- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------Use these links to rapidly review the document
EVANS & SUTHERLAND COMPUTER CORPORATION FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2003UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON,
Washington, D.C. 20549--------------------------FORM 10-K
(MARK ONE)
/X/(Mark One)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
/ /
For the Fiscal Year ended December 31, 2003
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from toFOR THE TRANSITION PERIOD FROM ________________ TO ________________ COMMISSION FILE NUMBERCommission file number 0-8771
--------------------------EVANS & SUTHERLAND
COMPUTER CORPORATION(Exact(Exact Name of Registrant as Specified in Its Charter)
UTAH 87-0278175 (StateUtah
(State or Other Jurisdiction of(I.R.S. Employer Identification No.)
Incorporation or Organization)87-0278175
(I.R.S. Employer
Identification No.)
600KOMAS DRIVE, SALT LAKE CITY, UTAH 84108 (AddressKomas Drive, Salt Lake City, Utah
(Address of Principal Executive(ZipOffices)
84108
(Zip Code)Offices)
Registrant's telephone number, including area code:(801) 588-1000
Securities registered pursuant to Section 12(b) of the Act:
"None"
Securities registered pursuant to Section 12(g) of the Act:Registrant's telephone number, including area code: (801) 588-1000 Securities registered pursuant to Section 12(b) of the Act: "NONE" Securities registered pursuant to Section 12(g) of the Act: TITLE OF CLASS COMMON STOCK, $.20 PAR VALUE 6% CONVERTIBLE DEBENTURES DUE 2012 PREFERRED STOCK PURCHASE RIGHTS ------------------------------
Title of Class Common Stock, $.20 par value
6% Convertible Debentures Due 2012
Preferred Stock Purchase RightsIndicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
/X/ý No/ /oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
/ /oIndicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o No ý
The aggregate market value of the voting and non-voting Common Stock held by non-affiliates of the registrant as of
March 1, 2002June 27, 2003, the last business day of the registrant's most recently completed second fiscal quarter was approximately$33,242,000,$27,165,816 based on the closing market price of the Common Stock on such date as reported by The Nasdaq Stock Market.The number of shares of the registrant's Common Stock outstanding at
March 1, 2002February 27, 2004 was10,398,314.10,486,637.DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the
20022004 Annual Meeting of Shareholders to be held on May16, 200218, 2004, are incorporated by reference into Part III hereof.- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------(This page has been left blank intentionally.) 2
EVANS & SUTHERLAND COMPUTER CORPORATION
FORM 10-K
FOR THE YEAR ENDED DECEMBER 31,200120033(This page2
The financial data in this Annual Report on Form 10-K for the first three quarters of 2003 has been
left blank intentionally.) 4FORM 10-K PART I ITEM 1. BUSINESS GENERALrestated from amounts previously reported. A discussion of the restatement in relation to the affected quarters of 2003 is provided in Note 3 of the Notes to Consolidated Financial Statements. An overview of the restatement is also provided in Management's Discussion and Analysis of Financial Condition and Results of Operations.General
Evans & Sutherland Computer Corporation ("Evans &
Sutherland,Sutherland", "E&S®""E&S," "we," "us,", "we", "our", or"our""the Company") produces high-quality visual systems used to display computer-generated images of the real world rapidly and accurately. With a 35-year history in computer graphics, E&S is widely regarded as both a pioneer and leader in providing the world's most realistic visual systems. We design, manufacture, market and support visual systems to provide simulation training for a wide range of military and commercial applications. We also provide visual systems for planetariums, science centers, and entertainment venues. Our products use a wide range of hardware, from desktop personal computers (PCs) to what we believe are the most advanced image generation and display components in the world.E&S was incorporated in the
Statestate of Utah on May 10, 1968.An established high-technology company, E&S is a worldwide leader in providing visual system solutions for simulation. E&S visual systems are used in military and commercial training simulators, planetariums and interactive domed theaters, as well as engineering and other applications. E&S is unique among visual simulation companies in that it offers a complete range of solutions from low cost, PC-based products to the most advanced systems in the world. All E&S products are backed by unrivaled customer service and support, ensuring customers low life-cycle cost and the best value in visual simulation. E&S'sOur principal offices are located at 600 Komas Drive, Salt Lake City, Utah 84108, anditsour telephone number is (801) 588-1000.E&S's home pageThrough a link on our Web site,www.es.com, we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to theInternet is www.es.com. You can learn more about E&S by reviewing SEC filings on the E&S web site. The SEC also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including E&S. E&S makes its webSEC. We make our Web site content available forinformationinformational purposes only.It shouldThe information provided on our Web site is notbe relied upon for investment purposes, nor is itincorporated by reference into this Form 10-K.During 2001,The above reports and other information are available, free of charge, atwww.sec.gov. Alternatively, the public may read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330.For more than 30 years, we have had a significant share of the overall market for visual systems. We believe our
coremarket share has ranged from 20% to 50%. The market for simulation visual systems varies from year to year, but we have estimated that it is generally in the range of $300 million to $500 million annually. Many visual system providers serve this market, but our most significant competitors are companies that build the entire simulator. These companies sometimes choose to follow a strategy of vertical integration by providing their own visual systems. Other competitors include a number of smaller companies that generally offer components rather than complete visual systems. In addition, large contractors and system integrators sometimes build visual systems from components available in the open market.E&S visual systems are extremely important components of a complete simulator because the visual system is the most critical element in creating a realistic immersive environment—the visual system is, by definition, "what you see." Most E&S visual systems are used as part of vehicle simulators, which are models of actual vehicles, such as aircraft cockpits. These simulators are used for training operators as well as for practicing tactics or strategy, which may require the coordinated operation of multiple simulators. Simulators are used in both commercial and military settings and include all types of vehicles operating in space, air, ground, sea or undersea locations. The simulator itself may be built by one of many companies, often the same company that built the actual vehicle.
3
We also produce digital planetarium systems, which are based on the same technology as our products for simulation. These systems are essentially simulators of the larger universe, and can create simulated trips through other worlds, or through parts of our own world not accessible to real vehicles.
Visual systems are made of three major components: a visual computer, a display and a visual database. E&S designs and manufactures all of these components at varying prices and performance levels.
The computer portion of an E&S visual system is made of hardware and software, which is either designed and manufactured by us or is based on commercially available components. The hardware may be as simple as a standard PC with a commercial graphics
technology was shared among three business groups: (1) Simulation Group, which producescard, or as complex as a connected system of multiple racks of sophisticated electronics. The software takes advantage of commercially available programs (such as Microsoft Windows) where possible, augmenting them with E&S-designed software to achieve the required image quality, functionality, and system performance.The displays offered by E&S also cover a broad range, from standard computer monitors, to domes (as large as 24 meters in diameter), to cockpit-type displays with complex mirrors and other optics. The image may be projected by different types of equipment, including multiple projector types.
Visual databases are an important and growing part of our business. The visual database is the "content" that the system will display. Most customers have a desire for more content (visual databases) to enhance the richness and variety of their training and simulations. In addition, visual databases are finding new applications in mission planning, damage assessment, intelligence and other highly-time-sensitive defense and homeland security initiatives. We have developed a sophisticated set of tools to make the development of databases more efficient and less costly, whether built by E&S or by others. E&S has an extensive library of databases, including airports, vehicles, large geographic areas, oceans, and seas with accurate wave dynamics, and special effects.
All E&S products are supported by an extensive R&D program as well as innovative, customer-tailored service and support. These programs, as well as specific E&S products, are discussed in the Description of Products section of this report.
Description of Products
E&S offers a full range of
image generators, software, databases,visual system products for simulation, strategic visualization anddisplay systems for military and commercial simulation; (2) REALimage Solutions Group, which provides graphics acceleration technology for PC-based simulation, the professionaldigitalcontent creation (DCC) market, and video processing technology for animation, broadcasting, and netcasting applications; and (3) Applications Group, which leverages our core technologies and applies them to other growth markets, such as digital theaters and visualization software for real estate development applications. RESTRUCTURING Early in 2001, we announced our intention to spin out or sell our REALimage Solutions Group. In the third quarter of 2001, E&S sold the REALimage Group to Real Vision, Inc., a Japanese company that has been a partner with E&S in the development of technology for professional video applications. The sale was for a maximum value of $12 million, consisting of cash of $6.3 million plus future royalties, on a when and if earned basis, of up to $6 million for REALimage technology, other assets, and the performance of certain development support during a seven-month transition period leading to closing the transaction in April 2002. Real Vision has indicated it will continue the development of the technology, and E&S is maintaining a technical staff to support Real Vision in Salt Lake City during the transition period. Shortly after the sale of the REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose, California. Throughout 2001, we had been actively seeking sale or spin-off opportunities for our RAPIDsite-TM- visualization solutions business which is part of the Applications Group. The general economic downturn made it difficult to sell this business. In December, we decided to discontinue the RAPIDsite business and incorporate its technology into the core simulation business. In the third quarter of 2001, we initiated a restructuring plan focused on reducing the operating cost structure of E&S. As part of the plan, we recorded a charge of $2.1 million relating to a reduction 5in force of approximately 80 employees. In the fourth quarter of 2001, we extended the restructuring plan initiated in the third quarter. As part of the plan, we recorded a charge of $0.7 million relating to a reduction in force of approximately 12 employees. We estimate that this restructuring plan will reduce expenses by $8.2 million per year going forward. As of December 31, 2001, we had paid $1.9 million in severance benefits. The majority of the remaining benefits will be paid out over the next two quarters. The charge was recorded in accordance with Emerging Issues Task Force Issue 94-03 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit (Including Certain Cost Incurred in a Restructuring)" and Staff Accounting Bulletin No. 100, "Restructuring and Impairment Charges". In the third quarter of 1999, E&S initiated a restructuring plan focused on reducing the operating cost structure of its REALimage Solutions Group. As part of the plan, E&S recorded a charge of $1.5 million relating to 28 employee terminations, including 17 employees in San Jose and 11 employees in Salt Lake City. The charge was recorded in accordance with Emerging Issues Task Force Issue 94-03, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit (Including Certain Costs Incurred in a Restructuring)." During 2000, after all employee severance costs were incurred, E&S reversed $0.8 million of the restructuring charge as a result of certain employees being transferred within E&S rather than being terminated and estimated severance and related charges being lower than expected for the terminated employees. FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS This annual report, including all documents incorporated herein by reference, includes certain "forward-looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended, including, among others, those statements preceded by, followed by or including the words "estimates," "believes," "expects," "anticipates," "plans," "projects," and similar expressions.theaters. Theseforward-looking statements include, but are not limited to, the following statements: - the successful execution of the Big 6 programs by the end of 2002; - we will generate $5 million of cash per quarter and will be profitable in the second half of 2002; - projections of sales and net income and issues that may affect sales or net income; - projections of capital expenditures; - plans for future operations; - financing needs or plans; - plans relating to our products and services; - Simulation Group will experience growth in its markets as simulation training increases in value as an alternative to other training methods, and as simulation training technology and cost-effectiveness improve; - additional enhancements to iNTegrator will expand its functionality and help secure E&S's dominant position in its main target markets, both commercial and military simulation; - E&S is able to compete effectively in the simulation market and will continue to be able to do so in the foreseeable future; - approximately two-third's of Simulation Group's 2001 backlog will be converted to sales in 2002 and replaced with new orders; 6- the Applications Group's new product will be launched in the first half of 2002; - our properties are suitable for our immediate needs; - total research and development spending will be lower in 2002 than in 2001; - E&S will ultimately prevail in the litigation with Lockheed Martin Corporation; - E&S will not be liable for any further material liquidated damages and late delivery penalties during 2002; - existing cash, cash equivalents, borrowings available under E&S's various borrowing facilities, other asset-related cash sources and expected cash from future operations will be sufficient to meet E&S's anticipated working capital needs, routine capital expenditures and current debt service obligations for the next twelve months; - the guarantees of E&S issued in connection with the services of our joint venture entity, Quest Flight Training Ltd., to the UK Ministry of Defence or other parties will not be called upon for payment or performance; - revenue is expected to contract by 10% from 2001 to 2002; and - assumptions relating to the foregoing. Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking information. Our actual results could differ materially from these forward-looking statements. In addition to the other risks described in the "Factors That May Affect Future Results" discussion under Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations on page 35 of this annual report, important factors to consider in evaluating such forward-looking statements include risk of product demand, market acceptance, economic conditions, competitive products and pricing, difficulties in product development, product delays, commercialization and technology, and E&S's ability to maintain credit facilities to support its operations on favorable and acceptable terms. In light of these risks and uncertainties, there can be no assurance that the events contemplated by the forward-looking statements contained in this annual report will, in fact, occur. REPORTABLE SEGMENTS During 2001, our business units were aggregated into the following three reportable segments: the Simulation Group, the REALimage Solutions Group, and the Applications Group. The three groups benefit from shared core graphics technology, and each group's newproducts arebased on open Intelavailable either as complete systems or subsystems andMicrosoft hardwarecan include system integration andsoftware standards. Each reportable segment markets its products to a worldwide customer base. As described above under the heading "Restructuring", we sold the REALimage Solutions Groupinstallation service anddiscontinued the RAPIDsite business in the Applications Group. Financial information by reportable segment for each of the three years ended December 31, 2001 is included in Note 18 of the Notes to Consolidated Financial Statements included in Part II of this annual report. SIMULATION GROUP E&S is an industry leader in providing visual systems to both government and commercial simulation customers. The Simulation Group provides more than 30% of the worldwide market for government and military applications and commercial airline training simulators. The group anticipates growth in these markets as simulation training increases in value as an alternative to other training methods, and as simulation training technology and cost-effectiveness improve. 7Throughout 2001, we continued development of our iNTegrator-Registered Trademark- software product, which provides the real-time control and modeling tools for the Symphony-TM- family of hardware platforms. Performance optimizations and new functionality have continuously been added with each new software release to meet existing contract requirements and to increase the product performance. While the majority of iNTegrator development is complete, some additional enhancements are planned in 2002, which management believes will expand its functionality and help secure our dominant position in our main target markets, both commercial and military. In addition to continued development of iNTegrator software, we completed the major development efforts on our most advanced image generator product, Harmony-Registered Trademark-. All major Harmony programs are now in training or in final stages of completion and acceptance. PRODUCTS & MARKETS The Simulation Group provides a complete line of visual systems for flight and ground training and related services to the United States and international armed forces, NASA, commercial airlines, and aerospace companies. E&S remains an industry leader in visual systems sales to many U.S. government agencies and more than 20 foreign governments for training military vehicle operators. The Simulation Group is also a leading independent supplier of visual systems for commercial airline flight simulators. This group provides over 30% of the visual systems installed in full-flight training simulators for commercial airlines, training centers, simulator manufacturers, and aircraft manufacturers. The group's visual systems create high-quality, interactive, out-the-window scenes that realistically simulate what vehicle operators see under actual operating conditions. The visual systems are an integral part of full mission simulators, which incorporate a number of other components, including cockpits or vehicle cabs and large hydraulic motion systems. Generally, the Simulation Group's visual systems products consist of the six major components listed below. These components are available as subsystems, but are typically sold together as a complete visual system solution delivered to an end user or prime contractor. (1)support.Image Generators
Image generators (IGs) create computer-generated real-time images and send these images to display devices, such as projectors or computer monitors.
The group's primaryPrimary IG offerings span the full range of price and performance, and simulation of all types of sensors is available, often configured as a separate IG, for nearly all E&S IG products. IGs are used for military and commercial training simulation, strategic visualization and digital theater applications.Our high-end products include, EP™-1000CT, EPX™-5000, Harmony® 2 and ESIG® products. EP-1000CT and EPX-5000 are based on E&S's Environment Processor™ (EP) software. EP offers a revolutionary approach to the way visual databases are created, updated, and stored, and it is equipped with a whole-earth database model as part of the standard offering. Unlike traditional systems that use separate databases of specific, contained areas, this whole-earth model provides customers with a trainable database of the entire world, an excellent advantage for long-range flight training. EP-1000CT, introduced in 2002, is designed for commercial airline training and other simulation applications that require turnkey visual systems. EP-1000CT was certified Level D by the Joint Aviation Authority ("JAA") in 2003. EPX-5000, introduced in late 2003, is the top of the line of our EPX (Environment
4
Processor Technology with Military Extensions) products. EPX-5000 has all the features of the EP-1000CT along with additional functionality required for military training, such as sensor simulation. EPX-5000 shares a common hardware platform with the other E&S high-end image generators, the Pixel Engine™-1. Harmony 2, another of our high-end offerings, operates on our Integrator software but uses the same hardware as the EPX-5000. Typical applications include fast jet and helicopter training.
The ESIG image generator family has been sold worldwide in both the military and commercial markets for more than a decade. The ESIG product line was one of the most popular IGs in the history of the simulation industry, and continues to operate successfully in thousands of applications, often with E&S service and support. We still supply ESIGs to allow our customers to maintain compatibility with installed systems.
Our mid-range products include EPX-500 and RenderBeast™. EPX-500, based on the same EPX technology as the EPX-5000, runs on our simFUSION value-added PC IG. EPX-500 is extremely scalable, allowing customers a variety of configurations and price points. RenderBeast, introduced in 2003, is aimed at the design visualization market. RenderBeast is made of a rack of simFUSION® image generators and application specific software that allows engineers and designers to create immersive visualizations of their designs.
Our low-cost IGs include the
SymphonysimFUSION product family and the EPX-50. The simFUSION value-added PC IG family of productsfrom Harmonywas introduced in 1999. The product's newest version, the simFUSION 6500, we believe offers the best simulation performance for its price. EPX-50 was designed for price-sensitive simulation applications and offers the features of EPX software running onthe high end to OpenGL, PC-based simFUSION-TM- at the low end,a commercially available PC andits legacy ESIG-Registered Trademark- products, which continue to show strong sales. E&S offersacomplete, high-to-low family of IGs that can use the same software and databases. Harmony is our flagship for highest performance, Ensemble-TM- is the first PC-basedcommercially available graphics accelerator board. A true image generator,offering deterministicEPX-50 provides customers with the most realistic scene fidelity, image quality, and performance available using consumer graphics boards.Our Digital Theater products include Digistar® 3, Digistar 3 SP, and
simulation-specific functionality,Digistar II. Digistar 3 is designed for planetariums andsimFUSION is the first OpenGL PC-based hardware platform targeted at low-cost applications. E&S is the only visual system provider offeringdomed theaters. It combines a completeline of compatiblecolor star projection andscalable productsastronomy package with a fully interactive, real-time 3D computer graphics system (image generator) adding all-dome video playback and digital surround sound. Digistar 3 offers planetariums another unique advantage—it can interact in real time with large audiences. Digistar 3 SP uses the same hardware and software as Digistar 3 projected through a single DLP projector at lower resolution forreal-time simulationdomes 30 feet in diameter andvisualization. (2)smaller. Digistar II, a monochrome digital planetarium system, is still offered and supported.Display Systems
Display systems consist of projectors, display screens, computer monitors and specialized optics.
TheseWe offer these display systemsare offeredin a broad range of configurations, from onboard instrument displays to domes offering a 360-degree field of view, depending on theapplications. (3) Databases depicting synthetic environments are offeredapplication. Our fully integrated systems include full dome mosaics, collimated displays, rear projection systems, and retrofits and upgrades. Our display system products include the ESCP® family of calligraphic projectors, the TargetView® family of target projectors, and the VistaView® head-tracked area-of-interest projector. In addition E&S offers supplemental display functions, such asoptions or as custom solutions. The group provides database developmenthead trackers, night vision goggles, distortion correction and edge blending.In 2003, we delivered the first-generation prototypes of our new laser based projector. This projector uses lasers and grating light valves to create images with unprecedented resolution, brightness, contrast and color. In 2004, we plan to build the next generation of prototypes as well as
database development tools such as iNTegratorplan to begin delivery of production laser projectors. The first deliveries will go to the United States Air Force andEaSIEST-Registered Trademark-.to customers in the digital theater market, then to our other markets in 2005.5
Visual Databases,
developed using iNTegrator are a key element of the Symphony product family. These can be run onTools, and ContentWe offer a full
rangecomplement ofimage generators. (4) Simulationdatabase (often referred to as synthetic environments) products and services. In addition to development ofsensor imagery such as radar, infrared, and night vision goggles (NVG) is often provided with the visual systems for high-performance fixed and rotary wing aircraft.new databases, we will update existing databases created by E&Sdevelops and manufacturesor other companies. We offer a complete set of correlated databases in a variety ofhardwareindustry-standard formats. In addition, E&S has an extensive library of models andsoftware products to achieve realistic 8sensor simulation, includingtextures that includes theVanguard-Registered Trademark- radar image generator, infrared postprocessors, and customized systems for either simulated or stimulated NVG solutions. (5) System integration and installation services are offered in supportmajority of thetotal simulator system. We have the capability to act as the main prime contractor for large commercialworld's major airports and militarycontracts requiring totalairfields. We also provide database training and support. In addition, we have an extensive library of shows and show content for our digital theater market. These databases and shows constitute a significant competitive advantage for us.In 2003, we introduced our EP and EPX software technology (described below). An extremely important part of this software is the way the software handles the visual databases used to depict the real world. In the past, simulation systems
integration. (6) A full range of customer support services is offered(including those built by E&S) prepared the visual database by first collecting all the needed source data (such as imagery, elevation data, features such as roads and buildings, moving models, etc.), then compiling all this data into a single database toprime contractors, system integrators,be used by the image generator. The compilation step was difficult andmilitary or commercial end users. Servicegenerally lengthy, andSupport product offerings include customized support packages, called Encore(SM),resulted in a form thatprovide complete maintenance, spares, and round-the-clock technical support; SimTech Training, which provides trainingwas proprietary to thecustomers'specific hardware for which it was designed. It was difficult to make any changes in this database, since a change would require that the entire process of compilation be started again.In contrast, with EP and EPX, we have launched a revolutionary new way to build and distribute the visual database. As before, the first step is still to collect source data. However, these source materials are not compiled into a single final form. Instead, the individual source elements are kept in their original form and stored in separate files. The EP or EPX software, running on IG hardware, then assembles the source components in real time to create the image just as it is being viewed. In using this method, a "database" is actually a correlated set of source data, not a single, pre-assembled entity.
We believe this approach provides several significant benefits to our customers. First, it is very easy to make changes and update data, since new information can simply be inserted into the relevant files. The EP or EPX system will identify the new information and use it in the simulation
techniciansas needed. Second, our customers receive the actual source data, andengineers;with appropriate licensing can use it with other systems that they may already have, since it is delivered in standard open formats.Finally, all EP and
Computer-Based Training. E&S also developsEPX systems are shipped with a whole-earth database already in place. Customers can begin using this database immediately. Later, they can add inserts with more details or with special qualities for any geography of special interest or training value. Each additional area of interest simply adds to the whole-earth background already in place with the system. Airports, military landing sites, mission-rehearsal zones and other items of interest can be added quite simply as inserts in this way.Complete Training Solutions
We develop complete
simulationcustom training solutions,for specific training applications. In 2001, we announced two new products,such as the Mission Command Traineror MCT-TM-,(MCT™) now in training for the United Kingdom's School of Army Aviation (Aviation Command andthe Air Traffic ControlTactics Trainer,or ATCT-TM-. TheACTT). MCT is a low-cost tactics simulator that provides realistic command training, mission planning, and mission rehearsal in a virtual environment against an intelligent virtualenemy, allenemy.Customer Support Services
Customer support services are offered to prime contractors, system integrators and military and commercial end-users. Our service and support product offerings include a customized support package, called EncoreSM, which provides complete maintenance, spares and round-the-clock technical support; SimTech™ Training, which provides training to customers' simulation technicians and engineers; and computer-based training.
6
Description of Markets
We operate as one business; providing visual simulation solutions to an international customer base. Our customer base can be categorized into four customer markets: military simulation, commercial simulation, digital theater and strategic visualization.
Military Simulation
We are an industry leader in providing visual systems to government simulation customers, offering tailored solutions to meet a full range of training requirements. We offer a complete line of products, from low-cost desktop solutions to highly advanced visual systems, to the domestic and international military simulation market. In addition, we offer complete training solutions for tactical command and air traffic control, database development services, custom display systems, and long-term service and support.
The military simulation market has continued to shrink as funds have been and continue to be diverted to immediate military requirements. As a result, we project this market to remain flat at least for the next year, and then expect to see growth in 2005.
During 2003, we launched a new visual system product line for military simulation, EPX. EPX is Environment Processor (EP) Technology with Military Extensions. Already in training for commercial aviation applications, EP offers customers unprecedented value, flexibility and reliability. EPX is available in our high-end, mid-range and low cost IG products, EPX-5000, EPX-500 and EPX-50. The EP and EPX systems are the only software products in the
safetysimulation industry that can run across a full range of hardware platforms, using the same software andsecurity of a classroom. Developedthe same databases. This commonality offers customers the significant capability to exactly match hardware performance and cost to their specific application, and to mix different platforms in apartnershiptotal system while maintaining software, database and training commonality.EPX features rapid database creation and update, a whole-earth model with
MicroNav, Ltd.,high-resolution insets, host compatibility with our ESIG system, revolutionary environment creation tools, legacy database compatibility, and a common sensor architecture. EPX is already gaining market acceptance worldwide.Early in 2004, we announced that the U.S. Army has chosen the EPX-50 system for the Close Combat Tactical Trainer (CCTT) visual upgrade program. CCTT is one of the largest simulation programs ever fielded, using the E&S ESIG image generator for nearly 450 simulators for ground warfare operations. The EPX-50 will offer the U.S. Army increased performance and lower cost, while assisting in their transformation objectives to use standardized hardware to reduce costs over time.
We continue to market and sell other visual systems products in this market, including Harmony 2, simFUSION and ESIG, along with a variety of display systems solutions.
Commercial Simulation
E&S supplies visual systems to the world's commercial airlines, airframe manufacturers, and independent training providers for pilot training. Developed to meet the exacting statutory requirements of the world's civil aviation authorities, we believe our commercial simulation products have an excellent reputation for quality, reliability and innovation.
During 2003, commercial airlines reduced their purchases of new aircraft compared to prior years. This resulted in a reduction in the number of new simulators required for training. However, many airlines are upgrading their installed simulators as a cost-effective way to improve training at minimal additional cost. Due to our large share of the installed base of visual systems in this market and because our EP products provide an attractive upgrade path, we have benefited from significant upgrade activity. In 2003, we were successful in securing contracts for both new simulators and
7
upgrades from customers that include Lufthansa, Air France, Southwest Airlines, Emirates, Federal Express, GECAT, Alteon and CHC. We project this market to remain flat with expected market recovery to occur sometime in 2005.
EP-1000CT received its first JAA Level D certification in May of 2003, and an additional nine systems were certified before the year ended. In 2003, we received an order for an EP-1000CT visual system for a helicopter simulator. This will be the first application of EP-1000CT for this very demanding form of pilot training.
Digital Theater
E&S uses state-of-the-art visual simulation technology to provide one of the world's
leading producersmost advanced digital theater systems for planetariums, science centers and themed entertainment venues. During 2003, the digital theater market grew and our products gained market share. We expect a rebounding worldwide economy and project funding increases to continue to drive the digital theater market growth into 2004. We believe that the Digistar 3 Laser now being introduced to this market also has the potential to broaden the market and increase our market share.Sales of
air traffic control training software,Digistar 3 products in 2003 were strong, with Digistar 3 now sold to or installed in 25 locations around theATCT is a complete, advanced 3D tower simulatorworld. Key wins forlicensing, refresher training,Digistar 3 included new installations at planetariums in Hamburg andconversion training. The Simulation Group's products are marketed worldwide by E&SKiel, Germany andqualified distributors. Products and services are sold directly to end users by E&S as a prime contractor, through simulator prime contractors with E&S acting as a subcontractor, and through system OEMs.the Eugenides Foundation in Athens, Greece, which will be open for the 2004 Summer Olympics.E&S continues to
form both domesticproduce andinternational alliances with aerospacelicense show content for Digistar customers. E&S also introduced the Digistar 3 Laser™ to the science center and planetarium community late in 2003. This product was well received, and we expect to receive orders for the first Digistar 3 Laser systems early in 2004.Strategic Visualization
In 2002, we began leveraging our simulation
companiestechnologies and capabilities to address the emerging market for defense, intelligence and homeland security visualization applications. Using our EP technology, we are developing strategic databases, which are special forms of visual databases built to allow visualization of a geographic area for mission planning, mission preview, damage assessment and other time-sensitive applications.In 2003, we received a 3-year contract from the Navy's Defense Modeling and Simulation Office to conceptualize, create, and test an architecture and process that
dominate their respective market segments. Such strategic alliances have provedwill enable imagery and sensor data from disparate sources to bean effective method for accessing specific markets.rapidly validated, correlated, distributed and displayed in a standard format. In addition, wehave OEM and Value Added Reseller agreements with several major distributorsprovided this visualization technology to ABC News for its coverage of the war inEurope and Asia. COMPETITIVE CONDITIONS PrimaryIraq.Competitive Conditions
The primary competitive factors for our visual simulation products in the
Simulation Group's productsmilitary, commercial and strategic visualization markets are performance, price, service, and product availability.BecauseMany of our competitors in the military and commercial simulation markets, not only provide visual systems, they also build entire simulators and may sometimes choose to follow a strategy of vertical integration by providing their own visual system. Such competitors include Boeing, CAE and Lockheed Martin. Other prime contractors that offer competing visual systems are Flight Safety International and Thales Training and Simulation. Due to these competitive forces, we constantlystrivingstrive to improvetheirour productsthe group must ensure that it continuesin order to offerproducts withthe best performance possible at a competitive price.Prime contractors, including Lockheed Martin, Flight Safety International (FSI), Thales Training & Simulation Ltd., and CAE Electronics, Ltd. (CAE), offer competing visual systems in the simulation market.We believewe are ableour range of products at different price points and performance points, our research and development investments and our ability to design and manufacture value-added parts when not available as commercial parts enable us to compete effectively in this environment and will continue tobe able todo so in the foreseeable8
future.
In 2001, the group was awarded several highly competitive orders against FSI and CAE, the principal competitors in the commercial simulation market.In the military simulation market,the group competeswe compete primarily withSilicon Graphics, Inc.Lockheed Martin Training Systems, CAE andCAE.Quantum 3D. In the low-cost, PC-based market, our simFUSION product competes against companies that focus on PC simulation using graphics acceleratorcards, such as Quantum 3D.cards. InFebruary 2001, a team of industry leaders led by Evans & Sutherland was selected bytheU.S. Army Simulation, Training,commercial simulation market we compete primarily with CAE. In the strategic visualization market we compete primarily with General Dynamics, BAE andInstrumentation Command (STRICOM)Northrop Grumman.The primary competitive factors in the digital theater market are functionality, performance, price, and access to
receive an Indefinite Delivery/Indefinite Quantity (ID/IQ) contract. Under the terms of the contract, the E&S team is prequalified to bid as a prime contractor on STRICOM contracts valued at up to $4 billion over the next eight years. A team comprised of E&Scustomers andothers is one of 17 prime contractor teams selected by STRICOM for the Virtual Domain, one of four business domains that include Constructive, Live,distribution channels. Our digital theater products compete with traditional optical-mechanical products andTest-Instrumentation. Core members of the E&S team include Cubic Applications, Inc., CACI, J.F. Taylor, Inc., Raydon, and MTI. The team also includes 13 subcontractors with extensive backgrounds in military simulation. 9E&S is also a member of two contractor teams selected by STRICOM last fall for the Constructive Domain. These key contract awards position Evans & Sutherland to provide its state-of-the-art visual systems support, including image generation,digital display systems offered by Konica-Minolta Planetarium Co. Ltd., GOTO Optical Mfg. Co., Carl Zeiss Inc., Spitz, Inc. anddatabase development, for future STRICOM programs. BACKLOG The Simulation Group'sSky-Skan, Inc.Backlog
On December 31, 2003, our backlog was
$104.2$65 million compared with $60 million on December 31,2001, compared with $134.62002. The 2003 ending backlog contains $9.8 millionon December 31, 2000. It is anticipatedof government firm, unfunded orders. All government orders included in the 2002 year ending backlog were firm and funded orders. We anticipate that approximately two-thirds of the20012003 backlog will be converted to sales in2002. BUSINESS SUBJECT TO GOVERNMENT CONTRACT RENEGOTIATION2004.Significant Customers
Worldwide customers using E&S products include U.S. and international armed forces, aerospace companies, most major airlines, laboratories, museums, planetariums, and science centers. We measure and identify our significant customers based on direct sales. We no longer measure significant customers based on indirect sales through subcontractors or prime contractors. While we no longer measure indirect sales, the U.S. government and the United Kingdom Ministry of Defence have been considered significant customers based on indirect sales in prior years.
In 2003, direct sales to the U.S. government totaled $15.2 million or 18% of total sales, sales to Thales Training & Simulation Ltd. totaled $7.2 million or 9% of total sales, and sales to The Boeing Company totaled $3.3 million or 4% of total sales.
In 2002, direct sales to the U.S. government totaled $35.4 million or 29% of total sales, sales to Thales Training & Simulation Ltd. totaled $19.8 million or 16% of total sales, sales to The Boeing Company totaled $17.1 million or 14% of total sales, and sales to Lockheed Martin Corporation totaled $2.9 million or 2% of sales.
In 2001, sales to the U.S. government totaled $35.1 million or 24% of total sales, sales to Thales Training & Simulation Ltd. totaled $23.9 million or 16% of total sales, sales to The Boeing Company totaled $15.1 million or 10% of total sales, and sales to Lockheed Martin Corporation totaled $1.8 million or 1% of sales.
Seasonality
We believe there is no inherent seasonal pattern to our business. Sales volume fluctuates quarter-to-quarter due to relatively large and nonrecurring individual sales and customer driven shipping dates.
Intellectual Property
We own a number of patents and trademarks and we are a licensee under several others. Our portfolio of patents and trademarks is, as a whole, material to our business. However, no one piece of intellectual property is critical to our business, thus no individual piece of our intellectual property is discussed on its own. In the U.S. and internationally, we hold active patents that cover many aspects of our visualization technology. Several patent applications are presently pending in the U.S., Japan and several European countries, and other patent applications are in preparation. We actively pursue
9
patents on our new technology and we intend to vigorously protect our patent rights. We routinely copyright software, documentation and chip masks designed by us and institute copyright registration for such software, documentation and masks when appropriate.
Research & Development
We consider the timely development and introduction of new products to be essential to maintain a competitive position and to capitalize on market opportunities. Our research and development expenses were $21.7 million, $26.0 million and $32.8 million, in 2003, 2002 and 2001, respectively. As a percentage of sales, research and development expenses were 26%, 21% and 23%, in 2003, 2002 and 2001, respectively. We continue to fund essentially all research and development efforts internally. We anticipate that high levels of research and development will be needed to continue to ensure that we maintain our technical excellence, leadership and market competitiveness.
As planned, E&S completed the next-generation civil airline product, EP-1000CT, enhanced the simFUSION PC image generator product line, and completed the development of an improved in-line calligraphic projector in 2003. We also leveraged our EP technology for military applications, resulting in the EPX product line. This development included the development of our PC image generator products EPX-50 and EPX-500, which are based on the EPX software architecture. Also, the associated toolset to complement these products, Environment Creation Tool (ECT™), was initiated in 2003. We anticipate completion of these products and toolset in 2004.
Another focus for our R&D over the past five years has been the development of what we believe is a revolutionary new type of projector. This projector uses lasers and grating light valves to create images with unprecedented resolution, brightness, contrast and color. We developed several prototypes of the laser projector in 2003, including deliveries to the U.S. Air Force. The prototypes used first-generation components to provide proof-of-concept and allowed us to gather data on the applications and reliability of the grating light valves, the lasers, and the electronic components. In 2004, we anticipate we will complete the second generation of the laser projector, and plan to begin delivery of production-ready laser projectors. In addition, in 2004 we anticipate we will develop additional display applications for the laser projector, including planetariums and wide displays used in commercial airline and military simulation applications.
Dependence on Suppliers
Most of our current parts and assemblies are readily available through multiple sources in the open market; however, a limited number are available only from a single source. In these cases, we either stock adequate inventory to cover the future product demands, or obtain the agreement of the vendor to maintain adequate stock for future demands, and/or attempt to develop alternative components or sources where appropriate.
International Sales
International sales are calculated based on the location of the purchasing customer and were $45.2 million, $48.4 million, and $49.5 million in 2003, 2002 and 2001, respectively. International sales represented 53%, 39% and 34% of total sales in 2003, 2002 and 2001, respectively. We believe that any inherent risk that may exist in our foreign operations is not material. For additional information on our international sales and long-lived assets by location, see Note 21 of Notes to Consolidated Financial Statements included in Part II of this annual report.
10
Employees
As of February 27, 2004, Evans & Sutherland and its subsidiaries employed a total of 364 persons compared to 500 employees as of February 28, 2003. We believe our relations with our employees are good. None of our employees is subject to collective bargaining agreements.
Environmental Standards
We believe our facilities and operations are within standards fully acceptable to the Environmental Protection Agency and that all facilities and procedures are in accordance with environmental rules and regulations, and international, federal, state and local laws.
Strategic Relationships
In the normal course of business E&S develops and maintains various types of relationships with key customers and technology partners. These relationships include joint technology and product development agreements, research and development agreements, joint marketing agreements, teaming and joint venture agreements, value-added reseller agreements and original equipment manufacturer agreements. These agreements are of necessity somewhat dynamic in nature to enable us to rapidly address changes in market and customer needs and leverage key trends in related technology areas. It is anticipated that this philosophy will continue in 2004, and agreements will be continued or consummated as necessary to maintain our industry leading position.
Acquisitions and Dispositions
Pursuant to our most recent quarterly report filed on November 7, 2003, we announced our execution of an agreement to sell one of our buildings for $8 million. The agreement required that we close on the sale no later than December 29, 2003; however, pursuant to the terms of the agreement, the potential buyer elected to terminate the agreement on December 2, 2003, and we did not sell the building. We continue to market the property to prospective buyers.
Business Subject to Government Contract Renegotiation
A significant portion of the
Simulation Group'svisual simulation business is dependent on contracts and subcontracts associated with government business. The U.S. Government, and other governments, may terminate any of our government contracts and, in general, subcontracts, at their convenience as well as for default based on lack of performance. If any of our government contracts were to be terminated for convenience, we generally would be entitled to receive payment for workcompleted andcompleted; work performed, but not completed; allowable termination or cancellationcosts.costs; and a negotiated profit for work performed, but not completed. Depending on the contract, if such an event was to occur, it could materially affect our sales, profits, and cash flow. Historically, our experience indicates that termination for convenience is a rare occurrence.Upon termination for convenience of a fixed-price type contract, we normally are entitled, to the extent of available funding, to receive the purchase price for delivered items, reimbursement for allowable costs for work-in-progress and an allowance for profit on the contract or adjustment for loss if completion of performance would have resulted in a loss. Upon termination for convenience of a cost reimbursement contract, we normally are entitled, to the extent of available funding, to reimbursement of allowable costs plus a portion of the fee. The amount of the fee recovered, if any, is related to the portion of the work accomplished prior to termination and is determined by negotiation.
