EXHIBIT 13
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PORTIONS OF
ENVIRONMENTAL TECTONICS CORPORATION
2002
ANNUAL SHAREHOLDERS' REPORT
FINANCIAL REVIEW
($ in thousands, except share and per share data)
Fiscal Year End 2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Net sales $32,527 $32,452 $34,920 $29,225 $29,284
Gross profit 11,465 13,075 12,798 11,672 9,298
Operating income 2,873 4,122 5,327 4,759 4,208
Net income 1,741 2,021 2,837 2,170 1,794
Earnings per common share:
Basic .24 .29 .40 .32 .25
Diluted .23 .27 .36 .29 .23
Working capital 30,683 25,070 16,306 13,755 11,462
Long-term obligations 16,688 12,778 4,455 4,219 4,356
Total assets 48,482 40,705 31,897 35,448 22,955
Total stockholders' equity 20,782 18,796 16,245 11,030 8,579
Weighted average common shares:
Basic 7,143,000 7,087,000 6,604,000 5,861,000 5,981,000
Diluted 7,499,000 7,499,000 7,319,000 6,312,000 6,496,000
All earnings per share and share amounts have been restated to reflect a 2 for 1
stock split effective May 28, 1999. No cash dividends have ever been paid on the
Company's common stock, and the Company is currently prohibited from declaring
any cash dividends on common stock under the terms of its credit facility.
1
Management's Discussion and Analysis of Financial Condition and Results of
Operations
FORWARD-LOOKING STATEMENTS
This Annual Report includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. These forward-looking
statements are based on our current expectations and projections about future
events. These forward-looking statements are subject to known and unknown risks,
uncertainties and assumptions about us and our subsidiaries, that may cause our
actual results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements.
These forward-looking statements includes statements with respect to
the Company's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of the Company, including but not
limited to, (i) projections of revenues, costs of raw materials, income or loss,
earnings or loss per share, capital expenditures, growth prospects, dividends,
the effect of currency fluctuations, capital structure and other financial
items, (ii) statements of plans and objectives of the Company or its management
or board of directors, including the introduction of new products, or estimates
or predictions of actions by customers, suppliers, competitors or regulating
authorities, (iii) statements of future economic performance, (iv) statements of
assumptions and other statements about the Company or its business, and (v)
statements preceded by, followed by or that include the words, "may," "could,"
"should," "pro forma," "looking forward," "would," "believe," "expect,"
"anticipate," "estimate," "intend," "plan," or similar expressions. These
forward-looking statements involve risks and uncertainties, which are subject to
change based on various important factors (some of which, in whole or in part,
are beyond the Company's control). The following factors, among others, could
cause the Company's financial performance to differ materially from the goals,
plans, objectives, intentions and expectations expressed in such forward-looking
statements: (1) the strength of the United States and global economies in
general and the strength of the regional and local economies in which the
Company conducts operations; (2) the effects of, and changes in U.S. and foreign
governmental trade, monetary and fiscal policies and laws; (3) the impact of
domestic or foreign military or political conflicts and turmoil; (4) the timely
development of competitive new products and services by the Company and the
acceptance of such products and services by customers; (5) willingness of
customers to substitute competitors' products and services and vice versa; (6)
the impact on operations of changes in U.S. and governmental laws and public
policy, including environmental regulations; (7) the level of export sales
impacted by export controls, changes in legal and regulatory requirements,
policy changes affecting the markets, changes in tax laws and tariffs, exchange
rate fluctuations, political and economic instability, and accounts receivable
collection; (8) technological changes; (9) regulatory or judicial proceedings;
(10) the impact of any current or future litigation involving the Company; and
(11) the success of the Company at managing the risks involved in the foregoing.
The Company cautions that the foregoing list of important factors is
not exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
Results of Operation
Fiscal 2002 versus Fiscal 2001
The company had a net income of $1,741,000 or $.23 per share (diluted)
in 2002, versus a net income of $2,021,000 or $.27 per share (diluted) in 2001.
Operating income was $2,873,000, a decrease of $1,249,000 or 30.3% over 2001.
This decrease was primarily the result of a reduced gross margin partially
offset by lower general and administrative expenses and research and development
expenses. On a pro-forma basis, excluding claims revenue booked in both periods,
gross profit for 2002 actually increased $452,000 or 4.2% in 2002 as compared to
2001 as most operating groups experienced both higher gross profit and an
improved gross profit rate as a percentage of revenues.
The Company recognizes revenue utilizing three methods. On long-term
contracts, the percentage of completion method is applied based on costs
incurred as a percentage of estimated total costs. Revenue recognized on
uncompleted long-term contracts in excess of amounts billed to customers is
reflected as an asset. Amounts billed to customers in excess of revenue
recognized on uncompleted long-term contracts are reflected as a liability. When
it is estimated that a contract will result in a loss, the entire amount of the
loss is accrued. The effect of revisions in cost and profit estimates for
long-term contracts is reflected in the accounting period in which the facts
requiring the revisions become known. Contract progress billings are based upon
contract provisions for customer advance payments, contract costs incurred, and
completion of specified contract milestones. Contracts may provide for customer
retainage of a portion of amounts billed until contract completion. Retainage is
generally due within one year of completion of the contract. Revenue recognition
under the percentage of completion method involves significant estimates.
Revenue for contracts under $100,000, or to be completed in less than one year,
and where there are no post-shipment services included in the contract, and
revenue on parts and services, is recognized as shipped. Revenue on contracts
under $100,000, or to be completed in less than one year, and where
post-shipment services (such as installation and customer acceptance) are
required, is recognized after customer acceptance. Revenue for service contracts
is recognized ratably over the life of the contract with related material costs
expensed as incurred.
2
In accordance with accounting principles generally accepted in the
United States of America, revenue on contract claims and disputes, for customer
caused delays, errors in specifications and designs, and other unanticipated
causes, and for amounts in excess of contract value, is generally appropriate if
it is probable that the claim will result in additional contract revenue and if
the amount can be reliably estimated.
Revenue recorded on a contract claim cannot exceed the incurred
contract costs related to that claim. Significant claims outstanding at February
22, 2002 included the U.S. Navy ($5.5 million recorded) and an international
customer ($5.7 million recorded). On May 9, 2002, the Company reached a final
settlement agreement totaling approximately $6.9 million with the U.S. Navy for
all outstanding amounts. The gain, if any, resulting from the settlement would
be recognized in fiscal 2003. The outstanding claims with the international
customer are either under review by the customer or in litigation. Although
recorded as a current asset in the financial statements, all claim revenues may
not be received in full during fiscal 2003.
Total sales increased $75,000 or 0.2% in 2002 over 2001 representing
increases in entertainment (up $7,459,000, 88.8%), environmental (up $428,000,
17.7%) and hyperbaric systems (up $967,000, 31.1%). Partial offsets were Aircrew
training Systems (ATS) sales (down $6,793,000, 50.3%) including sales from the
Company's Polish subsidiary, sales of sterilizers and simulation sales of the
Company's Florida branch. Entertainment sales benefited from increased
production on the Company's main ride contract. Environmental sales were up
internationally representing a test room for Russia and two large chamber
contracts in China. Hyperbaric sales increased as two large chambers for a
Southeast Asian customer were shipped. ATS sales were negatively impacted by the
general economic downturn and global disruption that affected the world last
year. With the tightening of worldwide governmental spending and the political
fall out from the September 11, 2001 tragedy, as an international supplier of
aircrew training devices, the Company saw a significant impairment in its
ability to close many large international contracts, most of which have been
under proposal for some time. This was coupled with a major economic disruption
and currency devaluation in Turkey, where the Company's ETC-Information Systems
performs contract software for local customers, and the inability of the Polish
Government to approve a national budget, which delayed contract awards for our
Polish Subsidiary. Sterilizer shipments were hindered by customer schedule
slippages, while decreases in the Simulation line reflected reduced activity on
a percentage of completion revenue basis for a large contract for a simulator at
Chicago's O'Hare and Midway Airports, although this group was awarded four
contracts in the second half of the year. Geographically, domestic sales were up
$6,092,000 or 40.3%, and represented 65.2% of total sales, up from 46.6% in
2001, primarily reflecting the aforementioned entertainment activity. U.S.
Government sales were down $869,000 or 42.1%, and represented 3.7% of total
sales, down from 6.4% in 2001, on lower claims revenue. International sales,
including those from the Company's foreign subsidiaries, were down $5,148,000 or
33.7% and represented 31.1% of total sales, down from 47.0% from 2001,
reflecting the aforementioned global conditions during much of fiscal 2002.
Additionally, international sales were down due to reduced sales in the United
Kingdom and Nigeria, as large contracts were completed or stopped in these
regions. U.S. Government sales reflected reduced ATS claim revenue. Throughout
the Company's history, most of the sales for Aircrew Training products have been
made to international customers. The Company has subsidiaries in the United
Kingdom, Poland and Turkey, maintains regional offices in the Middle East, Asia,
and Canada, and uses the services of approximately 100 independent sales
organizations and agents throughout the World. Customers in 2002 representing
10% or more of sales were the Walt Disney companies, $15,859,000, or 48.8%, and
the Royal Thai Air Force $3,285,000 or 10.1%. In 2002, international sales
totaling at least $500,000 per country were made to customers in Great Britain,
Japan, Turkey, Thailand, Russia, and Nigeria. Fluctuations in sales to
international countries from year to year primarily reflect percentage of
completion revenue recognition on the level and stage of development and
production on multi-year long-term contracts. Open orders for the Walt Disney
companies constituted 44.1% of the Company's backlog at February 22, 2002.
Risks associated with international operations that might be different
from those domestically include the strength of global economies in general and
the strength of the regional and local economies in which the Company conducts
operations, the effect of foreign military or political conflicts and turmoil,
changes in foreign governmental trade, monetary and fiscal policies and laws,
export controls, exchange rate fluctuations and political and economic
instability. Unusual risks that might be associated with sales to less developed
nations include U.S. Dollar and monetary system controls and a heightened risk
of political, economic and civil turmoil.
The Company considers its business activities to be divided into two
segments: Aircrew Training Systems (ATS) and Industrial Group. On a segment
basis, sales of the Company's Aircrew Training Systems (ATS) products, which
create and monitor the physiological effects of motion (including spatial
disorientation and centrifugal forces) on humans and equipment for medical,
training, research and entertainment markets, were $22,629,000 in 2002, a
decrease of $692,000, or 3.0% over 2001. Sales of these products accounted for
69.6% of the Company's sales compared to 72.6% in 2001. Sales in the Company's
other segment, the Industrial Group, which designs and produces chambers that
create environments that are used for sterilization, research and medical
applications, increased $766,000 to $9,898,000, an increase of 8.4%, and
constituted 30.4% of the Company's total sales compared to 27.4% in 2001.
3
Gross profit decreased $1,160,000, 12.3%, primarily reflecting reduced
claims revenue. On a pro-forma basis, excluding claims revenue booked in each
period, gross profit for 2002 increased $452,000 or 4.2% over 2001, as most of
the business groups except ATS evidenced both increased gross profit dollars and
an improved gross margin rate as a percent of sales.
