Confidential background of Hawking Corporation

CONFIDENTIAL BACKGROUND OF HAWKING CORPORATION

        Hawking hired McKinsey & Company to conduct a study of the businesses it is in.  The conclusion in the report is that several of its businesses are beginning to decline, indicating that Hawking needs to get into new business areas if it expects to keep its stock price at its current level or to increase the price.  Hawking has told securities analysts in the last two quarterly earnings calls that it intends to make acquisitions.  The securities analysts have recently asked why Hawking hasn’t yet announced an acquisition.

        If Hawking uses cash to acquire companies, it can avoid the direct dilution that would result if additional shares were issued for the acquisition, but it would have to pay interest on any borrowed funds in excess of the $10,000,000 of excess cash that it has.  The interest rate on long-term debt for Hawking would be approximately 7% per year, and there would be fairly severe loan covenants imposed on Hawking by the lender.  The loan covenants could be risky for Hawking if other lines of business were to decline before the new businesses began to produce significant new revenues and profits.

        Hawking has a very staid culture because of the nature of its businesses and its history.  The CEO and CFO have never done an acquisition before and do not know how they would integrate the culture of EpiTel into its own culture.  There is a risk that Hawking could lose the three founders of EpiTel due to the culture clash, as well as lose several key engineers at EpiTel.

        Hawking knows that EpiTel has a license from MilTech for a number of patents but does not know the terms of the license.  Hawking suspects that the MilTech license prohibits assignment of the license in connection with an acquisition or sale of the Company since this is customary when a licensee has the exclusive right to exploit the patents for a certain area of use.  The license probably defines a merger as an assignment, as well.  Hawking has licensed several of its patents to MilTech in the past, although Hawking does not know at this time how important these patents are to MilTech.  Hawking has been in discussions recently with MilTech where MilTech wants to license several more patents from Hawking to use in its missile systems.  The discussions have gone very slowly due to the bureaucratic nature of MilTech and Hawking doesn’t know if Hawking can use these patents to its advantage in the negotiations with MilTech over the assignment of the license from the Company to Hawking. However, Hawking will require the EpiTel stockholders to bear any payment necessary to MilTech for the transfer of the license.

        Hawking knows that the Company has the product made in China and has been advised confidentially by the NVA director of EpiTel that EpiTel must withdraw from China or be in default of its license with MilTech.  Hawking is quite experienced at having items manufactured in Mexico under NAFTA, which contains liberal provisions for export and import.   Under NAFTA, the restrictions on exporting military technology are generally not applicable.  Hawking believes the direct labor costs in China and Mexico are approximately the same (the hourly rates are higher in Mexico, but the workers’ productivity is greater, making the direct labor cost per unit about the same).  The direct material costs in the product of about $100 (US) will probably be the same no matter where the product is made.  Shipping costs from China to the United States are probably twice the shipping costs from Mexico to the United States.

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