U.S. government contracts also are conditioned upon the continuing availability of
Congressionalcongressional appropriations. Long-term government contracts and related orders are subject to cancellation or restructuring if appropriations for subsequent performance periods becomeunavailable.unavailable or are reduced from planned levels. Congress usually appropriates funds on a fiscal-year basis even though contract performance may extend over many years. Consequently, at the outset of a program,thea contractis usuallymay be partially funded, and Congressannuallydeterminesif additional funds arethe annual appropriations and authorizations for subsequent fiscal-years in a multi-year contract.11
Restructuring
In the first quarter of 2003, we restructured to
be appropriated to the contract. REALIMAGE SOLUTIONS GROUP The REALimage Solutions Group was sold to Japan-based Real Vision, Inc.,reduce our operating costs inSeptember 2001.line with anticipated sales. As part ofReal Vision,this restructuring, we recorded a charge of $1.3 million related to a reduction in force of approximately 50 full-time equivalent employees. In thegroup is continuingthird quarter of 2003, we restructured todevelopreduce our operating costs in order to operate profitably going forward based on projected sales and expenses. As part of this restructuring, we recorded a total charge of $2.1 million, related primarily to a reduction in force of approximately 70 full-time equivalent employees. We estimate that these restructurings will reduce expenses approximately $7.5 million per year going forwardForward-Looking Statements and Associated Risks
This annual report, including all documents incorporated herein by reference, includes certain "forward-looking statements" within the
"Studio-on-a-Chip" technology, which brings together real-time graphics and videomeaning of that term ina unique and effective way to support all aspects of visual content creation for broadcasting and netcasting applications. The sale was for a maximum value of $12 million, consisting of cash of $6.3 million plus future royalties, on a when and if earned basis, up to $6 million for REALimage technology, other assets, and the performance of certain development support during a seven-month transition period leading to closing the transaction in April 2002. Real Vision has indicated it will continue the developmentSection 27A of thetechnology,Securities Act of 1933, as amended, andE&S is maintaining a technical staff to support Real Vision in Salt Lake City during the transition period. Shortly after the saleSection 21E of theREALimage Group, E&S closed its offices in Seattle, Washington,Exchange Act of 1934, as amended, including, among others, those statements preceded by, followed by or including the words "estimates," "believes," "expects," "anticipates," "plans," "projects" andSan Jose, California. PRODUCTS & MARKETS Prior to 2002, the REALimage Solutions Group developedsimilar expressions. See Item 7 Management's Discussion andsold graphics chipsAnalysis of Financial Condition andgraphics subsystems for professional PC workstations. Early in 2000, the group's strategic focus changedResults fromdevelopment and manufacture of graphics accelerator cards for professional digital content creation customers to development of the next generation REALimage chip, the RI 5000. This chip, referred to 10as "Studio-on-a-Chip", brings together both graphics and video processing technology on a single chip for digital video content creation and post-production. The group also began to establish a new application and market for REALimage technology in 2000 when REALimage chips were selected by Honeywell for use in cockpit navigation systems for military aircraft and business jets. COMPETITIVE CONDITIONS Due to the sale of the REALimage Solutions Group to Real Vision, Inc. of Japan, we do not compete in this industry or market any longer. BACKLOG Because of the shift in strategic focus, the in-process development of the new RI 5000 chipset, and the sale of REALimage, the group has no backlog as of December 31, 2001, compared to $0.7 million as of December 31, 2000. APPLICATIONS GROUP The Applications Group is composed of synergistic businesses that use E&S core technology in growth markets. The group's products are applications that leverage E&S's technology and apply them to other growth markets. After these applications have been developed and produced, our strategy is to spin them off or sell them to companies involved in complementary businesses. PRODUCTS & MARKETS The Applications Group's digital theater products include hardware, software, and content for both the entertainment and educational marketplaces. Digital theater focuses on immersive all-dome theater applications combining colorful, digitally produced imagery, full-spectrum audio, and audience- participation capability. The group provides turnkey solutions incorporating visual systems and subsystems from the Simulation Group. E&S integrates these systems with projection equipment, audio components, and audience-participation systems from other suppliers. Products include Digistar-Registered Trademark- II, a calligraphic star projection system designed to compete with analog star projectors in planetariums, and StarRider-Registered Trademark-, a full-color, domed theater experience available in interactive or video playback formats. The Applications Group is a leading supplier of digital display systems in the planetarium marketplace. In addition to projection and theater systems, the Applications Group develops and markets show content for planetariums and domed theaters. In 2001, the Applications Group achieved several important milestones. The Applications Group launched its second interactive show called Crack the Cosmic Code. The show debuted at the StarRider theater at Exploration Place in Wichita, Kansas. The Applications Group continued its development of its new product, which will be launched in the first half of 2002, as well as several new domed theater shows, which are available to theaters around the world for licensing. In 2001, the Applications Group continued to expand the market for E&S RAPIDsite-TM-. E&S RAPIDsite is a photorealistic visualization tool designed for use by real-estate developers, consulting engineers, architects, and municipal planners involved with all types of land development projects. RAPIDsite features fast 3D-model construction, accelerated graphics rendering performance and easy-to-use interactive exploration of a proposed development on a Windows NT computer with an OpenGL graphics accelerator. Throughout 2001, we had been actively seeking sale or spin-off opportunities for our RAPIDsite-TM- visualization solutions business which is part of the Applications Group. The general economic 11downturn made it difficult to sell this business. In December, we decided to discontinue the RAPIDsite business. COMPETITIVE CONDITIONS Primary competitive factors for the Applications Group's products are functionality, performance, price, and access to customers and distribution channels. Our digital theater products compete with traditional optical-mechanical products and digital display systems offered by Minolta Planetarium Co. Ltd., GoTo Optical Mfg. Co., Carl Zeiss Inc., Spitz, Inc., Trimension, Inc. and Sky-Skan, Inc. BACKLOG The Applications Group's backlog was $2.7 million December 31, 2001, compared with $7.4 million on December 31, 2000. It is anticipated that most of the 2001 backlog will be converted to sales in 2002. SIGNIFICANT CUSTOMERS Worldwide customers using E&S products include U.S. and international armed forces, NASA, aerospace companies, most major airlines, laboratories, museums, planetariums, and science centers. Sales to the U.S. government, either directly or indirectly through sales to prime contractors or subcontractors, accounted for $69.5 million or 48% of total sales, $66.7 million or 40% of total sales, and $84.5 million or 42% of total sales in 2001, 2000, and 1999, respectively. Sales to the United Kingdom Ministry of Defense, either directly or indirectly through sales to prime contractors or subcontractors, accounted for $13.6 million or 9% of total sales, $22.3 million or 13% and $33.8 million or 17% of total sales in 2001, 2000 and 1999, respectively. In 2001, sales to Thales Training & Simulation Ltd. totaled $23.9 million or 16.4% of total sales of which 57% related to U.S. government and United Kingdom Ministry of Defence contracts and sales to The Boeing Company totaled $15.1 million or 10% of total sales of which 100% related to U.S. government and United Kingdom Ministry of Defence contracts. In 2000, sales to Lockheed Martin Corporation were $22.5 million or 14% of total sales, of which 100% related to U.S. government and United Kingdom Ministry of Defence contracts and sales to Thales Training & Simulation Ltd. were $19.6 million or 12% of total sales, of which 58% related to United Kingdom Ministry of Defence contracts. In 1999, sales to Lockheed Martin Corporation were $35.8 million or 18% of total sales, of which 100% related to U.S. government and United Kingdom Ministry of Defence contracts and sales to The Boeing Company were $25.4 million or 13% of total sales, of which 100% related to U.S. government and United Kingdom Ministry of Defence contracts. All of our sales to significant customers are within the Simulation Group. DEPENDENCE ON SUPPLIERS Most of our current parts and assemblies are readily available through multiple sources in the open market; however, a limited number are available only from a single source. In these cases, we stock a substantial inventory, or obtain the agreement of the vendor to maintain adequate stock for future demands, and/or attempt to develop alternative components or sources where appropriate. On June 3, 1999, we entered into an electronic manufacturing services agreement with Sanmina Corporation (now Sanmina-SCI). The agreement commits us to purchase a minimum of $22 million of electronic products and assemblies from Sanmina-SCI each year until June 3, 2002. If we fail to meet these minimum purchase levels, subject to adjustment, we may be required to pay 25 percent of the 12difference between the $22 million and the amount purchased. We have fully satisfied the requirements of this contract, which ends in June 2002. Various alternatives, which include a renewed contract with Sanmina-SCI, are being evaluated. SEASONALITY E&S believes there is no inherent seasonal pattern to its business. Sales volume fluctuates quarter-to-quarter due to relatively large and nonrecurring individual sales and customer-established shipping dates. INTELLECTUAL PROPERTY E&S owns a number of patents and trademarks and is a licensee under several others. In the U.S. and internationally, we hold active patents that cover many aspects of our graphics technology. Several patent applications are presently pending in the U.S., Japan, and several European countries, and other patent applications are in preparation. E&S actively pursues patents on its new technology. E&S routinely copyrights software, documentation, and chip masks designed by us and institutes copyright registration for such software, documentation, and masks when appropriate. RESEARCH & DEVELOPMENT E&S considers the timely development and introduction of new products to be essential to maintaining its competitive position and capitalizing on market opportunities. Our research and development expenses were $28.8 million, $44.3 million, and $44.4 million in 2001, 2000, and 1999, respectively. As a percentage of sales, research and development expenses were 20%, 27%, and 22% in 2001, 2000, and 1999, respectively. We continue to fund substantially all research and development efforts internally. It is anticipated that high levels of research and development will be needed to continue to ensure that we maintain technical excellence, leadership, and market competitiveness. However, due to the sale of the REALimage Solutions Group, the discontinuation of the RAPIDsite business and the reduction of effort required to develop our Harmony and iNTegrator products, management expects that the total research and development spending necessary to continue the timely development of products will be lower in 2002 than in 2001. INTERNATIONAL SALES Sales of products known to be ultimately installed outside the United States are considered international sales by E&S and were $49.5 million, $60.9 million, and $86.7 million in 2001, 2000, and 1999, respectively. International sales represented 34%, 36%, and 43% of total sales in 2001, 2000, and 1999, respectively. For additional information, see Note 19 of Notes to Consolidated Financial StatementsOperations, included in Part II of this annualreport. EMPLOYEES Asreport, for a list ofMarch 1, 2002, Evans & Sutherland and its subsidiaries employed a total of 724 persons compared to 847 employees as of March 2, 2001. We believe our relations with our employees are good. None of our employees is subject to collective bargaining agreements. ENVIRONMENTAL STANDARDS We believe our facilities and operations are within standards fully acceptable to the Environmental Protection Agency and that all facilities and procedures are in accordance with environmental rules and regulations, and international, federal, state, and local laws. 13STRATEGIC RELATIONSHIPS In October 2001, we announced an agreement with NVIDIA-Registered Trademark- Corporation. As part of this agreement, NVIDIA Corporation acquired certain key 3D-graphics patents from E&S and the companies agreed to a broad cross-license of technologies. This agreement with NVIDIA allows E&S to leverage its general graphics technology into high volume markets, while adding new capabilities including NVIDIA's programmable Shader technology to E&S's base of unique technology and patents for the simulation industry. During the fourth quarter of 2001, E&S entered into a multiyear agreement with graphics technology leader ATI Technologies Inc., under which ATI will provide graphics accelerator chips for our next-generation PC-based visual systems. ATI chips will replace REALimage chips in E&S's next-generation Ensemble and simFUSION image generators. On July 22, 1998, Intel purchased 901,408 shares of E&S's preferred stock plus a warrant to purchase an additional 378,462 sharessome of thepreferred stock at an exercise price of $33.28125 per share for approximately $24.0 million. In March 2001, Intel converted the 901,408 shares of E&S's preferred stock into 901,408 shares of E&S's common stock. In March 2001, Intel and E&S amended the preferred stock and warrant purchase agreement to terminate certain contractual rights of Intel, including registration rights, board and committee observation rights, right of first refusal, right of participation, right of maintenance, standstill agreement, and right to require E&S to repurchase the preferred stock in the event of any transaction qualifying as a specific corporate event. E&S also entered into an agreement to accelerate development of high-end graphics and video subsystems for Intel-based workstations in July 1998. ACQUISITIONS AND DISPOSITIONS Early in 2001, we announced our intention to spin out or sell our REALimage Solutions Group. In the third quarter of 2001, E&S sold the REALimage Solutions Group to Real Vision, Inc., a Japanese company that has been a partner with E&S in the development of technology for professional video applications. The sale was for a maximum value of $12 million, consisting of cash of $6.3 million plus future royalties, on a when and if earned basis, up to $6 million for REALimage technology, other assets, and the performance of certain development support during a seven-month transition period leading to closing the transaction in April 2002. Real Vision has indicated it will continue the development of the technology, and E&S is maintaining a technical staff to support Real Vision in Salt Lake City during the transition period. As part of the sale of the REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose, California. In December 2000, we completed the divestiture of our German subsidiary via a management-led buyout and recorded a loss of $0.3 million. The former subsidiary, which was called Evans & Sutherland Computer GmbH, now operates under a new name. The divested company has no remaining connection with E&S. We will continue to operate in Germany and throughout Europe under our own name, providing marketing, sales, and support for our growing visual systems business and traditional customer base. On March 28, 2000, we sold certain assets of our Application Group relating to digital video products to RT-SET Real Time Synthesized Entertainment Technology Ltd. and its subsidiary, RT-SET America Inc., for $1.4 million in cash, common stock of RT-SET Real Time Synthesized Entertainment Technology Ltd. valued at approximately $1.0 million, and the assumption of certain liabilities. On June 15, 2000, we received additional common stock of RT-SET Real Time Synthesized Entertainment Technology Ltd. valued at $1.5 million related to the successful development of a productforward-looking statements included, inthe purchased assets. 14On June 3, 1999, we sold certain of our manufacturing capital assetsthis Form 10-K, andinventory of $6.0 million to Sanmina Corporation (now Sanmina-SCI) as part of our efforts to outsource the production of certain electronic products and assemblies. In addition, we entered into an electronic manufacturing services agreement with Sanmina-SCI. The electronic manufacturing services agreement commits us to purchase a minimum of $22.0 million of electronic products and assemblies from Sanmina-SCI each year until June 3, 2002. If we fail to meetfactors that may affect theseminimum purchase levels, subject to adjustment, we may be required to pay 25% of the difference between the $22.0 million and the amount purchased. We have fully satisfied the requirements of this contract, which ends in June 2002. Various alternatives, which include a renewed contract with Sanmina-SCI, are being evaluated. On June 26, 1998, E&S, through its wholly-owned subsidiary, Evans & Sutherland Graphics Corporation ("ESGC"), acquired all of the outstanding stock of AccelGraphics, Inc. ("AGI") to expand E&S's workstation graphics development, integration and distribution within the workstation graphics marketplace. To acquire AGI, E&S paid approximately $23.7 million in cash and 1,109,303 shares of E&S's common stock, which was valued at $25.7 million. In addition, E&S converted all outstanding AGI options into options to purchase approximately 351,000 shares of common stock of E&S with a fair value of $3.4 million and incurred transaction costs of approximately $1.1 million. To further expand E&S's presence within the workstation graphics marketplace, on June 26, 1998, E&S acquired the assets and assumed certain liabilities of Silicon Reality, Inc. ("SRI"), a designer and developer of 3D graphics hardware and software products for the PC workstation marketplace. E&S paid approximately $1.2 million and incurred transaction costs of approximately $250,000.forward-looking statements.Evans & Sutherland's principal executive, engineering, manufacturing and operations facilities
for each of its business segmentsare located in the University of Utah Research Park, in Salt Lake City, Utah, whereit owns sevenwe own five buildings totaling approximately450,000350,000 square feet.E&S occupiesWe occupy four buildings andleases one ofthe remainingthree buildings to other businesses. The remaining two buildings arebuilding is vacant. We plan to sell thethree buildingsbuilding we do not occupy. The buildings are located on land leased from the University of Utah (the "U of U Property") with an initial term of40-years40 years or longer.FiveAll of the buildingshaveare on land leases that expire in 2030, with a ten-year renewal option.The remaining two buildings have land leases that expire in 2012 and 2014 respectively, with 40-year renewal options.All of our interests in the U of U Property are subject to a lien held by Wells Fargo FoothillCapital Corporationto secure repayment of the borrowing facility as set forth inthe Liquidity and Capital Resources sectionNote 12 of theManagement's Discussion and AnalysisNotes to Consolidated Financial Statements in Part II ofFinancial Condition and Results of Operations. E&S and its subsidiariesthis Form 10-K. We hold leases, including our subsidiaries, on several sales, operations, service and production facilities located throughout the United States, Europe and Asia, none of which is material to our manufacturing, engineering or operating facilities.E&S believesWe believe that these properties are suitable foritsour immediate needs andit doeswe do not currently plan to expanditsour facilities or relocate.
ITEM 3. LEGAL PROCEEDINGSLOCKHEED MARTIN CORPORATION V. EVANS & SUTHERLAND COMPUTER CORPORATION (UNITED STATES (MIDDLE) DISTRICT COURT (FLORIDA), CASE NO. 6:00-CV-755-ORL-19C, FILED ON MAY 23, 2000). OnIn May
23, 2000, Lockheed Martin Corporation served E&S with2003, acivil complaint filedclaim was made against the Company by RealVision, Inc. relative to matters arising from the sale of a business unit to RealVision, Inc. in 2001. The parties entered mediation in theCircuit Courtfourth quarter of 2003, and continued discussions into 2004. In March 2004, an agreement was reached under which RealVision will receive a settlement in the amount of $2.4 million of which E&S will pay approximately $0.9 million to resolve this claim, with the remainder of theNinth Judicial Circuit in and for Orange County, Florida. Lockheed alleged in the complaint that we breached a contract to provide certain visual systems for the Combined Arms Tactical Trainer program for the United Kingdom Ministry of Defence.settlement amount being paid by E&S's insurance carrier. ThecontractCompany hasan original value of $33.9 million. In the complaint, Lockheed seeks compensatory damages of $8.5 million plus interest as well as consequential damages and attorneys' fees. The $8.5 million being sought from E&S by Lockheed was paid to us from May 1999 to March 2000 and was recognized as revenue by us during 1999. On June 12, 2000, we filed our answer and counterclaim. In the counterclaim, we allege as grounds for 15recovery against Lockheed (1) breach of contract, (2) breach of implied covenant of good faith and fair dealing, (3) unjust enrichment, (4) unfair competition, (5) misappropriation of trade secrets, (6) intentional interference with advantageous business relationship, (7) replevin, and (8) promissory estoppel. In our counterclaim, we seek compensatory damages of not less than $10.0 million and not more than $25.4 million. On June 14, 2000, the case was removed to the Orlando Divisionaccrued its portion of theUnited States District Court for the District of Florida where it currently remains. On July 7, 2000, Lockheed answered our counterclaim but also filed a motion for dismissal of our counterclaims for unjust enrichment, unfair competition, promissory estoppel, and incidental damages. On July 24, 2000, we filed our opposition to Lockheed's motion to dismiss our counterclaims. On October 20, 2000 the court denied Lockheed's motion to dismiss in its entirety, without prejudice. On January 16, 2001, we filed a motion for partial summary judgment, asking the court to dismiss all of Lockheed's breach of contract claims. The court denied that motion on August 30, 2001, citing the existence of material disputed facts. On September 6, 2001 the court granted Lockheed's leave to amend its complaint, which was filed on September 17, 2001. We filed a motion to dismiss these new claims on October 4, 2001, and Lockheed has opposed it. The court currently has that motion under advisement. Discovery in the matter is scheduled to conclude on September 30, 2002. A trial date is currently set for March, 2003. We dispute Lockheed's allegations in the complaint, are vigorously defending the action, and are vigorously prosecuting our counterclaims. Although management believes E&S will ultimately prevail in the litigation, an unfavorable outcome of these matters would have a material adverse impact on our financial condition and operations.settlement.In the normal course of business, E&S has various
otherlegal claims and other contingent matters, including items raised by government contracting officers and auditors. Although the final outcome of such matters cannot be predicted, we believe the ultimate disposition of these matterswouldwill not have a material adverse effect on our consolidated financial condition, liquidity or results of operations.16
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERSNo matters were submitted to a vote of security holders during the fourth quarter of fiscal year
2001.2003.12
EXECUTIVE OFFICERS OF THE REGISTRANT
The following sets forth certain information regarding the executive officers of E&S as of
March 1, 2002:February 27, 2004:
NAME AGE POSITION - ---- -------- ------------------------------------------Name Age Position James R. Oyler 5557 President and Chief Executive Officer David B. Figgins 53 Vice President and General Manager, Product Marketing L. Eugene Frazier 56 Vice President and General Manager, Strategic Visualization William M.E. Thomas 47Atchison55 Vice President, Chief Financial Officer, Treasurerand Corporate SecretaryE. Thomas AtchisonBob Morishita 53 Vice President Manufacturing, Service, and Support Nicholas Gibbs 43 Vice President and General Manager, Simulation Systems Richard Flitton 39 Vice President and General Manager, Commercial SimulationHuman ResourcesMr.James R. Oyler was appointed President and Chief Executive Officer of
E&SEvans & Sutherland and a member of the Board of Directors inDecemberNovember 1994.He is also a director of Ikos Systems, Inc.Before joining Evans & Sutherland, Mr. Oyler served asPresident of AMG, Inc. from mid-1990 until December 1994, anda Senior Vice President for HarrisCorporation from 1976 through mid-1990.Corporation. He hassevennine years of service with E&S.Mr. FigginsE. Thomas Atchison was appointed
Vice President, Product Marketing,Chief Financial Officer and Corporate Secretary inJanuary 2002.July 2003. He joined Evans & Sutherland in 1998 as a Director, when E&Sas Vice President and General Manager, PC Simulation, in April of 1998,acquired Silicon Reality, Inc., and was appointed Vice President ofthe Simulation Group in January 1999. In June 2001, he was appointed Vice President and Operating Officer, Simulation Group. Before joining E&S, Mr. Figgins served as Vice President of Business Development and Marketing for Raytheon Training, where he was employed from May 1986 to April 1998. Mr. Figgins has over 25 years experience in the simulation and training industry and has held increasingly responsible technical, marketing and management positions in small, medium and large organizations with senior executive positions in the last decade. Mr. Figgins is a graduate of Royal Air Force Halton and holds a M.S in Management from Purdue University. He has four years of service with E&S. Mr. Frazier was appointed Vice President, Strategic Visualization, in January 2002. He joined E&S in September 1997 as Vice President, Programs. In June of 1998, Mr. Frazier was appointed Vice President, Programs and Shared Technology. In April of 1999, he was appointed Vice President and General Manager, Systems. Mr. Frazier served as Vice President and General Manager of Simulation Systems until June of 2001, when he was appointed Vice President and Operating Officer for Simulation. Prior to his assignment at E&S, he was Director, Technology Development and Advanced Programs at Lockheed Martin Tactical Defense Systems. Before working with Lockheed Martin, he held increasingly responsible assignments in Simulation for LORAL Corporation. He has four years of service with E&S. Mr. Thomas was appointed Vice President and Chief Financial Officer in December 2000 and Corporate Secretary in February 2001. He became Treasurer in January 2002. He joined E&S in 17August 2000 as Vice President, Finance, for the Simulation Group. From May 1998 to August 2000, Mr. Thomas was Executive Vice President and Chief Financial Officer for Edge Technologies, Inc. During the three year period from 1995 to 1998, Mr. Thomas was Chief Financial Officer for Stanley Aviation Corporation. Previously, he was a Director of Finance for a Hughes Aircraft Company subsidiary, Financial Executive and Strategic Planner for a Large Scale Information Technology Business Unit, and Senior Business Manager and Assistant Controller for multiple divisions of Hughes. Mr. Thomas was employed by Hughes from 1982 to 1995. He has one year of service with E&S. Mr. Atchison was appointed Vice President,Manufacturing, Service, and Support in October 2001.He joined E&S in 1998, when E&S acquired Silicon Reality, Inc. in June 1998, and served as Director, Materials, until July of 1999, when he was appointed Vice President, Manufacturing.At Silicon Reality, Mr. Atchison was Vice President, Operations, Chief Operating Officer, and Chief Financial Officer from October 1997 to June 1998.Prior to Silicon Reality, he was Vice President, Investor Relations and Business Development for Alphatec, and managed production control for National Semiconductor/ Fairchild.He hasthreefive years of service with E&S.Mr. GibbsBob Morishita is
theVice Presidentand General Managerofthe Simulation Systems Business Unit. Prior to this role, he served as General Manager of the Service and Support Division.Human Resources. Hehas also held management positions in Supply Chain Management and Quality Assurance. Mr. Gibbs received a B.S. in Mathematics from the University of Utah. Mr. Gibbs has been with E&S for over 15 years. Mr. Flitton was appointed Vice President and General Manager for the Commercial Simulation division ofjoined Evans & Sutherland as Compensation Manager inJanuary 2002. Mr. Flitton1982 and was appointed Human Resources Director in 1997 and Human Resources Vice President in 2000. He hasbeen in the simulation industry since 1979, and has been22 years of service with E&S since 1994. His first assignment with E&S, was as UK Product Manager for the Commercial Simulation group, followed by an 18-month assignment as Program Manager for the E&S subsidiary Xionix Simulation, in Dallas TX. Mr. Flitton then moved to the E&S Salt Lake City Headquarters and held the positions of US Regional Program Manager and then Products Director for the Commercial Airline group. His prior assignment was as the Product Manager for high-end IG systems within the Simulation Systems Group in Salt Lake City. Prior to joining E&S, Mr. Flitton served a full engineering apprenticeship with Rediffusion Simulation in the UK. Mr. Flitton was Principal Engineer and then Group Leader of the Visual Engineering Group of Rediffusion. Mr. Flitton has a BEng Hons in Electo/Mechanical Engineering from the University of Brighton (UK) and an M.B.A. from the University of Warwick (UK). He is also Member of The Royal Aeronautical Society (MRAeS). 18FORM 10-K&S.13
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCKPrice Range of Common Stock
Our common stock trades on The Nasdaq Stock Market under the symbol "ESCC." The following table sets forth the range of the high and low
sales pricesbids per share of our common stock for the fiscal quarters indicated, as reported by The Nasdaq Stock Market. Quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actualtransactions in Nasdaq's quotation system but do not include retail markup, markdown or commission.
HIGH LOW -------- --------2001 First Quarter $ 8 $ 6 3/8 Second Quarter $8 11/16 $ 7 1/16 Third Quarter $ 8 5/16 $ 5 7/8 Fourth Quarter $ 7 3/16 $ 5 3/8 2000 First Quarter $ 13 1/2 $10 1/16 Second Quarter $ 11 3/8 $ 6 1/4 Third Quarter $ 7 1/4 $ 5 3/8 Fourth Quarter $ 7 3/4 $ 5 1/8APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERStransactions.
HIGH LOW 2003 First Quarter $ 6.90 $ 5.00 Second Quarter $ 6.42 $ 3.30 Third Quarter $ 6.74 $ 5.25 Fourth Quarter $ 6.20 $ 3.92
2002
First Quarter $ 7.35 $ 5.83 Second Quarter $ 10.00 $ 7.11 Third Quarter $ 8.35 $ 3.72 Fourth Quarter $ 6.25 $ 2.06 Approximate Number of Equity Security Holders
On
March 1, 2002,February 27, 2004, there were657613 shareholders of record of our common stock. Because brokers and other institutions hold many of our shares on behalf of shareholders, we are unable to estimate the total number of shareholders represented by these record holders.DIVIDENDSDividends
We have never paid a cash dividend on our common stock,
retaining ouras previous retained earnings were used for the operation and expansion of our business.We intend forCurrently, we have an accumulated deficit. For the foreseeable future, we intend tocontinue thefollow our policy of retainingourany future earnings to finance the development and growth of our business. The payment of dividends is restricted under the terms of our credit facilities. See"Item 7--Management's DiscussionNote 12 of the Notes to Consolidated Financial Statements in Part II of this Form 10-K.14
Securities Authorized For Issuance Under Equity Compensation Plans
As of December 31, 2003:
Number of securities to
be issued upon exercise
of outstanding options,
warrants, and rights
(a)Weighted average
exercise price of
outstanding options,
warrants and rights
(b)Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)Equity compensation plans approved by security holders 2,344,418 $ 11.33 338,530
Equity compensation plans not approved by security holders
—
—
—Total 2,344,418 $ 11.33 338,530 Stock Purchase Plan—We have an employee stock purchase plan whereby qualified employees are allowed to have up to 10% of their gross pay withheld each pay period to purchase our common stock at 85% of the market value of the stock at the time of the sale. During the period of December 24, 2002, through February 18, 2003, the Employee Stock purchase Plan was inadvertently oversubscribed in the amount of 10,373 shares. On February 27, 2003, our Board of Directors increased the number of shares available under this plan from 500,000 to 800,000 shares, and
Analysisratified all prior issuances ofFinancial Condition and Resultsshares under the plan. We filed an S-8 Registration Statement registering these shares on April 25, 2003. As ofOperations--Liquidity and Capital Resources." 19December 31, 2003, 265,751 shares of our Common Stock remain available for future purchase under the Stock Purchase Plan. Our shareholders approved the Stock Purchase Plan on May 24, 2001. Information regarding the employee Stock Purchase Plan is not included in the above table. 15
ITEM 6. SELECTEDCONSOLIDATEDFINANCIAL DATAThe following selected financial data for the five fiscal years ended December 31
2001are derived from our Consolidated Financial Statements. The selected financial data should be read in conjunction with our Consolidated Financial Statements and related notes included elsewhere in this annual report. See also "Management's Discussion and Analysis of Financial Condition and Results of Operations."
2001(1) 2000(2) 1999(3) 1998(4) 1997 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)FOR THE YEAR Sales $ 145,263 $ 166,980 $ 200,885 $ 191,766 $ 159,353 Net income (loss) before accretion of preferred stock (27,457) (69,570) (23,454) (15,983) 5,080 Net income (loss) per common share: Basic (2.70) (7.45) (2.49) (1.70) 0.56 Diluted (2.70) (7.45) (2.49) (1.70) 0.53 Average weighted number of common shares outstanding Basic 10,169 9,372 9,501 9,461 9,060 Diluted 10,169 9,372 9,501 9,461 9,502 AT END OF YEAR Total assets $ 177,353 $ 216,078 $ 258,464 $ 275,668 $ 234,390 Long-term debt, less current portion 18,086 25,563 18,015 18,062 18,015 Redeemable preferred stock -- 24,000 23,772 23,544 -- Stockholders' equity 64,659 67,634 137,194 165,083 165,634- ------------------------ (1) During 2001, we incurred an impairment loss
2003 2002 2001 2000 1999 (in thousands, except per share amounts) For the Year Sales $ 84,776 $ 122,578 $ 145,263 $ 166,980 $ 200,885 Cost of sales 53,252 78,052 115,823 137,532 127,556 Inventory impairment 14,566 1,392 — — 13,230 Gross profit 16,958 43,134 29,440 29,448 60,099 Expenses: Selling, general, and administrative 27,039 27,131 31,374 34,406 44,554 Research and development 21,730 25,970 32,828 44,264 44,358 Restructuring charges 3,416 4,492 2,843 (761 ) 1,460 Impairment loss 1,151 311 220 — 9,693 Operating expenses 53,336 57,904 67,265 77,909 100,065 Gain on sale of assets held for sale 1,406 1,212 9,000 — — Gain on sale of business unit — 253 774 1,918 — Gain on curtailment of pension plan — 3,575 — — — Operating loss (34,972 ) (9,730 ) (28,051 ) (46,543 ) (39,966 ) Other income (expense), net (1,987 ) (2,454 ) (2,578 ) (4,004 ) 1,009 Loss before income taxes (36,959 ) (12,184 ) (30,629 ) (50,547 ) (38,867 ) Income tax expense (benefit) (971 ) (463 ) (3,172 ) 19,023 (15,413 ) Net loss (35,988 ) (11,721 ) (27,457 ) (69,570 ) (23,454 ) Accretion of redeemable preferred stock — — — 228 228 Net loss applicable to common stock $ (35,988 ) $ (11,721 ) $ (27,457 ) $ (69,798 ) $ (23,682 ) Net loss per common share Basic and diluted $ (3.44 ) $ (1.12 ) $ (2.70 ) $ (7.45 ) $ (2.49 ) Average weighted number of common shares outstanding: Basic and diluted 10,471 10,422 10,169 9,372 9,501
At End of Year
Total assets $ 93,382 $ 127,576 $ 177,353 $ 216,078 $ 258,464 Long-term debt, less current portion 18,015 20,685 18,086 25,563 18,015 Redeemable, preferred stock — — — 24,000 23,772 Stockholders' equity 15,566 53,363 64,659 67,634 137,194 16
Quarterly Financial Data (Unaudited)
The financial data in this Annual Report on Form 10-K for the first three quarters of
$0.2 million and restructuring charges2003 has been restated from amounts previously reported on Forms 10-Q. A discussion of$2.8 million. See Notes 1 and 21the restatement in relation to the affected quarters of 2003 is provided in Note 3 of the Notes to Consolidated FinancialStatements included in Part II of this annual report. (2) During 2000, we recorded deferred tax expense of $20.6 million as a result of our decision to fully reserve net deferred tax assets due to cumulative net operating losses and the cancellation of a significant contract and the related complaint filed by Lockheed Martin Corporation. (3) During 1999, we incurred a write-off of inventories of $13.2 million, an impairment loss of $9.7 million and a restructuring charge of $1.5 million. See Notes 1 and 21Statements. An overview of theNotesrestatement is provided in the introduction toConsolidatedManagement's Discussion and Analysis of FinancialStatements included in Part IICondition and Results ofthis annual report. (4) During 1998, we incurred a $20.8 million chargeOperations.
Quarter Ended March 28 June 27 Sep. 26 Dec. 31(3) Restated Restated Restated (in thousands, except per share data) 2003(1) Sales $ 22,578 $ 16,010 $ 20,765 $ 25,423 Gross profit (loss) (6,986 ) 6,086 7,393 10,465 Net income (loss) before income taxes (24,543 ) (5,005 ) (8,228 ) 817 Net income (loss) (24,275 ) (5,124 ) (8,040 ) 1,451 Net income (loss) per share:(2) Basic (2.32 ) (0.49 ) (0.77 ) 0.14 Diluted (2.32 ) (0.49 ) (0.77 ) 0.14 Quarter Ended
March 29
June 28
Sep. 27
Dec. 31
2002 Sales $ 32,563 $ 34,221 $ 26,592 $ 29,202 Gross profit 9,594 12,185 11,268 10,087 Net loss before income taxes (3,872 ) (649 ) (1,684 ) (5,979 ) Net loss (3,189 ) (724 ) (1,759 ) (6,049 ) Net loss per share:(2) Basic (0.31 ) (0.07 ) (0.17 ) (0.58 ) Diluted (0.31 ) (0.07 ) (0.17 ) (0.58 )
- (1)
- The effects of the restatement, depicted as increases (decreases) to
expense acquired in-process technology in connection withtheacquisitions of AccelGraphics, Inc. and Silicon Reality, Inc. 20QUARTERLY FINANCIAL DATA (UNAUDITED) (In thousands, exceptamounts previously reported, for each quarter restated are detailed below:
March 28, June 27, September 26, (in thousands, except per share info) Sales $ (115 ) $ (6,186 ) $ (2,645 ) Cost of sales 1,128 (3,634 ) (762 ) Gross profit (1,243 ) (2,552 ) (1,883 ) Net income before income taxes (1,243 ) (2,552 ) (1,883 ) Net income (1,243 ) (2,552 ) (1,883 ) Income per share: basic and diluted (0.12 ) (0.24 ) (0.18 )
- (2)
- Net income (loss) per share
amounts)
QUARTER ENDED -------------------------------------------------- MARCH 30 JUNE 29 SEPT. 28(2) DEC. 31(3) ---------- ---------- ----------- ----------2001 Sales $ 39,632 $ 48,097 $ 29,601 $ 27,933 Gross profit 13,215 11,973 1,793 2,459 Net loss before income taxes (6,048) (5,208) (17,987) (1,386) Net income (loss) applicable to common stock (6,124) (5,132) (16,309) 108 Net income (loss) per common share(1): Basic (0.64) (0.50) (1.57) 0.01 Diluted (0.64) (0.50) (1.57) 0.01
QUARTER ENDED -------------------------------------------------- MARCH 31 JUNE 30(4) SEPT. 29(5) DEC. 31(6) ---------- ---------- ----------- ----------2000 Sales $ 45,955 $ 25,589 $ 48,092 $ 47,344 Gross profit 16,113 (12,303) 14,804 10,834 Net income (loss) before income taxes (4,827) (31,598) 448 (14,570) Net income (loss) applicable to common stock (3,229) (52,253) 244 (14,560) Net income (loss) per common share(1): Basic (0.35) (5.58) 0.03 (1.55) Diluted (0.35) (5.58) 0.03 (1.55)- ------------------------ (1) Earnings per share areis computed independently for each of the quarters presented and therefore may not sum to the total for the year.(2) During- (3)
- In the fourth quarter of 2003, we reversed $0.5 million in restructure charges that were originally charged as a result of our restructure in the third quarter of
2001,2003. This charge was related to a liability for a license agreement for a certain software tool that werecorded a restructuring chargedetermined to be of$2.1 million and an income tax benefit of $2.0 millionno future value to us as a result of theresolution of certain tax contingencies. (3) Duringrestructure. However, in the fourth quarter of2001,2003, werecorded a $9 million gain on the sale of certain patents. Also during this quarter, we recorded an impairment loss of $0.2 million, a restructuring charge of $0.7 million and an income tax benefit of $1.6 million as a resultwere able to negotiate out of theresolution of certain tax contingencies. (4) During the second quarter of 2000, we recorded a negative adjustmentliability related torevenue of $10.9 million as a result of the cancellation of a significant contract by Lockheed. Additionally, we recorded deferred tax expenses of $20.6 million as a result of our decision to fully-reserve net deferred tax assets due to cumulative net operating losses and the cancellation of a significant contract and the related civil complaint filed by Lockheed. (5) During the third quarter of 2000, we recorded a $6.7 million gain on the sale of certain investment securities and a $1.9 million loss on available for sale investment securities whose market value decline was determined to be other than temporary. (6) During the fourth quarter of 2000, we recorded a $5.9 million loss on available for sale investment securities whose market value decline was determined to be other than temporary. 21this software tool license. 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSCRITICAL ACCOUNTING POLICIESThe
preparationfollowing discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with our Consolidated Financial Statements and notes thereto, included herein under Item 8 of this Annual Report. Information set forth in "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes forward-looking statements that involve risks and uncertainties. Many factors could cause actual results to differ materially from those contained in the forward-looking statements below. See "Forward Looking Statements" and "Factors That May Affect Future Results," below.Executive Overview
Business
Evans & Sutherland Computer Corporation ("Evans & Sutherland", "E&S", "we", "our", or "the Company") produces high-quality visual systems used to display images of the real world rapidly and accurately. E&S is widely regarded as both a pioneer and a leader in providing the world's most realistic visual systems. We design, manufacture, market and support visual systems for simulation with solutions that meet the training requirements for a wide range of military and commercial applications. We also provide this leading-edge visual system technology and experience to planetariums, science centers, and entertainment venues. We develop and deliver a complete line of image generators, displays, databases, services and support products that match technology to customer requirements. Our products and solutions range from the desktop PC to what we believe are the most advanced visual systems in the world.
2003 Highlights and 2004 Outlook
2003 was an important year for E&S. We made substantial progress resolving many problems from prior years, and achieved initial success with new products and strategies. This combination enabled us to achieve profitable operations in the final quarter of the year and lay the foundation for a return to sustained profitability in the future.
The problems from past years were in two general categories: large military programs with cost overruns, and declining sales for our products.
The large military programs, which we refer to in this report as the "Big Six programs", involved the delivery of advanced visual systems in the US and Europe between 1997 and 2003. The total value was over $130 million, which made up a substantial portion of our sales in those years. The programs were complex in many ways, both contractually and technically, and for various reasons we fell behind and incurred large excess costs and penalties, creating losses which we were not able to offset in other parts of the business. While these programs were extremely difficult for us and caused major financial stress, we nevertheless successfully completed and delivered all requirements, with the exception of a few remaining items which we expect to complete in early 2004.
Declining sales for our products occurred both for external and internal reasons. The primary external reason was a drastic shrinkage in our markets following the events of September 11, 2001. Commercial airlines suffered severe financial disruptions and generally reduced purchases of equipment. In the United States military market, funds were diverted to operational requirements and purchases of simulation equipment fell sharply. Overall, our markets shrank to half their former size, a significant decline in any industry. Internally, we suffered from difficulties with our scheduling systems related to very complex programs and development.
18
Our response was to shrink the size of our company in accordance with the size of our markets and with the completion of the Big Six programs, and to install new management and systems. Overall, we reduced employment by about 60% from the peak in 2000, while revenue has fallen by about 50% from the same year. We reduced other recurring costs similarly. In addition, such a drastic reduction in the size of the company led us to reduce excess inventories procured for previously higher sales projections, as well as to recognize other restructuring charges.
To address the problems that we encountered with the Big Six programs and related development, we installed sophisticated new hardware and software infrastructure to provide more accurate and timely management of information. These systems reached maturity in 2003 in our military market, and we have since had no further problems of the types encountered in earlier military programs such as the Big Six programs. We had scheduled the installation of these same systems in 2004 in our United Kingdom subsidiary, where we manage our commercial airline business. However, prior to their installation we encountered problems there, arising from the incorrect recognition of costs, revenue, and profit on percent-complete contracts. To correct the errors, we restated the first three quarters of 2003 condensed consolidated financial statements, which were previously unaudited. As a result, revenues were reduced and losses were increased for the quarters restated. Despite these actions, our transition to profitability in
conformitythe fourth quarter was still achieved.Throughout this very difficult period, we steadfastly maintained investment in new products as the primary pathway to rebuilding the company once our markets stabilize. We believe that these efforts have now begun to bear fruit, and will do so increasingly during 2004 and the years beyond. In 2003, we introduced new products in both our simulation and digital theater businesses, and delivered first prototypes of our new laser projector. In 2004, we anticipate we will continue to introduce new products in all these markets, with special emphasis on the delivery of the first production-level model of the laser projector. All of the new products have enjoyed enthusiastic acceptance from our customers, enabling us to gain market share in a down market. We believe that our EP (Environment Processor) software is, in fact, revolutionary in its structure and impact on rapid development of databases for training and mission rehearsal, and we believe that the laser projector will revolutionize the market for large-format, high-accuracy displays. We have already received patents on the laser projector, with a large number of additional patents in process but not yet awarded.
We expect the continued success of our new products to return the company to profitability for the full year 2004, although the pattern of our current order book suggests we are likely to operate moderately below break-even in the first half. Beyond this year, we anticipate a modest recovery in our markets in 2005. In addition, we believe the laser projector will start to ship in higher volumes in 2005 and beyond, contributing a substantial new revenue stream to the company and potentially opening entirely new markets.
Because of the major cost reductions which we have already completed, and because of our major investment in systems and software for internal operations, our infrastructure is capable of meeting substantially higher sales requirements with very little increase in overhead or fixed costs. Therefore, we believe revenue growth will produce accelerating profit growth.
19
Results of Operations
Year Ended December 31, 2003 2002 2001 Sales $ 84,776 100.0 % $ 122,578 100.0 % $ 145,263 100.0 % Cost of sales 53,252 62.8 78,052 63.7 115,823 79.7 Inventory impairment 14,566 17.2 1,392 1.1 — — Gross profit 16,958 20.0 43,134 35.2 29,440 20.3 Expenses: Selling, general, and administrative 27,039 31.9 27,131 22.1 31,374 21.6 Research and development 21,730 25.6 25,970 21.2 32,828 22.6 Restructuring charges 3,416 4.0 4,492 3.7 2,843 2.0 Impairment loss 1,151 1.4 311 0.2 220 0.2 Operating expenses 53,336 62.9 57,904 47.2 67,265 46.3 Gain on curtailment of pension plan — — 3,575 2.9 — — Gain on sale of assets held for sale 1,406 1.6 1,212 1.0 9,000 6.2 Gain on sale of business unit — — 253 0.2 774 0.5 Operating loss (34,972 ) (41.3 ) (9,730 ) (7.9 ) (28,051 ) (19.3 ) Other income (expense), net: (1,987 ) (2.3 ) (2,454 ) (2.0 ) (2,578 ) (1.8 ) Loss before income taxes (36,959 ) (43.6 ) (12,184 ) (9.9 ) (30,629 ) (21.1 ) Income tax benefit (971 ) (1.1 ) (463 ) (0.3 ) (3,172 ) (2.2 ) Net loss $ (35,988 ) (42.5 ) $ (11,721 ) (9.6 ) $ (27,457 ) (18.9 ) Results of Operations Summary
Our 2003 sales significantly decreased primarily as a result of current conditions in the military market as military customers diverted funds to more pressing requirements. Deliveries to commercial customers also declined because of cutbacks by airline customers after the terrorist attacks in 2001. We did achieve sales growth in both our PC-based image generators and planetarium systems as a result of strong demand for our new simFUSION and Digistar 3 products.