Operating profit decreased $1,249,000 or 30.3% in 2002 compared to
2001. On a segment basis, ATS had an operating profit of $2,631,000, a decrease
of $3,163,000 from 2001, while the Industrial Group had an operating profit of
$1,347,000 compared to an operating loss of $906,000 in 2001. These segment
operating profits were offset, in part, by unallocated corporate expenses of
$1,105,000, an increase of 339,000 over 2001.
Selling and administrative expenses decreased $58,000 or 0.7% in 2002
as compared to 2001 primarily reflecting reduced legal expenses to support
international claims. As a percentage of sales, selling and administrative
expenses were 24.6% compared to 24.8% in 2001.
Research and development expenses decreased significantly, down
$303,000 or 33.6% in 2002 as compared to 2001, as these activities were curbed
during the year, especially at the Company's Turkish branch. Most of the
Company's research efforts, which were and continue to be a significant cost of
its business, are included in cost of sales for applied research for specific
contracts, as well as research for feasibility and technology updates.
Capitalized software development costs for 2002 were $989,000 compared to
$550,000 in 2001. Amortization of software costs, which was charged to cost of
sales, was $496,000 and $455,000 for 2002 and 2001, respectively.
Interest expense (net of interest income) increased $269,000 or 32.6%
in 2002 over 2001 reflecting higher borrowings albeit at a lower average rate.
Additionally, during the third fiscal quarter of 2002, $195,000 of deferred
finance costs associated with the Company's refinancing in March 1997, which
debt was subsequently paid off in March 2000, were charged off. Letter of credit
and other expenses increased $45,000 or 41.3% in 2002 over 2001 principally due
to increased letter of credit fees.
The Company's provision for taxes, rate-wise, reflected a rate of 30%
before the impact of approximately $619,000 of research and experimentation tax
credit refunds. The Company will continue to use research and experimentation
tax credits, if applicable, to reduce its federal income tax.
During fiscal 2002, the Company received inquiries and estimated tax
assessments for the years 1995 through 1999 from Inland Revenue in Great Britain
related to the Company's Great Britain operation. The Company believes that the
assessments are arbitrary and have no legal basis. The Company has responded to
Inland Revenue and has agreed to review all in-country activity and taxes paid
related to the Company's subsidiary, ETC Europe, for the years in question. At
this point, the Company believes that additional taxes, if any, will be
immaterial, and the Company has some options to offset some or all of any
additional payments including applying any additional tax liability against the
company's current income tax reserve.
Subsequent to fiscal year end, the Company was notified that the
Internal Revenue Service was going to conduct an audit of the Company's U.S.
Fiscal 2000 tax filing. As of the date of this Annual Report, this audit was
still in process and the Company is not able to assess whether any additional
taxes will result from the review.
Fiscal 2001 versus Fiscal 2000
The Company had a net income of $2,021,000 or $.27 per share (diluted)
in 2001, versus a net income of $2,837,000 or $.36 per share (diluted) in 2000.
Operating income was $4,122,000 in 2001, a decrease of $1,205,000 or 22.6% over
2000. This decrease was primarily the result of higher general and
administrative expenses partially offset by an increased gross margin as the
rate as a percentage of sales was up by 3.7 percentage points. The improvement
in the gross margin rate as a percentage of sales reflected both an improvement
in Entertainment line performance and an overall increase in Aircrew Training
Systems gross margin on higher domestic and international claims revenue and
corresponding gross margin. Claims bookings for the year increased operating
income by $1,325,000, net of associated manufacturing costs and legal expenses.
Included in the above was a claim against an international customer which was
settled in the three months ended February 23, 2001. On a pro-forma basis,
excluding claims revenue booked in both periods, gross profit for 2001 decreased
by $1,988,000 or 15.5%, from Fiscal 2000 primarily reflecting lower sales and
corresponding gross margin in international Hyperbaric systems and PTS and
domestic simulation sales.
The Company recognizes revenue utilizing three methods. On long-term
contracts, the percentage of completion method is applied based on costs
incurred as a percentage of estimated total costs. Revenue recognized on
uncompleted long-term contracts in excess of amounts billed to customers is
reflected as an asset. Amounts billed to customers in excess of revenue
recognized on uncompleted long-term contracts are reflected as a liability. When
it is estimated that a contract will result in a loss, the entire amount of the
loss is accrued. The effect of revisions in cost and profit estimates for
long-term contracts is reflected in the accounting period in which the facts
requiring the revisions become known. Contract progress billings are based upon
contract provisions for customer advance payments, contract costs incurred, and
completion of specified contract milestones. Contracts may provide for customer
retainage of a portion of amounts billed until contract completion. Retainage is
generally due within one year of completion of the contract. Revenue recognition
under the percentage of completion method involves significant estimates.
Revenue for contracts under $100, or to be completed in less than one year, and
where there are no post-shipment services included in the contract, and revenue
on parts and services, are recognized as shipped. Revenue on contracts under
$100, or to be completed in less than one year, and where post-shipment services
(such as installation and customer acceptance) are required, is recognized after
customer acceptance. Revenue for service contracts is recognized ratably over
the life of the contract with related material costs expensed as incurred.
4
In accordance with accounting principles generally accepted in the
United States of America, revenue on contract claims and disputes, for customer
caused delays, errors in specifications and designs, and other unanticipated
causes, and for amounts in excess of contract value, is generally appropriate if
it is probable that the claim will result in additional contract revenue and if
the amount can be reliably estimated.
Revenue recorded on a contract claim cannot exceed the incurred
contract costs related to that claim. Significant claims outstanding at February
23, 2001, included the U.S. Navy ($5.5 million recorded) and an international
customer ($5.8 million recorded). Although recorded as current in the financial
statements, claim revenues may not be received in full during fiscal 2002.
Claims against the U.S. Navy, totaling approximately $12.0 million, were filed
in previous years. One of the claims against an international customer was
settled in the fourth quarter of fiscal 2001, and another claim was formally
filed with the customer subsequent to fiscal year end. A third claim is still
being developed.
Total sales decreased $2,468,000 or 7.1% in 2001 from 2000 as sales
performance was mixed, with the most significant decreases being evidenced in
the Company's Polish Subsidiary and Simulation and Hyperbaric product areas.
Sales of the Polish Subsidiary were negatively impacted by economic and
political issues in Poland, most notably the inability of the Polish Government
to finalize the national budget. Decreases in the Simulation line reflected
reduced activity on a percentage of completion revenue basis for a large
contract for a simulator at Chicago's O'Hare and Midway Airports. Due to a
change in administration, the City of Chicago has experienced delays in
completing the building to house the simulator. Hyperbaric sales were down from
the prior year primarily due to reduced percentage of completion sales to a
customer in Nigeria. A partial offset was seen in the Environmental, Sterilizer
and Entertainment lines (Entertainment was up $4,719,000 or 128.2%) and sales
from the Company's UK Subsidiary, which was purchased in March 2000.
Environmental sales benefited from higher domestic sales of standard products
including environmental test rooms, air supply units, and conditioned air supply
units. Sterilizer sales were helped by the Company's new line of sterilizer
control upgrades, retrofits, and an increase in autoclave sales to domestic
customers. Entertainment sales benefited from increased revenue on a percentage
of completion basis for a large entertainment ride contract currently in
process. Geographically, international sales, including those from the Company's
foreign subsidiaries, were down $7,363,000 or 31.0% in 2001 and represented
50.6% of total sales, down from 68.5% in 2000. International sales were down
primarily due to reduced sales in Nigeria. U.S. Government sales reflected
reduced ATS products and revenues. Throughout the Company's history, most of the
sales for Aircrew Training Products have been made to international customers.
The Company has subsidiaries in the United Kingdom, Poland and Turkey, maintains
regional offices in the Middle East, Asia, and Canada, and uses the services of
approximately 100 independent sales organizations and agents throughout the
World. U.S. Government sales were down $671,000 or 42.3% in 2001, and
represented 2.8% of total sales, down from 4.5% in 2000. Providing a partial
offset was an increase in domestic sales, which were up $5,566,000 or 58.2% in
2001, primarily from the aforementioned increase in the Entertainment line.
Domestic sales represented 46.6% of the Company's total sales, up from 27.0% in
the prior period. Customers in 2001 representing 10% or more of sales were the
United Kingdom Ministry of Defense, $5,524,000 or 17.0%, and the Walt Disney
companies, $8,400,000 or 25.9%. In 2001, international sales totaling at least
$500,000 per country were made to customers in Great Britain, Poland, Japan,
Turkey, Thailand, Egypt and Spain. Fluctuations in sales to international
countries from year to year primarily reflect percentage of completion revenue
recognition on the level and stage of development and production on multi-year
long-term contracts. Additionally, open orders for the Walt Disney companies
constituted 56.5% of the Company's backlog at February 23, 2001.
Risks associated with international operations that might be different
from those domestically include the strength of global economies in general and
the strength of the regional and local economies in which the Company conducts
operations, the effect of foreign military or political conflicts and turmoil,
changes in foreign governmental trade, monetary and fiscal policies and laws,
export controls, exchange rate fluctuations and political and economic
instability. Unusual risks that might be associated with sales to less developed
nations include U.S. Dollar and monetary system controls and a heightened risk
of political, economic and civil turmoil.
The Company considers its business activities to be divided into two
segments: Aircrew Training Systems (ATS) and Industrial Simulation. On a segment
basis, sales of the Company's Aircrew Training Systems (ATS) products, which
create and monitor the physiological effects of motion (including spatial
disorientation and centrifugal forces) on humans and equipment for medical,
training, research and entertainment markets, were $23,567,000 in 2001, a
decrease of $2,794,000 or 10.6% over 2000. Sales of these products accounted for
72.6% of the Company's sales in 2001 compared to 75.5% in 2000. Sales in the
Company's other segment, the Industrial Group, which designs and produces
chambers that create environments that are used for sterilization, research and
medical applications, increased $326,000 to $8,885,000, an increase of 3.8%, and
constituted 27.4% of the Company's total sales compared to 24.5% in 2000.
5
Gross profit increased $277,000 or 2.2% in 2001 over 2000. As a
percentage of sales, gross profit was 40.3% in 2001, up from 36.6% in 2000. This
increase was attributable to an improvement in the rate as a percentage of sales
and higher domestic and international claims revenue and resulting gross margin.
Operating profit decreased $1,205,000 or 22.6% in 2001 compared to
2000. On a segment basis, ATS had an operating profit of $5,794,000 in 2001, an
increase of $755,000 from 2000, while the Industrial Group had an operating loss
of $906,000 compared to an operating profit of $1,355,000 in 2000. These segment
operating profits were offset, in part, by unallocated corporate expenses of
$766,000 in 2001, a decrease of $170,000 over 2000. Unallocated corporate
expenses include corporate officers' salaries and benefits, stockholder
expenses, accounting and legal expenses and contributions.
