Exhibit 2.s.4

DEFIANCE INTEGRATED TECHNOLOGIES, INC

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

Napoleon, Ohio

CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

CONTENTS

 

INDEPENDENT AUDITOR’S REPORT

     1   

CONSOLIDATED FINANCIAL STATEMENTS

  

CONSOLIDATED BALANCE SHEETS

     3   

CONSOLIDATED STATEMENTS OF OPERATIONS

     4   

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

     5   

CONSOLIDATED STATEMENTS OF CASH FLOWS

     6   

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

     7   

 


LOGO

INDEPENDENT AUDITOR’S REPORT

To the Shareholders

Defiance Integrated Technologies, Inc.

Napoleon, Ohio

Report on the Financial Statements

We have audited the accompanying consolidated financial statements of Defiance Integrated Technologies, Inc., which comprise the consolidated balance sheets as of December 31, 2015, 2014 and 2013, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015, and the related notes to the financial statements.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditor’s Responsibility

Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

 

 

1.


Opinion

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Defiance Integrated Technologies, Inc. as of December 31, 2015, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015 in accordance with accounting principles generally accepted in the United States of America.

 

LOGO

Crowe Horwath LLP

Fort Wayne, Indiana

March 14, 2016

 

 

2.


 

 

CONSOLIDATED FINANCIAL STATEMENTS

 

 


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2015, 2014 and 2013

 

 

 

     2015      2014      2013  
            As revised      As revised  
            (Note 2)      (Note 2)  

ASSETS

        

Current assets

        

Cash in bank

   $ 5,253       $ 1,659,805       $ 487,392   

Accounts receivable, trade net of allowance for doubtful accounts: 2015 - $26,700; 2014 - $12,000; 2013 - $24,000

     3,094,626         3,628,147         2,900,899   

Accounts receivable, other

     70,804         293,827         207,785   

Income tax receivable

     942,237         —           —     

Inventories

     2,083,612         2,799,282         2,162,382   

Prepaid expenses

     394,470         302,069         56,601   
  

 

 

    

 

 

    

 

 

 

Total current assets

     6,591,002         8,683,130         5,815,059   

Property, plant and equipment

        

Land

     300,250         300,250         300,250   

Leasehold improvements

     566,010         305,482         240,532   

Machinery and equipment

     7,462,956         6,428,385         5,603,987   

Office equipment

     137,284         148,809         139,258   

Construction in process

     222,688         232,096         61,991   
  

 

 

    

 

 

    

 

 

 
     8,689,188         7,415,022         6,346,018   

Less accumulated depreciation

     3,344,663         2,616,385         1,969,349   
  

 

 

    

 

 

    

 

 

 
     5,344,525         4,798,637         4,376,669   

Goodwill

     2,159,134         2,159,134         2,159,134   

Unpatented technology

     5,120,000         5,120,000         5,120,000   

Customer relationships, net

     194,780         216,224         237,667   

Non-compete agreement, net

     20,000         27,500         37,500   

Debt issuance costs, net

     43,139         —           —     
  

 

 

    

 

 

    

 

 

 

Total assets

   $ 19,472,580       $ 21,004,625       $ 17,746,029   
  

 

 

    

 

 

    

 

 

 

 

 

(Continued)


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2015, 2014 and 2013

 

 

 

     2015      2014      2013  
            As revised      As revised  
            (Note 2)      (Note 2)  

LIABILITIES

        

Current liabilities

        

Bank overdraft

   $ 5,633       $ 143,713       $ 14,717   

Accounts payable

     1,027,497         2,109,786         1,071,610   

Accrued expenses

     791,365         601,513         971,493   

Current maturities of long-term debt

     508,959         633,333         520,000   
  

 

 

    

 

 

    

 

 

 

Total current liabilities

     2,333,454         3,488,345         2,577,820   

Revolving credit facility

     942,436         —           —     

Fair value of derivative liability

     833,168         1,534,717         1,391,748   

Long-term debt, less current maturities

     6,888,917         6,898,777         6,914,623   

Deferred tax liability

     2,092,000         1,956,855         1,485,126   
  

 

 

    

 

 

    

 

 

 

Total liabilities

     13,089,975         13,878,694         12,369,317   

SHAREHOLDERS’ EQUITY

        

Preferred stock (4,750 shares authorized, issued and outstanding with $.01 par value, $366,478, $345,290 and $325,326 liquidation preference at December 31, 2015, 2014 and 2013, respectively)

     48         48         48   

Common stock (50,000 shares authorized with $.01 par value, issued and outstanding 20,316 shares at December 31, 2015, 2014 and 2013)

     203         203         203   

Additional paid in capital

     686,090         665,508         647,508   

Retained earnings

     5,696,264         6,460,172         4,728,953   
  

 

 

    

 

 

    

 

 

 

Total shareholders’ equity

     6,382,605         7,125,931         5,376,712   
  

 

 

    

 

 

    

 

 

 

Total liabilities and shareholders’ equity

   $ 19,472,580       $ 21,004,625       $ 17,746,029   
  

 

 

    

 

 

    

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements.

