtor shall pay to Secured Party promptly when due all amounts payment of which is secured by this Security Agreement and shall strictly perform all obligations imposed upon Debtor by this Security Agreement and the Related Agreements. 2.2 Perfection of Security Interest. Debtor agrees to execute financing statements and to take whatever other action is requested by Secured Party to perfect and continue Secured Party's security interest in the Collateral. Any certificate of title existing on any of the Collateral will be endorsed and delivered to Secured Party reciting Secured Party?s security interest. Debtor hereby appoints Secured Party Debtor's attorney in fact for the purpose of executing any documents necessary to perfect or continue the security interest. Secured Party may file copies or reproductions of this Security Agreement as a financing statement at any time and without further authorization from Debtor. Debtor will reimburse Secured Party for all expenses incurred in perfecting or continuing this security interest. Secured Party's interest is junior to the interest of Sterling Savings Bank as set forth in any and 2 all Security Agreements, including those dated July 1, 1997 and January 25, 1999, between Nova-Tech Engineering, Inc. and Sterling Savings Bank and recorded as Washington State UCC-1 Number 942060455 (filing date July 25, 1994) and its continuation 990430160 dated February 12, 1999, which cover all existing and future indebtedness of Nova-Tech Engineering, Inc. to Sterling Savings Bank and/or its assigns. 2.3 Removal of Collateral. Debtor warrants that the Collateral is located at Debtor's address set forth above. Except in the ordinary course of Debtor's business, Debtor shall not remove the Collateral from its location without the prior written consent of Secured Party, which shall not be unreasonably withheld. To the extent the Collateral constitutes vehicles, Debtor shall not take or permit any action which would require registration of the vehicles outside of the State of Washington without the prior written consent of Secured Party. 2.4 Transactions Involving Collateral. Except for inventory sold in the ordinary course of Debtor's business, Debtor shall not sell, offer to sell, or otherwise transfer the Collateral. Debtor shall not pledge, mortgage, encumber, or otherwise permit the Collateral to be subject to any lien, security interest, or charge, other than the security interest in favor of Secured Party and those created prior to the date hereof, without the prior written consent of Secured Party. 2.5 Title. Debtor warrants that it holds good and marketable title to the Collateral subject only to the lien of this Security Agreement and security interests created prior to the date hereof and that Debtor has full power and authority to execute this Security Agreement, to perform Debtor?s obligations hereunder, and to subject the Collateral to the security interest created hereby. Debtor shall defend Secured Party's rights against the claims and demands of all persons. 2.6 Compliance with Laws. Debtor warrants that its use of the Collateral complies with, and that Debtor will in the future promptly comply with, all applicable laws, ordinances, and regulations of governmental authorities. 2.7 Use. Debtor shall maintain the Collateral in good condition and repair and not use the Collateral for any unlawful purpose or in any way that would void an effective insurance policy. Debtor will not commit or permit damage to or destruction of the Collateral or any part of the Collateral. 2.8 Taxes, Assessments, and Liens. Debtor will pay when due all taxes, assessments, and liens upon the Collateral, its use or operation, upon this Security Agreement, or upon any promissory notes evidencing the Indebtedness. Debtor may withhold any such payment or may elect to contest any lien if Debtor is in good faith conducting appropriate proceedings to contest the obligation to pay, so long as Secured Party's interest in the Collateral is not jeopardized. If the Collateral is subjected to a lien which is not discharged within 15 days, Debtor shall deposit with Secured Party cash, a sufficient corporate surety bond, or other security satisfactory to Secured Party in an amount adequate to provide for the discharge of the lien plus any interest, costs, attorneys' fees, or other charges that could accrue as a result of foreclosure or sale. In any contest proceedings, Debtor shall defend itself and 3 Secured Party and will name Secured Party as an additional obligee under any surety bond, and Debtor shall satisfy any final adverse judgment before enforcement against the Collateral. 2.9 Maintenance of Property Damage Insurance. Debtor shall procure and maintain policies of fire insurance with standard extended coverage endorsements on a replacement cost basis covering the Collateral, in an amount sufficient to avoid application of any coinsurance clause and with loss payable to Secured Party. Policies shall be written in amounts, in form, on terms, and with companies reasonably acceptable to Secured Party. Upon request, Debtor shall deliver to Secured Party certificates of coverage from each insurer containing a stipulation that coverage will not be canceled or diminished without a minimum of 10 days' written notice to Secured Party. 