EXHIBIT 13
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PORTIONS OF
ENVIRONMENTAL TECTONICS CORPORATION
2004
ANNUAL REPORT TO STOCKHOLDERS
FINANCIAL REVIEW
($ in thousands, except share and per share data)
FISCAL YEAR END 2004 2003 2002 2001 2000
--------------- ------- ------- ------- ------- -------
Net sales $25,995 $43,123 $32,527 $32,452 $34,920
Gross profit 9,943 14,198 11,465 13,075 12,798
Operating income 131 4,116 2,873 4,122 5,327
Net (loss)/income (793) 2,493 1,741 2,021 2,873
(Loss)/earnings
per common share:
Basic (.11) .35 .24 .29 .40
Diluted (.11) .33 .23 .27 .36
Working capital 29,907 31,216 30,683 25,070 16,306
Long-term
obligations 12,157 12,643 16,688 12,778 4,455
Total assets 48,696 47,698 48,482 40,705 31,897
Total
stockholders'
equity 25,054 25,907 20,782 18,796 16,245
Weighted average
common shares:
Basic 7,163,000 7,153,000 7,143,000 7,087,000 6,604,000
Diluted 7,163,000 7,497,000 7,499,000 7,499,000 7,319,000
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 existing credit facilities.
1
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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 the Company's current expectations and
projections about future events. These forward-looking statements are subject to
known and unknown risks, uncertainties and assumptions about the Company and its
subsidiaries that may cause 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 include statements with respect to the
Company's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of the company, including but not
limited to, (i) projections of revenues, costs of raw materials, income or loss,
earnings or loss per share, capital expenditures, growth prospects, dividends,
capital structure, other financial items and the effects of currency
fluctuations, (ii) statements of our 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 of customers, suppliers, competitors or
regulatory 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," "looking forward," "would," "believe," "expect,"
"anticipate," "estimate," "intend," "plan," or the negative of such terms 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 the Company's
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.
The Company cautions that the foregoing list of important factors is
not exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We are 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 following factors had an adverse impact on our performance for the
fiscal year ended February 27, 2004:
o Unfavorable global economic and political conditions;
o Completion in the prior period of a major entertainment contract;
o Increased product development costs;
o Integration costs of new personnel in environmental business;
o Higher costs of capital;
o Customer induced shipping delays.
During fiscal 2004, our sales efforts were hampered by continuing
unfavorable global economic and political conditions. We saw many of our
potential new contracts delayed by budget constraints and delays of our
customers located throughout the world. This was especially true in our Aircrew
Training Systems business, where most of the sales are to international
customers. Sales in our entertainment business declined as a result of the
completion in fiscal 2003 of our contract with Walt Disney World for the
amusement ride Mission:Space for Epcot Center in Florida. Disputes related to
this contract, which was reduced in scope and prematurely terminated by the
customer, are the subject of current litigation. In fiscal 2004, our
entertainment business did not replace this business with new projects to offset
the decrease in revenues from fiscal 2003. In fiscal 2005, our entertainment
business has started several new projects that will result in increased revenues
over fiscal 2004. However, we do not at this point have sales backlog in this
segment of our business to ensure that revenues from our entertainment business
will return to the levels we experienced in fiscal 2003. We believe that our
entertainment business remains one of the areas where we will continue to
experience growth in our business.
2
In many of our product lines, especially sterilizers and
environmental products, we must wait for new building or major plant expansion
construction to finalize our contracts. Delays in construction schedules lead to
delays in our ability to ship and install what are basically complete devices.
Fiscal 2004 saw numerous examples of these and other customer delays, including
government paperwork complications and procedural issues. In the environmental
line, we made a significant investment in new personnel, hiring the key former
employees from a competitor, although under a legal settlement we were
restricted from any major sales effort until January 1, 2004. Since the
restriction has been lifted, we have seen an increase in new business generated
by the new sales employees. Additionally, given the highly technical skills of
the new service and installation staff, we anticipate an increase in efficiency
that will result in faster, less costly installations of environmental
equipment.
Fiscal 2004 also saw the culmination of over 30 years of our work with
aeromedical technology with the introduction of our Authentic Tactical Flight
Simulator ("ATFS") and significant enhancements to our GAT and Gyro-IPT family
of flight trainers. The evolution of these exciting and state-of-the-art
technologies is an important step in our goal of integrating flight and
aeromedical training in a simulator device. This technology allows a fighter
pilot to practice tactical air combat maneuvers such as dodging enemy missiles,
ground fire and aircraft obstacles while experiencing the real life environment
of a high-G Force fighter aircraft. These flight trainers provide a low cost and
extremely less risky alternative to actual air flight. We believe that armed
forces agencies of various governments will appreciate the efficiency of these
technologies, especially in this time of fiscal conservatism and budgetary
constraints throughout the world.
One of the greatest challenges we face is adequately capitalizing our
business. Many of our projects are capital intensive and our business requires
us to have a substantial amount of available capital in order to increase our
sales. As a result of our February 2003 financing, we received a sufficient
amount of capital to allow us to operate and continue to grow our business.
However, in fiscal 2004, as a result of this refinancing, our costs of capital,
namely interest payments on our subordinated debt, increased dramatically over
fiscal 2003. Our liquidity and capitalization improved in fiscal 2004 when we
reached a final settlement on a long-standing contract dispute with an
international customer pursuant to which we received $10.5 million subsequent to
February 27, 2004. This settlement contributed approximately $2.3 million to our
pre-tax income for fiscal 2004. Subsequent to fiscal year end, PNC Bank advised
us that it was considering certain changes to the revolving credit facility
including reducing the total facility and requiring us to cash collateralize
some or all of the facility. As of the filing date of this Annual Report on Form
10-K, these discussions were still ongoing. In the event that PNC Bank takes
these actions, we may need to obtain additional sources of capital in order to
continue growing our business. We believe that we will be able to locate such
additional sources of capital and that any such action by PNC Bank will not have
a long-term material adverse effect on our business.
In addition, we face the following challenges and business goals in order to
make fiscal 2005 a successful year:
o Sell through all the products we technologically enhanced in
fiscal 2004.
During fiscal 2004 we invested heavily in enhancing functionality and
product capability of three ATS products: - our centrifuge-based flight
simulator - our General Aviation Trainer (GAT) and - our Gyro-IPT.
Repeat sales of these state-of-the-art simulators will allow us to
recoup non-recurring engineering and design effort.
o Continue to evolve Advanced Tactical Flight Simulation (ATFS).
Our challenge will be to find funding to continue this critical
development objective, either through U.S. government grants or a
customer order.
o Re-engineer the products in our ATS group to remain competitive.
The initial development and engineering required to integrate the
latest technology into existing products is a costly process. We need
to follow through to evaluate and eliminate duplicate processes,
materials, etc., in order to remain cost competitive.
o Standardize the environmental line of products.
Estimating the engineering effort and production costs of custom
products is risky and often significantly under budgeted. To alleviate
some of the variables in the process, we need to, as much as is
possible given the technology and application, develop and sell
standard modular-based offerings with a range of functionality.
o Expand the entertainment line by repeat sales and the introduction
of story line enhancements.
Fiscal 2004 saw the introduction of a new amusement ride directed
towards the location-based entertainment and educational markets.
