Zareba Systems (ZRBA) - Description of business

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Company Description
A. Business DevelopmentOur vision is to aggressively increase sales to $50 million by introducing new products and successfully acquiring and integrating companies that fit our selected market segments. Zareba Systems, Inc. (“Zareba” or the “Company”) designs, manufactures and markets electronic perimeter fence, access control systems and medical products. During fiscal years 2006 and 2005, sales were conducted through two principal business units: electric fence systems, d/b/a Zareba Systems/Zareba Systems Europe/Zareba Security; and medical products, d/b/a Waters Medical Systems (WMS). 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 IP (Induced Pulse), products include insulators, fence energizers, high tensile fencing, polypropylene (poly) wire, rope and tape and security fencing. Zareba Systems Europe has 46 employees and annual sales of approximately $8.4 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 market segments, as well as expand distribution of the Rutland Electric Fencing Product 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 lines of products from the Company’s other Zareba lines.On June 30, 2005, all the assets of the WMS division were transferred to a wholly-owned subsidiary, Waters Medical Systems, Inc.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. At the closing of the purchase, the parties also entered into an Earn-out Agreement that required Zareba to pay the sellers up to an additional $750,000 if operating results of Zareba in fiscal year 2003 through 2006 exceed predetermined levels. The determination of any contingent purchase price was required to be made annually. As of June 30, 2006 and 2005, earn-out payments of $56,000 and $49,000, respectively, were assigned to goodwill based on management’s assessment of operating results (See Footnote 4). No further earn-out payment obligations remain.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.B. Business of Issuer1) Zareba SystemsThe Zareba Systems division (“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, automatic gate openers, 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.In North America, Zareba Systems primarily sells to major retail merchandisers through direct sales personnel and independent representatives in the “Do It Yourself” (DIY) hobby farm and hardware markets. Zareba Systems’s 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 began marketing the Guard Tower™ perimeter security 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. Zareba Systems electric fence system sales in fiscal year 2006 accounted for 94 percent of the Company’s total sales from continuing operations, as compared to 93 percent in the prior year. In fiscal year 2006, one Zareba Systems customer had sales greater than 10 percent of the Company’s total sales. Sales to this customer totaled $6.2 million.Zareba Systems made no significant electric fence system sales 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 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 also has registered the following trademarks 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; Oxicom; Pet Controller; ProSwitch, Red Snap’r & Design, Rutland Professional Products, Sting Ray, Super Charger, Tarantula, Waters Instruments, Inc., 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.2) Waters Medical SystemsWaters Medical Systems, Inc. (WMS), a wholly owned subsidiary of Zareba, designs, manufactures and markets electronic medical instruments for cardiovascular and organ preservation used in laboratories, clinics and hospitals. The RM3 and Waters’ Oxicom family of whole blood oximeters represent WMS’ primary products.The RM3 Renal Preservation System (RM3), a two-part kidney preservation system that includes the medical device and disposable cassette, was designed to preserve kidneys prior to transplant, evaluate kidney performance, and to significantly improve post-surgical patient outcomes. The RM3 utilizes pulsatile preservation technology to improve the outcome of kidney transplants while reducing associated costs. The RM3 continues to serve global markets as well as the United States market. WMS works closely with Organ Procurement Organizations and independent organizations to design and complete perfusion and preservation laboratories, and works actively with the International Society for Organ Preservation to increase training opportunities for new customers. Independent scientific research strongly recommends pulsatile preservation as the standard for renal preservation.As the brand leader used in cardiac catheterization labs, Waters’ Oxicom family of whole blood oximeters continues to maintain its product and disposable cuvette sales. The Oxicom measures the oxygen saturation of the blood. WMS continues to be a strong supplier in its two market niches. Sales by WMS in fiscal year 2006 were 6.2 percent of Zareba’s total sales from continuing operations compared to 7.2 percent in fiscal 2005.In June 2006, WMS received ISO 13485:2003 certification for quality medical management systems standards. WMS also has CE Marks on both its RM3 and Oxicom products, a requirement to market products in Europe. CE Marking on a product is a manufacturer’s declaration that the product complies with the essential requirements of the relevant European health, safety and environmental protection legislations.No significant sales of WMS products are made to the United States government, and no such contracts are subject to renegotiation. Although this business unit does not require large working capital funds, accounts receivable can approach two month’s sales due to the slow reimbursement practices of third-party insurers and administrators. WMS sales are made through direct sales personnel and independent representatives. Raw materials necessary in the manufacture of this business unit’s products are generally available from a number of suppliers.The products of Waters Medical Systems are subject to governmental regulation under the Federal Food and Drug and Cosmetic Act (the “FDA”). Before a Class I or Class II device can be marketed, Section 510(k) of the FDA requires that the manufacturer submit a pre-market notification of its intent to market a device at least 90 days prior. If the FDA accepts the sufficiency of the pre-market notification, the device may then be marketed. All of WMS’ products are FDA approved Class II devices. Any new versions of the current products as well as new products will require the timely process of obtaining FDA approval.All manufacturers of medical devices are subject to general controls by the FDA, which include regulations on annual registration, device listing, good manufacturing practices, labeling, and the misbranding and adulteration provisions of the FDA. Also, the FDA typically conducts unscheduled inspections of facilities. Waters Medical Systems believes that it is in compliance with all applicable FDA regulations and practices, and that continued compliance will not result in significant additional expenditures.3) Information as to Zareba’s Business as a WholeDuring fiscal years 2006 and 2005, Zareba spent $1.4 million and $1.3 million for research and development projects, respectively.As of June 30, 2006, Zareba and its subsidiaries had a total of 141 employees, with 137 full-time employees, as compared to a total of 139 employees, with 133 full-time employees the prior year.4) Financial Information about Foreign and Domestic Operations and Export SalesThe majority of Zareba’s products are sold in the United States and United Kingdom, with export and foreign sales of $9.6 million in fiscal year 2006, compared to $8.0 million in fiscal year 2005. On September 27, 2004, through its newly formed subsidiary, Zareba Systems Europe, Zareba acquired Rutland 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. Sales in Canada totaled $829,000 for fiscal year 2006.

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