2.10 Application of Insurance Proceeds. Debtor shall promptly notify Secured Party of any loss or damage to the Collateral or any portion thereof having a fair market value in excess of $1,000. Secured Party may make proof of loss if Debtor fails to do so within 15 days of the casualty. Secured Party may, at its election, apply the proceeds to the reduction of the Indebtedness or the restoration and repair of the Collateral. If Secured Party elects to apply the proceeds to restoration and repair, Debtor shall repair or replace the damaged or destroyed Collateral in a manner satisfactory to Secured Party. Upon satisfactory proof of such expenditure, Secured Party shall pay or reimburse Debtor from the proceeds for the reasonable cost of repair or restoration. Any proceeds which have not been paid out within 180 days after their receipt and which Secured Party has not committed to the repair or restoration of the Collateral shall be used to prepay first accrued interest and then principal of Debtor's Indebtedness. If Secured Party holds any proceeds after payment in full of the Indebtedness, such proceeds shall be paid to Debtor. 3. Debtor's Right to Possession. Until in default, Debtor may have possession of the tangible personal property and beneficial use of all of the Collateral and may use it in any lawful manner not inconsistent with this Security Agreement or the Related Agreements. 4. Release on Full Performance. If Debtor pays all of the Indebtedness when due and otherwise performs all the obligations imposed upon Debtor under this Security Agreement, Secured Party shall execute and deliver to Debtor suitable statements of termination of any financing statement on file. The filing fees shall be paid by Debtor. 5. Default. 5.1 Events of Default. The following shall constitute events of default: (1) Failure to pay any portion of the Indebtedness when it is due. (2) Any warranty, representation, or statement made or furnished to Secured Party by or on behalf of Debtor proves to have been false in any material respect when made or furnished. 4 (3) Transfer or agreement to transfer any part or interest in the Collateral without the prior written consent of Secured Party, to the extent required by this Security Agreement. (4) Dissolution, termination of existence as a going business, insolvency on a balance sheet basis or business failure of Debtor; the commencement by Debtor of a voluntary case under the federal bankruptcy laws or under any other federal or state law relating to insolvency or debtor's relief; the entry of a decree or order for relief against Debtor in an involuntary case under the federal bankruptcy laws or under any other applicable federal or state law relating to insolvency or debtor's relief; the appointment or the consent by Debtor to the appointment of a receiver, trustee, or custodian of Debtor or of any of Debtor's property; an assignment for the benefit of creditors by Debtor; the making or suffering by Debtor of a fraudulent transfer under applicable federal or state law; concealment by Debtor of any of its property in fraud of creditors; the making or suffering by Debtor of a preference within the meaning of the federal bankruptcy law; the imposition of a lien through legal proceedings or distraint upon any of the property of Debtor which is not discharged or bonded in the manner permitted by Section 2.8; or Debtor's failure generally to pay its debts as such debts become due. The events of default in this paragraph shall apply and refer to Debtor and to each of the individuals or entities which are collectively referred to as "Debtor." (5) Failure of Debtor to perform any other obligation under this Security Agreement, the Related Agreements or any other present or future agreement between Debtor and Secured Party evidencing the Indebtedness or securing the Indebtedness within 10 days after receipt of written notice from Secured Party specifying the nature of the default. No notice of default and no opportunity to cure shall be required if during the prior 12 months Secured Party has already sent a notice to Debtor concerning default in performance of the same obligation. 6. Rights of Secured Party. 6.1 Rights Prior to Default or Thereafter. Secured Party and its designated representatives or agents may examine and inspect the Collateral, wherever located, at all reasonable times. 6.2 Rights Upon Default or Thereafter. Upon the occurrence of any event of default and at any time thereafter, Secured Party may exercise any one or more of the following rights and remedies: (1) Secured Party may, but shall have no obligation to, pay and discharge any taxes, liens and encumbrances against the Collateral or any part thereof which Debtor has failed to discharge in a timely fashion, and pay for any necessary maintenance and preservation of the Collateral. (2) Secured Party may declare the entire Indebtedness immediately due and payable, including any prepayment penalty which Debtor would be required to pay. 5 (3) Secured Party may require Debtor to deliver to Secured Party all or any portion of the Collateral and any and all certificates of title and other documents relating to the Collateral. Secured Party may require Debtor to assemble the Collateral and make it available to