Free Motion in Limine - District Court of Colorado - Colorado

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 1 of 20

EXHIBIT A

EXHIBIT A

Case 1:03-cv-01973-PSF-MJW
~~

Document 166-2

~~L~-L

Filed 10/17/2005

Page 2 of 20
____

McGladrey& Pullen
Certified Public Accountants

Walker Group, Inc. and Subsidiaries Consolidated Financial Report September 27, 2002

EXHIBIT

21
WalkerOO5l 97

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 3 of 20

CONTENTS.
INDEPENDENT AUDITOR'S REPORT FINANCIAL STATEMENTS Consolidated balance sheets Consolidated statements of operations Consolidated statements of retained earnings Consolidated statements of cash flows Notes to consolidated financial statements
. . .

.

~.

--

1

2--3 4 5 6--7 8--17

WaLkerOOSi9S

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 4 of 20

McGladrey& Pullen
Cerlifled Public Accountants

INDEPENDENT AUDITOR'S REPORT

To the Board of Directors Walker Group, Inc. Welcome, North Carolina We have audited the accompanying consolidated balance sheets of Walker Group, Inc. and subsidiaries as of September 27, 2002 and September 28, 2001, and the related consolidated statements of operations, retained earnings, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overafi financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Walker Group, Inc. and subsidiaries as of September 27, 2002 and September 28, 2001, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of Amenca.

Greensboro, North Carolina December 3, 2002, except for the second paragraph of Note 4 as to which the date is December 20, 2002, and Note 15 as to which the date is February 6, 2003

ad~8Pu~n.LLPsan~ndependentmernberIiimof RSM International, anaffiliation of independent accounting ardconsu~ng hens

W 1k O(~5199
a er
-.

I

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 5 of 20 I I
I

WALKER GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BAlANCE SHEETS September 27, 2002 and September 28, 2001

4 4 I 4 I

ASSETS Current Assets Cash Accounts receivable: Trade, less allowance for doubtful accounts 2002 $538,570; 2001 $739,519 (Notes 4 and 5)

2002

2001 4

$

27,746

$

57,082
.

Other Sales tax overpayment
Refundable income taxes (Note 4) Inventories (Notes 2,4 and 5) Prepaid expenses and other assets Deferred taxes (Note 7) Total current assets Investment and Advances First Layer Communications, Inc. (Note 13)
-

8,251,955 101,077 72,056 4,419,620 14,434,023 490,092
-

15,235,854 49,172

4 4

54,494
2,108,445 19,936,364 516,308 2,639,147 40,596,866 118,153 879,887 74,747 13,687,424 9,995,846 3,691,578

4
1 4 4

27,796,569

Deferred Taxes (Note 7) Other Assets Property and Equipment (Notes 3, 4 and 5) Less accumulated depreciation and amortization

-

63,748 13,095,891 10,617,840 2,478,051

I

.

$
See Notes to Consolidated Financial Statements.

30,338,368

$

45,361,231

WalkerOOSZOO

2

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 6 of 20

LIABIUTIES AND STOCKHOLDERS' EQUITY Cunent Uabilities Checks issued in excess of bank balance Notes payable (Note 4) Current maturities of long-term debt (Note 5) Accounts payable Accrued expenses Accrued restructuring costs (Note 14)

2002

2001 $ 1,561,281 9,649,255 850,000 15,607,963 1,053,136 612,060

$

1,606,091 4,336,679 850,000 13,880,532 976,195
-

Total current liabilities Long-Term Debt, less current maturities (Note 5)

21,649,497 2,725,000 20,555 1,281,331

29,333,695 3,575,000 146,144 1,103,628

Deferred Compensation (Note 9)
Interest Rate Swap Agreement (Note 6) Commitments (Notes 11 and 12) Stockholders' Equity (Notes 10 and 12) Preferred stock; authorized 100,000 shares; issued none Common stock: Class A, voting, par value $1 per share; authorized 200,000 shares; issued 6,768 shares Class C, nonvoting, par value $1 per share; authorized 800,000 shares; issued 67,681 shares Class E, nonvoting, no par value; authorized 200,000 shares; issued none Retained earnings $

