Zareba Systems - Recent Material Event2
Table of Contents
PART I
Item 1. Business
A. Business Development
Zareba Systems, Inc. (“Zareba”, “Zareba Systems” or the “Company”) designs, manufactures and
markets electronic perimeter fence and access control systems, operating in one world-wide business
segment. Zareba has three subsidiaries, Zareba Systems Europe Limited, Zareba Security, Inc. and
Zareba Systems of Canada LTD. The Company was incorporated in Minnesota in 1960.
On September 27, 2004, through its newly formed subsidiary, Zareba Systems Europe Limited (Zareba
Systems Europe), Zareba acquired Rutland Electric Fencing Company Ltd. (Rutland), a manufacturer
and distributor of electronic fencing equipment located in Oakham, United Kingdom (U.K.) pursuant
to a stock purchase agreement. Under the stock purchase agreement, Zareba purchased all of the
issued and outstanding share capital for a purchase price of approximately $10.4 million, or
approximately $8.5 million net of cash acquired. The transaction was funded with bank debt and
cash. This acquisition has strengthened our product offerings in both the security and electronic
perimeter fence markets.
Under the brand names Rutland Electric Fencing, Electric Shepherd®, and Induced Pulse® (IP),
products include insulators, fence energizers, high tensile fencing, polypropylene (poly) wire,
rope and tape and security fencing. Zareba Systems Europe has 48 employees and annual sales of
approximately $9.7 million. Zareba Systems Europe continues the former Rutland operations in its
existing Oakham, England and Brechin, Scotland facilities. The acquisition of Rutland allowed
Zareba to gain an entry into the UK, Europe, and the Middle East markets, as well as expand
distribution of Rutland Electric Fencing products in the U.S.
On May 1, 2006, Zareba Security Inc. was established as a wholly-owned subsidiary of Zareba for the
purpose of separating the security product line from the Company’s other product lines.
On August 6, 2001, Zareba purchased all outstanding shares of North Central Plastics, Incorporated
(NCP) pursuant to a stock purchase agreement. The acquisition was partially funded with new bank
debt.
Under the brand name Red Snap’r®, North Central Plastic’s products included insulators, fence
energizers, high tensile fencing, polypropylene (poly) wire, rope and tape and accessories. The
acquisition of NCP allowed Zareba to consolidate operations in NCP’s 64,000 square foot facility
located in Ellendale, Minnesota, and to further expand its distribution in the U.S., Canada,
Mexico, Central and South America, Europe and New Zealand.
At June 30, 2007, the Company substantially completed negotiation of the sale of the Company’s
Waters Medical Systems, Inc., (WMS) subsidiary to a third party. The WMS subsidiary, a provider of
medical products was initially formed on June 30, 2005, when all the assets of the WMS division of
Zareba were transferred to the newly-formed subsidiary, and has operated in a separate business
segment of the Company. With the impending sale, subsequently completed on August 1, 2007, all
results of operations and assets and liabilities of WMS for all periods presented have been
restated and classified as discontinued operations, and the Company now operates in one business
segment. All references to the business are based on results of operations from continuing
operations. The sale of WMS, completed subsequent to fiscal 2007 year end, was for $5 million
cash, resulting in a pre-tax gain of approximately $4 million to be reported in the Company’s first
quarter fiscal 2008 results. Cash proceeds from the sale were used to reduce borrowing under the
Company’s existing credit facility.
B. Business of Issuer
Zareba Systems designs, manufactures and sells electronic perimeter fence and access control
systems in both North America and the United Kingdom. These products are used for the control,
containment and deterrent of everything from humans (in the case of terrorists or prison inmates in
security applications) to horses, livestock, and lawn and garden applications (in the growing hobby
farm market). An electronic perimeter fence system consists of an alternating current (also
referred to as “AC”), direct current (also referred to as “DC”) or solar energizer insulators for
the fence posts, poly wire, tape and rope, and a wide range of hardware and accessories. Automatic
gate openers are incorporated as a means to open gates safely from a distance, such as from a
vehicle.
3
Table of Contents
In North America, Zareba Systems primarily sells to major retail merchandisers through direct sales
personnel and independent representatives under written agreements in the “Do It Yourself” (DIY)
hobby farm and hardware markets. Zareba Systems’ business is seasonal, with peak customer demand
occurring in the spring and summer months. In the United Kingdom, Zareba Systems sells directly to
dealers through direct sales personnel and delivers products with its factory owned tractor/trailer
system. Backlog is not significant in this unit’s operations since most orders are filled within
days after receipt of a purchase order.
Zareba Systems released several new electronic perimeter fence products during fiscal year 2005,
including an electronic automatic gate opener for both residential and commercial use. These
products open gates from a distance using a radio frequency transmitter signal and battery
backed-up motors to swing open various styles of gates allowing access to secured property. In
addition, Zareba Systems has developed and begun marketing the patent-pending Guard Tower™
perimeter fence security system and the patent-pending rapid pulse energizer system designed to
deter, detect, delay, assess and respond to intrusions or escapes in a wide range of security
applications. Potential applications include airports, oil refineries, remote utility sites, high
value storage sites, correctional facilities as well as other commercial or government properties.
