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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES E EXCHANGE ACT OF 1934
For the transition period from _____________ to ________________
Commission file number 0-19688
DESTRON FEARING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 84-1079037
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
490 Villaume Avenue, South St. Paul, MN 55075
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (612) 455-1621
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
None None
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Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 Par Value
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(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. ( )
The aggregate market value of the voting stock of the Registrant, as of
November 28, 1997, computed by reference to the closing sale price of the voting
stock held by non-affiliates on such date, was approximately $26,369.000.
As of December 29, 1997, there were outstanding 13,293,982 shares of Common
Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the issuer's definitive Proxy Statement for the Annual
Meeting of Stockholders to be held in 1998 have been incorporated by reference
into Part III of this Report. See the Cross Reference Sheet set forth on page
(ii).
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DESTRON FEARING CORPORATION
CROSS REFERENCE SHEET
Between Items in Part III
of Form 10-K and
Proxy Statement
Pursuant to Paragraph G-4 of General Instructions to Form 10-K
Item Number and Caption Section Headings in Proxy Statement
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Item 10 Directors and Executive Officers Election of Directors;
of the Registrant Compliance with Section 16(a)
Item 11 Executive Compensation Election of Directors
Item 12 Security Ownership of Certain Beneficial Ownership of
Beneficial Owners and Management Common Stock
Item 13 Certain Relationships and Related Election of Directors
Transactions
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DESTRON FEARING CORPORATION
Table of Contents
Page
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Item 2. Properties . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Item 3. Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . 13
Item 4. Submission of Matters to a Vote of Security Holders . . . . . . 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 6. Selected Financial Data . . . . . . . . . . . . . . . . . . . . 15
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations . . . . . . . . . 15
Item 7A. Quantitative and Qualitative Disclosures about Market Risk . . 15
Item 8. Financial Statements and Supplementary Data . . . . . . . . . . 15
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure . . . . . . . . . . . . . . . . . . . 15
PART III
Item 10. Directors and Executive Officers of the Registrant . . . . . . 15
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . 15
Item 12. Security Ownership of Certain Beneficial Owners
and Management . . . . . . . . . . . . . . . . . . . . . . . . 15
Item 13. Certain Relationships and Related Transactions . . . . . . . . 16
PART IV
Item 14. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . 16
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PART I
ITEM 1. BUSINESS
Certain statements in this Annual Report on Form 10-K constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act"), and Section 21B of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). Any
statements contained herein or incorporated herein that are not statements of
historical fact may be deemed to be forward-looking statements. Without
limiting the foregoing, the words "believes," "anticipates," "plans," and
"expects" and similar expressions are intended to identify forward-looking
statements.
BACKGROUND AND OVERVIEW
The Company was incorporated in 1984 as a Canadian corporation (subsequently
changed to a Delaware corporation on October 1, 1993) under the name Destron
Technologies, Inc. In 1987, Destron acquired the assets of Identification
Devices, Inc. (IDI) of Boulder, Colorado, a manufacturer of radio frequency
identification (RFID) products and a supplier to Destron. Concurrent with such
acquisition, Destron changed its name to Destron/IDI, Inc.
Fearing Manufacturing Co., Inc. ("Fearing"), a wholly-owned subsidiary of
Destron, manufactures identification and pesticide ear tags for livestock.
Fearing's business was founded in 1945 and incorporated on September 30, 1955 in
the State of Minnesota. Fearing became a subsidiary of Destron pursuant to a
merger effective on November 12, 1993.
On August 2, 1994, the shareholders authorized the Company to change its name to
"Destron Fearing Corporation." (As used hereinafter, the term "Destron" or the
"Company" shall mean Destron Fearing Corporation and Fearing Manufacturing Co.,
Inc. on a consolidated basis.)
Destron manufactures animal identification systems and devices. Its products
can be divided into two classes, Radio Frequency Identification (RFID) devices
and visible plastic tags used mainly for production animals. Where the two
classes of devices are used together, such as an ear tag which incorporates a
transponder, the device is treated as an RFID device. Some of the RFID products
have other applications outside the animal market, but such uses are incidental
for the strategic focus of the Company.
ANIMAL ID MARKET SEGMENTS
Destron's animal ID market segments and their corresponding percentages of
Destron's total revenues for the fiscal years ended September 30, 1997, 1996 and
1995 consist of products for the identification of the following:
1997 1996 1995
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Livestock 45% 50% 34%
Companion animals 30 32 50
Fish, wildlife and
laboratory animals 25 18 16
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100% 100% 100%
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The livestock segment consists mainly of visual tag sales, although RFID
products are expected to become increasingly important in future years. The
other segments currently consist primarily of RFID product sales. Sales of
Destron products outside the United States have been primarily in Europe.
Export sales as a percentage of total revenue were 30% for fiscal 1997, 32% for
fiscal 1996 and 11% for fiscal 1995. Destron generally sells its products in
United States dollars although it is reviewing the potential for sales in
certain local currencies in the future. See "Item 8: Financial Statements and
Supplementary Data" for further information regarding export sales by geographic
area.
RFID PRODUCTS
The RFID products that Destron currently manufactures and markets to the animal
identification industry consist principally of transponders, portable readers,
stationary readers, and transponder injecting devices.
TRANSPONDERS
The identification devices manufactured by Destron are passive and operate at
low radio frequencies, below 500 kHz. Operating range is limited by the power
range limitations permitted by regulators, generally 50 centimeters (20 inches)
or less. Destron manufactures permanently programmed transponders. The
programmed device contains a custom integrated circuit ("IC") whose
identification code is inscribed during the manufacturing process. Transponders
for animal ID generally contain the custom IC and a tuned radio frequency
circuit consisting of a small inductor and capacitor. Destron's transponders
for animal ID are packaged in sealed glass rods ranging in size from 11 to 28
millimeters in length and from 2.1 to 3.5 millimeters in diameter and are
compatible with subcutaneous injection in animals. Other packaging designs are
used for non-injected applications related to animal markets. The distribution
prices of each of the Company's transponders range from $3.00 to $9.00.
"INTELLIGENT" PORTABLE READERS
Transponders are powered and their identification codes are read by a variety of
scanning devices (readers). Portable readers are battery operated and easily
hand-carried. The portable readers manufactured by Destron are all based on
similar electronic designs and differ principally in the hardware and software
options offered and packaging design. The resulting identification code is
displayed on a video display or can be relayed via computer interface to other
equipment. Portable readers range in price from $175 to $225.
"INTELLIGENT" STATIONARY READING SYSTEMS
For fish, farm animals, and certain other applications, it is necessary to read
the codes transmitted by the transponders implanted into animals as they pass by
or through a fixed scanner. These stationary reading systems manufactured by
Destron may take the form of a gate, a panel, a loop, or other configuration.
These systems are usually linked to a computer, via sophisticated communications
facilities. Custom installations are the norm, but modular standardization is
enlarging the scope of applications of this type of system at reasonable costs.
Prices vary from $2,000 to $20,000.
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INJECTING SYSTEMS
In order to identify animals in a secure, unalterable manner, the transponder
devices require subcutaneous injections by means of a hypodermic-type injector.
Destron currently supplies a variety of injecting devices intended for a wide
range of animal applications, including livestock, pets and laboratory animals.
The Company purchases the injection devices from outside suppliers. The prices
of the Company's injecting systems range from $3.00 to $55.00.
POTENTIAL NEW PRODUCTS
The Company follows a clear policy of requiring either joint development
projects or very strong market potential before committing funds for new
products. In this regard, the Company not only works closely with major new
users, but also maintains close liaisons with users, certain potential joint
developers, and the ongoing work of the International Standards Organization
('ISO') in anticipating market needs. Destron has development projects underway
in three countries with three species of livestock, with the expectation of
being able to offer complete new systems on a global basis within one to two
years. Success in any one of these would place Destron in a leading position in
the world market for livestock RFID systems. All of the basic technology is
available within the Company. No assurance can be given that any of these
projects will be successful.
VISUAL IDENTIFICATION PRODUCTS
Destron also manufactures and sells identification and insecticide ear tags for
herd animals, as well as various equine products.
IDENTIFICATION EAR TAGS
Identification ear tags manufactured by the Company are numbered plastic tags
that hang from the ear of farm animals and are used for visual identification.
Animals marked in this manner generally include beef and dairy cattle, hogs and
sheep. The purpose of this identification includes tracking of dairy
production, weight gain in beef cattle and hogs, identification of animals
requiring feed supplements, maintenance of animal health records and farm
inventory control. The Company holds a patent, which expires in February 2002,
on the applicator that applies the ear tag, and a patent, which expires in
December 2000, on an antiseptic coating that is placed on the stud that holds
the ear tag in the animal's ear. The antiseptic coating is marketed under the
trade name Infecta-Guard-TM-. The Company currently offers 14 different styles
of identification products and seven to nine colors in each style. Fearing
began manufacturing insecticide ear tags in 1984 and also manufactures the studs
used to attach these ear tags to the animal's ear. The Company supplies such
devices to the largest insecticide ear tag distributor in the United States.
Ear tags are typically packaged in quantities of 25, and these packages sell for
$7.50 to $30.00, depending upon the size and configuration of the tags.
NEW ELECTRONIC EAR TAGS
As a result of the combination of the technologies of Destron and Fearing, an
electronic ear tag management system developed by Destron was introduced in 1994
and patented in 1995. These ear tags are read using the intelligent readers
described above. The electronic ear tags and intelligent readers described
above are being sold to system integrators and large corporate farms. These
systems give the farmer "source data entry" directly in the barn or on the range
and, as a
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result, offer the opportunity to improve management of the farm's resources,
improve overall productivity, reduce manual data entry errors and allow direct
connection to proven herd management systems. Destron expects to continue the
development and marketing of this electronic ear tag. No assurance can be given
that this market will develop or that Destron will be successful in selling this
electronic ear tag. Electronic ear tags have a distribution price ranging from
$3.00 to $5.00 each.
MARKETING OF RFID PRODUCTS
Destron serves three major markets. The companion animal market, which exists
mainly in Europe, requires portable low-cost readers, injectable transponders to
ISO standards and a strong distribution network to associations, veterinarians,
and others. In the fisheries market, which exists principally in the United
States, Destron's strategy is to use a very sophisticated, permanently installed
reading system, special injectable transponders, ongoing technical support and
development, and a variety of lesser services and products. Destron's strategy
in the livestock market is to use "Value Added Resellers" ("VARs") who combine
devices and software to install and service complete management information
systems in farms. The Destron transponders are of several types, and are either
injectable or external. Additionally, Destron supplies users of equipment,
usually through VARs, in a wide variety of industries. The most important of
these is the laboratory animal market served by Bio Medic Data Systems, Inc., a
highly sophisticated VAR and marketer with several patents and its own
manufacturing capability. Most of the distributors and VARs have exclusive
territories and markets with annual commitments. Certain major clients with
special needs are served directly.
COMPANION ANIMALS. Dogs, cats and pets of all kinds present risk of loss,
theft, disease transmission, and illness. In Europe, mainly because of the
threat of disease transmission and the suffering of stray animals, an increasing
number of countries require the identification of all companion animals.
Moreover, the use of RFID is increasingly either a recommended option or the
only acceptable method. Normally, the identification is done by a veterinarian,
and Destron has developed excellent marketing partnerships to serve this
particular marketing avenue. Unlike the "volunteer" markets, such as the United
States, where pet owners often do not use RFID to protect their companion
animals, compliance rates in Europe are over 75% of dogs identified where
legislation is in effect. Although this business is not seasonal, it is
irregular because purchases for official campaigns to identify dogs are often
controlled by local governments.
Destron has appointed several exclusive distributors worldwide to serve this
developing market for companion animal ID. Each distributor maintains a
relationship with a central computerized registry serving its franchised country
or countries. These registries link the animal's unique ID number to
information on its owner, providing electronic retrieval networks for the return
of lost animals.
In Europe, companion animal market distribution is effected through exclusive
distributor arrangements with two veterinary product companies -- AnimalCare
Limited ("AnimalCare") in the United Kingdom and Merial (formerly known as Rhone
Merieux) in certain other European countries. In January 1995, an operating
unit of Schering-Plough Corporation ("Schering-Plough") became the exclusive
distributor in the United States for Destron's electronic identification
products for companion animals.
Under its distribution agreement with Destron, AnimalCare is responsible for
soliciting purchasers of Destron's animal ID products in the United Kingdom and
for all advertising, while Destron is obligated to provide products to
AnimalCare and to provide general, technical,
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marketing and advertising support. AnimalCare must meet certain minimum
purchase commitments to maintain its distribution rights, revised annually. The
minimum purchase obligations were achieved in fiscal years 1997, 1996 and 1995.
AnimalCare has established the companion animal infrastructure of Destron
readers and sells Destron's products to key veterinary clinics. As a result,
Destron's products have established strong name recognition and veterinary/
shelter acceptance in the United Kingdom. Government approvals are
not required in the United Kingdom for distribution of ID products for companion
animals.
In 1997, Rhone Merieux merged with Merck Sharpe, Dohme to form Merial,
resulting in a much larger firm which provides a wider range of animal products.
Merial sells the Destron products under its own name, "INDEXEL."
Merial is the world's largest animal health companies and is the largest vaccine
marketer in Europe. It markets Destron's products in connection with its own
vaccines through its companion animal distribution channels. Merial also is
establishing placement of Destron readers at the veterinary/shelter level and
has undertaken a multicountry promotional effort through its direct sales force
in continental Europe. Under its distribution agreement, Merial is responsible
for obtaining necessary government approvals for distribution of the products.
Destron's initial five-year agreement with Merial was renewed in December 1990
for an additional term of 15 years ending February 28, 2005. Merial failed to
meet minimum purchase requirements under its distribution agreement for the
fiscal periods ended September 30, 1997, 1996 and 1995. Destron subsequently
waived these requirements in view of the market disturbance caused by the change
to the ISO technology and replacement of all readers in use.
In the United States, Schering-Plough distributes and markets the companion
animal permanent identification products manufactured by the Company.
Statistics from the United States Humane Society indicate that up to 20 million
pets stray or are abandoned each year, and up to 13 million are euthanized
annually. As a result, a large potential market exists for the Company's
products. However, the domestic market has developed slower than the
international markets because, at the present time, companion animal electronic
identification is largely non-mandated in the United States.
Schering-Plough has continued its marketing efforts, which include campaigns
aimed at veterinarians and animal shelters, as well as those focusing directly
on pet owners as the ultimate consumers. Various municipalities also are being
targeted, since government-mandated identification is an important means for
achieving increased product placement. There can be no assurance of any success
in capitalizing on these market opportunities.
FISH AND WILDLIFE. The tagging of fish, especially salmon, has been conducted
for many years for identification in migratory studies and other purposes.
Destron's injectable transponder has been accepted as a safe, reliable
alternative to traditional identification methods because the fish can be
identified without capturing or sacrificing the fish.
To date, several million Destron transponders have been sold for implanting into
salmon to monitor their passage through the hydroelectric diversion systems of
the Pacific Northwest. In fiscal 1997, the United States Department of Energy
named the Company as its exclusive supplier of readers and microchips for a
five-year period in a program to track salmon and steelhead trout migrating
through hydroelectric dams in the Pacific Northwest. The Company expects
revenue from this contract to exceed $8.0 million over the five-year period.
This business is entirely seasonal and is related to the timing of the salmon
downstream runs.
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LIVESTOCK. Through fiscal 1997, most sales of Destron's transponders for use
with livestock have been outside of the United States. Countries that export
significant quantities of meat or animals have recognized the potential uses of
RFID to trace diseases or drug residues which could adversely affect sales of
their products. An RFID system works well for this purpose because the animals
are permanently identified with an encoded, injected transponder within a few
weeks of birth and retain this identification through the point at which they
are weighed and graded. Injection is generally considered to be the only
feasible method of providing unalterable, complete life-cycle identification
with reliability close to 100%.
In fiscal 1996, the ISO published a new standard for animal ID products that
includes Destron's products through a two-year transition period. The Company
completed development of the new ISO qualified products and began shipments of
these products during fiscal 1996. The cost to Destron to conform its products
to the new ISO standard has been significant.
Destron believes that major sales of identification systems for livestock will
likely be achieved when a substantial stimulus to the use of a system is
provided by a government or some association. For example, this may occur if a
government requires that all animals of a certain type be identified by RFID
methods or if a marketing organization, breed association or similar group
conditions a right, such as participating in a market or obtaining breed status
certification, upon identifying the animals by an RFID system. Portions of
these markets will be seasonal because they will relate to the season of birth
in the various species.
In the fiscal year ended 1996, the United States Department of Agriculture
("USDA") and the United States Food and Drug Administration ("FDA") approved the
use of transponders for injection into livestock in the United States thereby
permitting Destron to sell transponders for use in the United States livestock
market. The Company plans to leverage its traditional core business of visual
identification products in domestic and overseas markets to promote permanent
electronic identification of livestock. As the size of farms has increased,
automated permanent individual identification has become a necessary tool for
managing large livestock herds. With over four billion livestock animals
worldwide, the Company believes that implantable electronic identification
devices will be used in an increasing number of programs to manage herds, to
reduce the loss of livestock, to implement feeding programs, and to track,
control and eradicate diseased livestock.
Destron's distributors are primarily responsible for providing information and
assistance to governmental agencies in the countries that they service in order
to facilitate the adoption of RFID programs in which Destron's products can
participate. Destron actively cooperates with its distributors in all such
efforts.
MARKETING AND DISTRIBUTION OF VISUAL IDENTIFICATION PRODUCTS
Destron's visual identification products are sold through a long-established
network of approximately 200 distributors. Fearing assists distributors with
their inventory planning through a sophisticated computer network that monitors
inventory levels and prepares reordering documents. Fearing bar codes all of
its products, on a custom basis if requested, to enable distributors and dealers
to control their inventories with scanners. The business is highly seasonal,
concentrated between November and April.
PRODUCT DEVELOPMENT
Destron has developed substantially all of its own products internally, and it
presently maintains
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an internal research and development department. This department is responsible
for all new product development as well as for ongoing product technical support
and maintenance. Destron supplements its design staff with several consulting
and contract design engineering firms that specialize in areas that Destron
considers outside its core technology focus. Contracted design work has
included mechanical packaging, software development, and drafting/documentation
support. Destron uses computer-based design technologies for electrical and
mechanical design as well as for record keeping and documentation control.
Research and development expenses for the Company were $870,000, $955,000 and
$1,038,000 for the years ended September 30, 1997, 1996 and 1995, respectively.
SIGNIFICANT CUSTOMERS
During the fiscal years ended September 30, 1997 and 1996, Merial, a distributor
of Destron, accounted for 16% and 18% of the Company's sales, respectively.
Also, during fiscal 1997 and 1996, Pacific States Marine, a customer who uses
the Company's product to identify fish, accounted for 10% of the Company's
sales. During the fiscal year ended September 30, 1995, Schering-Plough
accounted for 41% of the Company's sales. No other customer accounted for 10%
or more of sales in these years.
BACKLOG
The Company generally produces goods to fill orders received and anticipated
orders based on distributors' forecasts, and it also maintains inventories of
finished goods to fill customer orders with short lead times. As a result, the
Company has no significant backlog of orders, and any such backlog is not
necessarily indicative of future sales.
COMPETITION
RFID
In the fisheries market, Destron enjoys a significant lead in technology as
compared to its competitors, including Texas Instruments. Destron's proposal to
replace all existing installations under the control of the authority of the
U.S. Department of Energy was accepted. It also won the right to supply
transponders to the related users for a number of years, the largest single user
of fisheries systems in the world. The competitions were based upon product
availability, performance and price.
In the companion animal market, there are two competitors, one in Europe and one
in the United States. Other competitors are expected to enter the European
market in 1998. Because Europe requires that all transponders comply with ISO
standards, competition is based on features, distribution arrangements and
price. In the United States, there is no standardization thus competition is
based primarily on distribution arrangements.
In the livestock market, Destron has strong competition from two other firms,
both of which are well-financed and are effective marketers. To date, the
market has not yet adopted the ISO standards, thus, competition is based on
features, total system price, and distribution arrangements between incompatible
systems. However, the market is relatively small at present, and it is moving
toward standardization required for official disease control and residue
traceback programs. The Company believes that pricing of systems components
will become much more critical as a basis of competition. The Company plans to
compete by providing ISO compliant systems and components at relatively low
costs.
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VISUAL IDENTIFICATION
The ear tag industry, which includes the insecticide ear tag segment, is highly
competitive. Destron believes that it effectively competes with other
manufacturers based primarily on its network of qualified and responsible
distributors and its quality customer service approach.
PATENTS AND TRADE NAMES
Destron considers its patented technologies as important strategic and
competitive assets in the RFID market for animal identification. Four key U.S.
patents in RFID technology (Milheiser No. 5,041,826 - expiration August 20,
2008, Milheiser No. 4,730,188 - expiration March 8, 2005, Walton No. 4,546,241 -
expiration October 8, 2003 and Taylor, Koturov, Bradin and Loeb No. 5,211,129 -
expiration May 18, 2010) provide Destron with protection for its product
designs. Destron's U.S. Patent No. 5,211,129 by Taylor et al. is an improved
transponder for transmitting an identification signal for an animal. The
transponder is sufficiently miniaturized and encapsulated in glass to be
syringe-implantable in the animal, thus avoiding the necessity of surgical
procedures. This transponder uses a coil to receive an interrogation signal and
then transmits an identification signal in response to interrogation. The
transponder receives the energy required for transmission from the interrogation
signal and transmits the identification signal immediately upon commencement of
the interrogation signal. The Company considers this patent to have significant
value.
Destron has also applied for international patent protection in jurisdictions
where it intends to focus its marketing efforts. Patents have been granted, or
are pending, in Canada, Japan, New Zealand and European countries for the
technologies of the Milheiser patents and the syringe injectable transponder.
