SCHEDULE 14A INFORMATION
Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No. )
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[_] Soliciting Material Pursuant to ss. 240.14a-11(c) or ss. 240.14a-12
ENCORE MEDICAL CORPORATION
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
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Notes:
[ENCORE MEDICAL CORPORATION LOGO]
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD MAY 16, 2002
To our Stockholders:
The 2002 annual meeting of stockholders of Encore Medical Corporation
(the "Company") will be held at the University Club, One West 54th St., New
York, New York, on Thursday, May 16, 2002, beginning at 10:00 a.m. local time.
At the meeting, stockholders will act on the following matters:
(1) Election of two directors by the holders of Common Stock, each
for a term of three years, election of one director by the
holders of Common Stock for a term of two years, and the
election of two directors by the holders of Series A Preferred
Stock, each for a term of one year;
(2) To approve (i) an increase from 2,150,000 shares to 2,198,694
shares of Common Stock of the Company that may be acquired by
CapitalSource Holdings LLC ("CSH") pursuant to a warrant to
acquire Common Stock issued by the Company to CSH, (ii) the
issuance of up to an initial 120,000 shares of Series A
Preferred Stock of the Company to Galen Partners III, L.P.,
Galen Partners International III, L.P. and Galen Employee Fund
III, L.P. (collectively, the "Galen Entities") if the Galen
Entities ultimately become obligated to purchase up to
$6,000,000 aggregate principal amount of senior subordinated
notes of the Company (the "Notes") held by CapitalSource
Finance LLC, an affiliate of CSH, those Notes being
automatically convertible into Series A Preferred Stock upon
purchase by the Galen Entities, and (iii) the issuance to the
Galen Entities of options to acquire up to that number of
shares of Common Stock with a value of $6,000,000 at an
exercise price equal to the greater of $3.50 per share or
one-half of the trailing ten-day average closing price of the
Common Stock on the date of exercise;
(3) To approve an amendment to the Certificate of Incorporation of
the Company, as amended, to increase the number of shares of
Common Stock the Company has the authority to issue by
15,000,000 shares, from 35,000,000 shares to 50,000,000
shares;
(4) To approve an amendment to the 1996 Incentive Stock Plan of
the Company to increase the number of shares of Common Stock
that may be awarded thereunder by 1,000,000 shares, from
2,000,000 shares to 3,000,000 shares;
(5) To approve amendments to the 2000 Non-Employee Director Option
Plan of the Company to (i) increase the number of shares of
Common Stock that may be awarded thereunder by 450,000 shares,
from 300,000 shares to 750,000 shares, and (ii) to increase
the number of shares of Common Stock that may be acquired
pursuant to annual options automatically granted to
non-employee directors of the Company by 5,000 shares, from
10,000 shares to 15,000 shares;
(6) Ratification of the appointment of KPMG LLP as the Company's
independent accountants for fiscal 2002; and
(7) Any other matters that properly come before the meeting.
Stockholders of record at the close of business on April 1, 2002 are entitled to
vote at the meeting or any postponement or adjournment.
By order of the Board of Directors,
/s/ Harry L. Zimmerman
Harry L. Zimmerman
Corporate Secretary
April 16, 2002
Austin, Texas
[ENCORE MEDICAL CORPORATION LOGO]
9800 Metric Blvd.
Austin, Texas 78758
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PROXY STATEMENT
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This proxy statement contains information related to the annual meeting
of stockholders of Encore Medical Corporation (the "Company") to be held at the
University Club, One West 54th St., New York, New York, on Thursday, May 16,
2002, beginning at 10:00 a.m. local time, and at any postponements or
adjournments thereof.
ABOUT THE MEETING
What is the purpose of the annual meeting?
At the Company's annual meeting, stockholders will act upon the matters
outlined in the accompanying notice of meeting, including the (a) election of
three directors (the "Common Directors") by the holders of common stock of the
Company, par value $.001 per share (the "Common Stock"), and the election of two
directors (the "Series A Preferred Directors") by the holders of Series A
Preferred Stock of the Company, par value $.001 per share (the "Series A
Preferred Stock"), (b) approval of (i) an increase from 2,150,000 shares to
2,198,694 shares of Common Stock that may be acquired by CapitalSource Holdings
LLC ("CSH") pursuant to a warrant to acquire Common Stock previously issued by
the Company to CSH, (ii) the issuance of up to an initial 120,000 shares of
Series A Preferred Stock to Galen Partners III, L.P., Galen Partners
International III, L.P. and Galen Employee Fund III, L.P. (collectively, the
"Galen Entities") if the Galen Entities ultimately become obligated to purchase
up to $6,000,000 aggregate principal amount of senior subordinated notes of the
Company (the "Notes") held by CapitalSource Finance LLC, an affiliate of CSH
("CSF"), those Notes being automatically convertible into Series A Preferred
Stock upon purchase by the Galen Entities, and (iii) the issuance to the Galen
Entities of options to acquire up to that number of shares of Common Stock with
a value of $6,000,000 at an exercise price equal to the greater of $3.50 per
share or one-half of the trailing ten-day average closing price of the Common
Stock on the date of exercise (collectively, the "Transactions"), (c) approval
of an amendment to the Certificate of Incorporation of the Company, as amended
(the "Certificate of Incorporation"), to increase the number of shares of Common
Stock the Company has the authority to issue by 15,000,000 shares, from
35,000,000 shares to 50,000,000 shares, (d) approval of an amendment to the 1996
Incentive Stock Plan of the Company to increase the number of shares of Common
Stock that may be awarded thereunder by 1,000,000 shares, from 2,000,000 shares
to 3,000,000 shares, (e) approval of amendments to the 2000 Non-Employee
Director Option Plan of the Company to (i) increase the number of shares of
Common Stock that may be awarded thereunder by 450,000 shares, from 300,000
shares to 750,000 shares, and (ii) to increase the number of shares of Common
Stock that may be acquired pursuant to annual options automatically granted to
non-employee directors of the Company by 5,000 shares, from 10,000 shares to
15,000 shares, and (f) ratification of the Company's independent accountants. In
addition, the Company's management will report on the performance of the Company
during 2001 and respond to questions from stockholders.
Who is entitled to vote?
Only holders of record of Common Stock and Series A Preferred Stock at
the close of business on the record date, April 1, 2002, are entitled to receive
notice of the annual meeting and to vote the shares of Common Stock or Series A
Preferred Stock that they held on that date at the meeting, or any postponement
or adjournment of the meeting. Each outstanding share of Common Stock entitles
its holder to cast one vote on each matter to be voted upon other than the
election of the Series A Preferred Directors. Each outstanding share of Series A
Preferred Stock entitles its holder to cast 100 votes on each matter to be voted
upon, other than (i) the election of the Common Directors and (ii) the approval
of the amendment to the Certificate of Incorporation (which must be approved by
the holders of a majority of the outstanding shares of both the Common Stock and
Series A Preferred Stock voting as separate classes). Except as noted above, the
holders of Common Stock and Series A Preferred Stock will vote on all matters as
a single class.
Who can attend the meeting?
All holders of Common Stock and Series A Preferred Stock as of the
record date, or their duly appointed proxies, may attend the meeting.
What constitutes a quorum?
The presence at the meeting, in person or by proxy, of the holders of
shares of capital stock outstanding on the record date with a majority of the
voting power for a matter will constitute a quorum, permitting the meeting to
conduct its business. As of the record date, 11,027,347 shares of Common Stock
were outstanding and 132,353 shares of Series A Preferred Stock were
outstanding. Proxies received but marked as abstentions and broker non-votes
will be included in the calculation of the number of shares considered to be
present at the meeting.
How do I vote?
If you complete and properly sign the accompanying proxy card and
return it to the Company, it will be voted as you direct. If you attend the
meeting, you may deliver your completed proxy card in person.
Can I vote by telephone or electronically?
No.
Can I change my vote after I return my proxy card?
Yes. Even after you have submitted your proxy, you may change your vote
at any time before the proxy is exercised by filing with the Secretary of the
Company either a notice of revocation or a duly executed proxy bearing a later
date. The powers of the proxy holders will be suspended if you attend the
meeting in person and so request, although attendance at the meeting will not by
itself revoke a previously granted proxy.
How do I vote my 401(k) shares?
If you participate in the Encore Medical Corporation 401(k) Plan, you
may vote shares of Common Stock equivalent to the value of the interest credited
to your account by instructing Wells Fargo Bank, N.A., the trustee of the plan,
pursuant to the instruction card being mailed with this proxy statement to plan
participants. The trustee will vote your shares in accordance with your duly
executed instructions received by May 10, 2002. If you do not send instructions,
the share equivalents credited to your account will be voted by the trustee in
the same proportion that it votes share equivalents for which it did receive
timely instructions.
You may also revoke previously given voting instructions by May 10,
2002 by filing with the trustee either a written notice of revocation or a
properly completed and signed voting instruction card bearing a later date.
What are the Board's recommendations?
Unless you give other instructions on your proxy card, the persons
named as proxy holders on the proxy card will vote in accordance with the
recommendations of the Board of Directors of the Company (the "Board"). The
Board's recommendation is set forth together with the description of each item
in this proxy statement. In summary, the Board recommends a vote:
o For election of the nominated slate of directors (see pages
6-15);
o For the approval of the Transactions (see pages 16-20);
o For the approval of an amendment to the Certificate of
Incorporation to increase the number of shares of Common Stock
the Company has the authority to issue by 15,000,000 shares,
from 35,000,000 shares to 50,000,000 shares (see page 20-21);
o For the approval of an amendment to the 1996 Incentive Stock
Plan of the Company to increase the number of shares of Common
Stock that may be awarded thereunder by 1,000,000 shares, from
2,000,000 shares to 3,000,000 shares (see pages 21-22);
o For the approval of amendments to the 2000 Non-Employee
Director Option Plan of the Company to (i) increase the number
of shares of Common Stock that may be awarded thereunder by
450,000 shares, from 300,000 shares to 750,000 shares, and
(ii) to increase the number of shares of Common Stock that may
be acquired pursuant to annual options automatically granted
to non-employee directors of the Company by 5,000 shares, from
10,000 shares to 15,000 shares (see pages 22-23); and
o For ratification of the appointment of KPMG LLP as the
Company's independent accountants (see page 23-24).
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What vote is required to approve each item?
o Election of Directors. The affirmative vote of a plurality of
the votes cast at the meeting that are entitled to elect each
director is required for the election of both the Common
Directors and the Series A Preferred Directors. A properly
executed proxy marked "WITHHOLD AUTHORITY" with respect to the
election of one or more directors will not be voted with
respect to the director or directors indicated, although it
will be counted for purposes of determining whether there is a
quorum.
o Approval of the Transactions. To approve the Transactions, it
is necessary to obtain the affirmative vote of a majority of
the shares entitled to vote in person or by proxy that vote on
this proposal. A properly executed proxy marked "ABSTAIN" with
respect to the approval of the Transactions will have the
effect of a negative vote, although it will be counted for
purposes of determining whether there is a quorum.
Accordingly, an abstention will have the effect of a negative
vote. The Galen Entities have advised the Company of their
intention to vote in favor of the Transactions. Since the
shares of Common Stock and Series A Preferred Stock owned by
the Galen Entities constitutes more than a majority of the
outstanding voting power entitled to vote on this proposal,
approval of this proposal is assured.
o Amend the Certificate of Incorporate. The Certificate of
Incorporation must be amended to increase the number of shares
authorized for issuance, which requires, under Delaware law,
the affirmative vote of the holders of a majority of the
outstanding shares of Common Stock voting as a separate class.
The Certificate of Designations, Preferences and Limitations
of Series A Preferred Stock of the Company also requires that
the amendment to the Certificate of Incorporation be approved
by the affirmative vote of the holders of a majority of the
outstanding shares of Series A Preferred Stock voting as a
separate class. A properly executed proxy marked "ABSTAIN"
with respect to the approval of the amendment to the
Certificate of Incorporation will have the effect of a
negative vote, although it will be counted for purposes of
determining whether there is a quorum. Accordingly, an
abstention will have the effect of a negative vote.
o Other Items. For each other item, the affirmative vote of the
holders of shares of capital stock with a majority of the
voting power represented in person or by proxy and entitled to
vote on the item will be required for approval. A properly
executed proxy marked "ABSTAIN" with respect to any such
matter will not be voted, although it will be counted for
purposes of determining whether there is a quorum.
Accordingly, an abstention will have the effect of a negative
vote.
If you hold your shares in "street name" through a broker or other
nominee, your broker or nominee may not be permitted to exercise voting
discretion with respect to some of the matters to be acted upon. Thus, if you do
not give your broker or nominee specific instructions, your shares may not be
voted on those matters and will not be counted in determining the number of
shares necessary for approval. Shares represented by such "broker non-votes"
will, however, be counted in determining whether there is a quorum.
STOCK OWNERSHIP
Who are the largest owners of the Company's stock?
The Company knows of only eight persons (or entities) that are, as of
March 15, 2002, the beneficial owners of more than five percent of the Common
Stock or Series A Preferred Stock. They are:
Name and Address of Beneficial Owner Number of Shares Percent of Class
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SHARES OF COMMON STOCK
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Galen Partners III, L.P.(1) 11,176,691 51.9%
160 Fifth Avenue
New York, NY 10020
Galen Partners International III, L.P.(2) 1,011,633 8.5%
160 Fifth Avenue
New York, NY 10020
Ivy Orthopedics Partners, LLC(3) 1,042,049 8.7%
Four Brighton Road, Suite 250
Clifton, New Jersey 07012
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Nicholas Cindrich(4) 1,170,872 10.6%
9800 Metric Blvd.
Austin, Texas 78758
CF Holdings, Ltd.(5) 1,123,164 10.1%
6831 Prospect Ave.
Pittsburgh, PA 15202
Kenneth W. Davidson(6) 814,100 7.3%
9800 Metric Blvd.
Austin, Texas 78758
John H. Abeles, M.D. (7) 629,431 5.6%
9800 Metric Blvd.
Austin, Texas 78758
SHARES OF SERIES A PREFERRED STOCK
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Galen Partners III, L.P.(8) 105,201 79.5%
160 Fifth Avenue
New York, NY 10020
Galen Partners International III, L.P.(8) 9,522 7.2%
160 Fifth Avenue
New York, NY 10020
Ivy Orthopedics Partners, LLC 9,804 7.4%
Four Brighton Road, Suite 250
Clifton, New Jersey 07012
(1) Includes 10,520,100 shares of Common Stock issuable upon the conversion
of the 105,201 shares of Series A Preferred Stock it beneficially owns.
Does not include (i) the 43,500 shares of Common Stock issuable upon
the conversion of the 435 shares of Series A Preferred Stock or (ii)
the 1,189 shares of Common Stock, beneficially owned by Galen Employee
Fund III, L.P., the beneficial ownership of which is disclaimed by this
person.
(2) Includes 952,200 shares of Common Stock issuable upon the conversion of
the 9,522 shares of Series A Preferred Stock it beneficially owns. Does
not include (i) the 43,500 shares of Common Stock issuable upon the
conversion of the 435 shares of Series A Preferred Stock or (ii) the
1,189 shares of Common Stock, beneficially owned by Galen Employee Fund
III, L.P., the beneficial ownership of which is disclaimed by this
person.
(3) Includes 980,400 shares of Common Stock issuable upon the conversion of
the 9,804 shares of Series A Preferred Stock it beneficially owns.
(4) Includes 1,058,885 shares of Common Stock owned by CF Holdings, Ltd.,
of which Mr. Cindrich is a significant stockholder of the corporate
general partner and a limited partner. Mr. Cindrich disclaims
beneficial ownership of Common Stock held by CF Holdings, Ltd., except
to the extent of his pecuniary interest therein. Also includes 111,987
shares that Mr. Cindrich has the right to acquire within 60 days of
March 15, 2002.
(5) Includes Common Stock owned beneficially by Mr. Cindrich.
(6) Includes 196,100 shares of Common Stock issuable upon the conversion of
the 1,961 shares of Series A Preferred Stock he beneficially owns.
(7) Includes 296,931 shares of Common Stock held by Northlea Partners,
Ltd., 98,000 shares of Common Stock issuable upon the conversion of the
980 shares of Series A Preferred Stock Northlea Partners, Inc.
beneficially owns, and 194,500 shares Dr. Abeles has the right to
acquire within 60 days of March 15, 2002.
(8) Does not include 435 shares of Series A Preferred Stock beneficially
owned by Galen Employee Fund III, L.P.
How much stock do the Company's directors and officers own?
The following table shows the Common Stock ownership of (i) the
Company's directors, (ii) the executive officers of the Company named in the
Summary Compensation Table below, and (iii) the directors and executive officers
of the Company as a group, in each case as of March 15, 2001.
Acquirable
Aggregate Number of within Percent of Shares
Name Shares Beneficially Owned(1) 60 days(2) Outstanding
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Nicholas Cindrich 1,058,885 111,987 10.6%
Craig L. Smith, Ph.D. 276,031 0 2.5%
Harry L. Zimmerman 256,750 0 2.3%
August Faske 271,442 0 2.4%
Kenneth W. Davidson 618,000 196,100 7.3%
John H. Abeles, M.D. 296,931 332,500 5.6%
Jay M. Haft 141,250 275,000 3.7%
Joel S. Kanter 132,500 140,000 2.4%
Richard O. Martin, Ph.D. 8,883 60,000 *
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Bruce F. Wesson 751,713 11,515,800 54.4%
Zubeen Shroff 718,713 11,515,800 54.4%
All Directors and executive officers
as a group (13 persons) 3,991,407 12,587,887 70.3%
* Represents less than 1% of the Company's outstanding Common Stock.