Selling and administrative expenses increased $1,499,000 or 22.9% in
2001, due principally to higher legal expenses to support the Company's domestic
and international claims, higher staffing and related expenses in support of the
Company's aggressive new initiatives, a corporate-wide ramp-up of worldwide
marketing efforts, and additional selling and administrative expenses for the
Company's UK subsidiary, which was purchased in March 2000. As a percentage of
sales, selling and administrative expenses were 24.8% in 2001 compared to 18.8%
in 2000.
Research and development expenses decreased by $17,000 or 1.8% in 2001
from 2000, primarily due to ATS and entertainment product applications. Most of
the Company's research efforts, which were and continue to be a significant cost
of its business, are included in cost of sales for applied research for specific
contracts, as well as research for feasibility and technology updates.
Capitalized software development costs for 2001 were $550,000 compared to
$555,000 in 2000. Amortization of software costs, which was charged to cost of
sales, was $455,000 and $596,000 for 2001 and 2000, respectively.
Interest expense (net of interest income) increased $87,000 or 11.8% in
2001 from 2000 reflecting higher borrowings at a higher average rate. Letter of
credit and other expenses decreased by $10,000 or 9.2% in 2001 principally due
to decreased bank charges.
The Company's provision for taxes, rate-wise, remained unchanged in
2001 from 2000 and approximated the statutory rate.
Liquidity and Capital Resources
At February 22, 2002, the Company had a Credit Agreement with a bank
that provided a credit facility of $15 million. This agreement was amended on
March 29, 2002. This amendment extended the expiration date of the Credit
Agreement to November 30, 2002 and increased the interest rate from (i) the
bank's prime rate less a factor ranging from 0% to 0.5% based on the Company's
leverage ratio or adjusted LIBOR, to (ii) the bank's prime rate plus 1% for
adjusted base rate loans or adjusted LIBOR plus 3.5% for adjusted LIBOR rate
loans. The amendment also adjusted the Funds Flow Ratio through the expiration
date of the Credit Agreement. On June 5, 2002, the Company's bank agreed to
extend the expiration date of the Credit Agreement to February 28, 2003.
Substantially all of the company's short-term financing is provided by this
bank. As of June 5, 2002, the Company had $1,485,000 available under the credit
agreement.
During fiscal 2002, the Company used $720,000 of cash for operating
activities. This was primarily the result of an increase in accounts receivable
and inventories coupled with a reduction in billings in excess of costs and
estimated earnings on uncompleted long-term contracts. Partial offsets were
provided by net income, non-cash charges, and an increase in accounts payable
and customer deposits. In general, the net use of cash for operations reflected
a build up of current assets, primarily accounts receivable (which includes
claims receivables) partially offset by a smaller increase in current
liabilities.
Investing activities used $1,638,000 and consisted of purchases for
capital equipment and capitalized software.
Financing activities generated $3,714,000 of cash. This included the
net effect of bank borrowing and cash from the issuance of stock partially
offset by an increase in restricted cash and payments on other long term
obligations. During the first quarter of fiscal 2002 the Company made a payment
of $350,000 representing the final balance due for the purchase of ETC-PZL
Aerospace Industries, the Company's Polish subsidiary. (Reference Notes to the
Consolidated Financial Statements Number 7, Long-Term Obligations and Credit
Arrangements.)
6
The Company believes it will be able to meet the revised covenant and
also that cash generated from operating activities, available borrowing under
the Credit Agreement, coupled with cash to be received from the approximate $6.9
million final settlement agreement reached with the U.S. government on May 9,
2002, will be sufficient to meet its future obligations.
In reference to the Company's outstanding claims with an international
customer, to the extent the Company is unsuccessful in further recovery of
contract costs, such an event could have a material adverse effect on the
Company's liquidity and results of operations. Historically, the Company has had
good experience in that recoveries have exceeded claims (see Note 3 of Notes to
Consolidated Financial Statements).
The Company's sales backlog at February 22, 2002 and February 23, 2001,
for work to be performed and revenue to be recognized under written agreements
after such dates, was $28,148,000 and $40,439,000, respectively. In addition,
the Company's training, maintenance and upgrade contracts backlog at February
22, 2002 and February 23, 2001, for work to be performed and revenue to be
recognized after that date under written agreements, was approximately
$1,485,000 and $1,347,000, respectively. Of the February 22, 2002 backlog,
approximately $20,967,000 was under contracts for ATS and maintenance support
including $13,069,000 for the Walt Disney companies. Approximately 94% of the
February 22, 2002 backlog is expected to be completed prior to February 28,
2003. The decline in the Company's backlog primarily reflected continued
production on a large entertainment project for the Walt Disney Companies which
was not offset by additional contracts in the other product areas. It should be
noted that the Company's order flow does not follow any seasonal pattern and
that large contracts can and have been booked at various times during the fiscal
year.
Recent Accounting Pronouncements
Reporting Comprehensive Income:
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards to provide prominent
disclosure of comprehensive income items. Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. SFAS No. 130 is effective for
all periods beginning after December 15, 1997. Other comprehensive income
consists of foreign currency translation adjustments. The adoption of SFAS No.
130 did not have a material impact on the Company's consolidated financial
position or results of operations.
Business Segment Presentation:
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 requires that public
business enterprises report certain information about operating segments in
complete sets of financial statements of the enterprise and in condensed
financial statements of interim periods issued to shareholders. It also requires
that public business enterprises report certain information about their products
and services, the geographic areas in which they operate, and their major
customers. SFAS No. 131 is effective for all periods beginning after December
15, 1997. The adoption of SFAS No. 131 had no impact on the Company's
consolidated financial position or results of operations.
Derivative Financial Instruments:
In January 2001, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 requires the
recognition of all derivative financial instruments as either assets or
liabilities in the Consolidated Balance Sheet, and the periodic adjustment of
those instruments to fair value. The classification of gains and losses
resulting from changes in the fair value of derivatives is dependent on the
intended use of the derivative and its resulting designation. Adjustments to
reflect changes in fair values of derivatives that are not considered highly
effective hedges are reflected in earnings. Adjustments to reflect changes in
fair values of derivatives that are considered highly effective hedges are
either reflected in earnings and largely offset by corresponding adjustments
related to the fair values of the hedged items, or reflected in other
comprehensive income until the hedged transaction matures and the entire
transaction is recognized in earnings. The change in fair value of the
ineffective portion of a hedge is immediately recognized in earnings. SFAS No.
133 is effective for all periods beginning after June 15, 1999. This effective
date was later deferred to all periods beginning after June 15, 2000 by SFAS No.
137, "Accounting for Derivative Instruments and Hedging activities-Deferral of
the Effective Date of FASB Statement Number 133." The adoption of SFAS No. 133
had no impact on the Company's consolidated financial position or results of
operations.
7
Business Combinations and Goodwill and Intangible Assets:
On July 20, 2001, the FASB issued SFAS No. 141, Business Combinations,
and SFAS No. 142, Goodwill and Intangible Assets. SFAS 141 is effective for all
business combinations completed after June 30, 2001. SFAS 142 is effective for
fiscal years beginning after December 15, 2001; however, certain provisions of
this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001, and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates are as follows:
* all business combinations initiated after June 30, 2001 must use
the purchase method of accounting. The pooling of interest
o method of accounting is prohibited except for transactions
initiated before July 1, 2001.
o intangible assets acquired in a business combination must be
recorded separately from goodwill if they arise from contractual
or other legal rights or are separable from the acquired entity
and can be sold, transferred, licensed, rented or exchanged,
either individually or as part of a related contract, asset or
liability.
o goodwill, as well as intangible assets with indefinite lives,
acquired after June 30, 2001, will not be amortized. Effective
February 23, 2002, all previously recognized goodwill and
intangible assets with indefinite lives will no longer be
subject to amortization.
o effective February 23, 2002, goodwill and intangible assets with
indefinite lives will be tested for impairment annually and
whenever there is an impairment indicator.
o all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting.
Although it is still reviewing the provisions of these Statements, management's
preliminary assessment is that these Statements will not have a material impact
on the Company's financial position or results of operations.
Asset Retirement Obligations:
In August 2001, The FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 applies to all entities, including
rate-regulated entities, that have legal obligations associated with the
retirement of a tangible long-lived asset that result from acquisition,
construction or development and (or) normal operations of the long-lived asset.
The application of this statement is not limited to certain specialized
industries, such as the extractive or nuclear industries. This Statement also
applies, for example, to a company that operates a manufacturing facility and
has a legal obligation to dismantle the manufacturing plant and restore the
underlying land when it ceases operation of that plant. A liability for an asset
retirement obligation should be recognized if the obligation meets the
definition of a liability and can be reasonably estimated. The initial recording
should be at fair value. SFAS No. 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. The provisions of this statement are not expected to have a material
impact on the financial condition or results of operations of the Company.
Impairment or Disposal of Long-Lived Assets:
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. However, SFAS No. 144 makes changes
to the scope and certain measurement requirements of existing accounting
guidance. SFAS No. 144 also changes the requirements related to reporting the
effects of a disposal or discontinuation of a segment of a business. SFAS No.
144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and interim periods within those fiscal years. The
adoption of this statement is not expected to have a significant impact on the
financial condition or results of operations of the Company.
Market for the Registrant's Common Stock and Related Security Holder
Matters
The Company's Common Stock (the Common Stock) is traded on the American
Stock Exchange under the symbol ETC. As of May 15, 2002, the Company had 294
shareholders of record.
8
The following table sets forth the quarterly ranges of high and low
sale prices, and the closing sale price, for shares of the Common Stock for the
periods indicated. Such prices represent quotations between dealers and do not
include mark-ups, markdowns or commissions, and may not necessarily represent
actual transactions.
Sale Prices
-----------
Closing
High Low Sale Price
---- --- ----------
2002
First Quarter $10.05 $8.30 $ 9.10
Second Quarter 9.05 6.80 7.20
Third Quarter 8.50 6.60 7.00
Fourth Quarter 7.50 5.70 6.45
2001
First Quarter $15-5/8 $7-7/8 $9-1/2
Second Quarter 10-1/2 8-1/8 9-1/16
Third Quarter 9-3/4 7 7-5/16
Fourth Quarter 8-3/5 6-3/8 8-2/5
The Company has never paid any cash dividends on the Common Stock in
the past and does not anticipate that any cash dividends will be declared or
paid in the foreseeable future. The Company's current line of credit facility
prohibits the payment of any dividends by the Company without the lender's prior
written consent.
9
Report of Independent Certified Public Accountants
Board of Directors
Environmental Tectonics Corporation
We have audited the accompanying consolidated balance sheets of
Environmental Tectonics Corporation and Subsidiaries as of February 22, 2002 and
February 23, 2001, and the related consolidated statements of operations,
changes in stockholders' equity and cash flows for each of the three fiscal
years in the period ended February 22, 2002. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform our 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 consolidated financial position of
Environmental Tectonics Corporation and Subsidiaries as of February 22, 2002 and
February 23, 2001, and the consolidated results of their operations and cash
flows for each of the three fiscal years in the period ended February 22, 2002,
in conformity with accounting principles generally accepted in the United States
of America.