Destron continues to develop new products with patentable technologies in order
to further protect its business interests. There can be no assurance, however,
that the protection afforded by these patents will provide Destron with a
competitive advantage or that Destron will be able to successfully assert its
intellectual property rights in any infringement action. In addition, there can
be no assurance that Destron's current products and products under development
will not infringe any patent or other rights of others. Destron is currently
involved in litigation relating to certain of its patents. See "Item 3. Legal
Proceedings."
Destron holds a patent, which expires in February 2002, on the applicator which
applies the ear tags to the animal, and a patent, which expires in December
2000, on an antiseptic coating which is placed on the stud which holds the ear
tag to the animal's ear. The antiseptic coating is marketed under the trade
name Infecta-Guard-TM-.
OPERATIONS
The Company presently purchases its transponders solely from a European
manufacturer who has the capability to produce up to 10 million transponders per
year. The Company expects to continue the relationship with this supplier,
although continuance of such purchases depends upon the competitiveness of the
price, quality and delivery of the products purchased. The Company presently is
evaluating additional sources for the purchase of transponders.
Destron supports its RFID manufacturing by using several outside contractors.
These suppliers, located primarily in Minnesota, produce and repair some models
of the Company's electronic readers and provide needle assembly, packaging and
sterilization services for the sale of transponders.
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Manufacturing of visual identification products is done in the Company's
facility located in South St. Paul, Minnesota and is supported by subcontract
plastic injection molders located in the Minneapolis-St. Paul metropolitan area,
Detroit, Michigan, and Chicago, Illinois.
GOVERNMENT REGULATION
Many of the products manufactured by Destron are subject to compliance with
government agency requirements. Destron's readers are tested for compliance
with the FCC Part 15 Regulations for Electromagnetic Emissions. When
appropriate, products are also tested by independent product safety testing
organizations to ensure that user injury hazards do not exist with respect to
the equipment's operation and storage. In fiscal 1996, the USDA and the FDA
approved the use of transponders for injection into livestock, thereby
permitting Destron to sell transponders for use in the United States livestock
market. Heretofore, most sales of Destron's transponders for use with livestock
have been outside of the United States. The Company's current efforts to
address the U.S. livestock market are principally based upon the use of
electronic ear tags which do not require FDA approval. The Company believes
that electronic ear tags and implantable electronic identification devices will
be used in an increasing number of programs to manage herds, to reduce the loss
of livestock, to implement feeding programs, and to track, control and eradicate
diseased livestock. No FDA approval is required for transponders injected into
fish because the transponders are injected into the fishes' abdominal cavities,
which are discarded when the fish are processed. As a result, the transponders
do not appear in any part of the fish that is used as food.
Destron's products are also subject to compliance with foreign government agency
requirements. Destron's contracts with its distributors generally require the
distributors to obtain all necessary regulatory approvals from the governments
of the countries into which they sell Destron's products. Destron supports the
distributors' regulatory compliance efforts by making any technical changes to
the products that may be required.
Fearing insecticide products are approved by the EPA and produced under EPA
regulations. The Company strictly controls the manufacture of these products
and prepares and maintains all necessary registration documents.
The Company believes that it complies with all environmental regulations and
this compliance does not have a material effect on the Company's capital
expenditures, earnings or competitive position. Further, it is expected that
future compliance will not have a material effect on future fiscal years'
operating results.
EMPLOYEES
As of September 30, 1997, Destron employed 67 full-time and 21 part-time
individuals, 26 of whom are represented by the United Food and Commercial
Workers Union. The Company has not experienced any work stoppages. Destron
believes that its employee relations are good.
ITEM 2. PROPERTIES
The Company owns one facility of approximately 25,000 square feet in South St.
Paul, Minnesota. The facility consists of the corporate headquarters in
approximately 5,000 square feet of office space, approximately 10,000 square
feet of manufacturing space, and approximately 10,000 square feet of
distribution space. All of this space is fully utilized.
-12-
<PAGE>
Manufacturing demand for visual identification products ranges from a seasonal
low of 50% of capacity to a seasonal high of 100%, which is accomplished through
two work shifts and weekend production. RFID products, with a more stable
demand, utilize approximately 40% of the Company's production capacity. Demand
can reach 100% of capacity, however, when initial orders are filled for new,
incremental customers.
ITEM 3. LEGAL PROCEEDINGS
In November 1993, the Company initiated a lawsuit for patent infringement
against three competitors in the U.S. District Court in Colorado. (The patent
involved is No. 5,211,129, which relates to the Company's injectable transponder
technology.) At a hearing on November 12, 1993, the Court found that it did not
have jurisdiction in Colorado over two of the competitors and dismissed the
Colorado case against them without prejudice. The Court suggested that the
third competitor may be an infringer on the patent, but did not order the
temporary injunction requested by the Company.
On December 1, 1993, the two dismissed competitors commenced an action against
the Company in U.S. District Court for Southern Illinois requesting actual
damages of $20,000,000. This action was subsequently transferred to the U.S.
District Court of Colorado. In the suit, the plaintiffs sought to invalidate
the above-described patent of the Company and alleged unfair competition,
violation of U.S. antitrust laws, interference with business relationships and
abuse of process due to the actions the Company had allegedly taken in
obtaining, announcing and enforcing its patent rights against the plaintiffs.
The trial in the litigation commenced on January 8, 1996. On January 29, 1996,
the jury in the trial returned a verdict in favor of the Company and found that
the defendants had willfully infringed on the Company's patent and awarded
damages of $444,000, including prejudgment interest. The defendants have
appealed the judgment against them and the Company cross-appealed the failure of
the court to increase Destron's damages. On July 24, 1997, the Court of Appeals
for the Federal Circuit handed down its decision in the appeal. The decision of
the Court of Appeals affirmed the trial court's judgment, holding the Company's
patent is valid and was willfully infringed by the competitors. In addition,
the issue of inequitable conduct was remanded to the trial court for further
proceedings as to the Company's intent in prosecuting the patent application
before the United States Patent Office.
On November 7, 1997, the U.S. District Court of Colorado, on remand on the issue
of inequitable conduct, found that the Company's patent was enforceable because
of the lack of clear and convincing evidence of inequitable conduct before the
U.S. Patent and Trademark Office.
Further, during the pendency of the appeal, the Company pursued a contempt
action against the defendants for willful violations of the District Court's
permanent injunction. On November 7, 1997, the District Court found the
defendants in willful contempt of the permanent injunction and awarded the
Company double damages, amounting to $33,000, as well as attorney fees and
costs.
On December 17, 1996, three competitors filed a lawsuit against the Company and
its United States distributor, Schering-Plough, in the United States District
Court for the District of Minnesota. The plaintiffs alleged that the defendants
participated in unfair competition, breached an oral contract and infringed on
three of the plaintiffs' United States patents. On January 24, 1997, the
plaintiffs withdrew this lawsuit in its entirety.
-13-
<PAGE>
On April 21, 1997, four plaintiffs (including the three competitors identified
in the foregoing paragraph) filed a lawsuit against the Company and
Schering-Plough and another of the Company's competitors in the United States
District Court for the District of Minnesota. The plaintiffs allege that the
defendants participated in unfair competition, breached an oral agreement and
infringed on three of the plaintiffs' United States patents and requested that
the Court award compensatory and treble damages of an unspecified amount.
On May 16, 1997, the plaintiffs amended the lawsuit and, in their complaint as
amended, the plaintiffs allege patent infringement, false advertising, unfair
competition and attempted monopolization on the part of the Company, among other
matters, stemming from the ISO standards. While management of the Company is
unable, at this time, to estimate the potential impact of this litigation, the
Company and its legal counsel believe that its products do not infringe any
valid asserted claims of the patents owned by the plaintiffs, that the false
advertising and unfair competition claims are without merit, that the Company is
likely to prevail on the attempted monopolization claim, and that the ultimate
outcome of this litigation will not have a significant adverse impact on the
Company's future financial position, cash flows or result of operations.
However, any litigation has an inherent risk of loss at trial, and there can be
no assurance of the ultimate outcome of this lawsuit. Furthermore, the costs of
litigation could be substantial.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1997 ended September 30, 1997 or during the period from that
date to the date of this Annual Report of fiscal 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Fiscal Year Ended Fiscal Year Ended
Quarters September 30, 1997 September 30, 1996
-------- ------------------ ------------------
High Low High Low
------------------ ------------------
First $4.19 $2.13 $5.00 $2.75
Second $3.88 $2.00 $5.25 $3.25
Third $2.50 $1.38 $4.44 $2.94
Fourth $2.50 $1.25 $4.63 $1.94
The above quotes for the fiscal years ended September 30, 1997 and 1996
represent the high and low prices on The Nasdaq SmallCap market that were
provided by Nasdaq. As of December 15, 1997, were 364 holders of record.
DIVIDEND POLICY
Certain of the Company's debt agreements prohibit the payment of dividends. To
date, Destron has not paid any cash dividends on its Common Stock, and it does
not anticipate doing so in the foreseeable future.
-14-
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The information required by Item 6 is incorporated by reference to the
information included in the Company's Annual Report to Stockholders on page
A-4of Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The information required by Item 7 is incorporated by reference to the
information under the caption "Management's Discussion and Analysis or Plan of
Operation" beginning on page A-1 of Exhibit 13.1 hereto, which consists of
portions of the Company's Annual Report to Shareholders for the year ended
September 30, 1997.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of September 30, 1997, the Company did not have any market risk exposure
categories, as defined in Item 305 of Regulation S-K, and therefore, no related
market risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by Item 8 is incorporated by reference to the
consolidated financial statements and Report of Independent Public Accountants
thereon contained on pages A-6 to A-21 and A-5 of Exhibit 13.1 hereto, which
consists of portions of the Company's Annual Report to Shareholders for the Year
ended September 30, 1997.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with the Company's principal
independent public accountant during the Company's last two fiscal years or
since the end of the Company's last fiscal year to the date of this report.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by Item 10 is incorporated by reference to the
information under the caption "Election of Directors" of the Company's Proxy
Statement for its 1998 Annual Meeting of Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Item 11 is incorporated by reference to the
information under the caption "Election of Directors" of the Company's Proxy
Statement for its 1998 Annual Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by Item 12 is incorporated by reference to the
information under the caption "Beneficial Ownership of Common Stock" of the
Company's Proxy Statement for its 1998 Annual Meeting of Shareholders.
-15-
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference to the
information under the caption "Election of Directors" of the Company's Proxy
Statement for its 1998 Annual Meeting of Shareholders.
PART IV
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a)(1) INDEX TO FINANCIAL STATEMENTS
Page Reference
--------------
Report of Independent Public Accountants (1)
Consolidated Balance Sheets as of September 30, 1997 and 1996 (1)
Consolidated Statements of Operations for the Years Ended
September 30, 1997, 1996 and 1995. (1)
Consolidated Statements of Shareholders' Equity for the Years
Ended September 30, 1997, 1996 and 1995 (1)
Consolidated Statements of Cash Flows for the Years Ended
September 30, 1997, 1996 and 1995 (1)
Notes to Consolidated Financial Statements (1)
- -------------------------
(1) Included in the Company's Annual Report to Shareholders for the year ended
September 30, 1997.
(a)(3) EXHIBITS
Except for exhibits 13.1 and 23.1 (which are filed as a part hereof), the
exhibits listed on the exhibit Index on page E-1 of this Form 10-K are hereby
incorporated by reference to the exhibits named therein filed with, or
incorporated by reference to, the Company's Transition Report on Form 10-KSB for
the seven months ended September 30, 1993.
The following exhibits are hereby incorporated by reference to the exhibits 3.5
and 22.1, respectively, filed with the Company's Annual Report on Form 10-KSB
for the year ended September 30, 1995.
3.4 Amendment to Certificate of Incorporation of the Company as filed with
the Delaware Secretary of State on August 2, 1994.
21.1 List of Subsidiaries of Destron Fearing Corporation.
The following exhibits are hereby filed as part of this Annual Report on Form
10-K.
13.1 Portions of Annual Report to Shareholders for the fiscal year ended
September 30, 1997 incorporated herein by reference (including signed
report of independent public accountants).
23.1 Consent of Arthur Andersen LLP
27.1 Financial Data Schedule.
(b) REPORTS ON FORM 8-K
No reports on Form 8-K were filed during the fourth quarter of fiscal 1997 or
during the period from the end of that quarter to the date of this Annual
Report.
-16-
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
DESTRON FEARING CORPORATION
Date: December 24, 1997
-------------------------
By: /s/ Randolph K. Geissler
----------------------------------------
Randolph K. Geissler, Chief Executive
Officer, Chairman, President and
Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
- --------------------------- ------------- ---------------
/s/ Randolph K. Geissler Chief Executive Officer,
- --------------------------- Chairman, President
Randolph K. Geissler and Director
/s/ Thomas J. Ahmann Vice President, Chief
- --------------------------- Financial Officer, Secretary,
Thomas J. Ahmann Treasurer and Principal
Accounting Officer
/s/ Stanley Goldberg Director
- ---------------------------
Stanley Goldberg
/s/ David A. Henderson Director
- ---------------------------
David A. Henderson
/s/ Richard E. Jahnke Director
- ---------------------------
Richard E. Jahnke
/s/ Kenneth D. Larson Director
- ---------------------------
Kenneth D. Larson
/s/ Douglas M. Pihl Director
- ---------------------------
Douglas M. Pihl
-17-
<PAGE>
Exhibit
Number Description
- ------ -----------
3.1 Articles of Incorporation of Destron/IDI, Inc., a Delaware corporation.
Filed as Exhibit 3.3 to the Company's S-4 Registration Statement ("S-4
Registration Statement") declared effective by the Securities and
Exchange Commission ("Commission") on October 12, 1993.
3.2 Bylaws of Destron/IDI, Inc., a Delaware corporation. Filed as Exhibit
3.4 to the Company's S-4 Registration Statement.
3.3 Amendment to Certificate of Incorporation of the Company as filed with
the Delaware Secretary of State on August 2, 1994.
10.1 Common Stock Warrant issued by the Company to Hughes Aircraft Company
dated September 27, 1991. Filed as Exhibit 10(j) to the Company's Form
10 Registration Statement.
10.2 License Agreement between the Company and Charles A. Walton dated June
5, 1991. Filed as Exhibit 10(m) to the Company's Form 10 Registration
Statement.
10.3 License Agreement between Identification Devices, Inc. and Bio Medic
Data Systems, Inc. dated May 16, 1986. Filed as Exhibit 10(n) to the
Company's Form 10 Registration Statement.
10.4 License Agreement between the Company and Anitech Identification
Systems, Inc. dated November 11, 1988. Filed as Exhibit 10(p) to the
Company's Form 10 Registration Statement.
10.5 Distribution Agreement between the Company and Nippon ID System Co.,
Ltd. Dated July 13, 1989. Filed as Exhibit 10(q) to the Company's Form
10 Registration Statement.
10.6 Development Agreement between the Company and Nippon ID System Co., Ltd.
dated July 13, 1989. Filed as Exhibit 10(r) to the Company's Form 10
Registration Statement.
10.7 Distribution Agreement between the Company and AnimalCare Limited dated
May 25, 1989. Filed as Exhibit 10(s) to the Company's Form 10
Registration Statement.
10.8 Distribution Agreement between the Company and Rhone Merieux dated
September 26, 1989 and amendments. Filed as Exhibit 10(t) to the
Company's Form 10 Registration Statement.
10.9 Distribution Agreement between the Company and Milk Marketing Board of
England and Wales dated September 30, 1989. Filed as Exhibit 10(v) to
the Company's Form 10 Registration Statement.
10.10 Development Agreement between the Company and Milk Marketing Board of
England and Wales dated September 30, 1989. Filed as Exhibit 10(w) to
the Company's Form 10 Registration Statement.
10.11 Distribution Agreement between the Company and Animal Electronics ID
Systems PTY Limited dated December 1, 1989. Filed as Exhibit 10(x) to
the Company's Form 10 Registration Statement.
E-1
<PAGE>
Exhibit
Number Description
- ------ -----------
10.12 Distribution Agreement between the Company and Superior Identification
Systems dated December 31, 1989. Filed as Exhibit 10(y) to the
Company's Form 10 Registration Statement.
10.13 Development Agreement between the Company and Superior Identification
Systems dated December 31, 1989. Filed as Exhibit 10(z) to the
Company's Form 10 Registration Statement.
10.14 Distribution Agreement between the Company and Identity Devices (PTY)
Ltd. dated January 1, 1990. Filed as Exhibit 10(aa) to the Company's
Form 10 Registration Statement.
10.15 Distribution Agreement between the Company and Kubota, Ltd. dated
January 20, 1990. Filed as Exhibit 10(bb) to the Company's Form 10
Registration Statement.
10.16 Development Agreement between the Company and Kubota, Ltd. dated
January 20, 1990. Filed as Exhibit 10(cc) to the Company's Form 10
Registration Statement.,
10.17 Distribution Agreement between the Company and Electronic Livestock
Systems, Inc. dated January 23, 1990. Filed as Exhibit 10(ad) to the
Company's Form 10 Registration Statement.
10.18 Development Agreement between the Company and Electronic Livestock
Systems, Inc. dated January 23, 1990. Filed as Exhibit 10(ae) to the
Company's Form 10 Registration Statement.
10.19 License Agreement between the Company and Anitech Identification
Systems, Inc., dated February 1, 1990. Filed as Exhibit 10(af) to the
Company's Form 10 Registration Statement.
10.20 Distribution Agreement between the Company and Animal Electronics ID
Systems PTY Limited dated February 1, 1990. Filed as Exhibit 10(ag) to
the Company's Form 10 Registration Statement.
10.21 Development Agreement between the Company and Animal Electronics ID
Systems PTY Limited dated February 1, 1990. Filed as Exhibit 10(ah) to
the company's Form 10 Registration Statement
10.22 Basic Ordering Agreement between the Company and Nippon ID System Co.,
Ltd. dated April 27, 1990. Filed as Exhibit 10(ai) to the Company's
Form 10 Registration Statement.
10.23 Basic Ordering Agreement between the Company and Nippon ID System Co.,
Ltd. dated April 27, 1990. Filed as Exhibit 10(aj) to the Company's
Form 10 Registration Statement.
10.24 Distribution Agreement between the Company and Identity Devices (PTY)
Ltd. dated July 1, 1990. Filed as Exhibit 10(al) to the Company's Form
10 Registration Statement.
10.25 Distribution Agreement between the Company and Identity Devices (PTY)
Ltd. dated July 31, 1990. Filed as Exhibit 10(am) to the Company's Form
10 Registration Statement.
E-2
<PAGE>
Exhibit
Number Description
- ------ -----------
10.26 Development Agreement between the Company and Identity Devices (PTY)
Ltd. dated July 31, 1990. Filed as Exhibit 10(an) to the Company's Form
10 Registration Statement.
10.27 Distribution Agreement between the Company and Anitech Identification
Systems, Inc. dated April 22, 1991. Filed as Exhibit 10(ao) to the
Company's Form 10 Registration Statement.
10.28 Distribution Agreement between the Company and Kubota, Ltd. dated
February 26, 1988. Filed as Exhibit 10(ap) to the Company's Form 10
Registration Statement.
10.29 Destron/IDI, Inc. Employee Stock Option Plan. Filed as Exhibit 10.42 to
the Company's 1992 Annual Report on Form 10-K.
10.30 Destron/IDI, Inc. Nonemployee Director Stock Option Plan. Filed as
Exhibit 10.43 to the Company's 1992 Annual Report on Form 10-K.
10.31 Employment Agreement between the Company and Randolph K. Geissler dated
November 12, 1993. Filed as Exhibit 10.48 to the Company's 1993
Transition Report on Form 10-KSB.
*10.32 Promissory Note, dated June 1, 1997, with Hughes Microelectronics Europa
Espana S.A.
*10.33 Loan and Security Agreement, dated June 25, 1997, with Coast Business
Credit.
- -------------------------
* Filed herewith
E-3
<PAGE>
PROMISSORY NOTE
U.S.$4,290,562.00 South St. Paul, Minnesota
June 1, 1997
FOR VALUE RECEIVED, the undersigned, Destron Fearing Corporation, a
Delaware corporation ("Maker"), promises to pay to Hughes Microelectronics
Europa Espana S.A. ("Holder") or order, the principal amount of Four Million
Two Hundred Ninety Thousand Five Hundred and Sixty-two U.S. Dollars (U.S.
$4,290,562.00), with interest, from the date hereof on the unpaid principal
balance hereunder at the rate shown for each applicable time period on the
attached Exhibit A and with first installment of interest and principal due
June 30, 1997. Unless accelerated as provided hereunder, the outstanding
principal amount under this Promissory Note (this "Note"), together with all
accrued and unpaid interest thereon, shall be due and payable in the
installments and at the times shown on the attached Exhibit A.
This Note arises from a debt owing on the sale of industrial
property from the Holder in Spain to the Maker in the United States. Analysis
of this debt, a listing of invoices, is set forth in Exhibit C.
Each payment under this Note shall first be credited against costs
and expenses provided for hereunder, second to the payment of accrued and
unpaid interest, and the remainder shall be credited against principal.
Holder and each holder hereof shall have the continuing and exclusive right
to apply any and all payments hereunder. All amounts due hereunder shall be
payable without defense, set off or counterclaim, in lawful money of the
United States of America, and in the same day funds and delivered to Holder
by wire transfer to Holder's account number 221240 at Banco Santander,
Armengual de la Mota 3, 29007 Malaga, Spain, or at such other place as Holder
or any holder hereof shall designate in writing for such purpose from time to
time. If a payment hereunder otherwise would become due and payable on a
Saturday, Sunday or legal holiday, the due date thereof shall be extended to
the next succeeding business day, and
1
<PAGE>
interest shall be payable thereon during such extension at the rate
applicable if the payment had been made on the date originally due and
payable.