Our gross margins also declined in 2003. This was due primarily to a $14.6 million inventory impairment caused by customer order cancellations as the military realigned its spending priorities. However, offsetting the impairment charges was improvement due to essentially completing the six large Harmony programs ("Big Six programs") which have driven significant losses or extremely low margins in prior years. We also saw a decrease in our commercial gross margins, but expect improvements in 2004.
To offset current market conditions, we executed two restructuring plans in 2003 and reduced our headcount by approximately 120 employees to reduce operating costs and create a cost structure in line with our anticipated sales. These actions were the primary cause of our $4.6 million reduction in our operating expenses from 2002 to 2003.
We achieved strong reductions in our other expenses as we reduced interest expenses and debt levels in 2003, and reduced income tax expenses.
More detailed explanations of our 2003 results are provided below.
20
Consolidated Sales and Gross Profit
Our total sales were $84.8 million in 2003, compared with $122.6 million in 2002 and $145.3 million in 2001. The 2003 sales decrease was driven mainly by a reduction in sales in the military market. Sales to the military market decreased in 2003 primarily because 2002 contained two large programs with significant final product deliveries. No new programs of this magnitude were awarded during 2003 to produce replacement sales. Also contributing to a decrease in sales to the military market was that approximately 85% of the remaining sales from our Big Six programs were recognized in 2002, while approximately 10% was recognized in 2003. Four of these Big Six programs are now 100% complete and the remaining two are 99.9% complete. Sales to the commercial market also declined in 2003. While orders increased significantly in 2003 from this market, a significant portion of those 2003 orders will routinely be delivered in 2004. In addition, we experienced a slight decrease in service and support sales. Sales of our PC-based image generator increased 70% in 2003 as a result of a strong demand for our new simFUSION products. Sales of our planetarium systems also increased significantly in 2003, 129%, as a result of strong demand for our new Digistar 3 product.
From 2001 to 2002 sales to the military market decreased primarily as a result of a significant drop in orders over a period of these two years. Orders decreased approximately 35% in 2002 and 24% in 2001. Sales of our PC-based image generator declined approximately 50% in 2002 because the updated simFUSION product line was not launched until the third quarter of 2002 and customers were waiting for the release of this enhanced PC-based image generator. The new simFUSION product generated orders and sales in the third and fourth quarters of 2002. In 2002, sales of our planetarium systems declined 60% as customers delayed their orders of existing products in anticipation of our next generation products, which have now been launched and are producing growth in orders and sales. Sales were also impacted by a worldwide slowdown of demand for planetarium equipment in 2002. In 2001, we also sold our REALimage business and discontinued the operations of our RAPIDsite business; therefore, losing related sales in 2002. These 2002 decreases in sales were partially offset by a slight increase in service and support sales.
Trends in the commercial and military markets remained unchanged in 2003, and are expected to continue through 2004. In the commercial market, commercial airlines have reduced purchases of new aircraft compared to prior years. This has resulted in a reduction in the number of new simulators they require for training. However, many commercial airlines are upgrading their currently installed simulators. As a result, we have benefited from this change because we had a large share of the installed base of visual systems and because our newly introduced EP-1000CT product provides an attractive upgrade path due to its compatibility with the installed base. Military markets have continued to shrink as funds are diverted to more pressing military requirements. We believe this diversion of funds will continue during 2004, but may result in some pent-up demand in 2005. In the military and commercial markets some large prime contractors, with whom we may subcontract with, are moving the high-margin database and software work in-house instead of subcontracting out to other companies in order to protect their revenues and margins. If this trend continues in future years it could negatively affect our revenues and profitability.
Our gross margin percentages were 20.0% in 2003, compared with 35.2% in 2002 and 20.3% in 2001. Our 2003 gross margins primarily decreased as a result of a $14.6 million inventory impairment loss. During 2003 certain significant orders that we had expected to receive as of December 31, 2002, and into early 2003 were cancelled by customers. These cancellations were primarily the result of a re-alignment of military spending priorities during the first part of 2003. Accordingly, the future demand for our Harmony 1, ESIG, and TargetView products significantly decreased compared to our prior projections because of these cancellations. As a result, we recorded a $14.6 million impairment to specific inventory during 2003. Note 4 of the Notes to Condensed Consolidated Financial Statements of this annual report on Form 10-K contains a detailed description of this impairment.
21
From 2002 to 2003 gross margins percentages on sales to the military market decreased significantly as a result of a majority of the $14.6 million of inventory impairment consisting mainly of products sold in the military market. Offsetting this was a significant reduction in the negative impact that the Big Six programs had. Gross margin percentages on sales to commercial airline customers decreased significantly in 2003 as a result of pricing pressure that is currently in the commercial market and due to cost overruns. In addition, we experienced higher than normal warranty and support costs due to part failures and an increase in our warranty provision for anticipated future warranty costs. These decreases were slightly offset by a small increase in our service & support gross margin percentages.
From 2001 to 2002 our gross margins increased significantly because the Big Six programs had less of a negative impact in 2002 than in 2001. These six programs heavily contributed either losses or small positive gross margins to 2001's overall gross profit. Additionally, gross margins on sales to commercial airline customers were up as 2002 included both positive adjustments for completing programs below cost estimates and improved overall cost performance. In 2002 gross margin improvements were offset by an inventory impairment loss of $1.4 million related to our restructuring plan decision to exit the simFUSION 4000 product line. The $1.4 million charge encompassed the total value for the simFUSION 4000 inventory on hand. We took this impairment write-off because we anticipated reduced demand for simFUSION 4000 products as a result of customer migration to the updated simFUSION products.
Operating Expenses, Other Items and Taxes
Our operating expenses were $53.3 million in 2003, compared with $57.9 million in 2002 and $67.3 million in 2001. Selling, general, and administrative ("SG&A") expenses decreased $0.1 million during 2003. We achieved significant SG&A expense reductions primarily as a result of lower headcount and reductions in expenditures for travel, consultants, and facilities costs. However, SG&A expenses remained near the 2002 level because in 2002 we reversed previous bad debt accruals of $0.7 million as a result of improved collection experience. Additionally, our SG&A expenses in 2003 increased as a result of reductions in our rental income, which affect our rent expense. Research and development ("R&D") expenses decreased $4.2 million in 2003 as a result of lower headcount and reduced development expenditures for materials and software.
SG&A expenses decreased $2.9 million during 2002 as a result of lower headcount, lower labor costs, reduced use of consultants, and lower overheads. Additionally, due to improved collection experience, previous bad debt accruals were reversed, which lowered 2002 SG&A expenses. SG&A also decreased $1.3 million in 2002 compared to 2001 as a result of our sale of the REALimage Solutions Group in 2001. R&D expenses decreased $2.9 million in 2002 as a result of lower headcount, decreased effort on our Integrator software product as it neared completion, and reduced overhead costs. R&D also decreased $4.0 million in 2002 compared to 2001 as a result of our sale of the REALimage Solutions Group in 2001. These R&D decreases were partly offset by one-time material purchases for the development of both our EP-1000 line of new visual systems for commercial simulation and our new PC-based products.
During 2003, we recorded restructuring charges of $3.4 million related to reductions in force of approximately 120 full-time equivalent employees to reduce operating costs as well as to create a cost structure in line with anticipated sales. We estimate that this restructuring will reduce expenses by approximately $7.5 million per year going forward. We are continuing cost reduction actions in order to further reduce operating expenses to return to profitable performance.
During 2002, we recorded a restructuring charge of $4.5 million related to a reduction in force of approximately 230 employees in an attempt to reduce the operating cost structure as well as to create a cost structure in line with future sales. We estimate that this restructuring reduced expenses by
22
approximately $14 million per year going forward. During 2001, we recorded a restructuring charge of $2.8 million relating to a reduction in force of approximately 92 employees.
During 2003, we recognized an impairment loss of $1.2 million on certain fixed assets specifically used to build, test, and demonstrate our Harmony 1 product. During 2002, we recognized an impairment loss of $0.3 million on software licenses that were used by employees who were terminated as a result of the 2002 reduction-in-force actions. During 2001, we recognized an impairment loss of $0.2 million related to the write-off of goodwill acquired in the E&S acquisition of AccelGraphics, Inc. and Silicon Reality, Inc. in 1998.
During 2002, we recognized a gain on the amendment of our pension plan of $3.6 million. In order to match current market practices, the pension plan was amended to curtail accrual of future benefits. At the same time, the E&S 401(k) plan was amended to permit the Board of Directors to grant additional discretionary matching contributions based on profitability as well as other financial and operational considerations.
During 2003, E&S recognized a gain on assets held for sale of $1.4 million on the sale of a building. During 2002, we recognized a gain on assets held for sale of $1.2 million on the sale of a building. During 2001, we recognized a gain on the sale of assets held for sale of $9.0 million due to the sale of certain 3D-graphics patents and a gain on the sale of a business unit of $0.8 million as a result of the sale of our REALimage Solutions Group.
Our other income (expense) was $2.0 million in net expense in 2003, $2.5 million in net expense in 2002, and $2.6 million in net expense in 2001. Interest expense decreased to $1.4 million in 2003 from $1.8 million in 2002 and from $2.5 million in 2001 due to our continued reduction of debt. During 2003 we also benefited from an increase in interest income; however this was offset primarily by a $0.5 million write-down of a nonmarketable investment in Quantum Vision, Inc. Based on our analysis and meeting with Quantum Vision, Inc. in the first part of 2003, we determined this technology would not enhance our own technology or strategic direction.
Our income tax benefits were $1.0 million in 2003 compared to $0.5 million in 2002 and $3.2 million in 2001. The income tax benefits in 2003 and 2001 were primarily due to the favorable resolution of certain potential tax liabilities of our foreign subsidiaries. The 2002 income tax benefit was the result of a change in the U.S. tax law, which allows us to use additional net operating losses to offset taxable income.
Liquidity and Capital Resources
Overview
Summary information about our financial position as of December 31, 2003 and December 31, 2002, is presented in the following table (in thousands):
2003 2002 Cash and cash equivalents $ 9,714 $ 7,375 Restricted cash 765 2,960 Line of credit agreements (7,685 ) (5,213 ) Net short term cash/(indebtedness) 2,794 5,122 Long-term debt (18,015 ) (20,685 ) Net cash/(indebtedness) $ (15,221 ) $ (15,563 ) Stockholders' equity $ 15,566 $ 53,363 During 2003 we continued to take actions to adjust our business in order to reach profitability, to complete certain Harmony 1 programs, and to market two of our Salt Lake City buildings for sale. In
23
addition, to bring costs in line with projected sales, we completed two restructurings during the year. We moved closer to completion of the Big Six programs, with only two remaining for final completion at the end of 2003. This allowed us to collect $11.6 million related to these programs. We sold one of the two buildings we had for sale, with cash proceeds of $4.8 million. These events allowed us rely less on our credit facilities during 2003 than in 2002. Our average balance outstanding on the credit facilities was $3.1 million in 2003 compared to $12.3 million in 2002.
In the first quarter of 2003 we were able to finalize the renewal of both of our lines of credit providing a maximum borrowing capability of $28.0 million. In addition, as discussed under Credit Facilities below, we were in breach of one of the covenants at the end of the first quarter of 2003 that resulted in a waiver and an amended agreement, changing our financial covenants and increasing our interest rates on borrowings. Both line of credit agreements expire in December 2004.
For 2004, we foresee decreasing reliance on our credit facilities, helped by the expected sale of our last building that remains for sale, to provide cash to fund our operating activities. Over the past three years we have taken actions to reduce our operating cash requirements and our capital expenditure requirements. While these actions have significantly reduced our total operating cash requirements, our current operations may not yield positive cash flow. Circumstances that could materially affect liquidity in 2004 include, but are not limited to, the following: (i) our ability to successfully develop and produce new technologies and products, (ii) our ability to meet our forecasted sales levels during 2004, (iii) our ability to reduce costs and expenses, and (iv) our ability to favorably negotiate a sale agreement related to the one building that is for sale.
For years beyond 2004, if our projections are broadly correct and our markets start to recover in 2005, we believe that cash from operations will be sufficient for our planned needs. If our projections are incorrect, then we may need to continue to supplement cash from operations with borrowing facilities. In addition, we have the option to use our remaining buildings that are currently not for sale to finance our operations by selling these buildings or using other options available at the time that decision is made. Also, we believe that long-term our investment in research and development and our current product strategy will allow our business to grow; thus future funding requirements are anticipated to be provided from our operating activities.
We believe that existing cash, restricted cash, borrowings available under our various borrowing facilities, the sale of the one building currently held for sale, and expected cash from future operations will be sufficient to meet our anticipated working capital needs, routine capital expenditures and current debt service obligations for the next twelve months. At December 31, 2003, our total indebtedness was $25.7 million. Both of our lines of credit expire in December 2004. If we continue to need these credit facilities, we may attempt to replace them; however, there can be no assurances that we will be successful in renegotiating our existing borrowing facilities or obtaining additional debt or equity financing. Our cash and restricted cash, subject to various restrictions previously set forth below, are available for working capital needs, capital expenditures, strategic investments, mergers and acquisitions, stock repurchases and other potential cash needs as they may arise.
Impact of Big Six Programs
We have six Harmony 1 programs that have had a negative impact on our overall financial condition in prior years. Our work is essentially complete on these programs and we are awaiting final acceptance by end users in two of these programs in order to invoice our last remaining milestones. Four of the Big Six programs are fully invoiced and collected.
At the end of 2002, costs and estimated earnings in excess of billings on uncompleted contracts relating to the Big Six programs were $8.1 million. Our collections in 2003 were $11.6 million. The Big Six programs balance of cost and estimated earnings in excess of billings on uncompleted contracts at
24
the end of 2003 was $3.3 million. We expect to convert this amount to invoicing and collections in 2004.
Cash Flow
For the following years ended Dec. 31 2003 2002 2001 (In thousands) Net cash provided by (used in) operating activities $ (771 ) $ 12,039 $ (28,312 ) Net cash provided by (used in) investing activities 997 (656 ) 12,416 Net cash provided by (used in) financing activities 2,113 (12,725 ) 12,701 Increase (decrease) in cash and cash equivalents $ 2,339 $ (1,342 ) $ (3,195 ) In 2003 and 2002 our overall liquidity improved as we were able to reduce the magnitude of our reliance on our credit facilities. As a result, in 2003 we were able to maintain much lower borrowing balances compared to prior years, and in 2002 we effectively reduced our borrowings on our lines of credit $12.8 million.
We were able to accomplish this in three ways. First, the Big Six programs were a significant drain on our cash flow during 2001. In 2002, we made significant progress and neared completion on most of these programs and were able to convert a significant portion of the related costs and estimated earnings in excess of billings on uncompleted contracts into invoicing and then into collections. This trend continued in 2003, where we ended the year with only two of the Big Six programs awaiting final completion. Second, over the last two years we have been selling unneeded facilities in Salt Lake City. In 2003 this provided $4.8 million and in 2002, $2.9 million in cash. Third, in each of the last three years we have taken actions to restructure our business several times, mainly through reductions in force and the sale of non-core businesses, which significantly reduced cash requirements.
At December 31, 2003, we had working capital of $22.8 million, including cash and restricted cash of $10.5 million, compared to working capital of $56.0 million at December 31, 2002, including cash and restricted cash of $10.3 million. During 2003, we used $0.8 million in our operating activities, generated $1.0 million from our investing activities, and generated $2.1 million from our financing activities.
In 2003 cash used in our operating activities was mainly attributable to a $36.0 million net loss, offset by non-cash changes primarily consisting of $15.7 million related to asset impairments and $6.8 million related to depreciation and amortization, and decreases in accrued expenses and accounts payables of $3.3 million and $1.2 million, respectively. Accrued expenses decreased as a result of a reduction in our compensation and benefits accruals. This reduction is a result of our headcount reductions during 2003 and 2002. Accounts payables decreased as a result of our improved liquidity in 2003 as well as a result of an overall shrinkage of our business. Cash from our operating activities was provided by an $11.6 million decrease in the net costs and estimated earnings in excess of billings on uncompleted contracts and a $2.4 million increase in customer deposits. Costs and estimated earnings in excess of billings on uncompleted contracts decreased $11.1 million due to the completion and billings of all but two of the Big Six programs. Customer deposits increased due to strong fourth quarter orders from both the commercial simulation and digital theater customer markets.
In 2002, cash provided by our operating activities was mainly attributable to decreases of $11.9 million in net costs and estimated earnings in excess of billings on uncompleted contracts, $8.8 million in accounts receivables and $3.9 million in inventory. While the $11.7 million loss had a negative impact on cash, it was mainly offset by $9.3 million in depreciation and amortization. Net costs and estimated earnings in excess of billings on uncompleted contracts decreased as a result of a decrease in costs and estimated earnings in excess of billings on uncompleted contracts of
25
approximately $25.7 million primarily due to successful near completion of the Big Six programs and a decrease in billings in excess of costs and estimated earnings on uncompleted contracts of approximately $14.0 million due primarily to $6.0 million in deliveries made in 2002 related to commercial simulation customer orders booked in 2001 and $3.6 million in deliveries made in 2002 related to military simulation product orders in 2001. Also contributing to cash from operations was an $8.8 million decrease in accounts receivable due primarily to collections on the Big Six programs and improved collections overall. The inventory decrease was mainly due to a decrease in raw material requirements as our sales decreased and due to converting work-in-process inventory related to the Big Six programs into cost of sales as these contracts moved further towards completion.
Cash provided by our investing activities was $1.0 million in 2003. The primary source was the sale of one of our buildings, which provided $4.8 million. This was offset by investments in property, plant and equipment, which used $3.8 million. This is a continuation of our cost reduction plan associated with our restructuring efforts. Investments in property, plant, and equipment were $3.4 million in 2002, $6.6 million in 2001, and $13.9 million in 2000.
Cash provided by our financing activities was $2.1 million in 2003. This was primarily due to a change in restricted cash that generated $2.1 million. In 2002, we used cash provided from operating activities to mainly reduce our credit facility borrowings by $12.9 million.
Credit Ratings
Our credit ratings were lowered by Moody's Investor Services ("Moody's") on multiple occasions during 2003. Our 6% Convertible Subordinated Debentures due in 2012 credit ratings were lowered from B2 to Caa2. Our Senior Implied Rating was downgraded from Ba to B3. These credit rating downgrades may affect our future ability to renew our credit facilities, negotiate new credit facilities, and issue debt and equity securities.
With respect to Moody's, issuers with a Ba rating are judged to have speculative elements and are subject to substantial credit risk. Issuers with a B rating are judged to have speculative elements and are subject to high credit risk. Issuers with Caa ratings are in poor standing with Moody's and subject to very high credit risk. These issuers may be in default, according to Moody's, or there may be present elements of danger with respect to principal and interest. The "1,2,3" modifiers show relative standing within the major categories, 1 being the highest, or best, modifier in terms of credit quality.
Moody's Senior Implied Ratings are generally
acceptedemployed for speculative grade corporate issuers. The Senior Implied Rating is an opinion of a corporate family's ability to honor its financial obligations and is assigned to a corporate family as if it had a single class of debt and a single consolidated legal entity structure.Credit Facilities
We have in place two lines of credit that allow us to bridge the gap between our daily cash requirements and the cash we have on hand, as well as provide for the ability to issue letters of credit. We require access to these lines of credit, or others, in order to operate.
The ability to issue letters of credit has become more important to our business as sales in countries other than North America and Western Europe have grown and become a larger percentage of our gross sales. Letters of credit in many of these countries are required as part of any final contract.
In December 2000, E&S entered into a secured credit facility (the "Foothill Facility") with Foothill Capital Corporation ("Foothill") that provided for borrowings and the issuance of letters of credit up to $30.0 million. In December 2002, E&S and Foothill renegotiated and renewed the terms of the Foothill Facility, providing for borrowings and the issuance of letters of credit up to $25.0 million. The
26
Foothill Facility, among other things, (i) requires E&S to maintain certain financial ratios and covenants, including a combined cash and borrowing availability financial covenant that adjusts each quarter and a limitation of $12.0 million of aggregate capital expenditures in any fiscal year; (ii) restricts our ability to incur debt or liens; sell, assign, pledge or lease assets; merge with another company; and (iii) restricts the payment of dividends and repurchase of any of our outstanding shares without the prior consent of the lender. The Foothill Facility expires in December 2004.
Borrowings under the Foothill Facility bear interest at the Wells Fargo Bank National Association prevailing prime rate plus 3.0% to 4.5%, depending on the amount outstanding. In addition, the Foothill Facility has an unused line fee equal to 0.375% per annum times the difference between $25 million and the sum of the average undrawn portion of the borrowings, payable each quarter. The Foothill Facility provides Foothill with a first priority perfected security interest in substantially all of our assets, including, but not limited to, all of our intellectual property.
In March 2003, we were not in compliance with the tangible net worth financial covenant of our Foothill Facility. In July 2003, the Foothill Facility was amended and the March 2003 covenant breach was waived. The amendments deleted the tangible net worth covenant from the Foothill Facility and replaced it with a combined cash and borrowing availability financial covenant that went into effect on June 27, 3003, and is in effect until the Foothill Facility expires. In addition, the interest rate that borrowings bear interest at was amended, from a range of 1.5% to 3.0% to a range of 3.0% to 4.5% over the Wells Fargo Bank, N.A. prevailing prime rate, depending on the amount outstanding. Also, at no time will borrowings under the Foothill Facility bear interest at a rate less than 10.25%. As of December 31, 2003, we were in compliance with all covenants.
As of December 31, 2003, E&S had $3.7 million in outstanding borrowings and $3.6 million in outstanding letters of credit under the Foothill Facility. Our customers can draw against these letters of credit if we fail to meet the performance requirements contained within the terms of each letter of credit. As of December 31, 2003, no amounts have been accrued for any estimated losses under the obligations, as we believe it is probable that we will perform as required under our contracts. As of February 27, 2004, there were no outstanding borrowings and the outstanding letters of credit were $4.3 million.
Evans & Sutherland Computer Limited, a wholly-owned subsidiary of Evans & Sutherland Computer Corporation, had a $3.0 million overdraft facility (the "Overdraft Facility") with Lloyds TSB Bank plc ("Lloyds"). At the discretion of Lloyds, the maximum amount borrowed against the Overdraft Facility can be increased for a short period of time that is predetermined by Lloyds. Borrowings under the Overdraft Facility bear interest at Lloyds' short-term offered rate plus 1.75% per annum. As of December 31, 2003, there were $4.0 million in outstanding borrowings. The Overdraft Facility is subject to reduction or demand repayment for any reason at any time at Lloyds' discretion. The Overdraft Facility expired on December 31, 2003. We have renewed the Overdraft Facility with essentially the same terms, except that the borrowing limit is $2.5 million and it expires on December 31, 2004. Evans & Sutherland Computer Limited executed a letter of negative pledge in favor of Lloyds whereby it agreed not to sell or encumber its assets, except in the ordinary course of business. Covenants contained in the Overdraft Facility restrict dividend payments from Evans & Sutherland Computer Limited and required maintenance of certain financial covenants. In addition, at December 31, 2003, we had $0.8 million on deposit with Lloyds in a restricted cash collateral amount to support certain obligations that the bank guarantees. As of February 27, 2004, there were not outstanding borrowings.
6% Convertible Subordinated Debentures due in 2012
As of December 31, 2003, we had approximately $18.0 million of 6% Convertible Subordinated Debentures due in 2012 (the "6% Debentures"). The 6% Debentures are unsecured and are convertible at each bondholder's option into shares of our common stock at a conversion price of $42.10 or 428,000 shares of our common stock, subject to adjustment. The 6% Debentures are redeemable at our option, in whole or in part, at par.
27
In 2004, we expect capital expenditures to be similar to 2003, spending approximately $3.0 million. There were no material capital expenditure commitments at the end of 2003, nor do we anticipate any over the next several years.
On February 18, 1998, E&S's Board of Directors authorized the repurchase of up to 600,000 shares of our common stock, including the 327,000 shares still available from the repurchase authorization approved by the Board of Directors on November 11, 1996. On September 8, 1998, our Board of Directors authorized the repurchase of an additional 1,000,000 shares of our common stock. On February 27, 2004, 463,500 shares remained available for repurchase. No shares were repurchased during 2003, 2002, or 2001. Stock may be acquired on the open market or through negotiated transactions. Under the program, repurchases may be made from time to time, depending on market conditions, share price and other factors. The Foothill Facility requires that we obtain prior consent from Foothill before we repurchase any shares.
We also maintain trade credit arrangements with certain of our suppliers. The unavailability of a significant portion of, or the loss of, the various borrowing facilities of E&S or trade credit from suppliers would have a material adverse effect on our financial condition and operations.
In the event our various borrowing facilities were to become unavailable, we were unable to make timely deliveries of products pursuant to the terms of various agreements with third parties, or certain of our contracts were adversely impacted for failure to meet delivery requirements, we may be unable to meet our anticipated working capital needs, routine capital expenditures, and current debt service obligations on a short-term and long-term basis.
Effects of Inflation
The effects of inflation were not considered material during fiscal years 2003, 2002, and 2001, and are not expected to be material for fiscal year 2004.
Off-Balance Sheet Arrangements
As part of our ongoing business, we normally do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities ("SPEs"), which can be established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
In July 2000, we formed a joint venture with Quadrant Group plc ("Quadrant") known as Quest Flight Training Limited ("Quest"). Quest provides certain equipment, software, training and other goods and services to the U.K. Ministry of Defence ("U.K. MoD") and other related governmental entities with regard to an upgrade of the U.K. MoD E-3D Facility and E-3D Sentry Aircrew Training Services. We have a 50% interest in Quest which is accounted for as an investment under the equity method and therefore is not consolidated in our financial statements. The financial position and operating results of Quest are immaterial to our financial results.
In connection with the services of Quest to the U.K. MoD, during 2000 we entered into guarantees of various obligations of Quest. As of December 31, 2003, we had four guaranties outstanding related to Quest. Pursuant to the first guaranty, we have guarantied, jointly and severally with Quadrant, the performance of Quest in relation to its contract with the U.K. MoD. If Quest fails to meet its obligations under the contract then we (and Quadrant) are required to perform under the terms of the contract. Due to the length of the contract and the uncertainty of performance for which we would be liable if Quest fails to perform, we cannot estimate the maximum amount of possible future payments. This guaranty is in place until 2030. Pursuant to the second guaranty, we have guarantied, jointly and severally with Quadrant, up to a maximum amount of £1.0 million ($1.8 million as of December 31,
28
2003), the performance of Quest, where not subcontracted, and the performance of Quest where subcontracted, and the subcontractor is not liable to meet its obligation due to any limitation of liability in the sub-contract agreement, thus preventing Quest from meeting its obligation under its contract with the U.K. MoD. This guaranty is in place until 2020. Pursuant to the third guaranty, we have pledged our equity shares in Quest to guaranty payment by Quest of a loan agreement executed by Quest. The loan agreement terminates in 2020. The pledge of our equity shares in Quest will expire at such time as Quest's obligations under the loan agreement are satisfied or the date on which the loan agreement is otherwise terminated. In the event of default on this loan agreement, the lending institution can request that the trustee holding such equity shares surrender them to the lending institution in order to satisfy all amounts then outstanding under the loan agreement. Pursuant to the fourth guaranty, we have guarantied payment, up to a maximum of £0.13 million ($0.2 million as of December 31, 2003), in the event that Quest has a default event, as defined by its loan agreement. This guaranty is in place until 2020. As of December 31, 2003, no amounts have been accrued for any estimated losses under these guaranties because we believe that Quest will meet all of its performance and financial obligations in relation to its contract with the U.K. MoD. However, if we are required to perform under any or all of the four guaranties, it could have a material adverse impact on our operating results and liquidity.
Contractual Obligations
The impact that our contractual obligations as of December 31, 2003, are expected to have on our liquidity and cash flow in future periods is as follows:
Payments due by period Total Less than
1 year1-3 years 3-5 years More than 5 years Contractual obligations Long-term debt, including current portion(1) $ 25,700 $ 7,685 $ — $ — $ 18,015 Operating lease obligations 12,582 1,330 1,592 855 8,805 Purchase obligations(2) 1,447 923 524 — — Total(3) $ 39,729 $ 9,938 $ 2,116 $ 855 $ 26,820
- (1)
- Amounts represent the expected cash payments of our long-term debt and our credit facilities, and do not include any fair value adjustments or bond premiums or discounts.
- (2)
- Purchase obligations include agreements to purchase goods or services that are enforceable and legally binding on E&S and that specify all significant terms, including: fixed or minimum quantities to be purchased and the approximate timing of the transaction. Purchase obligations exclude agreements that are cancelable without penalty.
- (3)
- We estimate that we will make no contributions to any of our pension and post-retirement plans in fiscal year 2004, and we currently have no plans to make contributions beyond fiscal year 2004, unless required to by statutory funding requirements.
Restatement of 2003 Quarterly Financial Statements
The financial data in this Annual Report on Form 10-K for the first three quarters of 2003 has been restated from amounts previously reported for the correction of certain accounting errors. A discussion of the restatement in relation to the affected quarters of 2003 is provided in Note 3 of the Notes to Consolidated Financial Statements. All information presented in this Management's Discussion and Analysis of Financial Condition and Results of Operations reflects the restatement.
29
Management Overview
Restatement of Financial Information. We restated certain of our previously filed unaudited condensed consolidated financial statements for the three fiscal quarters ended March 28, 2003, June 27, 2003 and September 26, 2003 for the correction of accounting errors identified by management.
The aggregate effect of the restatement decreased sales previously reported for the first three quarters of 2003 by an aggregate of $8.9 million, increased net loss previously reported for these periods by an aggregate of $5.7 million and increased the loss per share by $0.12, $0.24 and $0.18 for the fiscal quarter ended March 28, June 27 and September 26, 2003, respectively.
Background on the Restatement. During our 2003 year-end close process and review, we discovered certain errors that affected our previously issued quarterly unaudited condensed consolidated financial statements of the first three quarters of 2003. Accordingly, our 2003 quarterly unaudited, condensed consolidated financial statements have been restated.
The adjustments reflected in the restatement resulted from the incorrect application of certain accounting principles
requiresat our wholly-owned subsidiary, Evans & Sutherland Computer Limited, that we determined were in error as a result of our in depth review of all aspects of the matter.Management and the Audit Committee took a leadership role in assessing these issues and in taking corrective action. Management performed an in depth review into several accounting issues that arose in connection with the restatement, as more specifically described in Note 3 of the Notes to Consolidated Financial Statements included in this Form 10-K. Following our in depth review, we concluded that while there were material weaknesses in our control environment, we cannot conclude that there was misconduct or that our employees intentionally used improper accounting practices to manipulate earnings or that there was any fraud or intentional misconduct on the part of our officers or employees. Item 9A of this Annual Report on Form 10-K provides a description of actions we have taken to improve our internal controls and procedures based on our review of our accounting and reporting policies.
Critical Accounting Policies
The policies discussed below are considered by management to
makebe critical to an understanding of E&S's financial statements. Their application places significant demands on management's judgment, with financial reporting results relying on estimatesand assumptionsabout the effect of matters thataffectare inherently uncertain. Specific risks for these critical accounting policies are described in thereported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.following paragraphs. A summary of significant accounting policies can be found in Note12 of the Notes tothe consolidated financial statements. We have identified the accountingConsolidated Financial Statements. For all of these policies,which are critical to our businessmanagement cautions that future results rarely develop exactly as forecast, and theunderstanding of our results of operation and financial position. REVENUE RECOGNITIONbest estimates routinely require adjustment.Revenue Recognition
Revenue from long-term contracts
which requirerequiring significant production, modification or customization is recorded using the percentage-of-completion method. This methodusinguses the ratio of costs incurred to management's estimate of total anticipated costs. Our estimates of totalanticipatedcosts include assumptions, such asestimatedman-hours to complete, estimated materialscosts,cost, and estimates of other direct and indirect costs. Actual results may vary significantly from our estimates. If the actual costs are higher than management's anticipated total costs, then an adjustment is required to reduce the previously recognized revenue as the ratio of costs incurred to management's estimate was overstated. If actual costs are lower than management's anticipated total costs, then an adjustment is required to increase the previously recognized revenue as the ratio of costs incurred to management's estimatewasis understated.COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS AND BILLINGS IN EXCESS OF COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS30
Costs and Estimated Earnings in Excess of Billings on Uncompleted Contracts and Billings in Excess of Costs and Estimated Earnings on Uncompleted Contracts
Billings on uncompleted long-term contracts may be greater than or less than incurred costs and estimated
earnings andearnings. As a result, these differences are recorded as an asset or liability on the balance sheets.AsSince revenue recognized on these long-term contracts includes estimates of management's anticipated total costs, the amounts in costs and estimated earnings in excess of billings on uncompleted contracts and billings in excess of costs and estimated earnings on uncompleted contracts also include these estimates.INVENTORIESInventories
Inventory
amounts includeincludes materials at standardcosts. Inventory also includescosts, which approximates average costs, as well as inventoried costs on programsand long-term contracts which includes direct engineering and production(including material, labor, subcontracting costs,and applicable overhead, not in excessas well as an allocation ofestimated realizable value, which have not yet been recognized as cost of sales.indirect costs). We periodically review inventories for excess supply, obsolescence, andobsolete amounts as well as for amounts which are in excess ofvaluations above estimated realizablevalue,amounts, and then provide a reservethatwe consider sufficient to cover these items.AssumptionsReserve adequacy is based onwhich we estimate this reserve includeestimates of future sales, product pricing,of future productsandestimates of total anticipated costsrequirements to complete projects.Changes in anyRevisions of theseassumptionsestimates would result in adjustments to our operating results.ACCRUED EXPENSESAccrued Expenses
Accrued expenses include amounts for liquidated damages and late delivery penalties
on contracts on which we are late in delivering our products.(See Note810 of the Notes tothe consolidated financial statements)Consolidated Financial Statements).WeWhile current contracts could include additional liquidated damages and late delivery penalties, we have included all amountswhichmanagement believeswe areE&S is liable for as of December 31,2001.2003. These liquidated damages are basedin part,primarily onour estimateestimates ofwhen we will complete certain projects.project completion dates. To the extentdeliverycompletion dates are not consistent with our estimates, theseliquidateddamage22and penalty accruals may require additional adjustments. Allowance for Doubtful Accounts
The preparation of our financial statements requires us to make estimates and assumptions that affect the reported amount of assets at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We
are currently a partyspecifically analyze accounts receivables and consider historic experience, customer creditworthiness, facts and circumstances specific tocontracts which include further possible liquidated damagesoutstanding balances, current economic trends, andlate delivery penalties. LEGAL PROCEEDINGS Lockheed Martin Corporation served us with a complaint on March 23, 2000 alleging breachpayment term changes when evaluating adequacy ofcontract and is seeking $8.5 millionthe allowance for doubtful accounts. Changes incompensatory damages plus interest as well as consequential damages and attorneys' fees. We believe that a loss with respectthese factors could result in material adjustments to the$8.5 million collected from Lockheed as asserted in their legal proceedings is remote and that no amount can be currently estimated. As additional information becomes available, we will assess the appropriateness of the accounting and reflect adjustments as considered necessary. Although management believes we will ultimately prevail in the litigation, an unfavorable outcome of these matters would have a material adverse effect on our financial condition and liquidity. INCOME TAXESexpense recognized for bad debts.Income Taxes
As part of the process of preparing our consolidated financial statements we are required to estimate our actual income taxes in each of the jurisdictions in which we operate. This involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatments of items, such as accrued liabilities, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance
sheet.sheets. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, we must include a corresponding adjustment within the tax provision in the statement of operations. Significant management judgment is required to determine our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets.ALLOWANCE FOR DOUBTFUL ACCOUNTS The preparation31
Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board ("FASB") issued a revised Financial Accounting Standard No. 132 ("SFAS 132 (revised)"), "Employer's Disclosures about Pension and Other Postretirement Benefits—an amendment of
ourFASB Statements No. 87, 88, and 106." SFAS 132 (revised) revises employer's disclosure about pension plans and other post retirement benefits. SFAS 132 (revised) does not change the recognition or measurement of those plans required by SFAS Nos. 87, 88, and 106. It retains the disclosure requirements of the original SFAS 132 as well as requires additional disclosures about the assets, obligations, cash flow, and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. Certain of the additional disclosure are required for fiscal years ending after December 15, 2003, and are included in the notes to these consolidated financial statements as applicable.In December 2003, the FASB issued a revision to Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN46R"). FIN46R clarifies the application of ARB No. 51, "Consolidated Financial Statements" to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN46R requires
us to make estimatesthe consolidation of these entities, known as variable interest entities, by the primary beneficiary of the entity. The primary beneficiary is the entity, if any, that will absorb a majority of the entity's expected losses, receive a majority of the entity's expected residual returns, or both. Among other changes, the revisions of FIN46R (a) clarified some requirements of the original FIN46, which had been issued in January 2003, (b) eased some implementation problems, andassumptions that affect(c) added new scope exceptions. FIN46R deferred thereported amount of assets at theeffective date of thefinancial statements and the reported amounts of revenues and expenses during the reporting period. We specifically analyze accounts receivable and consider historic experience, customer creditworthiness, facts and circumstances specificInterpretation for public companies, tooutstanding balances, current economic trends and changes in our payment terms when evaluating the adequacy of the allowance for doubtful accounts. Changes in any of these factors may result in material differences in the expense recognized for bad debts. CERTAIN DEFENSE CONTRACTS A significant factor in our financial performance is six large, fixed price defense contracts which use our Harmony image generator. These six contracts represented a significant portion of our $27.5 million net loss for the year 2001. We entered into these contracts between two and four years ago. However, these six contracts are now 90% complete and we expect to have these contracts essentially completed by 2002 year end. 23RESULTS OF OPERATIONS The following discussions should be read in conjunction with our Consolidated Financial Statements contained herein under Item 8 of this annual report.