(1) The number of shares shown includes shares that are individually or
jointly owned, as well as shares over which the individual has either
sole or shared investment or voting authority. Certain of the Company's
directors and executive officers disclaim beneficial ownership of some
of the shares included in the table, as follows:
A. Mr. Cindrich is a significant owner of the corporate general
partner and is a limited partner of CF Holdings, Ltd. and
disclaims beneficial ownership of the 1,058,885 shares of
Common Stock held by CF Holdings, Ltd. except to the extent of
his pecuniary interest therein.
B. Dr. Abeles' stock (both Common Stock and Series A Preferred
Stock) is held by Northlea Partners, Ltd., a limited
partnership of which Dr. Abeles is the general partner and the
Abeles Family Trust is the sole limited partner. Dr. Abeles
has sole voting and investment power with respect to such
shares.
C. Mr. Kanter's shares include 32,500 shares owned by Windy City,
Inc., and 100,000 shares of Common Stock and 100,000 shares of
Common Stock issuable upon the conversion of the 1,000 shares
of Series A Preferred Stock beneficially owned by the Kanter
Family Foundation, a charitable not-for-profit corporation.
Mr. Kanter is the President and a member of the Board of
Directors for both Windy City, Inc. and the Kanter Family
Foundation and has sole voting and investment control over
said securities. Mr. Kanter disclaims any and all beneficial
ownership of securities owned by either corporation.
D. Mr. Shroff's and Mr. Wesson's shares include shares of Common
Stock and Series A Preferred Stock owned by the Galen
Entities, of which they are partners of entities that control
the general partner of the Galen Entities. They do not have
sole voting or investment power with respect to such shares,
nor do they have full beneficial ownership of such shares.
They disclaim beneficial ownership of these shares except to
the extent of each of their pecuniary interest therein.
(2) Reflects the number of shares that could be purchased by exercise of
options or warrants or by conversion of Series A Preferred Stock on
March 15, 2002 or within 60 days thereafter under the Company's stock
option plans or pursuant to outstanding warrants or shares of Series A
Preferred Stock.
Based upon a review of filings with the Securities and Exchange
Commission and written representations that no other reports were required, the
Company believes that all of the Company's directors and executive officers
complied during 2001 with the reporting requirements of Section 16(a) of the
Securities Exchange Act of 1934.
ITEM 1 - ELECTION OF DIRECTORS
Directors Standing for Election
The Board is currently divided into three classes, each having
three-year terms that expire in successive years. The term of office of
directors in Class II expires at the 2002 annual meeting. The Board proposes
that the nominees described below, both of whom are currently serving as Class
II directors, be re-elected to Class II for a new term of three years and until
their successors are duly elected and qualified. In addition, in order to make
the three classes be equal in membership, the Board proposes that one Director
who is currently serving as a Class III Director with one year remaining in his
term, be elected to a two-year term as a Class I Director.
Each of the Class II nominees has consented to serve a three-year term.
The Class I nominee has consented to serve a two-year term. If any of them
should become unavailable to serve as a director, the Board may designate a
substitute nominee. In that case, the persons named as proxies will vote for the
substitute nominee designated by the Board.
Since the time of the last annual meeting of the Company, two
directors, Craig Smith and Dennis Enright, resigned from the Board.
Class II Directors. The Directors standing for election by the holders of
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Common Stock are:
Jay M. Haft
Mr. Haft was Chairman of the Board and Secretary of Healthcare
Acquisition Corporation ("HCAC") prior to the merger between Healthcare
Acquisition Inc, a wholly owned subsidiary of HCAC and Encore
Orthopedics, Inc. ("Encore") (the "Merger") and has served as a
Director of the Company since the Merger. Mr. Haft is a director of
numerous public and private corporations, including Robotic Vision
Systems, Inc. (OTC), Isotope Solutions, Inc. (OTC), and DUSA
Pharmaceuticals, Inc. (OTC). He is currently of counsel to Reed &
Smith. He was previously a senior corporate partner (1989-1994) and of
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counsel to (1995-2001) Parker Duryee Rosoff & Haft, in New York, New
York, and prior to that a founding partner of Wofsey, Certilman, Haft
et al. (1966-1988). He has served as a member of the Florida Commission
for Government Accountability to the People and is a trustee of Florida
International University Foundation as well as a member of the Advisory
Board of the Wolfsonion Museum. Mr. Haft earned both his B.A. and J.D.
degrees from Yale University. Mr. Haft is 67 years old.
Kenneth W. Davidson
Mr. Davidson became Chief Executive Officer and President of the
Company in October 2000. He became Chairman of the Board of Directors
of the Company on February 1, 2001. Mr. Davidson was a director of
Encore from November 1996 until March 1997 and became a director of the
Company in March 1997. Mr. Davidson served as Chairman, President and
CEO of Maxxim Medical, Inc. from November 1986 to July 2000.
Previously, Mr. Davidson held various positions with Intermedics, Inc.,
Baxter Laboratories, and Merck & Co. Mr. Davidson presently serves on
the Board of Directors and is the past President of Operation Rainbow,
an international charity organization. Mr. Davidson serves on the Board
of Directors of Bovie Medical Corp., a public company involved in
electrosurgery, Maxxim Medical Corporation, and Circon Corporation. Mr.
Davidson received a Bachelor of Science degree in Biology and Chemistry
from Laurentian University, Sudbury Ontario, Canada. Mr. Davidson is 54
years old.
Class I Directors. The following Director is standing for election by the
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holders of Common Stock for a two-year term as a Class I Director:
Richard O. Martin, Ph.D.
Dr. Martin was a director of Encore from February 1996 until March 1997
and became a director of the Company in March 1997. Dr. Martin retired
in October 2001 as President of Medtronic Physio-Control, a position he
held since the merger of Physio-Control and Medtronic in September
1998. Prior to the merger, Dr. Martin served as Chairman and Chief
Executive Officer of Physio-Control International Corporation,
positions that he held since 1991. Prior to joining Physio-Control, Dr.
Martin held a variety of positions culminating as President and Chief
Operating Officer of Intermedics, Inc. of Angelton, Texas. He has also
served as President and Chief Operating Officer of Positron Corporation
of Houston, Texas. Dr. Martin is the past National Chairman of the AeA,
the nation's largest trade association representing the high-tech
industry. He is also past Chairman of the American Heart Association's
Northwest Affiliate. He holds a B.S. in Electrical Engineering from
Christian Brothers College (1962), a M.S. in Electrical Engineering
from Notre Dame University (1964) and a Ph.D. in Electrical/Biomedical
Engineering from Duke University (1970). Dr. Martin also serves on the
Board of Directors of Scout Medical Technologies, Cardio Dynamics, Inc.
and Inovise Medical, Inc. Dr. Martin is 62 years old.
Directors Elected by the Holders of Series A Preferred Stock. The term of office
- ------------------------------------------------------------
for the following Series A Preferred Directors will end at the 2002 annual
meeting and the Board proposes that the nominees below, both of whom are
currently serving as Series A Preferred Directors, be re-elected for a new term
of one year and until their successors are duly elected and qualified.
Zubeen Shroff
Mr. Zubeen has served as a director since June 2001. He is a director
nominated by the holders of the Series A Preferred Stock. Mr. Shroff is
a general partner of Galen Associates, a healthcare focused private
equity investment fund. Mr. Shroff jointed Galen in January 1997 from
The Wilkerson Group, a provider of management consulting services to
the health care products and services industry, where he was a
principal from 1995 to 1996. Mr. Shroff currently serves on the boards
of Halsey Drug Co., Inc., Cognia, Inc., Cortek, Inc., and
AmericasDoctor, Inc. Mr. Shroff is 37 years old.
Bruce F. Wesson
Mr. Wesson has served as a director since June of 2001. He is a
director nominated by the holders of the Series A Preferred Stock. Mr.
Wesson is a General Partner of Galen Associates, a healthcare focused
private equity investment fund. Prior to his association with Galen,
Mr. Wesson served as a Managing Director in the Corporate Finance
Division of Smith Barney. He currently serves as a director for
Crompton Corporation, Halsey Drug Co., Inc., and several privately held
companies. Mr. Wesson is 58 years old.
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Directors Continuing in Office
Class I Directors. The term of office for the following Class I Director shall
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end at the 2004 annual meeting:
John H. Abeles, M.D.
Dr. Abeles was President, Treasurer and a director of HCAC prior to the
Merger and has served as a Director of the Company since the Merger.
From 1971 to 1975, Dr. Abeles was an executive with several major
pharmaceutical companies in the United Kingdom and the United States,
including Sterling Drugs (UK), Pfizer Labs and USV Pharmaceuticals (a
division of Revlon Healthcare). From 1975 to 1980, he was an analyst in
Kidder Peabody's healthcare research department. Since 1980, Dr. Abeles
has been President of MedVest Inc., which has provided consulting
services to, and has been active in the founding and financing of,
emerging companies, principally in the healthcare industry. Dr. Abeles
is currently a member of the Board of Directors of Oryx Technology
Corporation, DUSA Pharmaceuticals, Inc., and I-Flow Corporation. Dr.
Abeles earned a M.B., Ch.B. from the University of Birmingham
(England). Dr. Abeles is 57 years old.
Class III Directors. The term of office for the following Class III directors
- -------------------
will end at the 2003 annual meeting:
Nicholas Cindrich
Mr. Cindrich, who founded Encore in March 1992, served as its President
from March 1992 until August 1992. From August 1992 through August
1994, Mr. Cindrich was self-employed as a business consultant. From
August 1994 to October 2000, he served as the Chief Executive Officer
of Encore and from August 1994 to February 2001 served as Chairman of
the Board of Directors of Encore. From March 1997 to October 2000 he
served as the Chief Executive Officer of the Company and from March
1997 to February 2001 served as Chairman of the Board of the Company.
Mr. Cindrich is currently a consultant to the Company. Mr. Cindrich has
over 25 years of experience in the medical device industry. He founded
Encore after leaving Intermedics Orthopedics, Inc. ("Intermedics")
where he had served as President from 1984 to 1991. From 1980 to 1984,
Mr. Cindrich was the Group Vice President-Operations for DePuy, Inc. In
that position, he headed worldwide operations for one of the oldest
full-line orthopedic companies. From 1969 to 1980, Mr. Cindrich held a
series of positions at Zimmer, Inc., the last of which was Vice
President of Manufacturing. Mr. Cindrich is 70 years old.
Joel S. Kanter
Mr. Kanter was a director of HCAC prior to the Merger, and has served
as a Director of the Company since the Merger. Since June 1986, Mr.
Kanter has served as President of Windy City, Inc., a publicly held
investment company specializing in early stage venture capital. From
1993 through 1999, Mr. Kanter was also President and a Director of
Walnut Financial Services, Inc., a venture capital and financial
service firm listed on the Nasdaq National Market. Mr. Kanter currently
serves as a director of several publicly traded companies including
I-Flow Corporation, Magna-Labs, Inc., Mariner Post Acute Network, Inc.,
and Logic Devices, Inc. Mr. Kanter earned a B.A. degree from Tulane
University. Mr. Kanter is 45 years old.
How are directors compensated?
Cash Compensation. Each Director is reimbursed his travel expenses for
attending Board meetings. No other cash compensation is paid to the Directors.
Options. Each nonemployee director receives, pursuant to the terms of
the 2000 Non-Employee Director Option Plan, a grant, on the date of the annual
meeting for each year, of options to purchase 10,000 shares of Common Stock. For
2001, Messrs. Haft and Kanter and Drs. Abeles and Martin received grants under
this plan. Each option grant, vesting in one year and having a 5-year term,
permits the holder to purchase shares at the fair market value on the date of
grant, which was $1.40 in the case of nonemployee director options granted in
2001. Under the proposal contained in this Proxy Statement to amend the
Non-Employee Director Option Plan, if approved, each nonemployee director will
receive a grant, on the date of the annual meeting in each year, of options to
purchase 15,000 shares of Common Stock.
How often did the Board meet during 2001?
The Board met seven times during 2001. Each director attended more than
75% of the total number of meetings of the Board and Committees on which he
served.
- 7 -
What committees has the Board established?
The Board has standing Compensation, Audit and Nominating Committees.
BOARD COMMITTEE MEMBERSHIP
Compensation Audit Nominating
Name Committee Committee Committee
---- --------- --------- ---------
John H. Abeles, M.D. * *
Kenneth W. Davidson **
Jay M. Haft **
Joel S. Kanter *
Richard O. Martin, Ph.D. **
Zubeen Shroff *
Bruce F. Wesson *
* Member
** Chairperson
Compensation Committee. The Compensation Committee is charged with
reviewing the Company's general compensation strategy; establishing salaries and
reviewing benefit programs (including pensions) for the Chief Executive Officer;
reviewing, approval, recommending and administering the Company's incentive
compensation and stock option plans for employees and certain other compensation
plans; and approving certain employment contracts. In 2001, the Compensation
Committee met four times.
Audit Committee. The Audit Committee met five times during 2001. Its
functions are to recommend the appointment of independent accountants; review
the arrangements for and scope of the audit by independent accountants; review
the independence of the independent accountants; consider the adequacy of the
system of internal accounting controls and review any proposed corrective
actions; review and monitor the Company's policies relating to ethics and
conflicts of interests; and discuss with management and the independent
accountants the Company's draft annual financial statements and key accounting
and/or reporting matters. One of the members of the Audit Committee, Bruce F.
Wesson, by virtue of being a partner of Galen Partners, which indirectly is the
controlling entity of the Galen Entities, is deemed for purposes of NASDAQ
Marketplace Rules not to be an independent director. However, the Board of
Directors, after evaluating the circumstances and relevant facts has determined
that, due to Mr. Wesson's broad experience and expertise, it is in the best
interest of the Company and its shareholders that he serve as a member of the
Audit Committee.
Nominating Committee. The Nominating Committee is responsible for
soliciting recommendations for candidates for the Board; developing and
reviewing background information for candidates; and making recommendations to
the Board regarding such candidates. The Nominating Committee met once during
2001.
Executive Officers
Kenneth W. Davidson - Chairman, Chief Executive Officer and President
Mr. Davidson became Chief Executive Officer and President of the Company in
October 2000. He became Chairman of the Board of Directors of the Company on
February 1, 2001. Mr. Davidson was a director of Encore from November 1996 until
March 1997 and became a director of the Company in March 1997. Mr. Davidson
served as Chairman, President and CEO of Maxxim Medical, Inc. from November 1986
to July 2000. Previously, Mr. Davidson held various positions with Intermedics,
Inc., Baxter Laboratories, and Merck & Co. Mr. Davidson presently serves on the
Board of Directors and is the past President of Operation Rainbow, an
international charity organization. Mr. Davidson serves on the Board of
Directors of Bovie Medical Corp., a public company involved in electrosurgery,
Maxxim Medical Corporation, and Circon Corporation. Mr. Davidson received a
Bachelor of Science degree in Biology and Chemistry from Laurentian University,
Sudbury Ontario, Canada. Mr. Davidson is 54 years old.
Jack Cahill, Executive Vice President - President, Surgical Division
Mr. Cahill joined the Company as Executive Vice President - Sales and Marketing
in January 2001. He was promoted to President, Surgical Division in March 2002.
He has almost 20 years of prior experience with Johnson & Johnson in a variety
of sales and marketing positions, including Director of Marketing for Johnson &
Johnson Medical, Inc., Director of Sales for the Medical Specialties Division of
Johnson & Johnson Medical, Inc., and Director of Sales and Marketing for the
Sterile Design Division of Johnson & Johnson Medical, Inc. In addition, Mr.
Cahill had over 7 years of experience with
- 8 -
Maxxim Medical, Inc. as its Executive Vice President of Sales and Marketing
where he oversaw a sales and marketing effort that grew Maxxim from $200 million
in annual sales to almost $700 million in annual sales. Mr. Cahill has a B.A.
from Westminster College (1971). Mr. Cahill is 52 years old.
Paul Chapman, Executive Vice President - President, Chattanooga Group
Mr. Chapman joined the Company in February 2002 upon the Company's acquisition
of Chattanooga Group, Inc. He joined Chattanooga Group in February, 1994, as
President and Chief Operating Officer. In January, 1995, he was elected Chief
Executive Officer. Prior to joining Chattanooga Group, Mr. Chapman was employed
by Stryker Corporation in Kalamazoo, Michigan. During his six years at Stryker
he held a variety of following positions, including Vice President and General
Manager, Patient Care Division, Vice President of Marketing and New Business
Development, Vice President of Sales, Medical Division and Vice President of
Operations, Medical Division. Mr. Chapman graduated from Pepperdine University,
in Malibu, California. Mr. Chapman is 43 years old.
August Faske, Executive Vice President & Chief Financial Officer
Mr. Faske joined Encore in April 1992 with four years prior experience in the
orthopedics industry and now has a total of 27 years experience in finance and
accounting. Prior to joining Encore, he served from 1988 to April 1992 as Vice
President-Finance and Controller for Intermedics. Prior to joining Intermedics,
Mr. Faske was the Manager of Financial Accounting for Cooper Industries, Inc.
and Internal Staff Auditor and Factory Accounting Manager for Hughes Tool
Company. Mr. Faske has a B.B.A. in Accounting from Southwest Texas State
University (1974). He is a Certified Public Accountant and is a member of the
Texas Society of Certified Public Accountants and the American Institute of
Certified Public Accountants. Mr. Faske is 49 years old.
