Exhibit 99.2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders Breg, Inc.
We have audited the accompanying consolidated balance sheets of Breg, Inc. and
subsidiary as of December 30, 2003 and December 31, 2002 and the related
consolidated statements of income, shareholders' equity, and cash flows for the
period from January 1, 2003 to December 30, 2003 and for the years ended
December 31, 2002 and 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Breg, Inc. and subsidiary at
December 30, 2003 and December 31, 2002 and the results of their operations and
their cash flows for the period from January 1, 2003 to December 30, 2003 and
for the years ended December 31, 2002 and 2001 in conformity with accounting
principles generally accepted in the United States of America.
As described in Note 14, the Company was sold at the close of business on
December 30, 2003.
/s/ DELOITTE & TOUCHE LLP
San Diego, California
February 18, 2004
BREG, INC.
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 30, 2003 AND DECEMBER 31, 2002
(U.S. Dollars, in thousands except share data) 2003 2002
----------------- ------------------
Assets
Current assets:
Cash ................................................................. $1,223 $13
Accounts receivable, net of allowance for returns and doubtful accounts
of $424 in 2003 and $411 in 2002...................................... 9,080 7,337
Notes receivable from related parties................................. 8,129 26
Income taxes receivable............................................... 2,464 144
Inventories........................................................... 4,639 3,816
Deferred tax assets................................................... 910 842
Prepaid expenses and other current assets............................. 926 845
----------------- ------------------
Total current assets................................................ 27,371 13,023
Property and equipment, net.............................................. 4,066 4,176
Intangible assets, net................................................... 371 338
Notes receivable from related parties, net of current portion............ 3,390 3,394
Deferred tax assets ..................................................... 321 188
Other assets ............................................................ 199 272
----------------- ------------------
Total assets........................................................ $35,718 $21,391
================= ==================
Liabilities and shareholders' equity
Current liabilities:
Accounts payable...................................................... $1,966 $2,173
Accrued salaries and related costs.................................... 3,940 1,785
Accrued expenses...................................................... 2,326 2,289
Current portion of notes payable to shareholders...................... 766 467
----------------- ------------------
Total current liabilities........................................... 8,998 6,714
Line of credit........................................................... 8,800 6,900
Notes payable to shareholders, net of current portion.................... 300 515
Deferred rent............................................................ 134 200
----------------- ------------------
Total liabilities.................................................... 18,232 14,329
----------------- ------------------
Commitments and contingencies (Notes 8)
Shareholders' equity
Common stock, no par value, - 4,000,000 shares authorized, 2,692,414 and
2,416,200 shares issued and outstanding in 2003 and 2002, respectively 10,869 3,817
Retained earnings..................................................... 24,874 18,804
Treasury stock - at cost, 959,978 shares in 2003 and
1,236,192 shares in 2002............................................ (18,257) (15,559)
----------------- ------------------
Total shareholders' equity............................................... 17,486 7,062
----------------- ------------------
Total liabilities and shareholders' equity............................... $35,718 $21,391
================= ==================
See notes to consolidated financial statements.
BREG, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 30, 2003 AND
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
(U.S. Dollars, in thousands) 2003 2002 2001
------------- ------------- -------------
Net sales...................................................... $61,907 $54,788 $46,312
Cost of sales.................................................. 21,853 19,455 17,851
------------- ------------- -------------
Gross profit................................................... 40,054 35,333 28,461
Operating expenses
Selling and marketing...................................... 18,274 16,451 14,073
Research and development................................... 3,112 2,565 1,964
General and administrative.................................. 6,932 4,648 4,027
------------- ------------- -------------
Total operating expenses 28,318 23,664 20,064
------------- ------------- -------------
Income from operations ........................................ 11,736 11,669 8,397
------------- ------------- -------------
Other income (expense)
Interest income............................................ 136 135 94
Interest expense .......................................... (293) (673) (1,098)
Other expense, net......................................... (11) (34) (2)
------------- ------------- -------------
Total other expense, net.................................. (168) (572) (1,006)
------------- ------------- -------------
Income before income taxes..................................... 11,568 11,097 7,391
Income tax expense............................................. 5,498 4,388 2,819
------------- ------------- -------------
Net income .................................................... $6,070 $6,709 $4,572
============= ============= =============
See notes to consolidated financial statements.
