EXHIBIT 7.1
Nor-Cote International, Inc. and Subsidiaries
Financial Statements
Years Ended December 31, 2002 and 2001
Table of Contents
Independent Accountants' Report.........................................1
Report of the Other Accountants......................................2
Consolidated Financial Statements
Balance Sheets......................................................3
Statements of Income................................................4
Statements of Shareholders' Equity..................................5
Statements of Cash Flows............................................6
Notes to Financial Statements.......................................7
Independent Accountants' Report
Board of Directors and Shareholders
Nor-Cote International, Inc. and Subsidiaries
Crawfordsville, Indiana
We have audited the accompanying consolidated balance sheet of Nor-Cote
International, Inc. and Subsidiaries as of December 31, 2002, and the related
consolidated statements of income, shareholders' equity and cash flows for the
year then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit. The consolidated
financial statements of Nor-Cote International, Inc. and Subsidiaries as of
December 31, 2001, were audited by other accountants whose report dated February
7, 2002, included an explanatory paragraph describing conditions that raised
substantial doubt about the Company's ability to continue as a going concern.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Nor-Cote
International, Inc. and Subsidiaries as of December 31, 2002, and the results of
its operations and its cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States of America.
/s/ BKD, LLP
March 21, 2003
1
Report of Independent Auditors
Board of Directors and Shareholders
Nor-Cote International, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Nor-Cote
International, Inc. and Subsidiaries as of December 31, 2001 and 2000, and the
related consolidated statements of income, shareholders' equity and cash flows
for the years then ended. 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 auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Nor-Cote International, Inc. and Subsidiaries at December 31, 2001 and 2000 and
the consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 2 to the
financial statements, the Company has not complied with certain covenants of its
bank debt agreement. This condition raises substantial doubt about its ability
to continue as a going concern. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Ernst & Young LLP
February 7, 2002
2
Nor-Cote International, Inc. and Subsidiaries
Consolidated Balance Sheets
December 31, 2002 and 2001
Assets
2002 2001
-----------------------------
Current Assets
Cash and cash equivalents $ 1,122,904 $ 1,085,182
Investments -- 1,727,815
Accounts receivable, less allowance for doubtful accounts of 1,812,823 1,733,842
$116,000 in 2002 and $100,000 in 2001
Inventories 1,239,182 1,409,099
Prepaid expenses and other current assets 150,321 248,545
Recoverable income taxes -- 115,585
Deferred income taxes 233,337 54,188
------------ ------------
Total current assets 4,558,567 6,374,256
------------ ------------
Property and Equipment, net 2,579,419 2,877,343
------------ ------------
Other Assets
Note receivable, related party 145,697 138,759
Cash surrender value of officer's life insurance -- 830,157
Deferred income taxes -- 39,584
Sundry 73,805 93,805
------------ ------------
219,502 1,102,305
------------ ------------
$ 7,357,488 $ 10,353,904
============ ============
Liabilities and Shareholders' Equity
Current Liabilities
Accounts payable $ 555,937 $ 287,202
Income taxes payable 91,948 20,898
Accrued expenses and other liabilities 667,464 558,681
Current portion of capital lease obligations 141,853 128,781
Current portion of long-term debt 493,954 --
Bank debt in default -- 6,521,023
------------ ------------
Total current liabilities 1,951,156 7,516,585
------------ ------------
Fair Value of Interest Rate Swap 227,765 172,034
------------ ------------
Capital Lease Obligations, less current portion 19,840 138,779
