-----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, DPv/p2aHE9Rf3H2e7ykHTHjHAKgeakIuJ/0c6gi9JfPRxu8mE23MqgZG3mzOjjui qgGzQYM15w9LC6ub24hs9w== 0000074697-97-000001.txt : 19970130 0000074697-97-000001.hdr.sgml : 19970130 ACCESSION NUMBER: 0000074697-97-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961031 FILED AS OF DATE: 19970129 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: OPTICAL COATING LABORATORY INC CENTRAL INDEX KEY: 0000074697 STANDARD INDUSTRIAL CLASSIFICATION: OPTICAL INSTRUMENTS & LENSES [3827] IRS NUMBER: 680164244 STATE OF INCORPORATION: DE FISCAL YEAR END: 1031 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-02537 FILM NUMBER: 97513177 BUSINESS ADDRESS: STREET 1: 2789 NORTHPOINT PKWY CITY: SANTA ROSA STATE: CA ZIP: 95407 BUSINESS PHONE: 7075456440 MAIL ADDRESS: STREET 1: 2789 NORTHPOINT PARKWAY CITY: SANTA ROSA STATE: CA ZIP: 95407-7397 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K Mark one [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended OCTOBER 31, 1996 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ OPTICAL COATING LABORATORY, INC. (Exact name of registrant as specified in its charter) COMMISSION FILE NUMBER 0-2537 DELAWARE 68-0164244 (State or other jurisdiction of (IRS Identification No.) incorporation or organization) 2789 NORTHPOINT PARKWAY, SANTA ROSA CALIFORNIA 95407-7397 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (707) 545-6440 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01 PAR VALUE (Title of each 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. [X] Yes [ ] No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At December 31, 1996, the aggregate market value of the registrant's common stock (based upon the closing price of these shares on the NASDAQ National Market System) held by non-affiliates, which excludes shares held by officers and directors and the Employee Stock Ownership Plan of the registrant (not all of whom claim to be affiliates), was approximately $86.7 million. At December 31, 1996, there were 9,787,330 shares of the registrant's common stock, $.01 par value, issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive Proxy Statement for the Company's Annual Meeting of Stockholders to be held March 18, 1997 are incorporated by reference into Part III of this Form 10-K. The Exhibit index appears on Pages 42-45. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES INDEX TO ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED OCTOBER 31, 1996 PART I Item 1. Business 3 Item 2. Properties 10 Item 3. Legal Proceedings 11 Item 4. Submission of Matters to a Vote of Security Holders 11 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters 14 Item 6. Selected Financial Data 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 8. Consolidated Financial Statements and Supplemental Financial Information 21 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 42 PART III Item 10. Directors and Executive Officers of the Registrant 42 Item 11. Executive Compensation 42 Item 12. Security Ownership of Certain Beneficial Owners and Management 42 Item 13. Certain Relationships and Related Transactions 42 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 42 THE INFORMATION CONTAINED IN THIS REPORT INCLUDES FORWARD LOOKING STATEMENTS WHICH ARE TYPICALLY IDENTIFIED BY THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FORECASTS," "PLANS," "FUTURE," "STRATEGY," OR WORDS OF SIMILAR IMPORT. VARIOUS IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD LOOKING STATEMENTS ARE IDENTIFIED BELOW AND IN PART II, ITEM 7 OF THIS REPORT. ACTUAL RESULTS MAY VARY SIGNIFICANTLY BASED ON A NUMBER OF FACTORS INCLUDING, BUT NOT LIMITED TO, PRODUCT DEVELOPMENT, COMMERCIALIZATION AND TECHNOLOGICAL DIFFICULTIES; MANUFACTURING COSTS AND YIELD ISSUES ASSOCIATED WITH INITIATING PRODUCTION AT NEW FACILITIES; THE IMPACT OF COMPETITIVE PRODUCTS AND PRICING; CHANGING CUSTOMER REQUIREMENTS; AND THE CHANGE IN ECONOMIC CONDITIONS OF THE VARIOUS MARKETS THE COMPANY SERVES. PART I ITEM 1. BUSINESS GENERAL Optical Coating Laboratory, Inc. and its consolidated subsidiaries (the "Company" or "OCLI") is the world's largest independent manufacturer of optical thin film coated components. OCLI designs, develops and manufactures multi-layer thin film coatings which control and enhance light by altering the transmission, reflection and absorption of its various wavelengths to achieve a desired effect such as anti-reflection, anti- glare, electromagnetic shielding, electrical conductivity and abrasion resistance. OCLI markets and distributes components to original equipment manufacturers (OEMs) of optical and electro-optical systems, such as personal computers, photocopiers, LCD desktop projectors, point-of-sale scanners, medical instruments and satellites. OCLI sells its Glare/Guard brand ergonomic computer display products through resellers and office retailers. OCLI manufactures its products at Company-owned facilities in Santa Rosa, California, Goslar, Germany and Hillend, Scotland. The Company has developed many of its thin film coating processes and has designed and fabricated most of the coating equipment used to manufacture its products. The Company believes its ability to design and build this specialized equipment has been an important factor in its ability to compete successfully. The Company maintains an extensive array of thin film coating equipment, glass fabrication equipment, precision injection molding equipment and support facilities to satisfy its customers' requirements for thin film coated products, fabricated glass components and precision injection molded plastic optics components. Through its wholly-owned subsidiary in Goslar, Germany and its principal manufacturing facility in Santa Rosa, California, the Company operates fully integrated precision glass fabrication operations with capability for sawing, machining, heat-treating, chemical-treating, silk screening and etching glass products to customer specifications. Fabricated glass product lines include mirrors, platens, filters, panels and an array of optics and components made of glass. OCLI supplies fabricated glass elements for use as components in copiers, cameras and other electro- optical devices and instruments. The Company also operates a fully integrated coating facility with additional optical fabrication capability at its wholly-owned subsidiary in Hillend, Scotland. From this platform, OCLI markets a broad array of coated products with applications in commercial, scientific and military markets. OCLI's Hillend facility also performs research and development under scientific and U.K. Ministry of Defense sponsorships. Through its Netra operation, the Company manufactures precision injection molded plastic optical components that are used in a variety of applications such as inkjet printers, point-of-sale scanners and sunglasses. Precision molded plastic optics allow for the production of aspheric surfaces and have significant cost advantages over similar products made with glass. Plastic optics also improve impact resistance and offer a substantial weight advantage over glass components. Flex Products, Inc. ("Flex Products" or "Flex"), of which the Company holds a controlling 60% interest, is a manufacturer of thin film coatings on plastic film produced by a proprietary vacuum deposition technology on large-scale, high-speed roll coating equipment, which was developed by OCLI in the 1980's. Flex's principal product, optically variable pigment (OVP), was also invented by the Company and is used primarily in currency printing as a security and anti-counterfeiting measure. SICPA Holding S.A., a Swiss company that is OCLI's 40% partner in Flex Products, is the largest manufacturer of printing inks in the world and is currently Flex Products' largest customer. Flex Products also manufactures and sells energy efficient window film used for residential, commercial and automotive energy conservation; printing plates used in offset color printing; photoreceptor ground planes used in copiers; and pigment used in automotive paint. MARKETS AND PRODUCTS DISPLAY-OEM AND AFTERMARKET. The Company is a leading supplier of anti- reflection coatings to original equipment manufacturers (OEMs) for use on computer terminals and other cathode ray tube (CRT) displays, flat panel displays, liquid crystal displays (LCDs) and touch panel displays (among other applications) to improve the readability of the information displayed by reducing glare from reflected light while optimizing the transmission of light from the display. The coatings are produced in several configurations to meet varied customer requirements, including as laminates with conductive qualities to reduce electromagnetic and electrostatic discharge. The Company also produces ergonomic enhancement products which are sold in the computer end-user market under its Glare/Guard brand and on a private label basis. The filters provide viewing comfort and health and safety protection for computer users by improving the visibility of the information displayed on computer display monitors. Several models are also capable of minimizing electrical and magnetic field radiation and static charge buildup of display devices. PROJECTION DISPLAY. The Company manufactures a variety of components used in projection display products, such as front surface mirrors used in large screen projection televisions and dichroic color filters used in LCD and digital light processing projector systems. OFFICE AUTOMATION. The Company manufactures a complete line of high quality products for office automation OEMs, including front surface mirrors for photocopiers, document scanners, overhead projectors, facsimile machines and laser beam printers; platen glass and photoreceptors for photocopiers; hot and cold mirrors used in micrographic readers and overhead projectors; color separation filters for desktop document scanners; and precision molded plastic components used in inkjet printers. SECURITY PRODUCTS. Through Flex Products, OCLI manufactures and markets optically variable pigment used in currency printing as an anti- counterfeiting measure. Flex Products' largest customer for OVP, and OCLI's partner in Flex Products' ownership, is SICPA Holding S.A., one of the leading manufacturers of printing inks in the world. Currently, over 40 countries have adopted the use of ink made with optically variable pigment in the printing of currencies and other valued documents, including Albania, Argentina, Belgium, Bermuda, Czech Republic, France, Germany, Italy, Kazakhstan, Kenya, Lebanon, Luxembourg, Morocco, Nigeria, Philippines, Poland, Singapore, Slovak Republic, Slovenia, Switzerland, Thailand, Tunisia, Turkey, United Arab Emirates, United States and Zaire. INSTRUMENTATION. The Company manufactures a wide array of filters, reflectors and optical components for use in medical, biochemical, scientific and analytical instruments, manufacturing process control instruments, barcode scanners, point-of-sale scanners, focus devices in cameras and slide projectors, instruments used to monitor blood glucose levels and instruments used to measure color in paint pigment. SPECIALTY MARKETS. The Company manufactures products for a variety of specialty applications including dichroic filters for specialty stage lighting; energy control window film for architectural applications; optically variable pigment used in automotive paint; precision molded plastic optics for sunglasses and anti-reflection linear polarizers for viewcams. DEFENSE AND AEROSPACE. The Company designs and manufactures many sophisticated, high precision coated products and optical components to meet the specific performance requirements of advanced scientific, space and defense systems. Examples include coated infrared optics for use in all-weather missile guidance systems, reconnaissance systems and satellites; coatings to protect photovoltaic solar cells on satellites from overheating and from harmful ultraviolet energy and micro meteorite damage; coated thermal control mirrors to regulate spacecraft temperature in areas of sensitive instrumentation; and coated laser optics for use in defense applications, the development of alternative energy sources and commercial high energy laser instrumentation. MANUFACTURING The Company's initial growth came from the development of high precision coated products for use primarily in defense and aerospace applications and in sophisticated analytical equipment. These types of coated products are produced by relatively costly batch processes and continue to represent a portion of the Company's revenues. From this base, the Company has expanded into commercial markets by designing and fabricating continuous coating equipment capable of producing a high volume of relatively less complex products at lower unit costs. This large-scale equipment has enabled the Company to serve broad commercial markets with many of its products. The Company has developed many of its thin film coating processes and has designed, fabricated or significantly customized most of the coating equipment used in production, including its continuous coaters, batch coaters and high speed roll-to-roll coaters. The Company believes its ability to design and build this specialized equipment, and its ability to develop proprietary process technologies, has been an important factor in enabling it to compete successfully. Consequently, the Company maintains an extensive array of thin film coating equipment, glass fabrication equipment and metrology equipment to meet customer requirements for coated products and fabricated glass components. The Company employs various coating processes which it has developed and established over many years. It employs batch coating by evaporation as its historic coating process and batch coating by reactive metal mode sputtering as a proprietary, patented process. In its continuous in-line coating systems, the Company similarly employs evaporation and sputtering processes. The Company's Flex Products subsidiary also employs proprietary evaporation processes and sputtering in its high speed roll-to-roll coating systems. The Company and its subsidiary operations have extensive auxiliary material preparation and glass fabrication equipment in place which allow the Company to produce a broad array of coated glass and plastic components and coated products for a wide variety of applications. The Company has developed and procured extensive state-of-the-art metrology and test equipment to allow testing and verification of technological and performance characteristics of its products. This capability, including the expertise of the Company's scientific and technical staff to develop and design specific thin film coatings to meet a customer's application requirements, is frequently an integral aspect sought by customers in selecting the Company as a supplier. The Company has established strong, long-term customer relationships and serves a wide range of markets, including leading manufacturers of computers, photographic equipment, copier products, medical instrumentation, home entertainment products, and space and defense systems. The Company's Flex Products subsidiary also has long-term relationships with customers in its markets. RESEARCH AND DEVELOPMENT The Company devotes substantial resources to research and development in order to develop new and improve existing thin film products, processes and manufacturing equipment. As a result, the Company has developed a technological leadership position in the thin film coatings industry, and customers rely on the Company's thin film consulting expertise as well as its products. The Company has focused considerable effort over the past several years to the development of solid-state electrochromic devices using thin film coating technologies. Electrochromic devices dim or brighten in response to low level variations in electrical current over their surface, allowing for regulated changes in reflection or transmission of light. The Company's research and development efforts in electrochromic coatings envision a number of product applications, including plano and prescription electrochromic sunglasses, photographic applications, privacy screens, energy conserving architectural glass forms and brightness or reflection controls for display devices. The Company's ongoing research and development commitments include techniques to improve coating uniformity on plastic substrates for flat panel display applications; automation of the Company's coating equipment to improve product and increase equipment productivity; development of new and improved product configurations for the Glare/Guard market; and reduction and eventual elimination of coating and cleaning materials that may be hazardous to the environment. Flex Products' major research and development effort has been toward the development and integration of state-of-the-art coating processes for use in new coating machines which the subsidiary installed during fiscal 1996. Company funded research and development expenditures totaled $11.7 million, $8.4 million and $5.2 million, or 6.2%, 5.0% and 4.0% of revenues, during fiscal years 1996, 1995 and 1994. In addition to the research and development funded by the Company, many of the Company's customer contracts involve state-of-the-art coating applications requiring substantial amounts of development in support of specific customer applications. PATENTS AND LICENSES The Company believes its proprietary technology, its trade secrets and its patents to be of considerable value to its business. The Company believes that its patents demonstrate and support its technological leadership position, safeguard its competitive position and support existing and potential sales volume. The Company has 47 patents and 51 patent applications in the United States which cover materials, processes, products and production equipment. The Company also has patents and patent applications pending in various foreign countries covering the same technology. Expiration dates for the Company's various patents range from 1997 to 2012. Flex Products currently has 35 patents and 13 new patent applications pending that are separate from the