BREG, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 30, 2003 AND
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
Common Stock
-----------------------------
(U.S. Dollars, in thousands, except Number of Retained Treasury
share data) Shares Amount Earnings Stock Total
------------ ----------- -------------- ------------ -------------
Balance - January 1, 2001 ......... 2,428,064 $ 2,298 $ 7,530 $ (11,498) $ (1,670)
Repurchase of common stock......... (85,440) - - (2,438) (2,438)
Exercise of options to purchase
common stock....................... 62,480 2 - 155 157
Income tax benefit from stock options -
exercised.......................... 304 - - 304
Compensation expense for stock -
options granted.................... 303 - - 303
Net income......................... - - 4,572 - 4,572
------------ ----------- -------------- ------------ -------------
Balance - December 31, 2001........ 2,405,104 2,907 12,102 (13,781) 1,228
Repurchase of common stock......... (51,536) - - (1,942) (1,942)
Exercise of options to purchase
common stock....................... 62,632 - (7) 164 157
Income tax benefit from stock options -
exercised.......................... 831 - - 831
Compensation expense for stock -
options granted.................... 79 - - 79
Net income......................... - - 6,709 - 6,709
------------ ----------- -------------- ------------ -------------
Balance - December 31, 2002........ 2,416,200 3,817 18,804 (15,559) 7,062
Repurchase of common stock......... (138,368) - - (6,127) (6,127)
Exercise of options to purchase
common stock....................... 414,582 - - 3,429 3,429
Income tax benefit from stock options -
exercised.......................... 7,052 - - 7,052
Net income......................... - - 6,070 - 6,070
------------ ----------- -------------- ------------ -------------
Balance - December 30, 2003........ 2,692,414 $ 10,869 $ 24,874 $ (18,257) $ 17,486
------------ ----------- -------------- ------------ -------------
See notes to consolidated financial statements.
BREG, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 30, 2003 AND
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
(U.S. Dollars, in thousands) 2003 2002 2001
Net cash provided by operating activities............................ ----------- ----------- -----------
Cash flows from operating activities:
Net income .......................................................... $6,070 $6,709 $4,572
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization.................................... 1,652 1,395 1,327
Loss on disposal of assets....................................... 7 32 5
Impairment of long-lived assets.................................. 16 -- --
Deferred income taxes............................................ (202) (243) (277)
Compensation expense for stock options granted to non-employees.. -- 79 303
Tax benefit on non-qualified stock options....................... 7,052 831 304
Changes in assets and liabilities:
Accounts receivable, net......................................... (1,742) (1,294) (264)
Inventories...................................................... (823) (796) 941
Prepaid expenses and other current assets........................ (82) 16 (234)
Other assets..................................................... 73 (63) (34)
Accounts payable................................................. (206) 153 (166)
Accrued expense, salaries and related costs...................... 2,191 561 901
Income taxes receivable.......................................... (2,319) (357) 344
Deferred rent.................................................... (67) (49) 5
----------- ----------- -----------
Net cash provided by operating activities............................ 11,620 6,974 7,727
Cash flows from investing activities:
Purchases of property and equipment.............................. (1,519) (1,619) (1,670)
Proceeds from sale of equipment.................................. -- 3 180
Notes receivable from related parties............................ (8,099) (1,282) (1,805)
Expenditures for patents and trademarks.......................... (79) (70) (86)
----------- ----------- -----------
Net cash used for investing activities............................... (9,697) (2,968) (3,381)
----------- ----------- -----------
Cash flows from financing activities:
Net borrowing (payments) under line of credit.................... 1,900 (1,400) 400
Payments on notes payable to shareholders and capital leases..... (515) (904) (4,345)
Repurchase of common stock....................................... (5,527) (1,851) (566)
Net proceeds from issuance of common stock....................... 3,429 157 157
----------- ----------- -----------
Net cash used for financing activities............................... (713) (3,998) (4,354)
----------- ----------- -----------
Net increase (decrease) in cash ..................................... 1,210 8 (8)
Cash, beginning of period............................................ 13 5 13
----------- ----------- -----------
Cash, end of period.................................................. $1,223 $13 $5
----------- ----------- -----------
Supplemental disclosure of cash flow information
Cash paid during the year for:
Interest........................................................... $270 $645 $933
Income taxes....................................................... $1,480 3,997 $2,448
Non-cash investing and financing activities
Promissory notes issued and settlement of notes receivable in
connection with the repurchase of common stock.................... $600 $91 $1,872
Tax benefit from the exercise of non-qualified stock options and
reduction of income tax liability................................. $7,052 $831 $304
See notes to consolidated financial statements.
BREG, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE PERIOD FROM JANUARY 1, 2003 TO DECEMBER 30, 2003 AND
FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
- --------------------------------------------------------------------------------
1. THE COMPANY AND SUMMARY OF ACCOUNTING POLICIES
The Company--Breg, Inc. (the "Company") was organized on March 15, 1989 in
the state of California. The Company develops, manufactures and distributes
medical products primarily used in orthopedic rehabilitation in the
healthcare industry.