As discussed in Note 1 to the consolidated financial statements, the
Company has recorded receivables in the amount of $11.9 million related to
claims made to or against the United States government and an international
customer for contract costs incurred through February 22, 2002. The total net
claims amount made is approximately $26 million based on costs incurred through
February 22, 2002, and is subject to negotiation, arbitration and audit by the
U.S. government and the international customer. On May 9, 2002, the Company
reached a final settlement agreement with the United States government on one of
its claims totaling approximately $6.9 million.
/s/ Grant Thornton LLP
- ----------------------
Philadelphia, Pennsylvania
April 24, 2002 (except for notes 1 and 3,
as to which the date is May 9, 2002 and
Note 7, as to which the date is June 5, 2002)
10
Consolidated Balance Sheets ($ in thousands, except share data)
February 22, February 23,
2002 2001
---- ----
ASSETS
Cash and cash equivalents $2,261 $851
Cash equivalents restricted for letters of credit 569 544
Accounts receivable, net 19,856 16,776
Costs and estimated earnings in excess of
billings on uncompleted long-term contracts 9,391 9,595
Inventories 7,161 4,624
Deferred tax asset 715 615
Prepaid expenses and other current assets 921 423
------- -------
Total current assets 40,874 33,428
Property, plant and equipment, net 5,318 5,337
Software development costs, net of accumulated
amortization of $6,166 and $5,670
in 2002 and 2001, respectively 1,684 1,191
Other assets 606 749
------- -------
Total assets $48,482 $40,705
======= =======
LIABILITIES
Current portion of long-term obligations $ 281 $ 643
Accounts payable - trade 3,438 1,929
Billings in excess of costs and estimated earnings
on uncompleted long-term contracts 499 1,712
Customer deposits 3,684 1,443
Accrued income taxes 731 754
Accrued commissions 738 668
Other accrued liabilities 820 1,209
------- -------
Total current liabilities 10,191 8,358
------- -------
Long-term obligations, less current portion:
Credit facility payable to banks 11,755 7,564
Long term bonds 4,920 5,195
Other 13 19
------- -------
16,688 12,778
------- -------
Deferred tax liability 735 674
------- -------
Total liabilities 27,614 21,810
------- -------
Minority Interest 86 99
STOCKHOLDERS' EQUITY
Common stock - authorized 20,000,000 shares, $.05 par value; 7,142,946 and
7,110,546 shares issued and
outstanding in 2002 and 2001, respectively 357 355
Capital contributed in excess of par value of common stock 6,703 6,514
Accumulated other comprehensive loss (172) (226)
Retained earnings 13,894 12,153
------- -------
Total stockholders' equity 20,782 18,796
------- -------
Total liabilities and stockholders' equity $48,482 $40,705
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
11
Consolidated Statements of Operations ($ in thousands, except share data)
52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 22, February 23, February 25,
2002 2001 2000
---- ---- ----
Net sales $32,527 $32,452 $34,920
Cost of goods sold 21,062 19,377 22,122
------ ------ ------
Gross profit 11,465 13,075 12,798
------ ------ ------
Operating expenses:
Selling and administrative 7,992 8,050 6,551
Research and development 600 903 920
------ ------ ------
8,592 8,953 7,471
------ ------ ------
Operating income 2,873 4,122 5,327
----- ----- -----
Other expenses:
Interest expense (net) 1,094 825 738
Letter of credit fees 102 65 53
Other, net 42 34 56
------ ------ ------
1,238 924 847
------ ------ ------
Income before provision for/(benefit from) income taxes
and minority interest 1,635 3,198 4,480
Provision for/(benefit from) income taxes (93) 1,126 1,573
------ ------ ------
Income before minority interest $1,728 $2,072 $2,907
====== ====== ======
Income (loss) attributable to minority interest (13) 51 70
Net income $1,741 $2,021 $2,837
Per share information Earnings per common share:
Basic $.24 $.29 $.40
Diluted $.23 $.27 $.36
Income available to common stockholders $1,741 $2,021 $2,671
Weighted average common shares:
Basic 7,143,000 7,087,000 6,604,000
Diluted 7,499,000 7,499,000 7,319,000
The accompanying notes are an integral part of the consolidated financial
statements.
12
Consolidated Statements of Changes in Stockholders' Equity
($ in thousands, except share data)
For the years ended February 22, 2002, February 23, 2001, and February 25, 2000
Capital
contributed
in excess of Accumulated
Common stock par value of other Total
------------ common comprehensive Retained stockholders'
Shares Amount stock income (loss) earnings equity
------ ------ ------ ------------- -------- ------
Balance, February 26, 1999 3,083,206 $308 $3,240 $21 $7,461 $11,030
Net income for the year - - - - 2,837 2,837
Foreign currency translation
adjustment - - (83) - (83)
--------- ---- ------ -------
Total comprehensive income - - - (83) 2,837 2,754
Stock Split effective May 28, 1999 3,083,206 - - - - -
Accretion of preferred stock - - - - (128) (128)
Dividends on preferred stock - - - - (38) (38)
Shares issued in connection
with conversion of preferred stock 666,666 33 2,467 - - 2,500
Shares issued in connection with
employee stock purchase and stock
option plans 31,202 2 125 - - 127
--------- ---- ----- ----- ------ -------
Balance, February 25, 2000 6,864,280 343 5,832 (62) 10,132 16,245
Net income for the year - - - - 2,021 2,021
Foreign currency translation
adjustment - - - (164) - (164)
--------- ---- ----- ----- ----- -------
Total comprehensive income - - - (164) 2,021 1,857
Shares issued in connection
with conversion of warrants 212,866 10 508 - - 518
Shares issued in connection with
employee stock purchase and
stock option plans 33,400 2 174 - - 176
--------- ---- ----- ----- ------ -------
Balance, February 23, 2001 7,110,546 355 6,514 (226) 12,153 18,796
Net income for the year - - - - 1,741 1,741
Foreign currency translation
adjustment - - - 54 - 54
--------- ---- ----- ----- ------ -------
Total comprehensive income - - - (172) 1,741 1,795
Shares issued in connection
with employee stock purchase
and stock option plans 32,400 2 189 - - 191
Balance, February 22, 2002 7,142,946 $357 $6,703 $(172) $13,894 $20,782
========= ==== ====== ===== ======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
13
Consolidated Statements of Cash Flows ($ in thousands)
Year Ended Year Ended Year Ended
February 22, February 23, February 25,
2002 2001 2000
---- ---- ----
Cash flows from operating activities:
Net income $1,741 $2,021 $2,837
Adjustments to reconcile net income to net cash used in
operating activities
Depreciation and amortization 1,475 1,278 1,395
Increase (decrease) in allowance for accounts receivable and inventory 111 (87) 77
Minority interest in net (loss) income (13) (170) (6)
Deferred income taxes (benefit) (39) 96 397
Changes in operating assets and liabilities:
(Increase) decrease in assets
Accounts receivable (3,083) (6,007) (1,097)
Costs and estimated earnings in excess of billings on uncompleted
long-term contracts 204 (717) 1,538
Inventories (2,645) (630) (888)
Prepaid expenses and other current assets (530) 5 145
Other assets (136) 34 (125)
Increase (decrease) in liabilities:
Accounts payable 1,509 99 276
Billings in excess of costs and estimated earnings on uncompleted
long-term contracts (1,213) (1,570) (3,493)
Customer deposits 2,241 (1,492) (2,761)
Accrued income taxes (23) 291 (465)
Other accrued liabilities (319) 264 (93)
Payments under settlement agreements - (85) (120)
------ ------ ------
Net cash used in operating activities (720) (6,670) (2,383)
Cash flows from investing activities:
Acquisition of equipment (649) (2,628) (1,014)
Software development costs (989) (550) (555)
Purchase of subsidiary, net of cash acquired - 195 -
------ ------ ------
Net cash used in investing activities (1,638) (2,983) (1,569)
------ ------ ------
Cash flows from financing activities:
Borrowings under credit facility 10,899 8,071 4,093
Payments under credit facility (6,708) (4,600) -
Proceeds from (payments on) long-term bonds (275) 5,470 -
Net payments on subordinated debt - - (3,774)
Payment of dividends on preferred stock - - (38)
Deferred financing costs - (175) -
Decrease (increase) in restricted cash (25) (512) 15
Net decrease in other long-term obligations (368) (5) (40)
Proceeds from issuance of common stock/warrants 191 694 160
Net cash provided by financing activities 3,714 8,943 416
------ ------ ------
Effect of exchange rates on cash 54 (164) (83)
------ ------ ------
Net (decrease) increase in cash and cash equivalents 1,410 (874) (3,619)
Cash and cash equivalents at beginning of year 851 1,725 5,344
------ ------
Cash and cash equivalents at end of year $2,261 $ 851 $1,725
====== ====== ======
Supplemental schedule of cash flow information:
Interest paid $766 $806 $421
Income taxes paid $582 $649 $1,533
Supplemental information on non-cash operating and investing activities:
During the year ended February 23, 2001, the Company purchased for $100
a 99% ownership in ETC Europe, resulting in goodwill of $26.
During the year ended February 25, 2000, the Company reclassified $216
from inventory to property, plant and equipment.
During the year ended February 25, 2000, 25,000 shares of the Company's
Series A Preferred Stock were converted into 666,666 shares of common stock,
which was subsequently issued to Sirrom Capital Corporation. (Reference Footnote
7, Long-term Obligation and Credit Arrangement).
The accompanying notes are an integral part of the consolidated
financial statements.
14
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies:
Nature of Business:
Environmental Tectonics Corporation ("ETC" or the "Company") is
primarily engaged in the development, marketing and manufacturing of Aircrew
Training Systems (ATS) and industrial simulation equipment. The Company utilizes
its internally developed software systems in virtually all of its products. ETC
focuses on software enhancements, product extensions, new product development
and new marketplace applications. Sales of ATS products are made principally to
U.S. and foreign government agencies and to the entertainment market. Sales of
industrial simulation equipment, which includes sterilizers, environmental
systems, and hypo/hyperbaric equipment, are made to both commercial customers
and governmental agencies worldwide.
Stock Split: On February 25, 1999, the Company's Board of Directors
declared a 2-for-1 stock split for stockholders of record on May 17, 1999. All
earnings per share and share amounts in the financial statements for all years
presented have been restated to reflect the 2-for-1 split.
Principles of Consolidation:
The consolidated financial statements include the accounts of
Environmental Tectonics Corporation, its wholly owned subsidiary, ETC
International Corporation, its 95% owned subsidiary, ETC-PZL Aerospace
Industries SP. Z 0.0, and its 99% owned subsidiary, ETC Europe. All material
inter-company accounts and transactions have been eliminated. The Company's
fiscal year is the 52- or 53-week annual accounting period ending the last
Friday in February.