3.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

For the years ended December 31, 2015, 2014 and 2013

 

 

 

     2015     2014      2013  
           As revised      As revised  
           (Note 2)      (Note 2)  

Net sales

   $ 26,661,374      $ 30,444,424       $ 24,075,377   

Cost of sales

     22,453,973        23,634,935         19,237,081   
  

 

 

   

 

 

    

 

 

 

Gross profit

     4,207,401        6,809,489         4,838,296   

Selling, general and administrative expenses

     2,372,937        2,759,288         2,414,993   

Relocation expenses

     2,263,749        —           —     

Share based compensation

     20,582        18,000         (35,276
  

 

 

   

 

 

    

 

 

 

Income (loss) before other expense

     (449,867     4,032,201         2,458,579   

Other (income) expenses

       

Change in fair value of derivative liability

     48,451        142,969         135,133   

Other (income) expense

     (30,725     521,743         204,462   

Interest expense

     778,800        756,857         813,801   
  

 

 

   

 

 

    

 

 

 

Total other expense

     796,526        1,421,569         1,153,396   
  

 

 

   

 

 

    

 

 

 

Income (loss) before (benefit from) provision for income taxes

     (1,246,393     2,610,632         1,305,183   

(Benefit from) Provision for income taxes

     (482,485     879,413         382,029   
  

 

 

   

 

 

    

 

 

 

Net income (loss)

   $ (763,908   $ 1,731,219       $ 923,154   
  

 

 

   

 

 

    

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements.

4.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

For the years ended December 31, 2015, 2014 and 2013

 

 

 

     Preferred Stock      Common Stock                     
     Number of             Number of             Additional Paid     Retained        
     Shares      Amount      Shares      Amount      in Capital     Earnings     Total  
                                       As revised     As revised  
                                       (Note 2)     (Note 2)  

Balance at January 1, 2013

     4,750       $ 48         20,316       $ 203       $ 682,784      $ 3,805,799      $ 4,488,834   

Stock option compensation

     —           —           —           —           (35,276     —          (35,276

Net income for the year ended December 31, 2013 (as revised - Note 2)

     —           —           —           —           —          923,154        923,154   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2013

     4,750       $ 48         20,316       $ 203       $ 647,508      $ 4,728,953      $ 5,376,712   

Stock option compensation

     —           —           —           —           18,000        —          18,000   

Net income for the year ended December 31, 2014 (as revised - Note 2)

     —           —           —           —           —          1,731,219        1,731,219   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2014

     4,750       $ 48         20,316       $ 203       $ 665,508      $ 6,460,172      $ 7,125,931   

Stock option compensation

     —           —           —           —           20,582        —          20,582   

Net loss for the year ended December 31, 2015

     —           —           —           —           —          (763,908     (763,908
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

     4,750       $ 48         20,316       $ 203       $ 686,090      $ 5,696,264      $ 6,382,605   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

 

 

See accompanying notes to the consolidated financial statements.

5.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the years ended December 31, 2015, 2014 and 2013

 

 

     2015     2014     2013  
           As revised     As revised  
           (Note 2)     (Note 2)  

Cash flows from operating activities

      

Net income (loss)

   $ (763,908   $ 1,731,219      $ 923,154   

Adjustments to reconcile net income (loss) to net cash provided by operating activities

      

Depreciation and amortization

     862,683        703,883        625,750   

Loss on asset disposal

     36,798        10,065        15,514   

Share based compensation

     20,582        18,000        (35,276

Change in fair value of derivative liability

     48,451        142,969        135,133   

Deferred taxes

     135,145        471,729        25,176   

Changes in current assets and liabilities

      

Inventories

     715,670        (636,900     126,898   

Accounts receivable

     756,544        (813,290     195,517   

Income tax receivable

     (942,237     —          —     

Prepaid expenses

     (92,401     (245,468     50,794   

Accounts payable and accrued expenses

     (892,437     668,196        688,759   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used for) operating activities

     (115,110     2,050,403        2,751,419   
  

 

 

   

 

 

   