------------ ------------
Long-Term Debt, less current portion 1,857,464 --
------------ ------------
Deferred Income Taxes 130,650 --
------------ ------------
Shareholders' Equity
Common stock, no par value
Authorized - 10,000,000 shares
Issued - 2,622,645 shares 24,764 24,764
Preferred stock, no par value
Authorized - 2,000,000 shares
Issued - 747,993 shares 7,383 7,383
Retained earnings 18,753,436 18,781,461
Accumulated other comprehensive income (331,097) (284,175)
Cost of common stock in treasury
1,170,658 shares (9,493,438) (9,493,438)
Unearned ESOP shares (5,790,435) (6,509,489)
------------ ------------
Total shareholders' equity 3,170,613 2,526,506
------------ ------------
$ 7,357,488 $ 10,353,904
============ ============
3
Nor-Cote International, Inc. and Subsidiaries
Consolidated Statements of Income
Years Ended December 31, 2002 and 2001
2002 2001
Amount % of Amount % of
Sales Sales
------------------------------------------------
Sales
Domestic $ 6,828,331 59.8% $ 8,154,589 63.2%
International 4,580,974 40.2 4,738,664 36.8
------------ ----- ------------ -----
11,409,305 100.0 12,893,253 100.0
Cost of Sales 5,891,831 51.6 6,677,981 51.8
------------ ----- ------------ -----
Gross Profit 5,517,474 48.4 6,215,272 48.2
------------ ----- ------------ -----
Operating Expenses
Selling 1,319,099 11.6 1,292,455 10.0
General and administrative 2,923,902 25.6 3,386,519 26.3
Technical service 238,640 2.1 276,950 2.1
Research and development 293,354 2.6 396,939 3.1
------------ ----- ------------ -----
4,774,995 41.9 5,352,863 41.5
------------ ----- ------------ -----
Income From Operations 742,479 6.5 862,409 6.7
------------ ----- ------------ -----
Other Income (Expense)
Interest and dividend income 136,859 1.2 152,047 1.2
Royalty income 258,304 2.3 223,175 1.7
Interest expense (490,440) (4.3) (747,834) (5.8)
Gain (loss) on investments 125,873 1.1 (159,456) (1.2)
Other, net 59,580 .5 (52,735) (.4)
------------ ----- ------------ -----
90,176 .8 (584,803) (4.5)
------------ ----- ------------ -----
Income Before Income Taxes 832,655 7.3 277,606 2.2
Income taxes 520,310 4.6 192,874 1.5
------------ ----- ------------ -----
Net Income $ 312,345 2.7% $ 84,732 .7%
============ ===== ============ =====
4
Nor-Cote International, Inc. and Subsidiaries
Consolidated Statements of Shareholders' Equity
Years Ended December 31, 2002 and 2001
Accumulated
Other
Additional Comprehensive Unearned Total
Common Preferred Paid-in Retained Income Treasury ESOP Shareholders'
Stock Stock Capital Earnings (Loss) Stock Shares Equity
-------------------------------------------------------------------------------------------------
Balance, January 1, 2001 $ 24,764 $ 7,383 $ 26,540 $18,889,223 $(168,149) $(9,493,438) $(7,203,145) $ 2,083,178
Comprehensive income
Net income 84,732 84,732
Other comprehensive
income
Unrealized losses (86,290) (86,290)
on securities,
net of tax of
$61,820
Foreign currency (29,736) (29,736)
transaction ------------
adjustment
Total (31,294)
comprehensive
loss
ESOP shares committed (45,520) (192,494) 693,656 455,642
for release
Tax benefit of ESOP 18,980 18,980
transactions -------- -------- -------- ----------- --------- ----------- ----------- -----------
Balance, December 31, 2001 24,764 7,383 0 18,781,461 (284,175) (9,493,438) (6,509,489) 2,526,506
Comprehensive income
Net income 312,345 312,345
Other comprehensive
income
Unrealized losses (178,583) (178,583)
on securities,
net of tax of
$127,734
Foreign currency 131,661 131,661
transaction ------------
adjustment
Total 142,956
comprehensive
income
ESOP shares committed (87,597) (340,370) 719,054 291,087
for release
Tax benefit of ESOP 87,597 87,597
transactions -------- -------- -------- ----------- --------- ----------- ----------- -----------
Balance, December 31, 2002 $ 24,764 $ 7,383 $ 0 $18,753,436 $(331,097) $(9,493,438) $(5,790,435) $ 3,170,613
======== ======== ======== =========== ========= =========== =========== ===========
5
Nor-Cote International, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2002 and 2001
2002 2001