Initial reaction from customers has been very favorable with multiple
units sold. In fiscal 2005, we need to aggressively pursue the large
venues of zoos and museums and to expand our story line based
offerings.
o Expand the South American market.
3
In the mid-1980's we sold many altitude chambers and other ATS products
in South America. Since then, deteriorating political and economic
conditions have severely restricted international business with most
countries in this continent. In fiscal 2004, we received the first new
significant order from this area since many years ago. We need to find
creative financing alternatives for our customers in this area if we
are to properly cultivate this market.
o Settle at least one major claim.
At February 27, 2004, we had two significant claims outstanding
totaling $5.5 million. To the extent we can settle either or both of
these claims, we may receive significant cash payments that will
improve our liquidity position and allow us to grow our business.
REVENUE RECOGNITION
We currently market our products and services primarily through our
sales offices and employees. In addition, we also utilize the services of
approximately 100 independent sales agents and organizations in seeking foreign
orders for our products.
We generally customize our products using our proprietary software
based on specifications provided by our customers. Many of these products are
capital intensive and take more than one year to manufacture and deliver to the
customer. In the ATS segment, we sell our Aircrew Training Devices to military
and commercial airline operators both in the United States and internationally.
We sell our Entertainment products to amusement parks, zoos and museums. We sell
our Disaster Management Simulation products to state and local governments. In
our Industrial Group, we sell our sterilizers to pharmaceutical and medical
device manufacturers. We sell our Environmental systems primarily to commercial
automobile manufacturers and heating, ventilation and air conditioning (HVAC)
manufacturers and our Hyperbaric products to the military (mainly larger
chambers) and hospitals and clinics (mainly monoplace chambers). To a lesser
degree, we provide upgrade, maintenance and repair services for our products and
for products manufactured by other parties. .
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 its 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 of America, 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.
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 a holding company
established for federal income tax purposes and is not an operating subsidiary.
The Company considers its business activities to be divided into two segments:
Aircrew Training Systems (ATS) and the Industrial Group.
4
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of the Company's financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. 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 twelve-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, 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
creditworthiness. 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 of America, 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 2004 versus Fiscal 2003
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The Company had a net loss of $793,000 or $.11 per share (diluted) in
2004 versus net income of $2,493,000 or $.33 per share (diluted) in fiscal 2003.
Operating income was $131,000, a decrease of $3,985,000 or 96.8% over 2003. This
decrease was primarily the result of reduced gross profits due to lower sales
volume, primarily in domestic entertainment sales, partially offset by lower
research and development expenses.
5
Sales ($000 except for %)
Domestic Government International Total
$ % $ % $ % $ %
Fiscal Year 2004 8,856 34.1 1,717 6.6 15,422 59.3 25,995 100.0
Fiscal Year 2003 23,692 54.9 4,626 10.8 14,805 34.3 43,123 100.0
Total sales in fiscal 2004 were $25,995,000, a decrease of $17,128,000
or 39.7% over 2003, representing decreases in entertainment ($16,998,000),
hyperbaric ($1,519,000) and environmental ($1,701,000). Entertainment suffered
from the completion in fiscal 2003 of a large project. Hyperbaric sales
reflected reduced effort on a large US government submarine decompression
chamber project. Environmental sales were down in the current period as fiscal
2003 reflected significant sales for large chamber projects in China. Providing
partial offsets were increased sales for domestic sterilizers (up $1,662,000)
and higher International Aircrew Training Systems (up $1,702,000) primarily for
International Logistics Services (equipment upgrades and maintenance on various
aeromedical equipment). Geographically, domestic sales were down $14,835,000 or
62.6%, and represented 34.1% of total sales, down from 54.9% in fiscal 2003,
primarily reflecting decreased entertainment activity. U.S. government sales
decreased to $1,717,000, as compared to $4,626,000 in fiscal 2003, and
represented 6.6% of total sales, down from 10.8% of total sales in fiscal 2003.
International sales, including those from the Company's foreign subsidiaries,
were up $616,000 or 4.2%, and represented 59.3% of total sales, up from 34.3% in
fiscal 2003, 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 2004 were the
Royal Malaysian Air Force, $2,874,000 or 11.1%, and the United Kingdom Ministry
of Defense, $2,840,000 or 10.9%. In fiscal 2004, international sales totaling at
least $500,000 per country were made to customers in Malaysia, the United
Kingdom, Indonesia, Venezuela, Egypt, Nigeria, Thailand, China and Norway.
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 foreign customer constituted 19.4% and 20.0%
respectively of the Company's backlog at February 27, 2004. 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.
Segment Sales ($000 except for %)
Aircrew Training Systems Industrial Group Total
$ % $ % $ %
Fiscal 2004 15,880 61.1 10,115 38.9 25,995 100.0
Fiscal 2003 31,612 73.3 11,511 26.7 43,123 100.0
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 $15,880,000 in fiscal 2004, a
decrease of $15,732,000, or 49.8% over fiscal 2003. Sales of these products
accounted for 61.1% of the Company's sales compared to 73.3% in fiscal 2003. The
decrease in ATS product sales primarily reflected the completion in the prior
period of a major entertainment contract. 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,
decreased $1,396,000 to $10,115,000, a decrease of 12.1%, and constituted 38.9%
of the Company's total sales compared to 26.7% in fiscal 2003.
Significant claims outstanding at February 27, 2004 included a claim
with the U.S. Navy for a submarine decompression chamber ($2.9 million recorded)
and a claim with an international customer ($2.6 million recorded). Significant
claims outstanding at February 28, 2003 included $2.1 million for the
aforementioned U.S. Navy claim and $9.5 million for two claims with an
international customer. Effective February 27, 2004 the Company reached an
agreement totaling $10.5 million on one of these international claims, thus
resolving all outstanding amounts related to this claim. Although recorded as a
current asset in the financial statements, all claim revenues may not be
received in full during fiscal 2005. For a more complete discussion of
outstanding claims, see "Note 2. Accounts Receivable" to our consolidated
financial statements in the Annual Report to Stockholders following.
Gross profit for fiscal 2004 decreased by $4,255,000 or 30.0% from
fiscal 2003 reflecting the aforementioned sales decrease which was partially
offset by a 5.3 percentage point increase in the rate as a percentage of sales.
Product development costs, both to enhance functionality of existing products
and to develop product extensions, negatively impacted gross profit as these
costs are primarily charged directly to the cost of sales for specific orders.
Increased rates were evidenced in all business groups except environmental and
entertainment, but the primary positive impact came from the ATS group primarily
reflecting the aforementioned settlement of an international claim.
6
Operating income for fiscal 2004 was $131,000, a decrease of $3,985,000
or 96.8% over fiscal 2003. On a segment basis, ATS had an operating income of
$1,231,000, a decrease of $3,748,000 or 75.3% from fiscal 2003, while the
Industrial Group had an operating loss of $248,000 in fiscal 2004 compared to an
operating income of $52,000 in fiscal 2003. These segment operating results were
offset, in part, by unallocated corporate expenses of $852,000, a decrease of
$63,000 from fiscal 2003.
The decrease in operating income for the ATS segment in fiscal 2004
reflected the aforementioned sales decrease partially offset by higher gross
margins as a percentage of sales. The segment also experienced higher selling
and marketing expenses including commissions.
The Industrial Group segment's decrease in operating income in fiscal
2004 reflected the aforementioned slight reduction in sales coupled with a 2.9
percentage point drop in the gross profit rate as a percentage of sales
partially offset by reduced selling and marketing expenses.