The foregoing notwithstanding, to the extent permitted by Maker's
existing Loan and Security Agreement with Coast Business Credit-Registered
Trademark- ("Senior Lender") any and all amounts received by Maker for existing
transponder inventory designated for and sold to Schering-Plough will
immediately be paid in full to Holder. If said inventory is sold to any other
customer, any and all amounts received for a monthly sale of $100,000.00 and
over, or $500,000.00 and over for an individual sale, will immediately be
paid in full to Holder. Any proceeds from sale of this inventory will be
credited against principal owing under this Note, provided that such
application shall first be made to the principal amount due on October 31,
1998, to the extent it has not yet been paid.
At the end of each calendar quarter commencing with the quarter
ending December 31, 1997, to the extent Maker is in compliance with the
Senior Lender's payment schedule and default covenants, has a ratio of at
least 1:1 of current assets minus cash to current liabilities minus
overdraft, and has cash or cash equivalents, less amounts due to Senior
Lender, on hand in excess of $1,000,000.00, such excess shall be paid
immediately to Holder and applied first against the principal amount due on
October 31, 1998, and then against the remaining principal owing under this
Note. (Example: Should Destron have cash on hand of $2.7M and an amount of
$1.5M due to the Senior Lender, then Destron would pay down $200,000.00 of
the principal under this Note, leaving net cash of $1,000,000.00.)
This Note may be prepaid in whole or in part at any time at the
option and sole discretion of Maker, whether or not advance notice of any
such prepayment, which shall not be required, shall have been given or
revoked. Any prepayment shall be without premium or penalty except that
accrued and unpaid interest shall be paid to the date of payment on the
principal amount prepaid. Any partial principal prepayment under this Note
will not relieve Maker from its obligation hereunder to make future mandatory
payments each month until all principal hereof is repaid in full. Upon the
occurrence of a default hereunder including, without limitation, failure to
pay any principal hereof or
2
<PAGE>
interest hereon by five (5) days after the due date (whether by acceleration or
otherwise) for such payment, interest shall thereafter accrue on the entire
unpaid principal balance hereunder, including without limitation any delinquent
interest which has been added to the principal amount due under this Note
pursuant to the terms hereof, at the rate of thirteen and one-quarter percent
(13.25%) per annum, or the highest rate allowed by law, whichever is less. In
addition, upon the occurrence of a default hereunder, the Holder may, at its
option, following fifteen (15) business days notice from the Holder to Maker,
without any other demand upon Maker or any other party, declare immediately due
and payable the entire principal balance hereof together with all accrued and
unpaid interest thereon, plus any other amounts then owing pursuant to this
Note, whereupon the same shall be immediately due and payable, except as
provided herein.
Maker covenants to notify Holder before incurring any debt or
guarantee obligations outside the ordinary course of business (i.e., outside of
trade payables, and the like) at any time while this Note is outstanding.
Upon the occurrence that Maker should be found in default as stated
under Senior Lender's Events of Default (Exhibit B), then payments to Holder
will cease until such time as Maker has resolved the situation and is again
in compliance with Senior Lender's covenants or Holder has prior written
consent of the Senior Lender (or any substitute Senior Lender). The payment
of the principal, interest, fees and other sums arising pursuant to this Note
(the "Subordinated Debt") is expressly subordinated, in the manner
hereinafter set forth, in right of payment to the prior payment and
satisfaction in full of the Senior Debt. As used herein, "Senior Debt" means
the principal, interest, fees and other sums payable to the Senior Lender and
any future restructuring of such indebtedness (including any restructurings
where a new lender is substituted for the Senior Lender) but not including
any additional borrowings from the Senior Lender (or any substitute Senior
Lender) made after the date of this Agreement. The Senior Lender must
immediately notify Holder of the event of default before it becomes
effective. Notwithstanding the Events of Default set forth in Exhibit B,
should default occur under Items (g) (h) (l) or (m) of Exhibit B, a
materiality standard of $50,000.00, in the
3
<PAGE>
aggregate, will apply, wherein Maker's payments to Holder will continue for any
occurrences valued at $50,000.00 and under.
Maker covenants that at all times while this Note is outstanding, at
Holder's option, Holder may designate a person to serve on Maker's Board of
Directors, and Maker shall arrange for any such designated person, or such
person's successors as designated by Holder to be appointed to Maker's Board of
Directors. At all times while this Note is outstanding, Maker will provide the
Holder and a copy to its parent, Hughes Electronics Corp, its Form 10Q quarterly
filings and Form 10K annual filing with the Securities and Exchange Commission
(the "SEC") simultaneously with making its filing with the SEC. If Maker ceases
to be registered with the SEC while this Note is outstanding, Maker will provide
similar quarterly financial information in writing to the Holder at the times
when such filings would have been due to the SEC, if Maker were still a
registered company.
Maker covenants to deliver to Holder, to the attention of Mr. Amnon
Carr, on or before June 30, 1997, a letter or letters from Maker's outside
legal counsel representing that since the date of this Note, Maker has
received contributions of additional equity in the amount of at least Three
Million Three Hundred Thousand Dollars ($3,300,000.00) and has obtained an
additional bank line of credit, totaling at least One Million Five Hundred
Thousand Dollars ($1,500,000.00).
Maker covenants to deliver to Holder, to the attention of Mr. Amnon
Carr, within ninety (90) days after the end of each of Maker's fiscal years,
while this Note is outstanding, a letter from Maker's independent auditors
setting forth in detail the amount, if any, received by Maker in the prior
fiscal year from Schering-Plough for the inventory currently designated for that
company, and the amount thereof which was paid to Holder under this Note.
Maker covenants that Holder may, at Holder's discretion, either
directly or through its independent auditors, audit Maker's quarterly financial
statements to determine that the working capital and cash balances then
maintained by Maker are in reasonable amounts taking into account Maker's normal
business requirements.
4
<PAGE>
The breach of any of the foregoing covenants shall be deemed a
material default under this Note.
No waiver or modification of any of the terms of this Note shall
be valid or binding unless set forth in a writing specifically referring to
this Note and signed by a duly authorized officer of Holder or any holder
hereof, and then only to the extent specifically set forth therein.
If any default occurs in any payment due under this Note, Maker and
its successors and assigns promise to pay all costs and expenses, including
reasonable attorneys' fees, incurred by each holder thereof in collecting or
attempting to collect the indebtedness under this Note, whether or not any
action or proceeding is commenced. None of the provisions hereof and none of
the Holder's rights or remedies hereunder on account of any past or future
defaults shall be deemed to have been waived by the Holder's acceptance of
any past due payments or by any indulgence granted by the Holder to Maker.
Maker and its successors and assigns hereby waive presentment,
demand, diligence, protest and notice of every kind, and agree that they
shall remain liable for all amounts due hereunder notwithstanding any
extension of time or change in the terms of payment of this Note granted by
any holder hereof, any change, alteration or release of any property now or
hereafter securing the payment hereof or any delay or failure by the Holder
hereof to exercise any rights under this Note. Maker and its successors and
assigns hereby waive their right to plead any and all statutes of limitation
as a defense to a demand hereunder to the full extent permitted by law.
This Note shall inure to the benefit of Holder, its successors and
assigns and shall bind the successors and assigns of Maker; provided,
however, that nothing herein shall be construed to permit Maker to assign (by
operation of law or otherwise) its obligations hereunder to any person or
entity without the express written consent of Holder in Holder's sole
discretion. Each reference herein to powers or rights of Holder shall also be
deemed a reference to the same power or right of Holder's assignees, to the
extent of the interest assigned to them.
5
<PAGE>
In the event that any one or more provisions of the Note shall be
held to be illegal, invalid or otherwise unenforceable, the same shall not
affect any other provision of this Note and the remaining provisions of this
Note shall remain in full force and effect.
This Note shall be governed by and construed in accordance with the
laws of the State of California, excluding any choice of law provisions or
conflict of laws principles which would require reference to the laws of any
other jurisdiction. With respect to any claim of any party arising out of or
under this Note, (a) Maker irrevocably submits to the exclusive jurisdiction
of the State and federal courts located in the State of California, and (b)
Maker irrevocably waives any objection which it may have at any time to the
venue of any suit, action or proceeding arising out of or relating to this
Note brought in any such courts and irrevocably waives any claim that such
suit, action or proceeding is brought in an inconvenient forum, and further
irrevocably waives the right to object, with respect to such suit, claim or
proceeding brought in any such court, that such court does not have
jurisdiction over Maker.
Notices to the Holder required in the terms of this Note shall be
provided to both the Holder, at P.O. Box 73, Campanillas, Malaga, Spain
(Attn: Finance Director) and a copy to its parent, Hughes Electronics Corp at
P.O. Box 80028, Los Angeles, CA 90080 (Attn: Treasurer).
IN WITNESS THEREOF, Maker has caused this Note to be duly executed
the day and year first above written.
DESTRON FEARING CORPORATION
By: /s/ Randolph K. Geissler
------------------------
Its: President
By: /s/ Thomas J. Ahmann
------------------------
Its: Secretary
6
<PAGE>
COAST
LOAN AND SECURITY AGREEMENT
BORROWER: DESTRON FEARING CORPORATION
CO-BORROWER: FEARING MANUFACTURING CO., INC.
ADDRESS: 490 VILLAUME AVENUE
SOUTH ST. PAUL, MN 55075
DATE: JUNE 25, 1997
THIS LOAN AND SECURITY AGREEMENT is entered into on the above date between COAST
BUSINESS CREDIT-Registered Trademark-, a division of Southern Pacific Thrift &
Loan Association ("Coast"), a California corporation, with offices at 12121
Wilshire Boulevard, Suite 1111, Los Angeles, California 90025, and Destron
Fearing Corporation ("Borrower") and Fearing Manufacturing Co., Inc.
("Co-Borrower") herein jointly and severally liable (Borrower and Co-Borrower
jointly and severally are sometimes referred to herein as "Borrowers").
Borrower and Co-Borrower have identified their chief executive office at the
above address ("Borrowers' Address"). The Schedule to this Agreement (the
"Schedule") shall for all purposes be deemed to be a part of this Agreement, and
the same is an integral part of this Agreement. (Definitions of certain terms
used in this Agreement are set forth in Section 8 below.)
1. LOANS.
1.1 LOANS. Coast will make loans to Borrowers (the "Loans"), in amounts
determined by Coast in its sole discretion, up to the amounts (the "Credit
Limit") shown on the Schedule, provided no Default or Event of Default has
occurred and is continuing.
1.2 INTEREST. All Loans and all other monetary Joint Obligations shall
bear interest at the rate shown on the Schedule, except where expressly set
forth to the contrary in this Agreement. Interest shall be payable monthly, on
the last day of the month. Interest may, in Coast's discretion, be charged to
Borrowers' Joint Loan Account, and the same shall thereafter bear interest at
the same rate as the other Loans. Regardless of the amount of Joint Obligations
that may be outstanding from time to time, Borrowers' shall pay Coast minimum
monthly interest during the term of this Agreement with respect to the
Receivable Loans and the Inventory Loans in the amount set forth on the Schedule
(the "Minimum Monthly Interest").
1.3 FEES. Borrowers shall pay Coast the fee(s) shown on the Schedule,
which are in addition to all interest and other sums payable to Coast and are
not refundable. Such fees shall be fully earned upon the initial funding of
this credit facility.
1.4 LETTERS OF CREDIT. At the request of Borrower or Co-Borrower, Coast
may, in its sole discretion, arrange for the issuance of letters of credit for
the account of Borrower or Co-Borrower (collectively, "Letters of Credit"), by
issuing guarantees to the issuer of the letter of credit or by other means. All
Letters of Credit shall be in form and substance satisfactory to Coast in its
sole discretion. The aggregate face amount of all outstanding Letters of Credit
from time to time shall not exceed the amount shown on the Schedule (the "Letter
of Credit Sublimit"), and shall be reserved against Loans which would otherwise
be available hereunder. Borrower and Co-Borrower shall pay all bank charges for
the issuance of Letters of Credit. Any payment by Coast under or in connection
with a Letter of Credit shall constitute a Loan hereunder on the date such
payment is made. Each Letter of Credit shall have an expiry date no later than
thirty days prior to the Maturity Date. Borrower and Co-Borrower hereby agree
to indemnify, save, and hold Coast harmless from any loss, cost, expense, or
liability, including payments made by Coast, expenses, and reasonable attorneys'
fees incurred by Coast arising out of or in connection with any Letters of
Credit. Borrower and Co-Borrower agree to be bound by the regulations and
interpretations of the issuer of any Letters of Credit guaranteed by Coast and
opened for Borrower's and Co-Borrower's account or by Coast's interpretations of
any Letter of Credit issued by Coast for Borrower's and Co-Borrower's account,
and Borrower and Co-Borrower understand and agree that Coast shall not be liable
for any error, negligence, or mistake, whether of omission or commission, in
following Borrower's or Co-Borrower's instructions or those contained in the
Letters of Credit or any modifications, amendments, or supplements thereto.
Borrower and Co-Borrower understand that Letters of Credit may require Coast to
indemnify the issuing bank
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COAST BUSINESS CREDIT LOAN AND SECURITY AGREEMENT
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for certain costs or liabilities arising out of claims by Borrower and/or
Co-Borrower against such issuing bank. Borrower and Co-Borrower hereby agree to
indemnify and hold Coast harmless with respect to any loss, cost, expense, or
liability incurred by Coast under any Letter of Credit as a result of Coast's
indemnification of any such issuing bank. The provisions of this Agreement, as
it pertains to Letters of Credit, and any other present or future documents or
agreements between Borrower and Co-Borrower and Coast relating to Letters of
Credit are cumulative.
2. SECURITY INTEREST.
2.1(a) GRANT OF SECURITY INTEREST BY BORROWER. To secure the payment
and performance of all of the Joint Obligations when due, Borrower hereby grants
to Coast a security interest in all of Borrower's interest in the following,
whether now owned or hereafter acquired, and wherever located: All Receivables,
Inventory, Investment Property, Equipment, and General Intangibles, including,
without limitation, all of Borrower's Deposit Accounts, and all money, and all
property now or at any time int he future in Coast's possession (including
claims and credit balances), and all proceeds of any of the foregoing (including
proceeds of any insurance policies, proceeds of proceeds, and claims against
third parties), all products of any of the foregoing, and all books and records
related to any of the foregoing (all of the foregoing, together with all other
property in which Coast may now or in the future be granted a lien or security
interest, is referred to herein, collectively, as the "Borrower's Collateral").
2.1(b) GRANT OF SECURITY INTEREST BY CO-BORROWER. To secure the
payment and performance of all of the Joint Obligations when due, Co-Borrower
hereby grants to Coast a security interest in all of Co-Borrower's interest in
the following, whether now owned or hereafter acquired, and wherever located:
All Receivables, Inventory, Investment Property, Equipment, and General
Intangibles, including, without limitation, all of Co-Borrower's Deposit
Accounts, and all money, and all property now or at any time in the future in
Coast's possession (including claims and credit balances), and all proceeds of
any of the foregoing (including proceeds of any insurance policies, proceeds of
proceeds, and claims against third parties), all products of any of the
foregoing, and all books and records related to any of the foregoing (all of the
foregoing, together with all other property in which Coast may now or in the
future be granted a lien or security interest, is referred to herein,
collectively, as the "Co-Borrower's Collateral").
3. REPRESENTATIONS, WARRANTIES AND COVENANTS OF THE BORROWERS.
In order to induce Coast to enter into this Agreement and to make Loans,
Borrowers represent and warrant to Coast as follows, and Borrowers covenant that
the following representations will continue to be true, and that Borrowers will
at all times comply with all of the following covenants:
3.1 CORPORATE EXISTENCE AND AUTHORITY. If Borrower and Co-Borrower are
each a corporation, each of Borrower and Co-Borrower is and will continue to be,
duly organized, validly existing and in good standing under the laws of the
jurisdiction of its incorporation. Each of Borrower and Co-Borrower is and will
continue to be qualified and licensed to do business in all jurisdictions in
which any failure to do so would have a material adverse effect on Borrowers.
The execution, delivery and performance by Borrowers of this Agreement, and all
other documents contemplated hereby (i) have been duly and validly authorized,
(ii) are enforceable against Borrowers in accordance with their terms (except as
enforcement may be limited by equitable principles and by bankruptcy,
insolvency, reorganization, moratorium or similar laws relating to creditors'
rights generally), and (iii) do not violate Borrowers' respective articles or
certificates of incorporation, or Borrowers' respective by-laws, or any law or
any material agreement or instrument which is binding upon Borrowers or their
respective property, and (iv) do not constitute grounds for acceleration of
any material indebtedness or obligation under any material agreement or
instrument which is binding upon Borrowers or their respective property.
3.2 NAME; TRADE NAMES AND STYLES. The name of Borrowers set forth in the
heading to this Agreement are the correct names. Listed on the Schedule are all
prior names of Borrowers and all of Borrowers' present and prior trade names.
Borrowers shall give Coast 30 days' prior written notice before changing their
names or doing business under any other name. Borrowers have complied, and will
in the future comply, with all laws relating to the conduct of business under a
fictitious business name.
3.3 PLACE OF BUSINESS; LOCATION OF BORROWER'S AND CO-BORROWERS'
COLLATERAL. The address set forth in the heading to this Agreement is the chief
executive office for Borrowers. In addition, Borrowers have places of business
and Borrower's and Co-Borrower's Collateral are located only at the locations
set forth on the Schedule. Borrowers will give Coast at least 30 days prior
written notice before opening any additional place of business, changing the
chief executive office, or moving any of the Borrower's Collateral and
Co-Borrower's Collateral to a location other than Borrowers' Address or one of
the locations set forth on the Schedule.
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3.4 (a) BORROWER'S TITLE TO COLLATERAL; PERMITTED LIENS. Borrower is
now, and will at all times in the future be, the sole owner of all the
Borrower's Collateral, except for items of Equipment which are leased by
Borrower. The Borrower's Collateral now is and will remain free and clear of
any and all liens, charges, security interests, encumbrances and adverse
claims, except for Permitted Liens. Coast now has, and will continue to have,
a first-priority perfected and enforceable security interest in all of the
Borrower's Collateral, subject only to the Permitted Liens, and Borrower will
at all times defend Coast and the Borrower's Collateral against all claims of
others. None of the Borrower's Collateral now is or will be affixed to any
real property in such a manner, or with such intent, as to become a fixture.
Borrower is not and will not become a lessee under any real property lease
pursuant to which the lessor may obtain any rights in any of Borrower's
Collateral and no such lease now prohibits, restrains, impairs or will
prohibit, restrain or impair Borrower's right to remove any of Borrower's
Collateral from the leased premises. Whenever any of Borrower's Collateral is
located upon premises in which any third party has an interest (whether as
owner, mortgagee, beneficiary under a deed of trust, lien or otherwise),
Borrower shall, whenever requested by Coast, use its best efforts to cause
such third party to execute and deliver to Coast, in form acceptable to
Coast, such waivers and subordinations as Coast shall specify, so as to
ensure that Coast's rights in Borrower's Collateral are, and will continue to
be, superior to the rights of any such third party. Borrower will keep in
full force and effect, and will comply with all the terms of, any lease of
real property where any of Borrower's Collateral now or in the future may be
located.
3.4 (b) CO-BORROWER'S TITLE TO COLLATERAL; PERMITTED LIENS. Co-Borrower
is now, and will at all times in the future be, the sole owner of all the
Co-Borrower's Collateral, except for items of Equipment which are leased by
Co-Borrower. The Co-Borrower's Collateral now is and will remain free and
clear of any and all liens, charges, security interests, encumbrances and
adverse claims, except for Permitted Liens. Coast now has, and will continue
to have, a first-priority perfected and enforceable security interest in all
of the Co-Borrower's Collateral, subject only to the Permitted Liens, and
Co-Borrower will at all times defend Coast and the Co-Borrower's Collateral
against all claims of others. None of the Co-Borrower's Collateral now is or
will be affixed to any real property in such a manner, or with such intent,
as to become a fixture. Co-Borrower is not and will not become a lessee under
any real property lease pursuant to which the lessor may obtain any rights in
any of Co-Borrower's Collateral and no such lease now prohibits, restrains,
impairs or will prohibit, restrain or impair Borrower's right to remove any
of Co-Borrower's Collateral from the leased premises. Whenever any of
Co-Borrower's Collateral is located upon premises in which any third party
has an interest (whether as owner, mortgagee, beneficiary under a deed of
trust, lien or otherwise), Co-Borrower shall, whenever requested by Coast,
use its best efforts to cause such third party to execute and deliver to
Coast, in form acceptable to Coast, such waivers and subordinations as Coast
shall specify, so as to ensure that Coast's rights in Co-Borrower's
Collateral are, and will continue to be, superior to the rights of any such
third party. Co-Borrower will keep in full force and effect, and will comply
with all the terms of, any lease of real property where any of the
Co-Borrower's Collateral now or in the future may be located.
3.5 MAINTENANCE OF COLLATERAL. Borrower and Co-Borrower will maintain
Borrower's Collateral and Co-Borrower's Collateral in good working condition,
and Borrower and Co-Borrower will not use the Borrower's Collateral and
Co-Borrower's Collateral for any unlawful purpose. Borrowers will immediately
advise Coast in writing of any material loss or damage to Borrower's
Collateral and Co-Borrower's Collateral.
3.6 BOOKS AND RECORDS. Borrowers have maintained and will maintain at
Borrower's Address complete and accurate books and records, comprising an
accounting system in accordance with generally accepted accounting principles.
3.7 FINANCIAL CONDITION, STATEMENTS AND REPORTS. All financial
statements now or in the future delivered to Coast have been, and will be,
prepared in conformity with generally accepted accounting principles (except,
in the case of unaudited financial statements, for the absence of footnotes
and subject to normal year-end adjustments) and now and in the future will
fairly reflect the financial condition of Borrowers', at the times and for
the periods therein stated. Between the last date covered by any such
statement provided to Coast and the date hereof, there has been no material
adverse change in the financial condition or business of Borrowers. Borrowers
are now and will continue to be solvent.