Company's patents. Expiration dates for Flex Products' patents range from 1997 to 2013. Flex Products also has patents and patent applications pending in various foreign countries covering the same technology. In 1988, at the formation of Flex Products as a joint venture, the Company and Flex Products entered into a License Agreement under which certain of the Company's patents relating to roll coating technology were assigned to Flex Products and Flex Products agreed to make royalty payments to the Company for the use of these patents. The License Agreement provides for royalties of 4% of Flex Products' revenues. The royalty payments are to continue for several years until a total of $13.7 million is paid. At fiscal year end 1996, $6.6 million remained to be paid. Also, under the License Agreement, the Company and Flex Products each hold royalty-free licenses to use certain of the others' underlying technologies that are applicable to their respective markets. In addition, the Company and Flex Products hold royalty-free shared use licenses for technologies applicable to both markets. TECHNOLOGY LICENSING The Company selectively licenses its coating technology to other companies, primarily for integrated, mass production applications that the Company would not otherwise be able to provide as a manufacturer in the ordinary course of its business. During the past five years, these licenses, together with sales of equipment built for licensees in support of the licenses, have generated revenues to the Company totaling approximately $10 million. MARKETING The Company's products are sold by its sales organizations, headquartered in Santa Rosa, California and Reinheim, Germany, who communicate directly with customers' engineering, manufacturing and purchasing personnel in determining the design, performance and cost specifications for customer product requirements. The Company has regional sales offices in several major cities throughout the United States and in Germany, France, Italy, Spain and the United Kingdom. In Japan and other Asian countries, the Company uses independent distributors and sales representatives, supported by Company sales staff members, for product marketing and sales. With the exception of its Glare/Guard(R) product line, the Company markets most of its standard, high volume coated products and fabricated glass components to OEMs. Its customized, technically sophisticated products are also marketed to OEMs in addition to defense and aerospace contractors. The Company exports some of its products to major distributors who perform product conversion and other value-added process steps before resale. The Company's Glare/Guard(R) product line is marketed through distributors and dealers directly to end users. Flex Products sells into several significant markets with a small, technically oriented sales organization supported by operations and engineering personal in a sales team approach. The Company's ten largest customers accounted for 36% of its sales in 1996. The Company's largest customer in 1996, who is also the Company's 40% partner in the ownership of Flex Products, accounted for approximately 13% of total sales for fiscal 1996 and 12% of total sales for the six months of consolidation of Flex Products in fiscal 1995. The Company's second largest customer in 1996 and largest customer in 1995 accounted for 5%, 8% and 7% of its sales in fiscal years 1996, 1995, and 1994. Because relatively few customers account for a substantial portion of the Company's sales, the loss of their business could have a material adverse effect on the Company's operating results. However, the Company believes that it has the resources and capabilities to replace any lost business over time through the development of new products and new applications for its products. Foreign sales, primarily in Europe and Asia, including foreign sales of Flex Products for fiscal 1996 and six months of 1995, represented 48%, 47% and 45% of revenues for fiscal years 1996, 1995 and 1994. Sales by the Company's wholly-owned subsidiary in Scotland represented 5%, 10% and 16% of revenues for fiscal years 1996, 1995 and 1994. Sales by the Company's wholly-owned subsidiary in Germany represented 13%, 13% and 15% of revenues for fiscal years 1996, 1995 and 1994. Sales by these subsidiaries are primarily to customers in European countries. Export sales by U.S. operations to Asian countries represented 13%, 13% and 11% and to European countries 14%, 9% and 3% of revenues for fiscal years 1996, 1995 and 1994. Export sales can be affected by adverse currency alignments. Since the Company also manufactures in two European countries to serve local markets, the Company believes its exposure to fluctuations in foreign currencies is reduced. In addition, a major portion of export sales are to long-standing customers of the Company who have participated in the development of product specifications and standards for their use and who are, therefore, not relying on competitive pricing alone in their decision to buy from the Company. Accordingly, the Company believes its export sales portfolio to be well-balanced and with limited risk of substantial overall loss. Sales of products to the federal government, primarily under subcontracts, accounted for 9%, 10% and 11% of revenues for the fiscal years 1996, 1995 and 1994. The Company's cost-plus-fixed fee (CPFF) government contracts for fiscal years 1996 and 1995 are subject to pending governmental audit review. The audits entail, primarily, a review of costs and expenses charged to government contracts with the focus on potential adjustments to the allocation of general and administrative expenses. General and administrative expense allocations to CPFF contracts were $796,000 for 1996 and $1.8 million for 1995. The Company does not expect pending governmental audits to result in adjustments that will have a material impact on future operating results. RAW MATERIALS AND SUPPLIERS The primary raw materials used by the Company in its coating operations are various forms of glass, germanium, fused silica and several types of plastic and inorganic coating materials, such as magnesium fluoride, silicon dioxide, aluminum or germanium. The Company has more than one supplier for each of its raw materials and maintains adequate inventories and close working relationships with its suppliers to assure a continuous and adequate supply for production. The Company purchases special grade flat glass under long-term allocation arrangements from one major U.S. glass supplier and cannot routinely increase its supply of such special grade flat glass. The Company has not experienced any significant interruptions in production due to a shortage of raw material. Substrate materials are purchased by the Company or supplied by customers, while coating materials and their composition are generally supplied by the Company, as they are often considered a proprietary element of the manufacturing process. In the Company's Netra operation, the primary raw material used is high quality granular polycarbonite plastic base stock which the Company procures from one principal supplier. Although the Company has experienced price increases for this raw material, and there is currently product supply allocation, it has been able to maintain its supply because of the long-term customer relationship with the supplier. Flex Products uses significant quantities of plastic film and inorganic coating materials in the manufacture of its products. There is more than one supplier for both materials, and Flex Products has not experienced production interruptions due to a shortage of raw materials. SEASONALITY The Company's business is not seasonal in any material sense. However, the Company customarily shuts down a major portion of its operations between Christmas and New Year's Day. As a result, during the last five fiscal years, normally scheduled work days for the first fiscal quarter have averaged 56 compared to an average of 64 for the other three fiscal quarters. Nonetheless, the Company generally has sufficient manufacturing capacity and the ability to schedule additional production shifts to meet its customers' shipment requirements in any period of the year. The Company believes that its revenues and costs are consistently matched in each fiscal quarter since labor costs during the holiday shutdown period are generally charged to holiday and vacation labor expense categories which are accounted for on a pro rata basis over the fiscal year. The Company's European subsidiaries customarily shut down their operations for a two week summer vacation. The summer shutdown has historically reduced the Company's fiscal fourth quarter sales in Europe as compared to sales in the other three fiscal quarters. In 1996 and prior years, the decline in sales during the summer in Europe has not been significant to the consolidated operations of the Company. However, such seasonality could become significant in future periods depending upon the overall significance of European sales to total Company sales. BACKLOG The Company's backlog of orders at the end of each of the last three fiscal years ended October 31, 1996, 1995 and 1994 was as follows: 1996 1995 1994 (In Millions) $51.6 $47.9 $35.0 At October 31, 1996, backlog includes $4.9 million from Flex Products, which represents orders and specifically scheduled releases on long-term contracts for delivery within 12 months. Substantially all orders in backlog at October 31, 1996 are scheduled for shipment during 1997. The amount of backlog at October 31, 1996 represents only a portion of anticipated sales in 1997, with new orders historically comprising the major portion of sales in a fiscal year. Backlog consists of new orders on which shipments have not yet started or unfilled portions of orders which are only partly completed. Some of these orders are completed within several days of receipt, while others are not completed for a number of months. Substantially all orders included in backlog are subject to cancellation without penalty; however, the Company generally has not experienced significant order cancellations. Contractually specified delivery dates on orders sometimes are adjusted at the request of either the customer or the Company. Flex Products has multi-year supply contracts with two of its customers which include annual buy requirements with take or pay provisions. It is the practice of Flex Products to only include specifically scheduled shipment releases under these contracts in reported backlog. COMPETITION The Company believes its ability to compete successfully in its markets depends on a number of factors, both within and outside of its control, including the price, quality and performance of the Company's products, the emergence of new optical standards, the ability to maintain adequate coating capacity and sources of raw materials, the efficiency of its manufacturing and production, the rate at which customers design the Company's products into their products, the number and nature of the Company's competitors in a given market, the assertion of intellectual property rights and general market and economic conditions. The Company attempts to position itself as the exclusive or principal supplier to most of its key customers. To the extent competitors offer similar products to the Company's customers, pricing pressure may result. When the Company is unable to differentiate its product offerings, competition and related pressure on profit margins can be intense. The Company's competitors include several private companies whose sales of coated products are believed to be considerably less than the Company's, as well as coating operations that comprise only a portion of the total business of other companies. The Company's glass fabrication operation in Germany also has local and foreign competitors. The Company believes none of these competitors has the wide array of technologies or manufacturing capabilities available at OCLI. The Company has a larger number of domestic and foreign competitors for its Glare/Guard anti-glare optical filters. Companies that purchase coated glass and assemble and sell filters in competition with the Company include Fellows, Polaroid, ACCO and 3M. The Company is the world's largest manufacturer of anti-reflective optical filters, as measured by total number of units produced, manufacturing filters for both Glare/Guard products and private label distributors. Glare/Guard is one of the most recognized brand names in its market, both domestically and internationally. Flex Products' position in its major market is technologically proprietary and patent protected. In this market, and in the remainder of its business, Flex Products competes through product innovation, customer service and willingness to invest in additional manufacturing capacity. The Company responds to competition primarily on the basis of the advanced technical characteristics and quality of its products; its ability to meet and exceed individual customer design and performance specifications; its dependability and capability as a manufacturer and supplier; the quality of technical assistance and service furnished to its customers; and the competitive pricing of its products. EMPLOYEES At October 31, 1996, the Company, including Flex Products, had 1,362 employees of whom 1,083 were employed domestically, 97 were employed by the Company's operations in Hillend, Scotland; 156 were employed by the Company's OCLI/MMG Division in Goslar, Germany; and 26 were employed in the Company's sales and administrative offices in Europe. The Company has not experienced a work stoppage due to labor difficulties. The Company believes its employee relations are satisfactory. None of the Company's employees in its domestic operations, in its operations in Scotland or in its European sales and administrative offices are subject to collective bargaining agreements. Approximately 70% of the Company's employees in Goslar, Germany, are members of the national chemical, paper and ceramic union organization in Germany. The unionized employees work under a collective bargaining agreement. In 1987, the Board of Directors approved increases in severance benefits for its domestic employees, not including Flex Products, in the event of certain changes in control of the Company. These severance arrangements have been extended through November 1997. OCLI attributes much of its success to its strong relationship with its employees. The Company has instituted several employee oriented programs, including Total Quality Management and high performance work system practices, to enhance the quality and efficiency of its operations while improving employee relations. JOINT VENTURES, INVESTMENTS AND ACQUISITIONS Information regarding joint ventures, investments and acquisitions is included in Note 4 to the Consolidated Financial Statements filed as part of this Annual Report on Form 10-K. ITEM 2. PROPERTIES The Company's corporate headquarters and principal manufacturing and research and development facilities are located on a Company-owned campus in Santa Rosa, California. The site consists of approximately 75 acres of land of which approximately 53 acres are occupied by existing operations, with the remaining 22 acres currently held available for development or sale. The site is within an industrial park area and is served by well- developed road access and utilities. In addition, the Company leases offices for its sales personnel located in various cities in the U.S., Europe and the Far East. The following table sets forth certain information concerning the Company's principal facilities. NO. OF LEASED/ TOTAL SITE LOCATION BUILDINGS OWNED SQ. FT. (ACRES) USE Santa Rosa, CA 12 Owned(1) 426,000 75 Optical Coating Laboratory, Inc. and Flex Products, Inc. corporate offices, manufacturing, engineering, research and development Santa Rosa, CA 1 Leased 23,000 -- Netra operations administrative offices and manufacturing Santa Rosa, CA 1 Leased 30,000 -- Glare/Guard warehousing Hillend, Scotland 1 Owned(2) 56,000 16 OCLI Optical Coating Laboratory, Ltd. administrative offices, manufacturing and research and development Hillend, Scotland 1 Leased 9,000 -- OCLI Optical Coating Laboratory, Ltd. warehousing Goslar, Germany 2 Owned(3) 74,000 22 OCLI/MMG Division administrative offices and manufacturing Reinheim, Germany 2 Leased(4) 7,400 -- OCLI Optical Coating Laboratory GmbH administrative and sales offices; European Glare/Guard distribution center (1) During fiscal 1996, the Company entered into two mortgage loan agreements in the amount of $2.6 million and $3.0 million, respectively. The loans are collateralized by the land and buildings of two newly constructed manufacturing and office buildings located on the Company's Santa Rosa, California campus. The term of each non-recourse loan is 15 years, with fixed interest rates of 8% and 7.5%, respectively. Payments of principal and interest for the loans are $25,000 and $28,000 per month, respectively. The Company leases one of the new buildings to Flex Products for its corporate offices and additional manufacturing facilities. (2) The facility occupied by OCLI Optical Coating Laboratory, Ltd. (OCLI Ltd.) in Scotland was constructed for the subsidiary by the Scottish Development Agency (SDA). The facility consists of a manufacturing and office building on a 16 acre site in an industrial park area. The property is owned by the Company subject to a mortgage held by SDA that has a remaining balance of $4.0 million as of October 31, 1996, with 10 years left on the term of the mortgage. At the beginning of 1995, OCLI Ltd. negotiated a three year mortgage interest moratorium, with principal continuing to be payable to Locate in Scotland (formerly SDA), as economic inducement to encourage business and employment growth in this region of Scotland. (3) The Company's OCLI/MMG Division in Goslar, Germany, occupies two manufacturing buildings totaling approximately 68,000 square feet and an adjacent 6,000 square foot office building located on approximately 22 acres in an industrial park area. The land is held under a long-term hereditary rights agreement. The manufacturing facility is pledged as