-----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, CYo+WTIUDYGYNW91YQO1Ol7qOHSou6UIuwqnyY6/qpJ137vgVkwzTir0SHehB43z Zz8qCmZi+V4u5cj/KjrSQg== 0000892569-97-002978.txt : 19971104 0000892569-97-002978.hdr.sgml : 19971104 ACCESSION NUMBER: 0000892569-97-002978 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19971103 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: MODTECH INC CENTRAL INDEX KEY: 0000864601 STANDARD INDUSTRIAL CLASSIFICATION: PREFABRICATED WOOD BLDGS & COMPONENTS [2452] IRS NUMBER: 330044888 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-37473 FILM NUMBER: 97706895 BUSINESS ADDRESS: STREET 1: 2830 BARRETT AVE STREET 2: PO BOX 1240 CITY: PERRIS STATE: CA ZIP: 92370 BUSINESS PHONE: 9099434014 MAIL ADDRESS: STREET 1: 2830 BARRETT AVENUE STREET 2: P O BOX 1240 CITY: PERRIS STATE: CA ZIP: 92370 S-1/A 1 AMENDMENT NO. 1 TO FORM S-1 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 3, 1997 REGISTRATION NO. 333-37473 ================================================================================ SECURITIES AND EXCHANGE COMMISSION ------------------------ AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ MODTECH, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 33-0044888 (STATE OF INCORPORATION) (I.R.S. EMPLOYER IDENTIFICATION NO.)
2830 BARRETT AVENUE, PERRIS, CALIFORNIA 92571, (909) 943-4014 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) EVAN M. GRUBER, CHIEF EXECUTIVE OFFICER 2830 BARRETT AVENUE, PERRIS, CALIFORNIA 92571, (909) 943-4014 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE OF PROCESS) COPIES TO: JAMES M. PHILLIPS, JR., ESQ. DHIYA EL-SADEN, ESQ. PHILLIPS & HADDAN LLP GIBSON DUNN & CRUTCHER LLP 4675 MACARTHUR COURT, SUITE 710 333 SOUTH GRAND AVENUE NEWPORT BEACH, CALIFORNIA 92660 LOS ANGELES, CALIFORNIA 90071
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after the Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE ================================================================================
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM AMOUNT OF OF SECURITIES TO BE AMOUNT TO OFFERING PRICE AGGREGATE REGISTRATION REGISTERED BE REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) FEE(2) - ------------------------------------------------------------------------------------------------- Common Stock................. 3,450,000 shares $25.00 $86,250,000 $26,136.34
================================================================================ (1) Includes 1,000,000 shares to be issued and sold by the Company, 2,000,000 shares to be sold by certain Selling Shareholders, and 450,000 shares that may be sold by certain Selling Shareholders upon exercise of the Underwriters' over-allotment option. (2) Calculated pursuant to Rule 457(c), based on the average of the high and low prices for a share of the Common Stock on The Nasdaq National Market on October 6, 1997. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(a), MAY DETERMINE. ================================================================================ 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE. SUBJECT TO COMPLETION, DATED OCTOBER 14, 1997 PROSPECTUS MODTECH LOGO Of the 3,000,000 shares of Common Stock offered hereby (the "Offering"), 1,000,000 shares are being sold by Modtech, Inc. ("Modtech" or the "Company") and 2,000,000 shares are being sold by certain shareholders of the Company (the "Selling Shareholders"). See "Principal and Selling Shareholders." The Company will not receive any of the proceeds from the sale of shares by the Selling Shareholders. See "Use of Proceeds." The Company's Common Stock is listed on The Nasdaq National Market under the symbol "MODT." On October 13, 1997, the last reported sales price for a share of the Company's Common Stock on The Nasdaq National Market was $28.625. See "Market Information and Related Matters." ------------------------ SEE "RISK FACTORS" BEGINNING AT PAGE 6 FOR CERTAIN INFORMATION WHICH SHOULD BE CAREFULLY CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ====================================================================================================== UNDERWRITING PROCEEDS PROCEEDS TO PRICE TO DISCOUNTS AND TO THE THE SELLING THE PUBLIC COMMISSIONS(1) COMPANY(2) SHAREHOLDERS - ------------------------------------------------------------------------------------------------------ Per Share......................... $ $ $ $ - ------------------------------------------------------------------------------------------------------ Total(3).......................... $ $ $ $ ======================================================================================================
(1) The Company and the Selling Shareholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriting." (2) Before deducting expenses payable by the Company (including expenses of the Selling Shareholders) estimated at $300,000. (3) Certain of the Selling Shareholders have granted the Underwriters an option, exercisable within 30 days of the date hereof, to purchase up to 450,000 additional shares of the Company's Common Stock, at the same price and subject to the same Underwriting Discounts and Commissions as set forth above, solely to cover over-allotments, if any. If the Underwriters exercise such option in full, the total Price to the Public, Underwriting Discounts and Commissions and Proceeds to the Selling Shareholders will be $ , $ and $ , respectively. See "Underwriting." ------------------------ The shares of Common Stock are offered subject to prior sale, when, as and if delivered to and accepted by the Underwriters and subject to certain other conditions. The Underwriters reserve the right to withdraw, cancel or modify said offer and to reject orders in whole or in part. It is expected that delivery of the Common Stock will be made on or about October , 1997, at the offices of Bear, Stearns & Co. Inc., 245 Park Avenue, New York, New York 10167. BEAR, STEARNS & CO. INC. CRUTTENDEN ROTH INCORPORATED L.H. FRIEND, WEINRESS, FRANKSON & PRESSON, INC. THE DATE OF THIS PROSPECTUS IS OCTOBER , 1997. 3,000,000 SHARES MODTECH, INC. COMMON STOCK 3 [ PHOTOGRAPHS ] CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK, INCLUDING OVER-ALLOTMENTS, STABILIZING AND SHORT-COVERING TRANSACTIONS AND THE IMPOSITION OF PENALTY BIDS. SEE "UNDERWRITING." CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ALSO ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON THE NASDAQ NATIONAL MARKET. SEE "UNDERWRITING." 2 4 PROSPECTUS SUMMARY The following summary should be read in conjunction with, and is qualified in its entirety by, the more detailed information and financial statements and notes thereto appearing elsewhere in this Prospectus. Unless otherwise indicated, the information contained in this Prospectus assumes that there has been no exercise of the Underwriters' over-allotment option and options to purchase shares of Common Stock granted or to be granted under the Company's stock option plans. THE COMPANY Modtech designs, manufactures, markets and installs modular relocatable classrooms. Based upon 1996 net sales, the Company believes that it is the largest manufacturer of modular relocatable classrooms in California. The Company's classrooms are sold primarily to California school districts, and to third parties and the State of California principally for lease to California's school districts. Modtech's products include standardized classrooms, as well as customized structures for use as libraries, gymnasiums, computer rooms and bathroom facilities. The Company believes that its modular structures can be substituted for virtually any part of a school. The Company's classrooms are engineered and constructed in accordance with structural and seismic safety specifications adopted by the California Department of State Architects which regulates all school construction on public land, standards which are more rigorous than the requirements for other portable units. In recent years, population growth and demographic and geographic shifts in California student enrollments have necessitated the addition of more classrooms at existing schools and the construction of new schools to serve new residential developments. However, as a consequence of budget shortfalls experienced by the State of California and many California school districts from 1991 through the middle of 1996, the level of funding for the construction of schools declined, even though school enrollments increased annually during this period. As a result, classrooms in many California school districts currently are reported to be among the most crowded in the nation, with an average of 29 students per class, compared to a national average class size of 17. Without the addition of new classrooms, the average class size will continue to grow since the California Department of Finance has estimated that student enrollment in grades kindergarten through 12 will increase by approximately 18% from 1995 through 2005. Funding for new school construction is provided primarily at the State level, (i) through annual budget allocations of funds derived from general revenue sources and (ii) from the sale of statewide bond issues. As the State of California budget deficit has ameliorated, the legislature has increased funding for the addition of classrooms in an effort to reduce the average number of students per classroom. For the 1996 - 1997 school year, the State spent $822 million in funding under the California Class Size Reduction Program adopted in 1996, including $200 million specifically for facilities which may be relocatable classrooms. The Company believes that State funding for the reduction of class sizes during the 1997 - 1998 school year will be as high as $1.5 billion for both general operations and school facilities. In addition to funding out of its annual budget, the State is empowered to issue general obligation bonds to finance, among other things, the construction of school facilities. The California State School Facilities Conference Committee recently adopted a package of bills which, if approved by the Legislature, would, among other things, place an $8.2 billion school construction bond on the June 1998 California ballot. If these proposals are on the ballot and are approved by the voters, $4 billion of the bonds would be sold in 1998, followed by $4.2 billion in 2000, the proceeds of which would be used to construct and modernize existing school facilities, acquire land to build new schools, and construct or add classrooms. See "Business -- Legislation and Funding." These factors have combined to increase the demand for modular relocatable classrooms, which cost significantly less and take much less time to construct and install than conventional school facilities, and which permit a school district to relocate the units as student enrollments shift. In addition, the Company's products provide added flexibility to school districts in financing the costs of adding classroom space, since modular relocatable classrooms are considered personal property which can be financed out of a district's operating budget in addition to its capital budget. In recognition of these advantages, California legislation currently requires, with certain exceptions, that at least 30% of all new classroom space added using State funds must be relocatable structures. See "Business -- Legislation and Funding." 3 5 The Company currently operates a total of six production lines at four plants, which serve both the Northern and Southern California markets. The Company's manufacturing process is vertically integrated in that the Company fabricates many of the components used in the construction of its classrooms. The Company believes that this capability enables it to be one of the low-cost producers in California of standardized modular relocatable classrooms, and provides it with a competitive advantage over other manufacturers who must use third parties to supply these parts. During recent periods, the Company's net sales and profitability have increased. Net sales increased from $19.4 million for the year ended December 31, 1995, to $49.9 million for the year ended December 31, 1996. During the first six months of 1997, net sales were $58.9 million, as compared to $12.7 million during the same period of 1996. Net income for the year ended December 31, 1996 and the six months ended June 30, 1997 was $4.3 million and $5.2 million, respectively. The Company attributes these recent improved results to the heightened demand for modular relocatable classrooms in California, the Company's ability to increase production capacity to accommodate this demand, its efficient and cost effective manufacturing processes, and the quality and attractive pricing of its classrooms. The Company's strategy is to expand its production capacity to meet the increased demand for modular relocatable classrooms, to increase its share of the California market for such classrooms, and to continue to develop new product designs and manufacturing alternatives. In addition, the Company intends to increase its efforts to expand the market for its classrooms to include neighboring states and to develop and more extensively market additional non-classroom products. Recent diversification initiatives have included the acquisition of a manufacturing operation that enhanced the Company's ability to produce relocatable buildings for sale to commercial customers and modular shelters for electronics used in the telecommunications industry. The Company also recently hired a salesperson to market the Company's relocatable classrooms to customers in the States of Arizona and Nevada and to private schools and child care providers within California. Organized in 1982, the Company is a California corporation whose executive offices are located at 2830 Barrett Avenue, Perris, California 92571, and its telephone number is (909) 943-4014. The Company maintains a website that contains information concerning its products and personnel and copies of its most recent press releases, the address of which is http://www.modt.com. 4 6 RECENT DEVELOPMENTS The Company issued a press release on October 21, 1997, announcing operating results, for the third quarter ended September 30, 1997. Net sales for the third quarter ended September 30, 1997 were $39.8 million, compared to $14.3 million for the quarter ended September 30, 1996, an increase of 178%. Net sales for the nine months ended September 30, 1997 were $98.7 million, compared to $27.0 million for the nine months ended September 30, 1996, an increase of 266%. Operating income for the third quarter of 1997 was $7.2 million, compared to operating income of $1.5 million for the third quarter of 1996. Net income for the third quarter of 1997 was $4.4 million, or $0.45 per share, compared to $1.3 million, or $0.14 per share, for the third quarter of 1996, and net income for the nine months ended September 30, 1997 was $9.7 million, or $1.00 per share, compared to $2.2 million, or $0.24 per share, for the nine months ended September 30, 1996. Net income per share is computed on a fully diluted basis. At September 30, 1997, the Company's backlog was $85.0 million, compared to $80.4 million at June 30, 1997 and $40.0 million at September 30, 1996. THE OFFERING Common Stock offered by the Company........... 1,000,000 shares Common Stock offered by the Selling Shareholders................................ 2,000,000 shares Common Stock to be outstanding after the Offering(1)................................. 9,705,836 shares Use of proceeds by the Company................ Debt repayment, additions to working capital and other general corporate purposes. See "Use of Proceeds." Nasdaq National Market symbol................. MODT
- --------------- (1) Excludes 1,206,933 shares issuable upon exercise of outstanding options, and 196,667 shares available for the grant of additional options under the Company's stock option plans. See "Management -- Stock Options." 5 7 SUMMARY FINANCIAL AND OPERATING DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The historical income statement data, certain of the selected operating data, and the balance sheet data set forth below have been derived from the Company's audited and unaudited financial statements included elsewhere herein and should be read in conjunction with such financial statements and the notes thereto.
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ------------------------------- ------------------- 1994 1995 1996 1996 1997 ------- ------- ------- ------- ------- INCOME STATEMENT DATA: Net sales................................ $20,355 $19,386 $49,886 $12,704 $58,906 Gross profit............................. 2,589 2,985 7,257 1,842 11,218 Income from operations................... 1,035 1,372 4,912 994 9,036 Interest expense, net.................... (471) (387) (422) (107) (549) Net income............................... 602 965 4,269 889 5,195 Net income available for Common Stock(1)............................... 602 799 4,221 841 5,195 Earnings per common share(2)............. $ 0.11 $ 0.12 $ 0.47 $ 0.10 $ 0.55 Weighted average shares outstanding (in thousands)(2)...................... 5,294 6,712 9,041 8,750 9,370 SELECTED OPERATING DATA: Gross margin............................. 12.7% 15.4% 14.5% 14.5% 19.0% Operating margin......................... 5.1% 7.1% 9.8% 7.8% 15.3% Standard classrooms sold(3).............. 680 605 1,610 413 2,066 Backlog at period end(4)................. $ 7,000 $ 4,100 $58,000 $20,400 $80,400
AS OF JUNE 30, 1997 ------------------------ ACTUAL AS ADJUSTED(6) ------- -------------- BALANCE SHEET DATA Working capital....................................................... $26,647 $ 40,066 Total assets.......................................................... 58,387 71,806 Total liabilities..................................................... 37,800 24,468 Long-term debt, excluding current portion(5).......................... 15,132 1,800 Shareholders' equity.................................................. 20,587 47,338
- --------------- (1) After deduction of preferred stock dividends of $166,000 and $48,000 for the years ended December 31, 1995 and 1996, respectively, and $48,000 for the six months ended June 30, 1996. No preferred stock was outstanding during the six months ended June 30, 1997, and none currently is outstanding. See Note 11 of Notes to Financial Statements. (2) Computed on a fully diluted basis. (3) Determined by dividing the total square footage of floors sold during the year by 960 square feet, the floor area of a standard classroom. See "Business -- Modular Classrooms." (4) The Company manufactures classrooms to fill existing orders only, and not for inventory. Backlog consists of sales orders scheduled for completion during the next 12 months. (5) For a description of the Company's long-term debt, see Notes 5 and 6 of Notes to Financial Statements. (6) Adjusted to reflect the sale of 1,000,000 shares of Common Stock by the Company in the Offering at an assumed offering price of $28.625 per share, and the application of the estimated net proceeds therefrom. See "Use of Proceeds" and "Capitalization." 5 8 RISK FACTORS In addition to the other information in this Prospectus, the following risks and other factors should be considered carefully in evaluating the Company and its business before purchasing any of the Common Stock offered hereby. The statements contained in this Prospectus that are not purely historical are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including but not limited to statements regarding the Company's assumptions, expectations, anticipations, hopes, beliefs, plans, proposals, intentions or strategies regarding the future. Actual results could differ materially from those projected in any forward-looking statements as a result of a number of factors, including those detailed in this "Risk Factors" portion of this Prospectus as well as those set forth elsewhere in this Prospectus. The forward-looking statements are made as of the date of this Prospectus and the Company assumes no obligation to update the forward-looking statements, or to update the reasons why actual results could differ materially from those projected in the forward-looking statements. LEGISLATION AND SCHOOL FUNDING The demand for modular relocatable classrooms in California is affected by various statutes which, among other things, prescribe the way in which all school classrooms to be constructed on public lands must be designed and engineered, the methods by which the Company's customers, primarily individual school districts, obtain funding for the construction of new facilities, and the manner in which available funding is to be spent. The Company's business therefore is, to a material degree, dependent upon the legislative and educational policies and financial condition of the State of California. Funding for new school construction and rehabilitation of existing schools by California school districts currently is provided primarily at the State level, through annual allocations of funds derived from general revenue sources and statewide bond issues. In addition, school districts obtain funding for the purchase or lease of school facilities through the imposition of Developers' Fees and local bond issuances. The availability of this funding is subject to financial and political considerations which vary from district to district. The use of funding provided by the State is also affected by the legislative policies of the State of California. For example, California legislation currently requires, with certain exceptions, that 30% of new classroom space added using State funds must be relocatable structures. The Company's classroom units qualify as relocatable structures. There are, however, alternative structures that are less modular in nature than the Company's classrooms that may also satisfy this legislative requirement. Shortages of financial resources at either State or local levels, or changes in the legislative or educational policies of the State of California, could have a material adverse effect upon the Company. The California State School Facilities Conference Committee recently adopted a package of proposals that, if approved by the Legislature, would provide, among other things, for the inclusion on the June 1998 ballot of an $8.2 billion bond issue for school construction and a proposed amendment to the California Constitution that would reduce the percentage of voter approval required for local bond issues from that currently specified in Proposition 13. In addition, the provision of California legislation which requires that 30% of all new classrooms added using State funds be relocatable structures would be eliminated. As currently drafted, approval of each of these proposals is linked, and in order for any of them to become effective the $8.2 billion bond issue must be approved by a majority of the California voters and the proposed Constitutional Amendment must be approved by two-thirds of the California voters. See "Business -- Legislation and Funding." CYCLICAL INDUSTRY The Company's modular classrooms are purchased predominately by school districts in California. The ability of California school districts to finance the acquisition of the Company's products is largely dependent upon the level of funding available from the State. Although the need for additional classrooms remained unabated in the early to mid 1990's as California school districts continued to encounter student population growth, the increasing budget shortfalls that the State and many California school districts were experiencing imposed severe limitations on the levels of funding for the construction of schools. As a result, the Company experienced declines in net sales, and reported losses from 1991 through 1993, forcing it to reduce the number of production lines in operation from six at the end of 1991 to two at the end of 1993 and to reduce its workforce by approximately 53%. 6 9 The State of California recently has increased the amount of funds available for expenditures on school facilities, and the market for the Company's modular relocatable classrooms has grown rapidly, particularly since the implementation of the State's Class Size Reduction Program in November 1996. Since the beginning of 1995, the Company has re-opened three production lines and acquired a fourth line, resulting in six production lines in operation at the end of 1996. The Company currently is completing a seventh line and plans to open another line in 1998. However, there can be no assurance that the funding for school construction provided by the State of California will continue to increase, or even remain at current levels, in future periods particularly since the Class Size Reduction Program has already produced the desired result for over half of the student population in the target grade levels of kindergarten through the third grade. If demand for modular classrooms declines, or the Company's share of the market is reduced, the Company may again be faced with excess production capacity. On the other hand, if demand for the Company's classrooms were to increase to levels beyond current expectations, the Company's growth would be restricted by its production capacity unless and until the Company were able to construct or acquire additional production lines, at costs and over a period of time which might prove substantial. Primarily as a result of the adoption of the Class Size Reduction Program, the Company's net sales and profitability increased significantly in 1996, and have continued to increase during the first six months of 1997. Future operating results could be affected by a number of factors, including changes in the legislative and educational policies and financial condition of the State of California, reductions in sales and/or margins caused by competitive pressures and other factors, increases in operating costs including costs of raw materials, production, supplies, personnel, equipment and transportation, and increases in governmental regulation imposed under federal, state or local laws, including regulations applicable to environmental, labor and trade matters. For these reasons, among others, there can be no assurance that the Company will be able to sustain rates of revenue growth and profitability in future periods that are comparable to those experienced in the past one and one-half years. CONCENTRATION OF CUSTOMERS The Company's sales to date have been almost exclusively limited to sales of classrooms to customers in California, and the Company has sold only a limited number of classrooms to private schools and child care facilities. The Company markets and sells its modular classrooms primarily to California school districts, as well as to the State of California and leasing companies who lease the classrooms principally to school districts. Given the costs of transportation, the Company believes that it can compete cost-effectively primarily within a radius of approximately 300 miles from any one of its production facilities. Although parts of Nevada and Arizona are within such distance, neither Nevada nor Arizona has a legislative and regulatory environment regarding the construction and financing of schools that is comparable to that which has given rise to the modular relocatable classroom industry in California. During the year ended December 31, 1996, approximately 94% of the Company's net sales was attributable to the sale of classrooms, with sales of classrooms to individual school districts and third party lessors to school districts representing approximately 81% of the Company's net sales, and sales of classrooms directly to the State of California accounting for approximately 13% of net sales for the year. Unless and until the Company is successful in implementing its strategy for increasing sales out of state and of non-classroom products, the Company's operating results will continue to be largely dependent on sales of modular relocatable classrooms to California school districts. MANAGEMENT OF GROWTH The Company's business has grown rapidly during the past one and one-half years and such growth has placed and, if sustained, will continue to place significant demands on the Company's management and resources. The Company's work force increased to 832 employees at June 30, 1997, from 93 employees at December 31, 1995. The Company's future operating results will depend on management's ability to manage future growth and there can be no assurance that efforts to manage future growth will be successful. Should such growth continue, it is likely that the Company would be required to hire and train additional technical, marketing and administrative personnel, implement additional operating and financial controls, install additional reporting and management information systems for order processing, system monitoring, customer service and financial reporting, and otherwise improve coordination between the design and engineering, marketing, sales, manufacturing and finance functions. 7 10 From time to time the Company has reviewed possible acquisitions of other companies, with a view to expanding its operations to other geographic areas or acquiring the capability of manufacturing other, non-classroom products. Although it is not currently a party to any agreement or understanding with respect to any prospective acquisition, the Company expects that it will continue to explore possible acquisitions for the purpose of, among other things, implementing its strategies for reducing its dependence on sales of classrooms within California. Should the Company determine to make an acquisition to extend its operations outside of California, expand its non-classroom product line, increase its production capacity and/or market share within California, or add the capability of manufacturing more of the components used in the construction of its classrooms through one or more acquisitions, the completion of any such acquisition could require sizeable amounts of capital and is likely to involve the diversion of management's attention for other business concerns. There can be no assurance that any acquired operations will be integrated efficiently or prove profitable, and unexpected problems encountered in connection with any such acquisition could have a material adverse effect on the Company. DEPENDENCE ON KEY PERSONNEL The Company is dependent upon its executive officers, Evan M. Gruber and Michael G. Rhodes, and the loss of either of these key executive officers could have a material adverse effect on the Company. Although the Company has entered into an employment agreement with Mr. Gruber which continues through December 31, 1999, each of the these key executive officers may voluntarily terminate his employment with the Company at any time. The continued success of the Company also will depend upon its ability to attract and retain skilled employees. See "Management." PRODUCT SPECIFICATIONS AND REGULATION Most of the Company's contracts require the Company to build classrooms which meet certain established state mandated function and manufacturing specifications. Under such contracts, which are typically fixed-price contracts, the Company assumes the liability for correcting, without additional compensation, any deficiencies which cause its classrooms to fail inspection and certification tests. The Company relies upon its experience and expertise to evaluate the potential for such liability inherent in prospective projects and to price its bids accordingly. In addition, the Company attempts to minimize the risk of additional exposure by adopting strict quality control standards, and subjecting its units under construction to extensive testing under the supervision of inspectors hired by the Company's customers. To date, the Company's operating performance has not been materially impacted adversely by such liability. However, should the Company incur such liability significantly in excess of that estimated, its profitability would be adversely affected. See "Business -- Marketing; -- Manufacturing; -- Regulation." COMPETITION The modular relocatable classroom industry is highly competitive, with the market divided among a number of privately owned companies each of whose share of the market the Company believes is smaller than that of the Company. In addition, other firms with resources greater than the Company's, including mobile home and modular office builders and recreational vehicle manufacturers, may enter into competition with the Company in the future. Furthermore, as the Company attempts to implement its strategy to increase sales outside of California and to increase its sales of non-classroom products, it is anticipated that it will encounter new competitors with more experience and a more established position than the Company in those markets. There can be no assurance that the Company will not encounter increased competition in the future which could limit the Company's ability to maintain or increase its market share and could adversely effect the Company's prices, gross margins, and overall operating results. See "Business -- Competition." 8 11 FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; SEASONALITY The Company's quarterly revenue typically has been highest in the second and third quarters of the year when school districts generally place a large number of orders for modular classrooms to be delivered in time for the upcoming school year. Additionally, first and fourth quarter revenues typically are lower due to a greater number of holidays and days of inclement weather during such periods. The Company's operating results may vary significantly from quarter to quarter due to a variety of factors including legislative and funding developments, changes in the Company's product and customer mix, the availability and cost of raw materials, the introduction of new products by the Company or its competitors, pricing pressures, general economic and industry conditions that affect customer demand, and other factors. The Company's results of operations for any quarter would be adversely affected if orders are not shipped in any quarter as anticipated. FLUCTUATION OF STOCK PRICE In recent periods, there has been a relatively limited market for the Company's Common Stock, and the market price for a share of the Company's Common Stock has fluctuated significantly. See "Market Information and Related Matters." Although both the number of shares of the Common Stock outstanding in the public float and the number of the Company's shareholders are expected to increase significantly following the Offering, there can be no assurance that a more active trading market for the Common Stock will develop or be sustained following the Offering. Factors such as quarterly variations in the Company's results of operations, trends in the Company's industry and market conditions generally, and the limited and sporadic trading volume of the Company's Common Stock which has been experienced from time to time, have caused, and may continue to cause, the market price of the Company's Common Stock to fluctuate significantly. In addition, the stock markets have experienced extreme price and volume fluctuations during certain periods. These broad market fluctuations and other factors may adversely affect the market price of the Company's Common Stock for reasons unrelated to the Company's operating performance. Accordingly, the price at which shares are offered hereby should not be considered an indication of any price at which the Common Stock may trade in the future. SHARES ELIGIBLE FOR FUTURE SALE Of the 9,705,836 shares of the Company's Common Stock to be outstanding immediately following this Offering, 4,649,081 shares are held by affiliates of the Company but are not subject to the restrictions on resale under the Securities Act of 1933, as amended (the "Securities Act"), having been registered for public resale from time to time under the Securities Act. All of these shares (with certain limited exceptions) are subject to agreements which restrict their public sale for 180 days after the date of this Prospectus without prior approval of Bear, Stearns & Co. Inc. In addition, the Company has registered 1,650,000 shares of Common Stock issuable upon exercise of options granted and to be granted under the Company's existing stock option plans. Sales of substantial amounts of these shares, or even the potential for such sales, could have a depressive effect on the market price of shares of the Company's Common Stock and could impair the Company's ability to raise capital through the sale of its equity securities. CONTROL BY EXISTING MANAGEMENT Upon completion of this Offering, the current executive officers and directors of the Company will continue to own or have voting control over, in the aggregate, approximately 30% of the shares of the Company's Common Stock then outstanding. Accordingly, the Company's current management will continue to be able to significantly influence the outcome of elections of directors and other matters presented to a vote of shareholders. See "Principal and Selling Shareholders." ABILITY TO ISSUE PREFERRED STOCK; ANTI-TAKEOVER DEVICES The Company is authorized to issue up to 5,000,000 shares of Preferred Stock in one or more series, the terms of which may be determined at the time of issuance by the Board of Directors, without further action by the Company's shareholders, and may include voting rights, preferences as to dividends and liquidation, 9 12 conversion and redemptive rights and sinking fund provisions. Although the Company currently has no plans to issue any shares of Preferred Stock, the issuance of Preferred Stock in the future could affect the rights of the holders of the Company's Common Stock and thereby reduce the value of the Common Stock. In particular, specific rights granted to future holders of Preferred Stock could be used to restrict the Company's ability to merge with or sell its assets to a third party, or otherwise delay, discourage, or prevent a change in control of the Company. In addition, the Company's Articles of Incorporation provide for the elimination of cumulative voting and the classification of the Company's Board of Directors in certain circumstances, provisions which are also likely to delay, discourage, or prevent a change in control of the Company. The Company has been advised by the Underwriters that the number of holders of the Company's Common Stock is likely to increase to at least 800 as a consequence of this Offering, in which event the Company intends to cause these provisions of its Articles of Incorporation to become operative by electing a classified Board of Directors, without cumulative voting, at the next annual meeting of shareholders. USE OF PROCEEDS The net proceeds to the Company from the sale of the 1,000,000 shares of Common Stock offered by the Company are estimated to be approximately $26.8 million, based on an assumed offering price of $28.625 per share (the last reported sales price for a share of the Company's Common Stock on The Nasdaq National Market on October 13, 1997), and after deduction of underwriting discounts and commissions and estimated offering expenses payable by the Company. The Company will not receive any proceeds from the sale of shares by the Selling Shareholders. The Company plans to use a portion of the net proceeds to repay amounts then outstanding under the Company's $20.0 million revolving loan agreement with a bank (the "Credit Facility"). As of September 30, 1997, borrowings of $12.6 million were outstanding under the Credit Facility. Amounts borrowed under the Credit Facility are secured by substantially all of the Company's assets, bear interest at a floating rate equal to 0.75% above the lender's reference rate, and must be repaid in full by September 30, 2000. The Company expects that it will continue to use the Credit Facility as a source of working capital after this Offering is consummated. The remaining net proceeds are expected to be used as additions to working capital to finance higher levels of accounts receivable and inventories, and for other general corporate purposes. Pending the uses described herein, it is anticipated that all or a portion of the net proceeds will be invested in high quality income-producing instruments such as short-term corporate investment grade or United States Government interest-bearing securities. 10 13 MARKET INFORMATION AND RELATED MATTERS The Company's Common Stock is currently traded on The Nasdaq National Market under the symbol "MODT." The following table sets forth on a per share basis the high and low closing sales prices per share for the Common Stock on The Nasdaq National Market for the periods indicated.