 

 

 

Cash flows from investing activities

      

Capital expenditures

     (1,218,464     (484,591     (339,693

Proceeds from asset disposal

     500        6,137        10,419   
  

 

 

   

 

 

   

 

 

 

Net cash used for investing activities

     (1,217,964     (478,454     (329,274

Cash flows from financing activities

      

Checks written in excess of bank balance

     (138,080     128,996        (220,630

Debt issuance costs

     (50,097     —          —     

Payments on revolving credit facility

     (11,294,623     (603,805     (6,915,173

Borrowings on revolving credit facility

     12,237,059        603,805        5,727,999   

Payments on long-term debt

     (1,110,737     (208,532     (217,266

Borrowings on long-term debt

     865,000        —          —     

Payments on derivative liability

     (750,000     —          —     

Payments on subordinated debt

     (80,000     (320,000     (320,000
  

 

 

   

 

 

   

 

 

 

Net cash used for financing activities

     (321,478     (399,536     (1,945,070
  

 

 

   

 

 

   

 

 

 

Net change in cash

     (1,654,552     1,172,413        477,075   

Cash, beginning of period

     1,659,805        487,392        10,317   
  

 

 

   

 

 

   

 

 

 

Cash, end of period

   $ 5,253      $ 1,659,805      $ 487,392   
  

 

 

   

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

      

Cash paid for interest

   $ 766,932      $ 758,194      $ 818,113   

Cash (received) paid for income taxes

   $ (13,984   $ 1,049,308      $ 36,966   

Supplementation disclosure of noncash investing and financing activity

      

Capital expenditures paid by borrowings on long-term debt

   $ 191,503      $ 626,019      $ —     

 

 

 

See accompanying notes to the consolidated financial statements.

6.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the accounts of Defiance Integrated Technologies, Inc. (the “Company”) and its wholly-owned subsidiaries Defiance Stamping Company and Pro Shear Corporation. All intercompany accounts and transactions have been eliminated.

General: The Defiance Stamping Company manufactures stamped metal products at its Napoleon, Ohio facility primarily for customers in the heavy truck and automotive industry. Pro Shear Corporation manufactures and assembles components used in cars and trucks at its Fort Wayne, Indiana facility.

Revenue Recognition: Revenue is recognized upon shipment of product. Surcharges assessed on raw material price increases or decreases are recorded when earned.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates are considered to be share based compensation, reserves related to uncollectible accounts receivable, inventory, a derivative liability and carrying values of goodwill and other intangible assets.

Accounts Receivable, trade: The Company sells to customers using credit terms customary in its industry. Interest is not normally charged on outstanding receivables. Based principally on historical losses, aging from invoice dates, and prevailing economic conditions, the Company reduces recorded receivables to their estimated net realizable value by a valuation allowance.

Inventories: Inventories are stated at the lower of cost, first-in, first-out (FIFO) method or market.

Property, Plant and Equipment: Depreciation is provided using the straight-line method over the estimated useful lives of the respective acquired assets. Leasehold improvements are amortized over the lesser of the improvement’s estimated economic useful life or the remaining term of the lease to which the improvement is subject. Costs and related accumulated depreciation are removed from the accounts for assets retired from service and a gain or loss on disposition is recorded in income when realized. Depreciation expense for 2015, 2014 and 2013 was $826,781, $672,440 and $601,806, respectively.

The Company annually, or as required, evaluates the recoverability of its long-lived assets, primarily property, plant and equipment. The Company evaluates recoverability when events and circumstances indicate that the net carrying value of its long-lived assets may not be recoverable. There were no such impairments in 2015, 2014 and 2013.

Goodwill: Goodwill is recorded at cost and is assessed at least annually for impairment with any such impairment recognized in the current results of operations. The Company reviewed the carrying value of goodwill during fiscal 2015, 2014 and 2013 and determined no impairment exists.

Other Intangible Assets: The Company assessed the value of intangible assets at the time the Company was organized. Intangible assets having a finite life are amortized by the straight-line method over the estimated benefit period (customer relationships – 180 months). The Company reviewed the carrying value of non-amortizable intangible assets during fiscal 2015, 2014 and 2013 and determined no impairment exists.

 

 

(Continued)

7.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Debt Issue Costs: Fees paid to creditors and third-party costs directly associated with debt agreements are capitalized as debt issue costs and amortized over the term of the related debt using the straight-line method for revolving credit and term debt through interest expense on the statement of income and is reported as an operating cash flow through amortization on the statement of cash flows. Amortization under the straight line method approximates amortization using the effective interest method for term debt.