security on loans totaling approximately $2.5 million with repayment terms running through 2013. The office building is collateralized on an approximately $617,000 mortgage loan with repayment over ten years by 2005. (4) The Company leases approximately 3,100 square feet of office space for its European headquarters and sales activities and approximately 4,300 square feet of warehousing space for its European Glare/Guard distribution operation in Reinheim, Germany. In December 1996, subsequent to fiscal year end, the Company began moving its European distribution center activities to an outside warehousing company in the Netherlands. It is expected that the transfer will be completed by the end of the second quarter of 1997. Management believes that the Company's facilities are adequate for its current level of business and the near-term growth requirements of the Company and its subsidiaries. ENVIRONMENTAL In 1988, the Company discovered ground water contamination at its principal facilities in Santa Rosa. The Company conducted extensive investigations to determine the lateral and vertical extent and the environmental impact of the contamination. During 1990, the Company substantially completed its investigation and study and formulated a plan of remediation. The total cost of the investigation was approximately $5 million which has been charged to operations in prior periods. Based upon extensive tests conducted to date, it has not been demonstrated that contaminant levels pose a current public health hazard. The Company has established a program for reducing contaminant concentration levels to acceptable federal and state levels with the assistance of its environmental consultants and under the regulatory guidance of the California Regional Water Quality Control Board. In 1996, the California Regional Water Quality Control Board approved the Company's final remediation plan, thus establishing the extent of the Company's responsibility for ground water remediation. In prior years, the Company recorded accruals to cover the future estimated cost of drilling additional extraction and monitoring wells and considers those accruals to be adequate. The Company is continuing to evaluate the effectiveness of its monitoring, extraction and remediation systems. Based upon the extensive tests conducted and advice of environmental consultants, the Company believes the accruals it has previously established to complete the remediation plan are sufficient and that the annual cost of maintaining compliance with environmental standards related to the above matter will not have a material adverse effect on the Company's business, financial position or prospects. ITEM 3. LEGAL PROCEEDINGS During the past several years, the Company has been engaged in litigation in the United Kingdom (U.K.) involving infringement of a Company patent by a U.K. company. The Company won its action at the Patents County Courts level but lost on appeal to the U.K. House of Lords. During the injunction period, the U.K. company submitted a claim for damages totaling approximately $1.6 million for lost profits. The Company and legal counsel are in the process of reviewing the claim. Management believes that the amount of the claim is substantially overstated and that the ultimate settlement will not have a material adverse effect on the financial statements. During fiscal 1996, SICPA Holding S.A. (SICPA), the 40% joint owner of Flex Products, filed suit in Delaware Chancery Court seeking injunctive and other relief against the Registrant, Flex Products and certain of Flex Products' directors. In the suit, SICPA alleges that Flex Products cannot proceed with an initial public offering of its common stock without the consent of SICPA and that SICPA has the right to purchase the Registrant's 60% ownership of Flex Products pursuant to a call option beginning after May 8, 1998. In January 1997, the Delaware Chancery Court rendered a decision that upheld the position of OCLI and Flex Products that a simple majority of the Flex Products' Board of Directors has the legal authority to authorize a public offering of Flex Products' securities without the approval of SICPA. The Court's decision did not address the specific requirements of any future public offering by Flex Products which may still need to be addressed by the Court. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of the Company's security holders during the three months ended October 31, 1996. EXECUTIVE OFFICERS OF THE COMPANY The names, ages and positions of the executive officers of the Company as of January 15, 1997 are listed below, followed by a brief description of their business experience during at least the past five years. Officers are appointed annually by the Board of Directors at the next regularly scheduled meeting of the Board following the Annual Meeting of Stockholders. There are no family relationships among these officers nor any arrangements or understandings between any officer and any other person pursuant to which an officer was selected. NAME AGE POSITION BUSINESS EXPERIENCE Herbert M. Dwight , Jr. 66 Chairman of the Board, Chairman of the Board, President and Chief President and Chief Executive Officer Executive Officer since August 1991; Chairman, President and Chief Executive Officer, Superconductor Technologies, Inc. from 1988 to 1991; Chief Executive Officer, Spectra Physics from 1967 to 1988 Charles J. Abbe 55 Vice President and Vice President and General Manager, General Manager, Santa Rosa Division Santa Rosa Division since April 1996; various senior management positions with Raychem Corporation from 1989 to 1996 William C. Burgess 50 Vice President, Vice President, Human Human Resources Resources since June 1994; Vice President, Human Resources and Administration, Teknekron Communica- tion Systems, Inc. from 1991 to 1994 Klaus F. Derge 59 Vice President, Vice President, International International Operations Operations since July 1992; various senior management positions with Spectra-Physics, Sweden from 1969 to 1992. John McCullough 63 Vice President Vice President since and Director January 1992; Director since 1985; Executive Vice President from 1988 to 1992; Senior Vice President from 1978 to 1988; Vice President, Commercial Products and Raytek Divisions from 1976 to 1977; Vice President, Finance and Administration from 1958 to 1967 Laurence D. Parson 48 Vice President, Vice President, Sales Sales since October 1996; Vice President and General Manager, Glare/Guard Division from 1993 to 1996; General Manager, Glare/Guard Division from 1992 to 1993; various manufacturing, marketing and sales positions from 1973 to 1992 Kenneth D. Pietrelli 48 Vice President, Vice President, Corporate Services Corporate Services since June 1993; Corporate Materials Manager from 1980 to 1993 James W. Seeser, Ph.D. 53 Vice President and Vice President since Chief Technical March 1986 and Chief Officer Technical Officer since November 1993; General Manager, Advanced Products Division from 1987 to 1989; various engineering and engineering management positions from 1983 to 1986 Joseph C. Zils 42 Vice President, Acting Chief Financial General Counsel, Officer since January Corporate Secretary 1997; Vice President and Acting Chief since June 1993; Financial Officer Corporate Secretary since December 1993; General Counsel since February 1989 Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 is set forth in the definitive Proxy Statement relating to the Company's 1996 Annual Meeting of Stockholders, which information is incorporated herein by reference. PART II ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded on the NASDAQ National Market System under the symbol OCLI. The table below sets forth the high and low prices of the Company's common stock during the two most recent fiscal years ended October 31, 1996 and 1995. 1Q 2Q 3Q 4Q FY 1996 High 15-3/8 14-3/8 19-1/4 15 19-1/4 Low 9-1/4 10-1/8 12-1/2 10-1/4 9-1/4 1995 High 7-7/8 10-1/8 11-3/8 13-7/8 13-7/8 Low 5-3/4 7-1/2 8-3/8 10-1/4 5-3/4 DIVIDEND INFORMATION Since June 1991, the Company has paid a semiannual cash dividend of $.06 per share on its common stock. APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK There were 806 holders of record of the Company's common stock as of December 31, 1996. ITEM 6. SELECTED FINANCIAL DATA Years ended October 31, 1996, 1995, 1994, 1993 and 1992 (Amounts in thousands, except per share amounts) 1996 1995 1994 1993 1992 Revenues $189,195 $169,417 $131,780 $123,013 $115,016 Net income (loss) before cumulative effect of changes in accounting principles and dividend on preferred stock $5,196 $7,391 $4,604 $(5,737) $6,027 Net income (loss) applicable to common stock $4,236 $6,929 $4,604 $(5,737) $6,537 Net income (loss) per common and common equivalent share $.41 $.73 $.51 $(.65) $.69 Average common and common equivalent shares outstanding 10,301 9,510 9,023 8,795 8,636 Cash dividend paid on common stock $1,153 $1,083 $1,075 $1,043 $967 Working capital $38,087 $28,015 $28,692 $16,251 $27,399 Total assets $172,771 $169,834 $118,879 $99,226 $91,313 Long-term debt $45,788 $47,267 $35,441 $23,110 $14,900 Convertible redeemable preferred stock $11,309 $11,357 Stockholders' equity $68,250 $62,537 $52,037 $47,135 $52,254 Stockholders' equity per share $6.99 $6.59 $5.79 $5.25 $6.16 Number of employees 1,362 1,407 1,162 1,107 1,000 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION THE INFORMATION CONTAINED IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION INCLUDES FORWARD LOOKING STATEMENTS WHICH ARE TYPICALLY IDENTIFIED BY THE WORDS "ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FORECASTS," "PLANS," "FUTURE," "STRATEGY," OR WORDS OF SIMILAR IMPORT. VARIOUS IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE FORWARD LOOKING STATEMENTS ARE IDENTIFIED BELOW. ACTUAL RESULTS MAY VARY SIGNIFICANTLY BASED ON A NUMBER OF FACTORS INCLUDING, BUT NOT LIMITED TO, PRODUCT DEVELOPMENT, COMMERCIALIZATION AND TECHNOLOGICAL DIFFICULTIES; MANUFACTURING COSTS AND YIELD ISSUES ASSOCIATED WITH INITIATING PRODUCTION AT NEW FACILITIES; THE IMPACT OF COMPETITIVE PRODUCTS AND PRICING; CHANGING CUSTOMER REQUIREMENTS; AND THE CHANGE IN ECONOMIC CONDITIONS OF THE VARIOUS MARKETS THE COMPANY SERVES. RESULTS OF OPERATIONS FISCAL 1996 COMPARED TO FISCAL 1995 REVENUES. Revenues for the Company were $189.2 million for its fiscal year ended October 31, 1996 compared to revenues of $169.4 million for fiscal year 1995. Excluding the revenues of Flex Products, Inc. (Flex Products), fiscal 1996 revenues would have been $158.6 million an increase of $4.8 million, or 3%, over 1995 adjusted revenues of $153.8 million. The 1996 revenue increase was due to higher sales in the Company's display products business for products used in projection display applications, higher sales in the Company's defense and aerospace business for products used in telecommunications applications and licensing revenue from the sale of a coating machine. These increases were partially offset by decreased sales in the Company's office automation and OEM display and computer aftermarket display businesses. Flex Products reported 1996 revenues of $30.6 million compared to six month revenues of $15.6 million in 1995. The Company increased its ownership in Flex Products from 40% to a controlling 60% in May of 1995, resulting in the consolidation of Flex Products' financial results into the Company's financial statements for the last six months of fiscal 1995. GROSS PROFIT. Gross profit as a percent of revenue was 33.0% in 1996 compared to 37.4% in 1995. Excluding the effect of Flex Products, the 1996 gross profit percentage would have been 31.4% compared to a gross profit percentage of 36.6% in 1995. The gross profit percentage decrease in 1996 was primarily due to lower shipments of higher margin products used in computer display applications and start-up costs and additional fixed costs associated with adding new manufacturing facilities and coating capacity. These expenses were partially offset by the gross profit associated with the sale of a coating machine. In addition, the Company experienced price decreases and lower unit volumes both domestically and in Europe in its office automation and computer aftermarket display businesses. These decreases were partially offset by initiatives to shift resources to other markets and initiatives to increase manufacturing efficiencies in order to decrease unit cost. Flex Products' gross profit percentage for 1996 was 41.1% compared to a gross profit percentage of 45.8% for its six months of consolidation in 1995. Flex Products' gross profit percentage decrease was due to start-up costs of bringing a new coating machine and manufacturing process on line. Flex Products' gross profit margins are higher than the rest of the Company due to the high proprietary content of its products. RESEARCH AND DEVELOPMENT. Research and development expenditures for 1996 increased $3.3 million over research and development expenditures for 1995. Excluding the results of Flex Products, 1996 research and development expenditures would have increased 3% over expenditures for 1995 and would have been consistent with the research and development expenditures for 1995 of 4.8% of revenues. Flex Products incurred research and development expenses of $4.2 million compared to research and development expenses of $1.1 million for its six months of consolidation in 1995. The 1996 increase is attributable to the development and integration of state-of-the- art coating processes for use in two new coating machines installed during fiscal 1996. SELLING AND ADMINISTRATIVE. Selling and administrative expenses decreased $317,000 in 1996 over 1995. Excluding the results of Flex Products, 1996 selling and administrative expenses would have decreased $2.9 million, or 8%, compared to 1995. The 1996 decrease is primarily due to higher expenses recorded in 1995 associated with the Company's European sales operations that were not incurred in 1996. Flex Products' selling and administrative expenses for 1996 were $4.8 million, which was consistent with its run rate for 1995. The Company recorded amortization of intangibles of $1.1 million in 1996 and $975,000 in 1995, primarily resulting from amortization of goodwill relating to the acquisitions of MMG and Netra. INCOME FROM OPERATIONS. The Company had income from operations of $12.4 million in 1996 compared to $16.6 million in 1995, resulting from the changes in pricing and unit volume discussed above. Excluding the effect of Flex Products, income from operations would have been $9.1 million in 1996 compared to income from operations of $12.9 million in 1995. The Flex Products operation contributed income from operations of $3.3 million in 1996 compared to $3.7 million for the six month period of consolidation in 1995. INTEREST INCOME AND EXPENSE. Interest income decreased $288,000 in 1996 compared to 1995. The 1996 decrease was due to lower average short-term investments, primarily resulting from a time lag between the cash outlay for investments versus the completion of financing arrangements. Interest expense decreased $23,000 in 1996. Excluding the effect of Flex Products, interest expense would have increased $231,000 in 1996 over 1995. The 1996 adjusted increase results from mortgage financing on two new buildings completed in 1996. Flex Products' positive impact on interest expense is due to capitalized interest recorded on significant capital projects in 1996. PROVISION FOR INCOME TAXES. The Company's effective income tax rate was 37.0% in 1996 and 40.1% 1995. The 1996 effective income tax rate decrease resulted from the recognition of state business tax credits arising from the purchase of new manufacturing equipment, partially offset by losses incurred by the Company's subsidiary in Germany for which tax benefits were not provided. MINORITY INTEREST. In 1996, the Company recorded $636,000 as minority interest representing the share of net income of Flex Products accruing to its 40% stockholder. NET INCOME. The Company had net income of $5.2 million in 1996 compared to $7.4 million in 1995. Excluding the results of Flex Products, 1996 net income would have been $2.9 million compared to 1995 net income of $5.9 million. Dividends of $960,000 in 1996 and $462,000 in 1995 were paid on the 8% Convertible Redeemable Preferred Stock issued in connection with the Flex Products investment transaction. As a result, consolidated net income attributable to common stock was $4.2 million for 1996 compared to $6.9 million for 1995. FACTORS AFFECTING FUTURE PERIODS. 1996 fourth quarter and full year results were adversely affected by delays in product shipments and additional expenses resulting from new manufacturing equipment coming on line more slowly than scheduled. In addition, 1996 fourth quarter results were significantly impacted by the results of the Company's German subsidiary which has experienced weak demand for its office automation products. The Company continues to make slow but steady progress in addressing the manufacturing yields and throughput levels of the new machines, and steps have been taken to lower the costs of the German operation. In order to enhance profitability, the Company is aggressively implementing initiatives to improve safety and manufacturing yields and decrease cycle times on existing processes and new product development. FISCAL 1995 COMPARED TO FISCAL 1994 REVENUES. Revenues for the Company were $169.4 million for its fiscal year ended October 31, 1995 compared to revenues of $131.8 million in fiscal 1994. Excluding the results of Flex Products, 1995 revenue would have been $153.8 million, an increase of $22.0 million, or 17%, over 1994. Revenues in 1995 for fabricated glass components and precision molded plastic optics used in office automation applications, filters used in medical and analytical instrumentation and front surface mirrors used in office automation and projection television applications were strong in 1995. Fiscal 1995 revenues also included higher invoicing on the Company's contract for the coating of the X-ray space telescope project for NASA. Revenues for the Company's Glare/Guard computer display aftermarket business declined due to increased competition in the private label segment and reduced product demand in several European countries. GROSS PROFIT. Gross profit as a percent of revenue was 37.4% in 1995 compared to a gross profit percentage of 36.3% in 1994. Excluding the results of Flex Products, 1995 gross profit as a percent of revenue would have been 36.6% which is approximately even with the gross profit percentage in 1994. During 1995, the Company experienced price decreases for its office automation products in the United States and for its GlareGuard products in the United States and Europe. 