HIGH LOW ------- ------- 1995 First Quarter............................................ $ 1.750 $ 1.125 Second Quarter........................................... 1.875 1.125 Third Quarter............................................ 2.625 1.188 Fourth Quarter........................................... 2.375 1.875 1996 First Quarter............................................ 3.625 2.250 Second Quarter........................................... 5.750 2.875 Third Quarter............................................ 9.625 3.500 Fourth Quarter........................................... 9.500 6.875 1997 First Quarter............................................ 13.875 7.875 Second Quarter........................................... 13.000 10.625 Third Quarter............................................ 25.250 11.625 Fourth Quarter (through October 13)...................... 28.625 21.625
On October 13, 1997, the closing sales price on The Nasdaq National Market for a share of the Company's Common Stock was $28.625. The approximate number of holders of record of the Company's Common Stock as of September 30, 1997, was 78. DIVIDEND POLICY The Company has not paid cash dividends on its Common Stock since 1990. The Board of Directors currently intends to follow a policy of retaining all earnings, if any, to finance the continued growth and development of the Company's business and does not anticipate paying cash dividends in the foreseeable future. Any future determination as to the payment of cash dividends will be dependent upon the Company's financial condition and results of operations and other factors deemed relevant by the Board of Directors. Moreover, the Company's Credit Facility currently prohibits the payment of cash dividends. 11 14 CAPITALIZATION The following table sets forth the capitalization of the Company as of June 30, 1997, and as adjusted to give effect to receipt by the Company of the net proceeds from the sale of the 1,000,000 shares of Common Stock offered by the Company hereby (assuming a public offering price of $28.625 per share) and the anticipated application of the net proceeds therefrom. See "Use of Proceeds."
JUNE 30, 1997 ----------------------- ACTUAL AS ADJUSTED ------- ----------- (IN THOUSANDS) Long-term debt (1): Bank debt (less current portion).................................... $13,332 $ -- Industrial development bonds........................................ 1,800 1,800 ------- ------- Total long-term debt........................................ 15,132 1,800 ======= ======= Shareholders' equity: Preferred Stock, $0.01 par value: 5,000,000 shares authorized; none issued and outstanding........................................... -- -- Common Stock, $0.01 par value: 20,000,000 shares authorized, 8,679,000 shares outstanding(2), (9,679,000 shares outstanding as adjusted)........................................................ 4,043 4,053 Additional paid-in capital............................................ 15,744 42,485 Retained earnings..................................................... 800 800 ------- ------- Total shareholders' equity....................................... 20,587 47,338 ------- ------- Total capitalization........................................ $35,719 $49,138 ======= =======
- --------------- (1) For a description of the Company's long-term debt, see Notes 5 and 6 of Notes to Financial Statements. (2) Excludes 1,206,933 shares issuable upon exercise of currently outstanding options, and 196,667 shares available for the grant of additional options under the Company's stock option plans. See "Management -- Stock Options." 12 15 SELECTED FINANCIAL DATA (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) The selected income statement and balance sheet data set forth below for the three years ended December 31, 1994, 1995 and 1996 have been derived from the audited financial statements of the Company included elsewhere herein. The selected income statement and balance sheet data set forth below for the years ended December 31, 1992 and 1993 have been derived from audited financial statements of the Company that are not included herein. The selected income statement and balance sheet data for the six month periods ended June 30, 1996 and 1997 have been derived from the unaudited financial statements of the Company included elsewhere herein and, in the opinion of management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of the Company's operations for such periods. The selected income statement and balance sheet data set forth below should be read in conjunction with those financial statements (including the notes thereto) and with "Management's Discussion and Analysis of Results of Operations and Financial Condition" also included elsewhere herein. The results of the Company's operations for the six months ended June 30, 1997 are not necessarily indicative of results to be expected for any future period or the fiscal year ending December 31, 1997.
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ------------------------------------------------------- ------------------- 1992 1993 1994 1995 1996 1996 1997 ------- ------- ------- ------- ------- ------- ------- INCOME STATEMENT DATA: Net sales...................................... $31,192 $19,658 $20,355 $19,386 $49,886 $12,704 $58,906 Cost of sales.................................. 30,601 21,764 17,766 16,401 42,629 10,862 47,688 ------- ------- ------- ------- ------- ------- ------- Gross profit (loss)............................ 591 (2,106) 2,589 2,985 7,257 1,842 11,218 Selling, general and administrative expenses... 2,193 1,871 1,554 1,613 2,345 848 2,182 Restructuring charge(1)........................ -- 2,470 -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- Income (loss) from operations.................. (1,602) (6,447) 1,035 1,372 4,912 994 9,036 Interest expense, net.......................... (705) (565) (471) (387) (422) (107) (549) Other income (expense)......................... (19) 47 42 (1) (13) 22 64 ------- ------- ------- ------- ------- ------- ------- Income (loss) before income taxes.............. (2,326) (6,965) 606 984 4,477 909 8,551 Provision for income taxes..................... 40 1 4 19 208 20 3,356 ------- ------- ------- ------- ------- ------- ------- Net income (loss).............................. (2,366) (6,966) 602 965 4,269 889 5,195 ======= ======= ======= ======= ======= ======= ======= Net income (loss) available for Common Stock(2)..................................... $(2,366) $(6,966) $ 602 $ 799 $ 4,221 $ 841 $ 5,195 ======= ======= ======= ======= ======= ======= ======= Earnings (loss) per common share(3)............ $ (0.64) $ (1.97) $ 0.11 $ 0.12 $ 0.47 $ 0.10 $ 0.55 Weighted average shares outstanding (in thousands)(3)................................ 3,701 3,529 5,294 6,712 9,041 8,750 9,370
AS OF DECEMBER 31, AS OF JUNE 30, ------------------------------------------------------- ------------------- 1992 1993 1994 1995 1996 1996 1997 ------- ------- ------- ------- ------- ------- ------- BALANCE SHEET DATA: Working capital................................ $ 6,263 $ 3,063 $ 4,403 $ 4,383 $14,069 $ 7,738 $26,647 Total assets................................... 28,903 16,620 15,919 15,154 34,029 21,833 58,387 Total liabilities.............................. 17,193 11,889 7,900 6,411 18,716 11,712 37,800 Long-term debt, excluding current portion(4)... 6,075 6,506 4,400 3,590 7,844 5,642 15,132 Shareholders' equity........................... 11,709 4,732 8,019 8,743 15,313 10,121 20,587
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ------------------------------------------------------- ------------------- 1992 1993 1994 1995 1996 1996 1997 ------- ------- ------- ------- ------- ------- ------- SELECTED OPERATING DATA: Gross margin................................... 1.9% (10.7%) 12.7% 15.4% 14.5% 14.5% 19.0% Operating margin............................... (5.1%) (32.8%) 5.1% 7.1% 9.8% 7.8% 15.3% Standard classrooms sold(5).................... 899 698 680 605 1,610 413 2,066 Backlog at period end(6)....................... $13,000 $ 6,000 $ 7,000 $ 4,100 $58,000 $20,400 $80,400
- --------------- (1) Reflects the write-off of intangible assets related to the Company's 1989 purchase of "Del-Tec", which manufactured more extensively customized, higher priced units, whose operations were discontinued in the third quarter of 1993. (2) After deduction of preferred stock dividends paid or accrued of $166,000 and $48,000 for the years ended December 31, 1995 and 1996, respectively, and $48,000 for the six months ended June 30, 1996. No shares of the Company's preferred stock were outstanding during the six months ended June 30, 1997, and no shares currently are outstanding. See Note 11 of Notes to Financial Statements. (3) Computed on a fully diluted basis. (4) For a description of the Company's long-term debt, see Notes 5 and 6 of Notes to Financial Statements. (5) Determined by dividing the total square footage of floors sold during the year by 960 square feet, the floor area of a standard classroom. See "Business -- Modular Classrooms." (6) The Company manufactures classrooms to fill existing orders only, and not for inventory. Backlog consists of sales orders scheduled for completion during the next 12 months. 13 16 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION GENERAL Since its inception in 1982, the Company's principal business has been the design, manufacture, marketing and installation of modular relocatable classrooms. The Company's primary customers consist of individual school districts located in California and the State of California. The need for new classrooms in California school districts is generally governed by the number of students per class, which is a function of the net migration of families into and out of school districts and the total number of new students entering the school system in any given year. Specific provisions of California legislation govern the amount of the State's budget which must be directed toward the public school system. A portion of these funds may be allocated for the addition of new classrooms. In addition, the State can raise funds to build or add new classrooms through the issuance of general obligation bonds. One condition currently governing the receipt of State funding for new classroom additions is that at least 30% of the classroom space to be added must be relocatable structures, unless the school district can demonstrate that the use of such structures is not practical in any given situation. See "Business -- Legislation and Funding." In the early to mid 1990's, California suffered through a recession that resulted in statewide budgetary constraints. During this period, the amount of State funds available for the addition of new classrooms was severely limited. As a result, the Company experienced a decline in net sales in 1992 and 1993, and net sales in 1994 and 1995 were essentially the same as those generated in 1993. In response, the Company initiated a cost control program which included layoffs of approximately 80% of its staff as compared to the June 1991 work force, and temporarily closed its plant in Lathrop, California. In addition, the Chief Executive Officer of the Company agreed to a 50% salary reduction and each of the Company's other top management personnel agreed to a 10% salary reduction. Due in large measure to the amelioration of the State budget crises and the realization that the need for new classrooms in California far exceeded supply, beginning in the second half of 1996 and continuing into 1997, the State has increased the amount of funds targeted specifically for the addition of new classrooms. In November 1996, the State implemented the Class Size Reduction Program, the goal of which is to reduce public school class sizes in kindergarten through the third grade. For the 1996-1997 school year the State spent $822 million under this program, including $200 million specifically for facilities, which may be relocatable classrooms. Primarily as a result of the implementation of the Class Size Reduction Program, the Company's net sales increased to $49.9 million for the year ended December 31, 1996, compared to $19.4 million in 1995, and have increased to $58.9 million for the first half of 1997, compared to $12.7 million in the first six months of 1996. Although the State's upcoming budget has not been finalized, based upon information available to it, the Company believes that total State funding under the Class Size Reduction Program for the 1997-1998 school year will be as high as $1.5 billion for both general operations and school facilities. In addition, an $8.2 billion school construction bond issue has been proposed, as part of a package of legislation, for inclusion on the June 1998 California ballot, the proceeds of which, if on the ballot and approved by the voters, would be used to construct and modernize existing school facilities, acquire land to build new schools, and construct or add classrooms. See "Business -- Legislation and Funding." In response to the increased demand for its modular relocatable classrooms, the Company re-opened the Northern California Lathrop plant in 1997, is expanding its Southern California production capacity in Perris, and intends to further expand production capacity at the Lathrop plant in late 1998. 14 17 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, the percentages of net sales represented by certain items in the Company's statements of operations. PERCENTAGE OF NET SALES
SIX MONTHS YEARS ENDED DECEMBER 31, ENDED JUNE 30, ----------------------------- ----------------- 1994 1995 1996 1996 1997 ----- ----- ----- ----- ----- Net sales.................................. 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales.............................. 87.3 84.6 85.5 85.5 81.0 ------ ------ ------ ------ ------ Gross profit............................... 12.7 15.4 14.5 14.5 19.0 Selling, general and administrative expenses................................. 7.6 8.3 4.7 6.7 3.7 ------ ------ ------ ------ ------ Income from operations..................... 5.1 7.1 9.8 7.8 15.3 Interest expense, net...................... (2.3) (2.0) (0.8) (0.8) (0.9) Other income............................... 0.2 -- -- 0.2 0.1 ------ ------ ------ ------ ------ Income before income taxes................. 3.0 5.1 9.0 7.2 14.5 Provision for income taxes................. -- 0.1 0.4 0.2 5.7 ------ ------ ------ ------ ------ Net income................................. 3.0% 5.0% 8.6% 7.0% 8.8% ====== ====== ====== ====== ======
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996 Net sales for the six months ended June 30, 1997 were $58.9 million, an increase of $46.2 million, or approximately 364%, over net sales of $12.7 million for the six months ended June 30, 1996. The increase in net sales is principally attributable to the economic recovery of the State of California and the continued implementation of the Class Size Reduction Program for kindergarten through third grade classes in California's public elementary schools, which was adopted in 1996. Gross profit for the six months ended June 30, 1997 was $11.2 million, an increase of $9.4 million over gross profit of $1.8 million for the same period in 1996. Gross profit as a percentage of net sales for the six months ended June 30, 1997 was 19.0%, compared to 14.5% for the same period in 1996. The increase was due to the increased volume, utilization of a previously idle facility, and the realization of manufacturing efficiencies. Selling, general and administrative expenses for the six months ended June 30, 1997 totaled $2.2 million, representing an increase of $1.3 million over the $848,000 in selling, general and administrative expenses incurred for the six months ended June 30, 1996. The increase was primarily due to an increase in the number of employees required to handle the greater sales volume. However, as a percentage of net sales, selling, general and administrative expenses decreased to 3.7% for the six months ended June 30, 1997, from 6.7% for the same period in 1996, largely as a result of the Company's strategy of controlling selling, general and administrative expenses in a period of growth. Due to increased volume and average borrowings outstanding, net interest expense increased from $107,000 for the six months ended June 30, 1996 to $549,000 for the six months ended June 30, 1997. The provision for income taxes was $3.4 million for the six months ended June 30, 1997, compared to $20,000 for the six months ended June 30, 1996. The Company's effective tax rate increased to 39.3% for the six months ended June 30, 1997, compared to 2.2% for the six months ended June 30, 1996. The effective tax rate for the six months ended June 30, 1996 was favorably impacted by the federal income tax benefit of remaining net operating loss carryforwards that were generated in prior years. 15 18 YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Net sales for the year ended December 31, 1996 increased to $49.9 million, an increase of $30.5 million, or approximately 157%, from $19.4 million in 1995. The increase in 1996 was due principally to the amelioration of the State of California budget deficit and the implementation during the year of the Class Size Reduction Program for kindergarten through third grade classes in California's public elementary schools. For the year ended December 31, 1996, gross profit was $7.3 million, an increase of $4.3 million, or approximately 143%, over 1995 gross profit of $3.0 million. However, as a percentage of net sales, gross profit declined to 14.5% in 1996, from 15.4% in 1995. The decline of gross profit as a percentage of net sales was primarily attributable to a change in product mix as the Company focused its resources on manufacturing more standardized classrooms which could be sold in greater numbers. In 1996, selling, general and administrative expenses increased to $2.3 million from $1.6 million, due to increases in the number of employees and an increase in selling costs. However, because net sales increased substantially during the year, selling, general and administrative expenses as a percentage of net sales decreased to 4.7% in 1996 from 8.3% in 1995. For the year ended December 31, 1996, net interest expense increased by $35,000, from $387,000 in 1995 to $422,000 in 1996, due to slightly higher borrowings to finance growing levels of accounts receivables and work-in-progress inventories attributable to the large 1996 increase in net sales. The provision for income taxes was $208,000 for the year ended December 31, 1996, compared to $19,000 for the year ended December 31, 1995. The Company's effective tax rate increased to 4.6% for the year ended December 31, 1996, from 1.9% for the year ended December 31, 1995, due to differences between financial and tax accounting treatment of certain items, primarily accrued liabilities. The effective tax rate in both periods was positively impacted by the utilization for federal income tax purposes of net operating loss carryforwards generated in prior years. YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994 Net sales for the year ended December 31, 1995 were $19.4 million, a decrease of $969,000, or approximately 5%, from 1994 net sales of $20.4 million. This slight decline in net sales from year to year was indicative of a stabilized market during the California recession. Although net sales were slightly lower in 1995 than in 1994, gross profit increased to $3.0 million in 1995, an increase of $396,000, or approximately 15%, from $2.6 million in 1994. Gross profit as a percentage of sales increased to 15.4% in 1995 from 12.7% in 1994. These increases were primarily due to savings associated with the Company's cost cutting measures initiated in 1993. In 1995 and 1994, selling, general and administrative expenses remained at approximately $1.6 million. However, selling, general and administrative expenses as a percentage of net sales increased to 8.3% in 1995, from 7.6% in 1994, as a result of the slight decline in 1995 net sales. Net interest expense for the year ended December 31, 1995 decreased from $471,000 in 1994 to $387,000 in 1995, as borrowing decreased during part of the year due to a decline in sales. In addition, the Company was able to reduce its borrowing by utilizing the proceeds from the 1994 Financing described below under "Liquidity and Capital Resources." The provision for income taxes was $19,000 for the year ended December 31, 1995, compared to $4,000 for the year ended December 31, 1994. The Company's effective tax rate increased to 1.9% for the year ended December 31, 1995, from 0.7% for the year ended December 31, 1994, due to differences between financial and tax accounting treatment of certain items, primarily accrued liabilities. The effective tax rate in both periods was positively impacted by the utilization for federal income tax purposes of net operating loss carryforwards generated in prior years. INFLATION The Company does not believe that inflation had a material effect on its results of operations during the past two years. However, there can be no assurance that the Company's business will not be affected by inflation in the future. 16 19 QUARTERLY RESULTS The Company's quarterly operating results may fluctuate significantly due to a variety of factors, including changes in the Company's product and customer mix, the introduction of new products by the Company or its competitors, pricing pressures, general economic conditions and other factors. In addition, it can be expected that the Company will continue to incur product development, marketing and promotional expenses based upon management's expectations as to future sales. Since many of these expenses are committed in advance, the Company generally is unable to adjust spending in a timely manner to compensate for any unexpected shortfall in sales. If operating revenues do not meet the Company's expectations in any given quarter, quarterly operating results may be adversely affected. There can be no assurance that the Company will be profitable in any given quarter. Historically, the Company's quarterly revenues have been highest in the second and third quarters of each calendar year because a large number of orders for modular classrooms placed by school districts require that classrooms be constructed, delivered and installed in time for the upcoming new school year, which generally commences in September. Additionally, first and fourth quarter revenues are typically lower due to a greater number of holidays and days of inclement weather during such periods. The Company typically has been able to add employees as needed to respond to the corresponding increases in manufacturing output required to meet this seasonal demand. In addition, the Company's operating margins may vary on a quarterly basis depending upon the mix of revenues between standardized classrooms and higher margin customized classrooms and the timing of the completion of large, higher margin customized contracts. The following table sets forth certain quarterly financial data for each of the four quarters in 1995 and 1996 and the first two quarters of 1997 which has been derived from unaudited financial statements that, in the opinion of management, reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such quarterly information. The operating results for any quarter are not necessarily indicative of the results to be expected for any future quarter. In contrast to the typical seasonality of the Company's business, net sales in the fourth quarter of 1996 were much higher than in any other quarter of that year, reflecting the increasing demand for the Company's classrooms experienced in recent periods.
QUARTER ENDED -------------------------------------------------------------------------------------------- FISCAL 1995 FISCAL 1996 FISCAL 1997 ---------------------------------- ----------------------------------- ----------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 30, JUNE 30, 1995 1995 1995 1995 1996 1996 1996 1996 1997 1997 -------- ------- -------- ------- ------- ------- -------- -------- ------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net sales.............. $3,665 $5,712 $6,758 $3,251 $3,621 $9,083 $14,285 $22,897 $25,813 $33,093 Gross profit........... 516 877 958 634 433 1,409 2,121 3,294 4,376 6,842 Income from operations........... 123 412 630 207 117 877 1,498 2,420 3,338 5,698 Interest income (expense)............ (100) (138) (182) 33 (38) (70) (142) (172) (219) (330) Income before income taxes................ 21 280 457 226 97 812 1,378 2,190 3,135 5,416 Net income............. 21 280 457 207 97 792 1,329 2,051 1,912 3,283 Net income available for Common Stock(1)............. 21 280 457 41 97 744 1,329 2,051 1,912 3,283 Net income per common share(2)............. $ 0.01 $ 0.04 $ 0.07 $ 0.00 $ 0.01 $ 0.09 $ 0.14 $ 0.23 $ 0.20 $ 0.35 Weighted average shares outstanding(2)....... 6,123 6,128 6,550 6,712 7,358 8,750 9,200 9,041 9,350 9,370
- --------------- (1) After deduction of preferred stock dividends paid or accrued of $166,000 and $48,000 in the quarters ended December 31, 1995 and June 30 1996, respectively. No shares of the Company's preferred stock were outstanding during the six months ended June 30, 1997, and no shares currently are outstanding. See Note 11 of Notes to Financial Statements. (2) Computed on a fully diluted basis. 17 20 LIQUIDITY AND CAPITAL RESOURCES Since the 1994 Financing described below, the Company has funded its operations and capital expenditures with cash generated internally by operations, supplemented by borrowings under various credit facilities. During the years ended December 31, 1994, 1995 and 1996, and the six months ended June 30, 1997, the Company's operations provided (used) cash in the amounts of approximately $428,000, $1.2 million, ($4.9 million) and ($4.5 million), respectively. At June 30, 1997, the Company had approximately $2.7 million in cash. In September 1997, the Company amended its Credit Facility to increase the amount which the Company is entitled to borrow thereunder and extend the term of the commitment to September 30, 2000. The Company is entitled to borrow, from time to time, up to $20.0 million, with actual borrowings limited to specified percentages of eligible accounts receivable, equipment and inventories. On June 30, 1997, the Company was entitled to borrow up to the maximum amount of the Credit Facility, and approximately $13.3 million was outstanding. Interest on outstanding balances is payable at a floating rate equal to 0.75% above the lender's reference rate. Borrowings are secured by substantially all of the Company's assets. The Company had working capital of $4.4 million, $14.1 million and $26.6 million at December 31, 1995, December 31, 1996 and June 30, 1997, respectively. In the first six months of 1997, current assets increased by $24.4 million, with an increase of $18.3 million in contracts receivable and an increase of $3.7 million in inventories, primarily as a result of the increase in net sales for the period. Current liabilities increased by $11.8 million, with accrued liabilities and billings in excess of costs and estimated earnings increasing by $5.4 million and $5.7 million, respectively, as a result of the higher level of net sales. In 1996, contracts receivable, costs and estimated earnings in excess of billings on contracts, and inventories increased by $7.1 million, $7.6 million, and $3.5 million, respectively, as the Company's net sales increased significantly during the second half of the year following implementation of the State's Class Size Reduction Program. Accounts payable and accrued liabilities increased by $5.3 million and $2.3 million, respectively, in 1996, also as a result of the increase in net sales. Capital expenditures amounted to $482,000, $2.0 million and $570,000 during the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997, respectively. In 1995, the majority of these expenditures was concentrated on maintenance of equipment. Capital expenditures increased significantly in 1996 primarily as a result of the re-opening of the Company's Lathrop, California manufacturing facility. In September 1997, the Company began construction of an additional production line at one of its Perris, California facilities. The Company estimates that 1997 capital expenditures, including the costs of this additional production line, will total approximately $2.0 million. The Company expects that capital expenditures in 1998 will be approximately $2.0 million, which includes the costs of adding a new production line at the Northern California plant in Lathrop in late 1998. The Company has a $4.0 million Industrial Development Bond issued by the Industrial Development Authority of the County of San Joaquin, California, the net proceeds of which were used to partially finance the $6.0 million cost of construction of the Company's Lathrop, California facility. The loan to the Company must be repaid over a 26 year period, and bears interest at a variable rate (initially 6.75% per annum), which is repriced weekly, subject to conversion to a fixed rate at the option of the Company under certain conditions. The Company's obligation to make payments of principal and interest on this loan is secured by an irrevocable letter of credit obtained by the Company from Union Bank of California N.A. Accordingly, the Company's borrowing capacity will be reduced during the period the letter of credit is outstanding. As of June 30, 1997, $1.9 million principal amount of this loan remained outstanding. In May 1994, the Company raised net proceeds of approximately $2.7 million through the sale of 2,850,000 shares of Series A Preferred Stock to several private investors who are Selling Shareholders in this Offering (the "1994 Financing"). In April 1996, all of the Series A Preferred Stock was converted into 2,850,000 shares of Common Stock. In December 1996, warrants issued to the investors in connection with the 1994 Financing were exercised, resulting in cash proceeds to the Company of approximately $1.6 million and the issuance of 2,204,000 additional shares of Common Stock. 18 21 Management believes that the Company's existing product lines and manufacturing capacity will enable the Company to generate sufficient cash through operations, supplemented by the net proceeds to the Company from this Offering and continued use of its existing line of credit, to finance the Company's business over the next twelve months. However, additional cash resources may be required if the Company's rate of growth exceeds currently anticipated levels. Moreover, it may prove necessary for the Company to construct or acquire additional manufacturing facilities in order for the Company to compete effectively in new market areas or states which are beyond a 300 mile radius from one of its production facilities. The construction or acquisition of new facilities could require significant additional capital. NEW ACCOUNTING PRONOUNCEMENTS In March 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"), effective for fiscal years ending after December 15, 1997. SFAS 128 introduces and requires the presentation of "basic" earnings per share which represents net earnings divided by the weighted average shares outstanding excluding all common stock equivalents. Dual presentation of "diluted" earnings per share, reflecting the dilutive effects of all common stock equivalents, will also be required. The diluted presentation is similar to the current presentation of fully diluted earnings per share. Management has not determined whether the adoption of SFAS 128 will have a material impact on the Company's combined financial position or results of operations. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for the reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general- purpose financial statements. SFAS 130 requires all items that are required to be recognized under accounting standards as components of comprehensive income to be reported in a financial statement that is displayed with the same prominence as other financial statements. SFAS 130 does not require a specific format for that financial statement but requires that an enterprise display an amount representing total comprehensive income for the period covered by that financial statement. SFAS 130 requires an enterprise to (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS 130 is effective for fiscal years beginning after December 15, 1997. Management has not determined whether the adoption of SFAS 130 will have a material impact on the Company's combined financial position or results of operations. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 establishes standards for public business enterprises to report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise," but retains the requirement to report information about major customers. It amends FASB Statement No. 94, "Consolidation of All Majority-Owned Subsidiaries," to remove the special disclosure requirements for previously unconsolidated subsidiaries. SFAS 131 requires, among other items, that a public business enterprise report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets, information about the revenues derived from the enterprise's products or services, and major customers. SFAS 131 also requires that the enterprise report descriptive information about the way that the operating segments were determined and the products and services provided by the operating segments. SFAS 131 is effective for financial statements for periods beginning after December 15, 1997. In the initial year of application, comparative information for earlier years is to be restated. SFAS 131 need not be applied to interim financial statements in the initial year of its application, but comparative information for interim periods in the initial year of application is to be reported in financial statements for interim periods in the second year of application. Management has not determined whether the adoption of SFAS 131 will have a material impact on the Company's segment reporting. 19 22 BUSINESS GENERAL The Company designs, manufactures, markets and installs modular relocatable classrooms. Based upon 1996 net sales, the Company believes that it is the largest manufacturer of modular relocatable classrooms in California. The Company's classrooms are sold primarily to California school districts and to third parties and the State of California principally for lease to California's school districts. The Company's products include standardized classrooms, as well as customized structures for use as libraries, gymnasiums, computer rooms and bathroom facilities. The Company believes that its modular structures can be substituted for virtually any part of a school. The Company's products are engineered and constructed in accordance with structural and seismic safety specifications adopted by the California Department of State Architects which regulates all school construction on public land, standards which are more rigorous than the requirements for other portable units. As a result of net enrollment increases in California schools and budgetary constraints experienced by the State of California which limited the availability of funds for the addition of new classrooms over the last few years prior to 1996, California's schools are reported to be among the most crowded in the nation. As the State budget deficit has ameliorated, the legislature has increased funding for new classrooms in an effort to reduce the average number of students per class. State funding initiatives include funds from both (i) the State's operating budget, such as the $200 million allocated for construction or addition of classrooms out of the total of $822 million spent under the Class Size Reduction Program for the 1996-1997 school year and as much as $1.5 billion allocated for the 1997-1998 school year for both general operations and school facilities, and (ii) the sale of statewide bond issues, such as the $8.2 billion bond issue for school construction, including the addition of classrooms, proposed as part of a package of legislation for inclusion on the June 1998 ballot. See "Business -- Legislation and Funding." These factors have combined to increase the demand for modular relocatable classrooms, which cost significantly less and take much less time to construct and install than conventional school facilities, and which permit a school district to relocate the units as student enrollments shift. In addition, the Company's products provide added flexibility to school districts in financing the costs of adding classroom space, since modular relocatable classrooms are considered personal property which can be financed out of a district's operating budget in addition to its capital budget. In recognition of these advantages, California legislation currently requires, with certain exceptions, that at least 30% of all new classroom space added using state funds must be relocatable structures. See "Business -- Legislation and Funding." STRATEGY The Company's objective is to maintain and enhance its position as the leading provider of modular relocatable classrooms to California's school districts, and to diversify its business by obtaining new customers for its classrooms both within and outside California and by further developing its non-classroom business. The Company has adopted the following strategies to achieve these goals: (i) further expand production capacity to meet the increased demand for modular relocatable classrooms in California; (ii) increase market share in California by developing products designed and engineered to meet a variety of customer needs that can be manufactured and sold at competitive prices; (iii) expand the market for its modular relocatable classrooms to include private schools and day care facilities in California and public and private schools and day care facilities out of state; (iv) expand its non-classroom product line; and (v) continue to refine its manufacturing processes to increase profit margins on modular relocatable classrooms. Expand Capacity: As a result of increased demand for modular relocatable classrooms, the Company currently is operating at or near capacity at both its Southern California and Northern California manufacturing facilities. The Company operates a total of six production lines in four plants, and is currently adding a seventh production line to serve the Southern California market. This line is expected to be fully operational by the end of 1997. The Company is also planning to add an eighth production line to serve the Northern California market in late 1998. Increase Market Share: The Company believes that it has attained its position as the largest manufacturer of modular relocatable classrooms in California because of its ability to increase production capacity to accommodate recent increases in demand, its efficient manufacturing processes which have enabled the 20 23 Company to be one of the low-cost providers of modular relocatable classrooms in California, and the quality and design features of its classrooms. In addition, the Company's Northern and Southern California manufacturing facilities enable it to serve efficiently all of California with a minimum of transportation costs. The Company believes that its streamlined organizational structure, the vertical integration of its manufacturing process, and the level of its bonding capacity and access to capital combine to provide it with several advantages over most of its competitors, which generally are smaller, privately-owned businesses. The Company intends to capitalize on these advantages by expanding its marketing efforts, aggressively pursuing new contract opportunities, and continuing to offer quality products at competitive prices, in an effort to further increase its share of the market. Expand the Market for Modular Classrooms: In addition to the State of California and California school districts, the Company believes that there are a significant number of other potential customers for its classrooms both within and outside of California. Several adjacent states such as Arizona and Nevada exhibit population growth and increasing levels of school enrollment. Although a comparable regulatory environment does not exist in either of these states, the Company believes that Arizona and Nevada will face similar problems of overcrowded classrooms and limited funding for the financing of new classroom construction in the next several years. In an effort to increase classroom sales to private schools in California, and to intensify the Company's classroom marketing efforts in Arizona and Nevada, the Company recently hired a salesperson whose primary responsibility will be to market and sell the Company's classrooms to these new customers. Diversify Markets and Product Mix: The Company believes that opportunities exist to significantly increase sales of non-classroom products from 1996 levels. The Company recently has taken steps to take advantage of these opportunities. In 1996, the Company acquired a manufacturing facility in Patterson, California, which enhanced the Company's ability to manufacture and sell modular structures intended for uses other than as classrooms. Since 1995, the Company has designed, manufactured and sold a limited number of modular units which shelter valuable electronic equipment used by the cellular telephone industry. From time to time, the Company also has used excess production capacity to manufacture a variety of modular, portable buildings for commercial uses that are not designed and engineered to the California Department of State Architect standards for classrooms. The Company believes that its manufacturing expertise and capacity will enable it to significantly increase its presence in these, and possibly other, non-classroom markets. Increase Profit Margins: The Company recently has been able to generate increasing operating income margins. Operating income as a percentage of net sales for the years ended December 31, 1995 and 1996, and for the six months ended June 30, 1997, was 7.1%, 9.8% and 15.3%, respectively. These margin improvements have been the result of increased sales, improved operating efficiencies, and a disciplined management plan to permit only modest growth in the overall level of general and administrative expenses as revenue grows. Additional efficiencies are expected to be realized as the Company's new production lines are activated and attain normalized utilization rates. The Company also will continue to endeavor to develop new design and manufacturing enhancements or alternatives which could be expected to reduce production costs. INDUSTRY OVERVIEW In recent years, the growth in population in California, both from births and from immigration, has led to increasing school enrollments. As a result, classrooms in many California school districts currently are reported to be among the most crowded in the nation, with an average of 29 students per class compared to a national average class size of 17. The California Department of Finance has estimated that student enrollment in grades kindergarten through 12 will increase by approximately 18% over the period from 1995 through 2005. Additionally, changes in population demographics have left many existing permanent school facilities in older residential areas with excess capacity due to declining enrollments, while many new residential areas are faced with a continuing shortage of available classrooms. Consequently, it has become necessary to add additional classrooms at many existing facilities, and to build a number of new schools. The construction of new schools and the addition of classrooms at existing schools are tied to the sources and levels of funding available to California school districts. The availability of funding for new school and 21 24 classroom additions, in turn, is determined in large measure by the amount of tax revenue raised by the State, the level of annual allocations for education from the State's budget which is determined by educational policies that are subject to political concerns, and the willingness of the California electorate to approve state and local bond issues to raise money for school facilities. In 1978, California voters approved Proposition 13, which rolled back local property taxes (a traditional source of funding for school districts) and limited the ability of local school districts to raise taxes to finance the construction of school facilities. The passage of Proposition 13, coupled with growing student populations, has increased the need for local school districts to find ways to reduce the cost of adding classrooms. The California legislature has adopted several statutes designed to alleviate some of the problems associated with the shortage of classrooms and lack of local funding alternatives. For example, in 1976, California adopted legislation that currently requires, with certain exceptions, that at least 30% of all new classroom space added using State funds must be relocatable structures. This requirement may be satisfied through the purchase or lease of the Company's classrooms. See "Business -- Legislation and Funding." Additionally, in 1979 the California legislature adopted legislation that provides for State funding for the purchase of relocatable classrooms that could be leased to local school districts. As the number of students enrolled in California schools continued to increase throughout the 1990's, the State of California and California school districts experienced increasing budget shortfalls. The resulting shortage of funding available at both the State and local level led to declining sales of modular relocatable classrooms, by the Company and on an industry-wide basis. However, as the State budget deficit ameliorated, funding for modular relocatable classrooms began to increase. This growth was accelerated when the California Class Size Reduction Program was implemented in November 1996, the goal of which is to reduce class sizes to 20 students in public elementary schools at the kindergarten through third grade levels. For the 1996-1997 school year, the State spent $822 million under this program, including $200 million specifically for facilities which may be relocatable classrooms. The Company believes that total State funding under the Class Size Reduction Program for the 1997-1998 school year will be as high as $1.5 billion for both general operations and school facilities. In addition, an $8.2 billion bond issue for school construction, including the addition of classrooms, has been proposed for inclusion on the June 1998 ballot. As a result, the Company anticipates that the near-term market for modular relocatable classrooms in California will be significantly greater than it was in 1996, when the Company believes that industry-wide sales of modular classrooms within California were approximately $175 million. See "Risk Factors -- Legislation and School Funding." When compared to the construction of a conventionally built classroom, modular classrooms offer a number of advantages, including, among others: Lower Cost -- The cost of the Company's standard classroom may be as low as $29,000 installed, as compared to $80,000 to $100,000 for conventional construction of a comparable classroom; Shorter Construction Time -- A modular classroom can be built and ready for occupancy in a shorter period of time than that required for state approval and construction of a conventional facility; Flexibility of Use -- Modular relocatable classrooms enable a school district to use the units for short or long term needs and to move them if necessary to meet shifts in student populations; and Ease of Financing -- As personal rather than real property, modular classrooms may be leased on a long or short-term basis from manufacturers and leasing companies. This allows school districts to finance modular classrooms out of both their operating and capital budgets.