Selling and administrative expenses were flat between the two periods
as increases in legal and accounting costs and sales commissions were offset by
reduced claims expenses. Approximately 41% of selling and administrative costs
in the current fiscal were related to legal and accounting fees, claim costs and
sales commissions. As a percentage of sales, selling and administrative expenses
were 36.4% in fiscal 2004 compared to 21.9% in fiscal 2003.
Research and development expenses decreased $278,000 or 43.7% in fiscal
2004 as compared to fiscal 2003. This decrease reflected government grants in
our Turkish subsidiary under a government research award for work on our
multi-axis centrifuge tactical flight simulator. 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 2004 were $1,716,000 compared to $1,193,000 in
fiscal 2003. Amortization of software costs, which was charged to cost of sales,
was $851,000 and $653,000 for fiscal 2004 and fiscal 2003, respectively.
Interest expense (net of interest income) increased $1,088,000 or
210.0% in fiscal 2004 from fiscal 2003 reflecting higher average borrowings at
higher rates and increased amortization of both deferred finance expenses from
the Company's February 2003 refinancing and subordinated debt discount
associated with the Company's subordinated debt. Letter of credit and other
income/expenses decreased $208,000 or 61.5% in fiscal 2004 over fiscal 2003
reflecting reduced letter of credit fees on a lower balance and the net receipt
of insurance proceeds for a stolen simulator.
Given the Company's pre-tax loss for the fiscal period and the impact
of some large permanent book/tax differences for some accounts, the Company
experienced a domestic tax benefit based on an effective rate of 55.4% and a
consolidated rate of 50.5%. Part of the reduction in the effective rate
reflected the impact of research and experimentation tax credit refunds. The
Company intends to 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, during fiscal 2004 the Company
successfully concluded an Internal Revenue Service routine audit of the
Company's fiscal 2000 tax filing with no additional liability.
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.
Total sales in fiscal 2003 were $43,123,000, an increase of $10,596,000
or 32.6% over fiscal 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.
7
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.
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 intends to continue to use
research and experimentation tax credits, if applicable, to reduce its federal
income tax.
8
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.
LIQUIDITY AND CAPITAL RESOURCES
During fiscal 2004, the Company used $2,864,000 of cash to support
operating activities. Cash usages included the net operating loss, increases in
current assets, most notably receivables, inventories and prepaids and a
decrease in billings in excess of costs and estimated earnings on uncompleted
long-term contracts. Acting as partial offsets were non-cash expenses such as
depreciation and amortization and increases in current liability accounts,
primarily accounts payable, customer deposits and other accrued liabilities. The
primary impact on cash usage was an increase in an international receivable to
reflect a $10.5 million claim settlement that was subsequently paid to us in
March 2004, a build-up in inventories reflecting pre-engineering costs on the
Authentic Tactical Flight Simulator and customer induced delays on shipping
completed products.
The Company's investing activities used $1,695,000 in fiscal 2004 and
consisted of purchases of capital equipment ($475,000) and capitalized software
($1,220,000). Given the nature of the Company's market and products, the
continued development of generic control and core software and software tools is
a critical objective of management.
The Company's financing activities generated $1,780,000 of cash during
fiscal 2004. This primarily reflected a significant decrease in restricted cash
to cash collateralize international letters of credit (reflecting both the
nature and amount of new contracts, outstanding international letters of credit
decreased $2,277,000 during the fiscal year) which was only partially offset by
net repayments under the Company's bank facility. (See "Note 6. Long-Term
Obligations and Credit Arrangements" to the Consolidated Financial Statements.)
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 repayment 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 increased 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 27, 2004, availability under the $14,800,000 revolving facility was
$7,567,000.
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.
Subsequent to fiscal year end, PNC Bank advised the Company that it was
considering certain changes to the revolving credit facility including reducing
the total facility and requiring the Company to cash collateralize some or all
of the facility. As of the filing date of this Form 10-K, these discussions were
still ongoing. In the event that PNC Bank takes these actions, we may need to
obtain additional sources of capital in order to continue growing our business.
We believe that we will be able to locate such additional sources of capital and
that any such action by PNC Bank will not have a long-term material adverse
effect on our business.
As of April 30, 2004 the Company had used approximately $5,426,000 of
the facility for international letters of credit and as collateral for a portion
of the PNC Bank letter of credit that serves as collateral for the Company's
long-term bonds.
9
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, Advanced Technology Asset
Management, LLC ("ATAM") (formerly 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, ATAM waived,
solely in connection with such issuance, the anti-dilution rights contained in
its warrant. In exchange for ATAM's consent, the Company issued to ATAM 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 ATAM warrants have
substantially the same terms as the warrants issued to Mr. Lenfest. In March,
2004, ATAM exercised all its warrants and received a total of 437,820 shares of
common stock of the Company. The Company received proceeds of $586,410 from the
exercise of these warrants.
The Company believes that cash generated from operating activities
(including claim settlements) as well as future availability under its credit
agreement will be sufficient to meet its future obligations through at least May
31, 2005. However, as was noted above, the Company is in discussions with PNC
Bank concerning the Company's revolving credit facility.
In reference to the Company's outstanding claims with both the U.S.
Navy and 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 a favorable experience in that recoveries have exceeded recorded
claims, including significant settlement agreements in fiscal 2003 and 2004.
(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.
PAYMENTS DUE BY PERIOD (IN THOUSANDS)
--------------------------------------------------------------------------------------------
TOTAL LESS THAN 1 YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS
---------- ---------------- --------- --------- -------------
(IN THOUSANDS)
Long-term debt, including current
maturities* $12,474 $317 $946 $11,211 -
Operating leases 384 159 225 - -
Total ------- ---- ------ ------- -------
12,858 $476 $1,171 $11,211 -
* Long-term debt is reported net of unamortized discount of $2,334 on the
company's subordinated debt. See "Note 6. Long-Term Obligations and Credit
Arrangements" to the Consolidated Financial Statements.
The Company's sales backlog at February 27, 2004 and February 28, 2003,
for work to be performed and revenue to be recognized under written agreements
after such dates, was $16,914,000 and $21,454,000, respectively. This decline
primarily reflected continued production and corresponding percentage of
completion revenue recognition in the current fiscal year on two significant
contracts. In addition, the Company's training, maintenance and upgrade
contracts backlog at February 27, 2004 and February 28, 2003, for work to be
performed and revenue to be recognized after such dates under written
agreements, was approximately $2,637,000 and $3,931,000, respectively. Of the
February 27, 2004 backlog, approximately $14,417,000 was under contracts for ATS
and maintenance support including $3,798,000 for the Royal Malaysian Air Force.
Approximately 89% of the February 27, 2004 backlog is expected to be completed
prior to February 25, 2005.
The Company's order flow does not follow any seasonal pattern as the
Company receives orders in each fiscal quarter of its fiscal year.
OFF-BALANCE SHEET ARRANGEMENTS
There were no off-balance sheet arrangements during the fiscal year
ended February 27, 2004 that have or are reasonably likely to have a current or
future effect on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources that is material to the Company's investors.
10
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
this statement did not have a significant impact on the Company's consolidated
financial position, results of operations, or cash flows.
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 this statement did not have a significant impact on
the Company's consolidated financial position, results of operations, or cash
flows.