1995 gross profit margins were maintained through higher sales volume, production efficiency gains and manufacturing yield improvements; and for the GlareGuard product line, through product redesign for cost reduction. RESEARCH AND DEVELOPMENT. Research and development expenditures for 1995 increased $3.2 million compared to 1994. Excluding the results of Flex Products, the 1995 increase would have been $2.1 million or 40%. The increase in 1995 was due to increased research and development expenditures relating to the development of additional continuous platform coating capacity, development of coatings on plastic for flat panel display applications and further development of the Company's electrochromic technology and related products. SELLING AND ADMINISTRATIVE. Selling and administrative expenses increased $6.1 million in 1995 over 1994. Excluding the results of Flex Products, the 1995 increase over 1994 would have been $3.9 million or 12%. The increase in 1995 over 1994 was due to initial selling expenses associated with increasing regional sales activities in the United States and Europe and higher administrative and legal expenses. The Company recorded amortization of intangibles of $975,000 in 1995 and $648,000 in 1994 representing the amortization of goodwill relating to the acquisitions of MMG and Netra. INCOME FROM OPERATIONS. As a result of the foregoing changes in revenues and costs and expenses, the Company had income from operations of $16.6 million in 1995 compared to $10.6 million in 1994. Excluding the results of Flex Products, 1995 income from operations would have been $12.9 million compared to $10.6 million in 1994, an increase of $2.3 million or 22%. INTEREST INCOME AND EXPENSE. Interest income increased $329,000, or 97%, in 1995 over 1994. The increase in 1995 was due to higher cash and temporary investment balances which resulted from the Company's financing activities during the year. Interest expense increased $332,000, or 10%, in 1995 over 1994. The increase in interest expense for 1995 resulted from higher debt incurred to finance the investments in additional coating capacity and in Flex Products. Fiscal 1995 interest expense was, in part, offset by higher capitalized interest relating to self-constructed assets. PROVISION FOR INCOME TAXES. In 1995 and 1994, the Company's effective income tax rate was 40.1% which approximates the statutory combined federal, state and applicable foreign tax rates for the Company. MINORITY INTEREST. In 1995, the Company recorded $816,000 as minority interest representing the share of net income of Flex Products accruing its 40% stockholder for the six month period that the Company consolidated the results of Flex Products. NET INCOME. The Company had net income of $7.4 million in 1995 compared to $4.6 million in 1994. Excluding the results of Flex Products, 1995 net income would have been $5.9 million, an increase of $1.3 million or 29% over 1994. In 1995, dividends of $462,000 were paid on the 8% Convertible Redeemable Preferred Stock issued in connection with the Flex Products investment transaction. As a result, net income attributable to common stock was $6.9 million for 1995. INFLATION EFFECT. Inflation did not have a significant effect on the operations of the Company during 1996, 1995 or 1994. FOREIGN CURRENCY. The Company has significant investments in Germany and Scotland. Changes in the value of those countries' currencies relative to the U.S. dollar are recorded as direct charges or credits to equity. The Company also has manufacturing operations in Germany and Scotland and sales presence in several other European countries. A significant weakening of the currencies of those countries in relation to the U.S. dollar could reduce the reported results of those operations. A significant amount of the Company's sales are export sales which could be subject to competitive price pressures if the U.S. dollar was to strengthen compared to the currency of foreign competitors. The Company is exposed to foreign currency risk on open intercompany balances between the U.S. and certain of its foreign subsidiaries and on open intercompany balances that some of the foreign subsidiaries have with each other. In addition, the Company's foreign subsidiaries make sales and purchase commitments in currencies other than their own which exposes them to currency risk on open receivable and payable balances. The Company does not consider any of these risks to be material. ENVIRONMENTAL MATTERS. In 1988, the Company discovered ground water contamination at its facilities in Santa Rosa, California. With the assistance of its environmental consultants and under the regulatory guidance of the California Regional Water Quality Control Board, the Company established a program for reducing contaminant concentration levels to acceptable federal and state levels. In 1996, the California Regional Water Quality Control Board approved the Company's final remediation plan, thus establishing the extent of the Company's responsibility for ground water remediation. In prior years, the Company recorded accruals to cover the future estimated cost of drilling additional extraction and monitoring wells and considers those accruals to be adequate. Ongoing ground water remediation expenses for the years 1994 through 1996 have not been material to the operations of the Company, and the Company does not expect them to be material in the future. LITIGATION. The Company has been engaged, over the past several years, in litigation in the United Kingdom (U.K.) involving infringement of a Company patent by a U.K. company. The Company won its action at the Patents County Courts level but lost on appeal to the U.K. House of Lords. During the injunction period, the U.K. Company submitted a claim for damages totaling approximately $1.6 million for lost profits. The Company and legal counsel are in the process of reviewing the claim. Management believes that the amount of the claim is substantially overstated and that the ultimate settlement will not have a material adverse effect on its future operating results. COMMITMENTS. During the first quarter of 1997, the Company initiated an innovative program to modernize its business processes in order to reduce cycle time and improve profitability. The program is being deployed worldwide with the goal of streamlining, automating and applying best practices to all of the Company's business processes. In conjunction with this initiative, the Company identified the need for a state-of-the-art Enterprise Resource Planning System, selected a product and made a commitment to a vendor for hardware and software requirements. Expected total cost of the system, including hardware, software, training and consulting, is approximately $4.3 million, of which the Company has committed $1.9 million for hardware and software which is expected to be financed under a five year operating lease with monthly payments of approximately $50,000 commencing in the fourth quarter of 1997. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. Except for historical information contained in this report, matters discussed in this report are forward-looking statements that involve risks and uncertainties. Actual results may vary significantly based on a number of factors including, but not limited to, product development, commercialization and technological difficulties; manufacturing costs and yield issues associated with initiating production at new facilities; the impact of competitive products and pricing; changing customer requirements; and the change in economic conditions of the various markets the Company serves. ACQUISITION AND INVESTMENT TRANSACTIONS FLEX PRODUCTS, INC. In May 1995, the Company acquired controlling ownership of Flex Products with the purchase of an additional 20% interest in Flex Products from ICI Americas Inc. (ICIA), an affiliate of Imperial Chemical Industries PLC. Flex Products was founded as a division of the Company in the early 1980's and subsequently established as a joint venture between the Company and ICIA in 1988, with ICIA owning 60% and the Company owning 40%. In conjunction with the Company's increase in ownership, ICIA's remaining 40% interest in Flex Products was acquired by SICPA Holding S.A. (SICPA), a privately held Swiss Corporation headquartered in Lausanne, Switzerland. SICPA is the world's largest manufacturer of printing inks and a major customer of Flex Products. Pursuant to the terms of the Stock and Note Purchase Agreement dated May 1, 1995 by and among the Company, SICPA, ICIA and Flex Products, the Company acquired an incremental 20% interest in Flex Products for a cash payment of $8.4 million and paid an affiliate of ICIA approximately $7.0 million in cash to acquire a 60% interest in an $11.7 million promissory note previously issued by Flex Products to ICIA to fund Flex Products' working capital requirements. SICPA acquired a 40% equity interest in Flex Products and the balance of the $11.7 million promissory note. In connection with this transaction, the Company entered into a Put and Call, Right of First Refusal and Co-Sale Agreement with SICPA pursuant to which SICPA was granted a call option to purchase the Company's 60% interest in Flex Products and the Company was granted a put option to sell the Company's 60% interest in Flex Products to SICPA. The call price is $25 million plus (i) two times the amount by which Flex Products' annual sales immediately preceding the call exceed $23.6 million (ii) times 60% (the Company's ownership percentage of Flex Products). The put price is $20 million plus (i) 1.5 times the same increase in Flex Products' sales (ii) times 60%. The put and call options can be exercised at any time after May 8, 1998 and before May 8, 2003, and cannot be exercised in the event Flex Products goes public. This agreement also provides for a right of first refusal in favor of each party to buy the other's shares and also provides a co-sale right which requires that on any sale of a party's shares, the other party is allowed to participate on a pro rata basis in the sale. The agreement with SICPA also provides conditions under which the above mentioned put and call and right of first refusal would be terminated upon an underwritten public offering of the securities of Flex Products. In July of 1996, SICPA filed a lawsuit in Delaware Chancery Court in order to block an attempted initial public offering by Flex Products arguing that such an offering was prohibited by Flex Products' articles of incorporation, as well as by certain contractual provisions between OCLI and SICPA, without SICPA's consent. In January 1997, the Delaware Chancery Court rendered a decision on one of the issues in dispute, upholding the position of OCLI and Flex Products that a simple majority of the Flex Products Board of Directors has the authority to authorize a public offering of Flex Products' securities. The lawsuit did not have, nor is it expected to have, an impact on Flex Products' operations or on the sale of product to SICPA given the proprietary nature of the product and the 15 year exclusive supply contract between Flex Products and SICPA which requires SICPA to make annual minimum purchases from Flex Products or to pay liquidated damages in the event that such minimum purchases are not satisfied. NETRA CORPORATION. In February 1995, the Company acquired the assets and liabilities of Netra Corporation, a precision molded plastic component manufacturer, for a total purchase price of approximately $3.1 million. The purchase price consisted of a cash payment of $1.5 million and the balance of approximately $1.6 million paid by the issuance of 164,735 shares of the Company's common stock to the sellers. Upon completion of the acquisition, Netra was relocated from its facilities in Mountain View, California to a facility immediately adjacent to the Company's principal manufacturing site in Santa Rosa, California. FINANCIAL CONDITION AND LIQUIDITY In 1996, the Company's cash and short-term investment position increased by $9.4 million, resulting primarily from cash generated by operations of $20.2 million, proceeds from sale/lease-back arrangements on new equipment of $18.9 million, new debt issuance net of repayment of $1.6 million and proceeds from exercise of stock options of $1.7 million, offset by investments in plant and equipment of $30.5 million, payment of dividends on preferred stock of $960,000 and payment of dividends on common stock of $1.2 million. At fiscal year end 1996, the Company had cash and short-term investments totaling $16.0 million. In addition, the Company has available domestically a $15 million revolving line of credit and separate credit arrangements in place for the operating requirements of its subsidiaries in Germany and Scotland. During 1996, the Company entered into three sale/lease-back arrangements for a newly acquired continuous coating machine and related equipment and for two newly acquired coating machines to be used in the manufacturing operations of Flex Products. The lease terms are six years with monthly payments totaling approximately $290,000 and buyout provisions at the end of each lease. For the fourth quarter of 1996, Flex Products was granted a waiver for one of its financial covenants. The Company believes Flex Products will need continued relief under this covenant for fiscal 1997 and is in negotiations with the lessor to obtain an amendment to the covenant. In 1996, the Company entered into a $2.6 million mortgage loan agreement on a newly constructed 72,000 square foot manufacturing building. The loan carries a fixed interest rate of 8% and is repayable over 15 years in monthly installments of approximately $25,000. Also in 1996, the Company entered into a $3.0 million mortgage loan agreement for a newly constructed 65,000 square foot manufacturing and office building leased by Flex Products. The loan carries a fixed interest rate of 7.5% and is repayable over 15 years in monthly installments of approximately $28,000. In 1995, cash and short-term investments decreased $13.1 million primarily due to investments in plant and equipment of $30.9 million, the purchase of additional equity interest and note of Flex Products totaling $15.2 million, and the purchase of Netra of $1.5 million offset by cash generated from operations of $13.1 million, proceeds from issuance of preferred stock of $11.4 million and proceeds from long-term debt net of debt repayment of $9.8 million. Cash and short-term investments at the end of fiscal 1995 were $6.6 million. During 1995, the Company increased the amount of and extended the term of its primary bank credit agreement to provide a $30 million unsecured credit facility comprised of a $15 million term loan and a $15 million revolving line of credit. In addition, in connection with the Flex Products investment transaction and to increase the equity component of the Company's capital structure, the Company issued $12 million of 8% Convertible Redeemable Preferred Stock. In 1996, the Company's working capital, excluding cash and short-term investments, increased by $647,000. Increased inventory (due to product mix changes) and decreased accounts payable and accrued expenses (primarily due to decreased spending and construction activity at the end of 1996) was almost completely offset by decreased accounts receivable (due to more aggressive collection efforts) and changes in net current tax assets and liabilities (due to the utilization of loss carryforwards and refunds). In 1995, the Company's working capital, excluding cash and short- term investments, had increased by $12.4 million due primarily to the consolidation of Flex Products and the acquisition of Netra. Management believes that the cash on hand at October 31, 1996, cash anticipated to be generated from future operations, new lease agreements and the available funds from revolving credit arrangements will be sufficient for the Company to meet its near-term working capital needs, capital expenditures, debt service requirements and payment of dividends as declared. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTAL FINANCIAL INFORMATION INDEX PAGE(S) Report of Independent Auditors 22 Consolidated Balance Sheets as of October 31, 1996 and 1995 23 Consolidated Statements of Income for the years ended October 31, 1996,1995 and 1994 24 Consolidated Statements of Cash Flows for the years ended October 31, 1996,1995 and 1994 25-26 Consolidated Statements of Common Stockholders' Equity for the years ended October 31, 1996, 1995 and 1994 27 Notes to Consolidated Financial Statements 28 Supplemental Financial Information (Quarterly Financial Information for 1996 and 1995 - Unaudited) 40-41 INDEPENDENT AUDITORS' REPORT Board of Directors Optical Coating Laboratory, Inc. Santa Rosa, California We have audited the accompanying consolidated balance sheets of Optical Coating Laboratory, Inc. and subsidiaries (the Company) as of October 31, 1996 and 1995, and the related consolidated statements of operations, common stockholders' equity and cash flows for each of the three years in the period ended October 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Flex Products, Inc., who became a consolidated subsidiary effective May 1, 1995 and whose assets represent 11% and 9%, respectively, of consolidated total assets at October 31, 1996 and 1995, and whose total revenues for the year ended October 31, 1996 and for the period from May 1, 1995 to October 31, 1995 represent 15% and 9%, respectively, of consolidated total revenues for the years ended October 31, 1996 and 1995. The financial statements of Flex Products, Inc. were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Flex Products, Inc., is based solely on the report of such other auditors. 