MODULAR RELOCATABLE CLASSROOMS The Company's modular relocatable classrooms are designed, engineered and constructed in accordance with structural and seismic safety specifications adopted by the California Department of State Architects, 22 25 standards which are more rigorous than the requirements for other portable units. The Department of State Architects, which regulates all school construction on public land, has prescribed extensive regulations regarding the design and construction of school facilities, setting minimum qualifications for the preparation of plans and specifications, and reviews all plans for the construction of material modifications to any school building. Construction authorization is not given unless the school district's architect certifies that a proposed project satisfies construction cost and allowable area standards. The Company subcontracts with structural engineering firms to interface with each school district's architect or engineer to process project specifications through the Department of State Architects. The Company believes that the regulated environment in which the Company's classrooms are manufactured serves as a significant barrier to market entry by prospective competitors. See "Business -- Competition." Conventional school facilities constructed by school districts using funds from the State Office of Public School Construction typically require two to three years for approval and funding. By contrast, factory-built school buildings like the Company's standard classrooms may be pre-approved by the State for use in school construction. Once plans and specifications for a given classroom have been pre-approved, school districts can thereafter include in their application to obtain State funds for new facilities a notification that they intend to use pre-approved, standardized factory-built classrooms. This procedure reduces the time required in the State's approval process to as little as 90 days, thereby providing an additional incentive to use factory-built relocatable classrooms. In all cases, continuous on-site inspection by a licensed architect or structural engineer is required during actual manufacture of the classrooms, with the school district obligated to reimburse the Department for the costs of such inspection. The Company's classrooms are manufactured and installed in accordance with the applicable Department of State Architects building code, which supersedes all local building codes for purposes of school construction. The classrooms must comply with accessibility requirements for the handicapped, seismic and fire code requirements. The Company manufactures and installs standard, largely pre-fabricated modular relocatable classrooms, as well as customized classrooms which are modular in design but assembled on-site using components manufactured by the Company together with components purchased from third party suppliers. The Company's classrooms vary in size from two modular units containing a total of 960 square feet to 20 units that can be joined together to produce a facility comprising 9,600 square feet. Larger configurations are also possible. Typical prices for the Company's standard classrooms range from $29,000 to $34,000, while prices for a custom classroom generally exceed $50,000, depending upon the extent of customization required. The two basic structural designs for standard and custom modular classrooms are a rigid frame structure and a shear wall structure. The rigid frame structure uses a steel floor and roof system, supported at each corner with square steel tubing. These buildings have curtain walls to enclose the interior from the outside, and have the advantage of unlimited width and length. Rigid frame structures may be used for multipurpose rooms and physical education buildings as well as standard classrooms. Shear wall classrooms have a maximum width of 48 feet (four 12 foot modules) and a maximum length of 60 feet. These classrooms use the exterior and interior walls to produce the required structural strength and can be built at lower costs than rigid frame structures. The Company's most popular factory-built classroom is a rigid frame design, with two modules connected side by side to complete a 24 by 40 foot classroom. Custom built classrooms, libraries and gymnasiums contain design variations and dimensions such as ceiling height, pitch, overall size and interior configuration. These units typically are not assembled at the factory but instead are shipped in pieces, including floors, walls and roofs, and assembled on-site. Contracts for custom built units may include the design, engineering and layout for an entire school or an addition to a school, and involve site preparation, grading, concrete and asphalt work and landscaping. Customized classrooms are generally more expensive and take longer to complete than the Company's standard classrooms. The interior and exterior of all of the Company's modular classrooms can be customized by employing different materials, design features and floor plans. Most classrooms are open, but the interior of the buildings can be divided into individual rooms by permanent or relocatable partitions. The floor covering is usually 23 26 carpet but may be linoleum or wood depending upon the intended use of the classroom. Interior wall material is usually vinyl covered firtex over gypsum board, while other finishes such as porcelain enamel or painted hardboard may be used in such places as restrooms and laboratories. Electrical wiring, air conditioning, windows, doors, fire sprinklers and plumbing are installed during the manufacturing process. The exterior of the units is typically plywood siding, painted to the customer's specifications, but other common siding material may also be applied. CLASSROOM CUSTOMERS The Company markets and sells its modular classrooms primarily to California school districts. The Company also sells its classrooms to the State of California and leasing companies, both of which lease the classrooms principally to California school districts. Sales of classrooms accounted for 90.5%, 94.2% and 97.2% of the Company's total net sales for the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997. The Company's customers typically pay cash from general operating funds or the proceeds of local bond issues, or lease classrooms through banks, leasing companies and other private funding sources. See "Legislation and Funding." Sales of classrooms to individual California school districts accounted for approximately 80.7%, 74.5% and 82.0%, respectively, of the Company's net sales during the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997, with sales of classrooms to third party lessors to California school districts during these periods accounting for approximately 3.1%, 7.2% and 11.6%, respectively, of the Company's net sales. The mix of school districts to which the Company sells its products varies somewhat from year to year. Sales of classrooms directly to the State of California during the six months ended June 30, 1997 represented approximately 3.6% of the Company's net sales for the period, compared to approximately 12.5% of the Company's 1996 net sales and approximately 6.7% of the Company's 1995 net sales. Sales of classrooms to private schools, day care providers and out-of-state customers accounted for less than one percent of the Company's net sales during the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997. One of the lessors to which the Company sells classrooms for lease to California school districts is affiliated with the Company through common ownership by two of the Company's directors. During the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997, sales of classrooms to this affiliated leasing company comprised approximately 3.1%, 2.9% and 1.2%, respectively, of the Company's net sales. See "Management -- Certain Transactions." OTHER PRODUCTS In addition to modular relocatable classrooms that are designed and manufactured in accordance with the California Department of State Architects standards, the Company also manufactures modular, portable buildings which can be used as office facilities and construction trailers and for other commercial purposes. Currently, most of these non-classroom products are manufactured at the Patterson, California plant which the Company acquired in 1996. During the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997, sales of such modular, portable buildings to commercial customers accounted, in the aggregate, for approximately 9.5%, 5.8% and 2.8%, respectively, of the Company's net sales. The Company also manufactures a small number of modular structures that house and shelter electronic equipment used in the wireless telecommunications industry. During the years ended December 31, 1995 and 1996 and the six months ended June 30, 1997, sales of modular telecommunications equipment shelters, which are included above in sales to commercial customers, accounted for less than one percent of the Company's net sales for each period. SALES AND MARKETING The Company's classroom sales force is currently divided into three marketing regions: Northern, Central and Southern California. The Company currently employs three classroom salespersons, each of whom is compensated on a commission basis. These salespersons maintain contact with the individual school districts in their respective marketing regions on a quarterly basis. They are also in contact with architects and building inspectors employed by the school districts, as well as school officials who may be in a position to influence purchasing decisions. 24 27 Most of the Company's contracts are awarded on an open bid basis. The marketing process for many of the Company's contracts begins prior to the time the bid process begins. After the Company selects bids or contracts that it desires to pursue, the Company's marketing and engineering personnel interface directly with various school boards, superintendents or architects during the process of formulating bid or contract specifications. The Company prepares its bids or proposals using various criteria, including current material prices, historical overhead costs and a targeted profit margin. Substantially all of the Company's contracts are turnkey, including engineering and design, manufacturing, transportation, installation and necessary site work. Open bid contracts are normally awarded to the lowest responsible bidder. A fourth salesperson is charged with increasing the Company's sales of buildings to the commercial and telecommunications markets. In addition, effective as of October 1997, the Company has hired a salesperson whose focus will be the sale of classrooms in Nevada and Arizona, and to private schools and day care operators in California. MANUFACTURING AND ON-SITE INSTALLATION The Company uses an assembly-line approach in the manufacture of its standardized classrooms. The process begins with the fabrication of the steel floor joists. The floor joists are welded to steel frames to form the floor sub-assembly, which is covered by plywood flooring. Metal roof trusses and structural supports are fabricated separately and added as the unit progresses down the assembly-line. Installation of walls, insulation, suspended grid ceilings, electrical wiring, air conditioning, windows, doors, fire sprinklers, plumbing and chalk boards follow, with painting and finishing crews completing the process. Once construction of a standard classroom commences, the building can be completed in as little as three days. The construction of custom units on-site, from pre-manufactured components, is similar to factory-built units in its progressively-staged assembly process but may involve more extensive structural connections and finish work depending upon the size and type of building, and typically takes 30 to 60 days to complete. The Company is vertically-integrated in the manufacture of its standardized modular classrooms, in that the Company fabricates substantially all of its own metal components at its facility in Perris, California, including structural floor and roof joists, exterior roof panels, gutters, down spouts, vents, ramps, stairs and railings. The Company believes that the ability to fabricate its own metal components helps it reduce the costs of its products and to control their quality and delivery schedules. The Company maintains a quality control system throughout the manufacturing process, under the supervision of its own quality control personnel and inspectors engaged by its customers. In addition, the Company tracks the status of all classrooms from sale through installation. Completed standard classroom units, or components used in customized units, are loaded onto specially designed flat-bed trailers for towing by trucks to the school building site. Upon arrival at the site, the units are structurally connected, or components are assembled, and the classroom is installed on its foundation. Connection with utilities is completed in the same manner as in conventional on-site construction. Installation of the modular classrooms may be on a separate foundation, or several units may be incorporated on a common foundation under a unified roof, so that upon installation they appear to be an integral part of an existing school facility or function as a larger building, such as a gymnasium or cafeteria. The Company oversees installation of its modular classrooms on-site, using its own employees for job supervision as a general contractor and, whenever possible, for utility hook-ups and other tasks. In many custom projects, the Company performs or supervises subcontracted electrical, plumbing, grading, paving and foundation work, landscaping and other site preparation work and services. Sub-contractors are typically used for larger utility, grading, concrete and landscaping jobs. The Company has a general contractor's license in the State of California. In addition to approvals by the Department of State Architects, licensed inspectors representing various school districts are on-site at each manufacturing facility of the Company to continuously inspect the construction of classrooms for structural integrity. On-site inspections after installation are also made by local fire departments for purposes of determining adequate accessibility. 25 28 The Company currently has four manufacturing facilities. Two are located in Southern California, in Perris, California which is approximately 60 miles east of Los Angeles. The Company has another two facilities near Lathrop, California. Lathrop is located approximately 75 miles east of San Francisco. With the re-opening of the Lathrop plant in early 1997, the Company currently has a total of six production lines in operation, with a seventh scheduled to commence production in Perris by the end of 1997. An eighth production line is scheduled to be added at the Lathrop plant in late 1998. The standard contractual warranty for the Company's modular relocatable classrooms is one year, although it may be varied by contract specifications. Purchased equipment installed by the Company, such as air conditioning units, carry the manufacturers' standard warranty. Warranty costs have not been material in the past. The Company believes that there are multiple sources of supplies available for all raw materials and equipment used in manufacturing its classrooms, most of which are standard construction items such as steel, plywood and wallboard. BACKLOG The Company manufactures classrooms to fill existing orders only, and not for inventory. As of December 31, 1996, the backlog of sales orders was approximately $58.0 million, up from approximately $7.0 million at December 31, 1994 and $4.1 million at December 31, 1995. Backlog at June 30, 1997 was $80.4 million, compared to backlog of $20.4 million at June 30, 1996. Only orders which are scheduled for completion during the following 12-month period are included in the Company's backlog. The rate of booking new contracts can vary from month to month, and customer changes in delivery schedules can occur. For these reasons, among others, the Company's backlog as of any particular date may not be representative of actual sales for any succeeding period. COMPETITION The Company believes that, based upon 1996 net sales, it is the largest modular relocatable classroom manufacturer in California. However, the modular relocatable classroom industry is highly competitive, with the market divided among a number of privately-owned companies whose share of the market is smaller than that of the Company. The Company believes that the nature of the bidding process, the level of performance bonding required, and the industry's regulated environment serve as barriers to market entry, and that the expertise of its management gives it an advantage over competitors. Nevertheless, the Company believes that additional competitors may enter the market in the future, some of whom may have significantly greater capital and other resources than are available to the Company, and that competition may therefore increase. The Company also believes that its expertise in site preparation and on-site installation gives it a competitive advantage over many manufacturers of higher-priced, customized modular units, while its vertically integrated, assembly-line approach to manufacturing enables the Company to be one of the low cost producers of standardized, modular relocatable classrooms in California. Unlike many of its competitors, the Company manufactures most of its own metal components which allows the Company to maintain quality control over these components and to produce them at a lower average cost than that at which they could be obtained from outside sources. The Company also believes that the quality and appearance of its buildings, and its reputation for reliability in completion of its contracts, enable it to maintain a favorable position among its competition. The Company categorizes its current competition based upon the geographic market served (Northern California versus Southern California), as well as upon the relative degree of customization of products sold. Beyond a radius of approximately 300 miles, the Company believes that transportation costs typically will either significantly increase the prices at which it bids for given projects, or will substantially erode the Company's gross profit margins. The primary competitors of the Company for standardized classrooms are believed to be Aurora Modular Industries in Southern California and American Modular Systems in Northern California. Profiles Structures, 26 29 Inc. in Southern California and Design Mobile Systems in Northern California are the Company's primary competitors in the market for higher-priced, customized classrooms. Each of these four competitors is a privately-owned company. PERFORMANCE BONDS A substantial portion of the Company's sales require that the Company provide bonds to ensure that the contracts will be performed and completed in accordance with contract terms and conditions, and to assure that subcontractors and materialmen will be paid. In determining whether to issue a performance bond on behalf of the Company, bonding companies consider a variety of factors concerning the specific project to be bonded, as well as the Company's levels of working capital, shareholders' equity and outstanding indebtedness. From time to time the Company has had, and in the future may again encounter, difficulty in obtaining bonding for a given project. Although it has had no difficulty in obtaining the necessary bonding in the last twelve months, the Company believes that its difficulty in obtaining bonding for certain large projects from time to time in the past has been attributable to the Company's levels of working capital, shareholders' equity and indebtedness, and not to concerns about the Company's ability to perform the work required under the contract. To assist the Company in obtaining performance bonds in certain instances, the Company's executive officers have been required to indemnify the bonding companies against all losses they might suffer as a result of providing performance bonds for the Company. The proceeds to the Company from this Offering are expected to enhance the Company's ability to obtain performance bonds, furnish security, and meet other financial requirements associated with bidding for larger contracts and performing work simultaneously under a greater number of contracts. REGULATION OF CLASSROOM CONSTRUCTION In 1933, the California Legislature adopted the Field Act, which generally provides that school facilities must be constructed in accordance with more rigorous structural and seismic safety specifications than are applicable to general commercial buildings. Under the Field Act, the Department of General Services, through the Department of State Architects, has prescribed extensive regulations regarding the design and construction of school facilities, and reviews all plans for the construction of material modifications to any school building. Construction authorization is not given unless the school district's architect certifies that a proposed project satisfies construction cost and allowable area standards. In addition, the Field Act provides for the submittal of complete plans, cost estimates, and filing fees by the school district to the Department of General Services, for the adoption of regulations setting minimum qualifications for the preparation of plans and specifications, and the supervision of school construction by a licensed architect or structural engineer. Additionally, California legislation provides that certain factory-built school buildings may be pre-approved by the State for use in school construction. Once plans and specifications for a given classroom have been pre-approved by the Department of General Services, school districts can thereafter include in their application to obtain State funds for new facilities a notification that they intend to use pre-approved, standardized factory-built classrooms. This procedure reduces the time required in the State's approval process thereby providing additional incentive to use factory-built relocatable classrooms. The Department of General Services provides for the continuous on-site inspection during actual manufacturing of the classrooms, with the school districts obligated to reimburse the Department for the costs of such inspection. LEGISLATION AND FUNDING The demand for modular relocatable classrooms in California is affected by various statutes. These statutes, among other things, prescribe the methods by which the Company's customers, primarily individual school districts, obtain funding for the construction of new school facilities, and the manner in which available funding is to be spent by the school districts. In 1978, Proposition 13 was approved, which rolled back property taxes and limited the ability of local school districts to rely upon revenue from such taxes to finance the construction of school facilities. As a result, financing for new school construction and rehabilitation of existing schools by California school districts 27 30 is currently provided, at the state level, by funds derived from general revenue sources or statewide bond issues, and, at the local level, by local bond issues and fees imposed on the developers of residential, commercial and industrial real property ("Developer Fees"). Historically, the primary source of financing for the purchase or lease of relocatable classrooms has been state funding. STATE FUNDING Until the adoption of the Class Size Reduction Program in 1996, the most important source of funding at the State level for new school facilities was through the issuance and sale of statewide general obligation bonds which are repaid out of the State's General Funds. Proposals to issue such bonds are placed on statewide ballots from time-to-time in connection with general or special elections, and require approval by a majority of the votes cast in connection with such proposals. As in the case of the Class Size Reduction Program, the State also may annually allocate funds from the State's budget for the support of school districts and community college districts. Authority for Bond Financing. Under the School Building Lease -- Purchase Law of 1976, the State Allocation Board is empowered to purchase or lease school facilities using funds from the periodic issuance of general obligation bonds of the State of California. These purchased or leased school facilities may be made available by the State Allocation Board to school districts. Certain matching funds, usually derived from Developer Fees, are required to be supplied by the school districts seeking state funded facilities. If the school districts acquire relocatable structures using Developer Fees, the amount of the required matching funds is reduced by the cost of such facilities. This reduction in matching funds is intended to provide an incentive for school districts to lease relocatable classrooms. As a condition of funding any project under this program, at least 30% of new classroom space to be added must be comprised of relocatable structures, unless relocatable structures are not available or special conditions of terrain, climate or unavailability of space make the use of relocatable structures impractical. In addition, State funds under this program are not available to school districts which are determined to have an adequate amount of square footage available for their student population. Recently, a package of bills was introduced that would, among other things, (i) revise the School Building Lease-Purchase Law of 1976 including elimination of the requirement that at least 30% of all classroom space to be added using State funds be relocatable classrooms, (ii) place an $8.2 billion bond issue for school construction on the June 1998 ballot, and (iii) include a proposed amendment to the California Constitution on the June 1998 ballot. The proposed Constitutional amendment would modify Proposition 13 by reducing the percentage vote required for approval of tax increases to support local bond issuances from two-thirds to a simple majority. However, both houses of the California Legislature passed different versions of this package of bills, which were returned to a conference committee. Each bill must still be approved by both houses of the Legislature as revised by the conference committee. In addition, none of these bills would become operative as currently proposed unless the $8.2 billion bond issue is approved by a majority of the California voters and the proposed amendment to the California Constitution is approved by two-thirds of the California voters. In response to the adoption of Proposition 13, the State of California adopted the California Emergency Classroom Law of 1979, pursuant to which the State Allocation Board may spend up to $35 million per year from available funds to purchase relocatable classrooms to be leased to school districts. Relocatable classrooms are not available to school districts under this program if the school district has available local bond proceeds that could be used to purchase classroom facilities, unless the district has approved projects pending under the School Building Lease-Purchase Law of 1976. The State has, in the past, funded this program primarily from the proceeds of statewide bond issues approved by voters. Budget Allocations. Proposition 98, which was approved in 1988, requires the State to allocate annually from the State's budget, for the support of school districts and community college districts, a minimum amount equal to the same percentage of funds as was appropriated for the support of those institutions in fiscal year 1986-87. While this requirement may be suspended for a given year by emergency legislation, it has the effect of limiting the ability of the California legislature to reduce the level of school funding from that in 28 31 existence in 1986-87. The State raises the necessary funds through proceeds from the sale of statewide bond issues, income tax revenues and other revenues. A recent reduction in California's corporate tax rates, and a proposed reduction in personal income tax rates, may affect future levels of the State's income tax revenues. In November 1996, California implemented the Class Size Reduction Program in response to overcrowding in classrooms in the state and its assumed negative impact on learning. An additional impetus for the program was a study conducted by Tennessee State University which indicated that students in small classrooms outperformed their peers from larger classes at least through the eighth grade on standardized tests in math and reading. The goal of the California Class Size Reduction Program is to reduce public elementary school class sizes in kindergarten through the third grade. Under this program, schools that reduce class size to 20 students in those grades will receive additional funds. For the 1996-1997 school year, a school district was entitled to receive $25,000 for each new classroom added which reduced the average class size for a specified grade level to 20 students or less. Among other ways new classrooms can quickly and inexpensively be added, school districts may reconfigure existing space to convert it to classrooms from other uses, or purchase or lease a modular relocatable classroom. LOCAL FUNDING Local school districts in California have the ability to issue local general obligation bonds for the acquisition and improvement of real property for school construction. These bond issues require the approval of two-thirds of the voters in the district and are repaid using the proceeds of increases in local property taxes. A local school district may also levy Developer Fees on new development projects in the district, subject to a maximum rate set by state law. The Developer Fees can only be levied if the project can be shown to contribute to the need for additional school facilities and the fee levied is reasonably related to such need. In addition, California law provides for the issuance of bonds by Community Facilities Districts which can be formed by a variety of local government agencies, including school districts. These districts, known as "Mello-Roos" districts, can have flexible boundaries and the tax imposed to repay the bonds can be based on property use, acreage, population density or other factors. OTHER LEGISLATION California legislation adopted in 1989 provides that school districts which currently lease any building which does not meet the prescribed structural standards must have replaced nonconforming buildings with conforming ones by September 1, 1990. However, any district has the right to request a one-time waiver for a maximum of three years upon presentation of satisfactory evidence to the State Allocation Board that the district is proceeding in a timely fashion with a program that will eliminate the need for the nonconforming facilities within that time period. The State has authorized districts to renew these waivers through 2000 and may grant further waivers. The Company understands that a number of school districts have requested and been granted such waivers. Based upon information received by the State Allocation Board from school districts and provided to the Company, it is believed that there are more than 4,500 trailers currently being used as classrooms by school districts throughout California that eventually must be replaced with conforming facilities by these school districts. California has taken steps to encourage local school districts to adopt year-round school programs to help increase the use of existing school facilities and reduce the need for additional school facilities. School districts requesting state funding under the School Building Lease-Purchase Law of 1976 or the Emergency Classroom Law of 1979 discussed above must submit a study examining the feasibility of implementing in the district a year-round educational program that is designed to increase pupil capacity in the district or in overcrowded high school attendance areas. The feasibility study requirement is waived, however, if the district demonstrates that emergency or urgent conditions exist in the district that necessitate the immediate need for relocatable buildings. The demand for new school facilities, including relocatable classrooms, would be adversely affected in the event that a significant number of California school districts implemented year-round school programs. In addition, a significant increase in the level of voluntary or mandatory busing of students from overcrowded schools to schools with excess capacity could adversely affect demand for new school facilities. 29 32 LITIGATION The Company from time to time is involved in various lawsuits related to its ongoing business operations, primarily collection actions or vendor disputes. In the opinion of management, no pending lawsuit will result in any material adverse effect upon the Company or its financial condition. ENVIRONMENTAL MATTERS The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use and disposal of any hazardous materials used by the Company in connection with the manufacture of its products. Both the governmental regulations and the costs associated with complying with such regulations are subject to change in the future. EMPLOYEES At June 30, 1997, the Company had 832 employees, including 789 in manufacturing, 4 in sales, 20 in operations and 19 in general management and administration. The Company's employees are not represented by a labor union, and it has experienced no work stoppages. The Company believes that its employee relations are good. PROPERTIES The Company's principal executive and administrative facilities are located in approximately 11,400 square feet of modular buildings at its primary manufacturing facility located in Perris, California. This manufacturing facility occupies twenty-five acres, with approximately 200,000 square feet of covered production space under roof, pursuant to a lease expiring in 2014. A second facility in Perris occupies approximately thirty acres, with approximately 120,000 square feet of covered production space under roof, pursuant to a lease expiring in 2014. This second facility also includes approximately 80,000 square feet under roof used as a metal working facility. The Company's third plant consists of a 400,000 square foot manufacturing facility on a 30-acre site in Lathrop, California that is leased through 2019. The fourth plant, which was leased for up to five years in October 1996, consists of approximately 50,000 square feet of manufacturing areas on a 4 acre site in Patterson, California. The Company believes that its existing facilities are well-maintained and in good operating condition, and, with the additional production lines currently being added or planned for addition in 1998, meet the requirements for its immediately foreseeable business needs. Each of the Company's current facilities other than the Patterson plant is leased from an affiliate. See "Management -- Certain Transactions." 30 33 MANAGEMENT DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES The directors, executive officers and key employees of the Company are as follows:
NAME AGE POSITIONS ------------------------------ ---- ---------------------------------------------------- Gerald B. Bashaw.............. 62 Chairman of the Board of Directors Evan M. Gruber................ 44 Chief Executive Officer and Director Michael G. Rhodes............. 36 Chief Operating Officer and Chief Financial Officer Robert W. Campbell............ 41 Director James D. Goldenetz............ 47 Director Charles C. McGettigan......... 52 Director James M. Phillips, Jr......... 49 Director Myron A. Wick III............. 53 Director
Mr. Bashaw founded the Company in 1982. Previously, he served as the Vice President of Operations and then President of Aurora Modular Industries, a manufacturer of modular classrooms, mobile homes, office trailers, and modular houses and buildings, which he co-founded in 1965. Mr. Gruber joined the Company in January 1989 as its Chief Financial Officer, and was elected to the Company's Board of Directors and as its Chief Executive Officer in January 1990. Prior to joining the Company, Mr. Gruber, who is a certified public accountant, worked at his own public accounting firm in Costa Mesa, California, which he founded in 1978. Mr. Rhodes joined the Company in 1988 and was the Company's controller through 1992. In 1993 he was elected Chief Financial Officer, and in 1996 was elected Chief Operating Officer. Prior to his joining the Company, Mr. Rhodes worked for a public accounting firm. Mr. Campbell, who was elected to the Company's Board of Directors in 1992, is a Managing Director of Corporate Finance at L.H. Friend, Weinress, Frankson & Presson, Inc. From 1993 to 1995, Mr. Campbell was Senior Vice President -- Investment Banking at Baraban Securities, Incorporated. From 1982 to 1993, Mr. Campbell was employed by The Seidler Companies, Inc. as Senior Vice President -- Corporate Finance. Mr. Goldenetz, who currently serves as the President of Class Leasing, Inc., joined the Company as a director in January 1988, after previously serving as the President of Aurora Modular Industries since January 1982. He began work in the modular classroom industry, in production, at Aurora Modular Industries in 1969. Mr. McGettigan was elected to the Board of Directors in June 1994 in connection with the 1994 Financing. Mr. McGettigan is a co-founder and managing director of the investment banking firm of McGettigan, Wick & Co., Inc. and a co-founder and general partner of Proactive Investment Managers, L.P., the general partner of Proactive Partners, L.P., a merchant banking fund formed in 1991. Prior to founding McGettigan, Wick & Co., Inc., he was a Principal, Corporate Finance of Hambrecht & Quist and a senior vice president of Dillon, Read & Co. Mr. McGettigan is a director of Digital Dictation, Inc.; I-Flow Corporation; Onsite Energy; Phoenix Network, Inc.; PMR Corporation; Sonex Research, Inc.; Vie de France Corporation; Tanknology-NDE and Wray-Tech Instruments Inc. Mr. Phillips became a director of the Company upon the consummation of the Company's initial public offering in July 1990. Mr. Phillips has been an attorney for the last 20 years, practicing primarily in the areas of corporate and securities law. After practicing law for 13 years with a number of law firms, including Gibson, Dunn & Crutcher, Paul, Hastings, Janfosky & Walker, and Brobeck, Phleger & Harrison, Mr. Phillips established his own firm in 1990. 31 34 Mr. Wick joined the Company's Board of Directors in June 1994 in connection with the 1994 Financing. Mr. Wick is currently a managing director and founder of McGettigan, Wick & Co., Inc., an investment banking firm formed in 1988, and a general partner of Proactive Investment Managers, L.P., the general partner of Proactive Partners, L.P., a merchant banking fund formed in 1991. Mr. Wick is a director of Children's Discovery Centers; Digital Dictation Inc.; Electrostatic Devices; Tanknology-NDE; Sonex Research, Inc. and Wray-Tech Instruments Inc. EXECUTIVE COMPENSATION The following table summarizes the annual and long term compensation paid by the Company during the fiscal years ended December 31, 1994, 1995 and 1996 to those persons who were, as of December 31, 1996, (i) the Chief Executive Officer of the Company, and (ii) the other compensated executive officers of the Company, if any, whose total annual salary and bonus exceeded $100,000 during the year ended December 31, 1996. SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ------------------------------ AWARDS -------------------- ANNUAL COMPENSATION RESTRICTED PAYOUTS --------------------------- STOCK ------- ALL OTHER SALARY BONUS OTHER AWARDS OPTIONS LTIP COMPENSATION(1) NAME AND PRINCIPAL POSITION YEAR $ $ $ $ # PAYOUTS $ - ------------------------------------- ---- -------- -------- ----- ---------- ------- ------- --------------- Evan M. Gruber....................... 1996 $158,000 $137,000 -- -- 110,000 -- $ 4,615 Chief Executive Officer 1995 150,000 15,000 -- -- 25,000 -- 3,654 and Director 1994 125,000 -- -- -- 350,000 -- 4,030 Michael G. Rhodes.................... 1996 $ 90,000 $ 24,000 -- -- 105,000 -- $ 4,827 Chief Operating Officer, 1995 87,000 12,100 -- -- 20,000 -- 129 Chief Financial Officer 1994 85,000 -- -- -- 10,000 -- 4,124
- --------------- (1) The figures shown in the last column designated "All Other Compensation" represent the executive officer's share of the Company's contribution to the 401(k) Plan. See "Management -- 401(k) Plan." Each non-employee director is paid an annual retainer of $4,000, plus $1,000 for each board and board committee meeting attended, and is granted an option to purchase 5,000 shares of the Company's Common Stock at the end of each year of service on the Board of Directors. See "Management -- Stock Options." The Company has and will continue to pay the expenses of its non-employee directors in attending Board meetings. No additional compensation is paid to any employee director for serving on the Company's Board of Directors. EMPLOYMENT AGREEMENT In connection with the 1994 Financing, the Company entered into a three-year employment agreement with Mr. Gruber, which in September 1996 the Compensation Committee voted unanimously to extend through 1999. The agreement includes, among other provisions, a base annual salary of not less than $150,000 per year, which was increased to $200,000 in October 1996, with periodic increases equal to the rate of increase in the Consumer Price Index, and the grant of an option to purchase 200,000 shares of the Company's Common Stock at $1.50 per share. Additionally, under the agreement, Mr. Gruber is entitled to receive a bonus equal to two and one-half percent of the amount, if any, by which the net income before taxes of the Company for the year in question exceeds $1 million. 401(K) PLAN Under the Company's 401(k) Plan, officers and other employees of the Company may elect to defer up to 12% of their compensation, subject to limitations under the Internal Revenue Code. The Company makes annual contributions on a 50% matching basis. Amounts deferred are deposited by the Company in a trust account for distribution to employees upon retirement, attainment of age 59 1/2, permanent disability, death, termination of employment or the occurrence of conditions constituting extraordinary hardship. For the year ended December 31, 1996, the Company contributed $4,615 and $4,827 as matching contributions for the accounts of Mr. Gruber and Mr. Rhodes, respectively. 32 35 STOCK OPTIONS In June 1989, the Company's Board of Directors adopted, and the Company's shareholders approved, the Modtech, Inc. 1989 Stock Option Plan (the "1989 Plan"). The 1989 Plan provides for the grant of both incentive and nonstatutory options to purchase up to an aggregate of 400,000 shares of the Company's Common Stock. Incentive stock options can be granted only to employees, including officers, of the Company, while nonstatutory stock options can be granted to employees, non-employee officers and Directors, consultants, vendors, customers and others expected to provide significant services to the Company. Participants in the 1989 Plan are selected by the Board of Directors of the Company, or by a committee of Directors selected by the Board as a whole. The Board or the committee is empowered to determine the terms and conditions of each option granted under the 1989 Plan, subject to the limitations that the exercise price of incentive stock options cannot be less than the fair market value of the Common Stock on the date of grant (110% if granted to an employee who owns 10% or more of the Common Stock), no option can have a term in excess of ten years (five years if granted to an employee owning 10% or more of the Common Stock) and no incentive stock option can be granted to anyone other than a full-time employee of the Company or its subsidiaries. Nonstatutory options may be granted under the 1989 Plan with an exercise price of not less than 85% of the fair market value of the Common Stock at the date of grant. As of December 31, 1996, options to purchase 265,500 shares, at a weighted average exercise price of $1.92, were outstanding under the 1989 Plan. In March 1994, the Company's Board of Directors authorized the grant of options to purchase up to 200,000 shares of the Company's Common Stock, and, in connection with the private placement of Series A Preferred Stock in May 1994, authorized the grant of options to purchase up to an additional 500,000 shares of the Company's Common Stock (collectively, the "1994 Plans"). Since approval of these options by the shareholders of the Company has not and will not be sought, all options granted under the 1994 Plans will be deemed nonstatutory options that do not entitle the recipients thereof the special federal income tax treatment afforded to the recipients of incentive stock options. The Company's Board of Directors, with Mr. Gruber abstaining, approved the grant to Mr. Gruber of an option to purchase up to 150,000 shares of Common Stock at $1.19 per share, and in May 1994, again with Mr. Gruber abstaining, approved the grant of an option to Mr. Gruber to purchase up to an additional 200,000 shares of Common Stock under the 1994 Plans, at $1.50 per share, as required by his new employment agreement. See "Management -- Employment Agreements." As of December 31, 1996, options to purchase a total of 620,000 of these shares, at exercise prices ranging from $1.19 to $4.50, were outstanding. In July 1996, the Company's Board of Directors authorized the grant of options to purchase up to 500,000 shares of the Company's Common Stock. These non-statutory options may be granted to employees, non-employee officers and Directors, consultants, vendors, customers and others expected to provide significant service to the Company. The exercise price of the stock options cannot be less than the fair market value at the date of the grant (110% if granted to an employee who owns 10% or more of the common stock). Additionally, each non-employee director will be granted a non-statutory stock option to purchase 5,000 shares at fair market value per share on the date of grant, for each year of continuous service on the Company's Board of Directors. At December 31, 1996, options to purchase an aggregate of 110,000 of these shares, at the exercise price of $4.50 per share, were outstanding. 33 36 The following table sets forth certain information regarding options granted by the Company during the year ended December 31, 1996 to the executive officers of the Company identified in the Summary Compensation Table set forth above: OPTIONS GRANTED IN CALENDAR YEAR 1996
POTENTIAL REALIZED VALUE AT ASSUMED NO. OF % OF ANNUAL RATES OF STOCK SHARES TOTAL PRICE APPRECIATION SUBJECT TO OPTIONS FOR OPTION TERM(3) OPTIONS GRANTED TO EXERCISE EXPIRATION --------------------- NAME OF OPTIONEE GRANTED(1) EMPLOYEES PRICE(2) DATE 5% 10% - ------------------------------------- ---------- ---------- --------- ---------- -------- -------- Evan M. Gruber....................... 110,000 35% $2.13 12/31/2005 $129,000 $318,000 Michael G. Rhodes.................... 105,000 33% 2.13-4.50 7/11/2006 188,500 464,500
- --------------- (1) Options are exercisable starting 12 months after the grant date with 25% vesting each year. (2) The exercise price was the market price of a share of the Company's Common Stock on the date of grant. (3) On December 31, 1996, the closing sales price for a share of the Company's Common Stock on The Nasdaq National Market was $7.875. The following table sets forth information regarding options exercised during the year ended December 31, 1996 by the executive officers of the Company identified in the Summary Compensation Table set forth above, as well as the aggregate value of unexercised options held by such executive officers at December 31, 1996. The Company has no outstanding stock appreciation rights, either freestanding or in tandem with options. AGGREGATED OPTION EXERCISES LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES
VALUE OF UNEXERCISED NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS SHARES OPTIONS AT FISCAL YEAR END AT FISCAL YEAR END($)(1) ACQUIRED ON VALUE ----------------------------- ----------------------------- NAME EXERCISE(#) REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------------------- ----------- -------- ----------- ------------- ----------- ------------- Evan M. Gruber........... -- -- 201,250 333,750 $ 1,312,000 $ 2,095,000 Michael G. Rhodes........ -- -- 62,000 148,000 248,000 760,000
- --------------- (1) Calculated based on the closing sales price of the Company's Common Stock as reported on The Nasdaq National Market on December 31, 1996, which was $7.875 per share. CERTAIN TRANSACTIONS The Company leases its two facilities located in Perris, California, and the land on which the manufacturing facility is located in Lathrop, California, from Mr. Bashaw and general partnerships of which Messrs. Bashaw, Goldenetz and Gruber together own a controlling interest, pursuant to standard industrial leases. Under the terms of these leases, the Company is obligated to pay base monthly payments which aggregate $67,000, subject to escalation in accordance with changes in applicable cost of living indices. Due to the recent declines in real estate values, Mr. Bashaw and the general partnerships reduced the base monthly lease rates for the year ending December 31, 1994, for the manufacturing facilities to an aggregate of $36,000. This base rent is subject to upward adjustment to market rates each year based on annual market surveys conducted by the parties. Because real estate values have remained depressed, no such adjustment has yet been made. These leases expire in 2014 and 2019. Messrs. Goldenetz and Gruber together own 60% of the capital stock of Class Leasing, Inc., a California corporation ("Class Leasing"), in which the Company has no ownership interest. Mr. Goldenetz is a full-time employee of Class Leasing, serving as its President. In 1996, Mr. Gruber spent less than 10 hours per month in connection with the affairs of Class Leasing. Class Leasing purchases modular relocatable classrooms from the Company, upon standard terms and at standard wholesale prices, and leases them to third parties primarily 34 37 under three-year leases, cancelable yearly. During the years ended December 31, 1994, 1995, and 1996, and the six months ended June 30, 1997, the Company sold modular relocatable classrooms to Class Leasing for aggregate purchase prices of $1,009,000, $600,000, $1,453,000 and $745,000, respectively, which represented approximately 5%, 3%, 3% and 1% of the Company's net sales for each of those periods. Messrs. Gruber and Rhodes have personally guaranteed certain of the Company's obligations and the repayment by the Company of amounts which surety companies may be required to expend under the terms of performance bonds issued in connection with manufacturing contracts undertaken by the Company. No payments have been made to Messrs. Gruber and Rhodes for the guarantees provided by them. In 1996, the Company paid $7,500 to L.H. Friend, Weinress, Frankson & Presson, Inc. ("L.H. Friend") for certain financial advisory services. Robert W. Campbell, a director of the Company, is an executive officer of L.H. Friend. In addition, L.H. Friend is one of the Underwriters of this Offering. For legal services rendered, the Company paid the law firm of Phillips & Haddan LLP legal fees of approximately $20,000 during the year ended December 31, 1996. James M. Phillips, Jr., a director of the Company, is a principal of the law firm of Phillips & Haddan LLP. The Company is a party to an employment agreement with Mr. Gruber, and to indemnification agreements with each of its directors and executive officers. See "Management -- Employment Agreement" and "Description of Capital Stock -- Limitation of Liability and Indemnification." 35 38 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock as of September 30, 1997, and as adjusted to reflect the sale of 1,000,000 shares by the Company and the sale of 2,000,000 shares by the Selling Shareholders, by (i) each director of the Company, (ii) each person or group known to the Company to be the beneficial owner of more than 5% of the outstanding Common Stock, (iii) each Selling Shareholder, and (iv) all Directors and executive officers of the Company as a group. Except as may be indicated in the footnotes to the table, each of such persons has the sole voting and investment power with respect to the shares owned, subject to applicable community property laws. Except as otherwise indicated, the address of each holder identified below is in care of the Company, 2830 Barrett Avenue, Perris, California 92571.
SHARES SHARES BENEFICIALLY OWNED BENEFICIALLY OWNED PRIOR TO NUMBER OF AFTER THE OFFERING(1) SHARES OFFERING(1) ------------------- BEING ------------------- NAME NUMBER PERCENT OFFERED NUMBER PERCENT - ----------------------------------------------- ---------- ------- ---------- ---------- ------- Gerald B. Bashaw (2)(15)....................... 583,674 6.7% 175,000 408,674 4.2% Evan M. Gruber (3)(15)......................... 416,995 4.6 75,000 341,995 3.4 Michael G. Rhodes (4)(15)...................... 88,250 1.0 25,000 63,250 * Robert W. Campbell (5)......................... 21,000 * -- 21,000 * James D. Goldenetz (6)(15)..................... 159,531 1.8 25,000 134,531 1.4 Charles C. McGettigan (7)(14).................. 3,014,186 34.6 992,000 2,022,186 20.8 James M. Phillips, Jr. (8)..................... 15,000 * -- 15,000 * Myron A. Wick, III (7)(14)..................... 3,014,186 34.6 992,000 2,022,186 20.8 Jon D. Gruber (9)(14).......................... 5,259,096 60.4 1,700,000 3,559,096 36.7 J. Patterson McBaine (10)(14).................. 5,199,896 59.7 1,700,000 3,499,896 36.1 Gruber & McBaine Capital Management (11)(14)(15)................................. 2,172,410 24.9 708,000 1,464,410 15.1 Platinum Partners, L.P. (12)................... 522,000 6.0 -- 522,000 5.4 Proactive Partners, L.P. (13)(14)(15).......... 2,983,441 34.3 992,000 1,991,441 20.5 All directors and officers as a group (9 persons) (2)(3)(4)(5)(6)(7)(8)(15)........... 4,298,636 46.5 1,292,000 3,006,636 29.3
- --------------- * Less than one percent. (1) In calculating beneficial and percentage ownership, all shares of Common Stock which a named shareholder will have the right to acquire within 60 days of the date of this Prospectus upon exercise of stock options are deemed to be outstanding for the purpose of computing the ownership of such shareholder, but are not deemed to be outstanding for the purpose of computing the percentage of Common Stock owned by any other shareholder. As of September 30, 1997, an aggregate of 8,705,836 shares of Common Stock were outstanding. Does not give effect to the potential issuance of 1,206,933 shares of Common Stock upon exercise of stock options that have been granted but currently are not, and within 60 days of the date of this Prospectus will not be, exercisable, or of up to 196,667 additional shares issuable upon exercise of options available for the future grant of options under the Company's stock option plans. See "Management -- Stock Options." (2) Includes 10,000 shares issuable upon exercise of stock options. (3) Includes 316,250 shares issuable upon exercise of stock options, but does not include 352,083 shares issuable upon exercise of stock options which have been granted but currently are not exercisable. Evan M. Gruber and Jon D. Gruber are not related. (4) Includes 61,250 shares issuable upon exercise of stock options, but does not include 204,250 shares issuable upon exercise of stock options which have been granted but currently are not exercisable. (5) Includes 15,000 shares issuable upon exercise of stock options. (6) Includes 105,000 shares issuable upon exercise of stock options. 36 39 (7) Includes 20,745 shares owned of record directly by each of Messrs. McGettigan and Wick, and all shares owned of record by Proactive Partners, L.P. and affiliates of which Messrs. McGettigan and Wick are general partners. Also includes options to purchase 10,000 shares which have been granted to each of Messrs. McGettigan and Wick for serving on the Company's Board of Directors. (8) All of these shares are issuable upon exercise of stock options. (9) Includes 103,245 shares owned of record directly by Mr. Gruber, all shares owned of record by Proactive Partners, L.P. and affiliates, of which Mr. Gruber is a general partner, and all shares owned of record by Gruber & McBaine Capital Management and affiliates, of which Mr. Gruber is a general partner. Jon D. Gruber and Evan M. Gruber are not related. (10) Includes 44,045 shares owned of record directly by Mr. McBaine, all shares owned of record by Proactive Partners and affiliates, of which Mr. McBaine is a general partner, and all shares owned of record by Gruber & McBaine Capital Management and affiliates, of which Mr. McBaine is a general partner. (11) Includes 110,200 shares owned of record directly by Gruber & McBaine Capital Management, all shares owned of record by Proactive Partners, L.P. and affiliates, and 2,062,210 shares owned of record by Lagunitas Partners, Gruber & McBaine International and GMJ Investments, affiliated entities. (12) These shares are owned of record by Platinum Partners, L.P., a Massachusetts limited partnership (the "Partnership"), and also are deemed to be beneficially owned by Hori Capital Management, Inc., the sole general partner of the Partnership, and by Calvin G. Hori, the sole shareholder, director and President of Hori Capital Management, Inc., the address of each of which is One Washington Mall, 7th Floor, Boston, Massachusetts 02108. (13) Includes 2,828,884 shares owned of record by Proactive Partners, L.P. and 154,557 shares owned of record by Fremont Proactive Partners, an affiliated entity. (14) The address of each of Charles C. McGettigan, Myron A. Wick, III, Jon D. Gruber, J. Patterson McBaine, Gruber & McBaine Capital Management and Proactive Partners, L.P. is 50 Osgood Place, San Francisco, CA 94133. (15) In the event the Underwriter's over-allotment option is exercised in full, Messrs. Bashaw, Gruber, Rhodes and Goldenetz, and Gruber & McBaine Capital Management and Proactive Partners, L.P. would sell an additional 18,125, 25,000, 15,000, 15,000, 159,300 and 217,575 shares, respectively, and would beneficially own 4.0%, 3.2%, 0.5%, 1.2%, 13.4% and 18.3%, respectively, of the Common Stock outstanding after the Offering. 37 40 DESCRIPTION OF CAPITAL STOCK The Company's authorized capital stock consists of 20,000,000 shares of Common Stock, $.01 par value, of which 8,705,836 shares were issued and outstanding as of September 30, 1997, and 5,000,000 shares of Preferred Stock, $.01 par value, of which no shares currently are outstanding. COMMON STOCK Holders of the Common Stock are entitled to one vote per share on each matter submitted to a vote of the shareholders of the Company and to cumulate votes for the election of directors. Subject to preferences that may be applicable to the holders of any outstanding Preferred Stock, each holder of Common Stock is entitled to receive ratably such dividends, if any, as may be declared by the Company's Board of Directors out of funds legally available therefor. See "Dividend Policy." Upon the liquidation, dissolution or winding up of the Company, the holders of Common Stock are entitled to share ratably in all assets of the Company which are legally available for distribution, after payment of all debts and other liabilities and the liquidation preference of any outstanding Preferred Stock. Holders of Common Stock have no preemptive, subscription, redemption or conversion rights. The outstanding shares of Common Stock are, and the shares to be sold by the Company in this Offering, will be, when issued and delivered, validly issued, fully-paid and nonassessable under the laws of the State of California. PREFERRED STOCK The Company's Board of Directors is authorized, subject to any limitations prescribed by the laws of the State of California, but without further vote or action by the Company's shareholders, to provide for the issuance of Preferred Stock in one or more series, to establish from time to time the number of shares to be included in each such series, to fix the designations, powers, preferences and rights of the shares of each such series and any qualifications, limitations or restrictions thereof, and to increase or decrease the number of shares of any such series (but not below the number of shares of such series then outstanding). The Board may authorize and issue Preferred Stock with voting or conversion rights that could adversely affect the voting power or other rights of the holders of Common Stock. In addition, the issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company. The Company has no current plans to issue any shares of Preferred Stock. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock is ChaseMellon Shareholder Services L.L.C. LIMITATION OF LIABILITY AND INDEMNIFICATION As allowed by the California General Corporation Law, the Articles of Incorporation of the Company provide that the liability of the directors of the Company for monetary damages shall be eliminated to the fullest extent permissible under California law. This is intended to eliminate the personal liability of a director for monetary damages in an action brought by or in the right of the Company for breach of a director's duties to the Company or its shareholders except for liability for acts or omissions that involve intentional misconduct or knowing and culpable violation of law, for acts or omissions that a director believes to be contrary the best interests of the Company or its shareholders or that involve the absence of good faith on the part of the director, for any transaction from which a director derived an improper personal benefit, for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, with respect to certain contracts in which a director has a material financial interest and for approval of certain improper distributions to shareholders or certain loans or guarantees. This provision does not limit or eliminate the rights of the Company or any shareholder to seek non-monetary relief such as an injunction or rescission in the event of a breach of a director's duty of care. 38 41 The Company's Bylaws require the Company to indemnify its officers, directors, employees and other agents to the full extent permitted by law, including those circumstances in which indemnification would otherwise be discretionary. In addition, the Company's Articles of Incorporation expressly authorize the use of indemnification agreements and, with the approval of its shareholders, the Company has entered into separate indemnification agreements with each of its directors. The Company's Board of Directors has authorized similar indemnification agreements for the Company's officers. These agreements may require the Company, among other things, to indemnify directors and officers against certain liabilities that may arise by reason of their status or service as directors and officers, and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. CHANGES UPON BECOMING A LISTED CORPORATION The Articles of Incorporation of the Company provide that, upon the Company becoming a "listed corporation" (as defined below), the Board of Directors will be divided into three classes of directors, serving staggered three-year terms, and cumulative voting will be eliminated. As a result, if the Company becomes a listed corporation, approximately one-third of the Board of Directors will be elected each year and no shareholder will be entitled to cumulate votes in the election of directors. The Company will be deemed to be a "listed corporation" if it has outstanding shares listed on the New York or American Stock Exchanges or the Company has outstanding securities designated as qualified for trading as a national market system security on the National Association of Securities Dealers Automated Quotation System ("Nasdaq"), or any successor national market system, if the Company has at least 800 holders of its equity securities as of the record date of the Company's most recent annual meeting of shareholders. For purposes of determining the number of holders of the Company's equity securities, there would be included, in addition to the number of record holders reflected on the Company's stock records, the number of holders of the equity securities held in the name of any nominee holder and certified by such nominee holder. The Company would be required to maintain any such certification with the record of shareholders for inspection and copying as provided under the General Corporation Law of California. The Company's Common Stock currently is listed on The Nasdaq National Market, and the Company has been advised by the Underwriters that the number of holders of the Company's Common Stock is likely to increase to at least 800 as a consequence of this Offering. In such event, the Company would be deemed to be a "listed corporation," and intends to cause the classified board provision in its Articles of Incorporation to become operative by electing a classified board, without cumulative voting, at its next annual meeting of shareholders. This may discourage a third party from making a tender offer or otherwise attempting to obtain control of the Company, even though such an attempt might be beneficial to the Company and its shareholders. In addition, the classified board provision could delay shareholders who do not like the policies of the Board of Directors from removing a majority of the Board for two years, unless they can show cause and obtain the requisite vote. Also, without cumulative voting, a purchaser of a block of stock of the Company constituting less than a majority of the outstanding shares will have no assurance of proportional representation on the Board of Directors. Following this offering, the current directors and executive officers of the Company will continue to own or have voting control over an aggregate of 4,649,081 shares of the Company's Common Stock, or approximately 30% of the shares then outstanding. See "Principal and Selling Shareholders." 39 42 UNDERWRITING The Underwriters named below have severally agreed, subject to the terms and conditions of the Underwriting Agreement, to purchase from the Company and the Selling Shareholders the number of shares of Common Stock set forth opposite their respective names below. The Underwriters are required to purchase and pay for all of such shares if any are purchased.