-

-

6,768 67,681
-

6,768 67,681
-

4,587,536 4,661,985 30,338,368

$

11,128,315 11,202,764 45,361,23F

WaIkerOtj~20j

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 7 of 20

a a
WALKER GROUP, INC. AND SUBSIDIARIES

a
CONSOLIDATED STATEMENTS OF OPERATIONS Years Ended September 27, 2002 and September 28, 2001

S S S
2002 2001 $ 85,171,409 77,644,776 7,526,633 13,049,850
-

Net sales Cost of goods sold (Note 2) Gross profit Operating expenses Restructuring costs (Note 14) Operating loss Nonoperating income (expense): Interest expense Dividend and interest income Impairment of investment in and advances to First Layer Communications, Inc. (Note 13) Change in fair value of interest rate swap agreement (Note 6) Other

$

195,219,486 174,641,785 20,577,701 24,865,252 738,562 25,603,814 (5,026,113)

a
5 5

a
5

13,049,850 (5,523,217)

a
(1,132,373) 2,580 (525,021) (117,703) 2,577 (1,829,940) (2,443,604) 65,626 (600,000) (865,416) 5,981 (3,837,413)

5

Loss before income tax benefits and cumulative accounting change Income tax benefits (Note 7) Loss before cumulative accounting change Cumulative accounting change, net of deferred income tax benefit of $91,997 (Note 6) Net loss See Notes to Consolidated Financial Statements.

(7,353,157) (812,378) (6,540,779)

(8,863,526) (3,477,537) (5,385,989)

S 5 S

S
(6,540,779)

$

(146,215) (5,532,204)

S
WalkerOO5202

4

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 8 of 20

WALKER GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF RETAINED EARNINGS Years Ended September 27, 2002 and September 28,2001

2002 Balance, beginning Net loss Balance, ending See Notes to Consolidated Financial Statements. $ 11,128,315 $ (6,540,779) 4,587,536 $

2001 16,660,519 (5,532,204) 11,128,315

$

5

WalkerOOS2O3

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 9 of 20

WALKER GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended September 27, 2002 and September 28, 2001

Cash Flaws From Operating Activities Net loss Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization Deferred income taxes (benefIts) Deferred compensation, net of forfeitures and payments Impairment of investment in and advances to First Layer Communications, Inc. Loss on disposal of property and equipment
Cumulative effect of accounting change Changes in assets and liabilities: (Increase) decrease in: Trade and other receivables Refundable income taxes

2002 $ (6,540,779) $
1,154,980

2001 (5,532,204) 1,554,387
(1,614,168) (111,305) 600,000
-

4

3,519,034
(125,589) 525,021 37,172
-

4

238,212

4 4 4
4

6,931,994

Sales tax overpayment Inventories Prepaid expenses and other assets Increase (decrease) in: Accounts payable and accrued expenses
Accrued restructuring costs Income taxes payable

(2,311,175) (17,562) 5,502,341
37,215 (1,804,372) (612,060)
-

32,855,486 (2,108,445)

465,917
22,192,463

(5,115)

4

(18,784,254)
612,060 (1,762,291) 865,416

4

Interest rate swap agreement Net cash provided by operating activities Cash Flows From Investing Activities Purchase of property and equipment Proceeds from sale of property and equipment Mvances and investment in First Layer Communications, Inc.
Net cash used in investing activities Cash Flows From Financing Activities Increase in checks issued in excess of bank balance Net payments on revolving credit arrangements Principal payments on long-term borrowings Net cash used in financing activities Net decrease in cash

171,703

6,474,523 (31,115) 51,890 (406,868)
(386,093) 44,810 (5,312,576) (850,000) (6,117,766) (29,336)

31,466,159

4
(832,325)
-

(718,153) (1,550,478) 1,494,874 ~(31,134,002) (850,000) (30,489,128) (573,447)