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 and the report of the other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of the other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Optical Coating Laboratory, Inc. and its subsidiaries at October 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1996 in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP San Jose, California December 18, 1996 OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of October 31, 1996 and 1995 (Amounts in thousands) ASSETS 1996 1995 CURRENT Cash and short-term investments $16,027 $ 6,602 ASSETS Accounts receivable, net of allowance for doubtful accounts of $1,775 and $1,229 27,700 29,565 Inventories 18,701 15,886 Income taxes receivable 1,248 38 Deferred income tax assets 5,165 6,665 Other current assets 1,230 2,438 Total Current Assets 70,071 61,194 OTHER Deferred income tax assets 4,451 4,597 ASSETS Other assets and investments 10,680 12,432 PROPERTY, Land and improvements 9,200 8,651 PLANT AND Buildings and improvements 40,953 31,461 EQUIPMENT Machinery and equipment 112,326 101,586 Construction-in-progress 6,190 23,717 168,669 165,415 Less accumulated depreciation (81,100) (73,804) Property, plant and equipment-net 87,569 91,611 Total Assets $172,771 $169,834 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT Accounts payable $ 7,199 $ 10,324 LIABILI- Accrued expenses 6,566 9,515 TIES Accrued compensation expenses 7,057 6,559 Income taxes payable 1,823 Current maturities on long-term debt 4,981 3,344 Notes payable 3,112 3,339 Deferred revenue 1,246 98 Total Current Liabilities 31,984 33,179 NON- Accrued postretirement health benefits CURRENT and pension liabilities 2,308 2,150 LIABILI- Deferred income tax liabilities 1,804 2,239 TIES Long-term debt 45,788 47,267 Commitments and contingencies (Note 10) Minority interest 11,328 11,105 Convertible redeemable preferred stock 11,309 11,357 COMMON Common stock, $.01 par value; authorized STOCK- 30,000,000 shares; issued and outstanding HOLDERS' 9,761,000 and 9,489,000 shares 98 95 EQUITY Paid-in capital 47,219 44,461 Retained earnings 20,984 17,901 Cumulative foreign currency translation adjustment (51) 80 Common Stockholders' Equity 68,250 62,537 Total Liabilities and Stockholders' Equity $172,771 $169,834 The accompanying notes are an integral part of these financial statements. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years ended October 31, 1996, 1995 and 1994 (Amounts in thousands, except per share amounts) 1996 1995 1994 REVENUES Revenues $189,195 $169,417 $131,780 Cost of sales 126,769 106,009 84,001 Gross Profit 62,426 63,408 47,779 COSTS AND Operating Expenses: EXPENSES Research and development 11,733 8,401 5,229 Selling and administrative 37,145 37,462 31,341 Amortization of intangibles 1,146 975 648 Total Operating Expenses 50,024 46,838 37,218 Income from Operations 12,402 16,570 10,561 Nonoperating Income (Expense): Interest income 379 667 338 Interest expense (3,524) (3,547) (3,215) EARNINGS Income Before Provision for Income Taxes and Minority Interest 9,257 13,690 7,684 Provision for income taxes 3,425 5,483 3,080 Minority interest 636 816 Net Income 5,196 7,391 4,604 Dividend on convertible redeemable preferred stock 960 462 Net Income Applicable to Common Stock $ 4,236 $ 6,929 $ 4,604 Net Income Per Common and Common Equivalent Share $ .41 $ .73 $ .51 Weighted average number of common shares used to compute earnings per share 10,301 9,510 9,023 The accompanying notes are an integral part of these financial statements. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended October 31, 1996, 1995 and 1994 (Amounts in thousands, except per share amounts) 1996 1995 1994 OPERA- Cash Flows From Operations: TIONS Cash received from customers $191,665 $162,568 $133,125 Interest received 258 733 268 Cash paid to suppliers and employees (165,565) (139,489) (112,341) Cash paid to ESOP+ (406) (947) Interest paid (5,196) (3,730) (2,567) Income taxes paid, net of refunds (954) (6,625) (986) Net Cash Provided By Operations 20,208 13,051 16,552 INVEST- Cash Flows From Investments: MENTS Purchase of plant and equipment (30,530) (30,911) (8,821) Proceeds from sale-leaseback of new equipment 18,940 Purchase of additional equity interest and note of Flex Products, net of cash from consolidation (15,185) Cash portion of payment for purchase of Netra, net of cash acquired (1,477) Net Cash Used For Investments (11,590) (47,573) (8,821) FINANCING Cash Flows From Financing: Net proceeds from issuance of preferred stock 11,357 Proceeds from long-term debt 8,596 21,542 4,005 Proceeds from issuance of senior notes 18,000 Proceeds from notes payable 8 494 283 Proceeds from exercise of stock options 1,713 1,627 16 Repayment of long-term debt (7,019) (11,700) (11,327) Repayment of notes payable (388) (400) Repayment of note to minority stockholder, net of amounts borrowed (413) Payment of dividend on preferred stock (960) (462) Payment of dividend on common stock (1,153) (1,083) (1,075) Net Cash Provided By Financing 772 21,387 9,502 Effect of exchange rate changes on cash 35 74 146 Increase (decrease) in cash and short-term investments 9,425 (13,061) 17,379 Cash and short-term investments at beginning of year 6,602 19,663 2,284 Cash and short-term investments at end of year $16,027 $6,602 $19,663 OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years ended October 31, 1996, 1995 and 1994 (Amounts in thousands) 1996 1995 1994 ADJUST- Reconciliation of Net Income MENTS To Cash Flows From Operations: Net income $5,196 $7,391 $4,604 Adjustments to reconcile net income to net cash provided by operations: Depreciation and amortization 13,669 10,261 7,635 Minority interest in earnings of Flex Products 636 816 Net book value of coating machine sold 880 Loss on disposal or abandonment of equipment 1,356 914 634 Accrued postretirement health benefits 184 238 76 Deferred income tax liabilities (468) 2,515 (1,650) Other non-cash adjustments to net income (681) 46 (98) Change in: Accounts receivable 1,378 (3,792) (973) Inventories (3,030) (2,391) 1,572 Income tax receivable (719) (76) 2,045 Deferred income tax assets 1,645 (2,237) 275 Other current assets and other assets and investments 716 (1,547) (312) Accounts payable, accrued expenses and accrued compensation expenses (3,094) 2,807 1,230 Deferred revenue 464 (538) (28) Income taxes payable 2,076 (1,356) 1,542 Total adjustments 15,012 5,660 11,948 Net Cash Provided By Operations $20,208 $13,051 $16,552 SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: During 1995, the Company acquired Netra Corporation for approximately $1.5 million in cash and the issuance of approximately $1.6 million in Company common stock. Cash and non-cash components of the acquisition were as follows: (Amounts in thousands) Fair value of assets acquired, including intangibles $3,529 Cash acquired (188) Liabilities assumed (279) $3,062 Cash paid to sellers, net of cash acquired $1,477 OCLI common stock issued to sellers 1,585 $3,062 In 1996, 1995 and 1994, common stock, with an aggregate fair market value of $52,000, $30,000 and $20,000 was awarded to the Company's outside directors as remuneration. During 1996, the Company issued 39,880 shares of common stock to its Employee Stock Ownership Plan (ESOP+) at fair market value to satisfy a portion of its Company contribution. The accompanying notes are an integral part of these financial statements. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY Years ended October 31, 1996, 1995 and 1994 Foreign Common Stock Paid-in Retained Currency (Amounts in thousands) Shares Amount Capital Earnings Translation BALANCE AT NOVEMBER 1, 1993 8,972 $90 $39,930 $8,526 $(1,411) ACTIVITY Exercise of stock options and IN FISCAL warrants, including tax benefit 1994 and shares issued to directors 6 37 Foreign currency translation adjustment for the year 1,336 Net income for the year 4,604 Dividend on common stock (1,075) BALANCE AT OCTOBER 31, 1994 8,978 90 39,967 12,055 (75) ACTIVITY Shares issued on purchase of Netra 165 1 1,584 IN FISCAL Shares issued to Employee Stock 1995 Ownership Plan 82 1 794 Exercise of stock options, including tax benefit and shares issued to directors 264 3 2,116 Foreign currency translation adjustment for the year 155 Net income for the year 7,391 Dividend on preferred stock (462) Dividend on common stock (1,083) BALANCE AT OCTOBER 31, 1995 9,489 95 44,461 17,901 80 ACTIVITY Shares issued to Employee Stock IN FISCAL Ownership Plan 39 1 439 1996 Exercise of stock options, including tax benefit and shares issued to directors 233 2 2,319 Foreign currency translation adjustment for the year (131) Net income for the year 5,196 Dividend on preferred stock (960) Dividend on common stock (1,153) BALANCE AT OCTOBER 31, 1996 9,761 $98 $47,219 $20,984 $(51)
The accompanying notes are an integral part of these statements. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended October 31, 1996, 1995 and 1994 (Amounts in thousands, except per share amounts) 1. GENERAL NATURE OF OPERATIONS. Optical Coating Laboratory, Inc. (OCLI) designs, develops and manufactures thin film coated products which control and enhance light by altering the transmission, reflection and absorption of its various wavelengths to achieve a desired effect. OCLI markets and sells its products worldwide to original equipment manufacturers (OEMs) who utilize thin film coated components or devices for optical and electro- optical systems for their products including computers, photocopiers, LCD and digital light processing projector systems, document scanners, point-of- sale scanners, instruments and satellites. OCLI sells its Glare/Guard ergonomic computer display products through distributors and office supply retailers. Flex Products, Inc. (Flex Products), OCLI's 60% owned subsidiary, develops and manufactures thin film coatings on plastic film with a proprietary, high speed process. USE OF ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. CERTAIN SIGNIFICANT ESTIMATES. At October 31, 1996, the Company had significant deferred tax assets related to operating losses available for carryforward. These deferred tax assets have been recorded under the guidelines of SFAS No. 109, Accounting for Income Taxes, on the premise that future taxable income will more likely than not be adequate to realize future tax benefits of the available net operating loss carryforwards. Under tax regulations, realization of tax benefits per period will be limited and full realization will depend on future taxable income over a number of years. As discussed in Note 10, the Company is subject to an asserted claim for lost profits made in the United Kingdom by a U.K. company relating to a court enforced injunction and finding for the Company that has been reversed by a higher court. The Company has ground water contamination at its facility in Santa Rosa, California. The Company has established a program for reducing contaminant concentration levels to acceptable federal and state levels under the regulatory guidance of the California Regional Water Quality Control Board. Based upon the extensive tests conducted and advice of environmental consultants, the Company believes that the recorded liability for completion of the ground water remediation plan is sufficient and that the annual cost of maintaining compliance with environmental standards related to the above matter will not have a material adverse effect on the Company's business, financial position or future operating results. 2. SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company and its wholly and majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The Company's fiscal year ends on the Sunday closest to the last day in October. Fiscal year 1996 was a 53 week year and fiscal years 1995 and 1994 were 52 week years. INVESTMENTS. Cash and short-term investments are comprised of cash, bank repurchase agreements and short-term commercial paper readily convertible to cash. Short-term investments are carried at cost which approximates market value. For purposes of the Statements of Cash Flows, all highly liquid short-term investments with a maturity of three months or less are considered cash equivalents. REVENUE RECOGNITION. Revenue from sales of manufactured products and from sales under fixed-price contracts is recorded at the time deliveries are made or work is performed. Revenue from cost reimbursement contracts is recorded as work is performed. INVENTORIES. Inventories are stated at the lower of cost, on a first-in, first-out basis, or market. Work-in-process inventories related to fixed- price contracts are stated at the accumulated cost of material, labor and manufacturing overhead, less the estimated cost of units delivered. To the extent total costs under fixed-price contracts are estimated to exceed the total sales price, charges are made to current operations to reduce inventoried costs to net realizable value. In addition, if future costs are estimated to exceed future revenues, an allowance for losses equal to the excess is provided by a charge to current operations. PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at cost. Estimated service lives range from 5 to 45 years for buildings and improvements and from 3 to 8 years for all other property, plant and equipment. Buildings and improvements and substantially all equipment are depreciated using accelerated methods. RESEARCH AND DEVELOPMENT. Research and development costs are charged to operations in the year incurred. The cost of equipment used in research and development activities which has alternative uses is capitalized as equipment and not treated as an expense of the period. Such equipment is depreciated over estimated lives of 5 years. FOREIGN OPERATIONS. The financial position and operating results of foreign operations are consolidated using the local currency as the functional currency. Local currency assets and liabilities are translated at the rate of exchange to the U.S. dollar on the balance sheet date, and the local currency revenues and expenses are translated at average rates of exchange to the U.S. dollar during the period. Resulting translation gains or losses are included in stockholders' equity under cumulative foreign currency translation adjustment. Foreign currency transaction gains and losses, which have not been material, are reflected in operating results. INCOME TAXES. Income taxes include provisions for temporary differences between earnings for financial reporting purposes and earnings for income tax purposes under the guidelines of SFAS No. 109, Accounting for Income Taxes, adopted by the Company in fiscal 1992. Tax credits are taken as a reduction of current income tax provisions when available. EARNINGS PER SHARE. Earnings per common and common equivalent share assumes dilutive stock options outstanding were exercised at the beginning of the year or the date of grant, whichever is later. Fully diluted earnings per share is not presented as it is not materially different from primary earnings per share. RECLASSIFICATIONS. Certain reclassifications have been made to prior year data to conform to the current year presentation. 3. LONG-TERM DEBT Long-term debt, including current maturities, at October 31, 1996 and 1995 consisted of the following: (Amounts in thousands) 1996 1995 Unsecured senior notes. Interest at 8.71% payable semiannually. Principal payable in annual installments of $3.6 million from 1998 through 2002. $18,000 $18,000 Unsecured borrowings under revolving bank line of credit repaid in 1996. 2,000 Unsecured bank term loan. Variable interest rates averaging 6.5% at October 31, 1996, payable quarterly. Principal payable semiannually as follows: Payment Dates Amounts April 1997 $1,000,000 Each October and April thereafter $2,000,000 13,000 14,500 Mortgage payable. Interest at 8%. Collateralized by a 72,000 sq. ft. newly constructed building and related land. Principal and interest payments0 of $25,000 per month through 2011. 2,523 Mortgage payable. Interest at 7.5%. Collateralized by a 65,000 sq. ft. newly constructed building and related land leased to Flex Products. Principal and interest payments of $28,000 per month through 2011. 2,945 Land improvement assessment. Interest at an average rate of 6.75%. Principal and interest payable in semiannual installments of $77,000 through 1998. 276 401 Scottish Development Agency (SDA) building loan, with a conditional interest moratorium from February 1, 1995 through January 31, 1998 with interest at 9.5% thereafter. Semiannual principal payments of approximately $100,000 are payable through January 1998 with subsequent payments of $331,000, comprising principal and interest, through 2006. Collateralized by the land and building of the Company's Scottish subsidiary. 3,996 4,026 Notes payable to private parties in connection with the purchase of the Company's wholly-owned subsidiary in Germany (MMG). Principal and interest at 8% payable over ten years in quarterly installments of approximately $420,000 through 2003. 6,188 7,721 Bank loans of MMG with interest rates ranging from 4.5% to 8.0%. Payable in semiannual and annual installments through 2005. Partly collateralized by mortgages on MMG land and buildings and liens on equipment. 3,760 3,050 Present value of obligations under capital leases at an imputed interest rate of 8.0% payable in monthly installments through 2004. 