-----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, Eo3jZW8t86s9m3+6+81Ur1ipjvUBnV1EV3tPW3QCCP5oL2WE5ebLOYGiWcOXO9wg +H2zR2Gi8u6yaquQFmQDuw== 0000950135-99-004921.txt : 19991101 0000950135-99-004921.hdr.sgml : 19991101 ACCESSION NUMBER: 0000950135-99-004921 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19990703 FILED AS OF DATE: 19991029 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FERROFLUIDICS CORP CENTRAL INDEX KEY: 0000353286 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRONIC COMPONENTS, NEC [3679] IRS NUMBER: 020275185 STATE OF INCORPORATION: MA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-12198 FILM NUMBER: 99736908 BUSINESS ADDRESS: STREET 1: 40 SIMON STREET CITY: NASHUA STATE: NH ZIP: 03061 BUSINESS PHONE: 6038839800 MAIL ADDRESS: STREET 1: 40 SIMON STREET CITY: NASHUA STATE: NH ZIP: 03061 10-K/A 1 FERROFLUIDICS CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------- FORM 10-K/A (Mark One) [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended July 3, 1999 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For transition period from _________ to _________ Commission file number 1-12198 FERROFLUIDICS CORPORATION (Exact name of registrant as specified in its charter) -------------------- MASSACHUSETTS 02-0275185 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 40 SIMON STREET NASHUA, NEW HAMPSHIRE 03061 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (603) 883-9800 -------------------- Securities registered pursuant to Section 12 (b) of the Act: None Securities registered pursuant to Section 12 (g) of the Act: Common Stock, par value $.004 per share (Title of class) Preferred Stock Purchase Rights (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. (1) Yes X No --- --- (2) 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. [ ] As of September 1, 1999, 6,226,675 shares of $.004 par value Common Stock of the registrant were outstanding. The aggregate market value of the voting stock held by non-affiliates of the registrant based upon the closing price of $3.50 per share for the registrant's Common Stock, as reported on the NASDAQ National Market as of September 1, 1999 was $19,235,377. 1 2 TABLE OF CONTENTS ITEM PAGE - ---- ---- PART I 1 Business...............................................................3 2. Properties.............................................................8 3. Legal Proceedings......................................................8 4. Submission of Matters to a Vote of Security Holders....................9 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters .................................................9 6. Selected Consolidated Financial Data .................................10 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...............................................11 7A. Quantitative and Qualitative Disclosures about Market Risk............17 8. Financial Statements and Supplementary Data...........................19 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................42 PART III 10. Directors and Executive Officers of the Registrant....................42 11. Executive Compensation................................................44 12. Security Ownership of Certain Beneficial Owners and Management......................................................52 13. Certain Relationships and Related Transactions........................54 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......54 (a) Financial Statement Schedules (b) Reports on Form 8-K Signatures..........................................................59 2 3 ITEM 1. BUSINESS Founded in 1968, Ferrofluidics Corporation (the "Company" or "Ferrofluidics") is engaged principally in developing, manufacturing and marketing ferrofluids and products based on or derived from its proprietary ferrofluid technology. Ferrofluids, the Company's core technology, are stable magnetic liquids that can be precisely positioned or controlled with a magnetic force. Ferrofluids consist of molecular-sized magnetic particles that are surface treated so that they can be dispersed in various fluids, usually a synthetic lubricating oil. Ferrofluids are designed to have a choice of properties such as viscosity, magnetic strength and vapor pressures to perform numerous specific functions such as sealing, sensing, lubricating, damping and heat transfer. The Company creates commercial applications for its ferrofluid technology either by creating a ferrofluid to serve one or more functions in an existing product (such as the utilization of ferrofluids in audio loudspeakers) or by combining proprietary ferrofluid technology with applications engineering to develop ferrofluid-based (Ferrofluidic(R)) products, such as the Company's various sealing devices. The Company manufactures all ferrofluids for sale or for use in its own proprietary products. With respect to its products incorporating ferrofluids, the Company generally designs the product and then procures from third party vendors the fabrication of all or a substantial proportion of machined parts and components for the product. The Company assembles, tests and ships the product from its Nashua, New Hampshire plant. The Company seeks to apply its Ferrofluidic(R) technologies in situations where their use significantly enhances the final product into which the technology is incorporated. As a result, pricing reflects value added rather than the direct cost of producing the fluid or Ferrofluidic(R) product supplied to the Company's customers. The Company also seeks to supply markets in which it can achieve a position of market leadership. The Company believes that it, along with a licensee, currently supplies the vast majority of the ferrofluids and ferrofluid-based products used in the world. On September 23, 1998, the Company entered into an agreement with General Signal Technology Corporation, an SPX Corporation company ("General Signal") whereby General Signal purchased the intellectual property and certain other assets of the Company's Crystal Growing Systems Division (the "Systems Division") for $10,800,000 in cash on such date (the "Systems Division Sale"). The Company recorded, in fiscal 1999, an estimated gain on the Systems Division Sale of $5,319,000. In accordance with generally accepted accounting principles, the Company reported the results of operations of this business as discontinued operations in fiscal 1998. The Company's consolidated financial statements for prior periods, as well as all related footnote and financial discussions, were restated to reflect this accounting treatment of the Systems Division in those periods. See Note K to the Consolidated Financial Statements for additional information about the Systems Division Sale. The System Division Sale did not include any accounts receivable or liabilities outstanding as of the closing of the Systems Division Sale ($6,472,000 and $2,777,000, respectively), which remained with the Company. The Systems Division Sale also did not include the obligation by the Company to complete backlog as of the date of the System Division Sale, and of which approximately $1,680,000 remained to be completed at July 3, 1999. In addition, the Company retained approximately $5,873,000 ($1,411,000 at July 3, 1999) in inventory, all of which was needed to fulfill existing backlog. In addition to the Systems Division Sale, the Company, in December 1998, decided to discontinue the Component Parts business of its wholly owned Japanese subsidiary (Ferrofluidics Japan Corporation ("FJC")). The Company intends to dissolve FJC in fiscal 2000. No significant gain or loss is expected from the discontinuance of the Component Parts business and no significant income or loss from operations of the Component Parts business of FJC occurred during fiscal 1999. The loss from the discontinuance, in September 1998, of the Systems business at FJC has been included in the estimated gain from the Systems Division Sale on September 23, 1998. The Company's consolidated financial statements for prior periods, as well as all related footnote and financial discussions, were restated to reflect this accounting treatment of the Component Parts business of FJC. CORPORATE STRUCTURE The Company has its headquarters in Nashua, New Hampshire where it conducts substantially all of the engineering and manufacturing of its products. The Company conducts its operations overseas through the following wholly owned subsidiaries: (1) FERROFLUIDICS, GMBH (FORMERLY ADVANCED PRODUCTS & TECHNOLOGIES, GMBH) ("GMBH"), with headquarters in Nurtingen, Germany and sales offices in Madrid, Spain, and Milan, Italy, which: (a) markets and services Ferrofluidic(R) products in Europe; 3 4 (b) designs, manufactures and markets products for the optical coating and thin-film deposition industries such as electron beam guns and related controllers; and (c) serves as an exclusive distributor in Europe for several U.S. and European corporations that manufacture products primarily for the vacuum coating industry. (2) FERROFLUIDICS LTD ("LTD"),with an office at Bicester (near Oxford), England which markets and services Ferrofluidic(R) products in the United Kingdom and Ireland, and also distributes GmbH's products as well as products of other manufacturers to the vacuum coating and other industries. (3) The Company also has a wholly-owned subsidiary, FJC, which currently conducts no business and which the Company intends to dissolve in fiscal 2000. (see Note K to the Consolidated Financial Statements). In addition to its wholly-owned subsidiaries, the Company has licensed its vacuum rotary feedthrough seals and ferrofluid technology, originally on a non-exclusive basis but converted to an exclusive basis in fiscal 1999, to Ferrotec Corporation ("Ferrotec," formerly Nippon Ferrofluidics Corporation), a former subsidiary located in Japan. In addition, under an exclusive license granted by Ferrofluidics in August 1993, Ferrotec manufactures and sells Ferrofluidic(R) exclusion seals for use on computer peripheral equipment. OPERATING STRUCTURE Following the Sale, the Company is organized into three business segments: (i) the COMPONENTS DIVISION, which manufactures and markets Ferrofluidic(R) sealing devices and subsystems, primarily for use in the semiconductor process, industrial process, lamp and fiber optic manufacturing, and medical equipment industries. Sales generated by the Components Division accounted for approximately 47.9%, 57.4% and 54.3% of total product sales from continuing operations in fiscal 1999, 1998 and 1997, respectively. (ii) the FLUIDS DIVISION, which manufactures and markets ferrofluids used in the Company's own engineered core products, audio loudspeakers for the commercial, home and automotive markets, and for use in nondestructive testing, inertia dampers, stepper motors and sensor applications. Sales generated by the Fluids Division accounted for approximately 9.7%, 8.1% and 10.5% of total product sales from continuing operations in fiscal 1999, 1998 and 1997, respectively. (iii) the DISTRIBUTED PRODUCTS DIVISION, which includes the sale in Europe and Asia by GmbH of products on an exclusive basis for several U.S. and European companies, as well as of products designed and assembled by GmbH itself. Sales generated by the Distributed Products Division accounted for 42.4%, 34.5% and 35.2% of total product sales from continuing operations in fiscal 1999, 1998 and 1997, respectively. In fiscal 1999, $14,463,000, or 62.5%, of the Company's sales from continuing operations were to unaffiliated foreign customers, primarily through GmbH. Sales to unaffiliated foreign customers in fiscal 1998 and 1997 totaled $15,557,000 (57.2%) and $12,941,000 (54.2%), respectively. All manufacturing and assembly of products for the Components and Fluids Divisions are conducted at the Company's headquarters in Nashua, NH. Marketing of those products for all markets, excluding Europe and Japan, is principally conducted by its direct sales force at the Company's headquarters. In the case of its standard seals to end-user markets, the Company has distribution agreements with the Kurt J. Lesker Company ("KJLC"), a worldwide distributor of vacuum related products, and with Varian Associates. In addition, the Company has established distributor relationships for its ferrofluid and Ferrofluidic(R) products in Korea, Taiwan, India, China, and developing Pacific Rim countries. 4 5 PRODUCT LINES Following the Systems Division Sale, the Company manufactures and sells products in three major product categories: (i) ferrofluids; (ii) magnetic fluid seals, sealing subsystems, and other Ferrofluidic(R) components products and (iii) distributed products. (i) FERROFLUIDS. The Company supplies ferrofluids for use in the Company's own engineered products, for use in home and automotive loudspeakers, for nondestructive testing, and for use in sensors and stepper motors. The Company currently supplies fluids for approximately 65 million speakers per year, representing the vast majority of the ferrofluid sold . The Company supplies Ferrofluidic(R) viscous inertia dampers that are used in semiconductor equipment, disk drives testers, XY plotters, computer printers and other computer peripheral equipment. The dampers eliminate resonance, reduce settling time, eliminate corrosion and improve positional accuracy. (ii) MAGNETIC FLUID SEALS AND SUBSYSTEMS. The Company combines proprietary ferrofluid technology with applications engineering to develop a variety of products that provide state-of-the-art seals and sealing subsystems that seal the environment from a manufacturing process. In each of the applications in which the Company provides Ferrofluidic(R) seals and sealing subsystems, it is the leading provider of such technology products. The Company's major magnetic sealing products are: Rotary Seals for Critical Process Applications: Historically, one of the Company's core commercial applications of ferrofluids is a rotary seal assembly with long life, virtually unmeasurable leakage and high-speed capability for transferring rotary motion into vacuum and other highly controlled, ultra-clean process environments. The Company supplies the semiconductor and other process industries with low vapor pressure seal assemblies and subsystems, which help exclude atmospheric contamination from manufacturing processes. These applications include semiconductor processing, electro-optical subsystems, thin-film vacuum coating, excimer laser and x-ray-based machines. The Company produces standard and custom-engineered sealing components and subsystems including multiport rotary valve assemblies. Customers include both original equipment manufacturers ("OEMs") and end users. The selling price for the majority of such seal assemblies sold by the Company is in the range of $500 to $25,000, with some seal subsystems approaching $100,000, depending on design complexity. In addition, the Company has two additional commercial applications for its rotary seals: (a) a Lamp Process Sealing System that is supplied to General Electric and certain other lighting manufacturers for use as an integral part of the process to produce energy efficient lamps for automotive, commercial and residential lighting; and (b) a Medical X-Ray Sealing System that is supplied to major medical equipment manufacturers for use to rotate, seal and cool target anodes inside the x-ray vacuum chamber of computer aided tomography scan equipment. Industrial Process Seals: The Company's industrial process seals eliminate volatile organic compounds and volatile hazardous air pollutants from petroleum refining and chemical processing plants. Using this magnetic fluid sealing technology, these facilities can comply cost-effectively with the strictest regulations, which mandate decreasing "fugitive emissions" (as they are referred to under the Federal Clean Air Act of 1990 and its Amendments of 1990) according to a phased program over the next few years and are subject to acceleration by certain state and local authorities. During fiscal 1997, a new series of gas tight seals (GT-6) for the industrial market was introduced. This product series is targeted at industrial fans, blowers, and other low-pressure gas handling devices where emissions control and process contamination are critical. Other products within the GT family will be introduced periodically and target other equipment such as compressors, centrifuges, mixers, agitators and pumps. The GT-6 product has received certification from TA Luft, the German air quality authority. Subsystems: As an extension of its core capability to design and manufacture rotary seals for a variety of vacuum processing applications, the Company sells sealing sub-systems to OEMs, which incorporate existing Ferrofluidic(R) sealing technology with other mechanical and electrical components to produce a fully integrated sub-system. Sub-systems allow the Company's customers to outsource more of their manufacturing without compromising quality. Some of the new opportunities include robotics, cluster tooling, and other semiconductor processing sub-assemblies. The Company continues to develop equipment and process technologies in several other areas in cooperation with major industrial companies and specific product specialists. 5 6 (iii) DISTRIBUTED PRODUCTS. For more than ten years, GmbH has been the exclusive distributor for the products of IGC-Polycold Systems Inc. in most European countries: Austria, Belgium, Denmark, Germany, Netherlands, Italy, Liechtenstein, Luxembourg, Portugal, Spain and Switzerland. The product spectrum covers a wide range of cryogenerators which are used to capture water vapor or vacuum pump oil in high vacuum deposition systems by cryocondensation. This system supplements the high vacuum pumping system which results in an increased productivity of the vacuum deposition system and a better product quality. Significant operations cost savings and short payback times are achieved. Polycold cryogenerators have developed into a standard component in most industrial vacuum applications, including coatings on glass, plastic and other materials used in the automotive, housing, optical computer and other industries. A variety of non-vacuum applications includes the cooling of chucks in semiconductor production systems, selective cryotrapping of volatiles, testing of materials at low temperatures and detector cooling. As almost all Polycold cryogenerators are used in industrial production where high reliability of the equipment is required. To meet the customers' demands, GmbH maintains inventories of spare parts in several locations in Europe, offers service contracts with a 24 hour reaction time, and provides service and maintenance training for customer repair personnel. Electron Beam Products: The Company manufactures and distributes products for thin film deposition by means of electron beam technology through GmbH in Germany. The product range includes electron beam evaporators for use in both R&D and production oriented vacuum systems and state-of-the-art high voltage power supplies and controllers. The Company supplies end users and original equipment manufacturers in the thin-film vacuum coating industry with electron beam subsystems and components which can be easily integrated in new vacuum systems or retrofitted into existing systems. The applications include optical and ophthalmic coating as well as semiconductor processing. Thin Film Products: The Company also distributes products for the thin-film coating industry in Europe from various American manufacturers. The Company supplies sputtering cathodes from Angstrom Sciences, Inc. as well as sputtering materials from Target Materials, Inc. through GmbH. The products are used in the photovoltaic, wear coating, flat panel display, and semiconductor industries. COMPETITION The Company believes that its competitive advantage will continue to depend upon its trade secrets, know-how and ability to develop both ferrofluids for specific applications and technologically advanced products which use ferrofluids. The Company believes that its competitive position with respect to its proprietary products, while aided by its patents, is not now materially dependent upon them. The Company does, however, believe that several of its pending patents, if issued, could further strengthen its competitive position. The Company's ferrofluids are proprietary to the Company. (i) MAGNETIC FLUIDS. Numerous other companies around the world supply various forms of magnetic fluids for commercial applications. Nevertheless, the Company, in conjunction with Ferrotec, its Japanese licensee and former subsidiary, supplies the vast majority of the world's commercial applications of ferrofluids and believes that its ferrofluids are the principal product used in applications utilizing magnetic fluids. The Company believes its principal competitor in the audio ferrofluid market is Ferrotec with respect to sales in the Pacific Rim. (ii) SEALS AND SEALING SUBSYSTEMS. In semiconductor and other process industry applications, the Company's magnetic fluid sealing devices and sealing subsystems compete against traditional, non-ferrofluid based sealing methods marketed by other vendors, some of which have lower initial cost than the Company's products. In comparison to the Company, some of these firms have greater financial, marketing, technical or other resources available to them. In the Pacific Rim, the Company's licensee competes with other suppliers of magnetic fluid seals, and one Japanese competitor sells feedthroughs in the United States. In addition, the Company has a significant competitor in the United Kingdom which competes throughout Europe. 6 7 In industrial process applications, Ferrofluidics' sealing system competes with various nonmagnetic fluid sealing devices and sealing subsystems; however, the Company believes that the competitive devices are either more expensive or have higher maintenance costs and are not adequate at the stricter compliance levels mandated by the EPA. EMPLOYEES AND MARKETING The Company currently has approximately 143 employees worldwide, of which 97 are employed in the United States and 46 in Europe. In the United States, the Company markets its products through a direct field sales force and an applications engineering staff with headquarters in Nashua, NH which is augmented by a third-party sales representative organization in the U.S and Europe with respect to its Components business. Abroad, products are sold in Europe through GmbH, the Company's wholly-owned German subsidiary, and elsewhere in Europe and Asia through various sales representative and distributor relationships. MANUFACTURING The Company produces all of its ferrofluids at its headquarters, and, to protect the proprietary nature of its ferrofluid technology, conducts such activities in a limited-access environment. The Company's manufacturing presently consists primarily of assembly and test operations, although it has in-house precision machining capabilities in the United States in support of special marketing and customer requirements. The Company's manufacturing operations rely substantially on outside vendors who fabricate components and subassemblies to the Company's specifications. These components are assembled at the Company's facilities and subjected to the Company's rigorous test and inspection procedures. The Company does however, have a state-of-the-art machining center, established in 1996, which has proven to be critical in the ability to meet ever shortening lead times for delivery of component products to customers. OUTSIDE SUPPLIERS With respect to its sealing devices, the Company relies on outside suppliers to manufacture, to the Company's specifications, a substantial portion of its metal components requirements. The Company performs assembly and quality control procedures at its headquarters. If the Company's current suppliers were unable to continue to manufacture components, the Company believes that other suppliers would be available to do such work, although there is no guarantee that the Company would be able to obtain all of its supply requirements from such other suppliers on terms comparable to those of its current suppliers. The in-house machining center supplies a portion of the Company's need for precision machined component parts, reducing its reliance on outside suppliers. It is not, however, the intent of management to conduct all of the component production in-house. INTELLECTUAL PROPERTY RIGHTS The Company owns a number of U.S. and foreign patents for its seals, dampers and bearings, with expiration dates ranging up to 2016. In addition, the Company has applied for additional patents for these and other products. In many cases, however, the Company relies more upon its trade secrets, know-how and ability to develop technological advances than patents to protect its technologies and products. The Company has registered trademarks for a logo design utilizing an "F" and for Ferromedic, Ferrofluidic, FerroSound, FerroSound-The solution is loud and clear, FerroMotion, FerroDamp, FerroStep, and Spin Technology. INTERNAL RESEARCH AND DEVELOPMENT The Company's internal research and development effort is aimed at developing proprietary ferrofluids and using the unique properties of magnetic fluid technology to develop new products and business. In addition, GmbH, the Company's German subsidiary conducts a research and development effort aimed at improving and expanding its electron beam gun products. The Company spent (and charged to expense) $1,373,000, $890,000 and $685,000 in fiscal years 1999, 1998 and 1997, respectively, on the development of new products and the improvement of existing products. All research is Company-directed and is conducted primarily by employees of the Company or its subsidiaries. The Company's research and development is carried out by an interdisciplinary group of product development engineers, physicists, chemists, technicians and marketing professionals who seek to apply ferrofluid technology in diverse and expanding markets where that 7 8 technology adds a significant value. The Company is experimenting with new ferrofluids and seals for higher speed and higher vacuum applications for new and existing markets. BACKLOG As of July 3, 1999, the Company had a consolidated order backlog from continuing operations of $6,536,000, as compared to $8,226,000 at June 27, 1998. A comparative summary of the consolidated backlog by business segment is as follows: 1999 1998 ---------- ---------- Components $3,473,000 $3,670,000 Distributed Products 2,631,000 3,891,000 Fluids 432,000 665,000 ---------- ---------- Total Backlog $6,536,000 $8,226,000 ========== ========== A majority of the backlog at July 3, 1999 is expected to ship during fiscal 2000. WARRANTY POLICY With respect to sales of seals to the semiconductor and other industries for controlled environment applications, the Company offers a one-year warranty. Warranty expenses have been within the reserves established by the Company. With respect to the Company's former Systems Division, the Company generally offered a one-year warranty as to workmanship and materials from date of acceptance by the customer. Warranty expenses have historically been within the reserves established by the Company. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS Financial information with respect to the Company's industry segments is hereby incorporated by reference to Note I to the Consolidated Financial Statements in Item 8 of this report. FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES Financial information about the Company's foreign and domestic operations and export sales is hereby incorporated by reference to Note I of Notes to the Consolidated Financial Statements in Item 8 of this report. ITEM 2. PROPERTIES The Company's offices, engineering and manufacturing operations are located in Nashua, New Hampshire in a 71,000 square foot facility situated on approximately 4.5 acres of land owned by the Company. This land, the building, and substantially all the Company's machinery and equipment at its Nashua facility have been pledged as security for its short and long term debt. (See Notes A and D to the Consolidated Financial Statements in Item 8.) In May 1999, the Company leased approximately 10,000 square feet of the former Systems Division floor space in its headquarters office in Nashua to an unaffiliated company. The operating lease expires in May 2002. The Company and its subsidiaries lease office space, aggregating approximately 15,000 square feet, under varying terms in Oxford, England; Nurtingen, Germany; Madrid, Spain; and Milan, Italy. ITEM 3. LEGAL PROCEEDINGS None 8 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year ended July 3, 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Ferrofluidics' Common Stock is traded on the NASDAQ National Market under the stock symbol "FERO". The following table sets forth the high and low closing transactions for the Common Stock of the Company for the fiscal periods indicated, as reported by the NASDAQ National Market. 1999 HIGH LOW ---- ---- --- 7/1/98 - 9/30/98 4 7/8 2 5/8 10/1/98 - 12/31/98 3 13/16 2 1/1/99 - 3/31/99 3 13/16 2 1/2 4/1/99 - 6/30/99 4 9/16 2 1/2 1998 HIGH LOW ---- ---- --- 7/1/97 - 9/30/97 8 7/8 5 7/8 10/1/97 - 12/31/97 7 13/16 4 5/8 1/1/98 - 3/31/98 6 7/16 4 5/8 4/1/98 - 6/30/98 5 11/16 3 1/8 On September 1, 1999, the closing sale price for the Company's Common Stock, as reported by the NASDAQ National Market, was $3.50. On that date, there were approximately 2,237 holders of record of the Common Stock of the Company. DIVIDEND POLICY The Company does not pay cash dividends on its Common Stock. Its policy is to retain earnings and use funds for the operation and expansion of its business. Future dividend policy will be determined by the Board of Directors based upon the Company's earnings, financial condition and capital requirements. 9 10 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data for the five years ended July 3, 1999, should be read in conjunction with the Consolidated Financial Statements, including the notes thereto, in Item 8 of this report and with Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this report.