NUMBER OF SHARES OF NAME OF UNDERWRITER COMMON STOCK --------------------------------------------------------------- ------------ Bear, Stearns & Co. Inc........................................ Cruttenden Roth Incorporated................................... L.H. Friend, Weinress, Frankson & Presson, Inc................. --------- Total................................................ 3,000,000 =========
The Underwriters have advised the Company and the Selling Shareholders that they propose to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow selected dealers a concession of not more than $ per share, and the Underwriters may allow, and such dealers may re-allow, a concession of not more than $ per share to certain other dealers. After the initial offering, the price and concessions and re-allowances to dealers may be changed by the Underwriters. The Common Stock is offered subject to receipt and acceptance by the Underwriters and to certain other conditions, including the right to reject orders in whole or in part. Certain of the Selling Shareholders have granted a 30-day option to the Underwriters to purchase up to a maximum of 450,000 additional shares of Common Stock to cover over-allotments, if any, at the same price per share as the initial 3,000,000 shares to be purchased by the Underwriters. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the foregoing table. The Underwriters may purchase such shares only to cover over-allotments made in connection with the sale of the Common Stock offered hereby. The Underwriting Agreement provides that the Company and the Selling Shareholders will indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act, or will contribute to payments the Underwriters may be required to make in respect thereof. The Company has also agreed not to offer, issue, sell, contract to sell, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or any rights to acquire Common Stock for a period of 90 days after the date of this Prospectus, without the prior written consent of Bear, Stearns & Co. Inc., subject to certain limited exceptions. The executive officers and directors of the Company, including the Selling Shareholders, have agreed with the Underwriters that they that they will not, without the prior written consent of Bear, Stearns & Co. Inc., offer, sell, contract to sell or otherwise dispose of any shares of Common Stock or any securities convertible into or exchangeable for Common Stock for a period of 180 days after the date of this Prospectus, subject to certain limited exceptions. The Underwriters may engage in over-allotments, stabilizing transactions, syndicate covering transactions and penalty bids in accordance with Regulation M under the Exchange Act. Over-allotment involves syndicate sales in excess of the offering size, which creates a syndicate short position. Stabilizing transactions permit bids for and purchases of the Common Stock so long as the stabilizing bids do not exceed a specified maximum. Syndicate covering transactions involve purchase of the Common Stock in the open market in order to cover syndicate short positions. Penalty bids permit the Underwriters to reclaim a selling concession from a syndicate member when the shares of Common Stock originally sold by such syndicate member are purchased in a stabilizing transaction or syndicate covering transaction to cover syndicate short positions. Such stabilizing transactions, syndicate covering transactions and penalty bids may cause the price of the Common Stock to be higher than it would otherwise be in the absence of such transactions. These transactions, if commenced, may be discontinued at any time. 40 43 LEGAL MATTERS Certain legal matters with respect to the legality under California law of the issuance of the shares of Common Stock offered hereby will be passed upon for the Company and the Selling Shareholders by Phillips & Haddan LLP, Newport Beach, California. James M. Phillips, Jr., a principal in the firm of Phillips & Haddan LLP, is a member of the Company's Board of Directors and holds options to purchase 15,000 shares of the Company's Common Stock. Certain legal matters will be passed upon for the Underwriters by Gibson, Dunn & Crutcher LLP, Los Angeles, California. EXPERTS The financial statements and schedules of the Company as of December 31, 1995 and 1996, and for each of the years in the three-year period ended December 31, 1996, have been included herein and in the Registration Statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. AVAILABLE INFORMATION The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith file reports, proxy statements and other information with the Securities and Exchange Commission (the "Commission"). The Commission file number for the Company is 0-18680. Such reports and other information may be inspected and copied at the Commission's Public Reference Section, Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549, where copies can be obtained at prescribed rates, as well as at the Commission's regional offices at Northwest Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York 10048. The Commission also maintains a website that contains reports, proxy and other information filed electronically with the Commission, the address of which is http://www.sec.gov. In addition, this material may also be inspected at the offices of The Nasdaq National Market at 1735 K Street, N.W., Washington, D.C. 20006, where copies may be obtained at prescribed rates. The Company has filed with the Commission under the Securities Act of 1933, as amended (the "Securities Act"), a Registration Statement on Form S-1 (the "Registration Statement") with respect to the shares of Common Stock to be offered and sold hereby. This Prospectus is included as a part of the Registration Statement, but does not contain all of the information set forth in the Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. Statements contained in this Prospectus as to the contents of any contract or other document referred to herein are not necessarily complete, and in each instance reference is made to the copy of such contract or other document filed as an exhibit or appendix to the Registration Statement, each such statement being qualified in all respects by such reference. The Registration Statement in full, including the exhibits and schedules thereto, may be inspected without charge at the Commission's Public Reference Section, Room 1024, located at 450 Fifth Street, N.W., Washington, D.C. 20549. Copies thereof may also be obtained from the Commission upon payment of prescribed fees by writing to the Commission at the above address. 41 44 INDEX TO FINANCIAL STATEMENTS
PAGE ---- Independent Auditors' Report.......................................................... F-2 Balance Sheets: December 31, 1995 and 1996, and June 30, 1997 (unaudited)........................... F-3 Statements of Income: Years ended December 31, 1994, 1995 and 1996, and Six Months ended June 30, 1996 and 1997 (unaudited).............................. F-4 Statements of Shareholders' Equity: Years ended December 31, 1994, 1995 and 1996, and Six Months ended June 30, 1997 (unaudited)....................................... F-5 Statements of Cash Flows: Years ended December 31, 1994, 1995 and 1996, and Six Months ended June 30, 1996 and 1997 (unaudited).............................. F-6 Notes to Financial Statements......................................................... F-7
F-1 45 INDEPENDENT AUDITORS' REPORT The Board of Directors Modtech, Inc.: We have audited the accompanying balance sheets of Modtech, Inc. as of December 31, 1995 and 1996 and the related statements of income, shareholders' equity and cash flows for each of the years in the three-year period ended December 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 conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Modtech, Inc. as of December 31, 1995 and 1996 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1996, in conformity with generally accepted accounting principles. KPMG Peat Marwick LLP Orange County, California March 21, 1997 F-2 46 MODTECH, INC. BALANCE SHEETS
DECEMBER 31, ------------------------- JUNE 30, 1995 1996 1997 ----------- ----------- ----------- (UNAUDITED) ASSETS (Note 5) Current assets: Cash.................................................. $ 561,000 $ 405,000 $ 2,703,000 Contracts receivable, less allowance for contract adjustments of $408,000, $413,000 and $410,000 at December 31, 1995, 1996 and June 30, 1997 (unaudited), respectively (note 2)................. 3,169,000 10,310,000 28,659,000 Costs and estimated earnings in excess of billings on contracts (notes 3 and 8).......................... 1,454,000 9,103,000 8,945,000 Inventories........................................... 646,000 4,167,000 7,852,000 Due from affiliates (note 8).......................... 766,000 754,000 886,000 Notes receivable from affiliates (note 8)............. 483,000 45,000 45,000 Prepaid assets........................................ 73,000 137,000 204,000 Other current assets.................................. 52,000 20,000 21,000 ----------- ----------- ----------- Total current assets.......................... 7,204,000 24,941,000 49,315,000 ----------- ----------- ----------- Property and equipment, net (note 4).................... 7,158,000 8,553,000 8,577,000 ----------- ----------- ----------- Notes receivable from affiliates (note 8)............... 237,000 -- -- Other assets............................................ 555,000 535,000 495,000 ----------- ----------- ----------- Total other assets............................ 792,000 535,000 495,000 ----------- ----------- ----------- $15,154,000 $34,029,000 $58,387,000 =========== =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable...................................... $ 1,105,000 $ 6,410,000 $ 7,137,000 Accrued liabilities................................... 956,000 3,214,000 8,580,000 Billings in excess of costs and estimated earnings on contracts (notes 3 and 8).......................... 760,000 1,148,000 6,851,000 Current maturities of long-term debt (notes 6 and 8)................................................. -- 100,000 100,000 ----------- ----------- ----------- Total current liabilities..................... 2,821,000 10,872,000 22,668,000 Note payable (note 5)................................... 1,590,000 5,944,000 13,332,000 Long-term debt, less current maturities (notes 6 and 8).................................................... 2,000,000 1,900,000 1,800,000 ----------- ----------- ----------- Total liabilities............................. 6,411,000 18,716,000 37,800,000 ----------- ----------- ----------- Shareholders' equity: 5% Convertible Preferred Stock, Series A. Authorized 5,000,000 shares; issued and outstanding 2,850,000, none and none at December 31, 1995, 1996 and June 30, 1997 (unaudited), respectively (note 11)....... 2,685,000 -- -- Common Stock, $.01 par. Authorized 20,000,000 shares; issued and outstanding 3,053,000, 8,649,000 and 8,679,000 at December 31, 1995, 1996 and June 30, 1997 (unaudited), respectively (notes 10 and 11)... 1,055,000 4,015,000 4,043,000 Additional paid-in capital............................ 13,619,000 15,693,000 15,744,000 Retained earnings (deficit)........................... (8,616,000) (4,395,000) 800,000 ----------- ----------- ----------- Total shareholders' equity.................... 8,743,000 15,313,000 20,587,000 Commitments and contingencies (notes 3, 5, 8 and 14).... ----------- ----------- ----------- $15,154,000 $34,029,000 $58,387,000 =========== =========== ===========
See accompanying notes to financial statements. F-3 47 MODTECH, INC. STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, --------------------------------------- ------------------------- 1994 1995 1996 1996 1997 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) Net sales (notes 8 and 12)...... $20,355,000 $19,386,000 $49,886,000 $12,704,000 $58,906,000 Cost of goods sold (note 8)..... 17,766,000 16,401,000 42,629,000 10,862,000 47,688,000 ----------- ----------- ----------- ----------- ----------- Gross profit............... 2,589,000 2,985,000 7,257,000 1,842,000 11,218,000 Selling, general and administrative expenses....... 1,554,000 1,613,000 2,345,000 848,000 2,182,000 ----------- ----------- ----------- ----------- ----------- Income from operations..... 1,035,000 1,372,000 4,912,000 994,000 9,036,000 ----------- ----------- ----------- ----------- ----------- Other income (expense): Interest expense.............. (576,000) (486,000) (446,000) (127,000) (572,000) Interest income (note 8)...... 105,000 99,000 24,000 20,000 23,000 Other -- net.................. 42,000 (1,000) (13,000) 22,000 64,000 ----------- ----------- ----------- ----------- ----------- (429,000) (388,000) (435,000) (85,000) (485,000) ----------- ----------- ----------- ----------- ----------- Income before income taxes.................... 606,000 984,000 4,477,000 909,000 8,551,000 Income taxes (note 7)........... 4,000 19,000 208,000 20,000 3,356,000 ----------- ----------- ----------- ----------- ----------- Net income................. $ 602,000 $ 965,000 $ 4,269,000 $ 889,000 $ 5,195,000 ----------- ----------- ----------- ----------- ----------- 5% Convertible Preferred Stock dividend (note 11)............ -- (166,000) (48,000) (48,000) -- Net income available for Common Stock............. $ 602,000 $ 799,000 $ 4,221,000 $ 841,000 $ 5,195,000 =========== =========== =========== =========== =========== Primary earnings per share...... $ 0.12 $ 0.13 $ 0.49 $ 0.10 $ 0.55 =========== =========== =========== =========== =========== Weighted-average shares outstanding................... 5,098,000 6,027,000 8,709,000 8,750,000 9,370,000 =========== =========== =========== =========== =========== Fully diluted earnings per share......................... $ 0.11 $ 0.12 $ 0.47 $ 0.10 $ 0.55 =========== =========== =========== =========== =========== Weighted-average shares outstanding................... 5,294,000 6,712,000 9,041,000 8,750,000 9,370,000 =========== =========== =========== =========== ===========
See accompanying notes to financial statements. F-4 48 MODTECH, INC. STATEMENTS OF SHAREHOLDERS' EQUITY
5% CONVERTIBLE PREFERRED STOCK STOCK COMMON STOCK PURCHASE ADDITIONAL RETAINED ------------------------ ---------------------- NOTES PAID-IN EARNINGS SHARES AMOUNT SHARES AMOUNT RECEIVABLE CAPITAL (DEFICIT) ---------- ----------- --------- ---------- ---------- ----------- ------------ Balance, December 31, 1993...................... -- $ -- 3,209,000 $1,109,000 $(274,000) $13,913,000 $(10,017,000) Sale of preferred stock (note 11)................. 2,850,000 2,685,000 -- -- -- -- -- Net income.................. -- -- -- -- -- -- 602,000 ---------- ----------- --------- ---------- --------- ----------- ------------ Balance, December 31, 1994...................... 2,850,000 $ 2,685,000 3,209,000 $1,109,000 $(274,000) $13,913,000 $ (9,415,000) Adjustment of stock purchase notes receivable.......... -- -- (156,000) (54,000) 274,000 (294,000) -- Dividend (note11)........... -- -- -- -- -- -- (166,000) Net income.................. -- -- -- -- -- -- 965,000 ---------- ----------- --------- ---------- --------- ----------- ------------ Balance, December 31, 1995...................... 2,850,000 2,685,000 3,053,000 1,055,000 -- 13,619,000 (8,616,000) Conversion of preferred stock (note 11)........... (2,850,000) (2,685,000) 2,850,000 2,685,000 -- -- -- Conversion of options and warrants (notes 10 and 11)....................... -- -- 2,746,000 275,000 -- 2,074,000 -- Dividend (note 11).......... -- -- -- -- -- -- (48,000) Net income.................. -- -- -- -- -- -- 4,269,000 ---------- ----------- --------- ---------- --------- ----------- ------------ Balance, December 31, 1996...................... -- -- 8,649,000 4,015,000 -- 15,693,000 (4,395,000) Conversion of options (notes 10 and 11) (unaudited).... -- -- 30,000 28,000 -- 51,000 -- Net income (unaudited)...... -- -- -- -- -- -- 5,195,000 ---------- ----------- --------- ---------- --------- ----------- ------------ Balance, June 30, 1997 (unaudited)............... -- $ -- 8,679,000 $4,043,000 $ -- $15,744,000 $ 800,000 ========== =========== ========= ========== ========= =========== ============
See accompanying notes to financial statements. F-5 49 MODTECH, INC. STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ------------------------------------------- ---------------------------- 1994 1995 1996 1996 1997 ----------- ----------- ----------- ----------- ------------ (UNAUDITED) Cash flows from operating activities: Net income............................... $ 602,000 $ 965,000 $ 4,269,000 $ 889,000 $ 5,195,000 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization.......... 608,000 563,000 540,000 257,000 534,000 Increase (decrease) in allowance for contract adjustments................. (275,000) (17,000) (5,000) -- 3,000 Loss (gain) on sale of equipment....... (39,000) (20,000) 17,000 (5,000) -- Changes in assets and liabilities: (Increase) decrease in contracts receivable........................... 1,363,000 (65,000) (7,136,000) (3,575,000) (18,352,000) (Increase) decrease in costs and estimated earnings in excess of billings............................. (551,000) 330,000 (7,649,000) (3,005,000) 158,000 (Increase) decrease in inventories..... (174,000) 338,000 (3,521,000) (857,000) (3,685,000) (Increase) decrease in amounts due from affiliates........................... (290,000) (257,000) 687,000 555,000 (132,000) (Increase) decrease in prepaids and other assets......................... 183,000 54,000 (12,000) 93,000 (28,000) Increase (decrease) in accounts payable.............................. (1,583,000) (436,000) 5,305,000 1,988,000 727,000 Increase in accrued liabilities........ 475,000 35,000 2,258,000 210,000 5,366,000 Increase (decrease) in billings in excess of costs and earnings......... 109,000 (276,000) 388,000 951,000 5,703,000 ----------- ----------- ----------- ----------- ------------ Net cash provided by (used in) operating activities................. 428,000 1,214,000 (4,859,000) (2,499,000) (4,511,000) ----------- ----------- ----------- ----------- ------------ Cash flows from investing activities: Proceeds from sale of equipment.......... 81,000 46,000 6,000 12,000 12,000 Purchase of property and equipment....... (200,000) (482,000) (1,958,000) (353,000) (570,000) ----------- ----------- ----------- ----------- ------------ Net cash used in investing activities........................... (119,000) (436,000) (1,952,000) (341,000) (558,000) ----------- ----------- ----------- ----------- ------------ Cash flows from financing activities: Net principal borrowings (payments) under revolving credit lines................. (1,804,000) (310,000) 4,354,000 2,152,000 7,388,000 Principal payments on long-term debt..... (1,185,000) (503,000) -- -- (100,000) (Adjustment of) stock purchase note receivable by exchange of Common Stock.................................. -- (74,000) -- -- -- Net proceeds from issuance of Common Stock shares........................... -- -- 2,349,000 -- 79,000 Declared dividends....................... -- (166,000) (48,000) (48,000) -- Conversion of stock warrants and options................................ -- -- -- 536,000 -- Net proceeds from sale of convertible preferred stock (note 11).............. 2,685,000 -- -- -- -- ----------- ----------- ----------- ----------- ------------ Net cash provided by (used in) financing activities................. (304,000) (1,053,000) 6,655,000 2,640,000 7,367,000 ----------- ----------- ----------- ----------- ------------ Net increase (decrease) in cash........ 5,000 (275,000) (156,000) (200,000) 2,298,000 Cash at beginning of year.................. 831,000 836,000 561,000 561,000 405,000 ----------- ----------- ----------- ----------- ------------ Cash at end of year........................ $ 836,000 $ 561,000 $ 405,000 $ 361,000 $ 2,703,000 =========== =========== =========== =========== ============
See accompanying notes to financial statements. F-6 50 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) 1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Modtech, Inc. (the "Company") designs, manufactures, markets and installs modular relocatable classrooms. The Company's classrooms are sold primarily to California school districts. The Company also sells classrooms to the State of California and to leasing companies, who lease the classrooms principally to California school districts. Effective October 1, 1996, the Company acquired substantially all of the operating assets of Miller Structures, Inc. - California. In addition, the Company assumed certain liabilities. The Company entered into a lease agreement to rent the manufacturing facility. Miller Structures, Inc. - California manufactures and markets factory-built buildings. 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 disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with original maturities of three months or less to be cash equivalents. Substantially all cash deposits are maintained in one financial institution. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying value of cash, contracts receivable and notes receivable, costs and estimated earnings in excess of billings on contracts, prepaid and other assets, accounts payable, accrued liabilities, billings in excess of estimated earnings on contracts and notes payable are measured at cost which approximates their fair value. CONSTRUCTION CONTRACTS The accompanying financial statements have been prepared using the percentage-of-completion method of accounting and, therefore, take into account the costs, estimated earnings and revenue to date on contracts not yet completed. Revenue recognized is that percentage of the total contract price that cost expended to date bears to anticipated final total cost, based on current estimates of costs to complete. Most contracts are completed within one year. Contract costs include all direct material and labor costs and those indirect costs related to contract performance, such as indirect labor, supplies, tools, repairs and depreciation costs. Selling, general and administrative costs are charged to expense as incurred. At the time a loss on a contract becomes known, the entire amount of the estimated ultimate loss is recognized in the financial statements. The current asset, "Costs and Estimated Earnings in Excess of Billings on Contracts," represents revenues recognized in excess of amounts billed. The current liability, "Billings in Excess of Costs and Estimated Earnings on Contracts," represents billings in excess of revenues recognized. F-7 51 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) The current contra asset, "Allowance for Contract Adjustments," is management's estimated adjustments to contract amounts due to disputes and or litigation. INVENTORIES Inventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out (FIFO) method. Inventories, generally include only raw materials, as any work-in-process or finished goods are accounted for in percentage of completion allocations. The Company held finished inventory of $202,000 and $0 at December 31, 1995 and 1996, respectively. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation and amortization is provided using the straight-line and accelerated methods over the following estimated useful lives: Leasehold improvements........................ 15 to 31 years Machinery and equipment....................... 5 to 7 years Trucks and automobiles........................ 3 to 5 years Office equipment.............................. 5 to 7 years
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF The Company adopted the provisions of Statement of Financial Accounting Standard No. 121 (SFAS No. 121), "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," on January 1, 1996. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount of fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position, results of operations or liquidity. STOCK OPTION PLAN Prior to January 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted Statement of Financial Accounting Standard No. 123 (SFAS No. 123), "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provision of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. F-8 52 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) TAXES ON INCOME Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. EARNINGS PER SHARE Earnings per share are computed on the basis of the weighted average number of common and dilutive common equivalent shares outstanding during each year. RECLASSIFICATION Certain amounts in the 1994 and 1995 financial statements have been reclassified to conform to the 1996 presentation. 2. CONTRACTS RECEIVABLE Contracts receivable consisted of customer billings for:
DECEMBER 31, -------------------------- JUNE 30, 1995 1996 1997 ---------- ----------- ----------- (UNAUDITED) Completed contracts.......................... $ 675,000 $ 7,723,000 $ 1,366,000 Contracts in progress........................ 2,613,000 2,103,000 25,288,000 Retentions................................... 289,000 897,000 2,415,000 ---------- ----------- ----------- 3,577,000 10,723,000 29,069,000 Less allowance for contract adjustments...... (408,000) (413,000) (410,000) ---------- ----------- ----------- $3,169,000 $10,310,000 $28,659,000 ========== =========== ===========
3. COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON CONTRACTS Net costs and estimated earnings in excess of billings on contracts consisted of:
DECEMBER 31, ----------------------------- JUNE 30, 1995 1996 1997 ------------ ------------ ----------- (UNAUDITED) Net costs and estimated earnings on uncompleted contracts................... $ 22,744,000 $ 39,093,000 $93,369,000 Billings to date.......................... (22,213,000) (31,173,000) 91,266,000 ------------ ------------ ----------- 531,000 7,920,000 2,103,000 Net unbilled receivables (payables) from completed contracts..................... 163,000 35,000 (9,000) ------------ ------------ ----------- $ 694,000 $ 7,955,000 $ 2,094,000 ============ ============ ===========
F-9 53 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) These amounts are shown in the accompanying balance sheets under the following captions:
DECEMBER 31, -------------------------- JUNE 30, 1995 1996 1997 ---------- ----------- ----------- (UNAUDITED) Costs and estimated earnings in excess of billings on uncompleted contracts.......... $1,254,000 $ 8,971,000 $ 8,812,000 Costs and estimated earnings in excess of billings on completed contracts............ 200,000 132,000 133,000 ---------- ----------- ----------- Costs and estimated earnings in excess of billings........................... 1,454,000 9,103,000 8,945,000 ---------- ----------- ----------- Billings in excess of costs and estimated earnings on uncompleted contracts.......... (722,000) (1,052,000) (6,709,000) Billings in excess of costs and estimated earnings on completed contracts............ (38,000) (96,000) (142,000) ---------- ----------- ----------- Billings in excess of costs and estimated earnings................................ (760,000) (1,148,000) (6,851,000) ---------- ----------- ----------- $ 694,000 $ 7,955,000 $ 2,094,000 ========== =========== ===========
4. PROPERTY AND EQUIPMENT, NET Property and equipment, net consists of:
DECEMBER 31, --------------------------- 1995 1996 ----------- ----------- Leasehold improvements.................................... $ 7,241,000 $ 7,581,000 Machinery and equipment................................... 2,492,000 3,536,000 Trucks and automobiles.................................... 164,000 107,000 Office equipment.......................................... 469,000 222,000 Construction in progress.................................. 261,000 567,000 ----------- ----------- 10,627,000 12,013,000 Less accumulated depreciation and amortization............ (3,469,000) (3,460,000) ----------- ----------- $ 7,158,000 $ 8,553,000 =========== ===========
5. NOTE PAYABLE -- REVOLVING CREDIT AGREEMENT In 1995 the Company entered into a new revolving loan commitment that will expire in September 1998. The Company is entitled to borrow, from time to time, up to $10,000,000 with actual borrowings limited to specific percentages of eligible contracts receivable, equipment and inventories. On December 31, 1996, borrowings were limited to $8,136,000 and actual outstanding borrowings were $5,944,000. The interest rate is calculated at the prime lending rate (8.25% at December 31, 1996) plus two percent (2%) per annum. The loan is secured by substantially all of the Company's assets. In addition, the Company has one standby letter of credit with the bank for $2,036,000 on which no amounts were outstanding as of December 31, 1996. F-10 54 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) 6. LONG-TERM DEBT Long-term debt consists of:
DECEMBER 31, ------------------------- 1995 1996 ---------- ---------- Industrial development bonds................................ $2,000,000 $2,000,000 Less current portion of long-term debt...................... -- (100,000) ---------- ---------- $2,000,000 $1,900,000 ========== ==========
In June 1990, the Industrial Development Authority of the County of San Joaquin, California issued $4,200,000 of Industrial Development Bonds. The net proceeds of approximately $4,000,000 were used to fund the construction of a manufacturing facility on leased property located in Lathrop, California. The Company fully utilized the bonds at December 31, 1991. The Company has executed financing statements covering the plant and equipment financed, as security for repayment of the bonds. The bonds are secured by a $2 million letter of credit, and bear interest at an initial rate of 6.75% and fluctuate weekly. The interest rate was 3.75% at December 31, 1996. Repayment of the bonds will be $100,000 per year through 2015, with the remaining balance paid off in 2016. Annual maturities of long-term debt outstanding at December 31, 1996 are as follows: Year ending December 31: 1997........................................................... $ 100,000 1998........................................................... 100,000 1999........................................................... 100,000 2000........................................................... 100,000 2001........................................................... 100,000 Thereafter..................................................... 1,500,000 ---------- $2,000,000 ==========
7. INCOME TAXES The components of the 1994, 1995 and 1996 provision for Federal and state income taxes are summarized below:
SIX MONTHS ENDED JUNE YEAR ENDED DECEMBER 31, 30, ------------------------------- ---------------------- 1994 1995 1996 1996 1997 ------ ------- -------- ------- ---------- (UNAUDITED) Current: Federal...................... $ -- $14,000 $ 91,000 $ 8,000 $2,600,000 State........................ 4,000 5,000 117,000 12,000 756,000 ------ ------- -------- ------- ---------- Deferred: Federal...................... -- -- -- -- -- State........................ -- -- -- -- -- ------ ------- -------- ------- ---------- $4,000 $19,000 $208,000 $20,000 $3,356,000 ====== ======= ======== ======= ==========
F-11 55 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) Income tax expense attributable to income from operations differed from the amounts computed by applying the U.S. Federal income tax rate to pretax income from operations as a result of the following:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, --------------------------- --------------- 1994 1995 1996 1996 1997 ----- ----- ----- ----- ---- (UNAUDITED) Taxes, U.S. statutory rates..................... 34.0% 34.0% 34.0% 34.0% 34.0% State taxes, less Federal benefit............... -- -- -- -- 5.8 Utilization of income tax benefit relating to loss carryover................................ (34.0) (34.0) (34.0) (34.0) (7.2) Other........................................... 0.7 1.9 4.6 2.2 6.7 ----- ----- ----- ----- ---- Total taxes on income................. 0.7% 1.9% 4.6% 2.2% 39.3% ===== ===== ===== ===== ====
Deferred tax liabilities, which amounted to approximately $68,000 and $270,000 at December 31, 1995 and 1996, respectively, primarily result from temporary differences between financial and tax accounting treatment of revenue recognition on contracts and depreciation. Deferred tax assets, which amounted to approximately $2,819,000 and $1,429,000 at December 31, 1995 and 1996, respectively, were mainly comprised of net operating loss carryforwards and accrued liabilities. The Company's net operating loss carryforward at December 31, 1996 amounted to approximately $615,000, and expires in 2008 and 2009. For the years ended December 31, 1995 to 1996 the Company reduced the net deferred tax asset to zero by a valuation allowance. The valuation allowance for the net deferred tax assets as of December 31, 1995 was $2,751,000. The net change for the year ended December 31, 1996 was a decrease of $1,592,000, resulting in a remaining valuation allowance of $1,159,000. 8. TRANSACTIONS WITH RELATED PARTIES SALES The Company sells modular classrooms to certain companies and partnerships, the shareholders and partners of which are either officers, shareholders or key employees of the Company. The buildings are then leased to various school districts by the related companies and partnerships. The table below summarizes the classroom sales to related parties:
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, -------------------------------------- --------------------- 1994 1995 1996 1996 1997 ---------- -------- ---------- -------- -------- (UNAUDITED) Sales............................ $1,009,000 $600,000 $1,453,000 $269,000 $745,000 Cost of goods sold............... 870,000 531,000 1,239,000 236,000 655,000 Gross profit percentage.......... 13.8% 11.5% 14.7% 12.3% 12.1% ========== ========= ========== ========= =========
The related party purchases modular relocatable classrooms from the Company, upon standard terms and at standard wholesale prices. F-12 56 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) Due from affiliates includes a portion of unpaid invoices as a result of the above transactions. As of December 31, 1995 and 1996 these amounts totaled $376,000 and $432,000, respectively. Additional amounts arising from these transactions are included in the following captions:
DECEMBER 31, JUNE 30, ------------------- -------- 1995 1996 1997 -------- -------- -------- Costs and estimated earnings in excess of billings on uncompleted contracts................................ $ -- $418,000 $397,000 Billings in excess of costs and estimated earnings on uncompleted contracts................................ (30,000) (13,000) (47,000) ======== ======== ========
NOTES RECEIVABLE At December 31, 1995, the Company had two notes receivable from a related party partnership aggregating $483,000. The partnership is composed of officers and shareholders of the Company. One note was paid in full during 1996 and the other note, in the amount of $45,000, which bears interest at 10% and is payable upon demand, remained outstanding at December 31, 1996. At December 31, 1995 the Company also had demand notes receivable of $132,000 and $105,000 due from related party partnerships. These notes were paid in full during 1996. Unpaid interest related to the above notes totaled $390,000 at December 31, 1995 and $322,000 at December 31, 1996 and are included in due from affiliates. The Company is negotiating payment terms on the accrued interest and anticipates full payment during 1997. OPERATING LEASES The Company leases various land at its manufacturing facilities. The present manufacturing facility leases are with the Company's primary shareholder and partnerships composed of officers and shareholders. All related party leases require monthly payments which aggregate $67,000. In connection with the lease at the Lathrop facility, the Company made a $83,000 security deposit during 1990. In 1994, due to declines in real estate values the Company's primary shareholder and partnerships reduced the monthly lease rates for the manufacturing facilities to an aggregate of $36,000. The reduced rents will continue for as long as real estate values remain depressed. Future minimum lease payments under these leases are discussed in Note 14. Included in cost of sales is $418,000, $435,000 and $447,000 in rent expense paid to related parties for the years ended December 31, 1994, 1995 and 1996, respectively. 9. 401(K) PLAN The Company has a tax deferred savings plan under Section 401(k) of the Internal Revenue Code. Eligible employees can contribute up to 12% of gross annual earnings. Company contributions, made on a 50% matching basis, are determined annually. The Company's contributions were $41,000, $37,000 and $53,000 in 1994, 1995 and 1996, respectively. 10. STOCK OPTIONS In 1989, the Company's shareholders approved a stock option plan (the 1989 Plan). The 1989 Plan provides for the grant of both incentive and non-qualified options to purchase up to 400,000 shares of the F-13 57 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) Company's Common Stock. The incentive stock options can be granted only to employees, including officers of the Company, while non-qualified stock options can be granted to employees, non-employee officers and directors, consultants, vendors, customers and others expected to provide significant services to the Company. The exercise price of the stock options cannot be less than the fair market at the date of the grant (110% if granted to an employee who owns 10% or more of the common stock). Stock options outstanding under this 1989 Plan are summarized as follows:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE -------- ---------------- December 31, 1993................................. 400,000 $ 1.91 Granted......................................... 75,000 1.50 Terminated...................................... (75,000) 1.45 Exercised....................................... -- -- -------- ------ December 31, 1994................................. 400,000 1.92 Granted......................................... 45,000 2.125 Terminated...................................... (45,000) 3.00 Exercised....................................... -- -- -------- ------ December 31, 1995................................. 400,000 1.82 Granted......................................... -- -- Terminated...................................... -- -- Exercised....................................... (134,500) 1.62 -------- ------ December 31, 1996................................. 265,500 1.92 Granted......................................... -- -- Terminated...................................... -- -- Exercised (unaudited)........................... (13,650) 2.78 -------- ------ June 30, 1997 (unaudited)......................... 251,850 $ 1.87 ======== ======
As of December 31, 1996, 185,900 options are vested and exercisable at prices ranging from $.625 to $10.00 per share under the 1989 Plan. As of June 30, 1997, 179,750 options are vested and exercisable at prices ranging from $.625 to $10.00 per share under the 1989 Plan (unaudited). In March of 1994, pursuant to a vote of the Board of Directors, a nonqualified option plan was approved (the March 1994 Plan). The March 1994 Plan provides for the grant of 200,000 options to purchase shares of the Company's common stock. The exercise price of the stock options cannot be less than the fair market at the date of the grant. All of these options were granted during 1994. F-14 58 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) Stock options outstanding under the March 1994 Plan, are summarized as follows:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE -------- ---------------- December 31, 1993................................. 180,000 $ 1.19 Granted......................................... 20,000 1.50 Terminated...................................... -- -- Exercised....................................... -- -- ------- ------ December 31, 1994................................. 200,000 1.22 Granted......................................... -- -- Terminated...................................... -- -- Exercised....................................... -- -- ------- ------ December 31, 1995................................. 200,000 1.22 Granted......................................... -- -- Terminated...................................... -- -- Exercised....................................... (20,000) 1.19 ------- ------ December 31, 1996................................. 180,000 1.22 Granted......................................... -- -- Terminated...................................... -- -- Exercised (unaudited)........................... (14,500) 1.37 ------- ------ June 30, 1997 (unaudited)......................... 165,500 $ 1.21 ======= ======