Kathy Wiederkehr, Executive Vice President - Human Resources
Mrs. Wiederkehr joined Encore in 1995 as Director of Human Resources and was
promoted to Vice President-Human Resources in December 1998. Mrs. Wiederkehr has
over 20 years experience in human resources. Prior to Encore, she was Director,
Human Resources, Code Alarm, Inc.-Tessco Division in Georgetown, Texas from
September 1994 to December 1995 and Manager of Human Resources for Kewaunee
Scientific from May 1991 to September 1994. She has also worked for Fortune 500
companies including Emerson Electric, Inc. and Cooper Industries, Inc. Mrs.
Wiederkehr has a B.B.A. (with honors) in Marketing from the University of Texas
at Austin (1976) and an M.B.A. (with honors) from the University of Texas at
Austin (1990). Mrs. Wiederkehr is 47 years old.
Harry L. Zimmerman, Executive Vice President & General Counsel
Mr. Zimmerman joined Encore in April 1994 with 12 years of experience in the
private practice of corporate, real estate and tax law. From 1992 to April 1994,
Mr. Zimmerman was associated with the law firm of Winstead Sechrest & Minick,
P.C., a law firm based in Texas, where he was responsible for the corporate, tax
and real estate practices. Mr. Zimmerman was a partner in the law firm of Bissex
& Hedricks, P.C. from 1991 to 1992. He has a B.S. (with honors) in Economics
from the Wharton School of the University of Pennsylvania (1977) and a J.D.
(with honors) from the University of Texas School of Law (1982). He is also
licensed as a Certified Public Accountant. Mr. Zimmerman is 46 years old.
Executive Compensation
The following Report of the Compensation Committee and the performance
graphs included elsewhere in this proxy statement do not constitute soliciting
material and should not be deemed filed or incorporated by reference into any
other Company filing under the Securities Act of 1933 or the Securities Exchange
Act of 1934, except to the extent the Company specifically incorporates this
Report or the performance graphs by reference therein.
Report of the Compensation Committee on Executive Compensation
The Compensation Committee of the Board has furnished the following
report on executive compensation for 2001.
What is the Company's philosophy of executive compensation?
The Company's compensation program for executives consists of three key
elements:
o A base salary
o A performance-based annual bonus, and
o Periodic grants of stock options
- 9 -
The Committee believes that this three-part approach best serves the
interests of the Company and its stockholders. It enables the Company to meet
the requirements of the highly competitive environment in which the Company
operates while ensuring that executive officers are compensated in a way that
advances both the short-and long-term interests of stockholders. Under this
approach, compensation for these officers involves a high proportion of pay that
is "at risk" - namely, the annual bonus and stock options. The variable annual
bonus permits individual performance to be recognized on an annual basis, and is
based, in significant part, on an evaluation of the contribution made by the
officer to Company performance. Stock options relate a significant portion of
long-term remuneration directly to stock price appreciation realized by all of
the Company's stockholders.
Base Salary. Base salaries for the Company's executive officers, as
well as changes in such salaries, are set by the Compensation Committee, taking
into account such factors as competitive industry salaries; a subjective
assessment of the nature of the position; the contribution and experience of the
officer, and the length of the officer's service. The Chief Executive Officer
reviews any salary recommendations with the Compensation Committee. The base
salary for the Chief Executive Officer is set by the Compensation Committee.
Annual Bonus. Annual bonuses for 2001 paid to executive officers of the
Company were governed by the Company's Annual Bonus Performance Plan (the "Bonus
Plan"). The Bonus Plan provides for performance-based bonuses for all executive
employees of the Company.
Under the Bonus Plan, executive employees are entitled to a
non-discretionary bonus if certain preset revenue and earnings before taxes,
interest, depreciation, and amortization amounts are achieved. The base bonus is
set as a percentage of an executive's salary and varies based on the employee's
position in the Company. If the targets are exceeded, then the amount of the
bonus is increased. If these targets are not met, then the bonus amounts, if
any, are at the discretion of the Compensation Committee.
Stock Options. Stock option grants may be made to executive officers
upon initial employment, upon promotion to a new, higher level position that
entails increased responsibility and accountability, in connection with the
execution of a new employment agreement, and/or whenever the Compensation
Committee or Board determines option grants are warranted. Using these
guidelines, the Chief Executive Officer recommends the number of options to be
granted, within a range associated with the individual's salary level, and
presents this to the Compensation Committee for review and approval. The Chief
Executive Officer may make recommendations that deviate from the guidelines
where he deems it appropriate. While options typically vest over a four-year
period, options granted to certain executive officers may have shorter vesting
periods, or may vest immediately.
How is the Company's Chief Executive Officer compensated?
As Chief Executive Officer, Mr. Davidson was compensated during 2001
initially pursuant to an employment agreement entered into in October 2000,
which was replaced by an employment agreement entered into on June 12, 2001. The
agreement, which has a term until December 31, 2003, subject to earlier
termination under certain circumstances, provides for an annual base salary of
$275,000. Mr. Davidson earned a bonus of $100,000 for 2001.
How is the Company addressing Internal Revenue Code limits on deductibility of
compensation?
Section 162(m) of the Internal Revenue Code generally disallows a tax
deduction to public corporations for compensation over $1,000,000 paid for any
fiscal year to the corporation's Chief Executive Officer and four other most
highly compensated executive officers as of the end of any fiscal year. However,
the statute exempts qualifying performance-based compensation from the deduction
limit if certain requirements are met. No executive of the Company receives
compensation at a level that would invoke the provision of Section 162(m).
The Board and the Compensation Committee reserve the authority to award
non-deductible compensation in other circumstances as they deem appropriate.
Further, because of ambiguities and uncertainties as to the application and
interpretation of Section 162(m) and the regulations issued thereunder, no
assurance can be given, notwithstanding the Company's efforts, that compensation
intended by the Company to satisfy the requirements for deductibility under
Section 162(m) does in fact do so.
Members of the Compensation Committee:
Richard O. Martin, Ph.D. (chair)
Joel S. Kanter
Zubeen Shroff
- 10 -
Compensation Committee Interlocks and Insider Participation
None of the members of the Board's Compensation Committee is or has
been an officer or employee of the Company.
Executive Compensation Summary Table
The following table sets forth information concerning total
compensation earned or paid to the Chief Executive Officer and the four other
most highly compensated executive officers of the Company who served in such
capacities as of December 31, 2001 (the "named executive officers") for services
rendered to the Company during each of the last three years.
EXECUTIVE COMPENSATION SUMMARY TABLE*
Long Term Compensation
Annual Compensation Awards
Other annual Securities underlying
Name and principal position Year Salary ($) Bonus ($) compensation options
--------------------------- ---- ---------- --------- ------------ -------
Kenneth W. Davidson 2001 $241,538 $216,525 $249,154(1) 0
Chief Executive Officer 2000 $50,000 $0 * 300,000
Craig L. Smith 2001 $181,852 $166,716 * 0
Executive Vice President 2000 $173,600 $0 * 0
1999 $173,600 $0 * 0
Jack Cahill 2001 $158,823 $72,993 * 30,000
Executive Vice President;
President, Surgical Division
Harry L. Zimmerman 2001 $153,582 $252,927 * 0
Executive Vice President & 2000 $133,200 $0 * 0
General Counsel 1999 $133,200 $0 * 0
August Faske 2001 $153,582 $202,440 * 0
Executive Vice President & 2000 $133,200 $0 * 0
Chief Financial Officer 1999 $133,200 $0 * 0
* Amounts totaling less than $50,000 have been omitted and there
were no awards of restricted stock under long-term incentive plans
made during the three-year period ending December 31, 2001.
(1) Relocation and related tax reimbursement accounts for
$235,719 of this amount.
Option Grants for Fiscal 2001
The following table sets forth information with respect to option
grants to the named executive officers during 2001 and the potential realizable
value of such option grants:
o The number of shares of Common Stock underlying options granted
during the year;
o The percentage that such options represent of all options granted
to employees during the year;
o The exercise price;
o The expiration date; and
o The hypothetical present value, as of the grant date, of the
options under the option pricing model discussed below.
The hypothetical value of the options as of their date of grant has
been calculated below, using the Black-Scholes option pricing model, as
permitted by the rules of the Securities and Exchange Commission, based upon a
set of assumptions set forth in the footnote to the table. It should be noted
that this model is only one method of valuing options, and the Company's use of
the model should not be interpreted as an endorsement of its accuracy. The
actual value of the options may be significantly different, and the value
actually realized, if any, will depend upon the excess of the market value of
the Common Stock over the option exercise price at the time of exercise.
- 11 -
OPTION GRANTS DURING 2001
% of Total Options
Number of Granted to Hypothetical
Options Employees in Exercise Price Expiration Value at Grant
Name Granted Fiscal Year ($/Share) Date (1) Date (2)
---- ------- ----------- --------- -------- --------
Kenneth W. Davidson 0 0% - - -
Craig L. Smith 0 0% - - -
Jack Cahill 30,000 78.7% $1.75 1/22/2011 $19,281
Harry L. Zimmerman 0 0% - - -
August Faske 0 0% - - -
(1) The Compensation Committee, which administers the Company's employee
stock option and incentive plans, has general authority to accelerate,
extend or otherwise modify benefits under option grants in certain
circumstances within overall plan limits, and, with the consent of the
affected optionee, to change the exercise price to a price not less
than 100% of the market value of the stock on the effective date of the
amendment. The Committee has no current intention to exercise that
authority with respect to these options.
(2) The estimated present value at grant date of options granted during
2001 has been calculated using the Black-Scholes option pricing model,
based upon the following assumptions: estimated time until exercise of
1 year; a risk-free interest rate of 6.09%, representing the interest
rate on a U.S. Government zero-coupon bond on the date of grant with a
maturity corresponding to the estimated time until exercise; a
volatility rate of 79.0%; and a dividend yield of 0%. The approach used
in developing the assumptions upon which the Black-Scholes valuation
was done is consistent with the requirements of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based
Compensation."
Option Exercises and Values for 2001
The table below sets forth the following information with respect to
option exercises during 2001 by each of the named executive officers and the
status of their options at December 31, 2001:
o The number of shares of Common Stock acquired upon exercise of
options during 2001;
o The aggregate dollar value realized upon the exercise of such
options;
o The total number of exercisable and non-exercisable stock options
held at December 31, 2001; and
o The aggregate dollar value of in-the-money exercisable options at
December 31, 2001.
AGGREGATED OPTION EXERCISES DURING 2001
AND
OPTION VALUES ON DECEMBER 31, 2001
Number of securities under- Value of unexercised
Shares Value lying unexercised options at acquired in-the-money options
Acquired On Realized December 31, 2001 December 31, 2001(1)
Exercise of Upon ---------------------------- -------------------------------
Name Option Exercise Exercisable Unexercisable Exercisable Unexercisable
---- ------ -------- ----------- ------------- ----------- -------------
Kenneth W. Davidson -0- -0- -0- -0- $-0- $-0-
Craig L. Smith 139,750 $64,285 -0- -0- $-0- $-0-
Jack Cahill -0- -0- -0- -0- $-0- $-0-
Harry L. Zimmerman -0- -0- -0- -0- $-0- $-0-
August Faske 114,450 $52,647 -0- -0- $-0- $-0-
(1) Values are calculated by subtracting the exercise price from the fair
market value of the underlying Common Stock. For purposes of this
table, fair market value is deemed to be $3.40, the closing Common
Stock price reported on the Nasdaq National Market on December 31,
2001.
Contractual Arrangements with Named Executive Officers
Messrs. Davidson, Smith, Cahill, Faske and Zimmerman, effective June
12, 2001, entered into agreements that provide for the base salaries noted
below, participation in all of the benefit programs available to the other
executive employees of the Company, and one year of severance pay in the event
of termination without cause by the Company. Each of these executive officers is
subject to a one year non-compete restriction. The base annual salaries for
Messrs. Davidson, Smith, Cahill, Faske and Zimmerman are $275,000, $188,500,
$150,000, $170,000 and $170,000, respectively.
Each of the named executive officers purchased from the Company shares
of Common Stock (noted below) at a price of $1.02 per share. These shares are
restricted, with the restrictions lapsing ratably over a 36-month period. If the
- 12 -
employee leaves the Company prior to the end of the 36-month period, he would be
required to sell back to the Company those shares that are still restricted at
the same $1.02 per share purchase price. The Company has made a full recourse,
8% interest bearing secured loan to each of the named executive officers to
allow them to purchase the shares. The number of shares that Messrs. Davidson,
Smith, Cahill, Faske and Zimmerman purchased is 550,000, 100,000, 100,000,
150,000 and 150,000 shares, respectively.
Performance Graph
The foregoing chart shows a comparison of the cumulative total
stockholder return among the Company, the NASDAQ CRSP Index and a peer group
comprised of other small and micro-cap orthopedic companies (Biomet Inc., Bionx
Implants, Inc., Exactech Inc., Interpore International, Inc., Orthologic Corp.,
Osteotech Inc., Stryker Corp., Sulzer Medica, dj Orthopedics, Inc., Wright
Medical Group, Inc., and Zimmer Holdings, Inc.):(1)
Comparison of 5 Year Cumulative Total Return
Assumes Initial Investment of $100
December 2001
[GRAPH APPEARS HERE]
1996 1997 1998 1999 2000 2001
---- ---- ---- ---- ---- ----
ENCORE $100.00 $ 76.82 $ 54.86 $ 44.51 $ 29.87 $ 66.23
NASDAQ $100.00 $122.48 $172.72 $320.98 $193.13 $152.62
PEER GROUP $100.00 $123.65 $163.31 $177.62 $255.38 $266.39
(1) The total return on investment (change in year end stock price plus
reinvested dividends) assumes $100 invested on March 8, 1996 (the date
of the IPO for the Company) in the Company, in the NASDAQ CRSP Index,
and in each of the peer group companies.
Report of the Audit Committee
of the Board Of Directors
The Company's Board has adopted a written charter for the Audit Committee, which
was included in the 2001 Proxy Statement and which can be obtained without cost
from the Company.
The Audit Committee hereby reports as follows:
1. The Audit Committee has reviewed and discussed the audited
financial statements with the Company's management.
2. The Audit Committee has discussed with KPMG LLP, the Company's
independent accountants, the matters required to be discussed by SAS 61
(Communication with Audit Committees).
3. The Audit Committee has received the written disclosures and the
letter from KPMG LLP required by Independence Standards Board Standard No. 1
(Independence Discussions with Audit Committees), and has discussed with KPMG
LLP their independence.
4. Based on the review and discussion referred to in paragraphs (1)
through (3) above, the Audit Committee recommended to the Board, and the Board
has approved, that the audited financial statements be included in the Company's
Annual Report on Form 10-K for the fiscal year ended December 31, 2001, for
filing with the Securities and Exchange Commission.
Jay M. Haft (chair)
John H. Abeles, M.D.
Bruce F. Wesson
- 13 -
ITEM 2 - APPROVAL OF THE TRANSACTIONS
Purpose and Background of the Transactions
During the past several years the Company has explored a number of
avenues to increase stockholder value. Management and the Board have explored
various options with regard to acquisitions that would benefit the Company, both
in terms of stockholder value and positioning in the marketplace.
It was during this process of analysis and consideration that
management and the Board decided it would be in the best interests of the
Company to acquire Chattanooga Group, Inc., a Delaware corporation
("Chattanooga"). To that end, the Company entered into a Stock Purchase
Agreement dated as of November 28, 2001 (as amended by letter agreement dated
December 26, 2001, the "Stock Purchase Agreement"), by and between the Company,
as purchaser, and Richard T. Niner and Robert W. Cruickshank, as trustees of and
on behalf of the Robert McNeil, Jr. 1983 Trust (the "McNeil Trust"), Chatt
Investment L.P., a Delaware limited partnership, Paul D. Chapman, Scott A.
Klosterman, David C. Linville, Charles M. Thomas and certain other stockholders
of Chattanooga (collectively, the "Sellers"). Pursuant to the terms of the Stock
Purchase Agreement, on February 8, 2002, the Company acquired 56,269 shares of
Class A Common Stock and 2,296,307 shares of Class B Common Stock of
Chattanooga, such shares constituting all of the issued and outstanding shares
of capital stock of Chattanooga (the "Acquisition"). Historical financial
statements of Chattanooga for the years ended June 30, 2001 and 2000, unaudited
condensed interim financial statements as of December 31, 2001 and 2000, as well
as pro forma financial statements for the year ended December 31, 2001, which
assume that the Acquisition had occurred on January 1, 2001, are included as
Appendix A to this proxy statement.
The Company paid on the date of closing a cash purchase price of
$31,500,000 for the Acquisition. There is an additional payment that will be due
no later than 90 days after the closing date, based on the change in stockholder
value between October 1, 2001 and the closing date. In addition, the Company
paid off the outstanding balances on the following debts of Chattanooga at the
closing of the Acquisition: (a) a term loan of $211,653 payable to Wachovia
National Bank, (b) a term loan of $2,798,430 payable to Wachovia National Bank,
(c) a term loan of $655,889 payable to the McNeil Trust, and (d) five promissory
notes in the aggregate principal amount of $1,109,984 payable to Robert L.