The market for electronic perimeter fence systems is competitive, with several global manufacturers
vying for market share. By providing a fully integrated line of products, Zareba Systems considers
itself the largest supplier of electronic perimeter fence systems in North America and the United
Kingdom. In fiscal year 2007, one Zareba Systems customer had sales greater than 10 percent of the
Company’s total sales. Sales to this customer totaled $7.2 million.
Zareba Systems made no significant electric fence system sales directly to governmental agencies,
and therefore no governmental contracts are subject to renegotiation. Raw materials used in the
production of electronic perimeter fence system products are generally available from a number of
suppliers.
Zareba Systems has several patents, including on its (i) Apparatus and Method for Control of
Electric Fence, issued August 4, 2003, (ii) Animal Containment System having a dynamically changing
perimeter which was filed in February 2002, (iii) combined front panel and mount for an electric
fence insulator filed in September 1992; (iv) direct capacitive discharge electric fence controller
filed in March 1997; (v) electric fence charger filed in September 1992, (vi) types of electric
fence insulators filed in October 1990, August 1989 and October 2001; (vii) fence post assembly,
portable fencing system and method filed in September 2000; (viii) fence post cap insulator filed
in December 1996; (ix) fence strand retainer clip for fence posts filed in September 1997; (x)
front panel for an electric fence insulator filed in April 1989; and (xi) insulator for backside of
a t-post filed in May 1998. Each of the patents has a 20 year duration from filing. Zareba has
several other patent applications pending related to its electric fencing systems. There is no
assurance the Zareba’s patents and rights to patents will afford the Company any competitive
advantage.
Zareba Systems has the following trademarks registered in the United States: American Farmworks &
Design, Blitzer, Bulldozer, Captivator, Electric Shepherd, Electro-line, Ezee Corral, Garden
Protector, Guard Tower, Hol-dem, Horse Sense Electric Fence System, Hot Spark, International, One
Stop Fencing and Design; Pet Controller;, Red Snap’r & Design, Rutland Professional Products, Snap
Fast, Super Charger, Tarantula, The Horse Fence That Makes Sense, Zareba, Zareba Security, and
Zareba Systems.
It has also registered the following trademarks in Australia, New Zealand, Canada and the European
Union: Horse Sense Electric Fence System, The Horse Fence That Makes Sense, and Red Snap’r. Zareba
also has a registered trademark for Zareba in the European Union.
During fiscal years 2007, 2006 and 2005, Zareba spent $1.3 million, $1.3 million and $1.1 million
for research and development projects, respectively.
As of June 30, 2007, Zareba and its subsidiaries had a total of 142 employees, with 134 full-time
employees, as compared to a total of 141 employees, with 137 full-time employees the prior year.
The majority of Zareba’s products are sold in the United States and United Kingdom, with export and
foreign sales of $10.7 million in fiscal year 2007, compared to $9.3 million and $7.9 million in
fiscal 2006 and 2005, respectively. On September 27, 2004, through its newly formed subsidiary,
Zareba Systems Europe, Zareba acquired Rutland
4
Table of Contents
Electric Fencing Company Ltd. (Rutland), a manufacturer and distributor of electronic fencing
equipment located in Oakham, UK. Operating results of the acquired company, which were included in
Zareba’s consolidated financial statements from the date of acquisition, comprised $6.7 million of
foreign sales in fiscal year 2005. Most sales for foreign exports that have originated from the
U.S. have been made through unrelated foreign and export dealers in major European, Asian, South
American and other foreign markets.
Available Information
The Company maintains a website at http://www.ZarebaSystemsInc.com. The Company files annual
reports on Form 10-K, quarterly reports on Form 10-Q and periodic reports on Form 8-K (and any
amendments to these reports). These reports are available free of charge on the Company’s website
as soon as reasonably practical after we file these reports with the SEC. To obtain copies of
theses reports, go to the website and click on SEC Reports.
These reports may also be viewed and copied at the SEC’s Public Reference Room at 100 F Street,
NE., Washington, DC 20549, phone number 1-800-SEC-0330, or electronically at http://www.sec.gov.
Item 1A. Risk Factors
The Company’s operations are subject to a number of risks, which include but are not limited to the
following:
Our business is subject to seasonality that may cause our quarterly operating results to fluctuate
materially and cause the market price of our common stock to decline. The vast majority of
Zareba’s business is seasonal, with peak customer demand occurring in the late spring, summer and
early autumn months. Therefore, the Company typically experiences peak revenues during the fourth
fiscal quarter and lowest sales levels during the second fiscal quarter. Additionally, consumer
demand for our products can be affected by weather patterns. Abnormally cold or wet spring or
autumn seasons may cause consumers to delay or cancel purchases. However, because the length and
severity of the season is difficult to anticipate, we cannot estimate the fluctuation of our sales
from quarter to quarter in a fiscal year or the seasonal impact year to year. If our operating
results are below financial analysts’ or investors’ expectations due to seasonality factors, the
market price of our common stock may decline.