During December 2002, the Company commenced the process of relocating
manufacturing lines from Vista, California to Mexicali, Mexico. Prior to
December 2002, the Company formed a majority-owned subsidiary, Breg Mexico,
Inc. (the "Subsidiary"), which operates under the Maquiladora program in
Mexico under which it provides labor services to the Company.
On December 30, 2003, all the common stock of the Company was acquired.
These financial statements are presented for the period from January 1,
2003 to December 30, 2003, just prior to the transaction and before
adjustments to reflect the acquisition. See Note 14 for further information
regarding the acquisition.
Principles of Consolidation--The consolidated financial statements include
the accounts of the Company and its majority-owned subsidiary. Intercompany
accounts and transactions have been eliminated in consolidation.
Use of Estimates and Financial Statement Presentation --The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and related disclosures at the date of the financial
statements, and the amounts of revenues and expenses reported during the
period. Actual results could differ from those estimates.
Cash and Cash Equivalents--The Company considers all highly liquid
investments with an original maturity of three months or less at the date
purchase to be cash equivalents.
Inventories--Inventories are stated at the lower of cost or market value.
Cost is determined using the first-in, first-out method.
Depreciation and Amortization--Property and equipment are stated at cost
and depreciated using the straight-line method over their estimated useful
lives. Machinery and equipment and furniture and fixtures have estimated
useful lives of three to seven years. Leasehold improvements are amortized
over the life of the lease or the life of the asset, whichever is shorter.
Amortization of Intangible Assets--The cost of intangible assets, comprised
primarily of patents and trademarks, is amortized on a straight-line basis
over estimated useful lives, which are seventeen and five years,
respectively.
Revenue Recognition--The Company generates revenue from product sales.
Revenue is recognized when the product is shipped to customers and title
and risk of loss is transferred to the customer and is recognized net of an
allowance for sales returns. The allowance for sales returns is an estimate
based on historical sales returns.
Warranty Reserves--The Company provides limited warranties on certain of
its products for periods of up to one year. The Company recognizes warranty
reserves when products are shipped based upon an estimate of total warranty
costs, and such reserves are included in accrued expenses. The estimate of
such costs is based upon historical and anticipated requirements. Warranty
expense is included in cost of sales in the financial statements.
Accrued warranty for the periods ended:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Balance at beginning of period $33 $24
Charged to costs and expenses 34 12
Deductions for costs incurred (16) (3)
Balance at end of period ----------------- ------------------
$51 $33
----------------- ------------------
Impairment of Long-Lived Assets and Intangibles with Definite Lives--The
Company assesses potential impairments to its long-lived assets and
intangibles with definite lives when there is evidence that events or
changes in circumstances have made recovery of the asset's carrying value
unlikely and the carrying amount of the asset exceeds the estimated future
undiscounted cash flows. When the carrying amount of the asset exceeds the
estimated future undiscounted cash flows, an impairment loss is recognized
to reduce the asset's carrying amount to its estimated fair value based on
the present value of the estimated future cash flows. Impairment expense of
$16,517 was recognized in cost of sales in the financial statements for
2003.
Foreign Currency Translation--The Company accounts for translation of
foreign currency in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 52, Foreign Currency Translation. The Subsidiary's
operations are a direct and integral component of the Company's operations
and therefore the U.S. dollar is used as the functional currency.
Nonmonetary assets and liabilities of the Subsidiary are remeasured at
historical exchange rates while monetary assets and liabilities are
remeasured at current exchange rates. Exchange gains and losses from
remeasurement of monetary assets and liabilities that are not denominated
in the U.S. dollar are immaterial.
Stock Based Compensation--As permitted by SFAS No. 123, Accounting for
Stock-Based Compensation, the Company accounts for the costs associated
with stock option grants to employees in accordance with Accounting
Principles Board Opinion ("APB") No. 25, Accounting for Stock Issued to
Employees, and, accordingly, discloses the pro forma effect on net income
using the fair value based method. Compensation expense for options granted
to non-employees has been determined and is recognized in accordance with
SFAS No. 123 and Emerging Issues Task Force ("EITF") 96-18, Accounting for
Equity Instruments that are Issued to Other than Employees for Acquiring,
or in Conjunction with Selling, Goods or Services.
In December 2002, SFAS No. 148, Accounting for Stock Based Compensation
Transition and Disclosure an amendment of FASB Statement No. 123 was
issued. This statement amends SFAS No. 123 to provide alternative methods
of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosure in both annual and interim financial statements about
the method of accounting for stock-based employee compensation and the
effects of the method used on reporting results (see below).