McNeil, Jr. (d/b/a the Evergreen Company).
In order to finance the Acquisition, the Company and its subsidiaries
entered into a Credit Agreement (the "Credit Agreement") dated as of February 8,
2002 with Bank of America, National Association, as agent, and the lenders
signatory thereto, and promissory notes in the aggregate amount of $30,000,000,
pursuant to the Credit Agreement. The Company and its subsidiaries executed
various security documents in order to secure the financing under the Credit
Agreement, including security agreements, a mortgage, guaranty agreements, a
copyright security agreement, patent security agreements, trademark security
agreements and various Uniform Commercial Code financing statements. As of
February 8, 2002, the Company had borrowed approximately $18,000,000 under the
Credit Agreement, with the availability of approximately an additional
$2,700,000 to borrow for working capital and general corporate purposes.
Further, in order to finance the Acquisition, the Company and its
subsidiaries entered into a Note and Equity Purchase Agreement (the "Note
Agreement") dated as of February 8, 2002 with CSF, as agent and purchaser ("the
Notes"), pursuant to which the Company sold $24,000,000 in senior subordinated
notes to CSF. The Company and its subsidiaries executed various security
documents in order to secure the financing under the Note Agreement, including
security agreements, a mortgage, guaranty agreements, a copyright security
agreement, patent security agreements, trademark security agreements and various
Uniform Commercial Code financing statements. The security interests created by
the security documents executed pursuant to the Note Agreement are junior and
subordinate to the security interests created by the security documents executed
pursuant to the Credit Agreement.
Pursuant to the terms of the Note Agreement, the Company issued a
warrant to CSH, pursuant to which CSH has the right to acquire for a period of
five years up to an aggregate of 2,198,614 shares of Common Stock (the
"Warrants"), though the initial number of shares of Common Stock that may be
acquired under the Warrants is 2,150,000. Further, under the terms of the Note
Agreement, if the Company fails to generate certain amounts of earnings before
interest, taxes, depreciation and amortization, then the Company would have the
right, commencing on March 31, 2003 and ending on August 15, 2003, to prepay
without penalty up to $6,000,000 of the aggregate principal amount of the Notes.
If the Company exercises this right, then a pro-rata portion of the Warrants
(the "Conveyed Warrants") will be conveyed by CSH to the Galen Entities. In the
event the Company has the right to prepay but does not choose to exercise this
right, then the Galen Entities will purchase the amount of Notes that the
Company has the right to prepay. In the event the Galen Entities purchase any
Notes from CSF, then upon such purchase, (a) those Notes will automatically
convert into additional shares of Series A Preferred Stock and (b) a pro-rata
portion of the Warrants will also be conveyed by CSH to the Galen Entities.
- 14 -
The Galen Entities and CSF have entered into an agreement (the
"CSF/Galen Agreement") to evidence certain of the foregoing obligations. As an
inducement for the Galen Entities to enter into the CSF/Galen Agreement, the
Company granted the Galen Entities options dated as of February 8, 2002 (the
"Galen Options") to acquire up to the number of shares of Common Stock which
have a value equal to $6,000,000, at an exercise price equal to the greater of
$3.50 per share or one-half of the trailing ten-day average closing price of the
Common Stock on the date of exercise. If the Galen Entities choose to exercise
the Galen Options, then any Conveyed Warrants will automatically be terminated.
Conversely, if the Galen Entities choose to exercise any Conveyed Warrants, then
the Galen Options will automatically be terminated. The Galen Options will
otherwise automatically terminate on the earlier of (i) the 30th day following
the date the Galen Entities are no longer obligated to purchase any Notes under
the CSF/Galen Agreement, (ii) the date the Galen Entities acquire any senior
subordinated notes or (iii) August 15, 2003. The increase in the amount of
shares that may be issued pursuant to the Warrants, the conversion of Notes into
Series A Preferred Stock and the issuance of the Galen Options are the
Transactions that the Board recommends that the holders of capital stock of the
Company approve and are discussed further below.
Management and the Board determined that the Acquisition is in the best
interests of the Company, in terms of stockholder value and positioning in the
marketplace. The Transactions are an integral part of the Acquisition, and
therefore are listed as one single item for voting by the stockholders. The
terms of the Transactions and the reasons why the stockholders are being asked
to vote on the Transactions are described below.
Terms of the Transactions
Pursuant to the terms of the Note Agreement, the Company issued a
Warrant to CSH, pursuant to which CSH has the right to acquire for a period of
five years up to an aggregate of 2,198,614 shares of Common Stock, which as of
February 8, 2002, constituted 20.3% of the issued and outstanding shares of
Common Stock. The number of shares of Common Stock that may be acquired under
the Warrant, however, is initially limited to 2,150,000. The Company must obtain
the approval of its stockholders to increase the amount of shares that can be
issued pursuant to the Warrants to 2,198,614, in order to comply with NASDAQ
Marketplace Rule 4350(i)(1)(D) because 2,198,614 shares of Common Stock
constituted more than 20% of the outstanding shares of Common Stock as of
February 8, 2002 (the date of the issuance of the Warrant).
Under the terms of the Note Agreement, if the Company fails to generate
certain amounts of earnings before interest, taxes, depreciation and
amortization, then the Company will have the right, commencing on March 31, 2003
and ending on August 15, 2003, to prepay without penalty up to $6,000,000 of the
aggregate principal amount of the Notes. If the Company exercises this right,
then the Conveyed Warrants would be conveyed by CSH to the Galen Entities. In
the event the Company has the right but chooses not to exercise this right, then
the Galen Entities will purchase the amount of Notes from CSF that the Company
has the right to prepay. The Galen Entities beneficially own approximately 54.3%
of the outstanding shares of Common Stock as of April 1, 2002. In the event the
Galen Entities purchase any Notes from CSF, then upon such purchase, (a) those
notes will automatically convert into additional shares of Series A Preferred
Stock at a conversion price equal to the lower of (i) $150 per share or (ii) 50
times the greater of (x) $1 or (y) the trailing ten-day average closing price of
the Common Stock on the date of conversion, and (b) a pro-rata portion of the
Warrants will also be conveyed by CSH to the Galen Entities. Assuming the Galen
Entities purchase all $6,000,000 aggregate principal amount of the Notes from
CSF, up to 120,000 shares of Series A Preferred Stock would be issuable to the
Galen Entities. Those shares of Series A Preferred Stock would be convertible
into 12,000,000 shares of Common Stock, which, together with the shares of
Common Stock the Galen Entities may acquire pursuant to the Galen Options,
constituted more than 20% of the outstanding shares of Common Stock as of
February 8, 2002.
Reasons for Seeking Stockholder Approval
Approval of the Transactions by the holders of capital stock of the
Company is being sought because: (a) of the requirements of the NASDAQ
Marketplace Rules, (b) the Company would be obligated to pay CSH a fee equal to
the greater of (i) $324,255.38 and (ii) the product of 48,614 multiplied by the
per share fair market value of the Common Stock as of July 1, 2002 if the
stockholders do not approve the Transactions, and (c) the Company covenanted to
the Galen Entities that it would seek approval of the Transactions in Amendment
No. 1 to Investors' Rights Agreement dated February 8, 2002, which covenant
would be breached if that approval is not obtained.
The Transactions are interlinked and inseparable, given the terms of
the Acquisition, and therefore they are listed as one Item in this Proxy
Statement. The Common Stock will continue to be listed on Nasdaq following the
Transaction. The Company is unable to predict the potential effects of the
Transactions on stock appreciation, trading activity and the market price of the
Common Stock.
- 15 -
Recommendation of the Board of Directors
THE BOARD OF DIRECTORS OF THE COMPANY HAS UNANIMOUSLY APPROVED THE
TRANSACTIONS, HAS DETERMINED THAT THE TRANSACTIONS ARE IN THE BEST INTERESTS OF
THE STOCKHOLDERS AND RECOMMENDS THAT THE STOCKHOLDERS VOTE "FOR" THE APPROVAL OF
THE TRANSACTIONS AND THE PURCHASE AGREEMENT.
Prior to negotiating and entering into the Acquisition, the Board of
Directors considered various options with regard to acquisitions that would
benefit the Company, both in terms of stockholder value and positioning in the
marketplace. In approving the Acquisition, and the corresponding Transactions,
the Board concluded that entering into the Acquisition would strengthen the
Company because acquisition of Chattanooga would broaden the Company's reach in
the marketplace, and the benefits to the stockholders of the Company of the
Acquisition would be felt over the long term. While the Board did explore other
acquisition opportunities, it felt that at this time the Acquisition was the
best available business opportunity, and therefore the Company needed to do what
was necessary to cause such an acquisition to take place, including the issuance
of warrants and execution of the Transactions.
Effects of the Transactions on Stockholders
Pursuant to the terms of the Transactions, the Galen Entities may
acquire up to 120,000 shares of Series A Preferred Stock, which in turn can be
converted into 12,000,000 shares of Common Stock, if the Galen Entities purchase
$6,000,0000 aggregate principal amount of the Notes. The Galen Entities may
alternatively acquire up to 1,714,286 shares of Common Stock pursuant to the
Galen Options. In the event the additional shares of Series A Preferred Stock
are exercised or the Galen Options are exercised, the Galen Entities would
beneficially own between 13,948,799 and 24,234,513 shares of the Common Stock.
The following table illustrates the pro forma effect of the issuance of
the maximum number of shares of Series A Preferred Stock that could be issued to
the Galen Entities and the assumed conversion of those shares to Common Stock on
the financial position and results of operations of the Company for the year
ended December 31, 2001, as if the shares were issued and outstanding at January
1, 2001, as compared to actual results for the same period.
Actual Results Pro Forma
-------------- ---------
Net Earnings (Loss) (in thousands) ($3,158) ($3,158)
Basic Earnings (Loss) Per Common Share (0.34) (0.15)
Basic Weighted Average Shares Outstanding (in thousands) 9,355 21,355
Stockholders' Equity (in thousands) $32,177 $38,177
Description of Preferred Stock
The Board is authorized, without action by the holders of the Common
Stock, to provide for the issuance of preferred stock in one or more series, to
establish the number of shares to be included in each series and to fix the
designations, powers, preferences and rights of the shares of each series and
the qualifications, limitations, or restrictions of each series. This includes,
among other things, voting rights, conversion privileges, dividend rates,
redemption rights, sinking fund provisions and liquidation rights which will be
superior to our Common Stock.
Currently, the Board has authorized the issuance of one series of
preferred stock, the Series A Preferred Stock, which consists of 225,000
authorized shares of which 132,353 shares are outstanding. The relative rights
and preferences of the Series A Preferred Stock are as follows:
o Each share of the Series A Preferred Stock is entitled to one vote
for each share of Common Stock into which such share of the Series A
Preferred Stock is then convertible. Except as provided by law or as
described below, holders of the Series A Preferred Stock are not
entitled to vote as a class on any matter.
o As long as 25% of the authorized shares of the Series A Preferred
Stock are outstanding, the holders of the Series A Preferred Stock
are entitled to elect members of the Board. If the Board consists of
10 or fewer members, the holders of the Series A Preferred Stock are
entitled to elect two members of the Board. If the Board consists of
more than 10 members, the holders of the Series A Preferred Stock
are entitled to elect 20% of the number of members of the Board. Any
vacancy of a directorship elected by the holders of the Series A
Preferred Stock will be filled by the majority vote of the remaining
directors elected by the holders of the Series A Preferred Stock.
The holders of the Series A Preferred Stock are not entitled to vote
on the election of directors other than the designated Series A
Preferred Directors.
- 16 -
o The Company may not, without the approval of the holders of at least
51% of the then outstanding shares of the Series A Preferred Stock,
take the following actions: cause any amendment of the Certificate
of Incorporation or Bylaws if such amendment would alter the rights
or privileges of the Series A Preferred Stock; increase the number
of authorized shares of the Series A Preferred Stock; create any new
class of its capital stock, or reclassify any class of its capital
stock, having rights and privileges on a parity with, or more
beneficial than, the Series A Preferred Stock; except in certain
circumstances, effect any merger, consolidation or other business
combination where the Company is the acquiror prior to the second
anniversary of the date the Series A Preferred Stock was first
issued; unless the holders of the Series A Preferred Stock are to
receive at least $306.00 per share as a result of such transaction,
effect any sale of the Company or other conveyance of all or
substantially all of our assets; or, except upon satisfaction of
certain criteria, incur any indebtedness.
o Shares of the Series A Preferred Stock bear non-cumulative dividends
at a rate of 8% per annum, which will be payable semi-annually, if
and only if, declared by the Company.
o The Company may not declare a dividend on the Common Stock unless a
dividend is also concurrently declared and paid on the Series A
Preferred Stock. No dividend paid on the Common Stock shall exceed
the dividend rate on the Series A Preferred Stock.
o At the option of the holders thereof, shares of the Series A
Preferred Stock may be converted into the number of shares of the
Common Stock equal to $102.00 divided by the Conversion Price.
o The initial "Conversion Price" is $1.02. In certain circumstances,
the Conversion Rate is subject to downward adjustment if the Company
issues additional shares of Common Stock for an amount less than the
then current Conversion Price. Additionally, the Conversion Price is
subject to appropriate adjustment upon approval of a stock dividend,
combination or subdivision of the Common Stock, or the
reclassification or reorganization of the Common Stock.
o If at any time less than 25% of the authorized shares of the Series
A Preferred Stock are outstanding, the Company's has the right to
convert all of the outstanding shares of the Series A Preferred
Stock into shares of Common Stock at the then current Conversion
Price.
o If, after November 15, 2003, the average closing price per share for
the Common Stock, as reported by NASDAQ, exceeds three times the
then current Conversion Price for at least 20 consecutive trading
days, the Series A Preferred Stock will automatically convert into
shares of Common Stock at the then current Conversion Rate.
o Upon the Company's dissolution, liquidation or winding up, whether
voluntary or involuntary, the holder of each outstanding share of
the Series A Preferred Stock is entitled to receive, out of the
Company's assets, $102 plus an amount equal to an 8% annual
compounded return on such amount from the date of the initial
purchase less any dividends previously paid; provided, however, the
holders are not be entitled to such amount if, in connection with
such dissolution, liquidation or winding up, the holders receive at
least $306 per outstanding share of the Series A Preferred Stock.
o After the payment to the holders of shares of the Series A Preferred
Stock of the full preferential amounts for those shares described in
the prior paragraph, the holders thereof have the further right to
share, ratably, in the distribution of the Company's remaining
assets based on the number of shares of the Common Stock which they
have the right to acquire based on the then current Conversion Rate.
o In the event the Company's assets available for distribution to the
holders of the Series A Preferred Stock upon the Company's
dissolution, liquidation or winding up are insufficient to fully pay
all amounts to which the holders of the Series A Preferred Stock are
entitled, no distribution may be made on account of any shares of a
class or series of capital stock ranking on a parity with the shares
of the Series A Preferred Stock, if any, unless proportionate
distributive amounts are paid on account of the shares of the Series
A Preferred Stock, ratably, in proportion to the full distributive
amounts for which holders of all parity shares are respectively
entitled upon a dissolution, liquidation or winding up.
o The Company's consolidation with, or merger into, another entity or
the sale, transfer or other disposition of all or substantially all
of our assets will be deemed a dissolution, liquidation or winding
up; provided, however, if the Company's stockholders prior to any
such transaction own, after consummation of such transaction, more
- 17 -
than 50% of the voting power of the surviving or purchasing entity,
such transaction will not be deemed a dissolution, liquidation or
winding up.
o Any right or preference of the Series A Preferred Stock may be
waived in writing by the holders of at least 51% of the outstanding
shares of the Series A Preferred Stock.
ITEM 3 - APPROVAL OF INCREASE IN AUTHORIZED SHARES
Amendment to the Certificate of Incorporation to Increase
Amount of Authorized Shares of the Company
On March 19, 2002, the Board adopted a resolution approving a proposal
to amend Article FOURTH of the Certificate of Incorporation in order to increase
the total number of shares of Common Stock that the Company is authorized to
issue by 15,000,000 shares from 35,000,000 shares to 50,000,000 shares. The
Board determined that such amendment is advisable and directed that the proposed
amendment be considered at the annual meeting. The affirmative vote of the
holders of at least a majority of the outstanding shares of Common Stock and the
affirmative vote of the holders of at least a majority of the outstanding shares
of Series A Preferred Stock, each voting as a separate class, is required to
approve the proposed amendment. There are no rights of appraisal or dissenter's
rights that arise as a result of a vote on this issue.
The full text of the proposed amendment to the Certificate of
Incorporation is set forth in Appendix B to this proxy statement. The proposed
amendment would not affect the number of authorized shares of Preferred Stock,
par value $.001 per share of the Company (the "Preferred Stock").
Purposes and Effects of Increasing the Number of Authorized
Shares of Common Stock
Under the Certificate of Incorporation, there are currently 36,000,000
authorized shares of capital stock, of which 35,000,000 shares are classified as
Common Stock and 1,000,000 shares are classified as Preferred Stock. As of April
1, 2002, there were 11,027,347 shares of Common Stock issued and outstanding,
486,250 shares of Common Stock reserved for issuance pursuant to the 1996
Incentive Stock Plan, 300,000 shares of Common Stock reserved for issuance
pursuant to the 2000 Non-Employee Directors Option Plan, 13,235,300 shares of
Common Stock reserved for issuance pursuant to the conversion of outstanding
shares of Series A Preferred Stock, 2,150,000 shares of Common Stock reserved
for issuance pursuant to exercise of the Warrants, 1,714,286 shares of Common
Stock reserved for issuance pursuant to the exercise of the Galen Options, and
1,161,800 shares of Common Stock reserved for issuance pursuant to the exercise
of other outstanding options and warrants. As of April 1, 2002, there were
132,353 shares of Series A Preferred Stock issued and outstanding.