FISCAL YEARS ENDED July 3, 1999 June 27, 1998(b)(c) June 28, 1997(b)(c) June 30, 1996(b)(c) June 30, 1995(b)(c) ------------ ------------------- ------------------- ------------------- ------------------- INCOME STATEMENT DATA: Net sales $35,323,000 $52,700,000 $67,785,000 $72,967,000 $34,155,000 Net sales from continuing operations 23,143,000 27,204,000 23,856,000 26,807,000 22,152,000 Nonrecurring operating income -- -- -- -- 1,156,000 Income (loss) from continuing operations (476,000) 1,546,000 260,000 342,000 2,639,000 Income (loss) from discontinued 5,319,000 (5,018,000) 1,412,000 3,478,000 (1,750,000) operations Net income (loss) 4,843,000 (3,472,000) 1,672,000 3,820,000 889,000 Per Share Data: Earnings Per Common Share-Basic: Income (loss) from continuing (0.08) 0.25 0.04 0.06 0.47 operations Income (loss) from discontinued 0.87 (0.81) 0.23 0.57 (0.31) operations Net income (loss) 0.79 (0.56) 0.27 0.63 0.16 Earnings Per Common Share-Diluted: Income (loss) from continuing (0.08) 0.25 0.04 0.05 0.47 operations Income (loss) from discontinued 0.87 (0.81) 0.23 0.56 (0.31) operations Net income (loss) 0.79 (0.56) 0.27 0.61 0.16 Balance Sheet Data: Working capital $15,095,000 $ 8,182,000 $13,323,000 $12,350,000 $ 7,811,000 Total assets 28,923,000 44,019,000 45,001,000 43,429,000 39,529,000 Total liabilities 8,394,000 25,818,000 23,420,000 23,727,000 23,748,000 Long-term debt 5,000,000 5,000,000 5,000,000 5,000,000 5,036,000 Stockholders' equity 20,529,000 18,201,000 21,581,000 19,702,000 15,781,000
Note: (a) Dividends have neither been declared nor paid during the five years ended July 3, 1999. (b) Certain amounts for fiscal years 1998, 1997, 1996 and 1995 have been restated to reflect the discontinuance of the Component Parts business of FJC as discontinued operations. (c) Certain amounts for fiscal years 1998, 1997, 1996 and 1995 have been reclassified to conform with the presentation of similar amounts in fiscal year 1999. 10 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion provides information to assist in the understanding of the Company's results from continuing operations, unless otherwise noted, and financial condition. As described in Item 1, on September 23, 1998, certain of the assets of the Company's Systems Division were sold to General Signal for $10,800,000 in cash. See Note K to the Consolidated Financial Statements for more information regarding the Systems Division Sale. In addition to the Systems Division Sale, in December 1998, management also decided to discontinue the Component Parts business of its wholly-owned Japanese subsidiary, FJC. This discussion reflects the fact that in accordance with generally accepted accounting principles, the Company is reporting the results of operations from the Systems Division and the Component Parts business of FJC as discontinued operations and that the Company's Consolidated Financial Statements for fiscal 1999 and prior periods, as well as all related footnotes, have been revised to reflect this accounting treatment of the Systems Division and the Component Parts business of FJC in those periods. It should be read in conjunction with the selected financial data in the preceding section and the consolidated financial statements and notes thereto that appear elsewhere herein. RESULTS OF OPERATIONS FISCAL 1999 VERSUS FISCAL 1998: In fiscal 1999, the Company's consolidated net revenues decreased to $23,143,000 from $27,204,000 in fiscal 1998. The changes in revenues by segment are shown in the following table: 1999 1998 ----------- ----------- Components $11,096,000 $15,626,000 Distributed Products 9,810,000 9,390,000 Fluids 2,237,000 2,188,000 ----------- ----------- Total Revenues $23,143,000 $27,204,000 =========== =========== Sales in the Components product lines decreased primarily due to the continued slow recovery of the semi-conductor industry from which the Company generates approximately 30% of its component sales. In the Distributed Products business segment, sales of components and power supplies for the thin film deposition industry contributed to the increase in sales. Sales of magnetic fluids increased by approximately 2% over the prior year; however, on a volume basis, unit sales in fiscal 1999 increased by 27% over 1998. Heavy competition in the audio fluid business, particularly in Asia, resulted in a significant decrease in the per unit sales price. Total sales of the Company's wholly-owned German subsidiary, GmbH, which includes the sale of the Company's components and fluid products in Europe, as well as comprising the Distributed Products segment, decreased in fiscal 1999 by 6.0% to $12,966,000 as compared to $13,801,000 in fiscal 1998. The decrease was primarily in the Ferrofluidic(R) product lines sold in the United Kingdom ("the U.K.") which was caused by a decrease in sales to its largest customer in the U.K. due to the slow-down in the semi-conductor market in the U.K. Bookings decreased from $31,263,000 in fiscal 1998 to $23,850,000 in fiscal 1999. The decrease is due primarily to a decrease in components bookings which is consistent with the decrease in sales of component parts for fiscal 1999. Bookings for magnetic fluid sales for 1999 were $2,510,000, as compared to $2,758,000 for 1998. The decrease was due to competitive pricing pressure in the Asian marketplace. Order backlog at the end of fiscal 1999 was $6,536,000, as compared to the backlog in the prior year of $8,226,000. The majority of the order backlog at the end of fiscal 1999 is expected to ship in fiscal 2000. Consolidated gross margin for fiscal 1999 was 41.4%, a decrease from 45.0% in fiscal 1998. The decrease in gross margin in the current year was due principally to the reduced sales of component parts, which shifted the product mix toward a lower gross margin, and resulted in reduced manufacturing efficiencies. Engineering and product development expenses in fiscal 1999 totaled $2,387,000, an increase of $410,000, or 20.7%, compared to $1,977,000 spent in fiscal 1998. As a percentage of revenues, engineering and product development expenses increased from 7.3% in fiscal 1998 to 10.3% for fiscal 1999. The increase in fiscal 1999 was due to increased labor costs as more personnel have been added to the newly created New Business Development group. Specifically, additional costs are being incurred in connection with the Company's development of its material separation applications and its transformer applications 11 12 (the latter in collaboration with ABB Power T&D Company, Inc., a major transformer manufacturer). The Company remains committed to a significant level of new product development in order to continue to maintain its leadership in the core ferrofluid technology. Engineering and product development expenses have been allocated between continuing operations and discontinued operations on the basis of the amounts actually spent by each Division. Selling, general and administrative ("SG&A") expenses in fiscal 1999 totaled $7,182,000, which is $917,000 or 11.3% less than the $8,099,000 incurred in 1998 but, as a percent of revenues, SG&A increased from 29.8% in 1998 to 31.0% in 1999. Selling and marketing costs decreased by $648,000, due in part to a $321,000 decrease in selling expenses at GmbH which was the result of the closure of the sales office in France in fiscal 1998. GmbH now uses sales representatives in France to sell its products. The remaining decrease in selling expenses was due primarily to cost reductions (head count reduction and reduced spending) made in the second quarter of fiscal 1999 which had a favorable impact on operations. Administrative expenses accounted for the remainder of the decrease, which was due primarily to a decrease in restructuring charges of $263,000 in fiscal 1999. In fiscal 1998, the Company had a significant layoff in March 1998, which resulted in severance costs of $383,000. Although the Company had layoffs in fiscal 1999, the severance payments ($120,000) were not as large as in fiscal 1998. Other expenses have been charged to continuing operations and discontinued operations on the basis of the actual amounts incurred on behalf of the respective divisions. Net interest expense in fiscal 1999 was $128,000, a decrease of $473,000 from net interest expense incurred in fiscal 1998. The decrease is due to the payoff of all short-term debt in fiscal 1999 with the proceeds from the Systems Division Sale (see Note K to the Consolidated Financial Statements regarding the Systems Division Sale). Net interest expense and other bank charges and fees have been allocated between continuing operations and discontinued operations on the basis of the net identifiable assets used in those operations. See Note D to the Consolidated Financial Statements for a more complete discussion of the Company's debt obligations. The Company records transaction gains and losses resulting from fluctuations of foreign currency as other income or expense. During fiscal 1999, $21,000 of net foreign currency transaction gains were recorded as compared to a net gain of $13,000 in fiscal 1998. The gains in 1999 and 1998 were generated by the Company's wholly-owned German subsidiary, GmbH, on sales to foreign countries in currencies other than its functional currency (the German Mark). The translation of the financial statements of subsidiaries whose functional currency is other than the U.S. dollar are recorded directly to equity as other comprehensive income (loss). The income tax expense of continuing operations in 1999 and 1998 of $350,000 and $74,000, respectively, is comprised of a provision for foreign income taxes on the Company's earnings. Due to the continued uncertainty surrounding the Company's ability to realize the benefit of the deferred tax asset, a valuation allowance in the amount of $11,210,000 is reflected at July 3, 1999. See Note C to the Consolidated Financial Statements for a more complete discussion of income taxes. The Company recorded an estimated gain on disposal of discontinued divisions, net of taxes, of $5,319,000 in 1999. The loss from operations of the discontinued divisions, net of income taxes, was approximately $5,018,000 for 1998. FISCAL 1998 VERSUS FISCAL 1997: In fiscal 1998, the Company's consolidated net revenues increased to $27,204,000 from the $23,856,000 reported in fiscal 1997. The changes in revenues by segment are shown in the following table: 1998 1997 ----------- ----------- Components $15,626,000 $12,957,000 Distributed Products 9,390,000 8,409,000 Fluids 2,188,000 2,490,000 ----------- ----------- Total Revenues $27,204,000 $23,856,000 =========== =========== Sales in the Components product lines increased due primarily to the upturn in semiconductor equipment manufacturing that began in the fourth quarter of fiscal 1997, and from a significant increase in sales of rotary feedthrough seals in Europe primarily in non-semiconductor markets. In addition, the recently introduced line of industrial gas tight seals also contributed to the increase in sales in fiscal 1998. In the Distributed Products business segment, sales of components and power supplies for the thin film 12 13 deposition industry contributed significantly to the increase. Sales of magnetic fluids decreased by 12% from the prior year as heavy competition in the audio fluid business, particularly in Asia, prevented a significant sales increase. Total sales of the Company's European subsidiary, GmbH, which includes the sale of the Company's components and fluid products in Europe, as well as comprising the Distributed Products segment, increased by 15.2% to $13,801,000 as compared to $11,979,000 in fiscal 1997. The increases were in both the Ferrofluidic(R) product lines and in the distributed products. Bookings increased from $26,595,000 in fiscal 1997 to $31,263,000 in fiscal 1998. This increase was both in Distributed Products and in rotary feedthrough seals. Bookings for magnetic fluid sales for 1998 were $2,758,000, which is slightly higher than the $2,542,000 for 1997. Order backlog at the end of fiscal 1998 was $8,226,000, as compared to the backlog in the prior year of $7,207,000. The majority of the order backlog at the end of fiscal 1998 shipped in fiscal 1999. Consolidated gross margin for fiscal 1998 was 45.0%, a decrease from the 49.5% reported in fiscal 1997. The decrease in margin was due to decreases in margin in the magnetic fluids product line and in the Company's European operations, which in turn was due to pricing pressures. Engineering and product development expenses in fiscal 1998 were $1,977,000, which is comparable to the $1,907,000 spent in fiscal 1997. Engineering and product development expenses have been allocated between continuing operations and discontinued operations on the basis of the amounts actually spent by each Division. Selling, general and administrative ("SG&A") expenses in fiscal 1998 were $8,099,000, which is $1,470,000 or 15.4% less than the $9,569,000 incurred in 1997 and, as a percent of revenues, decreased from 40.1% in 1997 to 29.8% in 1998. Selling and marketing costs decreased by $1,998,000, due primarily to a $872,000 decrease in selling expenses at GmbH which was the result of restructuring efforts undertaken in late fiscal 1997. Administrative expenses accounted for the remainder of the decrease, which was due in part to decreases in legal costs ($278,000) and insurance ($260,000). Other expenses have been allocated between continuing operations and discontinued operations on the basis of the actual amounts incurred on behalf of the respective divisions. Net interest expense in fiscal 1998 was $601,000, an increase of $178,000 from net interest expense incurred in fiscal 1997. The increase is due to higher average borrowings under the Company's line-of-credit agreement. Net interest expense and other bank charges and fees have been allocated between continuing operations and discontinued operations on the basis of the net identifiable assets used in those operations. See Note D to the Consolidated Financial Statements for a more complete discussion of the Company's debt obligations. The Company records transaction gains and losses resulting from fluctuations of foreign currency as other income or expense. During fiscal 1998, $13,000 of net foreign currency transaction gains were recorded as compared to a net gain of $5,000 in fiscal 1997. The gains in 1998 and 1997, were incurred by the Company's German subsidiary on sales to foreign countries in currencies other than its functional currency (the German Mark). The translation of the financial statements of subsidiaries whose functional currency is other than the U.S. dollar are recorded directly to equity as other comprehensive income (loss). The income tax expense in 1998 of $74,000 is comprised of a provision for foreign income taxes on the Company's earnings. The income tax benefit of $448,000 in 1997 consisted principally of a tax benefit of $467,000 recorded in the fourth quarter of 1997 which represents a reduction in the valuation allowance against deferred tax assets. See Note C to the Consolidated Financial Statements for a more complete discussion of income taxes. Income (loss) from discontinued operations, net of income taxes, was approximately $(5,018,000) for 1998 as compared to $1,412,000 for 1997. LIQUIDITY AND CAPITAL RESOURCES The discussion in this section reflects both continuing and discontinued operations. In fiscal 1999, the operations of the business provided $7,006,000 of cash, as compared to using $9,000 of cash in 1998. For fiscal 1999, the net income of $4,843,000 was augmented by decreases in accounts receivable, inventories and prepaids and other current assets of $8,144,000, $4,684,000 and $1,236,000, respectively. The aforementioned decreases in assets were partially offset by decreases in accounts payable and accrued liabilities and customer deposits of $4,834,000 and $2,778,000, respectively. 13 14 The cash requirements for 1998 were financed primarily from borrowings under the Company's revolving line of credit. The Company typically received advance payments from the sale of crystal growing systems under large multi-unit contracts as certain milestones were met, including receipt of the order, submission of accepted engineering drawings, shipment and final acceptance of the units. As a result of the Systems Division Sale in September 1998, no new customer orders were received in fiscal 1999, whereas, in 1998, the Company received advance payments of $4,196,000, in connection with orders for crystal growing systems. The Company has purchase contracts for inventory with various suppliers which, in some cases, extend beyond two years. At July 3, 1999, outstanding purchase commitments pursuant to these contracts totaled approximately $1,244,000, almost all of which were related to the component parts business. Cash flow from investing activities for fiscal 1999 consisted primarily of proceeds of $10,800,000 from the Systems Division Sale. In addition, during fiscal 1999, the Company sold a 300mm crystal growing system that had been included in property, plant and equipment, at its approximate book value of $1,610,000. Financing activities of the Company during fiscal 1999 included the complete paydown of all short-term debt from the cash proceeds of the Systems Division Sale (see also Note K to the Consolidated Financial Statements and the discussion below regarding the Systems Division Sale). In addition, in fiscal 1999, the Company initiated a stock buyback program pursuant to which up to 1,000,000 shares of the Company's common stock may be purchased in the open market over a twelve-month period. As of August 20, 1999, the Company had repurchased a total of 652,498 shares of common stock for $2,628,633 and is holding such shares as treasury stock. The consolidated results of operations for fiscal 1999 and 1998 includes a non-cash charge of $31,000 and $287,000, respectively, for compensation to employees as a result of restricted stock grants made in prior years. The ratio of current assets to current liabilities was 5.5 to 1 at July 3, 1999, which is up from 1.4 to 1 at June 27, 1998. Working capital at July 3, 1999 increased to $15,095,000 from $8,182,000 at June 27, 1998. Current assets decreased, principally due to lower accounts receivable, inventories and advances to suppliers as the Systems Division backlog was completed and receivables collected. The decrease in receivables resulted in a small improvement in receivable turnover in 1999 from 4.1 times in 1998 to 4.4 times in 1999. Although inventories decreased significantly in fiscal 1999, inventory turnover actually decreased slightly from 2.7 times annual consumption in 1998 to 2.4 times in 1999. Capital expenditures on a consolidated basis totaled $969,000 in fiscal 1999, as compared to $2,399,000 in fiscal 1998. The spending in both years consisted primarily of improvements to the Company's Nashua, NH facility, and, in 1998, included the construction of a 300mm machine and the replacement of two old and outdated lathes in the Company's in-house machine shop. Other spending included modifications to the manufacturing facility and upgrades to computer equipment and software, primarily for engineering purposes. Also, during 1998, the Company spent approximately $1,500,000, not including engineering costs which have been expensed, on the construction of a 300mm machine for demonstration purposes. As discussed above, on September 21, 1998, the Company sold this machine and certain optional equipment for approximately book value. The Company has long-term financing in the form of a $5,000,000 Variable Rate Industrial Revenue Bond ("VRIRB"). The VRIRB is subject to a variable rate of interest keyed to short-term nontaxable rates (4.02% at July 3, 1999), the proceeds of which were primarily used to fund the construction of the Company's Nashua, NH headquarters. The VRIRB is payable in full on September 1, 2004. The Company also had a credit facility with its bank which provided the Company with total credit of approximately $15,400,000, $5,400,000 of which was in the form of a stand-by letter of credit for the Company's VRIRB, $8,500,000 of which was a revolving line of credit for working capital purposes and $1,500,000 of which was in the form of a 90-day promissory note. The Company used a portion of the cash proceeds from the Systems Division Sale to pay off the entire $7,907,000 balance of the line of credit and the entire $1,500,000 balance of the promissory note outstanding at September 23, 1998. In connection with the Systems Division Sale, the Company and its bank agreed to reduce the maximum borrowings under the line of credit agreement from $8,500,000 to $2,000,000. See Note K to the Consolidated Financial Statements for a more complete discussion of the Systems Division Sale. As of June 30, 1999, the bank has agreed to renew the line of credit agreement at a level of $2,500,000. The line will expire on November 30, 1999. The stand-by letter of credit of $5,400,000 expires in August 2000. The letter of credit carries a fee of 1% per year and the revolving credit facility will bear interest at prime rate plus .75% (8.5% at July 3, 1999) with a fee of 1/8% on the unused portion. At July 3, 1999, there were no borrowings under the revolving line of credit. During 1996, the Company borrowed $800,000 in the form of an installment demand note with its bank, to finance the capital expansion of its in-house machine shop. The note bore interest at 9.75% and was scheduled to expire in January 2001. In March 1999, the then outstanding balance of $343,000 was paid off. In addition, the Company, through its wholly owned foreign subsidiaries, has various short-term financing arrangements with local banks totaling approximately $280,000 at July 3, 1999. During 1999, the maximum outstanding borrowing on these foreign credit lines was $140,000. The weighted-average interest rates during the year on these facilities ranged from 6.71% to 24.0% and the interest rates at July 3, 1999 ranged from 6.25% to 24.0%. 