Use of Estimates:
In preparing financial statements in conformity with accounting
principles generally accepted in the United States, management is required 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 revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant estimates are made
for revenue recognition under the percentage of completion method (see Note 1,
Revenue Recognition), claims receivable, inventory, and computer software costs.
At February 22, 2002, the Company had recorded receivables in the
amount of $11.9 million for claims made or to be made against the United States
government and an international customer for contract costs incurred through
February 22, 2002. The total net claims amount filed with the U.S. government
and an international customer at February 22, 2002, approximated $26.0 million
based on costs incurred through February 22, 2002, and additional claims are in
preparation for filing in fiscal 2003 against an international customer. On May
9, 2002, the Company reached a final settlement agreement totaling approximately
$6.9 million with the U.S. government for all outstanding amounts of
approximately $11.8 million. The international claims are subject to
negotiation, arbitration and audit by the international customer.
Revenue Recognition:
Revenue is recognized on long-term contracts utilizing the percentage
of completion method based on costs incurred as a percentage of estimated total
costs. Revenue recognized on uncompleted long-term contracts in excess of
amounts billed to customers is reflected as an asset. Amounts billed to
customers in excess of revenue recognized on uncompleted long-term contracts are
reflected as a liability. When it is estimated that a contract will result in a
loss, the entire amount of the loss is accrued. The effect of revisions in cost
and profit estimates for long-term contracts is reflected in the accounting
period in which the facts requiring the revisions become known. Contract
progress billings are based upon contract provisions for customer advance
payments, contract costs incurred, and completion of specified contract
milestones. Contracts may provide for customer retainage of a portion of amounts
billed until contract completion. Retainage is generally due within one year of
completion of the contract. Revenue for contracts under $100, or to be completed
in less than one year, and where there are no post-shipment services included in
the contract, and revenue on parts and services, are recognized as shipped.
Under these contracts, title passes at shipment. Revenue on those types of
contracts where post-shipment services (such as installation and acceptance) are
required is recognized after customer acceptance. Revenue for service contracts
is recognized ratably over the life of the contract with related material costs
expensed as incurred.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101) which addresses certain criteria for revenue recognition. SAB 101, as
amended by SAB 101A and SAB 101B, outlines the criteria that must be met to
recognize revenue and provides guidance for disclosures related to revenue
recognition policies. The Company implemented any applicable provisions of SAB
101 for the fiscal year ending February 23, 2001, with no impact on the
Company's results of operations.
15
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
In September 2000, the Emerging Issues Task Force reached a consensus
on Issue 00-10, "Accounting for Shipping and Handling Fees and costs" (Issue
00-10). Issue 00-10 requires that all amounts billed to customers related to
shipping and handling should be classified as revenues. In addition, Issue 00-10
specifies that the classification of shipping and handling costs is an
accounting policy decision that should be disclosed pursuant to APB 22,
"Disclosure of Accounting Policies". The Company's product costs includes
amounts for shipping and handling, therefore, it charges its customers shipping
and handling fees at the time the products are shipped or when its services are
performed. The cost of shipping products to the customer is recognized at the
time the products are shipped to the customer and is included in Cost of Goods
Sold. Accordingly, this consensus opinion had no effect on the Company's current
and previous classifications.
Cash and Cash Equivalents:
Cash and cash equivalents include short-term deposits at market
interest rates with original maturities of three months or less. The Company
maintains cash balances at several financial institutions located in the
Northeast United States and at some locations internationally. Accounts in each
domestic institution are insured by the Federal Deposit Insurance Corporation up
to $100. During the year the Company had cash and cash equivalents in excess of
insured amounts. However, most of the Company's funds are with one financial
institution which has had no experience of significant customer losses to date.
Inventories:
Inventories are valued at the lower of cost or market. Cost is
determined principally by the first-in, first-out method. The costs of finished
goods and work-in-process inventories include material, direct engineering,
manufacturing labor and overhead components. The Company periodically reviews
the net realizable value of the inventory and, if necessary, writes down the
recorded costs.
Depreciation of Property, Plant and Equipment:
Property, plant and equipment are depreciated over their estimated
useful lives by the straight-line method for financial reporting purposes.
Accelerated depreciation methods are used for tax purposes. Upon sale or
retirement of property, plant and equipment, the costs and related accumulated
depreciation are eliminated from the accounts. Any resulting gains or losses are
included in the determination of net income.
Amortization of Goodwill:
The Company amortizes costs in excess of fair values of net assets of
the businesses acquired using the straight - line method over a period not to
exceed 20 years. The Company periodically reviews the value of its goodwill to
determine if an impairment has occurred. Effective February 22, 2002, the
Company will no longer amortize goodwill pursuant to SFAS No. 142 Business
Combinations and Goodwill and Intangible Assets (see below).
Goodwill of $662 was recorded in fiscal 1999 for the Company's 65%
ownership purchase of ETC-PZL Aerospace Industries, SP. Z O.O. On September 27,
2000, the Company purchased an additional 30% ownership for $300 cash, bringing
the Company's total ownership to 95%. This transaction resulted in a reduction
in goodwill of $101. Amortization expense was $17, $35, and $36 in fiscal years
2002, 2001 and 2000, respectively, and accumulated amortization was $113 and $96
as of February 22, 2002 and February 23, 2001, respectively.
Amortization of Capitalized Software Development Costs:
The Company capitalizes the qualifying costs of developing software
contained in certain products. Capitalization of costs requires that
technological feasibility has been established. When the software is fully
documented and tested, capitalization of development costs cease and
amortization commences over a period ranging from 36 to 60 months (dependent
upon the life of the product) on a straight-line basis which, at a minimum,
approximates estimated sales. Realization of capitalized software costs is
subject to the Company's ability to market the related product in the future and
generate cash flows to support future operations. Capitalized software costs
totaled $989 and $550, respectively, for the years ended February 22, 2002 and
February 23, 2001. Related software amortization totaled $496, $455 and $596,
respectively, for fiscal 2002, 2001, and 2000.
16
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Research and Development:
Research and development expenses are charged to operations as
incurred. During fiscal 2002, 2001 and 2000 the Company incurred research and
development costs of approximately $600, $903, and $920, respectively.
Amortization of Deferred Financing Costs:
During fiscal 2002 all remaining capitalized costs relating to the
March 1997 financing of the Company were charged to income. Capitalized costs
relating to the Company's bond issuance on March 15, 2000 are being amortized
over the relevant term. Amortization expense relating to deferred financing
costs was $293, $146 and $331 in 2002, 2001, and 2000, respectively (see note
7).
Income Taxes:
The Company accounts for income taxes using the liability method, which
reflects the impact of temporary differences between values recorded for assets
and liabilities for financial reporting purposes and values utilized for
measurement in accordance with tax laws.
Long-Lived Assets:
The Company follows the provisions of Statement of Financial Accounting
Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of," which provides guidance on when to
recognize and how to measure impairment losses of long-lived assets and certain
identifiable intangibles, and how to value long-lived assets to be disposed of.
Basically, this involves reviewing goodwill and other intangibles to assess
recoverability from future operations using undiscounted future cash flows. Any
impairments are recognized in operating results to the extent that carrying
value exceeds fair value, which is determined based on the net present value of
estimated future cash flows. The adoption of SFAS No. 121 had no material effect
on the Company's consolidated financial position or results of operations.
Effective February 22, 2002, the Company adopted SFAS No. 144 Impairment or
Disposal of Long-Lived Assets (see below) which proscribes additional impairment
testing for long-lived assets.
Stock Options:
The Company accounts for stock options in accordance with SFAS No. 123,
"Accounting for Stock-Based Compensation," which contains a fair value-based
method for valuing stock-based compensation that entities may use, which
measures compensation cost at the grant date based on the fair value of the
award. Compensation is then recognized over the service period, which is usually
the vesting period. Alternatively, the standard permits entities to continue
accounting for employee stock options and similar instruments under Accounting
Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to
Employees." Entities that continue to account for stock options using APB
Opinion No. 25 are required to make pro-forma disclosures of net income and
earnings per share, as if the fair value-based method of accounting defined in
SFAS No. 123 had been applied (see note 12). The Company's Incentive Stock
Option Plan is accounted for under APB Opinion No. 25. Under the provisions of
that accounting pronouncement, noncompensatory stock options (that is, options
where the price to be paid for the shares is equal to the market price of the
stock on the date of grant) require no such accounting entries upon issuance.
When exercised, cash and additional equity are recognized. All of the Company's
stock options plans are noncompensatory.
Advertising Costs:
The Company expenses advertising costs (which include trade shows) as
incurred. Advertising expense was $438, $345 and $270 in 2002, 2001, and 2000,
respectively.
17
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Earnings Per Common Share:
The Company has adopted SFAS No. 128, "Earnings Per Share," which is
effective for financial statements issued after December 15, 1997. The new
standard eliminates primary and fully diluted earnings per share and requires
presentation of basic and diluted earnings per share together with disclosure of
how the per share amounts were computed. Basic earnings per share excludes
dilution and is computed by dividing income available to common shareholders by
the weighted average common shares outstanding for the period. Diluted earnings
per share reflects the potential dilution that could occur if securities or
other contracts to issue common stock were exercised and converted into common
stock or resulted in the issuance of common stock that then shared in the
earnings of the entity.
The following table illustrates the reconciliation of the numerators
and denominators of the basic and diluted earnings per share computations. All
earnings per share and share amounts have been restated to reflect a 2 for 1
stock split effective May 28, 1999.
Year ended February 22, 2002
----------------------------
Weighted
average Per share
Income ($000) shares amount
------------ ------ ------
(numerator) (denominator)
Net income $1,741
Basic earnings per share
Income available to common stockholders $1,741 7,142,946 $.24
====== ========= ====
Effective of dilutive securities
Stock options 44,180
Stock warrants 311,460
-------
Diluted earnings per share
Income available to common stockholders plus
effect of dilutive securities $1,741 7,498,586 $.23
====== ========= ====
Year ended February 23, 2001
----------------------------
Weighted
average Per share
Income ($000) shares amount
------------ ------ ------
(numerator) (denominator)
Net income $2,021
Basic earnings per share
Income available to common stockholders $2,021 7,087,163 $.29
====== ====
Effective of dilutive securities
Stock options 97,653
Stock warrants 313,901
---------
Diluted earnings per share
Income available to common stockholders plus
effect of dilutive securities $2,021 7,498,717 $.27
====== ========= ====
Year ended February 25, 2000
----------------------------
Weighted
average Per share
Income ($000) shares amount
------------ ------ ------
(numerator) (denominator)
Net income $2,837
Less preferred stock dividends (38)
Less accretion of preferred stock (128)
------
Basic earnings per share
Income available to common stockholders $2,671 6,604,184 $.40
------ --------- ----
Effective of dilutive securities
Stock options 224,151
Stock warrants 490,358
---------
Diluted earnings per share
Income available to common stockholders plus
effect of dilutive securities $2,671 7,318,693 $.36
------ --------- ----
18
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
At February 22, 2002, there were stock options to purchase the Company's common
stock totaling 313,750 shares which were not included in the computation of
diluted earnings per share, as the effect of such would be anti-dilutive.
