EXHIBIT 13
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PORTIONS OF
ENVIRONMENTAL TECTONICS CORPORATION
2003
ANNUAL REPORT TO STOCKHOLDERS
1
FINANCIAL REVIEW
($ in thousands, except share and per share data)
Fiscal Year End 2003 2002 2001 2000 1999
- --------------- ---- ---- ---- ---- ----
Net sales $ 43,123 $ 32,527 $ 32,452 $ 34,920 $ 29,225
Gross profit 14,198 11,465 13,075 12,798 11,672
Operating income 4,116 2,873 4,122 5,327 4,759
Net income 2,493 1,741 2,021 2,873 2,170
Earnings per common share:
Basic .35 .24 .29 .40 .32
Diluted .33 .23 .27 .36 .29
Working capital 31,216 30,683 25,070 16,306 13,755
Long-term obligations 12,643 16,688 12,778 4,455 4,219
Total assets 47,698 48,482 40,705 31,897 35,448
Total stockholders' equity 25,907 20,782 18,796 16,245 11,030
Weighted average common shares:
Basic 7,153,000 7,143,000 7,087,000 6,604,000 5,861,000
Diluted 7,497,000 7,499,000 7,499,000 7,319,000 6,312,000
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 prohibited from declaring any cash
dividends on its common stock under the terms of its credit facility.
2
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
our vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business, 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 these risks and
uncertainties, in whole or in part, are beyond the Company's control. Factors
that might cause or contribute to such a material difference include, but are
not limited to, those discussed in our Annual Report on Form 10-K, in the
section entitled "Risks Particular to Our Business." Shareholders are urged to
review these risks carefully prior to making an investment in the Company's
common stock.
We do not undertake to update any forward-looking statement, whether
written or oral, that we may make from time to time or that may be made on our
behalf from time to time.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Overview
The Company is principally engaged in the design, manufacture and sale
of software driven products used to create and monitor the physiological effects
of motion on humans and equipment and to control, modify, simulate and measure
environmental conditions. These products include aircrew training systems,
entertainment products, sterilizers, environmental and hyperbaric chambers and
other products that involve similar manufacturing techniques and engineering
technologies.
The Company recognizes revenue using three methods:
On long-term contracts, the percentage of completion method is applied
based on costs incurred as a percentage of estimated total costs. This
percentage is multiplied by the total estimated revenue under a contract to
calculate the amount of revenue recognized in an accounting period. 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 Company learns the facts which require it to revise the cost and profit
estimates. 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, is recognized on the date that the finished product is shipped to the
customer.
Revenue derived from the sale of parts and services is also recognized
on the date that the finished product is shipped to the customer. 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 following customer acceptance. Revenue for service
contracts is recognized ratably over the life of the contract with related
material costs expensed as incurred.
In accordance with accounting principles generally accepted in the
United States, recognizing revenue on contract claims and disputes, related to
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 Company can reliably estimate the amount of additional
contract revenue. However, revenue recorded on a contract claim cannot exceed
the incurred contract costs related to that claim.
3
The Company has operating subsidiaries in the United Kingdom and
Poland, 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. ETC International Corporation is not an operating
subsidiary. The Company considers its business activities to be divided into two
segments; Aircrew Training Systems (ATS) and Industrial Group.
Critical Accounting Policies
The discussion and analysis of the Company's financial condition and
results of operation are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires the Company to make estimates and judgments that affect the
reported amount of assets and liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities at the date of the Company's
financial statements. Actual results may differ from these estimates under
different assumptions or conditions.
Critical accounting policies are defined as those that reflect
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. The Company
believes that its critical accounting policies include those described below.
For a detailed discussion on the application of these and other accounting
policies, see Note 1 to the Consolidated Financial Statements, Summary of
Significant Accounting Policies.
Revenue Recognition on Long-Term Contracts
When the performance of a contract requires a customer to pay the
Company more than $100,000 and will extend beyond a 12 month period, revenue and
related costs are recognized on the percentage-of-completion method of
accounting. Profits expected to be realized on such contracts are recognized
based on total estimated sales for the contract compared to total estimated
costs at completion of the contract. These estimates are reviewed periodically
throughout the lives of the contracts, and adjustments to profits resulting from
any revisions are made cumulative to the date of the change. Estimated losses on
long-term contracts are recorded in the period in which the losses become known
to the Company.
The Company accounts for some its largest contracts, including its
contracts with the U.S. and other foreign governments, using the
percentage-of-completion method. If the Company does not accurately estimate the
total cost to be incurred on this type of contract, or if the Company is
unsuccessful in the ultimate collection of associated contract claims, the
estimated gross margins may be significantly impacted or losses may need to be
recognized in future periods. Any resulting reductions in margins or contract
losses could be material to the Company's results of operations and financial
position.
Accounts Receivable
The Company performs ongoing credit evaluations of its customers and
adjusts credit limits based on payment history and the customer's current credit
worthiness. The Company continuously monitors collections and payments from its
customers and maintains a provision for estimated credit losses based on
historical experience and any specific customer collection issues that have been
identified. While the Company's credit losses have historically been within its
expectations and the provisions established, the Company cannot guarantee that
it will continue to experience the same credit loss rates that it has in the
past. Additionally, as a result of the concentration of international
receivables, the Company cannot predict the effect, if any, which geopolitical
risk and uncertainty will have on the ultimate collection of its international
receivables.
In accordance with accounting principles generally accepted in the
United States, recognizing revenue on contract claims and disputes related to
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 Company can reliably estimate the amount of additional
contract revenue. However, revenue recorded on a contract claim cannot exceed
the incurred contract costs related to that claim. Claims are subject to
negotiation, arbitration and audit by the customer or governmental agency.
Results of Operations
Fiscal 2003 versus Fiscal 2002
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The Company had net income of $2,493,000 or $.33 per share (diluted) in
2003 versus net income of $1,741,000 or $.23 per share (diluted) in fiscal 2002.
Operating income was $4,116,000, an increase of $1,243,000 or 43.3% over 2002.
This increase was primarily the result of increased gross profits due to higher
sales volumes, partially offset by higher general and administrative expenses
and research and development expenses.
4
Total sales in fiscal 2003 were $43,123,000, an increase of $10,596,000
or 32.6% over 2002, representing increases in all segments except hyperbaric.
Primary contributors were additional international revenues for Aircrew Training
Systems (ATS) (increased by $5,404,000) which benefited from a human centrifuge
project in Southeast Asia, higher government sales for ATS (increased
$2,099,000) reflecting the impact of the settlement with the U.S. Navy on the
centrifuge contract and hyperbaric sales for a large U.S. Navy submarine rescue
project, higher domestic sterilizer sales (increased by $1,245,000), and
additional sales for domestic entertainment (increased by $1,409,000) which was
involved in full production of a large project. Geographically, domestic sales
were up $2,468,000 or 11.6%, and represented 54.9% of total sales, down from
65.2% in fiscal 2002, primarily reflecting sterilizer and entertainment
activity. U.S. government sales increased to $4,626,000, as compared to
$1,194,000 in fiscal 2002, and represented 10.8% of total sales, up from 3.7% of
total sales in fiscal 2002. International sales, including those from the
Company's foreign subsidiaries, were up $4,695,000 or 46.4%, and represented
34.3% of total sales, up from 31.1% in fiscal 2002, primarily reflecting an
increase in ATS sales. Throughout the Company's history, most of the sales for
Aircrew Training products have been made to international customers.
Customers representing 10% or more of sales in fiscal 2003 were the
Walt Disney Company, $17,268,000 or 40.0%, and the Royal Malaysian Air Force,
$7,203,000 or 16.7%. In fiscal 2003, international sales totaling at least
$500,000 per country were made to customers in Malaysia, Thailand and China.
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 Royal Malaysian Air Force and a domestic sterilizer customer constituted
27.6% and 11.8% respectively of the Company's backlog at February 28, 2003. For
a discussion of the additional risks associated with our international
operations, see "Risks Related to Our Business--There are certain risks inherent
in our international business activities, which constitute a significant portion
of our business," in our Annual Report on Form 10-K.