Fair Value of Financial Instruments: Cash, accounts receivable, accounts payable, and short-term accrued expenses are reflected in the financial statements at historical value, which approximates fair value, because of the short-term duration of these instruments. The carrying value of long-term debt approximates fair value due to interest rates which are currently available to the Company for debt with similar terms and maturities.

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods and significant assumptions to estimate the fair value of items:

Derivative: The Company’s derivative is related to a contingent interest feature on their subordinated debt (Note 2) is reported at fair value. The Company obtains fair value by obtaining the balance that is due to the holder of the instrument which is based on an initial amount owed with compounding interest on a monthly basis. The Company then prepares assumptions for an appropriate interest rate and an expected probability of a change in control to estimate the fair value of the instrument. The Company determined the fair value of the derivative to be recorded as a liability was $833,168, $1,534,717 and $1,391,748 at December 31, 2015, 2014 and 2013, respectively. The Company considers these to be Level 2 inputs.

Income Tax and Uncertain Tax Positions: The Company operates as a C Corporation for income tax purposes. Accordingly, deferred income tax assets and liabilities are computed based upon differences between the financial statements and tax basis of assets and liabilities that result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income.

 

 

(Continued)

8.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

The Company follows guidance issued by the Financial Accounting Standards Board (FASB) with respect to accounting for uncertainty in income taxes. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. Management is not aware of any uncertain tax positions.

The Company is subject to U.S. federal income tax, as well as various state income taxes. The Company is no longer subject to examination by taxing authorities for years before 2012. The Company does not expect the total amount of unrecognized tax benefits to significantly change in the next 12 months. The Company recognizes interest and/or penalties related to income tax matters in income tax expense. The Company did not have any amounts accrued for interest and penalties at December 31, 2015, 2014 and 2013.

Capital Structure: The Company’s equity structure consists of 50,000 duly authorized shares of common stock, $.01 par value per share, with 20,316 issued and outstanding and 4,750 duly authorized and issued shares of Preferred A Stock, $.01 par value per share at December 31, 2015, 2014 and 2013, respectively. The Preferred A Stock is convertible into common stock based on certain conditional provisions set forth in the amended articles of incorporation of the Company.

The holders of shares of Preferred A Stock shall be entitled to be paid in preference to the holders of any and all other classes of capital stock of the Company, out of funds legally available therefore, when and as declared by the board of directors. Dividends are cumulative at a rate of 6% per annum, compounded quarterly. The liquidation preference at December 31, 2015, 2014 and 2013 was $366,478, $345,290 and $325,326, respectively (includes $116,478, $95,290 and 75,326, respectively, of dividends in arrears).

In the event of any liquidation or dissolution of the Company, the holders of Preferred A Stock will receive amounts in accordance with the provisions set forth in the amended articles of incorporation of the Company, before any distributions are made to holders of any other then-outstanding series of common stock. Any remaining net assets will be distributed to holders of common stock.

Stock Based Compensation: The Company recognizes compensation expense in the consolidated financial statements for awards of equity instruments to employees based on the grant-date fair value of those awards, estimated in accordance with provisions of Accounting Standards Codification (ASC) 718. In 2013, an employee did not exercise their awarded stock options in accordance with the agreement following termination of employment. This resulted in a reversal of the unvested portion of compensation expense. Stock based compensation expense (income) for 2015, 2014 and 2013 approximated $20,582, $18,000 and ($35,276), respectively, and is recorded in share based compensation on the consolidated income statement and recorded as additional paid-in capital on the consolidated balance sheets.

Relocation Costs: The Company relocated its Defiance Stamping facility from Defiance, Ohio to Napoleon, Ohio during 2015. Relocation costs, which consist of moving costs, remaining lease payments, and other costs associated with replaced facilities and other related expenses, are expensed as incurred.

Reclassification: Certain prior year amounts have been reclassified for consistency with the current period presentation in the Balance Sheet. These reclassifications had no effect on the reported net income or shareholders’ equity for any period presented.

 

 

(Continued)

9.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Subsequent Events: Management has performed an analysis of the activities and transactions subsequent to December 31, 2015 to determine the need for any adjustments to and/or disclosures within the audited financial statements for the year ended December 31, 2015. Management has performed their analysis through March 14, 2016, the date the financial statements were available to be issued.