---------------------------
Operating Activities
Net income $ 312,345 $ 84,732
Items not requiring (providing) cash
Depreciation and amortization 558,559 600,419
(Gain) loss on investments (125,873) 159,456
Gain on disposal of property and equipment (17) (77,685)
Deferred income taxes 206,416 (33,545)
Fair value of interest rate swap 55,731 172,034
ESOP transactions 291,087 455,642
Changes in
Accounts receivable (78,981) 476,185
Inventories 169,917 414,284
Prepaid expenses and other current assets 98,224 11,201
Income taxes recoverable/payable 186,635 308,173
Accounts payable 268,735 (273,669)
Accrued expenses and other liabilities 108,783 (751,267)
----------- -----------
Net cash provided by operating activities 2,051,561 1,545,960
----------- -----------
Investing Activities
Purchases of investments (584,614) (11,239)
Sales of investments 2,131,985 --
Purchase of property and equipment (243,883) (321,690)
Proceeds from disposal of property and equipment 3,265 177,181
Net increase in notes receivable, related party (6,938) (3,053)
Increase in cash surrender value of officer's life insurance (93,266) (89,994)
Proceeds from surrender of officer's life insurance 923,423 --
----------- -----------
Net cash provided by (used in) investing activities 2,129,972 (248,795)
----------- -----------
Financing Activities
Proceeds from short-term borrowings under revolving loan -- 800,000
Payment on short-term borrowings under revolving loan -- (800,000)
Payment on long-term debt (4,169,605) (988,316)
Proceeds from capital lease obligations 24,657 --
Payments on capital lease obligations (130,524) (120,096)
----------- -----------
Net cash used in financing activities (4,275,472) (1,108,412)
----------- -----------
Effect of Foreign Currency Exchange Rate Changes on Cash and Cash 131,661 (29,736)
----------- -----------
Equivalents
Increase in Cash and Cash Equivalents 37,722 159,017
Cash and Cash Equivalents, Beginning of Year 1,085,182 926,165
----------- -----------
Cash and Cash Equivalents, End of Year $ 1,122,904 $ 1,085,182
=========== ===========
6
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Note 1: Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
Nor-Cote International, Inc., headquartered in Crawfordsville, Indiana,
specializes in the manufacturing and sale of ultraviolet curable ink and
related products. The Company grants credit to customers in several
industries including suppliers to consumer products and automotive
manufacturers, throughout the world. Consequently, the Company's ability
to collect amounts due from customers is affected by economic conditions
in the industries and countries within which it operates. The Company
performs periodic credit evaluations of its customers' financial
condition and generally does not require collateral. Credit losses have
been within management's expectations. Domestic sales and international
sales approximate 60% and 40% of total sales, respectively. The United
States represents approximately 108% of net income, while the United
Kingdom represents approximately 13% and Asia Pacific (Singapore and
Malaysia) approximates (21%) of net income. The net assets of the
Company located outside of the United States, predominately in the
United Kingdom, Singapore and Malaysia, are approximately $1,830,000 at
December 31, 2002.
Principles of Consolidation
The accompanying consolidated financial statements include the
accounts of the Nor-Cote International, Inc. and its wholly-owned
United States, United Kingdom, Singapore, and Malaysian subsidiaries,
U.V. Ink Trading Co. (inactive), Nor-Cote (UK), Ltd., Nor-Cote
International PTE, Ltd., and Nor-Cote (Malaysia) SDN, BHD.,
respectively. All significant intercompany accounts and transactions
have been eliminated in consolidation.
Foreign Currency Translation
Assets and liabilities of the Company's wholly-owned subsidiaries are
translated into U. S. dollars at the exchange rate in effect at the end
of the period. Revenue and expense accounts are translated at a
weighted-average of exchange rates which were in effect during the year.