On a segment basis, sales of the Company's 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 $31,612,000 in fiscal 2003,
an increase of $8,983,000, or 39.7% over fiscal 2002. Sales of these products
accounted for 73.3% of the Company's sales compared to 69.6% in fiscal 2002.
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 $1,613,000 to $11,511,000, an
increase of 16.3%, and constituted 26.7% of the Company's total sales compared
to 30.4% in fiscal 2002.
Significant claims outstanding at February 28, 2003 included a new
claim with the U.S. Navy ($2.1 million recorded) and two claims with an
international customer ($9.6 million recorded). On May 9, 2002, the Company
reached a final settlement agreement totaling approximately $6.9 million with
the U.S. Navy for a claim on a centrifuge contract completed in 1996 to resolve
all outstanding amounts related to this claim. The outstanding claims with the
international customer are both in arbitration. Although recorded as a current
asset in the financial statements, all claim revenues may not be received in
full during fiscal 2004.
Gross profit for fiscal 2003 increased by $2,733,000 or 23.8% from
fiscal 2002 as the increased sales volume was only partially offset by a 2.3
percentage point reduction in the rate as a percentage of sales. Reduced rates
as a percentage of sales were primarily evidenced in international
environmental, government hyperbaric and domestic simulation. Acting as a
partial offset was an increase in gross profit dollars and rate as a percentage
of sales for Aircrew Training Systems.
Operating income for fiscal 2003 was $4,116,000, an increase of
$1,243,000 or 43.3% over fiscal 2002. On a segment basis, ATS had an operating
income of $4,979,000, an increase of $2,348,000 or 89.2% from fiscal 2002, while
the Industrial Group had an operating income of $52,000 in fiscal 2003 compared
to an operating income of $1,347,000 in fiscal 2002. These segment operating
incomes were offset, in part, by unallocated corporate expenses of $915,000, a
decrease of $190,000 from fiscal 2002.
The improvement in operating income for the ATS segment in fiscal 2003
was due to increased international sales at a higher gross profit rate as a
percentage of revenues partially offset by higher general and administrative
expenses including commissions.
The Industrial Group segment's decrease in operating income in fiscal
2003 reflected increased sales offset by a 13.2 percentage point reduction in
the gross profit rate as a percentage of sales and additional general and
administrative expenses. Both the environmental and hyperbaric product lines
experienced reduced gross profit percentages.
Selling and administrative expenses increased $1,454,000 or 18.2% in
fiscal 2003 as compared to fiscal 2002 primarily reflecting increased
commissions on the sales increase and increased claims expenses associated with
the Company's ongoing claims activity. As a percentage of sales, selling and
administrative expenses were 21.9% in fiscal 2003 compared to 24.6% in fiscal
2002.
5
Research and development expenses increased slightly, up $36,000 or
6.0% in fiscal 2003 as compared to fiscal 2002, reflecting slightly higher
activity 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 fiscal 2003 were $1,193,000 compared to $989,000 in fiscal
2002. Amortization of software costs, which was charged to cost of sales, was
$653,000 and $496,000 for fiscal 2003 and fiscal 2002, respectively.
Interest expense (net of interest income) decreased $576,000 or 52.7%
in fiscal 2003 from fiscal 2002 reflecting reduced average borrowings at lower
rates and reduced amortization of deferred finance expenses. During fiscal 2002,
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 $194,000 or 134.7% in fiscal 2003 over
fiscal 2002, principally due to increased banking fees associated with the
Company's former lender.
The Company's provision for taxes in fiscal 2003 was calculated based
on a consolidated rate of 24.7%, primarily reflecting the impact 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 the second quarter of fiscal 2003, the Company reached a
settlement with Inland Revenue in Great Britain which resulted in an additional
tax assessment of $15,000. Additionally, the Internal Revenue Service is
currently performing a routine audit of the Company's fiscal 2000 tax filing.
The Company is currently not able to assess whether any additional tax liability
will result from the audit, although at this point the Company believes that any
additional taxes, if any, will be immaterial.
Fiscal 2002 versus Fiscal 2001
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The Company had net income of $1,741,000 or $.23 per share (diluted) in
fiscal 2002, versus a net income of $2,021,000 or $.27 per share (diluted) in
fiscal 2001. Operating income was $2,873,000, a decrease of $1,249,000 or 30.3%
over fiscal 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.
Total sales increased $75,000 or 0.2% in fiscal 2002 over fiscal 2001
representing increases in entertainment (increased by $7,459,000, 88.8%),
environmental (increased by $428,000, 17.7%) and hyperbaric systems (increased
by $967,000, 31.1%). Partial offsets were Aircrew Training Systems (ATS) sales
(decreased by $6,793,000, 50.3%) including sales from the Company's Polish
subsidiary, sales of sterilizers and simulation sales by 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 in fiscal 2002. 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. 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
fiscal 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 fiscal 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
fiscal 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.
Customers representing 10% or more of sales in fiscal 2002 were the
Walt Disney Company, $15,859,000 or 48.8%, and the Royal Thai Air Force,
$3,285,000 or 10.1%. In fiscal 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 Company constituted 44.1% of the
Company's backlog at February 22, 2002.
6
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 fiscal 2002, a decrease of $692,000, or 3.0% over fiscal 2001.
Sales of these products accounted for 69.6% of the Company's sales compared to
72.6% in fiscal 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 fiscal 2001.
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 outstanding claims with the international customer were either
under review by the customer or in litigation at February 28, 2002.
Gross profit decreased $1,160,000 or 12.3%, primarily reflecting
reduced claims revenue.
Operating income decreased $1,249,000, or 30.3%, in fiscal 2002
compared to fiscal 2001. On a segment basis, ATS had an operating income of
$2,631,000, a decrease of $3,163,000 from fiscal 2001, while the Industrial
Group had an operating income of $1,347,000 compared to an operating loss of
$906,000 in fiscal 2001. These segment operating incomes were offset, in part,
by unallocated corporate expenses of $1,105,000, an increase of 339,000 over
fiscal 2001.
Selling and administrative expenses decreased $58,000, or 0.7%, in
fiscal 2002 as compared to fiscal 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 fiscal 2001.
Research and development expenses decreased significantly by $303,000,
or 33.6%, in fiscal 2002 as compared to fiscal 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 fiscal 2002 over fiscal 2001 reflecting higher borrowings albeit at a lower
average rate. Additionally, during the third quarter of fiscal 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 fiscal 2002 over
fiscal 2001 principally due to increased letter of credit fees.
The Company's benefit from taxes was calculated based on a consolidated
rate of (5.7%), primarily reflecting 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.
Liquidity and Capital Resources
During fiscal 2003, the Company generated $7,580,000 of cash from
operating activities. This primarily reflected cash from net income and non-cash
expenses such as depreciation and amortization and significant reductions in
receivables and costs and estimated earnings in excess of billings on
uncompleted long-term contracts. Providing a partial offset were an increase in
inventory and reductions in accounts payable, customer deposits and accrued
income taxes. In general, the cash generation from operations reflected strong
collections on long-term contracts, the settlement on the centrifuge contract
with the U.S. Navy, and positive operating performance.
The Company's investing activities used $784,000 in fiscal 2003 and
consisted of purchases of capital equipment and capitalized software.
The Company's financing activities used $4,755,000 of cash during
fiscal 2003. This primarily reflected a significant repayment of the Company's
prior bank line and an increase in restricted cash to cash collateralize
international letters of credit which was only partially offset by cash from the
Company's new convertible note and additional paid-in capital associated with
the convertible note and common stock warrants under the new financing.
(Reference Note 6 to the Consolidated Financial Statements, Long-Term
Obligations and Credit Arrangements.)
7
The Company has historically financed operations through a combination
of cash generated from operations, equity offerings and bank debt. On February
19, 2003, the Company completed a refinancing of its indebtedness with PNC Bank,
National Association and H.F. Lenfest in the aggregate amount of $29,800,000.
The Company used a portion of the proceeds from the financing to satisfy its
existing debt obligations to Wachovia Bank, the Company's former lender, and to
permit PNC Bank to issue a letter of credit to support outstanding bonds issued
by Company. The transaction resulted in net proceeds (after transaction expenses
and payment of existing debt) to the Company of approximately $3,600,000. The
net proceeds have been used by the Company for working capital purposes, and
general corporate purposes directly related to growth.