YEAR ENDED DECEMBER 31, -------------------------------------- 2001 2000 1999 -------- -------- --------Sales 100.0% 100.0% 100.0% Cost of sales 79.7 82.4 63.5 Write-off of inventories -- -- 6.6 -------- -------- -------- Gross profit 20.3 17.6 29.9 -------- -------- -------- Operating expenses: Selling, general and administrative 20.7 20.6 22.2 Research and development 19.8 26.5 22.1 REALimage transition costs 3.6 -- -- Restructuring charge 2.0 (0.5) 0.7 Impairment loss 0.2 -- 4.8 -------- -------- -------- Operating expenses 46.3 46.6 49.8 -------- -------- -------- (26.0) (29.0) (19.9) Gain on sale of assets held for sale 6.2 -- -- Gain on sale of business unit 0.5 1.1 -- -------- -------- -------- Operating loss (19.3) (27.9) (19.9) Other income (expense) (1.8) (2.4) 0.6 -------- -------- -------- Pretax loss (21.1) (30.3) (19.3) Income tax expense (benefit) (2.2) 11.4 (7.6) -------- -------- -------- Net loss (18.9) (41.7) (11.7) Accretion of preferred stock -- 0.1 0.1 -------- -------- -------- Net loss applicable to common stock (18.9)% (41.8)% (11.8)% ======== ======== ========2001 VS. 2000 SALES In 2001, our total sales decreased $21.7 million, or 13% ($145.3 million in 2001 compared to $167.0 million in 2000). Sales in the Simulation Group declined $14.6 million, or 10% ($135.3 million in 2001 compared to $149.9 million in 2000). Sales in the REALimage Solutions Group declined $4.0 million, or 70% ($1.7 million in 2001 compared to $5.7 million in 2000). Sales in the Applications Group declined $3.1 million, or 27% ($8.2 million in 2001 compared to $11.3 million in 2000). The primary reason for the decline in sales in the Simulation Group is due to delays in government programs relating to our Harmony image generator. In addition, the Simulation Group also experienced a decline in sales volumes to its commercial airline customers. These declines more than offset increases in the sales volumes of our simFUSION PC-based image generator and support services. The decrease in the REALimage Solutions Group declined as this group was sold during the third quarter of 2001. Sales in the Applications Group declined due to lower sales volumes of our planetarium and large-format entertainment products. GROSS PROFIT Gross profit was essentially unchanged in 2001 from 2000 (both $29.4 million). As a percent of sales, gross profit increased to 20.3% in 2001 from 17.6% in 2000. Gross profit in the Simulation Group improved due to higher sales volumes and lower costs of sales for support services and lower 24costs of sales on sales to commercial airline customers. These improvements in the Simulation Group were offset by lower sales to government customers and higher costs of sales on sales of simFUSION PC-based image generators. The lower sales to government customers was due to delays and cost over-runs on programs involving our Harmony image generator. Gross profit in the Applications Group increased as cost of sales decreased on sales of planetarium systems and higher sales of our RAPIDsite real-estate planning tool. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses decreased $4.3 million, or 13% ($30.1 million in 2001 compared to $34.4 million in 2000). As a percent of sales, selling, general and administrative expenses increased to 20.7% in 2001 from 20.6% in 2000. These expenses decreased in the Simulation Group as the result of lower headcount and lower incentive bonus expense. Selling, general and administrative expenses decreased in the Application Group due to lower headcount, lower commissions due to lower orders, lower advertising and lower incentive bonus expense. The decrease in selling, general and administrative expenses in 2001 is also partially due to all operating costs from April 1 through August 31, 2001 of $1.3 million associated with the REALimage Solutions Group being recorded in the "REALimage transition costs" expense category. Selling, general and administrative expenses were $31.4 million including the $1.3 million of costs associated with the REALimage Solutions Group. RESEARCH AND DEVELOPMENT Research and development expenses decreased $15.5 million, or 35% ($28.8 million in 2001 compared to $44.3 million in 2000). As a percent of sales, research and development expenses declined to 19.8% in 2001 from 26.5% in 2000. Research and development expenses in the Simulation Group declined during 2001 as a result of lower labor and related expenses as the effort required on our Harmony, iNTegrator, Ensemble and PC-based simulation products has declined. Research and development expenses in the Applications Group were essentially unchanged. The decrease in research and development expenses in 2001 is also partially due to all operating costs from April 1 through August 31, 2001 associated with the REALimage Solutions Group being recorded in the "REALimage transition costs" expense category. Research and development expenses were $32.7 million including these costs associated with the REALimage Solutions Group. Due to the sale of the REALimage Solutions Group, the discontinuation of the RAPIDsite business and the reduction of effort required to develop our Harmony and iNTegrator products, management expects that the total research and development spending necessary to continue the timely development of products will be lower in 2002 than in 2001. REALIMAGE TRANSITION COSTS During the second quarter of 2001, we decided to sell the REALimage Solutions Group. Accordingly, REALimage transition costs include all the expenses associated with the REALimage Solutions Group that were incurred in the second and third quarters of 2001. These costs totaled $5.3 million and were 3.6% of revenues for 2001. On August 31, 2001, we finalized an asset purchase and intellectual property license agreement to sell the REALimage Solutions Group to Real Vision, Inc. of Japan for a maximum value of $12.3 million which is expected to close in April 2002. The consideration to E&S consisted of $4.0 million cash, a receivable for $2.3 million which was paid in December 2001, and future royalties payable on a when and if earned basis of up to a maximum of $6.0 million. The consideration to Real Vision, Inc. consists of REALimage technology, other assets, and an obligation from E&S to provide certain development support of the REALimage technology during a seven-month transition period concluding in April 2002. During 2000, no comparable transition costs were incurred. 25RESTRUCTURING CHARGE During 2001, we initiated a restructuring plan focused on reducing the operating cost structure of E&S. As part of the plan, we recorded a charge of $2.8 million relating to a reduction in force of approximately 92 employees. We estimate that this restructuring plan will reduce expenses by $8.2 million per year going forward. As of December 31, 2001, we had paid $1.9 million in severance benefits. The majority of the remaining benefits will be paid out over the next two quarters. We also recognized a restructuring charge of $1.5 million in 1999 and reversed $0.8 million of that charge in 2000. The charge in 1999 was based on the expected costs related to the termination of 28 employees. The reversal of a portion of these charges in 2000 was the result of certain of these employees being transferred within E&S rather than being terminated and, therefore, these termination costs were not incurred. In addition, estimated severance and related charges were lower than expected for the terminated employees. IMPAIRMENT LOSS We recognized an impairment loss of $0.2 million in 2001 and there was no such charge in 2000. The 2001 charge was 0.2% of sales. The impairment loss related to the write-off of goodwill, acquired in our acquisition of AccelGraphics, Inc. and Silicon Reality, Inc. in the second quarter of 1998. GAIN ON SALE OF ASSETS HELD FOR SALE In the fourth quarter of 2001, we recognized a gain of $9.0 million on the sale of certain of our key 3D-graphics patents. This gain on sale of assets held for sale was 6.2% of sales in 2001 and there was no such transaction in 2000. GAIN ON SALE OF BUSINESS UNIT We recognized a gain on sale of business unit of $0.8 million in 2001 and $1.9 million in 2000. As a percent of sales the gain was 0.5% in 2001 and 1.1% in 2000. The 2001 gain was the result of our sale of our REALimage Solutions Group to Real Vision, Inc. of Japan. The sale was for a maximum value of $12 million, consisting of cash of $6.3 million plus future royalties, on a when and if earned basis, up to $6 million, for REALimage technology, other assets, and the performance of certain development support during a seven-month transition period leading to closing the transaction in April 2002. The 2000 gain was the result of our sale of certain assets of our Application Group relating to its digital studio business to RT-SET Real Time Synthesized Entertainment Technology Ltd. ("RT-SET") and its subsidiary, RT-SET America Inc., for $1.4 million in cash, common stock of RT-SET and the assumption of certain liabilities. OTHER INCOME (EXPENSE), NET Other income (expense), net improved by $1.4 million (an expense of $2.6 million in 2001 compared to an expense of $4.0 million in 2000). The loss on write-down of investment securities improved $7.5 million ($0.3 million in 2001 compared to $7.8 million in 2000). The losses in both years are the result of other-than-temporary declines in the values of certain marketable investment securities of E&S. The gain on sale of investment securities declined $6.0 million ($0.5 million in 2001 compared to $6.5 million in 2000). The larger gain in 2000 was primarily due to the sale of our investment in Silicon Light Machines, Inc. to Cypress Semiconductor, Inc. ("Cypress") in which we received Cypress stock. Interest income was essentially zero in 2001 compared to $0.7 million in 2000. Interest expense increased $0.3 million to $2.5 million in 2001 from $2.2 million in 2000. The increase in net income expense was due to lower average cash balances and higher average borrowing balances in 2001 compared to 2000. 26INCOME TAXES E&S recorded an income tax benefit of $3.2 million in 2001 compared to an expense of $19.0 million in 2000. Income tax benefit of $3.2 million for 2001 is primarily attributable to adjustments to prior year tax provisions as the result of the resolution of certain worldwide tax contingencies. Included in this amount is $0.6 million for withholding taxes paid in Japan for taxes associated with the REALimage transaction. During the second quarter of 2000, we increased our deferred tax asset valuation allowance by $20.6 million. As a result of cumulative net operating losses, and the cancellation of a significant contract and the related civil complaint filed by Lockheed as discussed in Note 14 to the consolidated financial statements, we fully reserved our net deferred tax assets which previously existed atthe end of the firstquarter of 2000 and those deferred tax assets recognized during the second quarter of 2000. These net deferred tax assets relate to temporary differences, tax credit carry forwards and net operating loss carry forwards. The valuation allowance was recorded in accordance with SFAS 109, which requires that a valuation allowance be established when there is significant uncertainty as to the realizability of the deferred tax assets. We evaluate the realizability of our deferred tax assets on a quarterly basis. If the deferred tax assets are realized in the future, or if a portion or all of the valuation allowance is no longer deemed to be necessary, the related tax benefitsreporting period ending after March 15, 2004. Under these guidelines, we willreduce future income tax provisions. 2000 VS. 1999 SALES In 2000, our total sales decreased $33.9 million, or 17% ($167.0 million in 2000 compared to $200.9 million in 1999). Sales in the Simulation Group decreased $20.7 million, or 12% ($149.9 million in 2000 compared to $170.6 million in 1999). Sales in REALimage Solutions Group decreased $16.3 million, or 74% ($5.7 million in 2000 compared to $22.0 million in 1999). Sales in the Applications Group increased $3.0 million, or 36% ($11.3 million in 2000 compared to $8.3 million in 1999). The decrease in sales in the Simulation Group is due to the cancellation of the contract with Lockheed Martin Corporation for the delivery of visual systems to the United Kingdom Ministry of Defence ("UK MOD") for the Combined Arms Tactical Trainer program ("UK CATT") and an adjustment to revenue on percent complete contracts where a review of the estimated costs to complete the contracts resulted in a negative adjustment to revenue of $10.9 million in the second quarter of 2000. The decrease was partially offset by increased sales volume of visual systems to commercial airline customers, increased sales volumes of our simFUSION workstation-based product and increased sales related to customer service and support contracts. The decrease in sales in the REALimage Solutions Group is due to a decrease in the number of units sold and decreased selling prices of existing products due to increased competition and delays in the introduction of new products. The increase in sales in the Applications Group is due to an increase in sales volume of large-format entertainment products and planetarium systems which is partially offset by decreased sales of our digital video products due to the sale of this business to RT-SET Real Time Synthesized Entertainment Technology Ltd. and its subsidiary RT-SET America Inc. (together "RT-SET")adopt FIN46R in the first quarter of2000. GROSS PROFIT Gross profit decreased $30.7 million,fiscal 2004. The adoption of this interpretation is not expected to have a material effect on our business, results of operations, financial position, or51% ($29.4 million in 2000 compared to $60.1 million in 1999). As a percentliquidity.In May 2003, the FASB issued Statement of
sales, gross profit decreased to 17.6% in 2000 from 29.9% in 1999. Gross profit in the Simulation Group in 2000 was negatively impacted by (i) the cancellationFinancial Accounting Standard No. 150 (SFAS 150), "Accounting for Certain Financial Instruments with Characteristics ofthe UK CATT contract due to the lossboth Liabilities and Equity." SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics ofrevenueboth liabilities andthe write-off of obsoleteequity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, andexcess inventory specific to the UK CATT contract, (ii) adjustment for estimated actual costs at completion of contract on percent-complete contracts of $16.7 million ($10.9 million as a reduction in sales as discussed previously, and $5.8 million as an increase in cost of sales relating to contracts with total estimated actual costs that 27exceed the contract value) and (iii) higher costs on several contracts to government customers which include the Harmony image generator. Gross profit in the REALimage Solutions Group decreased due to lower revenue attributed to a decrease in the number of units sold and decreased selling prices of existing products due to increased competition and delays in the introduction of new products. Gross profit in the Applications Group increased due to increased revenue from sales of large-format entertainment products and planetarium systems which was partially offset by decreased sales of our digital video products. SELLING, GENERAL AND ADMINISTRATIVE Selling, general and administrative expenses decreased $10.2 million, or 23% ($34.4 million in 2000 compared to $44.6 million in 1999). As a percent of sales, selling, general and administrative expenses were 20.6% in 2000 compared to 22.2% in 1999. The decrease in these expenses in the Simulation Groupotherwise isdue primarily to lower marketing headcount, lower marketing consulting expenses and lower marketing travel expenses. The decrease in these expenses in the REALimage Solution Group is due to decreased sales volume resulting in decreased commissions and other selling-related costs and decreased labor and associated costs due to lower headcount as a result of the restructuring which took placeeffective at theend of the third quarter of 1999. The decrease in these expenses in the Applications Group is due to the reduction of employees and related expenses as a result of the sale of certain assets of our digital video products business to RT-SET. RESEARCH AND DEVELOPMENT Research and development expenses decreased $10.2 million, or 23% ($34.4 million in 2000 compared to $44.6 million in 1999). As a percent of sales, research and development expenses were 20.6% in 2000 compared to 22.2% in 1999. Research and development expenses in the Simulation Group increased due to increased efforts of the continued development of our simFUSION workstation-based product and other value-priced simulation products. Research and development expenses relating to the REALimage Solutions Group decreased due to decreased headcount as a result of the group's restructuring at the end of the third quarter of 1999. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS Amortization of goodwill and other intangible assets decreased $1.3 million, or 87% ($0.2 million in 2000 compared to $1.5 million in 1999). The decrease in this expense was due to the write-off of $9.3 million of goodwill and other intangible assets during the third quarter of 1999 in the REALimage Solutions Group. IMPAIRMENT LOSS We recognized an impairment loss of $9.7 million in 1999 and related to the write-down to fair value of goodwill, intangibles and other long-lived assets acquired in our acquisitions of AccelGraphic, Inc. and Silicon Reality, Inc. in the second quarter of 1998. The impairment consisted of the write-off of $4.9 million of goodwill, $4.4 million of intangible assets and $0.4 million of property, plant and equipment. There was no such charge in 2000. RESTRUCTURING CHARGE We recognized a restructuring charge of $1.5 million in 1999 and reversed $0.8 million of that charge in 2000. The charge in 1999 was based on the expected costs related to the termination of 28 employees. The reversal of a portion of these charges in 2000 was the result of certain of these employees being transferred within E&S rather than being terminated and, therefore, these termination costs were not incurred. In addition, estimated severance and related charges were lower than expected for the terminated employees. 28GAIN ON SALE OF BUSINESS UNIT During 2000, we sold certain assets of our Applications Group relating to its digital video business and recognized $1.9 million of gain on the transaction. See "Item 1--Business--Acquisitions and Dispositions." There was no such event in 1999. OTHER INCOME (EXPENSE), NET Other income (expense), net was a net expense of $4.0 million in 2000 compared to a net income of $1.1 million in 1999. Interest income declined $1.1 million, or 61% ($0.7 million in 2000 compared to $1.8 million in 1999). The decline in interest income is due to lower average balances of cash, cash equivalents and short-term investments in 2000 compared to 1999 and due to interest income received in 1999 on delayed income tax refunds. Interest expense increased $0.9 million or 69% ($2.2 million in 2000 compared to $1.3 million in 1999). The increase was due to higher average borrowing balances and a higher average rate of interest paid on those borrowings in 2000 compared to 1999. Loss on write-down of investment securities increased $7.4 million, or 1,850% ($7.8 million in 2000 compared to $0.4 million in 1999). The losses in both years are the result of other-than-temporary declines in the values of certain marketable investment securities of E&S. In 2000 we recognized $6.5 million gain on the sale of investment securities. This gain was primarily due to the sale of our investment in Silicon Light Machines, Inc. to Cypress in which we received Cypress stock. There was no such event in 1999. INCOME TAXES Income tax expense (benefit) increased $34.4 million (expense of $19.0 million in 2000 compared to a benefit of $15.4 million in 1999). During the second quarter of 2000, we increased our deferred tax asset valuation allowance by $20.6 million. As a result of the net operating loss in the second quarter of 2000, the cumulative net operating losses for 2000, 1999 and 1998, and the cancellation of a significant contract and the related civil complaint filed by Lockheed as discussed in Note 14 to the consolidated financial statements, we fully reserved our net deferred tax assets which previously existed at the endbeginning of the firstquarterinterim period beginning after June 15, 2003. The adoption of2000 and those deferred tax assets recognized during the second quarter of 2000. These net deferred tax assets relate to temporary differences, tax credit carry forwards and net operating loss carry forwards. The valuation allowance was recorded in accordance with SFAS 109, which requires that a valuation allowance be established when there is significant uncertainty as to the realizability of the deferred tax assets. We evaluate the realizability of our deferred tax assets on a quarterly basis. If the deferred tax assets are realized in the future, or if a portion or all of the valuation allowance is no longer deemed to be necessary, the related tax benefits will reduce future income tax provisions. LIQUIDITY AND CAPITAL RESOURCES At December 31, 2001, we had working capital of $54.5 million, including cash, cash equivalents and restricted cash of $11.5 million, compared to working capital of $75.1 million at December 31, 2000 including cash, cash equivalents, short-term investments and restricted cash of $13.9 million. During 2001, we used $28.2 million of cash in our operating activities, generated $12.4 million of cash in our investing activities and generated $14.6 million of cash in our financing activities. Cash from our operating activities was provided by a $12.5 million decrease in net costs and estimated earnings in excess of billings on uncompleted contracts. The decrease in net costs and estimated earnings in excess of billings on uncompleted contracts was due to the achievement of billing milestones during the year and the adjustment to revenue on percent complete contracts due to the change in estimated actual costs to complete the contracts. Cash used in our operating activities included a $15.6 million decrease in accounts payable and a $8.5 million decrease in accrued expenses. 29Our investing activities included purchases of property, plant and equipment of $6.6 million, proceeds from the sale of certain patents of $9.0 million, proceeds from the sale of our REALimage Solutions Group of $6.3 million and proceeds from sale of investment securities of $3.8 million. Our financing activities during the year included net borrowings of $13.0 million, proceeds from issuances of common stock of $0.4 million, and a decrease in restricted cash of $1.2 million. In December 2000, we entered into a secured credit facility (the "Foothill Facility") with Foothill Capital Corporation ("Foothill"). The Foothill Facility provides for borrowings and the issuance of letters of credit up to $30.0 million. On February 22, 2002, E&S and Foothill amended the Foothill Facility whereby Foothill waived all events of financial covenant default through December 31, 2001 and revised E&S's 2002 financial covenants. The Foothill Facility expires in December 2002. Borrowings under the Foothill Facility bear interest at the Wells Fargo Bank National Association prevailing prime rate plus 1.5% to 3.0%, depending on the amount outstanding. The Foothill Facility provides Foothill with a first priority perfected security interest in substantially all of our assets, including, but not limited to, all of our intellectual property. Pursuant to the terms of the Foothill Facility, all cash receipts of E&S must be deposited into a Foothill controlled account. The Foothill Facility, among other things, (i) requires E&S to maintain certain financial ratios and covenants, including a minimum tangible net worth that adjusts each quarter, a minimum unbilled receivables to billed receivables ratio, and a limitation of $12.0 million of aggregate capital expenditures in any fiscal year; (ii) restricts our ability to incur debt or liens; sell, assign, pledge or lease assets; merge with another company; and (iii) restricts the payment of dividends and repurchase of any of our outstanding shares without the prior consent of the lender. Due to Foothill's waiver on February 22, 2002 of E&S's noncompliance with financial covenants through December 31, 2001 and the modification of the financial covenants, we are currently in compliance with our financial covenants and ratios, although a continuation of recent negative trends could impact future compliance with such covenants. Should the need arise, we will negotiate with Foothill to modify and expand various financial ratios and covenants, however no assurance can be given that such negotiations will result in modifications that will allow us to continue to be in compliance or otherwise be acceptable to us. E&S will need to replace the Foothill Facility on or before December 14, 2002. In the event E&S is not able to obtain an acceptable credit facility to replace the Foothill Facility on or before December 14, 2002, E&S may be unable to meet its anticipated working capital needs, routine capital expenditures, and current debt service obligations on a short-term and long-term basis. As of December 31, 2001, we have $15.7 million in outstanding borrowings and $6.0 million in outstanding letters of credit under the Foothill Facility. Since the end of 2001, we have progressed against the facility, and as of March 12, 2002 have $6.1 million in outstanding debt and $4.8 million in outstanding letters of credit. Evans & Sutherland Computer Limited, a wholly-owned subsidiary of Evans & Sutherland Computer Corporation, has a $3.0 million overdraft facility (the "Overdraft Facility") with Lloyds TSB Bank plc ("Lloyds"). Borrowings under the Overdraft Facility bear interest at Lloyds' short-term offered rate plus 1.75% per annum. As of December 31, 2001, there were $4.9 million in outstanding borrowings. As of March 12, 2002, we had fully paid-off the outstanding balance. The Overdraft Facility is subject to reduction or demand repayment for any reason at any time at Lloyds' discretion and expires on November 30, 2002. Evans & Sutherland Computer Limited executed a letter of negative pledge in favor of Lloyds whereby it agreed not to sell or encumber its assets, except in the ordinary course of business. Covenants contained in the Overdraft Facility restrict dividend payments from Evans & Sutherland Computer Limited and require maintenance of certain financial covenants. In addition, at December 31, 2001, we have $0.9 million of cash on deposit with Lloyds in a restricted cash collateral account to support certain obligations that the bank guarantees. In July 2000, we formed a joint venture with Quadrant Group plc known as Quest Flight Training Limited ("Quest"). Quest provides certain equipment, software, training and other goods and services to the Secretary of State for Defence of the U.K. Ministry of Defence and other related governmental 30entities with regard to an upgrade of the Ministry of Defence E3D Facility and E3D Sentry Aircrew Training Services. In connection with the services of Quest to the U.K. Ministry of Defence, we guaranteed various obligations of Quest. Some of our guaranteed obligations are without any maximum amount. We believe that the guarantees we isssued in connection withthisproject will not be called upon for payment or performance; however, no assurance can be made that we will not be obligated to satisfy the obligations of the guarantees. As of December 31, 2001, we had approximately $18.0 million of 6% Convertible Subordinated Debentures due in 2012 (the "6% Debentures"). The 6% Debentures are unsecured and are convertible at each bondholder's option into shares of our common stock at a conversion price of $42.10 or 428,000 shares of our common stock, subject to adjustment. The 6% Debentures are redeemable at our option, in whole or in part, at par. On February 18, 1998, our Board of Directors authorized the repurchase of up to 600,000 shares of our common stock, including the 327,000 shares still available from the repurchase authorization approved by the Board of Directors on November 11, 1996. On September 8, 1998, our Board of Directors authorized the repurchase of an additional 1,000,000 shares of our common stock. Between February 18, 1998 and December 31, 1999, we repurchased 1,136,500 shares of our common stock, leaving 463,500 shares available for repurchase as of March 12, 2002. Westatement did notrepurchase any shares of our stock during 2001. Stock may be acquired on the open market or through negotiated transactions. Under the program, repurchases may be made from time to time, depending on market conditions, share price and other factors. The Foothill Facility requires that we obtain prior consent from Foothill before we repurchase any shares. We also maintain trade credit arrangements with certain of our suppliers. The unavailability of a significant portion of, or the loss of, the various borrowing facilities of E&S or trade credit from suppliers wouldhave a materialadverse effectimpact on our financialcondition and operations.statements.In
the event our various borrowing facilities were to become unavailable, we were unable to make timely deliveries of products pursuant to the terms of various agreementsMay 2003, FASB's Emerging Issues Task Force (EITF) finalized EITF Issue 00-21, "Revenue Arrangements withthird parties, orMultiple Deliverables." EITF Issue 00-21 addresses certainof our contracts were adversely impacted for failure to meet delivery requirements, we may be unable to meet our anticipated working capital needs, routine capital expenditures, and current debt service obligations on a short-term and long-term basis. We believe that the principal sources of liquidity for 2002 will be a result of cash flows from operations and proceeds on the sale of certain of our buildings which, subsequent to December 31, 2001, have been designated by management as assets to be disposed of. Positive cash flows from operations during 2002 are largely expected as a resultaspects of therestructuringaccounting by a vendor for arrangements under whichhas taken place,it will perform multiple revenue-generating activities. Specifically, this EITF Issue 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. EITF Issue 00-21 applies to all deliverables within contractually binding arrangements in all industries under which a vendor will perform multiple revenue-generating activities, except as noted in theprogress to dateIssue. EITF Issue 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF Issue 00-21 did not have a material impact on ourHarmony image generator fixed-pricefinancial statements.In April 2003, the FASB issued Statement of Financial Accounting Standard No. 149 ("SFAS 149"), "Amendment to Statement 133 on Derivative Instruments and Hedging Activities." SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and
other cost-cutting measures which will be implemented during 2002. Circumstances that could materially affect liquidity in 2002 include, but arefor hedging activities under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003. The adoption of this statement did notlimited to, the following: (i) our ability to meet contractual milestones related to the delivery and integration of our Harmony image generators, (ii) our ability to successfully develop and produce new technologies and products, (iii) our ability to meet our forecasted sales levels during 2002, (iv) our ability to reduce costs and expenses, (v) our ability to maintain our commercial simulation business in light of current economic conditions and (vi) our ability to favorably negotiate sale agreements related to certain of our buildings. Management believes that existing cash, cash equivalents, borrowings available under our various borrowing facilities, other asset-related cash sources and expected cash from future operations will be sufficient to meet our anticipated working capital needs, routine capital expenditures and current debt service obligations for the next twelve months. The Foothill Facility expires in December 2002 and the Overdraft Facility expires on November 30, 2002. We anticipate the need to replace these credit facilities; however, there can be no assurances that we will be successful in renegotiating our existing borrowing facilities or obtaining additional debt or equity financing. Our cash and cash equivalents, 31subject to various restrictions previously set forth, are available for working capital needs, capital expenditures, strategic investments, mergers and acquisitions, stock repurchases and other potential cash needs as they may arise. EFFECTS OF INFLATION The effects of inflation were not considered material during fiscal years 2001, 2000 and 1999, and are not expected to be material for fiscal year 2002. ACQUIRED IN-PROCESS TECHNOLOGY In connection with the acquisitions of AGI and SRI, we made allocations of the purchase price to various acquired in-process technology projects. These amounts were expensed as non-recurring charges in the quarter ended June 26, 1998 because the acquired in-process technology had not yet reached technological feasibility and had no future alternative uses. Failure to complete the development of these projects in their entirety, or in a timely manner, has hadhave a materialadverseimpact onE&S's results of operations. We recorded an impairment loss of $0.2 million relating to the remaining balance of goodwill at the time of the sale of the REALimage Solutions Group, in the third quarter of 2001. During the third quarter of 1999, we recorded an impairment loss of $9.7 million consisting of a write-off of $4.9 million of goodwill, $4.4 million of intangible assets and $0.4 million of property, plant and equipment. Actual sales, operating profits and cash flows attributable to acquired in-process technology have been significantly lower than the original projections used to value such technology in connection with each of the respective acquisitions. On-going operations and financial results for the acquired technology and E&S as a whole are subject to a variety of factors which may not have been known or estimable at the date of such acquisitions, and the estimates discussed below should not be considered our current projections for operating results for the acquired businesses or E&S as a whole. Following is a description of the acquired in-process technology and the estimates made by E&S for each of the technologies. MID-RANGE PROFESSIONAL GRAPHICS SUBSYSTEM (2100). This technology is a graphics subsystem with built in VGA core and integral DMA engines. This technology provides superior graphics performance over previous technologies, and includes features such as stereo and dual monitor support and various texture memory configurations. The technology is used in the AccelGALAXY product, which was completed and began shipping to customers in late third quarter of 1998. The cost to complete this project subsequent to the acquisition of AGI was $0.3 million, $0.1 million over the budgeted amount and was funded by working capital. The project was also completed a month later than scheduled. The assigned value for this acquired in-process technology was $6.1 million. CAD-FOCUSED PROFESSIONAL GRAPHICS SUBSYSTEM (1200). This technology is a graphics subsystem with lower costs compared to the mid-range technology, resulting in a more cost-effective graphics solution for the end-user. It provides the cost sensitive user with adequate graphics performance, with few features and a single texture configuration option. The technology is used in the E&S Lightning 1200 product, which was completed in March 1999 and began shipping to customers in April 1999. The cost to complete this project subsequent to the acquisition of AGI was $0.5 million, $0.2 million over the budgeted amount and was funded by working capital. This project was completed five months later than originally projected. The assigned value for this acquired in-process technology was $6.2 million. MULTIPLE-CONTROLLER GRAPHICS SUBSYSTEMS (2200). This technology is a high-end graphics subsystem involving the parallel use of two or four controllers. This technology is aimed at super users in the graphics area who need significant increases in performance and features to accomplish their tasks and are willing to pay the increased price necessary to support those 32requirements. During the third quarter of 1999, we determined the technology and graphics subsystem, as originally designed, would not be a viable product in the workstation marketplace. The cost to complete this project subsequent to the acquisition of AGI was $1.7 million. The project was completed in the fourth quarter of 1999, approximately 9 months later than planned. This project was funded by working capital. The assigned value for this acquired in-process technology was $2.7 million. ON-BOARD GEOMETRY ENGINE GRAPHICS SUBSYSTEM (ACCELGMX). This technology is a mid-range graphics subsystem with a geometry engine on board. This technology is aimed at the performance intensive graphics end-user. It has fewer features than the mid-range professional technology, but faster geometry performance compared to the mid-range professional technology on Pentium II processors. This technology was completed in the third quarter of 1998 and the AccelGMX product that uses this technology began shipping to customers at that time. The cost to complete this project subsequent to the acquisition of AGI was $0.1 million and was funded by working capital. The assigned value for this acquired in-process technology was $5.3 million. The AccelGALAXY performed below sales estimates due to the delay in our product introduction by E&S and a delayed design win at one major OEM. These delays, in addition to increased competition, caused an erosion of approximately 50% of the projected average selling price for the AccelGALAXY and a loss of projected unit sales. Subsequent to our acquisition of AGI, the developer of the chip used on the AccelGMX also acquired a board company and entered the graphics accelerator market in direct competition with the AccelGMX. Due to the advantage of producing the chip, the competitor can produce a comparable product at a lower cost; thus, the AccelGMX has performed below sales estimates and we no longer expects to generate significant sales from this product. The E&S Lightning 1200 performed below sales estimates due to the delay in our product introduction. As a result of the delay in product introduction, most OEMs selected a competing product. The expected sales volume and average selling price of the E&S Lightning 1200 have been significantly reduced. At the time of the sale of the REALimage Solutions Group in the third quarter of 2001, sales of all the group's products had decreased to nominal levels. We periodically review the value assigned to the separate components of goodwill, intangibles and other long-lived assets through comparison to anticipated, undiscounted cash flows from the underlying assets to assess recoverability. The assets are considered to be impaired when the expected future undiscounted cash flows from these assets do not exceed the carrying balances of the related assets. Based on the events described above and in accordance with SFAS 121 during the third quarter of 1999 we recorded an impairment loss of $9.7 million related to the acquisition of AGI and SRI. The impairment loss consisted of the write-off of $4.9 million of goodwill, $4.4 million of intangible assets and $0.4 million of property, plant and equipment. We recorded an impairment loss of $0.2 million relating to the remaining value of goodwill at the time of the sale of the REALimage Solutions Group in the third quarter of 2001. OUTLOOK 2002 is expected to be a year that returns E&S to a focus on its core business. This encompasses visualization systems, components, spares, repairs, and training for the simulation marketplace. Our focus is a function of the sale of the REALimage Solutions Group in 2001 and closing down the RAPIDsite business in 2001. Implicit in these changes is a consolidation of the business base. Revenues are expected to contract by 10% from the $145 million mark set in 2001. However, a more focused management team coupled with core product offerings is expected to reviveour financialperformance through higher margin business. New 2001 core business bookings, averaging greater than 40% gross margin, have positioned our year-end backlog, of $104 million, to support this improvement. Our main near-term challenge continues to be the completion of our initial Harmony programs (referred to as the "Big 6 Programs"). We did make significant progress on these programs during 332001. Our return to profitability, on a quarter-by-quarter basis, is dependent in large part on the successful execution of these programs in the first half of 2002. Year-to-date 2002, milestones are being met, a majority of first unit systems have passed testing, and several are already in training. Combined, the Big 6 Programs are in excess of 90% complete. In looking towards the second half of the year when these programs are expected to be essentially complete, we believe that the financial posture will be much improved. Cash generation for the second half of 2002 is expected to increase to a level of $5 million per quarter from operations and profits are expected to be produced.statements.32
Forward Looking Statements
The foregoing contains "forward-looking statements" within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act of 1934, as amended, including, among others, those statements preceded by, followed by or including the words "estimates," "believes," "expects," "anticipates," "plans," "projects," and similar expressions.
These forward-looking statements include, but are not limited to, the following statements:
-
- •
- Our belief that the
successful execution of2003 restructurings will reduce expenses approximately $7.5 million per year going forward.- •
- Our belief that the
Big 6 programs2002 restructurings did reduce expenses bythe end of 2002; -approximately $14 million per year going forward.- •
- Our belief that we will
generate $5make no contributions to any of our pension and post-retirement plans in fiscal year 2004, unless required to by statutory funding requirements.- •
- Our belief that a settlement agreement we entered into in 2003 with one of our customers will result in no more than $1.2 million
of cash per quarter and will be profitableinthe second half of 2002; - projections of sales and net income and issuesadditional costs in 2004.- •
- Our belief that
may affect sales or net income; - projections of capital expenditures; - plans for future operations; - financing needs or plans; - plans relating to our products and services; - Simulation Group will experience growth in its markets as simulation training increases in value as an alternative to other training methods, and as simulation training technology and cost-effectiveness improve; - additional enhancements to iNTegrator will expand its functionality and help secure E&S's dominant position in its main target markets, both commercial and military simulation; - E&S is able to compete effectively in the simulation market and will continue to be able to do so in the foreseeable future; - approximately two-third's of Simulation Group's 2001 backlog will be converted to sales in 2002 and replaced with new orders; - the Applications Group's new product will be launched in the first half of 2002; -our properties are suitable for our immediateneeds; - totalneeds.- •
- Our belief that the ultimate disposition of various legal claims and other contingent matters will not have a material adverse effect on our consolidated financial condition, liquidity or results of operations.
- •
- Our belief that our newest PC image generator, the simFUSION 6500, offers the best simulation performance for its price.
- •
- Our belief that the Digistar 3 Laser has the potential to broaden the market and increase our market share.
- •
- "Our belief that our range of products at different price points and performance points, our research and development
spendinginvestments and our ability to design and manufacture value-added parts when not available as commercial parts will continue to enable us to compete effectively in this environment in the foreseeable future.- •
- Our belief there is no inherent seasonal pattern to our business.
- •
- Our belief that any inherent risk that may exist in our foreign operations is not material.
- •
- Our belief that our relations with our employees are good.
- •
- Our belief that our continued strategy of investment in new products and product development as the primary pathway to rebuilding the company will continue to be successful during 2004 and the years beyond.
- •
- Our belief that our laser projector, when fully developed, will revolutionize the market for large-format, high accuracy displays.
- •
- Our belief that customers in the military market will continue to divert funds to more pressing military requirements during 2004 resulting in this market showing no growth, and that this may result in pent up demand and growth in 2005.
- •
- Our belief that, cash from operations will be
lowersufficient for our planned needs in2002 than2005 and later, and that our business will grow, if our markets recover in2001; - E&S will ultimately prevail2005 and we maintain our long-term investment inthe litigation with Lockheed Martin Corporation; - E&S will not be liable for any further material liquidated damagesresearch andlate delivery penalties during 2002; -development and our current product strategy.33
- •
- Our belief that existing cash, restricted cash,
equivalents,borrowings available underE&S'sour various borrowing facilities,other asset-related cash sourcesthe sale of the one building currently held for sale, and expected cash from future operations will be sufficient to meetE&S'sour anticipated working capital needs, routine capital expenditures and current debt service obligations for the next twelvemonths; -months.- •
- Our belief we will perform under the
guaranteesconditions ofE&S issuedour letters of credit and therefore incur no losses inconnection2004 or future years.- •
- Our belief that Quest will meet all of its performance and financial obligation in relation to its contract with the
servicesU.K. MoD and we will therefore incur no losses as a result of ourjoint venture entity, Quest Flight Training Ltd.guarantees.- •
- Our belief that based upon our current level of operations and anticipated growth, that available cash flow, together with available credit, will be adequate to meet our financial needs.
- •
- Our belief that our internal controls and procedures and our disclosure controls and procedures have now been improved due to the
UK Ministryscrutiny ofDefence or other partiessuch controls and procedures and that they will continue to improve as we complete the implementation of the actions described in Item 9A.- •
- Our belief that the commercial simulation market will remain flat in 2004 and start to recover and grow in 2005.
- •
- Our belief that we will see a rebounding worldwide economy and project funding increases to continue to drive the digital theater market growth into 2004.
- •
- Our belief we will receive orders for the Digistar 3 Laser systems in early 2004.
- •
- Our belief that we will complete the remaining two Big Six programs in early 2004.
- •
- Our belief that the continued success of our new products will result in a return of profitability for the full year 2004, although the pattern of our current order book suggests we are likely to operate moderately below break-even in the first half.
- •
- Our belief that our commercial simulation products gross margins will increase in 2004.
- •
- Our belief that 2003 trends in the commercial and military markets will continue in 2004.
- •
- Our belief that we will convert the December 31, 2003, $3.3 million balance of cost and estimated earnings in excess of billings on uncompleted contracts related to the Big Six programs to invoicing and collections in 2004.
- •
- Our belief that capital expenditures in 2004 will be similar to capital expenditures in 2003.
- •
- Our belief that the effects of inflation will not be
called uponmaterial forpaymentfiscal year 2004.- •
- Our belief that we will continue to see increased competition in the markets we operate in.
- •
- Our belief that we will continue to have a limited number of customers to account for a substantial portion of our sales in the foreseeable future.
- •
- Our belief that international sales will continue to be a significant portion of our overall business in the foreseeable future.
- •
- Our belief that approximately two-thirds of the 2003 backlog will be converted to sales in 2004.
- •
- Our belief that high levels of research and development will be needed to continue to ensure that we maintain our technical excellence, leadership and market competitiveness.
34
- •
- Our expectation that we will complete development of certain products and related toolsets in 2004.
- •
- Our philosophy related to certain strategic relationships we enter with certain key customers and technology partners will continue in 2004, and agreements will be continued or
performance; - revenue is expectedconsummated as necessary tocontract by 10% from 2001maintain our industry leading position.- •
- Our expectation that there will be no material capital expenditure commitments over the next several years.
- •
- Our belief we will begin delivery of our next generation of laser projector prototypes, as well as begin to
2002;delivery of production laser projectors in 2004.- •
- Our belief we will sell the building we do not occupy in 2004.
- •
- Our expectation that we will continue to make significant investment in research and
34- assumptions relatingdevelopment- •
- Our expectation that the first deliveries of the laser projector will go to the
foregoing.United States Air Force and to customers in the digital theater market, then to our other markets in 2005.- •
- Our belief that visual databases are an important and growing part of our business.
- •
- Our expectation that we will continue to introduce new products in our markets, with special emphasis on the delivery of the first production-level model of the laser projector in 2004.
- •
- Our expectation that our laser projector will start to ship in higher volume in 2005 and beyond, contributing a substantial new revenue stream to the company and potentially opening entirely new markets.
- •
- Our belief that our infrastructure is capable of meeting substantially higher sales requirements with very little increase in overhead or fixed costs, thus resulting in accelerating profit growth as revenue grows.
- •
- Our expectation that we will have a decreasing reliance on our credit facilities, helped by the expected sale of our last building that remains for sale, to provide cash to fund our operating activities in 2004.
- •
- Our belief that we can use our remaining buildings that are currently not for sale to finance operations or use other options that may be available to us in future years.
- •
- Our belief that our anticipated revenue growth will produce accelerated profit growth.
- •
- Our belief that our recent progress resolving historical problems and our initial successes with new product and strategies has laid the foundation for a return to sustainable profitability in the future.
Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by, or underlying the forward-looking information. Our actual results could differ materially from these forward-looking statements. In addition to the other risks described in the "Factors That May Affect Future Results" discussed below, important factors to consider in evaluating such forward-looking statements include risk of product demand, market acceptance, economic conditions, competitive products and pricing, difficulties in product development, product delays, commercialization and technology, and our ability to maintain credit facilities to support our operations on favorable and acceptable terms. In light of these risks and uncertainties, there can be no assurance that the events contemplated by the forward-looking statements contained in this annual report will, in fact, occur.
FACTORS THAT MAY AFFECT FUTURE RESULTS35
Factors that may affect future results
Our domestic and international businesses operate in highly competitive markets that involve a number of risks, some of which are beyond our control. While we are optimistic about our long-term prospects, the following discussion highlights some risks and uncertainties that should be considered in evaluating our growth outlook.
OUR BUSINESS MAY SUFFER IF OUR COMPETITIVE STRATEGY IS NOT SUCCESSFULCash Flow May Be Insufficient to Guarantee Access to Capital and Retire Existing Debt
If the company does not generate sufficient earnings to increase its cash position, then our ability to obtain future capital and to repay existing debt will be reduced. While we have significantly reduced our debt in the last two years, we still have both short term and long term debt.
The long term debt is in the form of convertible preferred bonds due in 2012. A portion of our short term debt bears interest at variable rates. Any increase in interest rates will reduce funds available to us for our operations and future business opportunities.
Our
continuedBusiness Model Is Changing and May Not Produce Consistent EarningsOur success depends on our ability to compete in an industry that is highly competitive, with rapid technological advances and constantly improving products in both price and performance.
AsIn most market areas in which we operatecontinue to grow,we are experiencing increased competition, and we expect this trend to continue.In recent years, we have been forcedWhen new systems are ordered, prices are below similar systems in the past. This condition requires a new business model to
adaptbe successful in the market for visual systems. The new business model emphasizes smaller systems and associated hardware revenue, with more dependence on software, databases, and support services.While E&S has made significant progress in adapting to
domestic and worldwide political, economic, and technological developments that have strongly affected our markets. Under our current competitive strategy, we endeavor to remain competitivethis business model bygrowing existing businesses, developingintroducing products emphasizing the newbusinesses internally, selectively acquiring businesses, increasing efficiency, improving access to new markets, and reducing costs. Although our executive management team and Board of Directors continue to review and monitor our strategic plans, we havefactors for success, there is no assurance thatwethis model willbe able to continue to follow our current strategy or that this strategy will be successful. OUR STOCK PRICE MAY BE ADVERSELY IMPACTED IF OUR SALES OR EARNINGS FAIL TO MEET EXPECTATIONS Our stock price is subject to significant volatilityachieve its full objectives andwill likely be adversely affected if sales or earnings in any quarter fail to meet the investment community's expectations. Our sales and earnings may fail to meet expectations because they fluctuate and are difficult to predict. Our earnings during 2001 and 2000 fluctuated significantly from quarter to quarter. One of the reasons we experience such fluctuations is that the largest share of our sales and earnings is from our Simulation Group, which typically has long delivery cycles and contract lengths. The timing of customer acceptance of certain large-scale commercial or government contracts may affect the timing and amount of sales that can be recognized; thus, causing our periodic operating results to fluctuate. Our results may further fluctuate if United States and international governments delay or even cancel production on large-scale contracts due to lack of available funding. 35Our earnings may not meet either investor or internal expectations because our budgeted operating expenses are relatively fixedensure profitability in theshort termfuture.Covenants and
even a small sales shortfall may cause a period's resultsRestrictions in Our Credit Documents Limit Our Ability tobe below expectations. Such a sales shortfall could arise from any number of factors, including: - delays in the availability of products, - delays from chip suppliers, - discontinuance of key components from suppliers, - other supply constraints, - transit interruptions, - overall economic conditions, and - customer demand. Another reason our earnings may not meet expectations is that our gross margins are heavily influenced by mix considerations. These mix considerations include the mix of lower-margin prime contracts versus sub-contracts, the mix of new products and markets versus established products and markets, the mix of high-end products versus low-end products, as well as the mix of configurations within these product categories. Future margins may not duplicate historical margins or growth rates. OUR SIGNIFICANT DEBT COULD ADVERSELY AFFECT OUR FINANCIAL RESOURCES AND PREVENT US FROM SATISFYING OUR DEBT SERVICE OBLIGATIONS We have a significant amount of indebtedness and may also incur additional indebtedness in the future. We may not generate sufficient cash flow from operations, or have future borrowings available to us, sufficient to pay our debt. At December 31, 2001, total indebtedness was $38.9 million and our total stockholders' equity was $64.7 million. Our ability to make debt payments or refinance our indebtedness depends on future performance, which, to a certain extent, is subject to general economic, financial, competitive and other factors, some of which are beyond our control. Based upon our current level of operations and anticipated growth, management believes that available cash flow, together with available credit, will be adequate to meet our financial needs. There can be no assurance, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to pay our debts or to make necessary capital expenditures, or that any refinancing of debt would be available on commercially reasonable terms or at all. Our substantial indebtedness could have important consequences including, but not limited to, the following: - the ability to obtain additional financing for working capital, capital expenditures, acquisitions, or other purposes may be impaired or unavailable; - a portion of cash flow will be used to pay interest expense, which will reduce the funds that would otherwise be available for operations and future business opportunities; - a substantial decrease in net operating cash flows or an increase in expenses could make it difficult for us to meet our debt service requirements and force us to modify operations; - we may be more highly leveraged than our competitors, which may place us at a competitive disadvantage; - our substantial indebtedness may make us more vulnerable to a downturn in our business or in the economy generally; and 36- some of our existing debt contains financial and restrictive covenants that limit our ability to, among other things, borrow additional funds, acquire and dispose of assets, and pay cash dividends. A portion of our outstanding indebtedness bears interest at variable rates. Any increase in interest rates will reduce funds available to us for our operations and future business opportunities and will exacerbate the consequences of our leveraged capital structure. COVENANTS AND RESTRICTIONS IN OUR CREDIT DOCUMENTS LIMIT OUR ABILITY TO TAKE CERTAIN ACTIONSTake Certain ActionsOur credit documents contain significant financial and operating covenants that limit the discretion of management with respect to certain business matters. These covenants include, among others, restrictions on our ability to:
-
- •
- declare dividends or redeem or repurchase capital stock;
-- •
- incur certain additional debt;
-- •
- grant liens;
-- •
- make certain payments and investments;
-- •
- sell or otherwise dispose of assets; and
-- •
- consolidate with other entities.