14 15 As described in Item 1, certain of the assets of the Company's Systems Division were sold on September 23, 1998 to General Signal for $10,800,000 in cash (the "Systems Division Sale"). Assets sold included approximately $2,818,000 in inventory, and approximately $625,000 in fixed assets and intangibles. As discussed below, the Systems Division is currently being operated by the Company only to complete existing backlog. After providing for transaction fees of $333,000 and income taxes of $1,400,000, the Company recorded a gain on the Systems Division Sale of $5,319,000 during fiscal 1999. The gain on the Systems Division Sale is net of an operating loss of $368,000 that was incurred by the Systems Division during the quarter ended September 26, 1998. For the period from September 27, 1998 to July 3, 1999, the Systems Division's operations were approximately break-even. The Company also anticipates approximately break-even operations for the Systems Division through the end of the phase-out period which is expected to end on or about October 2, 1999. As discussed above, a portion of the cash proceeds from this Systems Division Sale had been used to pay off certain outstanding debt as of the closing of the Systems Division Sale. The Systems Division Sale, as structured, did not include any of the Systems Division accounts receivable or liabilities, which remained with the Company. The Systems Division Sale also did not include the obligation by the Company to complete approximately $18,433,000 ($1,680,000 at July 3, 1999) in Systems Division backlog, or approximately $5,873,000 ($1,411,000 at July 3, 1999) in inventory on hand on the date of the Systems Division Sale, all of which was needed to fulfill such backlog. The terms of the Systems Division Sale provided that, generally, any backlog existing on December 31, 1998, would be transferred to General Signal. The remaining backlog at July 3, 1999, however, will be completed and shipped by the Company as agreed to by General Signal. The backlog at September 23, 1998 included a purchase order from a customer for nine machines (valued at approximately $7,658,000) for which the customer did not provide firm delivery dates. On December 26, 1998, the customer canceled delivery of the nine machines. In connection with these machines and other orders, on September 23, 1998, the Company had inventory of approximately $1,712,000 on hand and approximately $2,471,000 in parts on order at vendors. Prior to June 15, 1999, the Company had settled almost all of its commitments with its vendors at a cost of approximately $1,765,000, which had been considered in calculating the estimated gain on disposal of the Systems Division reflected during the first quarter of fiscal 1999. On June 15, 1999, the Company and its customer negotiated a settlement with respect to the canceled delivery of the nine machines, which settlement had no adverse financial impact to the Company. The remaining backlog at July 3, 1999 of $1,680,000 is planned to be completed and shipped in the first quarter of fiscal 2000. The Systems Division Sale did not include approximately $6,472,000 ($210,000 at July 3, 1999) in accounts receivable which were outstanding as of the closing of the Systems Division Sale. The Company believes that it will be able to collect the remaining $210,000 of these receivables within established reserves, but there can be no assurance that the Systems Division Sale has not adversely affected their collectibility. See Note K to the Consolidated Financial Statements for a more complete discussion of discontinued operations. The proceeds received from the Systems Division Sale and other cash flow have significantly reduced the Company's need for short-term borrowing arrangements to finance working capital needs in the near future. Management, therefore, believes that available cash, anticipated funds from operations and the current borrowing arrangements will be adequate to meet cash requirements for the year ahead. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted for all fiscal quarters of all fiscal years beginning after June 15, 2000, as amended. The Statement permits early adoption as of the beginning of any fiscal quarter after its issuance. The Company expects to adopt the new Statement effective for fiscal 2001 (beginning on July 2, 2000). The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company does not anticipate that the adoption of this Statement will have a significant effect on its results of operations or financial position. EFFECTS OF INFLATION Inflation rates over the past three years have remained relatively low and, as a result, have not had a material impact on the financial results of the Company. 15 16 YEAR 2000 The Company is currently working to resolve the potential impact of the Year 2000 on the processing of date-sensitive information by the Company's computerized information systems. The Year 2000 problem is a result of computer programs being written using two digits (rather than four) to define the applicable year. The Company's products in the Components and Fluids Businesses are mechanical devices or fluids and do not contain any electronic components. The Company's products in its Distributed Products Business include an electron beam gun for use in vacuum deposition processes, which is electronically controlled, but is Year 2000 compliant. Consequently, the Company has no need to make any changes to its products in anticipation of the Year 2000. Prior to the Systems Division Sale, the Division sold products that were controlled by computerized hardware and software. The software involved was purchased off-the-shelf, and was not customized by the Company, and accordingly, some systems contain versions of the software that may not be Year 2000 compliant. The Company has made no express warranties with respect to Year 2000 compliance in connection with such products. The Company has sent requests to all of its principal providers of services and component parts to advise the Company of their progress in making their internal systems Year 2000 compliant. The Company believes it has a sufficient base of critical component suppliers so that if any supplier is unable to deliver parts due to Year 2000 problems, alternate sources will be available and that any supply interruption will not be material to its operations. There can be no assurances, however, that the Company would be able to obtain all of its supply requirements from such alternate sources on terms comparable with that of its current suppliers. The Company has identified one critical service supplier (its bank), the failure of whose systems for an extended period for any reason, including Year 2000 problems, could cause financially material adverse consequences to the Company. The bank has provided assurance in writing to the Company that its systems now are Year 2000 compliant. With respect to its internal systems, the Company has undertaken an assessment of its vulnerability to the Year 2000 issue. The Company does not rely on electronic interaction with customers or vendors, and has in recent years relied almost entirely on purchased off-the-shelf software packages for both business and engineering purposes. These packages have not been materially customized by the Company for its purposes. These software packages run on a personal computer-based local area network which was installed by the Company in 1993, and which has been upgraded as needed since then. The assessment was based upon formal and informal communications with the software vendors, literature supplied with the software, literature received in connection with maintenance contracts, and test evaluations of the software. Systems critical to the business which have been identified as vulnerable to the Year 2000 problem have been replaced with new software or corrected by upgrades available from vendors. The Company is currently in the process of making all other non-critical systems Year 2000 compliant and the Company anticipates that this will be done by the end of November 1999. Outside companies such as vendors, major customers, service suppliers, communications providers and banks have been asked to verify their Year 2000 readiness and the Company has tested interaction with such systems where appropriate. The assessment has been completed utilizing the Company's existing resources.. To date, the Company has incurred less than $35,000 on efforts directed towards Year 2000 compliance (most of which was the replacement of a software application that was primarily undertaken to improve efficiency in sales management) and expects to incur a total of less than $50,000 when the process of making the Company's internal systems Year 2000 compliant is completed, although there can be no assurance that the Company will not incur costs in excess of such amount in connection therewith. The Company has concluded, based on this assessment, that all of the Company's critical business systems software is Year 2000 compliant, and all other non-critical systems will be Year 2000 compliant by the end of November 1999, and that the Year 2000 issue is not likely to have a material impact on the Company's operations. However, there can be no assurances that the systems or software of third parties on which the Company relies will be timely converted and the Company may be adversely affected by the failure of such a third party to become Year 2000 compliant. In the event that any such third party fails to be compliant, the Company will have to make arrangements, if necessary, with alternate third parties to obtain the products and services that were previously provided by such non-compliant third party. EURO CURRENCY The Company derived approximately 56% of its revenue from continuing operations in fiscal 1999 from its operations in Germany and England. Historically, transactions in Europe have been denominated in a variety of currencies. 16 17 Effective January 1, 1999, eleven of the fifteen member countries of the European Union established fixed conversion rates between their sovereign currencies and the Euro and adopted the Euro as their common legal currency. During the three-year transition, the Euro will be available for non-cash transactions and legacy currencies will remain legal tender. Ferrofluidics GmbH, the Company's German subsidiary, is continuing to address the Euro impact on its business, including the ability to handle the conversion in the accounting and other information systems, ability of foreign banks to report on dual currencies, the legal and contractual implications of contracts, and reviewing pricing strategies. The Company expects that any additional modifications to its operations and systems will be completed on a timely basis and does not believe the conversion will have a material adverse impact on the Company's operations. However, there can be no assurance that the Company will be able to successfully modify all systems and contracts to comply with the Euro requirements on a timely basis. DISTRIBUTION AGREEMENTS For the year ended July 3, 1999, GmbH derived approximately 76% of its revenue (42.4% of the Company's consolidated revenues) from the sales of products under distribution agreements with manufacturers other than the Company. The reliance on these distribution agreements subjects GmbH to certain risks, including continuation of the agreements, geographic exclusivity and availability of inventory. In fiscal 1998, one of Ferrofluidics GmbH's main suppliers reduced the geographic exclusivity from continental Europe to the United Kingdom and Spain. The reduction in distribution territory resulted in a decrease in sales of $1,000,000 in fiscal 1999. There can be no assurance that GmbH will be able to maintain its distribution agreements at the current levels and failure to do so could have an adverse impact on the Company's results of operations. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. There are certain factors that could cause actual results to differ materially from those anticipated by the statements made above. These include, but are not limited to, changes in revenues in the Company's components, fluids and thin film deposition businesses, expected working capital needs of the continuing operations, a material change in the market conditions within the semiconductor industry and, changes in management's assessments regarding the Company's obligations under outstanding purchase orders, ability to fulfill existing sales order backlog, the ability to collect accounts receivable relating to the discontinued Systems Division, the possibility of operations of the Systems Division through the end of the phase-out period (which is expected to end on or about October 2, 1999) being less than break-even, and failure of the Company's systems or software, or the systems or software of a third party on which the Company relies to be Year 2000 compliant, the ability of GmbH to comply with the Euro requirements on a timely basis and the ability of GmbH to maintain its distribution agreements at the current levels. For additional information concerning these and other important factors, which may cause the Company's actual results to differ materially from expectations and underlying assumptions, please refer to the reports filed by the Company with the Securities and Exchange Commission. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company maintains foreign operations in England and Germany and conducts business in many other countries. As a result of these international activities, the Company is exposed to changes in foreign currency exchange rates, which could have some impact on the results of operations. The Company manages exposure to changes in foreign currency exchange rates through its normal operating and financing activities, as well as through the use of forward exchange contracts. The Company enters into forward foreign exchange contracts as a balance sheet translation hedge for the remaining assets and liabilities of its wholly-owned Japanese subsidiary. This subsidiary uses the U.S. dollar as its functional currency and, as a result, the gains or losses on remeasurement are recorded in the statement of operations. At July 3, 1999, the Company had a one-month forward contract to sell 60 million Japanese Yen for $495,000. At July 3, 1999, the Company also had foreign currency exposure relating to its four subsidiaries located in Germany, the U.K., Spain and Italy. These subsidiaries use the local currency as their functional currency, and gains or losses on the translation of the local currency balance sheets and statements of operations are recorded as a separate component of stockholders' equity as other comprehensive income (loss). Relative to foreign currency exposures existing at July 3, 1999, a 10% unfavorable movement in foreign exchange rates would not significantly diminish the fair value of its financial instruments (approximately a 1% impact on consolidated equity). The estimate assumes that each exchange rate would change in the same direction relative to the U.S. dollar. In addition to the direct effects of changes in exchange rates, such changes typically affect the volume of sales or the foreign currency 17 18 sales price as competitors' products become more or less attractive. The Company's sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency selling prices. In addition, it is unlikely that all currencies would uniformly strengthen or weaken relative to the U.S. dollar. In reality, some currencies may weaken while others may strengthen. The Company engages neither in speculative nor derivative trading activities. The Company also is exposed to changes in interest rates primarily from its long-term Variable Rate Industrial Revenue Bond ("VRIRB"). Under its current policies, the Company does not use interest rate derivative instruments to manage exposure to interest rate changes. A hypothetical 100 basis point increase in the interest rate on the VRIRB would adversely impact annual cash flows by $50,000. 18 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS Page(s) Reports of Independent Auditors...............................................20 Consolidated Balance Sheets as of July 3, 1999 and June 27, 1998..............21 Consolidated Statements of Operations for each of the three years in the period ended July 3, 1999.......................................22 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended July 3, 1999....................23 Consolidated Statements of Cash Flows for each of the three years in the period ended July 3, 1999.......................................24 Notes to Consolidated Financial Statements....................................25 19 20 REPORT OF INDEPENDENT AUDITORS To the Stockholders and Directors of Ferrofluidics Corporation We have audited the accompanying consolidated balance sheets of Ferrofluidics Corporation as of July 3, 1999 and June 27, 1998, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended July 3, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ferrofluidics Corporation at July 3, 1999 and June 27, 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended July 3, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Manchester, New Hampshire August 20, 1999 20 21 FERROFLUIDICS CORPORATION CONSOLIDATED BALANCE SHEETS JULY 3, 1999 AND JUNE 27, 1998 ASSETS 1999 1998 - ------ ---- ---- Current Assets: Cash and cash equivalents $ 8,038,000 $ 1,516,000 Accounts receivable - trade, less allowance of $260,000 ($329,000 in 1998) 3,855,000 12,083,000 Inventories 6,325,000 13,855,000 Advances to suppliers -- 578,000 Prepaid and other current assets 246,000 783,000 ----------- ----------- Total Current Assets 18,464,000 28,815,000 ----------- ----------- Property, plant and equipment, at cost, net of accumulated depreciation of $11,205,000 ($12,462,000 in 1998) 6,403,000 8,826,000 Cash value of life insurance, net 2,097,000 1,921,000 Deferred income taxes, net 1,139,000 3,154,000 Other assets, net 820,000 1,303,000 ----------- ----------- TOTAL ASSETS $28,923,000 $44,019,000 =========== =========== LIABILITIES Current Liabilities: Bank notes payable $ -- $ 9,710,000 Accounts payable 1,627,000 3,860,000 Customer deposits -- 2,777,000 Accrued expenses and other current liabilities 1,742,000 4,286,000 ----------- ----------- Total Current Liabilities 3,369,000 20,633,000 ----------- ----------- Long-term debt obligation 5,000,000 5,000,000 Other liabilities 25,000 185,000 Commitments and contingencies STOCKHOLDERS' EQUITY Preferred stock, $.001 par value, authorized 100,000 shares, issued and outstanding - none -- -- Common stock, $.004 par value, authorized 12,500,000 shares, outstanding 6,226,675 (6,218,581 in 1998) 25,000 25,000 Additional paid-in capital 36,764,000 36,738,000 Accumulated deficit (12,600,000) (17,443,000) Accumulated other comprehensive loss (1,461,000) (1,119,000) ----------- ----------- 22,728,000 18,201,000 Treasury stock, at cost (553,998 shares) 2,199,000 -- ----------- ----------- Total Stockholders' Equity 20,529,000 18,201,000 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $28,923,000 $44,019,000 =========== =========== The accompanying notes are an integral part of the consolidated financial statements. 21 22 FERROFLUIDICS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED JULY 3, 1999, AND JUNE 27, 1998, AND JUNE 28, 1997
1999 1998 1997 ---- ---- ---- Net sales $23,143,000 $27,204,000 $23,856,000 Cost of sales 13,568,000 14,959,000 12,036,000 ----------- ----------- ----------- Gross profit 9,575,000 12,245,000 11,820,000 Operating expenses: Engineering and product development expense 2,387,000 1,977,000 1,907,000 Selling, general and administrative expense 7,182,000 8,099,000 9,569,000 ----------- ----------- ----------- Operating income 6,000 2,169,000 344,000 Interest income 197,000 33,000 80,000 Interest expense (325,000) (634,000) (503,000) Other income (expense), net (4,000) 52,000 (109,000) ----------- ----------- ----------- Income (loss) from continuing operations before income taxes (126,000) 1,620,000 (188,000) Income taxes (benefit) 350,000 74,000 (448,000) ----------- ----------- ----------- Income (loss) from continuing operations (476,000) 1,546,000 260,000 Discontinued operations--Note K: Income (loss) from operations of discontinued divisions, less applicable income taxes (benefit) of $(1,339,000) in 1998; and $(727,000) in 1997 -- (5,018,000) 1,412,000 Gain on disposal of discontinued division, less applicable income taxes of $1,400,000 5,319,000 -- -- ----------- ----------- ----------- Net income (loss) $ 4,843,000 $(3,472,000) $ 1,672,000 =========== =========== =========== Per Share Income (loss) from continuing operations: Basic $(0.08) $0.25 $0.04 Diluted $(0.08) $0.25 $0.04 Income (loss) from discontinued operations: Basic $0.87 $(0.81) $0.23 Diluted $0.87 $(0.81) $0.23 Net income (loss): Basic $0.79 $(0.56) $0.27 Diluted $0.79 $(0.56) $0.27 Weighted average common shares outstanding: Basic 6,137,192 6,198,603 6,116,176 Diluted 6,137,192 6,232,429 6,196,070
The accompanying notes are an integral part of the consolidated financial statements. 22 23 FERROFLUIDICS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED JULY 3, 1999, AND JUNE 27, 1998, AND JUNE 28, 1997
Accumulated Common Stock Additional Other ------------ Paid-In Accumulated Comprehensive Treasury Shares Par Value Capital Deficit Loss Stock Total --------- --------- ----------- ------------ ------------ ----------- ----------- BALANCE, JUNE 30, 1996 6,060,902 $24,244 $35,871,000 $(15,643,000) $ (550,000) $19,702,244 Issuance of common stock for: Restricted stock plan, charge to operations 93,762 375 511,000 -- -- 511,375 Exercise of options 33,138 132 166,000 -- -- 166,132 Redemption of stock for (9,540) (38) (71,000) -- -- (71,038) taxes Net income -- -- -- 1,672,000 -- 1,672,000 Current year translation adjustments -- -- -- -- (400,000) (400,000) ----------- Comprehensive income -- -- -- -- -- 1,272,000 --------- ------- ----------- ------------ ----------- ----------- BALANCE, JUNE 28, 1997 6,178,262 24,713 36,477,000 (13,971,000) (950,000) 21,580,713 --------- ------- ----------- ------------ ----------- ----------- Issuance of common stock for restricted stock plan, charge to 44,531 236 287,000 -- -- 287,236 operations Redemption of stock for (4,212) (17) (26,000) -- -- (26,017) taxes Net loss -- -- -- (3,472,000) -- (3,472,000) Current year translation adjustments -- -- -- -- (169,000) (169,000) ----------- Comprehensive loss -- -- -- -- -- (3,641,000) --------- ------- ----------- ------------ ----------- ----------- BALANCE, JUNE 27, 1998 6,218,581 24,932 36,738,000 (17,443,000) (1,119,000) 18,200,932 --------- ------- ----------- ------------ ----------- ----------- Issuance of common stock for restricted stock plan, charge to 9,828 39 31,000 -- -- 31,039 operations Redemption of stock for (1,734) (7) (5,000) -- -- (5,007) taxes Purchase of treasury stock -- -- -- -- -- $(2,199,000) (2,199,000) Net income -- -- -- 4,843,000 -- -- 4,843,000 Current year translation adjustments -- -- -- -- (342,000) -- (342,000) ----------- Comprehensive income -- -- -- -- -- -- 4,501,000 --------- ------- ----------- ------------ ----------- ----------- ----------- BALANCE, JULY 3, 1999 6,226,675 $24,964 $36,764,000 $(12,600,000) $(1,461,000) $(2,199,000) $20,528,964 ========= ======= =========== ============ =========== =========== ===========