Pro forma information regarding the Company's net income for the period
from January 1, 2003 to December 30, 2003 and the years ended December 30,
2002 and 2001 is required by SFAS No. 123, Accounting For Stock-Based
Compensation and has been determined as if the Company had accounted for
its employee stock option plans under the fair value method, utilizing the
minimum value methodology (no consideration of volatility of the underlying
stock) allowed by SFAS No. 123. For purposes of pro forma disclosures, the
estimated fair value of the options is amortized to expense over the
options' vesting period. Under APB No. 25, there was no compensation
expense recorded.
For the periods ended:
(In thousands) December 30, December 31, December 31,
2003 2002 2001
----------------- ------------------ ------------------
Net income
As reported $6,070 $6,709 $4,572
Total stock compensation expense (254) (85) (80)
under the fair value method
Pro Forma ----------------- ------------------ ------------------
$5,816 $6,624 $4,492
----------------- ------------------ ------------------
The fair value of the options under each plan is estimated on the date of
grant using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 2003, 2002 and 2001,
respectively: volatility of 0%; dividend yield of 0%; risk-free interest
rates of 3.20%, 3.82% and 4.92%; expected lives of 7.0 years. The fair
value of options granted during 2003, 2002, and 2001 was $8.84, $8.42 and
$5.77, respectively.
Compensation expense for options granted to non-employees has been
determined in accordance with SFAS No. 123 and EITF 96-18 using the
Black-Scholes option pricing model. Compensation expense related to
non-employee stock options awards is included in sales and marketing
expense and totaled $0, $78,934 and $303,963 for the period from January 1,
2003 to December 30, 2003 and for the years ended December 30, 2002 and
2001, respectively.
Income Taxes--The Company accounts for income taxes in accordance with SFAS
No. 109, Accounting for Income Taxes. Deferred tax assets and liabilities
are determined based on the difference between the financial statement and
tax bases of assets and liabilities, using the enacted tax rates in effect
for the year in which the differences are expected to reverse.
Interest Rate Protection Agreement--The Company uses an interest rate
collar to hedge a portion of its borrowings against changes in interest
rates. The interest differential to be paid or received is accrued as
interest expense and the fair value of the interest rate collar is
reflected in the accompanying balance sheet. The Company's counterparty is
a major financial institution. See Note 7.
Research and Development Costs--The Company expenses research and
development costs as incurred.
Concentration of Credit Risk--The Company performs on-going credit
evaluations of its customers and generally does not require collateral.
When the Company becomes aware of a customer's inability to meet its
obligations, such as in the case of a bankruptcy filing or deterioration in
the customer's financial condition, the Company records a specific reserve
to reduce the related receivable to the amount the Company reasonably
believes is collectible. The Company also records reserves for bad debt for
all other customers based on a variety of factors including the length of
time the receivables are past due, the financial condition of the customer,
macroeconomic conditions and historical experience. The Company maintains
reserves for potential credit losses and such losses have been within
management's expectations. The Company invests its excess cash in deposits
with major banks. The Company has not experienced any losses on its
deposits.
Reclassifications--Certain amounts from 2002 and 2001 have been
reclassified to conform to the 2003 presentation.
Acquisition and Issuance of Treasury Stock--It is the Company's practice,
where appropriate, to buy its own shares to enhance shareholder value.
Treasury stock is held at cost until it is retired or reissued. Purchased
shares are available for general corporate purposes.
Fair Value of Financial Instruments-- The carrying amounts reflected in the
consolidated balance sheet for cash and cash equivalents, accounts
receivables, notes receivable, accounts payable and debt approximate fair
value due to the short term maturities of these instruments.
Advertising Costs--The Company expenses all advertising costs as incurred.
Recent Accounting Pronouncements--In November 2002, the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. 45 ("FIN
45"), Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires
that a liability be recorded in the guarantor's balance sheet upon issuance
of a guarantee. In addition, FIN 45 requires certain disclosures about each
of the entity's guarantees. The disclosure provisions of FIN 45 are
effective for annual and interim periods that end after December 15, 2002.
The adoption of FIN 45 did not have a material effect on the Company's
results of operations or financial position.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure. SFAS No. 148 provides alternative
methods of transition for those entities that elect to voluntarily adopt
the fair value accounting provisions of SFAS No. 123, Accounting for
Stock-Based Compensation. SFAS No. 148 also requires more prominent
disclosures of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation as well as pro forma
disclosure of the effect in interim financial statements. The transition
and annual disclosure provisions of SFAS No. 148 are effective for fiscal
years ending after December 15, 2002. The interim disclosure requirements
are effective for the first interim period ending after December 15, 2002.