Reliance on a significant customer. In fiscal years 2007, 2006 and 2005 we had one significant
customer that accounted for approximately 20%, 19% and 20% of net sales, respectively. We
anticipate, but cannot assure, that this customer will continue to be significant in fiscal 2008.
The loss of, or a significant decrease in sales to, this customer could have a material adverse
effect on the Company’s financial condition and results of operation.
Requirements for availability of working capital. We depend on our revolving credit facilities for
working capital. The lenders have security interests in substantially all of the Company’s assets.
Our ability to borrow under the credit facilities depends on maintaining a borrowing base of
eligible accounts receivable and, to a lesser extent, eligible inventory and complying with
financial covenants concerning debt service coverage, interest coverage and maximum capital
expenditures. If the Company is unable to generate a sufficient borrowing base and comply with the
financial covenants and other requirements of the credit facilities, it will limit or prevent
borrowing under the credit facilities and could have a serious adverse effect on the Company.
Substantial operations in foreign markets. Zareba has foreign subsidiaries in Canada and the United
Kingdom and generates approximately 28% of its net sales from outside North America. The ability to
sell products in foreign markets may be affected by changes in economic, political or market
conditions in those foreign markets that are outside the Company’s control. Additionally, managing
geographically dispersed operations presents difficult challenges associated with organizational
alignment and infrastructure, communications and information technology, inventory control,
customer relationship management, terrorist threats and related security matters and cultural
diversities. If we are unsuccessful in managing such operations effectively, our business and
results of operations will be adversely affected.
Reliance on critical suppliers. We use numerous vendors to supply raw materials, parts, components
and subassemblies for the manufacture of our products. It is not always possible to maintain
multiple qualified suppliers for all of our parts, components and subassemblies. As a result,
certain key items may be available only from a single supplier or a limited number of suppliers. In
addition, suppliers may cease manufacturing certain components that are difficult to replace
without significant reengineering of our products. Furthermore, some key items are
5
Table of Contents
sourced from foreign suppliers with long lead time requirements for economical shipping. As a
result, unanticipated changes in inventory requirements may cause significant delays in receiving
parts, or require the Company to incur significant shipping costs to expedite delivery of the
items. Our results of operations may be materially and adversely impacted if we do not receive
sufficient parts to meet our requirements in a timely and cost effective manner.
We have experienced significant volatility in our stock price. A variety of factors may cause the
price of our stock to be volatile. In recent years, the stock market in general, and the market for
shares of many small-capitalized companies, including ours, have experienced extreme price
fluctuations, which have often been unrelated to the operating performance of affected companies.
During the last three years the price of our common stock has ranged from $1.75 to $11.80. The
price of our stock may be more volatile than other companies due to, among other factors, the
unpredictable and seasonal nature of the markets we serve, our significant customer concentration
and our relatively low daily stock trading volume. The market price of our common stock is likely
to continue to fluctuate significantly in the future, including fluctuations related and unrelated
to our performance.
Recently enacted and future changes in securities laws and regulations have increased our costs.
Changing laws, regulations and standards relating to corporate governance and public disclosure,
including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ National Market rules, are
creating challenges for all publicly-held companies. We are committed to maintaining high standards
of corporate governance and public disclosure. As a result, our efforts to comply with evolving
laws, regulations and standards have resulted in, and are likely to continue to result in,
increased general and administrative expenses and a diversion of management time and attention from
revenue-generating activities to compliance activities. In particular, our efforts to meet and
maintain compliance with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations
regarding the required assessment of our internal controls over financial reporting and our
external auditors’ audit of that assessment has required and is expected to increasingly require
the commitment of significant financial and managerial resources. Further, our board members,
chief executive officer and chief financial officer could face an increased risk of personal
liability in connection with the performance of their duties. As a result, we may have difficulty
attracting and retaining qualified board members and executive officers, which could harm our
business.
Our future growth will depend in part upon our ability to develop and achieve sales of new products
and successful entry into new markets. Our growth strategy depends upon the successful development
and market introduction of the Company’s automatic gate opener products and security products and
niche products into our core DIY business. In addition, in the case of security products, we will
be entering new customer markets where we have no previous brand recognition or experience, and
with longer sales cycles. We cannot assure you that we will be successful in completing
development of any new products. Further, in developing new products, we will incur additional
research and development and marketing expenses. Revenues, if any, which we generate from new
products may not be sufficient to recoup the expenses we will incur in the development and
introduction of new products. Customers may be slow to accept our new products, if at all, and
therefore, we cannot assure you that we will generate significant sales from any new products we
develop. If we cannot successfully develop new products and achieve sales of our new products, our
financial performance and results of operations will be adversely affected.
Item 2. Properties
Zareba owns a 64,000 square foot facility in Ellendale, Minnesota that houses its manufacturing and
support functions. In connection with the Company’s credit facility , the building and land are
subject to a Negative Pledge Agreement in favor of JPMorgan Chase Bank, N.A. The Company currently
leases 6,895 square feet of office space in a Plymouth, Minnesota, office complex for its corporate
headquarters. The lease extends through January 31, 2008, and requires a monthly payment of $5,338.