In accordance with the terms of an amendment, dated April 30, 2003, the
PNC Bank facility was incureased and, as of the date of this Annual Report on
Form 10-K, includes: (i) a revolving credit facility in the maximum aggregate
principal amount of $14,800,000 to be used for the Company's working capital and
general corporate purposes, including capital expenditures, with a sublimit for
issuances of letters of credit in the maximum amount of $10,300,000, and (ii) a
standby letter of credit in the amount of $5,025,410 as credit support for the
Company's bonds.
The terms and conditions of the revolving loan and the line of credit
are set forth in a Credit Agreement, as amended, between the Company and PNC
Bank. Availability under the facility is determined each month based on a
borrowing base consisting of a portion of the Company's receivables, inventory
and costs and estimated earnings in excess of billings, net of billings in
excess of costs and estimated earnings on uncompleted long-term contracts. As of
February 28, 2003, availability under the $14,800,000 revolving facility was
$7,913,000, which the Company had fully utilized.
The obligations of the Company to PNC Bank under the Credit Agreement
are secured by a senior security interest in all of the assets of the Company,
including all real property owned by the Company.
In connection with the financing provided by Mr. Lenfest, the Company
entered into a Convertible Note and Warrant Purchase Agreement with Mr. Lenfest,
pursuant to which the Company issued to Mr. Lenfest (i) a senior subordinated
convertible promissory note in the original principal amount of $10,000,000 and
(ii) warrants to purchase 803,048 shares of the Company's common stock. Upon the
occurrence of certain events, the Company will be obligated to issue additional
warrants to Mr. Lenfest. The note accrues interest at the rate of 10% per annum
and matures on February 18, 2009. The note entitles Mr. Lenfest to convert all
or a portion of the outstanding principal of, and accrued and unpaid interest
on, the note into shares of common stock at a conversion price of $6.05 per
share. The warrants may be exercised into shares of common stock at an exercise
price equal to the lesser of $4.00 per share or two-thirds of the average of the
high and low sale prices of the common stock for the 25 consecutive trading days
immediately preceding the date of exercise.
The obligations of the Company to Mr. Lenfest under the Convertible
Note and Warrant Purchase Agreement are secured by a second lien on all of the
assets of the Company, junior in rights to the lien in favor of PNC Bank,
including all real property owned by the Company.
Prior to the consummation of the refinancing, ETC Asset Management,
LLC, a shareholder of the Company and a holder of warrants to purchase 332,820
shares of the Company's common stock, consented to the transactions contemplated
under the Credit Agreement and the financing provided by Mr. Lenfest, including
the below market issuance of warrants to Mr. Lenfest. As a result of its
consent, ETC Asset Management waived, solely in connection with such issuance,
the anti-dilution rights contained in its warrant. In exchange for ETC Asset
Management's consent, the Company issued to ETC Asset Management warrants to
purchase an additional 105,000 shares of common stock. Except for the number of
shares issuable upon exercise of the warrants, the new ETC Asset Management
warrants have substantially the same terms as the warrants issued to Mr.
Lenfest.
The Company believes that cash generated from operating activities as
well as future availability under its credit agreement will be sufficient to
meet its future obligations through at least May 31, 2004.
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 recorded claims (see Note 2 to
the Consolidated Financial Statements, Accounts Receivable).
The following table presents our contractual cash flow commitments on
long-term debt and operating leases. See Notes 6 and 7 to the consolidated
financial statements for additional information on our long-term debt and
operating leases.
8
Payments Due by Period
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Total Less Than 1 Year 1-3 Years 4-5 Years After 5 Years
----- ---------------- --------- --------- -------------
(in thousands)
Long-term debt, including current
maturities $12,924 $281 $1,432 $ 550 $10,661
Operating leases 530 249 281 - -
Total ------- ---- ------ ----- -------
13,454 $530 $1,713 $ 550 $10,661
The Company's sales backlog at February 28, 2003 and February 22, 2002,
for work to be performed and revenue to be recognized under written agreements
after such dates, was $21,454,000 and $28,148,000, respectively. This decline is
primarily due to the near completion of a large contract for the Walt Disney
Company. In addition, the Company's training, maintenance and upgrade contracts
backlog at February 28, 2003 and February 22, 2002, for work to be performed and
revenue to be recognized after such dates under written agreements, was
approximately $3,931,000 and $1,485,000, respectively. Of the February 28, 2003
backlog, approximately $16,428,000 was under contracts for ATS and maintenance
support including $7,007,000 for the Royal Malaysian Air Force. Approximately
91% of the February 28, 2003 backlog is expected to be completed prior to
February 27, 2004.
The Company's order flow does not follow any seasonal pattern as the
Company receives orders in each fiscal year of its fiscal year.
Recent Accounting Pronouncements
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB No. 13, and
Technical Corrections:
In April 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 145, "Rescission of FASB statements No. 4, 44, and 64, Amendment of
FASB No. 13, and Technical Corrections." SFAS No. 145 changes the accounting
principles governing extraordinary items by clarifying, and to some extent,
modifying, the existing definition and criteria, specifying disclosure for
extraordinary items and specifying disclosure requirements for other unusual or
infrequently occurring events and transactions that are not extraordinary items.
SFAS No. 145 is effective for financial statements issued for fiscal years
beginning after June 15, 2002, with early adoption encouraged. The adoption of
SFAS No. 145 is not expected to have a significant impact on the financial
condition or results of operations of the Company.
Accounting for Costs Associated with Exit or Disposal Activities:
In June 2002 the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". This statement provides financial
accounting and reporting guidance for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring". SFAS
No. 146 is effective for exit or disposal activities initiated after December
31, 2002, with early adoption encouraged. The adoption of the statement is not
expected to have a significant impact on the financial condition or results of
operations of the Company.
Accounting for Costs Associated with Exit or Disposal Activities:
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This statement provides financial
accounting and reporting guidance for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring." SFAS
No. 146 is effective for exit or disposal activities initiated after December
31, 2002. The adoption of the statement is not expected to have a significant
impact on the financial condition or results of operations of the Company.
In November 2002, FASB Interpretation 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (FIN 45), was issued. FIN 45 requires a guarantor entity,
at the inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company previously did not record a
liability when guaranteeing obligations unless it became probable that the
Company would have to perform under the guarantee. FIN 45 applies prospectively
to guarantees the Company issues or modifies subsequent to December 31, 2002,
but has certain disclosure requirements effective for interim and annual periods
ending after December 15, 2002. The Company has not historically issued
guarantees and does not anticipate FIN 45 will have a material effect on its
fiscal 2004 consolidated financial statements.
In January 2003, the FASB issued FASB Interpretation 46 (FIN 46),
Consolidation of Variable Interest Entities. FIN 46 clarifies the application of
Accounting Research Bulletin 51, Consolidated Financial Statements, for certain
entities that do not have sufficient equity at risk for the entity to finance
its activities without additional subordinated financial support from other
parties or in which equity investors do not have the characteristics of a
controlling financial interest ("variable interest entities"). Variable interest
entities within the scope of FIN 46 will be required to be consolidated by their
primary beneficiary. The primary beneficiary of a variable interest entity is
determined to be the party that absorbs a majority of the entity's expected
losses, receives a majority of its expected returns, or both. FIN 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise acquires an interest after
that date. It applies in the first fiscal year or interim period beginning after
June 15, 2003, to variable interest entities in which an enterprise holds a
variable interest that it acquired before February 1, 2003. The adoption of FIN
46 did not have material effect on the Company's consolidated financial
position, results of operations, or cash flows.
On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS
No. 150 establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. It
requires that an issuer classify a financial instrument that is within its scope
as a liability (or an asset in some circumstances). Many of those instruments
were previously classified as equity. SFAS No. 150 affects the issuer's
accounting for three types of freestanding financial instruments.
o mandatorily redeemable shares, which the issuing company is
obligated to buy back in exchange for cash or other assets
o instruments that do or may require the issuer to buy back some of
its shares in exchange for cash or other assets; includes put
options and forward purchase contracts
o obligations that can be settled with shares, the monetary value of
which is fixed, tied solely or predominantly to a variable such as a
market index, or varies inversely with the value of the issuers'
shares.