The Company has not elected to adopt the fair value accounting provisions
of SFAS No. 123 and therefore the adoption of SFAS No. 148 did not have a
material effect on the Company's results of operations or financial
position.
In January 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51, which was subsequently revised prior to implementation in December
2003. The revised Interpretation, known as "FIN 46-R", requires the
consolidation of certain variable interest entities by the primary
beneficiary of the entity if the equity investment at risk is not
sufficient to permit the entity to finance its activities without
additional subordinated financial support from other parties, or if the
equity investors lack the characteristics of a controlling financial
interest. Based upon the Company's review, no variable interest entities
exist, therefore this new standard does not have a material impact on the
Company's financial position or results of operations.
2. INVENTORIES
Inventories consist of the following as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Raw materials $2,418 $1,896
Work in process 763 792
Finished goods 1,946 1,601
================= ==================
5,127 4,289
Less inventory obsolescence reserve (488) (473)
----------------- ------------------
$4,639 $3,816
----------------- ------------------
3. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consist of the following as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Prepaid expenses $452 $453
Deposits 231 126
Interest receivable 58 53
Other receivables 161 192
Other 24 21
Total ----------------- ------------------
$926 $845
----------------- ------------------
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Machinery and equipment $6,229 $6,747
Furniture and fixtures 3,836 1,777
Leasehold improvements 1,614 1,235
Construction in progress -- 391
================= ==================
11,679 10,150
Less accumulated depreciation and amortization (7,613) (5,974)
----------------- ------------------
$4,066 $4,176
----------------- ------------------
5. INTANGIBLE ASSETS
Intangible assets consist of the following as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Patents $442 $420
Trademarks 57 47
================= ==================
499 467
Less accumulated amortization (128) (129)
----------------- ------------------
$371 $338
----------------- ------------------
Amortization expense for the period from January 1, 2003 to December 30,
2003 and for the years ended December 31, 2002 and 2001 was $29,303,
$22,795 and $20,714, respectively.
Estimated annual amortization expense is as follows for the years ended
December 31:
(In thousands)
2004 $26
2005 $25
2006 $24
2007 $22
2008 $20
6. ACCRUED EXPENSES
Accrued expenses consist of the following as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Accrued expenses $153 $208
Accrued interest 31 275
Accrued warranty expense 51 33
Commissions payable 1,665 1,528
Sales tax payable 139 89
Insurance payable 287 156
Total ----------------- ------------------
$2,326 $2,289
----------------- ------------------
7. FINANCING
Line of Credit--The Company has a line of credit with a bank which allows
the Company to borrow up to $11,500,000 and bears interest at the bank's
reference rate 4.0% , 3.31% and 4.13% at December 30, 2003, December 31,
2002 and 2001, respectively with interest payable monthly and the principal
balance due December 31, 2005. The agreement also contains a provision for
periodic borrowings at rates which are based on LIBOR plus 1.35% at
December 30, 2003 and 2% at December 31, 2002 and 2001, respectively. The
line of credit is collateralized by substantially all of the Company's
assets and is guaranteed by certain shareholders. As of December 30, 2003
and December 31, 2002, $8,800,457 and $6,900,000, respectively, were
outstanding under the line of credit. The loan agreement with the bank
contains various covenants, including profitability and debt to tangible
net worth requirements. Interest expense on the line of credit for the
period from January 1, 2003 to December 30, 2003 and for the years ended
December 31, 2002 and 2001 was $238,314, $343,485 and $588,528,
respectively. In conjunction with the acquisition described in Note 14, the
lending institution for this line of credit waived all debt covenant
compliance and reporting requirements as the liability was settled on
December 30, 2003.
Interest Rate Collar--During the year ended December 31, 2001, the Company
entered into an interest rate collar on $9 million notional principal to
mitigate the interest rate risk exposure on the Company's line of credit.
The contract limits the float on the remainder of the line of credit
balance between a floor of 4.5% and a cap of 7%. This agreement expires
December 31, 2003. The agreement was accounted for as a fair market value
hedge, in accordance with SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended. The interest differential
for the period from January 1, 2003 to December 30, 2003 and for the years
ended December 31, 2002 and 2001 was approximately ($5,853), $259,000 and
$240,000,
respectively. The capitalized fair value of the liability has been
reflected in the line of credit obligation and the change in fair value has
been recorded to interest expense in the financial statements.
8. COMMITMENTS AND CONTINGENCIES
The Company leases its facility and certain equipment under non-cancelable
operating leases that expire on various dates through December 31, 2007.
