Attached files
file | filename |
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10-K - FORM 10-K - ENVIRONMENTAL TECTONICS CORP | w78650e10vk.htm |
EX-32 - EX-32 - ENVIRONMENTAL TECTONICS CORP | w78650exv32.htm |
EX-23 - EX-23 - ENVIRONMENTAL TECTONICS CORP | w78650exv23.htm |
EX-21 - EX-21 - ENVIRONMENTAL TECTONICS CORP | w78650exv21.htm |
EX-31.1 - EX-31.1 - ENVIRONMENTAL TECTONICS CORP | w78650exv31w1.htm |
EX-31.2 - EX-31.2 - ENVIRONMENTAL TECTONICS CORP | w78650exv31w2.htm |
EXHIBIT 13
PORTIONS OF
ENVIRONMENTAL TECTONICS CORPORATION
2010
ANNUAL REPORT TO STOCKHOLDERS
ENVIRONMENTAL TECTONICS CORPORATION
2010
ANNUAL REPORT TO STOCKHOLDERS
FINANCIAL REVIEW
(amounts in thousands, except share and per share information)
(amounts in thousands, except share and per share information)
Fiscal year ended: | ||||||||
February 26, 2010 | February 27, 2009 | |||||||
Net sales |
$ | 42,271 | $ | 36,687 | ||||
Gross profit |
18,824 | 11,858 | ||||||
Operating profit (loss) |
6,600 | (346 | ) | |||||
Net income (loss) |
6,453 | (1,974 | ) | |||||
Income (loss) per common share: |
||||||||
Basic |
$ | 0.50 | $ | (0.32 | ) | |||
Diluted |
$ | 0.30 | $ | (0.32 | ) | |||
Working capital |
$ | 15,326 | $ | 4,684 | ||||
Long-term obligations |
9,820 | 22,072 | ||||||
Total assets |
51,729 | 37,278 | ||||||
Total stockholders equity
(deficiency) |
$ | 17,414 | $ | (11,710 | ) | |||
Weighted average common shares: |
||||||||
Basic |
9,069,000 | 9,037,000 | ||||||
Diluted |
21,235,000 | 9,037,000 |
We have never paid any cash dividends on our common stock and do not anticipate that any cash
dividends will be declared or paid in the foreseeable future.
Dividends on the Companys Preferred Stock as declared are accrued according to the terms of
the Preferred Stock and paid in cash.
1
Managements Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
Discussions of some of the matters contained in this Annual Report on Form 10-K for
Environmental Tectonics Corporation may constitute forward-looking statements within the meaning
of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and
Exchange Act of 1934, as amended, and as such, may involve risks and uncertainties. Some of these
discussions are contained under the captions Item 1.
Business and Item 6. Managements
Discussion and Analysis of Financial Condition and Results of Operations. We have based these
forward-looking statements on our current expectations and projections about future events or
future financial performance, which include implementing our business strategy, developing and
introducing new technologies, obtaining, maintaining and expanding market acceptance of the
technologies we offer, and competition in our markets. These forward-looking statements are subject
to known and unknown risks, uncertainties and assumptions about ETC 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
these forward-looking statements.
These forward-looking statements include statements with respect to the Companys 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 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, (v) statements
made about the possible outcomes of litigation involving the Company, (vi) statements regarding the
Companys ability to obtain financing to support its operations and other expenses, and (vii)
statements preceded by, followed by or that include terminology such as may, will, should,
expect, plan, anticipate, believe, estimate, future, predict, potential, intend,
or continue, and 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 Companys control. Factors that might cause
or contribute to such a material difference include, but are not limited to, those discussed in
this 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
Companys common stock.
The Company cautions that the foregoing list of important factors is not exclusive. Except as
required by federal securities law, 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.
References to fiscal 2010 or the 2010 fiscal year are references to the fifty-two week period
ended February 26, 2010. References to fiscal 2009 or the 2009 fiscal year are references to the
fifty-two week period ended February 27, 2009.
In this report all references to ETC, the Company, we, us, or our, mean
Environmental Tectonics Corporation and our subsidiaries.
Overview
We are principally engaged in the design, manufacture and sale of software driven products and
services used to recreate and monitor the physiological effects of motion on humans and equipment
to control, modify, simulate and measure environmental conditions. These products include aircrew
training systems (aeromedical, tactical combat and general), disaster management systems and
services, entertainment products, sterilizers (steam and gas), environmental testing products and
hyperbaric chambers and other products that involve similar manufacturing techniques and
engineering technologies. We are a designer, developer and contract manufacturer of various types
of high-technology equipment. Our business activities are divided into two segments: the Training
Services Group (TSG) and the Control Systems Group (CSG). Product categories included in TSG are
pilot training and flight simulators, disaster management systems and entertainment applications.
CSG includes sterilizers, environmental control devices, hyperbaric chambers and parts and service
support.
We sell utilizing two business approaches: integrated training services and products. Some of
our products are customized, using our proprietary software based on specifications provided by our
customers. Some of our products take more than one year to manufacture and deliver to the customer.
In the TSG segment, we offer integrated training services to both commercial and government
military defense agencies and training devices to government military defense agencies both in the
United States and internationally. We sell our entertainment products to amusement parks, zoos and
museums. We sell our disaster management
simulation training and products to fire and emergency training schools and state and local
governments. In the CSG segment, we sell our sterilizers to pharmaceutical and medical device
manufacturers. We sell our environmental testing systems primarily to
2
commercial automobile manufacturers and heating, ventilation and air conditioning (HVAC) manufacturers. We sell our
hyperbaric products to the military (mainly larger chambers) and hospitals and clinics (mainly
single occupant monoplace chambers). To a lesser degree, we provide upgrade, maintenance and repair
services for our products and for products manufactured by other parties.
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
representatives and organizations in seeking foreign orders for our products.
We have operating subsidiaries in Turkey and Poland, maintain regional offices in the United
Kingdom, Middle East, Asia and Canada, and use the services of numerous independent sales
representatives and organizations throughout the world. ETC International Corporation is a holding
company established for federal income tax purposes and is not an operating subsidiary.
Significant Impacts and Transactions during Fiscal 2010
The following items had a material impact on our financial performance, cash flow and
financial position for the fiscal year ended February 26, 2010:
| Increased production under U.S. Government contracts |
The Base Realignment and Closure (BRAC) Act passed in 2005 by Congress mandated base
closures and consolidations through all the U.S. defense services. As a result of this Act, in
the past two years we have been awarded two major contracts for pilot training. Our fiscal 2010
opening backlog of firm orders included approximately $19 million for a significant contract
from the U.S. Navy for a research disorientation trainer. In September 2009, we were awarded a
$35 million contract from the U.S. Air Force to provide a high performance training and research
human centrifuge. As a result of engineering and production activity on these two contracts,
sales to the U.S. Government increased by $3.6 million in our Training Services Group during the
current fiscal year versus the prior year. Although at the current time we have a significant
open proposal to the U.S. Government for additional equipment to be procured under the BRAC Act,
given the current domestic economic conditions and political environment, it should not be
assumed that any additional contracts will be awarded to us.
| Contract performance in our Simulation Division |
Sales activity during fiscal 2010 in our Simulation Division that produces disaster
management simulators was significantly higher than in any prior fiscal year, totaling $4.4
million, an increase of $3.6 million from the prior period. This Division opened the fiscal year
with a backlog in excess of $6 million, most under international contracts, and successfully
executed a majority of those orders. Most importantly, we successfully delivered a multiple
Advanced Disaster Management Simulator (ADMS)COMMAND to a national training institute in the
Middle East.
| Market disruptions in our Control Systems Group |
The product groups in our CSG sell primarily to domestic commercial accounts. These
businesses have been adversely impacted by current domestic economic conditions. Sales of
automotive test products dropped by almost $2.9 million as this industry experienced
bankruptcies for two of the three major domestic producers. Additionally, sales for our domestic
monoplace hyperbaric chamber line decreased by about $1.1 million reflecting the cutback of
capital expansion in hospitals and wound care centers.
| Exchange of long term debt, establishment of additional facility, and increase in bank line |
On April 24, 2009, we entered into a transaction with H. F. Lenfest, a member of our Board
of Directors and a significant shareholder, that provided for the following: (i) a $7,500,000
credit facility to be provided by Lenfest to ETC; (ii) exchange of the Subordinated Note held by
Lenfest, together with all accrued interest and warrants issuable under the Subordinated Note,
and all Series B Preferred Stock and Series C Preferred Stock held by Lenfest, together with all
accrued dividends thereon, for a new class of preferred stock, Series E Preferred Stock, of the
Company; and (iii) an increase of the existing $15,000,000 revolving line of credit with PNC
Bank to $20,000,000. The completion of this transaction coupled with the generation of income
and significant collections under major contracts resulted in free cash from operations of $5.3
million and a net increase in cash of $1.9 million. Having adequate cash from operations and
additional availability under new and existing credit lines allowed us to effectively and
efficiently execute on our contracts. Additionally, we expect to be adequately cash funded
throughout fiscal 2011.
| Positive impact of income taxes |
During fiscal 2010, an income tax benefit of $1.8 million was reflected in our Consolidated
Statements of Operations. We use the asset and liability method of accounting for income taxes.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying
amounts of assets and liabilities for financial and tax reporting purposes as well as the
valuation of net loss carryforwards. Valuation allowances are reviewed each fiscal period to
determine whether there is sufficient positive or negative evidence to support a change in
judgment about the realizability of the related deferred tax asset. Valuation
3
allowances had
been recorded against the entire deferred tax asset as of February 27, 2009 due an uncertainty
of sustaining an appropriate level of profitability in future periods. As a result of our
increase in booked contracts and our positive operating results, we reduced this reserve during
the fiscal period.
| Continued expanded use of our NASTAR Center |
Our National Aerospace Training and Research (NASTAR) Center, which opened in fiscal 2008,
is an integrated pilot training center offering a complete range of aviation training and
research support for military jet pilots and civil aviation as well as space travel and tourism.
The NASTAR Center houses state of the art equipment including the ATFS-400, a GYROLAB GL-2000
Advanced Spatial Disorientation Trainer, a Hypobaric Chamber, an Ejection Seat Trainer, and a
Night Vision and Night Vision Goggle Training System. These products represent 37 years of
pioneering development and training solutions for the most rigorous stresses encountered during
high performance aircraft flight including the effects of altitude exposure, High G-force
exposure, spatial disorientation and escape from a disabled aircraft.
During the past two fiscal years we have been successful in utilizing the NASTAR Center for
research, space training and as a showroom to market our Authentic Tactical Fighting System
technology. We feel that demonstrating tactical flight simulation in our NASTAR center was
highly instrumental in our obtaining significant orders in our Aircrew Training Systems
Division. Going forward, we hope to expand research aimed at examining the effectiveness of
using centrifuge based simulation for Upset Recovery Training (URT).
Loss of control in flight is a major cause factor in loss of life and hull damage aircraft
accidents. Modern day commercial aviation currently has no requirement for training of pilots
to deal with these situations, commonly referred to as upsets. Realistic training for
responding to and recovering from upsets, or URT, requires more than a non-centrifuged based
simulator because non-centrifuge-based simulators do not reproduce the physiological stresses
and disorientation that a pilot experiences during an actual upset. We believe our GYROLAB
simulator series is an answer to providing pilots with the dynamic environment necessary for
effective training.
| Increased selling and marketing expenses. |
Selling and marketing expenses increased about 7% in fiscal 2010 versus fiscal 2009. This
increase primarily reflected higher commissions on international contracts and increased bid and
proposal expenses to prepare technical submissions to requests for quotes. The cost of
pre-engineering and other technical development required to submit a response to a complex
request for proposal can exceed $500,000. Given the significant mix shift to U.S. Government
work in the fiscal 2011 opening backlog, it is anticipated that commission expense will decrease
in the coming fiscal year.
| Charge for loss on extinguishment of debt. |
During fiscal 2010, we recorded a $315,000 charge for loss on extinguishment of debt
representing two transactions. In July 2009, the Companys Subordinated Note was exchanged for
preferred stock under the aforementioned Lenfest refinancing transaction, resulting in a charge
of $224,000, which represented the unamortized portion of the debt discount that was recorded at
the issuance of this instrument. Additionally, a charge of $91,000 resulted from the unamortized
portion of the debt discount on a $2 million note, which was repaid on September 1, 2009.
| Continued capital and consulting spending to enhance and market worldwide our Authentic Tactical Fighting Systems (ATFS) and other technologies. |
During the past two fiscal years we have spent over $4.8 million (including $2.3 million in
fiscal 2010) in capital, software development and consulting expenses. Most of this spending has
been related to our pilot training simulation equipment. This includes engineering costs to
improve the technical abilities of our ATFS line of products, validation effort associated with
Upset Recovery Training, and consulting arrangements. Going forward, we expect spending to be
significant for these efforts.
| Common stock dilution. |
As a result of our aforementioned refinancing transaction with H. F. Lenfest, our average
fully diluted shares have increased by approximately 12.2 million shares. Given our positive
financial performance, this increase in equivalent common shares has a dilutive impact on our
earnings per share.