We must also meet certain financial ratios and tests, including a
minimum tangible net worthcombined cash and borrowing availability financial covenant that adjusts each quarteran unbilled receivables to billed receivables ratio,and a limitation of $12.0 million of aggregate capital expenditures in any fiscal year. Failure to comply with the obligations contained in the credit documents could result in an event of default, and possibly the acceleration of the related debt and the acceleration of debt under other instruments evidencing debt that may contain cross-acceleration or cross-default provisions.On February 22, 2002, Foothill agreedDue towaive all eventsFoothill's amendments and waivers on July 16, 2003 and July 25, 2003, of E&S's noncompliance with financialcovenant default through December 31, 2001 and to revise our 2002 financial covenants. Therefore,covenants on March 28, 2003, weare currentlywere in compliance with our36
financial covenants
although a continuationas ofrecent negative operating trends could impact our future compliance with such covenants.December 31, 2003. Should the need arise, we will negotiate with our lenders to modify and expand various financial covenants, however, no assurance can be given that such negotiations will result in modifications that will allow us to continue to be in compliance or otherwise be acceptable to us.DELAYS IN THE TIMELY DELIVERY OF OUR PRODUCTS MAY PREVENT US FROM INVOICING OUR COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS ON UNCOMPLETED CONTRACTS. In accordance with accounting for long-term contracts, we record an asset for our costs and estimated earnings that exceed the amount we are able to bill our customers on uncompleted contracts. At December 31, 2001, $29.8 million of our costs and estimated earnings that exceeded our billings on uncompleted contracts related to four contracts with four different customers. We are not able to bill these amounts unless we meet certain contractual milestones related to the delivery and integration of our Harmony image generators.Competitors May Infringe Our
failure to achieve these contractual milestones by timely delivering and integrating our Harmony image generators may significantly impact our ability to recover our costs and estimated earnings that exceeded our billings on uncompleted contracts, which could severely impact our cash flow. 37FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY COULD HARM OUR NAME RECOGNITION EFFORTS AND ABILITY TO COMPETE EFFECTIVELYIntellectual PropertyCurrently, we rely on a combination of patents, trademarks, copyrights and common law safeguards including trade secret protection. To protect our intellectual property rights in the future, we intend to continue to rely on a combination of patents, trademarks, copyrights and common law safeguards, including trade secret protection. We also rely on restrictions on use, confidentiality and nondisclosure agreements and other contractual arrangements with our employees, affiliates, customers, alliance partners and others. The protective steps we have taken may be inadequate to deter misappropriation of our intellectual property and proprietary information.
A third party could obtain our proprietary information or develop products or technology competitive with ours. WeSpecifically, we may be unable to detect the unauthorized use of, or take appropriate steps to enforce our intellectual property rights. Effective patent, trademark, copyright and trade secret protection may not be available in every country in which we offer or intend to offer our products and services to the same extent as in the United States. Failure to adequately protect our intellectual property could harm or even destroy our brands and impair our ability to compete effectively. Further, enforcing our intellectual property rights could result in the expenditure of significant financial and managerial resources and may not prove successful.
OUR SIGNIFICANT INVESTMENT IN RESEARCH AND DEVELOPMENT MAY NOT BE REALIZEDThese factors all become more important as we rely more on software and other forms of intellectual property that are more difficult to control than hardware.
Military Markets May Not Recover, Depressing Our Revenue and Earnings
Since September 11, 2001 both commercial and military markets for our products have declined significantly. The size of this decline was unprecedented in our industry, and has created a condition of gross oversupply and extreme competition. This condition has put intense pressure on prices and margins, as well as forcing every company to significantly reduce costs and operating expenses used in the production of visual systems.
While commercial markets have begun to recover, military markets have not yet produced significant new revenue. In the US, the reduction in military spending for visual systems is generally due to the demands of overseas deployments, while in Europe defense budgets have been under pressure for a number of years.
There is no assurance that military spending will recover in the years ahead, leading to continued pressure on our revenue and earnings.
The Market for Visual Systems May Not Support Our Current R&D Spending
In a very fragmented market, there may be insufficient business to support current Research and Development. The market for visual systems is unusual in that it is a small market that requires specialized and expensive R&D to achieve optimal results.
Unless there is significant consolidation among competitors, the market may be too small to support any company large enough to invest in the necessary R&D. Currently, only two companies are significantly investing in visual system R&D—E&S, which invests its own funds, and CAE, whose R&D is supported by Canadian government subsidies.
37
E&S has addressed this situation by sharply targeting its R&D. We believe our R&D is highly efficient at this time, but we have no assurance that
our significant investmentthe market will provide sufficient earnings inresearch and development will generatethe futuresales or benefits. We currently make and planto continue this program.Prime Contractors May Bring Workshare into Their Own Company and Decrease the Demand for E&S Products
Large prime contractors in the defense and aerospace industry have encountered the same competitive pressures described earlier for simulation and training revenue. To protect their own revenue and margins, most have responded by putting pressure on smaller suppliers, as well as bringing work in-house to
makeprotect established engineering organizations wherever possible.This trend has, in effect, created new competitors for E&S's traditional business. These in-house engineering groups attempt to do only the most profitable work, such as software and databases, and leave hardware to others. Often the costs of these efforts are not visible to the end customer because they are part of a
significant investment in researchmuch larger contract.If these trends continue and
development. Total spendingthe end customers accept the results, they could reduce demand forresearchthe most profitable future portions of our revenue stream anddevelopment was $28.8 million or 19.8% of sales in 2001 as comparedbusiness model, software and databases.We May Not Continue to
$44.3 million or 26.5% of sales in 2000. Developing new productsbe Successful if We Are Unable to Develop, Produce andsoftware is expensive and often involves a long payback cycle. While we have every reason to believe these investments will be rewarded with sales-generating products, customer acceptance ultimately dictates the success of development and marketing efforts. WE MAY NOT CONTINUE TO BE SUCCESSFUL IF WE ARE UNABLE TO DEVELOP, PRODUCE AND TRANSITION OUR PRODUCTSTransition Our ProductsOur continued success depends on our ability to develop, produce and transition technologically complex and innovative products that meet customer needs. We have no assurance that we will be able to successfully continue such development, production and transition.
The development of new technologies and products is increasingly complex and expensive, which among other risks, increases the risk of product introduction delays. The introduction of a new product requires close collaboration and continued technological advancement involving multiple hardware and software design and manufacturing teams within E&S as well as teams at outside suppliers of key components. The failure of any one of these elements could cause our new products to fail to meet specifications or to miss the aggressive timetables
that we establish andthe market demands.As the variety and complexity of our product families increase, theThe process of planning and managing production, inventory levels, and delivery schedules also
becomesis increasingly complex. There is no assurance that acceptance of and demand for our new products will not be affected by delays in this process.Additionally, if we are unable to meet our delivery schedules, we may be subject toChanges in Government Priorities May Impact the
penalties, including liquidated damages that are includedMilitary Simulation MarketDuring the last several years significant changes have been taking place in
somebudget priorities for both US and international government spending, especially military spending. Some ofour customer contracts, and terminationthese changes have resulted in delays or reductions ofour contracts. Product transitions are a recurring part of our business. Our short product life cycles require our ability to successfully manage the timely transition from current products to new products. In fact, it is not unusual for us to announce a new product while its predecessor is still in the final stages of its development. Our transition results could be adversely affected by such factors as: - development delays, 38- late release of products to manufacturing, - quality or yield problems experienced by production or suppliers, - variations in product costs, - excess inventories of older products and components, and - delays in customerpurchases ofexisting products in anticipation of the introduction of new products. IN THE EVENT WE SUFFER FURTHER PRODUCT DELAYS, WE MAY BE REQUIRED TO PAY CERTAIN CUSTOMERS SUBSTANTIAL LIQUIDATED DAMAGES AND OTHER PENALTIES The variety and complexity of our high technology product lines require us to deal with suppliers and subcontractors supplying highly specialized parts, operating highly sophisticated and narrow tolerance equipment in performing highly technical calculations. The processes of planning and managing production, inventory levels and delivery schedules are also highly complex and specialized. Many of our products must be custom designed and manufactured, which is not only complicated and expensive, but can also require a number of months to accomplish. Slight errors in design, planning and managing production, inventory levels, delivery schedules, or manufacturing can result in unsatisfactory products that may not be correctable. If we are unable to meet our delivery schedules, we may be subject to penalties, including liquidated damages that are included in some of our customer contracts. During the fourth quarter of 1999, we accrued $8.2 million for payments of liquidated damages and penalties due to product delays. As of December 31, 2000,visual systems. While we havepaid $6.0 milliondownsized our company inconnectionaccordance withliquidated damages. During 2000, we accrued an additional $0.9 million for late delivery penalties. During 2001 we accrued $2.9 million to cover penalties, against which we paid $2.7 million. In 2001, we also accrued $1.5 million to cover additional costs incurred by customers. There is no assurance that we may not incur substantial liquidated damages in the future in connection with further product delays. WE MAY NOT MAINTAIN A SIGNIFICANT PORTION OF OUR SALES IF WE FAIL TO MAINTAIN OUR UNITED STATES GOVERNMENT CONTRACTS In 2001, 48% of our sales were to agencies of the United States government, either directly or through prime contractors or subcontractors, for which there is intense competition. Accordingly,these changes, we have no assurance thatwesuch delays willbe ablenot continue tomaintain a significant portion of our sales. These sales are subject to the inherent risks related to government contracts, including uncertainty of economic conditions, changes in government policiesoccur or accelerate andrequirements that may reflect rapidly changing military and political developments, and unavailability of funds. These risks also include technological uncertainties and obsolescence, and dependence on annual Congressional appropriation and allotment of funds. In the past, some of our programs have been delayed, curtailed, or terminated. Although we cannot predict such uncertainties,cause further declines in ouropinion there are no spending reductions or funding limitations pending that would impactrevenue from this market.We Depend on Several Significant Customers and our
contracts. Other characteristics of the government contract market that may affect our operating results include the complexity of designs, the difficulty of forecasting costs and schedules when bidding on developmental and highly sophisticated technical work, and the speed with which product lines become obsolete due to technological advances and other factors characteristic of the market. Our earnings may vary materially on some contracts depending upon the types of government long-term contracts undertaken, the costs incurred in their performance, and the achievement of other performance objectives. Furthermore, due to the intense competition for available United States government business, maintaining or expanding government business increasingly requires us to commit additional working capital for long-term programs and additional investments in company-funded research and development. 39Our dependence on government contracts may lead to other perils as well because as a United States government contractor or sub-contractor, our contracts and operations are subject to government oversight. The government may investigate and make inquiries of our business practices and conduct audits of our contract performance and cost accounting. These investigations may lead to claims against E&S. Under United States government procurement regulations and practices, an indictment of a government contractor could result in that contractor being fined and/or suspended for a period of time from eligibility for bidding on, or for award of, new government contracts; a conviction could result in debarment for a specified period of time. OUR SALES MAY SUFFER IF WE LOSE CERTAIN SIGNIFICANT CUSTOMERSNet Sales Could Suffer if Their Purchases DeclineWe currently derive a significant portion of our sales from a limited number of non-U.S. government customers. The loss of any one or more of these customers could have a material adverse effect on our business, financial condition and results of operations. We were dependent on
fourfive of our non-U.S. government customers for approximately32%25% of our consolidated sales in2001.2003. We expect that sales to a limited number of customers will continue to account for a substantial portion of our sales in the foreseeable future. We have no assurance that sales from this limited number of customers will continue to reach or exceed historical levels in the future. We do not have supply contracts with any of our significant customers.OUR SALES WILL DECREASE IF WE FAIL TO MAINTAIN OUR INTERNATIONAL BUSINESS Any reduction38
Our Operations Could Be Hurt by Terrorist Attacks and Other Activities that Make Air Travel Difficult or Reduce the Willingness of
our international business could significantly affect our sales.Ourinternational business accounted for 34% of our 2001 sales. We expect that international sales will continueCommercial Airline Customers tobe a significant portion of our overall business in the foreseeable future.Purchase Ourinternational business experiences many of the same risks our domestic business encounters as well as additional risks such as exposure to currency fluctuations and changes in foreign economic and political environments. Despite our exposure to currency fluctuations, we are not engaged in any material hedging activities to offset the risk of exchange rate fluctuations. Our international transactions frequently involve increased financial and legal risks arising from stringent contractual terms and conditions and widely differing legal systems, customs, and standards in foreign countries. In addition, our international sales often include sales to various foreign government armed forces, with many of the same inherent risks associated with United States government sales identified previously. FUTURE LOSSES COULD IMPAIR OUR ABILITY TO RAISE CAPITAL OR BORROW MONEY AND CONSEQUENTLY AFFECT OUR STOCK PRICE Although we recorded net sales of $145.3 million for the twelve months ended December 31, 2001, we incurred a net loss of $27.5 million in 2001. We have incurred net losses totaling $136.5 million over the past four years. We cannot assure you that we will be profitable in future periods. Losses in future periods could impair our ability to raise additional capital or borrow money as needed, could decrease our stock price and could cause a violation of certain covenants in our credit facilities. IF OUR COMMERCIAL SIMULATION BUSINESS DECLINES, OUR SALES WILL DECREASE We have no assurance that our commercial simulation (airline) business will continue to succeed. Our commercial simulation business currently accounts for approximately 15% to 20% of our sales. This business is subject to many of the risks related to the commercial simulation market that may 40adversely affect our business. The following risks are characteristic of the commercial simulation market: - uncertainty of economic conditions, - dependence upon the strength of the commercial airline industry, - air pilot training requirements, - competition, - changes in technology, and - timely performance by subcontractors on contracts in which E&S is the prime contractor. WE MAY MAKE ACQUISITIONS THAT ARE UNSUCCESSFUL OR STRAIN OR DIVERT OUR RESOURCES FROM MORE PROFITABLE OPERATIONS We intend to consider acquisitions, alliances, and transactions involving other companies that could complement our existing business. However, we may not be able to identify suitable acquisition parties, joint venture candidates, or transaction counterparties. Also, even if we can identify suitable parties, we may not be able to obtain the financing necessary to complete any such transaction or consummate these transactions on terms that we find favorable. We may not be able to successfully integrate any businesses that we acquire into our existing operations. If we cannot successfully integrate acquisitions, our operating expenses may increase. This increase would affect our net earnings, which could adversely affect the value of our outstanding securities. Moreover, these types of transactions may result in potentially dilutive issuances of equity securities, the incurrence of additional debt, and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect our profitability. These transactions involve numerous other risks as well, including the diversion of management attention from other business concerns, entry into markets in which we have had no or only limited experience, and the potential loss of key employees of acquired companies. Occurrence of any of these risks could have a material adverse effect on us. OUR OPERATIONS COULD BE HURT BY TERRORIST ATTACKS AND OTHER ACTIVITIES THAT MAKE AIR TRAVEL DIFFICULT OR REDUCE THE WILLINGNESS OF OUR COMMERCIAL AIRLINE CUSTOMERS TO PURCHASE OUR SIMULATION PRODUCTS.Simulation ProductsDuring
2001, $30.02003, $20.0 million, or21%24% of our total revenue generatedfrom our Simulation Group,was derived from sales of our simulation products to commercial airline companies and other third parties in the commercial airline industry. The demand for our various commercial simulation products and services is heavilydependantdependent upon new orders from these commercial airline customers. In the event terrorist attacks or other activities make air travel difficult or reduce the demand or willingness of our customers to purchase our commercial simulation products, our revenue may decline substantially.Since September 11, 2001, training requirements have increased to certify pilots, co-pilots and flight engineers for different aircraft types and changing flight procedures. In conjunction with this trend,Our Shareholders May Not Realize Certain Opportunities Because of the
Simulation Group has been contacted by oneAnti-Takeover Effect ofour largest commercial customers to deliver two-times the average annual number of systems. In addition to these additional systems, the contract provides for an option to deliver further systems in 2002. However, at this time, we are unable to predict the long-term impact of these events on either our industry as a whole or on our operations and financial condition in particular. OUR SHAREHOLDERS MAY NOT REALIZE CERTAIN OPPORTUNITIES BECAUSE OF THE ANTI-TAKEOVER EFFECT OF STATE LAWState LawWe may be subject to the Utah Control Shares Acquisition Act which provides that any person who acquires 20% or more of the outstanding voting shares of a publicly held Utah corporation will
41not have voting rights with respect to the acquired shares unless a majority of the disinterested shareholders of the corporation votes to grant such rights. This could deprive shareholders of opportunities to realize takeover premiums for their shares or other advantages that large accumulations of stock would provide because anyone interested in acquiring E&S could only do so with the cooperation of our board of directors. We May Face Risks Related to an SEC Investigation and Securities Litigation in Connection with the Restatement of our Financial Statements.
We are not aware that the SEC has begun any formal or informal investigation in connection with accounting errors requiring restatement of 2003 quarterly financial statements for the first three quarters, or that any laws have been violated. However, if the SEC makes a determination that the Company has violated Federal securities laws, the Company may face sanctions, including, but not limited to, monetary penalties and injunctive relief. In addition, the Company or its officers and directors could be named defendants in civil proceedings arising from the restatement. We are unable to estimate what our liability in either event might be.
39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKThe principal market risks to which we are exposed are changes in foreign currency exchange rates and changes in interest rates. Our international sales, which accounted for
34%53% of our total sales in20012003, are concentrated in the United Kingdom, continental Europe and Asia. Foreign currency purchase and sale contractsaremay be entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. We do not enter into contracts for trading purposes and do not use leveraged contracts. As of December 31,2001,2003, we hadnonine materialsalessale or purchase contracts in currencies other than U.S.dollars anddollars. As of December 31, 2003, we had no foreign currencysales or purchasederivative contracts.We reduce our exposure to changes in interest rates by maintaining a high proportion of our debt in fixed-rate instruments. As of December 31,
2001, 47%2003, 70% of our total debt was in fixed-rate instruments. Had we fully drawn on our$30$25 million revolving line of credit with Foothill Capital Corporation and our foreign line of credit, 39% of our total debt would be in fixed-rate instruments.The information below summarizes E&S's market risks associated with debt obligations as of December 31,
2001.2003. Fair values have been determined by quoted market prices. For debt obligations, the table below presents the principal cash flows and related interest rates at year end by fiscal year of maturity. Bank borrowings bear variable rates of interest and the 6% Debentures bear a fixed rate of interest. The information below should be read in conjunction with Note1012 of the Notes totheConsolidated Financial Statements in Part II of this annual report.
THERE- FAIR RATE 2002 2003 2004 2005 2006 AFTER TOTAL VALUE -------- -------- -------- -------- -------- -------- -------- -------- --------DEBT Bank Borrowings 9.1% $ 20,830 -- $ 71 -- -- -- $ 20,901 $ 20,901 ======== ======== ======== ======== ======== ======== ======== ======== 6% Debentures 6.0% -- -- -- -- -- $ 18,015 $ 18,015 $ 6,756 -------- -------- -------- -------- -------- -------- -------- -------- Total debt $ 20,830 -- $ 71 -- -- $ 18,015 $ 38,916 $ 27,657 ======== ======== ======== ======== ======== ======== ======== ========42
Rate 2004 2005 2006 2007 2008 Thereafter Total Fair
ValueDebt Bank Borrowings 6.1 % $ 7,685 — — — — — $ 7,685 $ 7,685 6% Debentures 6.0 % — — — — — $ 18,015 $ 18,015 $ 10,291 Total debt $ 7,685 — — — — $ 18,015 $ 25,700 $ 17,976 40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe following constitutes a list of Financial Statements included in Part II of this report:
- Report of Management - Report of Independent Auditors -
- •
- Consolidated Balance Sheets as of December 31,
20012003 and2000 -2002- •
- Consolidated Statements of Operations for each of the years in the three-year period ended December 31,
2001 -2003- •
- Consolidated Statements of Comprehensive Loss for each of the years in the three-year period ended December 31,
2001 -2003- •
- Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended December 31,
2001 -2003- •
- Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31,
2001 -2003- •
- Notes to Consolidated Financial Statements for each of the years in the three-year period ended December 31,
20012003The following consists of a list of Financial Statement Schedules included in Part IV of this report:
-
- •
- Schedule
II--ValuationII—Valuation and Qualifying Accounts for each of the years in the three-year period ended December 31,20012003Schedules other than those listed above are omitted because of the absence of conditions under which they are required or because the required information is presented in the Financial Statements or notes thereto.
43REPORT OF MANAGEMENT Responsibility for the integrity and objectivity
Report ofthe financial information presented in this report rests with the management of Evans & Sutherland. The accompanying financial statements have been prepared in conformity with generally accepted accounting principles applied on a consistent basis and, where necessary, include estimates based on management judgment. Management also prepared other information in this report and is responsible for its accuracy and consistency with the financial statements. Evans & Sutherland has established and maintains an effective system of internal accounting controls. We believe this system provides reasonable assurance that transactions are executed in accordance with management authorization in order to permit the financial statements to be prepared with integrity and reliability and to safeguard, verify, and maintain accountability of assets. In addition, Evans & Sutherland's business ethics policy requires employees to maintain the highest level of ethical standards in the conduct of our business. Evans & Sutherland's financial statements have been audited by KPMG LLP, independent public accountants. Management has made available all of our financial records and related data to allow KPMG LLP to express an informed professional opinion in their accompanying report. The Audit Committee of the Board of Directors is composed of three independent directors and meets regularly with the independent accountants, as well as with Evans & Sutherland management, to review accounting, auditing, internal accounting control and financial reporting matters.
James R. Oyler William M. Thomas Vice President and Chief Financial President and Chief Executive Officer OfficerREPORT OF INDEPENDENT AUDITORSIndependent AuditorsThe Board of Directors and Stockholders
Evans & Sutherland Computer Corporation:We have audited the consolidated financial statements of Evans & Sutherland Computer Corporation and subsidiaries ("the Company") as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule are the responsibility of
Evans & Sutherland'sthe Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule 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 overall 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 Evans & Sutherland Computer Corporation and subsidiaries as of December 31,
20012003 and2000,2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31,2001,2003, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Salt Lake City, Utah
March15, 2002 4412, 2004 42
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, ---------------------- 2001 2000 -------- --------Assets: Cash and cash equivalents $ 10,651 $ 11,898 Restricted cash 870 2,024 Accounts receivable, less allowances for doubtful receivables of $6,413 in 2001 and $4,411 in 2000 30,516 34,572 Inventories 38,226 38,383 Costs and estimated earnings in excess of billings on uncompleted contracts 47,761 68,464 Prepaid expenses and deposits 4,817 5,326 -------- -------- Total current assets 132,841 160,667 Property, plant and equipment, net 41,967 48,665 Investments 1,952 5,429 Goodwill and other intangible assets, net -- 374 Other assets 593 943 -------- -------- Total assets $177,353 $216,078 ======== ======== Liabilities and stockholders' equity: Current portion of long-term debt $ 154 $ 344 Line of credit agreements 20,676 -- Accounts payable 11,503 27,087 Accrued expenses 17,272 26,527 Customer deposits 3,650 3,908 Billings in excess of costs and estimated earnings on uncompleted contracts 25,053 27,710 -------- -------- Total current liabilities 78,308 85,576 -------- -------- Long-term debt 18,086 25,563 Pension and retirement obligations 16,300 13,305 -------- -------- Total liabilities 112,694 124,444 Commitments and contingencies (notes 6, 9 and 13) Redeemable preferred stock, class B-1, no par value; authorized 1,500,000 shares; issued and outstanding zero shares in 2001 and 901,408 shares in 2000 -- 24,000 -------- -------- Stockholders' equity: Preferred stock, no par value; authorized 8,500,000 shares; no shares issued and outstanding -- -- Common stock, $.20 par value; authorized 30,000,000 shares; issued 10,739,753 shares in 2001 and 9,772,118 shares in 2000 2,148 1,954 Additional paid-in capital 49,030 24,752 Common stock in treasury, at cost; 352,500 shares (4,709) (4,709) Retained earnings 18,561 46,018 Accumulated other comprehensive loss (371) (381) -------- -------- Total stockholders' equity 64,659 67,634 -------- -------- Total liabilities and stockholders' equity $177,353 $216,078 ======== ========45
(In thousands, except share amounts)
December 31, 2003 2002 ASSETS Current assets: Cash and cash equivalents $ 9,714 $ 7,375 Restricted cash 765 2,960 Accounts receivable, less allowances for doubtful receivables of $351 in 2003 and $856 in 2002 22,298 22,481 Inventories, net 15,973 31,373 Costs and estimated earnings in excess of billings on uncompleted contracts 10,922 22,083 Prepaid expenses and deposits 4,731 4,487 Assets held for sale 2,463 5,793 Total current assets 66,866 96,552 Property, plant and equipment, net 24,115 28,288 Investments 2,011 2,002 Other assets 390 734 Total assets $ 93,382 $ 127,576 LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt $ — $ 53 Line of credit agreements 7,685 5,213 Accounts payable 8,446 9,671 Accrued expenses 12,526 13,093 Customer deposits 3,928 1,507 Billings in excess of costs and estimated earnings on uncompleted contracts 11,499 11,022 Total current liabilities 44,084 40,559 Long-term debt 18,015 20,685 Pension and retirement obligations 15,717 12,969 Total liabilities 77,816 74,213 Commitments and contingencies (Notes 8, 11, and 15) Stockholders' equity: Preferred stock, no par value; authorized 10,00,000 shares; no issued and no outstanding shares — — Common stock, $0.20 par value; authorized 30,000,000 shares; issued 10,836,072 in 2003 and 10,806,040 in 2002 2,167 2,161 Additional paid-in-capital 49,575 49,413 Common stock in treasury, at cost; 352,500 shares (4,709 ) (4,709 ) Retained earnings (accumulated deficit) (29,148 ) 6,840 Accumulated other comprehensive loss (2,319 ) (342 ) Total stockholders' equity 15,566 53,363 Total liabilities and stockholders' equity $ 93,382 $ 127,576 See accompanying Notes to the Consolidated Financial Statements
43
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31, ------------------------------------ 2001 2000 1999 -------- -------- --------Sales $145,263 $166,980 $200,885 Cost of sales 115,823 137,532 127,556 Write-off of inventories -- -- 13,230 -------- -------- -------- Gross profit 29,440 29,448 60,099 -------- -------- -------- Expenses: Selling, general and administrative 30,061 34,406 44,554 Research and development 28,844 44,264 44,358 REALimage transition costs 5,297 -- -- Restructuring charges 2,843 (761) 1,460 Impairment loss 220 -- 9,693 -------- -------- -------- Operating expenses 67,265 77,909 100,065 -------- -------- -------- (37,825) (48,461) (39,966) Gain on sale of assets held for sale 9,000 -- -- Gain on sale of business unit 774 1,918 -- -------- -------- -------- Operating loss (28,051) (46,543) (39,966) Other income (expense): Interest income 31 659 1,849 Interest expense (2,456) (2,195) (1,333) Loss on write down of investment securities (306) (7,786) (350) Gain on sale of investment securities 538 6,472 -- Other (385) (1,154) 933 -------- -------- -------- (2,578) (4,004) 1,099 -------- -------- -------- Loss before income taxes (30,629) (50,547) (38,867) Income tax expense (benefit) (3,172) 19,023 (15,413) -------- -------- -------- Net loss (27,457) (69,570) (23,454) Accretion of redeemable preferred stock -- 228 228 -------- -------- -------- Net loss applicable to common stock $(27,457) $(69,798) $(23,682) ======== ======== ======== Net loss per common share: Basic and Diluted $ (2.70) $ (7.45) $ (2.49) ======== ======== ======== Basic and diluted weighted average common shares outstanding 10,169 9,372 9,501 ======== ======== ========46
(In thousands, except per share amounts)
Year ended December 31, 2003 2002 2001 Sales $ 84,776 $ 122,578 $ 145,263 Cost of sales 53,252 78,052 115,823 Inventory impairment 14,566 1,392 — Gross profit 16,958 43,134 29,440 Expenses: Selling, general, and administrative 27,039 27,131 31,374 Research and development 21,730 25,970 32,828 Restructuring charges 3,416 4,492 2,843 Impairment loss 1,151 311 220 Operating expenses 53,336 57,904 67,265 Gain on sale of assets held for sale 1,406 1,212 9,000 Gain on curtailment of pension plan — 3,575 — Gain on sale of business unit — 253 774 Operating loss (34,972 ) (9,730 ) (28,051 ) Other income (expense): Interest income 412 25 31 Interest expense (1,376 ) (1,839 ) (2,456 ) Loss on write-down of investment securities (500 ) (16 ) (306 ) Gain on sale of investment securities — 27 538 Other (523 ) (651 ) (385 ) Total other income (expense), net (1,987 ) (2,454 ) (2,578 ) Loss before income taxes (36,959 ) (12,184 ) (30,629 ) Income tax benefit (971 ) (463 ) (3,172 ) Net loss $ (35,988 ) $ (11,721 ) $ (27,457 ) Net loss per common share: Basic and diluted $ (3.44 ) $ (1.12 ) $ (2.70 ) Basic and diluted weighted average common shares outstanding 10,471 10,422 10,169 See accompanying Notes to the Consolidated Financial Statement
44
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS(IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------------ 2001 2000 1999 -------- -------- --------Net loss $(27,457) $(69,570) $(23,454) Other comprehensive income (loss): Foreign currency translation adjustments 14 (419) (337) Unrealized losses on securities (4) (27) (48) Reclassification adjustment for losses included in net loss -- -- 275 -------- -------- -------- Other comprehensive income (loss) before income taxes 10 (446) (110) Income tax expense related to items of other comprehensive income (loss) -- -- 70 -------- -------- -------- Other comprehensive income (loss), net of income taxes 10 (446) (180) -------- -------- -------- Comprehensive loss $(27,447) $(70,016) $(23,634) ======== ======== ========47
(In thousands)
Year Ended December 31, 2003 2002 2001 Net loss $ (35,988 ) $ (11,721 ) $ (27,457 ) Other comprehensive income (loss): Foreign currency translation adjustments — — 14 Unrealized gain (loss) on securities 444 29 (4 ) Minimum pension liability adjustment (Note 11) (2,421 ) — — Other comprehensive income (loss) before income taxes (1,977 ) 29 10 Income tax expense related to items of other comprehensive income (loss) — — — Other comprehensive income (loss), net of income taxes (1,977 ) 29 10 Comprehensive loss $ (37,965 ) $ (11,692 ) $ (27,447 ) See accompanying Notes to the Consolidated Financial Statements
45
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY(IN THOUSANDS)
ACCUMULATED COMMON STOCK ADDITIONAL OTHER ----------------------- PAID-IN TREASURY RETAINED COMPREHENSIVE SHARES AMOUNT CAPITAL STOCK EARNINGS INCOME (LOSS) TOTAL ---------- ---------- ---------- ---------- ---------- ---------------- ----------Balance at December 31, 1998 9,598 $ 1,920 $ 23,420 $ -- $ 139,498 $ 245 $ 165,083 Issuance of common stock for cash 142 28 1,361 -- -- -- 1,389 Repurchase of 413,500 common shares (61) (12) (911) (4,709) -- -- (5,632) Compensation expense on employee stock purchase plan -- -- 117 -- -- -- 117 Tax benefit from issuance of common stock to employees -- -- 99 -- -- -- 99 Other comprehensive loss -- -- -- -- -- (180) (180) Net loss -- -- -- -- (23,454) -- (23,454) Accretion of redeemable preferred stock -- -- -- -- (228) -- (228) ---------- ---------- ---------- ---------- ---------- ---------------- ---------- Balance at December 31, 1999 9,679 1,936 24,086 (4,709) 115,816 65 137,194 Issuance of common stock for cash 93 18 562 -- -- -- 580 Compensation expense on employee stock purchase plan -- -- 104 -- -- 104 Other comprehensive loss -- -- -- -- -- (446) (446) Net loss -- -- -- -- (69,570) -- (69,570) Accretion of redeemable preferred stock -- -- -- -- (228) -- (228) ---------- ---------- ---------- ---------- ---------- ---------------- ---------- Balance at December 31, 2000 9,772 1,954 24,752 (4,709) 46,018 (381) 67,634 Issuance of common stock for cash 67 14 392 -- -- -- 406 Compensation expense on employee stock purchase plan -- -- 66 -- -- -- 66 Other comprehensive income -- -- -- -- -- 10 10 Net loss -- -- -- -- (27,457) -- (27,457) Conversion of redeemable preferred stock for common stock 901 180 23,820 -- -- -- 24,000 ---------- ---------- ---------- ---------- ---------- ---------------- ---------- Balance at December 31, 2001 10,740 $ 2,148 $ 49,030 $ (4,709) $ 18,561 $ (371) $ 64,659 ========== ========== ========== ========== ========== ================ ==========48
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
Common Stock Retained
Earnings
(Accumulated
Deficit)Accumulated
Other
Comprehensive
Income (Loss)Additional
Paid-In
CapitalTreasury
StockShares Amount Total Balance at December 31, 2000 9,772 $ 1,954 $ 24,752 $ (4,709 ) $ 46,018 $ (381 ) $ 67,634 Issuance of common stock for cash 67 14 458 — — — 472 Other comprehensive income — — — — — 10 10 Net loss — — — — (27,457 ) — (27,457 ) Conversion of preferred stock for common stock 901 180 23,820 — — — 24,000 Balance at December 31, 2001 10,740 2,148 49,030 (4,709 ) 18,561 (371 ) 64,659 Issuance of common stock for cash 66 13 383 — — — 396 Other comprehensive income — — — — — 29 29 Net loss — — — — (11,721 ) — (11,721 ) Balance at December 31, 2002 10,806 2,161 49,413 (4,709 ) 6,840 (342 ) 53,363 Issuance of common stock for cash 30 6 162 — — — 168 Other comprehensive income — — — — — (1,977 ) (1,977 ) Net loss — — — — (35,988 ) — (35,988 ) Balance at December 31, 2003 10,836 $ 2,167 $ 49,575 $ (4,709 ) $ (29,148 ) $ (2,319 ) $ 15,566 See accompanying Notes to the Consolidated Financial Statements
46
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS(IN THOUSANDS)
YEAR ENDED DECEMBER 31, --------------------------------------- 2001 2000 1999 ----------- ----------- -----------Cash flows from operating activities: Net loss $ (27,457) $ (69,570) $ (23,454) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Write-off of inventories -- -- 13,230 Impairment loss 220 -- 9,693 Depreciation and amortization 13,709 14,264 15,499 Gain on sale of a business unit (774) (1,918) -- Gain on sale of assets held for sale (9,000) -- -- Loss on disposal of property, plant and equipment 130 2,794 -- Provision for losses on accounts receivable 2,358 3,829 558 Provision for obsolete and excess inventories 943 6,613 910 Provision for warranty expense 2,197 1,189 958 Deferred income taxes -- 20,341 (8,475) Loss on write-down of investment securities 306 7,786 350 Gain on sale of investment securities (538) (6,472) -- Other, net 18 852 732 Changes in assets and liabilities, net of effect of purchase/sale of business: Accounts receivable 1,698 (9,977) 17,474 Inventories (786) (5,992) (6,104) Costs and estimated earnings in excess of billings on uncompleted contracts, net 12,520 27,296 (16,446) Prepaid expenses and deposits 508 2,407 (565) Accounts payable (15,584) 6,932 (5,041) Accrued expenses (8,456) (1,720) 9,695 Customer deposits (258) (812) 1,381 ----------- ----------- ----------- Net cash provided by (used in) operating activities (28,246) (2,158) 10,395 ----------- ----------- ----------- Cash flows from investing activities: Purchases of short-term investments -- (1,875) (14,700) Proceeds from sale of short-term investments -- 2,627 39,767 Purchase of investment securities -- (500) (636) Proceeds from sale of investment securities 3,780 1,428 -- Proceeds from sale of business unit 6,300 1,400 -- Proceeds from sale of assets held for sale 9,000 -- -- Investment in joint venture -- (754) -- Purchases of property, plant and equipment (6,646) (13,868) (14,530) Proceeds from sale of property, plant and equipment 26 1,382 -- Proceeds from sale of certain manufacturing assets -- -- 6,010 Decrease (increase) in other assets (44) -- -- ----------- ----------- ----------- Net cash provided by (used in) investing activities 12,416 (10,160) 15,911 ----------- ----------- ----------- Cash flows from financing activities: Borrowings under line of credit agreements and other long-term debt 239,223 22,365 716 Payments under line of credit agreements and other long-term debt (226,214) (16,919) (1,869) Payments of debt issuance costs -- (1,296) -- Decrease (increase) in restricted cash 1,154 (2,024) -- Proceeds from issuance of common stock 406 580 1,389 Proceeds from issuance of preferred stock -- -- -- Payments for repurchases of common stock -- -- (5,478) ----------- ----------- ----------- Net cash provided by (used in) financing activities 14,569 2,706 (5,242) ----------- ----------- ----------- Effect of foreign exchange rates on cash and cash equivalents 14 (600) (788) ----------- ----------- ----------- Net change in cash and cash equivalents (1,247) (10,212) 20,276 Cash and cash equivalents at beginning of year 11,898 22,110 1,834 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 10,651 $ 11,898 $ 22,110 =========== =========== =========== Supplemental Disclosures of Cash Flow Information Cash paid (received) during the year for: Interest $ 2,426 $ 1,539 $ 1,321 Income taxes 846 (5,887) (5,846) Accretion of redeemable preferred stock -- 228 22849
(In thousands)
2003 2002 2001 Cash flows from operating activities: Net loss $ (35,988 ) $ (11,721 ) $ (27,457 ) Adjustments to reconcile net loss to net cash provided by (used in) operating activies: Depreciation and amortization 6,782 9,311 13,709 Gain on sale of business unit — (253 ) (774 ) Gain on curtailment of pension plan — (3,575 ) — Inventory impairment 14,566 1,392 — Impairment loss 1,151 311 220 Gain on sale of assets held for sale (1,406 ) (1,212 ) (9,000 ) Loss on disposal of property, plant, and equipment 16 40 130 Gain on sale of investment securities — (27 ) (538 ) Write-down of investment 500 16 306 Provisions for losses on accounts receivable 68 (734 ) 2,358 Provision for excess and obsolete inventory 1,499 1,802 943 Provision for warranty expense 2,274 617 2,197 Other 107 214 (48 ) Change in assets and liabilities: Accounts receivable 333 8,769 1,698 Inventories 141 3,898 (786 ) Costs and estimated earnings in excess of billings on uncompleted contracts, net 11,638 11,900 12,520 Prepaid expenses and deposits (328 ) (181 ) 508 Accounts payable (1,225 ) (1,832 ) (15,584 ) Accrued expenses (3,320 ) (4,553 ) (8,456 ) Customer deposits 2,421 (2,143 ) (258 ) Net cash provided by (used in) operating activities (771 ) 12,039 (28,312 )
Cash flows from investing activities:
Proceeds from sale of investment securities — 39 3,780 Proceeds from sale of business unit — — 6,300 Purchases of property, plant and equipment (3,767 ) (3,394 ) (6,646 ) Proceeds from sale of property, plant and equipment 4 — 26 Proceeds from sale of assets held for sale 4,760 2,917 9,000 Decrease (increase) in other assets — (218 ) (44 ) Net cash provided by (used in) investing activities 997 (656 ) 12,416
Cash flows from financing activities:
Net borrowings (payments) on line of credit agreements (250 ) (12,965 ) 13,009 Decrease (increase) in restricted cash 2,195 (156 ) (780 ) Proceeds from issuance of common stock 168 396 472 Net cash provided by (used in) financing activities 2,113 (12,725 ) 12,701 Effect of foreign exchange rate changes on cash and cash equivalents — — 14
Net change in cash and cash equivalents
2,339
(1,342
)
(3,181
)
Cash and cash equivalents at beginning of year
7,375
8,717
11,898
Cash and cash equivalents at end of year
$
9,714
$
7,375
$
8,717
Supplemental Disclosure of Cash Flow Information
Cash paid (received) during the year for: Interest $ 965 $ 1,814 $ 2,426 Income taxes (209 ) (534 ) 846 See accompanying Notes to the Consolidated Financial Statements
47
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTSDECEMBER
December 31,2001, DECEMBER2003, December 31,20002002 and December 31, 2001(1) BUSINESS AND
DECEMBER 31, 1999 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESSBACKGROUNDDescription of Business
Evans & Sutherland Computer Corporation ("Evans &
Sutherland,"Sutherland", "E&S," "we," "us"&S", "we", "our", or"our""the Company")is an established high-technology company with outstanding computer graphics technology and a worldwide presence in high-performance 3Dproduces visualsimulation. In addition, E&S is now applying this core technology into higher-growth personal computer ("PC") products for both simulation and workstations. Our core computer graphics technology issystems used toproduce high performancedisplay images of the real world rapidly and accurately. We design, manufacture, market and support visual systems for simulation for use in a wide range of military and commercial applications. We also provide visual system technology to planetariums, science centers, and entertainment venues. We develop and deliver a complete line of image generators,for simulation including PC-based visual systemdisplays, databases, services and support productsto provide graphics accelerationthat match technology to customer requirements. Our products and solutions range from theprofessional digital content creation market,desktop PC to what we believe are the most advanced visual systems in the world.Restatement
During our 2003 fiscal year-end close process, we identified certain errors that affected our previously issued quarterly unaudited condensed consolidated financial statements for 2003. Accordingly, our 2003 quarterly unaudited condensed consolidated financial statements and
to applyrelated financial information previously issued for the first three quarters of 2003 have been restated. For further details on the nature of the errors and the related effects on ourcore technologies topreviously issued quarterly unaudited condensed consolidated financial statements see Note 3. Where appropriate, we have identified all amounts that have been restated with theexpanding marketnotation "restated" and all amounts previously reported in our previously issued quarterly unaudited condensed consolidated financial statements for 2003 "previously reported."(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of
PC-based applications and products. BASIS OF PRESENTATIONPresentationThe consolidated financial statements include the accounts of
E&Sthe Company and its wholly-owned subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made in the20002002 and19992001 consolidated financial statements and notes to conform to the2001 presentation. LIQUIDITY Management believes2003 presentations.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
existing cash, cash equivalents, borrowings available under its various borrowing facilities, cash expected fromaffect theanticipated salereported amounts ofcertainassets and liabilities, the disclosure ofE&S's buildings, other asset-related cash sourcescontingent assets andexpected cash from future operations will be sufficient to meet our anticipated working capital needs, routine capital expenditures and current debt service obligations forliabilities at thenext twelve months. The Foothill Facility expires in December 2002date of the financial statements and theOverdraft Facility expiresreported amounts of sales and expenses during the reporting period. Critical accounting estimates include revenue recognition based onNovember 30, 2002 (see Note 10). There can be no assurances that we will be successful in renegotiating our existing borrowing facilities or obtaining additional debt or equity financing. Our cashthe percentage-of completion method, inventory reserve estimates, accruals for potential liquidated damages andcash equivalents, subject to various restrictions, are availablelate penalties, allowance forworking capital needs, capital expenditures, strategic investments, mergersdoubtful accounts estimates andacquisitions, stock repurchases and other potential cash needs as they may arise. During 2002, we expect to generate cash due to improved earnings, moving unbilled receivables into receivables and cash, reducing inventory and the sale of someestimates of ourreal estate. Due to these expected developments, we expect our liquidity position to improve and for Foothill to continue the facility. In the event our various borrowing facilities were to become unavailable, we were unable to timely deliver products pursuant to the terms of various agreements with third parties, or certain of our contracts were adversely impacted for failure to meet delivery requirements, we may be unable to meet our anticipated working capital needs, routine capital expenditures, and current debt service obligations on a short-term and long-term basis. REVENUE RECOGNITIONincome taxes. Actual results could differ from those estimates.Revenue Recognition
Sales include revenue from system hardware and software products, database and software
license rightslicenses and service contracts.50EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) We have adopted48
The following table provides information concerning revenue recognized based on type of revenue recognition applied (in thousands):
2003 2002 2001 Percentage of completion $ 38,358 $ 63,263 $ 73,626 Product sales 40,590 54,939 65,167 Time and materials 4,602 1,168 3,814 Other 1,226 3,208 2,656 Total sales $ 84,776 $ 122,578 $ 145,263 Percentage-of-Completion. In arrangements where software is considered more than incidental to the arrangement, revenue is recognized in accordance with SOP 97-2, "Software Revenue Recognition". In accordance with the provisions of SOP 97-2, revenue from arrangements that require significant production, modification or customization of the software is recognized in accordance with the provisions of American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP")
97-2, "Software Revenue Recognition", as modified by SOP 98-9. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements such as software products, enhancements, post-contract customer support, installation and training to be allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on evidence that is specific to the vendor. The revenue allocated to software products is generally recognized upon delivery of the products. The revenue allocated to post-contract customer support is generally recognized over the support period. We recognize revenues from product sales that do not require significant production, modification, or customization when the following criteria are met: we have signed a non-cancelable agreement; we have delivered the product; there are no uncertainties surrounding product acceptance; the fees are fixed and determinable; and collection is considered probable. Revenue from long-term contracts which require significant production, modification or customization is recognized in accordance with provisions of SOP81-1 "Accounting for Performance of Construction-Type and Certain Production-Type Contracts" using the percentage-of-completion method. The Company utilizes a methodology of estimating the percent complete by calculating the ratio of costs incurred to management's estimate of total anticipated costs.If estimated totalContract costs include material, labor and subcontracting costs, as well as an allocation of indirect costs. We routinely review estimates onany contract indicate a loss, we provide currentlypercent-complete contracts and estimates are regularly revised to adjust forthe total anticipated loss on the contract.changes. Billings on uncompleted long-term contracts may be greater than or less than incurred costs and estimated earnings and are recorded as an asset or liability in the accompanying consolidated balance sheets.CASH AND CASH EQUIVALENTS We consider all highly liquid financial instruments purchased with an original maturityOur percentage of completion sales include the design, manufacture and installation of complex visual systems generally sold as a single element arrangement to
E&S of 90 days or lessour customers. In those rare cases where arrangements include multiple elements, we utilize SOP 97-2 as modified by SOP 98-9. SOP 97-2 generally requires revenue earned on software arrangements involving multiple elements such as software and maintenance to becash equivalents.allocated to each element based on the relative fair values of the elements. The fair value of an element must be based on vendor specific objective evidence ("VSOE") that is specific to the vendor. The revenue allocated to software is generally recognized upon delivery of the products. The revenue allocated to maintenance is recognized over the maintenance period, based upon VSOE, which we determine based on renewal rates in contracts.Product Sales. Product sales are comprised of contracts which typically require a relatively short period of time to complete the production, modification and customization of the software, and accordingly revenue is not recognized until delivery of the completed embedded software product occurs, the fee is fixed and determinable, and collection is considered probable.
