FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 24, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File No. 1-10655
ENVIRONMENTAL TECTONICS CORPORATION
-------------------------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-1714256
-------------------------------- -------------------
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
COUNTY LINE INDUSTRIAL PARK
SOUTHAMPTON, PENNSYLVANIA 18966
----------------------------------------
(Address of principal executive offices)
(Zip Code)
(215) 355-9100
----------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for at least the past 90 days.
Yes x No
------- -------
The number of shares outstanding of the registrant's common stock as of
July 1, 2002 is: 7,153,428
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Environmental Tectonics Corporation
Consolidated Income Statements
(unaudited)
Three months ended
---------------------------
May 24, May 25,
2002 2001
------------ ------------
(in thousands, except share and per share information)
Net Sales $11,207 $ 8,340
Cost of goods sold 7,624 5,647
------- -------
Gross profit 3,583 2,693
------- -------
Operating expenses:
Selling and administrative 2,402 2,076
Research and development 106 168
------- -------
2,508 2,244
------- -------
Operating income 1,075 449
------- -------
Other expenses:
Interest expense 141 258
Other, net 103 33
------- -------
244 291
------- -------
Income before income taxes 831 158
Provision for/(benefit from)
income taxes 273 (61)
Income before minority interest 558 219
Loss attributable to
minority interest (27) (5)
------- -------
Net income $ 585 $ 224
======= =======
Per share information:
Income available to common
stockholders $ 585 $ 224
Income per share: basic $ 0.08 $ 0.03
Income per share: diluted $ 0.08 $ 0.03
Number of shares: basic 7,147,000 7,139,000
Number of shares: diluted 7,496,000 7,557,000
The accompanying notes are an integral part of the consolidated financial
statements.
2
Environmental Tectonics Corporation
Consolidated Balance Sheets
May 24, February 22,
2002 2002
----------- ------------
(unaudited)
-----------
(amounts in thousands,
except share information)
Assets
Current assets:
Cash and cash equivalents $ 632 $ 2,261
Cash equivalents restricted for letters of credit 752 569
Accounts receivable, net 19,969 19,856
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 9,287 9,391
Inventories 8,003 7,161
Deferred tax asset 715 715
Prepaid expenses and other current assets 1,400 921
------- -------
Total current assets 40,758 40,874
Property, plant and equipment, at cost, net of accumulated
depreciation of $9,472 at May 24, 2002 and $9,303 at
Feb. 22, 2002 5,410 5,318
Software development costs, net of accumulated amortization of
$6,322 at May 24, 2002 and $6,166 at February 22, 2002 1,560 1,684
Other assets 592 606
------- -------
Total assets $48,320 $48,482
======= =======
Liabilities and Stockholders' Equity
Liabilities
Current liabilities:
Current portion of long-term debt $ 280 $ 281
Accounts payable - trade 3,611 3,438
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 588 499
Customer deposits 3,946 3,684
Accrued income taxes 692 731
Accrued liabilities 1,744 1,558
------- -------
Total current liabilities 10,861 10,191
------- -------
Long-term debt, less current portion:
Credit facility payable to banks 10,671 11,755
Long-Term Bonds, net 4,645 4,920
Other 14 13
------- -------
15,330 16,688
------- -------
Deferred income taxes 735 735
------- -------
Total liabilities 26,926 27,614
------- -------
Minority interest 59 86
------- -------
Stockholders' Equity
Common stock; $.05 par value; 20,000,000 shares authorized;
7,147,096 and 7,142,946 issued and outstanding at
May 24, 2002 and February 22, 2002, respectively 358 357
------- -------
Capital contributed in excess of par value of common stock 6,722 6,703
------- -------
Accumulated other comprehensive loss (224) (172)
Retained earnings 14,479 13,894
------- -------
Total stockholders' equity 21,335 20,782
------- -------
Total liabilities and stockholders' equity $48,320 $48,482
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
Environmental Tectonics Corporation
Consolidated Statements of Cash Flows
(unaudited)
Three months ended
May 24, May 25,
2002 2001
------------ ------------
(amounts in thousands)
Cash flows from operating activities:
Net income $ 585 $ 224
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 327 307
Provision for losses on accounts receivable and inventories 27 27
Minority interest (27) (5)
Changes in operating assets and liabilities:
Accounts receivable (113) 294
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 104 (1,659)