3.8 TAX RETURNS AND PAYMENTS; PENSION CONTRIBUTIONS. Borrowers have
timely filed, and will timely file, all tax returns and reports required by
foreign, federal, state and local law, and Borrowers have timely paid, and
will timely pay, all foreign, federal, state and local taxes, assessments,
deposits and contributions now or in the future owed severally by Borrowers.
Borrower or Co-Borrower may, however, defer payment of any contested taxes,
provided that Borrower or Co-Borrower (i) in good faith contests the
obligation to pay the taxes by appropriate proceedings promptly and
diligently instituted and conducted, (ii) notifies Coast in writing of the
commencement of, and any material development in, the proceedings, and (iii)
posts bonds or takes any other steps
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required to keep the contested taxes from becoming a lien upon any of
Borrower's Collateral or Co-Borrower's Collateral. As of the date hereof,
Borrower and Co-Borrower are unaware of any claims or adjustments proposed
for any of Borrower's or Co-Borrower's prior tax years which could result in
additional taxes becoming due and payable by Borrower or Co-Borrower.
Borrower or Co-Borrower have paid, and shall continue to pay all amounts
necessary to fund each of their respective present and future pension, profit
sharing and deferred compensation plans in accordance with their terms, and
Borrowers have not and will not withdraw from participation in, permit
partial or complete termination of, or permit the occurrence of any other
event with respect to, any such plan which could result in any liability of
Borrowers, including any liability to the Pension Benefit Guaranty
Corporation or its successors or any other governmental agency. Borrowers
shall, at all times, utilize the services of an outside payroll service
providing for the automatic deposit of all payroll taxes payable by Borrower
or Co-Borrower.
3.9 COMPLIANCE WITH LAW. Borrowers have complied, and will comply, in
all material respects, with all provisions of all material foreign, federal,
state and local laws and regulations relating to Borrower and Co-Borrower,
including, but not limited to, those relating to Borrower's or Co-Borrower's
ownership of real or personal property, the conduct and licensing of
Borrower's or Co-Borrower's business, and environmental matters.
3.10 LITIGATION. Except as disclosed in the Schedule, there is no claim,
suit, litigation, proceeding or investigation pending or (to best of
Borrowers' knowledge) threatened by or against or affecting Borrower or
Co-Borrower in any court or before any governmental agency (or any basis
therefor known to Borrowers) which may result, either separately or in the
aggregate, in any material adverse change in the financial condition or
business of Borrower or Co-Borrower, or in any material impairment in the
ability of Borrower to carry on their businesses in substantially the same
manner they are now being conducted. Borrowers will promptly inform Coast in
writing of any claim, proceeding, litigation or investigation in the future
threatened or instituted by or against Borrower and/or Co-Borrower involving
any single claim of $50,000 or more, or involving $100,000 or more in the
aggregate.
3.11 USE OF PROCEEDS. All proceeds of all Loans shall be used solely for
lawful business purposes. Neither Borrower nor Co-Borrower is purchasing or
carrying any "margin stock" (as defined in Regulation G of the Board of
Governors of the Federal Reserve System) and no part of the proceeds of any
Loan will be used to purchase or carry any "margin stock" or to extend credit
to others for the purpose of purchasing or carrying any "margin stock."
4. RECEIVABLES.
4.1 REPRESENTATIONS RELATING TO RECEIVABLES. Borrowers represent and
warrant to Coast as follows: Each Receivable with respect to which Loans are
requested by Borrowers shall, on the date each Loan is requested and made,
represent an undisputed bona fide existing unconditional obligation of the
Account Debtor created by the sale, delivery, and acceptance of goods or the
rendition of services in the ordinary course of Borrower's and/or
Co-Borrower's business.
4.2 REPRESENTATIONS RELATING TO DOCUMENTS AND LEGAL COMPLIANCE.
Borrowers represent and warrant to Coast as follows: All statements made and
all unpaid balances appearing in all invoices, instruments and other
documents evidencing the Receivables are and shall be true and correct and
all such invoices, instruments and other documents and all of Borrower's and
Co-Borrower's books and records are and shall be genuine and in all respects
what they purport to be. All sales and other transactions underlying or
giving rise to each Receivable shall fully comply with all applicable laws
and governmental rules and regulations. All signatures and endorsements on
all documents, instruments, and agreements relating to all Receivables are
and shall be genuine, and all such documents, instruments and agreements are
and shall be legally enforceable in accordance with their terms.
4.3 SCHEDULES AND DOCUMENTS RELATING TO RECEIVABLES. Borrowers shall
deliver to Coast transaction reports and loan requests, schedules of
Receivables, and schedules of collections, all on Coast's standard forms;
provided, however, that Borrowers, failure to execute and deliver the same
shall not affect or limit Coast's security interest and other rights in all
of Borrower's and Co-Borrower's Receivables, nor shall Coast's failure to
advance or lend against a specific Receivable affect or limit Coast's
security interest and other rights therein. Joint Loan requests received after
10:30 AM will not be considered by Coast until the next Business Day.
Together with each such schedule, or later, if requested by Coast, Borrowers
shall furnish Coast with copies (or, at Coast's request, originals) of all
contracts, orders, invoices, and other similar documents, and all original
shipping instructions, delivery receipts, bills of lading, and other evidence
of delivery, for any goods the sale or disposition of which gave rise to such
Receivables, and Borrower and Co-Borrower warrant the genuineness of all of
the foregoing. Borrowers shall also furnish to Coast aged accounts receivable
trial balances in such form and at such intervals as Coast shall request. In
addition, Borrowers shall deliver to Coast the originals of all
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instruments, chattel paper, security agreements, guarantees and other documents
and property evidencing or securing any Receivables, upon receipt thereof and in
the same form as received, with all necessary endorsements, all of which shall
be with recourse. Borrowers shall also provide Coast with copies of all credit
memos issued by Borrower or Co-Borrower as and when requested by Coast.
4.4 COLLECTION OF RECEIVABLES. Borrowers shall have the right to collect
each of Borrower's or Co-Borrower's Receivables, unless and until an Event of
Default has occurred. Borrowers shall hold all payments on, and proceeds of,
Receivables in trust for Coast, and Borrowers shall deliver all such payments
and proceeds to Coast within one Business Day after receipt by Borrowers in
their original form, duly endorsed to Coast, to be applied to the Joint
Obligations in such order as Coast shall determine. Coast may, in its
discretion, require that all proceeds of Borrower's Collateral and Co-Borrower's
Collateral be deposited by Borrowers into a lockbox account, or such other
"blocked account" as Coast may specify, pursuant to a blocked account agreement
in such form as Coast may specify. Coast or its designee may, at any time,
notify Account Debtors of Borrower and/or Co-Borrower that Coast has been
granted a security interest in the Receivables.
4.5 REMITTANCE OF PROCEEDS. All proceeds arising from the disposition
of any Borrower's Collateral or Co-Borrower's Collateral shall be delivered
to Coast within one Business Day after receipt by Borrowers, in their
original form, duly endorsed to Coast, to be applied to the Joint Obligations
in such order as Coast shall determine. Borrowers agree that they will not
commingle proceeds of the Borrower's Collateral and Co-Borrower's Collateral
with any of Borrower's and/or Co-Borrower's other funds or property, but will
hold such proceeds separate and apart from such other funds and property and
in an express trust for Coast. Nothing in this Section limits the
restrictions on disposition of Borrower's Collateral or Co-Borrower's
Collateral set forth elsewhere in this Agreement.
4.6 DISPUTES. Borrowers shall notify Coast promptly of all disputes or
claims relating to Receivables. Borrowers shall not forgive (completely or
partially), compromise or settle any of Borrower's or Co-Borrower's
Receivables for less than payment in full, or agree to do any of the
foregoing, except that each of Borrower or Co-Borrower may do so for their
respective Receivables, provided that: (i) Borrower or Co-Borrower does so in
good faith, in a commercially reasonable manner, in the ordinary course of
business, and in arm's length transactions, which are reported to Coast on
the regular reports provided to Coast; (ii) no Default or Event of Default
has occurred and is continuing; and (iii) taking into account all such
discounts settlements and forgiveness, the total outstanding Loans will not
exceed the Credit Limit. Coast may, at any time after the occurrence of an
Event of Default, settle or adjust disputes or claims directly with Account
Debtors of Borrower's and/or Co-Borrower's for amounts and upon terms which
Coast considers advisable in its reasonable credit judgment and, in all
cases, Coast shall credit Borrowers,- Joint Loan Account with only the net
amounts received by Coast in payment of any Receivables.
4.7 RETURNS. Provided no Event of Default has occurred and is continuing,
if any Account Debtor of Borrower or Co-Borrower returns any Inventory to
Borrower or Co-Borrower in the ordinary course of its business, Borrower and
Co-Borrower shall promptly determine the reason for such return and promptly
issue a credit memorandum to the Account Debtor in the appropriate amount. In
the event any attempted return occurs after the occurrence of any Event of
Default, Borrower or Co-Borrower shall (i) hold the returned Inventory in trust
for Coast, (ii) segregate all returned Inventory from all of Borrower's or
Co-Borrower's other property, (iii) conspicuously label the returned Inventory
as subject to Coast's security interest, and (iv) immediately notify Coast of
the return of any Inventory, specifying the reason for such return, the location
and condition of the returned Inventory, and on Coast's request deliver such
returned Inventory to Coast.
4.8 VERIFICATION. Coast may, from time to time, verify directly with the
respective Account Debtors the validity, amount and other matters relating to
the Receivables, by means of mail, telephone or otherwise, either in the name of
Borrowers or Coast or such other name as Coast may choose.
4.9 NO LIABILITY. Coast shall not under any circumstances be responsible
or liable for any shortage or discrepancy in, damage to, or loss or destruction
of, any goods, the sale or other disposition of which gives rise to a
Receivable, or for any error, act, omission, or delay of any kind occurring in
the settlement, failure to settle, collection or failure to collect any
Receivable, or for settling any Receivable in good faith for less than the full
amount thereof, nor shall Coast be deemed to be responsible for any of
Borrower's and/or Co-Borrower's obligations under any contract or agreement
giving rise to a Receivable. Nothing herein shall, however, relieve Coast from
liability for its own gross negligence or willful misconduct.
5. ADDITIONAL DUTIES OF THE BORROWERS.
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5.1 FINANCIAL AND OTHER COVENANTS. Borrowers shall at all times comply
with the financial and other covenants set forth in the Schedule.
5.2 INSURANCE. Borrowers shall, at all times insure all of their
respective tangible personal property Borrower's Collateral and Co-Borrower's
Collateral and carry such other business insurance, with insurers reasonably
acceptable to Coast, in such form and amounts as Coast may reasonably require,
and Borrowers shall provide evidence of such insurance to Coast, so that Coast
is satisfied that such insurance is, at all times, in full force and effect.
All liability insurance policies of Borrowers shall name Coast as an additional
insured, and all property casualty and related insurance policies of Borrowers
shall name Coast as a loss payee thereon and Borrowers shall cause a lenders
loss payee endorsement in form reasonably acceptable to Coast. Upon receipt of
the proceeds of any such insurance, Coast shall apply such proceeds in reduction
of the Joint Obligations as Coast shall determine in its sole discretion, except
that, provided no Default or Event of Default has occurred and is continuing,
Coast shall release to Borrower or Co-Borrower insurance proceeds with respect
to Borrower's or Co-Borrower's Equipment totaling less than $50,000, which shall
be utilized by Borrower or Co-Borrower for the replacement of the Equipment with
respect to which the insurance proceeds were paid. Coast may require reasonable
assurance that the insurance proceeds so released will be so used. If Borrower
or Co-Borrower fails to provide or pay for any insurance, Coast may, but is not
obligated to, obtain the same at Borrower's expense. Borrowers shall
promptly deliver to Coast copies of all reports made to insurance companies.
5.3 REPORTS. Borrowers, at their expense, shall provide Coast with the
written reports set forth in the Schedule, and such other written reports with
respect to Borrowers (including budgets, sales projections, operating plans and
other financial documentation), as Coast shall from time to time reasonably
specify.
5.4 ACCESS TO COLLATERAL, BOOKS AND RECORDS. At reasonable times, and on
one Business Day's notice, Coast, or its agents, shall have the right to
inspect, audit and copy Borrowers' respective books and records and Borrower's
Collateral and Co-Borrower's Collateral (the "Audits"). Coast shall take
reasonable steps to keep confidential all confidential information obtained in
any Audit, but Coast shall have the right to disclose any such information to
its auditors, regulatory agencies, and attorneys, and pursuant to any subpoena
or other legal process. The Audits shall be conducted every ninety (90) days at
Borrowers' expense and the charge for the Audits shall be $750 per person per
day (or such higher amount as shall represent Coast's then current standard
charge for the same), plus reasonable out of pocket expenses. Borrowers will
not enter into any agreement with any accounting firm, service bureau or third
party to store Borrowers' books or records at any location other than Borrowers'
Address, without first notifying Coast of the same and obtaining the written
agreement from such accounting firm, service bureau or other third party to give
Coast the same rights with respect to access to books and records and related
rights as Coast has under this Loan Agreement.
5.5 NEGATIVE COVENANTS. Borrowers shall not, without Coast's prior
written consent, do any of the following:
(i) merge or consolidate with another corporation or entity, except in a
transaction in which (A) the shareholders of the Borrowers hold at least 50% of
the common stock and all other capital stock of the surviving corporation
immediately after such merger or consolidation, and (B) one of the Borrowers is
the surviving corporation;
(ii) acquire any assets, except (A) in the ordinary course of business, or
(B) in a transaction or a series of transactions not involving the payment of an
aggregate amount in excess of $100,000;
(iii) enter into any other transaction outside the ordinary course of
business;
(iv) sell or transfer any of Borrower's Collateral and/or Co-Borrower's
Collateral except for the sale of finished Inventory in the ordinary course of
Borrower's business, and except for the sale of obsolete or unneeded Equipment
in the ordinary course of business;
(v) store any Inventory or other of Borrower's Collateral and/or
Co-Borrower's Collateral with any warehouseman or other third party except as
expressly permitted in Exhibit A;
(vi) sell any Inventory on a sale-or-return, guaranteed sale, consignment,
or other contingent basis; except as permitted by the existing contract with
Schering-Plough
(vii) make any loans of any money or other assets, except (A) advances to
customers or suppliers in the ordinary course of business, (B) travel advances,
employee relocation loans and other employee loans and advances in the ordinary
course of business, and (C) loans to employees, officers and directors for the
purpose of purchasing equity securities of the Borrower or Co-Borrower;
(viii) incur any debts, outside the ordinary course of business, which
would have a material, adverse effect on Borrower and/or Co-Borrower or on the
prospect of repayment of the Joint Obligations;
(ix) guarantee or otherwise become liable with respect to the obligations
of another party or entity in excess of an amount totaling more than $50,000 in
the aggregate;
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(x) pay or declare any dividends on Borrower's or Co-Borrower's stock
(except for dividends payable solely in stock of Borrower or Co-Borrower);
(xi) redeem, retire, purchase or otherwise acquire, directly or
indirectly, any of Borrower's or Co-Borrower's stock, except that Borrowers
may repurchase stock owned by employees, directors and consultants pursuant
to terms of employment, consulting or other stock restriction agreements at
such time as any such employee, director or consultant terminates his or her
affiliation with the Borrower and/or Co-Borrower, for an aggregate purchase
price not to exceed $100,000 in any fiscal year;
(xii) make any change in Borrower's and/or Co-Borrower's capital
structure which would have a material adverse effect on Borrowers or on the
prospect of repayment of the Joint Obligations; or
(xiii) dissolve or elect to dissolve.
Transactions permitted by the foregoing provisions of this Section are only
permitted if no Default or Event of Default would occur as a result of such
transaction.
5.6 LITIGATION COOPERATION. Should any third-party suit or proceeding be
instituted by or against Coast with respect to any of Borrower's Collateral
and/or Co-Borrower's Collateral or relating to Borrower and/or Co-Borrower,
Borrower and Co-Borrower shall, without expense to Coast, make available,
their respective officers, employees and agents, and their respective books
and records, to the extent that Coast may deem them reasonably necessary in
order to prosecute or defend any such suit or proceeding.
5.7 INDEMNITY. Borrowers hereby agree to indemnify Coast and hold Coast
harmless from and against any and all claims, debts, liabilities, demands,
obligations, actions, causes of action, penalties, reasonable costs and
expenses (including reasonable attorneys' fees), of every nature, character
and description, which Coast may sustain or incur based upon or arising out
of any of the Joint Obligations, any actual or alleged failure to collect and
pay over any withholding or other tax relating to Borrowers or their
respective employees, any relationship or agreement between Coast and
Borrowers, any actual or alleged failure of Coast to comply with any writ of
attachment or other legal process relating to Borrowers or any of their
property, or any other matter, cause or thing whatsoever occurred, done,
omitted or suffered to be done by Coast relating to Borrowers or the Joint
Obligations (except any such amounts sustained or incurred as the result of
the gross negligence or willful misconduct of Coast). Notwithstanding any
provision in this Agreement to the contrary, the indemnity agreement set
forth in this Section shall survive any termination of this Agreement and
shall for all purposes continue in full force and effect.
5.8 FURTHER ASSURANCES. Borrowers agree, at their expense, on request by
Coast, to execute all documents and take all actions, as Coast, may deem
reasonably necessary or useful in order to perfect and maintain Coast's
perfected security interest in Borrower's Collateral and Co-Borrower's
Collateral, and in order to fully consummate the transactions contemplated by
this Agreement.
6. TERM.
6.1 MATURITY DATE. This Agreement shall continue in effect until the
maturity date set forth on the Schedule (the "Maturity Date"); provided that
the Maturity Date shall automatically be extended, and this Agreement shall
automatically and continuously renew, for successive additional terms of one
year each, unless one party gives written notice to the other, not less than
forty-five days prior to the next Maturity Date, that such party elects to
terminate this Agreement effective on the next Maturity Date.
6.2 EARLY TERMINATION. This Agreement may be terminated prior to the
Maturity Date as follows: (i) by Borrowers, effective three Business Days
after written notice of termination by both Borrower and Co-Borrower is given
to Coast; or (ii) by Coast at any time after the occurrence of an Event of
Default, without notice, effective immediately. If this Agreement is
terminated by Borrowers or by Coast under this Section 6.2, Borrowers shall
pay to Coast a termination fee (the "Early Termination Fee") in the amount
shown on the Schedule except in the event this Agreement is terminated by
Coast pursuant to Section 7.1(q) or 7.1(r). The Early Termination Fee shall
be due and payable on the effective date of termination and thereafter shall
bear interest at a rate equal to the rate applicable to the Receivable Loans.
6.3 PAYMENT OF OBLIGATIONS. On the Maturity Date or on any earlier
effective date of termination, Borrowers shall pay and perform in full all
Joint Obligations, whether evidenced by installment notes or otherwise, and
whether or not all or any part of such Joint Obligations are otherwise then
due and payable. Without limiting the generality of the foregoing, if on the
Maturity Date, or on any earlier effective date of termination, there are any
outstanding Letters of Credit issued by Coast or issued by another
institution based upon an application, guarantee, indemnity or similar
agreement on the part of Coast, then on such date Borrowers shall provide to
Coast cash collateral in an amount equal to the face amount of all such
Letters of Credit plus all interest, fees and cost due or to become due in
connection therewith, to secure all of the Obligations relating to said
Letter of Credit, pursuant to Coast's then standard form cash pledge
collateral agreement. Notwithstanding any termination of this Agreement, all
of Coast's security interests in all of
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the Borrower's Collateral and Co-Borrower's Collateral and all of the terms
and provisions of this Agreement shall continue in full force and effect until
all Joint Obligations have been paid and performed in full; provided that,
without limiting the fact that Loans are subject to the discretion of Coast,
Coast may, in its sole discretion, refuse to make any further Loans after
termination. No termination shall in any way affect or impair any right or
remedy of Coast, nor shall any such termination relieve Borrowers of any
Joint Obligation to Coast, until all of the Joint Obligations have been paid
and performed in full. Upon payment and performance in full of all the Joint
Obligations and termination of this Agreement, Coast shall promptly deliver
to Borrowers termination statements, requests for reconveyances and such
other documents as may be required to fully terminate Coast's security
interests.