4
CRITICAL ACCOUNTING ESTIMATES
The discussion and analysis of our financial condition and results of operations are based
upon our consolidated financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States of America. The preparation of financial
statements requires the use of judgments and estimates. Our critical accounting policies are
described below to provide a better understanding of how we develop our assumptions and judgments
about future events and related estimations and how they can impact our financial statements. A
critical accounting estimate is one that requires our most difficult, subjective, or complex
estimates and assessments and is fundamental to our results of operations. We identified our most
critical accounting estimates (not in any specific order) to be:
| forecasting our effective income tax rate, including our future ability to utilize tax credits and to realize the deferred tax assets, and providing for uncertain tax positions; | ||
| legal matters; | ||
| valuations of long-lived assets, including intangible assets; | ||
| inventory valuation and reserves; and | ||
| percentage-of-completion accounting for long-term, construction-type contracts. |
We base our estimates on historical experience and on various other assumptions we believe to
be reasonable according to the current facts and circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that are not readily
apparent from other sources. We believe the following are the critical accounting policies used in
the preparation of our consolidated financial statements, as well as the significant estimates and
judgments affecting the application of these policies. This discussion and analysis should be read
in conjunction with our consolidated financial statements and related notes included in this
report.
We have discussed the development and selection of these critical accounting policies and
estimates with the Audit Committee of our Board of Directors, and the Audit Committee has reviewed
the disclosure presented below.
| Revenue Recognition |
We recognize revenue using three methods:
On long-term contracts over $250,000 in value and over six months in length, the percentage of
completion (POC) revenue recognition method is utilized. Under this method a percentage is
calculated based on costs incurred from inception to date on a contract as compared to the
estimated total costs required to fulfill the contract. This percentage is then multiplied by the
contract value to determine the amount of revenue to be recognized in any given accounting period.
Revenue recognized on uncompleted long-term contracts in excess of amounts billed to customers is
reflected as a current asset on the balance sheet under the caption Costs and estimated earnings
in excess of billings on uncompleted long-term contracts. Amounts billed to customers (milestone
payments) in excess of revenue recognized are reflected as a current liability on the balance sheet
under the caption Billings in excess of costs and estimated earnings on uncompleted long-term
contracts. At any time during performance if it is estimated that a contract at completion will
result in a loss, the entire amount of the estimated loss is accrued. The effect of revisions in
cost and profit estimates for long-term contracts is reflected in the accounting period in which we
learn the facts which require us to revise our 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, both at inception and throughout the performance period.
Revenue for contracts under $250,000, or to be completed in less than six months, and where
there are no post-shipment services (such as installation and customer acceptance) is recognized on
the date that the finished product is shipped to the customer.
Revenue for the sale of parts and services is also recognized on the date that the part is
shipped to the customer or when the service is completed. 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, for amounts in excess of contract
value, is appropriate if it is probable that the claim will result in an increase in the contract
value and if the company can reliably estimate the amount of potential additional contract revenue
(claim 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.
5
| Inventory |
We periodically evaluates our inventory, which affects gross margin, to ensure that it is
carried at the lower of cost or net realizable value. Cost includes appropriate overheads.
Overheads allocated to inventory cost are only those directly related to our manufacturing
activities. These include general supervision, utilities, supplies, etc., and depreciation and
software amortization expense. Where necessary, provision is made for obsolete, slow-moving or
damaged inventory. This provision represents the difference between the cost of the inventory and
its estimated market value, based on the future demand of our products. To the extent that future
events affect the salability of inventory these provisions could vary significantly.
| Income Taxes |
We use the asset and liability method of accounting for income taxes. Deferred income taxes
reflect the net tax effects of temporary differences between the carrying amounts of assets and
liabilities for financial and tax reporting purposes as well as the valuation of net loss carry
forwards. Valuation allowances are reviewed each fiscal period to determine whether there is
sufficient positive or negative evidence to support a change in judgment about the reliability of
the related deferred tax asset.
6
Results of Operations
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: Training Services Group (TSG) and Control Systems Group (CSG). Product
categories included in TSG are pilot training and flight simulators, disaster management systems
and entertainment applications. CSG includes sterilizers, environmental control devices, hyperbaric
chambers along with parts and service support.
We have historically experienced significant variability in our quarterly revenue, earnings
and other operating results, and our performance may fluctuate significantly in the future.
Fiscal 2010 versus Fiscal 2009
Summary Table of Results | ||||||||||||||||
Fiscal year | ||||||||||||||||
ended: | ||||||||||||||||
February 26, | February 27, | Variance | Variance | |||||||||||||
2010 | 2009 | $ | % | |||||||||||||
(amounts in thousands) | ||||||||||||||||
Sales: |
||||||||||||||||
Domestic |
$ | 12,870 | $ | 14,442 | $ | (1,572 | ) | (10.9 | )% | |||||||
US Government |
7,711 | 3,096 | 4,615 | 149.1 | ||||||||||||
International |
21,690 | 19,149 | 2,541 | 13.3 | ||||||||||||
Total Sales |
42,271 | 36,687 | 5,584 | 15.2 | ||||||||||||
Gross Profit |
18,824 | 11,858 | 6,966 | 58.7 | ||||||||||||
Selling and marketing expenses |
5,010 | 4,670 | (340 | ) | (7.3 | ) | ||||||||||
General and administrative expenses |
6,405 | 6,424 | 19 | 0.3 | ||||||||||||
Research and development expenses |
809 | 1,110 | 301 | 27.1 | ||||||||||||
Operating income (loss) |
6,600 | (346 | ) | 6,946 | 2,007.5 | |||||||||||
Interest expense, net |
1,308 | 1,569 | 261 | 16.6 | ||||||||||||
Other expense, net |
347 | 67 | (280 | ) | (417.9 | ) | ||||||||||
Loss on early extinguishment of debt |
315 | | (315 | ) | | |||||||||||
Income tax benefit |
(1,819 | ) | | 1,819 | | |||||||||||
Minority interest |
(4 | ) | (8 | ) | (4 | ) | 50.0 | |||||||||
Net income (loss) |
$ | 6,453 | $ | (1,974 | ) | $ | 8,427 | 426.9 | % | |||||||
Net income (loss) per common share basic |
$ | 0.50 | $ | (0.32 | ) | $ | 0.82 | |||||||||
Net Income (loss) per common share diluted |
$ | 0.30 | $ | (0.32 | ) | $ | 0.73 | |||||||||
Net Income
ETC had net income of $6,453,000 or $0.30 per share (diluted), in fiscal 2010 versus a net
loss of $1,974,000, or $(0.32) per share (diluted), in fiscal 2009, an increase in net income of
$8,427,000 or 426.9%. Operating profit in fiscal 2010 was $6,600,000 versus an operating loss of
$346,000 in fiscal 2009, an increase in operating profit of $6,946,000. The major factor
contributing to the favorable performance in both operating and net income was an increase in sales
and corresponding gross profit. Increased gross profit reflected the sales increase and a 12.2
percentage point increase in the gross margin rate. Net income also benefited from a reduction in
the Companys deferred tax asset reserve related to the expected realization of net operating loss
carryforwards.
7
Sales
The following schedule presents the Companys sales by segment, business unit and geographic
area:
(amounts in thousands) | ||||||||||||||||||||||||||||||||
Fiscal year ended | Fiscal year ended | |||||||||||||||||||||||||||||||
February 26, 2010 | February 27, 2009 | |||||||||||||||||||||||||||||||
Inter- | Inter- | |||||||||||||||||||||||||||||||
Segment sales: | Domestic | USG | national | Total | Domestic | USG | national | Total | ||||||||||||||||||||||||
Training Services Group: |
||||||||||||||||||||||||||||||||
Pilot Training Services |
$ | 93 | $ | 6,261 | $ | 13,101 | $ | 19,455 | $ | 108 | $ | 2,612 | $ | 14,633 | $ | 17,353 | ||||||||||||||||
Simulation |
480 | | 4,384 | 4,864 | 553 | | 703 | 1,256 | ||||||||||||||||||||||||
ETC-PZL and other |
440 | | 1,276 | 1,716 | 87 | | 1,912 | 1,999 | ||||||||||||||||||||||||
Total |
$ | 1,013 | $ | 6,261 | $ | 18,761 | $ | 26,035 | $ | 748 | $ | 2,612 | $ | 17,248 | $ | 20,608 | ||||||||||||||||
Control Systems Group: |
||||||||||||||||||||||||||||||||
Environmental |
$ | 980 | $ | 1,450 | $ | 1,717 | $ | 4,147 | $ | 3,841 | $ | 484 | $ | 393 | $ | 4,718 | ||||||||||||||||
Sterilizers |
5,841 | | 2 | 5,843 | 3,685 | | 172 | 3,857 | ||||||||||||||||||||||||
Hyperbaric |
3,116 | | 1,062 | 4,178 | 4,259 | | 1,232 | 5,491 | ||||||||||||||||||||||||
Service and spares |
1,920 | | 148 | 2,068 | 1,909 | | 104 | 2,013 | ||||||||||||||||||||||||
Total |
11,857 | 1,450 | 2,929 | 16,236 | 13,694 | 484 | 1,901 | 16,079 | ||||||||||||||||||||||||
Company total |
$ | 12,870 | $ | 7,711 | $ | 21,690 | $ | 42,271 | $ | 14,442 | $ | 3,096 | $ | 19,149 | $ | 36,687 | ||||||||||||||||
For the fiscal year ended February 26, 2010, total sales were $42,271,000, an increase of
$5,584,000 or 15.2% from fiscal 2009. The increase reflected favorable performance in the U.S.
Government and international geographic areas and in the pilot training, simulation and sterilizer
product lines.
Geographically, domestic sales were $12,870,000, down $1,572,000, or 10.9%, from fiscal 2009,
and represented 30.4% of total sales, down from 39.4% in fiscal 2009. The current period reflected
reductions in environmental (down $2,861,000, 74.5%) and hyperbaric (down $1,143,000, 26.8%)
partially offset by increased sterilizer sales (up $2,156,000, 58.5%). Environmental sales in the
prior period benefited from significant work on a large domestic automotive contract basically
completed by the prior fiscal year end. Reduced hyperbaric sales reflected domestic economic
disruptions and resulting reduced capital spending. Conversely, sterilizer sales benefited from
production on two significant orders. U.S. Government sales increased $4,615,000 or 149.1% from the
prior fiscal year. Significant increases were evidenced in aircrew training systems sales
reflecting three contracts with three different U.S. defense agencies. U.S. Government sales
represented 18.3% of total sales, up from 8.4% in fiscal 2009. Given the existing U.S. Government
sales contracts in the Companys backlog and the potential for significant awards in the future,
the Company anticipates this increase in the concentration of sales with the U.S. Government to
continue.
International sales, including those in the Companys foreign subsidiaries, were $21,690,000,
up $2,541,000 or 13.3%, from the prior fiscal period, primarily due to increased simulation and
environmental sales, and represented 51.3% of total sales, down slightly from 52.2% in fiscal 2009.
In fiscal 2010, two customers, both in the ATS division, each represented 10% or more of total
sales. For the Companys February 26, 2010 sales backlog of $96,964,000, three contracts (two with
U.S. defense agencies and one with an international customer), each representing at least 10% of
the total backlog, constituted $85,724,000 or 88.4% of the total sales backlog. Aircrew training
systems backlog totaled $81,707,000 or 84.3% of the total backlog.
We have historically experienced significant variability in our sales performance. This
reflects the existing sales backlog, product and the nature of contract (size and performance time)
mix, the manufacturing cycle and amount of time to effect installation and customer acceptance, and
certain factors not in our control such as customer delays and the time required to obtain U.S.
Government export licenses. One or a few contract sales may account for a substantial percentage of
our revenue in any period.
Domestic Sales
Domestic sales in fiscal 2010 were $12,870,000 as compared to $14,442,000 in fiscal 2009, a
decrease of $1,572,000 or 10.9%, The current period reflected reductions in environmental (down
$2,861,000, 74.5%) and hyperbaric (down $1,268,000, 28.9%) partially offset by increased sterilizer
sales (up $2,156,000, 58.5%). Environmental sales in the prior period benefited from significant
work on a large domestic automotive contract basically completed by the prior fiscal year end.
Reduced hyperbaric sales reflected domestic economic disruptions and resulting reduced capital
spending. Conversely, sterilizer sales benefited from production on two significant orders.
Domestic sales represented 30.4% of our total sales in fiscal 2010, down from 39.4% in fiscal 2009.
8
Sales to the U.S. Government in fiscal 2010 were $7,711,000 as compared to $3,096,000 in
fiscal 2009, representing an increase of $4,615,000 or 149.1%. Significant increases were evidenced
in aircrew training systems sales reflecting three contracts with three different U.S. defense
agencies. U.S. Government sales represented 18.3% of total sales, up from 8.4% in fiscal 2009.