Accounting and Disclosure Requirements for Guarantees:
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 adoption of this statement did not have a significant impact on
the Company consolidated financial position, results of operations, or cash
flow.
Consolidation of Variable Interest Entities:
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 this
statement did not have a significant impact on the Company's consolidated
financial position, results of operations, or cash flows since the Company
currently has no VIEs. In December 2003, the FASB issued FIN 46R with respect to
VIEs created before January 31, 2003, which, among other things, revised the
implementation date to the first fiscal year or interim period ending after
March 15, 2004, with the exception of Special Purpose Entities (SPE). The
consolidation requirements apply to all SPEs in the first fiscal year or interim
period ending after December 15, 2003. The Company adopted the provision of FIN
46R effective February 27, 2004, and such adoption did not have a material
impact on the consolidated financial statements since the Company currently has
no SPEs.
Accounting for Certain Financial Instruments:
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.
11
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, and
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 this statement did not 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 14, 2004, the Company had 281 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 2004
First Quarter $6.00 $5.00
Second Quarter 6.10 5.00
Third Quarter 8.70 6.08
Fourth Quarter 9.95 7.00
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
On May 14, 2004, the closing price of the Company's common stock was
$8.59. 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 facilities prohibit 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 FOR FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
- ------------- -------------------------- ----------------------------- ------------------------
(a) (b) (c)
EQUITY COMPENSATION PLANS
APPROVED BY
SECURITY HOLDERS 376,002 $7.21 623,998
EQUITY COMPENSATION PLANS
NOT APPROVED BY SECURITY
HOLDERS - N/A 209,058
------- ----- -------
TOTAL 376,002 $7.21 833,056
======= ===== =======
12
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.
13
Report of Independent Registered Public Accounting Firm
Board of Directors and
Shareholders of Environmental Tectonics Corporation
We have audited the accompanying consolidated balance sheets of Environmental
Tectonics Corporation and Subsidiaries as of February 27, 2004 and February 28,
2003, 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 27, 2004. 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Environmental Tectonics Corporation and Subsidiaries as of February 27, 2004 and
February 28, 2003, and the consolidated results of its operations and its cash
flows for each of the three fiscal years in the period ended February 27, 2004,
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 27, 2004 and February 28, 2003 and
for each of the three fiscal years in the period ended February 27, 2004. 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 $5.5 million related to claims made to or
against the United States government and an international customer for contract
costs incurred through February 27, 2004. The total net claims amount made is
approximately $26.9 million based on costs incurred through February 27, 2004,
and is subject to negotiation, arbitration and audit by the United States
government and the international customer.
As discussed in note 1 to the consolidated financial statements, the
Company adopted Statement of Financial Accounting Standards No. 142, Goodwill
and Other Intangible Assets, on February 23, 2002.
/s/ Grant Thornton LLP
- --------------------------
Philadelphia, Pennsylvania
April 28, 2004
14
CONSOLIDATED BALANCE SHEETS ($ IN THOUSANDS, EXCEPT SHARE DATA)
FEBRUARY 27, 2004 FEBRUARY 28, 2003
ASSETS
Cash and cash equivalents $ 1,366 $ 4,305
Cash equivalents restricted for letters of credit 784 3,189
Accounts receivable, net 19,233 16,193
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 5,333 5,441
Inventories 9,843 8,494
Deferred tax asset 1,337 689
Prepaid expenses and other current assets 1,949 983
-------- --------
Total current assets 39,845 39,294
Property, plant and equipment, net 4,886 5,086
Software development costs, net of accumulated amortization
of $7,494 and $6,819 in 2004 and 2003, respectively 3,089 2,224
Goodwill 477 477
Other assets, net 399 617
-------- --------
Total assets $ 48,696 $ 47,698
======== ========
LIABILITIES
Current portion of long-term obligations $ 317 $ 281
Accounts payable - trade 2,431 1,778
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 945 1,463
Customer deposits 3,657 3,000
Other accrued liabilities 2,588 1,556
-------- --------
Total current liabilities 9,938 8,078
-------- --------
Long-term obligations, less current portion:
Credit facility payable to banks 30 600
Long term bonds 4,370 4,645
Subordinated debt 7,666 7,391
Capitalized lease obligations 91 7
-------- --------
12,157 12,643
-------- --------
Deferred tax liability 1,502 1,022
-------- --------
Total liabilities $ 23,597 $ 21,743
-------- --------
Minority Interest 45 48
STOCKHOLDERS' EQUITY
Commonstock - authorized 20,000,000 shares, $.05 par value;
7,176,552 and 7,157,239 shares issued and outstanding
in 2004 and 2003, respectively $ 359 $ 358
Capital contributed in excess of par value of common stock 9,430 9,331
Accumulated other comprehensive loss (329) (169)
Retained earnings 15,594 16,387
-------- --------
Total stockholders' equity $ 25,054 $ 25,907
-------- --------
Total liabilities and stockholders' equity $ 48,696 $ 47,698
======== ========
The accompanying notes are an integral part of the consolidated financial statements.
15
CONSOLIDATED STATEMENTS OF OPERATIONS ($ IN THOUSANDS, EXCEPT SHARE DATA)
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED
FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002
----------------- ----------------- -----------------
Net sales $25,995 $43,123 $32,527
Cost of goods sold 16,052 28,925 21,062
------- ------- -------
Gross profit 9,943 14,198 11,465
Operating expenses:
Selling and administrative 9,454 9,446 7,992
Research and development 358 636 600
------- ------- -------
9,812 10,082 8,592
------- ------- -------
Operating income 131 4,116 2,873
------- ------- -------
Other expenses:
Interest expense (net) 1,606 518 1,094
Letter of credit fees 127 154 102
Other, net 3 184 42
------- ------- -------
1,736 856 1,238
------- ------- -------
(Loss)/income before (benefit from)/provision
for income taxes and minority interest (1,605) 3,260 1,635
(Benefit from)/provision for income taxes (810) 805 (93)
------- ------- -------
(Loss)/income before minority interest (795) 2,455 1,728
Loss attributable to minority interest (2) (38) (13)
------- ------- -------
Net (loss)/income $(793) $2,493 $1,741
======= ======= =======
Per share information: (Loss)/earnings per common share:
Basic $(.11) $.35 $.24
Diluted $(.11) $.33 $.23
(Loss)/income applicable to common stockholders $(793) $2,493 $1,741
Weighted average common shares:
Basic 7,163,000 7,153,000 7,143,000
Diluted 7,163,000 7,497,000 7,499,000
The accompanying notes are an integral part of the consolidated financial statements.
16
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY ($ IN THOUSANDS,
EXCEPT SHARE DATA)
For the years ended February 27, 2004, February 28, 2003 and February 22, 2002
COMMON STOCK CAPITAL
---------------------- CONTRIBUTED ACCUMULATED
IN EXCESS OF OTHER TOTAL
PAR VALUE OF COMPREHENSIVE RETAINED STOCKHOLDERS'
SHARES AMOUNT COMMON STOCK INCOME (LOSS) EARNINGS EQUITY
------ ------ ------------ ------------- -------- ------
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 - - 1,400 - - 1,400
associated with issuance of
subordinated convertible debt
Value of warrants issued in connection - - 1,209 - - 1,209
with issuance of subordinated
convertible debt
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
Net loss for the year - - - - (793) (793)
Foreign currency translation adjustment (160) - (160)
----- ------- -------
Total comprehensive loss (953)
Shares issued in connection with
employee stock purchase and stock
option plans 19,313 1 99 - - 100
--------- ---- ------ ----- ------- -------
Balance, February 27, 2004 7,176,552 $359 $9,430 $(329) $15,594 $25,054
========= ==== ====== ===== ======= =======
The accompanying notes are an integral part of the consolidated financial statements.