Translation adjustments that arise from translating the subsidiaries
financial statements from local currency to U. S. dollars are
accumulated and presented, net of tax, as a separate component of
shareholders' equity.
Comprehensive Income (Loss)
Comprehensive income (loss) refers to the change in an entity's equity
during a period resulting from all transactions and events other than
capital contributed by and distributions to the entities' owners. For
the Company, comprehensive income is equal to net income plus the change
in unrealized gains or losses on investments and the change in foreign
currency translation adjustments. The Company has elected to report
comprehensive income in the consolidated statements of shareholders'
equity.
7
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash Equivalents
The Company considers all liquid investments with original maturities of
three months or less to be cash equivalents. At December 31, 2002, the
Company's cash accounts exceeded federally insured limits by
approximately $433,000.
Securities
Debt and equity securities for which the Company has no immediate plan
to sell but that may be sold in the future are classified as available
for sale and carried at fair value. Unrealized gains and losses are
recorded, net of related income tax effects, in stockholders' equity.
Realized gains and losses, based on the specifically identified cost of
the security, are included in net income.
Accounts Receivable
Accounts receivable are stated at the amount billed to customers. The
Company provides an allowance for doubtful accounts, which is based upon
a review of outstanding receivables, historical collection information
and existing economic conditions. Accounts receivable are ordinarily due
30 days after the issuance of the invoice. Delinquent receivables are
written off based on individual credit evaluation and specific
circumstances of the customer.
Inventory Pricing
Inventories are stated at the lower of cost or market. Costs of
inventory are determined using the first-in, first-out (FIFO) method.
Property and Equipment
Property and equipment are depreciated over the estimated useful life of
each asset. Annual depreciation is computed using the straight-line
method. The cost of maintenance and repairs is charged to expense as
incurred; significant renewals and improvements are capitalized. The
Company leases real estate facilities from a related party. The Company
has made leasehold improvements to such property and is depreciating
such leasehold improvements over a period of 3 to 40 years.
8
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Income Taxes
Deferred tax assets and liabilities are recognized for the tax effects
of differences between the financial statement and tax bases of assets
and liabilities. A valuation allowance is established to reduce deferred
tax assets if it is more likely than not that a deferred tax asset will
not be realized. The Company files separate U. S., U. K., Singapore, and
Malaysia income tax returns.
Research and Development Costs
Research and development costs are expensed as incurred.
Revenue Recognition
Revenue from the sale of the Company's products is recognized as
products are shipped to customers.
Self Insurance
The Company has elected to act as a self-insurer for certain costs
related to employee health and accident benefit programs. Costs
resulting from non-insured losses are estimated and charged to income
when incurred. The Company has purchased insurance which limits its
annual exposure for individual claims to $30,000 and which limits its
aggregate annual exposure to approximately $250,000.
Note 2: Investments
Available-for-Sale Securities
The amortized cost and approximate fair values of available-for-sale
securities held at December 31, 2001 are as follows:
Cost Gross Gross Estimated
Unrealized Unrealized Fair Value
Gains Losses
-----------------------------------------------------------
Mutual fund $ 1,001,442 $ -- $ (26,604) $ 974,838
Equity securities 420,056 332,921 -- 752,977
----------- ----------- ----------- ------------
$ 1,421,498 $ 332,921 $ (26,604) $ 1,727,815
=========== =========== =========== ============
9
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Proceeds from sales of available-for-sale securities were $2,131,985 for
2002. Gross gains and losses of $204,431 and $78,558 were realized and
included in net income for 2002. While there were no sales of
available-for-sale securities in 2001, a loss was realized for what
management believed to be a permanent decline in estimated fair value.