International Sales
International sales, including those in the Companys foreign subsidiaries, were $21,690,000,
up $2,541,000 or 13.3%, from the prior fiscal period, primarily due to increased simulation and
environmental sales, and represented 51.3% of total sales, slightly down from 52.2% in fiscal 2009.
International sales totaling at least $500,000 per country were made to customers in Saudi Arabia,
Korea, Malaysia and Turkey. 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.
Segment Sales
Sales of our TSG products were $26,035,000 in fiscal 2010, an increase of $5,427,000, or 26.3%
from fiscal 2009. Sales of these products accounted for 61.6% of our sales versus 56.2% in fiscal
2009. Sales in our other segment, the CSG, increased $157,000 or 1.0%, and constituted 38.4% of our
total sales compared to 43.8% in fiscal 2009.
Given the Companys backlog at February 26, 2010 and the existing and continuing difficult
domestic economic conditions, going forward it is anticipated that the TSG segment will continue to
experience growth at some level while the CSG segment will be significantly negatively impacted by
the domestic marketplace. In the CSG, we expect domestic environmental sales to continue to be
limited by the disruptions in that marketplace. The hyperbaric monoplace line will be hampered
until capital and liquidity become more accessible. The sterilizer line will suffer from delays in
government funding for universities which have been steady customers for our steam sterilizers.
Given the product mix in the Companys opening backlog, we would expect most of the Companys
anticipated earnings performance in fiscal 2011 to be generated by the TSG segment.
Gross Profit
Gross profit for fiscal 2010 increased by $6,966,000 or 58.7%, from fiscal 2009. This
reflected the increase in sales and resulting gross profit (approximately $1.9 million).
Improvement in gross margin as a percent of sales was due to higher sales in the TSG segment, which
included high gross profit projects. Gross profit rate as a percent of sales improved to 44.5% for
fiscal 2010 versus 32.3% for fiscal 2009. Significantly favorable margin rates were realized
internationally in simulation and aircrew training systems and domestically in sterilizers.
Selling and marketing expenses
Selling and marketing expenses increased $340,000, or 7.3%, from fiscal 2009. This increase
primarily reflected increased marketing expenses (commissions and bid and proposal costs). As a
percentage of sales, selling and marketing expenses were 11.9% in fiscal 2010 compared to 12.7% in
fiscal 2009.
General and administrative expenses
General and administrative expenses decreased by $19,000 or 0.3%. As a percentage of sales,
general and administrative expenses were 15.2% compared to 17.5% in fiscal 2009.
Research and Development Expenses
Research and development expenses include spending for potential new products and technologies
and work performed under government grant program, both in the United States and internationally.
This spending, net of grant payments from the U.S., Polish and Turkish governments, totaled
$809,000 in fiscal 2010 as compared to $1,110,000 for fiscal 2009, a decrease of $301,000 or 27.1%.
Gross spending for the periods was $2,846,000 and $1,195,000, which amounts were partially offset
by funds under government grants in ETC Southampton, ETC-PZL, and our Turkish operation.
Most of the Companys 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.
Operating Income
Operating income was $6,600,000 in fiscal 2010 compared to an operating loss of $346,000 in
fiscal 2009, an increase in income of $6,946,000. This improvement in operating results
represented a combination of higher sales volume and gross profit coupled with reduced research and
development expenses.
On a segment basis, the TSG had an operating income of $6,128,000, a $3,697,000 improvement
over the segment operating income of $2,431,000 in fiscal 2009. The CSG had an operating income of
$1,727,000 in fiscal 2010, an increase in operating income
9
of $3,224,000, from fiscal 2009. These segment operating results were offset, in part, by
unallocated corporate expenses of $1,255,000 which were down $25,000, from fiscal 2009.
Given the positive operating performance in fiscal 2010 versus the prior period, the level and
mix of the Companys backlog at February 26, 2010, open proposals and proposals under preparation,
which include quotations for some significant potential U.S. Government and international contract
awards, and the Companys continuing positive feedback from potential customers for its ATFS
technology, it is anticipated that the Company will experience positive performance in fiscal 2011.
However, it is also anticipated that the product lines in the Companys CSG segment will continue
to suffer from negative market conditions.
Interest Expense
Interest expense for fiscal 2010 was $1,308,000 as compared to $1,569,000 for fiscal 2009, a
decrease of $261,000 or 16.6%. The current period expense reflected a $702,000 decrease in bank
borrowings and reduced interest expense on the Companys subordinated debt. This debt was
exchanged for preferred stock under the Lenfest Financing Transaction which was completed in July
2009.
Other Income/Expense, Net
Other income/expense, net, was a net expense of $347,000 for fiscal 2010 versus a net expense
of $67,000 for fiscal 2009. The current period consisted primarily of foreign currency exchange
losses whereas the prior period included proceeds from a property damage claim and a litigation
settlement.
Loss on Extinguishment of Debt
During fiscal 2010, the Company recorded a loss on extinguishment of debt representing two
transactions. In July 2009, the Companys Subordinated Note was exchanged for preferred stock under
the Lenfest Financing Transaction, resulting in a charge of $224,000, which represented the
unamortized portion of the debt discount that was recorded at the issuance of this instrument.
Additionally, a charge of $91,000 resulted from the unamortized portion of the debt discount on a
$2 million note, which was repaid on September 1, 2009. See Note 2 Long-term Obligations and
Credit Arrangements in the accompanying Notes to the Condensed Consolidated Financial Statements.
Income Taxes
As a result of the Companys analysis during fiscal 2010 of the various components and
realizability of the Companys net loss carryforwards, an income tax benefit of $1,819,000 was
recorded in the fiscal year ended February 26, 2010. No income tax expense or benefit was recorded
in the prior fiscal year.
The Company uses the asset and liability method of accounting for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial and tax reporting purposes as well as the valuation of net
loss carryforwards. Valuation allowances are reviewed each fiscal period to determine whether there
is sufficient positive or negative evidence to support a change in judgment about the realizability
of the related deferred tax asset.
Valuation allowances had been recorded against the entire deferred tax asset as of February
27, 2009 due an uncertainty of sustaining an appropriate level of profitability in future periods.
As of February 26, 2010, the Company has reviewed the components of its deferred tax asset and has
determined, based upon all available information, that its current and expected future operating
income will more likely than not result in the realization of a portion of its deferred tax assets
relating primarily to its net operating loss carryforwards. The Company has realized a deferred tax
asset related to its net operating loss carryforwards of $4,983,000. As of February 26, 2010, the
Company has approximately $36.5 million of federal net loss carry forwards available to offset
future income tax liabilities, beginning to expire in 2025. In addition, the Company has the
ability to offset deferred tax assets against deferred tax liabilities created for such items as
depreciation and amortization.
Liquidity and Capital Resources
The Companys liquidity position and borrowing availability improved significantly during
fiscal 2010. Cash flow from operations was a positive $5,272,000 and net cash increased by
$1,888,000. Working capital was $15,326,000 and $4,684,000 at February 26, 2010 and February 27,
2009, respectively. This positive performance primarily reflected the net income in the period and
milestone payment collections under long term contracts. During fiscal 2010, availability under our
existing bank line increased by $5,000,000 and we also established a $7,500,000 operating line with
H. F. Lenfest to fund certain U.S. Government contracts.
On April 24, 2009, we entered into a transaction with H. F. Lenfest, a member of our Board of
Directors and a significant shareholder, that provides for the following: (i) a $7,500,000 credit
facility to be provided by Lenfest to ETC; (ii) exchange of the
Subordinated Note held by Lenfest, together with all accrued interest and warrants issuable under
the Subordinated Note, and all Series B Preferred Stock and Series C Preferred Stock held by
Lenfest, together with all accrued dividends thereon, for a new class of
10
preferred stock, Series E Preferred Stock, of the Company; and (iii) an increase of the existing $15,000,000 revolving line
of credit with PNC Bank to $20,000,000. Having adequate cash from operations and additional
availability under new and existing credit lines allowed us to effectively and efficiently execute
on our contracts. Additionally, we expect to be adequately cash funded throughout fiscal 2011.
Net cash provided by (used for) operating activities:
Cash provided by operations is driven by income from sales of our products offset by the
timing of receipts and payments in the ordinary course of business.
During fiscal 2010, we generated $5,272,000 of cash from operating activities versus a usage
of $739,000 for fiscal 2009, an improvement of $6,011,000. The current period favorable performance
primarily reflected significantly improved operating results, customer advanced billings under
long-term POC contracts, a reduction in inventories, and non-cash expenses of depreciation and
amortization.
Net cash used for investing activities:
Cash used for investing activities primarily relates to funds used for capital expenditures in
property and equipment. These uses of cash are offset by sales and borrowings under our credit
facilities. The Companys investing activities used $1,824,000 in fiscal 2010 and consisted
primarily of costs for the continued construction activities and the manufacturing of demonstration
simulators for our NASTAR Center coupled with higher software enhancements for our Advanced
Tactical Fighter Systems technology.
Net cash used for financing activities:
The Companys financing activities used $1,686,000 of cash during fiscal 2010. This primarily
reflected the repayments under the Companys bank line and payments of preferred stock dividends.
Outlook
We expect to use our cash, cash equivalents and credit facilities for working capital and
general corporate purposes, products, product rights, technologies, property, plant and equipment,
the payment of contractual obligations, including scheduled interest payments on our credit
facilities and dividends on our preferred stock, the acquisition of businesses, and/or the
purchase, redemption or retirement of our credit facilities and preferred stock. We expect that net
sales of our currently marketed products should allow us to continue to generate positive operating
cash flow in fiscal 2011. At this time, however, we cannot accurately predict the effect of certain
developments on our anticipated rate of sales growth in 2012 and beyond, such as the degree of
market acceptance, the impact of competition, the effectiveness of our sales and marketing efforts
and the outcome of our current efforts to develop, receive approval for and successfully market our
products.
At the end of each fiscal quarter in fiscal 2011 and thereafter we expect to maintain a
minimum aggregate EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of
$4,000,000 (calculated as the total of the fiscal quarter then ending and the three immediately
preceding fiscal quarters.
Off-Balance Sheet Arrangements
There were no off-balance sheet arrangements during the fiscal year ended February 26, 2010
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 our investors.
11
Equity Compensation Plan Information
Number of securities | ||||||||||||
remaining available | ||||||||||||
Number of securities to be | Weighted-average exercise | for future issuance under | ||||||||||
issued upon exercise of | price of outstanding | equity compensation plans | ||||||||||
outstanding options, | options, | (excluding securities | ||||||||||
Plan Category | warrants and rights | warrants and rights | reflected in column (a)) | |||||||||
(a) | (b) | (c) | ||||||||||
Equity compensation
plans approved by
Security holders |
863,519 | $ | 2.23 | 1,437,001 | ||||||||
Equity compensation
plans not approved
by security holders |
| N/A | 187,322 | |||||||||
Total |
863,519 | $ | 2.23 | 1,624,323 | ||||||||
The following plans have not been approved by our shareholders:
Employee Stock Purchase Plan
We have 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. We make a matching contribution equal to 20% of the employees contribution.
12
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Environmental Tectonics Corporation
Environmental Tectonics Corporation
We have audited the accompanying consolidated balance sheets of Environmental Tectonics
Corporation and Subsidiaries (the Company) as of February 26, 2010 and February 27, 2009 and the
related consolidated statements of operations, changes in stockholders equity (deficiency), and
cash flows for the fifty-two week periods ended February 26, 2010 and February 27, 2009. These
consolidated financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these consolidated 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 audits to
obtain reasonable assurance about whether the consolidated financial statements are free of
material misstatement. The Company is not required to have, nor were we engaged to perform an
audit of its internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Companys internal control over financial reporting. Accordingly, we express
no such opinion. An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the consolidated financial statements, assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall
consolidated financial statement presentation. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Environmental Tectonics Corporation and Subsidiaries
as of February 26, 2010 and February 27, 2009, and the consolidated results of their operations and
their cash flows for the each of the fifty-two weeks ended February 26, 2010 and February 27, 2009
in conformity with accounting principles generally accepted in the United States of America.