17
CONSOLIDATED STATEMENTS OF CASH FLOWS ($ IN THOUSANDS)
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED
FEBRUARY 27, FEBRUARY 28, FEBRUARY 22,
2004 2003 2002
-------------- -------------- --------------
Cash flows from operating activities:
Net (loss)/income $(793) $2,493 $1,741
Adjustments to reconcile net (loss)/income to net cash (used
in)/provided by operating activities
Depreciation and amortization 1,847 1,401 1,475
Deferred financing costs 275 - -
(Decrease)/increase in allowance for accounts receivable and (149) (19) 111
inventory
Loss attributable to minority interest (2) (38) (13)
Deferred income taxes (benefit) (168) 313 (39)
Changes in operating assets and liabilities:
(Increase) decrease in assets
Accounts receivable (2,973) 3,590 (3,083)
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 108 3,950 204
Inventories (1,763) (2,091) (2,645)
Prepaid expenses and other current assets (720) 62 (530)
Other assets (103) 32 (136)
Increase (decrease) in liabilities:
Accounts payable 653 (1,660) 1,509
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts (518) 964 (1,213)
Customer deposits 657 (684) 2,241
Accrued income taxes (247) (731) (23)
Other accrued liabilities 1,032 (2) (319)
------ ------ ------
Net cash (used in)/provided by operating activities (2,864) 7,580 (720)
Cash flows from investing activities:
Acquisition of equipment (475) (215) (649)
Software development costs (1,220) (569) (989)
------ ------ ------
Net cash used in investing activities (1,695) (784) (1,638)
Cash flows from financing activities:
Borrowings under credit facility 2,514 26,396 10,899
Payments under credit facility (3,084) (37,551) (6,708)
Payments on long-term bonds (275) (275) (275)
Proceeds from subordinated debt - 7,391 -
Deferred financing costs - (719) -
Increase/(decrease) in restricted cash 2,405 (2,620) (25)
Net increase/(decrease) in other long-term obligations 120 (6) (368)
Proceeds from issuance of common stock/warrants 100 2,629 191
------ ------ ------
Net cash provided by/(used in) financing activities 1,780 (4,755) 3,714
Effect of exchange rates on cash (160) 3 54
------ ------ ------
Net (decrease)/increase in cash and cash equivalents (2,939) 2,044 1,410
Cash and cash equivalents at beginning of year 4,305 2,261 851
------ ------ ------
Cash and cash equivalents at end of year $1,366 $4,305 $2,261
====== ====== ======
Supplemental schedule of cash flow information:
Interest paid $854 $480 $766
Income taxes paid $78 $1,720 $582
Supplemental information on non-cash operating and investing activities:
During the year ended February 27, 2004, the Company reclassified $496
from inventory to capitalized software.
During the year ended February 28, 2003, the Company reclassified $226
from inventory to property, plant and equipment and $624 from inventory to
capitalized software.
The accompanying notes are an integral part of the consolidated
financial statements.
18
Notes to Consolidated Financial Statements ($ 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, Entertainment 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, inventories and computer software
costs.
At February 27, 2004, the Company had recorded receivables in the
amount of $5.5 million for claims made or to be made against the U.S. government
and an international customer for contract costs incurred through February 27,
2004. The total net claims amount filed with the U.S. government and an
international customer at February 27, 2004, was approximately $26.9 million
based on costs incurred through February 27, 2004. Effective February 27, 2004,
the Company reached a final settlement agreement totaling $10.5 million on one
of its claims with a foreign customer. This settlement was paid to the Company
in March 2004. 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 27, 2004 was approximately $26.9
million based on costs incurred through February 27, 2004. However, under
generally accepted accounting principles, the Company had recorded only $5.5
million or 20.5% of this amount on its books.
19
Notes to Consolidated Financial Statements ($ in thousands, except share data)
Revenue Recognition:
Revenue is recognized on long-term contracts utilizing the percentage
of completion method based on costs incurred as a percentage of estimated total
costs. Revenue recognized on uncompleted long-term contracts in excess of
amounts billed to customers is reflected as an asset. Amounts billed to
customers in excess of revenue recognized on uncompleted long-term contracts are
reflected as a liability. When it is estimated that a contract will result in a
loss, the entire amount of the loss is accrued. The effect of revisions in cost
and profit estimates for long-term contracts is reflected in the accounting
period in which the facts requiring the revisions become known. Contract
progress billings are based upon contract provisions for customer advance
payments, contract costs incurred and completion of specified contract
milestones. Contracts may provide for customer retainage of a portion of amounts
billed until contract completion. Retainage is generally due within one year of
completion of the contract. Revenue for contracts under $100, or to be completed
in less than one year, and where there are no post-shipment services included in
the contract, and revenue on parts and services, are recognized as shipped.
Under these contracts, title passes at shipment. Revenue on those types of
contracts where post-shipment services (such as installation and acceptance) are
required is recognized 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 include 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, significant portions 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, $0, and $17 in fiscal years
2004, 2003 and 2002, respectively, and accumulated amortization was $113 as of
February 27, 2004 and February 28, 2003.
20
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
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.
Reported net income, exclusive of amortization expense that is related to
goodwill that is no longer being amortized, would have been:
FISCAL YEAR ENDED
-----------------
FEBRUARY FEBRUARY FEBRUARY
2004 2003 2002
-------- -------- --------
Reported net (loss)/earnings $ (793) $2,493 $1,741
Goodwill amortization - - 17
Adjusted net (loss)/earnings $ (793) $2,493 $1,758
Basic (loss)/earnings per share:
Reported net (loss)/earnings $(0.11) $ 0.35 $ 0.24
Goodwill amortization - - .01
Adjusted net (loss)/earnings $(0.11) $ 0.35 $ 0.25
Diluted (loss)/earnings per share:
Reported net (loss)/earnings $(0.11) $ 0.33 $ 0.23
Goodwill amortization - - -
Adjusted net (loss)/earnings $(0.11) $ 0.33 $ 0.23
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 $1,716 and $1,193, respectively, for the fiscal years ended February 27,
2004 and February 28, 2003. Related software amortization totaled $851, $653 and
$496, respectively, for fiscal 2004, 2003 and 2002.
Research and Development:
Research and development expenses are charged to operations as
incurred. During fiscal 2004, 2003 and 2002, the Company incurred research and
development costs of approximately $358, $636 and $600, 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 and costs associated with the
February 2003 PNC/Lenfest financing are being amortized over the relevant term.
Amortization expense relating to deferred financing costs was $321, $75 and $293
in fiscal 2004, 2003 and 2002, respectively (see "Note 6. Long-Term Obligations
and Credit Arrangements" to Consolidated Financial Statements).
21
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Subordinated Debt 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. Accreted interest expense related to the beneficial conversion option
and the warrants was $275 in fiscal 2004 and $0 in fiscal 2003.
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, 2004, 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 this plan 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.