SFAS No. 150 does not apply to features embedded in a financial
instrument that is not a derivative in its entirety.
Most of the guidance in SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The adoption of SFAS No. 150 is not expected to have a material effect on
the Company's consolidated financial position, results of operations or cash
flows.
Market for the Registrant's Common Stock and Related Security Holder Matters
The Company's common stock is traded on the American Stock Exchange
under the symbol "ETC." As of May 15, 2003, the Company had 295 shareholders of
record.
The following table sets forth the quarterly ranges of high and low
sale prices for shares of the common stock for the periods indicated.
Sale Prices
-----------
High Low
---- ---
Fiscal 2003
First Quarter $9.15 $6.20
Second Quarter 7.85 6.00
Third Quarter 6.45 5.80
Fourth Quarter 6.40 5.86
Fiscal 2002
First Quarter $10.05 $8.30
Second Quarter 9.05 6.80
Third Quarter 8.50 6.60
Fourth Quarter 7.50 5.70
9
The Company has never paid any cash dividends on its common stock and
does not anticipate that any cash dividends will be declared or paid in the
foreseeable future. The Company's current credit facility prohibits the payment
of any dividends by the Company without the lender's prior written consent.
Equity Compensation Plan Information
Number of securities
remaining available
Number of securities to be Weighted-average exercise for future issuance under
issued upon exercise of price of outstanding equity compensation plans
outstanding options, options, warrants and (excluding securities
Plan Category warrants and rights rights reflected in column (a))
- ------------------ --------------------------- ------------------------- ------------------------
(a) (b) (c)
Equity compensation plans
approved by
security holders 1,000,000 $7.20 421,614
Equity compensation plans
not approved by security
holders 420,000 N/A 342,999
--------- ----- -------
Total 1,420,000 $7.20 764,613
========= ===== =======
The following plans have not been approved by our stockholders:
Employee Stock Purchase Plan
- ----------------------------
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% stockholders, 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.
Stock Award Plan
- ----------------
The Company has a Stock Award Plan which was adopted by the Board of
Directors on April 7, 1993. All employees including officers of the Company
meeting service requirements are eligible to receive awards under the Plan.
10
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 28, 2003 and
February 22, 2002, 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 28, 2003. 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 28, 2003 and
February 22, 2002, and the consolidated results of their operations and cash
flows for each of the three fiscal years in the period ended February 28, 2003,
in conformity with accounting principles generally accepted in the United States
of America.
We have also audited the accompanying Schedule II of Environmental
Tectonics Corporation and Subsidiaries as of February 28, 2003 and February 22,
2002 and for each of the three fiscal years in the period ended February 28,
2003. In our opinion, this schedule presents fairly, in all material respects,
the information required to be set forth herein.
As discussed in Note 1 to the consolidated financial statements, the
Company has recorded receivables in the amount of $11.7 million related to
claims made to or against the United States government and an international
customer for contract costs incurred through February 28, 2003. The total net
claims amount made is approximately $38.3 million based on costs incurred
through February 28, 2003, and is subject to negotiation, arbitration and audit
by the United States government and the international customer.
As discussed in note 1 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, on February 23, 2002.
Grant Thornton LLP
- --------------------------
Philadelphia, Pennsylvania
May 8, 2003
11
Consolidated Balance Sheets ($ in thousands, except share data)
February 28, 2003 February 22, 2002
----------------- -----------------
ASSETS
Cash and cash equivalents $ 4,305 $ 2,261
Cash equivalents restricted for letters of credit 3,189 569
Accounts receivable, net 16,193 19,856
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 5,441 9,391
Inventories 8,494 7,161
Deferred tax asset 689 715
Prepaid expenses and other current assets 983 921
-------- --------
Total current assets 39,294 40,874
Property, plant and equipment, net 5,086 5,318
Software development costs, net of accumulated amortization
of $6,819 and $6,166 in 2003 and 2002, respectively 2,224 1,684
Goodwill and intangibles 477 477
Other assets, net 617 129
-------- --------
Total assets $ 47,698 $ 48,482
======== ========
LIABILITIES
Current portion of long-term obligations $ 281 $ 281
Accounts payable - trade 1,778 3,438
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 1,463 499
Customer deposits 3,000 3,684
Accrued income taxes -- 731
Other accrued liabilities 1,556 1,558
-------- --------
Total current liabilities 8,078 10,191
-------- --------
Long-term obligations, less current portion:
Credit facility payable to banks 600 11,755
Long term bonds 4,645 4,920
Subordinated debt 7,391 --
Other 7 13
-------- --------
12,643 16,688
-------- --------
Deferred tax liability 1,022 735
-------- --------
Total liabilities $ 21,743 $ 27,614
-------- --------
Minority Interest 48 86
STOCKHOLDERS' EQUITY
Commonstock - authorized 20,000,000 shares, $.05 par value;
7,157,239 and 7,142,946 shares issued and
outstanding in 2003 and 2002, respectively $ 358 $ 357
Capital contributed in excess of par value of common stock 9,331 6,703
Accumulated other comprehensive loss (169) (172)
Retained earnings 16,387 13,894
-------- --------
Total stockholders' equity $ 25,907 $ 20,782
-------- --------
Total liabilities and stockholders' equity $ 47,698 $ 48,482
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
12
Consolidated Statements of Operations ($ in thousands, except share data)
53 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 28, 2003 February 22, 2002 February 23, 2001
----------------- ----------------- -----------------
Net sales $ 43,123 $ 32,527 $ 32,452
Cost of goods sold 28,925 21,062 19,377
-------- -------- --------
Gross profit 14,198 11,465 13,075
-------- -------- --------
Operating expenses:
Selling and administrative 9,446 7,992 8,050
Research and development 636 600 903
-------- -------- --------
10,082 8,592 8,953
-------- -------- --------
Operating income 4,116 2,873 4,122
-------- -------- --------
Other expenses:
Interest expense (net) 518 1,094 825
Letter of credit fees 154 102 65
Other, net 184 42 34
-------- -------- --------
856 1,238 924
-------- -------- --------
Income before provision for/(benefit from)
income taxes and minority interest 3,260 1,635 3,198
Provision for/(benefit from) income taxes 805 (93) 1,126
-------- -------- --------
Income before minority interest 2,455 1,728 2,072
Income (loss) attributable to minority interest (38) (13) 51
-------- -------- --------
Net income $ 2,493 $ 1,741 $ 2,021
======== ======== ========
Per share information Earnings per common share:
Basic $.35 $.24 $.29
Diluted $.33 $.23 $.27
Income available to common stockholders $2,493 $1,741 $2,021
Weighted average common shares:
Basic 7,153,000 7,143,000 7,087,000
Diluted 7,497,000 7,499,000 7,499,000
The accompanying notes are an integral part of the consolidated financial statements.
13
Consolidated Statements of Changes in Stockholders' Equity ($ in thousands,
except share data)
For the years ended February 28, 2003, February 22, 2002 and February 23, 2001
Capital
contributed Accumulated
Common Stock in excess of other Total
------------------------ par value of comprehensive Retained stockholders'
Shares Amount common stock income (loss) earnings equity
--------- ------ ------------ ------------- -------- ------------
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 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 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
Net income for the year - - - - 2,493 2,493
Foreign currency translation adjustment 3 - 3
-------
Total comprehensive income 2,496
Value of beneficial conversion option
associated with issuance of
subordinated convertible debt - - 1,400 - - 1,400
Value of warrants issued in connection
with issuance of subordinated
convertible debt - - 1,209 - - 1,209
Shares issued in connection with
employee stock purchase and stock
option plans 14,293 1 19 - - 20
---------- ----- ------- ------ ------- -------
Balance, February 28, 2003 7,157,239 $ 358 $ 9,331 $ (169) $16,387 $25,907
========== ===== ======= ====== ======= =======
The accompanying notes are an integral part of the consolidated financial statements.