For financial reporting purposes, rent expense is recorded on the
straight-line basis over the terms of the leases. Accordingly, deferred
rent in the accompanying balance sheets represents the difference between
rent expense accrued and amounts paid under the lease agreements. Rent
expense for 2003, 2002 and 2001 was $944,405, $860,944 and $889,284,
respectively.
Annual future minimum lease payments under noncancelable operating leases
are as follows for the years ended December 31:
(In thousands)
2004 $1,022
2005 1,022
2006 186
2007 94
------------------
Total $2,324
------------------
In January 2003, the Company entered into a Joint Development and
Technology Rights agreement with an entity for purposes of creating new
commodities for commercialization. Under the terms of the arrangement, the
entity will provide product specifications to the Company, who will then
develop, manufacture, and market the goods for customer use. The Company in
turn is liable to the entity for monthly payments of $15,000 through June
30, 2004.
Litigation--The Company is subject to various lawsuits and claims with
respect to matters arising in the normal course of business. Due to the
uncertainty of the ultimate outcome of these matters, the impact on future
financial results is not subject to reasonable estimates. However,
management believes that the final resolution of these matters,
individually and in the aggregate, will not have a material adverse impact
upon the Company's financial position, results of operations or cash flows.
9. INCOME TAXES
The provision for income taxes is as follows for the periods ended:
(In thousands) December 30, December 31, December 31,
2003 2002 2001
----------------- ------------------ ------------------
Current:
Federal $4,145 $3,664 $2,528
State 1,555 968 568
================= ================== ==================
5,700 4,632 3,096
================= ================== ==================
Deferred:
Federal 123 (207) (235)
State (325) (37) (42)
================= ================== ==================
(202) (244) (277)
Total income tax expense ----------------- ------------------ ------------------
$5,498 $4,388 $2,819
----------------- ------------------ ------------------
The components of deferred tax balances are as follows as of:
(In thousands) December 30, December 31,
2003 2002
----------------- ------------------
Deferred tax assets:
Inventory allowance $209 $203
Allowance for doubtful accounts 182 176
Accrued liabilities 193 259
Depreciation 321 188
Other 326 204
----------------- ------------------
Total deferred tax assets $1,231 $1,030
----------------- ------------------
The income tax expense differs from the federal statutory rate because of
the effect of the following items for the periods ended:
December 30, December 31, December 31,
2003 2002 2001
----------------- ------------------ ------------------
U.S. statutory income tax rate 34.0% 34.0% 34.0%
State taxes, less effect for federal benefit 7.0% 5.5% 4.7%
Transaction costs 6.3% -- --
Other 0.2% 0.1% (0.5%)
----------------- ------------------ ------------------
Total effective tax rate 47.5% 39.6% 38.2%
----------------- ------------------ ------------------
10. EMPLOYEE BENEFIT PLANS
Profit Sharing Plan--The Company has a 401(k) profit sharing plan covering
substantially all employees meeting certain requirements. The Company
matches 100% of the employee's contributions up to $750 and can make
additional discretionary contributions. The Company's total contributions
for the period from January 1, 2003 to December 30, 2003 and for the years
ended December 31, 2002 and 2001 were $94,563, $96,435 and $77,496,
respectively.
11. SHARE OPTION PLANS
Executive Stock Option Plan
In February 1996, the Company adopted the Executive Stock Option Plan (the
"Executive Plan"), under which 400,000 shares of common stock are reserved
for issuance upon exercise of options granted by the Company. The Executive
Plan provides for the grant of non-qualified stock options to management
and employees which are issued at the discretion of the Board of Directors
to provide an incentive to key employees. The option price shall not be
less than 100% of the fair market value of the stock on the date of the
grant. Options granted under the Executive Plan generally vest in equal
installments over a five-year period with 20% vesting on each anniversary
and are exercisable for a period of ten years. In the event of a change in
control, all options granted are subject to accelerated vesting provisions.
In accordance with the original terms of the Executive Plan, all options
became immediately one hundred percent vested as a result of the total
stock of the Company being acquired. See Note 14 for further discussion of
the acquisition. Consequently, all options outstanding under the Executive
Plan were exercised and the Executive Plan was terminated.
Sales Organization Stock Option Plan
In April 1996, the Company adopted the Sales Organization Stock Option Plan
(the "Sales Organization Plan"), under which 260,000 shares of common stock
are reserved for issuance upon exercise of options granted by the Company.
The Sales Organization Plan provides for the grant of non-qualified stock
options to key sales organizations and are issued at the discretion of the
Board of Directors. The option price shall not be less than 100% of the
fair market value of the stock on the date of grant. Options granted under
the Sales Organization Plan generally vest in equal installments over a
three-year period with 33-1/3% vesting on each anniversary and are
exercisable for a period of five years. In the event of a change in
control, all options granted are subject to accelerated vesting provisions.