22
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
Fiscal Year Ended
-------------------------------------------------------------
February 27, 2004 February 28, 2003 February 22, 2002
----------------- ----------------- -----------------
Net (loss)/income, as reported $ (793) $ 2,493 $ 1,741
Deduct: Total stock-based employee compensation expense
determined under fair value based method for all
awards, net of related tax effects (27) (275) (456)
------ ------- -------
Pro forma net (loss)/income $ (820) $ 2,218 $ 1,285
====== ======= =======
(Loss)/earnings per share:
Basic--as reported $(0.11) $.35 $.24
Basic--pro forma $(0.11) $.31 $.18
Diluted--as reported $(0.11) $.33 $.23
Diluted--pro forma $(0.11) $.30 $.17
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 2003 and fiscal 2004.
Advertising Costs:
The Company expenses advertising costs, which include trade shows, as
incurred. Advertising expense was $324, $464 and $438 in fiscal 2004, 2003, and
2002, 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 the reconciliations of the numerators
and denominators of the basic and diluted earnings per share computations.
FISCAL YEAR ENDED FEBRUARY 27, 2004
---------------------------------------------
WEIGHTED
LOSS AVERAGE PER SHARE
($000) SHARES AMOUNT
------ ------ ------
(NUMERATOR) (DENOMINATOR)
Net loss $793
Basic loss per share
Loss applicable to common stockholders $793 7,163,000 $.11
==== ========= ====
Effective of dilutive securities
Stock options -
Convertible Debt -
Stock warrants -
---------
Diluted loss per share
Loss applicable to common stockholders plus
effect of dilutive securities $793 7,163,000 $.11
==== ========= ====
23
Notes to Consolidated Financial Statements ($ in thousands, except share data)
1. Summary of Significant Accounting Policies (Continued):
At February 27, 2004, there were stock options to purchase the Company's common
stock totaling 376,002 shares that were not included in the computation of
diluted loss per share as the effect of such would be anti-dilutive.
Additionally, there was subordinated debt with a face value of $10,000,000,
which was convertible at an exercise price of $6.05 per share, equating to
1,652,893 shares of common stock if fully converted. Upon each conversion of the
subordinated note, the holder would be entitled to receive a warrant to purchase
additional shares of common stock equal to ten percent of the shares issued
pursuant to such conversion. If the entire face value of the subordinated note
is converted into shares of common stock, then warrants to purchase an
additional 165,289 shares of common stock will be issued, bringing the total
shares of common stock to be issued to 1,818,182. Additionally, at February 27,
2004, there were outstanding warrants to purchase the Company's stock totaling
1,240,868 shares. None of these shares were included in the computation of
diluted earnings per share as the effect would be anti-dilutive.
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.
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 $.23
====== ========= ====
At February 22, 2002, options to purchase the Company's common stock totaling
448,514 shares were outstanding, 313,750 of which were not included in the
computation of diluted earnings per share as the effect of such inclusion would
be anti-dilutive.
24
Notes to Consolidated Financial Statements ($ in thousands, except share data)
2. Accounts Receivable:
The components of accounts receivable at February 27, 2004 and February
28, 2003 are as follows:
2004 2003
---- ----
U.S. government receivables billed and unbilled contract costs
subject to negotiation $ 3,128 $ 2,719
U.S. commercial receivables billed 1,508 2,002
International receivables billed and unbilled
contract costs subject to negotiation 14,976 11,918
------- -------
19,612 16,639
Less allowance for doubtful accounts (379) (446)
------- -------
$19,233 $16,193
======= =======
U.S. government receivables billed and unbilled contract costs subject
to negotiation:
Unbilled contract costs subject to negotiation as of February 27, 2004
represent claims made against the U.S. government under a contract for a
submarine decompression chamber project. These costs, totaling $2,899, were
recorded beginning in fiscal 2002, and include $1,691 recorded during fiscal
2003 and $833 recorded during fiscal 2004. In November 2003, the U.S. Government
completed an audit of the claim, rejecting most of the items due to audit or
engineering reasons. The Company was not provided a copy of the Government's
Technical Report that questioned approximately half of the claim costs. The
Company has submitted a written rebuttal to the draft report and has formally
requested a copy of the Technical Report. The U.S. Government has agreed to
issue a final decision on September 15, 2004. The Company considers the recorded
costs to be realizable due to the fact that they relate to customer caused
delays, errors and changes in specifications and designs, disputed liquidated
damages and other out of scope items. Subsequent to fiscal year end, the Company
submitted a supplement to the claim incorporating additional cost items. During
the fiscal 2004 third quarter, the U.S. Government, citing failure to deliver
product within contract terms, began assessing liquidated damages by offsetting
progress payments due the Company under the contract. Subsequent to fiscal 2004
year end, citing "substantial material progress" on the project, the U.S.
Government agreed to release all outstanding invoice payments which had
previously been withheld for liquidated damages. The Company disputes the basis
for these liquidated damages, noting that applicable U.S. Government purchasing
regulations allow for a waiver of these charges if the delay is beyond the
control and not due to the fault or negligence of the Company. However, in
accordance with accounting principles generally accepted in the United States of
America, the Company has reduced contract values and corresponding revenue
recognition for an estimated amount of $330 to cover a delay through the
extended delivery period.
International receivables billed and unbilled contract costs subject to
negotiation:
The Royal Thai Air Force:
In October 1993, the Royal Thai Air Force (RTAF) notified the Company
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 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 $230 representing the amount due on the
performance bond.
25
Notes to Consolidated Financial Statements ($ in thousands, except share data)
The open balance of $700 at February 27, 2004 and February 28, 2003 due
on the contract represents the total net exposure to the Company on this
contract. As of February 27, 2004, 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. A
date for arbitration has not been set as of yet, although the parties are
currently in the process of choosing their individual arbitrators. 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.
International customer:
Unbilled contract costs subject to negotiation as of February 27, 2004
included a claim ($2,600 recorded) made against an international customer for a
contract covering 1997 to the present. 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 2005. 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 and the
customer are currently in the arbitration process. The Company has filed its
"Points of Claim" to which the customer has replied and also the customer has
filed a counterclaim, which the Company expects to respond to shortly.
Additionally, the discovery process is continuing. The customer, citing failure
to deliver product within contract terms, has assessed liquidated damages
totaling approximately $400 on the contract. 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 $400.
Effective February 27, 2004, the Company reached an agreement totaling
$10.5 million with the same international customer on another claim of which
$6.8 million was included in unbilled contract costs subject to negotiation as
of February 28, 2003, thus resolving all outstanding amounts related to this
claim.
Claim bookings and settlements in fiscal 2004 increased operating
income by $1,802. Claim bookings in fiscal 2003 and 2002 decreased operating
income by $675 and $661 respectively. All amounts are net of associated
manufacturing costs and legal expenses.
Net claims receivables were $5,508 and $11,700 at February 27, 2004 and
February 28, 2003, respectively.
26
Notes to Consolidated Financial Statements ($ in thousands, except share data)
3. Costs and Estimated Earnings on Uncompleted Contracts:
Unbilled costs
Amounts not billed or yet billable totaled $16,638 at February 27,
2004. 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 27, 2004 and February 28, 2003:
2004 2003
---- ----
Costs incurred on uncompleted long-term contracts $28,802 $23,941
Estimated earnings 5,508 9,757
------- -------
34,310 33,698
Less billings to date (29,922) (29,720)
------- -------
$ 4,388 $ 3,978
======= =======
2004 2003
---- ----
Included in accompanying balance sheets under the following captions:
Costs and estimated earnings in excess of billings
on uncompleted long-term contracts $5,333 $5,441
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts (945) (1,463)
------ ------
$4,388 $3,978
====== ======
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 2004, 2003 and 2002.