14
Consolidated Statements of Cash Flows ($ in thousands)
53 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 28, February 22, February 23,
2003 2002 2001
----------------- ------------------ -----------------
Cash flows from operating activities:
Net income $ 2,493 $ 1,741 $ 2,021
Adjustments to reconcile net income to net cash provided by (used
in) operating activities
Depreciation and amortization 1,401 1,475 1,278
Increase (decrease) in allowance for accounts receivable and (19) 111 (87)
inventory
Minority interest in net loss (38) (13) (170)
Deferred income taxes (benefit) 313 (39) 96
Changes in operating assets and liabilities:
(Increase) decrease in assets
Accounts receivable 3,590 (3,083) (6,007)
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 3,950 204 (717)
Inventories (2,091) (2,645) (630)
Prepaid expenses and other current assets 62 (530) 5
Other assets 32 (136) 34
Increase (decrease) in liabilities:
Accounts payable (1,660) 1,509 99
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 964 (1,213) (1,570)
Customer deposits (684) 2,241 (1,492)
Accrued income taxes (731) (23) 291
Other accrued liabilities (2) (319) 264
Payments under settlement agreements - - (85)
------- ------- -------
Net cash provided by (used in) operating activities 7,580 (720) (6,670)
Cash flows from investing activities:
Acquisition of equipment (215) (649) (2,628)
Software development costs (569) (989) (550)
Purchase of subsidiary, net of cash acquired - - 195
------- ------- -------
Net cash used in investing activities (784) (1,638) (2,983)
------- ------- -------
Cash flows from financing activities:
Borrowings under credit facility 26,396 10,899 8,071
Payments under credit facility (37,551) (6,708) (4,600)
Payments on long-term bonds (275) (275) 5,470
Proceeds from subordinated debt 7,391 - -
Deferred financing costs (719) - (175)
Increase in restricted cash (2,620) (25) (512)
Net decrease in other long-term obligations (6) (368) (5)
Proceeds from issuance of common stock/warrants 2,629 191 694
------- ------- -------
Net cash provided by financing activities (4,755) 3,714 8,943
Effect of exchange rates on cash 3 54 (164)
------- ------- -------
Net increase (decrease) in cash and cash equivalents 2,044 1,410 (874)
Cash and cash equivalents at beginning of year 2,261 851 1,725
------- ------- -------
Cash and cash equivalents at end of year $ 4,305 $ 2,261 $ 851
======= ======= =======
Supplemental schedule of cash flow information:
Interest paid $ 480 $ 766 $ 806
Income taxes paid $ 1,720 $ 582 $ 649
Supplemental information on non-cash operating and investing activities:
During the year ended February 28, 2003, the Company reclassified $226
from inventory to property, plant and equipment and $624 from inventory to
capitalized software.
During the year ended February 23, 2001, the Company purchased for $100
a 99% ownership in ETC Europe, resulting in goodwill of $26.
The accompanying notes are an integral part of the consolidated
financial statements.
15
Notes to Consolidated Financial Statements ($ 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.
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 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.
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.
Principles of Consolidation:
The consolidated financial statements include the accounts of
Environmental Tectonics Corporation, Environmental Technology Corporation and
ETC Delaware, its wholly owned subsidiaries, 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 in consolidation. 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 28, 2003, the Company had recorded receivables in the
amount of $11.7 million for claims made or to be made against the U.S.
government and an international customer for contract costs incurred through
February 28, 2003. The total net claims amount filed with the U.S. government
and an international customer at February 28, 2003, was approximately $38.3
million based on costs incurred through February 28, 2003. On May 9, 2002, the
Company reached a final settlement agreement on one of its prior claims totaling
approximately $6.9 million with the U.S. government. This settlement was paid to
the Company in July 2002. The international claims are subject to negotiation,
arbitration and audit by the international customer.
Total claims outstanding at February 28, 2003 was approximately $38.3
million based on costs incurred through February 28, 2003. However, under
generally accepted accounting principles, the Company had recorded only $11.7
million or 30.5% of this amount on its books.
Revenue Recognition:
Revenue is recognized on long-term contracts utilizing the percentage
of completion method based on costs incurred as a percentage of estimated total
costs. Revenue recognized on uncompleted long-term contracts in excess of
amounts billed to customers is reflected as an asset. Amounts billed to
customers in excess of revenue recognized on uncompleted long-term contracts are
reflected as a liability. When it is estimated that a contract will result in a
loss, the entire amount of the loss is accrued. The effect of revisions in
16
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
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 upon 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 the applicable provisions of SAB
101 for the fiscal year ending February 23, 2001, with no material impact on the
Company's results of operations.
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 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, the Company 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. Adoption of 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 each fiscal year, the Company periodically has cash and cash
equivalents in excess of insured amounts. However, a significant portion 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:
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 $0, $17, and $35 in fiscal years
2003, 2002 and 2001, respectively, and accumulated amortization was $113 as of
February 28, 2003 and February 22, 2002.
On February 23, 2002, we adopted SFAS No. 142 "Goodwill and Intangible
Assets" (SFAS No. 142). SFAS No. 142 includes requirements to annually test
goodwill and indefinite lived intangible assets for impairment rather than
amortize them. Accordingly, we no longer amortize goodwill, thereby eliminating
an annual amortization charge of approximately $29. We have completed
documentation of our transitional goodwill impairment tests and have not
recorded any transitional goodwill impairment loss as a result of our adoption
of SFAS No. 142. Additionally, we did not record any transitional intangible
asset impairment loss upon adoption of SFAS No. 142.
17
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Reported net income, exclusive of amortization expense that is related to
goodwill that is no longer being amortized, would have been:
February February February
Fiscal year ended 2003 2002 2001
----------------- --------- --------- ---------
Reported net earnings $2,493 $1,741 $2,021
Goodwill amortization - 17 35
Adjusted net earnings $2,493 $1,758 $2,056
Basic earnings per share:
Reported net earnings $0.35 $0.24 $0.29
Goodwill amortization - .01 -
Adjusted net earnings $0.35 $0.25 $0.29
Diluted earnings per share:
Reported net earnings $0.33 $0.23 $0.27
Goodwill amortization - - -
Adjusted net earnings $0.33 $0.23 $0.27
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 on a straight-line basis over a period ranging from 36 to
60 months, depending upon the life of the product, 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 $1,193 and $989, respectively, for the fiscal years ended February 28,
2003 and February 22, 2002. Related software amortization totaled $653, $496 and
$455, respectively, for fiscal 2003, 2002, and 2001.
Research and Development:
Research and development expenses are charged to operations as
incurred. During fiscal 2003, 2002 and 2001 the Company incurred research and
development costs of approximately $636, $600, and $903, respectively.
Amortization of Deferred Financing Costs:
During fiscal 2002, all remaining capitalized costs relating to the
March 1997 financing of the Company were expensed. 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
$75, $293 and $146 in fiscal 2003, 2002 and 2001, respectively (see Note 6 to
Consolidated Financial Statements).
During fiscal 2003, $719 of deferred finance costs associated with the
PNC/Lenfest financing had been recorded. These costs will be amortized beginning
in fiscal 2004 at a rate of $240 per year for fiscal 2004 and fiscal 2005 and
$239 for fiscal 2006.
18
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Original Issue Discount
During fiscal 2003, the Company had recorded $2,609 in additional
paid-in capital representing an allocation of the proceeds from the convertible
debt element of its financing with PNC and Lenfest. This allocation represents
the value assigned to the beneficial conversion option of the Lenfest promissory
note and the value of the associated warrants. Such values were derived pursuant
to an independent appraisal of these financial instruments obtained by the
Company. This amount will be amortized using the effective interest method over
six years, the term of the convertible promissory note, beginning in fiscal
2004.
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 applicable tax laws.
Long-Lived Assets:
The Company followed 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 provided
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. This involved a review of goodwill and other intangibles to
assess recoverability from future operations using undiscounted future cash
flows. Any impairments were recognized in operating results to the extent that
carrying value exceeded fair value, which was determined based on the net
present value of estimated future cash flows. Effective February 22, 2002, the
Company adopted SFAS No. 144, "Impairment or Disposal of Long-Lived Assets"
which requires additional impairment testing for long-lived assets.
Stock Options:
The Company accounts for stock options under the alternate provisions
of SFAS No. 123 (discussed below), "Accounting for Stock-Based Compensation," as
amended by SFAS No. 148, 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, SFAS No. 123 permits entities to continue accounting for employee
stock options and similar equity instruments under Accounting Principles Board
(APB) Opinion 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.