7. EVENTS OF DEFAULT AND REMEDIES.
7.1 EVENTS OF DEFAULT. The occurrence of any of the following events
shall constitute an "Event of Default" under this Agreement, and Borrowers
shall give Coast immediate written notice thereof: (a) Any material warranty,
representation, statement, report or certificate made or delivered to Coast
by Borrower and/or Co-Borrower or any of Borrower's and/or Co-Borrower's
officers, employees or agents, now or in the future, shall be untrue or
misleading in a material respect; or (b) Borrower and/or Co-Borrower shall
fail to pay when due any Loan or any interest thereon or any other monetary
Obligation; or (c) the total Loans and other Joint Obligations outstanding at
any time shall exceed the Credit Limit; or (d) Borrowers shall fail to
deliver the proceeds of Borrower's Collateral and/or Co-Borrower's Collateral
to Coast as provided in Section 4.5 above, or shall fail to give Coast access
to their respective books and records or Borrower's Collateral and/or
Co-Borrower's Collateral as provided in Section 5.4 above, or shall breach
any negative covenant set forth in Section 5.5 above; or (e) Borrowers shall
fail to comply with the financial covenants (if any) set forth in the
Schedule or shall fail to perform any other non-monetary Joint Obligation
which by its nature cannot be cured; or (f) Borrowers shall fail to perform
any other non-monetary Joint Obligation, which failure is not cured within
fifteen (15) Business Days after the date due; or (g) Any levy, assessment,
attachment, seizure, lien or encumbrance (other than a Permitted Lien) is
made on all or any part of Borrower's Collateral and/or Co-Borrower's
Collateral which is not cured within ten (10) days after the occurrence of
the same; or (h) any default or event of default occurs under any obligation
secured by a Permitted Lien, which is not cured within any applicable cure
period or waived in writing by the holder of the Permitted Lien; or (i)
Borrowers breach any material contract or obligation, which has or may
reasonably be expected to have a material adverse effect on Borrower's or
Co-Borrower's business or financial condition; or (j) Dissolution,
termination of existence, insolvency or business failure of either Borrower
or Co-Borrower; or appointment of a receiver, trustee or custodian, for all
or any part of the property of, assignment for the benefit of creditors by,
or the commencement of any proceeding by Borrower and/or Co-Borrower under
any reorganization, bankruptcy, insolvency, arrangement, readjustment of
debt, dissolution or liquidation law or statute of any jurisdiction, now or
in the future in effect; or (k) the commencement of any proceeding against
Borrower and/or Co-Borrower or any guarantor of any of the Joint Obligations
under any reorganization, bankruptcy, insolvency, arrangement, readjustment
of debt, dissolution or liquidation law or statute of any jurisdiction, now
or in the future in effect, which is not cured by the dismissal thereof
within thirty (30) days after the date commenced; or (l) revocation or
termination of, or limitation or denial of liability upon, any guaranty of
the Joint Obligations or any attempt to do any of the foregoing, or
commencement of proceedings by any guarantor of any of the Joint Obligations
under any bankruptcy or insolvency law; or (m) revocation or termination of,
or limitation or denial of liability upon, any pledge of any certificate of
deposit, securities or other property or asset of any kind pledged by any
third party to secure any or all of the Joint Obligations, or any attempt to
do any of the foregoing, or commencement of proceedings by or against any
such third party under any bankruptcy or insolvency law; or (n) Borrower
and/or Co-Borrower makes any payment on account of any indebtedness or
obligation which has been subordinated to the Joint Obligations, other than
as permitted in the applicable subordination agreement, or if any Person who
has subordinated such indebtedness or obligations terminates or in any way
limits his subordination agreement; or (o) any person or two or more persons
acting in concert shall have acquired after the date of this Agreement,
beneficial ownership of 25% or more of the outstanding voting stock of
Borrower and/or Co-Borrower and the power to elect a majority of Borrower's
and/or Co-Borrower's board of directors without the prior written consent of
Coast; or (p) Borrower and/or Co-Borrower shall generally not pay its debts
as they become due, or Borrower and/or Co-Borrower shall conceal, remove or
transfer any part of its property, with intent to hinder, delay or defraud
its creditors, or make or suffer any transfer of any of its property which
may be fraudulent under any bankruptcy, fraudulent conveyance or similar law;
or (q) there shall be a material adverse change in Borrower's and/or
Co-Borrower's business or financial condition. Coast may cease making any
Loans hereunder during any of the above cure periods, and thereafter if an
Event of Default has occurred.
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7.2 REMEDIES. Upon the occurrence, and during the continuance, of any
Event of Default, Coast, at its option, and without notice or demand of any
kind (all of which are hereby expressly waived by Borrowers), may do any one
or more of the following: (a) Cease making Loans or otherwise extending
credit to Borrower and Co-Borrower under this Agreement or any other document
or agreement; (b) Accelerate and declare all or any part of the Joint
Obligations to be immediately due, payable, and performable, notwithstanding
any deferred or installment payments allowed by any instrument evidencing or
relating to any Joint Obligation; (c) Take possession of any or all of the
Borrower's Collateral and/or Co-Borrower's Collateral wherever it may be
found, and for that purpose Borrowers hereby authorize Coast without judicial
process to enter onto any of Borrowers' premises without interference to
search for, take possession of, keep, store, or remove any of the Borrower's
Collateral and/or Co-Borrower's Collateral, and remain on the premises or
cause a custodian to remain on the premises in exclusive control thereof,
without charge for so long as Coast deems it reasonably necessary in order to
complete the enforcement of its rights under this Agreement or any other
agreement; provided, however, that should Coast seek to take possession of
any of the Borrower's Collateral and/or Co-Borrower's Collateral by Court
process, Borrower and Co-Borrower hereby irrevocably waive: (i) any bond and
any surety or security relating thereto required by any statute, court rule
or otherwise as an incident to such possession; (ii) any demand for
possession prior to the commencement of any suit or action to recover
possession thereof; and (iii) any requirement that Coast retain possession
of, and not dispose of, any of Borrower's Collateral and/or Co-Borrower's
Collateral until after trial or final judgment; (d) Require Borrowers to
assemble any or all of Borrower's Collateral and/or Co-Borrower's Collateral
and make it available to Coast at places designated by Coast which are
reasonably convenient to Coast and Borrowers, and to remove the Borrower's
Collateral and/or Co-Borrower's Collateral to such locations as Coast may
deem advisable; (e) Complete the processing, manufacturing or repair of any
of Borrower's Collateral and/or Co-Borrower's Collateral prior to a
disposition thereof and, for such purpose and for the purpose of removal,
Coast shall have the right to use Borrower's premises, vehicles, hoists,
lifts, cranes, equipment and all other property without charge; (f) Sell,
lease or otherwise dispose of any of Borrower's Collateral and/or
Co-Borrower's Collateral, in its condition at the time Coast obtains
possession of it or after further manufacturing, processing or repair, at one
or more public and/or private sales, in lots or in bulk, for cash, exchange
or other property, or on credit, and to adjourn any such sale from time to
time without notice other than oral announcement at the time scheduled for
sale (Coast shall have the right to conduct such disposition on Borrowers'
premises without charge, for such time or times as Coast deems reasonable, or
on Coast's premises, or elsewhere and the Collateral need not be located at
the place of disposition; further, Coast may directly or through any
affiliated company purchase or lease any of Borrower's Collateral and/or
Co-Borrower's Collateral at any such public disposition, and if permissible
under applicable law, at any private disposition and sale or other
disposition of Borrower's Collateral and/or Co-Borrower's Collateral shall
not relieve Borrowers of any liability Borrowers may have if any of
Borrower's Collateral and/or Co-Borrower's Collateral is defective as to
title or physical condition or otherwise at the time of sale); (g) Demand
payment of, and collect any Receivables and General Intangibles comprising
Borrower's Collateral and/or Co-Borrower's Collateral and, in connection
therewith, Borrowers irrevocably authorize Coast to endorse or sign
Borrower's and/or Co-Borrower's names on all collections, receipts,
instruments and other documents, to take possession of and open mail
addressed to Borrowers and remove therefrom payments made with respect to any
item of Borrower's Collateral and/or Co-Borrower's Collateral or proceeds
thereof, and, in Coast's sole discretion, to grant extensions of time to pay,
compromise claims and settle Receivables and the like for less than face
value; (h) Offset against any sums in any of Borrowers' general, special or
other Deposit Accounts with Coast; and (i) Demand and receive possession of
any of Borrowers' respective federal and state income tax returns and the
books and records utilized in the preparation thereof or referring thereto.
All reasonable attorneys' fees, expenses, costs, liabilities and obligations
incurred by Coast with respect to the foregoing shall be due from the
Borrowers to Coast on demand. Coast may charge the same to Borrowers' Joint
Loan Account, and the same shall thereafter bear interest at the same rate as
is applicable to the Receivable Loans. Without limiting any of Coast's rights
and remedies, from and after the occurrence of any Event of Default, the
interest rate applicable to the Joint Obligations shall be increased by an
additional three percent per annum.
7.3 STANDARDS FOR DETERMINING COMMERCIAL REASONABLENESS. Borrowers and
Coast agree that a sale or other disposition (collectively, "sale") of any of
Borrower's Collateral and/or Co-Borrower's Collateral which complies with the
following standards will conclusively be deemed to be commercially
reasonable: (i) Notice of the sale is given to Borrowers at least seven days
prior to the sale, and, in the case of a public sale, notice of the sale is
published at least seven days before the sale in a newspaper of general
circulation in the county where the sale is to be conducted; (ii) Notice of
the sale describes the collateral in general, non-specific terms; (iii) The
sale is conducted at a place designated by Coast, with or without Borrower's
Collateral and/or Co-Borrower's Collateral being present; (iv) The sale
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commences at any time between 8:00 a.m. and 6:00 p.m.; (v) Payment of the
purchase price in cash or by cashier's check or wire transfer is required;
(vi) With respect to any sale of any of Borrower's Collateral and/or
Co-Borrower's Collateral, Coast may (but is not obligated to) direct any
prospective purchaser to ascertain directly from Borrowers any and all
information concerning the same. Coast shall be free to employ other methods
of noticing and selling Borrower's Collateral and/or Co-Borrower's
Collateral, in its discretion, if they are commercially reasonable.
7.4 POWER OF ATTORNEY. Upon the occurrence, and during the continuance,
of any Event of Default, without limiting Coast's other rights and remedies,
Borrower and Co-Borrower grant to Coast an irrevocable power of attorney
coupled with an interest, authorizing and permitting Coast (acting through
any of its employees, attorneys or agents) at any time, at its option, but
without obligation, with or without notice to Borrowers, and at Borrowers'
expense, to do any or all of the following, in Borrower's and/or
Co-Borrower's name or otherwise, but Coast agrees to exercise the following
powers in a commercially reasonable manner: (a) Execute on behalf of Borrower
and/or Co-Borrower any documents that Coast may, in its sole discretion, deem
advisable in order to perfect and maintain Coast's security interest in the
Collateral, or in order to exercise a right of Borrower and/or Co-Borrower or
Coast, or in order to fully consummate all the transactions contemplated
under this Agreement, and all other present and future agreements; (b)
Execute on behalf of Borrower and/or Co-Borrower any document exercising,
transferring or assigning any option to purchase, sell or otherwise dispose
of or to lease (as lessor or lessee) any real or personal property which this
part of Coast's Collateral or in which Coast has an interest; (c) Execute on
behalf of Borrower and/or Co-Borrower, any invoices relating to any
Receivable, any draft against any Account Debtor and any notice to any
Account Debtor, any proof of claim in bankruptcy, any Notice of Lien, claim
of mechanic's, materialman's or other lien, or assignment or satisfaction of
mechanic's, materialman's or other lien; (d) Take control in any manner of
any cash or non-cash items of payment or proceeds of Borrower's Collateral
and/or Co-Borrower's Collateral; endorse the name of Borrower and/or
Co-Borrower upon any instruments, or documents, evidence of payment or
Borrower's Collateral and/or Co-Borrower's Collateral that may come into
Coast's possession; (e) Endorse all checks and other forms of remittances
received by Coast; (f) Pay, contest or settle any lien, charge, encumbrance,
security interest and adverse claim in or to any of Borrower's Collateral
and/or Co-Borrower's Collateral, or any judgment based thereon, or otherwise
take any action to terminate or discharge the same; (g) Grant extensions of
time to pay, compromise claims and settle Receivables and General Intangibles
for less than face value and execute all releases and other documents in
connection therewith; (h) Pay any sums required on account of Borrower's
and/or Co-Borrower's taxes or to secure the release of any liens therefor, or
both; (i) Settle and adjust, and give releases of, any insurance claim that
relates to any of Borrower's Collateral and/or Co-Borrower's Collateral and
obtain payment therefor; (j) Instruct any third party having custody or
control of any books or records belonging to, or relating to, Borrower and/or
Co-Borrower to give Coast the same rights of access and other rights with
respect thereto as Coast has under this Agreement; and (k) Take any action or
pay any sum required of Borrower and/or Co-Borrower pursuant to this
Agreement and any other present or future agreements. Any and all reasonable
sums paid and any and all reasonable costs, expenses, liabilities,
obligations and attorneys' fees incurred by Coast with respect to the
foregoing shall be added to and become part of the Joint Obligations, and
shall be payable on demand. Coast may charge the foregoing to Borrowers'
Joint Loan Account and the foregoing shall thereafter bear interest at the
same rate applicable to the Receivable Loans. In no event shall Coast's
rights under the foregoing power of attorney or any of Coast's other rights
under this Agreement be deemed to indicate that Coast is in control of the
business, management or properties of Borrower and/or Co-Borrower.
7.5 APPLICATION OF PROCEEDS. All proceeds realized as the result of any
sale of Borrower's Collateral and/or Co-Borrower's shall be applied by Coast
first to the reasonable costs, expenses, liabilities, obligations and
attorneys' fees incurred by Coast in the exercise of its rights under this
Agreement, second to the interest due upon any of the Joint Obligations, and
third to the principal of the Joint Obligations, in such order as Coast shall
determine in its sole discretion. Any surplus shall be paid to Borrowers or
other persons legally entitled thereto; Borrowers shall remain liable to
Coast for any deficiency. If, Coast, in its sole discretion, directly or
indirectly enters into a deferred payment or other credit transaction with
any purchaser at any sale of Borrower's Collateral and/or Co-Borrower's
Collateral, Coast shall have the option, exercisable at any time, in its sole
discretion, of either reducing the Joint Obligations by the principal amount
of purchase price or deferring the reduction of the Joint Obligations until
the actual receipt by Coast of the cash therefor.
7.6 REMEDIES CUMULATIVE. In addition to the rights and remedies set
forth in this Agreement, Coast shall have all the other rights and remedies
accorded a secured party under the Code and under all other applicable laws,
and under any other instrument or agreement now or in the future entered into
between Coast and Borrower and/or Co-Borrower, and all of such
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rights and remedies are cumulative and none is exclusive. Exercise or partial
exercise by Coast of one or more of its rights or remedies shall not be
deemed an election, nor bar Coast from subsequent exercise or partial
exercise of any other rights or remedies. The failure or delay of Coast to
exercise any rights or remedies shall not operate as a waiver thereof, but
all rights and remedies shall continue in full force and effect until all of
the Joint Obligations have been fully paid and performed.
8. Definitions. AS USED IN THIS AGREEMENT, THE FOLLOWING TERMS HAVE THE
FOLLOWING MEANINGS:
"ACCOUNT DEBTOR" means the obligor on a Receivable.
"AFFILIATE" means, with respect to any Person, a relative, partner,
shareholder, director, officer, or employee of such Person, or any parent or
subsidiary of such Person, or any Person controlling, controlled by or under
common control with such Person.
"BUSINESS DAY" means a day on which Coast is open for business.
"CODE" means the Uniform Commercial Code as adopted and in effect in the
State of California from time to time.
"BORROWER'S COLLATERAL AND CO-BORROWER'S COLLATERAL" has the meaning set
forth in Section 2.1 above.
"CONSOLIDATED TANGIBLE NET WORTH" means Borrowers' shareholders'
combined equity plus debt subordination to Coast less goodwill, patents,
trademarks, copyrights, franchises, formulas, leaseholds, non-compete
agreements, engineering plans, deferred tax benefits, organization costs,
start-up costs and any other intangibles as defined by generally accepted
accounting principles, all stated on a consolidated basis.
"DEFAULT" means any event which with notice or passage of time or both,
would constitute an Event of Default.
"DEPOSIT ACCOUNT" has the meaning set forth in Section 9105 of the Code.
"DILUTION" means all non-cash reductions, including but not limited to
credit memos, discounts, journal entries and advertising allowances, in the
total amount of Receivables, expressed as a percentage of Receivables.
"ELIGIBLE INVENTORY" means Inventory which Coast, in its sole judgment,
deems eligible for borrowing, based on such considerations as Coast may from
time to time deem appropriate. Without limiting the fact that the
determination of which Inventory is eligible for borrowing is a matter of
Coast's discretion, Inventory which does not meet the following requirements
will not be deemed to be Eligible Inventory: Inventory which (i) consists of
finished goods, in good, new and salable condition which is not perishable,
not obsolete or unmerchantable, and is not comprised of raw materials, work
in process, packaging materials or supplies; (ii) meets all applicable
governmental standards; (iii) has been manufactured in compliance with the
Fair Labor Standards Act; (iv) conforms in all respects to the warranties and
representations set forth in this Agreement; (v) is at all times subject to
Coast's duly perfected, first priority security interest; and (vi) is
situated at one of the locations set forth on the Schedule.
"ELIGIBLE RECEIVABLES" means Receivables arising in the ordinary course
of Borrower's or Co-Borrower's business from the sale of goods or rendition
of services, which Coast, in its good faith business judgment, shall deem
eligible for borrowing, based on such considerations as Coast may from time
to time deem appropriate, including acceptable credit checks. Receivables
which do not meet the following requirements will not be deemed Eligible
Receivables: Receivables which are (i) more than ninety (90) days past
invoice date; (ii) foreign Receivables, unless, and subject to Coast's
discretion: (a) the foreign Receivable is insured by a Foreign Credit
Insurance Association ("FCIA") policy acceptable to Coast or by an
alternative insurer and policy acceptable to Coast, (b) the foreign
Receivable is secured by a letter of credit, (c) the foreign Receivable
originates from a large foreign company with whom Borrower or Co-Borrower has
a verifiable credit history, (d) the foreign Receivable originates from a
company with a minimum 3A2 D&B rating acceptable to Coast, or (e) the foreign
Receivable originates from a wholly-owned subsidiary of a United States
company; and (iii) United States Federal Government Receivables, unless
perfected and supported by documentation acceptable to Coast.
"EQUIPMENT" means all of Borrower's and Co-Borrower's present and
hereafter acquired machinery, molds, machine tools, motors, furniture,
equipment, furnishings, fixtures, trade fixtures, motor vehicles, tools,
parts, dies, jigs, goods and other tangible personal property (other than
Inventory) of every kind and description used in Borrower's and
Co-Borrower's operations or owned by Borrower and Co-Borrower and any
interest in any of the foregoing, and all attachments, accessories,
accessions, replacements, substitutions, additions or improvements to any of
the foregoing, wherever located.
"EVENT OF DEFAULT" means any of the events set forth in Section 7.1 of
this Agreement.
"GENERAL INTANGIBLES" means all general intangibles of Borrower or
Co-Borrower, whether now owned or hereafter created or acquired by Borrower
or Co-Borrower, including, without limitation, all choses in action, causes
of action, corporate or other business records, Deposit Accounts, inventions,
designs, drawings, blueprints, patents, patent applications, trademarks and
the goodwill of the business symbolized thereby, names, trade names, trade
secrets, goodwill, copyrights, registrations, licenses, franchises, customer
lists, security and other deposits, rights in all litigation presently or
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hereafter pending for any cause or claim (whether in contract, tort or
otherwise), and all judgments now or hereafter arising therefrom, all claims
of Borrowers against Coast, rights to purchase or sell real or personal
property, rights as a licensor or licensee of any kind, royalties, telephone
numbers, proprietary information, purchase orders, and all insurance policies
and claims (including without limitation life insurance, key man insurance,
credit insurance, liability insurance, property insurance and other
insurance), tax refunds and claims, computer programs, discs, tapes and tape
files, claims under guaranties, security interests or other security held by
or granted to Borrowers, all rights to indemnification and all other
intangible property of every kind and nature (other than Receivables).
"INVENTORY" means all of Borrower's and Co-Borrower's now owned and
hereafter acquired goods, merchandise or other personal property, wherever
located, to be furnished under any contract of service or held for sale or
lease (including without limitation all raw materials, work in process,
finished goods and goods in transit, and including without limitation all
farm products), and all materials and supplies of every kind, nature and
description which are or might be used or consumed in Borrower's and/or
Co-Borrower's business or used in connection with the manufacture, packing,
shipping, advertising, selling or finishing of such goods, merchandise or
other personal property, and all warehouse receipts, documents of title and
other documents representing any of the foregoing.
"INVESTMENT PROPERTY" AS DEFINED IN THE CODE.
"MAXIMUM DOLLAR AMOUNT" has the meaning set forth in Section 1 of the
Schedule.
"JOINT OBLIGATIONS" means all present and future Loans, advances, debts,
liabilities, obligations, guaranties, covenants, duties and indebtedness at
any time owing by Borrower and Co-Borrower to Coast, whether evidenced by
this Agreement or any note or other instrument or document, whether arising
from an extension of credit, opening of a letter of credit, banker's
acceptance, loan, guaranty, indemnification or otherwise, whether direct or
indirect (including, without limitation, those acquired by assignment and any
participation by Coast in Borrower's and/or Co-Borrower's debts owing to
others), absolute or contingent, due or to become due, including, without
limitation, all interest, charges, expenses, fees, attorney's fees, expert
witness fees, audit fees, letter of credit fees, collateral monitoring fees,
closing fees, facility fees, termination fees, minimum interest charges and
any other sums chargeable to Borrower and/or Co-Borrower under this Agreement
or under any other present or future instrument or agreement between Borrower
and/or Co-Borrower and Coast.
"PERMITTED LIENS" means the following: (i) purchase money security
interests in specific items of Equipment; (ii) leases of specific items of
Equipment; (iii) liens for taxes not yet payable; (iv) additional security
interests and liens consented to in writing by Coast, which consent shall not
be unreasonably withheld; (v) security interests being terminated
substantially concurrently with this Agreement; (vi) liens of materialmen,
mechanics, warehousemen, carriers, or other similar liens arising in the
ordinary course of business and securing obligations which are not
delinquent; (vii) liens incurred in connection with the extension, renewal or
refinancing of the indebtedness secured by liens of the type described above
in clauses (i) or (ii) above, provided that any extension, renewal or
replacement lien is limited to the property encumbered by the existing lien
and the principal amount of the indebtedness being extended, renewed or
refinanced does not increase; (viii) liens in favor of customs and revenue
authorities which secure payment of customs duties in connection with the
importation of goods. Coast will have the right to require, as a condition to
its consent under subparagraph (iv) above, that the holder of the additional
security interest or lien sign an intercreditor agreement on Coast's then
standard form, acknowledge that the security interest is subordinate to the
security interest in favor of Coast, and agree not to take any action to
enforce its subordinate security interest so long as any Joint Obligations
remain outstanding, and that Borrowers agree that any uncured default in any
obligation secured by the subordinate security interest shall also constitute
an Event of Default under this Agreement.