Zareba Systems Europe leases certain facilities in the UK for its manufacturing and distribution
operations. The UK leases vary in term, with the principal facility lease commencing on September
22, 2004 and continuing for a twenty-five year period. The lease provides for an early termination
election every five years upon six months written notice, the first of which occurs September 22,
2009. The combined monthly lease rate for the UK facilities as of fiscal year end 2007 was
approximately $28,000.
6
Table of Contents
On August 1, 2007, Zareba’s lease of an 11,000 square foot facility in Rochester, Minnesota where
the WMS manufacturing facility is located was assumed by the buyer of WMS. The monthly lease rate
was $5,146 at June 30, 2007.
Zareba believes that its current facilities are adequate to meet its business needs and that
insurance coverage on its properties is adequate.
Item 3. Legal Proceedings
Zareba did not have any legal proceedings during fiscal years 2007, 2006 and 2005 that were outside
of routine litigation, incidental to the business.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Zareba’s shareholders during the fourth quarter of fiscal
year 2007.
7
Table of Contents
PART II
Item 5. Market for Common Equity and Related Stockholder Matters and Issuer Purchases of Equity
Securities
Market Information
Zareba’s common stock is traded on the NASDAQ Capital Market under the symbol ZRBA.
Shareholders
As of September 5, 2007 Zareba had approximately 454 shareholders of record.
Dividend Summary
At a regularly scheduled meeting on October 26, 2006, the Board of Directors of Zareba voted to
suspend payments of cash dividends for fiscal 2006 to retain cash for investment in the Company’s
sales growth initiatives. Zareba paid a dividend in December 2005 at the rate of $.04 per share, or
an aggregate amount of $96,000.
The Board of Directors will review its dividend policy and make an appropriate decision at its
regularly scheduled meeting to be held in connection with Zareba’s 2007 Annual Meeting of
Shareholders. There is no assurance Zareba will declare a dividend.
Equity Compensation Plan Information
The following table sets forth certain information regarding outstanding options to purchase Common
Stock as of June 30, 2007:
8
Table of Contents
Stock Performance
The graph below matches Zareba Systems, Inc.’s cumulative 5-year total shareholder return on common
stock with the cumulative total returns of the Dow Jones Wilshire 5000 index and the DJ Wilshire
Technology index. The graph assumes that the value of the investment in our common stock and in
each of the indexes (including reinvestment of dividends) was $100 on 6/30/2002 and tracks it
through 6/30/2007.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Zareba Systems, Inc., The Dow Jones Wilshire 5000 Index And The DJ Wilshire Technology Index 
The stock price performance included in this graph is not necessarily indicative of future
stock price performance.
9
Table of Contents
Item 6. Selected Financial Data
10
Table of Contents
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
The following discussion of the Company’s results of operations and financial condition should be
read together with the other financial information and Consolidated Financial Statements included
in this Annual Report on Form 10-K. The results of operations relate to continuing operations
unless noted. This discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated in the
forward-looking statements as a result of a variety of factors, including those discussed in
Item 1A. Risk Factors, and elsewhere in this report.
Executive Summary
Zareba Systems, Inc. (“Zareba”, “Zareba Systems” or the “Company”) experienced a 10.5% increase in
net sales to $ 35.7 million, and a return to profitability in fiscal 2007, following the
challenging previous year. Net sales increased across most areas of the business, with the larger
contributions coming from sales of electric fencing systems in the UK and North America, as well as
from perimeter security system sales. Improved weather conditions which extended the buying season
of our customers, and payment of the farm subsidies in the UK, and a large perimeter security
products order form several prisons drove much of the sales increase.
Income from continuing operations and net income improved in fiscal 2007, benefiting from the
profit contribution of the increased sales and improved gross margins. In addition to the effects
of an inventory valuation charge recorded in fiscal 2006, the current year margin improvement also
reflected selective sales price adjustments and cost reduction initiatives.
At June 30, 2007, the Company substantially completed negotiation of the sale of the Company’s
Waters Medical Systems, Inc., (WMS) subsidiary to a third party. The WMS subsidiary, a provider of
medical products was initially formed on June 30, 2005, when all the assets of the WMS division of
Zareba were transferred to the newly-formed subsidiary, and has operated in a separate business
segment of the Company. With the impending sale, subsequently completed on August 1, 2007, all
results of operations and assets and liabilities of WMS for all periods presented have been
classified as discontinued operations. The sale of WMS, completed subsequent to fiscal 2007 year
end, was for $5 million cash, resulting in a pre-tax gain of approximately $4 million to be
reported in the Company’s first quarter fiscal 2008 results. Cash proceeds from the sale were used
to reduce borrowing under the Company’s Wells Fargo credit facility.
On August 29, 2007, subsequent to our fiscal 2007 year end, the Company entered into a $6 million
secured revolving credit facility with JPMorgan Chase Bank, N.A. Proceeds form the facility will
be used for general working capital purposes as well as to repay the existing Wells Fargo Business
Credit facility, totaling approximately $1.1 million.