The accompanying notes are an integral part of the consolidated financial statements. 23 24 FERROFLUIDICS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED JULY 3, 1999, AND JUNE 27, 1998, AND JUNE 28, 1997
1999 1998 1997 ---- ---- ---- Cash flows from operating activities: Net income (loss) $ 4,843,000 $(3,472,000) $1,672,000 Adjustments to reconcile net income (loss) to cash flow provided by (used in) operating activities: Depreciation and amortization 1,458,000 1,818,000 1,602,000 Deferred income taxes (credits) 2,015,000 (1,339,000) (1,200,000) Increase in cash surrender value (176,000) (170,000) (20,000) Gain on disposal of discontinued division (6,719,000) -- -- Stock-related compensation 31,000 287,000 511,000 Foreign currency transaction (gains) losses (33,000) 94,000 217,000 Other (865,000) (28,000) (524,000) Changes in operating assets and liabilities: Accounts receivable, net 8,144,000 1,432,000 (1,144,000) Inventories 4,684,000 1,326,000 (1,632,000) Prepaid and other current assets 1,236,000 451,000 764,000 Accounts payable and accrued expenses (4,834,000) (760,000) (463,000) Customer deposits (2,778,000) 352,000 (1,936,000) ----------- ----------- ---------- Net cash provided by (used in) operating activities 7,006,000 (9,000) (2,153,000) ----------- ----------- ---------- Cash flows from investing activities: Acquisition of property, plant and equipment (969,000) (2,399,000) (1,249,000) Proceeds from sale of assets 1,655,000 70,000 37,000 Proceeds from disposal of Systems Division 10,800,000 -- -- Other -- 90,000 -- ----------- ----------- ---------- Net cash provided by (used in) investing activities 11,486,000 (2,239,000) (1,212,000) ----------- ----------- ---------- Cash flows from financing activities: Proceeds from (repayments of) short-term borrowings (9,710,000) 2,929,000 2,519,000 Purchase of treasury stock (2,199,000) -- -- Exercise of stock options -- -- 166,000 ----------- ----------- ---------- Net cash provided by (used in) financing activities (11,909,000) 2,929,000 2,685,000 ----------- ----------- ---------- Effect of currency rate changes on cash (61,000) (48,000) (138,000) ----------- ----------- ---------- Net increase (decrease) in cash and cash equivalents 6,522,000 633,000 (818,000) Cash and cash equivalents at beginning of year 1,516,000 883,000 1,701,000 ----------- ----------- ---------- Cash and cash equivalents at end of year $ 8,038,000 $ 1,516,000 $ 883,000 =========== =========== ==========
The accompanying notes are an integral part of the consolidated financial statements. 24 25 FERROFLUIDICS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Ferrofluidics Corporation (the "Company") is a multinational company engaged principally in developing, manufacturing and marketing ferrofluids (magnetic fluids) and rotary sealing devices based on or derived from its proprietary ferrofluid technology. Note K to these consolidated financial statements describes the discontinuance of the Company's Crystal Growing Systems business. In addition, in December 1998, the Company also decided to discontinue the Component Parts business of its wholly-owned Japanese subsidiary (Ferrofluidics Japan Corporation ("FJC")). The Company plans to dissolve FJC in fiscal 2000. Information on the Company's operations by segment and geographic area are included in Note I. Approximately 30% of the Company's sales are attributable to the semiconductor industry, which can experience cyclical fluctuations. A prolonged decline in the semiconductor industry could have, and has in the past had, a materially adverse effect on the Company's operating results. FISCAL YEAR The Company has a 52 or 53-week year ending on the Saturday nearest June 30. Accordingly, the 1999, 1998 and 1997 fiscal years ended July 3, 1999, June 27 and June 28, respectively, PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All inter-company accounts and transactions have been eliminated. USE OF ESTIMATES The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents consist of cash on hand, money market funds with original maturities of less than 90 days and certificates of deposit that can be liquidated without penalty. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial instruments, including cash and cash equivalents, accounts receivable and accounts payable, approximate fair value due to the short-term maturity of these instruments. Forward foreign exchange contracts not designated to hedge specific receivables are valued at the spot exchange rate in effect on the balance sheet date. The carrying amount of the Company's long-term debt obligation under its Variable Rate Industrial Revenue Bond approximates fair value because the interest rate is at a variable rate of interest generally keyed to short-term nontaxable rates. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash investments and trade accounts receivable. The Company places its cash and temporary cash investments with high credit quality institutions. Such investments are often in excess of the FDIC insurance limit. The Company performs ongoing credit evaluations of its customers' financial condition and, under certain conditions, requires collateral from its foreign unaffiliated customers in the form of irrevocable letters of credit or other acceptable guarantees. With regard to the Company's Components, Distributed Products and Fluids segments, concentrations of trade credit risk are limited due to the large number of customers and their dispersion across many different geographical regions. 25 26 INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market. Inventories consist of the following elements at July 3, 1999 and June 27, 1998: 1999 1998 ---- ---- Raw materials and purchased parts $1,756,000 $ 6,348,000 Work-in-process 1,725,000 2,650,000 Finished goods 2,844,000 4,857,000 ---------- ----------- $6,325,000 $13,855,000 ========== =========== The Company has purchase contracts for inventory with various suppliers which, in some cases, extend beyond two years. At July 3, 1999 and June 27, 1998, outstanding purchase commitments pursuant to these contracts totaled approximately $1,244,000 and $7,000,0000, respectively. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment are recorded at cost. Depreciation on machinery and equipment and furniture and fixtures is computed on a straight-line method over estimated useful lives of three to eight years; leasehold improvements are amortized using the straight-line method over the lesser of the life of the lease or the estimated useful life of the improvements. Depreciation on buildings and building improvements is computed using the straight-line method over estimated lives of ten to thirty years. Depreciation charges for assets begin in the month after the asset is placed in service. Property, plant and equipment consisted of the following at July 3, 1999 and June 27, 1998: 1999 1998 ---- ---- Land and improvements $ 330,000 $ 330,000 Buildings and improvements 7,875,000 8,072,000 Machinery and equipment 4,578,000 5,730,000 Furniture, fixtures and vehicles 4,533,000 5,597,000 Construction in process 292,000 1,559,000 ----------- ----------- 17,608,000 21,288,000 Less: Accumulated depreciation and amortization 11,205,000 12,462,000 ----------- ----------- $ 6,403,000 $ 8,826,000 =========== =========== INTANGIBLE ASSETS At July 3, 1999, the Company had recorded goodwill in an amount of $1,023,000, which is included on the accompanying balance sheet with other assets, resulting from the acquisition in fiscal 1989 of Ferrofluidics GmbH, a wholly-owned subsidiary. This amount is being amortized over a 16-year life on a straight-line basis. Accumulated amortization as of July 3, 1999 and June 27, 1998 amounted to $642,000 and $578,000, respectively. All other intangible assets, including patents and trademarks, are recorded at cost and amortized on a straight-line basis over their estimated useful lives, generally ten years. INCOME TAXES Income taxes have been provided using the liability method in accordance with FASB Statement No. 109, Accounting for Income Taxes. REVENUE RECOGNITION The Company recognizes revenue upon shipment of products to the customer. 26 27 PRODUCT DEVELOPMENT EXPENSES Product development expenditures are charged to expense when incurred. The Company spent $1,373,000, $890,000, and $685,000 for product development during 1999, 1998, and 1997, respectively, from continuing operations. TRANSLATION OF FOREIGN CURRENCIES The Company translates the assets and liabilities of its foreign subsidiaries whose functional currency is other than the U.S. dollar at the exchange rates in effect at the balance sheet date. Income statement amounts are translated at average exchange rates for the period. Translation adjustments are reported in other comprehensive income (loss). In addition, the Company recognizes, in current income, gains or losses from the remeasurement of transactions denominated in currencies other than the Company's functional currencies. The effect on the statements of operations of transaction gains and losses is insignificant to all years presented. FOREIGN EXCHANGE CONTRACTS The Company, from time to time, enters into forward foreign exchange contracts to hedge against adverse exchange losses on certain assets or liabilities denominated in a foreign currency. Market value gains and losses are recognized, with the resulting credit or debit offsetting foreign exchange gains or losses on those instruments. At July 3, 1999, there was one foreign exchange contract outstanding to sell 60 million Japanese Yen at 121.30 per U.S. Dollar, or $495,000, for delivery, at the Company's option, between June 28 and July 15, 1999, in which there was no material exchange gain or loss. STOCK-BASED COMPENSATION The Company has stock-based compensation programs and has elected to account for them in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and, accordingly, except for restricted stock awards, recognizes no compensation expense for the stock option grants (see Note H). EARNINGS PER SHARE Basic and diluted earnings per share are calculated in accordance with FASB Statement No. 128, Earnings per Share. STATEMENT OF CASH FLOWS For the years ended July 3, 1999, June 27, 1998 and June 28, 1997, cash payments for income taxes amounted to $80,000, $20,000 and $473,000, respectively. Cash payments for interest in each of the three years amounted to $533,000, $1,092,000 and $795,000, respectively. COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income in the first quarter of fiscal 1999. Statement 130 established new rules for reporting and disclosure of comprehensive income and its components. Such disclosure, however, has no impact on the Company's results of operations, financial position or cash flows. Comprehensive income is defined as the change in equity of a company during a reporting period which is a result of certain transactions and other events and circumstances, but not including transactions resulting from investments by owners and distributions to owners. The difference between net income (loss) and comprehensive income (loss) for the Company is from foreign currency translation adjustments. The Company has elected to disclose comprehensive income in its Consolidated Statements of Stockholders' Equity. The earnings associated with the Company's investment in its foreign subsidiaries are considered to be permanently invested and no provision for U.S. federal and state income taxes on those earnings or translation adjustments has been provided. 27 28 IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1998, the FASB issued Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, which is required to be adopted for all fiscal quarters of all fiscal years beginning after June 15, 2000, as amended. The Statement will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either be offset against the change in fair value of the hedged asset, liability, or firm commitment through earnings, or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The Company does not anticipate that the adoption of this Statement will have a significant effect on its results of operations or financial position. RECLASSIFICATION Certain amounts for fiscal years 1998 and 1997 have been reclassified to conform with the presentation of similar amounts in fiscal year 1999. B. CASH VALUE OF LIFE INSURANCE At July 3, 1999 and June 27, 1998, the Company had two single-premium life insurance policies on the life of a former CFO. The policies had an aggregate cash value of $2,232,000 and $2,075,000 at July 3, 1999 and June 27, 1998, respectively, against which the Company had $2,232,000 and $2,064,000, respectively, in loans and accrued interest outstanding at an interest rate of 8%. In addition, the Company has recorded its interest in the value of certain key man life insurance policies under split-dollar agreements with a former CEO of $2,097,000 and $1,910,000 at July 3, 1999 and June 27, 1998, respectively. This former CEO's estate is the principal beneficiary of the aggregate face value of these policies of approximately $8,000,000, from which the Company will receive, upon death or surrender, an amount equal to the premiums paid by the Company plus interest at the rate of 6%. C. INCOME TAXES Income (loss) from continuing operations before income taxes for the years ended July 3, 1999, June 27, 1998 and June 28, 1997 was taxed in the following jurisdictions: 1999 1998 1997 ---- ---- ---- Domestic $(1,031,000) $ 642,000 $(392,000) Foreign 905,000 978,000 204,000 ----------- ---------- --------- Total $ (126,000) $1,620,000 $(188,000) =========== ========== ========= Significant components of the provision for income taxes (benefit) from continuing and discontinued operations are as follows: 1999 1998 1997 ---- ---- ---- Continuing operations $ 350,000 $ 74,000 $ (448,000) Discontinued operations 1,400,000 (1,339,000) (727,000) ---------- ----------- ----------- Total $1,750,000 $(1,265,000) $(1,175,000) ========== =========== =========== 28 29 The components of the provision for income taxes (benefit) attributable to continuing operations are as follows: 1999 1998 1997 ---- ---- ---- Current: Federal $ -- $ -- $ -- State -- -- -- Foreign (265,000) 74,000 19,000 -------- ------- --------- Total current (265,000) 74,000 19,000 -------- ------- --------- Deferred: Federal -- -- (467,000) State -- -- -- Foreign 615,000 -- -- -------- ------- --------- Total deferred 615,000 -- (467,000) -------- ------- --------- Total income taxes $350,000 $74,000 $(448,000) ======== ======= ========= The following is a reconciliation between the statutory provision for federal income taxes and the effective income taxes from continuing operations for the years ended July 3, 1999, June 27, 1998 and June 28, 1997: 1999 1998 1997 ---- ---- ---- Income tax expense (benefit) at federal statutory rate $(43,000) $551,000 $ (64,000) Change in valuation allowance 58,000 (633,000) (194,000) Foreign income taxes at differing statutory rates 100,000 138,000 (24,000) Restricted stock compensation -- (31,000) (109,000) Adjustment to estimated income tax accruals 230,000 -- (82,000) Meals and entertainment expenses disallowed 5,000 20,000 25,000 Other -- 29,000 -- -------- -------- --------- Income tax expense (benefit) $350,000 $ 74,000 $(448,000) ======== ======== ========= The components of the net deferred tax asset as of July 3, 1999 and June 27, 1998 were as follows: 1999 1998 ---- ---- Deferred tax assets: Net operating loss carryforwards $11,506,000 $11,408,000 Capital loss carryforward -- 1,821,000 Compensation related items 52,000 276,000 Valuation allowances 134,000 142,000 Inventories 754,000 1,446,000 Research and development credits 150,000 150,000 Alternative minimum tax credits 186,000 186,000 Other 128,000 613,000 ----------- ----------- Total deferred tax assets 12,910,000 16,042,000 Valuation allowance for deferred tax assets (11,210,000) (12,217,000) ----------- ----------- Net deferred tax assets 1,700,000 3,825,000 Deferred tax liabilities: Depreciable assets (561,000) (461,000) Other -- (210,000) ----------- ----------- Total deferred tax liabilities (561,000) (671,000) ----------- ----------- Net deferred tax assets $ 1,139,000 $ 3,154,000 =========== =========== 29 30 Undistributed earnings of the Company's foreign subsidiaries amounted to approximately $200,000 at July 3, 1999. Those earnings are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable because of the complexities associated with its hypothetical calculation. However, unrecognized foreign tax credit carryforwards would be available to reduce some portion of the U.S. liability. Withholding taxes of approximately $20,000 would be payable upon remittance of all previously unremitted earnings at July 3, 1999. FASB Statement No. 109, Accounting for Income Taxes, requires a valuation allowance against deferred tax assets if it is more likely than not that some or all of the deferred tax assets will not be realized. Due to the uncertainty about the Company's ability to realize the benefit of the entire deferred tax asset, a valuation allowance in the amount of $11,210,000 has been established at July 3, 1999. As of July 3, 1999, the Company had remaining net operating loss carryforwards for Federal income tax purposes of approximately $33,697,000, which can be used to offset future taxable income. The net operating loss carryforwards for Federal income tax purposes will expire at various dates through 2013. Included in the loss carryforward, for income tax purposes, is approximately $16,800,000 of tax deductions resulting from the excess of the market price over the exercise price on the date of exercise of the Company's stock purchase options and warrants which were exercised during 1993 and prior years. The tax benefit to be realized upon utilization of the $16,800,000 of loss carryforwards will result in a decrease in current income taxes payable and an increase to additional paid-in capital. D. SHORT-TERM BORROWINGS AND OTHER DEBT OBLIGATIONS As of July 3, 1999 and June 27, 1998, the Company and its subsidiaries have the following debt obligations outstanding: 1999 1998 ---- ---- Revolving line of credit $ -- $ 7,749,000 1984 Industrial Revenue Bond 5,000,000 5,000,000 Bank notes -- 1,961,000 ---------- ----------- 5,000,000 14,710,000 Less: current portion of debt obligations -- 9,710,000 ---------- ----------- Long-term debt obligation $5,000,000 $ 5,000,000 ========== =========== In fiscal 1985, the Company secured long-term financing in the form of a $5,000,000 Variable Rate Industrial Revenue Bond ("VRIRB"). The VRIRB is subject to a variable rate of interest generally keyed to short-term nontaxable rates, and has a seven-day call feature. The interest rate at July 3, 1999 was 4.02%. The proceeds from these bonds were used to fund the construction of the Company's Nashua, New Hampshire facility and the purchase of machinery and equipment. The VRIRB is payable in full on September 1, 2004 and is guaranteed by a bank stand-by letter of credit (through August 16, 2000) which is a part of the credit facility extended to the Company by a bank as described below. Prior to September 23, 1998, the Company had a credit facility with a bank which provided the Company with a total credit of approximately $13,900,000, including approximately $5,400,000 in the form of a stand-by letter of credit for the Company's $5,000,000 VRIRB, and a $8,500,000 revolving line of credit for working capital purposes. As further discussed below, the credit facility was amended and decreased in September 1998. The stand-by letter of credit has a one-year term, which expires in August 2000 and has a fee of 1% per year. The revolving line of credit bore interest at the bank's prime rate plus 1% with a fee of 1/8% on the unused portion. The credit facility is collateralized by substantially all of the assets of the Company. In February 1997, the Company obtained an additional increase of approximately $1,500,000 in the credit facility from its bank in the form of a stand-by letter of credit to secure a customer prepayment received with an order for crystal growing systems. Subsequent to the shipment of the systems, the letter of credit was rewritten into a 90-day promissory note. The $1,500,000 promissory note, which was renewed on June 30, 1998, bore interest at the same rate as the revolving credit line. On September 23, 1998, in connection with the Systems Division Sale (see Note K), the note was paid off. 30 31 On September 23, 1998, in connection with the Systems Division Sale, the Company used a portion of the cash proceeds to pay off the then outstanding balance of the line of credit. As a result of the Systems Division Sale, the Company and its bank agreed to reduce the maximum available borrowings under the line of credit agreement from $8,500,000 to $2,000,000. See Note K to the Consolidated Financial Statements for additional discussion of the Systems Division Sale. As of June 30, 1999, the bank has agreed to renew the revolving line of credit agreement at a level of $2,500,000. Interest on the line will be at prime plus .75% per year (8.5% at July 3, 1999). Under the new arrangement with its bank, the Company will have available to it a total credit facility of approximately $7,900,000, which includes the $5,400,000 standby letter of credit for the Company's VRIRB and the revolving line of credit. The credit facility is collateralized by substantially all of the assets of the Company. At July 3, 1999, there were no borrowings outstanding under the line. The line will expire in November 1999. During 1996, the Company borrowed $800,000 in the form of an installment note with its bank in order to finance the capital expansion of its in-house machine shop. The note, which was payable upon demand, was being amortized in 59 monthly installments of $16,899 with a final payment due on January 25, 2001 of $21,151. The note bore interest at 9.75% and was collateralized by the machinery and equipment acquired. In March 1999, the Company paid off the then outstanding balance of the note. In addition, the Company, through its wholly-owned foreign subsidiaries, has various short-term financing arrangements with local banks totaling approximately $280,000 at July 3, 1999. Approximately $140,000 and $110,000 were borrowed against one of these facilities during fiscal 1999 and 1998, respectively, and repaid prior to the end of the fiscal year. The weighted average interest rates during the year on these facilities ranged from 6.71% to 24.0%, and the interest rates at July 3, 1999 ranged from 6.25% to 24.0%. E. COMMITMENTS AND CONTINGENCIES The Company has entered into operating leases for office space and equipment. Future minimum aggregate lease payments for the five years subsequent to fiscal 1999 amount to: $268,000 in 2000; $84,000 in 2001; $72,000 in 2002; $64,000 in 2003; and $64,000 in 2004. Rent expense under operating leases amounted to $433,000 in 1999, $446,000 in 1998 and $489,000 in 1997. During fiscal 1999, the Company entered into a royalty agreement with Ferrotec Corporation ("Ferrotec", formerly Nippon Ferrofluidics Corporation), a Japanese corporation, whereby the Company agreed to pay Ferrotec a 5% royalty on all sales of Vacuum Rotary Feedthrough Seals and agreed to discontinue the sale of such feedthroughs in Japan. The agreement expires on December 31, 2005. For fiscal 1999, the Company incurred $272,000 in royalty expense under this agreement. In May 1999, the Company leased approximately 10,000 square feet in its headquarters in Nashua to an unaffiliated company. The operating lease expires in May 2002. Future minimum lease payments to be received for the three years subsequent to fiscal 1999 amount to: $148,000 in 2000; $152,000 in 2001; and $128,000 in 2002. During 1997, the Company terminated its agreement to lease to a third party approximately 11,000 square feet of its headquarters office in Nashua in exchange for payment to the tenant of $100,000, which was charged to operations during fiscal 1997. The Company received total lease payments of $28,000 in 1997 from this third party. In connection with the sale of the Company's former UK Subsidiary, AF Technologies, Ltd. (AF) in June 1990, the Company agreed to provide a guarantee of the lease of AF's facility, in the amount of (pound)300,000, which amount was deposited in an interest-bearing escrow account under the terms of the guarantee. In view of the uncertainty of the collectibility of the deposit, an allowance of $265,000 was established. In June 1997, the Company was notified by the landlord of the property that the tenant had accumulated approximately $112,000 of arrearages under the lease, and that the landlord intended to draw that amount from the escrow deposit. During fiscal 1999, this matter was settled by negotiations, and the Company agreed to accept a return of (pound)76,000 ($122,000), including accrued interest, on the deposit in exchange for release of any further obligation under the guarantee. As a result, the Company charged a net amount of $104,000 to operations during fiscal 1999. 