Note 3: Inventories
2002 2001
-------------------------------
Raw materials $ 459,170 $ 548,323
Work-in-process 3,946 5,101
Finished goods 776,066 855,675
------------- -------------
$ 1,239,182 $ 1,409,099
============= =============
Note 4: Property and Equipment
Property and equipment at December 31 are as follows:
2002 2001
-------------------------------
Land and building $ 2,841,710 $ 2,841,710
Machinery and equipment 1,560,123 1,587,941
Leasehold improvements 667,219 650,484
Technology service equipment 125,001 116,325
Sales equipment 567,452 406,329
Office equipment 1,271,308 1,199,078
Vehicles 113,676 93,888
Furniture and fixtures 487,137 477,885
Research equipment 334,276 334,277
------------- -------------
7,967,902 7,707,917
Less: accumulated depreciation
and amortization (5,388,483) (4,830,574)
------------- -------------
$ 2,579,419 $ 2,877,343
============= =============
Note 5: Long-Term Debt
To facilitate the adoption of the Nor-Cote International, Inc. Employee
Stock Ownership Plan, the Company entered into a credit agreement with a
bank. The loans are collateralized by substantially all the assets of
the Company and the shares held by the ESOP.
10
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Due to the December 31, 2001 violation of certain covenants in the
credit agreement, the unpaid balance was reported as current at December
31, 2001. These violations were waived as a result of the Company paying
down the loan balance and negotiating amendments to the credit agreement
in 2003.
The credit agreement also includes a revolving loan for borrowings not
to exceed the lesser of $700,000 or 80% of eligible domestic accounts
receivable plus the lesser of $500,000 or the sum of 40% of eligible
domestic raw materials plus 60% of eligible domestic finished goods.
There were no borrowings against the revolving loan as of December 31,
2002 and 2001. The revolving loan expires in December 2005.
The term loan bears interest at a variable rate (4.50% at December 31,
2002) and requires monthly payments of $36,788 plus interest with a
balloon payment due in December 2005. In addition, on an annual basis,
the Company is required to make principal payments equal to a cash flow
formula as provided for in the credit agreement. The annual payments are
due on each May 1 through maturity of the loan. No annual payment was
due on May 1, 2002 and based on the cash flow formula no annual payment
will be due on May 1, 2003. The term loan matures in December 2005 at
which time the outstanding principal is due in full. The future
maturities of the term loan are as follows: 2003: $493,954, 2004:
$441,456 and 2005: $1,416,008. The original proceeds of the term loan
amounting to $7,500,000 were loaned to the ESOP to finance the ESOP's
purchase of the Company's stock.
Cash paid for interest approximated $450,000 and $580,000 in 2002 and
2001, respectively.
Capital leases include leases covering a building and other property
from a related-party (see Note 12) and a delivery vehicle. The building
and property leased from a related-party expires on January 1, 2004; the
lease of the delivery vehicle was scheduled to expire in 2009 but was
paid off subsequent to December 31, 2002. Aggregate scheduled payments
on capital lease obligations at December 31, 2002 are $173,010 of which
$11,317 represents interest.
Property and equipment include the following property under capital
leases:
2002 2001
-------------------------------
Buildings $ 1,020,000 $ 1,020,000
Equipment 26,000 --
------------- -------------
1,046,000 1,020,000
Less: accumulated depreciation 922,000 817,000
------------- -------------
$ 124,000 $ 203,000
============= =============
11
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Note 6: Derivative Financial Instruments
Effective January 1, 2001, the Company adopted FASB Statement of
Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended (FAS 133). FAS 133
requires the Company to recognize all derivatives on the balance sheet
at fair value. Derivatives that are not hedges must be adjusted to fair
value through income. If the derivative is a hedge, depending on the
nature of the hedge, changes in the fair value of derivatives will
either be offset against the change in fair value of the hedged assets,
liabilities or firm commitments through earnings or recognized in other
comprehensive income until the hedged item is recognized in earnings.
The ineffective portion of a derivative's change in fair value must be
immediately recognized in earnings.
The Company has entered into an interest rate swap agreement for
interest rate risk exposure management purposes. The Company pays a
fixed rate of 5.98% and receives a floating rate equal to the 30-day
LIBOR rate of interest. At December 31, 2002, the notional principal
amount of the interest rate swap was $2,723,214 and the floating rate
was 1.44%.