81 913 50,769 50,611 Less current maturities (4,981) (3,344) Total long-term debt, net of current maturities $45,788 $47,267 Annual long-term debt maturities and capital lease payments for the ensuing five years are as follows: YEAR PAYMENT (Amounts in thousands) 1997 $4,981 1998 10,204 1999 9,414 2000 7,322 2001 5,294 Thereafter 13,554 $50,769 The Company has a $30 million unsecured credit facility comprised of a $15 million term loan and a $15 million revolving line of credit. The revolving line of credit carries a commitment fee of .375% per year on the unused portion of the facility and expires on April 28, 2000. The Company has an incremental credit facility to cover a surety letter for approximately $3.1 million issued to secure 50% of the Company's notes payable arising from the purchase of MMG. The Company also has a letter of credit for approximately $775,000 to satisfy the Company's workers' compensation self- insurance requirements. The surety commitment and letter of credit facilities carry a fee of 1.25% per year. The Company's subsidiary in Scotland has a credit arrangement of up to approximately $490,000 at market interest rates and has outstanding letters of credit of approximately $330,000 to guarantee import duty. There were no borrowings under the credit arrangement in fiscal years 1996 or 1995. The Company's subsidiary in Germany has various credit facilities with local banks totaling approximately $3.1 million which are used for working capital requirements. These credit facilities are utilized as part of normal local payment practices. During 1996, the Company entered into three sale/lease-back arrangements for a newly acquired continuous coating machine and related equipment and for two newly acquired coating machines to be used in the manufacturing operations of Flex Products. The lease terms are six years with monthly payments totaling approximately $290,000 and buyout provisions at the end of each lease. For the fourth quarter of 1996, Flex Products was granted a waiver for one of its financial covenants. The Company believes Flex Products will need continued relief under this covenant for fiscal 1997 and is in negotiations with the lessor to obtain an amendment to the covenant. The Company has certain financial covenants and restrictions under its bank credit arrangements and the unsecured senior notes. 4. ACQUISITIONS FLEX PRODUCTS, INC. In May 1995, the Company acquired controlling ownership of Flex Products with the purchase of an additional 20% interest in Flex Products from ICI Americas Inc. (ICIA), an affiliate of Imperial Chemical Industries PLC. Flex Products was founded as a division of the Company in the early 1980's and subsequently established as a joint venture between the Company and ICIA in 1988, with ICIA owning 60% and the Company owning 40%. Upon formation of the 1988 joint venture, the Company received proceeds in excess of the carrying amount of the assets contributed to the joint venture. The proceeds were allocated first to reduce the carrying amount of the Company's investment to zero, with the remaining proceeds reported as gain on sale of equity in affiliated company. Since the Company carried its investment in the joint venture at zero and was not obligated to make further investment in the joint venture, it did not recognize losses attributable to its equity position in the joint venture. Pursuant to the terms of the Stock and Note Purchase Agreement dated May 1, 1995, by and among the Company, SICPA Holding S.A. (SICPA), ICIA, ICIAH and Flex Products, the Company acquired an incremental 20% interest in Flex Products for a cash payment of $8.4 million and paid ICIAH approximately $7.0 million in cash to acquire a 60% interest in an $11.7 million promissory note previously issued by Flex Products to ICIA to fund Flex Products' working capital requirements. In conjunction with the Company's increase in ownership, ICIA's remaining 40% interest in Flex Products was acquired by SICPA, a privately held Swiss corporation headquartered in Lausanne, Switzerland. SICPA is the largest manufacturer of printing inks in the world and the major customer of Flex Products. SICPA also acquired the balance of the note. The incremental investment in Flex Products was recorded as a purchase transaction. The funding for the purchase of the additional equity interest and note of Flex Products, totaling $15.4 million, came from a $4 million draw down from the Company's existing bank line of credit and from the issuance of $12 million in convertible redeemable preferred stock in a private placement. The following pro forma consolidated results of operations for 1995 and 1994 include the operating results of Flex Products, assume that effective tax rates were consistent with statutory rates and incorporate the effect of financing the transaction: (Amounts in thousands) 1995 1994 Revenue $181,389 $154,288 Net income before change in accounting principle 7,847 4,550 Net income applicable to common stock 6,887 3,521 Net income per common and common equivalent share $.72 $.39 In connection with this transaction, the Company entered into a Put and Call, Right of First Refusal and Co-Sale Agreement with SICPA pursuant to which SICPA was granted a call option to purchase the Company's 60% interest in Flex Products and the Company was granted a put option to sell the Company's 60% interest in Flex Products to SICPA. The call price is $25 million plus (i) two times the amount by which Flex Products' annual sales immediately preceding the call exceed $23.6 million (ii) times 60% (the Company's ownership percentage of Flex Products). The put price is $20 million plus (i) 1.5 times the same increase in Flex Products' sales (ii) times 60%. The put and call options can be exercised at any time after May 8, 1998 and before May 8, 2003, and cannot be exercised in the event Flex Products completes a public offering. This agreement also provides for a right of first refusal in favor of each of SICPA and the Company to buy the other's shares and also provides a co-sale right which requires that on any sale of a party's shares, the other party is allowed to participate on a pro rata basis in the sale. The Agreement with SICPA also provides conditions under which either party may cause Flex Products to have an initial public offering of its common stock. In July of 1996, SICPA filed a lawsuit in Delaware Chancery Court in order to block an attempted initial public offering by Flex Products arguing that such an offering was prohibited by Flex Products' articles of incorporation, as well as by certain contractual provisions between OCLI and SICPA without SICPA's consent. In January 1997, the Delaware Chancery Court rendered a decision on one of the issues in dispute, upholding the position of OCLI and Flex Products that a simple majority of the Flex Products Board of Directors has the authority to authorize a public offering of Flex Products' securities prior to May 8, 1998, independent of the rights of either SICPA or OCLI to cause Flex Products to have an initial public offering of its common stock created under the Put and Call, Right of First Refusal and Co-Sale Agreement. The lawsuit did not have, nor is it expected to have, an impact on Flex Products' operations or on the sale of product to SICPA given the proprietary nature of the product and the 15 year exclusive supply contract between Flex Products and SICPA which requires SICPA to make annual minimum purchases from Flex Products or to pay liquidated damages in the event that such minimum purchases are not satisfied. NETRA CORPORATION. In February 1995, the Company acquired the assets and liabilities of Netra Corporation, a precision injection molded plastic optics manufacturer, for a total purchase price of approximately $3.1 million. The purchase price consisted of a cash payment of $1.5 million and the balance of approximately $1.6 million paid by the issuance of 164,735 shares of the Company's common stock. The acquisition was recorded as a purchase. If the acquisition of Netra had occurred at the beginning of fiscal 1995, the results of operations would not have been materially different. GOODWILL. At October 31, 1996, other assets and investments includes $6.9 million of goodwill, of which $5.9 million is attributed to the purchase of MMG and is being amortized over fifteen years and $1.0 million is attributed to the purchase of Netra and is being amortized over five years. 5. STOCKHOLDERS' EQUITY STOCKHOLDER RIGHTS PLAN. In November 1987, the Company adopted a Stockholder Rights Plan which expires in November 1997, under which the Company declared a dividend of preferred stock purchase rights which only become exercisable, if not redeemed, ten days after a person or group has acquired 20% or more of the Company's common stock or the announcement of a tender offer which would result in a person or group acquiring 30% or more of the Company's common stock. Under certain circumstances, the plan allows stockholders, other than the acquiring person or group, to purchase the Company's common stock or the common stock of the acquirer having a market value of twice the exercise price. PREFERRED STOCK. The Company has authorized 100,000 shares of preferred stock at $.01 par value of which 10,000 shares were designated Series A Preferred Stock in connection with the Company's Stockholder Rights Plan. None of the Series A Preferred Stock is issued. Additionally, 15,000 shares were designated Series B Preferred Stock, of which 8,350 shares were issued and subsequently converted to common stock on call for redemption. None of the Series B Preferred Stock is currently issued and outstanding. In May 1995, as part of the financing of the acquisition of a controlling interest in Flex Products, Inc., the Company issued 12,000 shares of 8% Series C Convertible Redeemable Preferred Stock (the "Series C Preferred Stock") in consideration for $1,000 per share. The Series C Preferred Stock is convertible into common stock at any time by the holders at a conversion price of $10.50 per common share (subject to adjustment in certain circumstances). The Series C Preferred Stock is redeemable by the Company commencing two years from the date of issuance (if the Company's common stock is trading at $17 per share or more for any 20 consecutive day period) and, after three years, unconditionally, at 108% of the purchase price per share, declining to 100% over four years. The holders of the Series C Preferred Stock are entitled to receive a cumulative annual dividend of $80 per share, which is payable quarterly and has preference to any other dividends being paid by the Company. The holders of shares of Series C Preferred Stock are not entitled to notice of any stockholders' meetings or to vote on any matter, except as provided by law or as otherwise specified in the Series C Preferred Stock Certificate of Designation, Preferences and Rights. If, however, dividends on the Series C Preferred Stock are in arrears in an amount equal to four quarterly dividends, a default period would begin in which the holders of the Series C Preferred Stock, voting as a class, would have the right to elect the greater of 2 directors or a number of directors not less than 25% of the total number of authorized directors. Such right terminates upon expiration of the default period. The holders of the Series C Preferred Stock are entitled to a liquidation preference equal to $1,000 per share plus accrued and unpaid dividends. The Company may not create any series or class of capital stock ranking prior or equal to the Series C Preferred Stock unless the terms of any such series or class is approved by the holders of not less than sixty-six and two-thirds percent (66-2/3%) of the outstanding shares of Series C Preferred Stock, voting separately as a class. Pursuant to the terms of a Stock Purchase Agreement entered into with the holders of the Series C Preferred Stock, the Company may not pay any dividends or make any other distributions in respect of, or redeem or repurchase any, securities of the Company to the extent such payments exceed 25% of the difference between (a) aggregate "Net Income" (as such term is defined in the Stock Purchase Agreement) of the Company after January 31, 1995 and (b) all losses suffered by the Company during such period. 6. INCENTIVE COMPENSATION PLANS, STOCK OPTION PLANS AND WARRANTS Under the Company's incentive compensation and employee stock option plans, options have been granted to purchase the common stock of the Company at prices equal to 100% of the market price of the Company's common stock at the date of grant. At October 31, 1996, outstanding options were exercisable at prices ranging from $6.125 to $17.375 per share. Options expire five and ten years from the date of grant. Changes in options, shares reserved for issuance and options available for future grants under these plans were as follows: SHARES SUBJECT TO AVAILABLE OUTSTANDING FOR FUTURE RESERVED OPTIONS GRANTS BALANCE AT NOVEMBER 1, 1993 1,505,492 1,090,679 414,813 Granted 819,900 (819,900) Exercised for cash (2,884) (2,884) Canceled (3,300) (564,100) 560,800 BALANCE AT OCTOBER 31, 1994 1,499,308 1,343,595 155,713 Authorized and reserved 600,000 600,000 Granted 474,500 (474,500) Exercised for cash (261,295) (261,295) Canceled (25,000) 25,000 BALANCE AT OCTOBER 31, 1995 1,838,013 1,531,800 306,213 Authorized and reserved 950,000 950,000 Granted 546,450 (546,450) Exercised for cash (229,800) (229,800) Canceled (13,200) 13,200 BALANCE AT OCTOBER 31, 1996 2,558,213 1,835,250 722,963 EXERCISABLE AT OCTOBER 31, 1996 1,015,934 The weighted average exercise price of the exercisable options at October 31, 1996 was $7.60 per share. 7. INCOME TAXES The provision for income taxes consisted of: (Amounts in thousands) 1996 1995 1994 CURRENT: Federal $2,120 $3,617 $2,174 State 309 964 516 Foreign (149) 609 58 2,280 5,190 2,748 DEFERRED: Federal 1,535 626 249 State (369) (586) 281 Foreign (21) 253 (198) 1,145 293 332 $3,425 $5,483 $3,080 The reconciliation of the effective income tax rates to the federal statutory rates was as follows: 1996 1995 1994 Statutory federal income tax rate 34.0% 34.0% 34.0% State taxes, net of federal tax benefit 7.1 6.3 6.9 Foreign income taxes at rates different from U.S. statutory rates 4.8 3.6 0.7 Business tax credits (state tax credits net of federal tax effect) (10.3) (3.0) Tax benefit from export sales corporation (1.7) (1.0) (1.3) Adjustment of prior year provisions 3.1 0.2 (0.2) Effective tax rate 37.0% 40.1% 40.1% DEFERRED TAX ASSETS (LIABILITIES). The Company's deferred tax assets and liabilities at October 31, 1996 and 1995 under SFAS 109 arise from the following temporary differences in accounting for financial versus tax reporting purposes: (Amounts in thousands) 1996 1995 CURRENT: Valuation reserves and accruals not deductible for tax purposes until paid or utilized $ 4,112 $ 4,700 Intercompany profit eliminated for financial reporting purposes which is taxable currently 440 570 Domestic net operating losses available for carryforward 521 896 Asset valuation difference between financial and tax reporting basis due to purchase accounting 189 254 State tax credits eligible for carryforward related to purchased equipment 118 Other (215) 245 Total deferred tax assets (liabilities) 5,165 6,665 NONCURRENT: Domestic net operating losses available for carryforward 4,655 4,838 Foreign net operating losses available for carryforward 2,273 1,245 Tax depreciation greater than financial reporting depreciation (2,825) (3,169) Intangible assets, difference between financial and tax reporting basis and periods (858) (1,204) Burden and interest on self-constructed assets expensed for tax purposes and depreciated for financial reporting purposes (548) (659) Plant and equipment written off for financial reporting purposes, depreciable for tax purposes 308 497 Valuation reserves and accruals not deductible for tax reporting purposes until utilized or paid (21) 136 Costs required to be capitalized under the uniform capitalization tax rules which are deducted for financial reporting purposes 389 781 Liability for postretirement health benefits not deductible for tax purposes until paid 690 674 State tax credits eligible for carryforward related to purchased equipment 678 419 Other 98 (42) 4,839 3,516 Less valuation allowance (2,192) (1,158) 2,647 2,358 Total deferred tax balances $7,812 $9,023 The Company has provided a valuation allowance related to the deferred tax asset resulting from the operating loss carryforwards of certain of its foreign subsidiaries until the realization of the loss carryforwards is more likely than not. The 1996 valuation allowance increase is primarily due to losses reported in 1996 by certain of those subsidiaries. The Company has recognized benefits in 1996, 1995 and 1994 for research and development tax credits and, in 1996, for California manufacturers investment credit. Income taxes have not been provided on approximately $9.2 million of unremitted earnings of the Company's subsidiary in Scotland. The Company intends to continue to reinvest these amounts in the subsidiary's operations. Should any of these amounts be distributed to the Company, any taxes on these distributions would be substantially offset by foreign tax credits. During 1995, the Company recorded $873,000 of deferred tax assets related to the purchase of Netra and $4.7 million of deferred tax assets with the consolidation of Flex Products. These deferred tax assets have been recorded under the guidelines of SFAS No. 109, Accounting for Income Taxes, on the premise that future taxable income will more likely than not be adequate to realize future tax benefits of the available net operating loss carryforwards giving rise to these deferred tax assets. 