Secured Party at a place to be designated by Secured Party which is reasonably convenient to both parties. Secured Party also shall have full power to enter upon the property of Debtor to take possession of and remove the Collateral. (4) Secured Party shall have full power to sell, lease, transfer, or otherwise deal with the Collateral or proceeds thereof in its own name or that of Debtor. Secured Party may sell the Collateral at public auction or private sale. Unless the Collateral threatens to decline speedily in value or is of the type customarily sold on a recognized market, Secured Party will give Debtor reasonable notice of the time after which any private sale or any other intended disposition of the Collateral is to be made. The requirements of reasonable notice shall be met if such notice is mailed by registered or certified mail, postage prepaid, to the address of Debtor stated in this Security Agreement at least 10 days before the time of the sale or disposition. Debtor shall be liable for expenses of retaking, holding, preparing for sale, selling, or the like. (5) Secured Party may have a receiver appointed as a matter of right. The receiver may be an employee of Secured Party and may serve without bond. All fees of the receiver and its attorney shall be secured hereby. (6) Secured Party may revoke Debtor's right to collect Debtor?s accounts receivable and revenues from the Collateral and may collect the same, either itself or through a receiver. To facilitate collection, Secured Party may: (i) notify any account debtors of Debtor to make payments directly to Secured Party, (ii) demand, collect, settle, and prosecute and discontinue any suits or proceedings in respect of any or all of the Collateral, in the name of Debtor or otherwise, (iii) and otherwise take any action which Secured Party may deem desirable in order to realize on the Collateral. (7) Secured Party may obtain a judgment for any deficiency remaining in the Indebtedness due to Secured Party after application of all amounts received from the exercise of the rights provided in this section. Debtor shall be liable for a deficiency even if the underlying transaction is a sale of accounts or chattel paper. (8) Secured Party shall have and may exercise any or all of the rights and remedies of a secured creditor under the provisions of the Uniform Commercial Code, in addition to any other rights or remedies that may be available at law, in equity, or otherwise. 6.3 Waiver; Election of Remedies. A waiver by either party of a breach of a provision of this Security Agreement shall not constitute a waiver of or prejudice the party's right otherwise to demand strict compliance with that provision or any other provision. Election by Secured Party to pursue any remedy shall not exclude pursuit of any other remedy, and all remedies of Secured Party under this Security Agreement are cumulative and not exclusive. An election to make expenditures or take action to perform an obligation of Debtor 6 shall not affect Secured Party's right to declare a default and exercise its remedies under this Security Agreement. 6.4 Attorneys' Fees; Expenses. In the event suit or action is instituted to enforce any of the terms of this Security Agreement, the prevailing party shall be entitled to recover its reasonable attorneys' fees at trial and on any appeal, in addition to all other sums provided by law. Whether or not any court action is involved, all reasonable expenses incurred by Secured Party that are necessary at any time in Secured Party's opinion for the protection of its interest or the enforcement of its rights shall become a part of the Indebtedness payable on demand and shall bear interest from the date of expenditure until repaid at the same interest rate as provided in Section 7.3. 7. Indemnity. Debtor agrees to defend, indemnify and hold harmless Secured Party and its officers, employees, and agents against (a) all obligations, demands, claims and liabilities claimed or asserted by any other party in connection with the transactions contemplated by this Security Agreement and (b) all losses or expenses in any way suffered, incurred or paid by Secured Party as a result of or in any way arising out of, following or consequential to transactions between Secured Party and Debtor, whether under this Security Agreement or otherwise (including without limitation, reasonable attorneys' fees and expenses), except for losses arising from or out of Secured Party's gross negligence or willful misconduct. 8. Miscellaneous. 8.1 Time of Essence. Time is of the essence of this Security Agreement. 8.2 Successor Interests. Subject to the limitations on transfer of Debtor's interest, this Security Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. 8.3 Expenditure by Beneficiary. If Debtor fails to comply with any provision of this Security Agreement, Secured Party may elect to take the required action on Debtor's behalf, and any amount that Secured Party expends in so doing shall be added to the Indebtedness. Amounts so added shall be payable on demand with interest from the date of expenditure at the rate of 18 percent (18%) per annum or at the rate the Indebtedness bears, whichever is higher, but not in any event at a rate higher than the maximum rate permitted by law. Such action by Secured Party shall not constitute a cure or waiver of the default or any other right or remedy which Secured Party may have on account of Debtor's default. 