/s/ Friedman LLP
East Hanover, New Jersey
May 27, 2010
East Hanover, New Jersey
May 27, 2010
13
Environmental Tectonics Corporation
Consolidated Balance Sheets
(amounts in thousands, except share information)
Consolidated Balance Sheets
(amounts in thousands, except share information)
February 26, | February 27, | ||||||||
2010 | 2009 | ||||||||
ASSETS |
|||||||||
Cash and cash equivalents |
$ | 2,408 | $ | 520 | |||||
Restricted cash |
2,751 | 4,454 | |||||||
Accounts receivable, net |
17,356 | 5,100 | |||||||
Costs and estimated earnings in excess of billings on uncompleted long-term contracts |
3,576 | 2,460 | |||||||
Inventories, net |
5,114 | 4,435 | |||||||
Deferred tax assets, current |
4,983 | 2,350 | |||||||
Prepaid expenses and other current assets |
545 | 479 | |||||||
Total current assets |
36,733 | 19,798 | |||||||
Property, plant and equipment, at cost, net |
13,643 | 15,786 | |||||||
Construction in progress |
316 | 275 | |||||||
Software development costs, net |
691 | 1,013 | |||||||
Other assets |
346 | 406 | |||||||
Total assets |
$ | 51,729 | $ | 37,278 | |||||
LIABILITIES |
|||||||||
Current portion of long-term debt |
$ | 285 | $ | 9 | |||||
Accounts payable trade |
1,783 | 2,105 | |||||||
Billings in excess of costs and estimated earnings on uncompleted long-term contracts |
13,944 | 4,155 | |||||||
Customer deposits |
1,799 | 2,397 | |||||||
Accrued interest and dividends |
782 | 4,197 | |||||||
Other accrued liabilities |
2,814 | 2,251 | |||||||
Total current liabilities |
21,407 | 15,114 | |||||||
Long-term obligations, less current portion: |
|||||||||
Credit facility payable to bank |
9,808 | 10,510 | |||||||
Promissory note payable |
| 1,891 | |||||||
Subordinated convertible debt |
| 9,664 | |||||||
Other long-term debt |
12 | 7 | |||||||
9,820 | 22,072 | ||||||||
Deferred tax liabilities |
3,066 | 2,350 | |||||||
Unearned interest |
22 | 152 | |||||||
Total liabilities |
34,315 | 39,688 | |||||||
Commitments and contingencies |
| | |||||||
Cumulative convertible participating preferred stock, Series B, $.05 par value,
15,000 shares authorized; 6,000 shares issued and outstanding |
| 6,000 | |||||||
Cumulative convertible participating preferred stock, Series C, $.05 par value,
3,300 shares authorized, issued and outstanding |
| 3,300 | |||||||
STOCKHOLDERS EQUITY (DEFICIENCY) |
|||||||||
Cumulative convertible participating preferred stock, Series D, $.05 par value,
11,000 shares authorized; 155 shares outstanding |
155 | | |||||||
Cumulative convertible participating preferred stock, Series E, $.05 par value,
25,000 shares authorized; 23,741 shares outstanding |
23,741 | | |||||||
Common stock, $.05 par value, 20,000,000 shares authorized; 9,083,573 and 9,049,351
shares issued and outstanding as February 26, 2010 and February 27,
2009, respectively |
454 | 452 | |||||||
Additional paid-in capital |
14,050 | 15,399 | |||||||
Accumulated other comprehensive loss |
(431 | ) | (557 | ) | |||||
Accumulated deficit |
(20,593 | ) | (27,046 | ) | |||||
Total stockholders equity (deficiency) before noncontrolling interest |
17,376 | (11,752 | ) | ||||||
Noncontrolling interest |
38 | 42 | |||||||
Total stockholders equity (deficiency) |
17,414 | (11,710 | ) | ||||||
Total liabilities and stockholders equity (deficiency) |
$ | 51,729 | $ | 37,278 | |||||
The accompanying notes are an integral part of the consolidated financial statements.
14
Environmental Tectonics Corporation
Consolidated Statements of Operations
(amounts in thousands, except share and per share information)
Consolidated Statements of Operations
(amounts in thousands, except share and per share information)
Fiscal Years ended: | ||||||||
February 26, 2010 |
February 27, 2009 |
|||||||
Net sales |
$ | 42,271 | $ | 36,687 | ||||
Cost of goods sold |
23,447 | 24,829 | ||||||
Gross profit |
18,824 | 11,858 | ||||||
Operating expenses: |
||||||||
Selling and marketing |
5,010 | 4,670 | ||||||
General and administrative |
6,405 | 6,424 | ||||||
Research and development |
809 | 1,110 | ||||||
12,224 | 12,204 | |||||||
Operating profit (loss) |
6,600 | (346 | ) | |||||
Other expenses: |
||||||||
Interest expense |
1,308 | 1,569 | ||||||
Loss on extinguishment of debt |
315 | | ||||||
Other, net |
347 | 67 | ||||||
1,970 | 1,636 | |||||||
Income (loss) before income taxes |
4,630 | (1,982 | ) | |||||
Income tax benefit |
1,819 | | ||||||
Income (loss) before noncontrolling interest |
6,449 | (1,982 | ) | |||||
Loss attributable to noncontrolling interest |
(4 | ) | (8 | ) | ||||
Net income (loss) |
6,453 | (1,974 | ) | |||||
Preferred stock dividends |
(1,885 | ) | (927 | ) | ||||
Income (loss) applicable to common shareholders |
$ | 4,568 | $ | (2,901 | ) | |||
Per share information: |
||||||||
Earnings (loss) per common share: |
||||||||
Basic |
$ | 0.50 | $ | (0.32 | ) | |||
Diluted |
$ | 0.30 | $ | (0.32 | ) | |||
Weighted average common shares: |
||||||||
Basic |
9,069,000 | 9,037,000 | ||||||
Diluted |
21,235,000 | 9,037,000 | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
15
Environmental Tectonics Corporation
Consolidated Statements of Changes in Stockholders Equity (Deficiency)
For the fiscal years ended February 26, 2010 and February 27, 2009
(amounts in thousands, except share information)
Consolidated Statements of Changes in Stockholders Equity (Deficiency)
For the fiscal years ended February 26, 2010 and February 27, 2009
(amounts in thousands, except share information)
Common Stock | Additional Paid-in | Accumulated other | Total Stockholders | |||||||||||||||||||||||||
Preferred Stock | Shares | Amount | Capital | comprehensive loss | Accumulated deficit | Equity | ||||||||||||||||||||||
Balance, February 29, 2008 |
$ | | 9,035,355 | $ | 451 | $ | 16,139 | $ | (349 | ) | $ | (25,072 | ) | $ | (8,831 | ) | ||||||||||||
Net loss for the year |
| | | | | (1,974 | ) | (1,974 | ) | |||||||||||||||||||
Interest hedge valuation |
| | | | (40 | ) | | (40 | ) | |||||||||||||||||||
Foreign currency
translation adjustment |
| | | | (168 | ) | | (168 | ) | |||||||||||||||||||
Total comprehensive loss |
(2,182 | ) | ||||||||||||||||||||||||||
Stock compensation expense |
| | | 44 | | | 44 | |||||||||||||||||||||
Warrants issued with $2
million promissory note |
| | | 128 | | | 128 | |||||||||||||||||||||
Issuance of stock under
employee stock purchase
plan and Board of
Directors compensation |
| 13,996 | 1 | 15 | | | 16 | |||||||||||||||||||||
Preferred stock dividends |
| | | (927 | ) | | | (927 | ) | |||||||||||||||||||
Balance, February 27, 2009 |
| 9,049,351 | 452 | 15,399 | (557 | ) | (27,046 | ) | (11,752 | ) | ||||||||||||||||||
Net income for the year |
| | | | | 6,453 | 6,453 | |||||||||||||||||||||
Interest hedge valuation |
| | | | 184 | | 184 | |||||||||||||||||||||
Foreign currency
translation adjustment |
| | | | (58 | ) | | (58 | ) | |||||||||||||||||||
Total comprehensive income |
6,579 | |||||||||||||||||||||||||||
Issuance of common shares
to Lenfest |
| 20,000 | 1 | | | | 1 | |||||||||||||||||||||
Issuance of Series D
Preferred Stock |
155 | | | | | | 155 | |||||||||||||||||||||
Issuance of Series E
Preferred Stock |
23,741 | | | | | | 23,741 | |||||||||||||||||||||
Preferred stock dividends |
| | | (1,885 | ) | | | (1,885 | ) | |||||||||||||||||||
Stock compensation expense |
| | | 33 | | | 33 | |||||||||||||||||||||
Warrants issued to
Lenfest in connection
with line of credit
guarantee |
| | | 485 | | | 485 | |||||||||||||||||||||
Issuance of stock under
employee stock purchase
plan and Board of
Directors compensation |
| 14,222 | 1 | 18 | | | 19 | |||||||||||||||||||||
Balance
before noncontrolling interest |
23,896 | 9,083,573 | 454 | 14,050 | (431 | ) | (20,593 | ) | 17,376 | |||||||||||||||||||
Noncontrolling interest |
| | | | | | 38 | |||||||||||||||||||||
Balance, February 26, 2010 |
$ | 23,896 | 9,083,573 | $ | 454 | $ | 14,050 | $ | (431 | ) | $ | (20,593 | ) | $ | 17,414 | |||||||||||||
The accompanying notes are an integral part of the consolidated financial statements.
16
Environmental Tectonics Corporation
Consolidated Statements of Cash Flows
(amounts in thousands)
Consolidated Statements of Cash Flows
(amounts in thousands)
Fiscal years ended | ||||||||
February 26, 2010 |
February 27, 2009 |
|||||||
Cash flows from operating activities: |
||||||||
Net income (loss) |
$ | 6,453 | $ | (1,974 | ) | |||
Adjustments to reconcile net income (loss) to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
1,309 | 1,797 | ||||||
Decrease in valuation allowance for deferred tax assets |
(1,917 | ) | (38 | ) | ||||
Loss on extinguishment of debt |
315 | | ||||||
Accretion of debt discount and amortization of deferred finance costs |
258 | 298 | ||||||
Increase in allowances for accounts receivable and inventories, net |
577 | 212 | ||||||
Loss attributable to noncontrolling interest |
(4 | ) | (8 | ) | ||||
Stock option and stock compensation expense |
51 | 44 | ||||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(12,308 | ) | (1,483 | ) | ||||
Costs and estimated earnings in excess of billings on uncompleted long-term contracts |
(1,116 | ) | 962 | |||||
Inventories |
1,735 | 1,740 | ||||||
Prepaid expenses and other assets |
506 | 11 | ||||||
Accounts payable |
(322 | ) | (955 | ) | ||||
Billings in excess of costs and estimated earnings on uncompleted long-term contracts |
9,789 | (2,336 | ) | |||||
Customer deposits |
(598 | ) | (592 | ) | ||||
Other accrued liabilities |
544 | 1,583 | ||||||
Net cash provided by (used in) operating activities |
5,272 | (739 | ) | |||||
Cash flows from investing activities: |
||||||||
Acquisition of equipment |
(1,603 | ) | (1,566 | ) | ||||
Capitalized software development costs |
(221 | ) | (342 | ) | ||||
Net cash used in investing activities |
(1,824 | ) | (1,908 | ) | ||||
Cash flows from financing activities: |
||||||||
(Repayments) borrowings under lines of credit, net |
(702 | ) | 1,700 | |||||
(Repayment) issuance of note payable, Lenfest |
(2,000 | ) | 2,000 | |||||
(Decrease) increase in restricted cash from notes payable, Lenfest |
2,000 | (2,000 | ) | |||||
Issuance of common stock |
2 | 16 | ||||||
Borrowings (payments) of other debt obligations |
281 | (9 | ) | |||||
Payment of dividends |
(970 | ) | | |||||
Payment of claim settlement costs |
| (2,275 | ) | |||||
(Decrease) increase in restricted cash |
(297 | ) | 2,072 | |||||
Net cash (used in) provided by financing activities |
(1,686 | ) | 1,504 | |||||
Effect of exchange rate changes on cash |
126 | (208 | ) | |||||
Net increase (decrease) in cash |
1,888 | (1,351 | ) | |||||
Cash at beginning of period |
520 | 1,871 | ||||||
Cash at end of period |
$ | 2,408 | $ | 520 | ||||
Supplemental schedule of cash flow information: |
||||||||
Interest paid |
$ | 982 | $ | 475 | ||||
Income taxes paid |
| | ||||||
Supplemental information on non-cash operating and investing activities: |
||||||||
Accrued dividends on preferred stock |
$ | 319 | $ | 927 |
On July 2, 2009, the Company exchanged certain existing related-party financial instruments for a newly-created class of Series E Convertible Preferred Stock. The
value of this exchange was $23,741,000. Additionally, the Company issued $155,000 of Series D Preferred Stock as loan origination fees in connection with the
$7,500,000 Lenfest Credit Facility. See Note 2 Long-Term Obligations and Credit Arrangements.
In November 2009, the Company reclassified $2,939,000 from property, plant and equipment to inventory.
The accompanying notes are an integral part of the consolidated financial statements.
17
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements
Notes to the Consolidated Financial Statements
1. Nature of Business:
Environmental Tectonics Corporation (ETC or the Company) is principally engaged in the
design, manufacture and sale of software driven products and services used to recreate 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 (aeromedical,
tactical combat and general), disaster management systems and services, entertainment products,
sterilizers (steam and gas), environmental testing products and hyperbaric chambers and other
products that involve similar manufacturing techniques and engineering technologies. ETC focuses on
software enhancements, product extensions, new product development and new marketplace
applications. Sales of its products are made principally to U.S. and foreign government agencies
and to the entertainment market. We operate in two primary business segments, the Training Services
Group (TSG) and the Control Systems Group (CSG).
Training Services Group. This segment includes three primary product groups: aircrew
training devices and services, disaster management training and systems, and entertainment
products.