8. EMPLOYEE BENEFIT PLANS U.S. OPERATIONS. The Company has an Employee Stock Ownership Plan (ESOP+), a defined contribution plan, for its non-Flex Products Santa Rosa employees and a 401(k) plan with a Company match for the employees of Flex Products. Company matching contributions to ESOP+ are determined by a profit sharing formula with additional contributions, if any, determined by the Company's Board of Directors. Company matching contributions to Flex Products' 401(k) plan are 75% of the first 6% of employee contributions under the plan. The Company follows the policy of funding Company contributions as accrued. Company contributions to ESOP+ are made in the form of the Company's common stock or in the form of cash to purchase the Company's common stock. Company contributions under Flex Products' 401(k) plan are paid in cash. The Company contributed to ESOP+ and charged to operations $580,000, $1,225,000 and $950,000 in 1996, 1995 and 1994. Contributions to Flex Products' 401(k) plan were $207,000 for 1996 and $84,000 for the six months May through October 1995. SCOTTISH OPERATIONS. The Company's Scottish subsidiary maintains a contributory defined benefit pension program covering most of its employees. Benefits are primarily based on years of service and compensation. The program is funded in conformity with the requirements of applicable U.K. government regulations. Plan assets are invested in fixed interest and balanced fund units which are primarily comprised of corporate equity securities. The funded status of the plan at October 31, 1996, 1995 and 1994 is as follows: (Amounts in thousands) 1996 1995 1994 Plan assets at fair value $6,704 $5,464 $4,971 Projected benefit obligation (6,250) (5,575) (4,820) Plan assets greater (less) than projected benefit obligation 454 (111) 151 Unrecognized net loss 301 870 640 Unrecognized transition asset being amortized over 19 years (453) (473) (521) Prepaid pension cost included in other assets $ 302 $ 286 $ 270 At October 31, 1996, 1995 and 1994, the projected benefit obligations include accumulated benefit obligations of $5,658,000, $5,344,000 and $4,621,000 of which $5,643,000, $5,323,000 and $4,602,000 are vested. A discount rate of 8.5% was used in determining the present value of the projected benefit obligation. The expected long-term rate of return on assets was 9% and the assumed rate of increase in future compensation levels was 5.5%. The net pension expense recorded in 1996, 1995 and 1994 included the following components: (Amounts in thousands) 1996 1995 1994 Service-cost benefits earned during the period $ 364 $ 313 $ 275 Interest cost on projected benefit obligation 474 439 317 Actual return on plan assets (674) (318) (479) Net amortization and deferral 163 (160) 92 Net pension expense $ 327 $ 274 $ 205 9. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS The Company sponsors a contributory defined benefit postretirement plan for its U.S. operations which provides medical, dental and life insurance benefits to employees who meet age and years of service requirements prior to retirement and who agree to contribute a portion of the cost. The Company has the right to modify or terminate these benefits at any time. The Company's contribution is a set amount per retiree depending on the retiree's years of service and dependent status at the date of retirement and the age of the retiree and dependents when benefits are provided. Cost increases are paid by the retiree. The postretirement plan's benefit obligation was as follows for the years ended October 31, 1996, 1995 and 1994: (Amounts in thousands) 1996 1995 1994 Accumulated postretirement benefit obligation: Retirees $1,058 $1,012 $ 894 Fully eligible plan participants 336 243 175 Other active plan participants 756 744 590 Total accumulated postretirement benefit obligation (unfunded) 2,150 1,999 1,659 Unrecognized loss (279) (227) (91) Accrued postretirement benefit obligation $1,871 $1,772 $1,568 The following components were included in net periodic postretirement benefit cost for the years ended October 31, 1996, 1995 and 1994: (Amounts in thousands) 1996 1995 1994 Service-cost benefits earned during the period $ 69 $ 50 $ 59 Interest cost on accumulated postretirement benefit obligation 141 133 120 Amortization and deferral 55 Net postretirement benefit cost $265 $183 $179 Because the Company has established a maximum amount it will pay per retiree under the plan, health care cost trends do not affect the calculation of the accumulated benefit obligation or the net postretirement benefit cost. The weighted average discount rate used in determining the accumulated benefit obligation was 8.0% in 1996, 7.25% in 1995 and 8.0% in 1994. 10. CONTINGENCIES AND COMMITMENTS U.K. PATENT INFRINGEMENT SUIT. During the past several years, the Company has been engaged in litigation in the United Kingdom (U.K.) involving infringement of a Company patent by a U.K. company. The Company won its action at the Patents County Courts level but lost on appeal to the U.K. House of Lords. During the injunction period, the U.K. company submitted a claim for damages totaling approximately $1.6 million for lost profits. The Company and legal counsel are in the process of reviewing the claim. Management believes that the amount of the claim is substantially overstated and that the ultimate settlement will not have a material adverse effect on the financial statements. CONCENTRATIONS OF CREDIT RISK. The Company grants credit to customers, subject to credit approval, for most of its sales. At October 31, 1996, accounts receivable from customers in foreign countries, primarily in Europe and Asia, were $16.1 million, constituting 58% of accounts receivable. OPERATING LEASE AGREEMENTS. The Company and its subsidiaries lease computer equipment, manufacturing space and warehouse space. The operating lease payments are recorded as rental expense and totaled $4,881,000, $2,481,000 and $2,186,000 for 1996, 1995 and 1994. Future minimum operating lease payments amount to $23.1 million, and for the years 1997 through 2001 are $5,343,000, $4,215,000, $4,068,000, $3,822,000 and $3,745,000 under operating lease agreements in effect at October 31, 1996. During 1996, the Company entered into three operating lease arrangements to finance the cost of a continuous coating machine and related equipment and to finance the cost of two coating machines to be used in the manufacturing operations of Flex Products. The lease terms are six years with monthly payments totaling approximately $290,000 and buyout provisions at the end of each lease term. EMPLOYMENT AGREEMENTS. The Company has approved employment agreements for officers and employment assurance agreements for certain management and technical employees, as well as increases in severance benefits for full- time employees, to be effective in the event of certain changes in control of the Company. These agreements are currently effective through 1997. 11. INFORMATION ON OPERATIONS INVENTORIES. Inventories as of October 31, 1996 and 1995 consisted of: (Amounts in thousands) 1996 1995 Raw materials and supplies $7,483 $7,330 Work-in-process 8,797 7,527 Finished goods 2,421 1,029 Total inventories $18,701 $15,886 ACCRUED EXPENSES. Accrued expenses at October 31, 1996 and 1995 consisted of the following: (Amounts in thousands) 1996 1995 Workers' compensation reserve $ 659 $ 937 Ground water remediation reserve 659 1,187 Other accrued liabilities 5,248 7,391 Total accrued expenses $6,566 $9,515 INTEREST. Interest expense and amounts capitalized were as follows for the years ended October 31, 1996, 1995 and 1994: (Amounts in thousands) 1996 1995 1994 Interest costs incurred $4,696 $4,326 $3,372 Less amounts capitalized 1,172 779 157 Net interest expense $3,524 $3,547 $3,215 SALES INFORMATION. Significant customers and sales to the federal government were as follows: The Company's largest customer in 1996 is also a 40% owner of Flex Products. Sales to this customer were 13% of consolidated sales for 1996 and 12% of consolidated sales for the six months of 1995 in which Flex Products' sales were consolidated. The Company's second largest customer in 1996 is also an approximate 10% common stockholder. Sales to this customer accounted for approximately 5% of sales in 1996, 8% of sales in 1995 and 7% of sales in 1994. Sales of products and services to the federal government, primarily under subcontracts, were 9%, 10% and 11% of net revenues in 1996, 1995 and 1994. Certain of these contracts are subject to cost review by various governmental agencies. Management believes that adjustments, if any, will not be material to the operating results of the Company. FOREIGN OPERATIONS. Foreign sales for the years ended October 31, 1996, 1995 and 1994 were as follows: (Amounts in thousands) 1996 1995 1994 Export sales by U.S. operations: To Asian countries $24,911 $21,305 $15,012 To European and other countries 26,761 16,012 4,243 51,672 37,317 19,255 Foreign sales by European operations 38,795 42,840 40,241 Total foreign sales $90,467 $80,157 $59,496 Identifiable assets of the Company's foreign operations were $37.7 million at October 31, 1996, $43.2 million at October 31, 1995 and $43.3 million at October 31, 1994. DOMESTIC AND FOREIGN INCOME (LOSS). The Company's domestic and foreign income (loss) before income taxes was as follows for the years ended October 31, 1996, 1995 and 1994: (Amounts in thousands) 1996 1995 1994 Domestic $10,885 $12,867 $ 8,311 Foreign (1,628) 823 (627) Total $ 9,257 $13,690 $ 7,684 CHANGES IN ACCOUNTING PRINCIPLES. In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation," which requires the Company to adopt the disclosure provisions of the accounting standard for fiscal year 1997. Pursuant to the new standard, companies are encouraged, but are not required, to adopt the fair value method of accounting for employee stock-based transactions. Companies are also permitted to continue to account for such transactions under Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees," but would be required to disclose pro forma net income and earnings per share in a note to the financial statements as if the Company had applied the new method of accounting. The Company expects to continue to account for its employee stock compensation plans in accordance with the provisions of APB 25. Accordingly, SFAS No. 123 is not expected to have any impact on the Company's results of operations or financial position. In March 1995, the Financial Accounting Standards Board issued SFAS No. 121, Accounting for the Impairment of Long-Lived Assets, which requires the Company to adopt the accounting and disclosure provisions of the accounting standard for fiscal year 1997. The new standard requires that long-lived assets, certain identifiable intangibles and goodwill related to those assets be reviewed for impairment, measured by comparing the carrying amount of the asset to its fair value, whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable. The Company has not assessed the effect, if any, of adopting SFAS 121. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited) Results of operations for each quarter of fiscal 1996 were as follows: Three months ended JAN 28, APR 28, JUL 28, OCT 31, (Amounts in thousand, 1996(1) 1996(1) 1996(1) 1996(1) 1996 except per share data) Revenues $43,911 $48,451 $48,772 $48,061 $189,195 Cost of sales 29,495 30,652 33,353 33,269 126,769 Gross profit 14,416 17,799 15,419 14,792 62,426 Operating Expenses: Research and development 2,388 2,622 2,934 3,789 11,733 Selling and administrative 9,107 10,094 8,109 9,835 37,145 Amortization of intangibles 287 278 284 297 1,146 Total operating expenses 11,782 12,994 11,327 13,921 50,024 Income from operations 2,634 4,805 4,092 871 12,402 Other income (expense): Interest income 74 65 52 188 379 Interest expense (911) (812) (829) (972) (3,524) Income before provision for income taxes and minority interest 1,797 4,058 3,315 87 9,257 Provision (benefit) for income taxes 754 1,705 1,117 (151) 3,425 Minority interest 303 282 165 (114) 636 Net income 740 2,071 2,033 352 5,196 Dividend on convertible redeemable preferred stock 240 240 240 240 960 Net income applicable to common stock $ 500 $1,831 $1,793 $112 $ 4,236 Net income per common and common equivalent share $ .05 $ .18 $ .17 $ .01 $ .41 Weighted average number of common shares outstanding (in thousands) 10,119 10,158 10,550 10,358 10,301 (1) Reflects the consolidation of Flex Products, Inc., a 60% owned subsidiary. OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES SUPPLEMENTAL FINANCIAL INFORMATION (Unaudited) Results of operations for each quarter of fiscal 1995 were as follows: Three months ended JAN 31, APR 30, JUL 31, OCT 31, (Amounts in thousand, 1995 1995 1995(1) 1995(1) 1995 except per share data) Revenues $35,993 $41,487 $47,289 $44,648 $169,417 Cost of sales 21,352 25,923 29,536 29,198 106,009 Gross profit 14,641 15,564 17,753 15,450 63,408 Operating Expenses: Research and development 1,387 1,632 2,546 2,836 8,401 Selling and administrative 9,244 9,390 9,707 9,121 37,462 Amortization of intangibles 171 304 213 287 975 Total operating expenses 10,802 11,326 12,466 12,244 46,838 Income from operations 3,839 4,238 5,287 3,206 16,570 Other income (expense): Interest income 226 196 127 118 667 Interest expense (920) (991) (974) (662) (3,547) Income before provision for income taxes and minority interest 3,145 3,443 4,440 2,662 13,690 Provision for income taxes 1,321 1,445 1,866 851 5,483 Minority interest 443 373 816 Net income 1,824 1,998 2,131 1,438 7,391 Dividend on convertible redeemable preferred stock -- -- 222 240 462 Net income applicable to common stock $ 1,824 $ 1,998 $ 1,909 $ 1,198 $ 6,929 Net income per common and common equivalent share $.20 $.21 $.20 $.12 $.73 Weighted average number of common shares outstanding (in thousands) 9,025 9,377 9,557 10,066 9,510 (1) Reflects the consolidation of Flex Products, Inc., a 60% owned subsidiary. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Pursuant to Paragraph G(3) of the General Instructions to Form 10-K, the information called for in Part III, Items 10, 11, 12 and 13 of Form 10-K is omitted since the Company will file with the Securities and Exchange Commission, not later than 120 days after the close of the fiscal year ended October 31, 1996, a definitive proxy statement pursuant to Regulation 14A in connection with its 1997 Annual Meeting of Stockholders. The information contained under the caption "Executive Officers of the Registrant" in Part I of this Form 10-K is incorporated by reference into Item 10. PART IV ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) 1. CONSOLIDATED FINANCIAL STATEMENTS: The following consolidated financial statements are included in Item 8: PAGE(S) Independent Auditors' Report 22 Consolidated Balance Sheets 23 Consolidated Statements of Income 24 Consolidated Statements of Cash Flows 25-26 Consolidated Statements of Common Stockholders' Equity 27 Notes to Consolidated Financial Statements 28 Supplemental Financial Information 40-41 (A) 2. FINANCIAL STATEMENT SCHEDULES The following consolidated financial statement schedules are included in Item 14(d): Schedule II - Valuation and Qualifying accounts 46 All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or the accompanying notes. (A) 3. LISTING OF EXHIBITS The following are filed as Exhibits to this Annual Report on Form 10-K. The numbers refer to the Exhibit Table of Item 601 of Regulation S-K. Exhibit No. Description 3.1 Restated Certificate of Incorporation. Incorporated by reference to Exhibit (4)(a) of the Registrant's Form 10-Q for the quarter ended July 31, 1988. 3.2 By-Laws. Incorporated by reference to Exhibit (3)(b) of the Registrant's Form 8-K under Item 5 dated November 20, 1987. 4.1 Rights Agreement between Registrant and First Interstate Bank of California dated November 25, 1987. Incorporated by reference to Exhibit (4) of the Registrant's Form 10-K for the year ended October 31, 1987. 4.2 Note Purchase Agreement(s) dated as of May 27, 1994 for the private placement of $18,000,000 of 8.71% Senior Notes due June 1, 2002 between the Registrant and Connecticut Mutual Life Insurance Company, Modern Woodman of America and American Life and Casualty Insurance Company. Incorporated by reference to Exhibit (4)(a) of the Registrant's Form 10-Q for the quarter ended July 31, 1994. 4.3 Stock Purchase Agreement dated as of February 8, 1995 by and between the Registrant, Netra Corporation and the Sellers as identified on the signature page of said agreement, each a shareholder of Netra Corporation, for the purchase by the Registrant of all of the shares of common and preferred stock of Netra Corporation. Incorporated by reference to Exhibit (4) of the Registrant's Form 10-Q for the quarter ended April 30, 1995. 4.4 Optical Coating Laboratory, Inc. 12,000 shares of 8% Series C Convertible Redeemable Preferred Stock Purchase Agreement among the Registrant and the investors named therein dated as of May 1, 1995. Incorporated by reference to Exhibit 4(e) of Registrant's Form S-8 dated July 6, 1995. 4.5 Certificate of Designation, Preferences and Rights of Series C Convertible Redeemable Preferred Stock of Optical Coating Laboratory, Inc. dated May 2, 1995. Incorporated by reference to Exhibit 4(f) of Registrant's Form S-8 dated July 6, 1995. 4.6 Credit Agreement dated as of May 24, 1995 among the Registrant, Bank of America NT&SA as agent, and Letter of Credit Issuing Bank and the other Financial Institutions party thereto arranged by BA Securities, Inc. Incorporated by reference to Exhibit (4)(a) of the Registrant's Form 10-Q for the quarter ended July 31, 1995. 4.7 Second Amended and Restated Credit Agreement dated as of May 24, 1995 between Optical Coating Laboratory, Inc. and Bank of America NT&SA. Incorporated by reference to Exhibit (4)(b) of the Registrant's Form 10-Q for the quarter ended July 31, 1995. 4.8 Secured Promissory Note between Optical Coating Laboratory, Inc. and Aid Association for Lutherans dated November 8, 1995. Incorporated by reference to Exhibit 4.8 of the Registrant's Form 10-K for the year ended October 31, 1995. 4.9 First Amendment to Credit Agreement dated as of May 24, 1995 between Optical Coating Laboratory, Inc., Bank of America, NT&SA, as agent for itself and the Banks, and the several financial institutions party to the Credit Agreement, which amendment is dated as of December 15, 1995. Incorporated by reference to Exhibit 4.9 of the Registrant's Form 10-K for the year ended October 31, 1995. 9 Not applicable. Exhibit No. Description 10.0 Registrant's Employee Stock Ownership Plan (OCLI ESOP+), as amended. Incorporated by reference to Exhibit (10)(c) of the Registrant's Form 10-K for the year ended October 31, 1988. 10.1 Registrant's 1996 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated March 8, 1996.(1) 10.2 Registrant's 1995 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated March 10, 1995.(1) 10.3 Registrant's 1993 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated March 8, 1993.