At February 28, 2003, the Company has one stock-based employee
compensation plan, which is described more fully in Note 10 to Consolidated
Financial Statements. The Company accounts for those plans under the recognition
and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
Employees, and related Interpretations. No stock-based employee compensation
cost is reflected in net income, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. The following table illustrates the effect on net income and
earnings per share if the company had applied the fair value recognition
provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation,
to stock-based employee compensation.
19
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Fiscal year ended
-------------------------------------------------------------
February 28, 2003 February 22, 2002 February 23, 2001
----------------- ----------------- -----------------
Net income, as reported $ 2,493 $ 1,741 $ 2,021
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (275) (456) (472)
-------- -------- -------
Pro forma net income $ 2,218 $ 1,285 $ 1,549
-------- -------- -------
Earnings per share:
Basic--as reported $.35 $.24 $.29
Basic--pro forma $.31 $.18 $.22
Diluted--as reported $.33 $.23 $.27
Diluted--pro forma $.30 $.17 $.21
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 fiscal 2002: expected volatility of
30.1%; risk-free interest rate of 5.01%; and an expected life of 10 years. There
were no grants in fiscal 2001 and fiscal 2003.
Advertising Costs:
The Company expenses advertising costs, which include trade shows, as
incurred. Advertising expense was $464, $438 and $345 in fiscal 2003, 2002, and
2001, respectively.
Earnings Per Common Share:
The Company has adopted SFAS No. 128, "Earnings Per Share." This
standard requires presentation of basic and diluted earnings per share together
with disclosure describing the computation of the per share amounts. 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 reconciliations of the numerators and
denominators of the basic and diluted earnings per share computations.
Fiscal year ended February 28, 2003
--------------------------------------------------
Weighted
average Per share
Income ($000) shares amount
------------- ------ ------
(numerator) (denominator)
Net income $2,493
Basic earnings per share
Income available to common stockholders $2,493 7,153,000 $.35
====== ========= ====
Effective of dilutive securities
Stock options 22,717
Convertible Debt 4,151
Stock warrants 317,407
-------
Diluted earnings per share
Income available to common stockholders plus
effect of dilutive securities $2,493 7,497,275 $.33
====== ========= ====
At February 28, 2003, options to purchase the Company's common stock totaling
421,614 shares were outstanding, 341,314 of which were not included in the
computation of diluted earnings per share as the effect of such inclusion would
be anti-dilutive.
20
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Fiscal 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
====== ========= ====
At February 22, 2002, options to purchase the Company's common stock totaling
448,514 shares were outstanding, 313,750 of which were not included in the
computation of diluted earnings per share as the effect of such inclusion would
be anti-dilutive.
Fiscal 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
====== ========= ====
21
2. Accounts Receivable:
The components of accounts receivable at February 28, 2003 and February
22, 2002 are as follows:
2003 2002
---- ----
U.S. government receivables billed and unbilled contract costs
subject to negotiation $ 2,719 $ 6,281
U.S. commercial receivables billed 2,002 2,918
International receivables billed and unbilled
contract costs subject to negotiation 11,918 11,030
-------- --------
16,639 20,229
Less allowance for doubtful accounts (446) (373)
-------- --------
$ 16,193 $ 19,856
======== ========
U.S. government receivables billed and unbilled contract costs subject
to negotiation:
Unbilled contract costs subject to negotiation as of February 28, 2003
represent claims made against the U.S. government under a contract for a
submarine rescue decompression project. These costs, totaling $2,066, were
recorded beginning in fiscal year 2002, and include $1,691 recorded during
fiscal year 2003. Unbilled contract costs subject to negotiation as of February
22, 2002 included claims made against the U.S. government under a contract for a
centrifuge of $5,547. On May 9, 2002, the Company reached a final settlement
agreement totaling $6,910 with the U.S. Navy for all outstanding amounts on this
claim.
22
Notes to Consolidated Financial Statements ($ in thousands, except share data)
2. Accounts Receivable (Continued):
International receivables billed:
International receivables billed included $700 at February 28, 2003 and
February 22, 2002 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 $4,600 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 $1,100 one 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 the testing 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 representing the amount due on the
performance bond.
The open balance of $700 due on the contract represents the total net
exposure to the Company on this contract. As of February 28, 2003, the Company
has authorized its Thai attorneys to commence and prosecute arbitration
proceedings, and it is anticipated that this will occur in the near future.
However, since the circumstances that caused a delay are commonly considered
"force majeure" events, and since the contract under question allows for
consideration of "force majeure" events, the Company believes that the open
balance related to this contract is collectible and will continue to treat this
balance as collectible until a final unappealable legal decision is rendered by
a competent Thai tribunal. The Company has enjoyed a favorable relationship with
the RTAF. It currently has both maintenance and upgrade contracts with the RTAF
for the trainers that are the subject of the dispute, and it is not anticipated
that the initiation of legal action against the RTAF will have any material
adverse impact on future sales to the RTAF. As of the date of this Annual Report
on Form 10-K, 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
amount 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. Trade and claims receivables and resulting revenue aggregating
$9,451 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 2004. In conformity with accounting principles generally accepted in the
United States, revenue recorded by the Company from a claim does not exceed the
incurred contract costs related to the claim. The Company is currently in
arbitration with the international customer on both contracts. The company is
currently updating and finalizing additional claims. As a related item, during
the third quarter of fiscal 2000, an international customer, citing failure to
deliver product within contract terms, assessed liquidated damages totaling
approximately $1,600 on two contracts currently in progress. The Company
disputes the basis for these liquidated damages and is vigorously contesting
them. However, following generally accepted accounting principles, the Company
has reduced contract values and corresponding revenues by approximately $1,600.
On July 20, 2001, the Company was notified by an 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.
The Company is arbitrating disputes which have arisen under this
contract in the United Kingdom but is unable to assess the ultimate impact of
the termination of the contract on current operations and financial condition. A
limited hearing was held in January 2003 to review certain threshold contractual
interpretation issues related to performance and safety. A full hearing on all
issues is tentatively scheduled for October and November 2003.
Based on witness statements, expert reports and other facts, the
Company believes that it has a reasonable basis to refute the safety concerns of
the U.K. Ministry of Defense. The Company has installed seven centrifuges in the
last 15 years throughout the world and none of these centrifuges have caused any
accidents or injuries. The Company does not plan to reduce the carrying value of
the trade and claims receivables of $6,842 until all unresolved matters have
been properly adjudicated in the arbitration proceedings.
23
Notes to Consolidated Financial Statements ($ in thousands, except share data)
2. Accounts Receivable (Continued):
Claim bookings in fiscal 2003 and 2002 decreased operating income by
$675 and $661 respectively. Claims bookings in fiscal 2001 increased operating
income by $1,325. All amounts are net of associated manufacturing costs and
legal expenses.
Net claims receivables were $11,700 and $9,600 at February 28, 2003 and
February 28, 2002, respectively.
3. Costs and Estimated Earnings on Uncompleted Contracts:
Unbilled costs
Amounts not billed nor yet billable totaled $25,700 at February 28,
2003. 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, or upon shipment.
Service contracts are billed monthly or quarterly. Parts and service are billed
as shipped or completed.
The following is a summary of long-term contracts in progress at
February 28, 2003 and February 22, 2002:
2003 2002
-------- --------
Costs incurred on uncompleted long-term contracts $ 23,941 $ 29,004
Estimated earnings 9,757 12,677
-------- --------
33,698 41,681
Less billings to date (29,720) (32,789)
-------- --------
$ 3,978 $ 8,892
======== ========
2003 2002
-------- --------
Included in accompanying balance sheets under the following captions:
Costs and estimated earnings in excess of billings
on uncompleted long-term contracts $ 5,441 $ 9,391
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts (1,463) (499)
-------- --------
$ 3,978 $ 8,892
======== ========
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 fiscal 2003, 2002 and 2001.