Time and Materials. Services sold to customers on a time and materials or cost-plus basis are recognized as the related services are performed.
Other. Other revenue consists primarily of amounts earned under maintenance contracts that are generally sold as a single element to our customers. Revenue from product maintenance contracts,
49
including separately priced extended warranty contracts, is deferred and recognized on a straight-line basis over the contract period.
Restricted Cash
equivalents include debt securities and money-market funds of $0 and $3.8 million at December 31, 2001 and 2000, respectively. RESTRICTED CASHWe have restricted deposits related to borrowings on one of our line of credit agreements that are pledged as collateral
on overdraft protection, letters of creditandcertain other obligations all ofwhich mature or expire within one year.INVENTORIESTrade Accounts Receivable
In the normal course of business, we provide unsecured credit terms to our customers. Accordingly, we maintain an allowance for doubtful accounts for possible losses on uncollectable accounts receivable. We routinely analyze accounts receivable and costs in excess of billings, and consider history, customer creditworthiness, facts and circumstances specific to outstanding balances, current economic trends, and payment term changes when evaluating adequacy of the allowance for doubtful accounts. Changes in these factors could result in material differences to bad debt expense. Past due balances are reviewed individually for collectibility.
For uncollectable accounts receivable we record a loss against the allowance for doubtful accounts only after exhaustive efforts have been made to collect and with management's approval. Generally, realized losses have been within the range of management's expectations.
The table below represents changes in allowance for doubtful receivables, in thousands:
Balance at
beginning
of yearAdditions
charged
(reversed)
to cost and
expensesDeductions
charged
(recovered)
against
provisionBalance
at end of
yearAllowance for doubtful receivables December 31, 2003 $ 856 $ 68 $ 573 $ 351 December 31, 2002 6,413 (734 ) 4,823 856 December 31, 2001 4,411 2,358 356 6,413 Inventories
Inventory
amounts includeincludes materials at standardcosts. Inventory also includescosts, which approximates average costs, as well as inventoried costs on programs and long-termcontracts which includescontracts. Inventoried costs include material, direct engineering and production costs, and applicable overhead, not in excess of estimated realizablevalue,value. In accordance with industry practice, inventoried costs include amounts relating to programs and contracts with long production cycles, a portion of whichhaveis notyet been recognized as cost of sales.expected to be realized within one year. Spare parts and general stock materials are stated at cost not in excess of realizable value. We periodically review inventories for excess supply, obsolescence, andobsoletevaluations above estimated realizable amounts, and provide a reservethatwe consider sufficient to coverany excessthese items. Revisions of these estimates could result in the need for adjustments.50
Property, Plant and
obsolete inventories. PROPERTY, PLANT AND EQUIPMENTEquipmentProperty, plant and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method based on the estimated useful lives of the related assets.
ACCOUNTING FOR IMPAIRMENT OF LONG-LIVED ASSETS WeExpenditures that materially increase values or capacities or extend useful lives of property and equipment are capitalized. Routine maintenance, repairs and renewal costs are expensed as incurred.Accounting for Impairment of Long-Lived Assets
Long-lived assets are reviewed for impairment when events or changes in circumstances indicate that the book value of an asset may not be fully recoverable. When this occurs, we periodically review the value assigned to the separate components of
goodwill, intangibles and otherlong-lived assets through comparison to anticipated, undiscounted cash flows from the underlying51EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)assets to assess recoverability.The assets are considered to be impaired whenWhen the expected future undiscounted cash flows from these assets do not exceed the carrying balances of the relatedassets. The impairment loss of $9.7 million forassets, theyear ended December 31, 1999, as determined in accordance with Statement of Financial Accounting Standards No. 121 ("SFAS 121"), "Accounting forCompany then determines theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", relates to the write-down toestimated fair value ofgoodwill, intangibles and other long-lived assets acquired insuch assets. The amount of impairment to be recognized is measured by theacquisition of AccelGraphics, Inc. ("AGI") and Silicon Reality, Inc. ("SRI"). Fair value was determined utilizing discounted cash flow analyses andamount by which thereplacement cost approach. The impairment loss consistedcarrying amount of thewrite-off of $4.9 million of goodwill, $4.4 million of intangibleassetsand $0.4 million of property, plant and equipment. In addition to continued losses at AGI,exceeds theimpairment loss was the resultfair value of thefollowing additional circumstances: (i) delays in production introductionsassets. Assets held for sale are reported at theAccelGALAXY, E&S Lightning 1200 and the multiple-controller graphics subsystems product line; (ii) the developerlower ofthe chip used on the AccelGMX acquired a board company and entered the graphics accelerator market in direct competition with the AccelGMX; and (iii) introduction of lower-end products by competitors which can perform many of the functions of the higher-end 3D graphics cards. Furthermore, we determined that a manufacturer of a chiptheir carrying amount or fair value less costs tobe used in various new board products was unable to manufacture a designed chip with agreed upon specifications. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets at December 31, 2000 consisted primarily of goodwill and other intangible assets recorded in connection with the acquisitions of AccelGraphics, Inc. and Silicon Reality, Inc. on June 26, 1998. The goodwill and other intangible assets were being amortized using the straight-line method over a period of seven years for goodwill and six months to seven years for other intangible assets. As of December 31, 2000 accumulated amortization of goodwill and other intangible assets was $15.9 million. SOFTWARE DEVELOPMENT COSTSsell.Software Development Costs
Software development costs, if material, are capitalized from the date technological feasibility is achieved until the product is available for general release to customers. Such
deferrablecosts have not been material during the periods presented.INVESTMENTSInvestments
We classify our marketable debt and equity securities as available-for-sale. Available-for-sale securities are recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a component of accumulated other comprehensive income (loss) until realized. Dividend income is recognized when earned. Realized gains and losses from the sale of securities are included in results of operations and are determined on the
specific-identificationspecific- identification basis. A decline in the market valuebelow costthat is deemed other than temporary is charged to results of operations, resulting in the establishment of a new cost basis forbothmarketable, non-marketable andnon-marketableequity method investment securities.Non-marketable investmentWe account for our investments in non-marketable securities
are recorded aton both thelowercost and equity methods ofcost or fair value. Some of the factors that are considered in determiningaccounting. In assessing the fair value ofthese securities include analysessuch investments, we consider recent equity transactions that investees have entered into, the status of each investee'sfinancial condition and operations, the status of itstechnology and strategies in place to52EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)achieveits objectives. Our 50%their objectives, as well as the investee's financial condition and results of operations. To the extent there are changes in these assessments, adjustments may need to be recorded. For our investmentin a joint venture is stated at cost, adjustedaccounted for on the equity method, adjustments are made to the carrying amount of the investment to account for our equity in undistributed earningssince acquisition. WARRANTY RESERVEof the investee. Investments are periodically evaluated for a decline in value that is considered other-than-temporary. Any such decline is recognized as a loss in the statement of operations.51
Warranty Reserve
We provide a warranty reserve for estimated future costs of servicing products under warranty agreements extending for periods from 90 days to
one year.several years. Anticipated costs for productwarrantywarranties are based upon estimates derived from experience factors and are recorded at the time of sale or over the contract period for long-term contracts.STOCK-BASED COMPENSATIONThe following table provides the changes in our warranty reserves (in thousands):
2003 2002 Beginning balance $ 968 $ 1,966 Provision for warranty expense 2,274 617 Warranty charges against the reserve (1,952 ) (1,615 ) Ending Balance $ 1,290 $ 968 Stock-Based Compensation
We have adopted the footnote disclosure provisions of
StatementStatements of Financial Accounting StandardsNo.("SFAS") 123("SFAS 123"),and 148, "Accounting for Stock Based Compensation". SFAS 123 encourages entities to adopt a fair value based method of accounting for stock options or similar equity instruments. However, it also allows an entity to continue measuring compensation cost for stock based compensation using the intrinsic-value method of accounting prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees". We have elected to continue to apply the provisions of APB 25 and provide pro forma footnote disclosures required by SFAS123. INCOME TAXES123 and 148.We account for our stock option plans under APB 25, under which no compensation cost has been recognized as all options granted under these plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Had compensation cost for these plans been determined consistent with SFAS 123, our net loss and loss per common share would have been changed to the following pro forma amounts (in thousands, except per share data):
2003 2002 2001 Net loss, as reported $ (35,988 ) $ (11,721 ) $ (27,457 ) Deduct: Total stock based employee compensation expense determined under the fair value method for all awards (442 ) (688 ) (1,482 ) Pro forma net loss $ (36,430 ) $ (12,409 ) $ (28,939 ) Loss per share: Basic and diluted—as reported $ (3.44 ) $ (1.12 ) $ (2.70 ) Basic and diluted—pro forma (3.48 ) (1.19 ) (2.85 ) 52
Income Taxes
We use the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
FOREIGN CURRENCY TRANSLATION Prior to their disposition in 2000 (See Note 2) the local foreign currency was the functional currency for our German subsidiaries. Our United Kingdom subsidiary uses the U.S. dollar as its functional currency. Assets and liabilitiesConcentration of
German operations were translated to U.S. dollars at the current exchange rates as of the applicable balance sheet date. Sales and expenses were translated at the average exchange rates prevailing during the period. Adjustments resulting from translation were reported as a separate component of stockholders' equity. Certain transactions of the German subsidiaries were denominated in currencies other than the functional currency, including transactions with the parent company. Transaction gains and losses were included in other income (expense) for the period in which the transaction occurred. 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, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates. 53EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject E&S to concentrations of credit risk are primarily cash, cash equivalents, short-term investments and accounts receivable. Our short-term investment portfolio consists of investment-grade securities diversified among security types, industries and issuers. Our investments are managed by recognized financial institutions that follow our investment policy. Our policy limits the amount of credit exposure in any one issue, and we believes no significant concentration of credit risk exists with respect to these investments.Credit RiskIn the normal course of business,
E&S provideswe provide unsecured credit terms toitsour customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have generally been within the range of management's expectations.In accordance with accounting for long-term contracts,As discussed further in Note 22, werecord an asset for costs and estimated earnings in excessderive a significant portion ofbillings on uncompleted contracts. At December 31, 2001, $29.8 millionour sales from a limited number ofthe costs and estimated earnings in excess of billings on uncompleted contracts pertain to four contracts with four differentcustomers. Thebillingloss of any one or more of theseamounts is contingent upon the successful completion of contractual milestones related to the delivery and integration of Harmony image generators. We expect to achieve most of the remaining billing milestones during 2002. Our inability to achieve these contractual milestones may significantly impact the realization of such amounts andcustomers could have a material adverseimpacteffect on our financial condition and results of operations.(3) RESTATEMENT OF 2003 QUARTERLY FINANCIAL STATEMENTS—UNAUDITED
The Company's previously issued unaudited condensed consolidated balance sheets and unaudited condensed consolidated statements of operations, comprehensive loss and cash flows for the first three fiscal quarters of 2003 have been restated to correct certain accounting errors.
The aggregate effect of the restatement increased previously reported net loss for the quarters ended March 28, 2003, June 27, 2003 and September 26, 2003 by $1.2 million, $2.6 million and $1.9 million, respectively. The aggregate effect of the restatement increased previously reported basic and diluted loss per share for the quarters ended March 28, 2003, June 27, 2003 and September 26, 2003, by $0.12, $0.24 and $0.18, respectively.
During our 2003 year-end close process and review of the financial statements of our wholly-owned subsidiary, Evans & Sutherland Computer Limited ("E&S Ltd."), we identified certain errors in E&S Ltd.'s 2003 quarterly financial statements due to the
operating results and liquidityincorrect application ofE&S. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998,certain accounting principles during theFinancial Accounting Standards Board (FASB) issued Statementfirst three quarters ofFinancial Accounting Standards No. 133 ("SFAS 133"), "Accounting2003.Adjustments as a result of the restatement have been divided into the following three categories:
1.Early Recognition of Costs. During 2003, hardware costs were charged to certain long-term projects before the underlying costs were actually incurred. Because these long-term projects are accounted for
Derivative Instruments and Hedging Activities". SFAS 133, as amended by SFAS 137 and SFAS 138, is effective for all fiscal years beginning after June 15, 2000. SFAS 133 establishes new accounting and reporting standards for companies to report information about derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilitiesunder the percentage of completion method, these charges resulted in thebalance sheetrecognition of both sales andmeasure those instruments at fair value. For a derivative not designated as a hedging instrument, changescosts of sales in periods earlier than appropriate. These overstatements of sales and costs of sales occurred during 2003 and were included in thefairCompany's previously issued 10-Q filings for the first three quarters of 2003.2.Overstatement of Program Margins. During 2003, gross margins on certain long-term projects were recorded in excess of the actual gross margins expected to be realized based upon
53
the percentage of completion revenue recognition method. This resulted in an overstatement of sales and gross profit during 2003 and were included in the Company's previously issued 10-Q filings for the first three quarters of 2003.
3.Recognition of Sales and Margin in Excess of Contract Value. During 2003, hardware costs were charged to certain long-term projects which exceeded the aggregate total estimated costs for completion of each of these projects. Sales for these projects were recognized using the original ratio of contract value to estimated total costs at project completion. As a result, underlying project sales were recognized in excess of total contract value. These overstatements of sales and gross margin were included in the Company's previously issued 10-Q filings for the first three quarters of 2003.
Summary of Restated Items
Three months ended Three months ended Three months ended March 28,
2003March 28,
2003Net
EffectJune 27,
2003June 27,
2003Net
EffectSep. 26
2003Sep. 26
2003Net
EffectRestated Previously
ReportedRestated Previously
ReportedRestated Previously
Reported(in thousands, except per share amounts) Sales $ 22,578 $ 22,693 $ (115 ) $ 16,010 $ 22,196 $ (6,186 ) $ 20,765 $ 23,410 $ (2,645 ) Cost of sales 14,998 13,870 1,128 9,924 13,558 (3,634 ) 13,372 14,134 (762 ) Gross profit (loss) (6,986 ) (5,743 ) (1,243 ) 6,086 8,638 (2,552 ) 7,393 9,276 (1,883 ) Operating loss (23,703 ) (22,460 ) (1,243 ) (4,507 ) (1,955 ) (2,552 ) (7,426 ) (5,543 ) (1,883 ) Loss before income taxes (24,543 ) (23,300 ) (1,243 ) (5,005 ) (2,453 ) (2,552 ) (8,228 ) (6,345 ) (1,883 ) Net loss $ (24,275 ) $ (23,032 ) $ (1,243 ) $ (5,124 ) $ (2,572 ) $ (2,552 ) $ (8,040 ) $ (6,157 ) $ (1,883 )
Net loss per common share:
Basic and diluted $ (2.32 ) $ (2.20 ) $ (0.12 ) $ (0.49 ) $ (0.25 ) $ (0.24 ) $ (0.77 ) $ (0.59 ) $ (0.18 ) Comprehensive loss $ (24,248 ) $ (23,005 ) $ (1,243 ) $ (5,059 ) $ (2,507 ) $ (2,552 ) $ (7,819 ) $ (5,936 ) $ (1,883 )
March 28,
2003March 28,
2003Net
EffectJune 27,
2003June 27,
2003Net
EffectSep. 26
2003Sep. 26
2003Net
EffectRestated Previously
ReportedRestated Previously
ReportedRestated Previously
Reported(in thousands, except per share amounts) Costs and estimated earnings in excess of billings on uncompleted contracts $ 19,975 $ 18,630 $ 1,345 $ 14,422 $ 13,077 $ 1,345 $ 12,081 $ 16,924 $ (4,843 ) Total current assets 82,102 80,757 1,345 70,837 69,492 1,345 64,451 69,294 (4,843 ) Total assets $ 110,429 $ 109,084 $ 1,345 $ 98,099 $ 96,754 $ 1,345 $ 90,979 $ 95,822 $ (4,843 )
Customer deposits
$
3,665
$
2,538
$
1,127
$
1,262
$
3,768
$
(2,506
)
$
1,843
$
5,111
$
(3,268
)Billings in excess of costs and estimated earnings on uncompleted contracts 10,684 9,223 1,461 14,140 6,494 7,646 10,996 6,893 4,103 Total current liabilities 50,128 47,540 2,588 39,874 34,734 5,140 39,447 38,612 835 Total liabilities 81,262 78,674 2,588 73,944 68,804 5,140 74,595 73,760 835 Accumulated deficit (17,435 ) (16,192 ) (1,243 ) (22,558 ) (18,763 ) (3,795 ) (30,599 ) (24,921 ) (5,678 ) Total stockholders' equity 29,167 30,410 (1,243 ) 24,155 27,950 (3,795 ) 16,384 22,062 (5,678 ) Total liabilities and stockholders' equity $ 110,429 $ 109,084 $ 1,345 $ 98,099 $ 96,754 $ 1,345 $ 90,979 $ 95,822 $ (4,843 ) There was no net effect due to the errors discovered on cash provided by (used in) operations, cash provided (used in) investing activities, and cash provided by (used in) financing activities in our previously issued quarterly condensed consolidated statements of cash flow in each of the first three quarters of 2003.
54
(4) IMPAIRMENTS
Inventory impairments and impairment losses in 2003, 2002, and 2001 are presented in the table below (dollars in thousands):
2003 2002 2001 Inventory impairment (by product): Harmony 1 $ 10,000 $ — $ — ESIG 3,300 — — TargetView 1,266 — — simFUSION 4000 — 1,392 — Total inventory impairment $ 14,566 $ 1,392 $ — Impairment loss: Fixed assets $ 1,151 $ — $ — Software licenses — 311 — Goodwill — — 220 Total impairment loss $ 1,151 $ 311 $ 220 During the first quarter of 2003 certain significant orders that we had expected to receive as of December 31, 2002, and into early 2003, were canceled by customers. We believe these cancellations were primarily the result of a re-alignment of military spending priorities which occurred during the first quarter of 2003. The future demand for our Harmony 1, ESIG, and TargetView products significantly decreased compared to our prior projections because of these cancellations. As a result, during the quarter ended March 28, 2003, we recorded a $14.6 million impairment to specific inventory and a $1.2 million impairment to certain fixed assets related to the manufacture of these products.
Approximately $10.0 million of the first quarter 2003 impairment related to our Harmony 1 inventory. Through the end of 2002 and into early 2003, we expected to finalize a sale of two Harmony 1 systems, one as an option to a current U.S. government contract and another to a European prime contractor. During March 2003, we received notification from the U.S. customer that it would not purchase the Harmony 1 system, as had been forecasted, due to a decision to migrate to a more current technology, specifically commercial off-the-shelf PCs or our next-generation Harmony 2 product. Feedback from the European prime contractor was quite similar. Thus, the loss of these orders coupled with the overall shift in market demand resulted in our determination that we had excess Harmony 1 inventory on hand. We currently do not have other prospects to sell this excess Harmony 1 inventory, and these components cannot be used in the manufacture of other products. Accordingly, we determined that $10.0 million of inventory related to these systems was impaired. In addition, because we do not expect to sell any additional Harmony 1 systems, we determined we had no further need for certain fixed assets specifically used to build, test, and demonstrate our Harmony 1 product. We recorded an additional impairment related to these fixed assets, as we believe this equipment has no alternative use.
Approximately $3.3 million of the first quarter 2003 impairment related to our ESIG inventory. Through the end of 2002 and into early 2003, we expected to finalize the sale of as many as nine ESIG systems to a particular commercial customer. During March of 2003, we received notification from this customer that it would not purchase the ESIG systems as had been forecasted due to its interest in our
55
next-generation EP™-1000CT technology, which provides enhanced functionality at a comparable price. While we continue to have ESIG related inventory on hand for other forecasted ESIG systems, the loss of this order, coupled with the increased demand for our next-generation EP-1000CT product, caused us to determine that we had inventory in excess of our current purchase orders and forecasted demand.
Approximately $1.3 million of the first quarter 2003 impairment related to our TargetView 100 inventory. In the first quarter of 2003, we had opportunities to propose TargetView 100 technology for a significant number of systems. During this timeframe, we discussed many potential solutions to the customer's requirements and became convinced that the TargetView 100 technology had been superseded by newer technology. In light of this, our business opportunities for TargetView 100 systems have all but been eliminated and has resulted in our determination that we had excess inventory on hand. Accordingly, we determined that $1.3 million of inventory related to these systems was impaired.
In 2002, we recorded an inventory impairment loss of $1.4 million related to our decision to exit the simFUSION 4000 product line. This impairment encompassed the total value of the
derivative are recognized in earnings in the periodsimFUSION 4000 inventory on hand. This decision was based on anticipated reduced demand as a result ofchange. We adopted SFAS 133 as of January 1, 2001. The impact of adopting SFAS 133 was not materialcustomer migration to thefinancial statements.next-generation simFUSION products.In
July 2001, the FASB issued SFAS No. 141, "Accounting for Business Combinations" and No. 142, "Accounting for Goodwill and Other Intangible Assetds". SFAS 141 is effective for E&S beginning July 1, 2001. The Statement establishes accounting and reporting standards for business combinations and prohibits the use2002, we recorded an impairment loss of $0.3 million related to software licenses that were used by employees that were terminated as a result of thepooling-of-interests method of accounting for those transactions after June 30, 2001. SFAS 142 is effective for E&S beginning January 1, 2002. The Statement establishes accounting and reporting standards for goodwill and intangible assets. Beginning January 1,fourth quarter 2002we do not have any goodwill, therefore the impact of adopting SFAS 142 is not expected to be material to the financial statements.reduction-in-force.In
October2001,the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" and No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", that replaces SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of". SFAS 143 is effective for E&S beginning July 1, 2002. The Statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. The impact of adopting SFAS 143 is not expected to be material 54EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) to the financial statements. SFAS 144 establishes one accounting model for long-lived assets to be disposed of by sale and addresses significant implementation issues. SFAS No. 144 is effective for E&S beginning after January 1, 2002. Management does not expect the adoption of this statement to have a material impact on its financial statements. (2) ACQUISITIONS AND DISPOSITIONS In the third quarter of 2001, E&S sold the REALimage group to Real Vision, Inc., a Japanese company. The sale was for a maximum value of $12 million, consisting of cash of $6.3 million plus future royalties, on a when and if earned basis, up to $6 million for REALimage technology, other assets, and the performance of certain development support during a seven-month transition period leading to closing the transaction in April 2002. Real Vision has indicated it will continue the development of the technology, and E&S is maintaining a technical staff to support Real Vision in Salt Lake City during the transition period. As part of the sale of the REALimage Group, E&S closed its offices in Seattle, Washington, and San Jose, California andwe recorded an impairment loss of $0.2 millionrelated tofor the write-off ofcertain remaininggoodwillbalances. E&S is recognizing the proceeds received on the saleacquired in our acquisition ofthe REALimage Group on a percent complete basis over the seven-month transition period endingAccelGraphics, Inc. and Silicon Reality, Inc. inApril, 2002. The gain on sale of business unit recognized through December 31, 2001 is calculated based on the ratio of costs incurred to management's estimate of anticipated costs to be incurred during the transition period and excludes $0.6 million of withholding taxes which have been recorded as income tax expense on the accompanying statement of operations. In the fourth quarter of 2001 we recognized $9.0 million on the sale of certain of our key 3D-graphics patents, which were being held for sale, to NVIDIA Corporation. In December 2000, we completed the divestiture of our German subsidiary via a management-led buyout and recorded a loss of $0.3 million. The former subsidiary, which was called Evans & Sutherland Computer GmbH, now operates under a new name. The divested company has no remaining connection with E&S. We will continue to operate in Germany and throughout Europe under our own name, providing marketing, sales, and support for our growing visual systems business and traditional customer base. On March 28, 2000, we sold certain assets of its Applications Group relating to digital video products to RT-SET Real Time Synthesized Entertainment Technology Ltd. and its subsidiary, RT-SET America Inc., for $1.4 million in cash, common stock of RT-SET Real Time Synthesized Entertainment Technology Ltd. valued at approximately $1.0 million, and the assumption of certain liabilities. On June 15, 2000, we received additional common stock of RT-SET Real Time Synthesized Entertainment Technology Ltd. valued at $1.5 million as consideration for the successful development of a product included in the purchased assets. We recognized a gain of $1.9 million on the sale of these assets. On June 3, 1999, we sold certain of our manufacturing capital assets and inventory of $6.0 million to Sanmina-SCI as part of our efforts to outsource the production of certain electronic products and assemblies. In addition, we entered into an electronic manufacturing services agreement with Sanmina-SCI. The electronic manufacturing services agreement commits E&S to purchase a minimum of $22.0 million of electronic products and assemblies from Sanmina-SCI each year until June 3, 2002. If we fail to meet these minimum purchase levels, subject to adjustment, we may be required to pay 25% of the difference between the $22.0 million and the amount purchased. 55EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (3)1998.(5) INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 31, ------------------------ 2001 2000 --------- ---------Raw materials $ 22,437 $ 26,701 Work-in-process 10,047 9,219 Finished goods 5,742 2,463 --------- --------- $ 38,226 $ 38,383 ========= =========(4)
December 31, 2003 2002 Raw materials $ 6,950 $ 13,597 Work-in-process 3,301 10,467 Finished goods 5,722 7,309 Total inventory $ 15,973 $ 31,373 56
EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, December 31, 2002 and December 31, 2001(6) COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS
Comparative information with respect to uncompleted contracts is summarized as follows (in thousands):
DECEMBER 31, ------------------------ 2001 2000 --------- ---------Accumulated costs and estimated earnings on uncompleted contracts $ 294,774 $ 252,012 Less total billings on uncompleted contracts (272,066) (211,258) --------- --------- $ 22,708 $ 40,754 ========= ========= Costs and estimated earnings in excess of billings on uncompleted contracts $ 47,761 $ 68,464 Billings in excess of costs and estimated earnings on uncompleted contracts (25,053) (27,710) --------- --------- $ 22,708 $ 40,754 ========= =========(5)
December 31, 2003 2002 Accumulated costs and estimated earnings on uncompleted contracts $ 229,970 $ 325,655 Less total billing on uncompleted contracts (230,547 ) (314,594 ) (577 ) $ 11,061 Costs and estimated earnings in excess of billings on uncompleted contracts 10,922 $ 22,083 Billings in excess of costs and estimated earnings on uncompleted contracts (11,499 ) (11,022 ) $ (577 ) $ 11,061 (7) PROPERTY, PLANT AND EQUIPMENT
The cost and estimated useful lives of property, plant and equipment are summarized as follows (dollars in thousands):
DECEMBER 31, ESTIMATED ------------------------ USEFUL LIVES 2001 2000 ------------ --------- ---------Buildings and improvements 40 years $ 42,044 $ 41,343 Manufacturing machinery and equipment 3 to 8 years 75,865 80,212 Office furniture and equipment 8 years 5,546 6,308 Construction-in-process -- 2,329 2,779 --------- --------- 125,784 130,642 Less accumulated depreciation and amortization (83,817) (81,977) --------- --------- $ 41,967 $ 48,665 ========= =========56EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) All buildings
December 31, Estimated
useful lives2003 2002 Buildings and improvements 40 years $ 29,249 $ 29,366 Manufacturing machinery and equipment 3 to 8 years 73,231 76,679 Office furniture and equipment 8 years 5,454 5,410 Construction-in-process — 1,702 128 109,636 111,583 Less accumulated depreciation and amortization (85,521 ) (83,295 ) $ 24,115 $ 28,288 See Note 4 for information concerning impairment of property, plant and
improvements owned by E&S are constructed on land leased from an unrelated third party. Such leases extend for a term of 40 years from 1986, with options to extend two of the leases for an additional 40 years and the remaining five leases for an additional ten years. At the end of the lease term, including any extension, the buildings and improvements revert to the lessor. We have undertaken actions to sell certain buildingsequipment thatare not, or will not be usedoccurred inoperations by us. Accordingly, subsequent to December 31, 2001, we have designated these as assets to be disposed of. (6)2003.(8) LEASES
We lease certain of our buildings and related improvements to third parties under non-cancelable operating leases. Cost and accumulated depreciation of the leased buildings and improvements at December 31, 2001 were $8.9 million and $3.7 million, respectively. RentalSublease rental income for all operating leases for 2003, 2002 and 2001
2000was $0.8 million, $1.3 million, and1999 was$2.2 million,$1.8 million and $1.6 million,respectively.We occupy real property and use certain equipment under lease arrangements that are accounted for as operating leases. Rental expenses for all operating leases for 2003, 2002 and 2001
2000were $3.9 million, $3.9 million, and1999 were$4.0 million,$2.0 million and $2.1 million,respectively.57
At December 31,
2001,2003, the future minimum sublease rental income and lease payments under operating leases that have initial or remaining noncancelable lease terms in excess of one year are as follows (in thousands):
RENTAL RENTAL INCOME COMMITMENT ----------- -----------Year ending December 31, 2002 $ 1,393 $ 3,527 2003 1,265 2,912 2004 180 971 2005 -- 667 2006 -- 665 Thereafter -- 9,460 ----------- ----------- $ 2,838 $ 18,202 =========== ===========57EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (7)
Rental
incomeRental
commitmentYear ending December 31, 2004 $ 237 $ 1,330 2005 — 828 2006 — 764 2007 — 427 Thereafter — 9,232 $ 237 $ 12,581 (9) INVESTMENTS
We had the following investments in
marketable equitysecuritiesadjusted for unrealized holding gains and losses and other-than-temporary declines in fair value, nonmarketable equity securities, adjusted for other-than-temporary declines in fair valueand a joint venture (in thousands):
DECEMBER 31, ------------------------ 2001 2000 --------- ---------Marketable securities: Cypress Semiconductor, Inc. (Cypress) $ -- $ 3,276 vi[z]rt (formerly RT-SET Real Time Synthesized Entertainment Technology Ltd.) 57 358 Iwerks Entertainment, Inc. (Iwerks) 37 9 C3-D Digital Inc. (C3-D) 14 16 --------- --------- 108 3,659 --------- --------- Nonmarketable securities: Quantum Vision, Inc. (Quantum) 500 500 Total Graphics Solutions N.V. (TGS) 500 500 Other 16 16 --------- --------- 1,016 1,016 --------- --------- Investment in joint venture: Quest Flight Training Ltd. 828 754 --------- --------- Total investment securities $ 1,952 $ 5,429 ========= =========
December 31, 2003 2002 Marketable securities available for sale $ 557 $ 112 Nonmarketable securities Quantum Vision Inc., (Quantum) — 500 Total Graphics Solution, N.V. (TGS) 500 500 Other 16 16 Total nonmarketable securities 516 1,016 Investment in joint venture Quest Flight Training Ltd. (Quest) 938 874 Total investment securities $ 2,011 $ 2,002 Quantum is a start-up company that owns patented technology to improve cathode
raytuberay tube (CRT) performance used in large projection systems. TGS develops and markets portable graphics software tools, which provide hardware independence for application developers. Each investment in non-marketable investment securities was made either to enhance a current technology of E&S or to complement our strategic direction.We own, including total shares purchased or available to purchase under warrants, less than
15%5% of the outstanding common stock and common stock equivalents of Quantum and less than 15% of TGS. We have rights to one of six seats on TGS's board of directors. There are no inter-company transactions, technological dependencies, related guarantees, obligations, contingencies, interchange of personnel, nor ability to exercise significant influenceon anyfor either ofthe companies in which we have investments.these companies. Accordingly, we account for Quantum and TGS utilizing the cost method.58
In 2003, we determined that the technology that Quantum was developing was no longer a marketable, leading edge technology that had a foreseeable future. Also it was determined that this technology would not benefit or enhance our current technology or strategic direction. As a result, management determined that the value of the investment had experienced a decline in value that was deemed to be other-than-temporary. As a result, we wrote down the total value of this security.