NOTE 2 – REVISION OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

During the year ended December 31, 2015, the Company identified that it was not appropriately recording a derivative liability for a contingent interest feature in its note payable to the Company’s majority equity holder. The feature requires the Company to pay contingent interest to the lender at the time of a change in control as defined in the debt agreement. The feature accrues at a rate of 3% of the outstanding debt balance subject to a floor of 50% of the initial principal borrowings of $6,325,000. The fee begins accruing at the inception date of the underlying debt agreement until the time at which a change in control is triggered. The contingent interest still accrues in the event the underlying debt agreement is extinguished. Based on the Company’s evaluation of ASC 815, Derivatives and Hedging, the Company determined that this feature was embedded and therefore evaluated it under ASC 815 and determined it is not clearly and closely related to the host instrument, the instrument is not accounted for at fair value through earnings, a separate instrument with the same features would meet the definition of a derivative if it was freestanding, and it does not qualify for an exception from derivative accounting. Therefore, it was determined the feature would be bifurcated and accounted for separately as a derivative. The fair value of the contingent interest feature is to be remeasured at each balance sheet date. The Company determined that the adjustments to record the derivative liability were not made beginning at the Company’s opening balance sheet date of July 31, 2009. The Company determined the fair value of the derivative to be recorded as a liability was $833,168, $1,534,717 and $1,391,748 at December 31, 2015, 2014 and 2013, respectively. The Company determined that the fair value of the derivative at the opening balance sheet date of July 31, 2009 should have been recorded as an assumed liability in the amount of $675,535 with a corresponding increase to goodwill.

From time to time, the Company is able to make prepayments of the contingent interest. The Company made prepayments in the total amount of $750,000 during 2015. No such prepayments occurred in 2014 or 2013. The Company previously recorded an unamortized prepayment of contingent interest in the amount of $333,333 as an acquired asset on its opening balance sheet as of July 31, 2009 which the Company then subsequently amortized into net income during 2009, 2010 and 2011. As a result of the Company’s identification of not appropriately recording the contingent interest feature as a derivative liability, the Company also determined the prepayment that was recorded as an acquired asset should have been a reduction in the fair value of the derivative liability at the time of the prepayment and therefore not capitalized and amortized.

The Company is therefore revising the previously reported financial information for the twelve months ended December 31, 2014 and 2013. The Company considers these adjustments to be immaterial to prior periods.

 

 

(Continued)

10.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 2 – REVISION OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS (Continued)

 

The adjustments recorded as of and for the years ended December 31, 2014 and 2013 are as follows:

 

     December 31, 2014      December 31, 2013  

Consolidated Balance Sheets:

     

Goodwill as previously reported

   $ 1,150,266       $ 1,150,266   

Adjustment for derivative liability and prepayment of contingent interest

     1,008,868         1,008,868   
  

 

 

    

 

 

 

Goodwill as adjusted

   $ 2,159,134       $ 2,159,134   
  

 

 

    

 

 

 

Derivative liability as previously reported

   $ —         $ —     

Adjustment for derivative liability

     1,534,717         1,391,748   
  

 

 

    

 

 

 

Derivative liability as adjusted

   $ 1,534,717       $ 1,391,748   
  

 

 

    

 

 

 

Deferred tax liability as previously reported

   $ 2,283,000       $ 1,757,000   

Adjusted to deferred tax liability

     (326,145      (271,874
  

 

 

    

 

 

 

Deferred tax liability as adjusted

   $ 1,956,855       $ 1,485,126   
  

 

 

    

 

 

 

Retained earnings as previously reported

   $ 6,659,876       $ 4,839,959   

Net income impact of adjustments for derivative liability remeasurement, amortization of prepayment of contingent interest and income taxes

     (199,704      (111,006
  

 

 

    

 

 

 

Retained earnings as adjusted

   $ 6,460,172       $ 4,728,953   
  

 

 

    

 

 

 
     For the year ended      For the year ended  
     December 31, 2014      December 31, 2013  

Consolidated Statements of Income:

     

Net income as previously reported

   $ 1,819,917       $ 1,006,991   

Adjustment for change in the fair value of the derivative liability

     (142,969      (135,133

Adjustment for income tax expense

     54,271         51,296   
  

 

 

    

 

 

 

Net income as adjusted

   $ 1,731,219       $ 923,154   
  

 

 

    

 

 

 

NOTE 3 – INVENTORIES

Inventories consisted of the following at December 31, 2015, 2014 and 2013:

 

     2015      2014      2013  

Raw materials

   $ 735,003       $ 1,079,423       $ 916,152   

Work in process

     916,487         1,029,294         705,819   

Finished goods

     432,122         690,565         540,411   
  

 

 

    

 

 

    

 

 

 
   $ 2,083,612       $ 2,799,282       $ 2,162,382   
  

 