In accordance with the original terms of the Sales Organization Plan, all
options became immediately one hundred percent vested as a result of the
total stock of the Company being acquired. See Note 14 for further
discussion of the acquisition. Consequently, all options outstanding under
the Sales Organization Plan were exercised and the Sales Organization Plan
was terminated. A summary of the Company's stock option activity and
related information is as follows for the periods ended:
December 30, 2003 December 31, 2002 December 31, 2001
----------------------- ------------------------ -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Fixed Options & Warrants Shares Price Shares Price Shares Price
------------- --------- ------------ ----------- ------------ ----------
Outstanding at beginning of year 405,404 $7.68 445,936 $5.40 503,856 $4.74
Granted 13,500 44.70 22,100 36.18 12,200 20.00
Forfeited (4,322) 45.79 -- -- (7,640) 8.30
Exercised (414,582) 8.29 (62,632) 2.50 (62,480) 2.52
------------- --------- ------------ ----------- ------------ ----------
Outstanding, end of period -- -- 405,404 $7.68 445,936 $5.40
------------- --------- ------------ ----------- ------------ ----------
Exercisable, end of period -- -- 276,504 $4.58 437,784 $3.40
------------- --------- ------------ ----------- ------------ ----------
12. NOTES PAYABLE TO SHAREHOLDERS
During 2003 the Board of Directors authorized the Company to purchase
138,368 shares of common stock from officers, employees and affiliates at
prices ranging from $42.12 to $46.41.
All common stock repurchased had no par value. The consideration for such
shares consisted of cash payments totaling $5,527,284, a 6% subordinated
note totaling $556,920 of which half is due July 1, 2004 and half is due
July 1, 2005, a 7% subordinated note totaling $21,264 of which half is due
April 1, 2004 and half is due April 1, 2005 and a 7% subordinated note
totaling $21,336 of which half is due April 1, 2004 and half is due April
1, 2005. Outstanding notes payable, including interest, to related parties
for these transactions as of December 30, 2003 was $608,518.
In May 2002, the Board of Directors authorized the Company to repurchase
5,304 shares of common stock from an affiliate and 10,000 shares of common
stock from an officer. In November 2002, the Board of Directors also
authorized the Company to repurchase shares of common stock from two
officers and an employee of the Company. During 2002, the Company purchased
a total of 51,536 shares of its outstanding common stock from officers,
employees and affiliates at prices ranging from $32.00 to $42.12
All common stock repurchased had no par value. The consideration for such
shares consisted of cash payments totaling $1,850,700, a 7% subordinated
note totaling $74,828 of which half is due June 1, 2003 and half is due
June 1, 2004 and a 7% subordinated note totaling $16,224 of which half is
due July 1, 2003 and
half is due July 1, 2004. Outstanding notes payable, including interest, to
related parties for these transactions as of December 30, 2003 and December
31, 2002 were $46,314 and $92,646, respectively.
In November 2001, the Board of Directors authorized the Company to
repurchase 68,468 shares of common stock from an officer of the Company in
addition to the 940,000 shares authorized by the Board of Directors in
March 2000. During 2001, the Company purchased a total of 85,440 shares of
its outstanding common stock, consisting of 4,628 shares, no par value,
purchased at $19.60 per share in April 2001, 12,344 shares, no par value,
purchased at $19.60 per share in August 2001, and 68,468 shares, no par
value, purchased at $30.75 per share from an officer of the Company in
December 2001. The consideration for such shares consisted of cash payments
totaling $566,265, notes payable of $90,720, a $842,156 subordinated note
with no stated interest due April 1, 2002, $96,788 in 9% notes of which
half is due August 15, 2002 and half is due August 15, 2003 and two 7%
subordinated notes of $421,078 each, of which half is due January 1, 2003
and half is due January 1, 2004. One of the subordinated notes of $842,156
was paid off on April 1, 2002. Outstanding notes payable, including
interest, to related parties for these transactions as of December 30, 2003
and December 31, 2002 were $428,365 and $906,377, respectively
13. NOTES RECEIVABLE FROM RELATED PARTIES
On November 5, 2003, the Company advanced to a certain officer who is also
a shareholder the sum of $500,000 under a 1.49% promissory note due
February 11, 2004. The outstanding note receivable, including interest, as
of December 30, 2003 was $501,021.