Control Systems Group. This segment includes three primary product lines:
sterilizers, environmental control systems and other products, and hyperbarics.
The Companys fiscal year is the 52-or 53-week annual accounting period ending the last Friday
in February. Certain amounts from prior consolidated financial statements have been reclassified to
conform to the presentation in fiscal 2010.
Sales Backlog
Below is a breakdown of the Companys February 26, 2010 sales backlog (amounts in thousands
except percentages):
Business segment: | ||||||||||||||||
Geographic area: | TSG | CSG | Total | % | ||||||||||||
Domestic |
$ | 210 | $ | 3,772 | $ | 3,982 | 4.1 | % | ||||||||
US Government |
49,111 | 48 | 49,159 | 51.0 | ||||||||||||
International |
36,244 | 7,579 | 43,823 | 44.9 | ||||||||||||
Total |
$ | 85,565 | $ | 11,399 | $ | 96,964 | 100.0 | % | ||||||||
% of total |
88.2 | % | 11.8 | % | 100.0 | % | ||||||||||
Our sales backlog at February 26, 2010, for work to be performed and revenue to be recognized
under written agreements after such dates, was $96,964,000. Of the February 26, 2010 sales backlog,
one product line represented at least 10% of the total backlog: aircrew training systems,
$81,707,000 or 84.3%. Additionally, three customers represented a total of $85,724,000, or 88.4%,
of the total backlog.
2. Summary of Significant Accounting Policies:
Basis of Presentation:
The consolidated financial statements include the accounts of Environmental Tectonics
Corporation, its wholly owned subsidiaries Entertainment Technology Corporation, ETC Delaware, and
ETC International Corporation, its 95% owned subsidiary, ETC-PZL Aerospace Industries SP. Z 0.0,
and its 99% owned subsidiary, ETC Europe. ETC SH refers to the companys corporate headquarters
and main production plant located in Southampton, Pennsylvania, USA. All material inter-company
accounts and transactions have been eliminated in consolidation.
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, claims receivable, inventories and computer software
costs.
18
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Fair Value of Financial Instrument:
This standard defines fair value, provides guidance for measuring fair value and requires
certain disclosures. The standard utilizes a fair value hierarchy which is categorized into three
levels based on the inputs to the valuation techniques used to measure fair value. The standard
does not require any new fair value measurements, but discusses valuation techniques, such as the
market approach (comparable market prices), the income approach (present value of future income or
cash flows) and the cost approach (cost to replace the service capacity of an asset or replacement
cost). The levels of the hierarchy are described below:
| Level 1: Observable inputs such as quoted prices in active markets for identical assets of liabilities; | ||
| Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices or identical assets or liabilities in markets that are not active; | ||
| Level 3: Unobservable inputs that are supported by little or no market activity, which require the reporting entitys judgment or estimation. |
The assessment of the significance of a particular input to the fair value measurement
requires judgment and may affect the valuation of financial assets and financial liabilities and
their placement within the fair value hierarchy. The Companys financial liabilities that are
accounted for at fair value on a recurring basis are summarized below:
Fair Value Measurement at | ||||||||||||||||
February 26, 2010 using: | ||||||||||||||||
Liabilities | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
(amounts in thousands) | ||||||||||||||||
Credit facility payable to bank |
$ | | $ | | $ | 10,551 | $ | 10,551 | ||||||||
ETC-PZL contract financing |
453 | 453 | ||||||||||||||
Interest rate swap agreements |
| 85 | | 85 | ||||||||||||
Total |
$ | | $ | 85 | $ | 11,004 | $ | 11,089 | ||||||||
For the interest rate swap agreements, fair value is calculated using standard industry
models used to calculate the fair value of the various financial instruments based on significant
observable market inputs such as swap rates, interest rates, and implied volatilities obtained from
various market sources. For the other financial instruments, fair value is determined using the
discounted cash flow methodology.
The carrying values of cash and cash equivalents, accounts receivable, accounts payable and
accrued liabilities are reasonable estimates of their fair values due to the short maturity of
these financial instruments.
Revenue Recognition:
On long-term contracts, with a contract value over $250,000 and a minimum completion period of
six months, the percentage-of-completion (POC) 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 an uncompleted contract will
result in a loss, the entire amount of the loss is accrued. The effect of revisions in cost and
profit estimates for long-term contracts is reflected in the accounting period in which the Company
learns the facts which require it to revise the cost and profit estimates. Contract progress
billings are based upon contract provisions for customer advance payments, contract costs incurred,
and completion of specified contract milestones. Contracts may provide for customer retainage of a
portion of amounts billed until contract completion. Retainage is generally due within one year of
completion of the contract.
For contracts under $250,000, or to be completed in less than six months, and where there are
no post-shipment services included in the contract, the completed contract method is applied and
revenue is recognized on the date that the finished product is shipped to the customer.
19
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
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 $250,000, or to be
completed in less than six months, 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 the
Company may receive. 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.
Cash and Cash Equivalents:
Cash includes 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 $250,000. During each
fiscal year, the Company periodically has cash and cash equivalents in excess of insured amounts.
Restricted Cash:
Restricted cash as of February 26, 2010 represents the partial collateralization of a
committed line of credit in the amount of $5,422,405 which the Company used to satisfy performance
bond and repayment guarantee requirements in a contract with an existing customer. As security for
this line of credit, ETC and H.F. Lenfest, a member of the Companys Board of Directors and a
significant shareholder of and investor in ETC (Lenfest), were each required to provide PNC Bank
with the equivalent of $2,711,000 in the form of cash or other financial instruments. To meet this
requirement, ETC has deposited cash in this amount in a restricted bank account with PNC Bank. (See
Note 7 Long-term Obligations and Credit Arrangements.) Restricted cash as of February 27, 2009
represents proceeds from the issuance of a $2 million promissory note to Lenfest in February 2009
specifically for a bid requirement as well as monies on deposit in Turkey securing a performance
guarantee in Turkey.
Subsequent to fiscal year end, the Company fulfilled its requirement to fund the balance of
the security to collateralize the committed line of credit by depositing approximately $2,711,000
in a certificate of deposit. Mr. Lenfests security was returned and his guarantee to cover the
$5.4 million line was terminated.
Accounts Receivable and Concentration of Credit Risk
The Company performs ongoing credit evaluations of our customers and adjusts credit limits
based on payment history and the customers current creditworthiness. The Company continuously
monitors collections and payments from its customers and maintain a provision for estimated credit
losses based on historical experience and any specific customer collection issues that have been
identified. While credit losses have historically been within the Companys expectations and the
provisions established, we cannot guarantee that we will continue to experience the same credit
loss rates that we have in the past. Additionally, as a result of the concentration of
international receivables, we cannot predict the effect, if any, that geopolitical disputes and
financial constraints will have on the ultimate collection of our international receivables.
Amounts due under contracts related to agencies of a foreign government totaled $14,539,000 or
83.8%, of the total accounts receivable, net as of February 26, 2010. The majority of these
receivables have been collected subsequent to fiscal year end.
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. Overheads allocated to
inventory cost are only those directly related to our manufacturing activities. Where necessary,
provision is made for obsolete, slow-moving or damaged inventory. This provision represents the
difference between the cost of the inventory and its estimated market value, based on the future
demand of our products.
In November 2009, the Company reclassified $2,939,000 from property, plant and equipment to
inventory. These costs had originally been capitalized as engineering costs associated with the
ATS-400 flight simulator which is being used a as a demonstrator model in ETCs NASTAR Center. The
costs will be equally charged over a four quarter period to cost of sales for three specific
contracts for this device. The Company currently has two contracts for these devices and, starting
with the fourth quarter of fiscal 2010, approximately $245,000 was transferred to each of these
contracts.
20
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Property, Plant and Equipment:
Property, plant and equipment are stated at cost. Property, plant and equipment are
depreciated over their estimated useful lives by the straight-line method for financial reporting
purposes. Buildings and building additions are depreciated over 40 years; machinery and equipment,
3 to 20 years; office furniture and equipment, 10 years; and building improvements, 5 to 10 years.
Upon sale or retirement of property, plant and equipment, the costs and related accumulated
depreciation are eliminated from the accounts with any resulting gains or losses.
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 Companys ability to market the related
product in the future and generate cash flows to support future operations. Software amortization
totaled $543,000 and $943,000, respectively, for fiscal 2010 and 2009.
Research and Development:
Research and development costs, which relate primarily to the development, design and testing
of products, are expensed as incurred. The Company enters into research grants with various
government entities, both in the United States and internationally. Payments received under these
grants are recorded as a reduction of research and development costs. Research and development
expenses include spending for potential new products and technologies and work performed under
government grant program, both in the United States and internationally. This spending, net of
grant payments from the U.S., and the governments of Poland and Turkey, totaled $809,000 in fiscal
2010 as compared to $1,110,000 for fiscal 2009. Gross spending for the periods was $2,846,000 and
$1,195,000, respectively.
Income Taxes:
The Company uses the asset and liability method of accounting for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial and tax reporting purposes as well as the valuation of net
loss carryforwards. Valuation allowances are reviewed each fiscal period to determine whether there
is sufficient positive or negative evidence to support a change in judgment about the realizability
of the related deferred tax asset.
Adequate provision has been made for all outstanding issues for all open years. Significant
judgments and estimates are required in determining the provision for taxes, including judgments
and estimates regarding the realization of deferred tax assets and the ultimate outcomes of
tax-related contingencies. During the normal course of business, there are many transactions and
calculations for which the ultimate tax determination is uncertain. A liability is recognized,
including interest, or a tax asset is reduced, for the anticipated outcome of tax audits. These
amounts are adjusted in light of changing facts and circumstances.
Long-Lived Assets:
The Company reviews its property and equipment for impairment whenever events or changes
in circumstances indicate the carrying value of an asset may not be recoverable. Recoverability is
measured by a comparison of the carrying amount to the net undiscounted cash flows expected to be
generated by the asset. An impairment loss would be recorded for the excess of net book value over
the fair value of the asset impaired. The fair value is estimated based on expected undiscounted
future cash flows. The results of impairment tests are subject to managements estimates and
assumptions of projected cash flows and operating results. Actual results may differ.
21
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Share-Based Compensation:
The Company follows Financial Accounting Standards Board (FASB) Accounting Standards
Codification (ASC or the Codification) accounting guidance which addressed the accounting for
stock-based payment transactions whereby an entity receives employee services in exchange for
either equity instruments of the enterprise or that may be settled by the issuance of such equity
instruments. The guidance generally requires that such transactions be accounted for using a
fair-value based method and stock-based compensation expense is recorded, based on the grant date
fair value, estimated in accordance with the guidance, for all new and unvested stock awards that
are ultimately expected to vest as the requisite service is rendered. The guidance requires
forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods
if actual forfeitures differ from these estimates.
The Company typically issues new shares of common stock upon the exercise of stock options, as
opposed to using treasury shares.
The Company uses a Black-Scholes option valuation method to determine the fair-value of the
stock-based compensation under the accounting guidance. The Black-Scholes model incorporates
various assumptions including the expected term of awards, volatility of stock price, risk-free
rates of return and dividend yield. The expected term of an award is no less than the award vesting
period and is based on the Companys historical experience. The risk-free interest rate is
approximated using rates available on U.S. Treasury securities in effect at the time of grant with
a remaining term similar to the awards expected life. The Company uses a dividend yield of zero in
the Black-Scholes option valuation model as it does not anticipate paying cash dividends in the
near future.
Advertising Costs:
The Company expenses advertising costs, which include trade shows, as incurred. Advertising
expense was $413,000 and $394,000 in fiscal 2010 and 2009, respectively.
Earnings Per Common Share:
Basic earnings (loss) per share is computed on the basis of the weighted average number of
common shares outstanding. Diluted earnings (loss) per share is computed on the basis of the
weighted average number of common shares outstanding plus the effect of outstanding stock options
and common stock warrants using the treasury stock method plus the effect of all convertible
financial instruments, including subordinated debt and preferred stock, as if they had been
converted at the beginning of each period presented. If the effect of the conversion of any
financial instruments would be anti-dilutive, it is excluded from the diluted earnings per share
calculation.
At February 26, 2010, there was $23,896,000 of cumulative convertible participating preferred
stock. These instruments were convertible at exercise prices of:
| Series D Preferred Stock of $55,000 at $0.94 per share, equating to 58,511 shares of common stock, issued in April 2009; | ||
| Series D Preferred Stock of $100,000 at $1.11 per share, equating to 90,090 shares of common stock, issued in July 2009; | ||
| Series E Preferred Stock of $23,741,000 at $2.00 per share, equating to 11,870,500 shares of common stock, issued in July 2009. |
On February 20, 2009, in connection with the issuance of a $2,000,000 promissory note, the
Company issued warrants to purchase 143,885 shares of the Companys common stock at $1.39 per
share. Additionally, on July 2, 2009, in consideration of an increase of the guarantee on the PNC
line of credit, the Company issued warrants to purchase 450,450 shares of the Companys common
stock at $1.11 per share. (See Note 2, Long-Term Obligations and Credit Arrangements.)