"PERSON" means any individual, sole proprietorship, partnership, joint
venture, trust, unincorporated organization, association, corporation,
government, or any agency or political division thereof, or any other entity.
"RECEIVABLES" means all of Borrower's and Co-Borrower's now owned and
hereafter acquired accounts (whether or not earned by performance), letters
of credit, contract rights, chattel paper, instruments, securities, documents
and all other forms of obligations at any time owing to Borrowers, all
guaranties and other security therefor, all merchandise returned to or
repossessed by Borrowers, and all rights of stoppage in transit and all other
rights or remedies of an unpaid vendor, lienor or secured party.
OTHER TERMS. All accounting terms used in this Agreement, unless
otherwise indicated, shall have the meanings given to such terms in
accordance with generally accepted accounting principles, consistently
applied. All other terms contained in this Agreement, unless otherwise
indicated, shall have the meanings provided by the Code, to the extent such
terms are defined therein.
9. GENERAL PROVISIONS.
9.1 INTEREST COMPUTATION. In computing interest on the Joint
Obligations, all checks, wire transfers and other items of payment received
by Coast
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(including proceeds of Receivables and payment of the Joint Obligations in full)
shall be deemed applied by Coast on account of the Joint Obligations two
Business Days after receipt by Coast of immediately available funds, and, for
the purposes of the foregoing, any such funds received after 10:30 AM on any day
shall be deemed received on the next Business Day. Coast shall not, however, be
required to credit Borrowers' Joint Loan Account for the amount of any item of
payment which is unsatisfactory to Coast in its sole discretion, and Coast may
charge Borrowers' joint loan account for the amount of any item of payment which
is returned to Coast unpaid.
9.2 APPLICATION OF PAYMENTS. All payments with respect to the Joint
Obligations may be applied, and in Coast's sole discretion reversed and
re-applied, to the Joint Obligations, in such order and manner as Coast shall
determine in its sole discretion.
9.3 CHARGES TO ACCOUNTS. Coast may, in its discretion, require that
Borrowers pay monetary Joint Obligations in cash to Coast, or charge them to
Borrowers' Joint Loan Account, in which event they will bear interest at the
same rate applicable to the Loans. Coast may also, in its discretion, charge
any monetary Joint Obligations to either or both of Borrower's and/or
Co-Borrower's Deposit Accounts maintained with Coast.
9.4 MONTHLY ACCOUNTINGS. Coast shall provide Borrowers monthly with an
account of advances, charges, expenses and payments made pursuant to this
Agreement. Such account shall be deemed correct, accurate and binding on
Borrowers and an account stated (except for reverses and reapplications of
payments made and corrections of errors discovered by Coast), unless Borrower
and/or Co-Borrower notifies Coast in writing to the contrary within thirty days
after each account is rendered, describing the nature of any alleged errors or
omissions.
9.5 NOTICES. All notices to be given under this Agreement shall be in
writing and shall be given either personally or by reputable private delivery
service or by regular first-class mail, or certified mail return receipt
requested, addressed to Coast or Borrowers at the addresses shown in the heading
to this Agreement, or at any other address designated in writing by one party to
the other party. Notices to Coast shall be directed to the Commercial Finance
Division, to the attention of the Division Manager or the Division Credit
Manager. All notices shall be deemed to have been given upon delivery in the
case of notices personally delivered, or at the expiration of one Business Day
following delivery to the private delivery service, or two Business Days
following the deposit thereof in the United States mail, with postage prepaid.
9.6 SEVERABILITY. Should any provision of this Agreement be held by any
court of competent jurisdiction to be void or unenforceable, such defect shall
not affect the remainder of this Agreement, which shall continue in full force
and effect.
9.7 INTEGRATION. This Agreement and such other written agreements,
documents and instruments as may be executed in connection herewith are the
final, entire and complete agreement between Borrowers and Coast and supersede
all prior and contemporaneous negotiations and oral representations and
agreements, all of which are merged and integrated in this Agreement. THERE ARE
NO ORAL UNDERSTANDINGS, REPRESENTATIONS OR AGREEMENTS BETWEEN THE PARTIES WHICH
ARE NOT SET FORTH IN THIS AGREEMENT OR IN OTHER WRITTEN AGREEMENTS SIGNED BY THE
PARTIES IN CONNECTION HEREWITH.
9.8 WAIVERS. The failure of Coast at any time or times to require
Borrowers to strictly comply with any of the provisions of this Agreement or
any other present or future agreement between Borrowers and Coast shall not
waive or diminish any right of Coast later to demand and receive strict
compliance therewith. Any waiver of any default shall not waive or affect
any other default, whether prior or subsequent, and whether or not similar.
None of the provisions of this Agreement or any other agreement now or in the
future executed by Borrower and/or Co-Borrower and delivered to Coast shall
be deemed to have been waived by any act or knowledge of Coast or its agents
or employees, but only by a specific written waiver signed by an authorized
officer of Coast and delivered to Borrowers. Borrowers waive demand,
protest, notice of protest and notice of default or dishonor, notice of
payment and nonpayment, release, compromise, settlement, extension or renewal
of any commercial paper, instrument, account, General Intangible, document or
guaranty at any time held by Coast on which Borrower and/or Co-Borrower is or
may in any way be liable, and notice of any action taken by Coast, unless
expressly required by this Agreement.
9.9 NO LIABILITY FOR ORDINARY NEGLIGENCE. Neither Coast, nor any of its
directors, officers, employees, agents, attorneys or any other Person affiliated
with or representing Coast shall be liable for any claims, demands, losses or
damages, of any kind whatsoever, made, claimed, incurred or suffered by
Borrowers or any other party through the ordinary negligence of Coast, or any of
its directors, officers, employees, agents, attorneys or any other Person
affiliated with or representing Coast, but nothing herein shall relieve Coast
from liability for its own gross negligence or willful misconduct.
9.10 AMENDMENT. The terms and provisions of this Agreement may not be
waived or amended, except in
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a writing executed by Borrowers and duly authorized officer of Coast.
9.11 TIME OF ESSENCE. Time is of the essence in the performance by
Borrowers of each and every obligation under this Agreement.
9.12 ATTORNEYS FEES, COSTS AND CHARGES. Borrowers shall reimburse Coast
for all reasonable attorneys' fees and all filing, recording, search, title
insurance, appraisal, audit, and other reasonable costs incurred by Coast,
pursuant to, or in connection with, or relating to this Agreement (whether or
not a lawsuit is filed), including, but not limited to, any reasonable
attorneys' fees and costs Coast incurs in order to do the following: prepare
and negotiate this Agreement and the documents relating to this Agreement;
obtain legal advice in connection with this Agreement or Borrowers; enforce, or
seek to enforce, any of its rights; prosecute actions against, or defend actions
by, Account Debtors; commence, intervene in, or defend any action or proceeding;
initiate any complaint to be relieved of the automatic stay in bankruptcy; file
or prosecute any probate claim, bankruptcy claim, third-party claim, or other
claim; examine, audit, copy, and inspect any of the Collateral or any of
Borrowers' respective books and records; protect, obtain possession of, lease,
dispose of, or otherwise enforce Coast's security interest in, the Borrower's
Collateral and/or Co-Borrower's Collateral; and otherwise represent Coast in any
litigation relating to Borrower and/or Co-Borrower. If either Coast or Borrower
and/or Co-Borrower files any lawsuit against the other predicated on a breach of
this Agreement, the prevailing party in such action shall be entitled to recover
its reasonable costs and attorneys' fees, including (but not limited to)
reasonable attorneys' fees and costs incurred in the enforcement of, execution
upon or defense of any order, decree, award or judgment. Borrowers shall also
pay Coast's standard charges for returned checks and for wire transfers, in
effect from time to time. All attorneys' fees, costs and charges to which Coast
may be entitled pursuant to this Paragraph may be charged by Coast to Borrower's
joint loan account and shall thereafter bear interest at the same rate as the
Receivable Loans.
9.13 BENEFIT OF AGREEMENT. The provisions of this Agreement shall be
binding upon and inure to the benefit of the respective successors, assigns,
heirs, beneficiaries and representatives of Borrower and/or Co-Borrower and
Coast; provided, however, that Borrower and/or Co-Borrower shall not assign or
transfer any of their rights under this Agreement without the prior written
consent of Coast, and any prohibited assignment shall be void. No consent by
Coast to any assignment shall release Borrower and/or Co-Borrower from their
liability for the Joint Obligations.
9.14 PUBLICITY. Coast is hereby authorized, at its expense, to issue
appropriate press releases and to cause a tombstone to be published announcing
the consummation of this transaction and the aggregate amount thereof.
9.15 JOINT AND SEVERAL LIABILITY. Borrowers' liability shall be joint and
several, and the compromise of any claim with, or the release of, Borrower or
Co-Borrower shall not constitute a compromise with, or a release of, any other
Borrower or Co-Borrower.
9.16 LIMITATION OF ACTIONS. Any claim or cause of action by Borrower
and/or Co-Borrower against Coast, its directors, officers, employees, agents,
accountants or attorneys, based upon, arising from, or relating to this Loan
Agreement, or any other present or future document or agreement, or any other
transaction contemplated hereby or thereby or relating hereto or thereto, or any
other matter, cause or thing whatsoever, occurred, done, omitted or suffered to
be done by Coast, its directors, officers, employees, agents, accountants or
attorneys, shall be barred unless asserted by Borrower and/or Co-Borrower by the
commencement of an action or proceeding in a court of competent jurisdiction by
the filing of a complaint within one year after the first act, occurrence or
omission upon which such claim or cause of action, or any part thereof, is
based, and the service of a summons and complaint on an officer of Coast, or on
any other person authorized to accept service on behalf of Coast, within thirty
(30) days thereafter. Borrowers agree that such one-year period is a reasonable
and sufficient time for Borrower and/or Co-Borrower to investigate and act upon
any such claim or cause of action. The one-year period provided herein shall
not be waived, tolled, or extended except by the written consent of Coast in its
sole discretion. This provision shall survive any termination of this Agreement
or any other present or future agreement.
9.17 PARAGRAPH HEADINGS; CONSTRUCTION. Paragraph headings are only used
in this Agreement for convenience. Borrowers and Coast acknowledge that the
headings may not describe completely the subject matter of the applicable
paragraph, and the headings shall not be used in any manner to construe, limit,
define or interpret any term or provision of this Agreement. The term
"including", whenever used in this Agreement, shall mean "including (but not
limited to)". This Agreement has been fully reviewed and negotiated between the
parties and no uncertainty or ambiguity in any term or provision of this
Agreement shall be construed strictly against Coast or Borrowers under any rule
of construction or otherwise.
9.18 GOVERNING LAW; JURISDICTION; VENUE. This Agreement and all acts and
transactions hereunder and all rights and obligations of Coast and Borrowers
shall be governed by the laws of the State of California.
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As a material part of the consideration to Coast to enter into this Agreement,
Borrowers (i) agree that all actions and proceedings relating directly or
indirectly to this Agreement shall, at Coast's option, be litigated in courts
located within California, and that the exclusive venue therefor shall be Los
Angeles County; (ii) consent to the jurisdiction and venue of any such court and
consents to service of process in any such action or proceeding by personal
delivery or any other method permitted by law; and (iii) waive any and all
rights Borrower and/or Co-Borrower may have to object to the jurisdiction of any
such court, or to transfer or change the venue of any such action or proceeding.
9.19 MUTUAL WAIVER OF JURY TRIAL. BORROWERS AND COAST EACH HEREBY WAIVE
THE RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED UPON, ARISING OUT
OF, OR IN ANY WAY RELATING TO, THIS AGREEMENT OR ANY OTHER PRESENT OR FUTURE
INSTRUMENT OR AGREEMENT BETWEEN COAST AND BORROWER AND/OR CO-BORROWER, OR ANY
CONDUCT, ACTS OR OMISSIONS OF COAST OR BORROWERS OF ANY OF THEIR DIRECTORS,
OFFICERS, EMPLOYEES, AGENTS, ATTORNEYS OR ANY OTHER PERSONS AFFILIATED WITH
COAST OR BORROWERS, IN ALL OF THE FOREGOING CASES, WHETHER SOUNDING IN CONTRACT
OR TORT OR OTHERWISE.
BORROWER:
DESTRON FEARING CORPORATION
BY /s/ Randolph K. Geissler
---------------------------------
RANDOLPH K. GEISSLER
TITLE: PRESIDENT AND
CHIEF EXECUTIVE OFFICER
CO-BORROWER:
FEARING MANUFACTURING, CO., INC.
BY /s/ Randolph K. Geissler
---------------------------------
RANDOLPH K. GEISSLER
TITLE: PRESIDENT AND
CHIEF EXECUTIVE OFFICER
COAST:
COAST BUSINESS CREDIT-Registered Trademark-,
A DIVISION OF SOUTHERN PACIFIC THRIFT & LOAN
ASSOCIATION
BY /s/ Robert D. Peters
---------------------------------
ROBERT D. PETERS
TITLE: VICE PRESIDENT
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<PAGE>
COAST
SCHEDULE
TO
LOAN AND SECURITY AGREEMENT
BORROWER: DESTRON FEARING CORPORATION
CO-BORROWER: FEARING MANUFACTURING CO., INC.
ADDRESS: 490 VILLAUME AVENUE
SOUTH ST. PAUL, MN 55075
DATE: JUNE 25, 1997
This Schedule forms an integral part of the Loan and Security Agreement
between Coast Business Credit-Registered Trademark-, a division of Southern
Pacific Thrift & Loan Association, and the above-borrowers of even date.
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1. CREDIT LIMIT
(Section 1.1): Loans in a total amount at any time outstanding not to
exceed the lesser of a total of $3,000,000 at any one
time outstanding (the "Maximum Dollar Amount"), or the
sum of (a),(b) and (c) below:
(a) Loans (the "Receivable Loans") in an amount
not to exceed (i) 80% of the amount of Borrowers'
Eligible Receivables (as defined in Section 8
above), with the exception that Coast may lend up
to 95% of the amount of Borrowers' foreign Eligible
Receivables that are backed by a Foreign Credit
Insurance Association ("FCIA") policy acceptable to
Coast or by an alternative insurer and policy
acceptable to Coast, plus
(b) Loans (the "Inventory Loans") in an amount
not to exceed the lesser of the sum of:
Up to 40% of the value of Eligible Inventory
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(as defined in Section 8 above) for Fearing
Manufacturing Co., Inc., consisting of finished
goods and purchased material and calculated at the
lower of cost or market value and determined on a
first-in, first-out basis and up to 35% of the
value of Eligible Inventory for Destron Fearing
Corporation, consisting of finished goods and
calculated at the lower of cost or market value and
determined on a first-in, first-out basis, or
$1,500,000; plus
(c) Letter of Credit Sublimit (Section 1.4) of
$1,000,000 as needed with a 100% reserve for
amounts available for drawing under Standby Letters
of Credit and Documentary Letters of Credit.
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2. INTEREST
INTEREST RATE
(Section 1.2): A rate equal to the "Prime Rate" plus 1.75% per annum,
calculated on the basis of a 360-day year for the actual
number of days elapsed. The interest rate applicable to
all Loans shall be adjusted monthly as of the first day
of each month, and the interest to be charged for each
month shall be based on the highest "Prime Rate" in
effect during said month, but in no event shall the rate
of interest charged on any Loans in any month be less
than 8% per annum. "Prime Rate" means the actual
"Reference Rate" or the substitute therefor of the Bank
of America NT & SA whether or not that rate is the
lowest interest rate charged by said bank. If the Prime
Rate, as defined, is unavailable, "Prime Rate" shall
mean the highest of the prime rates published in the
Wall Street Journal on the first business day of the
month, as the base rate on corporate loans at large U.S.
money center commercial banks.
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<PAGE>
MINIMUM MONTHLY
INTEREST (Section 1.2): An amount equal to 3/4% per annum of the
average monthly unused portion of the Credit
Limit payable monthly.
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3. FEES (Section 1.3):
ORIGINATION FEE: 1 1/4% of the Maximum Dollar Amount payable
concurrently herewith and 3/4% of the Maximum
Dollar Amount on the one year anniversary
date of the Agreement.
FACILITY FEE: $4,000, per quarter, payable in advance (pro
rated for any partial quarter at the
beginning of the term of this Agreement).
LETTER OF CREDIT FEES: 1/4% per month for Standby Letters of Credit
and Documentary Letters of Credit, plus all
bank charges and fees.
RENEWAL FEE: 1/2% of the Maximum Dollar Amount commencing
with any renewal after two years from the
date of this Agreement.
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4. MATURITY DATE
(Section 6.1): June 30, 1999, subject to automatic renewal
as provided in Section 6.1 above, and early
termination as provided in Section 6.2 above.
EARLY TERMINATION
FEE (Section 6.2): A termination fee of 3% of the Maximum Dollar
Amount for the first year of the Agreement;
2% of the Maximum Dollar Amount for the first
six months of the second year of the
Agreement; and 1% of the Maximum Dollar
Amount for the last six months of the second
year of the Agreement.
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5. REPORTING
(Section 5.3):
Borrower shall provide Coast with the
following:
1. Monthly Receivable agings, aged by
invoice date, within ten days after the
end of each month.
2. Monthly accounts payable agings, aged by
invoice date, and outstanding or held
check registers within ten days after
the end of each month.
3. Monthly perpetual inventory reports for
the Inventory valued on a first-in,
first-out basis at the lower of cost or
market (in accordance with generally
accepted accounting principles) or such
other inventory reports as are
reasonably requested by Coast, all
within ten days after the end of each
month.
4. Monthly schedule of all inventory
located off-site both domestically and
overseas by product and dollar value.
5. Monthly unaudited financial statements,
as soon as available, and in any event
within thirty days after the end of each
month.
6. Quarterly unaudited financial statements
and 10Q's, as soon as available and in
any event within forty-five days after
the end of each fiscal quarter of
Borrower.
7. Quarterly customer lists, including
customer name, address, and phone
number.
8. Annual Certified Public Accountant
audited consolidated and consolidating
financial statements and 10K's, as soon
as available and in any event within 90
days following the end of Borrower's
fiscal year, certified by independent
certified public accountants acceptable
to Coast
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6. BORROWER INFORMATION:
PRIOR NAMES OF
BORROWERS
(Section 3.2): Destron/IDI, Inc.
Destron Technologies, Inc.
International Destron Technologies, Inc.
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PRIOR TRADE
NAMES OF BORROWERS
(Section 3.2): None
EXISTING TRADE
NAMES OF BORROWERS Destron Fearing Corporation
(Section 3.2): Fearing Manufacturing Company
Destron Technologies Limited
OTHER LOCATIONS AND
ADDRESSES (Section 3.3): None.
MATERIAL ADVERSE
LITIGATION
(Section 3.10): TRACENET TECHNOLOGIES, INC., ET
AL. VS. DESTRON-FEARING CORP., ET AL.; false
advertising and patent infringement matter; filed
United States District Court, District of Minnesota.
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7. OTHER PROVISIONS
(Section 5.1):
(1) No accounts payable over 90
days past due at date of funding;
(2) All taxes to be paid and
current at funding;
(3) Remaining minimum loan availability of $300,000
at time of funding, after taking into account all
disbursements, including Coast's fees, that are
payable at funding;
(4) Borrowers, other than in the normal course of
business, will not, during the term of this
Agreement, make any payments or transfers of
money, property, rights or assets of any kind or
nature (including without limitation sales, loans,
repayment of loans, capital contributions,
purchases, loans, compensation arrangements,
consulting fees, management fees, licenses or
any other transaction of any kind or nature) to
any Affiliates' of Borrowers without the prior
written consent of Coast;
(5) Landlord Waivers in a form acceptable to Coast at
funding;
(6) Perfected security interest on all Borrowers'
assets at time of funding including accounts
receivables,
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inventory, equipment, patents, trademarks and
general intangibles at funding;
(7) An ongoing minimum Consolidated Tangible Net Worth
of $3,000,000;
(8) Prior to funding, terms and conditions of
Borrower's debt owed to Hughes Microelectronics
Europa Espana S.A. or its successor are to be
reviewed and accepted by Coast; and
(9) Within 90 days from funding, Borrower is to reduce
the Inventory held by Hughes Microelectronics
Europa Espana S.A. to a dollar amount reasonably
acceptable to Coast.
Borrower: Coast:
DESTRON FEARING CORPORATION COAST BUSINESS CREDIT-Registered
Trademark-, a division of Southern Pacific
Thrift & Loan Association
By /s/ Randolph K. Geissler By /s/ Robert D. Peters
--------------------------- ------------------------------------
Randolph K. Geissler Robert D. Peters
Title: President and Chief Title: Vice President
Executive Officer
Co-Borrower:
FEARING MANUFACTURING CO., INC.
By /s/ Randolph K. Geissler
---------------------------
Randolph K. Geissler
Title: President and Chief
Executive Officer
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<PAGE>
Exhibit 13.1
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
RESULTS OF OPERATIONS
FISCAL 1997 COMPARED TO FISCAL 1996
Revenue in fiscal 1997 was $12,889,000 which represented a 19% increase over
the $10,830,000 recorded in fiscal 1996. Revenue from the sale of electronic
products increased 30% principally because of higher sales volume in the
United States fisheries market and the introduction of electronic products
into the companion animal market in Japan. Revenue from visual
identification products rose 8% over fiscal 1996 as a result of price
increases and higher unit volumes.
Gross profit as a percentage of revenue for fiscal 1997 was 33% compared to
21% in the prior year. The improvement in gross margins resulted from a more
profitable mix of electronic and visual products combined with higher margins
on the sales of electronic readers and an increase in unit prices of certain
visual identification products. Also, in fiscal 1996, as noted below, the
Company incurred significant costs to retrofit and update certain reader
technologies. These costs were less significant in fiscal 1997.