4. Inventories:
Inventories consist of the following:
WORK IN
RAW MATERIAL PROCESS FINISHED GOODS TOTAL
------------ ------- -------------- -----
February 27, 2004 $311 $7,803 $1,729 $9,843
February 28, 2003 322 5,629 2,543 8,494
Inventory is presented above net of an allowance for obsolescence of $564 and
$646 in fiscal 2004 and 2003, respectively.
27
Notes to Consolidated Financial Statements ($ in thousands, except share data)
5. Property, Plant and Equipment:
The following is a summary of property, plant and equipment, at cost,
and estimated useful lives at February 27, 2004 and February 28, 2003:
ESTIMATED
USEFUL
2004 2003 LIVES
---- ---- -----
Land $100 $100
Building and building additions 3,763 3,763 40 years
Machinery and equipment 9,019 8,611 3-5 years
Office furniture and equipment 1,195 1,195 10 years
Building improvements 1,460 1,393 5-10 years
------- ------
15,537 15,062
Less accumulated depreciation (10,651) (9,976)
------- ------
Property, plant and equipment, net $4,886 $5,086
====== ======
Depreciation expense for the fiscal years ended February 27, 2004, February 28,
2003 and February 22, 2002 was $675, $673 and $668, respectively.
6. Long-Term Obligations and Credit Arrangements:
Long-term obligations at February 27, 2004 and February 28, 2003
consist of the following:
2004 2003
---- ----
Credit facility payable to banks $ 30 $ 600
Long term bonds 4,645 4,920
Subordinated debt, net of unamortized discount of $2,334 and $2,609
for 2004 and 2003, respectively 7,666 7,391
Term loans payable, accruing interest at between 9% and 9.9%
collateralized by priority liens on certain equipment 6 13
Capitalized lease obligations 127 -
-------- -------
12,474 12,924
Less current portion (317) (281)
-------- -------
$ 12,157 $12,643
======== =======
The amounts of future long-term obligations maturing in each of the
next five fiscal years are as follows:
2005 $317
2006 343
2007 314
2008 289
2009 and thereafter 11,211
-------
Total future obligations $12,474
=======
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
day's outstanding method as of February 27, 2004 and February 28, 2003 are as
follows:
2004 2003
---- ----
Approximate average loan balance 10,401 8,219
Maximum aggregate 11,200 11,445
Weighted average interest rate 8.45%* 4.37%
* The weighted average interest rate calculation for fiscal 2004
reflects the impact of the $10,000 senior subordinated debt obtained
as part of the February 19, 2003 financing.
28
Notes to Consolidated Financial Statements ($ in thousands, except share data)
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 2003 and 2002. The interest rates ranged from 4.75% to 5.00%
during fiscal 2004 and from 4.00% to 5.00% during fiscal 2003.
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 27, 2004,
availability under the $14,800 revolving facility was $7,567 all of which was
available for borrowing.
As part of our Bank and Subordinated agreements, the Company must also
meet certain financial covenants including a Leverage Ratio, a Fixed Charge
Ratio, a Tangible Net Worth Ratio, and maintain a full year profit. As of year
end the Company failed to meet all of these covenants and has obtained waivers
from both of its lenders.
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.
Subsequent to fiscal year end, PNC advised the Company that it was
considering certain changes to the revolving credit facility including reducing
the total facility and requiring the Company to cash collateralize some or all
of the facility. As of the filing date of this Annual Report on Form 10-K, these
discussions were still ongoing. As of April 30, 2004, the Company had utilized
approximately $5,426 of the facility for international letters of credit and as
collateral for a portion of the long-term bonds. (Reference the Liquidity and
Capital Resources Section of the Annual Report to Stockholders attached as
Exhibit 13 to this Annual Report on Form 10-K.)
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. Accreted
interest expense related to the note and warrants was $275 in fiscal 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 27, 2004 was $4,083. Fees on
letters of credit outstanding were 1.75% at February 27, 2004 and February 28,
2003.
29
Notes to Consolidated Financial Statements ($ in thousands, except share data)
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 1.20% on May 12, 2004)
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 27, 2004.
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 27, 2004 are $159 in 2005; $125 in
2006; $86 in 2007; $14 in 2008; and $0 in 2009 and thereafter.
Total rental expense for all operating leases for the fiscal years
ended February 27, 2004, February 28, 2003 and February 22, 2002 was $241, $255
and $197, respectively.
8. Income Taxes:
The components of the provision for income taxes are as follows:
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED
FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002
----------------- ----------------- -----------------
Currently payable:
Federal $(738) $285 $42
State - 188 134
Foreign taxes 96 19 (230)
----- ---- ----
(642) 492 (54)
----- ---- ----
Deferred:
Federal (101) 282 (36)
State (67) 31 (3)
----- ---- ----
(168) 313 (39)
----- ---- ----
$(810) $805 $(93)
===== ==== ====
A reconciliation of the statutory federal income tax rate to the effective tax
rate is as follows:
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED
FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002
----------------- ----------------- -----------------
Statutory income tax (34.0)% 34.0% 34.0%
State income tax, net of federal tax benefit (4.1) 3.7 5.4
Benefit of foreign sales corporation
And extraterritorial income (9.1) (4.5) (3.4)
Research and experimentation tax
credit refunds attributable to open tax years (0.0) (0.0) (37.8)
Research and experimentation and
Other tax credits (9.2) (5.0) (9.2)
Benefit of foreign and foreign-source
Income or loss (0.0) (0.0) (1.0)
Other, net 6.0 (3.5) 6.4
----- ---- ----
(50.4%) 24.7% (5.6)%
===== ==== ====
The tax effects of the primary temporary differences are as follows:
2004 2003 2002
---- ---- ----
Deferred tax assets:
Net products liability settlement - 75 75
Vacation reserve 44 44 58
Inventory reserve 212 244 275
Receivable reserve 8 168 139
Warranty reserve 142 47 46
Net operating loss and credits 302 - -
Other, net 629 111 122
------ ------ ----
Total current deferred tax asset $1,337 $689 $715
------ ------ ----
Deferred tax liabilities:
Amortization of capitalized software $1,166 $724 $488
------ ------ ----
Depreciation 336 298 247
------ ------ ----
Total noncurrent deferred tax liability $1,502 $1,022 $735
------ ------ ----
30
Notes to Consolidated Financial Statements ($ 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 the Industrial Group. 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 2004
-----------
Net sales $15,880 $10,115 $25,995
Interest expense 1,293 313 1,606
Depreciation and amortization 881 966 1,847
Operating income/(loss) 1,231 (248) 983
Income tax provision/(benefit) 62 (318) (256)
Goodwill 477 - 477
Identifiable assets 30,002 7,496 37,498
Expenditures for segment assets 380 95 475
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/(benefit) 1,139 (11) 1,128
Goodwill 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 477 - 477
Identifiable assets 33,160 5,408 38,568
Expenditures for segment assets 557 92 649
2004 2003 2002
---- ---- ----
Reconciliation to consolidated amounts:
------- ------- -------
Corporate assets 10,721 14,869 9,914
Total assets $48,696 $47,698 $48,482
Segment operating income $983 $5,031 $3,978
Less interest expense (1,606) (518) (1,094)
Income taxes (benefit)/provision (256) 1,128 282
------- ------- -------
Total loss for segments (367) 3,385 2,602
Corporate home office expense (852) (915) (1,105)
Interest and other expenses (130) (338) (144)
Income tax benefit 554 323 375
Minority interest 2 38 13
------- ------- -------
Net (loss)/income $(793) $2,493 $1,741
======= ======= =======
Segment operating income consists of net sales less applicable costs
and expenses relating to these revenues. Unallocated expenses including 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.