We have a 50% interest in Quest,
Flight Training Ltd. (Quest),a joint venture with Quadrant Group plc ("Quadrant") providing aircrew training services for the United Kingdom Ministry of Defence ("U.K. MoD") under a30 year30-year contract. The investment is accounted for under the equity method. Equity in earnings of Quest of$74,000 in 2001$64,000, $46,000, and$43,000 in 2000$74,000 is recorded in other income (expense).in 2003, 2002, and 2001, respectively. The financial position and operating results of Quest are immaterial to our financial results.We guarantee a portionIn connection with the services of Quest to the U.K. MoD, during fiscal 2000 we entered into guarantees of various obligations of Quest. As of December 31, 2003, we had four guaranties outstanding related to Quest. Pursuant to the first guaranty, we have guarantied, jointly and severally with Quadrant, the performance of Quest in relation to its contract with the U.K. MoD. If Quest fails to meet its obligations under the contract then we (and Quadrant) are required to perform under the terms of the
joint venture's third-party borrowings. Atcontract. Due to the length of the contract and the uncertainty of performance for which we would be liable if Quest fails to perform, we cannot estimate the maximum amount of possible future payments. This guaranty is in place until 2030. Pursuant to the second guaranty, we have guarantied, jointly and severally with Quadrant, up to a maximum amount of £1.0 million ($1.8 million as of December 31,2001,2003), the performance of Quest,had outstanding debt of $7.4 million. Management believes, based on current facts and circumstanceswhere not subcontracted, and thejoint venture's financial positionperformance of Quest where subcontracted, andoperating results,the subcontractor is not liable to meet its obligation due to any limitation of liability in the sub-contract agreement, thus preventing Quest from meeting its obligation under its contract with the U.K. MoD. This guaranty is in place until 2020. Pursuant to the third guaranty, we have guarantied a certain loan agreement that Quest has entered into by agreeing to have a trustee hold our equity shares in Quest until such time as the loan agreement ends in 2020, or is canceled. In the event of default on this loan agreement, the lending institution can request that thelikelihoodtrustee turn over our equity shares in Quest to satisfy all outstanding amounts against this loan agreement. Pursuant to the fourth guaranty, we have guarantied payment, up to a maximum of £0.13 million ($0.2 million as of December 31, 2003), in the event that Quest has apayment pursuantdefault event, as defined by its loan agreement. This guaranty is in place until 2020. As of December 31, 2003, no amounts have been accrued for any estimated losses under these guaranties because we believe that Quest will meet all of its performance and financial obligations in relation tosuch guarantee is remote.its contract with the U.K. MoD. However, if wewereare required tomake such a paymentperform under any or all of the four guaranties, itwouldcould have a material adverse impact on our operating results and liquidity.58EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) During 2000, we recognized a $6.7 million gain on the sale of our investment in SLM to Cypress in which we received shares of Cypress stock which was offset by a $0.2 million loss on the subsequent sale of certain Cypress shares. During 2001, we sold our remaining interest in Cypress for cash proceeds of $3.8 million. During 2001, 2000 and 1999 we wrote down our investments in marketable securities by $0.3 million, $7.8 million and $0.4 million respectively due to other-than-temporary declines in market value. These amounts are recorded in other income (expense), net in our consolidated statements of operations. (8)59
(10) ACCRUED EXPENSES
Accrued expenses consist of the following (in thousands):
DECEMBER 31, ------------------------ 2001 2000 --------- ---------Compensation and benefits $ 8,880 $ 11,277 Liquidated damages and late delivery penalties 1,500 3,091 Other 6,892 12,159 --------- --------- $ 17,272 $ 26,527 ========= =========On October 16, 1997, E&S and CAE Electronics Ltd. ("CAE") entered into a Sub-Contract (the "Sub-Contract") for E&S to design, develop and deliver the visual system components and visual databases required for certain dynamic mission simulators and tactical control centers, to be integrated with our Harmony image generation equipment (the "Harmony VSC"). As of December 31, 1999, the Harmony VSC had not been integrated with the dynamic mission simulators or tactical control centers. Pursuant to the terms of the Sub-Contract, the integration was to be completed during 1999. Consequently, as of December 31, 1999, in accordance with the liquidated damages provision of the Sub-Contract, we incurred liquidated damages on this Sub-Contract totaling $6.0 million. E&S and CAE agreed to an interim solution, which provides for the installation of our ESIG 4530 image generators to integrate with the dynamic mission simulators and tactical control centers until our Harmony VSC are able to support the dynamic mission simulators and tactical control centers. As of December 31, 2000, integration of a Harmony VSC with a dynamic mission simulator has been tested. A Harmony VSC is currently being installed and integrated with a dynamic mission simulator at the training site. Upon successful completion of the integration, the ESIG 4530 image generators currently installed at the training site will be replaced with Harmony VSCs. We have agreed to pay CAE (i) $0.5 million for reimbursement of certain expenses and costs incurred by CAE relating to the integration and retrofit of the ESIG 4530 to the dynamic mission simulators and tactical control centers and (ii) $5.5 million as liquidated damages resulting from certain delays of the Harmony VSC. As of December 31, 2000, we have paid $6.0 million to CAE. As of December 31, 2001 we have agreed to pay $1.5 million of additional costs incurred by CAE for retrofit of the simulators with the Harmony Visual System (VSC). If further delays in the integration of the Harmony VSC occur, we may be obligated to pay CAE additional penalties. 59EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (9)
December 31, 2003 2002 Compensation and benefits $ 3,924 $ 5,740 Liquidated damages and late delivery penalties 1,734 1,050 Restructuring (see Note 23) 1,611 2,032 Warranty reserve (see Note 2) 1,290 968 Other 3,967 3,303 $ 12,526 $ 13,093 (11) EMPLOYEE RETIREMENT BENEFIT PLANS
Pension Plan (the "Plan")
--We have a defined benefit—Effective April 23, 2002, the Board of Directors approved the redesign of our employee retirement plans to match contemporary market practices and to improve our competitive position by aligning future funding for employee retirement benefits into the 401(k) plan. This action was implemented by amending the Plan to curtail accrual of future benefits under the Plan. At the same time, the 401(k) plan was amended to permit the Board of Directors to grant additional discretionary matching contributions based on our profitability and other financial and operational considerations. This change to the pension plancovering substantially allhad no effect on the benefits vested to current and previous employeeswho have attained age 21 with service in excess of one year.for their past service. Those benefits will be paid on retirement. Retirees currently receiving pension payments are also unaffected. Benefits at normal retirement age (65) are based upon the employee's years of service, as of the date of the curtailment for employees not yet retired, and the employee'shighestcompensationfor any consecutive five ofprior to thelast ten years of employment.curtailment. This pension plan is a funded noncontributory defined benefit pension plan. Our funding policy is to contribute amounts sufficient to satisfy regulatory funding standards, based upon independent actuarial valuations.Supplemental Executive Retirement Plan ("SERP")
--We have—Amendments to curtail the SERP were approved at the May 16, 2002 Board meeting. Those amendments were made for consistency with changes to our pension plan earlier in 2002. Specifically, we changed the executive retirement benefits from defined pension benefits under the SERP, funded solely by E&S, to 401(k) and deferred compensation retirement benefits funded through both employee and Company contributions. As anon-qualified SERP.result of the curtailment, the SERP is now consistent with our pension plan in other areas including closing the SERP to new participants and freezing further SERP gains from any future salary increases. The SERP, which is unfunded, provides eligible executives defined pension benefits, outside our pension plan, based on average earnings, years of service, and age at retirement.The following provides a reconciliation of benefit obligations, plan assets, and funded assets of the Plan and SERP (in thousands):
PENSION PLAN SERP ------------------------ ------------------------ 2001 2000 2001 2000 --------- --------- --------- ---------Change in benefit obligation: Beginning of year $ 43,956 $ 36,904 $ 6,269 $ 5,749 Service cost 2,891 2,460 746 815 Interest cost 3,127 2,759 447 410 Actuarial (gain) loss 200 3,722 (518) (521) Benefits paid (1,075) (1,889) (200) (184) Curtailment -- -- -- -- --------- --------- --------- --------- End of year $ 49,099 $ 43,956 $ 6,744 $ 6,269 ========= ========= ========= ========= Change in plan assets: Fair value at beginning of year $ 44,566 $ 43,721 Actual return on plan assets (333) 2,086 Employer contributions -- 648 Benefits paid (1,075) (1,889) --------- --------- Fair value at end of year $ 43,158 $ 44,566 ========= ========= Reconciliation of funded status: Funded status $ (5,940) $ 610 $ (5,706) $ (6,269) Unrecognized actuarial (gain) loss (4,300) (9,018) (1,241) 68 Unrecognized prior service cost 688 730 -- 495 Unrecognized transition obligation -- 79 -- -- Contribution -- -- 199 -- --------- --------- --------- --------- Accrued benefit liability $ (9,552) $ (7,599) $ (6,748) $ (5,706) ========= ========= ========= ========= Assumptions (weighted average): Discount rate 7.25% 7.8% 7.25% 7.3% Expected return on plan assets 9.0% 9.0% N/A N/A Compensation increase 4.5% 4.5% 4.5% 4.5%60EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Net periodic pension and other postretirement benefit costs include the following components (in thousands):
PENSION PLAN SERP ------------------------------ ------------------------------ 2001 2000 1999 2001 2000 1999 -------- -------- -------- -------- -------- --------Components of net periodic benefit cost: Service cost $ 2,891 $ 2,460 $ 3,252 $ 746 $ 815 $ 739 Interest cost 3,127 2,759 2,892 447 410 418 Expected return on assets (3,921) (3,907) (3,575) -- -- -- Amortization of actuarial (gain) loss (264) (692) -- -- 1 53 Amortization of prior year service cost 41 41 37 48 48 73 Amortization of transition 79 79 79 -- -- -- -------- -------- -------- -------- -------- -------- Net periodic benefit cost $ 1,953 $ 740 $ 2,685 $ 1,241 $ 1,274 $ 1,283 ======== ======== ======== ======== ======== ========401(k) Deferred Savings
Plan--WePlan—We have a deferred savings plan that qualifies under Section 401(k) of the Internal Revenue Code. The plan covers all employees of E&S who have at least one year of service and who are age 18 or older. We make matching contributions on employee contributions. The 401(k) plan was amended on April 23, 2002, to permit the Board of50 percent of each employee's contribution notDirectors toexceed six percent of the employee's compensation.grant additional discretionary matching contributions based on our profitability and other financial and operational considerations. Our contributions to this plan for 2003, 2002 and 20012000 and 1999were$1.1$0.6 million,$1.0$0.9 million and $1.1 million, respectively.60
Executive Savings Plan (ESP)—The ESP is a deferred compensation plan that allows tax-deferred retirement savings beyond the amount that can be contributed to the 401(k) plan. The ESP, a nonqualified plan that does not have the same protections as a qualified 401(k) plan, covers only a select group of management employees. Participants earn matching amounts on their contributions. Consistent with the curtailment of the SERP, the ESP was amended on May 16, 2002 to permit the Board of Directors to grant additional discretionary contributions. This plan is unfunded.
Life
Insurance--WeInsurance—We purchase company-owned life insurance policies insuring the lives ofcertain employees.participants in the ESP. The policies accumulate asset values and exist tomeet future liabilities includingcover thepaymentcost of employeebenefits such assupplemental retirementbenefits.benefit liabilities. At December 31,20012003 and2000,2002, the investment in the policies was$2.7$2.2 million and$3.2$2.0 million, respectively, and net life insurance expense was $0.1 million $0.2 million, and $0.1 million, for 2003, 2002, and$0.22001, respectively.E&S uses a December 31 measurement date for both the Pension Plan and SERP.
Obligations and Funded Status
At December 31 Pension Plan SERP 2003 2002 2003 2002 (in thousands) Change in benefit obligation Benefit obligation at beginning of year $ 38,585 $ 49,099 $ 6,545 $ 6,744 Service cost — 700 451 454 Interest cost 2,533 2,442 480 446 Actuarial (gain) loss 3,591 (6,060 ) 135 156 Benefits paid (5,889 ) (4,021 ) (334 ) (270 ) Assumption change — — 388 454 Curtailment — (3,575 ) — (1,439 ) Benefit obligation at year end $ 38,820 $ 38,585 $ 7,665 $ 6,545 Change in plan assets Fair value at beginning of year $ 36,663 $ 43,158 Actual return on plan assets 254 (2,474 ) Employer contributions — — Benefits paid (5,889 ) (4,021 ) Fair value at end of year $ 31,028 $ 36,663 Funded status $ (7,792 ) $ (1,923 ) $ (7,665 ) $ (6,545 ) Unrecognized net actuarial loss (gain) 2,421 (3,727 ) 614 160 Unrecognized prior service cost (benefit) — — (875 ) (934 ) Net amount recognized $ (5,371 ) $ (5,650 ) $ (7,926 ) $ (7,319 ) 61
Amounts recognized in the balance sheet consist of:
Pension Plan SERP 2003 2002 2003 2002 Prepaid benefit cost $ — $ — $ — $ — Accrued benefit cost (7,792 ) (5,650 ) (7,926 ) (7,319 ) Accumulated other comprehensive income 2,421 — — — Net amount recognized $ (5,371 ) $ (5,650 ) $ (7,926 ) $ (7,319 ) The accumulated benefit obligation for the Pension Plan was $38.8 million and $38.6 million at December 31, 2003 and 2002, respectively. The accumulated benefit obligation for
2001, 2000, 1999,the SERP was $7.7 million and $6.5 million at December 31, 2003 and 2002, respectively.(10) LONG-TERMInformation for pension plans with an accumulated benefit obligation in excess of plan assets
Pension Plan SERP 2003 2002 2003 2002 Projected benefit obligation $ 38,820 $ 38,585 $ 7,665 $ 6,545 Accumulated benefit obligation 38,820 38,585 7,665 6,545 Fair value of plan assets 31,028 36,663 0 0 Components of Net Periodic Benefit Cost
Pension Plan SERP 2003 2002 2001 2003 2002 2001 Service cost $ — $ 700 $ 2,891 $ 451 $ 454 $ 746 Interest cost 2,533 2,442 3,127 480 446 447 Expected return on assets (2,813 ) (3,462 ) (3,921 ) — — — Amortization of actuarial (gain) loss — — (264 ) — — — Amortization of prior year service cost — (16 ) 41 (59 ) (59 ) 48 Curtailment gain — (3,575 ) — — — — Amortization of transition — 10 79 — — — Net periodic benefit cost $ (280 ) $ (3,901 ) $ 1,953 $ 872 $ 841 $ 1,241 Additional Information
Pension Plan SERP 2003 2002 2003 2002 Additional minimum liability included in other comprehensive income $ 2,421 $ — N/A N/A We recorded an additional minimum liability related to our Pension Plan of $2.4 million during 2003 due mainly to a net $5.6 million decrease in related plan assets. Because the accumulated benefit obligation exceeded the fair value of plan assets and the accrued benefit cost (before the additional
62
minimum liability) was less than the unfunded benefit obligation, the additional minimum liability was charged to other comprehensive income.
Assumptions
Weighted-average assumptions used to determine benefit obligations at December 31
Pension Plan SERP 2003 2002 2003 2002 Discount rate 6.25 % 6.75 % 6.25 % 6.75 % Rate of compensation increase N/A N/A N/A N/A Weighted-average assumptions used to determine net periodic benefit cost for years ended December 31
Pension Plan SERP 2003 2002 2003 2002 Discount rate 6.75 % 7.25 % 6.75 % 7.25 % Expected long-term return on plan assets 8.0 % 8.0 % N/A N/A Rate of compensation increase N/A N/A N/A N/A The long term rate of return on plan assets was determined as the weighted average of expected return of each of the asset classes in the target allocation of plan assets. The expected return of each asset class is the investment managers' assessment of future returns. These expectations were compared to historical market returns to ensure that the expected return for each class was a conservative estimate.
Plan Assets
E&S' Pension Plan weighted-average asset allocations at December 31, 2003 and 2002, by asset category, weighted-average planned targeted asset allocations going forward, by asset category, and expected long-returns on plan assets, by category:
Target % 2003
(actual)2002
(actual)Expected
ReturnAllocation of plan assets Cash and cash equivalents 0 % 100 % 100 % 0.0 % Fixed income 45 % 0 % 0 % 2.5 % Domestic equities Small cap growth 15 % 0 % 0 % 1.7 % Large cap growth 15 % 0 % 0 % 1.4 % Large cap value 15 % 0 % 0 % 1.4 % International equities 10 % 0 % 0 % 1.0 % 8.0 % 63
The asset allocation policy, consistent with the long-term growth objectives of the Pension Plan, will be to invest on a diversified basis among the various asset classes as determined by the Plan Administrative Committee. The assets of the Pension Plan were temporarily invested in cash equivalents beginning in September 2002. The Committee has implemented a plan in 2004 to return to the targeted asset allocation. Assets will be invested in a manner that will provide for long-term growth with a goal to achieve returns equal to or greater than applicable benchmarks. Investments will be managed by registered investment advisors. When investing Pension Plan assets, the investment managers of separately managed accounts shall not utilize derivative instruments for speculative purposes or to create leveraged positions.
No equity securities of E&S were part of the Pension Plan assets as of December 31, 2003, and 2002, respectively.
Cash Flow—Contributions
E&S does not expect to make any contributions to either the Pension Plan or the SERP in 2004. Our funding policy is to contribute amounts sufficient to satisfy regulatory funding standards, based upon independent actuarial valuations.
(12) DEBT
Included in long-term debt is approximately $18.0 million of 6% Convertible Subordinated Debentures due in 2012 (the "6% Debentures"). The 6% Debentures are unsecured and are convertible at each bondholder's option into shares of our common stock at a conversion price of $42.10 or 428,000 shares of our common stock subject to adjustment. The 6% Debentures are redeemable at our option, in whole or in part, at par.
61EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)The following is a summary of
linesour line of credit agreements (dollars in thousands):
2001 2000 --------- ---------Balance at end of year $ 20,676 $ 7,345 Weighted average interest rate at end of year 9.1% 12.5% Maximum balance outstanding during the year $ 25,530 $ 7,345 Average balance outstanding during the year $ 13,617 $ 1,612 Weighted average interest rate during the year 10.8% 9.6%
2003 2002 Balance at end of year $ 7,685 $ 7,883 Weighted average interest rate at end of year 6.1 % 5.2 % Maximum balance outstanding during the year $ 11,298 $ 24,647 Average balance outstanding during the year $ 3,054 $ 12,282 Weighted average interest rate during the year 4.1 % 7.8 % The average balance outstanding and weighted average interest rate are computed based on the outstanding balances and interest rates at month-end during each year.
In December 2000, we entered intoE&S has a secured credit facility (the "Foothill Facility") with Wells Fargo Foothill
Capital Corporation("Foothill"). The Foothill Facilitythat provides for borrowings and the issuance of letters of credit up to$30.0$25.0 million.On February 22, 2002, E&S and Foothill amended the Foothill Facility whereby Foothill waived all events of financial covenant default through December 31, 2001 and revised E&S's 2002 financial covenants. The Foothill Facility expires in December 2002. Borrowings under the Foothill Facility bear interest at the Wells Fargo Bank National Association prevailing prime rate plus 1.5% to 3.0%, depending on the amount outstanding. In addition, the Foothill Facility has an unused line fee equal to 0.375% per annum times the difference between $30.0 million and the sum of the average undrawn portion of the letters of credit and the average daily balance of all outstanding borrowings, payable each quarter. The Foothill Facility provides Foothill with a first priority perfected security interest in substantially all of our assets, including, but not limited to, all of our intellectual property. Pursuant to the terms of the Foothill Facility, all cash receipts of E&S must be deposited into a Foothill controlled account.The Foothill Facility, among other things, (i) requires E&S to maintain certain financial ratios and covenants, including aminimum tangible net worthcombined cash and borrowing availability financial covenant that adjusts each quartera minimum unbilled receivables to billed receivables ratio,and a limitation of $12.0 million of aggregate capital expenditures in any fiscal year; (ii) restricts our ability to incur debt or liens; sell, assign, pledge or lease assets; merge with another company; and (iii) restricts the payment of dividends and repurchase of any of our outstanding shares without the prior consent of the lender.Due to Foothill's waiver on February 22, 2002 of E&S's noncompliance with financial covenants throughThe Foothill Facility expires in December31, 2001 and the modification of the financial covenants, we are currently in compliance with its financial covenants and ratios, although a continuation of recent negative trends could impact future compliance with such covenants. Should the need arise, we will negotiate with Foothill to modify and expand various financial ratios and covenants, however no assurance can be given that such negotiations will result in modifications that will allow us to continue to be in compliance or otherwise be acceptable to E&S. E&S will need to replace2004.64
Borrowings under the Foothill Facility bear interest at the Wells Fargo Bank National Association prevailing prime rate plus 3.0% to 4.5%, depending on
or before December 14, 2002.the amount outstanding. Inthe event E&S is not able to obtain an acceptable credit facility to replaceaddition, the Foothill Facility has an unused line fee equal to 0.375% per annum times the difference between $25 million and the sum of the average undrawn portion of the borrowings, payable each quarter. The Foothill Facility provides Foothill with a first priority perfected security interest in substantially all of our assets, including, but not limited to, all of our intellectual property.In March 2003, the Foothill Facility was amended to delete the tangible net worth covenant from the Foothill Facility and replace it with a combined cash and borrowing availability financial covenant that went into effect at the end of our second quarter fiscal-end, June 2003, and is in effect until the Foothill Facility expires. In addition, the interest rate that borrowings bear interest at was amended, from a range of 1.5% to 3.0% to a range of 3.0% to 4.5% over the Wells Fargo Bank, N.A. prevailing prime rate, depending on
or before December 14, 2002, E&S may be unable to meet its anticipated working capital needs, routine capital expenditures, and current debt service obligations onthe amount outstanding. Also, at no time will borrowings under the Foothill Facility bear interest at ashort-term and long-term basis.rate less than 10.25%.As of December 31,
2001, we have $15.72003, E&S had $3.7 million in outstanding borrowings and$6.0$3.6 million in outstanding letters of credit under the Foothill Facility. Our customers can draw against these letters of credit if we fail to meet the performance requirements contained within the terms of each letter of credit. As of December 31, 2003, no amounts have been accrued for any estimated losses under the obligations, as we believe it is probable that we will perform as required under our contracts.Evans & Sutherland Computer Limited, a wholly-owned subsidiary of Evans & Sutherland Computer Corporation, has a $3.0 million overdraft facility (the "Overdraft Facility") with Lloyds TSB Bank plc ("Lloyds"). At the discretion of Lloyds, the maximum amount borrowed against the Overdraft Facility can be increased for a short period of time that is predetermined by Lloyds. Borrowings under the Overdraft Facility bear interest at Lloyds' short-term offered rate plus 1.75% per annum. As of December 31,
2001,2003, there were$4.9$4.0 million in outstanding62EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)borrowings. The Overdraft Facility is subject to reduction or demand repayment for any reason at any time at Lloyds'discretiondiscretion. The Overdraft Facility expired on December 31, 2003. The Overdraft Facility was renewed after December 31, 2003 with essentially the same terms except that the borrowing limit is $2.5 million and it expires onNovember 30, 2002.December 31, 2004. Evans & Sutherland Computer Limited executed a letter of negative pledge in favor of Lloyds whereby it agreed not to sell or encumber its assets, except in the ordinary course of business. Covenants contained in the Overdraft Facility restrict dividend payments from Evans & Sutherland Computer Limited and require maintenance of certain financial covenants. In addition, at December 31,2001,2003, wehave $0.9had $0.8 millionof cashon deposit with Lloyds in a restricted cash collateral account to support certain obligations that the bank guarantees.(11)(13) INCOME TAXES
IncomeThe income tax benefit of $1.0 million for 2003 is primarily attributable to adjustments to prior years tax provisions as a result of favorable resolution of certain worldwide tax contingencies. The income tax benefit of $0.5 million for 2002 is primarily attributable to the carryback of alternative minimum tax net operating losses pursuant to the Job Creation and Workers Assistance Act of 2002. The income tax benefit of $3.2 million for 2001 is primarily attributable to adjustments to prior years tax provisions as a result of
thefavorable resolution of certain worldwide tax contingencies.Included in this amount is $0.6 million for withholding taxes paid in Japan for taxes associated with the REALimage transaction. Components of income taxThe actual expense (benefit)
attributable to earnings before income taxes for 2000 and 1999 are as follows (in thousands):
SHARE AND STOCK OPTION CURRENT DEFERRED BENEFIT TOTAL ----------- ----------- ------------ -----------Year ended December 31, 2000: Federal $ (1,598) $ 17,750 $ -- $ 16,152 State (230) 2,591 -- 2,361 Foreign 510 -- -- 510 ----------- ----------- ----------- ----------- $ (1,318) $ 20,341 $ -- $ 19,023 =========== =========== =========== =========== Year ended December 31, 1999: Federal $ (6,734) $ (6,816) $ 85 $ (13,465) State (150) (2,056) 14 (2,192) Foreign 244 -- -- 244 ----------- ----------- ----------- ----------- $ (6,640) $ (8,872) $ 99 $ (15,413) =========== =========== =========== ===========The actual tax expense differsdiffer from the expected tax expense (benefit) as computed by applying the U.S. federal statutory tax rate of 35 percent, as a result of the following (in thousands):
2001 2000 1999 --------- --------- ---------Tax benefit at U.S. federal statutory rate $ (10,720) $ (17,692) $ (13,603) Losses (gains) of foreign subsidiaries (320) -- -- Adjustment to prior year tax provisions (3,172) -- -- Earnings of foreign sales corporation -- -- (232) State taxes (net of federal income tax benefit) -- 1,521 (1,425) Research and development and foreign tax credits (681) (437) (925) Change in federal valuation allowance 12,599 35,607 -- Other, net (878) 24 772 --------- --------- --------- $ (3,172) $ 19,023 $ (15,413) ========= ========= =========63EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2003 2002 2001 Tax benefit at U.S. federal statutory rate $ (12,936 ) $ (4,264 ) $ (10,720 ) Gains of foreign subsidiaries — (325 ) (320 ) Adjustment to prior year tax provisions (1,002 ) — (3,172 ) State taxes (net of federal income tax benefit) — — — Research and development and foreign tax credits — — (681 ) Change in federal valuation allowance attributable to operations 12,807 3,582 12,599 Other, net 160 544 (878 ) $ (971 ) $ (463 ) $ (3,172 ) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and
deferred taxliabilities as of December 31,20012003 and2000,2002 are presented below (in thousands):
2001 2000 --------- ---------Deferred tax assets: Warranty, vacation, and other accruals $ 5,475 $ 4,481 Inventory reserves and other inventory-related temporary basis differences 3,348 4,407 Pension accrual 6,387 5,204 Long-term contract related temporary differences 882 612 Net operating loss carryforwards 30,538 19,803 Unrealized loss on marketable equity securities -- -- Write-down of investment securities 2,191 2,350 Liquidated damages and late delivery penalties 1,034 134 Credit carryforwards 5,190 4,987 Other 343 332 --------- --------- Total gross deferred tax assets 55,388 42,310 Less valuation allowance 54,094 40,866 --------- --------- Total deferred tax assets 1,294 1,444 --------- --------- Deferred tax liabilities: Intangible assets -- (111) Plant and equipment, principally due to differences in depreciation (1,181) (1,108) Other (113) (225) --------- --------- Total gross deferred tax liabilities (1,294) (1,444) --------- --------- Net deferred tax asset $ -- $ -- ========= =========
2003 2002 Deferred tax assets: Warranty, vacation, and other accruals $ 2,516 $ 3,075 Inventory reserves and other inventory related temporary basis differences 9,037 4,832 Pension accrual 5,931 5,091 Long-term contract related temporary differences 180 181 Net operating loss carryforwards 48,750 38,109 Capital loss carryforwards 44 667 Write-down of investment securities 1,711 1,526 Credit carryforwards 3,561 3,552 Other 285 374 Total gross deferred tax assets 72,015 57,407 Less valuation allowance 71,027 56,796 Total deferred tax assets 988 611 Deferred tax liabilities Plant and equipment, principally due to differences depreciation (959 ) (543 ) Other (29 ) (68 ) Total gross deferred tax liabilities (988 ) (611 ) Net deferred tax asset $ — $ — 66
Worldwide income (loss) before income taxes for the years ended December 31,
2001, 20002003, 2002, and1999,2001 consisted of the following (in thousands):
2001 2000 1999 --------- --------- ---------United States $ (31,570) $ (51,395) $ (40,113) Foreign 941 848 1,246 --------- --------- --------- $ (30,629) $ (50,547) $ (38,867) ========= ========= =========
2003 2002 2001 United States $ (36,960 ) $ (13,140 ) $ (31,570 ) Foreign 1 956 941 $ (36,959 ) $ (12,184 ) $ (30,629 ) We have total federal net operating loss carryovers of
$81.0$130 million, of which,$24.3$26 millionexpireexpires in2021, $45.42023, $26 millionexpireexpires in2020,2022, $22 million expires in 2021, and the remainder expires between 2006 and 2019. We have various tax credit carryovers of$5.2$3.5 million that expire between20032004 and 2021. We also have state net operating loss carryovers that expire depending on the rules of the various states to which the loss is allocated.During the years ended December 31,
20012003 and2000,2002, we increased the valuation allowance on deferred tax assets by approximately$13.2$14.0 million and$40.7$3.6 million, respectively. These amounts relate to an increase in the general valuation allowance established undertheprovisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", which requires that a valuation allowance be established when it is more likely than not that the net deferred tax assets will not be realized.64EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) On March 9, 2002, President Bush signed into law the Jobs Creation and Worker Assistance Act of 1992. Among other provisions, the Act provides for a 5-year carryback of losses generated in 2001 without the normal alternative minimum tax limitation. We expect to be able to generate some additional federal tax refunds due to this new law. (12)(14) DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, receivables, line of credit agreements, accounts payable, and accrued expenses approximates fair value because of their short maturity. The fair value of our 6% Debentures ($
6.810.3 million and$7.9$5.1 million as of December 31,20012003 and2000,2002, respectively) is based on quoted market prices.(13)(15) COMMITMENTS AND CONTINGENCIES
On
November 27, 2000,September 23, 2003, we entered into athree yearpurchase agreement with a third partyto providethat commits E&S to purchase $1.1 million in software licenses and engineering support to be used in product development and future products over a two year period, withcertain copy service, mail service, software and equipment through November 30, 2003. Minimum commitments under this agreement totaled $640,000 atcontinuous one year extensions optional. As of December 31,2001.2003, our remaining commitment totaled $0.5 million.In November 2003, we entered into a settlement agreement with one of our customers. Based on our estimates, we expect that the costs associated with meeting the requirements of the settlement agreement will approximate $1.2 million and we have accrued this amount.
On
September 26, 2000,December 1, 2003 we entered into a purchase agreement with a third party that commits E&S to purchase a minimum$4.5$1.0 million of licensed products and support for design development software. The agreement is effective for a period ofthree years with an option to renew the agreement for an additional two-year term. On June 3, 1999, we entered into an electronic manufacturing services agreement with Sanmina Corporation (now Sanmina-SCI). The agreement commits us to purchase a minimumtwo years. As of$22 million of electronic products and assemblies from Sanmina-SCI each year until June 3, 2002. If we fail to meet these minimum purchase levels, subject to adjustment, we may be required to pay 25 percent of the difference between the $22 million and the amount purchased. We have fully satisfied the requirements of this contract, which ends in June 2002. Various alternatives, which include a renewed contract with Sanmina-SCI, are being evaluated.December 31, 2003, our remaining commitment totaled $1.0 million.Certain of our contracts to deliver Harmony image generators contain liquidated damage provisions for delays in delivery. We incurred
$2.9 million, $0.9$0.6 million and$8.2$2.9 million for such damages in 200367
and 2001,
2000 and 1999,respectively. No damages were incurred in 2002. If further delays in the delivery of the Harmony image generator occur, we may incur additional liquidated damages.(14)(16) LEGAL PROCEEDINGS
LOCKHEED MARTIN CORPORATION V. EVANS & SUTHERLAND COMPUTER CORPORATION (UNITED STATES (MIDDLE) DISTRICT COURT (FLORIDA), CASE NO. 6:00-CV-755-ORL-19C, FILED ON MAY 23, 2000). OnIn May
23, 2000, Lockheed Martin Corporation served E&S with2003, acivil complaint filedclaim was made against the Company by RealVision, Inc. relative to matters arising from the sale of a business unit to RealVision, Inc. in 2001. The parties entered mediation in theCircuit Courtfourth quarter ofthe Ninth Judicial Circuit in2003, andfor Orange County, Florida. Lockheed allegedcontinued discussions into 2004. In March 2004, an agreement was reached under which RealVision will receive a settlement in thecomplaint that we breached a contract to provide certain visual systems for the Combined Arms Tactical Trainer program for the United Kingdom Ministryamount ofDefence. The contract has an original value$2.4 million of$33.9 million. In the complaint, Lockheed seeks compensatory damages of $8.5 million plus interest as well as consequential damages and attorneys' fees. The $8.5 million being sought from E&S by Lockheed was paid to us from May 1999 to March 2000 and was recognized as revenue by us during 1999. On June 12, 2000, we filed its answer and counterclaim. In the counterclaim, we allege as grounds for recovery against Lockheed (1) breach of contract, (2) breach of implied covenant of good faith and fair dealing, (3) unjust enrichment, (4) unfair competition, (5) misappropriation of trade secrets, (6) intentional interference with advantageous business relationship, (7) replevin, and (8) promissory 65EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) estoppel. In its counterclaim, we seek compensatory damages of not less than $10.0 million and not more than $25.4 million. On June 14, 2000, the case was removed to the Orlando Division of the United States District Court for the District of Florida where it currently remains. On July 7, 2000, Lockheed answered our counterclaim but also filed a motion for dismissal of our counterclaims for unjust enrichment, unfair competition, promissory estoppel, and incidental damages. On July 24, 2000, we filed our opposition to Lockheed's motion to dismiss these certain counterclaims of E&S. On October 20, 2000 the court denied Lockheed's motion to dismiss in its entirety, without prejudice. On January 16, 2001, we filed a motion for partial summary judgment, asking the court to dismiss all of Lockheed's breach of contract claims. The court denied that motion on August 30, 2001, citing the existence of material disputed facts. On September 6, 2001 the court granted Lockheed's leave to amend its complaint,whichwas filed on September 17, 2001. We filed a motion to dismiss these new claims on October 4, 2001, and Lockheed has opposed it. The court currently has that motion under advisement. Discovery in the matter is scheduled to conclude on September 30, 2002. A trial date is currently set for March, 2003. We dispute Lockheed's allegations in the complaint, is vigorously defending the action, and is vigorously prosecuting its counterclaims. Although management believesE&S willultimately prevail inpay approximately $0.9 million to resolve this claim, with thelitigation, an unfavorable outcomeremainder ofthese matters would have a material adverse impact on our financial condition and operations.the settlement amount being paid by E&S's insurance carrier. The Company has accrued its portion of the settlement.In the normal course of business, E&S has various other legal claims and other contingent matters, including items raised by government contracting officers and auditors. Although the final outcome of such matters cannot be predicted, we believe the ultimate disposition of these matters
wouldwill not have a material adverse effect on our consolidated financial condition, liquidity or results ofoperations. (15)operations(17) STOCK OPTION AND STOCK PURCHASE PLANS
Stock Option
Plans--WePlans—We have stock incentive plans that provide for the grant of options to officers, employees, consultants, andemployeesindependent contractors to acquire shares of our common stock at a purchase price generally equal to the fair market value on the date of grant. Options generally vest ratably over three years and expire ten years from date of grant. We grant options to our non-employee directors under ourDirectorNon-Employee Directors Plan. Option grants are66EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)limited to 10,000 shares per director in each fiscal year. Options generally vest ratably overfourthree years and expire ten years from the date of grant. A summary of activity follows (shares in thousands):
2001 2000 1999 -------------------------- -------------------------- -------------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE NUMBER EXERCISE NUMBER EXERCISE NUMBER EXERCISE OF SHARES PRICE OF SHARES PRICE OF SHARES PRICE ---------- ---------- ---------- ---------- ---------- ----------Outstanding at beginning of year 2,657 $ 12.63 2,087 $ 14.05 2,084 $ 13.80 Granted 267 7.35 865 9.18 472 14.25 Exercised (3) 5.17 (9) 1.03 (84) 7.72 Canceled (411) 11.76 (286) 13.30 (385) 14.32 ---------- ---------- ---------- Outstanding at end of year 2,510 12.22 2,657 12.63 2,087 14.05 ========== ========== ========== Exercisable at end of year 1,803 1,480 14.12 1,219 14.16 ========== ========== ========== Weighted-average fair value of options granted during the year 1.92 5.91 5.32Shareholders authorized an additional 850,000 and 400,000 shares to be granted under the plans during 2001 and 2000, respectively.
2003 2002 2001 Number
of SharesWeighted-
average
exercise
priceNumber
of SharesWeighted-
average
exercise
priceNumber
of SharesWeighted-
average
exercise
priceOutstanding at beginning of year 2,410 $ 11.58 2,510 $ 12.22 2,657 $ 12.63 Granted 243 5.85 254 5.80 267 7.35 Exercised — 5.88 (12 ) 5.92 (3 ) 5.17 Cancelled (309 ) 8.83 (342 ) 12.17 (411 ) 11.76 Outstanding at end of year 2,344 11.33 2,410 11.58 2,510 12.22 Exercisable at end of year 1,951 12.41 1,879 12.86 1,803 13.45 Weighted-average per share fair value of options granted during the year $ 2.48 $ 2.58 $ 1.92 As of December 31,
2001,2003, options to purchase1,303,000338,530 shares of common stock were authorized and reserved for future grant.68
The following table summarizes information about fixed stock options outstanding as of December 31,
20012003 (options in thousands):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------- ---------------------------- WEIGHTED- NUMBER AVERAGE WEIGHTED- NUMBER WEIGHTED- OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE RANGE OF EXERCISE AS OF CONTRACTUAL EXERCISE AS OF EXERCISE PRICES 12/31/01 LIFE PRICE 12/31/01 PRICE ----------------- ----------- ----------- ----------- ----------- -----------$ 1.21 - $ 8.04 478 8.8 $ 6.75 86 $ 6.06 8.26 - 12.22 546 6.7 11.34 323 11.67 12.23 - 13.25 212 6.0 12.81 185 12.84 13.31 - 13.56 853 6.7 13.56 852 13.56 13.56 - 22.50 419 5.9 16.51 355 16.82 24.38 - 32.88 2 6.0 28.20 2 28.19 1.21 - 32.88 2,510 6.9 12.22 1,803 13.45We account for these plans under APB 25, under which no compensation cost has been recognized. Had compensation cost for these plans been determined consistent with SFAS 123, our net 67EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) loss and loss per common share would have been changed to the following pro forma amounts (in thousands, except per share data):
2001 2000 1999 ----------- ----------- -----------Net loss Pro forma $ (28,352) $ (71,923) $ (26,995) Basic and diluted loss per common share Pro forma (2.79) (7.67) (2.84)The per share weighted-average fair value of stock options granted during 2001, 2000 and 1999 was $1.92, $5.91 and $5.32, respectively.
Options outstanding Options Exercisable Weighted
average
remaining
contractual
lifeRange of exercise prices Number
outstanding
as of
12/31/03Weighted
average
exercise
priceNumber
exercisable
as of
12/31/03Weighted
average
exercise
price$ 3.15 - $ 6.01 442 8.36 $ 5.64 149 $ 5.70 6.03 - 10.69 439 7.02 8.43 339 8.80 11.00 - 13.25 447 3.57 12.26 447 12.26 13.38 - 13.56 669 4.64 13.56 669 13.56 13.57 - 32.88 347 3.87 16.76 347 16.76 3.15 - 32.88 2,344 5.47 11.33 1,951 12.41 The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during
2001, 20002003, 2002, and1999:2001:
2001 2000 1999 --------- --------- ---------Expected life (in years) 2.6 4.5 2.6 Risk-free interest rate 3.0% 6.1% 6.3% Expected volatility 37% 79% 52% Dividend yield -- -- --
2003 2002 2001 Expected life (in years) 2.6 2.5 2.6 Risk-free interest rate 1.5 % 1.4 % 3.0 % Expected volatility 69 % 75 % 37 % Dividend yield — — — Stock Purchase
Plan--WePlan—We have an employee stock purchase plan whereby qualified employees are allowed to have up to 10% of theirannual earningsgross pay withheld each pay period to purchase our common stock at 85% of the market value of the stock at the time of the sale.A total of 500,000 shares are authorized under the plan.Shares totaling63,000, 84,00030,031, 54,000, and58,00063,000, were purchased under this plan in fiscal2001, 20002003, 2002, and1999, and as2001. During the period of December31, 2001, 50,00024, 2002, through February 18, 2003, the Employee Stock purchase Plan was inadvertently oversubscribed in the amount of 10,373 shares,wereleaving no shares available for future issuance under this plan.(16)On February 27, 2003, our Board of Directors increased the number of shares available under this plan from 500,000 to 800,000 shares, and ratified all prior issuances of shares under the plan. As of December 31, 2003, there were 265,751 shares available for purchase under this plan.(18) PREFERRED STOCK
PREFERRED STOCK--CLASS
Preferred Stock—Class A
We have 5,000,000 authorized shares of Class A Preferred Stock. Prior to 1998, we had reserved 300,000 shares of Class A Preferred Stock as Series A Junior Preferred Stock under a shareholder rights plan which expired in November 1998. In November 1998, the Board of Directors declared a dividend of one preferred stock purchase right ("Right") for each outstanding share of common stock, par value $0.20 per share of E&S for shareholders of record on November 19, 1998, and for all future issuances of common stock. The Rights are not currently exercisable or transferable apart from the common stock and do not have voting rights or rights to receive dividends. Each Right entitles the
69
registered holder to purchase from E&S one thousandth of a share of Preferred Stock at a price per share of $60.00, subject to adjustment. The Rights will be exercisable ten business days following a public announcement of a person or group of affiliated persons acquiring beneficial ownership of 15% or more of our outstanding common shares or following the announcement of a tender offer or exchange offer upon the consummation of which would result in the beneficial ownership by a person or group of affiliated persons of 15% or more of the outstanding
Company'sE&S stock. The Rights may be redeemed by E&S at a price of $0.01 per Right before November 30, 2008.68EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)In the event that we are acquired in a merger or other business combination transaction, provision shall be made so that each holder of a Right, excluding the Rights beneficially owned by the acquiring persons, will have the right to receive, upon exercise thereof at the then current exercise price, that number of shares of common shares of the surviving company which at the time of such transaction will have a market value of two times the exercise price of the Right. In the event that a person or group of affiliated persons acquires beneficial ownership of 15% or more of our outstanding common shares, provision shall be made so that each holder of a Right, excluding the Rights beneficially owned by the acquiring persons, shall have the right to receive, upon exercise thereof, a share of common stock at a purchase price equal to 50% of the then current exercise price.
On June 7, 2000, E&S and American Stock Transfer & Trust Company amended the Rights to allow the State of Wisconsin Investment Board to acquire beneficial ownership up to 19.9% of our outstanding common shares without triggering the exercisability of the Rights.
PREFERRED STOCK--CLASS
Preferred Stock—Class B
We have 5,000,000 authorized shares of Class B Preferred Stock. On July 22, 1998, Intel Corporation ("Intel") purchased 901,408 shares of our preferred stock,
plus a warrant to purchase an additional 378,462 shares of the preferred stock at an exercise price of $33.28125 per share for approximately $24.0 million. In March 2001, Intelwhich were subsequently convertedthe 901,408 shares of our preferred stockinto 901,408 shares of our commonstock. In March 2001, Intel and E&S amended the preferred stock and warrant purchase agreement to terminate certain contractual rights of Intel, including registration rights, board and committee observation rights, right of first refusal, right of participation, right of maintenance, standstill agreement, and right to require E&S to repurchase the preferredstock inthe event of any transaction qualifying as a specific corporate event. (17)2001.(19) NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share is computed based on the weighted-average number of common shares and, as appropriate, dilutive common stock equivalents outstanding during the period. Stock options
warrants,and the 6% Debentures are considered to be common stock equivalents.Basic net income (loss) per common share is the amount of net income (loss) for the period available to each share of common stock outstanding during the reporting period. Diluted net income (loss) per share is the amount of net income (loss) for the period available to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the period.
In calculating net loss per common share, the net loss was the same for both the basic and diluted calculation. The diluted weighted average number of common shares outstanding during
2001, 20002003, 2002, and19992001 excludes common stock issuable pursuant to outstanding stock options and the 6% Debenturesand the Class B-1 Preferred Stockbecause to do so would have had an anti-dilutive effect on loss per common share. The total number of common shares excluded from diluted loss per share related to the above was approximately2.22.8 million, 2.8 million, and2.52.9 million in 2003, 2002, and 2001,2000 and 1999,respectively.(18)70
(20) SEGMENT AND RELATED INFORMATION
Our business units have been aggregated into three reportable segments:During 2001, our operations included the Simulation Group, the REALimage Solutions Group and
Applications. These reportable segments offer different products and services and are 69EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) managed and evaluated separately because each segment uses different technologies and requires different marketing strategies. The Simulation segment provides a broad linethe Applications Group. In the third quarter ofvisual systems for flight and ground simulators for training purposes to government, aerospace and commercial airline customers. The REALimage Solutions segment provides graphics acceleration technology to the professional digital content creation market. The Applications segment provides digital video applications for entertainment, educational and multimedia industries. As discussed in Note 2,2001 we sold the REALimage Solutions Group. In the fourth quarter of 2001 we discontinued the RAPIDsite business, which was part of the Applications Group. Also in the fourth quarter of 2001, we consolidated the planetarium equipment business of the Applications Group into the Simulation Group and incorporated the remaining technology of the Applications Group into the Simulation Group. As a result, we had only one reportable segment in 2002 and 2003, thethird quarterdevelopment and marketing of2001. The accounting policies of the segments are the same as those described in the summary of significant accounting policies (Note 1). We evaluate segment performance based on income (loss) from operations before income taxes, interest income and expense, other income and expense and foreign exchange gains and losses. Our assets are not identifiable by segment.