8.4 Notices. Any notice under this Security Agreement shall be in writing and shall be effective when either delivered in person or, if mailed, shall be deemed effective when deposited as registered or certified mail, postage prepaid, addressed to the party at the address stated in this Security Agreement. Any party may change its address for notices by written notice to the other. 7 8.5 Invalid Provisions to Affect No Others. If any of the provisions contained in this Security Agreement shall be invalid, illegal, or unenforceable in any respect, the validity of the remaining provisions shall not be affected. 8.6 Changes in Writing; No Waiver. This Security Agreement and any of its terms may only be changed, waived, discharged, or terminated by an instrument in writing signed by the party against which enforcement of the change, waiver, discharge, or termination is sought. Any agreement subsequently made by Debtor or Secured Party relating to this Security Agreement shall be superior to the rights of the holder of any intervening security interest, lien, or encumbrance. Secured Party shall not by any act, delay, omission or otherwise be deemed to have waived any of its respective rights or remedies hereunder, nor shall any single or partial exercise of any right or remedy hereunder on any one occasion preclude the further exercise thereof or the exercise of any other right or remedy. 8.7 Applicable Law. This Security Agreement has been executed and delivered to Secured Party in the State of Washington, and all payments are to be made to Secured Party in the State of Washington. The law of the State of Washington shall be applicable for the purpose of construing and determining the validity of this Security Agreement and, to the fullest extent permitted by the law of any state in which any of the Collateral is located, determining the rights and remedies of Secured Party on default. 8.8 Joint and Several Liability. If Debtor consists of more than one person or entity, the obligations imposed upon Debtor under this Security Agreement shall be joint and several. IN WITNESS WHEREOF, Debtor has caused this Security Agreement to be duly executed as of the day and year first written above. DEBTOR: NOVA-TECH ENGINEERING, INC. By /s/ HANS H. HERRMANN ------------------------------------- Its President --------------------------------- SECURED PARTY: PACIFIC AEROSPACE & ELECTRONICS, INC. By /s/ DONALD A. WRIGHT ------------------------------------- Its President and CEO --------------------------------- 8 EX-21.1 6 LIST OF SUBSIDIARIES Exhibit 21.1 LIST OF SUBSIDIARIES Jurisdiction of Name Organization Pacific Coast Technologies, Inc. Washington Ceramic Devices, Inc. Washington Northwest Technical Industries, Inc. Washington Electronic Specialty Corporation Washington Cashmere Manufacturing Co., Inc. Washington Aeromet America, Inc. Washington Seismic Safety Products, Inc. Washington Skagit Engineering & Manufacturing, Inc. Washington PA&E International, Inc. Washington Subsidiary: Pacific A&E Limited United Kingdom Subsidiary: Pacific Aerospace & Electronics (UK) Limited United Kingdom Subsidiary: Aeromet International PLC United Kingdom EX-23.1 7 CONSENT OF KPMG LLP EXHIBIT 23.1 Consent of Independent Auditors Board of Directors Pacific Aerospace & Electronics, Inc.: We consent to incorporation by reference in registration statement numbers 333-29007, 333-39799 and 333-66469 on Forms S-8 and registration statement numbers 333-25177 and 333-41407 on Forms S-3 of Pacific Aerospace & Electronics, Inc. of our report dated July 16, 1999, except as to note 24 which is as of August 19, 1999, relating to the consolidated balance sheets of Pacific Aerospace & Electronics, Inc. as of May 31, 1998 and 1999 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the two-year period ended May 31, 1999, which report appears in the May 31, 1999 annual report on Form 10-K of Pacific Aerospace & Electronics, Inc. /s/ KPMG LLP Seattle, Washington August 27, 1999 EX-23.2 8 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the inclusion in this Annual Report on Form 10-K of Pacific Aerospace & Electronics, Inc. for the year ended May 31, 1999 and to the incorporation by reference in Registration Statement Numbers 333-29007, 333-66469 and 333-39799 of Pacific Aerospace & Electronics, Inc. on Forms S-8, and 333-25177 and 333-41407 of Pacific Aerospace & Electronics, Inc. on Forms S-3, of our report dated July 2, 1997. /s/ MOSS ADAMS LLP Seattle, Washington August 30, 1999 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the audited financial statements of Pacific Aerospace & Electronics, Inc., and its subsidiaries for the year ended May 31, 1999, and is qualified in its entirety by reference to such financial statements YEAR MAY-31-1999 MAY-31-1999 8,134,000 0 25,347,000 355,000 24,616,000 60,938,000 55,574,000 10,295,000 158,727,000 22,609,000 81,498,000 0 0 19,000 54,000,000 158,727,000 107,366,000 107,366,000 86,094,000 86,094,000 17,308,000 0 8,672,000 (15,508,000) (2,639,000) (12,869,000) 0 0 0 (12,869,000) (0.74) (0.74)
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