31 32 At July 3, 1999, the Company had possible indemnification liabilities to its former CFO in connection with the single premium, paid-up life insurance policies described in Note B. The unrecorded portion of this contingent liability ranges from a nominal amount to $150,000. F. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
1999 1998 1997 ---- ---- ---- Numerator: Income (loss) from continuing operations $ (476,000) $ 1,546,000 $ 260,000 Income (loss) from discontinued operations 5,319,000 (5,018,000) 1,412,000 ---------- ----------- ---------- Net income (loss) $4,843,000 $(3,472,000) $1,672,000 ========== =========== ========== Denominator: Denominator for basic earnings per share - weighted average shares 6,137,192 6,198,603 6,116,176 Effect of dilutive securities: Employee stock options -- 1,763 5,047 Non-vested restricted stock awards -- 32,063 74,847 ---------- ----------- ---------- Dilutive potential common shares -- 33,826 79,894 ---------- ----------- ---------- Denominator for diluted earnings per share - adjusted weighted average shares 6,137,192 6,232,429 6,196,070 ========== =========== ========== Per Share: Income (loss) from continuing operations: Basic $ (0.08) $ 0.25 $ 0.04 Diluted $ (0.08) $ 0.25 $ 0.04 Income (loss) from discontinued operations: Basic $ 0.87 $ (0.81) $ 0.23 Diluted $ 0.87 $ (0.81) $ 0.23 Net income (loss): Basic $ 0.79 $ (0.56) $ 0.27 Diluted $ 0.79 $ (0.56) $ 0.27
At July 3, 1999, June 27, 1998, and June 28, 1997, options and warrants to purchase 673,505 shares at prices ranging from $3.16 to $13.00 per share, 443,259 shares at prices ranging from $6.13 to $13.50 per share and 688,987 shares at prices ranging from $9.00 to $15.25 per share, respectively, of common stock were anti-dilutive and therefore were excluded from the computation of diluted earnings per share. 32 33 G. COMMON STOCK At July 3, 1999, an aggregate of 673,505 shares of the Company's common stock had been reserved for issuance in connection with the nonqualified and incentive stock option plans, the restricted stock plan and stock purchase warrants outstanding (see Note H). In addition, 230,613 shares of the Company's common stock were available for future grants of options under the nonqualified and incentive stock option plans and the restricted stock plan. SHAREHOLDER RIGHTS PLAN On August 3, 1994, the Board of Directors of the Company adopted a Shareholder Rights Agreement (the "Rights Agreement"). Pursuant to the terms of the Rights Agreement, the Board of Directors declared a dividend distribution of one Preferred Stock Purchase Right (a "Right") for each outstanding share of common stock of the Company to stockholders of record as of the close of business on August 19, 1994 (the "Record Date"). Each Right entitles the registered holder to purchase from the Company, upon the occurrence of certain events, a unit consisting of one one-thousandth of a share (a "Unit") of Series A Junior Participating Cumulative Preferred Stock, par value $0.001 per share (the "Preferred Stock"), at a cash exercise price of $25.00 per Unit (the "Exercise Price"), subject to adjustment. The rights currently are not exercisable and are attached to and trade with the outstanding shares of common stock. Under the Rights Agreement, the Rights become exercisable (i) if a person becomes an "acquiring person" by acquiring 15% or more of the outstanding shares of common stock, (ii) if a person who owns 10% or more of the common stock is determined to be an "adverse person" by the Board of Directors, or (iii) if a person commences a tender offer that would result in that person owning 15% or more of the common stock. In the event that a person becomes an "acquiring person" or is declared an "adverse person" by the Board, each holder of a Right (other than the acquiring person or the adverse person) would be entitled to acquire such number of shares of the Company's preferred stock which are equivalent to such number of shares of common stock having a value of twice the then-current exercise price of the Right. If the Company is acquired in a merger or other business combination transaction after any such event, each holder of a Right would then be entitled to purchase, at the then-current exercise price, shares of the acquiring company's common stock having a value of twice the exercise price of the Right. Until a Right is exercised, the holder will have no rights as a stockholder of the Company (beyond those as an existing stockholder), including the right to vote or to receive dividends. While the distribution of the Rights will not be taxable to stockholders or to the Company, stockholders may, depending upon the circumstances, recognize taxable income in the event that the Rights become exercisable for Units, other securities of the Company, other consideration or for common stock of an acquiring company. STOCK REPURCHASE PROGRAM On February 23, 1999, the Company's Board of Directors authorized a stock repurchase program pursuant to which up to 1,000,000 shares of its common stock may be purchased in the open market, as market and business conditions warrant, over the next year. During the period ended July 3, 1999, the Company repurchased a total of 553,998 shares of common stock for $2,199,000 (652,498 shares through August 20, 1999) and is holding such shares as treasury stock. H. EMPLOYEE BENEFIT PLANS RESTRICTED STOCK PLAN In 1994, the Board of Directors adopted, and the stockholders approved, the Ferrofluidics Corporation 1994 Restricted Stock Plan (the "Restricted Stock Plan"). Persons eligible to participate in the Restricted Stock Plan are those full or part-time officers and other employees of the Company and its subsidiaries who are responsible for or contribute to the management, growth or profitability of the Company and its subsidiaries. Under the Restricted Stock Plan, the maximum number of shares of common stock that may be reserved and authorized for issuance by the Board of Directors may not exceed five percent of the total number of outstanding shares of common stock at the time of any award of restricted stock. Upon adoption of the plan, the Board of Directors initially reserved and authorized 271,000 shares of common stock for issuance, which represented not more than five percent of the outstanding shares of common stock as of the date of adoption. The grants are valued at the fair market value of the common stock on the date of grant and generally vest at a rate of 33-1/3% per year beginning one year from the date of grant. The charge to operations in connection with these restricted stock awards for the years ended July 3, 1999 and June 27, 1998 and June 28, 1997 amounted to $31,000, $287,000 and $511,000, respectively. 33 34 A summary of the changes in outstanding shares of restricted stock for the years ended July 3, 1999 and June 27, 1998 and June 28, 1997 is set forth below: Weighted Shares Average Price ------- ------------- OUTSTANDING, JUNE 30, 1996 145,073 $ 6.80 Granted 10,000 12.50 Forfeited (2,454) 8.87 Vested (93,762) 6.56 ------- OUTSTANDING, JUNE 28, 1997 58,857 $ 8.06 Granted -- -- Forfeited (4,500) 11.28 Vested (44,531) 7.37 ------- OUTSTANDING, JUNE 27, 1998 9,826 $ 9.75 Granted -- -- Forfeited -- -- Vested (9,826) 9.75 ------- OUTSTANDING, JULY 3, 1999 -- -- ======= NONQUALIFIED AND INCENTIVE STOCK OPTION PLANS The Company has a Nonqualified Stock Option Plan for its employees which was adopted in 1984 (the "1984 Plan"). During fiscal year 1995, the 1984 Plan's term expired and, accordingly, no further shares may be granted thereunder. The exercise price of the options granted under the plan is not less than the fair market value of the stock at the date of the grant. Under the 1984 Plan, 800,000 shares of the Company's common stock were made available for grant. In June 1995, the Board of Directors adopted the Ferrofluidics Corporation 1995 Nonqualified Stock Option Plan (the "1995 Plan") with the intent to replace options that had been granted under the 1984 Plan which were expected to expire during 1996. Neither directors nor employees of the Company who are subject to the provisions of Section 16 of the Securities and Exchange Act of 1934 are eligible to participate in the 1995 Plan and awards under the 1995 Plan consist only of nonqualified options to purchase shares of the Company's common stock. Under the 1995 Plan, 100,000 shares of the Company's common stock were made available for grant. On June 13, 1995, the Board of Directors adopted, and the stockholders approved, the Ferrofluidics Corporation 1995 Stock Option and Incentive Plan (the "1995 Incentive Plan"). Awards under the 1995 Incentive Plan include stock options (both incentive options and nonqualified options), stock appreciation rights, restricted and unrestricted stock, performance shares and dividend equivalent rights. The Board of Directors has authorized 750,000 shares of the Company's common stock for issuance pursuant to the 1995 Incentive Plan. 34 35 Generally, options granted by the Company are exercisable at rates of 25% to 100% per year beginning one or two years after the date of the grant, and expire from five to ten years from the grant date. A summary of the changes in outstanding stock options under the three plans discussed above for fiscal 1997, 1998 and 1999 is set forth below:
Weighted Average Shares Exercise Price ---------------------------------------------------------------- ---------------- "1995 "1984 Plan" "1995 Plan" Incentive Plan" Total --------- --------- -------------- ------- OUTSTANDING, JUNE 30, 1996 187,929 71,925 405,550 665,404 $11.21 Granted -- -- 95,210 95,210 8.41 Canceled/expired (58,416) (11,363) (20,500) (90,279) 13.23 Exercised (33,138) -- -- (33,138) 5.00 ------- ------ ------- ------- OUTSTANDING, JUNE 28, 1997 96,375 60,562 480,260 637,197 $10.83 Granted -- -- 115,000 115,000 4.68 Canceled/expired (96,375) (2,063) (125,000) (223,438) 12.63 Exercised -- -- -- -- -- ------- ------ ------- ------- OUTSTANDING, JUNE 27, 1998 -- 58,499 470,260 528,759 $ 8.73 Granted -- 25,000 278,330 303,330 3.78 Canceled/expired -- (50,874) (119,710) (170,584) 8.89 Exercised -- -- -- -- -- ------- ------ ------- ------- OUTSTANDING, JULY 3, 1999 -- 32,625 628,880 661,505 $ 6.37 ======= ====== ======= =======
In November 1998, the Company repriced stock options previously issued to non-officers and non-directors of the Company between June 29, 1995 and January 2, 1998 under its 1995 Plans. A total of 170,584 options with exercise prices ranging from $7.63 to $10.21 per share were cancelled and replaced with 68,910 options at an exercise price of $3.81 per share. The conversion ratio of the previously issued options to the repriced options was computed using the Black-Scholes method of valuing options. These options are reflected in the table above as options granted and cancelled for fiscal 1999. The following table summarizes information about stock options outstanding at July 3, 1999:
Options Outstanding Options Exercisable ---------------------------------------------------------------------- --------------------------- Weighted Average Remaining Weighted Weighted Range of Contractual Average Average Exercise Prices Shares Life (In Years) Exercise Price Shares Exercise Price --------------- ------- -------------- -------------- ------- -------------- $3.16 - $ 6.13 413,330 5.63 $ 4.01 365,830 $ 4.00 $9.00 - $13.00 248,175 6.41 $10.30 210,037 $10.48 ------- ------- $3.16 - $13.00 661,505 5.92 $ 6.37 575,867 $ 5.54 ======= =======
As of July 3, 1999 and June 27, 1998 and June 28, 1997, options to purchase 575,867, 217,320 and 367,572 shares were exercisable at a weighted average exercise price of, $5.54, $9.93 and $11.51 per share, respectively. 35 36 STOCK PURCHASE WARRANTS Stock purchase warrants have been granted by the Board of Directors to officers, directors, key employees and to consultants of the Company, with the exercise price of the warrant not less than the fair market value of the stock on the date of grant. At July 3, 1999, June 27, 1998 and June 28, 1997, 12,000 shares, 14,500 shares, and 97,000 shares, respectively, of common stock were reserved for issuance upon the exercise of outstanding stock purchase warrants at prices, and subject to expiration dates, as set forth below: Shares ------------------------------------------ July 3, 1999 June 27, 1998 June 28, 1997 Price Expiration Date ------------ ------------- ------------- ------ ---------------- -- -- 62,500 $11.75 August 31, 1997 -- -- 20,000 11.00 October 27, 1997 12,000 14,500 14,500 9.75 October 10, 2000 ------ ------ ------ 12,000 14,500 97,000 ====== ====== ====== A summary of the changes in outstanding stock purchase warrants for the three years ended July 3, 1999 is set forth below: Weighted Average Shares Exercise Price ------- ---------------- OUTSTANDING, JUNE 30, 1996 259,829 $12.28 Granted -- -- Canceled/expired (162,829) 12.87 Exercised -- -- ------- OUTSTANDING, JUNE 28, 1997 97,000 $11.30 Granted -- -- Canceled/expired (82,500) 11.57 Exercised -- -- ------- OUTSTANDING, JUNE 27, 1998 14,500 $ 9.75 Granted -- -- Canceled/expired (2,500) 9.75 Exercised -- -- ------- OUTSTANDING, JULY 3, 1999 12,000 $ 9.75 ======= At July 3, 1999, all 12,000 warrants were exercisable at a price of $9.75. In October 1995, the FASB issued Statement No. 123, Accounting for Stock-Based Compensation ("FAS 123"). Under this Statement, the Company had a choice of adopting a fair-value based method of accounting for employee stock-based compensation plans, as established by FAS 123, or retaining the intrinsic value-based method in accordance with APB Opinion No. 25 ("APB 25"), provided certain pro forma disclosures were made. The Company chose to retain the intrinsic value-based method of accounting for stock-based compensation in accordance with APB 25 and adopted the pro-forma disclosure provisions of FAS 123. Accordingly, no compensation expense has been recognized for stock option awards or warrants as they are granted at prices not less than fair market value of the stock on the date of grant. The following pro-forma disclosures required by FAS 123 have been prepared as if the Company accounted for the stock options and warrants using the fair-value method of accounting (in thousands, except per share data): 1999 1998 1997 ------ ------- ------ Net income (loss), as reported $4,843 $(3,472) $1,672 Pro-forma net income (loss) 4,547 (3,607) 603 Net income (loss) per share, as reported - basic $ 0.79 $(0.56) $0.27 Net income (loss) per share, as reported - diluted 0.79 (0.56) 0.27 Pro-forma net income (loss) per share - basic $ 0.74 $(0.58) $0.10 Pro-forma net income (loss) per share - diluted 0.74 (0.58) 0.10 36 37 The fair value of each option and warrant is estimated on the date of grant using the following weighted-average assumptions in fiscal 1999, 1998 and 1997: 1999 1998 1997 ---- ---- ---- Risk-free interest rate 4.73% 5.57% 6.12% Expected stock price volatility 71.0% 60.0% 60.0% Expected life of options and warrants (years) 1.4 2.0 4.3 The weighted average fair value of options granted during the years ended July 3, 1999, June 27, 1998 and June 28, 1997 were $1.25, $1.62 and $4.47, respectively. For purposes of this disclosure, the Company amortizes the fair value of the options and warrants over the vesting period of the option or warrant. In estimating the fair value of each option the Company uses the Black-Scholes option valuation method. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models, such as the Black-Scholes model, require the input of highly subjective assumptions, including the expected stock price volatility, which are subject to change from time to time. For this reason, and because the FAS 123 fair value-based method of accounting has not been applied to options and warrants granted prior to July 1, 1996, the resulting pro-forma compensation costs are not necessarily indicative of costs to be expected in future years. DEFERRED INCOME (401-K) PLAN The Company has an elective employees savings plan for all eligible employees. Ferrofluidics Corporation Tax Savings Deposit and Investment Plan (the "401-K Plan") is a qualified trust under Section 401(a) of the Internal Revenue Code and is, therefore, exempt from federal income taxes under the provisions of Section 501(a). The 401-K Plan allows an employee to contribute between 1% and 20% of his or her salary and bonus to the 401-K Plan, up to a maximum of $10,000 (for calendar 1998) per year (subject to annual adjustments based on increases in the consumer price index over the 1988 base year). In December 1993, the Board of Directors approved an annual Company match, effective January 1, 1994, of 50% of an employee's contribution of up to 4% of the employee's salary. In fiscal 1999, 1998 and 1997, the Company made matching contributions to the Plan, and corresponding charges to operations, in the amounts of $88,000, $105,000 and $155,000, respectively. The 401-K Plan consists of four equity funds, a fixed income fund, a balanced fund and a money market fund, and participants may choose to split their investments among funds. I. SEGMENT AND GEOGRAPHIC INFORMATION The Company has adopted the provisions of SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for the way the Company is required to report information about its operating segments. SFAS No. 131 did not materially change the manner in which the Company's segments are reported; however, information for prior years has been restated to conform to the 1999 presentation. The Company's operations, after the discontinuation of the Systems Division, are conducted in three industry segments: component products which combines proprietary ferrofluid technology with applications engineering to develop a variety of products that provide state-of-the-art seals and sealing subsystems that seal the environment from a manufacturing process; ferrofluids for use in the Company's own engineered products, for use in home and automotive loudspeakers and nondestructive testing, and for use in sensors and stepper motors; and distributed products manufactured and/or distributed by GmbH. Sales among segments and geographic enterprises are accounted for at cost plus a reasonable profit. See Note K for a further discussion regarding discontinued operations. Segment operating profit (loss) includes all costs and expenses directly related to the segment. General corporate expenses principally represent the costs associated with managing all industry segments which were not specifically identified with a particular industry segment. General corporate assets consist primarily of cash and cash equivalents, deferred income tax assets, certain fixed assets, and other non-current assets, including cash surrender value of life insurance, net of loans, at July 3, 1999 and June 27, 1998, respectively. 37 38 The following table presents financial information for the Company's industry segments from continuing operations for the years ended July 3, 1999, June 27, 1998 and June 28, 1997. All amounts are expressed in thousands of dollars.