22
Environmental Tectonics Corporation
Notes to the Condensed Consolidated Financial Statements, continued
Notes to the Condensed Consolidated Financial Statements, continued
At February 26, 2010 and February 27, 2009, there were options to purchase the Companys
common stock totaling 269,185 and 157,652 shares at an average price of $4.53 and $5.90 per share,
respectively. Due to the conversion price of these common stock options, these shares were excluded
from the calculation of diluted earnings (loss) per share because the effect was antidulutive.
Fiscal year ended | ||||||||||||
February 26, 2010 | ||||||||||||
Income | Weighted | Per | ||||||||||
(amounts in | average | share | ||||||||||
thousands) | shares | amount | ||||||||||
Net income |
$ | 6,453 | ||||||||||
Less preferred stock dividends |
(1,885 | ) | ||||||||||
Basic earnings per share: |
||||||||||||
Basic earnings available to common shareholders |
$ | 4,568 | 9,069,000 | $ | 0.50 | |||||||
Effect of dilutive securities: |
||||||||||||
Preferred stock |
12,019,000 | |||||||||||
Stock warrants |
147,000 | |||||||||||
Diluted earnings per share: |
||||||||||||
Basic earnings available to common shareholders |
$ | 4,568 | ||||||||||
Add: Preferred stock dividend |
1,885 | |||||||||||
Income available to common shareholders plus effect of
Dilutive securities |
$ | 6,453 | 21,235,000 | $ | 0.30 | |||||||
23
Environmental Tectonics Corporation
Notes to the Condensed Consolidated Financial Statements, continued
Notes to the Condensed Consolidated Financial Statements, continued
3. Accounts Receivable:
The components of accounts receivable at February 26, 2010 and February 27, 2009 are as
follows:
February 26, 2010 |
February 27, 2009 |
|||||||
(amounts in thousands) | ||||||||
U.S. government |
$ | 438 | $ | 551 | ||||
U.S. commercial |
1,403 | 1,002 | ||||||
International |
15,930 | 3,911 | ||||||
17,771 | 5,464 | |||||||
Less allowance for doubtful accounts |
(415 | ) | (364 | ) | ||||
Accounts receivable, net |
$ | 17,356 | $ | 5,100 | ||||
4. Costs and Estimated Earnings on Uncompleted Contracts:
Unbilled costs
The following is a summary of long-term contracts in progress at February 26, 2010 and
February 27, 2009:
February 26, 2010 |
February 27, 2009 |
|||||||
(amounts in thousands) | ||||||||
Cost incurred on uncompleted long-term contracts |
$ | 18,936 | $ | 26,777 | ||||
Estimated earnings |
18,535 | 16,911 | ||||||
37,471 | 43,688 | |||||||
Less billings to date |
(47,839 | ) | (45,383 | ) | ||||
$ | (10,368 | ) | $ | (1,695 | ) | |||
February 26, 2010 |
February 27, 2009 |
|||||||
(amounts in thousands) | ||||||||
Included in accompanying balance sheets under the
following captions: |
||||||||
Costs and estimated earnings in excess of billings
on uncompleted long-term contracts |
$ | 3,576 | $ | 2,460 | ||||
Billings in excess of costs and estimated
earnings on uncompleted long-term contracts |
(13,944 | ) | (4,155 | ) | ||||
$ | (10,368 | ) | $ | (1,695 | ) | |||
Included in billings in excess of costs and estimated earnings on uncompleted long-term
contracts is a provision for unexpected losses on contracts of $200,000 in fiscal 2010 and 2009.
24
Environmental Tectonics Corporation
Notes to the Condensed Consolidated Financial Statements, continued
Notes to the Condensed Consolidated Financial Statements, continued
5. Inventories:
Inventories consist of the following:
February 26, | February 27, | |||||||
2010 | 2009 | |||||||
(amounts in thousands) | ||||||||
Raw material |
$ | | $ | 92 | ||||
Work in process |
4,764 | 3,564 | ||||||
Finished goods |
350 | 779 | ||||||
Total inventory, net |
$ | 5,114 | $ | 4,435 | ||||
Inventory is presented above net of an allowance for obsolescence of $2,345,000 (Raw material
$138,000, Work in process $1,506,000 and Finished goods $701,000) and $1,820,000 (Raw material
$92,000, Work in process $1,027,000 and Finished goods $701,000) in fiscal 2010 and 2009,
respectively.
In November 2009, the Company reclassified $2,939,000 from property, plant and equipment to
inventory. These costs had originally been capitalized as engineering costs associated with the
ATS-400 flight simulator which is being used as a demonstrator model in ETCs NASTAR Center. The
costs will be equally charged over a four quarter period to cost of sales for three specific
contracts for this device. The Company currently has two contracts for these devices and, starting
with the fourth quarter of fiscal 2010, approximately $245,000 was transferred to each of these
contracts.
6. Property, Plant and Equipment:
The following is a summary of property, plant and equipment, at cost, and estimated useful
lives at February 26, 2010 and February 27, 2009:
February 26, | February 27, | |||||||
2010 | 2009 | |||||||
(amounts in thousands) | ||||||||
Land |
$ | 100 | $ | 100 | ||||
Buildings and building additions |
3,851 | 3,851 | ||||||
Machinery and equipment |
20,792 | 22,426 | ||||||
Office furniture and equipment |
1,194 | 1,194 | ||||||
Building improvements |
2,746 | 2,489 | ||||||
28,683 | 30,060 | |||||||
Less accumulated depreciation |
(15,040 | ) | (14,274 | ) | ||||
Property, plant and equipment, net |
$ | 13,643 | $ | 15,786 | ||||
Depreciation expense for the fiscal years ended February 26, 2010 and February 27, 2009
was $766,000 and $837,000, respectively.
As a result of the transfer of costs from property, plant and equipment to inventory, the
estimated depreciation of the remaining asset value for the ATS-400 was reviewed and, $233,000 of
depreciation expense which had previously been amortized to the cost of sales was reversed in the
fourth quarter of fiscal 2010.
7. | Long-Term Obligations and Credit Arrangements: |
Lenfest Financing Transaction
On April 24, 2009, the Company entered into a transaction (the Lenfest Financing
Transaction), which was approved by shareholders on July 2, 2009, with Lenfest that provided for
the following: (i) a $7,500,000 credit facility provided by Lenfest to ETC, which expires on
December 31, 2012; (ii) exchange of the Subordinated Note (as defined below) held by Lenfest,
together with all accrued interest and warrants issuable under the Subordinated Note, and all
Series B Preferred Stock (as defined below) and Series C Preferred Stock (as defined below) held by
Lenfest, together with all accrued dividends thereon, for a new class of preferred stock, Series E
Preferred Stock, of the Company; and (iii) the guarantee by Lenfest of all of ETCs obligations to
PNC Bank, National Association (PNC Bank) in connection with an increase of the Companys
existing $15,000,000 revolving line of credit with
25
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
PNC Bank (the 2007 PNC Credit Facility) to $20,000,000, and in connection with this guarantee,
the pledge by Lenfest to PNC Bank of $10,000,000 in marketable securities.
Lenfest Credit Facility
As part of the Lenfest Financing Transaction, the Company established a credit facility in the
maximum amount of $7,500,000 with Lenfest (the Lenfest Credit Facility) to be used to finance
certain government projects that ETC has been awarded or is seeking to be awarded. The terms of
the Lenfest Credit Facility are set forth in a Secured Credit Facility and Warrant Purchase
Agreement between the Company and Lenfest, dated as of April 24, 2009 (the Lenfest Credit
Agreement). In connection with the Lenfest Credit Agreement, the Company has executed, and will
in the future execute, promissory notes in favor of Lenfest, in the aggregate principal amount of
up to $7,500,000 (the Lenfest Credit Facility Note) based on the amount borrowed by the Company
pursuant to the Lenfest Credit Agreement. Each Lenfest Credit Facility Note issued under the
Lenfest Credit Facility will accrue interest at the rate of 10% per annum, payable in cash or, at
the option of Lenfest, in shares of Series D Preferred Stock of the Company, as described below.
The Lenfest Credit Facility expires on December 31, 2012. As of February 26, 2010, the Company had
not utilized any of the $7.5 million available funding under this facility.
Exchange of Existing Instruments for Series E Preferred Stock
On April 24, 2009, the Company authorized the issuance of two newly-created classes of
Convertible Preferred Stock, Series D and Series E. Shares of these have been issued in connection
with the Lenfest Financing Transaction. In accordance with standards defined by generally accepted
accounting principles on classification and measurement of redeemable securities, the Company has
accounted for both of these issues as permanent equity under Shareholders Equity in the
accompanying consolidated condensed balance sheets. The Companys Series B and C Preferred Stock
had been classified as mezzanine due to a preferential redemption feature of these instruments,
which provided that a change in ownership would result in a forced liquidation. The Series D and E
shares do not contain this provision. With respect to the convertibility of the Series D and E
shares, in accordance with standards defined by generally accepted accounting principles on
determining whether an instrument (or embedded feature) is indexed to an entitys own stock, and
the Company has concluded that the embedded conversion feature did not have a material effect on
its stated value.
As part of the Lenfest Financing Transaction, the senior subordinated convertible promissory
note (the Subordinated Note) in the original principal amount of $10,000,000 issued by ETC to
Lenfest on February 18, 2003, together with all accrued interest and warrants issuable pursuant to
the terms of the Subordinated Note, and all Series B Convertible Preferred Stock (the Series B
Preferred Stock) and Series C Cumulative Convertible Preferred Stock of the Company (the Series C
Preferred Stock) held by Lenfest, together with all accrued dividends thereon, were exchanged (the
Series E Exchange) for shares of a newly-created class of Series E Convertible Preferred Stock of
the Company (the Series E Preferred Stock).
On July 2, 2009, following the receipt of the Shareholder Approvals, the Company filed with
the Department of State of the Commonwealth of Pennsylvania a Statement with Respect to Shares of
Series E Convertible Preferred Stock creating a new class of preferred stock consisting of 25,000
shares with a stated value of $1,000 per share and designated Series E Convertible Preferred Stock.
Immediately thereafter, the Series E Exchange occurred and the Company issued 23,741 shares of
Series E Preferred Stock to Lenfest. The shares of Series E Preferred Stock are convertible to
common stock at a conversion price per share equal to $2.00 and would convert into 11,870,500
shares of ETC common stock.
Below is a summary of the instruments exchanged:
Balance | ||||
upon | ||||
Description | exchange | |||
Subordinated convertible note |
$ | 10,000,000 | ||
Accrued interest on subordinated convertible note |
2,275,000 | |||
Series B Preferred stock |
6,000,000 | |||
Series C Preferred Stock |
3,300,000 | |||
Accrued dividends on preferred stock, Series B and C |
2,166,000 | |||
Series E Preferred Stock issued in exchange |
$ | 23,741,000 | ||
As a result of this exchange, the Company recorded a loss on extinguishment of debt on
the Subordinated Note of $224,000, representing the unamortized portion of the debt discount.
26
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Subsequent to the fiscal year end, on March 10, 2010, the Company entered into an agreement
(Stock Repurchase Agreement) with H.F. Lenfest to repurchase and retire 1,000 shares of Series E
Preferred Stock currently owned by Lenfest. The repurchase price was the stated price of $1,000.00
per share, or $1,000,000 in the aggregate. Following this repurchase, Lenfest held 22,741 shares
of Series E Preferred Stock.
Lenfest Promissory Note
On February 20, 2009, Lenfest made a loan to ETC in the principal amount of $2,000,000 (the
$2 Million Loan), which amount was considered as advanced under the Lenfest Credit Facility. The
$2 million Loan was used by ETC solely to support ETCs requirements under a proposal for a U.S.
Government bid.
In connection with the $2 million Loan, the Company issued 143,885 warrants to purchase the
Companys common stock at $1.39 per share. Consequently, the Company recorded a debt discount of
$109,000 associated with these warrants using the Black-Scholes options-pricing model.
Additionally, the Company issued 20,000 shares of the Companys common stock as part of this
transaction. The value of the stock issued, $19,000, has been recorded as a loan origination fee.
The $2,000,000 in proceeds from the $2 Million Loan was included in Restricted Cash on the
accompanying Condensed Consolidated Balance Sheets as of February 27, 2009. On September 1, 2009,
the Company repaid the $2 Million Loan in full. The unamortized portion of the original debt
discount, $91,000, was expensed during the fiscal quarter ended November 27, 2009, and is reflected
as extinguishment of debt on the accompanying Condensed Consolidated Statement of Operations.
Bank Credit and Facility
Increased PNC Bank Credit Facility and Issuance of New Guarantee
On April 24, 2009, PNC Bank agreed to increase the amount of financing available under the
2007 PNC Credit Facility from $15,000,000 to $20,000,000, subject to the condition that Lenfest
continue to personally guarantee all of ETCs obligations to PNC Bank (the Lenfest Guaranty) and
that Lenfest pledged $10,000,000 in marketable securities as collateral security for his guarantee
(the Lenfest Pledge).