During the years ended December 31, 2002 and 2001, the Company
recognized a net loss of $55,731 and $172,034, respectively, related to
the adjustment of the fair value of the swap agreement. These amounts
have been included in interest expense in the 2002 and 2001 statements
of income. The fair value of the interest rate swap agreement was a
liability of $227,765 at December 31, 2002. The fair value was
calculated based on the estimated liquidation value as determined by a
third party financial institution.
The interest rate swap agreement expires during December 2005.
The fair value of the Company's other financial instruments approximate
their fair values.
Note 7: Operating Leases
The Company rents office and warehouse space in the United Kingdom,
Singapore and Malaysia under various operating lease arrangements. These
leases expire in various years through 2015. These leases generally
contain renewal options and require the Company to pay all executory
costs (property taxes, maintenance and insurance). Aggregate annual
minimum rentals due under the non-cancelable terms of these operating
leases are as follows:
2003 $ 89,139
2004 87,928
2005 52,127
2006 52,127
2007 52,127
After 2007 265,572
------------
$ 599,020
============
Total rent expense approximated $107,000 in 2002 and $119,000 in 2001.
12
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Note 8: Income Taxes
The provision for income taxes includes these components:
2002 2001
----------------------------
Current
Federal $ 195,000 $ 166,807
State 68,000 35,013
Foreign 51,372 24,373
------------ ------------
314,372 226,193
------------ ------------
Deferred
Federal 171,665 (24,570)
State 34,273 (8,749)
------------ ------------
205,938 (33,319)
------------ ------------
$ 520,310 $ 192,874
============ ============
A reconciliation of income tax expense at the statutory rate to the
Company's actual income tax expense is shown below:
2002 2001
----------------------------
Computed at the statutory rate (34%) $ 283,103 $ 94,386
Increase (decrease) resulting from
State income taxes 67,812 13,659
Changes in the deferred tax asset
valuation allowance 62,245 54,215
Foreign profits and losses 49,545 49,587
Other 57,605 (18,973)
------------ ------------
Actual tax expense $ 520,310 $ 192,874
============ ============
A tax benefit of $87,597 and $18,980 in 2002 and 2001, respectively,
relating to the release of ESOP shares has been charged to deferred tax
expense.
Income (loss) before income taxes for U. S. and foreign operations was
$879,697 and $(47,042), respectively, in 2002, and $310,474 and
$(32,868), respectively, in 2001. Cash paid for income taxes was
$253,000 and $398,000 in 2002 and 2001, respectively.
13
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
The components of the net deferred tax asset (liability) are as follows:
2002 2001
----------------------------
Assets
Capital loss carryforward $ 130,051 $ 183,853
Amortization 114,154 141,085
Other 104,793 111,095
Capital lease 14,390 25,633
Fair value of interest rate swap 94,978 71,724
------------ ------------
458,366 533,390
------------ ------------
Liabilities
Depreciation (143,565) (178,018)
Investments -- (127,676)
Other (82,063) (66,118)
------------ ------------
(225,628) (371,812)
------------ ------------
Valuation Allowance (130,051) (67,806)
------------ ------------
$ 102,687 $ 93,772
============ ============
The valuation allowance at December 31, 2002 is $130,051 and was
increased by $62,245 during the current year.