Selling, general and administrative expenses declined by 27% to $3,651,000
from $4,972,000 in fiscal 1996, in part due to a $400,000 reduction in legal
fees in the current fiscal year. Additionally, in fiscal 1996, charges of
$1,043,000 were recorded for the amortization of electronic readers provided
under a marketing and distribution agreement, with no similar amortization
expenses incurred in fiscal 1997. Selling expenses remained relatively
unchanged between fiscal 1997 and 1996.
Research and development expenses of $870,000 in fiscal 1997 were 9% lower
than the previous year's $955,000. The decrease primarily resulted from
lower outside production development expenses.
Interest and other of $562,000 increased in fiscal 1997 compared to $224,000
for the prior year, partially due to the collection in fiscal 1996 of an
indebtedness that had been charged to expense in a prior fiscal year.
Further, in fiscal 1997, the Company recognized certain imputed interest on
an outstanding balance payable to a vendor. This balance was converted into
a term note in June 1997. (See "Liquidity and Capital Resources.")
The Company derives a significant portion of its revenue from export sales.
The gross profit and cash requirements of these sales do not vary materially
from the requirements of its domestic sales.
FISCAL 1996 COMPARED TO FISCAL 1995
Revenue in fiscal 1996 of $10,830,000 was 33% lower than the $16,234,000
recorded in fiscal 1995. Electronic products sales declined 49% in fiscal
1996 principally because shipments into the United States companion animal
market were down 97% from fiscal 1995. Partially offsetting this were
significantly higher sales of electronic products in the European markets.
Visual identification product revenues remained relatively unchanged between
years.
Gross profit as a percentage of revenue for fiscal 1996 was 21% compared to
35% in the prior year. The lower margins in fiscal 1996 resulted from less
absorption of fixed manufacturing overhead because of lower revenue, as well
as low or negative margins on the sales of certain microchip readers.
Additionally, the Company incurred costs of approximately $590,000 in fiscal
1996, primarily in the fourth quarter, to retrofit and upgrade the technology
in certain microchip readers, as well as additional warranty costs of
approximately $200,000, also related primarily to technology upgrades. The
margins earned in the sale of visual identification products declined in
fiscal 1996 from the fiscal 1995 level because of changes in the mix of
products.
A-1
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Selling, general and administrative expenses increased to $4,972,000 in
fiscal 1996 from $3,727,000 in fiscal 1995. These increases were principally
the result of legal fees of approximately $1,200,000 (primarily related to
patent litigation) and charges of $1,043,000 related to amortization of
electronic readers provided under a marketing and distribution agreement
entered into in fiscal 1995. Lower depreciation and pension expenses
partially offset these increases.
Research and development expenses were $955,000 in fiscal 1996 compared to
$1,038,000 in the previous year. Lower usage of outside product development
services and reduced travel expenses accounted for the reductions in fiscal
1996 expenses, which were partially offset by higher salaries and fringe
benefits that resulted from personnel additions.
Interest and other of $224,000 in fiscal 1996 decreased from the prior year's
$285,000 principally because of the collection of an indebtedness that had
been charged to expense in a prior fiscal year. Interest expense increased
24% over fiscal 1995 because of higher average outstanding borrowings.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has utilized financing sources such as public and
private equity offerings and borrowings from financial institutions and
individual investors to fund its operating activities. The Company believes
that its cash on hand at September 30, 1997 and funds available under its
existing credit agreement combined with funds generated by operations and
from private placements of common stock in 1997 will provide the Company with
adequate liquidity and capital resources for working capital and other cash
requirements.
However, the information set forth in the preceding paragraph is
forward-looking information. Therefore, if, for any reason (including,
without limitation, those described below), the Company's operations require
more capital than anticipated, revenues do not reach anticipated levels, or
cash flow needs are greater than planned, the Company may need additional
financing in order to maintain its operations. There can be no assurance
that the Company would be able to obtain any required additional financing
when needed or that such financing, if obtained, would be on terms favorable
or acceptable to the Company. If the Company was unable to obtain additional
financing when needed and under acceptable conditions, it would be required
to significantly scale back plans for growth and perhaps reduce the scope of
its operations. Factors that may affect the Company's revenues, use of
capital, expenses and/or cash flow, and that would cause actual results to
differ materially from those anticipated include, but are not limited to, the
introduction of competing products with performance equivalent to or
exceeding that of the Company's products, a claim (whether or not
successfully made) that the Company's products infringe a patent held by
another company or individual, any performance problems involving the
Company's products, changes in technology that could cause the Company's
products to become obsolete, the departure of key members of management
and/or key employees, regulatory requirements that would make the Company's
products difficult or uneconomical to produce, and general economic
conditions.
The Company's operating activities used $43,000 during fiscal 1997,
$2,272,000 in fiscal 1996, and $482,000 in fiscal 1995, primarily to finance
the net losses incurred in each of those years. Net cash used in 1997
operations also reflects an increase in accounts receivable and reductions in
accounts payable and accrued liabilities. In fiscal 1997, these elements
were funded principally by depreciation and amortization and a decrease in
inventories. In fiscal 1996 and 1995, the primary use of cash in operations
related to increases in inventories, as funded by depreciation and
amortization, collection of royalties receivable, and decreases in accounts
payable and accrued liabilities. In addition, cash was provided by a
decrease in accounts receivable in fiscal 1996.
The Company's investing activities used $192,000, $261,000 and $654,000 for
the purchase of fixed assets in fiscal 1997, 1996 and 1995, respectively.
The Company expects to expend approximately $300,000 for fixed asset
additions in fiscal 1998.
The Company's financing activities provided net cash of $1,271,000 in fiscal
1997, $2,483,000 in
A-2
<PAGE>
fiscal 1996 and $1,271,000 in fiscal 1995. Primary sources of cash included
the issuance of common stock in private placements and borrowings under
long-term obligations and lines of credit. These were offset by repayments
on long-term obligations, in each year as well as a $493,000 net reduction
in bank line of credit borrowings in fiscal 1997.
As of September 30, 1997, the Company had net working capital of $5,566,000
with a current ratio of 3.0 to 1.0, which represents a $4,302,000 increase in
working capital from September 30, 1996. The increase is due primarily to
the conversion of a vendor account payable into a term loan (see discussion
below).
In March and April 1996, the Company borrowed a total of $900,000 from
private investors through the issuance of unsecured notes due October 21,
1997 and bearing interest at the rate of 11% per annum. Funds received from
these notes were used to retire outstanding indebtedness and to provide
additional working capital for operations. These notes were repaid in August
1997.
In April 1996, the Company borrowed $658,000 from a commercial bank through
the issuance of an 8.98% promissory note collateralized by its real estate.
The proceeds of the loan were used to retire a previous bank loan and
industrial development revenue bonds, and to provide additional working
capital for operations.
In January 1997, the Company sold an aggregate of 650,000 shares of common
stock to two United States investors for gross proceeds of $1.3 million.
Also in January 1997, the Company sold an aggregate of 1,000,000 shares of
common stock in a private placement to three foreign investors pursuant to
Regulation S under the Securities Act of 1933 for gross proceeds of
$2,000,000.
In June 1997, the Company entered into a $3,000,000 revolving credit facility
with Coast Business Credit, a division of Southern Pacific Thrift & Loan
Association of Los Angeles, California. The credit facility is secured by all
of the Company's receivables, inventories, investment property, equipment and
general intangibles, as defined in the agreement. Borrowings under the facility
are payable on demand and are limited to a portion of eligible accounts
receivable and inventories, as defined in a borrowing formula in the agreement.
The agreement is effective through June 30, 1999, with provisions for automatic
extensions of the maturity date. Interest on the credit facility is paid
monthly at a rate equal to the greater of eight percent (8%) or prime plus one
and three-quarters percent (1 3/4 %). At September 30, 1997, the Company had
outstanding borrowings of $373,000 under the facility and had a maximum
availability under the borrowing formula of $2,262,000. The new revolving
credit facility replaces a previous credit line agreement with a bank, and it
will be used for general corporate working capital needs.
In June 1997, the Company completed an agreement with a vendor whereby
$4,290,000 of an account payable was converted into a promissory note. The
note provides for monthly payments of $125,000 in the current fiscal year,
$150,000 in fiscal 1998 and $175,000 in fiscal 1999. An additional principal
payment of $600,000 is required in October 1998 and further principal
payments are called for under certain conditions set forth in the agreement.
The note bears interest at 7.25% per annum as of September 30, 1997, with
increases to 9.25% and 11.25% per annum at the beginning of fiscal years 1998
and 1999, respectively. The scheduled term of the note is twenty-seven (27)
months, with the final payment due in August 1999.
A-3
<PAGE>
ABOUT THE COMPANY
Destron Fearing Corporation develops, manufactures and markets a broad line
of electronic and visual identification devices for companion animals,
livestock, laboratory animals, fish and wildlife.
Visual identification products, such as numbered eartags, are marketed
under the Fearing brand name, principally to livestock producers.
Destron's radio frequency identification (RFID) products consist of
transponders, readers and injection systems. The miniaturized transponder
incorporates an antenna and a microchip with a unique identification code for
the animal in which it is implanted. The associated reader device uses radio
frequencies to interrogate the transponder and read the code. The transponder
is typically injected under the skin using a hypodermic syringe; no surgery
is required.
FINANCIAL HIGHLIGHTS
<TABLE>
<CAPTION>
SEVEN MONTHS
YEARS ENDED ENDED YEAR ENDED
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, FEBRUARY 28,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1997 1996 1995 1994 1993 (1) 1993
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenue . . . . . . . . . . . . . . . $12,889 $10,830 $16,234 $9,652 $ 2,348 $3,764
Gross margin. . . . . . . . . . . . . . . . 4,311 2,296 5,745 4,263 863 1,061
Income (loss) from operations . . . . . . . (772) (3,855) 695 131 (1,057) (5,159)
Net income (loss) . . . . . . . . . . . . . (772) (3,855) 661 491 (1,057) (5,159)
Net income (loss) per common share. . . . . (.06) (.33) .06 .05 (.16) (.80)
Weighted average number of common and
common equivalent shares outstanding . . . 12,886 11,520 10,944 10,032 6,459 6,409
BALANCE SHEET DATA:
Working capital surplus (deficit) . . . . . $ 5,566 $ 1,264 $ 893 $1,068 $ (732) $ (378)
Total assets. . . . . . . . . . . . . . . . 12,682 13,022 13,496 8,519 3,361 3,586
Current liabilities . . . . . . . . . . . . 2,923 7,038 7,111 2,640 2,334 2,150
Long-term debt obligations, net of
current portion. . . . . . . . . . . . . . 3,121 1,688 281 1,538 703 136
Shareholders' equity. . . . . . . . . . . . 6,638 4,296 6,104 4,341 324 1,300
(1) IN NOVEMBER 1993, THE COMPANY CHANGED ITS FISCAL YEAR TO SEPTEMBER 30, COMMENCING WITH THE YEAR ENDED SEPTEMBER 30, 1993.
</TABLE>
A-4
<PAGE>
COMMON STOCK INFORMATION
TRADING AND PRICE RANGE.
The common stock of Destron Fearing Corporation has traded on the Nasdaq
SmallCap Market since September 2, 1994, under the symbol DFCO. The
quotations set forth below were furnished by the National Association of
Securities Dealers and reflect the range of high and low bid prices.
FISCAL YEAR ENDED FISCAL YEAR ENDED
SEPTEMBER 30, 1997 SEPTEMBER 30, 1996
HIGH LOW HIGH LOW
- -----------------------------------------------------------------------
First Quarter. . . . . . . $4.19 $2.13 $5.00 $2.75
Second Quarter . . . . . . 3.88 2.00 5.25 3.25
Third Quarter. . . . . . . 2.50 1.38 4.44 2.94
Fourth Quarter . . . . . . 2.50 1.25 4.63 1.94
SHAREHOLDERS. As of December 15, 1997, the company had 364 shareholders
of record and an estimated 5,000 beneficial shareholders whose stock was held
in street name by brokerage houses.
DIVIDENDS. Certain of the Company's debt agreements prohibit the payment
of dividends. To date, Destron has not paid any cash dividends on its common
stock, and it does not anticipate doing so in the foreseeable future.
QUARTERLY FINANCIAL INFORMATION
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH ANNUAL
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS) QUARTER QUARTER QUARTER QUARTER
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
FISCAL 1997
Revenues. . . . . . . . . . . . . . . . . . . $ 3,168 $ 4,046 $ 3,058 $ 2,617 $12,889
Gross margin. . . . . . . . . . . . . . . . . 1,211 1,552 1,004 544 4,311
Net income (loss) . . . . . . . . . . . . . . 81 201 (190) (864) (772)
Net income (loss) per share . . . . . . . . . .01 .02 (.01) (.06) (.06)
Weighted average
shares outstanding . . . . . . . . . . . . . 11,946 13,010 13,294 13,294 12,886
FISCAL 1996
Revenues. . . . . . . . . . . . . . . . . . . $ 2,476 $ 4,206 $ 2,167 $ 1,981 $10,830
Gross margin. . . . . . . . . . . . . . . . . 845 1,260 496 (305) 2,296
Net loss. . . . . . . . . . . . . . . . . . . (302) (660) (748) (2,145) (3,855)
Net loss per share. . . . . . . . . . . . . . (.03) (.06) (.06) (.18) (.33)
Weighted average
shares outstanding . . . . . . . . . . . . . 11,186 11,612 11,640 11,641 11,520
</TABLE>
A-5
<PAGE>
DESTRON FEARING CORPORATION
AND SUBSIDIARIES
Consolidated Financial Statements as of
September 30, 1997 and 1996
Together With Report of
Independent Public Accountants
A-6
<PAGE>
<TABLE>
<CAPTION>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
As of September 30
<S> <C> <C>
1997 1996
------------ ------------
ASSETS
CURRENT ASSETS:
Cash........................................................ $ 1,075,000 $ 39,000
Accounts receivable, net of allowance for doubtful accounts
of $127,000 and $75,000................................... 1,911,000 1,016,000
Inventories, net............................................ 5,292,000 7,219,000
Prepaid expenses and other current assets................... 211,000 28,000
------------ -----------
Total current assets............................... 8,489,000 8,302,000
PROPERTY AND EQUIPMENT, net................................. 2,001,000 2,104,000
INVESTMENT IN JOINT VENTURE................................. - 225,000
GOODWILL, net............................................... 2,001,000 2,085,000
OTHER ASSETS, net........................................... 191,000 306,000
------------ -----------
$12,682,000 $13,022,000
------------ -----------
------------ -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Line of credit............................................ $ 373,000 $ 866,000
Accounts payable.......................................... 524,000 5,597,000
Accrued liabilities........................................ 472,000 528,000
Current portion of long-term obligations................... 1,554,000 47,000
----------- -----------
Total current liabilities......................... 2,923,000 7,038,000
LONG-TERM OBLIGATIONS, net of current portion................ 3,121,000 1,688,000
----------- ----------
Total liabilities.................................... 6,044,000 8,726,000
----------- ----------
COMMITMENTS AND CONTINGENCIES (Note 6)
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value, 20,000,000 sharesauthorized;
13,294,000 and 11,641,000 shares issued and outstanding.. 133,000 116,000
Additional paid-in capital................................. 19,789,000 16,692,000
Accumulated deficit........................................ (13,284,000) (12,512,000)
------------ -------------
Total shareholders' equity.............................. 6,638,000 4,296,000
------------ -------------
$12,682,000 $13,022,000
------------ -------------
------------ -------------
The accompanying notes are an integral part of these consolidated balance sheets.
</TABLE>
A-7
<PAGE>
<TABLE>
<CAPTION>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the Years Ended September 30
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
NET SALES................................................... $12,889,000 $10,830,000 $16,234,000
----------- -----------
COSTS AND EXPENSES:
Cost of sales............................................. 8,578,000 8,534,000 10,489,000
Selling, general and administrative....................... 3,651,000 4,972,000 3,727,000
Research and development.................................. 870,000 955,000 1,038,000
Interest expense and other................................ 562,000 224,000 285,000
---------- ----------- -----------
Total costs and expenses....................... 13,661,000 14,685,000 15,539,000
----------- ----------- ----------
INCOME (LOSS) BEFORE INCOME TAXES........................... (772,000) (3,855,000) 695,000
PROVISION FOR INCOME TAXES.................................. - - 34,000
----------- -----------
NET INCOME (LOSS)........................................... $ (772,000) $(3,855,000) $ 661,000
------------ ------------ ----------
------------ ------------ ----------
NET INCOME (LOSS) PER COMMON SHARE.......................... $ (0.06) $ (.33) $ .06
------------ ------------ ----------
------------ ------------ ----------
WEIGHTED AVERAGE COMMON AND
COMMON EQUIVALENT
SHARES OUTSTANDING........................................ 12,886,000 11,520,000 10,944,000
------------ ----------- -----------
------------ ----------- -----------
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
A-8
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
For the Years Ended September 30, 1997, 1996 and 1995
<TABLE>
<CAPTION>
Common Stock Additional Total
--------------------- Paid-In Accumulated Shareholders'
Shares Amount Capital Deficit Equity
---------- -------- ----------- ------------ -------------
<S> <C> <C> <C> <C> <C>
BALANCE, September 30, 1994 10,199,000 $102,000 $13,557,000 $ (9,318,000) $4,341,000
Issuance of common stock upon exercise of stock
options and warrants 783,000 8,000 1,094,000 - 1,102,000
Net income - - - 661,000 661,000
---------- -------- ----------- ------------ -------------
BALANCE, September 30, 1995 10,982,000 110,000 14,651,000 (8,657,000) 6,104,000
Issuance of common stock in private placement 625,000 6,000 1,994,000 - 2,000,000
Issuance of common stock upon exercise of stock options 34,000 - 47,000 - 47,000
Net loss - - - (3,855,000) (3,855,000)
---------- -------- ----------- ------------ -------------
BALANCE, September 30, 1996 11,641,000 116,000 16,692,000 (12,512,000) 4,296,000
Issuance of common stock in private placements 1,650,000 17,000 3,092,000 - 3,109,000
Issuance of common stock upon exercise of stock options 3,000 - 5,000 - 5,000
Net loss - - - (772,000) (772,000)
---------- -------- ----------- ------------ -------------
BALANCE, September 30, 1997 13,294,000 $133,000 $19,789,000 $(13,284,000) $ 6,638,000
---------- -------- ----------- ------------ -------------
---------- -------- ----------- ------------ -------------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
A-9
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended September 30
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) $ (772,000) $(3,855,000) $ 661,000
Adjustments to reconcile net income (loss) to net cash used in
operating activities-
Depreciation and amortization 494,000 1,536,000 571,000
Equity in income of joint venture and other 225,000 (14,000) (37,000)
Change in operating items:
Accounts receivable (895,000) 807,000 (83,000)
Inventories 1,927,000 (2,079,000) (3,909,000)
Prepaid expenses and other current assets (183,000) 33,000 (8,000)
Royalties receivable - 402,000 300,000
Accounts payable and accrued liabilities (839,000) 898,000 2,023,000
----------- ----------- -----------
Net cash used in operating activities (43,000) (2,272,000) (482,000)
----------- ----------- -----------
INVESTING ACTIVITIES:
Purchase of fixed assets (192,000) (261,000) (654,000)
Capitalized design costs - - (125,000)
Change in other assets - 27,000 10,000
----------- ----------- -----------
Net cash used in investing activities (192,000) (234,000) (769,000)
----------- ----------- -----------
FINANCING ACTIVITIES:
Issuance of common stock, net 3,114,000 2,047,000 1,102,000
Borrowings under long-term obligations - 1,558,000 -
Repayments of long-term obligations (1,350,000) (1,550,000) (113,000)
Net borrowings (repayments) on bank lines of credit (493,000) 428,000 282,000
----------- ----------- -----------
Net cash provided by financing activities 1,271,000 2,483,000 1,271,000
----------- ----------- -----------
NET CHANGE IN CASH 1,036,000 (23,000) 20,000
CASH, beginning of year 39,000 62,000 42,000
----------- ----------- -----------
CASH, end of year $1,075,000 $ 39,000 $ 62,000
----------- ----------- -----------
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ 512,000 $ 448,000 $ 364,000
----------- ----------- -----------
----------- ----------- -----------
SUPPLEMENTAL DISCLOSURE OF NONCASH ACTIVITIES:
Readers provided under marketing agreement $ - $ 165,000 $1,022,000
----------- ----------- -----------
----------- ----------- -----------
Conversion of trade payable to term loan $4,290,000 $ - $ -
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
A-10
<PAGE>
DESTRON FEARING CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 1997 and 1996
1. DESCRIPTION OF BUSINESS AND RISK FACTORS:
Destron Fearing Corporation (Destron or the Company) manufactures a broad
line of electronic and visual identification devices for the companion
animal, livestock, laboratory animal, fish and wildlife markets worldwide.
The Company's products are marketed primarily through a wide network of
domestic and international distributors. In November 1993, the Company
acquired Fearing Manufacturing Co., Inc. (Fearing), a 50-year-old company
engaged in the manufacture of visual identification products for the
livestock market.
During fiscal 1997, the Company resolved several matters which had raised
going concern uncertainties in fiscal 1996. These included the successful
negotiation of a new line of credit agreement (Note 3), conversion of a
significant trade payable to a term note (Note 3), private placements of
common stock (Note 4), as well as an overall improvement in operating results
and cash flows.
The Company's future operations are dependent on the attainment of certain
objectives, including the successful development, marketing and sale of new
and existing products and technology. There can be no assurance that these
objectives will be achieved, that the Company would be able to obtain any
required additional financing if or when needed, or that such financing, if
obtained, would be on terms favorable to the Company.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Company include the accounts of
the Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation.