 

    

 

 

    

 

 

 

 

 

(Continued)

11.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 4 – GOODWILL AND INTANGIBLE ASSETS

 

     2015     2014     2013  
     Gross Carrying      Accumulated     Gross Carrying      Accumulated     Gross Carrying      Accumulated  
     Amount      Amortization     Amount      Amortization     Amount      Amortization  

Un-amortized intangibles

               

Unpatented technology

   $ 5,120,000         N/A      $ 5,120,000         N/A        5,120,000         N/A   

Amortized intangibles

               

Non-compete agreement

     40,000         (20,000     40,000         (12,500     40,000         (2,500

Customer relationships

     321,656         (126,876     321,656         (105,432     321,656         (83,989
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 
   $ 5,481,656       $ (146,876   $ 5,481,656       $ (117,932   $ 5,481,656       $ (86,489
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Debt issuance costs

   $ 50,097       $ (6,958   $ —         $ —        $ —         $ —     

Goodwill

   $ 2,159,134         N/A      $ 2,159,134         N/A      $ 2,159,134         N/A   

Other intangible assets include the unpatented technology production process of heavy duty truck axle nuts and washers, customer relationships, and a non-compete agreement. The unpatented technology production process has an indefinite life and is evaluated each year for impairment.

The customer relationship intangible asset was acquired in 2010 as part of the purchase of Specialty Engine of America, Inc. The remaining useful life is approximately nine years. Estimated amortization expense for the customer relationships intangible will approximate $21,400 each of the next five years. The non-compete asset includes agreements with 2 key employees acquired as part of the purchase of JBM Tool & Die. Each agreement is amortized using the straight-line method over the 2 year benefit period when triggered by the respective employees no longer being employed by the Company. One of the employees departed the company in 2013, therefore amortization expense for the non-compete agreement was $7,500 in 2015, $10,000 in 2014 and $2,500 in 2013.

Debt issuance costs are amortized over the remaining life of the related revolving line of credit and long-term debt. The remaining useful is approximately 31 months. Estimated amortization expense for debt issuance costs will approximate $16,700 in 2016 and 2017 and $9,700 in 2018.

NOTE 5 – BANK LINE OF CREDIT

The credit agreement had a financing agreement that provided for a revolving line of credit of up to $3,000,000 and term notes (Note 6). The revolving line of credit was subject to a borrowing base calculation and bears interest at the 30 day LIBOR rate plus 2.50% (effective rate of 2.66% at both December 31, 2014 and 2013, respectively) and was due in June 2015. The Company had no outstanding borrowings on the line of credit at December 31, 2014 and 2013, respectively.

The Company replaced the existing credit agreement with a new credit agreement with a different commercial lender in August 2015. The new facility included a revolving line of credit with a borrowing capacity of $4,000,000 and long-term debt (See Note 6). The line of credit is due in August 2018. The new revolving credit agreement bears interest at either the one month LIBOR plus 3.00% or prime (effective rate of 3.50% at December 31, 2015). The agreement is collateralized by all the assets of the Company. The Company had outstanding borrowings of $942,436 and borrowing availability of $2,025,960 at December 31, 2015. In accordance with the terms of the credit agreement, the Company must comply with certain financial covenants. The Company was in compliance with its covenants at December 31, 2015, 2014 and 2013.

 

 

(Continued)

12.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 6—LONG-TERM DEBT

Long-term debt at December 31, 2015, 2014 and 2013 consists of the following:

 

     2015      2014      2013  

Note payable to the Company’s majority equity holder, due in quarterly principal installments of $80,000 commencing on October 1, 2010. Interest is computed at the higher of one-month LIBOR plus 8% or at 11% (11% efffective rate at December 31, 2015, 2014 and 2013). All remaining outstanding principal under this note is due on February 19, 2019. The total note is in the amount of $8,500,000. The Company may borrow up to the full amount of the note at the sole discretion of the lender. The note payable is secured by all assets of the Company. The lender is sub-ordinated to the collateral position of the bank with the term loan below and Revolving Credit Facility.

   $ 6,384,623       $ 6,464,623       $ 6,784,623   

Note payable, due in monthly principal installments of $16,667 commencing on April 15, 2012. Interest was computed at 30 day LIBOR rate plus 2.50% for an effective rate of 2.66% at December 31, 2014 and 2013, respectively. The total note was in the amount of $1,000,000. The note payable was secured by all assets of the Company. This loan was paid off in August 2015 in conjuction with the refinancing.