Note 9: Accumulated Other Comprehensive Income (Loss)
2002
Before-Tax Tax Net-of-Tax
Amount (Expense) Amount
Benefit
-----------------------------------
Unrealized gains (losses) on securities
Unrealized holding gains (losses)
arising during the year $ (180,444) $ 75,245 $ (105,199)
Less: reclassification adjustment for
gains (losses) realized in net income 125,873 (52,489) 73,384
---------- --------- ----------
Net unrealized gains (losses) (306,317) 127,734 (178,583)
Foreign currency adjustments 131,661 -- 131,661
---------- --------- ----------
Accumulated other comprehensive
income (loss) $ (174,656) $ 127,734 $ (46,922)
========== ========= ==========
14
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
2001
Before-Tax Tax Net-of-Tax
Amount (Expense) Amount
Benefit
-----------------------------------
Unrealized gains (losses) on securities
Unrealized holding gains (losses)
arising during the year $ (307,566) $ 128,313 $ (179,253)
Less: reclassification adjustment for
gains (losses) realized in net income (159,456) 66,493 (92,963)
---------- --------- ----------
Net unrealized gains (losses) (148,110) 61,820 (86,290)
Foreign currency adjustments (29,736) -- (29,736)
---------- --------- ----------
Accumulated other comprehensive
income (loss) $ (177,846) $ 61,820 $ (116,026)
========== ========= ==========
Significant components of accumulated other comprehensive income (loss)
are as follows:
Foreign Unrealized Accumulated
Currency Gains Other
Adjustments (Losses) Comprehensive
on Securities Income
(Loss)
----------------------------------------------
Balance at January 1, 2001 $ (433,022) $ 264,873 $ (168,149)
Period change (29,736) (86,290) (116,026)
------------ ------------ ------------
Balance at December 31, 2001 (462,758) 178,583 (284,175)
Period changed 131,661 (178,583) (46,922)
------------ ------------ ------------
Balance at December 31, 2002 $ (331,097) $ 0 $ (331,097)
============ ============ ============
Note 10: Profit-Sharing Plans
The Company has a 401(k) profit-sharing plan which is available to all
United States employees. Employees may contribute up to 15% of their
compensation to the plan. The Company matches a discretionary percentage
of contributions made by employees. The Company's cash contribution to
the Plan was $0 and $13,233 in 2002 and 2001, respectively. Beginning in
2001, the Company elected to match employee contributions with
allocations of stock released from the Employee Stock Ownership Plan
(see Note 12).
15
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
In January 2001, the Company adopted an incentive compensation plan to
grant certain key executives stock appreciation rights (SARS). Under the
terms of the plan, participants are granted stock appreciation rights
where the value of each right is equal to the appreciation, if any, in
the value of one share of common stock of the Company over an applicable
base line amount. At December 31, 2002, the value of one share of common
stock was $2.05, less than the applicable base line amount of
approximately $11.54, thus no appreciation exists at year-end. SARS
become fully vested and payable to a key executive on the last day of
the applicable performance period (December 31, 2005) provided the goals
for such performance period have been satisfied. At December 31, 2002
and 2001, the performance period has not yet expired nor did the Company
meet the required company performance goal, thus no liability is accrued
in the financial statements.
Note 11: Preferred Stock
The Company's Articles of Incorporation authorize the issuance of up to
2,000,000 shares of preferred stock with no par value.
Each holder of the preferred shares is entitled to one vote for each
share of preferred stock owned. Preferred stock may be converted to
common stock at the option of the holder pursuant to preferred stock
agreements.
The Company has the option to redeem all or any of the outstanding
preferred shares for a price of $9.9236 per share plus any unpaid
dividends at the earlier of December 28, 2015 or the date that the ESOP
loan (see Note 12) is repaid.
The holders of the Preferred Stock are entitled to receive fixed
cumulative dividends at a rate of $0.200535 per share per year. Such
dividends shall accrue from the respective issuance dates of the
preferred stock and shall accumulate, if not paid, whether or not
declared. The holders of the preferred stock are also entitled to
receive participating dividends, when and if, dividends are declared on
shares of common stock. In addition to the fixed dividends and
participating dividends, the preferred shareholders are entitled to a
special dividend of $0.396944 per share per year if such dividends are
declared by the Board of Directors. In the event of liquidation, the
holders of the Preferred Stock are entitled to a liquidation preference
over the common shareholders to the extent that there are accrued but
unpaid dividends.