4 4

4 4
4 1 I

Cash: Beginning Ending
(Continued)

57,082 27,746

$

630,529 57,082

4
WalkerOOS2O4

6

I

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 10 of 20

WALKER GROUP, INC. AND SUBSIDIARIES

CONSOLIDATEDSTATEMENTS OF CASH FLOWS ~Continued) Years Ended September 27,2002 and September28, 2001

2002

2001

j

Supplemental Disclosures of Cash Flow Information Cash payments (refunds) for Interest Income taxes See Notes to Consolidated Financial Statements.

$ $

1,129,984 (2,020,237)

$ $

2751031

(1,461 089)

-

WaIkerOO52O5

7

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 11 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies Nature of business: The Company and its subsidiaries are primanly involved in the distribution of electronic communications equipment and parts in the telecommunications industry. Sales are to companies within the industry, throughout the United States. Sales are on credit terms that the Company establishes for individual customers. A summary of the Companies' significant accounting policies follows: Reporting period: The Company and its subsidiaries~ reporting period is a fiscal year ending on the last Friday of September. The years ended September 27, 2002 and September 28, 2001 both contained 52 weeks. Principles of consolidation: The consolidated financial statements include the accounts of the Company and its two wholly-owned subsidiaries, Walker and Associates, Inc. and Walker Systems, Inc. All significant inteitompany accounts and transactions have been eliminated in consolidation. Concentration of credit risk: The Company, at times, has bank deposits in excess of federally-insured limits. Revenue reco~inition: The Company policy is to recognize revenue at the time of shipment of goods to a customer. The Company classifies those amounts billed to customers for shipping and handling in ~Net Sales~ and those costs incurred for shipping and handling in ~Cost Goods Sold~ the statement of operations. of in Accounts receivable, trade: The Company records its accounts receivable at cost, which approximates fair value at the balance sheet date. The Company estimates its allowance for doubtful accounts based on a combination of historical and current information as it relates to individual accounts. The Company determines past due status on accounts receivable based on the aging of the sales invoices. Specific accounts receivable that management believes to be uncollectible are written off upon such determination. Inventory: Inventory, consisting of memhandise for resale, is valued at the lower ofcost or market. The Company employs a full absorption procedure using standard cost techniques which approximates actual.cost. Property and equipment Property and equipment is stated at cost and depreciation is provided over the estimated useful lives of the assets, primarily on the straight-line method. Estimated useful lives for deprecIation purposes are: buildings 25 to 30 years, land improvements 10 to 15 years and equipment 5 to 10 years. Fa value of financial instruments: The carrying amount of cash, accounts receivable and accounts payable approximates fair value due to the short-term maturities of these instruments. The carrying values of notes payable and long-term debt approximates fair value because the respective interest rates used with these instruments fluctuate with either the prime rate, LI8OR, or other rates reflective of fair value. The fair value of interest rate agreements is estimated based on amounts chained by the bank.

8

WalkerOOS2O6

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 12 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1. Nature of Business and Significant Accounting Policies (Continued)

The fair value of the interest rate swap agreement is the estimated amount the Company would pay to terminate the agreement based on the net present value of the future cash flows as defined in the agreement. Income taxes: The Company and its subsidiaries file a consolidated federal income tax return. The subsidiaries are charged or credited with the federal income tax effect of their reported taxable income computed on a separate-return basis with differences allocated to the Company. Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. 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 at the date of the financial statements and the reported amounts or revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications: The Company's policy is to reclassify amounts reported in prior year financial statements when necessary for conformity with the current year presentation of those items. These reclassifications have no effect on net loss or stockholders' equity. Note 2. Inventory Due to the Company's restructuring efforts, inventory has been written down by $5,249,345 and $1,228,868 in 2002 and 2001, respectively. The inventory write-downs are a result of obsolete and idle inventory that has been scrapped. The write-downs are reflected in the accompanying 2002 and 2001 statements of operations as charges to cost of goods sold.