On November 20, 2003, the Company's Board of Directors resolved to amend
the stock option plans to allow holders of Company stock options, including
executive officers, directors, affiliates and employees to use full
recourse promissory notes in the total amount of $5,824,886 to exercise
stock options in connection with the acquisition of the Company on December
30, 2003. On December 29, 2003 thirty-five notes were issued with interest
at 1.68% and due December 29, 2004. The outstanding notes receivable,
including interest, as of December 30, 2003 total $5,824,886.
On December 29, 2003, the Company loaned $1,792,371 to certain executive
officers and directors in conjunction with the acquisition of the Company
on December 30, 2003. On December 29, 2003 six notes were issued with
interest at 1.68% and due on December 29, 2004. Outstanding notes
receivable, including interest, to related parties for these transactions
as of December 30, 2003 total $1,792,459.
On February 6, 2001, the Company's Board of Directors resolved to loan the
sum of $450,000 to each of its seven executive officers who are also
shareholders, a total of $3,150,000, for the purpose of purchasing common
stock of the Company directly from one of its directors. In April 2001, the
Company advanced $270,000 to each of the seven officers under a 5.0%
promissory note due April 1, 2006. In January 2002, the Company advanced
the remaining $180,000 to each of the seven officers in accordance with the
terms of the original promissory notes except for a change in the interest
rate to 3.9%. The loans are secured by the shares purchased with the loan
proceeds. In March 2001, the Company advanced to an officer, who is also a
shareholder, $500,000, which was paid off in April 2001. In September 2001,
the Company also advanced $34,531 to a shareholder based on a promissory
note due September 6, 2003. Outstanding notes receivable, including
interest, to related parties for these transactions as of December 30, 2003
and December 31, 2002 were $3,170,184 and $3,184,696, respectively.
In 2000, the Company advanced to certain officers $105,000 under a 6.0%
promissory note due March 1, 2003, $32,000 under an 8.78% promissory note
due July 1, 2001, which was paid off in 2001, and $25,000 under a 6.01%
promissory note due March 1, 2003. The notes for $105,000 and $25,000 were
amended January 2002 to reflect an interest rate of 2.45% and a maturity
date of January 1, 2005. Outstanding notes receivable, including interest,
to related parties for these transactions as of December 30, 2003 and
December 31, 2002 were $130,000 and $130,000, respectively.
In 1998, the Company advanced to another officer, who is also a
shareholder, $50,000 for which the officer signed an 8.5% promissory note
due on January 6, 2002. The promissory note was amended in February 2003 to
extend the due date to February 3, 2006 and to reduce interest rate to
4.25% from February 3, 2003 through the remainder of the term of the note.
As of December 30, 2003 and December 31, 2002, $73,503 and $71,192,
respectively, were outstanding on the note, including interest.
In 1997, the Company advanced to an officer, who is also a shareholder,
$50,000. In November 1997, the officer signed an 8.5% promissory note for
the amount previously advanced to him. The note was due on November 24,
2001. The outstanding promissory note was amended in February 2003 to
extend the due date to February 3, 2006 and to reduce the interest rate to
4.25% from February 3, 2003 through the remainder of the term of the note.
As of December 30, 2003 and December 31, 2002, $74,004 and $71,692,
respectively, were outstanding on the note, including interest.
In 1995, the Company advanced to an officer, who is also a shareholder,
$24,000. A promissory note with an initial interest rate of 8.5%, that
varies with the Company's line of credit rate, was signed and does not have
a specified due date. As of December 30, 2003 and December 31, 2002,
$10,192 and $14,292, respectively, were outstanding on the note, including
interest.
14. ACQUISITION OF THE COMPANY
At the close of business on December 30, 2003, a subsidiary of Orthofix
International N.V. ("Orthofix") completed the acquisition of the Company.
The acquisition was completed pursuant to an acquisition agreement among
Orthofix, Trevor Acquisition, Inc., an acquisition subsidiary of Orthofix
("Trevor"), the Company and a representative of the shareholders of the
Company. In the acquisition, Trevor merged with and into the Company, with
the Company being the surviving corporation of the merger and becoming an
indirect wholly owned subsidiary of Orthofix. The purchase price for the
acquisition was approximately $159 million after closing adjustments and
after valuing the Orthofix common stock issued in the transaction at
current trading price at the time of closing.
In accordance with this acquisition, the following balances per the
Company's December 30, 2003 balance sheet were settled at closing:
(In thousands)
Notes receivable from related parties $11,519
Notes payable to shareholders $1,066
Line of credit $8,800
In conjunction with this acquisition, the Company incurred acquisition
costs on behalf of its shareholders of approximately $2.1 million, recorded
as general and administrative expense for the period from January 1, 2003
to December 30, 2003.