Adoption of the proposed amendment would increase the number of
authorized shares of capital stock by 15,000,000 shares, all of which would be
classified as Common Stock. Therefore, upon adoption of the proposed amendment
the number of shares of Common Stock available for future issuance would
increase by 15,000,000 shares to 50,000,000 shares. Upon adoption of the
proposed amendment, the Board would be authorized to issue additional shares of
Common Stock at such time or times, to such persons and for such consideration
as it may determine, except as may be otherwise required by law. The additional
shares of Common Stock for which authorization is sought would, if and when
issued, have the same rights and privileges as the presently outstanding shares
of Common Stock. Holders of shares of Common Stock do not have preemptive rights
to subscribe for or purchase any part of any new or additional issuance of
shares of Common Stock or securities convertible into shares of Common Stock.
The Board of Directors believes that the number of authorized shares of
Common Stock should be increased by 15,000,000 to provide sufficient shares for
use for such corporate purposes as may be determined advisable by the Board,
without further action or authorization by the stockholders. Such corporate
purposes might include the acquisition of capital funds through the sale of
stock, the acquisition of other corporations, businesses or properties, or the
declaration of stock dividends in the nature of a stock split. There are no
current plans, agreements, arrangements, or understandings with respect to the
issuance of any of the shares of Common Stock which would be authorized by the
proposed amendment; however, the Board believes that the availability of shares
would afford the Company flexibility in considering and implementing any of the
corporate transactions enumerated above to take advantage of favorable market
conditions and opportunities without the delay and expense associated with the
holding of a special meeting of its stockholders.
The issuance of additional shares of Common Stock may have a dilutive
effect on earnings per share. In addition, the issuance of additional shares may
have a dilutive effect on the voting power of the current stockholders because
such stockholders do not have preemptive rights. Finally, the proposed amendment
could, under certain circumstances, have an anti-takeover effect, because it
would enable the Board to issue shares of Common Stock to persons who are
opposed to a takeover bid. This could deter transactions that may result in a
change of control of the Company, including transactions in
- 18 -
which stockholders may receive a premium for their shares over the current
market prices. The Board, however, has presented the proposed amendment for the
purposes described above and not with the intent that it be utilized as a type
of anti-takeover device.
THE BOARD OF DIRECTORS HAS APPROVED, AND RECOMMENDS THAT THE HOLDERS OF
CAPITAL STOCK VOTE "FOR" AN AMENDMENT TO ARTICLE FOURTH OF THE COMPANY'S
CERTIFICATE OF INCORPORATION, TO INCREASE THE AMOUNT OF AUTHORIZED SHARES OF
COMMON STOCK OF THE COMPANY FROM 35,000,000 SHARES TO 50,000,000 SHARES.
ITEM 4 - APPROVAL OF AMENDMENT TO 1996 INCENTIVE STOCK PLAN
Amendment to the Company's 1996 Incentive Stock Plan
to Increase Amount of Shares Awarded Under Such Plan
The Company has seven stock option plans. All options granted under the
plans are exercisable for Common Stock, and the purpose of such plans is to
provide the Company and its subsidiaries with a means to attract and retain
individuals eligible to participate in the plans. Additionally, the plans allow
the Company to provide incentive compensation opportunities that are competitive
with other similar companies and provide incentives to participants in the plans
to help assist in the Company's short-term and long-term profitable growth. The
stock options granted under all of the plans are granted at or in excess of the
fair market value on the date of grant, vest either immediately or ratably over
a predefined period, and expire no more than 10 years after the date of the
grant.
The 1996 Incentive Stock Plan provides for the grant of a variety of
equity-related awards, including, but not limited to, incentive stock options,
non-qualified stock options, stock appreciation rights and restricted stock, to
key employees of the Company and its subsidiaries. On March 19, 2002, the Board
of Directors of the Company approved, and is recommending to the holders of
capital stock, an amendment to the 1996 Incentive Stock Plan of the Company,
pursuant to which the amount of shares that may be awarded under the 1996
Incentive Stock Plan will be increased from 2,000,000 shares of Common Stock to
3,000,000 shares of Common Stock. The specific proposed amendments to the 1996
Incentive Stock Plan are attached as Appendix C to this proxy statement. If this
increase is ratified by the holders of capital stock of the Company, the Company
will be required at all times to reserve a sufficient number of shares of Common
Stock to meet the requirements of the 1996 Incentive Stock Plan.
Currently, approximately 425 employees are eligible to participate in
the 1996 Incentive Stock Plan. The number of participants could increase based
upon future growth by the Company. It is not possible to state the persons who
will receive options or awards under the 1996 Incentive Stock Plan in the
future, nor the amount of options or awards that will be granted thereunder. The
following table provides information with respect to options granted since the
beginning of fiscal year 2001 under the 1996 Incentive Stock Plan which are
still outstanding as December 31, 2001, to (i) each of the named executive
officers, (ii) all current executive officers as a group, (iii) all current
directors who are executive officers as a group, and (iv) all employees who are
not executive officers or directors of the Company.
Name Number of Options Dollar Value(1)
- ---- ----------------- ---------------
Kenneth W. Davidson 0 0
Craig L. Smith 0 0
Jack Cahill 0 0
Harry L. Zimmerman 0 0
August Faske 0 0
All current directors who are executive officers 0 0
All current executive officers 0 0
All employees who are not executive officers or directors 8,105 $19,711
----- -------
Total 8,105 $19,711
===== =======
(1) The dollar value of each option granted is estimated on the date
of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of zero; expected volatility
85%; risk-free interest rate of 5.14%; and expected option life of
seven years.
- 19 -
The Board of Directors believes that the proposed increase in the
amount of Common Stock that may be awarded under the 1996 Incentive Stock Plan
is advisable to maximize the flexibility of the Company with regard to providing
the Company and its subsidiaries with a means to attract and retain qualified
individuals, to provide incentive compensation opportunities that are
competitive with other similar companies, and to provide incentives to
participants in the plans to help assist in the company's long-term profitable
growth.
THEREFORE, THE BOARD OF DIRECTORS RECOMMENDS THAT THE HOLDERS OF
CAPITAL STOCK VOTE "FOR" AN AMENDMENT TO THE 1996 Incentive Stock Plan TO
AUTHORIZE SUCH INCREASE.
ITEM 5- APPROVAL OF AMENDMENTS TO 2000 NON-EMPLOYEE DIRECTOR OPTION PLAN
Amendment to the Company's 2000 Non-Employee Director Option Plan to Increase
Amount of Shares Awarded Under Such Plan and Amount of Annual Automatic Award
The 2000 Non-Employee Director Option Plan provides for the grant of
non-qualified stock options to non-employee directors of the Company. On March
19, 2002, the Board of Directors of the Company approved, and is recommending to
the holders of capital stock, amendments to the 2000 Non-Employee Director
Option Plan of the Company, pursuant to which (i) the amount of shares of Common
Stock that may be awarded under the 2000 Non-Employee Director Option Plan will
be increased by 450,000 shares, from 300,000 shares to 750,000 shares, and (ii)
the number of shares of Common Stock that may be acquired pursuant to annual
options automatically granted to non-employee directors of the Company will be
increased by 5,000 shares, from 10,000 shares to 15,000 shares. The specific
proposed amendments to the 2000 Non-Employee Director Option Plan are attached
as Appendix D to this proxy statement. If this increase is ratified by the
holders of capital stock of the Company, the Company will be required at all
times to reserve a sufficient number of shares of Common Stock to meet the
requirements of the 2000 Non-Employee Director Option Plan.
Currently, approximately six directors are eligible to participate in
the 2000 Non-Employee Director Option Plan. The number of participants could
increase based upon future growth by the Company. It is not possible to state
the persons who will receive options or awards under the 2000 Non-Employee
Director Option Plan in the future. The following table provides information
with respect to options granted since the beginning of fiscal year 2001 under
the 2000 Non-Employee Director Option Plan to each of the current non-employee
directors.
Name Number of Options Dollar Value(1)
----- ----------------- ---------------
Jay M. Haft 10,000 $11,703
Zubeen Shroff - 0 - - 0 -
Bruce F. Wesson - 0 - - 0 -
John H. Ables, M.D. 10,000 $11,703
Richard O. Martin, Ph.D. 10,000 $11,703
Joel S. Kanter 10,000 $11,703
------ -------
Total 40,000 $46,812
====== =======
(1) The dollar value of each option granted is estimated on the date
of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of zero; expected volatility
85%; risk-free interest rate of 5.28%; and expected option life of ten
years.
The Board of Directors believes that the proposed increase in the
amount of Common Stock that may be awarded and the increase in the amount of
Common Stock included in each automatic award under the 2000 Non-Employee
Director Option Plan is advisable to maximize the flexibility of the Company
with regard to providing the Company and its subsidiaries with a means to
attract and retain qualified non-employee directors.
THEREFORE, THE BOARD OF DIRECTORS RECOMMENDS THAT THE HOLDERS OF
CAPITAL STOCK VOTE "FOR" AN AMENDMENT TO THE 2000 NON-EMPLOYEE DIRECTOR OPTION
PLAN TO AUTHORIZE SUCH INCREASES.
- 20 -
ITEM 6 - RATIFICATION OF APPOINTMENT OF INDEPENDENT ACCOUNTANTS
The Company has appointed KPMG LLP as the Company's independent
accountants for the fiscal year ending December 31, 2002. Services provided to
the Company and its subsidiaries by KPMG LLP in 2001 included the examination of
the Company's consolidated financial statements, limited reviews of quarterly
reports, services related to filings with the Securities and Exchange
Commission, and consultations on various tax and accounting matters.
Representatives of KPMG LLP will be present at the annual meeting to
respond to appropriate questions and to make such statements as they may desire.
THE BOARD RECOMMENDS THAT STOCKHOLDERS VOTE "FOR" RATIFICATION OF THE
APPOINTMENT OF KPMG LLP AS THE COMPANY'S INDEPENDENT ACCOUNTANTS FOR 2002.
In the event stockholders do not ratify the appointment, the
appointment will be reconsidered by the Audit Committee and the Board of
Directors.
KPMG LLP are the principal accountants of the Company. KPMG LLP
provides tax advice to the Company and its subsidiaries. The Audit Committee of
the Board has considered whether the provision of non-audit services is
compatible with maintaining KPMG LLP's independence.
The accounting firm of PricewaterhouseCoopers LLP
("PricewaterhouseCoopers") served as independent accountant for the Company from
1992 until dismissed by the Company on September 19, 2001. The decision to
change accountants was recommended by the Audit Committee of the Board.
PricewaterhouseCoopers' report on the financial statements of the Company for
each of the years ended December 31, 2000 and 1999 contain no adverse opinion or
disclaimer of opinion and was not qualified or modified as to uncertainty, audit
scope or accounting principles, or as to any other matter. Furthermore, during
the Company's two most recent fiscal years and any subsequent interim periods,
there were no disagreements with PricewaterhouseCoopers on any matter of
accounting principles or practices, financial statement disclosure or accounting
scope or procedure, which disagreement if not resolved to the satisfaction of
PricewaterhouseCoopers would have caused them to make reference thereto in their
reports on the financial statements of the Company for such years. Additionally,
no reportable event as defined in paragraph 304 of Regulations S-K promulgated
by the Securities and Exchange Commission occurred during the years ended
December 31, 2000 and 1999 or any subsequent interim period.
Audit Fees
KPMG LLP billed the Company and its subsidiaries approximately $72,000
for the following professional services: audit of the annual financial
statements of the Company for the fiscal year ended December 31, 2001, and
review of the interim financial statements included in quarterly reports on Form
10-Q for the period ended September 29, 2001. In addition, KPMG LLP billed the
Company approximately $28,000 for other audit services related to accounting and
auditing issues connected with the Company's acquisition of Chattanooga Group,
Inc.
All Other Fees
KPMG LLP billed the Company and its subsidiaries approximately $4,000
for other services for the fiscal year ended December 31, 2001, all of which
were domestic tax services related to consulting on federal, state and local tax
matters.
OTHER MATTERS
As of the date of this proxy statement, the Company knows of no
business that will be presented for consideration at the annual meeting other
than the items referred to above. In the event that any other matter is properly
brought before the meeting for action by stockholders, proxies in the enclosed
form returned to the Company will be voted in accordance with the recommendation
of the Board of Directors or, in the absence of such a recommendation, in
accordance with the judgment of the proxy holder.
Proxy Solicitation Costs. The proxies being solicited hereby are being
solicited by the Company. The cost of soliciting proxies in the enclosed form
will be borne by the Company. Officers and regular employees of the Company may,
but without compensation other than their regular compensation, solicit proxies
by further mailing or personal conversations, or by telephone, telex, facsimile
or electronic means. The Company will, upon request, reimburse brokerage firms
and others for their reasonable expenses in forwarding solicitation material to
the beneficial owners of stock.
- 21 -
Proposals of Stockholders. If you wish to submit a proposal for
possible inclusion in the Company's 2003 proxy material, the Company must
receive your notice, in accordance with the rules of the Securities and Exchange
Commission, on or before January 12, 2003.
INCORPORATION OF DOCUMENTS BY REFERENCE
The following information is incorporated by reference from the
Company's annual Report on Form 10-K for the fiscal year ended December 31,
2001, a copy of which accompanies this proxy statement:
(a) Financial Statements
(i) Independent Auditors Reports.
(ii) Consolidated Balance Sheets as of December 31, 2001
and 2000.
(iii) Consolidated Statement of Operations for the years
ended December 31, 2001, 2000 and 1999.
(iv) Consolidated Statement of Stockholders' Equity for
the years ended December 31, 2001, 2000 and 1999.
(v) Consolidated Statement of Cash Flow for the years
ended December 31, 2001, 2000 and 1999.
(vi) Notes to Consolidated Financial Statements.
(b) Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Also incorporated by reference herein is the Company's Form 8-K filed
on February 25, 2002 as amended on Form 8-K/A on April 16, 2002.
Any statement contained in a document incorporated or deemed to be
incorporated by reference herein will be deemed to be modified or superseded for
purposes of this document to the extent that a statement contained herein which
also is or is deemed to be incorporated by reference herein modifies or
supersedes such statement. Any such statement so modified or superseded will not
be deemed, except as so modified or superseded, to constitute a part of this
document.
By order of the Board of Directors,
/s/ Harry L. Zimmerman
Harry L. Zimmerman
Corporate Secretary
April 16, 2002
- 22 -
APPENDIX A
FINANCIAL STATEMENTS
(a) Pro forma financial information.
INDEX TO UNAUDITED PRO FORMA FINANCIAL INFORMATION
Unaudited Pro Forma Condensed Combined Balance Sheet 24
Unaudited Pro Forma Condensed Combined Statement of Operations 25
Notes to Condensed Combined Pro Forma Financial Statements 26
(b) Financial statements of business acquired.
INDEX TO FINANCIAL STATEMENTS OF CHATTANOOGA GROUP, INC.
Report of Independent Public Accountants 29
Consolidated Balance Sheets at June 30, 2001 and 2000 30
Consolidated Statements of Operations for the Years Ended June 30, 2001, 2000 and 1999 31
Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 2001, 2000 and 1999 31
Consolidated Statements of Cash Flows for the Years Ended June 30, 2001, 2000 and 1999 32
Notes to Consolidated Financial Statements 33
Unaudited Condensed Consolidated Balance Sheet at December 31, 2001 41
Unaudited Condensed Consolidated Statements of Operations for the Six Months Ended December 31,
2001 and 2000 42
Unaudited Condensed Consolidated Statements of Cash Flows for the Six Months Ended December 31,
2001 and 2000 42
Notes to Unaudited Condensed Financial Statements 43
UNAUDITED PRO FORMA FINANCIAL DATA
The following presents summary unaudited combined pro forma financial data of
Encore Medical Corporation (the "Company"), and Chattanooga Group, Inc.
("Chattanooga"). The combined pro forma statement of operations was prepared as
if the acquisition of Chattanooga by the Company (the "Acquisition"), occurred
on January 1, 2001.
The historical data of the Company for the fiscal year ended December 31, 2001
have been derived from the Company's audited consolidated financial statements.
The historical data of Chattanooga for the fiscal year ended December 31, 2001
have been derived from Chattanooga's audited consolidated financial statements
for the years ended June 30, 2001, as well as Chattanooga's unaudited
consolidated financial statements for the six-month period ended December 31,
2001. The unaudited combined pro forma balance sheet and statement of operations
are based on assumptions and includes adjustments as explained in the notes
thereto.
The summary unaudited combined pro forma financial data does not necessarily
reflect the results of operations of the Company and Chattanooga that actually
would have resulted had the Acquisition been consummated as of the date referred
to above. Accordingly, such data should not be viewed as fully representative of
the past performance of the Company or Chattanooga or indicative of future
results.
The summary unaudited combined pro forma financial data should be read together
with the Financial Statements and Notes of the Company and Chattanooga included
elsewhere and herein.