As of December 31, 1996, 95,000 options are vested and exercisable at prices ranging from $1.19 to $1.50 per share under the March 1994 Plan. As of June 30, 1997, 123,000 options are vested and exercisable at prices ranging from $1.19 to $1.50 per share under the March 1994 Plan (unaudited). In May of 1994, in conjunction with the offering of preferred stock (note 11), the Board of Directors voted and approved an additional stock option plan (the May 1994 Plan). The May 1994 Plan provides for the grant of both incentive and non-qualified options to purchase up to 500,000 shares of the Company's common stock. The incentive stock options can be granted only to employees, including officers of the Company, while non-qualified stock options can be granted to employees, non-employee officers and directors, consultants, vendors, customers and others expected to provide significant services to the Company. The exercise price of the stock options cannot be less than the fair market at the date of the grant (110% if granted to an employee who owns 10% or more of the common stock). F-15 59 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) Stock options outstanding under this May 1994 Plan, are summarized as follows:
WEIGHTED-AVERAGE SHARES EXERCISE PRICE ------- ---------------- December 31, 1994.................................. 285,000 $ 1.50 Granted.......................................... 35,000 2.125 Terminated....................................... (35,000) 1.50 Exercised........................................ -- -- ------- ------ December 31, 1995.................................. 285,000 1.60 Granted.......................................... 205,000 2.59 Terminated....................................... (37,500) 1.50 Exercised........................................ (12,500) 1.50 ------- ------ December 31, 1996.................................. 440,000 2.06 Granted.......................................... -- -- Terminated....................................... -- -- Exercised (unaudited)............................ (1,250) 2.13 ------- ------ June 30, 1997 (unaudited).......................... 438,750 $ 2.06 ======= ======
As of December 31, 1996, 108,750 options are vested and exercisable at prices ranging from $1.50 to $4.50 per share under the May 1994 Plan. As of June 30, 1997, 198,750 options are vested and exercisable at prices ranging from $1.50 to $4.50 per share under the May 1994 Plan (unaudited). In July 1996, the Company's Board of Directors authorized the grant of options to purchase up to 500,000 shares of the Company's common stock. The non-statutory options may be granted to employees, non-employee officers and directors, consultants, vendors, customers and others expected to provide significant service to the Company. The exercise price of the stock options cannot be less than the fair market value at the date of the grant (110% if granted to an employee who owns 10% or more of the common stock). At December 31, 1996, 110,000 options were granted at an exercise price of $4.50 and of these, 30,000 options were vested and exercisable. In January 1997, an additional 215,833 options were granted at an exercise price of $7.88 and in June 1997, 25,000 options were granted at an exercise price of $12.62. At June 30, 1997, 30,000 options were vested and exercisable at $4.50 per share under the 1996 Plan (unaudited). The per share weighted-average fair value of stock options granted during 1995 and 1996 was $1.28 and $1.94, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions; 1995 -- expected dividend yield 0%, risk-free interest rate of 7.80%, volatility factor of 72.66%, and an expected life of four years; 1996 -- expected dividend yield 0%, risk-free interest rate ranging from 6.57% to 7.80%, volatility factor of 72.66%, and an expected life of four years. The Company applies APB Opinion No. 25 in accounting for its Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost F-16 60 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been reduced to the pro forma amounts indicated below:
SIX MONTHS ENDED JUNE YEAR ENDED DECEMBER 31, 30, ----------------------- ----------------------- 1995 1996 1996 1997 -------- ---------- -------- ---------- (UNAUDITED) Net income: As reported........................ $965,000 $4,269,000 $889,000 $5,195,000 Pro forma.......................... 862,000 3,658,000 783,000 4,434,000 ======== ========== ======== ========== Primary earnings per share: As reported........................ $ 0.13 $ 0.49 $ 0.10 $ 0.55 Pro forma.......................... 0.11 0.42 0.09 0.47 ======== ========== ======== ========== Fully diluted earnings per share: As reported........................ $ 0.12 $ 0.47 $ 0.10 $ 0.55 Pro forma.......................... 0.11 0.40 0.09 0.47 ======== ========== ======== ==========
Pro forma net income reflects only options granted in 1995 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period of four years and compensation cost for options granted prior to January 1, 1995 is not considered. 11. 5% CONVERTIBLE PREFERRED STOCK AND WARRANTS In May of 1994, in a private transaction without registration under the Securities Act, the Company sold 2,850,000 shares of Series A 5% Convertible Preferred Stock. The preferred stock was sold at the price of $1.00 per share resulting in proceeds before costs and expenses of $2,850,000. All of the Series A 5% Convertible Preferred Stock was converted into Common Stock during 1996. In connection with this private placement of the Series A 5% Preferred Stock, the shareholders were granted warrants to purchase an aggregate of 1,385,000 shares of common stock at $1.50 (subject to adjustment in certain events), as well as warrants to purchase an aggregate of 1,375,000 additional shares at $2.00 per share (subject to adjustments in certain events). All warrants were exercised during 1996 resulting in the issuance of 2,204,000 shares of common stock and proceeds to the Company of approximately $1,643,000. Dividends in the amount of $166,000 and $48,000 were declared for the years ended December 31, 1995 and 1996, respectively. The Company also had outstanding 375,000 stock warrants at a price of $1.1875 in connection with a 1994 bank financing agreement. All these warrants were exercised during 1996. 12. MAJOR CUSTOMERS The Company had sales to one major customer which represented the following percentage of net sales:
YEAR ENDED DECEMBER 31, ------------------------ 1994 1995 1996 ---- ---- ---- State of California................................. 28% 9% 13% == = ==
Sales to individual California school districts accounted 67.0%, 87.9% and 79.4% of the Company's net sales for 1994, 1995 and 1996, respectively. F-17 61 MODTECH, INC. NOTES TO FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994, 1995, 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED) 13. SUPPLEMENTAL CASH FLOW DISCLOSURES SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, ------------------------------ ------------------- 1994 1995 1996 1996 1997 -------- -------- -------- -------- -------- (UNAUDITED) Cash paid during the year for: Interest.................. $531,000 $248,000 $421,000 $180,000 $506,000 Income taxes.............. -- -- 24,000 -- -- ======== ======== ======== ======== ========
SUPPLEMENTAL DISCLOSURES OF NONCASH FINANCING ACTIVITIES: During 1995, $274,000 of notes receivable from officer shareholders was repaid by delivery of 155,988 shares of common stock at market value. During 1996, 2,850,000 shares of Series A 5% convertible Preferred Stock were converted into 2,850,000 shares of common stock, in accordance with the private placement (note 11). 14. COMMITMENTS AND CONTINGENCIES LAND LEASES The Company has entered into agreements to lease land at its manufacturing facilities in Perris and Lathrop, California. Minimum lease payments under these noncancelable operating leases for the next five years and thereafter are as follows: Year ending December 31: 1997........................................... $ 496,000 1998........................................... 489,000 1999........................................... 480,000 2000........................................... 435,000 2001........................................... 435,000 Thereafter..................................... 6,325,000 ---------- $8,660,000 ==========
Of the $8,660,000 in future rental payments, substantially all is payable to related parties (note 8). Rent expense for the years ended December 31, 1994, 1995 and 1996 was $418,000, $435,000 and $447,000, respectively. WARRANTY The Company provides a one year warranty relating to the workmanship on their modular units. To date, warranty costs incurred on completed contracts have been immaterial. PENDING CLAIMS AND LITIGATION In the normal course of business, the Company has been named in several claims and lawsuits arising out of the failure to pay subcontractors or for alleged breach of assigned security. In the opinion of management, the outcome of the claims will not have a material effect on the Company's financial position or results of operations. F-18 62 [PHOTOGRAPH] 63 ====================================================== NO DEALER, SALES REPRESENTATIVE, OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING SHAREHOLDER OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY SECURITIES OTHER THAN THE SECURITIES TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN WHICH THE PERSON MAKING THE OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. UNDER NO CIRCUMSTANCES SHALL THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER CREATE ANY IMPLICATION THAT INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT AS OF ANY TIME SUBSEQUENT TO DATE OF THIS PROSPECTUS. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary..................... 3 Risk Factors........................... 6 Use of Proceeds........................ 10 Market Information and Related Matters.............................. 11 Dividend Policy........................ 11 Capitalization......................... 12 Selected Financial Data................ 13 Management's Discussion and Analysis of Results of Operations and Financial Condition............................ 14 Business............................... 20 Management............................. 31 Principal and Selling Shareholders..... 36 Description of Capital Stock........... 38 Underwriting........................... 40 Legal Matters.......................... 41 Experts................................ 41 Available Information.................. 41 Index to Financial Statements.......... F-1
====================================================== ====================================================== 3,000,000 SHARES MODTECH LOGO COMMON STOCK -------------------- PROSPECTUS -------------------- BEAR, STEARNS & CO. INC. CRUTTENDEN ROTH INCORPORATED L.H. FRIEND, WEINRESS, FRANKSON & PRESSON, INC. OCTOBER , 1997 ====================================================== 64 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The Company anticipates that the expenses incurred or to be incurred by the Company in connection with the preparation and filing of this Registration Statement and the transactions contemplated hereby will be approximately as follows:
DESCRIPTION AMOUNT ------------------------------------------------------------------ -------- Registration fees................................................. $ 35,000 Transfer agent and registrar costs................................ 5,000 Printing and duplication costs.................................... 75,000 Legal fees and expenses........................................... 90,000 Accounting fees and expenses...................................... 70,000 Miscellaneous..................................................... 25,000 -------- Total................................................... $300,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS As allowed by the California General Corporation Law, the Articles of Incorporation of the Company provide that the liability of the directors of the Company for monetary damages shall be eliminated to the fullest extent permissible under California law. This is intended to eliminate the personal liability of a director for monetary damages in an action brought by or in the right of the Company for breach of a director's duties to the Company or its shareholders except for liability for acts or omissions that involve intentional misconduct or knowing and culpable violation of law, for acts or omissions that a director believes to be contrary the best interests of the Company or its shareholders or that involve the absence of good faith on the part of the director, for any transaction from which a director derived an improper personal benefit, for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, with respect to certain contracts in which a director has a material financial interest and for approval of certain improper distributions to shareholders or certain loans or guarantees. This provision does not limit or eliminate the rights of the Company or any shareholder to seek non-monetary relief such as an injunction or rescission in the event of a breach of a director's duty of care. The Company's Bylaws require the Company to indemnify its officers, directors, employees and other agents to the full extent permitted by law, including those circumstances in which indemnification would otherwise be discretionary. In addition, the Company's Articles of Incorporation expressly authorize the use of indemnification agreements and, with the approval of its shareholders, the Company has entered into separate indemnification agreements with each of its directors. The Company's Board of Directors has authorized similar indemnification agreements for the Company's officers. These agreements may require the Company, among other things, to indemnify directors and officers against certain liabilities that may arise by reason of their status or service as directors and officers, and to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES In May 1994, the Company raised net proceeds of approximately $2.7 million through the sale of 2,850,000 shares of Series A Preferred Stock to several private investors who are participating as Selling Shareholders in the Offering, without registration under the Securities Act of ,1933, as amended (the "Securities Act"), in reliance upon the exemption from such registration provided by Section 4(2) thereof. In April 1996, all of the Series A Preferred Stock was converted into 2,850,000 shares of Common Stock. In II-1 65 December 1996, warrants issued to the investors in connection with the preferred stock financing were exercised, resulting in cash proceeds to the Company of approximately $1.6 million and the issuance of 2,746,000 additional shares of Common Stock. All of these shares were also issued without registration under the Securities Act in reliance upon the exemption from such registration provided by Section 4(2) thereof. All of the 5,596,000 shares of Common Stock issued to the private investors have been registered for resale from time to time under the Securities Act pursuant to the Company's Registration Statement on Form S-3 which became effective under the Securities Act on January 6, 1995. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (a) The following exhibits are filed herewith as part of this Registration Statement: 1 Form of Underwriting Agreement 3.1 Articles of Incorporation * 3.2 Bylaws* 5 Opinion of Phillips & Haddan LLP 10.1 Lease between the Company and Pacific Continental Modular Enterprises, relating to the Barrett Street property in Perris, California.* 10.2 Lease between the Company and Gerald Bashaw, relating to the Morgan Street Property in Perris, California.* 10.3 Lease between the Company and BMG2, relating to the property in Lathrop, California.* 10.4 Industrial Development Bond agreements.* 10.5 Amendment to Loan and Security Agreement between the Company and Coast Business Credit Corporation (previously filed). 10.6 Form of Indemnity Agreement between the Company and its executive officers and directors.* 10.7 Employment Agreement between the Company and Evan M. Gruber.* 23.1 Consent of KMPG Peat Marwick LLP 23.2 Consent of Phillips & Haddan LLP (to be included as part of Exhibit 5) 24 Power of attorney (set forth on the Signatures page of the Registration Statement) 27 Financial Data Schedule (previously filed)
- --------------- * Incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (Commission File No. 0-18680). (b) The following financial statement schedules are filed herewith as part of this Registration Statement: Schedule II -- Valuation and Qualifying Accounts II-2 66 ITEM 17. UNDERTAKINGS (h) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registration pursuant to the provisions described under Item 15 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of competent jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. (i) The undersigned registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)1() or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-3 67 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Amendment No. 1 to Registration Statement on Form S-1 to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Perris, State of California, on November 3, 1997. MODTECH, INC. By: /s/ EVAN M. GRUBER ------------------------------------ Evan M. Gruber, Chief Executive Officer Each director and/or executive officer of the Company whose signature appears below hereby constitutes and appoints Evan M. Gruber and Michael G. Rhodes, and each of them, as true and lawful attorneys-in-fact and agents for the undersigned, acting together or alone, with full powers of substitution and resubstitution, for the undersigned and in the undersigned's name, place and stead, in any and all capacities, to sign and file any and all amendments (including post-effective amendments) and exhibits to this Registration Statement on Form S-1, and any and all applications and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, acting together or alone, full powers and authority to do and perform each and every act and thing requisite or necessary or desirable to be done, hereby ratifying and confirming all that said attorneys-in-fact and agents, acting together or alone, or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Amendment No. 1 to Registration Statement has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - ----------------------------------------------- -------------------------- ---------------- /s/ EVAN M. GRUBER Chief Executive Officer November 3, 1997 - ----------------------------------------------- and Director Evan M. Gruber /s/ MICHAEL G. RHODES Chief Operations and November 3, 1997 - ----------------------------------------------- Financial Officer Michael G. Rhodes (principal financial and accounting officer) Director November 3, 1997 - ----------------------------------------------- Gerald B. Bashaw /s/ JAMES D. GOLDENETZ Director November 3, 1997 - ----------------------------------------------- James D. Goldenetz /s/ JAMES M. PHILLIPS, JR. Director November 3, 1997 - ----------------------------------------------- James M. Phillips, Jr. /s/ ROBERT W. CAMPBELL Director November 3, 1997 - ----------------------------------------------- Robert W. Campbell /s/ CHARLES C. MCGETTIGAN Director November 3, 1997 - ----------------------------------------------- Charles C. McGettigan /s/ MYRON A. WICK, III Director November 3, 1997 - ----------------------------------------------- Myron A. Wick, III
II-4 68 SCHEDULE II MODTECH, INC. VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1994, 1995 AND 1996 AND JUNE 30, 1996 AND 1997 (UNAUDITED)
BALANCE AT BEGINNING CHARGED BALANCE AT DESCRIPTION OF YEAR TO EXPENSE DEDUCTIONS END OF YEAR - ------------------------------------------------- ---------- ---------- ---------- ----------- Allowance for contract adjustments: Year ended December 31, 1994................... $ 700,000 $ -- $ (275,000) $ 425,000 ========= ====== ========== ========= Year ended December 31, 1995................... $ 425,000 $ -- $ (17,000) $ 408,000 ========= ====== ========== ========= Six months ended June 30, 1996 (unaudited)..... $ 408,000 $ -- $ -- $ 408,000 ========= ====== ========== ========= Year ended December 31, 1996................... $ 408,000 $6,000 $ (1,000) $ 413,000 ========= ====== ========== ========= Six months ended June 30, 1997 (unaudited)..... $ 413,000 $ -- $ (3,000) $ 410,000 ========= ====== ========== =========
69 EXHIBIT INDEX
EXHIBIT NUMBER NAME OF EXHIBIT - ------ ---------------------------------------------------------------------------------- 1 Form of Underwriting Agreement 3.1 Articles of Incorporation* 3.2 Bylaws* 5 Opinion of Phillips & Haddan LLP 10.1 Lease between the Company and Pacific Continental Modular Enterprises, relating to the Barrett Street property in Perris, California.* 10.2 Lease between the Company and Gerald Bashaw, relating to the Morgan Street Property in Perris, California.* 10.3 Lease between the Company and BMG2, relating to the property in Lathrop, California.* 10.4 Industrial Development Bond agreements.* 10.5 Amendment to Loan and Security Agreement between the Company and Coast Business Credit Corporation (previously filed). 10.6 Form of Indemnity Agreement between the Company and its executive officers and directors.* 10.7 Employment Agreement between the Company and Evan M. Gruber.* 23.1 Consent of KMPG Peat Marwick LLP 23.2 Consent of Phillips & Haddan LLP (to be included as part of Exhibit 5) 24 Power of attorney (set forth on the Signatures page of the Registration Statement) 27 Financial Data Schedule (previously filed)
- --------------- * Incorporated by reference from the Company's Annual Report on Form 10-K for the year ended December 31, 1996 (Commission File No. 0-18680). EX-1 2 FORM OF UNDERWRITING AGREEMENT 1 EXHIBIT 1 3,000,000 Shares of Common Stock Modtech, Inc. UNDERWRITING AGREEMENT November , 1997 BEAR, STEARNS & CO. INC. CRUTTENDEN ROTH INCORPORATED L.H. FRIEND, WEINRESS, FRANKSON & PRESSON, INC. as the Underwriters c/o Bear, Stearns & Co. Inc. 245 Park Avenue New York, N.Y. 10167 Dear Sirs: Modtech, Inc., a corporation organized and existing under the laws of California (the "Company"), proposes, subject to the terms and conditions stated herein, to issue and sell to the several underwriters named in Schedule I hereto (the "Underwriters") an aggregate of 1,000,000 shares of common stock, par value $0.01 per share, of the Company (the "Common Stock") and the selling shareholders of the Company named in Schedule II hereto (the "Selling Shareholders") propose to sell to the Underwriters an additional 2,000,000 shares of Common Stock, which aggregate of 3,000,000 shares of Common Stock are referred to herein as the "Firm Shares." In addition, for the sole purpose of covering over-allotments in connection with the sale of the Firm Shares, certain Selling Shareholders (as set forth on Schedule II hereto) propose to sell to the Underwriters, at the option of the Underwriters, up to an additional 450,000 shares (the "Additional Shares") of Common Stock. The Firm Shares and any Additional Shares purchased by the Underwriters are referred to herein as the "Shares." The Shares are more fully described in the Registration Statement referred to below. 1. Representations and Warranties of the Company and the Selling Shareholders. A. The Company represents and warrants to, and agrees with, the Underwriters that: (a) The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement, and may have filed an amendment or amendments thereto, on Form S-1 (No. 333-37473), for the registration of the Shares under the Securities Act of 1933, as amended (the "Act"). Such registration statement, including the prospectus, financial statements and schedules, exhibits and all other documents filed as a part thereof, as amended at the time of effectiveness of the registration statement, including any 2 information deemed to be a part thereof as of the time of effectiveness pursuant to paragraph (b) of Rule 430A or Rule 434 of the Rules and Regulations of the Commission under the Act (the "Regulations"), is herein called the "Registration Statement" and the prospectus, in the form first filed with the Commission pursuant to Rule 424(b) of the Regulations or filed as part of the Registration Statement at the time of effectiveness if no Rule 424(b) or Rule 434 filing is required, is herein called the "Prospectus." The term "preliminary prospectus" as used herein means a preliminary prospectus as described in Rule 430 of the Regulations. (b) At the time of the effectiveness of the Registration Statement or the effectiveness of any post-effective amendment to the Registration Statement, when the Prospectus is first filed with the Commission pursuant to Rule 424(b) or Rule 434 of the Regulations, when any supplement to or amendment of the Prospectus is filed with the Commission and at the Closing Date and the Additional Closing Date, if any, (as hereinafter respectively defined), the Registration Statement and the Prospectus and any amendments thereof and supplements thereto complied or will comply in all material respects with the applicable provisions of the Act and the Regulations and does not or will not contain an untrue statement of a material fact and does not or will not omit to state any material fact required to be stated therein or necessary in order to make the statements therein (i) in the case of the Registration Statement, not misleading and (ii) in the case of the Prospectus, in light of the circumstances under which they were made, not misleading. When any related preliminary prospectus was first filed with the Commission (whether filed as part of the registration statement for the registration of the Shares or any amendment thereto or pursuant to Rule 424(a) of the Regulations) and when any amendment thereof or supplement thereto was first filed with the Commission, such preliminary prospectus and any amendments thereof and supplements thereto complied in all material respects with the applicable provisions of the Act and the Regulations and did not contain an untrue statement of a material fact and did not omit to state any material fact required to be stated therein or necessary in order to make the statements therein in light of the circumstances under which they were made not misleading. No representation and warranty is made in this subsection (b), however, with respect to any information contained in or omitted from the Registration Statement or the Prospectus or any related preliminary prospectus or any amendment thereof or supplement thereto in reliance upon and in conformity with information furnished in writing to the Company by or on behalf of any Underwriter through you as herein stated expressly for use in connection with the preparation thereof. If Rule 434 is used, the Company will comply with the requirements of Rule 434. (c) KPMG Peat Marwick LLP, who have certified the financial statements and supporting schedules included in the Registration Statement, are independent public accountants as required by the Act and the Regulations. (d) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, except as set forth in the Registration Statement and the Prospectus, there has been no material adverse change or any development involving a prospective material adverse change in the business, prospects, properties, operations, condition (financial or other) or results of operations of the Company and its subsidiary taken as a whole, 2 3 whether or not arising from transactions in the ordinary course of business, and since the date of the latest balance sheet presented in the Registration Statement and the Prospectus, neither the Company nor its subsidiary has incurred or undertaken any liabilities or obligations, direct or contingent, which are material to the Company and its subsidiary taken as a whole, except for liabilities or obligations which are reflected in the Registration Statement and the Prospectus. (e) This Agreement and the transactions contemplated herein have been duly and validly authorized by the Company and this Agreement has been duly and validly executed and delivered by the Company. (f) The execution, delivery, and performance of this Agreement by the Company and the consummation by the Company of the transactions contemplated hereby do not and will not (i) conflict with or result in a breach of any of the terms and provisions of, or constitute a default (or an event which with notice or lapse of time, or both, would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or its subsidiary pursuant to any material agreement, instrument, franchise, license or permit to which the Company or its subsidiary is a party or by which either of such corporations or their respective properties or assets may be bound or (ii) violate or conflict with any provision of the articles of incorporation or by-laws of the Company or its subsidiary or any judgment, decree, order, statute, rule or regulation of any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or its subsidiary or any of their respective properties or assets. No consent, approval, authorization, order, registration, filing, qualification, license or permit of or with any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or its subsidiary or any of their respective properties or assets is required for the execution, delivery and performance of this Agreement by the Company or the consummation by the Company of the transactions contemplated hereby, including the issuance, sale and delivery of the Shares to be issued, sold and delivered by the Company hereunder, except the registration under the Act of the Shares and such consents, approvals, authorizations, orders, registrations, filings, qualifications, licenses and permits as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters. (g) All of the outstanding shares of Common Stock are duly and validly authorized and issued, fully paid and nonassessable and were not issued and are not now in violation of or subject to any preemptive rights. The Shares, when issued, delivered and sold in accordance with this Agreement, will be duly and validly issued and outstanding, fully paid and nonassessable, and will not have been issued in violation of or be subject to any preemptive rights. The Company had, at October [10], 1997, an authorized and outstanding capitalization as set forth in the Registration Statement and the Prospectus. The Common Stock, the Firm Shares and the Additional Shares conform to the descriptions thereof contained in the Registration Statement and the Prospectus. (h) Other than ___________, a California corporation that is a wholly owned subsidiary of the Company, the Company does not have any subsidiaries and does not own 3 4 any equity interests in any other entity. Each of the Company and its subsidiary has been duly organized and is validly existing as a corporation in good standing under the laws of its respective jurisdiction of incorporation. Each of the Company and its subsidiary is duly qualified and in good standing as a foreign corporation in each jurisdiction in which the character or location of its properties (owned, leased or licensed) or the nature or conduct of its business makes such qualification necessary, except for those failures to be so qualified or in good standing which will not in the aggregate have a material adverse effect on the Company and its subsidiary taken as a whole. Each of the Company and its subsidiary has all requisite power and authority, and all necessary consents, approvals, authorizations, orders, registrations, qualifications, licenses and permits of and from all public, regulatory or governmental agencies and bodies, to own, lease and operate its properties and conduct its business as now being conducted and as described in the Registration Statement and the Prospectus, and no such consent, approval, authorization, order, registration, qualification, license or permit contains a materially burdensome restriction not adequately disclosed in the Registration Statement and the Prospectus. (i) Except as described in the Prospectus, there is no litigation or governmental proceeding to which the Company or its subsidiary is a party or to which any property of the Company or its subsidiary is subject or which is pending or, to the knowledge of the Company, contemplated against the Company or its subsidiary which could reasonably be expected to result in any material adverse change or any development involving a material adverse change in the business, prospects, properties, operations, condition (financial or other) or results of operations of the Company and its subsidiary taken as a whole or which is required to be disclosed in the Registration Statement and the Prospectus. (j) The Company has not taken and will not take, directly or indirectly, any action designed to cause or result in, or which constitutes or which might reasonably be expected to constitute, the stabilization or manipulation of the price of the shares of Common Stock to facilitate the sale or resale of the Shares. (k) The financial statements, including the notes thereto, and supporting schedules included in the Registration Statement and the Prospectus present fairly the financial position of the Company as of the dates indicated and the results of its operations for the periods specified; except as otherwise stated in the Registration Statement, said financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis; and the supporting schedules included in the Registration Statement present fairly the information required to be stated therein. (l) Except as described in the Prospectus, no holder of securities of the Company has any rights to the registration of securities of the Company because of the filing of the Registration Statement or otherwise in connection with the sale of the Shares contemplated hereby. 4 5 (m) The Company is not, and upon consummation of the transactions contemplated hereby will not be, subject to registration as an "investment company" under the Investment Company Act of 1940. (n) Except as disclosed in the Prospectus, and except as to violations, breaches, defaults and events of default that individually or in the aggregate would not have a material adverse effect on the Company and its subsidiary taken as a whole, (i) neither the Company nor its subsidiary is in violation or default of any provision of its articles of incorporation or bylaws, or other organizational documents, or is in breach of or default with respect to any provision of any agreement, judgment, decree, order, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument to which the Company or its subsidiary is a party or by which the Company or its subsidiary or any of its respective properties are bound; and (ii) there does not exist any state of facts that constitutes an event of default on the part of the Company or its subsidiary as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default. (o) There are no contracts or other documents required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement by the Act or by the Rules and Regulations that have not been described or filed as required. The descriptions of the contracts in the Prospectus are accurate in all material respects and fairly present the information required by the Act and/or the Rules and Regulations to be presented in Form S-1; except as disclosed in the Prospectus, the contracts so described in the Prospectus are in full force and effect on the date hereof, and, neither the Company, its subsidiary nor, to the best of the Company's knowledge, any other party is in breach of or default under any of such contracts other than any such breach or default as would not, individually or in the aggregate, prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole. (p) Except as disclosed in the Prospectus, there are no legal or governmental actions, suits or proceedings pending or, to the best of the Company's knowledge, threatened to which the Company is or may be a party or of which property owned or leased by the Company is or may be the subject or related to environmental or discrimination matters, that, individually or in the aggregate, could reasonably prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole; and no labor disturbance by the employees of the Company or its subsidiary exists or is imminent that might be expected to affect adversely such condition, properties, business, results of operations or prospects. Neither the Company nor its subsidiary is a party or subject to the provisions of any injunction, judgment, decree or order of any court, regulatory body, administrative agency or other governmental body that could reasonably be expected to result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole. 5 6 (q) Each of the Company and its subsidiary has good and marketable title to all the properties and assets reflected as owned by it in the financial statements hereinabove described (or elsewhere in the Prospectus), subject to no lien, mortgage, pledge, charge or encumbrance of any kind except (i) those, if any, reflected in such financial statements (or elsewhere in the Prospectus), or (ii) those which are not material in amount and do not adversely affect the use made and proposed to be made of such property by the Company or its subsidiary. Each of the Company and its subsidiary holds its leased properties under valid and binding leases, with such exceptions as are not materially significant in relation to the business of the Company and its subsidiary taken as a whole. Except as disclosed in the Prospectus, each of the Company and its subsidiary owns or leases all such properties as are necessary to its operations as now conducted or as proposed to be conducted. (r) Since the respective dates as of which information is given in the Registration Statement and Prospectus, and except as described in or specifically contemplated by the Prospectus: (i) neither the Company nor its subsidiary has incurred any material liabilities or obligations, indirect, direct or contingent, or entered into any material verbal or written agreement or other transaction that is not in the ordinary course of business or that could result in a material reduction in the future earnings of the Company and its subsidiary taken as a whole; (ii) neither the Company nor its subsidiary has sustained any loss or interference with its business or properties from fire, flood, windstorm, accident or other calamity, whether or not covered by insurance, that materially and adversely affects the condition (financial or other), business, results of operations or prospects of the Company and its subsidiary taken as a whole; (iii) neither the Company nor its subsidiary has paid or declared any dividends or other distributions with respect to its capital stock and neither the Company nor its subsidiary is in default in the payment of principal of or interest on any outstanding debt obligations; (iv) there has not been any change in the capital stock (other than upon the sale of the Shares hereunder and upon the exercise of options and other rights described in the Registration Statement) or increase in indebtedness material to the Company and its subsidiary taken as a whole (other than in the ordinary course of business); and (v) there has not been any material adverse change in the condition (financial or other), business, properties, results of operations or prospects of the Company and its subsidiary taken as a whole. (s) Except as disclosed in or specifically contemplated by the Prospectus, the Company has sufficient trademarks, trade names, patent rights, mask works, copyrights, licenses, approvals and governmental authorizations to conduct its business as now conducted; the expiration of any trademarks, trade names, patent rights, mask works, copyrights, licenses, approvals or governmental authorizations would not have a material adverse effect on the condition (financial or other), business, results of operations or prospects of the Company and its subsidiary taken as a whole; except as disclosed in or specifically contemplated by the Prospectus, the Company has no knowledge of any material infringement by it or its customers, with respect to their use of the Company's trademarks, trade name rights, patent rights, mask works, copyrights, licenses, trade secrets or other similar rights of others, and there is no claim being made against the Company, its subsidiary or its customers with respect to their use of the Company's products, which claims are regarding trademarks, trade names, patents, mask works, 6 7 copyrights, licenses, trade secrets or other infringements which could have a material adverse effect on the condition (financial or other), business, results of operations or prospects of the Company and its subsidiary taken as a whole. (t) Neither the Company nor its subsidiary has been advised, or has any reason to believe, that it is not conducting business in compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business, including, without limitation, all applicable local, state and federal environmental laws and regulations; except where failure to be so in compliance would not materially adversely affect the condition (financial or other), business, results of operations or prospects of the Company and its subsidiary taken as a whole. (u) Each of the Company