(1) 10.4 Registrant's 1992 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated March 8, 1992. (1) 10.5 Registrant's 1991 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated February 25, 1991. (1) 10.6 Registrant's 1987 Incentive Compensation Plan. Incorporated by reference to Exhibit A of the Registrant's Proxy Statement dated February 19, 1987. (1) 10.7 Registrant's 1984 Incentive Stock Option Plan. Incorporated by reference to Exhibit (10)(d) of the Registrant's Form 10-K for the year ended October 31, 1985. (1) 10.8 Registrant's 1983 Incentive Stock Option Plan. Incorporated by reference to Exhibit (10)(d) of the Registrant's Form 10-K for the year ended October 31, 1983. (1) 10.9 Registrant's 1982 Incentive Stock Option Plan. Incorporated by reference to Exhibit A of Proxy Statement of Registrant dated March 1, 1982. (1) 10.10 Registrant's Directors' and Officers' Liability and Corporate Reimbursement Insurance Policy. Incorporated by reference to Exhibit (10)(i) of the Registrant's Form 10-K for the year ended October 31, 1987. (1) 10.11 Form of Directors' and Officers' Indemnification Agreement. Incorporated by reference to Exhibit (10)(j) of the Registrant's Form 10-K for the year ended October 31, 1987. (1) 10.12 Employment Agreements between Registrant and its Executive Officers. Incorporated by reference to Exhibit (10)(k) of the Registrant's Form 10-K for the year ended October 31, 1987. Second Amendment thereto incorporated by reference to Exhibit (28)(a) of the Registrant's Form 10-Q for the quarter ended January 31, 1992. Third Amendment thereto incorporated by reference to Exhibit 10.13 of the Registrant's Form 10-K for the year ended October 31, 1993. (1) 10.13 Form of Fourth Amendment to Employment Agreements between Registrant and its Executive Officers dated November 20, 1995. Incorporated by reference to Exhibit 10.12 of the Registrant's Form 10-K for the year ended October 31, 1995. (1) Exhibit No. Description 10.14 Form of Employment Assurance Agreements between Registrant and its key technical and professional employees. Incorporated by reference to Exhibit (10)(l) of the Registrant's Form 10-K for the year ended October 31, 1987. Form of Amendment thereto incorporated by reference to Exhibit (28)(b) of the Registrant's Form 10-Q for the quarter ended January 31, 1992. (1) 10.15 Form of Amendment to Employment Assurance Agreements between Registrant and its key technical and professional employees dated November 20, 1995. Incorporated by reference to Exhibit 10.14 of the Registrant's Form 10-K for the year ended October 31, 1995.(1) 10.16 Mortgage Agreement between the Scottish Development Agency and Registrant's Scottish Subsidiary. Incorporated by reference to Exhibit (10)(o) of the Registrant's Form 10-K for the year ended October 31, 1987. 10.17 Acquisition Agreement between Henning Von Birkhahn and Ingo Mertens and the Registrant's German subsidiary, OCLI Optical Coating Laboratory GmbH, dated December 31, 1992 for the acquisition by the Registrant of MMG MinnahYtte Maschinelle Glasbearbeitung GmbH. Incorporated by reference to Exhibit 2A of Registrant's Form 8-K dated December 31, 1992. 10.18 Stock and Note Purchase Agreement by and among OCLI, SICPA Holdings S.A., ICIA, ICIAH and Flex Products, Inc. Incorporated by reference to the Registrant's Form 8-K dated May 23, 1995 and Registrant's Form 8-K/A dated April 11, 1996. 10.19 Employment Agreement Letter between John McCullough and the Registrant dated October 31, 1995. Incorporated by reference to Exhibit 10.18 of the Registrant's Form 10-K for the year ended October 31, 1995.(1) 10.20*1997 Management Incentive Plan (1) 11* Computation of earnings (loss) per share for the years ended October 31, 1996, 1995 and 1994. 12 Not applicable 13 Not applicable 16 Not applicable 18 Not applicable 21* Subsidiaries of the Registrant 22 Not applicable 23* Independent Auditors' Consent and Report on Schedules 24 Not applicable 27* Financial Data Schedule 28 Not applicable 99 Not applicable * Items not previously filed are designated by an asterisk. (1) Designates management contracts or compensatory plan arrangements required to be filed as exhibits pursuant to Item 14(c) of Form 10- K. (b) REPORTS ON FORM 8-K None OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (S-X, RULE 12-09) (AMOUNTS IN THOUSANDS) COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E ADDITIONS BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE BEGINNING COSTS AND TO OTHER AMOUNTS AT END DESCRIPTION OF PERIOD EXPENSES ACCOUNTS CHARGED OFF OF PERIOD ALLOWANCE FOR DOUBTFUL ACCOUNTS: Year ended October 31, 1996 $1,229 $674 $(7)(a) $121 $1,775 Year ended October 31, 1995 $1,810 $369 $136(a) $1,086 $1,229 Year ended October 31, 1994 $1,817 $667 $85(a) $759 $1,810 ALLOWANCE FOR INTERCOMPANY PROFIT IN INVENTORY: Year ended October 31, 1996 $1,316 $-0- $-0- $300 $1,016 Year ended October 31, 1995 $1,166 $150 $-0- $-0- $1,316 Year ended October 31, 1994 $1,130 $36 $-0- $-0- $1,166 VALUATION RESERVES FOR INVENTORY: Year ended October 31, 1996 $616 $1,496 $-0- $-0- $2,112 Year ended October 31, 1995 $765 $-0- $-0- $149 $616 Year ended October 31, 1994 $826 $-0- $-0- $61 $765 (a)The 1995 balance consists primarily of amounts recorded in connection with the acquisition of Flex Products. The 1996 and 1994 balances consist of recoveries and foreign currency translation effects. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. DATE: January 29, 1997 OPTICAL COATING LABORATORY, INC. By: /s/Joseph C. Zils Joseph C. Zils Chief Financial Officer 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 and on the dates indicated: SIGNATURE TITLE DATE Chairman of the Board, President, Chief Executive Officer (Principal Executive and /s/Herbert M. Dwight, Jr Operating Officer) January 29, 1997 Herbert M. Dwight, Jr. /s/John McCullough Director and Vice President January 29, 1997 John McCullough Vice President, General Counsel, Corporate Secretary and Chief Financial Officer /s/Joseph C. Zils (Principal Financial Officer) January 29, 1997 /s/Douglas C. Chance Director January 29, 1997 Douglas C. Chance /s/Shoei Kataoka Director January 29, 1997 Shoei Kataoka /s/Julian Schroeder Director January 29, 1997 Julian Schroeder /s/Renn Zaphiropoulos Director January 29, 1997 Renn Zaphiropoulos EX-11 2 OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES EXHIBIT 11. COMPUTATION OF EARNINGS PER SHARE Years Ended October 31, 1996, 1995 and 1994 (Amounts in thousands, except per share data) 1996 1995 1994 PRIMARY SHARES: Average common shares outstanding 9,629 9,144 8,975 Common equivalent shares outstanding 672 367 48 10,301 9,511 9,023 Net income $5,196 $7,391 $4,604 Less dividend on preferred stock 960 462 Net income applicable to common stock $4,236 $6,929 $4,604 Net income per common and common equivalent share, primary $.41 $.73 $.51 FULLY DILUTED SHARES: Average common shares outstanding 9,629 9,144 8,975 Common equivalent shares outstanding 685 456 70 Potential dilution of preferred stock * 553 10,314 10,153 9,045 Net income applicable to common stock $4,236 $6,929 $4,604 Add back dividend on preferred stock * 462 Net income for calculating fully diluted earnings per share $4,236 $7,391 $4,604 Net income per common and common equivalent share, fully diluted $.41 $.73 $.51 *Excluded because the result would be anti-dilutive. NOTE: Fully diluted earnings per share do not result in dilution of three percent or more or are anti-dilutive and, therefore, are not separately presented in the consolidated statements of income. EX-21 3 OPTICAL COATING LABORATORY, INC. AND SUBSIDIARIES EXHIBIT 21. SUBSIDIARIES OF THE REGISTRANT Optical Coating Laboratory, Inc. was incorporated in Delaware in 1948. The Company was reincorporated in California in 1963 and again reincorporated in Delaware November 2, 1987. Optical Coating Laboratory, Inc. has the following subsidiaries: PERCENT OF PLACE OF SUBSIDIARY NAME OWNERSHIP INCORPORATION OCLI International Service Corporation 100% California OCLI Foreign Sales Corporation 100% Guam OCLI Optical Coatings Limited 100% Scotland OCLI Optical Coating Laboratory GmbH 100% Germany MMG Glastechnik GmbH 100% Germany OCLI Monitor Produkte GmbH 100% Germany OCLI Optical Coatings Espana S.A. 100% Spain Optical Coating Laboratory B.V. 100% Netherlands Optical Coating Laboratory EURL 100% France Optical Coating Laboratory Srl 100% Italy OCLI Monitor Products Srl 100% Italy Flex Products, Inc. 60% Delaware EX-23 4 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT AND REPORT ON SCHEDULE We consent to the incorporation by reference in Registration Statements No. 33-41050, No. 33-26271, No. 33-12276, No. 33-48808, No. 33-65132, No. 33- 60891 and 33-13013 of Optical Coating Laboratory, Inc. on Form S-8 and Registration Statements No. 33-61177 and No. 33-65319 on Form S-3 of Optical Coating Laboratory, Inc. of our report dated December 18, 1996, appearing in this Annual Report on Form 10-K of Optical Coating Laboratory, Inc. for the year ended October 31, 1996. Our audits of the consolidated financial statements referred to in our aforementioned report also included the financial statement schedule of Optical Coating Laboratory, Inc., listed in Item 14(a)(2). The financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the 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. DELOITTE & TOUCHE LLP San Jose, California January 29, 1997 EX-27 5
5 12-MOS OCT-31-1996 OCT-31-1996 16,027 0 27,700 1,775 18,701 70,071 168,669 81,100 172,771 31,984 0 0 11,309 47,317 20,933 172,771 189,195 189,195 126,769 126,769 50,024 0 3,524 9,257 3,425 5,196 0 0 0 5,196 .41 .41
EX-10 6 1997 MANAGEMENT INCENTIVE PLAN Page 1 OBJECTIVES The objectives of the Optical Coating Laboratory, Inc. (OCLI) Fiscal Year 1997 Management Incentive Plan (MIP) are: To motivate key OCLI managers to achieve Fiscal Year (FY) 1997 financial objectives; and To reward key OCLI managers and employees who contribute significantly towards the achievement of OCLI's financial and operational objectives. ADMINISTRATION The Human Resources Department, in coordination with the Finance & Accounting Department, will administer the MIP under the direction of the Chairman of the Board and President of OCLI (Plan Administrator). ELIGIBILITY Employees in Salary Grades 11 and above, or equivalent (for non-US subsidiaries), are eligible to participate in the MIP. MIP participants are not eligible for "Spot" bonuses or "Superior Merit" bonuses. Concurrent participation in any other type of bonus program requires the approval of the Plan Administrator. Bonus awards are calculated annually based on OCLI's and the Divisions' financial results and on each participant's individual performance during the plan year. The plan year is defined as the fiscal year beginning November 4, 1996 and ending October 31, 1997. Employees who are newly hired, promoted or transferred into or out of eligible positions and those who move from one eligibility level to another will receive pro rata bonus awards based on actual base pay earned during the plan year in the eligible positions. In addition, participants who leave OCLI during the plan year under any of the following conditions may be eligible for pro rata bonus awards: participants who retire under the provisions of one of the Company's retirement plans or the Social Security Act; or Page 2 1997 MANAGEMENT INCENTIVE PLAN a disabled participant or the spouse or legal representative of a deceased participant. Participants leaving the Company under any conditions other than those outlined above are not eligible for bonus awards for the plan year in which they leave. APPROVED BONUS POOL The Board of Directors approved a combined quantitative and qualitative bonus pool totaling $1,232,000 which is a function of actual OCLI Consolidated and Division Return on Asset (ROA) Performance (defined on Page 3) versus budgeted ROA Performance. The qualitative portion of the pool is a fixed maximum of $246,400 based on Individual Performance (defined on Page 4). The size of the approved pool at budgeted performance was based on the number of participants, salary grades and actual salaries at the beginning of the plan year and budgeted OCLI Consolidated and Division ROA Performance. A bonus pool will be accrued and distributed as a function of OCLI's Consolidated and Divisional ROA Performance relative to budget plus a straight line accrual for the qualitative portion. The pool will not be adjusted due to a change in the composition of the participants due to hirings, terminations, salary increases or promotions. As the composition of the plan participants changes due to the addition or deletion of individuals or changes in salary grades or salaries, individual participant's pro rata percentage of the distribution will change accordingly (i.e., the total amount of the pool at a given level of ROA performance is fixed). The pro rata percentages for each participant at the beginning of the plan year by salary grade are shown below. TARGET BONUS OPPORTUNITY AS A PERCENT OF BASE SALARY EARNED SALARY GRADE PERCENT CEO 35% Vice Presidents 25% Level 14 20% Level 13 15% Level 12 15% Level 11 10% Page 3 1997 MANAGEMENT INCENTIVE PLAN BONUS DETERMINATION Performance levels attained in the following areas determine the extent to which participants in this incentive plan are eligible for cash awards. OCLI Consolidated ROA Performance -- OCLI must achieve a minimum of 60% of budgeted Return on Assets (ROA) Performance to qualify for OCLI Consolidated ROA Performance awards. OCLI Consolidated ROA Performance for the plan year is calculated by dividing net after tax earnings by average assets. - Net after tax earnings is defined as OCLI's consolidated net after tax earnings for the plan year, as certified by the Company's independent auditors, including appropriate accruals for all incentive awards estimated to be payable for that plan year. - Average assets is defined as the average of the four quarter's average consolidated total assets. A quarter's average consolidated total assets is defined as the total assets, as reported on OCLI's consolidated balance sheet at the beginning of each quarter plus the total assets as reported on OCLI's balance sheet at the end of each quarter, divided by two. Division ROA Performance -- Divisions must achieve a minimum of 70% of planned Return of Assets (ROA) Performance to qualify for Division ROA performance awards. Division ROA Performance for the plan year is calculated by dividing net after tax earnings by average assets. - Net after tax earnings is defined as the Division's consolidated net after tax earnings for the plan year, as determined by the Company's Chief Financial Officer, including appropriate accruals for all incentive awards estimated to be payable for that plan year. - Average assets is defined as the average of the four quarter's average division total assets. A quarter's division total average assets is defined as the total assets, as reported on the Division's balance sheet at the beginning of each quarter plus the total assets as reported on the Division's balance sheet at the end of each quarter, divided by two. Page 4 1997 MANAGEMENT INCENTIVE PLAN Individual Performance -- Individual performance is defined as each participant's performance rating for the plan year. Individual performance awards are separate from payments based upon ROA performance, and may be paid, in part or in whole, based on OCLI's and the Divisions' performance and/or ability to pay. Such payments are subject to the approval of the Plan Administrator. Multiplier -- A compounding multiplier of 10% for each 10% increment that ROA Performance exceeds budgeted ROA target is applied to calculate the bonus pool available. Any impact due to this multiplier's effect will be applied to the quantitative portion of the MIP payouts. The formula allows for interpolation between the 10% ranges. PERFORMANCE WEIGHTING The percent of target bonus opportunity (see Page 2) is broken down by the following performance measures. MIP PERFORMANCE WEIGHTING MATRIX DIVISION PERFORMANCE CORPORATE GENERAL DIVISION MEASURE STAFF MANAGERS MANAGEMENT OCLI Consolidated ROA 80% 20% 10% Performance Division ROA 0% 60% 70% Performance Individual Qualitative 20% 20% 20% Performance (Pool) TOTAL 100% 100% 100% Page 5 1997 MANAGEMENT INCENTIVE PLAN The Individual Qualitative Performance is a maximum of 20% of the planned target pay-out. Any unallocated amounts go to a discretionary pool to be allocated back to MIP participants and all other employees at the discretion of the Plan Administrator or rolled over into the subsequent plan year. In no case will any unallocated amounts be rolled over for more than one year. BONUS CALCULATION Bonus awards are based on the following thresholds and targets. The scales allow for interpolation between percentage points. OCLI CONSOLIDATED AND DIVISION ROA PERFORMANCE THRESHOLD (QUANTITATIVE BONUS POOL ENTITY BEGINS ACCRUING AT) TARGET Santa Rosa Division 3.71% ROA 5.30% ROA Hillend Technical Division TBD TBD MMG Division TBD TBD OCLI Consolidated 2.28% ROA 3.8% ROA All Division participants are included in the plan for their Division. The MMG and Hillend Technical Division plans will be an addendum to this document. RECOMMENDED POTENTIAL INDIVIDUAL PERFORMANCE BONUS PAYOUT AS A PERCENT OF TARGET INDIVIDUAL PERFORMANCE BONUS OPPORTUNITY (QUALITATIVE PORTION) INDIVIDUAL NEEDS FULLY PERFORMANCE IMPROVEMENT EFFECTIVE SUPERIOR % of Individual Performance Opportunity 0 - 19 20 - 79 80 - 100 Page 6 1997 MANAGEMENT INCENTIVE PLAN BONUS PAYMENT Bonus award payments will be approved by the Plan Administrator following the certification of OCLI's Consolidated Financial Statements by an independent auditor. Payments will be distributed to eligible participants during the second payroll in January, 1998. AMENDMENTS The Board of Directors of OCLI reviews the Company's incentive compensation plans annually to ensure equability both within the Company and in relation to current economic conditions. The Board of Directors reserves the right to amend, suspend, terminate or make exceptions to this plan at any time. The effects of any unusual and material accounting or non-recurring transactions may be excluded from the bonus calculations with the approval of the Plan Administrator. For example, performance objectives may be adjusted to reflect major acquisitions and/or divestitures during the plan year. -----END PRIVACY-ENHANCED MESSAGE-----