- 23 -
ENCORE MEDICAL CORPORATION
UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET
December 31, 2001
(In Thousands, Except Share Data)
Encore
Medical Chattanooga
Corporation Group, Inc. Adjustments Total
----------- ----------- -------------------- ----------
ASSETS
Cash and cash equivalents $5,401 $556 ($3,198) (a),(d),(e), $2,759
(f),(g)
Accounts receivable, net 5,828 7,587 - 13,415
Inventories, net 22,911 7,984 - 30,895
Deferred tax assets 2,461 301 - 2,762
Prepaid expense and other current assets 1,327 874 201 (a),(e),(f) 2,402
----------- ----------- --------- ----------
Total Current Assets 37,928 17,302 (2,996) 52,234
Property, plant and equipment, net 7,233 4,621 - 11,854
Intangible assets, net 6,044 349 22,639 (c) 29,032
Other noncurrent assets 457 54 2,000 (i) 2,511
----------- ----------- --------- ----------
$51,662 $22,326 $20,942 $94,930
=========== =========== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $2,737 $2,278 $0 $5,015
Accrued liabilities 3,355 3,515 - 6,870
Current portion of long-term debt 9,975 1,515 (8,087) (d),(g) 3,403
----------- ----------- --------- ----------
Total Current Liabilities 16,067 7,308 (8,087) 15,288
Capital lease payable 127 34 - 161
Notes payable 2,724 4,369 31,166 (d),(e),(f),(h) 38,259
Other long term liabilities 567 329 (178) (d) 718
----------- ----------- --------- ----------
Total Liabilities 19,485 12,040 22,901 54,426
Series A Preferred Stock 12,840 - - 12,840
Common stock 11 618 (618) (b) 11
Additional paid-in capital 22,052 5,943 2,384 (a),(b),(h),(i) 30,379
Deferred compensation (56) - - (56)
Notes receivable for sale of common stock (1,187) - - (1,187)
Retained earnings 560 5,431 (5,431) (b) 560
Other comprehensive income (loss) - (178) 178 (b) -
Less treasury stock (2,043) (1,528) 1,528 (b) (2,043)
----------- ----------- --------- ----------
Total Stockholders' Equity 32,177 10,286 (1,959) 40,504
----------- ----------- --------- ----------
Total Liabilities and Stockholders' Equity $51,662 $22,326 $20,942 $94,930
=========== =========== ========= ==========
- 24 -
ENCORE MEDICAL CORPORATION
UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
For the Year Ended December 31, 2001
(In Thousands)
Encore
Medical Chattanooga
Corporation Group, Inc. Adjustments Total
------------ ----------- ------------------ ------------
Sales $42,721 $49,382 $0 $92,103
Cost of sales 17,852 29,811 - 47,663
------------ ----------- ---------- ------------
Gross margin 24,869 19,571 - 44,440
Operating expenses:
Research and development 1,732 1,371 - 3,103
Selling, general & administrative 19,865 11,365 - 31,230
Other charges 1,623 - - 1,623
------------ ----------- ---------- ------------
Total Operating Expenses 23,220 12,736 - 35,956
------------ ----------- ---------- ------------
Operating Income 1,649 6,835 8,484
Interest income 186 - - 186
Interest expense (1,299) (671) (5,266) (k) - (o) (7,236)
Other, net 229 (744) (463) (j) (978)
------------ ----------- ---------- ------------
Income before taxes 765 5,420 (5,729) 456
Provision for income taxes 217 963 (1,011) (p) 169
------------ ----------- ---------- ------------
Net income 548 4,457 (4,718) 287
Beneficial conversion feature (3,706) - - (3,706)
-
------------ ----------- ---------- ------------
Net income (loss) available to
common stockholders ($3,158) $4,457 ($4,718) ($3,419)
============ =========== ========== ============
Earnings (Loss) Per Share:
Basic ($0.34) ($0.36)
Diluted ($0.34) ($0.36)
Shares used:
Basic 9,355 9,355
Diluted 9,355 9,355
- 25 -
NOTES TO CONDENSED COMBINED PRO FORMA FINANCIAL STATEMENT
(In thousands, except per share data)
1. BASIS OF PRESENTATION
The accompanying unaudited pro forma condensed combined balance sheet of Encore
Medical Corporation ("EMC" or the "Company") as of December 31, 2001 reflects
the acquisition of Chattanooga Group, Inc. and Subsidiaries ("Chattanooga") as
if it has occurred on that date.
The accompanying unaudited pro forma condensed combined statement of operations
for the year ended December 31, 2001 reflects the acquisition of Chattanooga as
if it had occurred on January 1, 2001.
The unaudited pro forma financial information gives effect to the acquisition
using the purchase method of accounting. The pro forma adjustments are described
in the accompanying notes to the unaudited pro forma financial information and
are based upon preliminary available information and upon certain assumptions
made by management. Accordingly, the pro forma adjustments reflected in the
unaudited pro forma financial information are preliminary and subject to
revision. Such revision could be material.
On February 8, 2002, EMC acquired all of the issued and outstanding shares of
capital stock of Chattanooga pursuant to a Stock Purchase Agreement for a cash
purchase price of $31,500. This price is subject to adjustment, if any, based on
the change in the net worth of Chattanooga between October 1, 2001 and February
8, 2002. In order to finance this acquisition, EMC entered into a Credit
Agreement (the "Credit Agreement") with Bank of America, N.A. for maximum
borrowings up to $30,000, subject to limitations based upon the Company's
Borrowing Base, as defined, and a Note and Equity Purchase Agreement (the "Note
Agreement") with CapitalSource Finance LLC ("CSF") for $24,000.
In connection with this acquisition and financing, EMC paid off the outstanding
balances of certain Chattanooga debt approximating $5,000. EMC also repaid all
amounts outstanding under its current revolving credit facility with proceeds
from a similar revolving credit facility as part of the Bank of America Credit
Agreement. As of February 8, 2002, EMC had borrowed approximately $18,000 under
the Credit Agreement and $24,000 under the Note Agreement.
Pursuant to the terms of the Note Agreement, the Company issued a warrant to
CapitalSource Holdings LLC ("CSH"), pursuant to which CSH has the right to
acquire for a period of five years up to an aggregate of 2,198,614 shares of the
Company's Common Stock (the "Warrants"). Further, under the terms of the Note
Agreement, if the Company fails to generate certain amounts of earnings before
interest, taxes, deprecation and amortization, the Company would have the right,
commencing on March 31, 2003 and ending on August 15, 2003, to prepay without
penalty up to $6,000 of the aggregate principal under the Note Agreement. If the
Company exercises this right, then a pro-rata portion of the Warrants (the
"Conveyed Warrants") will be conveyed by CSH to the Galen Entities. In the event
the Company has the right to prepay but does not choose to exercise this right,
then the Galen Entities will purchase the amount of Notes that the Company has
the right to prepay. In the event the Galen Entities purchase any Notes from
CSF, then upon such purchase, (a) those Notes will automatically convert into
additional shares of Series A Preferred Stock and (b) a pro-rata portion of the
Warrants will also be conveyed by CSH to the Galen Entities.
The Galen Entities and CSF have entered into an agreement (the "CSF/Galen
Agreement") to evidence certain of the foregoing obligations. As an inducement
for the Galen Entities to enter into the CSF/Galen Agreement, the Company
granted the Galen Entities options dated as of February 8, 2002 (the "Galen
Options") to acquire up to the number of shares of Common Stock which have a
value equal to $6,000,000, at an exercise price equal to the greater of $3.50
per share or one-half of the trailing ten-day average closing price of the
Common Stock on the date of exercise. If the Galen Entities choose to exercise
the Galen Options, then any Conveyed Warrants will automatically be terminated.
Conversely, if the Galen Entities choose to exercise any Conveyed Warrants, then
the Galen Options will automatically be terminated. The Galen Options will
otherwise automatically terminate on the earlier of (i) the 30th day following
the date the Galen Entities are no longer obligated to purchase any Notes under
the CSF/Galen Agreement, (ii) the date the Galen Entities acquire any senior
subordinated notes or (iii) August 15, 2003.
- 26 -
The total purchase price paid for Chattanooga approximating $32,924, including
cash payments of $31,500, and issuance costs of approximately $1,424, was
preliminary allocated as follows based upon the fair value of the assets
acquired and liabilities assumed (dollars in thousands):
Current assets $ 17,302
Tangible and other noncurrent assets 5,023
Liabilities assumed (12,040)
Intangible assets 13,641
Goodwill 8,998
--------------
$ 32,924
==============
The tangible assets are being depreciated over their useful lives of three to
twenty-five years. The acquired intangible assets consist of the following, and
are being amortized over their estimated economic life, where applicable:
Asset class Fair value Wtd. Avg. Useful life
- ---------------------------------------- --------------- ------------------------
Patents $ 1,699 11 years
Trademarks/ Trade names 6,426 Indefinite
Distributor network 5,277 20 years
Goodwill 9,237 Indefinite
---------------
$22,639
===============
2. PRO FORMA ADJUSTMENTS
The pro forma adjustments to the unaudited pro forma condensed combined
financial statements as of and for the year ended December 31, 2001 are as
follows:
Pro Forma Balance Sheet
(a) Adjustment to record the original purchase price of $31,500 and
approximately $1,424 of acquisition costs, comprised of cash payments
of approximately $221, reversal of prepaid acquisition costs of
approximately $772, and the issuance of approximately $431 of Company
common stock.
(b) Adjustment to eliminate the Chattanooga equity accounts in purchase
accounting.
(c) Adjustment to record goodwill and other intangible assets of
approximately $22,639.
(d) Adjustment to record pay down of Chattanooga debt totaling $5,979
including $1,515 of current portion of long-term debt, $4,286 of notes
payable and $178 of other long-term liabilities. Actual payoff of
Chattanooga debt on February 8, 2002 was approximately $5,000.
(e) Adjustment of $18,048 to record proceeds from Bank of America financing
and debt issuance costs of $300.
(f) Adjustment of $24,000 to record proceeds from CSF financing, and debt
issuance costs of $673.
(g) Adjustment of $6,572 to record the pay down of EMC's existing line of
credit with proceeds from the Bank of America Credit Agreement.
(h) Adjustment to record the issuance of the Warrants at an estimated fair
value of $6,596.
(i) Adjustment to record the issuance of the Galen Options at an estimated
fair value of $1,300.
Pro Forma Statement of Operations
(j) Adjustment of $463 to record one year of amortization of acquired
intangible assets.
- 27 -
(k) Adjustment of $1,319 to record one year of amortization of the
Warrants.
(l) Adjustment of $260 to record one year of amortization of Galen Options.
(m) Adjustment of $4,625 to record one year of interest expense on the
outstanding Bank of America and CSF debt.
(n) Adjustment of $478 to record reduction of interest expense for pay down
of Chattanooga debt.
(o) Adjustment of $460 to record reduction of interest expense for pay down
of EMC line of credit.
(p) Adjustment to reflect a combined effective tax rate of approximately
37%.
- 28 -
Chattanooga Group, Inc. and Subsidiaries
Consolidated Financial Statements as of
June 30, 2001, 2000 and 1999
Together With Auditors' Report
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Chattanooga Group, Inc.:
We have audited the accompanying consolidated balance sheets of CHATTANOOGA
GROUP, INC. (a Delaware corporation) and subsidiaries as of June 30, 2001 and
2000, and the related consolidated statements of operations, stockholders'
equity and cash flows for each of the three years in the period ended June 30,
2001. These financial statements are the responsibility of Chattanooga'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 financial statements referred to above present fairly, in
all material respects, the financial position of Chattanooga Group, Inc. and
subsidiaries as of June 30, 2001 and 2000, and the results of their operations
and their cash flows for each of the three years in the period ended June 30,
2001 in conformity with accounting principles generally accepted in the United
States.
ARTHUR ANDERSEN LLP
Chattanooga, Tennessee
September 12, 2001
(Except for matters discussed
in Note 15, as to which the
date is February 8, 2002)
- 29 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2001 AND 2000
(In Thousands, Except Share Data)
ASSETS 2001 2000
========================================================================== ======== ========
CURRENT ASSETS:
Cash $ 402 $ 564
Accounts receivable, less allowance for doubtful accounts of
$432 and $567 in 2001 and 2000, respectively 6,285 5,791
Inventories 7,594 7,163
Prepaid expenses and other 493 463
Deferred income taxes 51 145
-------- --------
Total current assets 14,825 14,126
-------- --------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Land and land improvements 1,010 1,010
Buildings 4,399 4,399
Machinery and equipment 4,966 5,453
Furniture and fixtures 2,385 1,942
-------- --------
12,760 12,804
Less accumulated depreciation and amortization (7,807) (7,291)
-------- --------
4,953 5,513
-------- --------
OTHER ASSETS:
Intangibles, net of accumulated amortization of $1,094 and $1,010 in
2001 and 2000, respectively 368 277
Other 65 11
-------- --------
433 288
-------- --------
Total assets $20,211 $19,927
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000
========================================================================== ======== ========
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 485 $ 524
Current maturities of capital lease obligations 65 117
Bank overdraft 90 321
Advances under line of credit 0 2,111
Trade accounts payable 3,011 2,586
Other accrued liabilities 3,814 2,960
-------- --------
Total current liabilities 7,465 8,619
-------- --------
LONG-TERM OBLIGATIONS, less current maturities 4,946 5,413
-------- --------
CAPITAL LEASE OBLIGATIONS, less current maturities 69 134
-------- --------
DEFERRED INCOME TAXES 51 145
-------- --------
COMMITMENTS AND CONTINGENCIES (Notes 14 and 15)
STOCKHOLDERS' EQUITY:
Common stock of $.25 par value:
Class A voting stock, 100,000 authorized; 75,395 issued and
outstanding 19 19
Class B nonvoting stock, 3,900,000 authorized; 2,396,701 issued
and outstanding 599 599
Contributed capital 5,943 5,943
Retained earnings (deficit) 2,767 (942)
Treasury stock, at cost (19,126 shares of Class A in 2001 and
364,234 and 840 shares of Class B in 2001 and 2000,
respectively) (1,528) (3)
Cumulative other comprehensive income (loss) (120) 0
-------- --------
Total stockholders' equity 7,680 5,616
-------- --------
Total liabilities and stockholders' equity $20,211 $19,927
======= =======
The accompanying notes are an integral part of these consolidated statements.
- 30 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED JUNE 30, 2001, 2000 AND 1999
(In Thousands)
2001 2000 1999
======== ========= =========
NET SALES $46,411 $39,798 $36,890
COST OF SALES 29,374 27,279 25,693
-------- --------- ---------
Gross profit 17,037 12,519 11,197
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 12,163 10,808 10,665
-------- --------- ---------
INCOME FROM OPERATIONS 4,874 1,711 532
-------- --------- ---------
OTHER EXPENSE:
Interest expense, net 793 938 939
Other, net 206 114 71
-------- --------- ---------
Income (loss) before income tax expense 3,875 659 (478)
INCOME TAX EXPENSE 166 155 78
-------- --------- ---------
NET INCOME (LOSS) $ 3,709 $ 504 $ (556)
======== ========= =========
The accompanying notes are an integral part of these consolidated statements.
CHATTANOOGA GROUP, INC. AND SUBSIDIARies
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JUNE 30, 2001, 2000 AND 1999
(In Thousands, Except Share Data)
Class A Class B Cumulative
Voting Nonvoting Retained Other
Common Common Contributed Earnings Treasury Comprehensive
Stock Stock Capital (Deficit) Stock Income (Loss) Total
===== ===== ======= ========= ======= ============= ======
BALANCE, June 30, 1998 $19 $499 $5,043 $ (890) $ (3) $4,663 (5)
Net loss 0 0 0 (556) 0 0 (556)
Currency translation adjustment 0 0 0 0 0 5 5
----- ----- ------- --------- ------- ------------- ------
BALANCE, June 30, 1999 19 499 5,043 (1,446) (3) 0 4,112
Net income 0 0 504 0 0 504
Issuance of 400,000 common shares 0 100 900 0 0 0 1,000
----- ----- ------- --------- ------- ------------- ------
BALANCE, June 30, 2000 19 599 5,943 (942) (3) 0 5,616
Net income 0 0 0 3,709 0 0 3,709
Currency translation adjustment 0 0 0 0 0 (3) (3)
Purchase of 382,520 treasury shares 0 0 0 0 (1,525) 0 (1,525)
Change in fair value of interest rate 0 0 0 0 0 (117) (117)
swap
----- ----- ------- --------- ------- ------------- ------
BALANCE, June 30, 2001 $19 $599 $5,943 $2,767 $(1,528) $(120) $7,680
===== ===== ======= ========= ======= ============= ======
The accompanying notes are an integral part of these consolidated statements.