     —           450,000         650,000   

Note payable, due in monthly installments of $2,071 commencing on August 1, 2014. Interest was computed at a rate of 3.89%. The total note was in the amount of $112,500. The note was secured by all assets of the Company. This loan was paid off in August 2015 in conjuction with the refinancing.

     —           103,968         —     

Note payable, due in monthly installments of $7,544 commencing on January 1, 2015. Interest was computed at a rate of 3.75%. The total note was in the amount of $409,570. The note was secured by all assets of the Company. This loan was paid off in August 2015 in conjuction with the refiancing.

     —           409,570         —     

Note payable, due in monthly installments of $1,914 commencing on March 1, 2015. Interest was computed at a rate of Prime minus 0.25% for an effective rate of 4.12% at December 31, 2014. The total note was in the amount of $103,949. The note payable was secured by all assets of the Company. This loan was paid off in August 2015 in conjuction with the refinancing.

     —           103,949         —     

Note payable, due in monthly principal installments of $14,417 commencing on October 1, 2015. Interest is computed at 30 day LIBOR rate plus 3.00% for an effective rate of 3.50% at December 31, 2015. All remaining principal under this note is due August 19, 2018. The total note is in the amount of $865,000. The note payable is secured by all assets of the Company

     821,750         —           —     

 

 

(Continued)

13.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 6 - LONG-TERM DEBT (Continued)

 

Note payable, due in monthly principal installments of $3,192 commencing on September 1, 2016. Interest is computed at 30 day LIBOR rate plus 3.00% for an effective rate of 3.50% at December 31, 2015. All remaining principal under this note is due August 19, 2018. The Company may borrow up to $1,500,000, how ever, the total amount drawn as of December 31, 2015 is $191,503.

     191,503         —           —     
  

 

 

    

 

 

    

 

 

 
     7,397,876         7,532,110         7,434,623   

Less, current maturities

     (508,959      (633,333      (520,000
  

 

 

    

 

 

    

 

 

 
   $ 6,888,917       $ 6,898,777       $ 6,914,623   
  

 

 

    

 

 

    

 

 

 

The aggregate maturities of long-term debt as of December 31, 2015 are:

 

2016

   $ 508,959   

2017

     531,301   

2018

     932,993   

2019

     5,424,623   
  

 

 

 
   $ 7,397,876   
  

 

 

 

NOTE 7 - EMPLOYEE BENEFIT PLANS

The Company maintains 401(k) plans covering all full-time employees. The Company matches employee’s contributions up to the first 4% contributed by the employee. The Company may also make a discretionary bonus contribution to the plan. During 2015, 2014 and 2013, the Company did not make a bonus contribution.

For the years ended December 31, 2015, 2014 and 2013, total contribution for the plans approximated $141,600, $139,500 and $141,600.

NOTE 8 – SIGNIFICANT CUSTOMERS

For the years ended December 31, 2015, 2014 and 2013 three, three and two customers exceeded 10% of sales and accounts receivable, respectively.

 

     2015      % of total     2014      % of total     2013      % of total  

Sales

   $ 11,515,279         43.19   $ 10,902,582         35.81   $ 7,623,039         31.66

Accounts receivable

   $ 1,664,284         53.78   $ 1,613,173         44.46   $ 1,095,524         37.76

 

 

(Continued)

14.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 9—INCOME TAXES

Income tax provision (benefit) consists of the following:

 

     2015      2014      2013  

Federal

        

Current

   $ (557,843    $ 358,196       $ 338,853   

Deferred

     135,145         471,729         25,176   

State

        

Current

     (59,787      49,488         18,000   
  

 

 

    

 

 

    

 

 

 

Provision for (benefit from) income taxes

   $ (482,485    $ 879,413       $ 382,029   
  

 

 

    

 

 

    

 

 

 

The difference between the effective tax rate and the federal statutory tax rate of 34% is primarily due to prior year true up of deferred tax liability and state and local income taxes.

 

     2015      2014      2013  

Non current deferred tax assets

   $ 833,808       $ 756,414       $ 613,269   

Non current deferred tax liabilities

     (2,925,808      (2,713,269      (2,098,395
  

 

 

    

 

 

    

 

 

 

Net deferred balance

   $ (2,092,000    $ (1,956,855    $ (1,485,126
  

 

 

    

 

 

    

 

 

 

The principal sources of deferred tax liabilities are attributable to differences between income tax and financial reporting methods used in recording depreciation, amortization, debt restructuring, and certain accrued liabilities. The deferred tax assets are primarily attributable to transaction costs being amortized for tax purposes, the derivative liability and various inventory and accounts receivable reserves.