Following the receipt of the Shareholder Approvals on July 2, 2009, ETC and PNC Bank entered
into the Amended and Restated Credit Agreement (the Amended and Restated PNC Credit Agreement)
and the Second Amended and Restated Reimbursement Agreement for Letters of Credit (the Amended and
Restated Reimbursement Agreement). The 2007 promissory note was cancelled and replaced with the
Amended and Restated Promissory Note in the principal amount of $20,000,000 (the Amended and
Restated PNC Note).
In connection with the execution of the 2009 PNC Financing Documents, ETC paid to Lenfest an
origination fee of 100 shares of Series D Convertible Preferred Stock of the Company (the Series D
Preferred Stock), which is equal to one percent (1%) of the market value of the $10,000,000 in
marketable securities pledged by Lenfest to PNC Bank to secure ETCs obligations to PNC Bank. The
100 shares of Series D Preferred Stock have a stated value of $1,000 per share, or $100,000 in the
aggregate. These shares of Series D Preferred Stock have a conversion price per share equal to
$1.11, which price equaled the average closing price of ETC common stock during the 120 days prior
to the issuance of such shares. Additionally, ETC will pay Lenfest annual interest equal to 2% of
the amount of the Lenfest Pledge, payable in Series D Preferred Stock.
In consideration of Lenfest entering into the Amended and Restated Guaranty, ETC issued to
Lenfest warrants to purchase 450,450 shares of ETC common stock, which shares were equal in value
to ten percent (10%) of the amount of the $5,000,000 increase under the 2007 PNC Bank Credit
Facility. The warrants are exercisable for seven years following issuance at an exercise price per
share equal to $1.11, which price equaled the average closing price of ETC common stock during the
120 days prior to the issuance of the warrant.
The Company has recorded a loan origination deferred charge associated with these warrants of
$487,000 using the Black-Scholes options-pricing model with the following weighted average
assumptions: expected volatility of 91.9%; risk-free interest rate of 0.49%; and an expected life
of seven years.
Amounts borrowed under the Amended and Restated PNC Credit Agreement could be borrowed, repaid
and reborrowed from time to time until June 30, 2010. Borrowings made pursuant to the Amended and
Restated PNC Credit Agreement bear interest at either the prime rate (as described in the
promissory note executed pursuant to the Amended and Restated PNC Credit Agreement) plus 0.50
27
Environmental Tectonics Corporation
Notes to the Condensed Consolidated Financial Statements, continued
Notes to the Condensed Consolidated Financial Statements, continued
percentage points or the London Interbank Offered Rate (LIBOR) (as described in the Promissory
Note) plus 2.50 percentage points. Additionally, ETC is obligated to pay a fee of 0.125% per year
for unused but available funds under the line of credit.
The Amended and Restated PNC Credit Agreement signed on April 24, 2009 contained affirmative
and negative covenants including, but not limited to, limitations with respect to indebtedness,
liens, investments, distributions, dispositions of assets, change of business and transactions with
affiliates. The Company was required to maintain a minimum Consolidated Tangible Net Worth (which,
as defined, is total assets excluding intangibles less liabilities excluding the Subordinated
Convertible Debt) of $3,500,000 for each fiscal quarter starting February 27, 2009 and thereafter.
Additionally, the Company was required to maintain a minimum Earnings Before Interest, Taxes,
Depreciation and Amortization (EBITDA), defined as net income plus interest expense plus income
tax expense plus amortization plus depreciation, as follows: fiscal 2010 third quarter $1,000,000,
fiscal 2010 fourth quarter $900,000 and all fiscal quarters ending after February 28, 2010,
$1,300,000. The Company is in full compliance of its covenants as of February 26, 2010.
Amendment to the Credit Agreement
On October 1, 2009, the PNC Credit Agreement was amended to extend the maturity date to June
30, 2011. Additionally, the affirmative covenants were adjusted. The Consolidated Tangible Net
Worth covenant was modified to reflect the impact on the Companys balance sheet of the Lenfest
Financing Transaction. Effective with each fiscal quarter ending after October 1, 2009, the Company
must maintain a minimum Consolidated Tangible Net Worth of at least $10,000,000. The EBITDA
covenant was changed for fiscal periods beginning after December 1, 2009. Beginning with the first
fiscal quarter ending after December 1, 2009, and for each fiscal quarter ending thereafter, the
Company must maintain a minimum cumulative aggregate EBITDA of $4,000,000 for the fiscal quarter
then ending and the three preceding fiscal quarters.
As of February 26, 2010, the Companys availability under the PNC Credit Agreement was
approximately $8,872,000. This reflected cash borrowings under the PNC Credit Agreement of
$9,600,000 and outstanding letters of credit of approximately $1,528,000.
For the purpose of reducing the risk associated with variable interest rates, ETC has entered
into an interest rate swap agreement (the Swap Agreement) with PNC Bank which provides for a
fixed rate through June 30, 2010, the maturity date of the Swap Agreement, for a portion of the
Companys bank borrowings. If the Swap Agreement is terminated prior to maturity, an additional
payment to PNC Bank or a credit to the Company might be due, based on the relative market rates at
the time of termination. The Swap Agreement transaction has been accounted for under the generally
accepted accounting principle for accounting for derivative instruments and hedging activities. At
February 26, 2010, ETC recorded a Comprehensive Loss of $85,000 reflecting the reduced value of the
interest rate hedge in the accompanying Condensed Consolidated Balance Sheets.
Due to the Companys accumulated deficit, all dividends accruing for the previous Series B and
C and current Series D and E Preferred Stock issuances have been recorded in the accompanying
financial statements as a reduction in additional paid-in capital.
Dedicated Line of Credit Agreement with PNC Bank
On November 16, 2009, the Company and PNC Bank entered into a Letter Agreement, Reimbursement
Agreement, Pledge Agreement, and Amendment to Subordination Agreement (collectively, the Dedicated
Line of Credit Agreement), pursuant to which the Company has received a committed line of credit
in the amount of $5,422,405 (the Line of Credit) which the Company used to satisfy performance
bond and repayment guarantee requirements in a contract with an existing customer. Use of this
dedicated line of credit is restricted to funding contract requirements under this specific
contract.
As security for the Line of Credit, ETC and H.F. Lenfest were each required to provide PNC
Bank with the equivalent of $2,711,000 in the form of cash or other financial instruments. To meet
this requirement, ETC has deposited cash in this amount in a restricted bank account with PNC Bank.
H.F. Lenfest has guaranteed the Companys obligations under the Dedicated Line of Credit Agreement,
and has pledged to PNC Bank $2,711,000 in certificated securities. ETC was required by August 19,
2010, to place additional cash funds of $2,711,000 with PNC Bank, at which time the Lenfest
guarantee would be terminated and the Lenfest securities would be returned to Lenfest.
Subsequent to fiscal year end, the Company fulfilled its requirement to fund the balance of
the security to collateralize the committed line of credit by depositing approximately $2,711,000
in a certificate of deposit. Mr. Lenfests security was returned and his guarantee to cover the
$5.4 million line was terminated.
28
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Subordinated Convertible Debt
As part of the Lenfest Financing Transaction, subordinated convertible debt, which had a
face-value of $10 million, was exchanged for Series E Preferred Stock on July 2, 2009. The
unamortized portion of the original debt discount of $224,000 is reflected as extinguishment of
debt on the accompanying Condensed Consolidated Statement of Operations.
At the Companys option, the quarterly interest payments due on this convertible debt were
deferred and added to the outstanding principal. As part of the Lenfest Financing Transaction,
$2,275,000 in accrued interest was exchanged for Series E Preferred Stock.
ETC-PZL Project Financing
In September 2009, ETC-PZL, located in Warsaw, Poland, entered into a project financing
agreement with a Warsaw bank to fund a research and development contract with the Polish
government. The amount of this facility is $604,000 and it is being repaid in quarterly
installments of approximately $70,000 which commenced in September 2009. This facility will expire
in September 2011. Use of this line of credit is restricted to funding contract requirements under
a specific research and development contract with the Polish government.
Long-term obligations at February 26, 2010 and February 27, 2009 consist of the following:
February 26, 2010 |
February 27, 2009 |
|||||||
(amounts in thousands) | ||||||||
Note payable to bank |
$ | 9,600 | $ | 10,510 | ||||
ETC-PZL project financing |
486 | | ||||||
Automobile loan |
7 | 16 | ||||||
Other |
| | ||||||
Promissory note, net of unamortized discount of $109 |
| 1,891 | ||||||
Subordinated convertible debt, net of unamortized discount $336 |
| 9,664 | ||||||
Total debt obligations |
10,093 | 22,081 | ||||||
Less current maturities |
285 | 9 | ||||||
Long-term obligations, net of current maturities |
$ | 9,808 | $ | 22,072 | ||||
The amounts of future long-term obligations maturing in each of the next five fiscal
years are as follows (amounts in thousands):
2010 |
$ | 285 | ||
2011 |
9,808 | |||
2012 and thereafter |
| |||
Total future obligations |
$ | 10,093 | ||
29
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
9. 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 non-cancelable operating
leases having a remaining term expiring after one fiscal year as of February 26, 2010 are $177,000
in 2011; $155,000 in 2012; $28,000 in 2013; and $16,000 in 2014 and thereafter. Total rental
expense for all operating leases for the fiscal years ended February 26, 2010 and February 27, 2009
was $256,000 and $211,000, respectively.
10. Income Taxes:
The Company uses the asset and liability method of accounting for income taxes. Deferred
income taxes reflect the net tax effects of temporary differences between the carrying amounts of
assets and liabilities for financial and tax reporting purposes as well as the valuation of net
loss carryforwards. Valuation allowances are reviewed each fiscal period to determine whether there
is sufficient positive or negative evidence to support a change in judgment about the realizability
of the related deferred tax asset.
Valuation allowances had been recorded against the entire deferred tax asset as of February
27, 2009 due an uncertainty of sustaining an appropriate level of profitability in future periods.
As of February 26, 2010, the Company has reviewed the components of its deferred tax asset and has
determined, based upon all available information, that its current and expected future operating
income will more likely than not result in the realization of a portion of its deferred tax assets
relating primarily to its net operating loss carryforwards. As of February 26, 2010, the Company
had approximately $36.5 million of federal net loss carry forwards available to offset future
income tax liabilities, beginning to expire in 2025. In addition, the Company has the ability to
offset deferred tax assets against deferred tax liabilities created for such items as depreciation
and amortization.
As a result of the Companys analysis, an income tax benefit of $1,819,000 has been recorded
in the Consolidated Statement of Operations for the fiscal year ended February 26, 2010.
(in thousands) | ||||||||
Fiscal Year Ended | Fiscal Year Ended | |||||||
February 26, 2010 | February 27, 2009 | |||||||
$ | $ | |||||||
Currently (receivable) payable |
||||||||
Federal |
133 | | ||||||
State |
| | ||||||
Foreign (benefits) taxes |
23 | | ||||||
156 | | |||||||
Deferred: |
||||||||
Federal |
(1,598 | ) | | |||||
State |
(377 | ) | | |||||
Foreign benefit |
| | ||||||
(1,975 | ) | |||||||
$ | (1,819 | ) | $ | | ||||
30
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows:
Fiscal year | Fiscal year | |||||||
ended | ended | |||||||
February 26, | February 27, | |||||||
2010 | 2009 | |||||||
Statutory income tax (benefit) |
34.0 | % | (34.0 | )% | ||||
State income tax, net of federal tax benefit |
3.8 | (2.5 | ) | |||||
Research and experimentation and other tax credits |
(3.1 | ) | (7.3 | ) | ||||
Benefit of foreign and foreign-source income or loss |
.6 | 5.5 | ||||||
Change in valuation allowance |
(73.4 | ) | 32.8 | |||||
Effect of change in effective tax rate |
| 4.0 | ||||||
Other, net |
(1.1 | ) | 1.5 | |||||
(39.2 | )% | | % | |||||
For the fifty-two week period ended February 27, 2009, the Company did not record any
benefit for income taxes due to the prior and continuing operating losses and the low probability
that any recorded tax receivables would ever be realized.