- 31 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JUNE 30, 2001, 2000 AND 1999
(In Thousands)
2001 2000 1999
======= ======== =======
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $3,709 $ 504 $ (556)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization 1,296 1,360 1,453
Foreign exchange (gain) loss 15 0 (4)
Loss on sale of equipment 0 0 44
Changes in operating assets and liabilities:
Accounts receivables, net (494) (487) (250)
Inventories (231) 1,062 30
Prepaid expenses and other (30) (319) 283
Trade accounts payable 425 (199) 322
Other accrued liabilities 737 503 (194)
Other, net (54) 25 0
------- -------- -------
Net cash provided by operating activities 5,373 2,449 1,128
------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (627) (528) (1,305)
Proceeds from sale of property, plant and equipment 0 26 21
Cash paid for acquisition (400) 0 0
------- -------- -------
Net cash used in investing activities (1,027) (502) (1,284)
------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term obligations (641) (3,782) (1,136)
Net repayments (advances) under line of credit (2,111) (2,934) 292
Borrowings under long-term obligations 18 4,229 650
Proceeds from issuance of common stock 0 1,000 0
Purchase of treasury stock (1,525) 0 0
Debt issuance costs 0 (186) 0
Increase (decrease) in bank overdraft (231) 66 (11)
------- -------- -------
Net cash used in financing activities (4,490) (1,607) (205)
------- -------- -------
EFFECT OF EXCHANGE RATE CHANGES ON CASH (18) 0 9
------- -------- -------
NET INCREASE (DECREASE) IN CASH (162) 340 (352)
CASH, beginning of year 564 224 576
------- -------- -------
CASH, end of year $ 402 $ 564 $ 224
======= ======== =======
SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT NONCASH INVESTING AND FINANCING
ACTIVITIES:
New equipment under capital lease financing $ 0 $ 175 $ 0
======= ======== =======
The accompanying notes are an integral part of these consolidated statements.
- 32 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2001, 2000 AND 1999
(In Thousands, Except Per Share Data)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of Chattanooga Group,
Inc. and its wholly-owned subsidiaries (collectively referred to as
"Chattanooga") including Chattanooga Europe b.v.b.a, Chattanooga Pacific Pty.
Ltd. and Chattanooga International, Inc., an Interest Charge Domestic
International Sales Corporation as defined by Internal Revenue Code Section 995.
All significant intercompany balances and transactions have been eliminated.
In fiscal year 2000, the Board of Directors approved a restructuring plan,
whereby Chattanooga dissolved Chattanooga International, Inc. The restructuring
was complete as of June 30, 2001.
In fiscal year 1999, the Board of Directors approved a restructuring plan,
whereby Chattanooga would close its Chattanooga Pacific Pty. Ltd. operations.
Chattanooga recorded a one-time charge of $438 in 1999 related to the
restructuring, which is included in selling, general and administrative expenses
in the consolidated statement of operations. The restructuring was complete as
of June 30, 2001.
Nature of Operations
Chattanooga manufactures and sells physical therapy, chiropractic and home care
products to many fields of physical medicine including physical therapy and
chiropractic clinics, hospitals, athletic training facilities and home
healthcare providers. Chattanooga sells mainly through dealers, and services a
world-wide market that includes virtually all major countries in the world.
A substantial part of Chattanooga's net revenues are derived from sales of
products to health service professionals and organizations reimbursed by
commercial insurers, health maintenance organizations and other third-party
payors, including reimbursement pursuant to the Medicare and Medicaid programs.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Foreign Currency Translation
Assets and liabilities of Chattanooga Europe b.v.b.a. and Chattanooga Pacific
are translated to United States dollars at year-end exchange rates. Income and
expense items are translated at average rates of exchange prevailing during the
year. Translation adjustments are accumulated as a separate component of
stockholders' equity. Gains and losses which result from foreign currency
transactions are included in the accompanying consolidated statements of
operations.
Bank Overdraft
Bank overdraft includes checks outstanding in excess of certain cash balances.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out method. Inventory costs are comprised of material, direct labor and
manufacturing overhead.
- 33 -
Property, Plant and Equipment
Property, plant and equipment are recorded at cost. When retired or otherwise
disposed of, the related cost and accumulated depreciation are removed from the
accounts and any resulting gain or loss is reflected in income. Depreciation for
financial reporting purposes is provided for using the straight-line method over
lives ranging from three to twenty-five years. For fiscal 2001, 2000 and 1999,
Chattanooga recognized approximately $1,212, $1,306 and $1,353, respectively, in
depreciation expense.
Amortization of Intangibles
The costs of patents, trademarks and manufacturing and distribution rights are
amortized on a straight-line basis over the estimated useful lives of the
assets. At June 30, 2001, the estimated useful lives range from three to nine
years. Chattanooga continually evaluates whether events and circumstances have
occurred that may warrant revision of the remaining useful lives of intangibles
or that would indicate the remaining balances may not be recoverable. For fiscal
2001, 2000 and 1999, Chattanooga recognized approximately $84, $54 and $100,
respectively, in amortization expense.
Derivative Financial Instruments
Effective July 1, 2000, Chattanooga adopted Statement of Financial Accounting
Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (SFAS No. 133). The impact of adopting SFAS 133 was not material.
Stock-Based Compensation
Chattanooga accounts for its stock-based compensation plan under Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB
No. 25). Chattanooga has adopted the disclosure option of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
No. 123).
Advertising Expenses
Chattanooga expenses production costs of advertising as incurred. Advertising
expense for fiscal 2001, 2000 and 1999 was $419, $540 and $411, respectively.
Research and Development Costs
Research and development costs are expensed as incurred. Such costs were
approximately $668, $540 and $1,070 in 2001, 2000 and 1999, respectively.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
period's presentation.
Revenue Recognition
Revenue is recognized when Chattanooga's products are shipped to its customers.
Shipping and Handling Costs
Chattanooga classifies shipping and handling costs billed to the customers as
revenues and costs related to shipping and handling as cost of sales.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires all business combinations initiated after June
30, 2001, to be accounted for using the purchase method. SFAS No. 142 eliminates
the amortization of goodwill over its estimated useful life and requires an
assessment of impairment by applying a fair-value-based test on at least an
annual basis. The provisions of SFAS No. 142 are effective for fiscal years
beginning after December 15, 2001. Chattanooga has elected to early adopt SFAS
No. 142, resulting in an effective date and transition of July 1, 2001.
Management does not believe SFAS No. 142 will have a material impact on its
financial position or results of operations.
- 34 -
2. INVENTORIES
Inventories as of June 30, 2001 and 2000 are as follows:
2001 2000
====== ======
Raw materials $3,282 $3,587
Work-in-progress 1,182 1,676
Finished goods 3,130 1,900
------ ------
$7,594 $7,163
====== ======
3. DEBT AND OTHER LONG-TERM OBLIGATIONS
Long-term obligations as of June 30, 2001 and 2000 are as follows:
2001 2000
====== ======
Term note payable in monthly installments of $7 plus accrued interest
beginning September 1999, and balance due August 1, 2004, at the
bank's base rate plus .50%, (7.25% at June 30, 2001) $ 268 $ 353
Term note payable in monthly principal installments of $31 plus accrued
interest beginning September 1999, and balance due August 1, 2004,
at the bank's base rate plus .50% (7.25% at June 30, 2001) 3,047 3,420
Term note payable in monthly principal installments of $2 plus accrued
interest beginning June 2000, and balance due May 1, 2003, at the
bank's base rate plus .50% (7.25% at June 30, 2001) 48 73
Subordinated notes to related party, principal and accrued interest due
July 1, 2005, at a fixed rate of 8.50% 1,950 1,950
Other 118 141
------ ------
5,431 5,937
Less current maturities (485) (524)
------ ------
$4,946 $5,413
====== ======
During fiscal 1998, Chattanooga entered into a capital lease obligation for
certain computer equipment. In connection with the acquisition of additional
computer equipment, Chattanooga extended a portion of this lease during fiscal
2000. At June 30, 2001, Chattanooga has $673 included in property, plant and
equipment relating to this lease with current year depreciation expense of $99
and accumulated depreciation of $348. The capital lease obligation was $134 and
$251 at June 30, 2001 and 2000, respectively, with current maturities of $65 in
fiscal 2002.
Chattanooga maintains a revolving line of credit, which bears interest at .25%
above the bank's base rate (7.00% at June 30, 2001) and expires December 31,
2002. The revolving line of credit permits borrowings of the lesser of $6,000,
or the borrowing base, as defined in the agreement, subject to a $40 letter of
credit. No amounts were outstanding under the revolving line of credit at June
30, 2001.
The future maturities of long-term obligations, including the capital lease
obligation outstanding as of June 30, 2001, are as follows:
- 35 -
Long-Term Capital Lease
Obligations Obligation
=========== =============
2002 $ 485 $65
2003 481 69
2004 455 0
2005 1,942 0
2006 1,950 0
Thereafter 118 0
The loan agreements for the line of credit and term notes contain certain
restrictive covenants including, among other restrictions, required maintenance
of minimum levels of tangible net worth and limitations on the payment of
dividends or repurchase of common stock. The bank also requires Chattanooga to
maintain a restricted cash balance of $250, which is included in cash on the
consolidated balance sheet as of June 30, 2001.
Substantially all assets of Chattanooga are pledged as collateral on the above
revolving line of credit and term notes.
In October 1996, Chattanooga entered into a term loan with the majority
shareholder. Maximum borrowings under the term loan are $1,500. The term loan is
due on July 1, 2005, subject to the terms of a subordination agreement with
Chattanooga's senior lender. Interest is payable quarterly at a fixed rate of
8.5%. Borrowings outstanding were $1,300 at June 30, 2001 and 2000. Interest
expense for the years ended June 30, 2001, 2000 and 1999 was $111, $117 and
$111, respectively. Accrued interest at June 30, 2001 and 2000 is $492 and $380,
respectively, and is included in other accrued liabilities on the consolidated
balance sheet.
In December 1998, Chattanooga entered into a term loan with the majority
shareholder. The term loan is due on July 1, 2005, subject to the terms of a
subordination agreement with Chattanooga's senior lender. Interest is payable
quarterly at a fixed rate of 8.5%. Borrowings outstanding were $650 at June 30,
2001 and 2000. Interest expense for the years ended June 30, 2001, 2000 and 1999
was $55, $55 and $28, respectively. Accrued interest at June 30, 2001 and 2000
is $138 and $83, respectively, and is included in other accrued liabilities on
the consolidated balance sheet.
Subsequent to June 30, 2001, Chattanooga paid all cumulative accrued interest
due on the notes to the majority shareholder.
Total interest paid during the years ended June 30, 2001, 2000 and 1999 was
$663, $796 and $888, respectively.
4. INCOME TAXES
The principal temporary differences which give rise to deferred tax assets and
liabilities at June 30, 2001 and 2000 result from differences in financial and
income tax reporting for allowance for doubtful accounts, property, plant and
equipment, deferred revenue and certain accruals. The total of all deferred tax
assets and deferred tax liabilities recognized at June 30, 2001 and 2000 consist
of the following:
2001 2000
====== ======
Deferred tax assets $1,467 $2,980
Less: Valuation allowance (991) (2,373)
------ ------
476 607
Deferred tax liabilities (476) (607)
------ ------
Net deferred tax asset $ 0 $ 0
====== ======
The difference between the income tax expense at the statutory income tax rate
and the effective tax rate for the years ended June 30, 2001, 2000 and 1999 is
due principally to the utilization of net operating losses to reduce income tax
expense. A valuation allowance was recorded in 2001 and 2000 due to management's
belief that it is more likely than not that all deferred tax assets will not be
realized. During 2001, Chattanooga fully utilized its net operating loss
carryforwards of
- 36 -
approximately $3,936. Due to the 100% valuation allowance, the total provision
for 2001, 2000 and 1999 represents the current provision.
Total income taxes paid for the years ended June 30, 2001, 2000 and 1999 were
approximately $68, $113 and $55, respectively.
5. FAIR VALUE OF FINANCIAL INSTRUMENTS
Unless otherwise indicated elsewhere in the notes to the consolidated financial
statements, the carrying value of Chattanooga's financial instruments
approximates fair value.
6. ACQUISITIONS
Effective May 11, 2001, Chattanooga purchased certain assets for an aggregate
purchase price of $400. The acquisition was accounted for under the purchase
method of accounting. The excess of the purchase price over the estimated fair
value of the assets acquired of approximately $175 was allocated to goodwill.
7. WARRANTS WITH REDEMPTION FEATURE
In connection with a guarantee from the majority shareholder to advance
Chattanooga funds needed in the event of settlement of the suit with a minority
shareholder (see Note 14) and a subordination agreement in the event of
advancement of funds, Chattanooga issued 25,000 stock purchase warrants
("Warrants"). The Warrants were issued on July 30, 1999 at an initial value of
$2.50 per Warrant. Each Warrant represents the right to purchase one share of
Chattanooga's Class B nonvoting common stock at an exercise price of $4.00,
until the expiration date of July 30, 2009. The fair value of the Warrants was
not material. As of June 30, 2001, no Warrants had been exercised.
8. COMMON STOCK AND STOCK OPTIONS
Chattanooga issued restricted Class B nonvoting common stock that is subject to
various restrictions including restrictions on the sale, transfer, pledge or
encumbrance of the stock. Employees become 100% vested in the restricted Class B
nonvoting common stock after five years, at which time the shares awarded are
transferred to the employees. There were 27,520 shares of restricted Class B
nonvoting common stock outstanding at June 30, 2001 and 2000, all of which are
fully vested.
Chattanooga established the Chattanooga Group Stock Option Plan (the "Plan")
which provides, among other things, for the granting of stock options and
restricted common stock to certain employees. The total number of shares that
may be issued as restricted shares or as shares subject to option under the Plan
shall not exceed 113,760 shares of Chattanooga's Class B nonvoting common stock.
In January 2000, the Plan was terminated and all options authorized but not
granted and all outstanding options were cancelled upon approval of the
participants in the Plan.
Options granted had terms ranging from seven to ten years. Employees vested in
options granted prior to 1993 at the rate of 50% after five years, 75% after six
years and 100% after seven years. Employees vested in options granted after 1993
ratably over a three-to-five year period.
Effective July 25, 2000, Chattanooga adopted the Chattanooga Group, Inc. 2000
Stock Option Plan (the "2000 Plan") which provides, among other things, for the
granting of stock options and restricted common stock to certain employees. The
total number of shares that may be issued as restricted shares or as shares
subject to option under the 2000 Plan is not to exceed 300,000 shares of
Chattanooga's Class B nonvoting common stock.
Stock options granted under the plan are granted at the fair market value at the
time of grant, vest immediately or ratably over a three or five year period, and
expire 10 years from the grant date.
Chattanooga accounts for its stock-based compensation plan under APB No. 25,
under which no compensation expense has been recognized as all employee stock
options have been granted with an exercise price equal to or above the fair
value of Chattanooga's common stock on the date of grant. Chattanooga adopted
SFAS No. 123 for disclosure purposes only. For
- 37 -
SFAS No. 123, the fair value of each employee option grant has been estimated as
of the date of grant using the Minimum Value option pricing model and the
following weighted average assumptions: risk-free interest rate of 5.67%, and
5.34% for 2001 and 1999, respectively, expected life of 10 years, and dividend
rate of 0%. Had compensation cost been determined in accordance with SFAS No.
123, utilizing the assumptions detailed above, Chattanooga's pro forma net
income (loss) would have been $3,663, $497 and $(570) for the years ended June
30, 2001, 2000 and 1999, respectively.
A summary of Chattanooga's stock option activity during the years ended June 30,
2001, 2000 and 1999 is as follows:
2001 2000 1999
===================== ====================== ======================
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
======= ========= ======== ========= ======== ==========
Outstanding at beginning of year 0 $0.00 66,500 $6.67 72,400 $6.58
Granted at fair value 240,000 2.50 0 0.00 0 0.00
Canceled or expired (2,000) 2.50 (66,500) 6.67 (5,900) 5.64
------- ----- -------- ----- ------- -----
Outstanding at end of year 238,000 $2.50 0 $0.00 66,500 $6.67
------- ----- -------- ----- ------- -----
Exercisable at end of year 0 0 66,500 $6.67
------- -------- ------- -----
Weighted average fair value of
options granted $1.06 $0.00 $0.00
----- ----- -----
9. EMPLOYEE BENEFIT PLAN
Chattanooga maintains a 401(k) profit sharing plan (the "401(k) Plan") covering
substantially all employees upon completion of six months of service, as
defined. The 401(k) Plan allows for employees to contribute a portion of their
compensation subject to certain limitations. Chattanooga may make discretionary
contributions to the 401(k) Plan. Total discretionary contributions during 2001,
2000 and 1999 were $191, $184 and $169, respectively.
10. DERIVATIVE FINANCIAL INSTRUMENTS
Interest rate swap agreements are used to manage well-defined interest rate
risks. Under an interest rate swap agreement, Chattanooga has agreed with
another party to exchange, at specified intervals, the difference between fixed
rate and variable rate interest amounts calculated by reference to an
agreed-upon notional amount. Under this agreement, Chattanooga receives interest
payments at rates equal to USD Prime, and pays interest at the fixed rate shown
below:
Fixed Rate Variable Rate
Notional Amount Component Component Effective Date Expiration Date
--------------- --------- --------- -------------- ---------------
$3,047 9.44% 6.97% March 20, 2001 August 1, 2004
Chattanooga is exposed to credit loss in the event of non-performance by the
counterparty to its interest rate swap agreement. Chattanooga anticipates,
however, that the counterparty will be able to fully satisfy their obligations
under the contract. Chattanooga does not obtain collateral or other security to
support financial instruments subject to credit risk, but monitors the
credit-standing of the counterparty.
The fair value of the interest rate swap agreement is defined as the amount
Chattanooga would receive or pay to relinquish itself from further obligations
under the agreements. At June 30, 2001, Chattanooga estimates the amount it
would pay to terminate the agreement approximates $117, which has been recorded
as a liability in the accompanying consolidated balance sheet as of June 30,
2001.