DISTRIBUTED COMPONENTS PRODUCTS FLUIDS CONSOLIDATED ---------- ----------- ------ ------------ YEAR ENDED JULY 3, 1999: Sales to unaffiliated customers $11,096 $9,810 $2,237 $23,143 ======= Segment operating profit 3,012 526 266 $ 3,804 General corporate expenses (3,798) ------- Operating income $ 6 ======= Net identifiable assets, continuing operations 11,523 3,159 1,065 $15,747 Net identifiable assets, discontinued operations 1,102 General corporate assets 12,074 ------- Total assets $28,923 ======= Depreciation and amortization 941 279 19 Capital expenditures 46 182 41 YEAR ENDED JUNE 27, 1998: Sales to unaffiliated customers $15,626 $9,390 $2,188 $27,204 ======= Segment operating profit 5,629 281 326 $ 6,236 General corporate expenses (4,067) ------- Operating income $ 2,169 ======= Net identifiable assets, continuing operations 14,258 3,557 761 $18,576 Net identifiable assets, discontinued operations 17,280 General corporate assets 8,163 ------- Total assets $44,019 ======= Depreciation and amortization 1,262 268 27 Capital expenditures 542 157 9 YEAR ENDED JUNE 28, 1997: Sales to unaffiliated customers $12,957 $8,409 $2,490 $23,856 ======= Segment operating profit 3,179 (35) 739 $ 3,883 General corporate expenses (3,539) ------- Operating income $ 344 ======= Net identifiable assets, continuing operations 16,411 2,854 969 $20,234 Net identifiable assets, discontinued operations 18,508 General corporate assets 6,259 ------- Total assets $45,001 ======= Depreciation and amortization 1,167 161 26 Capital expenditures 919 125 --
38 39 The following is a summary of certain financial data from continuing operations by geographic areas:
U.S. EUROPEAN OPERATIONS OPERATIONS ELIMINATIONS TOTAL ---------- ---------- ------------ ------- YEAR ENDED JULY 3, 1999: Sales to unaffiliated domestic customers $ 8,680 $ -- $ -- $ 8,680 Sales to unaffiliated foreign customers 1,497 12,966 -- 14,463 Sales to subsidiaries 1,757 -- (1,757) -- ------- ------- ------- ------- Total net sales and revenues 11,934 12,966 (1,757) $23,143 ======= Geographic operating profit 3,086 682 36 $ 3,804 General corporate expenses (3,798) ------- Operating income $ 6 ======= Net identifiable assets, continuing operations 12,895 3,682 (830) $15,747 Net identifiable assets, discontinued operations 1,102 General corporate assets 12,074 ------- Total assets $28,923 ======= YEAR ENDED JUNE 27, 1998: Sales to unaffiliated domestic customers $11,647 $ -- $ -- $11,647 Sales to unaffiliated foreign customers 1,756 13,801 -- 15,557 Sales to subsidiaries 2,133 -- (2,133) -- ------- ------- ------- ------- Total net sales and revenues 15,536 13,801 (2,133) $27,204 ======= Geographic operating profit 5,363 870 3 $ 6,236 General corporate expenses (4,067) ------- Operating income $ 2,169 ======= Net identifiable assets, continuing operations 18,137 4,973 (4,534) $18,576 Net identifiable assets, discontinued operations 17,280 General corporate assets 8,163 ------- Total assets $44,019 ======= YEAR ENDED JUNE 28, 1997: Sales to unaffiliated domestic customers $10,915 $ -- $ -- $10,915 Sales to unaffiliated foreign customers 962 11,979 -- 12,941 Sales to subsidiaries 834 -- (834) -- ------- ------- ------- ------- Total net sales and revenues 12,711 11,979 (834) $23,856 ======= Geographic operating profit 3,708 174 1 $ 3,883 General corporate expenses (3,539) ------- Operating income $ 344 ======= Net identifiable assets, continuing operations 18,346 4,416 (2,528) $20,234 Net identifiable assets, discontinued operations 18,508 General corporate assets 6,259 ------- Total assets $45,001 =======
39 40 J. LITIGATION From time to time, as a normal incidence of the nature of the Company's business, various claims, charges or litigation are or may be asserted or commenced against the Company relating to, among other things, contractual matters, patent disputes, environmental matters and product liability. While there can be no assurance that the Company will prevail in all these matters, the Company does not believe that these matters will have a material adverse effect on the Company's consolidated financial position or results of operations. However, an adverse resolution of one or more of such matters could have an adverse effect on the Company's consolidated results of operations in a quarter in which such matters might be resolved. K. DISCONTINUED OPERATIONS On September 23, 1998, the Company sold certain assets of the Systems Division to General Signal Technology Corporation, an SPX Corporation company ("General Signal") for $10,800,000 in cash (the "Systems Division Sale"). Assets sold included approximately $2,818,000 in inventory, and approximately $625,000 in fixed assets and intangibles. As discussed below, the Systems Division is currently being operated by the Company only to complete existing backlog. After providing for transaction fees of $333,000 and income taxes of $1,400,000, the Company recorded a gain on the Systems Division Sale of $5,319,000 during fiscal 1999. The gain on the Systems Division Sale is net of an operating loss of $368,000 that was incurred by the Systems Division during the quarter ended September 26, 1998. For the period from September 27, 1998 to July 3, 1999, the Systems Division's operations were approximately break-even. The Company also anticipates approximately break-even operations for the Systems Division through the end of the phase-out period which is expected to end on or about October 2, 1999. The Systems Division represented a separate line of business and, accordingly, its net operating results have been reported, net of applicable income taxes, as discontinued operations for all periods through June 29, 1998, the date management decided to dispose of the Systems Division. The Systems Division Sale, as structured, did not include any Systems Division accounts receivable or liabilities, which remained with the Company. The Systems Division Sale also did not include the obligation by the Company to complete approximately $18,433,000 ($1,680,000 at July 3, 1999) in Systems Division backlog, nor did it include approximately $5,873,000 ($1,411,000 at July 3, 1999) in inventory on hand on the date of the Systems Division Sale, all of which was needed to fulfill existing backlog. The terms of the Systems Division Sale provided that, generally, any backlog existing on December 31, 1998, would be transferred to General Signal. The remaining backlog at July 3, 1999, however, will be completed and shipped by the Company as agreed to by General Signal. The backlog at September 23, 1998 included a purchase order from a customer for nine machines (valued at approximately $7,658,000) for which the customer did not provide firm delivery dates. On December 26, 1998, the customer canceled delivery of the nine machines. In connection with these machines and other orders, on September 23, 1998, the Company had inventory of approximately $1,712,000 on hand and approximately $2,471,000 in parts on order at vendors. Prior to June 15, 1999, the Company had settled almost all of its commitments with its vendors at a cost of approximately $1,765,000, which had been considered in calculating the estimated gain on disposal of the Systems Division reflected during the first quarter of fiscal 1999. On June 15, 1999, the Company and its customer negotiated a settlement with respect to the canceled delivery of the nine machines, which settlement had no adverse financial impact to the Company. The remaining backlog at July 3, 1999 of $1,680,000 is planned to be completed and shipped in the first quarter of fiscal 2000. The Systems Division Sale also did not include approximately $6,472,000 ($210,000 at July 3, 1999) in accounts receivable which were outstanding as of the closing of the Systems Division Sale. The Company believes that it will be able to collect the remaining $210,000 of these receivables within established reserves, but there can be no assurance that the Systems Division Sale will not adversely affect their collectibility. The Company allocated approximately $490,000 and $593,000 of corporate expenses and $459,000 and $352,000 of interest expense to the Systems Division in determining income (loss) from discontinued operations for the years ended June 27, 1998 and June 28, 1997, respectively. Corporate expenses were allocated based on the actual amounts incurred on behalf of the Systems Division. Interest expense was allocated based on the proportionate share of the Systems Division's net identifiable assets to the total net assets of the Company. 40 41 In addition to the Systems Division Sale, the Company, in December 1998, decided to discontinue the Component Parts business of FJC, a wholly-owned subsidiary (see also Note E). The Company intends to dissolve FJC in fiscal 2000. The Component Parts business of FJC represented a separate line of business and, accordingly, its net operating results have been reported, net of any applicable income taxes, as discontinued operations for all periods through December 22, 1998, the date of the decision to dispose of the Component Parts business of FJC. No significant gain or loss is expected from the discontinuance of this business. For the period from June 28, 1998 to December 22, 1998, the Component Parts business operations of FJC were approximately break-even and, for the years ended June 27, 1998 and June 28, 1997, the Component Parts operations of FJC had operating losses of $358,000 and $544,000, respectively. The Company also anticipates approximately break-even operations for the Component Parts business of FJC through the end of the phase-out period, which is expected to end on or about October 2, 1999. The operating results of the discontinued divisions are summarized as follows (000's omitted): 1998 1997 ---- ---- Net sales $25,496 $43,929 ======= ======= Income (loss) from operations before income taxes $(6,357) $ 685 Income taxes (benefit) (1,339) (727) ------- ------- Income (loss) from operations $(5,018) $ 1,412 ======= ======= The net assets at July 3, 1999 of the discontinued divisions are summarized as follows (000's omitted) Current assets $ 1,621 Current liabilities (519) ------- Net assets of the discontinued divisions $ 1,102 ======= 41 42 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III On October 20, 1999, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Ferrotec Corporation ("Parent") and Ferrotec Acquisition, Inc. (the "Purchaser"). Pursuant to the Merger Agreement, the Purchaser began on October 26, 1999 a cash tender offer (the "Offer") for all of the outstanding shares of Common Stock of the Company at a price of $6.50 per share, net to the seller in cash, without interest. The Merger Agreement also provides, among other things, that as soon as practicable after the consummation of the Offer and the satisfaction or waiver of certain closing conditions, the Purchaser will be merged (the "Merger") with and into the Company, with the Company as the surviving corporation. The disclosure contained in certain of the items listed below reflects the fact that the Company entered into the Merger Agreement subsequent to the initial filing of the Company's Annual Report on Form 10-K for the fiscal year ended July 3, 1999 ("fiscal 1999"). ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The Company Board currently consists of four members and is divided into three classes, with one director in Class I, one director in Class II, and two directors in Class III. Directors serve for three-year terms with one class of Directors being elected by the Company's stockholders at each annual meeting. During fiscal 1999, each of Stephen B. Hazard and Robert P. Rittereiser resigned from the Company Board. Neither Mr. Hazard nor Mr. Rittereiser resigned from the Company Board because of a disagreement with the Company on any matter relating to the Company's operations, policies or practices. Set forth below is certain information regarding the Directors of the Company based on information furnished by them to the Company. DIRECTOR NAME AGE SINCE - ---- --- -------- CLASS I Dennis R. Stone*........................ 52 1994 CLASS II Howard F. Nichols....................... 71 1979 CLASS III Dean Kamen.............................. 48 1989 Paul F. Avery, Jr....................... 70 1998 - ----------------- * Nominee for election. MR. AVERY has been the President, Chief Executive Officer and Chairman of the Board of Directors of the Company since June 3, 1998. Mr. Avery also served as the Chief Executive Officer of the Company from October 1, 1993 until June 25, 1996, President of the Company from October 1, 1993 until January 1, 1995 and Chairman of the Board and Treasurer of the Company from October 1, 1993 until May 1, 1997. He is also President of P.F. Avery Corporation, a management-consulting firm, a position he has held since 1983. From 1967 to 1983 he was President and Treasurer of C.E. Avery, a wholly owned subsidiary of Combustion Engineering, Inc., and President and Chief Executive Officer of CE-KSB Pump Company, Inc. Both companies were involved in the design and fabrication of pumps and reactor internals for the utility industry. Mr. Avery is also general partner of a 3MW hydroelectric facility in Nashua, New Hampshire, and serves as a director of several privately held companies. MR. KAMEN is the founder and Chairman and Chief Executive Officer of DEKA Research and Development Corporation, which develops highly specialized medical equipment. Mr. Kamen is the founder and, from 1976 to 1982, was the Chief Executive Officer of Auto-Syringe, Inc., a manufacturer of medical devices that was acquired by Baxter Healthcare Corporation. 42 43 He is a member of the Board of Directors of Sander's Prototype, Inc. and Zero Emissions Technology. He also serves as a director of several privately held companies. MR. NICHOLS is a consultant. Until July 1989, he was a Vice President of The First National Bank of Boston, Trust Department. He is also a member of the Board of Directors of Doble Engineering Co., Bemis Associates, Inc., Weymouth Art Leather Co., McCrillis & Eldredge Insurance, Inc. and Seamans Supply Co., all of which are privately-held companies. MR. STONE is a stockholder and director of the accounting firm of Nathan Wechsler & Company, Professional Association, Portsmouth, New Hampshire. From 1989 to 1997 he was a principal in the firm of Dennis R. Stone, CPA, Portsmouth, New Hampshire. From 1989 to 1991 he also served as Executive Vice President and Chief Financial Officer of The Blake Insurance Group, Inc., Portsmouth, New Hampshire. Mr. Stone also serves as an investigative auditor for the New Hampshire Supreme Court Professional Conduct Committee. He is a member of the Board of Directors of Odyssey House, Inc. INFORMATION REGARDING EXECUTIVE OFFICERS The names and ages of all executive officers of the Company and principal occupation and business experience during at least the last five years for each are set forth below. Name Age Position - ---- --- -------- Paul F. Avery, Jr. 70 President, Chief Executive Officer and Chairman of the Board Alvan F. Chorney 54 Vice President--New Business Development William B. Ford 59 Vice President, Chief Financial Officer and Treasurer Timothy D. Barton 44 Vice President--Components Division MR. AVERY has held the positions of President, Chief Executive Officer and Chairman of the Board of the Company since June 3, 1998. Mr. Avery also served as Chief Executive Officer of the Company from October 1, 1993 until June 25, 1996, President of the Company from October 1, 1993 until January 1, 1995 and Chairman of the Board and Treasurer of the Company from October 1, 1993 until May 1, 1997. See "Information Regarding Directors" above. MR. CHORNEY has held the position of Vice President--New Business Development since July 27, 1998. He served as Vice President and General Manager--Components Division of the Company from April 19, 1996 to July 27, 1998. Prior to that, Mr. Chorney served as Senior Vice President of the Company from November 1991 to April 19, 1996. Mr. Chorney was also a Director of the Company from 1986 to April 1994. In September 1997, the Securities and Exchange Commission's Division of Enforcement brought a cease-and-desist proceeding against, among others, Mr. Chorney, alleging that in 1992 Mr. Chorney failed to properly report on Schedule 13D his beneficial ownership of certain shares of Common Stock. On May 20, 1999, without admitting or denying the Commission's allegations, Mr. Chorney agreed to cease and desist from committing or causing any violations of, and committing or causing any future violations of, Section 13(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Rule 13d-1 thereunder. MR. FORD has held the position of Treasurer of the Company since May 19, 1997 and the position of Vice President and Chief Financial Officer of the Company since September 23, 1996. From November 1993 until April 1995, Mr. Ford was Vice President and Chief Financial Officer of Versyss Incorporated, a software developer and distributor of integrated hardware and software systems for medical practice management and other small business applications. From 1987 to November 1993, he was a Director in the Financial Advisory Services consulting practice of Coopers & Lybrand L.L.P. MR. BARTON has held the position of Vice President--Components Division of the Company since July 27, 1998. From 1991 to 1998, Mr. Barton served as Director of Sales and Marketing of the Company. From 1985 to 1991, he served as Regional Sales Manager of the Company, and prior to that, from 1993 to 1985, he served as Project Engineer of the Company. 43 44 SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE The Company's Directors, executive officers and beneficial owners of more than 10% of its Common Stock are required under Section 16(a) of the Securities Exchange Act of 1934, as amended, to file reports of ownership and changes in ownership with the SEC. Copies of those reports must also be furnished to the Company. Based solely on a review of the copies of reports furnished to the Company and written representations that no other reports were required, the Company believes that during fiscal 1999, no person who was a Director, executive officer or greater than 10% beneficial owner of the Company's Common Stock failed to file on a timely basis all reports required by Section 16(a). ITEM 11. EXECUTIVE COMPENSATION COMPENSATION OF DIRECTORS Directors who are officers or employees of the Company receive no compensation for their service as Directors. Directors who are not officers or employees of the Company receive such compensation for their services as the Board of Directors may from time to time determine. During fiscal 1999, non-employee Directors each received an annual retainer of $16,000, payable quarterly. In addition, during fiscal 1999, non-employee Directors also received $1,000 for each Board of Directors meeting or committee meeting attended or $600 for attending each committee meeting that was held on the same day as a Board of Directors meeting or meeting of another committee on which such Director served. Beginning with fiscal year ending July 1, 2000, non-employee Directors shall receive an annual retainer of $20,000, payable quarterly, and no additional payments. Pursuant to the Ferrofluidics Corporation Amended and Restated 1995 Stock Option and Incentive Plan (the "1995 Incentive Plan"), eligible non-employee Directors are entitled to receive options to purchase shares of Common Stock in accordance with the formula provisions thereof. Under the 1995 Incentive Plan, eligible non-employee Directors automatically receive an option to purchase 3,000 shares of Common Stock on the fifth business day after each annual meeting of stockholders of the Company, commencing with the 1995 Annual Meeting. Accordingly, on December 24, 1998, each of Messrs. Stone, Nichols, Kamen, Hazard and Rittereiser was granted an option to purchase 3,000 shares of Common Stock at an exercise price of $3.16. All such options vested and became immediately exercisable upon grant and have an exercise price equal to 100% of the fair market value of a share of Common Stock on the grant date. COMPENSATION OF EXECUTIVE OFFICERS The following sections set forth and discuss the compensation paid or awarded during the last three years to the Company's Chief Executive Officer and the four most highly compensated executive officers who earned in excess of $100,000 during fiscal 1999 (the "Named Executive Officers"). SUMMARY COMPENSATION TABLE The following table shows for the fiscal years ended June 28, 1997, June 27, 1998 and July 3, 1999, the annual compensation paid by the Company to the Chief Executive Officer and the four most highly compensated executive officers who earned in excess of $100,000 during fiscal 1999. 44 45
Long Term Compensation ------------------------------------------------- Annual Compensation Awards Payouts ----------------------------------------- -------------------------------------- ---------- Securities Underlying Name and Salary Other Annual Restricted Stock Warrants/ LTIP All Other Principal Position Year ($)(1) Bonus($) Compensation($) Award($) Options(#) Payouts($) Compensation ------------------ ---- ------- -------- --------------- -------- ---------- ---------- ------------ Paul F. Avery, Jr....... President, Chief 1999 210,000 -- 15,604(2) -- 83,000(3) -- 11,570(4) Executive Officer and 1998 19,230(5) -- 1,111(6) -- 75,000(3) -- 120,450(7) Chairman of the Board 1997 183,814(5) -- 3,615(6) -- -- -- 19,350(8) Alvan F. Chorney........ 1999 180,000 231(9) -- 34,000(3) -- -- Vice President--New 1998 183,974 1,720 1,000(9) -- -- -- -- Business Development 1997 170,223 5,156 1,000(9) -- -- -- 2,099(10) William B. Ford......... Vice President, Chief 1999 121,519 -- -- -- 36,000(3) -- 2,745(11) Financial Officer and 1998 150,365 -- -- -- -- -- 5,832(10) Treasurer 1997 112,223(5) -- -- -- 30,000(3) -- -- Timothy D. Barton....... 1999 111,884 -- -- -- 19,000(3) -- -- Vice President and 1998 -- -- -- -- -- -- -- General Manager 1997 -- -- -- -- -- -- -- -Components Division
- ------------------------ (1) Includes all voluntary pre-tax contributions to the Ferrofluidics Corporation Tax Savings and Deposit and Investment Plan. (2) Of such amount, $12,982 represents an automobile allowance and $2,622 represents an allowance for medical and health expenses incurred by Mr. Avery in excess of amounts covered by the Company's group health plan. (3) This amount represents Shares subject to option agreements. (4) This amount includes the full dollar value of insurance premiums paid by the Company on behalf of Mr. Avery with respect to term life insurance. (5) This amount represents less than a full year's salary. (6) This amount represents an automobile allowance. (7) This amount includes the full dollar value of insurance premiums paid by the Company on behalf of Mr. Avery with respect to term life insurance in the amount of $10,450 and payments made to Mr. Avery pursuant to a consulting agreement with the Company in the amount of $110,000. See "Employment Agreements and Change in Control Agreements" below. (8) This amount includes the full dollar value of insurance premiums paid by the Company on behalf of Mr. Avery with respect to term life insurance in the amount of $9,350 and payments made to Mr. Avery pursuant to a consulting agreement with the Company in the amount of $10,000. See "Employment Agreements and Change in Control Agreements" below. (9) This amount represents an allowance for medical and health expenses incurred by Mr. Chorney in excess of amounts covered by the Company's group health plan. (10) This amount represents reimbursement by the Company to Mr. Chorney and Mr. Ford, respectively, of expenses incurred in connection with their relocation to New Hampshire. (11) This amount represents reimbursement by the Company for tax incurred by Mr. Ford relating to the reimbursement by the Company of certain relocation expenses incurred by Mr. Ford. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth information regarding each stock option granted during fiscal 1999 to each of the Named Executive Officers. The potential realizable values that would exist for the respective options are based on assumed rates of annual compound stock price appreciation of 5% and 10% from the date of grant over the full term of the option. Actual gains, if any, on stock options exercises and holdings of Common Stock are dependent on the future performance of the Common Stock. 45 46
Individual Grants ----------------------------------------------------------- Potential Realizable Value at Assumed Annual Number of % of Total Rates of Stock Securities Options Price Appreciation Underlying Granted to Exercise For Option Term Options Employees in or Base Price Expiration ------------------ Granted(1) Fiscal Year Per Share(2) Date 5% ($) 10%($) ---------- ----------- ------------ ---- ------ ------ Paul F. Avery, Jr........... 83,000 27.4% $ 3.81 11/5/03 $87,369 $193,062 Alvan F. Chorney............ 34,000 11.2 3.81 11/5/03 35,790 79,085 William B. Ford............. 36,000 11.9 3.81 11/5/03 37,895 83,738 Timothy D. Barton........... 19,000 6.3 3.81 11/5/03 20,000 44,195
- ------------------------ (1) The options were fully vested upon grant. Options are generally subject to the employee's continued employment. The options terminate five years after the grant date, subject to earlier termination in accordance with the 1995 Incentive Plan and the applicable option agreement. (2) The exercise price is equal to the market value on the date of the grant. The amounts shown as potential realizable value illustrate what might be realized upon exercise immediately prior to expiration of the option term using the 5% and 10% appreciation rates established in regulations of the Commission, compounded annually. The potential realizable value is not intended to predict future appreciation of the price of the Common Stock. The values shown do not consider nontransferability, vesting or termination of the options upon termination of employment. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END VALUES The following table sets forth the shares of Common Stock acquired and the value realized upon exercise of stock options during fiscal 1999 by each of the Named Executive Officers and certain information concerning stock options held by the Named Executive Officers as of July 3, 1999.