Approximately 22% of sales totaling $5,714 in 2004 were made to two
international customers in the ATS segment. Approximately 57% of sales totaling
$24,471 in fiscal 2003 were made to one international and one domestic customer
in the ATS segment. Approximately 59% of sales totaling $19,143 in fiscal 2002
were made to one international and one domestic customer in the ATS segment.
Included in the segment information for the year ended February 27,
2004, are export sales of $15,421. Of this amount, there are sales to or
relating to governments or commercial accounts in Malaysia of $2,874 and the
United Kingdom of $2,840. Sales to the U.S. government and its agencies
aggregated $1,717 for the year ended February 27, 2004.
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 aggregated $4,626 for the year ended February 28,
2003.
31
Notes to Consolidated Financial Statements ($ in thousands, except share data)
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 aggregated $1,194 for the year ended February 22,
2002.
10. Stock Options:
A summary of the status of the Incentive Stock Option Plan as of and for the
fiscal years ended:
FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002
--------------------------- ---------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
-------- -------------- -------- -------------- -------- --------------
Outstanding at beginning of year 421,614 $7.20 448,514 $7.04 464,350 $6.95
Granted -- -- - - 27,564 7.38
Exercised (17,800) 5.12 (4,150) 4.73 (32,400) 5.89
Forfeited (27,812) 7.74 (22,750) 4.52 (11,000) 7.43
------- ------- -------
Outstanding at end of year 376,002 7.21 421,614 7.20 448,514 7.04
======= ======= =======
Options exercisable at year end 370,564 - 408,981 - 240,325 -
Weighted average fair value of
options granted during the year - - - - - $7.01
The following information applies to options outstanding at February
27, 2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------- ------------------------------------------------
WEIGHTED
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
FEBRUARY 27, CONTRACTUAL EXERCISE FEBRUARY 27, EXERCISE
RANGE OF EXERCISE PRICES 2004 LIFE (YEARS) PRICE 2004 PRICE
------------------------ -------------- ------------- -------- -------------- --------
$2.25 to $3.38 9,200 2.45 years $2.25 9,200 $2.25
$5.00 to $7.50 82,302 5.01 years $5.67 76,864 $5.55
$7.81 284,500 4.65 years $7.81 284,500 $7.81
------- -------
Total 376,002 370,564
32
Notes to Consolidated Financial Statements ($ 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 was entered into with a
predecessor of B&S (the "B&S Agreement). B&S alleged that it contacted the
investors in the Company's February 2003 financing transaction and that it
earned the claimed financing fees pursuant to the terms of the B&S agreement.
The Company responded to the complaint and also filed a counterclaim for breach
of contract and professional malpractice. The Company 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.
In June 2003, Associated Mezzanine investors, LLC ("AMI") filed suit
against the Company in the United States District Court for the Eastern District
of Pennsylvania seeking payment of $196 for costs, fees and expenses allegedly
due to AMI pursuant to the terms of an agreement which the Company entered into
with AMI (the "AMI Agreement"). AMI claimed that it located suitable investors
for the Company's February 2003 financing transaction and that it earned the
claimed fees and is entitled to reimbursement of the claimed costs and expenses
pursuant to the terms of the AMI Agreement. In March 2004, this suit was settled
without any material impact on the Company's results of operations.
In June 2003 Entertainment Technology Corporation, a wholly-owned
subsidiary of the Company, filed suit against Walt Disney World Co. and other
entities ("Disney") in the United States District Court for the Eastern District
of Pennsylvania, alleging breach of contract for, among other things, failure to
pay all amounts due under a contract for the design and production of the
amusement park ride "Mission:Space" located in Disney's Epcot Center. In
response, in August 2003, Disney filed counterclaims against both Entertainment
Technology Corporation and the Company (under a guarantee) for, among other
things, alleged failures in performance and design in the contract. Disney is
seeking damages in excess of $150. Entertainment Technology Corporation and the
Company believe that they have valid defenses to each of Disney's counterclaims
and intend to vigorously defend against these counterclaims. At this time, the
parties are engaged in the discovery process. The parties have exchanged
self-executing disclosures and responses to interrogatories, and will be
producing documents shortly, after which depositions will occur. Accordingly,
Entertainment Technology Corporation and the Company are 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 maters, all such matters are reserved for or adequately covered by
insurance or, if not so covered, are without merit or are of such kind, or
involve such amounts, as would not have a significant effect on the financial
position or results of operations of the Company if disposed of unfavorably.
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
$107, $112 and $114 in fiscal 2004, fiscal 2003, and fiscal 2002, respectively.
The Company has an Employee Stock Purchase Plan which was adopted by
the Board of Directors on November 3, 1987. All employees meeting service
requirements, except officers, directors and 10% shareholders, are eligible to
voluntarily purchase common stock through payroll deductions up to 10% of
salary. The Company makes a matching contribution of 20% of the employee's
contribution. The Company has reserved 270,000 shares for issuance under the
plan.
33
Notes to Consolidated Financial Statements ($ in thousands, except share data)
13. Quarterly Consolidated Financial Information (Unaudited):
Financial data for the interim periods of fiscal 2004, 2003 and 2002
were as follows:
QUARTER ENDED
-------------
FISCAL YEAR 2004 MAY 30 AUGUST 29 NOVEMBER 28 FEBRUARY 27
Net sales $6,130 $4,752 $7,115 $7,998
Gross profit 2,287 1,786 1,774 4,096
Operating income/(loss) 520 (395) (700) 706
Income/(loss) before income taxes 133 (862) (987) 111
Minority interest (4) (2) (3) 6
Net income/(loss) 70 (622) (704) 463
Earnings/(loss) per common share:
Basic .01 (.09) (.10) .06
Diluted .01 (.09) (.10) .06
QUARTER ENDED
-------------
FISCAL YEAR 2003 MAY 24 AUGUST 23 NOVEMBER 22 FEBRUARY 23
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 $8,543
Gross profit 2,693 2,393 3,667 2,712
Operating income 449 546 1,351 527
Income before income taxes 58 275 805 398
Minority interest (5) (4) 2 (6)
Net income 224 297 662 558
Earnings per common share:
Basic .03 .04 .09 .08
Diluted .03 .04 .09 .07
34
Notes to Consolidated Financial Statements ($ 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 27, 2004:
Valuation and qualifying accounts related to:
Accounts receivable $446 $43 $110 $379
Inventory $646 $200 $282 $564
Property, plant and equipment $9,976 $675 $-- $10,651
Software development costs $6,819 $851 $-- $7,670
Other assets $113 $321 $-- $434
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
(1) Amounts written off or retired
35