As of June 30, 2001, management believes Chattanooga has met the hedge
effectiveness requirements of SFAS No. 133. Accordingly, the fair value of the
interest rate swap and changes in fair value has been recorded as a reduction of
cumulative other comprehensive income (loss) in the consolidated balance sheet
as of June 30, 2001.
- 38 -
11. LEASES
The following is a schedule of future annual minimum rental payments required
under operating leases that have initial or remaining noncancelable lease terms
in excess of one year as of June 30, 2001:
2002 $157
2003 102
2004 52
2005 12
2006 3
Total rental expense under all leases for the years ended June 30, 2001, 2000
and 1999 was $184, $222 and $215, respectively.
12. MANUFACTURING AND DISTRIBUTION RIGHTS
Chattanooga has various exclusive manufacturing and distribution agreements,
which include earned royalty and minimum royalty arrangements. Total royalty
expense during 2001, 2000 and 1999 was $140, $148 and $116, respectively.
13. COMPREHENSIVE INCOME
Comprehensive income (loss) consisted of the following components for the years
ended June 30, 2001, 2000 and 1999, respectively:
2001 2000 1999
====== ==== =====
Net income (loss) $3,709 $504 $(556)
Currency translation adjustment (3) 0 5
Change in fair value of interest rate swap (117) 0 0
------ ---- -----
Total $3,589 $504 $(551)
====== ==== =====
14. COMMITMENTS AND CONTINGENCIES
Chattanooga was a party to a Stock Purchase Agreement, pursuant to which a
minority shareholder acquired from Chattanooga and other shareholders
approximately 25% of the common stock of Chattanooga. The Stock Purchase
Agreement provided the minority shareholder with a right to "put" the stock to
Chattanooga at a price that was based upon the "fair market value" of
Chattanooga as of September 12, 1996. The minority shareholder exercised its put
option. However, Chattanooga and the minority shareholder were unable to reach
an agreement on the fair market value of Chattanooga for the purpose of
determining the purchase price of the shares subject to the put rights.
In accordance with the Stock Purchase Agreement, Chattanooga and the minority
shareholder jointly retained the services of an arbitrator to determine the fair
market value of Chattanooga. Chattanooga and the minority shareholder each
submitted a valuation of Chattanooga as of September 12, 1996, and the
arbitrator, after making an independent determination of value, selected the
valuation submitted by Chattanooga as the value closest to their determination.
This value then became the value for determining the purchase price of the
shares subject to the put rights. The minority shareholder failed to convey the
shares to Chattanooga and Chattanooga instituted a lawsuit on May 16, 1997 to
obtain a declaratory judgment requiring the minority shareholder to comply with
the terms of the Stock Purchase Agreement and for breach of contract.
On July 2, 1997, the minority shareholder filed an answer and counterclaim
against Chattanooga, Chattanooga's principal shareholder, and a member of the
Board of Directors, alleging causes of action by breach of contract, civil
conspiracy and tortuous interference with contract. The minority shareholder
requested declaratory judgment vacating the arbitration, and requested an award
of damages in an amount not less than $15,000.
- 39 -
On February 1, 2001, Chattanooga reached a settlement which required a payment
of $1,700 to the minority shareholder in return for the sale, assignment and
transfer of 19,126 and 363,394 of Class A voting and Class B nonvoting shares,
respectively. Chattanooga funded the settlement through borrowings under their
revolving line of credit of $1,525, with the remaining $175 paid by
Chattanooga's insurer.
Chattanooga is currently under review by the United States Department of
Commerce ("Department") for Compliance with Export Administration Regulations of
the Export Administration Act and Office of Foreign Asset Controls Regulations.
In May 2001, the Department initiated inquiries and has concluded that certain
limited violations occurred. Management asserts it was not aware of the
violations when they occurred and has done everything in its power to avoid
future violations.
Chattanooga is in the process of seeking a global administrative settlement of
the matter. While the exact amount of the settlement is not known, management
believes the settlement and related legal fees will be less than $300. This
amount has been recognized as an operating expense in the current year and that
amount, less legal fees paid, is included in other accrued liabilities in the
consolidated balance sheet as of June 30, 2001. The total payout could
ultimately be higher than Chattanooga's estimate (see Note 15).
Chattanooga is party to certain other legal proceedings incidental to its
business. The ultimate disposition of these matters is not presently
determinable but will not, in the opinion of management, have a material adverse
effect on the financial statements.
Purchase Commitments
The following is a schedule of long-term purchase commitments for production
components that have remaining noncancelable purchase commitments in excess of
one year as of June 30, 2001:
2002 $5,059
2003 1,195
15. SUBSEQUENT EVENTS
Subsequent to September 12, 2001, management increased the provision for the
settlement and related legal fees for the investigation by the Department
discussed in Note 14 to $600. This change in accounting estimate will be
reflected as expense in subsequent financial statements.
On February 8, 2002, all of the issued and outstanding shares of Chattanooga
were acquired by Encore Medical Corporation for a cash price of $31,500, which
is subject to adjustment based on the change in net worth of Chattanooga between
October 1, 2001 and February 8, 2002, and the repayment of certain Chattanooga
debt approximating $5,000.
- 40 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED
BALANCE SHEET
December 31, 2001
(In Thousands, Except Share Data)
ASSETS
Cash and cash equivalents $ 556
Accounts receivable, net 7,587
Inventories, net 7,984
Deferred tax assets 301
Prepaid expense and other current assets 874
-------
Total Current Assets 17,302
Property, plant and equipment, net 4,621
Intangible assets, net 349
Other noncurrent assets 54
-------
Total Assets $22,326
=======
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable $ 2,278
Accrued liabilities 3,515
Current portion of long-term debt 1,515
-------
Total Current Liabilities 7,308
Capital lease payable 34
Notes payable 4,369
Other long term liabilities 329
-------
Total Liabilities 12,040
Total Stockholders' Equity 10,286
-------
Total Liabilities and Stockholders' Equity $22,326
========
- 41 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Six Months Ended December 31, 2001 and 2000
(In Thousands)
2001 2000
========== =========
Sales $26,070 $23,100
Cost of sales 15,233 14,789
---------- ---------
Gross margin 10,837 8,311
Operating expenses:
Research and Development 682 693
Selling, General & Administrative 5,786 5,211
---------- ---------
Total operating expenses 6,468 5,904
---------- ---------
Operating income 4,369 2,407
Other expense, net 815 398
---------- ---------
Income before taxes 3,554 2,009
Provision for income taxes 891 94
---------- ---------
Net income $2,663 $1,915
========== =========
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended December 31, 2001 and 2000
(In Thousands)
2001 2000
======= =======
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 2,663 $ 1,915
Adjustments to reconcile net income to net cash provided by (used in)
operating activities:
Depreciation and amortization 576 659
Changes in operating assets and liabilities:
Accounts receivable (1,381) (1,409)
Inventories (390) (96)
Deferred tax assets (250) --
Prepaid expense and other current assets (291) (6)
Accounts payable and accrued liabilities (1,001) 607
------- -------
Net cash provided (used in) by operating activities (74) 1,670
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed assets (225) (233)
------- -------
Net cash used in investing activities (225) (233)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings / (repayments) on line of credit 965 (1,019)
Payments under long term obligations (512) (327)
------- -------
Net cash provided by (used in) financing activities 453 (1,346)
Net increase in cash and cash equivalents 154 91
Cash and cash equivalents at beginning of year 402 564
------- -------
Cash and cash equivalents at end of year $ 556 $ 655
======= =======
- 42 -
CHATTANOOGA GROUP, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001
(In Thousands)
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements include the
accounts of Chattanooga Group, Inc. and its wholly owned subsidiaries
(individually and collectively referred to as "Chattanooga"). All significant
intercompany balances and transactions have been eliminated in consolidation.
The unaudited condensed consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and notes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the six months ended December 31, 2001 are not
necessarily indicative of the results that may be expected for the year ended
June 30, 2002. For further information, refer to the audited financial
statements and notes thereto for Chattanooga included elsewhere herein.
2. EARNINGS PER SHARE
Chattanooga does not report earnings per share as it is a privately held
concern.
3. INVENTORIES
Inventories at December 31, 2001 are as follows (in thousands):
December 31,
2001
------------------
Raw materials $3,834
Work in process 1,707
Finished goods 3,210
Less-inventory reserves (768)
------------------
Total $7,984
==================
4. COMPREHENSIVE INCOME
The components of comprehensive income for the six months ended December 31,
2001 and 2000 are as follows (in thousands):
2001 2000
---------------- ----------------
Net income $2,663 $1,915
Change in fair value of interest rate swap (58) -
---------------- ----------------
Total $2,605 $1,915
================ ================
5. COMMITMENTS AND CONTINGENCIES
Chattanooga is currently under review by the United States Department of
Commerce ("Department") for Compliance with Export Administration Regulations of
the Export Administration Act and Office of Foreign Asset Controls Regulations.
In May 2001, the Department initiated inquiries and has concluded that certain
limited violations occurred. Management asserts it was not aware of the
violations when they occurred and has done everything in its power to avoid
future violations.
Chattanooga is in the process of seeking a global administrative settlement of
the matter. While the exact amount of the settlement is not known, management
believes the settlement and related legal fees will be less than $600. Of this
amount, $300 has been recognized as an operating expense in the period ended
December 31, 2001. As of December, 31, 2001,
- 43 -
Chattanooga has approximately $275 included in other accrued liabilities in the
consolidated balance sheet related to this contingency, which represents the
total estimated settlement of $600 less legal fees paid to date. The total
payout could ultimately be higher than Chattanooga's estimate.
Chattanooga is party to certain other legal proceedings incidental to its
business. The ultimate disposition of these matters is not presently
determinable but will not, in the opinion of management, have a material adverse
effect on the financial position and results of operations.
6. SUBSEQUENT EVENTS
On February 8, 2002, Encore Medical Corporation ("EMC") acquired all of the
issued and outstanding shares of capital stock of Chattanooga pursuant to a
Stock Purchase Agreement for a cash purchase price of $31,500. This price is
subject to adjustment, if any, based on the change in the net worth of
Chattanooga between October 1, 2001 and February 8, 2002.
Subsequent to December 31, 2001, Chattanooga repaid approximately $965 of the
outstanding notes payable. Additionally, in connection with this acquisition,
EMC paid off the outstanding balances of the majority of Chattanooga's remaining
debt approximating $5,000 as of February 8, 2002.
- 44 -
APPENDIX B
PROPOSED AMENDMENT TO THE CERTIFICATE OF INCORPORATION
RESOLVED, that the Certificate of Incorporation of Encore Medical Corporation be
amended so that the first sentence of Paragraph FOURTH reads in its entirety as
follows:
FOURTH: The total number of shares of all classes of capital stock
which the Corporation shall have the authority to issue is 51,000,000,
of which 50,000,000 shares shall be Common Stock of the par value of
$.001 per share and 1,000,000 shares shall be Preferred Stock of the
par value of $.001 per share.
- 45 -
APPENDIX C
PROPOSED AMENDMENT TO THE 1996 INCENTIVE STOCK PLAN
RESOLVED, that the 1996 Incentive Stock Plan of Encore Medical Corporation be
amended so that the first sentence of Section 3(a) reads in its entirety as
follows:
(a) Shares Issuable. The maximum number of shares of Stock
---------------
reserved and available for distribution pursuant to Awards under the
Plan shall be 3,000,000 shares.
- 46 -
APPENDIX D
PROPOSED AMENDMENTS TO THE
2000 NON-EMPLOYEE DIRECTOR OPTION PLAN
RESOLVED, that the 2000 Non-Employee Director Option Plan of Encore Medical
Corporation be amended so that the last sentence of Article 3A reads in its
entirety as follows:
The number of shares of Common Stock reserved for issuance over the
term of the Plan shall be fixed at seven hundred fifty thousand
(750,000) shares.
RESOLVED, FURTHER, that the 2000 Non-Employee Director Option Plan of Encore
Medical Corporation be amended so that the second sentence of Article 5A reads
in its entirety as follows:
Each Eligible Director who serves on the Board at the time of that
Annual Meeting, whether or not standing for re-election, shall
automatically be granted a non-statutory option to purchase fifteen
thousand (15,000) shares of Common Stock.
- 47 -
PROXY
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
ENCORE(R) MEDICAL CORPORATION
The undersigned hereby appoints Kenneth W. Davidson and Harry L.
Zimmerman, and each of them, as proxies, with full power of substitution and
resubstitution in each, and hereby authorizes them to represent and vote, as
designated on the other side of this Proxy, all the shares of common stock of
Encore Medical Corporation standing in the name of the undersigned with all
powers that the undersigned would possess if present in person at the Annual
Meeting of Stockholders of the Company to be held May 16, 2002, or any
adjournment or postponement thereof. In their discretion, the proxies may vote
upon such other business as may properly come before the meeting.
(CONTINUED AND TO BE MARKED, DATED AND SIGNED, ON THE OTHER SIDE)
PLEASE MARK YOUR VOTES AS INDICATED IN THIS EXAMPLE [X]
ENCORE(R) MEDICAL CORPORATION PROXY
Company # ___________
Control # ___________
TO VOTE YOUR PROXY,
Mark, sign and date your proxy card and return it in the postage-paid envelope
we've provided or return it to Encore Medical Corporation, c/o Shareowner
Services, P.O. Box 64873, St. Paul. MN 55164-0873
The Board of Directors Recommends a Vote FOR Items 1, 2, 3, 4, 5 and 6.
1. Election of Directors: 01 Jay M. Haft
02 Kenneth W. Davidson
03 Richard O. Martin
[_] Vote FOR all nominees (except as marked) [_] Vote WITHHELD from all nominees
(Instructions: To withhold
authority to vote for any indicated
nominee, write the number(s) of the ---------------------------------------
nominee(s) in the box provided to
the right.) ---------------------------------------
2. To approve the Transactions
[_] For [_] Against [_] Abstain
3. To approve the Increase in Authorized Shares
[_] For [_] Against [_] Abstain
4. To approve the Amendment to 1996 Incentive Stock Plan
[_] For [_] Against [_] Abstain
5. To approve Amendments to 2000 Non-Employee Director Option Plan
[_] For [_] Against [_] Abstain
6. To approve Appointment of KPMG LLP as Independent Accountants
[_] For [_] Against [_] Abstain
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED AS DIRECTED OR, IF NO
DIRECTION IS GIVEN, WILL BE VOTED FOR EACH PROPOSAL.
Address Change? Mark Box [_]
Indicate changes below: Date
-----------------------
------------------------------------
------------------------------------
SIGNATURE(S) IN BOX
Please sign exactly as your name(s)
appear on proxy; if held in joint
tenancy, all persons must sign.
Trustee, administrators, etc.,
should include title and authority.
Corporations should provide full
name of corporation and title of
authorized officer signing the
proxy.
PROXY
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
Encore(R) Medical Corporation
The undersigned hereby appoints Kenneth W. Davidson and Harry L. Zimmerman,
and each of them, as proxies, with full power of substitution and resubstitution
in each, and hereby authorizes them to represent and vote, as designated on the
other side of this Proxy, all the shares of Series A preferred stock of Encore
Medical Corporation standing in the name of the undersigned with all powers that
the undersigned would possess if present in person at the Annual Meeting of
Stockholders of the Company to be held May 16, 2002, or any adjournment or
postponement thereof. In their discretion, the proxies may vote upon such other
business as may properly come before the meeting.
(CONTINUED AND TO BE MARKED, DATED AND SIGNED, ON THE OTHER SIDE)
PLEASE MARK YOUR VOTES AS INDICATED IN THIS EXAMPLE [X]
ENCORE(R) MEDICAL CORPORATION PROXY
Company # ___________
Control # ___________
TO VOTE YOUR PROXY,
Mark, sign and date your proxy card and return it to Encore Medical Corporation,
c/o Shareowner Services, P.O. Box 64873, St. Paul. MN 55164-0873
The Board of Directors Recommends a Vote FOR Items 1, 2, 3, 4, 5 and 6.
1. Election of Directors: 01 Jay M. Haft
02 Kenneth W. Davidson
03 Richard O. Martin
[_] Vote FOR all nominees (except as marked) [_] Vote WITHHELD from all nominees
-----------------------------
(Instructions: To withhold authority to vote for
any indicated nominee, write the number(s) of
the nominee(s) in the box provided to the right.) -----------------------------
2. To approve the Transactions
[_] For [_] Against [_] Abstain
3. To approve the Increase in Authorized Shares
[_] For [_] Against [_] Abstain
4. To approve the Amendment to 1996 Incentive Stock Plan
[_] For [_] Against [_] Abstain
5. To approve Amendments to 2000 Non-Employee Director Option Plan
[_] For [_] Against [_] Abstain
6. To approve Appointment of KPMG LLP as Independent Accountants
[_] For [_] Against [_] Abstain
THIS PROXY WHEN PROPERLY EXECUTED WILL BE VOTED AS DIRECTED OR, IF NO
DIRECTION IS GIVEN, WILL BE VOTED FOR EACH PROPOSAL.
Address Change? Mark Box [_]
Indicate changes below: Date ___________________
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SIGNATURE(S) IN BOX
Please sign exactly as your
name(s) appear on proxy; if
held in joint tenancy, all
persons must sign. Trustee,
administrators, etc., should
include title and authority.
Corporations should provide
full name of corporation and
title of authorized officer
signing the proxy.