REVENUE RECOGNITION
The Company recognizes product revenue, net of estimated returns, at the time
the products are shipped.
INVENTORIES
Inventories consist of materials, labor and overhead and are valued at the
lower of first-in, first-out cost or market. Inventories consisted of the
following at September 30:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Raw materials $2,354,000 $3,352,000
Finished goods 2,938,000 3,867,000
---------- ----------
Total $5,292,000 $7,219,000
---------- ----------
---------- ----------
</TABLE>
A-11
<PAGE>
-2-
PROPERTY AND EQUIPMENT
Property and equipment are recorded at the lower of cost or net realizable
value. Depreciation and amortization are recorded on a straight-line basis
over the following useful lives:
<TABLE>
<CAPTION>
<S> <C>
Building 30 years
Improvements 10-20 years
Equipment 7-10 years
Furniture and fixtures 7 years
</TABLE>
Fixed assets consisted of the following at September 30:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Land, building and improvements $1,349,000 $1,349,000
Equipment 1,378,000 1,318,000
Furniture and fixtures 254,000 122,000
---------- ----------
2,981,000 2,789,000
Accumulated depreciation and amortization (980,000) (685,000)
---------- ----------
$2,001,000 $2,104,000
---------- ----------
---------- ----------
</TABLE>
GOODWILL AND OTHER ASSETS
Goodwill represents the excess of the purchase price of Fearing (see Note 1)
over the fair value of its net assets, and is being amortized on a
straight-line basis over 30 years. Other assets consist primarily of patents
and licenses related to the Company's technologies, which are being amortized
over their estimated useful lives of 17 to 20 years. Total accumulated
amortization of these other assets was $766,000 and $827,000 as of September
30, 1997 and 1996.
The Company periodically evaluates whether events or circumstances indicate
that the carrying values of goodwill and other assets may not be recoverable,
or whether the remaining estimated useful lives should be revised.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair values of long-term obligations approximated carrying value at September
30, 1997 and 1996. The fair values of all other financial instruments also
approximated carrying value at September 30, 1997 and 1996 due to the short
maturities of those instruments.
WARRANTIES
The Company provides various warranties on certain of its products.
Estimated warranty costs are accrued in the same period in which the related
revenue is recognized, based on anticipated parts and labor costs, and
utilizing historical experience.
RESEARCH AND DEVELOPMENT
Research and development costs consist primarily of salaries, supplies and
other direct costs and are charged to expense as incurred.
A-12
<PAGE>
-3-
INCOME TAXES
The Company accounts for income taxes under the liability method, which
requires recognition of deferred income tax assets and liabilities for the
expected future income tax consequences, based on enacted tax laws, of
temporary differences between the financial reporting and tax bases of assets
and liabilities as well as the expected future effects of loss carryforwards
and tax credit carryforwards. Resulting net deferred tax assets are reduced
by a valuation allowance for the amount of any tax benefits which may not be
realized.
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common and common equivalent share is based on the
weighted average number of common and common equivalent shares outstanding
for the period. Common equivalent shares consist primarily of stock options
granted to employees, directors and others, and outstanding warrants.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," which
changes the way companies calculate earnings (loss) per share data (EPS).
SFAS No. 128 replaces primary EPS with basic EPS. Basic EPS is computed by
dividing reported earnings (loss) by weighted average shares outstanding,
excluding potentially dilutive securities. Fully diluted EPS, termed diluted
EPS under SFAS No. 128, is also to be disclosed. The Company is required to
adopt SFAS No. 128 in fiscal 1998, at which time all prior year EPS
information will be restated in accordance with SFAS No. 128. If the Company
had adopted this pronouncement at the beginning of fiscal 1995, the effect of
this accounting change on reported EPS data would have been as follows for
the years ended September 30:
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Primary earnings (loss) per share as reported $(.06) $(.33) $ .06
Effect of SFAS No. 128 -- -- --
----- ----- -----
Basic earnings (loss) per share as restated $(.06) $(.33) $ .06
----- ----- -----
----- ----- -----
Fully diluted earnings (loss) per share as reported $ -- $ -- $ --
Effect of SFAS No. 128 (.06) (.33) .06
----- ----- -----
Diluted earnings (loss) per share as restated $(.06) $(.33) $ .06
----- ----- -----
----- ----- -----
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities as of the date of the financial statements.
Estimates also affect the reported amounts of revenues and expenses during
the periods presented. Estimates are used for such items as allowances for
doubtful accounts, inventory reserves, amortization periods for goodwill and
other assets, useful lives of property and equipment, warranty reserves and
others. Ultimate results could differ from those estimates.
A-13
<PAGE>
-4-
3. LINES OF CREDIT AND LONG-TERM OBLIGATIONS:
LINES OF CREDIT
Through May 1997, the Company maintained a $5,000,000 line of credit
agreement with a bank. In June 1997, the Company replaced this line of
credit with a $3,000,000 revolving credit facility with a different
institution. This credit facility bears interest at the greater of 8% or
prime plus 1.75%, payable monthly, and carries a commitment fee equal to 3/4%
of the unused portion of the commitment under the facility. Borrowings under
this facility are payable on demand and are limited to certain eligible
accounts receivable and inventories ($2,262,000 at September 30, 1997). The
agreement is effective through June 30, 1999, with certain provisions for
automatic extension of the maturity date, and is collateralized by accounts
receivable, inventories, property and equipment, and intangibles.
The following information relates to these credit facilities for the years
ended September 30:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Balance outstanding at end of year $ 373,000 $ 866,000
Maximum amount outstanding during the year 1,276,000 2,252,000
Average borrowings during the year 346,000 1,388,000
Weighted average interest rate during the year 9.6 % 8.6%
Interest rate at end of year 10.25% 8.5%
</TABLE>
This new credit facility contains various restrictive covenants which require
the Company to maintain minimum levels of tangible net worth, among other
matters. The credit facility also limits additional indebtedness, capital
expenditures and dividends. The Company was in compliance with all such
covenants as of September 30, 1997.
LONG-TERM OBLIGATIONS
Long-term obligations consisted of the following at September 30:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Note payable to vendor (see below) $3,891,000 $ -
Notes payable; interest at 11%; repaid in August 1997 - 900,000
Note payable; interest at 8.98%; payable in monthly
installments of principal and interest through
March 2001 with a balloon payment of approximately
$533,000 due April 2001; collateralized by real estate 622,000 649,000
Noncompete obligation; interest at 9% 162,000 186,000
---------- ----------
Total long-term obligations 4,675,000 1,735,000
Less- Current portion of long-term obligations 1,554,000 47,000
---------- ----------
Long-term obligations, net of current portion $3,121,000 $1,688,000
---------- ----------
---------- ----------
</TABLE>
In June 1997, the Company converted a $4,290,000 trade payable into an
unsecured term note. The note bears interest at 7.25% as of September 30,
1997, with scheduled increases to 9.25% and 11.25% at October 1, 1997 and
1998, respectively. Monthly principal and interest payments
A-14
<PAGE>
-5-
of $150,000 and $175,000 are required in fiscal 1998 and 1999, respectively,
with an additional principal payment of $600,000 due in October 1998.
Further principal payments are also called for under certain conditions set
forth in the note agreement. The final payment on the note is due in August
1999.
Future maturities of long-term obligations were as follows as of September 30,
1997:
1998 $1,554,000
1999 2,444,000
2000 61,000
2001 577,000
2002 39,000
----------
$4,675,000
----------
----------
4. PRIVATE PLACEMENTS OF COMMON STOCK:
In December 1995, the Company completed a private placement of 625,000 shares
of common stock for proceeds of $2,000,000. A portion of the proceeds was
used to retire outstanding indebtedness with the remainder used to finance
working capital needs.
In January 1997, the Company completed private placements of 1,000,000 and
650,000 shares of common stock for $2 per share, for net proceeds of
$3,109,000. The proceeds were used to repay outstanding indebtedness and
will also continue to provide additional working capital for operations.
5. STOCK OPTIONS AND WARRANTS:
STOCK OPTIONS
The Company has established an Employee Stock Option Plan (the Employee Plan),
a Nonemployee Director Stock Option Plan (the Nonemployee Director Plan), and a
Consultant Stock Option Plan (the Consultant Plan).
The Employee Plan authorizes the grant of options to purchase an aggregate of
up to 1,300,000 shares of common stock. All persons who are employees of the
Company, including directors who are also employees, are eligible to
participate. The plan provides for the grant of incentive stock options
(ISOs), as defined in the Internal Revenue Code, and nonincentive stock options
(NSOs). Options under this plan are granted at the discretion of a committee
of the Company's board of directors.
The Nonemployee Director Plan authorizes the grant of NSOs to purchase an
aggregate of 300,000 shares of common stock to nonemployee directors of the
Company. Each nonemployee director is granted an option to purchase 15,000
shares of common stock when elected or appointed to the board of directors and
receives an option to purchase an additional 2,500 shares of common stock upon
each reelection to the Company's board of directors. Options are granted at
exercise prices equal to the fair market value of the common stock at the date
of grant, and vesting terms are determined by the board of directors or its
designee.
The Consultant Plan authorizes the grant of options to purchase an aggregate of
500,000 shares of common stock to consultants of the Company who may be
directors, but not employees of
A-15
<PAGE>
-6-
the Company. Stock options granted under the Consultant Plan are
administered by a committee of the board of directors which determines the
grants, exercise prices, number of shares and vesting terms.
The Company accounts for its stock options under Accounting Principles Board
Opinion No. 25 and has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation cost
has been recognized in the accompanying consolidated statements of operations.
Had compensation cost related to these options been determined based on the
fair value at the grant date for awards granted in fiscal 1997 and 1996,
consistent with the provisions of SFAS No. 123, the Company's net loss and net
loss per share would have increased to the following pro forma amounts:
1997 1996
----------- -----------
Net loss:
As reported $ (772,000) $(3,855,000)
Pro forma (1,082,000) (4,025,000)
Net loss per common share:
As reported $(0.06) $(0.33)
Pro forma (0.08) (0.35)
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to October 1, 1995, the resulting pro forma compensation cost
may not be representative of that to be expected in future years.
The weighted average fair values of options granted in fiscal 1997 and 1996
were $1.73 and $2.56. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in fiscal 1997 and 1996,
respectively: risk-free interest rates of 6.4% and 5.7%; expected volatility
of 78% and 76%; and expected lives of four years. Dividend yields were not
used in the fair value computations as the Company has never declared or paid
dividends on its common stock and currently intends to retain earnings for use
in operations.
A-16
<PAGE>
-7-
Shares subject to option are summarized as follows, with per share exercise
prices presented in the currency in which they were denominated, without
conversion:
<TABLE>
<CAPTION>
U.S. Dollars Canadian Dollars
------------------- -------------------
Weighted Non- Weighted Non- Weighted
Incentive Average qualified Average qualified Average
Stock Exercise Stock Exercise Stock Exercise
Options Price Options Price Options Price
---------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Balance, September 30, 1994 395,000 $1.56 307,000 $1.75 52,000 $4.33
Granted 53,000 2.64 10,000 3.38 - -
Exercised (187,563) 1.56 (132,000) 1.58 (49,000) 3.01
Forfeited or canceled (18,937) 1.09 - - (3,000) 4.94
-------- ----- -------- ----- ------- -----
Balance, September 30, 1995 241,500 1.83 185,000 1.96 - -
Granted 235,000 4.25 7,500 4.63 - -
Exercised (9,750) 2.13 (25,000) 1.08 - -
Forfeited or canceled - - - - - -
-------- ----- -------- ----- ------- -----
Balance, September 30, 1996 466,750 3.04 167,500 2.21 - -
Granted 210,000 3.00 50,000 2.12 - -
Exercised (2,500) 2.13 - - - -
Forfeited or canceled (2,000) 2.13 (20,000) 2.45 - -
-------- ----- -------- ----- ------- -----
Balance, September 30, 1997 672,250 $3.04 197,500 $2.17 - $ -
-------- ----- -------- ----- ------- -----
-------- ----- -------- ----- ------- -----
Options exercisable at:
September 30, 1997 384,000 $2.69 197,500 $2.17 - $ -
-------- ----- -------- ----- ------- -----
-------- ----- -------- ----- ------- -----
September 30, 1996 236,583 $2.39 167,500 $2.21 - $ -
-------- ----- -------- ----- ------- -----
-------- ----- -------- ----- ------- -----
September 30, 1995 104,208 $1.79 185,000 $1.96 - $ -
-------- ----- -------- ----- ------- -----
-------- ----- -------- ----- ------- -----
</TABLE>
Additional information regarding stock options outstanding and exercisable at
September 30, 1997 is as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------- -----------------------
Weighted
Weighted Average Weighted
Average Remaining Average
Range of Options Exercise Contractual Options Exercise
Option Type Exercise Prices Outstanding Price Life (Years) Exercisable Price
- ---------------------- --------------- ----------- ---------- ------------ ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Incentive $0.88-$2.13 213,500 $1.63 6.1 204,000 $1.62
3.00- 4.56 458,750 3.69 8.7 180,000 3.90
----------- ------- -------
$0.88-$4.56 672,250 3.04 7.9 384,000 2.69
----------- ------- -------
----------- ------- -------
Nonqualified $0.69-$2.13 152,500 2.02 3.2 152,500 2.02
2.23- 4.63 45,000 2.66 9.2 45,000 2.66
----------- ------- -------
$0.69-$4.63 197,500 2.17 4.5 197,500 2.17
----------- ------- -------
----------- ------- -------
</TABLE>
A-17
<PAGE>
-8-
WARRANTS
Warrants to purchase 742,000 and 719,000 shares of the Company's common stock
were outstanding at September 30, 1997 and 1996. The warrants are
exercisable at prices ranging from $1.00 to $4.81 and at Canadian $9.88, and
are exercisable at various times through January 2002.
6. COMMITMENTS AND CONTINGENCIES:
LITIGATION
Destron has been a party to litigation in which it asserted infringement by a
competitor of one of the Company's patents related to certain of its
technologies. The defendants asserted that the patent was not infringed, was
invalid and was unenforceable. The defendants also asserted antitrust and
unfair competition claims against the Company and Hughes Aircraft Company
(Hughes).
On January 29, 1996, the jury in the trial returned a verdict in favor of the
Company and found that the defendants had willfully infringed on the
Company's patent, awarding damages of approximately $444,000. The defendants
appealed the verdict, and on July 24, 1997, the appellate court affirmed the
trial court's judgment. Additionally, on November 7, 1997, the trial court
ruled that there had been no inequitable conduct on the part of Destron in
connection with the issuance of the patent, and as such, upheld the validity
and enforceability of the patent. While additional appeal proceedings are
possible, the Company and its legal counsel continue to believe that the
ultimate outcome of this litigation will not have a significant adverse
impact on the Company's future financial position, cash flows, or results of
operations.
On April 21, 1997, the defendants in the above litigation filed suit against
the Company, alleging patent infringement and unfair competition on the part
of the Company, among other matters. Although management is unable, at this
time, to estimate the potential impact of this litigation, the Company and
its legal counsel believe that the claims are without merit and that the
ultimate outcome of the litigation will not have a significant adverse impact
on the Company's future financial position, cash flows, or results of
operations. However, there can be no assurance of the ultimate outcome.
EMPLOYEE BENEFIT PLAN
The Company has a tax-deferred employee savings plan which was established in
accordance with Section 401(k) of the Internal Revenue Code. The plan covers
all employees of the Company. Participants may contribute up to 15% of their
annual compensation on a before-tax basis, subject to certain limits. The
Company may elect to make matching and/or discretionary contributions to the
Plan.
7. INCOME TAXES:
As of September 30, 1997 and 1996, the Company had approximately $7.8 million
and $6.7 million of net operating loss (NOL) carryforwards. Further, the
Company has approximately $133,000 of research and development tax credits
available to offset future federal tax, subject to limitations for
alternative minimum tax. The NOL and credit carryovers expire from 2004
through 2012 and are subject to examination by the tax authorities.
Approximately $1.5 million of the $7.8 million of NOL carryforwards at
September 30, 1997, relates to the exercise and subsequent sale of stock
options. The tax benefit of approximately
A-18
<PAGE>
-9-
$555,000 associated with this stock option deduction will be recorded as
additional paid-in capital when realized.
The Tax Reform Act of 1986 contains provisions which may limit the net
operating loss and credit carryovers available to be used in any given year
upon the occurrence of certain events, including significant changes in
ownership interests. The Company does not believe that a change in ownership
has occurred since the NOLs were generated.
The income tax provision consisted of the following for the years ended
September 30:
1997 1996 1995
------- -------- -------
Current federal and state taxes payable $ - $ - $34,000
Deferred tax provision - - -
------- -------- -------
Income tax provision $ - $ - $34,000
------- -------- -------
------- -------- -------
The components of deferred income taxes at September 30 were as follows:
1997 1996
----------- -----------
Net operating loss carryforwards $2,785,000 $2,460,000
Other, net 32,000 314,000
Less- Valuation allowance (2,817,000) (2,774,000)
----------- -----------
$ - $ -
----------- -----------
----------- -----------
The Company has determined that certain deferred tax benefits may not be
realizable because such realization requires future taxable income, the
attainment of which is uncertain. Accordingly, a valuation allowance has
been established to eliminate the net deferred tax asset related to these
items.
The reconciliation between income taxes using the statutory federal income
tax rate and the recorded tax provision is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---------- ------------ -----------
<S> <C> <C> <C>
Federal taxes at
statutory rate $(262,000) $(1,311,000) $236,000
Effect of nonutilization (utilization) of net
operating losses and permanent differences 262,000 1,311,000 (202,000)
---------- ------------ -----------
Tax provision $ - $ - $ 34,000
---------- ------------ -----------
---------- ------------ -----------
Effective rate - - 4.9%
---------- ------------ -----------
---------- ------------ -----------
</TABLE>
A-19
<PAGE>
-10-
8. EXPORT SALES AND SIGNIFICANT CUSTOMERS:
The Company generally sells its products at prices quoted in U.S. dollars to
limit the risks associated with currency exchange rate fluctuations. Sales
to locations outside of the United States are summarized as follows for the
years ended September 30:
1997 1996 1995
---------- ---------- ----------
Europe $2,575,000 $2,331,000 $ 756,000
Canada 570,000 616,000 587,000
Asia and other 713,000 499,000 443,000
---------- ---------- ----------
Total $3,858,000 $3,446,000 $1,786,000
---------- ---------- ----------
---------- ---------- ----------
For the year ended September 30, 1997, sales to two customers represented 16%
and 10% of net sales. During the year ended September 30, 1996, sales to two
customers represented 18% and 10% of net sales, and in fiscal 1995, sales to
one customer represented 41% of net sales.
9. SALES OF PATENT RIGHTS:
In September 1991, the Company signed an agreement with Hughes for the sale
of patent rights related to its industrial and access control products along
with an exclusive perpetual licensing arrangement. The Company retained the
exclusive, worldwide rights to its animal ID product lines. The Company also
retained the right to license to a specified Japanese manufacturer the rights
to the applications acquired by Hughes (excluding transportation
applications) exclusively in Japan and nonexclusively in certain Pacific Rim
countries, with certain royalties to be paid to the Company over a five-year
period. In October 1995, all amounts outstanding under this royalty
agreement were received from Hughes.
The agreement also granted Hughes warrants to purchase 705,220 shares of the
Company's common stock. At September 30, 1997, warrants to purchase 141,000
shares, at an exercise price of Canadian $9.88, were outstanding. These
warrants expire in September 1998.
The Company and Hughes also formed a joint venture in September 1991 to
support both companies with high-volume automated manufacturing capacity.
H&D was a partnership between Hughes Identification Devices, Inc., a wholly
owned subsidiary of Hughes, and a subsidiary of the Company. The Company and
Hughes shared equally the gains and losses and capital requirements of H&D.
The joint venture agreement concluded effective September 19, 1996, and the
Company elected not to exercise its option to purchase the Hughes interest.
The joint venture was dissolved in fiscal 1997, without a significant impact
on the Company's financial position, cash flows, or results of operations.
Further, the Company expects that this termination will not have a
significant impact on its ability to purchase adequate quantities of
materials at favorable prices, due to the existence of alternate sources of
supply, including Hughes and various other suppliers.
A-20
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Destron Fearing Corporation:
We have audited the accompanying consolidated balance sheets of Destron
Fearing Corporation (a Delaware corporation) and Subsidiaries as of September
30, 1997 and 1996, and the related consolidated statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended September 30, 1997. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Destron Fearing Corporation
and Subsidiaries as of September 30, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended September 30, 1997, in conformity with generally accepted accounting
principles.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota,
November 11, 1997
A-21
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report incorporated by reference in this Form 10-K into the Company's
previously filed Registration Statement File Nos. 333-22381, 333-2080 and
33-88574.
ARTHUR ANDERSEN LLP
Minneapolis, Minnesota
December 24, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> SEP-30-1997
<CASH> 1,075
<SECURITIES> 0
<RECEIVABLES> 2,038
<ALLOWANCES> (127)
<INVENTORY> 5,292
<CURRENT-ASSETS> 8,489
<PP&E> 2,981
<DEPRECIATION> (980)
<TOTAL-ASSETS> 12,682
<CURRENT-LIABILITIES> 2,923
<BONDS> 0
0
0
<COMMON> 19,922
<OTHER-SE> (13,284)
<TOTAL-LIABILITY-AND-EQUITY> 12,682
<SALES> 12,889
<TOTAL-REVENUES> 12,889
<CGS> 8,578
<TOTAL-COSTS> 8,578
<OTHER-EXPENSES> 4,571
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 512
<INCOME-PRETAX> (772)
<INCOME-TAX> 0
<INCOME-CONTINUING> (772)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (772)
<EPS-PRIMARY> (0.06)
<EPS-DILUTED> (0.06)
</TABLE>