Overview
Zareba Systems, Inc. designs, manufactures and markets electronic perimeter fence and access
control systems, operating in one world-wide business segment. Zareba has three subsidiaries,
Zareba Systems Europe Limited, Zareba Security, Inc. and Zareba Systems of Canada LTD.
On September 27, 2004, through its newly formed subsidiary, Zareba Systems Europe, the Company
acquired Rutland, the largest manufacturer of electronic perimeter fence systems in the United
Kingdom. To facilitate the acquisition, the Company and Zareba Systems Europe utilized credit
facilities provided by Wells Fargo Bank and Bank of Scotland. The Company recorded the Rutland
acquisition in accordance with FAS No. 141, Business Combinations. Financial results from the
Zareba Systems Europe subsidiary have been included in the Company’s consolidated financial
statements since the date of acquisition. This acquisition impacted net sales significantly.
In the first quarter of calendar year 2005, the Company introduced two new product lines within the
Zareba Systems division, perimeter security systems and electric gate opener systems and
accessories. The perimeter security system is designed to deter, detect, delay, assess and respond
to intrusions or escapes in a wide range of applications including utilities, airports,
correctional facilities and other commercial and government properties. The Company completed
initial systems deliveries and established a distribution agreement with a key distributor in the
UK in fiscal 2006. The Company completed additional systems deliveries in fiscal 2007 along with
a large shipment of perimeter security products for several prisons. The Company continues to work
to establish similar agreements
11
Table of Contents
with other distributors to sell both non-lethal electric fencing and its patent-pending Guard
Tower® product lines in various countries around the world.
Products comprising the automatic gate opener systems and accessories targeting the Do-It-Yourself
(traditional) Zareba market are sold through existing retail channels in North America and the UK,
often to the same customer that purchased products of the traditional Zareba product line. During
the second half of fiscal 2007, the Company began shipping a new family of professional series
automatic gate openers available to the professional installer distribution channels, which the
Company believes will offer market growth opportunities.
Zareba Systems’ business is seasonal, with peak customer demand occurring in the late spring,
summer and early autumn months. Backlog is not significant in either of the Company’s operating
units since most orders are filled within days after receipt of a customer’s order. As a result of
Zareba Systems seasonality, there is a resulting variability in sales, manufacturing fixed overhead
absorption and a further resulting impact on gross margin, working capital and cash flow during the
Company’s fiscal year.
Results of Continuing Operations
Net sales for fiscal year ended June 30, 2007, increased 10.5% to $35.7 million compared to $32.3
million and $29.5 million in fiscal year 2006 and 2005, respectively. Several factors contributed
to the increased sales in fiscal year 2007, including the impact of selective sales price
adjustments, improved market conditions in the UK, increased electric fencing sales in North
America and the inclusion of a large security product sale in fiscal 2007. The increase in net
sales in fiscal year 2006 versus 2005 is due primarily to the inclusion of the full year operations
from its subsidiary, Zareba Systems Europe, which acquired Rutland on September 27, 2004. In
addition, fiscal year 2006 sales increases in North America electric fencing systems were offset by
the effects of a weakness of sales in Europe due to a late spring, compounded by deferred spending
by UK customers as a result of a delay in payment of farm subsidies by the UK government.
During the second half of fiscal 2007, the Company began shipping its professional series of
automatic gate openers and shipped a large order for electronic perimeter security fence products
for several prisons. The perimeter security systems and automatic gate openers are an expanded
focus for Zareba Systems, and are anticipated to be an emerging and growing market opportunity for
the Company.
Fiscal year 2007 gross margins increased to 34.1% an increase of 2.3% from 31.8% in fiscal year
2006 and compared to 36.4% in fiscal year 2005. An inventory valuation adjustment in fiscal 2006
decreased gross margins for that year by 2%, resulting in a large portion of the year-to-year
fluctuation. In addition, fiscal year 2007 margins benefited from selective sales price
adjustments and the higher margins on security product sales. Gross margins for fiscal 2006 were
adversely impacted by certain product cost increases and product mix changes, in addition to the
inventory valuation adjustment.
Selling, general and administrative expenses were $9.3 million, or 26.0% of sales, for fiscal year
2007, compared to $8.9 million, or 27.6 % and $8.0 million, or 27.1% on sales in fiscal years 2006
and 2005, respectively. Targeted investments in selling and marketing resulted in the increased
costs for fiscal 2007, while the inclusion of a full year’s results of the Rutland operations in
fiscal 2006 versus just over nine months in the prior year comprised a significant portion of the
increase from fiscal 2005. Costs related to expanded sales and marketing activities surrounding
product launch of automatic gate openers and security products, as well as hiring and severance
costs for management position changes made up the majority of the remaining increase over fiscal
2005.