The tax effects of the primary components of the temporary differences are as follows:
February 26, 2010 |
February 27, 2009 |
|||||||
(amounts in thousands) | ||||||||
Deferred tax assets: |
||||||||
Net operating loss and credits |
$ | 15,607 | $ | 16,520 | ||||
Vacation reserve |
80 | 74 | ||||||
Inventory reserve |
880 | 676 | ||||||
Receivable reserve |
156 | 135 | ||||||
Warranty reserve |
117 | 63 | ||||||
Compensation and other reserves |
32 | 76 | ||||||
Stock options |
| 96 | ||||||
Other, net |
74 | 74 | ||||||
16,946 | 17,714 | |||||||
Valuation Reserve |
(11,963 | ) | (15,364 | ) | ||||
Total current deferred tax asset |
4,983 | 2,350 | ||||||
Deferred tax liabilities: |
||||||||
Amortization of capitalized software |
350 | 462 | ||||||
Depreciation |
2,716 | 1,888 | ||||||
Total non-current deferred tax liability |
3,066 | 2,350 | ||||||
Net deferred tax asset |
$ | 1,917 | $ | | ||||
During the fiscal years ended February 26, 2010 and February 27, 2009, the Company did
not have any unrecognized tax benefits and accordingly did not recognize interest expense or
penalties related to unrecognized tax benefits. The Company or one of its subsidiaries files income
tax returns in U.S. federal jurisdiction, various states and foreign jurisdiction. The Company is
no longer subject to U.S. federal tax examinations by tax authorities for the fiscal years before
2007.
31
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
11. Business Segment Information:
The Company operates in two business segments Training Services Group (TSG) and Control
Systems Group (CSG). Core technologies include the design, manufacture and sale of training
services which includes (1) software driven products and services used to create and monitor the
physiological effects of flight; (2) high performance jet tactical flight simulation, and; (3)
driving and disaster simulation systems, and control systems which includes: (1) steam and gas
sterilization; (2) testing and simulation devices for the automotive industry, and; (3) hyperbaric
and hypobaric chambers. Product categories included in TSG are Aircrew Training Systems (ATS) and
flight simulators, disaster management systems and entertainment applications. CSG includes
sterilizers, environmental control devices and hyperbaric chambers along with parts and service
support.
The following segment information reflects the accrual basis of accounting.
Training | Control | |||||||||||||||
Services Group | Systems Group | Company | ||||||||||||||
(TSG) | (CSG) | Corporate | Total | |||||||||||||
(amounts in thousands) | ||||||||||||||||
Fiscal 2010 |
||||||||||||||||
Net sales |
$ | 26,035 | $ | 16,236 | $ | | $ | 42,271 | ||||||||
Interest expense |
1,023 | 285 | | 1,308 | ||||||||||||
Depreciation and amortization |
728 | 581 | | 1,309 | ||||||||||||
Operating income (loss) |
6,128 | 1,727 | (1,255 | ) | 6,600 | |||||||||||
Income tax benefit |
| | (1,819 | ) | (1,819 | ) | ||||||||||
Identifiable assets |
31,177 | 4,928 | 15,624 | 51,729 | ||||||||||||
Expenditures for segment assets |
1,206 | 358 | 378 | 1,824 | ||||||||||||
Fiscal 2009 |
||||||||||||||||
Net sales |
$ | 20,608 | $ | 16,079 | $ | | $ | 36,687 | ||||||||
Interest expense |
1,161 | 408 | | 1,569 | ||||||||||||
Depreciation and amortization |
616 | 1,181 | | 1,797 | ||||||||||||
Operating income (loss) |
2,431 | (1,497 | ) | (1,280 | ) | (346 | ) | |||||||||
Income tax benefit |
| | | | ||||||||||||
Identifiable assets |
19,545 | 5,046 | 12,687 | 37,278 | ||||||||||||
Expenditures for segment assets |
1,550 | 358 | | 1,908 |
2010 | 2009 | |||||||||||||||
Reconciliation to
consolidated net income (loss): |
||||||||||||||||
Operating income (loss) |
$ | 6,600 | $ | (346 | ) | |||||||||||
Interest expense |
(1,308 | ) | (1,569 | ) | ||||||||||||
Loss on extinguishment of debt |
(315 | ) | | |||||||||||||
Other, net |
(347 | ) | (67 | ) | ||||||||||||
Income tax benefit |
1,819 | | ||||||||||||||
Noncontrolling interest |
4 | 8 | ||||||||||||||
Net income (loss) |
$ | 6,453 | $ | (1,974 | ) | |||||||||||
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 and income taxes have been excluded from the determination of the total profit for
segments. For presentation purposes, income, expenses and assets not specifically identifiable to
an individual business group or applicable to all groups and general corporate expenses, primarily
central administrative office expenses, are reflected in the Corporate category. Property, plant,
and equipment associated with the Companys NASTAR Center are included in the TSG segment; the
remaining property, plant and equipment are not identified with specific business segments because
most of these assets are used in each of the segments.
32
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
In fiscal 2010, international sales totaling a least $500,000 per country were made to
customers in Saudi Arabia, Korea, Malaysia and Turkey. In fiscal 2009, international sales totaling
at least $500,000 per country were made to customers in Saudi Arabia, Turkey, Thailand, Malaysia
and Egypt. Fluctuations in sales to international countries from year to year primarily reflect
revenue recognition on the level and stage of development and production on multi-year long-term
contracts.
In both fiscal 2010 and 2009, sales to one customer (the same customer) represented
individually 10% or more of total sales, the Royal Saudi Air Force.
Included in the segment information for the fiscal years ended February 26, 2010 and February
27, 2009 are export sales of $21,690,000 and $19,149,000, respectively. Sales to the U.S.
government and its agencies aggregated $7,711,000 and $3,096,000 for the fiscal years ended
February 26, 2010 and February 27, 2009, respectively.
12. Stock Options:
A summary of the status of the Companys Stock Option Plans as of and for the fiscal years ended:
February 26, 2010 | February 27, 2009 | |||||||||||||||
Weighted | Weighted | |||||||||||||||
average | average | |||||||||||||||
Shares | Exercise price | Shares | exercise price | |||||||||||||
Outstanding at beginning of year |
157,652 | $ | 5.90 | 371,928 | $ | 6.70 | ||||||||||
Granted |
113,000 | 2.64 | | | ||||||||||||
Exercised |
| | | | ||||||||||||
Forfeited |
(1,467 | ) | 6.07 | (214,276 | ) | | ||||||||||
Outstanding at end of year |
269,185 | 4.53 | 157,652 | 5.90 | ||||||||||||
Options exercisable at year end |
156,185 | 157,652 | ||||||||||||||
Weighted average fair value of
options granted during the year |
$ | 2.64 | $ | |
The following information applies to options outstanding at February 26, 2010:
Options outstanding | Options exercisable | |||||||||||||||||||
Weighted | Number | |||||||||||||||||||
Number | average | Weighted | Exercisable | Weighted | ||||||||||||||||
outstanding | Remaining | Average | at | Average | ||||||||||||||||
at February | Contractual | Exercise | February | Exercise | ||||||||||||||||
Fiscal 2010 | 26, 2010 | Life (years) | Price | 26, 2010 | Price | |||||||||||||||
Range of exercise prices: |
||||||||||||||||||||
$2.64 | 113,000 | 9.75 | 2.64 | | $ | 2.64 | ||||||||||||||
$5.12 | 80,000 | 7.00 | 5.12 | 80,000 | 5.12 | |||||||||||||||
$6.07 to $7.35 | 76,185 | 5.07 | 6.71 | 76,185 | 6.71 | |||||||||||||||
Total |
269,185 | 156,185 |
The cost for stock option compensation was $33,000 and $44,000 for the years ended
February 26, 2010 and February 27, 2009, respectively. At February 26, 2010, the Company had two
stock-based compensation plans.
Employee, Director and Consultant Stock Plan:
In July 2009, the Company adopted the 2009 Employee, Director and Consultant Stock Plan. This
Plan authorizes the Board of Directors (or a committee appointed under the Board) to grant option
awards for the purchase of common stock or common stock awards of up to 1,000,000 shares of common
stock to employees, officers, directors, consultants and advisors of the Company and its
Subsidiaries. The plan allows for the establishment of an exercise price at the time each option is
granted. The exercise price shall not be less than the fair market value (or in the case of a ten
percent owner, 110%) of a share of the Companys common stock on the date of grant of such option.
The plan also allows the Board or its appointed committee to establish the exercise period(s) of
any option awards. Granted options have a maximum term of 10 years. This Plan was approved by the
shareholders on July 2, 2009. As of February 26, 2010, there were 887,000 shares available to be
granted under this Plan. At February 26, 2010, there were 76,185 options outstanding under the 1999
Incentive Stock Option Plan, which expired in August 2008,
33
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Non-employee Director Stock Plan:
In September 2005, the Company adopted a stock option plan which allows for the granting to
non-employee members of ETCs Board of Directors of options to purchase up to 600,000 shares of
common stock. The plan provides that option price shall not be less than 100% of the current market
price of the stock on the date of the grant. The amount of each individual award and the vesting
period are determined by the Board of Directors or its appointed committee. Granted options have a
maximum term of 10 years. The Plan shall remain in effect until terminated by the Board of
Directors. At February 26, 2010, there were 520,000 shares available to be granted under this Plan.
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
2010: expected volatility of 112.1% to 354.0%; risk-free interest rate of 0.41%; and an expected
life of 10 years. There were 113,000 grants in 2010 and no grants of stock options in fiscal 2009.
13. Other Related Party Transactions
ETC purchases industrial products from Industrial Instruments Corp. which is owned by
Christine and Charles Walter, the daughter and son-in-law of William F. Mitchell, ETCs President
and Chief Executive Officer. During fiscal 2010 and 2009, the Company purchased $626,000 and
$325,000, respectively, from Industrial Instruments. ETC also rents office space to Industrial
Instruments at ETCs corporate headquarters. During fiscal 2010 and 2009, Industrial Instruments
paid to ETC rent in the amounts of $5,200 and $8,450, respectively.
ETC purchases travel accommodations from Jet Set, a company that employs Kathleen Mahon, the
daughter of Mr. Mitchell. During fiscal 2010 and 2009, ETC purchased travel through Jet Set
totaling $317,000 and $237,000, respectively, and Ms. Mahon received approximately $9,000 in fiscal
2010 and $12,000 in fiscal 2009 from her employer in commissions on account of such purchases. Ms.
Mahon is also engaged by ETC as a consultant to review expense reports submitted by Company
employees. During fiscal 2010 and 2009, Ms. Mahon received $17,000 and $16,000, respectively, in
consideration of such services.
ETC also employs William F. Mitchell, Jr., the son of Mr. Mitchell, as its Vice President,
Contracts/Purchasing, and David Mitchell, the son of Mr. Mitchell, as its Business Unit Manager for
Sterilizers. In fiscal 2010, William F. Mitchell, Jr., received $134,000 and David Mitchell
received $132,000 in compensation from ETC.
14. Commitments and Contingencies
Mends International, Ltd.
On May 29, 2008, a Request for Arbitration was filed against the Company with the Secretariat
of the International Court of Arbitration by Mends International Ltd. (Mends). Mends Request
for Arbitration arose out of a February 3, 1999 contract between the Company and Mends wherein
Mends purchased aeromedical equipment for sale to the Nigerian Air Force. Mends asserted a claim
for breach of contract and demanded $797,486, plus interest and costs. On September 16, 2008,
Mends filed an Amended Request for Arbitration, adding tort claims for conversion and breach of
fiduciary duty and seeking punitive damages. In response, the Company asserted a counterclaim
seeking damages for other disputes with Mends that have arisen under the contract that Mends has
put at issue in this arbitration. On April 27, 2009 the Company participated in an arbitration
hearing in the United Kingdom on this matter. A decision had not been determined in this matter,
although one is anticipated in the near future. The Company is contesting this arbitration case;
however, the Company has recorded a reserve in this matter.
Administrative Agreement with U.S. Navy
In 2007, the Company entered into a settlement agreement with the Department of the Navy to
resolve litigation filed by the Company in May 2003 in connection with a contract for submarine
rescue decompression chambers. As of May 14, 2008, the Company made all payments required under
this settlement agreement and transferred the chambers to the Department of the Navy. From October
2, 2007 through December 12, 2007, the Company was suspended by the Department of the Navy from
soliciting work for the federal government pursuant to the Federal Acquisition Regulation.
However, effective December 12, 2007, the Department of the Navy lifted the Companys suspension
pursuant to the execution by the Company and the Department of the Navy of an Administrative
Agreement. In accordance with the Administrative Agreement, the Company has established and
implemented a program of compliance reviews, audits, and reports.
34
Environmental Tectonics Corporation
Notes to the Consolidated Financial Statements, continued
Notes to the Consolidated Financial Statements, continued
Other Matters
Certain other claims, suits, and complaints arising in the ordinary course of business have
been filed or are pending against the Company. In the event that the Company is unable to meet its
delivery schedules on certain of its contracts, the Company may be subject to penalties, which may
have an adverse impact on its business. In the Companys opinion, 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 Companys financial position or results of operations if
disposed of unfavorably.
15. Employee Benefit Plans:
The Company maintains a retirement savings 401(k) plan for eligible employees. The Companys
contributes 100% to the plan based on the first 4% of the employees qualifying contributions. The
Companys contributions totaled $177,000 and $145,000 in fiscal 2010 and fiscal 2009, 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 employees contribution. The
Company originally reserved 270,000 shares for issuance under this plan, of which 187,322 shares
are still remaining.
16. Subsequent Events:
See Note 7 to the Financial Statements regarding the repurchase of 1,000 shares of Series E
Preferred Stock for $1,000,000.
35