4. Inventories:
Inventories consist of the following:
Work in
Raw Material Process Finished Goods Total
------------ ------- -------------- -----
February 28, 2003 $322 $5,629 $2,543 $8,494
February 22, 2002 110 4,470 2,581 7,161
Inventory is presented above net of an allowance for obsolescence of $ 646 and $
738 in fiscal 2003 and 2002, respectively.
5. Property, Plant and Equipment:
The following is a summary of property, plant and equipment, at cost,
and estimated useful lives at February 28, 2003 and February 22, 2002:
24
Notes to Consolidated Financial Statements ($ in thousands, except share data)
5. Property, Plant and Equipment (Continued):
Estimated
useful
2003 2002 lives
---- ---- ---------
Land $ 100 $ 100
Building and building additions 3,763 3,763 40 years
Machinery and equipment 8,611 8,173 3-5 years
Office furniture and equipment 1,195 1,192 10 years
Building improvements 1,393 1,393 5-10 years
-------- --------
15,062 14,621
Less accumulated depreciation (9,976) (9,303)
-------- --------
Property, plant and equipment, net $ 5,086 $ 5,318
======= =======
Depreciation expense for the fiscal years ended February 28, 2003, February 22,
2002 and February 23, 2001, was $ 673, $ 668 and $ 602, respectively.
6. Long-Term Obligation and Credit Arrangements:
Long-term obligations at February 28, 2003 and February 22, 2002
consist of the following:
2003 2002
------- -------
Credit facility payable to banks $ 600 $11,755
Long Term Bonds 4,920 5,195
Subordinated debt, net of unamortized discount of $2,609 7,391 -
Term loans payable, accruing interest at between 9% and 9.9%
collateralized by priority liens on certain equipment 13 19
------- -------
12,924 16,969
Less current portion (281) (281)
------- -------
$12,643 $16,688
======= =======
The amounts of future long-term obligations maturing in each of the
next five fiscal years are as follows:
2004 $ 281
2005 281
2006 876
2007 275
2008 and thereafter 11,211
-------
Total future obligations $12,924
=======
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 28, 2003 and February 22, 2002 are as
follows:
2003 2002
---- ----
Approximate average loan balance 8,219 10,631
Maximum aggregate 11,445 11,926
Weighted average interest rate 4.37% 6.35%
The Company established a senior credit facility with PNC Bank,
National Association on February 19, 2003 and amended the facility on April 30,
2003. The PNC facility includes: (i) a revolving credit facility in the maximum
aggregate principal amount of $14,800 to be used for the Company's working
capital and general corporate purposes, including capital expenditures, with a
sublimit for issuances of letters of credit in the maximum amount of $10,300,
and (ii) a standby letter of credit in the amount of $5,025 as credit support
for the Company's bonds.
Interest is charged on direct borrowings at the bank's prime rate plus
0.75% for a base rate loan or for a Eurodollar loan, LIBOR plus 3.25% or
adjusted LIBOR in 2002 and 2001. The interest rates ranged from 4.00% to 5.00%
during fiscal 2003 and from 4.50% to 8.25% during fiscal 2002.
25
Notes to Consolidated Financial Statements ($ in thousands, except share data)
6. Long-Term Obligation and Credit Arrangements (Continued):
The terms and conditions of the revolving loan and the line of credit
are set forth in a credit agreement between the Company and PNC. Availability
under the facility is determined each month based on a borrowing base consisting
of a portion of the company's receivables, inventory and costs and estimated
earnings in excess of billings net of billings in excess of costs and estimated
earnings on uncompleted long-term contracts. As of February 28, 2003,
availability under the $12,000 revolving facility was $7,913, which the Company
had fully drawn.
The PNC credit facility is secured by (i) the grant of a first and
prior security interest in all of the personal property of the Company,
Entertainment Technology Corporation ("Entertainment"), and ETC Delaware, Inc.
("ETC Delaware"), each a wholly-owned subsidiary of the Company, in favor of
PNC; (ii) the Company's grant of a first and prior security interest in all of
the Company's accounts, deposits and all other negotiable and non-negotiable
instruments owned by the Company in favor of PNC; (iii) the Company's grant of a
first and prior mortgage on all of the Company's real property in favor of PNC;
and (iv) the Company's grant of a first and prior security interest in all of
the Company's rights to (a) all of the shares of capital stock of each of
Entertainment and ETC Delaware and (b) 65% of the shares of capital stock owned
by the company of each of its foreign subsidiaries in favor of PNC. In addition,
the PNC credit agreement requires that Entertainment and ETC Delaware guarantee
the Company's obligations under the PNC facility.
Also on February 19, 2003, the Company entered into a Convertible Note
and Warrant Purchase Agreement with H.F. Lenfest ("Lenfest") for $10,000 face
value of senior subordinated debt. The note accrues interest at the rate of 10%
per annum and matures on February 18, 2009. The note allows Lenfest to convert
all or part of the outstanding principal thereunder into shares of common stock
at a conversion price of $6.05 per share.
The promissory note allows for quarterly interest payments in arrears
with the principal due on February 18, 2009. At the Company's option, the
quarterly interest payments may be deferred and added to the outstanding
principal. At Lenfest's option, any deferred interest amounts may be converted
into shares of common stock under the same terms and conditions as the
convertible note.
The Company has obtained a valuation from an independent valuation firm
of the convertible note and the associated warrant. Based on the results of this
valuation, at February 28, 2003, $1,400 of value had been assigned to the
beneficial conversion feature of the convertible note and $1,209 had been
assigned to the value of the associated warrants. Both of these amounts have
been credited to additional paid-in capital as of February 28, 2003, and the
same amounts will be amortized to interest expense on the consolidated statement
of operations over six years, the term of the convertible note, beginning in
2004.
The Company used a portion of the proceeds from the financing to
satisfy its existing obligations to Wachovia Bank, the Company's former lender,
and to permit PNC to issue a letter of credit to support the Company's bonds.
The Company's letter of credit limit under the revolving credit
facility is $10,300, subject to borrowing base availability. The balance
outstanding under these facilities at February 28, 2003, was $6,360. Fees on
letters of credit outstanding were 1.75% at February 28, 2003 and 1.25% at
February 22, 2002.
On March 15, 2000, the Company issued approximately $5,500 of
unregistered Taxable Variable Rate Demand/Fixed Rate Revenue Bonds (Series of
2000). Net proceeds from these bonds were used to repay a $4,100 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 $5,000 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 1.41% on May 15, 2003)
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 these financial instruments approximates their fair values
at February 28, 2003.
7. 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 28, 2003 are $249 in 2004; $136 in
2005; $91 in 2006; $54 in 2007; and $0 in 2008 and thereafter.
26
Notes to Consolidated Financial Statements ($ in thousands, except share data)
7. Leases (Continued):
Total rental expense for all operating leases for the fiscal years
ended February 28, 2003, February 22, 2002, and February 23, 2001, was $255,
$197 and $117, respectively.