REALIMAGE SIMULATION SOLUTIONS APPLICATIONS TOTAL ------------ ------------ ------------ ------------YEAR ENDED DECEMBER 31, 2001: Sales $ 135,309 $ 1,714 $ 8,240 $ 145,263 Operating income (loss) (31,359) 4,132 (824) (28,051) YEAR ENDED DECEMBER 31, 2000: Sales $ 149,909 $ 5,736 $ 11,335 $ 166,980 Operating loss (43,106) (3,132) (305) (46,543) YEAR ENDED DECEMBER 31, 1999: Sales $ 170,578 $ 21,961 $ 8,346 $ 200,885 Operating loss (8,686) (26,685) (4,595) (39,966)The 2001 operating income amount for the REALimage Solutions segment includes a $9.0 million gain on the sale of assets held for sale, a $0.8 million gain on sale of business unit and an impairment loss of $0.2 million. The restructuring charge of $2.8 million in 2001 affected all segments. The operating loss amount for 2000 for the REALimage Solutions segment included a credit of $0.8 million related to the reversal of restructuring charge accruals established in prior years. The operating loss in 1999 for the Simulation segment includes a write-off of inventories of $12.1 million. The operating loss in 1999 for the REALimage Solutions segment includes an impairment loss of $9.7 million, a restructuring charge of $1.5 million and a write-off of inventories of $1.1 million. 70EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (19)visual simulation systems.(21) GEOGRAPHIC INFORMATION
The following table presents sales by geographic location based on the location of the use of the product or services. Sales within individual countries greater than 10% of consolidated sales are shown separately (in thousands):
2001 2000 1999 --------- --------- ---------United States $ 95,734 $ 106,045 $ 114,190 United Kingdom 26,960 26,584 50,100 Europe (excluding United Kingdom) 10,479 21,723 27,777 Pacific Rim 9,069 8,162 8,324 Other 3,021 4,466 494 --------- --------- --------- $ 145,263 $ 166,980 $ 200,885 ========= ========= =========
2003 2002 2001 United States $ 39,580 $ 74,220 $ 95,734 United Kingdom 11,924 25,821 26,960 Europe (excluding United Kingdom) 15,681 10,287 10,479 Pacific Rim 14,655 8,889 9,069 Other 2,936 3,361 3,021 Total Sales $ 84,776 $ 122,578 $ 145,263 The following table presents property, plant and equipment by geographic location based on the location of the assets (in thousands):
2001 2000 --------- ---------United States $ 40,488 $ 47,777 Europe 1,479 888 --------- --------- Total property, plant and equipment, net $ 41,967 $ 48,665 ========= =========(20)
2003 2002 United States $ 23,332 $ 26,687 Europe 783 1,601 Total property, plant and equipment, net $ 24,115 $ 28,288 (22) SIGNIFICANT CUSTOMERS
SalesIn 2003, sales to the U.S. government
either directlytotaled $15.2 million orindirectly through18% of total sales. We had no other individually significant customers in 2003 based on sales. However, we were dependent on five of our non-U.S. government customers for approximately 25% of our consolidated sales in 2003. In 2002, sales toprime contractors or subcontractors, accounted for $69.5the U.S. government totaled $35.4 million or48%29% of total sales,$66.7 million or 40% of total sales, and $84.5 million or 42% of total sales, in 2001, 2000 and 1999, respectively. Sales to the United Kingdom Ministry of Defence ("UK MOD"), either directly or indirectly through sales to prime contractors or subcontractors, accounted for $13.6 million or 9% of total sales, $22.3 million or 13% of total sales, and $33.8 million or 17% of total sales in 2001, 2000 and 1999, respectively. In 2001,sales to Thales Training & Simulation ("Thales")were $23.9totaled $19.8 million or 16% of totalsales, of which 57% related to UK MODsales, and sales to The Boeing Company ("Boeing")weretotaled $17.1 million or 14% of total sales. In 2001, sales to the U.S. government totaled $35.1 million or 24% of total sales, sales to Thales totaled $23.9 million or 16% of total sales, and sales to Boeing totaled $15.1 million of 10% of totalsales,sales.As of
which 100% related to U.S. government or UK MOD contracts. In 2000, sales to Lockheed Martin Corporation ("Lockheed")December 31, 2003, aggregated accounts receivable from Boeing were$22.5 million or 14% of total sales, of which 100% related to U.S. government and UK MOD contracts and sales to Thales Training & Simulation Ltd. were $19.6$2.5 million or 12% oftotal sales,gross receivables. As ofwhich 58% related to UK MOD contracts. In 1999, sales to LockheedDecember 31, 2002, aggregated accounts receivable from CAE, Inc. were$35.871
$6.1 million or
18%28% oftotal sales,gross accounts receivable and from agencies ofwhich 100% related to U.S.the U. S. governmentand UK MOD contracts, and sales to The Boeing Company ("Boeing")were$25.4$2.9 million or 13% oftotal sales, of which 100% related to U.S. government and UK MOD contracts. Aggregated accounts receivable from agencies of the United States government, either directly or indirectly through prime or subcontractors, was $10.8 million or 29% ofgross accountsreceivable atreceivable.As of December 31,
2001 and $9.3 million or 24% of gross accounts receivable at December 31, 2000. Aggregated accounts receivable from2003, theUK MOD, either directly or indirectly through prime or subcontractors, was $5.4 million or 15% of gross accounts receivable at December 31, 2001 and 71EVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) $2.1 million or 5% of gross accounts receivable at December 31, 2000. Aggregated accounts receivable from the Federal Department of Defense of the Federal Republic of Germany, either directly or indirectly through prime or subcontractors, was $3.3 million or 9% of gross accounts receivable at December 31, 2001 and $10.6 million or 27% of gross accounts receivable at December 31, 2000. Theamount of costs and estimated earnings in excess of billings on uncompleted contractsfrom agenciesrelated to CAE Inc., Fedex Corporation and Indra Systemas S.A. was 30%, 23%, and 11% of theUnited States government and the UK MOD, either directly or indirectly through prime or subcontractors was $9.8 million and $28.7 million, or 21% and 60%total, respectively. As oftotal costs and estimated earnings in excess of billings on uncompleted contracts, respectively, atDecember 31,2001. The2002, the amount of costs and estimated earnings in excess of billings on uncompleted contractsfrom agenciesrelated to CAE, the U.S. government, and Thales was 28%, 21%, and 14% of theUnited States government and the UK MOD, either directly or indirectly through prime or subcontractors, was $16.8 million and $20.5 million, or 25% and 30% oftotal,costs and estimated earnings in excess of billings on uncompleted contracts, respectively, at December 31, 2000. (21)respectively.(23) RESTRUCTURING
CHARGECHARGESIn the third quarter of 2001, we initiated a restructuring plan focused on reducing the operating cost structure of E&S. As part of the plan, we recorded a charge of $2.1 million relating to a reduction in force of approximately 80 employees. In the fourth quarter of 2001, we extended the restructuring plan
initiated in the third quarter. As part of the plan, weand recorded a charge of $0.7 million relating to a reduction in force ofapproximatelyan additional 12 employees. As of December 31, 2001, we had paid $1.9 million in severance benefits related to these restructurings.In the second quarter of 2002, we recorded an additional restructuring charge. As part of this restructuring, we recorded a charge of $1.9 million related to a reduction in force of approximately 90 employees. In the fourth quarter of 2002, we recorded another restructuring charge in order to create an operating cost structure in line with anticipated 2003 sales. As part of this restructuring, we recorded a charge of $2.6 million related to a reduction in force of approximately 140 employees. In 2002 we had a total reduction in force of approximately 230 employees resulting in recorded charges of $4.5 million, and paid $2.5 million in severance benefits.
In the first quarter of 2003, we restructured to reduce our operating costs in line with anticipated sales. As part of this restructuring, we recorded a charge of $1.3 million related to a reduction in force of approximately 50 full-time equivalent employees. In the third quarter of 2003, we restructured to reduce our operating costs to be in line with projected sales and expenses. As part of this restructuring, we recorded a restructuring charge of $2.1 million. This charge primarily related to a reduction in force of approximately 70 full-time equivalent employees. In 2003 we had a total reduction in force of approximately 120 full-time equivalent employees resulting in recorded charges of $3.4 million, and paid approximately $3.8 million in severance benefits.
The majority of
theall remaining benefits will be paid out over 2004. The following table summarizes restructuring charges, severance benefits paid and thenextremaining restructuring accrual for 2003, 2002, and 2001.
Balance at
12/31/02Restructure
chargesSeverance
benefits paidBalance at
12/31/03Remaining 2001 accrual $ 89 $ — $ 49 $ 40 Remaining 2002 accrual 1,943 — 1,614 329 2003 Q1 restructuring provision — 1,279 1,078 201 2003 Q3 restructuring provision — 2,137 1,096 1,041 $ 2,032 $ 3,416 $ 3,837 $ 1,611 72
(24) ASSETS HELD FOR SALE
In 2003 we sold one of the two
quarters. The charge was recorded in accordance with Emerging Issues Task Force Issue 94-03 "Liability Recognitionoffice buildings we had classified as assets held forCertain Employee Termination Benefits and Other Costs to Exit (Including Certain Cost Incurredsale, resulting in aRestructuring)"$1.4 million gain. In 2002, we sold one of three office buildings we had classified as assets held for sale, resulting in a $1.2 million gain. At December 31, 2003, we owned one office building, with a book value of $2.5 million that is being held for sale. This building is no longer depreciated andStaff Accounting Bulletin No. 100, "Restructuring and Impairment Charges".is considered a current asset. We continue to market this property to prospective buyers.In the
thirdfourth quarter of1999, we initiated a restructuring plan focused on reducing the operating cost structure of its REALimage Solutions Group. As part of the plan, we recorded a charge of $1.52001 E&S recognized $9.0 millionrelating to 28 employee terminations, including 17 employees in San Jose and 11 employees in Salt Lake City. During 2000, after all employee severance costs were incurred, we reversed $0.8 million of the 1999 restructuring charge as a result of certain employees being transferred within E&S rather than being terminated and estimated severance and related charges being lower than expected for the terminated employees. (22) RELATED PARTY TRANSACTIONS We had purchases of $0.4 million during 1999, from a supplier for which our Chief Executive Officer serves as a director. (23) REALIMAGE TRANSITION COSTS Early in 2001, we announced our intention to spin out or sell its REALimage Solutions Group. Therefore, we categorized all the costs and expenses associated with the REALimage Solutions Group from the beginning of 2001 untilupon the sale ofthe business in the third quartercertain of2001 in the REALimage transition costs expense category. These expenses totaled $5.3 million. 72our key 3D-graphics patents, which were being held for sale, to NVIDIA Corporation. 73
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE"None"
FORMITEM 9A. CONTROLS AND PROCEDURES
As of the end of the fiscal quarter ended December 31, 2003, we carried out an evaluation, under the supervision and with the participation of the principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2003. Disclosure controls and procedures are controls and procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in our reports filed with the SEC is accumulated and communicated to management, including the chief executive officer and chief financial officer to allow timely decisions regarding required disclosure.
Based on this evaluation, and except as discussed in the following paragraphs, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. To enhance our disclosure control procedures, we added a Disclosure Review Board to our process. This requires every executive, senior staff, and our legal counsel to participate in the planning, scheduling, drafting, and/or review process and to notify the Company's chief financial officer of their completion of their associated tasks. It should be noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
Evaluation of our internal controls and procedures related to the restatement. Our evaluation of our internal controls and procedures included an in depth review of all aspects of the matter of certain material weaknesses we identified in the internal controls and procedures of our wholly-owned subsidiary, Evans & Sutherland Computer Limited ("E&S Ltd.") as more fully disclosed in Note 3 of the Notes to Consolidated Financial Statements included as part of this Form 10-K, and an in depth review of all aspects of the matter by the Audit Committee, the results of which are described below.
Management and the Audit Committee took a leadership role in assessing the underlying issues giving rise to the restatement and in ensuring proper steps were taken to improve our internal control environment. Based on all information gathered during our in depth review of all aspects of the matter, we cannot conclude that there was misconduct or intentional use of improper accounting practices to manipulate earnings or any fraud or intentional misconduct on the part of our officers or employees. The Audit Committee, however, also concluded that our accounting, financial reporting and internal control functions needed improvement, including our system of documenting transactions. The Audit Committee determined that our management has proactively identified a number of these issues and has appropriately taken steps to address them.
Actions taken in response to our evaluation. As a result of our findings described above, during the first quarter of 2004, we began implementing the following improvements to our internal control procedures and our disclosure controls and procedures to address the issues we identified in our evaluation of the these controls and procedures and those of our subsidiary, E&S Ltd.:
- •
- We have altered our reporting structure so that the finance director of E&S Ltd. reports directly to our Chief Financial Officer.
- •
- We are establishing new internal control processes to remedy the problems identified.
74
- •
- We have appointed a Director of Internal Control whose primary responsibilities are to oversee the establishment of formalized policies and procedures throughout our organization and to document and assess our system of internal controls.
- •
- We are instituting more rigorous procedures for quarter-end analysis of balance sheet and income statement accounts, period-end reconciliations of subsidiary ledgers, and the correction of reconciling items in a timely manner. We are also enhancing our accounting documentation policies.
- •
- We are adopting, for the financial controls and procedures employed at E&S Ltd., the process currently employed by E&S whereby E&S uses monthly sales audit schedules and reconciles such schedules to the general ledger.
- •
- We are instituting new procedures around our quarterly reporting processes whereby significant accounting issues are discussed and documented, reviewed with our external auditors and the Audit Committee, formally approved by our management, and given timely effect in our books and records.
- •
- We will reconcile, on a monthly basis, operational assessments of the status of completion of each contract program and the financial accounting and reporting of such status.
We believe that our internal controls and procedures and our disclosure controls and procedures have now been improved due to the scrutiny of such controls and procedures by management and the Audit Committee. We believe our internal controls and procedures and our disclosure controls and procedures will continue to improve as we complete the implementation of the actions described above.
Based in part upon these changes, our CEO and CFO believe that as of the filing date of this Annual Report on Form 10-K, our disclosure controls and procedures are reasonably designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.
Other than as described above, there have been no significant changes in our internal controls and procedures identified in our in depth review of those accounting practices and errors giving rise to our restatement that have materially affected, or are reasonably likely to materially affect, our internal controls and procedures subsequent to the date of our evaluation.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding our directors is incorporated by reference from "Election of Directors" section in the Proxy Statement to be delivered to shareholders in connection with the
20022004 Annual Meeting of Shareholders to be held on May16, 2002.18, 2004.Information required by Item 405 of Regulation S-K is incorporated by reference from "Compliance with Section 16(a) of the Securities Exchange Act of 1934" section in the Proxy Statement to be delivered to shareholders in connection with the
20022004 Annual Meeting of Shareholders to be held on May16, 2002.18, 2004.Information concerning our current executive officers is incorporated by reference to the section in Part I hereof found under the the caption "Executive Officers of the Registrant."
All other information regarding directors and officers is herein incorporated by reference from the Proxy Statement to be delivered to shareholders in connection with the 2004 Annual Meeting of Shareholders to be held on May 18, 2004.
ITEM 11. EXECUTIVE COMPENSATIONInformation regarding this item is incorporated by reference from "Executive Compensation" section in the Proxy Statement to be delivered to shareholders in connection with the
20022004 Annual Meeting of Shareholders to be held on May16, 2002.18, 2004.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERSInformation regarding this item is incorporated by reference from "Security Ownership of Certain Beneficial Owners and Management" section in the Proxy Statement to be delivered to shareholders in connection with the
20022004 Annual Meeting of Shareholders to be held on May16, 2002.18, 2004.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSInformation regarding this item is incorporated by reference from the "Election of Directors" and "Executive
Compensation--Summary Compensation Table," "Report of the Compensation and Stock Options Committee of the Board of Directors," and "Termination of Employment and Change of Control Arrangements,"Compensation" sections in the Proxy Statement to be delivered to shareholders in connection with the20022004 Annual Meeting of Shareholders to be held on May16, 2002. 73FORM 10-K18, 2004.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICESInformation regarding this item is incorporated by reference from "Report of the Audit Committee of the Board of Directors" section in the Proxy Statement to be delivered to shareholders in connection with the 2004 Annual Meeting of Shareholders to be held on May 18, 2004.
76
ITEM
14.15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-KThe following constitutes a list of Financial Statements, Financial Statement Schedules, and Exhibits required to be used in this report:
- 1.
- Financial
Statements--IncludedStatements—Included in Part II, Item 8 of this report:Report of Management Report of Independent Auditors
Consolidated Balance Sheets as of December 31,
20012003 and20002002Consolidated Statements of Operations for each of the years in the three-year period ended December 31,
20012003Consolidated Statements of Comprehensive Loss for each of the years in the three-year period ended December 31,
20012003Consolidated Statements of Stockholders' Equity for each of the years in the three-year period ended December 31,
20012003Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31,
20012003Notes to Consolidated Financial Statements for each of the years in the three-year period ended December 31,
20012003
- 2.
- Financial Statement
Schedules--includedSchedules—included in Part IV of this report:
Schedule
II--ValuationII—Valuation and Qualifying AccountsSchedules other than those listed above are omitted because of the absence of conditions under which they are required or because the required information is presented in the financial statements or notes thereto.
- 3.
Exhibits 2.1 Agreement and Plan of Merger, dated April 22, 1998, among Evans & Sutherland Computer Corporation, E&S Merger Corp., and AccelGraphics, Inc., filed as Annex I to Evans & Sutherland Computer Corporation's Registration Statement- Reports on Form
S-4,8-K
On October 16, 2003, the Company furnished to the SEC
File No. 333-51041, and incorporated hereina Current Report pursuant to Item 9 of Form 8-K, "Regulation FD Disclosure." In the Report, the Company disclosed its announcement bythis reference. 3.1 Articlespress release on the same date ofIncorporation, as amended, filed as Exhibit 3.1 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771,the Company's financial results for thefiscal yearthree and nine months endedDecember 25, 1987, and incorporated herein by this reference. 3.1.1 Amendments to ArticlesSeptember 26, 2003. The Company included in the Report unaudited Summary Statements ofIncorporation filed as Exhibit 3.1.1 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771,Consolidated Operations for thefiscal year ended December 30, 1988,three andincorporated herein by this reference. 3.1.2 Certificate of Designation, Preferences and Other Rights of the Class B-1 Preferred Stock of Evans & Sutherland Computer Corporation, filed as Exhibit 3.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarternine months ended September25, 1998,26, 2003, Condensed Consolidated Balance Sheets dated September 26, 2003, andincorporated herein by this reference. 743.2 Amended and Restated Bylaws of Evans & Sutherland Computer Corporation, filed as Exhibit 3.2 to Evans & Sutherland Computer Corporation's Form 10-K for the year endedDecember 31,2000,2002, andincorporated herein by this reference. 3.3 Amendment No. 1 totheAmendedCompany's backlog as of September 26, 2003, andRestated Bylaws of Evans & Sutherland Computer Corporation, filed as Exhibit 3.3 to Evans & Sutherland Computer Corporation's Form 10-K for the year endedDecember 31,2000, and incorporated herein by this reference. 4.1 Form of Rights Agreement, dated as of November 19, 1998, between Evans & Sutherland Computer Corporation and American Stock Transfer Trust Company which includes as Exhibit A, the form of Certificate of Designation for the Rights, as Exhibit B, the form of Rights Certificate and as Exhibit C, a Summary of Rights, filed as Exhibit 1 to Evans & Sutherland Computer Corporation's Registration Statement on Form 8-A filed December 8, 1998, and incorporated herein by this reference. 4.22002.
- 4.
- Exhibits
2.1 Agreement and Plan of Merger, dated April 22, 1998, among Evans & Sutherland Computer Corporation, E&S Merger Corp., and AccelGraphics, Inc., filed as Annex I to Evans & Sutherland Computer Corporation's Registration Statement on Form S-4, SEC File No. 333-51041, and incorporated herein by this reference.
3.1
Articles of Incorporation, as amended, filed as Exhibit 3.1 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 25, 1987, and incorporated herein by this reference.
3.1.1
Amendments to Articles of Incorporation filed as Exhibit 3.1.1 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 30, 1988, and incorporated herein by this reference.77
3.1.2
Certificate of Designation, Preferences and Other Rights of the Class B-1 Preferred Stock of Evans & Sutherland Computer Corporation, filed as Exhibit 3.1 to Evans & Sutherland Computer Corporation's Form 10-Q, SEC File No. 000-08771, for the quarter ended September 25, 1998, and incorporated herein by this reference.
3.2
Amended and Restated Bylaws of Evans & Sutherland Computer Corporation, filed as Exhibit 3.2 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
3.3
Amendment No. 1 to the Amended and Restated Bylaws of Evans & Sutherland Computer Corporation, filed as Exhibit 3.3 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
4.1
Form of Rights Agreement, dated as of November 19, 1998, between Evans & Sutherland Computer Corporation and American Stock Transfer Trust Company which includes as Exhibit A, the form of Certificate of Designation for the Rights, as Exhibit B, the form of Rights Certificate and as Exhibit C, a Summary of Rights, filed as Exhibit 1 to Evans & Sutherland Computer Corporation's Registration Statement on Form 8-A filed December 8, 1998, and incorporated herein by this reference.
4.2
First Amendment to Rights Agreement dated as of June 7, 2000 between Evans & Sutherland Computer Corporation and American Stock Transfer & Trust Company, filed as Exhibit 10.14 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference.
*10.1
1985 Stock Option Plan, as amended, filed as Exhibit 1 to Evans & Sutherland Computer Corporation's Post-Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 2-76027, and incorporated herein by this reference.
*10.2
1989 Stock Option Plan for Non-employee Directors, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1989, and incorporated herein by this reference.
*10.3
1991 Employee Stock Purchase Plan of Evans & Sutherland Computer Corporation, as amended as of February 21, 2001, filed as exhibit 4.1 to Evans & Sutherland Computer Corporation's Post Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 33-39632, and incorporated herein by this reference.
*10.4
Evans & Sutherland Computer Corporation 1998 Stock Option Plan, as amended as through May 17, 2000, filed as exhibit 4.1 to Evans & Sutherland Computer Corporation's Post Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 333-58733, and incorporated herein by this reference.
*10.5
Evans & Sutherland Computer Corporation's 1995 Long-Term Incentive Equity Plan, filed as Exhibit 10.11 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1995, and incorporated herein by this reference.
10.6
Series B Preferred Stock and Warrant Purchase Agreement dated as of July 20, 1998, between Evans & Sutherland Computer Corporation and Intel Corporation, filed as Exhibit 4.2 to Evans & Sutherland Computer Corporation's Form 10-Q, SEC File No. 000-08771, for the quarter ended September 25, 1998, and incorporated herein by this reference.78
10.7
Warrant to Purchase Series B Preferred Stock dated as of July 22, 1998, between Evans & Sutherland Computer Corporation and Intel Corporation, filed as Exhibit 4.3 to Evans & Sutherland Computer Corporation's Form 10-Q, SEC File No. 000-08771, for the quarter ended September 25, 1998, and incorporated herein by this reference.
*10.8
Employment agreement between Evans & Sutherland Computer Corporation and James R. Oyler, dated May 16, 2000, filed as Exhibit 10.6 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference.
10.9
Overdraft Facility dated June 15, 2000 between Evans & Sutherland Computer Limited and Lloyds TSB Bank plc, filed as Exhibit 10.12 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference.
*10.10
Amendment to employment agreement between Evans & Sutherland Computer Corporation and James R. Oyler, dated September 22, 2000, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference.
10.11
Loan and Security Agreement by and between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.41 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 2000, and incorporated herein by this reference.
10.12
Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.42 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference herein.
10.13
Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.43 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference herein.
10.14
Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.44 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.15
Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2000, filed as Exhibit 10.45 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.16
Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2000, filed as Exhibit 10.46 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.17
Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2000, filed as Exhibit 10.47 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.79
10.18
Pledge and Security Agreement between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.48 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.19
Intellectual Property Security Agreement between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.49 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.20
Amendment No. 1 to Series B Preferred Stock and Warrant Purchase Agreement between Evans & Sutherland Computer Corporation and Intel Corporation, dated effective as of March 1, 2001, filed as Exhibit 10.50 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference.
10.21
Asset Purchase and Intellectual Property License Agreement between Real Vision Inc. and Evans & Sutherland Computer Corporation, dated August 31, 2001, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference.
10.22
Initial License Agreement between Real Vision Inc. and Evans & Sutherland Computer Corporation, dated August 31, 2001, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference.
10.23
Foothill Covenant waiver for the third quarter 2001, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference.
10.24
Amendment Number One to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated February 22, 2002, filed as Exhibit 10.56 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2001, and incorporated herein by reference.
10.25
Patent Purchase and License Agreement between Nvidia International Inc., Evans & Sutherland Computer Corporation, and Evans & Sutherland Graphics Corporation, dated October 15, 2001, filed as Exhibit 10.57 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2001, and incorporated herein by this reference.
10.26
Patent Cross License Agreement between Nvidia Corporation and Evans & Sutherland Computer Corporation, dated October 15, 2001, filed as Exhibit 10.58 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2001, and incorporated herein by this reference. Certain information in this exhibit was omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request under Rule 24b-2 of the Securities and Exchange Act of 1934, as amended.
10.27
Amendment Number Two to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated August 14, 2002, filed as Exhibit 10.30 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
10.28
Amendment Number Three to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated December 11, 2002, filed as Exhibit 10.31 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.80
10.29
Amendment Number Four to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated January 8, 2003, filed as Exhibit 10.32 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
10.30
Foothill Limited Waiver of Certain Financial Covenants for the second quarter 2002 by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated July 24, 2003, filed as Exhibit 10.33 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
10.31
Overdraft Facility Continuation agreement between Evans & Sutherland Computer Limited and Lloyds TSB Bank plc, dated February 18, 2003, filed as Exhibit 10.34 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
*10.32
Employment agreement between Evans & Sutherland Computer Corporation and L. Eugene Frazier, dated August 26, 2002, filed as Exhibit 10.35 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
*10.33
Amended and restated employment agreement between Evans & Sutherland Computer Corporation and David B. Figgins, dated August 26, 2002, filed as Exhibit 10.37 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
*10.34
Amended and restated Evans & Sutherland Computer Corporation's Supplemental Executive Retirement Plan (SERP), dated May 16, 2002, filed as Exhibit 10.38 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
*10.35
Amended and restated Evans & Sutherland Computer Corporation's Executive Savings Plan, dated May 16, 2002, filed as Exhibit 10.39 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
10.36
Consent and Subordination Agreement by Foothill Capital Corporation, dated December 14, 2002, filed as Exhibit 10.40 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2002, and incorporated herein by reference.
*10.37
Amended and restated employment agreement between Evans & Sutherland Computer Corporation and E. Thomas Atchison, dated July 1, 2003, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 26, 2003, and incorporated herein by reference.
10.38
Amendment Number Five to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated July 16, 2003, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 26, 2003, and incorporated herein by reference.
10.39
Amendment Number Six to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated July 25, 2003, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 26, 2003, and incorporated herein by reference.
21.1
Subsidiaries of Registrant, filed herein.
23.1
Consent of Independent Auditors, filed herein.81
24.1
Powers of Attorney for Messrs. James R. Oyler, E. Thomas Atchison, Gerald S. Casilli, Wolf-Dieter Hass, David J. Coghlan, and William Schneider, filed herein.
31.1
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, filed herein.
31.2
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended, filed herein.
32
Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herein.
- *
10.1 1985 Stock Option Plan, as amended, filed as Exhibit 1 to Evans & Sutherland Computer Corporation's Post-Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 2-76027, and incorporated herein by this reference. * 10.2 1989 Stock Option Plan for Non-employee Directors, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1989, and incorporated herein by this reference. * 10.3 1991 Employee Stock Purchase Plan of Evans & Sutherland Computer Corporation, as amended as of February 21, 2001, filed as exhibit 4.1 to Evans & Sutherland Computer Corporation's Post Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 33-39632, and incorporated herein by this reference. * 10.4 Evans & Sutherland Computer Corporation 1998 Stock Option Plan, as amended as through May 17, 2000, filed as exhibit 4.1 to Evans & Sutherland Computer Corporation's Post Effective Amendment No. 1 to Registration Statement on Form S-8, SEC File No. 333-58733, and incorporated herein by this reference. * 10.5 Evans & Sutherland Computer Corporation's 1995 Long-Term Incentive Equity Plan, filed as Exhibit 10.11 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1995, and incorporated herein by this reference. * 10.6 Evans & Sutherland Computer Corporation's Executive Savings Plan, filed as Exhibit 10.14 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1995, and incorporated herein by this reference. * 10.7 Evans & Sutherland Computer Corporation's Supplemental Executive Retirement Plan (SERP), filed as Exhibit 10.15 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K, SEC File No. 000-08771, for the fiscal year ended December 29, 1995, and incorporated herein by this reference. 10.8 Business Loan Agreement by and between U.S. Bank National Association and Evans & Sutherland Computer Corporation as of November 13, 1998, filed as Exhibit 10.8 to Evans & 75Sutherland Computer Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and incorporated herein by this reference. 10.9 Addendum to Business Loan Agreement by and between U.S. Bank National Association and Evans & Sutherland Computer Corporation as of February 5, 1999, filed as Exhibit 10.9 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and incorporated herein by reference. 10.11 Series B Preferred Stock and Warrant Purchase Agreement dated as of July 20, 1998, between Evans & Sutherland Computer Corporation and Intel Corporation, filed as Exhibit 4.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 25, 1998, and incorporated herein by this reference. 10.12 Warrant to Purchase Series B Preferred Stock dated as of July 22, 1998, between Evans & Sutherland Computer Corporation and Intel Corporation, filed as Exhibit 4.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 25, 1998, and incorporated herein by this reference. 10.13 Master Agreement for Electronic Manufacturing Services, dated as of June 3, 1999, between Evans & Sutherland Computer Corporation and Sanmina Corporation, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended July 2, 1999, and incorporated herein by this reference. 10.14 Loan Agreement by and between Zions First National Bank, a national banking association, and Evans & Sutherland Computer Corporation, dated March 31, 2000, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000 and incorporated herein by this reference. 10.15 $15,000,000 Promissory Note in favor of Zions First National Bank, a national banking association, dated March 31, 2000, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 10.16 Trust Deed, Assignment of Rents, Security Agreement and Fixture Filing executed by Evans & Sutherland Computer Corporation to Zions First National Bank, a national banking association, in favor of Zions First National Bank, a national banking association, dated March 31, 2000, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 10.17 Assignment of tenant's Interest in Ground Lease for Security executed by Evans & Sutherland Computer Corporation and Zions First National Bank, a national banking association, dated March 31, 2000, filed as Exhibit 10.4 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 10.18 Assignment of Lease by Evans & Sutherland Computer Corporation and Zions First National Bank, a national banking association, dated March 31, 2000, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 10.19 Commercial Credit and Security Agreement, dated March 2, 1998, between Evans & Sutherland Computer Corporation and First Security Bank, N.A., filed as Exhibit 10.6 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 7610.20 Modification Agreement dated February 22, 2000, between Evans & Sutherland Computer Corporation and First Security Bank, N.A., filed as Exhibit 10.7 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended March 31, 2000, and incorporated herein by this reference. 10.21 Letter of Credit and Reimbursement Agreement between Evans & Sutherland Computer Corporation and Zions First National Bank, dated April 24, 2000, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 10.22 Supplemental Letter of Credit and Reimbursement Agreement between Evans & Sutherland Computer Corporation and Zions First National Bank, dated May 31, 2000, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 10.23 Managed Agency Account Assignment Agreement between Evans & Sutherland Computer Corporation and Zions First National Bank, dated May 31, 2000, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 10.24 Second Loan Modification Agreement made and entered into effective June 30, 2000 by and among Evans & Sutherland Computer Corporation, Evans & Sutherland Computer GmbH, Evans & Sutherland Computer Limited, Evans & Sutherland Graphics Corporation and Zions First National Bank, a national banking association, filed as Exhibit 10.4 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 10.25 $15,000,000 Renewal and Substitute promissory Note in favor of Zions First National Bank, a national banking association, dated June 30, 2000, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.26 Employment agreement between Evans & Sutherland Computer Corporation and James R. Oyler, dated May 16, 2000, filed as Exhibit 10.6 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.27 Employment agreement between Evans & Sutherland Computer Corporation and Richard J. Gaynor, dated May 16, 2000, filed as Exhibit 10.7 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.28 Employment agreement between Evans & Sutherland Computer Corporation and David B. Figgins, dated May 16, 2000, filed as Exhibit 10.8 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.29 Employment agreement between Evans & Sutherland Computer Corporation and George K. Saul, dated May 16, 2000, filed as Exhibit 10.9 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.30 Employment agreement between Evans & Sutherland Computer Corporation and Robert H. Ard, dated May 16, 2000, filed as Exhibit 10.10 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 77* 10.31 Employment agreement between Evans & Sutherland Computer Corporation and Thomas Atchison, dated July 25, 2000, filed as Exhibit 10.11 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. 10.32 Overdraft Facility dated June 15, 2000 between Evans & Sutherland Computer Limited and Lloyds TSB Bank plc, filed as Exhibit 10.12 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended June 30, 2000, and incorporated herein by this reference. * 10.33 Amendment to employment agreement between Evans & Sutherland Computer Corporation and James R. Oyler, dated September 22, 2000, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.34 Amendment to employment agreement between Evans & Sutherland Computer Corporation and Richard J. Gaynor, dated September 22, 2000, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.35 Amendment to employment agreement between Evans & Sutherland Computer Corporation and David B. Figgins, dated September 22, 2000, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.36 Amendment to employment agreement between Evans & Sutherland Computer Corporation and George K. Saul, dated September 22, 2000, filed as Exhibit 10.4 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.37 Amendment to employment agreement between Evans & Sutherland Computer Corporation and Robert H. Ard, dated September 22, 2000, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.38 Amendment to employment agreement between Evans & Sutherland Computer Corporation and Thomas Atchison, dated September 22, 2000, filed as Exhibit 10.6 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.39 Employment agreement between Evans & Sutherland Computer Corporation and Nicholas J. Iuanow, dated September 22, 2000, filed as Exhibit 10.7 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 29, 2000, and incorporated herein by this reference. * 10.40 Employment agreement between Evans & Sutherland Computer Corporation and William M. Thomas, dated December 22, 2000, filed as Exhibit 10.40 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference herein. 10.41 Loan and Security Agreement by and between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2000, filed as Exhibit 10.41 to Evans & Sutherland Computer Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, and incorporated herein by this reference. 10.42 Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill 78Capital Corporation, dated December 14, 2001, filed as Exhibit 10.42 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference herein. 10.43 Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill Capital Corporation, dated December 14, 2001, filed as Exhibit 10.43 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference herein. 10.44 Leasehold Deed of Trust, Assignment of Rents, Security Agreement and Fixture filing between Evans & Sutherland Computer Corporation, Chicago Title Company, Foothill Capital Corporation, dated December 14, 2001, filed as Exhibit 10.44 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.45 Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2001, filed as Exhibit 10.45 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.46 Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2001, filed as Exhibit 10.46 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.47 Absolute Assignment of Sub-Leases and Rent by Evans & Sutherland Computer Corporation, dated December 14, 2001, filed as Exhibit 10.47 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.48 Pledge and Security Agreement between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2001, filed as Exhibit 10.48 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.49 Intellectual Property Security Agreement between Evans & Sutherland Computer Corporation and Foothill Capital Corporation, dated December 14, 2001, filed as Exhibit 10.49 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.50 Amendment No. 1 to Series B Preferred Stock and Warrant Purchase Agreement between Evans & Sutherland Computer Corporation and Intel Corporation, dated effective as of March 1, 2001, filed as Exhibit 10.50 to Evans & Sutherland Computer Corporation's Form 10-K for the year ended December 31, 2000, and incorporated herein by this reference. 10.51 Asset Purchase and Intellectual Property License Agreement between Real Vision Inc. and Evans & Sutherland Computer Corporation, dated August 31, 2001, filed as Exhibit 10.1 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference. 10.52 Initial License Agreement between Real Vision Inc. and Evans & Sutherland Computer Corporation, dated August 31, 2001, filed as Exhibit 10.2 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference. 7910.53 Foothill Covenant waiver for the third quarter 2001, filed as Exhibit 10.3 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference. 10.54 Master Sales Agreement between Evans & Sutherland Computer Corporation and ATI Technologies Inc., dated August 27, 2001, filed as Exhibit 10.4 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference. 10.55 Software License Agreement between Evans & Sutherland Computer Corporation and ATI Technologies Inc., dated August 27, 2001, filed as Exhibit 10.5 to Evans & Sutherland Computer Corporation's Form 10-Q for the quarter ended September 28, 2001, and incorporated herein by reference. 10.56 Amendment Number One to Loan and Security Agreement and Waiver by and between Foothill Capital Corporation and Evans & Sutherland Computer Corporation, dated February 22, 2002, filed herein. 10.57 Patent Purchase and License Agreement between Nvidia International Inc., Evans & Sutherland Computer Corporation, and Evans & Sutherland Graphics Corporation, dated October 15, 2001, filed herein. 10.58 Patent Cross License Agreement between Nvidia Corporation and Evans & Sutherland Computer Corporation, dated October 15, 2001, filed herein. Certain information in this exhibit will be omitted and filed separately with the Securities and Exchange Commission pursuant to a confidential treatment request under Rule 24b-2 of the Securities and Exchange Act of 1934, as amended. 21.1 Subsidiaries of Registrant, filed herein. 23.1 Consent of Independent Auditors, filed herein. 24.1 Powers of Attorney for Messrs. James R. Oyler, William M. Thomas, Gerald S. Casilli, Wolf-Dieter Hass and Ivan E. Sutherland, filed herein. - ------------------------ *- Management contract for Compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
TRADEMARKS USED IN THIS FORM82
Trademarks Used in this Form 10-K
AccelGALAXY, AccelGMX, Digistar,E&S,
E&S Lightning 1200, EaSIEST, Ensemble,Harmony, ESIG,Harmony, INTegrator,ESCP, Integrator, simFUSION, EPX, EP, Environment Processor, RenderBeast, TargetView, VistaView, MCT, RAPIDsite, REALimage,simFUSION, StarRider, SymphonyEncore, andVanguardDigistar are trademarks or registered trademarks of Evans & Sutherland Computer Corporation. All other product, service, or trade names or marks are the properties of their respective owners.80SCHEDULEEVANS & SUTHERLAND COMPUTER CORPORATION AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBERYears ended December 31, 2003, 2002 and 2001
2000 AND 1999 (IN THOUSANDS)
DEDUCTIONS BALANCE AT ADDITIONS CHARGED BEGINNING CHARGED TO (RECOVERED) BALANCE OF COST AND AGAINST AT END OF YEAR EXPENSES ALLOWANCE YEAR ----------- ----------- ----------- -----------Allowance for doubtful receivables December 31, 2001 $ 4,411 $ 2,358 $ 356 $ 6,413 December 31, 2000 1,322 3,829 740 4,411 December 31, 1999 1,616 558 852 1,322 Inventory Reserves December 31, 2001 $ 9,894 $ 943 $ 3,652 $ 7,185 December 31, 2000 6,047 6,613 2,766 9,894 December 31, 1999 6,963 910 1,826 6,047 Warranty Reserves December 31, 2001 $ 1,447 $ 2,197 $ 1,678 $ 1,966 December 31, 2000 1,376 1,189 1,118 1,447 December 31, 1999 1,436 958 1,018 1,37681
(in thousands)
Balance at
beginning
of yearAdditions
charged
(reversed)
to cost and
expensesDeductions
charged
(recovered)
against
provisionBalance
at end of
yearAllowance for doubtful receivables December 31, 2003 $ 856 $ 68 $ 573 $ 351 December 31, 2002 6,413 (734 ) 4,823 856 December 31, 2001 4,411 2,358 356 6,413
Inventory reserves
December 31, 2003 $ 9,111 $ 16,065 $ 2,231 $ 22,945 December 31, 2002 7,185 3,194 1,268 9,111 December 31, 2001 9,894 943 3,652 7,185
Warranty reserves
December 31, 2003 $ 968 $ 2,274 $ 1,952 $ 1,290 December 31, 2002 1,966 617 1,615 968 December 31, 2001 1,447 2,197 1,678 1,966
Accrued liquidated damages and penalties
December 31, 2003 $ 1,050 $ 1,850 $ 1,166 $ 1,734 December 31, 2002 1,500 150 600 1,050 December 31, 2001 3,091 1,500 3,091 1,500 84
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
EVANS & SUTHERLAND COMPUTER CORPORATION
March29, 200217, 2004
By:/s/
/s/ JAMES R. OYLER----------------------------------------- JAMES
James R.OYLER, PRESIDENTOyler, PresidentPursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Director, Chief Executive /s//s/ JAMES R. OYLER
James R. OylerDirector, Chief Executive
Officer and President------------------------------------------- (Principal
(Principal Executive Officer)March 29, 2002 JAMES R. OYLER Officer)17, 2004
/s/ E. THOMAS ATCHISON
E. Thomas Atchison
Vice President, Chief/s/ WILLIAM M. THOMASFinancial
Officer,Treasurer ------------------------------------------- andCorporate SecretaryMarch 29, 2002 WILLIAM M. THOMAS (Principal
(Principal Financial and Accounting Officer)* ------------------------------------------- Director
March29, 2002 GERALD17, 2004
*
Gerald S.CASILLI * -------------------------------------------Casilli
Director
March29, 2002 WOLF-DIETER HASS17, 2004
*-------------------------------------------
Wolf-Dieter Hass
Director
March29, 2002 IVAN17, 2004
*
David J. Coghlan
Director
March 17, 2004
*
William Schneider, Jr.
Director
March 17, 2004
By:
/s/ E.SUTHERLAND
*By: /s/ WILLIAM M.THOMAS-------------------------------------- WILLIAM M. THOMASATCHISON
E. Thomas Atchison
*Attorney-in-Fact
March29, 2002 *Attorney-in-Fact17, 200482