2 7 WalkerOOS O

9

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 13 of 20

I
WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCiAL STATEMENTS Note 3. Property and Equipment Property and equipment is composed of:

I
Land and improvements Buildings Equipment $ 2002 303,254 1,909,868 10,882,769 13,095,891

$
$

$

2001 303,254 1,952,668 11,431,502 13,687,424

I

*
Note 4. Notes Payable and Lines of Credit The Company has a line of credit under a loan agreement with Wachovia Bank of North Carolina, NA. whereby the lender will advance up to $8,000,000 (see below), on a revolving basis based upon eligible accounts receivable balances. The loan is collateralized by a pledge of trade receivables, inventory, substantiafly all property and equipment and by guarantee of the parent company. At September 27, 2002, the loan balance was $4,336,679. Customer remittances are mailed directly to the lender and serve to curtail the principal balance of the loan. The line of credit bears interest at either prime or the LIBOR plus an applicable percentage. The percentage added to prime or the LIBOR for determining the interest charged on the line of credit will be redetermined quarterly in accordance with the terms set forth in the credit agreement This percentage has a range up to .75% relating to the prime and a range of2.25% to 3.00% relating to the LIBOR. At September 27, 2002, the LIBOR was 1.819%. On September 28, 2001, the Company entered into a forbearance agreement with Wachovia Bankof North Carolina, N.A. as a result of the Company's default on the terms of the loan agreement The original forbearance agreement has been amended on several occasions. The latest forbearance agreement is dated December 20, 2002 and expires on June 20, 2003. This forbearance agreement reduces the amount that can be advanced under the letter of credit to $6,000,000 when the Company receives the proceeds of its refundable income taxes. This forbearance agreement also sets only one financial covenant for the line of credit and the letter of credit (see Note 5). This financial covenant is a minimum earnings before interest, taxes, depreciation and amortization beginning with the month of December 2002. In an agreement dated November 13, 2002, the Company has assigned to the lender all of the proceeds of the refundable income taxes for the year ended September 27, 2002. The proceeds of the tax refunds are to be applied (i) first, to any fees, expenses or accrued interest owed under the loan agreement (ii) second, to the costs and expenses associated with paying off the interest rate swap agreement between the Company and the lender (iii) third, to the unpaid principal balance of the line of credit, and (iv) fourth, to any other obligations as determined by the lender.

II

WaIkerOO52O8

10

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 14 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5. Long-Term Debt

Long-term debt at September 27, 2002 and September 28, 2001 consists of the following: 2002 Walker Group, Inc.: Promissory notes payable to former stockholders due in its entirety on September 22, 2008. The interest rate is adjusted every two years to reflect the then-current AFR (Applicable Federal Rate) in September. Interest is payable at 6.09% both at September 27, 2002 and September 28, 2002 Walker and Associates, Inc.: Letter of credit to Wachovia Bank of North Carolina, N.A., payable in annual installments of $800,000 which began in July of 1999. An annual fee of 1.75% of the outstanding letter of credit balance is payable quarterly, in arrears, and will continue until the note is satisfied (see below) Noninterest-bearing note payable to Davidson Electric Membership Corporation, due in quarterly installments of $12,500 Less current maturities $ The aggregate payments required on long-term debt are as follows: Year of Maturity 2003 2004 2005 2006 2007 Thereafter Amount 850,000 850,000 250,000 50,000 50,000 1,525,000 3,575,000 2001

$

1,500,000

$

1,500,000

1,800,000

2,600,000

275,000 3,575,000 850,000 2,725,000

$

325,000 4,425,000 850,000 3,575000

$

$

Wa11Cr005209

11

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 15 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 5. Long-Term Debt (Continued)