Number of Securities Value of Unexercised Shares Underlying Unexercised In-The-Money Options Acquired on Value Options At Fiscal Year-end at Fiscal Year-end(1) Name Exercise Realized Exercisable/unexercisable Exercisable/unexercisable - ------------------------------ -------- -------- ------------------------- ------------------------- Paul F. Avery, Jr............. 0 $0 288,000/ 0 $ 31,374/ $ 0 Alvan F. Chorney.............. 0 0 59,000/ 0 12,852/ 0 William B. Ford............... 0 0 43,000/ 23,000 10,584/ 3,024 Timothy Barton................ 0 0 26,625/ 0 7,182/ 0
- -------------------------- (1) Based on the fair market value of the Common Stock of $4.188 per Share, the price of the last reported trade of the Common Stock on the Nasdaq National Market on July 2, 1999, less the option exercise price per share. Options are in-the-money if the fair market value of the shares of Common Stock covered thereby is greater than the option exercise price. REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS ON EXECUTIVE COMPENSATION General The Compensation Committee consists of Messrs. Stone and Kamen, each of whom are non-employee Directors. The Compensation Committee is generally responsible for developing the Company's executive and management compensation policies, including awards of equity-based compensation. The Company's executive compensation program is designed to provide competitive levels of compensation, reward above-average individual performance and assist the Company in attracting and retaining qualified management. Where applicable, the Compensation Committee takes into account employment agreements between an executive officer and the Company. Mr. Avery, the President and Chief Executive Officer of the Company, makes general recommendations to 46 47 and reviews with the Compensation Committee salary increases and bonus compensation of executive officers and employees other than himself. Compensation Policy Review From time to time, the Compensation Committee evaluates its objectives regarding the Company's executive compensation policy. The Compensation Committee's primary objectives in evaluating the Company's executive compensation philosophy historically have been to (i) review base salaries, cash bonuses and short-term and long-term incentives for executive officers based upon a survey of compensation for executive officers in a group of comparable high-technology companies, and (ii) to develop an appropriate methodology for structuring long-term incentive awards to ensure that such awards more closely align the interests of the executive officers with those of the Company's stockholders. The Compensation Committee also has from time to time sought and received advice from an independent compensation consulting firm in its evaluation of the Company's executive compensation policies. The last occasion on which the Compensation Committee sought advice from a consultant was in 1995, at which time the consultant conducted a survey of executive compensation levels and practices of companies within a proxy peer group (the "Peer Group") of companies of similar size to the Company. The Peer Group consisted of seven companies in the specialty machinery industry having annual revenues of $30 million to $50 million. Compensation Policies for Executive Officers Base Salary. The annual base salary and base salary adjustments for executive officers are determined by the Compensation Committee in its discretion and are targeted according to the salaries of executives holding similar offices and having similar responsibilities within the Company's industry segment. The Compensation Committee also considers factors such as industry experience and executive retention. Annual salary adjustments for executive officers are determined by evaluating the competitive marketplace, the performance of the Company, the performance of the executive officer and any change in the responsibilities assumed by the executive officer. Salary adjustments are normally determined and made on an annual basis. The base salary of Paul F. Avery, Jr., the Chief Executive Officer of the Company, was established pursuant to his current Employment Agreement dated June 3, 1998, as amended to date, with the Company (the "Avery Employment Agreement"), which is described under "Employment Agreements and Change in Control Agreements" below, and was based on the foregoing criteria. The base salary of William B. Ford, Vice President and Chief Financial Officer of the Company, was established pursuant to his current Employment Agreement dated September 23, 1996 with the Company (the "Ford Employment Agreement"), which is described under "Employment Agreements and Change of Control Agreements" below, and was based on the foregoing criteria. Cash Bonuses. The Company has a cash incentive program (the "Cash Incentive Plan"), which became effective on July 1, 1995. The Cash Incentive Plan is intended to encourage, recognize and reward performance by executives by providing cash compensation based upon the achievement of a pre-determined annual operating budget and a combination of quantitative and qualitative measures (the relative weights of which are determined in the sole discretion of the Compensation Committee when it performs its performance review), including orders received (for marketing managers), percent defect rate (for production managers), timeliness and quality of monthly reporting (for accounting managers) and effectiveness of improvement projects (for all managers). The annual operating budget is determined by the Compensation Committee and the Board of Directors prior to the beginning of the fiscal year and the total pool from which cash incentives may be awarded under the plan is formed based upon the achievement of the operating profits contained in the annual operating budget. The Chief Executive Officer is eligible to receive up to 35% of his respective base salary depending upon the extent to which the operating profits contained in the annual operating budget are achieved, while executive officers other than the Chief Executive Officer are eligible to receive up to either 20% or 25% of their respective base salaries depending upon the extent to which the operating profits contained in the annual operating budget are achieved. Although cash bonuses generally are awarded pursuant to the Cash Incentive Plan, the Compensation Committee, in its discretion, may award a cash bonus to an executive officer for outstanding performance based upon individual performance reviews (which may or may not take into account specific performance measures relative to that executive officer), retention considerations and general industry practice. Based upon the foregoing criteria, no executive officers of the Company received a cash bonus under the Cash Incentive Plan for fiscal 1999 performance and no discretionary cash bonuses were awarded. Equity and Equity-Based Incentives. Equity and equity-based incentive awards are designed to attract and retain executives who can make significant contributions to the Company's success, reward executives for such significant contributions and give executives a longer-term incentive to increase shareholder value. The size and frequency of equity and equity-based incentive awards are determined by the Compensation Committee in its discretion, taking into account individual performance and responsibilities, but without any specific performance measures. The Compensation Committee also may grant stock options for executive retention 47 48 purposes, taking into account, among other things, general industry practice. To ensure that high levels of performance occur over the long-term, stock options granted to executives typically vest over a period of time. All outstanding options have been granted with an exercise price equal to 100% of the fair market value of the Common Stock on the grant date. The 1995 Incentive Plan is the principal vehicle by which the Company intends to achieve the executive compensation policy objective of providing long-term incentives to executive officers that will more closely align the interests of such executives with those of the Company's stockholders. Pursuant to the 1995 Incentive Plan, the Compensation Committee may grant a variety of long-term incentive awards based on the Common Stock, including stock options (both incentive options and non-qualified options), SARs, restricted stock, unrestricted stock, performance shares and dividend equivalent rights. In fiscal 1999, each of Messrs. Avery, Ford, Chorney and Barton received an option(s) to purchase 83,000 shares of Common Stock, 36,000 shares of Common Stock, 34,000 shares of Common Stock and 19,000 shares of Common Stock, respectively. Each of these options was fully vested upon grant. At its discretion, under the Ferrofluidics Corporation Amended and Restated 1994 Restricted Stock Plan (the "1994 Restricted Stock Plan"), the Compensation Committee may also award restricted stock bonuses to executive officers and other key employees. Shares of restricted stock granted to executive officers under the 1994 Restricted Stock Plan vest over a period of time and are subject to forfeiture in the event an officer's employment with the Company terminates prior to vesting. Shares of restricted stock are not transferable prior to vesting. During Fiscal 1999, no executive officers of the Company received an award of restricted stock. Any value received by an executive officer from a stock option grant and any increase in the value of stock received as a bonus depends entirely on increases in the price of the Common Stock. Other Compensation. The Company provides executive officers and management with health, retirement and other benefits under plans that are generally available to the Company's employees. Compensation of the Chief Executive Officer Mr. Avery's base salary was established pursuant to the criteria described above in "Base Salary" in the Avery Employment Agreement which is described under "Employment Agreements and Change in Control Agreements" below. Based on the criteria set forth in the Cash Incentive Plan, Mr. Avery did not receive a cash bonus for fiscal 1999 and the Compensation Committee did not exercise the discretion to award him a cash bonus. However, in consideration of Mr. Avery's outstanding commitment to the Company, and in accordance with the other objectives of the Compensation Committee's equity-based incentive philosophy, Mr. Avery received an option to purchase 83,000 shares of Common Stock on November 5, 1998, which was fully vested upon grant. Federal Tax Regulations Applicable to Executive Compensation As a result of Section 162(m) of the Internal Revenue Code of 1986, as amended (the "Code"), the Company's deduction of executive compensation may be limited to the extent that a "covered employee" (i.e., the chief executive officer or one of the four highest compensated officers who is employed on the last day of the Company's taxable year and whose compensation is reported in the Summary Compensation Table) receives compensation in excess of $1,000,000 in such taxable year of the Company (other than performance-based compensation that otherwise meets the requirements of Section 162(m) of the Code). The Company intends to take appropriate action to comply with such regulations, if applicable, in the future. DENNIS R. STONE, CHAIRMAN DEAN KAMEN COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Mr. Avery, the President and Chief Executive Officer of the Company, makes general recommendations to and reviews with the Compensation Committee the salary increases and bonus compensation of executives and management other than himself. 48 49 EMPLOYMENT AGREEMENTS AND CHANGE OF CONTROL ARRANGEMENTS AVERY EMPLOYMENT AGREEMENT AND CONSULTING AGREEMENT The terms of employment of Paul F. Avery, Jr., President, Chief Executive Officer and Chairman of the Board of the Company, are set forth in the Avery Employment Agreement. Under the Avery Employment Agreement, Mr. Avery serves as the President, Chief Executive Officer and Chairman of the Board of the Company until June 3, 2000 at a salary of $250,000 per year, subject to earlier termination for death, disability, cause or upon 60 days' written notice by either Mr. Avery or the Company. Pursuant to the Avery Employment Agreement, the Company is required to, among other things, (i) reimburse Mr. Avery for all reasonable business expenses incurred by Mr. Avery in the performance of his duties, (ii) provide Mr. Avery with an automobile for business and personal use and pay or reimburse Mr. Avery for all expenses associated therewith, and (iii) maintain insurance on Mr. Avery's life in the amount of $1,000,000, payable as directed by Mr. Avery, until the expiration of the term of the agreement, unless Mr. Avery is terminated by the Company for cause. In addition, Mr. Avery is entitled to participate in the health, welfare, retirement and other fringe benefit plans, which the Company makes available to management from time to time. Mr. Avery may terminate his employment at any time upon 60 days' written notice to the Company and the Company may terminate Mr. Avery's employment other than for cause (as defined in the Avery Employment Agreement) at any time upon 60 days' written notice to Mr. Avery. If Mr. Avery is terminated for cause, he is entitled to any earned but unpaid salary at the date of termination and the contribution by the Company to the cost of Mr. Avery's participation in the Company's group medical and dental insurance plans as permissible under applicable law and plan terms. If Mr. Avery's employment is terminated for reasons other than (i) by the Company for cause or (ii) voluntary termination by Mr. Avery, Mr. Avery is entitled to receive an amount equal to the aggregate base salary which Mr. Avery would have received had he been employed by the Company through the last day of the term of the agreement. If Mr. Avery dies or becomes disabled during the term of the Avery Employment Agreement, Mr. Avery's employment immediately terminates and he is entitled to any earned but unpaid salary. If the Company undergoes a "change of control" (as defined in the Avery Employment Agreement), and Mr. Avery is terminated, voluntarily or involuntarily, other than for cause after the date such change in control occurs, Mr. Avery is entitled to receive an amount equal to the aggregate base salary which Mr. Avery would have received had he been employed by the Company through the last day of the term of the agreement. In addition to any other payments to which he might be entitled upon termination of his employment, the terms of the Avery Employment Agreement also provide that, upon the termination of Mr. Avery's employment for reasons other than (i) by the Company for cause, (ii) the death or disability of Mr. Avery or (iii) the expiration of the term of the agreement, the Company and Mr. Avery shall immediately enter into an agreement pursuant to which Mr. Avery shall be engaged as a consultant to the Company. The terms and conditions of such consultancy shall be identical to those set forth in the Consulting Agreement dated as of May 1, 1997 between the Company and Mr. Avery (the "Avery Consulting Agreement"), which terminated upon Mr. Avery's engagement by the Company as President, Chief Executive Officer and Chairman of the Board on June 3, 1998. Under the Avery Consulting Agreement, Mr. Avery performed such consulting, advisory and related services for the Company as were reasonably requested by the Company from time to time for a consulting fee of $10,000 per month for a term of three years, which term could be extended upon mutual written agreement. In addition, under the Avery Consulting Agreement, the Company could also request that Mr. Avery serve as Chairman of the Board. If the Company so requested, and if Avery agreed to so serve, the Company would be required to pay Mr. Avery an annual retainer of $50,000 for such service for so long as Mr. Avery served in such position. Such retainer would be in addition to any payments to be made to Mr. Avery with respect to his consultancy. Under the Avery Consulting Agreement, the Company was required to reimburse Mr. Avery for all reasonable business expenses incurred by Mr. Avery in the performance of his duties. Mr. Avery was entitled to participate in and enjoy the benefit of the Company's retirement plans, but was not entitled to participate in the health, welfare, retirement and other fringe benefit plans, which the Company made available to management from time to time, except at his own expense. Mr. Avery could terminate his consultancy at any time upon 60 days written notice to the Company and the Company could terminate Mr. Avery's consultancy other than for cause (as defined in the Avery Consulting Agreement) at any time upon 60 days written notice to Mr. Avery. If Mr. Avery were terminated for cause, he would be entitled to any earned but unpaid consulting fees at the date of termination. If Mr. Avery were to die or become disabled during the term of the Avery Consulting Agreement, Mr. Avery's consultancy would be immediately terminated. If Mr. Avery's employment was terminated for reasons other than for cause or due to death or disability, the Company would continue to pay Mr. Avery his consulting fees for the duration of the term of the Avery Consulting Agreement. In connection with the Offer and the Merger, the Company, the Purchaser, Parent and Mr. Avery agreed, subject to certain modifications described below, that effective upon the acceptance for payment by the Purchaser or an affiliate thereof of the shares of Common Stock tendered pursuant to the Offer (the date on which such acceptance occurs being referred to as the "Acceptance Date"), Mr. Avery's employment with the Company will terminate and that Mr. Avery will serve as a consultant and advisor to the Company pursuant to the terms of the Avery Consulting Agreement. The Avery Consulting Agreement will commence as of the Acceptance 49 50 Date and will continue for a period of three years. Under the Avery Consulting Agreement as modified, the parties agreed that, in addition to the consulting fee of $10,000 per month, the Company will pay Mr. Avery $250,000 on the Acceptance Date (or, at Mr. Avery's option, over the three-year term on a weekly basis) and an additional $50,000 per annum advisory fee for so long as Mr. Avery is retained by the Company to provide advisory services. In addition, the Company will be required to maintain insurance on Mr. Avery's life in an amount of $1,000,000, payable as directed by Mr. Avery, for two years. In the event that the Acceptance Date does not occur, the Avery Consulting Agreement will not become effective and Mr. Avery will continued to be employed by the Company under the terms of the Avery Employment Agreement. FORD EMPLOYMENT AGREEMENT The terms of employment of William B. Ford, Vice President and Chief Financial Officer of the Company are set forth in the Ford Employment Agreement. The Ford Employment Agreement provides for Mr. Ford's employment at a salary of $140,000 per year, subject to annual salary reviews by the Compensation Committee or the President of the Company, as appropriate. Pursuant to the Ford Employment Agreement, the Company is required to reimburse Mr. Ford for all reasonable business expenses incurred by Mr. Ford in the performance of his duties. In addition, Mr. Ford is entitled to participate in the health, welfare, retirement and other fringe benefit plans which the Company makes available to management from time to time. Pursuant to the Ford Employment Agreement, the Company or Mr. Ford may terminate Mr. Ford's employment at will upon six months written notice if such notice is given within one year of his employment or upon one year's written notice if such notice is given after the first year of his employment. If the Company undergoes a change of control (as defined in the Ford Employment Agreement) and Mr. Ford is terminated by the Company other than for cause within 12 months after such change of control occurs, Mr. Ford shall be entitled to receive an amount equal to six months' salary at the rate then in effect if such termination occurs within the first year of Mr. Ford's employment, and an amount equal to 12 months' salary at the rate then in effect if such termination occurs after the first year of Mr. Ford's employment. If Mr. Ford dies or becomes disabled during the term of the Ford Employment Agreement, Mr. Ford's employment automatically terminates and he is entitled to any earned but unpaid salary. If Mr. Ford is terminated for cause (as defined in the Ford Employment Agreement), he is entitled to any earned but unpaid salary at the date of termination and the contribution by the Company to the cost of Mr. Ford's participation in the Company's group medical and dental insurance plans as permissible under applicable law and plan terms. In connection with the Offer and the Merger, the Company, the Purchaser, Parent and Mr. Ford have entered into an Employment Agreement (the "New Ford Employment Agreement") which becomes effective only if the Purchaser or an affiliate thereof accepts for payment Shares tendered pursuant to the Offer. Under the New Ford Employment Agreement, the parties agreed that Mr. Ford's employment with the Company pursuant to the Ford Employment Agreement would be terminated effective as of the Acceptance Date. The New Ford Employment Agreement will be effective from the Acceptance Date until March 31, 2000 and provides that Mr. Ford will continue to serve the Company in an executive capacity. Under the New Ford Employment Agreement, Mr. Ford will receive a payment of $45,000 on the Company's first payroll date after January 1, 2000 and a further payment of $104,000 on the Company's first payroll date after January 1, 2001. Mr. Ford will also be compensated by the Company at the annual rate of $145,000, payable not less than twice a month. The parties also agreed that the consideration payable to Mr. Ford with respect to his options to purchase shares of Common Stock in connection with the Merger would be payable in installments: $50,000 on January 2, 2000, and $48,750 on January 2, 2001. In addition, Mr. Ford will be entitled to participate in the health, welfare, retirement and other fringe benefit plans which the Company makes available to management from time to time and will be entitled to accrue vacation days at the rate of four weeks per year. Mr. Ford will be given credit under all of the Company's employee benefits and policies, including for accrued vacation time, for all services prior to the Acceptance Date. Mr. Ford will be paid upon the termination of his employment with the Company for all accrued vacation time as of the termination date in accordance with the Company's policy. If Mr. Ford dies or becomes disabled during the term of the New Ford Employment Agreement, Mr. Ford's employment automatically terminates and he, or his beneficiary, as the case may be, will be entitled to any earned but unpaid salary. If Mr. Ford is terminated for cause (as defined in the New Ford Employment Agreement), he will be entitled to any earned but unpaid salary at the date of termination and the contribution by the Company to the cost of Mr. Ford's participation in the Company's group medical and dental insurance plans as permissible under applicable law and plan terms. In the event that the Acceptance Date does not occur, then the New Ford Employment Agreement will not become effective and Mr. Ford will continued to be employed by the Company under the Ford Employment Agreement. CHORNEY SEVERANCE AGREEMENT On August 6, 1999, the Company entered into a Letter Agreement with Alvan D. Chorney, the Company's Vice President--New Business Development (the "Chorney Letter Agreement"), pursuant to which the parties agreed, among other things, to confirm certain 50 51 provisions of a Severance Agreement dated as of October 1, 1993 between the Company and Mr. Chorney (the "Chorney Severance Agreement") and provide for the payment of certain severance payments to Mr. Chorney in the event that his employment with the Company is terminated following a change of control. The Chorney Letter Agreement provides that if the Company undergoes a change of control and Mr. Chorney is terminated by the Company (other than for cause or by reason of Mr. Chorney's death or disability) within 12 months of such change of control event, Mr. Chorney will receive equal bi-weekly payments for 24 months at a rate equal to the highest annual salary rate during Mr. Chorney's employment with the Company. The Chorney Severance Agreement remains in effect with respect to any termination of Mr. Chorney's employment by the Company other than in connection with or following a change of control. The Chorney Severance Agreement provides Mr. Chorney with certain severance benefits in the event that his employment is terminated by the Company other than by reason of death, disability or cause. Pursuant to this agreement, if Mr. Chorney's employment is terminated other than for any of the aforementioned reasons, he is entitled to receive for a period of eighteen months an aggregate amount equal to the greater of (i) $225,000 and (ii) the annual base salary which he would have received over an eighteen-month period commencing on the date of such termination. BARTON SEVERANCE AGREEMENT On July 1, 1999, the Company entered into a Letter Agreement with Timothy D. Barton, the Company's Vice President and General Manager--Components Division (the "Barton Letter Agreement"). The Barton Letter Agreement provides, among other things, that if the Company undergoes a change of control and Mr. Barton is terminated by the Company, Mr. Barton will receive a payment equal to 6-months' salary. 