Recent Accounting Pronouncements:
Reporting Comprehensive Income:
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS No. 130 establishes standards to provide prominent
disclosure of comprehensive income items. Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. SFAS No. 130 is effective for
all periods beginning after December 15, 1997. Other comprehensive income
consists of foreign currency translation adjustments. The adoption of SFAS No.
130 did not have a material impact on the Company's consolidated financial
position or results of operations.
Business Segment Presentation:
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 requires that public
business enterprises report certain information about operating segments in
complete sets of financial statements of the enterprise and in condensed
financial statements of interim periods issued to shareholders. It also requires
that public business enterprises report certain information about their products
and services, the geographic areas in which they operate, and their major
customers. SFAS No. 131 is effective for all periods beginning after December
15, 1997. The adoption of SFAS No. 131 had no impact on the Company's
consolidated financial position or results of operations.
Derivative Financial Instruments:
In January 2001, the FASB issued SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities". SFAS No. 133 requires the
recognition of all derivative financial instruments as either assets or
liabilities in the Consolidated Balance Sheet, and the periodic adjustment of
those instruments to fair value. The classification of gains and losses
resulting from changes in the fair value of derivatives is dependent on the
intended use of the derivative and its resulting designation. Adjustments to
reflect changes in fair values of derivatives that are not considered highly
effective hedges are reflected in earnings. Adjustments to reflect changes in
fair values of derivatives that are considered highly effective hedges are
either reflected in earnings and largely offset by corresponding adjustments
related to the fair values of the hedged items, or reflected in other
comprehensive income until the hedged transaction matures and the entire
transaction is recognized in earnings. The change in fair value of the
ineffective portion of a hedge is immediately recognized in earnings. SFAS No.
133 is effective for all periods beginning after June 15, 1999. This effective
date was later deferred to all periods beginning after June 15, 2000 by SFAS No.
137, "Accounting for Derivative Instruments and Hedging activities-Deferral of
the Effective Date of FASB Statement Number 133." The adoption of SFAS No. 133
had no impact on the Company's consolidated financial position or results of
operations.
Business Combinations and Goodwill and Intangible Assets:
On July 20, 2001, the FASB issued SFAS No. 141, Business Combinations,
and SFAS No. 142, Goodwill and Intangible Assets. SFAS 141 is effective for all
business combinations completed after June 30, 2001. SFAS 142 is effective for
fiscal years beginning after December 15, 2001; however, certain provisions of
this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001, and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates are as follows:
* all business combinations initiated after June 30, 2001 must use
the purchase method of accounting. The pooling of interest.
o method of accounting is prohibited except for transactions
initiated before July 1, 2001.
o intangible assets acquired in a business combination must be
recorded separately from goodwill if they arise from contractual
or other legal rights or are separable from the acquired entity
and can be sold, transferred, licensed, rented or exchanged,
either individually or as part of a related contract, asset or
liability.
19
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
o goodwill, as well as intangible assets with indefinite lives,
acquired after June 30, 2001, will not be amortized. Effective
February 23, 2002, all previously recognized goodwill and
intangible assets with indefinite lives will no longer be
subject to amortization.
o effective February 23, 2002, goodwill and intangible assets with
indefinite lives will be tested for impairment annually and
whenever there is an impairment indicator.
o all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting.
Although it is still reviewing the provisions of these Statements, management's
preliminary assessment is that these Statements will not have a material impact
on the Company's financial position or results of operations.
Asset Retirement Obligations:
In August 2001, The FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 applies to all entities, including
rate-regulated entities, that have legal obligations associated with the
retirement of a tangible long-lived asset that result from acquisition,
construction or development and (or) normal operations of the long-lived asset.
The application of this statement is not limited to certain specialized
industries, such as the extractive or nuclear industries. This Statement also
applies, for example, to a company that operates a manufacturing facility and
has a legal obligation to dismantle the manufacturing plant and restore the
underlying land when it ceases operation of that plant. A liability for an asset
retirement obligation should be recognized if the obligation meets the
definition of a liability and can be reasonably estimated. The initial recording
should be at fair value. SFAS No. 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. The provisions of this statement are not expected to have a material
impact on the financial condition or results of operations of the Company.
Impairment or Disposal of Long-Lived Assets:
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. However, SFAS No. 144 makes changes
to the scope and certain measurement requirements of existing accounting
guidance. SFAS No. 144 also changes the requirements related to reporting the
effects of a disposal or discontinuation of a segment of a business. SFAS No.
144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and interim periods within those fiscal years. The
adoption of this statement is not expected to have a significant impact on the
financial condition or results of operations of the Company.
2. Acquisitions
ETC-PZL Aerospace Industries SP. Z 0.0.
--------------------------------------
On April 21, 1998, the Company acquired a 65% ownership in MP-PZL
Aerospace Industries, Ltd. ("MP-PZL"), a simulation and advanced training device
manufacturing company located in Warsaw, Poland, for $375 in cash, an 8%
interest-only three-year note payable for $350 and 55,000 shares of the
Company's common stock valued at $495. MP-PZL was subsequently renamed ETC-PZL
Aerospace Industries SP. Z O.O. ("ETC-PZL"). The Company's cost for this
acquisition was $1,220 and has been recorded in the accompanying balance sheet
under the purchase method of accounting for business combinations. In connection
with the acquisition, the Company recorded goodwill of $662.
On September 9, 2000, the Company purchased an additional 30% ownership
interest in ETC-PZL for $300 cash, bringing the Company's total ownership to
95%. This transaction resulted in a reduction in goodwill of $101.
Pro-Pilot Assets
----------------
During the fiscal quarter ended November 24, 2000, the Company
purchased the assets of the "Pro-Pilot" flight simulation game for $400. This
purchase was classified as an asset purchase (and not a business combination)
and thus no goodwill resulted from the transaction.
20
Notes to Consolidated Financial Statements ($ in thousands, except share data)
3. Accounts Receivable:
The components of accounts receivable at February 22, 2002 and February
23, 2001, are as follows:
2002 2001
---- ----
U.S. government receivables billed
and unbilled contract costs
subject to negotiation $6,281 $5,707
U.S. commercial receivables billed 2,918 2,484
International receivables billed and unbilled
contract costs subject to negotiation 11,030 8,955
------ ------
20,229 17,146
Less allowance for doubtful accounts (373) (370)
----- ------
$19,856 $16,776
======= =======
U.S. government receivables billed and unbilled contract costs subject
to negotiation:
Unbilled contract costs subject to negotiation represent claims made
against the U.S. government under a contract for a centrifuge. These costs,
totaling $3,898, were recorded beginning in fiscal year 1994, including $1,148
recorded during the three months ended May 26, 2000. Additionally, there is an
open receivable of $1,649 representing the balance due under the contract. On
May 9, 2002, the Company reached a final settlement agreement totaling
approximately $6.9 million with the U.S. Navy for all outstanding amounts. The
gain, if any, resulting from the settlement would be recognized in fiscal 2003.
International receivables billed:
International receivables billed included $700 and $930 respectively at
February 22, 2002 and February 23, 2001 related to a certain contract with the
Royal Thai Air Force.
In October 1993, the Company was notified by the Royal Thai Air Force
(RTAF) that the RTAF was terminating a certain $4.6 million simulator contract
with the Company. Although the Company had performed in excess of 90% of the
contract, the RTAF alleged a failure to completely perform. In connection with
the termination, the RTAF made a call on a $230 performance bond, as well as a
draw on an approximately $1.1 million advance payment letter of credit. Work
under this contract had stopped while under arbitration, but on October 1, 1996,
the Thai Trade Arbitration Counsel rendered its decision under which the
contract was reinstated in full and the Company was given a period of nine
months to complete the remainder of the work. Except as noted in the award, the
rights and obligations of the parties remain as per the original contract
including the potential invoking of penalties or termination of the contract for
delay. On December 22, 1997, the Company successfully performed acceptance
testing and the unit passed with no discrepancy reports. Although the contract
was not completed in the time allotted, the Company has requested an extension
on the completion time due to various extenuating circumstances, including
allowable "force majeure" events, one of which was a delay in obtaining an
export license to ship parts required to complete the trainers. On August 30,
2001, the Company received a payment of $230,000 representing the amount due on
the performance bond. The balance due on the contract is still under review by
the customer, but it is probable that the Company will initiate legal
proceedings to collect the balance. At this point, the Company is not able to
determine what, if any, impact the extended completion and payment period will
have upon the receipt of the total due.
Unbilled contract costs subject to negotiation represent claims made or
to be made against an international customer for two contracts covering 1996 to
the present. Claims receivables and resulting revenue aggregating $5,735 have
been recorded. Claim costs have been incurred in connection with customer caused
delays, errors in specifications and designs, and other out-of-scope items and
exchange losses and may not be received in full during fiscal 2003. In
conformity with accounting principles generally accepted in the United States of
America, revenue recorded by the Company from a claim does not exceed the
incurred contract costs related to the claim. The Company has submitted a claim
to the customer for one of the contracts and has also submitted to the customer
requests for equitable contract price adjustments on the other contract. The
company is currently updating and finalizing additional claims. As a related
item, during the third quarter of fiscal 2000, the aforementioned international
customer, citing failure to deliver product within contract terms, assessed
liquidated damages totaling approximately $1.6 million on two contracts
currently in progress. The Company disputes the basis for these liquidated
damages and plans to contest them vigorously. However, following generally
accepted accounting principles, the Company has reduced contract values and
corresponding revenues by approximately $1.6 million.
On July 20, 2001, the Company was notified by the international
customer that they were terminating the centrifuge contract, which was
approximately 90% complete. The termination included a request for the refund of
advance milestone payments made to date. At this point, the Company is not able
to assess the ultimate impact of the termination on current operations and
financial results.
21
Notes to Consolidated Financial Statements ($ in thousands, except share data)
3. Accounts Receivable (Continued):
The Company is currently in arbitration on this matter. As of February
22, 2002, the company had recorded on its books the following amounts for the
contract inception to date: revenue (including claims revenue) of $19,730, cost
of goods sold of $13,202, costs and estimated earnings in excess of billings on
uncompleted long term contracts of $16,604, claims receivables of $3,125, and
billings in excess of costs and estimated earnings on uncompleted long term
contracts of $10,099.
Claim bookings in fiscal 2002 decreased operating income by $661.
Claims bookings in fiscal 2001 increased operating income by $1,325. Both
amounts are net of associated manufacturing costs and legal expenses.
Unbilled costs
Amounts not billed nor yet billable totaled $28.5 million at February
22, 2002. Under most of the Company's contracts, invoices are issued upon the
attainment of certain contract milestones, for example upon receipt of order,
upon engineering drawing submittal, upon design acceptance, upon shipment, etc.
Service contracts are billed monthly or quarterly. Parts and service are billed
as shipped or completed.