As of December 31, 2002, all of the outstanding preferred stock is held
by the ESOP (see Note 12).
16
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Note 12: Employee Stock Plans
Employee Stock Ownership Plan
In December 2000, the Company adopted the Nor-Cote International, Inc.
Employee Stock Ownership Plan (ESOP) with an effective date of January
1, 2000. All employees of the Company located in the United States and
two employees located outside the United States are eligible to
participate in the ESOP upon meeting the eligibility requirements. All
U. S. employees who were employed by the Company as of December 28, 2000
were eligible to participate in the ESOP effective as of the later of
January 1, 2000 or their date of hire. All other U. S. employees hired
subsequently will become eligible to participate in the ESOP upon
attaining the age 21 and after having completed one year of service.
Contributions to the plan are made at the discretion of the Board of
Directors. Dividends received by the ESOP may be used at the discretion
of the trustee of the ESOP according to the guidelines established by
the ESOP plan document. During 2002 and 2001, dividends received by the
ESOP were used to repay principal of the ESOP loan from the Company.
On December 28, 2000, the ESOP borrowed $7,517,297 from the Company and
purchased 781,838 shares of the Company's common stock from
shareholders. Immediately following the purchase of the shares, each of
the common shares held by the ESOP was converted to .95671 preferred
shares or 747,993 preferred shares. The loan is to be repaid at a fixed
schedule of annual payments established by the loan document over 15
years with the final payment of principal and interest due in December
2014. Interest is payable annually at a rate of 8%. Shares are allocated
to the employees based on the ratio of each participant's compensation
for the plan year to the sum of all participants' compensation for the
plan year to the sum of all participants' compensation for such plan
year.
As the principal on the loan balance is reduced, the Company will
recognize compensation expense for the fair value of the shares
committed to be released and the unearned ESOP shares balance will be
reduced by the cost of the shares. The difference between fair value of
the shares and the ESOP's cost of the shares is charged or credited to
additional paid-in capital. Compensation expense of $291,088 and
$455,642 was recorded in 2002 and 2001, respectively, relating to the
ESOP.
The ESOP contains a "put" option that allows participants receiving a
distribution in Company stock to resell the shares to either the ESOP or
the Company at the then fair market value. As of December 31, 2002 and
2001, approximately 71,500 and 69,000 shares, respectively, were
committed to be released. The fair market value of approximately 576,000
unallocated shares held by the ESOP was approximately $1,890,000 at
December 31, 2002.
As part of a stock call option and put option agreement executed in
December 2000, the ESOP has the right to purchase all but not less than
all of the remaining outstanding shares of the Company at fair market
value at the date the additional shares are purchased. The agreement
allows for this option to be exercised at any time up to 120 days after
the fifth anniversary of the closing of the ESOP transaction. In the
event that the ESOP does not purchase the remaining outstanding shares,
the shareholders have the right to put the shares to the Company for a
period of 90 days after the expiration of the call option described
above at a price equal to fair market value.
17
Nor-Cote International, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
December 31, 2002 and 2001
Note 13: Related Party Transactions
Note Receivable, Officer and Shareholder
The Company has a $75,000 note receivable, plus accrued interest at 5.0%
of $70,697 and at 4.07% of $63,759 at December 31, 2002 and 2001, due
from an officer and shareholder.
Leases
The Company leases a building, which serves as its corporate
headquarters and research facility, and certain other properties from an
entity in which an officer and shareholder of the Company has a
significant ownership interest. The lease, which expires January 1,
2004, provides for fixed rental charges, plus additional rentals based
on increases in the Consumer Price Index and/or improvements made by the
lessor. The building lease, which is accounted for as a capital lease,
required payments of $144,480 for 2002 and 2001.
Note 14: Contingencies
The Company is subject to claims and lawsuits that arise primarily in
the ordinary course of business. It is the opinion of management that
the disposition or ultimate resolution of such claims and lawsuits will
not have a material adverse effect on the consolidated financial
position of the Company.
18