and its subsidiary has filed all necessary federal, state and foreign income and franchise tax returns and has paid all taxes shown as due thereon; and the Company has no knowledge of any tax deficiency which has been or might be asserted or threatened against the Company or its subsidiary which could materially and adversely affect the business, operations or properties of the Company and its subsidiary taken as a whole. (v) The Company has not distributed and will not distribute prior to the Closing Date any offering material in connection with the offering and sale of the Shares other than the Prospectus, the Registration Statement and the other materials permitted by the Act. (w) The Company and its subsidiary maintain insurance of the types, with insurers, and in the amounts as are reasonable and customary in the business in which it is engaged, including, but not limited to, insurance covering real and personal property leased by the Company or its subsidiary against theft, damage, destruction, acts of vandalism and all other risks customarily insured against, all of which insurance is in full force and effect. (x) Neither the Company nor its subsidiary has at any time during the last five years (i) made any unlawful contribution to any candidate for foreign or domestic office, or failed to disclose fully any contribution in violation of law, or (ii) made any payment to any foreign or federal or state governmental officer or official or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (y) Other than the Underwriters acting in their capacity as such, no person is or will be owed any finders fee or commission or similar payment in connection with the transactions contemplated by this Agreement. B. Each of the Selling Shareholder, severally and not jointly, represents and warrants to, and agrees with the Underwriters that: (a) Such Selling Shareholder has, and on the Closing Date and the Additional Closing Date hereinafter defined will have, good and valid title to the Firm Shares and/or the Additional Shares, as applicable, proposed to be sold by such Selling Shareholder 7 8 hereunder on such Closing Date and full right, power and authority to enter into this Agreement and to sell, assign, transfer and deliver such Shares hereunder, free and clear of all voting trust arrangements, liens, encumbrances, equities, security interests, restrictions, rights (including, to the knowledge of such Selling Shareholder, preemptive rights) and claims whatsoever. [None of the Firm Shares and none of the Additional Shares proposed to be sold by such Selling Shareholder are subject to any adverse claim (within the meaning of Section 8-102(a)(1) of the California Uniform Commercial Code) and, to the knowledge of such Selling Shareholder, no basis for such claim exists or will exist at the time of the Closing or the Additional Closing, as the case may be; and upon delivery of and payment for such Shares hereunder, such Selling Shareholder will transfer good and valid title thereto to the Underwriters who acquire such shares in good faith and without notice of any adverse claim (within the meaning of Section 8-105(a) of the California Uniform Commercial Code), free and clear of all liens, encumbrances, equities, claims, restrictions, rights (including preemptive rights), security interests, voting trusts or other defects of title whatsoever. (b) Such Selling Shareholder has executed and delivered a Custody Agreement and Power of Attorney (hereinafter referred to as the "Shareholders Agreement") and in connection herewith such Selling Shareholder further represents, warrants and agrees that such Selling Shareholder has deposited in custody, under the Shareholders Agreement, with the agent named therein (the "Agent") as custodian, certificates in negotiable form for the Shares to be sold hereunder by such Selling Shareholder, for the purpose of further delivery pursuant to this Agreement. Such Selling Shareholder agrees that the Shares to be sold by such Selling Shareholder on deposit with the Agent are subject to the interests of the Company and the Underwriters, that the arrangements made for such custody are to that extent irrevocable, and that the obligations of such Selling Shareholder hereunder shall not be terminated, except as provided in this Agreement or in the Shareholders Agreement, by any act of such Selling Shareholder, by operation of law, by the death or incapacity of such Selling Shareholder or by the occurrence of any other event. If the Selling Shareholder should die or become incapacitated, or if any other event should occur, before the delivery of the Shares hereunder, the documents evidencing Shares then on deposit with the Agent shall be delivered by the Agent in accordance with the terms and conditions of this Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Agent shall have received notice thereof. This Agreement and the Shareholders Agreement have been duly executed and delivered by or on behalf of such Selling Shareholder and the form of such Shareholders Agreement has been delivered to you. (c) This Agreement and the Shareholders Agreement and the transactions contemplated herein and in the Shareholders Agreement have been duly and validly authorized by such Selling Shareholder and the Shareholders Agreement has been duly and validly executed and delivered by such Selling Shareholder. (d) The performance of this Agreement, the execution, delivery and performance of the Shareholders Agreement and the consummation of the transactions contemplated hereby and by the Shareholders Agreement will not (i) conflict with or result in a breach of any of the terms and provisions of, or constitute a default (or an event which with 8 9 notice or lapse of time, or both, would constitute a default) under, or the creation or imposition of any lien, charge or encumbrance upon any property or assets of such Selling Shareholder pursuant to, any agreement, instrument, franchise, license or permit to which such Selling Shareholder is a party or by which such Selling Shareholder's properties or assets may be bound or (ii) violate or conflict with any provision of the charter documents of such Selling Shareholder, if such Selling Shareholder is not an individual, or any judgment, decree, order, statute, rule or regulation of any court or any public, governmental or regulatory agency or body having jurisdiction over such Selling Shareholder or any of its properties or assets. No consent, approval, authorization, order, registration, filing, qualification, license or permit of or with any court or any public, governmental or regulatory agency or body having jurisdiction over such Selling Shareholder or any of its properties or assets is required for the performance of this Agreement, the execution, delivery and performance of the Shareholders Agreement or the consummation of the transactions contemplated hereby and by the Shareholders Agreement, the registration under the Act of the Shares and such consents, approvals, authorizations, orders, registrations, filings, qualifications, licenses or permits as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters. (e) Such Selling Shareholder has not taken and will not take, directly or indirectly, any action designed to or which has constituted or that might reasonably be expected to cause or result in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Shares. (f) To the extent that any statements or omissions are made in the Registration Statement, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with written information furnished to the Company by such Selling Shareholder specifically for use therein, at the time of the effectiveness of the Registration Statement or the effectiveness of any post-effective amendment to the Registration Statement, when the Prospectus is first filed with the Commission pursuant to Rule 424(b) or Rule 434 of the Regulations, when any supplement to or amendment of the Prospectus is filed with the Commission and at the Closing Date and the Additional Closing Date, if any, (as hereinafter respectively defined), the Registration Statement and the Prospectus and any amendments thereof and supplements thereto complied or will comply in all material respects with the applicable provisions of the Act and the Regulations and does not or will not contain an untrue 9 10 statement of a material fact and does not or will not omit to state any material fact required to be stated therein or necessary in order to make the statements therein (i) in the case of the Registration Statement, not misleading and (ii) in the case of the Prospectus, in light of the circumstances under which they were made, not misleading. To the extent that any statements or omissions are made in any related preliminary prospectus or any amendment thereof or supplement thereto in reliance upon and in conformity with written information furnished by the Company by such Selling Shareholder specifically for use therein, when any such related preliminary prospectus was first filed with the Commission (whether filed as part of the registration statement for the registration of the Shares or any amendment thereto or pursuant to Rule 424(a) of the Regulations) and when any amendment thereof or supplement thereto was first filed with the Commission, such preliminary prospectus and any amendments thereof and supplements thereto complied in all material respects with the applicable provisions of the Act and the Regulations and did not contain an untrue statement of a material fact and did not omit to state any material fact required to be stated therein or necessary in order to make the statements therein in light of the circumstances under which they were made not misleading. No representation and warranty is made in this subsection (b), however, with respect to any information contained in or omitted from the Registration Statement or the Prospectus or any related preliminary prospectus or any amendment thereof or supplement thereto in reliance upon and in conformity with information furnished in writing to the Company by or on behalf of any Underwriter through you as herein stated expressly for use in connection with the preparation thereof. 2. Purchase, Sale and Delivery of the Shares. (a) On the basis of the representations, warranties, covenants and agreements herein contained, but subject to the terms and conditions herein set forth, (i) the Company agrees to sell to the Underwriters and the Underwriters, severally and not jointly, agree to purchase from the Company, at a purchase price per share of $_______, the number of Firm Shares set forth opposite the respective names of the Underwriters in Column 1 of Schedule I hereto, (ii) the Selling Shareholders, severally and not jointly, agree to sell to the several Underwriters and the Underwriters, severally and not jointly, agree to purchase from the Selling Shareholders, at the same price per share as specified in clause (i) hereof, the number of Firm Shares set forth opposite the respective names of the Underwriters in Column (2) of Schedule I hereto, plus (in either case) any additional number of Shares which such Underwriter may become obligated to purchase pursuant to the provisions of Section 9 hereof. The number of Firm Shares to be sold by each Selling Shareholder to each Underwriter shall be the number which bears the same proportion to the total number of Firm Shares to be sold by such Selling Shareholder, as specified in Column (1) of Schedule II hereto, as the number of Firm Shares set forth opposite the name of such Underwriter in Column (2) of Schedule I (or such number increased as set forth in Section 9 hereof) bears to 2,000,000, subject to such adjustments to eliminate any fractional shares as you in your sole discretion shall make. (b) Payment of the purchase price for, and delivery of certificates for, the Shares shall be made at the office of [Phillips & Haddan LLP, 4675 MacArthur Court, Suite 710, Newport Beach, California 92660], or at such other place as shall be agreed upon by you, the Selling Shareholders and the Company, at 7:00 A.M., California time, on the third or fourth business day (as permitted under Rule 15c6-1 under the Exchange Act) (unless postponed in accordance with the provisions of Section 9 hereof) following the date of the effectiveness of the Registration Statement (or, if the Company has elected to rely upon Rule 430A of the Regulations, the third or fourth business day (as permitted under Rule 15c6-1 under the Exchange Act) after the determination of the public offering price of the Shares), or such other time not later than ten business days after such date as shall be agreed upon by you, the Selling Shareholders and the Company (such time and date of payment and delivery being herein called the "Closing Date"). Payment shall be made to the Company by wire transfer in same day funds and to each of the Selling Shareholders by certified or official bank check drawn in federal funds or similar same day funds, against delivery to you for the respective accounts of the Underwriters of certificates for the Shares to be purchased by them. Certificates for the Shares shall be 10 11 registered in such name or names and in such authorized denominations as you may request in writing at least two full business days prior to the Closing Date. The Company and the Selling Shareholders will permit you to examine and package such certificates for delivery at least one full business day prior to the Closing Date. (c) In addition, certain of the Selling Shareholders (as set forth in Column (2) of Schedule II hereto) hereby grant to the Underwriters the option to purchase up to 450,000 Additional Shares at the same purchase price per share to be paid by the Underwriters to the Company and the Selling Shareholders for the Firm Shares as set forth in this Section 2, for the sole purpose of covering over-allotments in the sale of Firm Shares by the Underwriters. This option may be exercised at any time, in whole or in part, on or before the 30th day following the date of the Prospectus, by written notice by you to the Company and the Selling Shareholders or the Agent. Such notice shall set forth the aggregate number of Additional Shares as to which the option is being exercised and the date and time, as reasonably determined by you, when the Additional Shares are to be delivered (such date and time being herein sometimes referred to as the "Additional Closing Date"); provided, however, that the Additional Closing Date shall not be earlier than the Closing Date or earlier than the second full business day after the date on which the option shall have been exercised nor later than the eighth full business day after the date on which the option shall have been exercised (unless such time and date are postponed in accordance with the provisions of Section 9 hereof). The Company will cause certificates for the Additional Shares to be registered in such name or names and in such authorized denominations as you may request in writing at least two full business days prior to the Additional Closing Date. The Company and the Selling Shareholders will permit you to examine and package such certificates for delivery at least one full business day prior to the Additional Closing Date. The number of Additional Shares to be sold by each Selling Shareholder shall be the number which bears the same proportion to the total number of Additional Shares that are to be sold by the Selling Shareholders on the Additional Closing Date, as specified in the notice provided to the Selling Shareholders or the Agent, as the maximum number of Additional Shares that may be sold by such Selling Shareholder as set forth opposite such Selling Shareholder's name in Column (2) of Schedule II hereof bears to 450,000 (the "Additional Share Allotment"). The number of Additional Shares to be sold by each Selling Shareholder to each Underwriter shall be the number which bears the same ratio to such Selling Shareholder's Additional Share Allotment as the number of Additional Shares set forth opposite the name of such Underwriter in Column (3) of Schedule I hereto (or such number increased as set forth in Section 9 hereof) bears to 450,000, subject, however, to such adjustments to eliminate any fractional shares as you in your sole discretion shall make. Payment for the Additional Shares shall be made by certified or official bank check or checks drawn in federal funds or similar same day funds payable to the order of the applicable Selling Shareholders at the offices of [Phillips & Haddan LLP, 4675 MacArthur Court, Suite 710, Newport Beach, California 92660] or such other location as may be mutually acceptable, upon delivery of the certificates for the Additional Shares to you for the respective accounts of the Underwriters. 11 12 3. Offering. Upon your authorization of the release of the Firm Shares, the Underwriters propose to offer the Shares for sale to the public upon the terms set forth in the Prospectus. 4. Covenants of the Company and the Selling Shareholders. A. The Company covenants and agrees with the several Underwriters that: (a) If the Registration Statement has not yet been declared effective the Company will use its best efforts to cause the Registration Statement and any amendments thereto to become effective as promptly as possible, and if Rule 430A is used or the filing of the Prospectus is otherwise required under Rule 424(b) or Rule 434, the Company will file the Prospectus (properly completed if Rule 430A has been used) pursuant to Rule 424(b) or Rule 434 within the prescribed time period and will provide evidence satisfactory to you of such timely filing. If the Company elects to rely on Rule 434, the Company will prepare and file a term sheet that complies with the requirements of Rule 434. The Company will notify you immediately (and, if requested by you, will confirm such notice in writing) (i) when the Registration Statement and any amendments thereto become effective, (ii) of any request by the Commission for any amendment of or supplement to the Registration Statement or the Prospectus or for any additional information, (iii) of the mailing or the delivery to the Commission for filing of any amendment of or supplement to the Registration Statement or the Prospectus, (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or any post-effective amendment thereto or of the initiation, or the threatening, of any proceedings therefor, (v) of the receipt of any comments from the Commission, and (vi) of the receipt by the Company of any notification with respect to the suspension of the qualification of the Shares for sale in any jurisdiction or the initiation or threatening of any proceeding for that purpose. If the Commission shall propose or enter a stop order at any time, the Company will make every reasonable effort to prevent the issuance of any such stop order and, if issued, to obtain the lifting of such order as soon as possible. The Company will not file any amendment to the Registration Statement or any amendment of or supplement to the Prospectus (including the prospectus required to be filed pursuant to Rule 424(b)or Rule 434) that differs from the prospectus on file at the time of the effectiveness of the Registration Statement before or after the effective date of the Registration Statement to which you shall reasonably object in writing after being timely furnished in advance a copy thereof. (b) If at any time when a prospectus relating to the Shares is required to be delivered under the Act any event shall have occurred as a result of which the Prospectus as then amended or supplemented would, in the judgment of the Underwriters or the Company include an untrue statement of a material fact or omit to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or if it shall be necessary at any time to amend or supplement the Prospectus or Registration Statement to comply with the Act or the Regulations, 12 13 the Company will notify you promptly and prepare and file with the Commission an appropriate amendment or supplement (in form and substance satisfactory to you) which will correct such statement or omission and will use its best efforts to have any amendment to the Registration Statement declared effective as soon as possible. (c) The Company will promptly deliver to each of you two signed copies of the Registration Statement, including exhibits and all amendments thereto, and the Company will promptly deliver to each of the Underwriters such number of copies of any preliminary prospectus, the Prospectus, the Registration Statement, and all amendments of and supplements to such documents, if any, as you may reasonably request. (d) The Company will endeavor in good faith, in cooperation with you, at or prior to the time of effectiveness of the Registration Statement, to qualify the Shares for offering and sale under the securities laws relating to the offering or sale of the Shares of such jurisdictions as you may designate and to maintain such qualification in effect for so long as required for the distribution thereof; except that in no event shall the Company be obligated in connection therewith to qualify as a foreign corporation or to execute a general consent to service of process. (e) The Company will make generally available (within the meaning of Section 11(a) of the Act) to its security holders and to you as soon as practicable, but not later than 45 days after the end of its fiscal quarter in which the first anniversary date of the effective date of the Registration Statement occurs, an earnings statement (in form complying with the provisions of Rule 158 of the Regulations) covering a period of at least 12 consecutive months beginning after the effective date of the Registration Statement. (f) During the period of 90 days from the date of the Prospectus, the Company will not, without the prior written consent of Bear, Stearns & Co. Inc., on behalf of the Underwriters, issue, sell, offer or agree to sell, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any Common Stock (or any securities convertible into, exercisable for or exchangeable for Common Stock), and the Company will obtain the undertaking of each of its officers and directors, and such of its shareholders (other than the Selling Shareholders) as have been heretofore designated by you and listed on Schedule III attached hereto not to engage in any of the aforementioned transactions on their own behalf during the period 180 days from the date of the Prospectus, other than the sale by the Company and the Selling Shareholders of Shares hereunder and the Company's issuance of Common Stock upon the exercise of presently outstanding stock options, in each case as disclosed in the Prospectus. (g) During a period of three years from the effective date of the Registration Statement, the Company will furnish to you copies of (i) all reports to its shareholders; and (ii) all reports, financial statements and proxy or information statements filed by the Company with the Commission or any national securities exchange. 13 14 (h) The Company will apply the proceeds from the sale of the Shares as set forth under "Use of Proceeds" in the Prospectus. (i) The Company will use its best efforts to cause the Shares to be authorized for quotation on the Nasdaq National Market System. B. Each of the Selling Shareholders, severally and not jointly, covenants and agrees with the Underwriters that during the period of 180 days from the date of the Prospectus, such Selling Shareholder will not, without the prior written consent of Bear, Stearns & Co. Inc., on behalf of the Underwriters, sell, offer or agree to sell, encumber, pledge, grant any option for the sale of, or otherwise dispose of, directly or indirectly, any Common Stock (or any securities convertible into, exercisable for or exchangeable for Common Stock), other than the sale by such Selling Shareholder of Shares hereunder as disclosed in the Prospectus. 5. Payment of Expenses. Whether or not the transactions contemplated in this Agreement are consummated or this Agreement is terminated, the Company hereby agrees to pay all costs and expenses incident to the performance of the obligations of the Company and the Selling Shareholders hereunder, including those in connection with (i) preparing, printing, duplicating, filing and distributing the Registration Statement, as originally filed and all amendments thereof (including all exhibits thereto), any preliminary prospectus, the Prospectus and any amendments or supplements thereto (including, without limitation, fees and expenses of the Company's accountants and counsel and the fees and expenses of counsel representing the Selling Shareholders), the underwriting documents (including this Agreement, the Agreement Among Underwriters and the Selling Agreement) and all other documents related to the public offering of the Shares (including those supplied to the Underwriters in quantities as hereinabove stated), (ii) the issuance, transfer and delivery of the Shares to the Underwriters, including any transfer or other taxes payable thereon, (iii) the qualification of the Shares under state or foreign securities or Blue Sky laws, including the costs of printing and mailing a preliminary and final "Blue Sky Survey" and the fees of counsel for the Underwriters and such counsel's disbursements in relation thereto, (iv) quotation of the Shares on the Nasdaq National Market System, (v) filing fees of the Commission and the National Association of Securities Dealers, Inc., (vi) the cost of printing certificates representing the Shares and (vii) the cost and charges of any transfer agent or registrar. 6. Conditions of Underwriters' Obligations. The obligations of the Underwriters to purchase and pay for the Firm Shares and the Additional Shares, as provided herein, shall be subject to the accuracy of the representations and warranties of the Company and the Selling Shareholders herein contained, as of the date hereof and as of the Closing Date (for purposes of this Section 6 "Closing Date" shall refer to the Closing Date for the Firm Shares and any Additional Closing Date, if different, for the Additional Shares), to the absence from any certificates, opinions, written statements or letters furnished to you or to Gibson, Dunn & Crutcher LLP ("Underwriters' Counsel") pursuant to this Section 6 of any misstatement or omission, to the performance by the Company of its obligations hereunder, and to the following additional conditions: 14 15 (a) The Registration Statement shall have become effective not later than [4:00] P.M., New York time, on the date of this Agreement, or at such later time and date as shall have been consented to in writing by you; if the Company shall have elected to rely upon Rule 430A or Rule 434 of the Regulations, the Prospectus shall have been filed with the Commission in a timely fashion in accordance with Section 4(a) hereof; and, at or prior to the Closing Date no stop order suspending the effectiveness of the Registration Statement or any post-effective amendment thereof shall have been issued and no proceedings therefor shall have been initiated or threatened by the Commission. (b) At the Closing Date you shall have received the opinion of Phillips & Haddan LLP, counsel for the Company, dated the Closing Date addressed to the Underwriters and in form and substance satisfactory to Underwriters' Counsel, to the effect that: (i) Each of the Company and its subsidiary has been duly organized and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation. Each of the Company and its subsidiary is duly qualified and in good standing as a foreign corporation in each jurisdiction in which the character or location of its properties (owned, leased or licensed) or the nature or conduct of its business makes such qualification necessary, except for those failures to be so qualified or in good standing which will not in the aggregate have a material adverse effect on the Company and its subsidiary taken as a whole. Each of the Company and its subsidiary has all requisite corporate authority to own, lease and license its respective properties and conduct its business as now being conducted and as described in the Registration Statement and the Prospectus. All of the issued and outstanding capital stock of the subsidiary of the Company has been duly and validly issued and is fully paid and nonassessable and was not issued in violation of preemptive rights and, is owned directly or indirectly by the Company, free and clear of any lien, encumbrance, claim, security interest, restriction on transfer, shareholders' agreement, voting trust or other defect of title whatsoever. (ii) The Company has an authorized capital stock as set forth in the Registration Statement and the Prospectus. All of the outstanding shares of Common Stock are duly and validly authorized and issued, are fully paid and nonassessable and were not issued in violation of or subject to any preemptive rights. The Shares to be delivered on the Closing Date have been duly and validly authorized and, when delivered by the Company or the Selling Shareholders, as the case may be, in accordance with this Agreement, will be duly and validly issued, fully paid and nonassessable and will not have been issued in violation of or subject to any preemptive rights. The Common Stock, the Firm Shares and the Additional Shares conform to the descriptions thereof contained in the Registration Statement and the Prospectus. 15 16 (iii) The Common Stock currently outstanding is listed, and the Shares to be sold under this Agreement to the Underwriters are duly authorized for quotation on the Nasdaq National Market System. (iv) This Agreement has been duly and validly authorized, executed and delivered by the Company. (v) To the best knowledge of such counsel, there is no litigation or governmental or other action, suit, proceeding or investigation before any court or before or by any public, regulatory or governmental agency or body pending or threatened against, or involving the properties or business of, the Company or its subsidiary, that is of a character required to be disclosed in the Registration Statement and the Prospectus that has not been properly disclosed therein. (vi) The execution, delivery, and performance of this Agreement by the Company and the consummation by the Company of the transactions contemplated hereby by the Company do not and will not (A) conflict with or result in a breach of any of the terms and provisions of, or constitute a default (or an event which with notice or lapse of time, or both, would constitute a default) under, or result in the creation or imposition of any lien, charge or encumbrance upon any property or assets of the Company or its subsidiary pursuant to, any agreement, instrument, franchise, license or permit known to such counsel to which the Company or its subsidiary is a party or by which any of such corporations or their respective properties or assets may be bound or (B) violate or conflict with any provision of the articles of incorporation or by-laws of the Company or its subsidiary, or, to the best knowledge of such counsel, any judgment, decree, order, statute, rule or regulation of any court or any public, governmental or regulatory agency or body having jurisdiction over the Company or its subsidiary or any of their respective properties or assets. No consent, approval, authorization, order, registration, filing, qualification, license or permit of or with any court or any public, governmental, or regulatory agency or body having jurisdiction over the Company or its subsidiary or any of their respective properties or assets is required for the execution, delivery and performance by the Company of this Agreement or the consummation by the Company of the transactions contemplated hereby, except for (1) such as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Shares by the Underwriters (as to which such counsel need express no opinion) and (2) such as have been made or obtained under the Act. (vii) The Registration Statement and the Prospectus and any amendments thereof or supplements thereto (other than the financial statements and schedules and other financial data included or incorporated by reference 16 17 therein, as to which no opinion need be rendered) comply as to form in all material respects with the requirements of the Act and the Regulations. (viii) The Registration Statement is effective under the Act, and, to the best knowledge of such counsel, no stop order suspending the effectiveness of the Registration Statement or any post-effective amendment thereof has been issued and no proceedings therefor have been initiated or threatened by the Commission and all filings required by Rule 424(b) of the Regulations have been made. (ix) Except as disclosed in the Prospectus, and except as to violations, breaches, defaults and events of default that individually or in the aggregate would not have a material adverse effect on the Company and its subsidiary taken as a whole, (i) neither the Company nor its subsidiary is in violation or default of any provision of its articles of incorporation or bylaws, or other organizational documents, or, to the best knowledge of such counsel, is in breach of or default with respect to any provision of any judgment, decree or order, or any material agreement, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument to which the Company or its subsidiary is a party or by which the Company or its subsidiary or any of its respective properties are bound; and (ii) there does not exist any state of facts that constitutes an event of default on the part of the Company or its subsidiary as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default. (x) There are no contracts or other documents required to be described in the Registration Statement or to be filed as exhibits to the Registration Statement by the Act or by the Rules and Regulations that have not been described or filed as required. The descriptions of the contracts in the Prospectus are accurate in all material respects and fairly present the information required by the Act and/or the Rules and Regulations to be presented in Form S-1; except as disclosed in the Prospectus, the contracts so described in the Prospectus are in full force and effect on the date hereof, and, to the best knowledge of such counsel, neither the Company, its subsidiary nor any other party is in breach of or default under any of such contracts other than any such breach or default as would not, individually or in the aggregate, prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole. (xi) Except as disclosed in the Prospectus, to the best knowledge of such counsel, there are no legal or governmental actions, suits or proceedings pending or threatened to which the Company is or may be a party or of which property owned or leased by the Company is or may be the subject or 17 18 related to environmental or discrimination matters, that might, individually or in the aggregate, prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole. To the best knowledge of such counsel, neither the Company nor its subsidiary is a party or subject to the provisions of any injunction, judgment, decree or order of any court, regulatory body, administrative agency or other governmental body that could be expected to result in a material adverse change in the condition (financial or other), properties, business, results of operations or prospects of the Company and its subsidiary taken as a whole. (xii) To the best knowledge of such counsel, neither the Company nor its subsidiary has been advised, or has any reason to believe, that it is not conducting business in compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business, including, without limitation, all applicable local, state and federal environmental laws and regulations; except where failure to be so in compliance would not materially adversely affect the condition (financial or other), business, results of operations or prospects of the Company and its subsidiary taken as a whole. (xiii) To the best knowledge of such counsel, neither the Company nor its subsidiary has at any time during the last five years (i) made any unlawful contribution to any candidate for domestic office, or failed to disclose fully any contribution in violation of law, or (ii) made any payment to federal, state or local governmental officer or official or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (xiv) In addition, such opinion shall also contain a statement that such counsel has participated in conferences with officers and representatives of the Company, representatives of the independent public accountants for the Company and the Underwriters at which the contents of the Prospectus and related matters were discussed and, although such counsel does not assume responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus and expresses no opinion with respect thereto (except to the extent otherwise stated in the such opinion) , no facts have come to the attention of such counsel which would lead such counsel to believe that either the Registration Statement at the time it became effective (including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A(b) or Rule 434, if applicable), or any amendment thereof made prior to the Closing Date as of the date of such amendment, contained an untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus as of its date (or 18 19 any amendment thereof or supplement thereto made prior to the Closing Date as of the date of such amendment or supplement) and as of the Closing Date contained or contains an untrue statement of a material fact or omitted or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no belief or opinion with respect to the financial statements and schedules and other financial data included or incorporated by reference therein). In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws other than the laws of the United States and jurisdictions in which they are admitted, to the extent such counsel deems proper and to the extent specified in such opinion, if at all, upon an opinion or opinions (in form and substance reasonably satisfactory to Underwriters' Counsel) of other counsel reasonably acceptable to Underwriters' Counsel, familiar with the applicable laws; (B) as to matters of fact, to the extent they deem proper, on certificates of responsible officers of the Company and certificates or other written statements of officers of departments of various jurisdictions having custody of documents respecting the corporate existence or good standing of the Company and its subsidiary, provided that copies of any such statements or certificates shall be delivered to Underwriters' Counsel. The opinion of such counsel for the Company shall state that the opinion of any such other counsel is in form satisfactory to such counsel and, in their opinion, you and they are justified in relying thereon. (c) At the Closing Date you shall have received the opinions of Phillips & Haddan LLP, counsel for certain of the Selling Shareholders, and Cooley Godward LLP, counsel for certain of the Selling Shareholders, dated the Closing Date addressed to the Underwriters and in form and substance satisfactory to Underwriters' Counsel, to the effect that: (i) Each of the Selling Shareholders that is not an individual has been duly organized and is validly existing as a limited partnership or a limited liability company, as the case may be, in good standing under the laws of its jurisdiction of organization. Each of the Selling Shareholders that is not an individual has all requisite authority under its partnership agreement or limited liability company operating agreement, as the case may be, and each of the Selling Shareholders that is an individual has all requisite capacity to perform this Agreement, to execute, deliver and perform the Shareholders Agreement and to consummate the transactions contemplated hereby and by the Shareholders Agreement and to sell, transfer and deliver the shares being sold by such Selling Shareholder (the "Seller Shares") under this Agreement in the manner provided in this Agreement and in the Shareholders Agreement. This Agreement and the Shareholders Agreement have been duly executed and delivered by or on behalf of each of the Selling Shareholders and each of this Agreement and the Shareholders Agreement is the valid and legally binding obligation of each Selling Shareholder, enforceable against each Selling Shareholder in accordance with its terms, except as such enforceability may be limited by applicable bankruptcy, insolvency, 19 20 reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally or by equitable principles and limitations on availability of equitable relief, including specific performance, and except as rights to indemnity or contribution may be limited by federal or state securities laws or other applicable laws and the public policy underlying such laws. (ii) Upon the delivery by each Selling Shareholder to the several Underwriters of certificates, duly endorsed for transfer, for the Seller Shares against payment therefor as provided in this Agreement, assuming that each of the