The letter of credit to Wachovia Bank of North Carolina, N.A. is related to the issuance by Walker and Associates, inc. of taxable variable rate demand bonds collateralized by a pledge of trade receivables, inventory, substantially all property and equipment and by guarantees of the parent company. The variable rate is an average of various rates as determined quarterly by the lender. At September 27, 2002, this rate was 1.81%. In order to provide security for the payment of the bonds, the bank has issued an irrevocable, direct-pay letter of credit in the amount of $1,890,000 of which an aggregate amount not exceeding $1,800,000 may be drawn upon with respect to payment of principal of the bonds, and of which an aggregate amount not exceeding $90,000 may be drawn upon with respect to payment of interest on the bonds. The letter of credit to Wachovia represents advances made by the bank under the placement agreement Note 6. Interest Rate Swap Agreement

The Company entered into an interest rate swap agreement in July of 2000. This agreement has a notional amount of $10,000,000 and requires the Company to make payments on the difference between 7.10% (rate at which the Company is required to pay) and LIBOR. The interest rate swap agreement expires on July 20, 2005. The counterparty to this agreement is a major financial institution with which the Company also has other financial relationships. The Company is exposed to credit loss in the event of nonperformance by this counterparty. However, the Company does not anticipate nonperlormance by this counterparty. The Company has not designated this agreement asahedge. The Company adopted Statement of Financial Accounting Standards No. 133 (~FAS 33u), Accounting for Derivative 1 Instruments and Hedging Activities, on September 30, 2000. This Statement establishes accounting and reporting standards for certain derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. Changes in fair value of those instruments will be reported in earnings or other comprehensive income, depending on the use of the derivative and whether it qualities for hedge accounting. In accordance with the transition provisions of FAS 133, the Company recorded a net-of-tax cumulative-effect-type adjustment loss of $146,215 in earnings to recognize at fair value their interest rate swap agreement for the year ended September 28, 2001. The Company recognized a pretax loss of $177,703 and $865,416 in earnings for the change in the fair value of this interest rate swap agreement for the years ended September 27, 2002 and September 28, 2001, respectively.

WalkerOOS2iO

12

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 16 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 7. Income Tax Matters Net deterred tax assets consist of the following components as of September 27, 2002 and September 28, 2001: 2002 Deferred tax assets: Accounts receivable allowances Inventories Deferred compensation Accrued axpenses Loss carryforwards Impairment allowance interest rate swap agreement Other Deferred tax liabilities, Property and equipment Net deferred tax asset Deferred tax asset valuation allowance $ 206,218 76,645 59,688 3,952 714,040
-

2001

$

490,622 18,467 1,569,632 4,007 1,565,625 (1,565,625)
-

283,162 1,846,328 105,212 307,433 339,409 231,300 422,579 18,467 3,553,890 34,856 3,519,034
-

3,519,034

The components giving rise to the net deferred tax assets described above have been included in the accompanying consolidated balance sheets as of September 27, 2002 and September 28, 2001 as follows: 2002 Current assets Noncurrent assets $
-

$ $

-

$

-

2001 2,639,147 879,887 3,519,034

The provision for income taxes credited to continuing operations for the years ended September 27, 2002 and September 28, 2001 consist of the following:

Current benefit Deferred tax expense (benefit) Deferred tax benefit cumulative accounting change

$

2002 (4,331,412) 3,519,034
-

$

~81 2,378)

$

2001 (1,955,366) (1,522,171) (91,997) (3,569,534)
WaIkerOOS2l 1

13

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 17 of 20

`U

4
4 4
WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLiDATED FINANCIAL STATEMENTS Note 7. Income Tax Matters (Continued) The difference between income tax benefits computed at the statutory federal income tax rate and the Company's actual income tax benefits as reflected in the financial statements is as follows: Income tax benefits at statutory federal income tax rate Increase (decrease) attributable to: Change in deferred tax valuation allowance State income taxes, net of federal income tax benefit Other

I 4 I

$

2002 (2,500,073) 1,565,625 (3,957) 126,027 (812,378)

$

2001 (3,094,591)
.