8. Income Taxes:
The components of the provision for income taxes are as follows:
53 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 28, 2003 February 22, 2002 February 23, 2001
----------------- ----------------- ----------------
Currently payable:
Federal $285 $ 42 $ 906
State 188 134 109
Foreign taxes 19 (230) 15
---- ---- ------
492 (54) 1,030
---- ---- ------
Deferred:
Federal 282 (36) 88
State 31 (3) 8
---- ---- ------
313 (39) 96
---- ---- ------
$805 $(93) $1,126
==== ===== ======
A reconciliation of the statutory federal income tax rate to the effective tax
rate is as follows:
53 Weeks Ended 52 Weeks Ended 52 Weeks Ended
February 28, 2003 February 22, 2002 February 23, 2001
----------------- ----------------- -----------------
Statutory income tax 34.0% 34.0% 34.0%
State income tax, net of federal tax benefit 3.7 5.4 2.2
Benefit of foreign sales corporation
And extraterritorial income (4.5) (3.4) (5.5)
Research and experimentation tax
credit refunds attributable to open tax years (0.0) (37.8) -
Research and experimentation and
Other tax credits (5.0) (9.2) -
Benefit of foreign and foreign-source
Income or loss (0.0) (1.0) -
Other, net (3.5) 6.4 4.6
----- ---- ----
24.7% (5.6)% 35.3%
===== ==== ====
The tax effects of the primary temporary differences are as follows:
2003 2002 2001
------ ------ ------
Deferred tax assets:
Net products liability settlement 75 75 74
Vacation reserve 44 58 58
Inventory reserve 244 275 233
Receivable reserve 168 139 138
Warranty reserve 47 46 46
Other, net 111 122 66
------ ------ ------
Total current deferred tax asset $ 689 $ 715 $ 615
------ ------ ------
Deferred tax liabilities:
Amortization of capitalized software $ 724 $ 488 $ 429
------ ------ ------
Depreciation 298 247 245
------ ------ ------
Total noncurrent deferred tax liability $1,022 $ 735 $ 674
------ ------ ------
27
Notes to Consolidated Financial Statements ($ in thousands, except share data)
9. 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:
ATS Industrial Group Total
--- ---------------- -----
Fiscal 2003
-----------
Net sales $31,612 $11,511 $43,123
Interest expense 423 95 518
Depreciation and amortization 1,136 265 1,401
Operating income 4,979 52 5,031
Income tax provision 1,139 (11) 1,128
Goodwill and intangibles 477 - 477
Identifiable assets 26,481 6,348 32,829
Expenditures for segment assets 406 35 441
Fiscal 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
Goodwill and intangibles 477 - 477
Identifiable assets 33,160 5,408 38,568
Expenditures for segment assets 557 92 649
Fiscal 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) 4,999
Income tax provision 1,833 (350) 1,483
Goodwill and intangibles 495 - 495
Identifiable assets 28,029 4,652 32,681
Expenditures for segment assets 2,306 322 2,628
2003 2002 2001
------- ------- -------
Reconciliation to consolidated amounts:
Corporate assets 14,869 9,914 12,676
------- ------- -------
Total assets $47,698 $48,482 $40,705
Segment operating income $5,031 $3,978 $4,888
Less interest expense (518) (1,094) (652)
Less income taxes (1,128) (282) (1,483)
------- ------- -------
Total profit for segments 3,385 2,602 2,641
Corporate home office expense (915) (1,105) (766)
Interest and other expenses (338) (144) (272)
Income tax benefit 323 375 357
Minority interest 38 13 (51)
------- ------- -------
Net income $ 2,493 $ 1,741 $ 2,021
======= ======= =======
Segment operating income 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.
28
Notes to Consolidated Financial Statements ($ in thousands, except share data)
9. Business Segment Information (Continued):
Approximately 57% of sales totaling $24,471 in 2003 were made to one
international and one domestic customer in the ATS segment. Approximately 59% 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.
Included in the segment information for the year ended February 28,
2003, are export sales of $14,805. Of this amount, there are sales to or
relating to governments or commercial accounts in Malaysia of $7,203. Sales to
the U.S. government and its agencies aggregate $4,626 for the year ended
February 28, 2003.
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 this amount, 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 aggregated $2,064 for the year ended February
23, 2001.
10. Stock Options:
A summary of the status of the Incentive Stock Option Plan and the 1988
Incentive Stock Option Plan as of:
February 28, 2003 February 22, 2002 February 23, 2001
----------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
average average average
Shares exercise price Shares exercise price Shares exercise price
-------- -------------- -------- -------------- --------- ---------------
Outstanding at beginning of year 448,514 $7.04 464,350 $6.95 497,750 $6.80
Granted - - 27,564 7.38 - -
Exercised (4,150) 4.73 (32,400) 5.89 (33,400) 4.79
Forfeited (22,750) 4.52 (11,000) 7.43 - -
-------- -------- -
Outstanding at end of year 421,614 7.20 448,514 7.04 464,350 6.95
======== ======== =======
Options exercisable at year end 408,981 - 240,325 - 147,936 -
Weighted average fair value of
options granted during the year - - - $7.01 - -
The following information applies to options outstanding at February
28, 2003:
Options outstanding Options exercisable
------------------- -------------------
Weighted
Number average Weighted Number Weighted
Outstanding at remaining average exercisable at average
February 28, contractual exercise February 28, exercise
Range of exercise prices 2003 life (years) price 2003 price
------------------------ ---- ------------ ----- ---- -----
$2.25 to $3.38 7,800 3.5 years $2.25 7,800 $2.25
$5.00 to $7.50 100,064 5.96 years $5.65 87,431 $5.41
$7.81 313,750 6 years $7.81 313,750 $7.81
29
Notes to Consolidated Financial Statements ($ in thousands, except share data)
11. Claims and Litigation:
In April 2003, Boenning & Scattergood, Inc. ("B&S") filed suit against
the Company in the Court of Common Pleas in Philadelphia, Pennsylvania, seeking
payment of $902 for financing fees allegedly due to B&S pursuant to the terms of
an agreement for investment banking services which the Company entered into with
a predecessor of B&S (the "B&S Agreement"). The Company has not yet responded to
the complaint but believes that it has valid defenses to each of the claims of
B&S and intends to vigorously defend itself against these claims. At this time,
however, the Company is unable to predict the outcome of this matter.
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 matters, 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.
12. 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
$112, $114 and $124 in fiscal 2003, fiscal 2002, and fiscal 2001, respectively.
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.
13. Quarterly Consolidated Financial Information (Unaudited):
Financial data for the interim periods of fiscal 2003, 2002 and 2001
were as follows:
Quarter Ended
-------------
Fiscal Year 2003 May 24 August 23 November 22 February 28
Net sales $11,207 $11,041 $12,162 $8,713
Gross profit 3,583 3,263 3,579 3,773
Operating income 1,075 1,108 874 1,059
Income before income taxes 831 936 584 909
Minority interest (27) (5) (6) -
Net income 585 736 436 736
Earnings per common share:
Basic .08 .10 .06 .10
Diluted .08 .10 .06 .10
Quarter Ended
-------------
Fiscal Year 2002 May 25 August 24 November 23 February 22
Net sales $8,340 $7,414 $8,230 $8,543
Gross profit 2,693 2,393 3,667 2,712
Operating income 449 546 1,351 527
Income before income taxes 58 275 805 398
Minority interest (5) (4) 2 (6)
Net income 224 297 662 558
Earnings per common share:
Basic .03 .04 .09 .08
Diluted .03 .04 .09 .07
30
Notes to Consolidated Financial Statements ($ in thousands, except share data)
13. Quarterly Consolidated Financial Information (Unaudited) (Continued):
Quarter Ended
-------------
Fiscal Year 2001 May 25 August 24 November 23 February 23
Net sales $7,157 $6,994 $8,622 $9,679
Gross profit 3,355 2,678 2,809 4,233
Operating income 1,522 482 617 1,501
Income before income taxes 1,351 246 335 1,266
Minority interest 2 22 0 27
Net income 882 118 227 794
Earnings per common share:
Basic .13 .02 .03 .11
Diluted .12 .02 .03 .10
31
Notes to Consolidated Financial Statements ($ in thousands, except share data)
ENVIRONMENTAL TECTONICS CORPORATION AND SUBSIDIARIES SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
($ in thousands)
Column A Column B Column C Column D Column E
-------- -------- -------- -------- --------
Charges/
Balance at (Credits) Balance At
Beginning to Costs/ End of
Description of Period Expenses Reductions (1) Period
- ----------- --------- -------- -------------- ------
Year ended February 28, 2003:
Valuation and qualifying accounts related to:
Accounts receivable $373 $137 $64 $446
Inventory $738 $108 $200 $646
Property, plant and equipment $9,303 $673 $-- $9,976
Software development costs $6,166 $653 $-- $6,819
Other assets $113 $-- $-- $113
Year ended February 22, 2002
Valuation and qualifying accounts related to:
Accounts receivable $370 $3 $-- $373
Inventory $630 $108 $-- $738
Property, plant and equipment $8,635 $668 $-- $9,303
Software development costs $5,670 $496 $-- $6,166
Other assets $96 $311 $294 $113
Year ended February 23, 2001
Valuation and qualifying accounts related to:
Accounts receivable $367 $3 $-- $370
Inventory $720 $100 $190 $630
Property, plant and equipment $8,004 $631 $-- $8,635
Software development costs $5,215 $455 $-- $5,670
Other assets $61 $192 $157 $96
(1) Amounts written off or retired
32