Research and development expenses of $1.3 million for each of fiscal years 2007 and 2006, and $1.1
million for fiscal 2005 were directed toward new product development and testing for Zareba Systems
automatic gate openers and perimeter security systems as well as continued product enhancements of
existing electric fencing systems products. The Company’s long-term investments are designed to
protect and enhance our future financial performance.
Interest expense, principally related to the Company’s term debt to finance the Rutland
acquisition, was $844,000, $797,000 and $518,000 for fiscal years 2007, 2006 and 2005,
respectively. The increase for fiscal 2007 versus 2006 resulted from an increase in interest
rates, which more than offset decreased borrowing levels. The increase in fiscal 2006 versus 2005
resulted from the timing of the Rutland acquisition and the increases in interest rates during
2006.
12
Table of Contents
Income from continuing operations of $372,000, or $0.15 per basic and diluted share, in fiscal 2007
compared to a loss of $640,000, or $0.26 per basic and diluted share, in fiscal 2006 and income of
$642,000, or $0.27 and $0.26 per basic and diluted share, respectively in fiscal 2005. The
improved operating results for fiscal 2007 versus the prior year resulted primarily from the gross
profit contribution from increased fiscal 2007 sales and the impact of the fiscal 2006 inventory
valuation adjustment. The change in operating results for fiscal 2006 versus 2005 resulted from
increased investments in selling, marketing, engineering and administrative costs in fiscal 2006 to
support new product development and market introductions, decreased gross margins.
Results of Discontinued Operations and Net Income
Gain from discontinued operations, net of tax was $238,000, or $0.10 per basic and diluted share
for fiscal 2007, versus $339,000, or $0.14 per basic and diluted share for fiscal 2006, and
$208,000, or $0.09 and $0.08 per basic and diluted share, respectively for fiscal 2005, reflecting
the net results of the WMS for the respective periods.
Net income for fiscal 2007 was $610,000, or $0.25 per basic and diluted share, versus a net loss of
$301,000, or $0.12 per basic and diluted share for fiscal 2006 and net income of $850,000, or $0.36
and $0.34 per basic and diluted share, respectively for fiscal 2005. The differences result
primarily from the impact of the profit contribution from increased sales, the increased expenses
related to investments in product development, sales growth and infrastructure development and the
fiscal 2006 inventory valuation adjustment.
Liquidity and Capital Resources
The Company’s cash and working capital balances at June 30, 2007 were $1.6 million and $4.0
million, respectively, as compared to $1.4 million and $8.3 million at June 30, 2006. The decrease
in working capital resulted primarily from the classification of $5.0 million of borrowing under
the Wells Fargo revolving line, scheduled to mature on September 1, 2007, as a current liability at
June 30, 2007.
Accounts receivable decreased to $7.7 million at June 30, 2007 versus $8.0 million in the prior
year, reflecting the timing of timing of shipments and customer payments in the fourth quarter of
the respective years. Inventories increased to $6.5 million at June 30, 2007, versus $6.0 million
in the prior year, reflecting the increased investments in inventory to support the higher activity
levels and new product introductions.
Capital expenditures were $0.2 million for fiscal 2007 versus $0.3 million in each of fiscal years
2006 and 2005, and were used primarily for manufacturing and computer equipment and purchases of
new product tooling.
In September 2004, the Company paid in full the previous Wells Fargo Bank (WF) $3.0 million bank
line of credit and term debt facility and executed a new Wells Fargo Business Credit facility for
the Rutland acquisition. The WF credit facility initially included an aggregate credit limit of
$7.8 million, consisting of revolving credit up to $6.0 million and term credit of $1.8 million.
Under this credit facility, the Company borrowed approximately $5.1 million for the Rutland
acquisition. Under the terms of the new WF credit facility agreement and subsequent amendments,
interest is charged on outstanding balances at the rate of one half of one percent or (.50 percent)
above base rate. The initial term of the agreement runs for three years, maturing on September 1,
2007, and it is renewable on an annual basis thereafter. As a result, the entire balance
outstanding on the revolving credit facility of $5.0 million was classified as current at June 30,
2007. The effective interest rate was 8.75 percent on June 30, 2007 and June 30, 2006, and the
average effective rate for fiscal year 2007 was 8.75 percent. The term notes require monthly
principal payments of $19,168 plus interest. As of June 30, 2007 and 2006, the outstanding amount
on the WF credit facility was $5.0 and $5.2 million, respectively with an additional $1.0 million
and $0.8 million, respectively available for the future draws. Future WF availability is
determined by the daily eligible collateral net of outstanding loan balance.
Also, in September 2004, Zareba Systems Europe secured a £2,214,000 term loan (approximately $4.0
million) from the Bank of Scotland (BoS) in the United Kingdom for the Rutland acquisition (See
Notes 5 and 8 to consolidated financial statements). Under the terms of the BoS credit facility
agreement, interest is charged on outstanding balances at the rate of two and one eighth percent
(or 2.125 percent) above the base rate with a five-year term. On June 30, 2007 and 2006, the
effective interest rate was 7.63 percent and 6.63 percent, respectively and the average effective
rate for fiscal 2007 was 7.21 percent. The BoS term loan matures on September 27, 2009, with
monthly principal and interest payments of £49,355 (approximately $96,000). The balance
outstanding under this facility at June 30, 2007 and 2006 was £1.2 million, or approximately $2.4
million, and £1.7 million, or approximately $3.1 million, respectively. In September 2007, the BoS
waived all previous covenant violations for fiscal 2007 and agreed to work with the Company to
establish new covenant levels for the future. Based upon the discussions with
13
Table of Contents
BoS regarding the proposed new covenant levels, the Company believes it will be able to meet the
new financial covenants in fiscal 2008, once established.