4 4

4 4 4
4

$

$

(412,068) (62,875) (3,569,534)

I 4
Note 8. Employee Benefit Plans The Company has a profit-sharing plan that covers substantially all employees. Contributions are made at the sole discretion of the Board of Directors. No contribution was made for the years ended September 27, 2002 or September 28, 2001. The Company maintains a 401(k) salary savings plan, which provides that employees may contribute a portion of salary to the plan on a tax-deferred basis. The Company contributed 50% of the first 5% of base compensation that the participant contributed to the plan until December 2001. At that time, the employer match was temporarily suspended. Matching contributions totaled $42,031 for the year ended September 27, 2002 ($176,780 for 2001). Note 9. Deferred Compensation The Company has a deferred compensation plan which allows certain members of management to defer bonus earnings. The Company accrues interest annually at 6% on balances invested in the plan. In 1999, this plan was discontinued and no further deferrals were allowed. Balances in the plan, which totaled $154,829 at September 27, 2002 and $272,896 at September 28, 2001, are being paid ojit over a five-year period that commenced in the fiscal year 2000. Aggregate annual payments under the above defprred compensation agreements are $134,274 for fiscal year ending 2003, with the remaining amount of $20,555 due in fiscal year ending 2004. Earnings will continue to be credited at 6% per annum until all balances are paid out. The amount due in fiscal year ending 2003 has been included in accrued expenses.

I I 4 4 4

4 4
4

4 4
4 4 4 4
4

WaIkerOOS2l2

14

4 4 4 4
4

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 18 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Stock Options

The Company has a stock option plan with 200,000 shares of class E nonvoting common stock reserved for employees. Option prices are required to be at least 100% of the fair value of the common stock on the date the options are granted. The Company granted nonqualifled options for the purchase of 27,900, 54,120 and 33,000 shares of common stock under this plan during 2002, 2001 and 2000, respectively. Grants were with an exercise price of $1.00 per share for 2002 and $19.78 for both 2001 and 2000. These options have a term of ten years and a vesting period of 4 years. None of these options have been exercised at September 27, 2002. The Company applies Accounting Principles Board Opinion Number 25, Accounting for Stock Issued to Employees ("APB No. 25") and related interpretations in accounting for all of their options which requires compensation expense to be recognized only if the fair market value of the underlying stock exceeds the exercise price on the date of grant. Accordingly, the Company has not recognized any compensation expense in connection with these options. SFAS No. 123, Accounting for Stock-Based Compensation, requires pro forma disclosures for option grants when accounting for stock-based compensation plans in accordance with APB No. 25. The pro forma effects are determined as if compensation costs were recognized using a fair value based accounting method. The fair value based method to measure compensation expense under SFAS No. 123 is based on the option price at the grant date, the expected lives of the options, expected dividend payments and the risk-free interest rate over the expected lives of the options. The assumptions used by the Company to value these options were as follows: Expected lives of ten years for 2002 and 2001 and four years for 2000; risk-free interest rates of 3.940%, 4.570% and 6.375% for the 2002, 2001 and 2000 options, respectively, and a zero expected volatility and dividend yield. The pro forma effect on the net loss for 2002 and 2001 of applying SFAS No. 123 with the above assumptions is insignificant. A reconciliation of the Company's stock option activity and related information follows: 2002 Number of Options 63,620 27,900
-

2001 Number of Options 33,000 54,120
-

Outstanding, beginning of year Granted Exercised Forfeited Outstanding, end of year Exercisable at end of year

WeightedAverage Exercise Price $ 19.78 1.00
-

WeightedAverage Exercise Price ~ 19.78 19.78
-

(25,100) 66,420 14,430

16.19

$
$

13.25 19.78

(23,500) 63,620 4,950

$

19.78 19.78 19.78

$

15

Wa1ket00~13

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 19 of 20

4 4 4 4 I I 4

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 10. Stock Options (Continued) The following table summarizes information about stock options outstanding at September 27, 2002:
Options Outstanding Weighted Number Average Weighted Remaining Average Outstanding Contract Ufe Exercise Price 23,100 10.00 $ 1.00 43,320 867 19.78 66,420 9.13 13.25 Options Exercisable Weighted Average Exercise Price
-

a a
I

Exercise Prices
$ 1.00 19.78

Number Exercisable
-

14,430 14,430

19.78 19.78

Note 11.