4. Costs and Estimated Earnings on Uncompleted Contracts:
The following is a summary of long-term contracts in progress at
February 22, 2002 and February 23, 2001:
2002 2001
----- ----
Costs incurred on uncompleted long-term contracts $29,004 $30,251
Estimated earnings 12,677 10,209
------ -------
41,681 40,460
Less billings to date (32,789) (32,577)
------ ------
$8,892 $7,883
====== ======
2002 2001
---- ----
Included in accompanying balance sheets under the following captions:
Costs and estimated earnings in excess of billings
on uncompleted long-term contracts $9,391 $9,595
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts (499) (1,712)
------ ------
$8,892 $7,883
====== ======
Included in billings in excess of costs and estimated earnings on
uncompleted long-term contracts is a provision for anticipated losses
on contracts of $200 in 2002 and 2001 and $306 in 2000, respectively.
5. Inventories:
Inventories consist of the following:
Work in Finished
Raw Material Process Goods Total
------------ ------- -------- -----
February 22, 2002 $110 4,470 2,581 $7,161
February 23, 2002 359 2,105 2,160 $4,624
Inventory is presented net of an allowance for obsolescence of $ 738 and $ 630
in 2002 and 2001, respectively.
22
Notes to Consolidated Financial Statements ($ in thousands, except share data)
6. Property, Plant and Equipment:
The following is a summary of property, plant and equipment, at cost,
and estimated useful lives at February 22, 2002 and February 23, 2001:
Estimated
useful
2002 2001 lives
---- ---- -----
Land $100 $100
Building and building additions 3,763 3,260 40 years
Machinery and equipment 8,173 8,039 3-5 years
Office furniture and equipment 1,192 1,180 10 years
Building improvements 1,393 1,393 5-10 years
----- ----- ----------
14,621 13,972
Less accumulated depreciation (9,303) (8,635)
------ ------
Property, plant and equipment, net $5,318 $5,337
====== ======
Depreciation expense for the years ended February 22, 2002, February 23, 2001,
and February 25, 2000, was $ 668, $ 602 and $ 535, respectively.
7. Long-Term Obligation and Credit Arrangements:
Long-term obligations at February 22, 2002 and February 23, 2001
consist of the following:
2002 2001
-------- ------
Credit facility payable to banks $ 11,755 $7,564
Long Term Bonds 5,195 5,470
Subordinated debt, net - 350
Term loans payable, accruing interest at between 9% and 9.9%
collateralized by priority liens on certain equipment 19 37
16,969 13,421
Less current portion (281) (643)
-------- -------
$ 16,688 $12,778
======== =======
The amounts of future long-term obligations maturing in each of the
next five fiscal years are as follows:
2003 $281
2004 12,036
2005 281
2006 281
2007 and thereafter 4,090
-------
Total future obligations $16,969
The approximate average loan balance, maximum aggregate borrowings
outstanding at any month-end payable under the credit facility and subordinated
debt during the fiscal years, and weighted average interest rate computed by the
days outstanding method as of February 22, 2002 and February 23, 2001 are as
follows:
2002 2001
----- -----
Approximate average loan balance 10,631 3,764
Maximum aggregate 11,926 7,564
Weighted average interest rate 6.35% 8.74%
23
Notes to Consolidated Financial Statements ($ in thousands, except share data)
7. Long-Term Obligation and Credit Arrangements (Continued):
Interest is charged on direct borrowings at the bank's prime rate less
a factor ranging from 0% to 0.5% based on the Company's Leverage Ratio, as
defined, or adjusted LIBOR in 2002 and 2001. The interest rates ranged from
4.50% to 8.25% during fiscal 2002 and from 7.85% to 8.83% during fiscal 2001.
The Company's letter of credit limit is $5.0 million, provided that the
cumulative of all outstanding trade letters of credit does not exceed $2.5
million. The balance outstanding under these provisions at February 22, 2002,
was $3,034. Fees on letters of credit outstanding were 1.25% at February 22,
2002 and 0.75% at February 23, 2001.
On February 25, 2000, the Company signed an amendment to its revolving
Credit Agreement originally entered into on March 27, 1997, which increased its
credit facility to $15 million and extended its expiration date to August 31,
2002. These funds are available to support working capital needs and letters of
credit. Terms and conditions of the amendment remained essentially the same as
the original agreement. The Credit Agreement is collateralized by substantially
all of the Company's assets. The Company is prohibited from declaring any cash
dividends under the terms of the Credit Agreement. This facility bears interest
at the bank's prime lending rate less a factor ranging from 0% to 0.5% based on
the Company's Leverage Ratio, as defined, or adjusted LIBOR. A commitment fee of
0.2% is charged for unused available funds. The credit facility includes certain
covenants related to, among other things, prohibitions on incurring additional
debt, change in ownership of certain officers, payment of dividends and
maintenance, on a quarterly basis, of certain financial ratios. Substantially
all of the Company's short-term financing is provided by this bank.
At February 23, 2001, the Company was in violation of one of its Credit
Agreement loan covenants, specifically the requirement to maintain a specified
Funds Flow Ratio. This violation resulted from the unusually high capital
spending for the Company's modernization program in relation to net income in
the fiscal period. Accordingly, the Company received a waiver for this violation
at February 23, 2001, from its Bank and also the bank agreed to adjust this
covenant for the period through November 23, 2001.
On March 29, 2002, the Company signed an amendment to its revolving
credit agreement which extended the expiration date of the Credit Agreement to
November 30, 2002 and increased the interest rate from (i) the bank's prime rate
less a factor ranging from 0% to 0.5% based on the Company's leverage ratio or
adjusted LIBOR, to (ii) the bank's prime rate plus 1% for adjusted base rate
loans or adjusted LIBOR plus 3.5% for adjusted LIBOR rate loans. The amendment
also adjusted the Funds Flow Ratio through the expiration date of the Credit
Agreement. On June 5, 2002, the Company's bank agreed to extend the expiration
date of the Credit Agreement to February 28, 2003. Substantially all of the
company's short-term financing is provided by this bank. As of June 5, 2002, the
Company had $1,485,000 available under the credit agreement.
On March 27, 1997, the Company issued $4 million of subordinated
debentures, bearing interest at 12% per annum, due March 27, 2004, to a
financial institution. On January 11, 2000, the Company utilized $4.1 million of
its revolving credit facility to repay these subordinated debentures. See also
commentary concerning long term bonds. In connection with the subordinated
debentures, warrants were issued to acquire 332,820 shares of the Company's
common stock at an exercise price of $.50 per share; $499 of the proceeds from
the sale of the debentures was allocated to the warrants and credited to capital
contributed in excess of par value of common stock. This amount had been fully
amortized to interest expense as of February 22, 2002.
On March 27, 1997, the Company also issued 25,000 shares of 11%
redeemable convertible preferred stock for $2.5 million. Each share of preferred
stock was convertible, at the option of the shareholder, into 26.66 shares of
the Company's common stock at a price of $3.75 per share. On February 26, 1999,
the Company issued a redemption notice to redeem the outstanding 25,000 shares
of Series A Preferred Stock in their entirety. On March 25, 1999, the Company
received notice that Sirrom Capital Corporation had exercised its conversion
privilege under the terms of the agreement to convert its 25,000 shares of
Series A Preferred Stock into the Company's common shares. Consequently, on
April 19, 1999, the Series A Preferred was retired and 666,666 shares of common
stock were issued to Sirrom Capital Corporation. Concurrent with this
transaction the Company charged retained earnings for $128 representing the
difference between book and face value of the Preferred Stock and then
reclassified $2,500 of Preferred Stock value to common stock at par and
additional paid in capital.
Total financing fees associated with the March 27, 1997 financing were
approximately $876, all of which had been charged to interest expense or
accreted to retained earnings by February 22, 2002. The proceeds from these
transactions were used to repay, in full, amounts outstanding with a prior
lender.
Subordinated debt at February 25, 2001, consisted of debt issued for
the acquisition of ETC-PZL (see note 2).
24
Notes to Consolidated Financial Statements ($ in thousands, except share data)
7. Long-Term Obligation and Credit Arrangements (Continued):
As a condition to the extension of the prior credit facility through
March 31, 1997, warrants were issued to an affiliate of a Bank to purchase
200,000 shares of the Company's common stock at a price equal to $2.59. On March
6, 2000, these warrants were exercised and the Company received $518
representing the full purchase price. Subsequently, on March 20, 2000, the
Company issued 212,866 shares (representing the original warrant value as
adjusted) of its common shares.
On March 15, 2000, the Company issued approximately $5.5 million of
unregistered Taxable Variable Rate Demand/Fixed Rate Revenue Bonds (Series of
2000). Net proceeds from these bonds were used to repay a $4.1 million advance
taken on the Company's revolving credit facility and to finance construction of
an addition to the Company's main plant in Southampton, Pennsylvania. The bonds
are secured by a $5.6 million irrevocable direct pay Letter of Credit issued by
the Company's main lender which expires on March 15, 2005 and which is secured
by all assets of the Company. The Bonds carry a maturity date of April 1, 2020,
bear a variable interest rate which adjusts each week to a rate required to
remarket the bonds at full principal value (currently at 1.94% on May 16, 2002)
with a cap of 17%, and are subject to mandatory redemption of $275 per year for
19 years and $245 for the 20th year.
The carrying value of the aforementioned financial instruments approximates
their fair values at February 22, 2002
8. Leases:
Operating Leases
The Company leases certain premises and office equipment under
operating leases which expire over the next five years. Future minimum rental
payments required under noncancellable operating leases having a remaining term
expiring after one fiscal year as of February 22, 2002 are $194 in 2003; $141 in
2004; $127 in 2005; $84 in 2006; and $44 in 2007 and thereafter.
Total rental expense for all operating leases for the years ended
February 22, 2002, February 23, 2001, and February 25, 2000, was $197, $117, and
$39, respectively.
9. Income Taxes:
The components of the provision for income taxes are as follows:
52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 22, February 23, February 25,
2002 2001 2000
---- ---- ----
Currently payable:
Federal $42 $906 $889
State 134 109 179
Foreign taxes (230) 15 108
------ ------
(54) 1,030 1,176
---- ------ ------
Deferred:
Federal (36) 88 360
State (3) 8 37
------ ------
(39) 96 397
------ ------
$(93) $1,126 $1,573
==== ====== ======
A reconciliation of the statutory federal income tax to the effective tax is as
follows:
52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 22, February 23, February 25,
2002 2001 2000
------ ---- ----
Statutory income tax 34.0% 34.0% 34.0%
State income tax, net of federal tax benefit 5.4 2.2 2.9
Benefit of foreign sales corporation
And extraterritorial income (3.4) (5.5) (5.2)
Research and experimentation tax
credit refunds attributable to
open tax years (37.8) - -
Research and experimentation and
Other tax credits (9.2) - -
Benefit of foreign and foreign-source
25
Notes to Consolidated Financial Statements ($ in thousands, except share data)
9. Income Taxes (Continued):
Income or loss (1.0) - -
Other, net 6.4 4.6 3.4
--- ---
(5.6)% 35.3% 35.1%
==== ==== ====
The domestic Company has filed for federal income tax refunds
approximating $619 as a result of amended income tax returns to utilize the
research and experimentation tax credit for all open years. The Company will
continue to use research and experimentation tax credits, if applicable, to
reduce its federal income tax.