NOTE 10—STOCK OPTIONS

In July 2009, the Company adopted the 2009 Stock Incentive Plan. The Plan permits the grant of 4,967 various stock awards to purchase shares of common stock of the Company to approved key employees.

During 2011, 892 stock options (“options”) were granted to a key employee. The options vested over 3 years in equal yearly installments on the anniversary date of the date of grant until the employee terminated employment on January 21, 2013. The employee did not exercise the options within 60 days of cessation of employment, therefore in accordance with the agreement the options expired in 2013.

During 2013, a total of 524 options were granted to two employees. The options become exercisable in equal yearly installments on the anniversary date of each of the three years following the date of grant. The options expire in ten years from the date of grant.

 

 

(Continued)

15.


DEFIANCE INTEGRATED TECHNOLOGIES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2015, 2014 and 2013

 

 

 

NOTE 10—STOCK OPTIONS (Continued)

 

During 2015, the Company and the holders of these 524 options agreed to exchange the existing options to purchase shares of the Company’s common stock with 524 new options. The new options are for the same number of shares but at a lower exercise price. The termination date is ten years from the date of the modification. Due to the modification the Company had an additional stock option modification expense of $2,350. All additional expense is recorded as share based compensation.

During 2015, a total of 1,575 new options were granted to four employees or directors. The options become exercisable in equal yearly installments on the anniversary date of each of the three years following the date of grant. The options expire in ten years from the date of grant.

The fair value of each option award is estimated on the date of grant using a Black Scholes option valuation model that uses the assumptions noted in the table below. Expected volatilities are based on comparisons with similar companies. The expected term of the options are based on the exercisable period. The Company uses historical data to estimate employee termination within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The remaining weighted average life on the stock options approximates 9 years. The calculation fair value is then recorded net of expected forfeitures.

 

     2015     2014      2013  

Assumptions used for issuance of stock options:

       

Expected volatility

     35     n/a         39

Expected dividends

     0     n/a         0

Expected term

     10 years        n/a         10 years   

Risk-free rate

     2.55     n/a         2.74

A summary of option activity under the Plan as of December 31, 2015, 2014 and 2013:

 

     2015     2014      2013  
Options    Shares     Weighted-
Average
Exercise Price
    Shares      Weighted-
Average
Exercise Price
     Shares     Weighted-
Average
Exercise Price
 

Outstanding, beginning of year

     524      $ 195.78        524       $ 195.78         892        324.18   

Granted

     2,099        32.54        —           —           524        195.78   

Excerised

     —          —          —           —           —          —     

Cancelled

     (524     (195.78     —           —           (892     (324.18
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Outstanding, end of year

     2,099      $ 32.54        524       $ 195.78         524      $ 195.78   
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

 

(Continued)

16.


NOTE 10—STOCK OPTIONS (Continued)

 

A summary of the status of the Company’s options as of December 31, 2015, 2014 and 2013, and changes during the years ended are presented below:

 

     2015     2014     2013  
Options    Shares     Weighted-
Average
Grant Date
Fair Value
    Shares     Weighted-
Average
Grant Date
Fair Value
    Shares     Weighted-
Average
Grant Date
Fair Value
 

Nonvested, beginning of year

     350      $ 104.06        524      $ 104.06        595        257.64   

Granted

     2,099        15.88        —          —          524        104.06   

Vested

     (700     (15.88     (174     (104.06     —          —     

Cancelled

     (350     (104.06     —          —          (595     (257.64
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonvested, end of year

     1,399      $ 15.88        350      $ 104.06        524      $ 104.06   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

As of December 31, 2015, 2014 and 2013, there was approximately $36,500, $28,500 and $46,500, respectively, of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the Plan. This expense will be recognized over the next 2 years. In accordance with ASC 718, due to the fact that the options vest with time, the Company has recognized approximately $20,582, $18,000 and ($35,276) of stock based compensation as of December 31, 2015, 2014 and 2013, respectively, related to options that the employees have earned.

NOTE 11 – LEASE COMMITMENTS

The Company leases manufacturing and office facilities, and certain pieces of equipment under several operating leases. Rent expense for the years ending December 31, 2015, 2014 and 2013 approximated $1,095,000, $580,000 and $502,000, respectively. Total minimum rentals under non-cancellable operating leases as of December 31, 2015 over future fiscal years are approximately:

 

2016

   $ 847,000   

2017

     819,500   

2018

     598,400   

2019

     503,600   

2020

     465,000   

Thereafter

     1,821,300   
  

 

 

 
   $ 5,054,800   
  

 

 

 

 

 

17.