CommItments

a a a a

Operating leases: Walker and Associates, Inc. leases warehouse space under a noncancelable agreement that requires future minimum annual rentals. Future minimum lease payments under the above mentioned lease at September 27, 2002 is as follows: Year 2003 2004 2005 2006 2007 Thereafter Amount 753,300 771,300 784,800 784,800 789,300 ~02,100 4,485,600

$

a a

$
Total rent expense for 2002 was $1,313,865 ($1,264,886 for 2001).

O 0 0

Note 12. Stockholders' Equity In December of 1997, the stockholders of the Company approved a recapitalization plan that included an increase in the number of authorized Class A voting shares from 100,000 to 200,000, the establishment of a Class C nonvoting common stock with authorized shares of 800,000 and the removal of an existing Class B nonvoting common stock of which no shares were currently issued. Under the plan, each stockholder received 400 shares (105,200 shares in total) of Class A voting in exchange for each share currently owned. Simultaneously with this stock split, the stockholders exchanged 95,200 shares of the Class A voting for 100,000 shares of the new Class C nonvoting. Concurrent with this recapitalization plan, the Company also established a series preferred stock with an authorization of 100,000 shares. At September 27, 2002, none of the preferred stock had been issued and its preferences, limitation and relative rights had not been fixed by the Company's Board ofOirectors.
-~

-

0 0 0 0

WalkerOOS2I4

Case 1:03-cv-01973-PSF-MJW

Document 166-2

Filed 10/17/2005

Page 20 of 20

WALKER GROUP, INC. AND SUBSIDIARIES NOTES TO CONSOliDATED FINANCIAL STATEMENTS Note 12. Stockholders' Equity (Continued)

On September 22, 1998, the Company entered into an agreement with certain stockholders to purchase their entire interest consisting of 3,232 shares of Class A voting shares and 32,319 shares of Class C nonvoting shares. The total purchase price of $6,500,000 was satisfied by a cash payment at closing of $5,000,000 and the issuance of $1,500,000 in notes payable (see Note 4). As a part of this transaction, the Company also agreed to pay an annual amount of $80,000 for ten years to one of the former stockholders for an agreement not to compete. Note 13. Investment In and Advances to First Layer Communications, Inc. During 2001, the Company invested $73,333 in First LayerCommunications, Inc. CFirst Layer). The Company also made advances to First Layer of $644,820. The Company determined that the investment and advances to First Layer were impaired and reserved $600,000 of the outstanding investment and advancements at September 28, 2001. During 2002, the Company made additional advancements of $406,868 to First Layer. Prior to September 27, 2002, First Layer ceased operations. At that time, the Company wrote off their investment and advances to Frst Layer which resulted in a loss of $525,021 which is reconled on the consolidated statements of operations as an impairment of investment and advances to First Layer Communications, Inc. Note 14. Restructuring Costs

During the year ended September 28, 2001, the Company closed its Oregon and Pennsylvania warehouses and its California sales office. The restructuring costs recorded in the accompanying 2001 consolidated statement of operations relate to moving equipment and inventory to the North Carolina warehouse as well as costs associated with personnel and exiting the existing warehouses. The restructuring costs associated with the closing of these two warehouses were $126,502. The remainder of the restructuring costs recorded in the consolidated statement of operations is the cost of closing the warehousesin California, Iowa and Texas in 2002. These costs were accrued as of September 28, 2001 and consisted mainly of estimated lease buy-outs and severance costs. Note 15. Subsequent Event

In January of 2003, the Company received approximately $4.4 million in a federal income tax refund. The Company used $1,264,460 of these proceeds to terminate the interest rate swap agreement which is described in Note 6 of the notes to consolidated financial statements.

WalkerOOS2lS

17