Underwriters that has severally purchased such Seller Shares acquires such Seller Shares in good faith and without notice of any adverse claim (within the meaning of Section 8-102(a)(1) of the California Uniform Commercial Code), such Underwriter will have acquired all of the rights of such Selling Shareholder to the Seller Shares sold by such Selling Shareholder under this Agreement and, in addition, title to such Seller Shares will be been transferred to the several Underwriters, free and clear of any adverse claim. (iii) The sale of the Seller Shares to the Underwriters by each Selling Shareholder pursuant to this Agreement, the compliance by such Selling Shareholder with the other provisions of this Agreement and the Shareholders Agreement and the consummation of the other transactions contemplated hereby and by the Shareholders Agreement do not (A) to the best knowledge of such counsel, require the consent, approval, authorization, registration or qualification of or with any governmental authority, except such as have been obtained and such as may be required under state securities or "Blue Sky" laws, or (B) to the best knowledge of such counsel, conflict with or result in a breach or violation of any of the terms and provisions of, or constitute a default under, any indenture, mortgage, deed of trust, lease or other agreement or instrument known to such counsel to which such Selling Shareholder is a party or by which such Selling Shareholder or any of such Selling Shareholder's properties or assets are bound; and nothing has come to the attention of such counsel which causes such counsel to believe that the sale of the Seller Shares to the Underwriters pursuant to this Agreement, the compliance by such Selling Shareholder with the other provisions of this Agreement and the Shareholders Agreement and the consummation of the transactions contemplated hereby and by the Shareholders Agreement will result in a violation of any statute or any judgment, decree, order, rule or regulation of any court or other governmental authority or any arbitrator known to such counsel to be applicable to such Selling Shareholder, other than state securities or "Blue Sky" laws, as to which such counsel may express no opinion. (iv) In addition, such opinion shall also contain a statement (if and to the extent applicable) that such counsel has participated in conferences with officers and representatives of the Company, representatives of the 20 21 independent public accountants for the Company and the Underwriters at which the contents of the Prospectus and related matters were discussed and, although such counsel does not assume responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement or the Prospectus and expresses no opinion with respect thereto (except to the extent otherwise stated in the such opinion) , no facts have come to the attention of such counsel which would lead such counsel to believe that either the Registration Statement at the time it became effective (including the information deemed to be part of the Registration Statement at the time of effectiveness pursuant to Rule 430A(b) or Rule 434, if applicable), or any amendment thereof made prior to the Closing Date as of the date of such amendment, contained an untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus as of its date (or any amendment thereof or supplement thereto made prior to the Closing Date as of the date of such amendment or supplement) and as of the Closing Date contained or contains an untrue statement of a material fact or omitted or omits to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances under which they were made, not misleading (it being understood that such counsel need express no belief or opinion with respect to the financial statements and schedules and other financial data included or incorporated by reference therein). In rendering such opinion, such counsel may rely (A) as to matters involving the application of laws other than the laws of the United States and jurisdictions in which they are admitted, to the extent such counsel deems proper and to the extent specified in such opinion, if at all, upon an opinion or opinions (in form and substance reasonably satisfactory to Underwriters' Counsel) of other counsel reasonably acceptable to Underwriters' Counsel, familiar with the applicable laws; (B) as to matters of fact, to the extent they deem proper, on certificates of the Selling Shareholders or of responsible partners, officers, managers or managing members, as the case may be, of the Selling Shareholders and certificates or other written statements of officers of departments of various jurisdictions having custody of documents respecting the existence or good standing of any Selling Shareholder that is not an individual, provided that copies of any such statements or certificates shall be delivered to Underwriters' Counsel. [Such counsel, in rendering its opinion under subparagraph (iii)(B) above, may specifically state that it is relying solely upon a certificate of the Selling Shareholders or of responsible partners, officer, managers or managing members, as the case may be, of Selling Shareholders and has made no independent investigation] The opinion of such counsel for the Selling Shareholders shall state that the opinion of any such other counsel is in form satisfactory to such counsel and, in their opinion, you and they are justified in relying thereon. (d) All proceedings taken in connection with the sale of the Firm Shares and the Additional Shares as herein contemplated shall be satisfactory in form and substance to you and to Underwriters' Counsel, and the Underwriters shall have received from said Underwriters' Counsel a favorable opinion, dated as of the Closing Date with respect to the 21 22 issuance and sale of the Shares, the Registration Statement and the Prospectus and such other related matters as you may reasonably require, and the Company shall have furnished to Underwriters' Counsel such documents as they request for the purpose of enabling them to pass upon such matters. (e) At the Closing Date you shall have received a certificate of the Chief Executive Officer and Chief Financial Officer of the Company, dated the Closing Date, to the effect that (i) the condition set forth in subsection (a) of this Section 6 has been satisfied, (ii) as of the date hereof and as of the Closing Date the representations and warranties of the Company set forth in Section 1.A hereof are accurate, (iii) as of the Closing Date the obligations of the Company to be performed hereunder on or prior thereto have been duly performed and (iv) subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, the Company and its subsidiary have not sustained any material loss or interference with their respective businesses or properties from fire, flood, hurricane, accident or other calamity, whether or not covered by insurance, or from any labor dispute or any legal or governmental proceeding, and there has not been any material adverse change, or any development involving a material adverse change, in the business prospects, properties, operations, condition (financial or otherwise), or results of operations of the Company and its subsidiary taken as a whole, except in each case as described in or contemplated by the Prospectus. (f) At the Closing Date you shall have received a certificate of each of the Selling Shareholders, dated the Closing Date, to the effect that (i) as of the date hereof and as of the Closing Date the representations and warranties of such Selling Shareholder set forth in Section 1.B hereof are accurate and (ii) as of the Closing Date the obligations of such Selling Shareholder to be performed hereunder on or prior thereto have been duly performed. (g) At the time this Agreement is executed and at the Closing Date, you shall have received a letter, from KPMG Peat Marwick LLP, independent public accountants for the Company, dated, respectively, as of the date of this Agreement and as of the Closing Date addressed to the Underwriters and in form and substance satisfactory to you, to the effect that: (i) they are independent certified public accountants with respect to the Company within the meaning of the Act and the Regulations and stating that the answer to Item 10 of the Registration Statement is correct insofar as it relates to them; (ii) stating that, in their opinion, the financial statements and schedules of the Company included in the Registration Statement and the Prospectus and covered by their opinion therein comply as to form in all material respects with the applicable accounting requirements of the Act and the applicable published rules and regulations of the Commission thereunder; (iii) on the basis of procedures consisting of a reading of the latest available unaudited interim consolidated financial statements of the Company and its subsidiary, a reading of the minutes of meetings and consents of the shareholders and boards of directors of the Company and its subsidiary and the committees of such boards subsequent to December 31, 1996, inquiries of officers and other employees of the Company and its subsidiary who have responsibility for financial and accounting matters of the Company and its subsidiary with respect to transactions and events subsequent to December 31, 1996 and other specified procedures and 22 23 inquiries to a date not more than five days prior to the date of such letter, nothing has come to their attention that would cause them to believe that: (A) the unaudited consolidated financial statements and schedules of the Company presented in the Registration Statement and the Prospectus do not comply as to form in all material respects with the applicable accounting requirements of the Act and the applicable published rules and regulations of the Commission thereunder or that such unaudited consolidated financial statements are not fairly presented in conformity with generally accepted accounting principles applied on a basis substantially consistent with that of the audited consolidated financial statements included in the Registration Statement and the Prospectus; (B) with respect to the period subsequent to June 30, 1997 there were, as of the date of the most recent available monthly consolidated financial statements of the Company and its subsidiary, if any, and as of a specified date not more than five days prior to the date of such letter, any changes in the capital stock or long-term indebtedness of the Company or any decrease in the net current assets or stockholders' equity of the Company, in each case as compared with the amounts shown in the most recent balance sheet presented in the Registration Statement and the Prospectus, except for changes or decreases which the Registration Statement and the Prospectus disclose have occurred or may occur or which are set forth in such letter or (C) during the period from June 30, 1997 to the date of the most recent available monthly consolidated financial statements of the Company and its subsidiary, if any, and to a specified date not more than five days prior to the date of such letter, there was any decrease, as compared with the corresponding period in the prior fiscal year, in total revenues, or total or per share net income, except for decreases which the Registration Statement and the Prospectus disclose have occurred or may occur or which are set forth in such letter; (iv) on the basis of procedures consisting of a reading of the unaudited pro forma consolidated financial statements of the Company and its subsidiary, inquiries of officers and other employees of the Company and its subsidiary who have responsibility for financial and accounting matters of the Company and its subsidiary with respect to the basis for their determination of the pro forma adjustments and other specified procedures and inquiries to a date not more than five days prior to the date of such letter, nothing has come to their attention that would cause them to believe that such unaudited pro forma consolidated financial statements do not comply as to form in all materials respects with the applicable accounting requirements of Rule 11-02 of Regulation S-X and that the pro forma adjustments have not been properly applied to the historical amounts in the compilation of such statements; and (iv) stating that they have compared specific dollar amounts, numbers of shares, percentages of revenues and earnings, and other financial information pertaining to the Company and its subsidiary set forth in the Registration Statement and the Prospectus, which have been specified by you prior to the date of this Agreement, to the extent that such amounts, numbers, percentages, and information may be derived from the general accounting and financial records of the Company and its subsidiary or from schedules furnished by the Company, and excluding any questions requiring an interpretation by legal counsel, with the results obtained from the application of specified readings, inquiries, and other appropriate procedures specified by you set forth in such letter, and found them to be in agreement. (h) Prior to the Closing Date the Company shall have furnished to you such further information, certificates and documents as you may reasonably request. 23 24 (i) You shall have received from each person who is a director or officer of the Company or shareholder that has been heretofore designated by you and listed on Schedule III hereto an agreement to the effect that such person will not, directly or indirectly, without the prior written consent of Bear, Stearns & Co. Inc., on behalf of the Underwriters, offer, sell, offer or agree to sell, grant any option to purchase or otherwise dispose (or announce any offer, sale, grant of an option to purchase or other disposition) of any shares of Common Stock (or any securities convertible into, exercisable for or exchangeable or exercisable for shares of Common Stock) for a period of 180 days after the date of the Prospectus. (j) At the Closing Date, the Shares shall have been authorized for quotation on the Nasdaq National Market System. (k) Prior to the Closing Date, the Company and the Selling Shareholders shall have furnished to you such further information, certificates and documents as you may reasonably request. If any of the conditions specified in this Section 6 shall not have been fulfilled when and as required by this Agreement, or if any of the certificates, opinions, written statements or letters furnished to you or to Underwriters' Counsel pursuant to this Section 6 shall not be in all material respects reasonably satisfactory in form and substance to you and to Underwriters' Counsel, all obligations of the Underwriters hereunder may be cancelled by you at, or at any time prior to, the Closing Date and the obligations of the Underwriters to purchase the Additional Shares may be cancelled by you at, or at any time prior to, the Additional Closing Date. Notice of such cancellation shall be given to the Company and the Selling Shareholders in writing, or by telephone, telex or telegraph, confirmed in writing. 7. Indemnification. (a) The Company and the Selling Shareholders, jointly and severally, agree to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of Section 15 of the Act or Section 20(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), against any and all losses, liabilities, claims, damages and expenses whatsoever as incurred (including but not limited to attorneys' fees and any and all expenses whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, and any and all amounts paid in settlement of any claim or litigation), joint or several, to which they or any of them may become subject under the Act, the Exchange Act or otherwise, insofar as such losses, liabilities, claims, damages or expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the registration statement for the registration of the Shares, as originally filed or any amendment thereof, or any related preliminary prospectus or the Prospectus, or in any supplement thereto or amendment thereof, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that the Company will not be liable in any such case to the extent but only to 24 25 the extent that any such loss, liability, claim, damage or expense arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter through you expressly for use therein; provided, however, that the Company and the Selling Shareholders will not be liable in any such case to the extent but only to the extent that any such loss, liability, claim, damage or expense arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter expressly for use therein; provided, further, however, that in no case shall any Selling Shareholder be liable or responsible for any amount in excess of the total proceeds from the offering (net of underwriting discounts and commissions but before deducting expenses) received by such Selling Shareholder from the Underwriters for the Shares sold by such Selling Shareholder pursuant to this Agreement. This indemnity agreement will be in addition to any liability which the Company and any of the Selling Shareholders may otherwise have including under this Agreement. (b) Each Underwriter severally, and not jointly, agrees to indemnify and hold harmless the Company, each Selling Shareholder, each of the directors of the Company, each of the officers of the Company who shall have signed the Registration Statement, and each other person, if any, who controls the Company or any Selling Shareholder within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, against any losses, liabilities, claims, damages and expenses whatsoever as incurred (including but not limited to attorneys' fees and any and all expenses whatsoever incurred in investigating, preparing or defending against any litigation, commenced or threatened, or any claim whatsoever, and any and all amounts paid in settlement of any claim or litigation), jointly or severally, to which they or any of them may become subject under the Act, the Exchange Act or otherwise, insofar as such losses, liabilities, claims, damages or expenses (or actions in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of a material fact contained in the registration statement for the registration of the Shares, as originally filed or any amendment thereof, or any related preliminary prospectus or the Prospectus, or in any amendment thereof or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that any such loss, liability, claim, damage or expense arises out of or is based upon any such untrue statement or alleged untrue statement or omission or alleged omission made therein in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter through you expressly for use therein; provided, however, that in no case shall any Underwriter be liable or responsible for any amount in excess of the underwriting discount applicable to the Shares purchased by such Underwriter hereunder. This indemnity will be in addition to any liability which any Underwriter may otherwise have including under this Agreement. The Company and the Selling Shareholders acknowledge that the statements set forth in the last paragraph of the cover page and in the ______ paragraph[s] under the caption "Underwriting" in the Prospectus constitute the only information furnished in writing by or on behalf of any Underwriter expressly for use in the registration statement relating to the Shares as originally filed or in any amendment 25 26 thereof, any related preliminary prospectus or the Prospectus or in any amendment thereof or supplement thereto, as the case may be. (d) Promptly after receipt by an indemnified party under subsection (a) or (b) above of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party under such subsection, notify each party against whom indemnification is to be sought in writing of the commencement thereof (but the failure so to notify an indemnifying party shall not relieve it from any liability which it may have under this Section 7). In case any such action is brought against any indemnified party, and it notifies an indemnifying party of the commencement thereof, the indemnifying party will be entitled to participate therein, and to the extent it may elect by written notice delivered to the indemnified party promptly after receiving the aforesaid notice from such indemnified party, to assume the defense thereof with counsel satisfactory to such indemnified party. Notwithstanding the foregoing, the indemnified party or parties shall have the right to employ its or their own counsel in any such case, but the fees and expenses of such counsel shall be at the expense of such indemnified party or parties unless (i) the employment of such counsel shall have been authorized in writing by one of the indemnifying parties in connection with the defense of such action, (ii) the indemnifying parties shall not have employed counsel to have charge of the defense of such action within a reasonable time after notice of commencement of the action, or (iii) such indemnified party or parties shall have reasonably concluded that there may be defenses available to it or them which are different from or additional to those available to one or all of the indemnifying parties (in which case the indemnifying parties shall not have the right to direct the defense of such action on behalf of the indemnified party or parties), it being understood, however, that the indemnifying party shall, in connection with any one such action or separate but substantially similar or related actions in the same jurisdiction arising out of the same general allegations or circumstances, be liable at any time for the reasonable fees and expenses or only (i) one principal firm of attorneys and (ii) one local counsel in each jurisdiction in which, in the reasonable discretion of such principal firm, it is deemed necessary to retain such local counsel for the indemnified party or parties. Anything in this subsection to the contrary notwithstanding, an indemnifying party shall not be liable for any settlement of any claim or action effected without its written consent; provided, however, that such consent was not unreasonably withheld. 8. Contribution. In order to provide for contribution in circumstances in which the indemnification provided for in Section 7 hereof is for any reason held to be unavailable from any indemnifying party or is insufficient to hold harmless a party indemnified thereunder, the Company, any Selling Shareholder and the Underwriters who would otherwise be liable as an indemnifying party under Section 7 of this Agreement shall contribute to the aggregate losses, claims, damages, liabilities and expenses of the nature contemplated by such indemnification provision (including any investigation, legal and other expenses incurred in connection with, and any amount paid in settlement of, any action, suit or proceeding or any claims asserted, but after deducting in the case of losses, claims, damages, liabilities and expenses suffered by the Company, such Selling Shareholder or such Underwriter any contribution received by the Company, such Selling Shareholder or such Underwriter from persons, other than (i) the Underwriters or such Selling Shareholder in the case of the Company, (ii) the Company or any Underwriter, in the case 26 27 of such Selling Shareholder, and (iii) the Company or any Selling Shareholder in the case of the Underwriters, who may also be liable for contribution, including persons who control the Company within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, officers of the Company who signed the Registration Statement and directors of the Company) as incurred to which the Company, any such Selling Shareholder and one or more of the Underwriters may be subject, in such proportions as is appropriate to reflect the relative benefits received by the Company, such Selling Shareholder and the Underwriters from the offering of the Shares or, if such allocation is not permitted by applicable law or indemnification is not available as a result of the indemnifying party not having received notice as provided in Section 7 hereof, in such proportion as is appropriate to reflect not only the relative benefits referred to above but also the relative fault of the Company, such Selling Shareholder and the Underwriters in connection with the statements or omissions which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The relative benefits received by the Company, such Selling Shareholder and the Underwriters shall be deemed to be in the same proportion as (x) the total proceeds from the offering (net of underwriting discounts and commissions but before deducting expenses) received by the Company, (y) the total proceeds from the offering (net of underwriting discounts and commissions but before deducting expenses) received by such Selling Shareholder and (z) the underwriting discounts and commissions received by the Underwriters, respectively, in each case as set forth in the table on the cover page of the Prospectus. The relative fault of the Company, of such Selling Shareholder and the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company, such Selling Shareholder or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, the Selling Shareholders and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 8 were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above. Notwithstanding the provisions of this Section 8, (i) in no case shall any Underwriter be liable or responsible for any amount in excess of the underwriting discount applicable to the Shares purchased by such Underwriter hereunder, (ii) in no case shall any Selling Shareholder be liable or responsible for any amount in excess of the total proceeds from the offering (net of underwriting discounts and commissions but before deducting expenses) received by such Selling Shareholder and (iii) no person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. Notwithstanding the provisions of this Section 8 and the preceding sentence, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages that such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. For purposes of this Section 8, each person, if any, who controls an Underwriter within the meaning of Section 15 of the 27 28 Act or Section 20(a) of the Exchange Act shall have the same rights to contribution as such Underwriter, each person, if any, who controls any Selling Shareholder within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act shall have the same rights to contribution as such Selling Shareholder and each person, if any, who controls the Company within the meaning of Section 15 of the Act or Section 20(a) of the Exchange Act, each officer of the Company who shall have signed the Registration Statement and each director of the Company shall have the same rights to contribution as the Company, subject in each case to clauses (i) through (iii) of this Section 8. Any party entitled to contribution will, promptly after receipt of notice of commencement of any action, suit or proceeding against such party in respect of which a claim for contribution may be made against another party or parties, notify each party or parties from whom contribution may be sought, but the omission to so notify such party or parties shall not relieve the party or parties from whom contribution may be sought from any obligation it or they may have under this Section 8 or otherwise. No party shall be liable for contribution with respect to any action or claim settled without its consent; provided, however, that such consent was not unreasonably withheld. 9. Default by an Underwriter. (a) If any Underwriter or Underwriters shall default in its or their obligation to purchase Firm Shares or Additional Shares hereunder, and if the Firm Shares or Additional Shares with respect to which such default relates do not (after giving effect to arrangements, if any, made by you pursuant to subsection (b) below) exceed in the aggregate 10% of the number of Firm Shares or Additional Shares, to which the default relates shall be purchased by the non-defaulting Underwriters in proportion to the respective proportions which the numbers of Firm Shares set forth opposite their respective names in Schedule I hereto bear to the aggregate number of Firm Shares set forth opposite the names of the non-defaulting Underwriters. (b) In the event that such default relates to more than 10% of the Firm Shares or Additional Shares, as the case may be, you may in your discretion arrange for yourself or for another party or parties (including any non-defaulting Underwriter or Underwriters who so agree) to purchase such Firm Shares or Additional Shares, as the case may be, to which such default relates on the terms contained herein. In the event that within five calendar days after such a default you do not arrange for the purchase of the Firm Shares or Additional Shares, as the case may be, to which such default relates as provided in this Section 9, this Agreement or, in the case of a default with respect to the Additional Shares, the obligations of the Underwriters to purchase and of certain of the Selling Shareholders to sell the Additional Shares shall thereupon terminate, without liability on the part of the Company or the Selling Shareholders, as the case may be, with respect thereto (except in each case as provided in Section 5, 7(a), 7(b) and 8 hereof) or the Underwriters, but nothing in this Agreement shall relieve a defaulting Underwriter or Underwriters of its or their liability, if any, to the other Underwriters, the Company and the Selling Shareholders for damages occasioned by its or their default hereunder. (c) In the event that the Firm Shares or Additional Shares to which the default relates are to be purchased by the non-defaulting Underwriters, or are to be purchased by another party or parties as aforesaid, you or the Company shall have the right to postpone the 28 29 Closing Date or Additional Closing Date, as the case may be, for a period, not exceeding five business days, in order to effect whatever changes may thereby be made necessary in the Registration Statement or the Prospectus or in any other documents and arrangements, and the Company agrees to file promptly any amendment or supplement to the Registration Statement or the Prospectus which, in the opinion of Underwriters' Counsel, may thereby be made necessary or advisable. The term "Underwriter" as used in this Agreement shall include any party substituted under this Section 9 with like effect as if it had originally been a party to this Agreement with respect to such Firm Shares and Additional Shares. 10. Survival of Representations and Agreements. All representations and warranties, covenants and agreements of the Underwriters, the Company and the Selling Shareholders contained in this Agreement, including the agreements contained in Section 5, the indemnity agreements contained in Section 7 and the contribution agreements contained in Section 8, shall remain operative and in full force and effect regardless of any investigation made by or on behalf of any Underwriter or any controlling person thereof, by or on behalf of the Company, any of its officers and directors or any controlling person thereof or by or on behalf of any Selling Shareholder, any of its officers and directors or any controlling person, and shall survive delivery of and payment for the Shares to and by the Underwriters. The representations contained in Section 1 and the agreements contained in Sections 5, 7, 8 and 11(d) hereof shall survive the termination of this Agreement, including termination pursuant to Section 9 or 11 hereof. 11. Effective Date of Agreement; Termination. (a) This Agreement shall become effective, upon the later of when (i) you, the Company and the Selling Shareholders shall have received notification of the effectiveness of the Registration Statement or (ii) the execution of this Agreement. If either the public offering price or the purchase price per Share has not been agreed upon prior to 5:00 P.M., New York time, on the fifth full business day after the Registration Statement shall have become effective, this Agreement shall thereupon terminate without liability to the Company, the Selling Shareholders or the Underwriters except as herein expressly provided. Until this Agreement becomes effective as aforesaid, it may be terminated by the Company by notifying you and the Selling Shareholders or the Agent or by you notifying the Company and the Selling Shareholders or the Agent. Notwithstanding the foregoing, the provisions of this Section 11 and of Sections 1, 5, 7 and 8 hereof shall at all times be in full force and effect. (b) You shall have the right to terminate this Agreement at any time prior to the Closing Date or the obligations of the Underwriters to purchase the Additional Shares at any time prior to the Additional Closing Date, as the case may be, (i) if trading in the Common Stock shall have been suspended by the Commission or by the Nasdaq National Market System; (ii) if any domestic or international event or act or occurrence has materially disrupted, or in your opinion will in the immediate future materially disrupt, the market for the Company's securities or securities in general; or (iii) if trading on the New York or American Stock Exchanges or on the Nasdaq National Market System shall have been suspended, or minimum or maximum prices for trading shall have been fixed, or maximum ranges for prices for securities shall have been 29 30 required, on the New York or American Stock Exchanges or on the Nasdaq National Market System by the New York or American Stock Exchanges or by the Nasdaq National Market System or by order of the Commission or any other governmental authority having jurisdiction; or (iv) if a banking moratorium has been declared by a state or federal authority or if any new restriction materially adversely affecting the distribution of the Firm Shares or the Additional Shares, as the case may be, shall have become effective; or (v) (A) if the United States becomes engaged in hostilities or there is an escalation of hostilities involving the United States or there is a declaration of a national emergency or war by the United States or (B) if there shall have been such change in political, financial or economic conditions if the effect of any such event in (A) or (B) as in your judgment makes it impracticable or inadvisable to proceed with the offering, sale and delivery of the Firm Shares or the Additional Shares, as the case may be, on the terms contemplated by the Prospectus. (c) Any notice of termination pursuant to this Section 11 shall be by telephone, telex, or telegraph, confirmed in writing by letter. (d) If this Agreement shall be terminated pursuant to any of the provisions hereof (otherwise than pursuant to (i) notification by you as provided in Section 11(a) hereof or (ii) Section 9(b) or 11(b) hereof), or if the sale of the Shares provided for herein is not consummated because any condition to the obligations of the Underwriters set forth herein is not satisfied or because of any refusal, inability or failure on the part of the Company or any Selling Shareholder to perform any agreement herein or comply with any provision hereof, the Company will, subject to demand by you, reimburse the Underwriters for all out-of-pocket expenses (including the fees and expenses of their counsel), incurred by the Underwriters in connection herewith. 12. Notices. All communications hereunder, except as may be otherwise specifically provided herein, shall be in writing and, if sent to any Underwriter, shall be mailed, delivered, or telexed or telegraphed and confirmed in writing, to such Underwriter c/o Bear, Stearns & Co. Inc., 245 Park Avenue, New York, N.Y. 10167, Attention: Mr. Henry J. Aboodi; if sent to the Company, shall be mailed, delivered, or telegraphed and confirmed in writing to the Company, 2380 Barrett Avenue, Perris, California 92572, Attention: Mr. Evan M. Gruber; and if sent to any Selling Shareholder, shall be mailed, delivered, or telegraphed and confirmed in writing to the Company, 2380 Barrett Avenue, Perris, California 92572, Attention: Mr. Evan M. Gruber, as Attorney-in-Fact. 13. Parties. This Agreement shall insure solely to the benefit of, and shall be binding upon, the Underwriters, the Company and the Selling Shareholders, and the controlling persons, directors, officers, employees and agents referred to in Section 7 and 8, and their respective successors and assigns, and no other person shall have or be construed to have any legal or equitable right, remedy or claim under or in respect of or by virtue of this Agreement or any provision herein contained. The term "successors and assigns" shall not include a purchaser, in its capacity as such, of Shares from any of the Underwriters. 30 31 14. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York, but without regard to principles of conflicts of law. 31 32 If the foregoing correctly sets forth the understanding between you and the Company, please so indicate in the space provided below for that purpose, whereupon this letter shall constitute a binding agreement among us. Very truly yours, MODTECH, INC. By:___________________________________ Evan M. Gruber Chief Executive Officer -------------------------------------- Evan M. Gruber As Attorney-in-Fact for the Selling Shareholders named in Schedule II hereto Accepted as of the date first above written BEAR, STEARNS & CO. INC. CRUTTENDEN ROTH INCORPORATED L.H. FRIEND, WEINRESS, FRANKSON & PRESSON, INC. By: Bear, Stearns & Co. Inc. By: ________________________________________ Stephen Parish, Senior Managing Director 32 33 SCHEDULE I THE UNDERWRITERS
Column (2) Column (1) Number of Firm Number of Firm Shares to be Column (3) Shares to be Purchased from Maximum No. of Purchased from the Selling Additional Shares Name of Underwriter the Company Shareholders to be Purchased ------------------- ----------- ------------ --------------- Bear, Stearns & Co. Inc. Cruttenden Roth Incorporated L.H. Friend, Weinress, Frankson & Presson, Inc. Total....... 1,000,000 2,000,000 450,000
33 34 SCHEDULE II THE SELLING SHAREHOLDERS
Column (2) Column (1) Maximum No. of Number of Firm Shares Additional Shares Name of Selling Shareholder to be Sold to be Sold --------------------------- ---------- ---------- Gerald B. Bashaw 175,000 18,125 James D. Goldenetz 25,000 15,000 Evan M. Gruber 75,000 25,000 Michael G. Rhodes 25,000 15,000 Proactive Partners, L.P. 933,800 210,000 Fremont Proactive Partners, 58,200 7,575 L.P. Lagunitas Partners 708,000 159,300 Total 2,000,000 450,000
34 35 SCHEDULE III OTHER SHAREHOLDERS EXECUTING LOCK-UP AGREEMENTS Charles C. McGettigan Myron A. Wick, III Robert W. Campbell J. Patterson McBaine James M. Phillips Gruber & McBaine Capital Management GMJ Investments Gruber & McBaine International 35 EX-5 3 OPINION OF PHILLIPS & HADDAN LLP 1 PHILLIPS & HADDAN LLP Attorneys at Law 4675 MacArthur Court, Suite 710 Newport Beach, California 92660 (714) 752-6100 Facsimile (714) 752-6161 Exhibit 5 November 3, 1997 Modtech, Inc. 2830 Barrett Ave Perris, CA 92751 Gentlemen: In connection with the pending Registration Statement on Form S-1 (the "Registration Statement") filed by our client Modtech, Inc., a California corporation (the "Company"), with the Securities and Exchange Commission (File No. 333-37473) for the purpose of registering for sale under the Securities Act of 1933, as amended, up to an aggregate of 3,450,000 shares of the Company's Common Stock, $.01 par value, of which up to 1,000,000 are to be issued and sold by the Company ("Shares"), we have been requested to provide our opinion as to certain legal matters regarding the issuance of the Shares. For the purpose of rendering this opinion, we made such have legal and factual examination and inquiries as we have deemed necessary or appropriate for purposes of this opinion. On the basis of such examination and inquiries, and relying thereon, we are of the Opinion that the Shares, when issued and paid for in the manner described in the Registration Statement, will be duly authorized and validly issued, fully paid and nonassessable under the laws of the State of California. We hereby consent to the use of this opinion as an exhibit to the Registration Statement and to the reference to us under the caption "Legal Opinions" in the Prospectus which comprises a part of the Registration Statement. Very truly yours, /s/ PHILLIPS & HADDAN, LLP PHILLIPS & HADDAN, LLP EX-23.1 4 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23.1 The Board of Directors Modtech, Inc.: The audits referred to in our report dated March 21, 1997, included the related financial statement schedule as of December 31, 1996, and for each of the years in the three-year period ended December 31, 1996, included in the registration statement. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule 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. We consent to the use of our report included herein and to the reference to our firm under the heading "Experts" in the prospectus. KPMG Peat Marwick LLP Orange County, California October 31, 1997 -----END PRIVACY-ENHANCED MESSAGE-----