Both the WF Business Credit and the BoS credit facilities are collateralized by substantially all
of the assets of the Company and Zareba Systems Europe, in their respective localities. Line of
credit borrowings are limited to eligible accounts receivable and inventory.
The table below shows a summary of the Company’s remaining contractual cash obligations excluding
interest expense at June 30, 2007, including the above listed items to the Company’s credit
facility and other term debt.
Contractual Obligations-United States
Contractual Obligations-United Kingdom
On August 1, 2007, subsequent to fiscal 2007 year end, the Company completed the sale of the WMS
subsidiary, receiving $5 million cash, which was used to reduce the outstanding debt with WF
Business Credit.
On August 29, 2007, subsequent to fiscal 2007 year end, the Company entered into a secured
revolving credit facility with JPMorgan Chase Bank, N.A. (Chase), subsequently terminating the WF
facility and paying in full all outstanding balances under the WF facility, totaling approximately
$1.1 on August 30, 2007. The Chase facility provides for a $6 million secured revolving credit
facility (the “Credit Facility”), with the option to increase borrowings in additional $500,000
increments with the consent of the Lender, up to a total of $7.5 million. Amounts under the
facility may be borrowed, repaid and reborrowed from time to time until its maturity on August 29,
2010. Voluntary prepayments and commitment reductions under the Credit Facility are permitted at
any time without payment of any prepayment fee upon proper notice and subject to minimum dollar
amounts. Loans under the 2007 Credit Agreement will bear interest at either a base rate minus 1.0
percent to 0 percent, based upon financial performance, or a Eurocurrency rate equal to the London
Inter-Bank Offered Rate (“LIBOR”) for the relevant term plus 1.5 percent to 2.5 percent, based upon
financial performance. Notwithstanding the foregoing, borrowings until and including September 30,
2007 will bear interest at either a base rate minus 0.75 percent or LIBOR plus 1.75 percent. The
facility contains a financial covenant requiring that the Company maintain a minimum debt service
coverage ratio measured quarterly, and other covenants, and includes limitations on, among other
things, liens, certain acquisitions, consolidations and sales of assets. The Company also entered
into a Stock Pledge Agreement with the Lender, pursuant to which it pledged the stock of Zareba
Systems of Canada, Ltd. to the Lender as additional security under the 2007 Credit Agreement. In
addition, the Company entered into a Negative Pledge Agreement in favor of the Lender, pursuant to
which it agreed not to convey or otherwise transfer or pledge or otherwise encumber any of its
owned real property to any other party without the consent of the Lender, which consent is not to
be unreasonably withheld.
The Company believes that its existing funds, additional cash generated from operations, and
borrowings under the Company’s bank debt facility and cash proceeds from the subsequent sale of the
WMS subsidiary will be adequate to meet the Company’s foreseeable operating activities and outlays
for capital expenditures for at least the next twelve months.
Critical Accounting Policies
The Company’s critical accounting polices are discussed below.
Revenue Recognition
The Company recognizes revenue in accordance with the Securities Exchange Commission’s Staff
Accounting Bulletin No. 104 (SAB104) Revenue, which requires that four basic criteria be met before
revenue can be recognized: (i) persuasive evidence of a customer arrangement exists; (ii) the price
is fixed or determinable; (iii) collectibility is reasonably assured; and (iv) product delivery has
occurred or services have been rendered. Sales are
14
Table of Contents
not conditional based on customer acceptance provisions or installation obligations. The Company
primarily utilizes independent manufacturers’ representatives to facilitate sales orders (with no
right of return or other Company obligation), as well as having direct sales for key accounts or
product lines. The Company recognizes revenue as products are shipped based on FOB shipping point
terms when title passes to the customer. The Company accounts for customer rebates on the accrual
basis when they are probable and can be estimated. The Company estimates and accrues for sales
returns based upon historical experience.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses resulting from the
inability of its customers to make required payments. If the financial condition of the Company’s
customers were to deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
The allowance for doubtful accounts is an estimate based on specifically identified accounts. The
Company evaluates specific accounts where information that the customer may have an inability to
meet its financial obligations is known. In these cases, management uses its judgment, based on the
best available facts and circumstances, and records a specific reserve for that customer against
amounts due to reduce the receivable to the amount that is expected to be collected. These specific
reserves are re-evaluated and adjusted as additional information is received that impacts the
amount reserved. If circumstances change, the Company’s estimates of the recoverability of amounts
due could be reduced or increased by a material amount. Such a change in estimated recoverability
would be accounted for in the period in which the facts that give rise to the change become known.