The tax effects of the primary temporary differences are as follows:
2002 2001 2000
---- ---- ----
Deferred tax assets:
Net products liability settlement 75 74 115
Vacation reserve 58 58 59
Inventory reserve 275 233 270
Receivable reserve 139 138 138
Warranty reserve 46 46 46
Other, net 122 66 61
--- -- --
Total current deferred tax asset $715 $615 $689
---- ---- ----
Deferred tax liabilities:
Amortization of capitalized software $488 $429 $395
Depreciation 247 245 257
--- --- ----
Total noncurrent deferred tax liability $735 $674 $652
==== ==== ====
26
Notes to Consolidated Financial Statements ($ in thousands, except share data)
10. Business Segment Information
The Company primarily manufactures, under contract, various types of
high-technology equipment which it has designed and developed. The Company
considers its business activities to be divided into two segments: Aircrew
Training Systems (ATS) and Industrial Simulation. The ATS business produces
devices which create and monitor the physiological effects of motion, including
spatial disorientation and centrifugal forces for medical, training, research
and entertainment markets. The Industrial Group business produce chambers that
create environments that are used for sterilization, research and medical
applications. The following segment information reflects the accrual basis of
accounting:
Industrial
ATS Group Total
--- ----- -----
2002
----
Net sales $22,629 $9,898 $32,527
Interest expense 950 144 1,094
Depreciation and amortization 1,041 434 1,475
Operating income 2,631 1,347 3,978
Income tax provision 164 118 282
Identifiable assets 32,683 5,408 38,091
Expenditures for segment assets 557 92 649
2001
----
Net sales $23,567 $8,885 $32,452
Interest expense 558 94 652
Depreciation and amortization 796 482 1,278
Operating income 5,794 (906) 4,888
Income tax provision 1,833 (350) 1,483
Identifiable assets 27,534 4,652 32,186
Expenditures for segment assets 2,306 322 2,628
2000
----
Net sales $26,361 $8,559 $34,920
Interest expense 465 125 590
Depreciation and amortization 1,024 371 1,395
Operating income (loss) 5,039 1,355 6,394
Income tax provision (benefit) 1,601 431 2,032
Identifiable assets 20,344 5,538 25,882
Expenditures for segment assets 650 167 817
2002 2001 2000
---- ---- ----
Reconciliation to consolidated amounts:
Corporate assets 10,391 13,171 11,553
------- ------- -------
Total assets $48,482 $40,705 $31,897
Segment operating income $3,978 $4,888 $6,394
Less interest expense (1,094) (652) (590)
Less income taxes (282) (1,483) (2,032)
------- ------- -------
Total profit for segments 2,602 2,641 3,772
Corporate home office expense (1,105) (766) (936)
Interest and other expenses (144) (272) (388)
Income tax benefit 375 357 459
Minority interest 13 (51) (70)
------- ------- -------
Net income $1,741 $2,021 $2,837
======= ======= =======
Segment operating income (loss) consists of net sales less applicable
costs and expenses relating to these revenues. Unallocated general corporate
expenses, letter of credit fees, interest expense, and income taxes have been
excluded from the determination of the total profit for segments. General
corporate expenses are primarily central administrative office expenses.
Property, plant, and equipment are not identified with specific business
segments because most of these assets are used in each of the segments.
27
Notes to Consolidated Financial Statements ($ in thousands, except share data)
10. Business Segment Information (Continued):
Approximately 58.9% of sales totaling $19,143 in 2002 were made to one
international and one domestic customer in the ATS segment. Approximately 43% of
sales totaling $13,924 in 2001 were made to one international and one domestic
customer in the ATS segment. Approximately 63% of sales totaling $16,609 in 2000
were made to two international and one domestic customer in the ATS segment.
Included in the segment information for the year ended February 22,
2002, are export sales of $10,110. Of this amount, there are sales to or
relating to governments or commercial accounts in Thailand of $3,284. Sales to
the U.S. government and its agencies aggregate $1,194 for the year ended
February 22, 2002.
Included in the segment information for the year ended February 23,
2001 are export sales of $16,404. Of these amounts, there are sales to or
relating to governments or commercial accounts in Great Britain of $5,660. Sales
to the U.S. government and its agencies aggregate $2,064 for the year ended
February 23, 2001.
Included in the segment information for the year ended February 25,
2000 are export sales of $23,907. Of these amounts, there are sales to or
relating to governments or commercial accounts in Great Britain ($4,821), Poland
($4,201), and Nigeria ($8,107) for ATS sales. Sales to the U.S. government and
its agencies aggregated $1,587 for the year ended February 25, 2000.
11. Stock Options:
In August 1999 the Company adopted an Incentive Stock Option Plan to
replace the 1988 Incentive Stock Option Plan which expired in August 1999. The
plan authorizes a committee of the Board of Directors to grant options for the
purchase of up to 1,000,000 shares of common stock to qualifying officers and
other key employees. The Plan provides that the option price shall not be less
than 100% (or in the case of a ten- percent owner, 110%) of the current market
price of the stock on the date of the grant. Options may be exercised on a
cumulative basis at the rate of 25% per year commencing one year after the date
of grant and have a maximum term of 10 years. The Plan will terminate on August
1, 2008. At February 22, 2002, there were 622,436 shares available to be granted
under the Plan.
Since the exercise price of each option is not less than 100% of the
current market price of the Company's stock on the date of grant, no
compensation cost has been recognized for the Plan. Had compensation cost for
the Plan been determined based on the fair value of the options at the grant
dates consistent with the method of SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts indicated
below. Reported amounts reflect the 2 for 1 stock split declared by the Company
on February 25, 1999 (see note 1).
2002 2001 2000
---- ---- ----
Net income:
As reported $1,741 $2,021 $2,837
Pro forma $1,282 $1,549 $2,350
Basic earnings per share:
As reported $.24 $.29 $.40
Pro forma $.18 $.22 $.33
Diluted earnings per share:
As reported $.23 $.27 $.36
Pro forma $.17 $.21 $.30
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes options-pricing model with the following weighted
average assumptions used for grants in 2002: dividend yield of 0%; expected
volatility of 60.3%; risk-free interest rate of 5.15%; and expected life of five
years.
28
Notes to Consolidated Financial Statements ($ in thousands, except share data)
11. Stock Options (Continued):
A summary of the status of the current Incentive Stock Option Plan and
the 1988 Incentive Stock Option Plan as of February 22, 2002, February 23, 2001,
and February 25, 2000, and changes during the years ending on those dates is
presented below.
2002 2001
---- ----
Weighted Weighted
average average
exercise exercise
Shares price Shares price
------ ----- ------ -----
Outstanding at beginning of year 464,350 $6.95 497,750 $6.80
Granted 27,564 7.38 - -
Exercised (32,400) 5.89 (33,400) 4.79
Forfeited (11,000) 7.43 - -
Outstanding at end of year 448,514 7.04 464,350 6..95
------- ------- -----
Options exercisable at year end 240,325 147,936
Weighted average fair value of
options granted during the year $7.01 $-
2000
----
Weighted
Average
exercise
Shares price
------ -----
Outstanding at beginning of year 543,700 $6.57
Granted - -
Exercised (28,950) 3.59
Forfeited (17,000) 4.86
Outstanding at end of year 497,750 6.80
Options exercisable at year end 41,657
Weighted average fair value of
options granted during the year $-
The following information applies to options outstanding at February
22, 2002:
Options outstanding Options exercisable
------------------- -------------------
Weighted
Number average Weighted Number
Weighted
Outstanding at remaining average exercisable at
average
February 22, contractual exercise February 22,
exercise
Range of exercise prices 2002 life (years) price 2002 price
------------------------ ---- ------------ ----- ---- -----
$2.25 to $3.38 12,200 4.5 years $2.25 12,200 $2.25
$5.00 to $7.50 122,564 7.5 years $5.53 71,250 $5.00
$7.81 to $9.76 313,750 6 years $7.81 156,875 $7.81
12. Claims and Litigation
Certain other claims, suits, and complaints arising in the ordinary
course of business have been filed or are pending against the Company. In the
opinion of management, after consultation with legal counsel handling these
specific maters, all such matters are reserved for or adequately covered by
insurance or, if not so covered, are without merit or are of such kind, or
involve such amounts, as would not have a significant effect on the financial
position or results of operations of the Company if disposed of unfavorably.
13. Employee Benefit Plan
The Company maintains a retirement savings 401(k) plan for eligible
employees. The Company's contributions to the plan are based on a percentage of
the employees' qualifying contributions. The Company's contributions totaled
$114, $124, and $121 in 2002, 2001, and 2000, respectively.
29
Notes to Consolidated Financial Statements ($ in thousands, except share data)
13. Employee Benefit Plan (Continued):
The Company has an Employee Stock Purchase Plan which was adopted by
the Board of Directors on November 3, 1987. All employees meeting service
requirements, except officers, directors and 10% shareholders, are eligible to
voluntarily purchase common stock through payroll deductions up to 10% of
salary. The Company makes a matching contribution of 20% of the employee's
contribution. The Company has reserved 270,000 shares for issuance under the
plan.
14. Quarterly Consolidated Financial Information (Unaudited):
Financial data for the interim periods of 2002, 2001 and 2000 were as
follows:
Quarter Ended
-------------
Fiscal Year 2002 May August November February
25 24 23 22
-- -- -- --
Net sales $8,340 $7,414 $8,230 $8,543
Gross profit 2,693 2,393 3,667 2,712
Operating income 449 546 1,351 527
Income before income taxes 158 275 805 398
Minority interest (5) (4) 2 (6)
Net income 224 297 662 558
Earnings per common share:
Basic .03 .04 .09 .08
Diluted .03 .04 .09 .07
Quarter Ended
-------------
Fiscal Year 2001 May August November February
26 25 24 23
-- -- -- --
Net sales $7,157 $6,994 $8,622 $9,679
Gross profit 3,355 2,678 2,809 4,233
Operating income 1,522 482 617 1,501
Income before income taxes 1,351 246 335 1,266
Minority interest 2 22 0 27
Net income 882 118 227 794
Earnings per common share:
Basic .13 .02 .03 .11
Diluted .12 .02 .03 .10
Quarter Ended
Fiscal Year 2000 May August November February
28 27 26 25
-- -- -- --
Net sales $8,295 $8,279 $9,107 $9,239
Gross profit 3,418 2,679 3,381 3,320
Operating income 1,426 716 1,401 1,784
Income before income taxes 1,231 522 1,187 1,540
Minority Interest (35) (32) 8 129
Net income 835 372 763 867
Earnings per common share:
Basic .11 .05 .11 .13
Diluted .10 .05 .10 .11
Note: All earnings per share amounts have been restated to reflect a 2 for 1
stock split effective May 28, 1999.