51 52 STOCKHOLDER RETURN PERFORMANCE GRAPH Set forth below is a line graph comparing the yearly percentage change in the cumulative total stockholder return on the Company's Common Stock, based on the market price of the Company's Common Stock and assuming reinvestment of dividends, with the cumulative total return of companies within the NASDAQ Stock Market and the companies within the Dow Jones Industrial Technology Index. The calculation of total cumulative return assumes a $100 investment in the Company's Common Stock, the NASDAQ Stock Market and the Dow Jones Industrial Technology Index on July 1, 1994. The comparisons in this table are historical and are not intended to forecast or be indicative of possible future performance of the Common Stock of the Company. CUMULATIVE TOTAL RETURN ----------------------- 6/94 6/95 6/96 6/97 6/98 6/99 ---- ---- ---- ---- ---- ---- FERROFLUIDICS CORPORATION 100 183 257 160 79 86 NASDAQ STOCK MARKET (U.S.) 100 133 171 208 274 393 DOW JONES INDUSTRIAL TECHNOLOGY 100 142 141 151 133 169 ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS Solely for the purpose of calculating the aggregate market value of the voting stock held by non-affiliates of the Registrant as set forth on the cover of this report it has been assumed that directors and executive officers of the Registrant are affiliates. The following table sets forth, to the best knowledge and belief of the Company, certain information regarding the beneficial ownership of Common Stock as of October 1, 1999 by (i) each person known by the Company to be the beneficial owner of more than 5% of the outstanding Common Stock, (ii) each of the Company's Directors and nominees, (iii) each of the named executive officers in the Summary Compensation Table and (iv) all of the Company's executive officers and Directors as a group. Except as otherwise indicated, each person listed below has sole voting and investment power over the Shares shown as beneficially owned. 52 53 Shares Directors, Executive Officers Beneficially Percent of and 5% Stockholders Owned(1) Class(2) - ----------------------------- ------------ ---------- Paul F. Avery, Jr.............................. 331,900 (3) 5.7% Alvan F. Chorney............................... 62,000 (4) 1.1 William B. Ford................................ 63,500 (5) 1.1 Timothy Barton................................. 30,105 (6) * Howard F. Nichols.............................. 24,975 (7) * Dean Kamen..................................... 18,100 (8) * Dennis R. Stone................................ 16,350 (9) * All directors and executive officers as a group (7 persons)....................... 546,930 (10) 9.0 - -------------------------- * Less than 1%. (1) Beneficial share ownership is determined pursuant to Rule 13d-3 under the Securities Exchange Act. Accordingly, a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise has or shares the power to vote such security or the power to dispose of such security. The amounts set forth above as beneficially owned include shares of Common Stock owned, if any, by spouses and relatives living in the same home as to which beneficial ownership may be disclaimed. The amounts set forth above as beneficially owned also include shares of Common Stock, which such persons had the right to acquire within 60 days of October 1, 1999 pursuant to stock options. (2) Percentages are calculated on the basis of 5,574,177 shares of Common Stock outstanding as of October 1, 1999, together with applicable stock options for each stockholder. (3) Includes 288,000 shares of Common Stock, which Mr. Avery may acquire upon the exercise of stock options within 60 days of October 1, 1999. (4) Includes 59,000 shares of Common Stock, which Mr. Chorney may acquire upon the exercise of stock options within 60 days of October 1, 1999. (5) Includes 54,500 shares of Common Stock, which Mr. Ford may acquire upon the exercise of stock options within 60 days of October 1, 1999. (6) Includes 26,625 shares of Common Stock, which Mr. Barton may acquire upon the exercise of stock options within 60 days of October 1, 1999. (7) Includes 19,600 shares of Common Stock, which Mr. Nichols may acquire upon the exercise of stock options within 60 days of October 1, 1999. (8) Includes 17,350 shares of Common Stock, which Mr. Kamen may acquire upon the exercise of stock options within 60 days of October 1, 1999. (9) Includes 11,250 shares of Common Stock, which Mr. Stone may acquire upon the exercise of stock option within 60 days of October 1, 1999. (10) Includes 476,325 shares of Common Stock, which may be acquired by such persons upon the exercise of stock option, within 60 days of October 1, 1999. 53 54 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K The consolidated financial statements of the Company have been included in Item 8 herein. (a) FINANCIAL STATEMENT SCHEDULES PAGE for the years ended July 3, 1999 and June 27, 1998 and June 28, 1997 Schedule II - Valuation and Qualifying Accounts 60 Financial statement schedules other than that listed above are omitted because they are either not required or not applicable or the required information is shown in the financial statements or notes thereto. The above financial schedule does not include discontinued operations. (b) REPORTS ON FORM 8-K No reports on Form 8-K have been filed by the Company during the last quarter of the year ended July 3, 1999. (c) EXHIBITS 3.1 Restated Articles of Organization of the Registrant (incorporated by reference to Exhibit 2.1 to the Registrant's Registration Statement on Form S-18 (Registration No. 2-72394-B), filed May 19, 1981 (the "1981 Registration Statement"). 3.2 Articles of Amendment, filed November 19, 1980, increasing the authorized shares of Common Stock (incorporated by reference to Exhibit 2.2 to the 1981 Registration Statement). 3.3 Articles of Amendment, filed February 19, 1981, further increasing the authorized shares of Common Stock (incorporated by reference to Exhibit 2.3 to the 1981 Registration Statement). 3.4 Articles of Amendment, filed November 21, 1985, further increasing the authorized shares of Common Stock (incorporated by reference to Exhibit 4E to the Registrant's Registration Statement on Form S-2 (Registration No. 33-1000), filed October 18, 1985). 3.5 Articles of Amendment, filed November 25, 1987, eliminating certain liabilities of directors and reducing the vote required to effect certain corporate actions (incorporated by reference to Exhibit 4E to the Registrant's Form 10-K for the year ended 6/30/88). 3.6 Articles of Amendment, filed November 14, 1989, effecting reverse stock split and amending terms of Preferred Stock (incorporated by reference to Exhibit 3.6 to the Registrant's Registration Statement on Form S-3 (Registration No. 33-33736), filed March 5, 1990 (the "1990 Registration Statement"). 3.7 By-Laws of the Registrant (incorporated by reference to Exhibit 4G to the Registrant's Form 10K for the year ended 6/30/90). 3.8 Certificate of Vote of Directors Establishing the Series A Junior Participating Cumulative Preferred Stock, par value $.001 per share, dated August 3, 1994.(1) 54 55 4.1 Shareholder Rights Agreement, dated as of August 3, 1994, between the Registrant and American Stock Transfer and Trust Company (incorporated by reference to Exhibit 4.1 to Registrant's current report on Form 8-K dated August 3, 1994).(1) 10.1 Revolving Loan and Security Agreement, dated June 30, 1994, by and among the Registrant and Bank of New Hampshire.(1) 10.2 Letter of Credit Reimbursement Agreement, dated June 30, 1994 made by Ferrofluidics Corporation in favor of Bank of New Hampshire.(1) 10.3 Guarantee Agreement, dated June 30, 1994, between the Registrant, the Business Finance Authority of the State of New Hampshire and Bank of New Hampshire.(1) 10.4 Interbank Letter of Credit Agreement, dated June 30, 1994, between Bank of New Hampshire, a New Hampshire trust company and BayBank, a Massachusetts trust company.(1) 10.5 Master Term Note, dated June 30, 1994, by and among the Registrant and Bank of New Hampshire.(1) 10.6 Ferrofluidics Corporation Amended and Restated 1994 Restricted Stock Plan.(3) 10.7 Stipulation of Settlement, dated June 23, 1994, IN RE FERROFLUIDICS CORPORATION SECURITIES LITIGATION, Civil Action No. 93-11976PBS, United States District Court, District of Massachusetts.(1) 10.8 Order and Final Approval of Settlement and Final Judgment, dated August 19, 1994, IN RE FERROFLUIDICS CORPORATION SECURITIES LITIGATION, Civil Action No. 93-11976PBS, United States District Court, District of Massachusetts.(1) 10.9 Release and Settlement Agreement, dated April 13, 1994, between the Registrant and Molecular BioQuest, Incorporated.(1) 10.10 Consent and Undertaking of Ferrofluidics Corporation, dated June 20, 1997, In re the matter of the Securities and Exchange Commission vs. Ferrofluidics Corporation, et al, United States District Court, Southern District of New York.(4) 10.11 Amendment Agreement, dated December 23, 1987, to 1985 Letter of Credit Reimbursement Agreement and 1984 Letter of Credit Reimbursement Agreement between the Registrant and Fleet National Bank (incorporated by reference to Exhibit 10I to the Registrant's Form 10-K for the year ended 6/30/89). 10.14 Loan and Trust Agreement, dated September 1, 1984, among the Registrant, The Industrial Development Authority of the State of New Hampshire and State Street Bank and Trust Company, as Trustee (incorporated by reference to Exhibit 10 to the Registrant's Form 10-Q for the quarter ended September 30, 1984). 10.15 Assignment, Assumption and Amendment Agreement, dated June 18, 1991, by and among the Registrant, Chase Manhattan Capital Markets Corporation and Fleet Norstar Securities, Inc. (incorporated by reference to Exhibit 1000 to the Registrant's Form 10-K for the year ended 6/30/91). 10.16 Amendment Agreement, dated October 13, 1990, to 1984 Letter of Credit Reimbursement Agreement and 1985 Letter of Credit Reimbursement Agreement (incorporated by reference to Exhibit 10ZZ to the Registrant's Form 10-K for the year ended 6/30/90). 10.17 Escrow, Pledge and Security Agreement dated January 31, 1991, made by the Registrant in favor of State Street Bank and Trust Company, as Trustee, and Fleet National Bank (incorporated by reference to Exhibit 10.36 to the 1991 Registration Statement). 10.19 Amended and Restated Employment Agreement, dated May 17, 1996, between the Registrant and Salvatore J. Vinciguerra.(3) 10.20 Consulting Agreement, dated May 1, 1997, between the Registrant and Paul F. Avery, Jr.(4) 55 56 10.21 License Agreement, dated February 27, 1987, between the Registrant, Ferrofluidics GmbH and Ferrofluidics, Ltd. (incorporated by reference to the Exhibit to the Registrant's Form 8-K dated 5/13/87). 10.22 Deed relating to repayment of a promissory note dated August 25, 1994 by and among the Registrant, Rumpack Limited and Arbuthnot Latham and Co., Ltd.(1) 10.23 Release and discharge of certain guarantees and debentures and a Stock Pledge Agreement dated August 25, 1994 by and among the Registrant and Rumpack Limited and Arbuthnot Latham and Co., Ltd.(1) 10.24 Ferrofluidics Corporation Amended and Restated 1995 Stock Option and Incentive Plan.(3) 10.25 Ferrofluidics Corporation Amended and Restated 1995 Nonqualified Stock Option Plan.(3) 10.26 Employment Agreement, dated September 23, 1996, between the Registrant and William B. Ford.(4) 10.27 First Amendment to Note and Loan Agreement, dated December 3, 1996, by and between the Registrant and Bank of New Hampshire.(4) 10.28 Amended Master Term Note, dated December 3, 1996, by and between the Registrant and Bank of New Hampshire.(4) 10.29 Amendment to Mortgage, dated December 3, 1996, by and between the Registrant and Bank of New Hampshire.(4) 10.30 Amendment to Assignment of Leases, dated December 3, 1996, by and between the Registrant and Bank of New Hampshire.(4) 10.35 Form of Stock Purchase Agreement between the Registrant and certain Selling Stockholders (incorporated by reference to Exhibit 10.53 to Amendment No. 1, filed April 9, 1992, to the Registrant's Registration Statement on Form S-3 (Registration No. 33-46888), filed April 1, 1992 (the "April 1992 Registration Statement"). 10.36 Form of Stock Purchase Agreement between the Registrant and certain Selling Stockholders (incorporated by reference to Exhibit 10.54 to Amendment No. 2, filed April 30, 1992, to the April 1992 Registration Statement). 10.37 Form of Stock Purchase Agreement between the Registrant and certain Selling Stockholders (incorporated by reference to Exhibit 10.55 to Amendment No. 2 to the April 1992 Registration Statement). 10.55 Termination Agreement, dated November 25, 1993, between Registrant and Fuji Seiki, Inc. for the purpose of termination of The Patent, Technical Information and Trademark License Agreement, dated March 30, 1993, between the Registrant and Fuji Seiki, Inc.(4) 10.56 Preferred Vendor Agreement, dated November 30, 1993, between the Registrant and Fuji Seiki, Inc.(4) 10.57 Patent, Technical Information and Trademark License Agreement, dated November 30, 1993, between the Registrant and Fuji Seiki, Inc.(4) 10.58 Agreement, dated March 8, 1993, among the Registrant, Fuji Seiki, Inc., VSE Austria GmbH, and AP&T GmbH for the purchase of 80% of VSE GmbH by AP&T GmbH.(4) 10.59 Letter Agreement, dated September 15, 1993, between the Registrant and Dr. Ronald Moskowitz concerning Dr. Moskowitz' retirement from Ferrofluidics.(4) 10.62 Indemnification Agreement, dated October 1, 1993, between the Registrant and Alvan F. Chorney.(4) 10.63 Indemnification Agreement, dated October 1, 1993, between the Registrant and Stephen P. Morin.(2) 56 57 10.64 Severance Agreement dated October 1, 1993, between the Registrant and Alvan F. Chorney.(4) 10.66 Amended and Restated Insurance Loan Agreement, dated June 30, 1991, between the Registrant and Ronald Moskowitz (incorporated by reference to Exhibit 10R to the Registrant's Form 10-K for the year ended 6/30/91). 10.67 Amended and Restated Insurance Loan Agreement, dated May 31, 1989, between the Registrant and Frank Bloom (incorporated by reference to Exhibit 10.37 to the 1990 Registration Statement). 10.68 Form of Common Stock Purchase Warrant -- directors and key employees (incorporated by reference to Exhibit 10T to the Registrant's Form 10-K for the year ended 6/30/88). 10.69 Form of Common Stock Purchase Warrant -- employees (incorporated by reference to Exhibit 10U to the Registrant's Form 10-K for the year ended 6/30/88). 10.70 1984 Non-Qualified Stock Option Plan, as amended through December 15, 1992.(4) 10.71 1983 Employee Stock Purchase Plan, as amended through December 14, 1990 (incorporated by reference to Exhibit 4 to Post-Effective Amendment No. 1, filed January 23, 1991, to the Registrant's Registration Statement on Form S-8 (Registration No. 2-95090)). 10.72 Settlement Agreement and Release, dated June 30, 1993, between Nippon Ferrofluidics Corporation, Akira Yamamura, Koichi Goto, Yoshitada Akahori, Tadao Ishizawa, Atsumi Nakamura, Nobuo Yamamura, past and present members of NFC's Board of Directors and the Registrant.(4) 10.73 Stock Subscription Agreement, dated June 30, 1993 between the Registrant and Nippon Ferrofluidics Corporation pursuant to the acquisition of Nippon Ferrofluidics Corporation Common Stock by Ferrofluidics.(4) 10.74 Superseding 1993 Fluids License Agreement, dated June 30, 1993, between the Registrant and Nippon Ferrofluidics Corporation.(4) 10.75 Asset Purchase Agreement dated September 23, 1998, by and between the Registrant and General Signal Technology Corporation.(5) 10.76 Employment Agreement, dated June 3, 1998, between the Registrant and Paul F. Avery, Jr.(5) 10.77 Amendment to Employment Agreement, dated June 3, 1999, between the Registrant and Paul F. Avery, Jr.(6) 10.78 Letter Agreement, dated July 1, 1999, between the Registrant and Timothy D. Barton.(6) 10.79 Letter Agreement, dated July 1, 1999, between the Registrant and Barry D. Moskowitz.(6) 10.80 Letter Agreement, dated August 2 1999, between the Registrant and David C. Lewandoski.(6) 10.81 Amendment to Employment Agreement, dated August 6, 1999, between the Registrant and Alvan F. Chorney.(6) 10.82 Amendment to Employment Agreement, dated September 9, 1999, between the Registrant and Paul F. Avery, Jr.(6) 10.83 Consulting Agreement dated as of October 20, 1999 by and among the Registrant, Ferrotec Corporation, Ferrotec Acquisition, Inc. and Paul F. Avery, Jr.(7) 10.84 Letter Agreement dated as of October 20, 1999 by and among the Registrant, Ferrotec Corporation, Ferrotec Acquisition, Inc. and Paul F. Avery Jr.(7) 10.85 Amendment dated as of October 20, 1999 to the Shareholder Rights Agreement dated as of August 3, 1994 by and between the Registrant and the American Stock Transfer & Trust Company.(7) 57 58 10.86 Agreement and Plan of Merger dated as of October 20, 1999 by and among the Registrant, Ferrotec Corporation and Ferrotec Acquisition, Inc.(7) 21 Subsidiaries of the Registrant(6) 23.1 Consent of Ernst & Young LLP(6) 27 Financial Data Schedule for 1999(6) 27.1 Financial Data Schedule for 1998, as restated(6) 27.2 Financial Data Schedule for 1997, as restated(6) (1) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1994. (2) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1993. (3) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. (4) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 28, 1997. (5) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended June 27, 1998. (6) Incorporated by reference to the designated exhibit of the Registrant's Annual Report on Form 10-K for the fiscal year ended July 3, 1999. (7) Incorporated by reference to the designated exhibit of the Registrant's Schedule 14D-9 filed October 26, 1999. 58 59 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 authorize, this 29th day of October, 1999. FERROFLUIDICS CORPORATION By: /s/ Paul F. Avery, Jr. ---------------------------- Paul F. Avery, Jr. President, Chief Executive Officer and Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated. SIGNATURES TITLE DATE SIGNED /s/ Paul F. Avery, Jr. President, Chief Executive Officer and 10/29/99 - ------------------------- Chairman of the Board (Principal Paul F. Avery, Jr. Executive Officer) /s/ William B. Ford Vice President and Chief Financial 10/29/99 - ------------------------- Officer (Principal Financial Officer) William B. Ford /s/ Dean Kamen Director 10/29/99 - ------------------------- Dean Kamen /s/ Howard F. Nichols Director 10/29/99 - ------------------------- Howard F. Nichols /s/ Dennis R. Stone Director 10/29/99 - ------------------------- Dennis R. Stone 59 60 FERROFLUIDICS CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS Years Ended July 3, 1999, June 27, 1998 and June 28, 1997
Balance at Charges Balance at Beginning To Deductions End of of Period Expenses And Other Period --------- -------- ---------- -------- 1999 Reserve for doubtful accounts - trade $329,000 $ 88,000 $157,000(1) $260,000 ======== ======== =========== ======== 1998 Reserve for doubtful accounts - trade $199,000 $185,000 $ 55,000(2) $329,000 ======== ======== =========== ======== 1997 Reserve for doubtful accounts - trade $320,000 $ 50,000 $171,000(2) $199,000 ======== ======== =========== ========
(1) Uncollectible accounts written off, net of recoveries, of $99,000 and reduction in the Systems Division reserve of $58,000 due to the collection of the majority of the accounts. (2) Uncollectible accounts written off, net of recoveries. 60 -----END PRIVACY-ENHANCED MESSAGE-----