Valuation of Inventories
Our inventories are stated at the lower of cost or market and include materials, labor and
overhead. Cost is determined by the first-in, first-out (“FIFO”) method. Provisions to reduce
inventories to the lower of cost or market are made based on a review of excess and obsolete
inventories through an examination of historical component consumption, current market demands and
shifting product technology. Significant assumptions with respect to market trends are utilized to
formulate our provision methods. Sudden or downward changes in markets we serve may cause us to
record additional inventory revaluation charges in future periods.
Amortization of Intangible Assets
Customer relationships and non-compete agreements are amortized on a straight-line basis over seven
and five years, respectively. Intangible assets are amortized on a basis that corresponds to the
Company’s projections of future cash flows directly related to these intangible assets. The
estimates that are included in its projection of future cash flows are based on the best available
information at the time of the determination of useful life and amortization method. A change in
circumstances could result in a determination that the related assets are impaired and impairment
charges to reduce the carrying value of intangible assets may be necessary.
Impairment of Long-Lived Assets
The Company evaluates the carrying value of long-lived assets, including identifiable intangibles,
for impairment when events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. If impairment indicators are present and the estimated future
undiscounted cash flows are less than the carrying value of the assets, the carrying value is
reduced to the estimated fair value as measured by the associated discounted cash flows.
Under SFAS No. 142, the Company currently evaluates goodwill and indefinite lived intangible assets
(trade names) for impairment using a two-step test based upon a fair value approach. The first step
is used to identify a potential impairment through an estimate of the fair value of certain
reporting units (as defined by SFAS No. 142), while the second step calculates the amount of
impairment, if any. Additionally, goodwill shall be tested for impairment between annual tests if
an event occurs or circumstances change that would reduce the fair value of an entity below its
carrying value. The Company evaluated goodwill for impairment using the method described in the
preceding paragraph and determined the fair value of its reporting units by application of a
discounted cash flow analysis. The Company makes estimates that are included in its discounted cash
flow analyses based upon the best available information at the time of the fair value
determination. If circumstances change, the estimates of fair value will also change and could
necessitate additional impairment charges that reduce the carrying value of goodwill.
15
Table of Contents
Contingencies
We are subject to the possibility of various loss contingencies, including legal claims, in the
normal course of business. We accrue for loss contingencies when a loss is probable and can be
estimated. See footnote 9 to the consolidated financial statements for additional information.
Recently Issued Accounting Standards
In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48 (FIN No.
48), “Accounting for Uncertainty in Income Taxes”, to address the noncomparability in reporting tax
assets and liabilities resulting from a lack of specific guidance in SFAS No. 109, “Accounting for
Income Taxes”, on the uncertainty in income taxes recognized in an enterprise’s financial
statements. Specifically, FIN No. 48 prescribes (a) a consistent recognition threshold and (b) a
measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return, and provides related guidance on derecognition,
classification, interest and penalties, accounting interim periods, disclosure and transition. FIN
No. 48 will apply to fiscal years beginning after December 15, 2006, our fiscal year 2008. The
Company has not yet determined the impact the adoption of FIN No. 48 will have on the consolidated
financial statements.
Forward-Looking Statements and Risk Factors
Certain statements in this Report are forward-looking statements that involve a number of risks and
uncertainties that may cause the Company’s future operations and results of operations to differ
materially from those anticipated. Specifically, these include statements relating to (a) the
sufficiency of capital, which depends on the Company successfully maintaining adequate levels of
bank financing, the Company meeting its expenses and revenue projections and the success of the
Company’s new products, which further depend on the management’s ability to realize target sales
synergies, the impact new Zareba products have on seasonality, as well as general competitive,
market and economic conditions; (b) growth in Zareba Systems’ sales generally and as a result of
its new products, including sales within the corrections marketplace, and the expectation that the
security systems and gate openers will become an emerging and growing market opportunity, which
depend on the cost and success of the Company’s development efforts and new products, including the
professional series of automatic gate openers, the success of the Zareba Systems Europe subsidiary,
the actual development of the perimeter security system market, the extent to which weather and UK
farm subsidies affect sales and timing, the Company’s ability to finalize distribution agreements
with key distributors on acceptable terms, the success on new distribution channels, the actual
costs of supplies, the effect of consolidation within the agricultural retail industry, as well as
actual competition, market and economic conditions; (c) that the demand for customized electronic
perimeter security systems will increase, which depends on the quality of the product offerings,
the effectiveness of our sales force, the need and perceived need for increased security in the
markets we serve, and competition from other suppliers; and, (d the anticipation that additional
agreements will be established with other distributors following the recently obtained agreement
with a key distributor in the UK, which depends on the effectiveness of our sales force, the
quality of our products versus those otherwise available in Europe and elsewhere.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
Zareba has foreign subsidiaries in Canada and the United Kingdom, and we generate approximately 28%
of our net sales from outside North America. Our ability to sell our products in foreign markets
may be affected by changes in economic, political or market conditions in the foreign m | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||