Inventories (1,095) (957)
Prepaid expenses and other assets (479) (329)
Other assets 12 47
Accounts payable 173 415
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 89 (1,359)
Customer deposits 262 673
Accrued income taxes (39) (128)
Other accrued liabilities 186 42
------- -------
Net cash provided by/(used in) operating activities 12 (2,408)
------- -------
Cash flows from investing activities:
Acquisition of equipment (35) (474)
Capitalized software development costs (32) (123)
------- -------
Net cash used in investing activities (67) (597)
Cash flows from financing activities:
Borrowings under credit facility 6,262 3,922
Payments under credit facility (7,346) (1,008)
Repayment of long-term bonds (275) -
Deferred financing costs - (80)
Cash equivalents restricted for letters of credit (183) 348
Proceeds from issuance of common stock/warrants 20 171
Capital leases repayments/other - (631)
------- -------
Net cash (used in)/provided by financing activities (1,522) 2,722
------- -------
Effect of exchange rate changes on cash (52) 4
Net decrease in cash and cash equivalents (1,629) (279)
Cash and cash equivalents at beginning of period 2,261 851
------- -------
Cash and cash equivalents at end of period $ 632 $ 572
======= =======
Supplemental schedule of cash flow information:
Interest paid 110 234
Income taxes paid 472 193
Supplemental information on noncash operating and investing activities:
During the three months ended May 24, 2002, the Company reclassified
$226 from inventory to property, plant and equipment.
The accompanying notes are an integral part of the consolidated financial
statements.
4
Environmental Tectonics Corporation
Notes to Consolidated Financial Statements
(amounts in dollars, except where noted and share and per share information)
1. Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Environmental Tectonics Corporation ("ETC" or the "Company"), its wholly-owned
subsidiaries ETC International Corporation, Entertainment Technology
Corporation, and ETC Europe, and its majority-owned subsidiary ETC-PZL Aerospace
Industries, Ltd. ("ETC-PZL").
The accompanying consolidated financial statements have been prepared by
Environmental Tectonics Corporation, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission, and reflect all
adjustments which, in the opinion of management, are necessary for a fair
statement of the results for the interim periods presented. All such adjustments
are of a normal recurring nature.
Certain information in footnote disclosures normally included in financial
statements prepared in conformity with accounting principles generally accepted
in the United States of America has been condensed or omitted pursuant to such
rules and regulations and the financial results for the period presented may not
be indicative of the full year's results, although the Company believes the
disclosures are adequate to make the information presented not misleading. These
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's Annual Report on Form 10-K for
the year ended February 22, 2002. Certain reclassifications have been made to
the fiscal 2002 financial statements to conform with the fiscal 2003
presentation.
2. Earnings per Share
Basic earnings per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted average common shares
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common stock
were exercised and converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. The following table
demonstrates the components of basic and diluted earning per share for the three
month periods ended May 24, 2002 and May 25, 2001.
Three months ended
May 24, May 25,
2002 2001
-------- --------
(amounts in thousands, except
share and per share information)
Net income $585 $224
Income available to common
stockholders $585 $224
========= =========
Basic earnings per share:
Weighted average shares 7,147,000 7,139,000
Per share amount $0.08 $0.03
========= =========
Diluted earnings per share:
Weighted average shares 7,147,000 7,139,000
Effect of dilutive securities:
Stock options 38,000 104,000
Stock warrants 311,000 314,000
--------- ---------
7,496,000 7,557,000
Per share amount $0.08 $0.03
========= =========
5
At May 24, 2002, there were stock options to purchase the Company's stock
totaling 301,000 shares which were not included in the computation of diluted
earnings per share, as the effect of such would be anti-dilutive.
3. Accounts Receivable
The components of accounts receivable are as follows:
May 24, February 22,
2002 2002
------------ ------------
(amounts in thousands)
U.S. Government receivables billed and unbilled contract costs
subject to negotiation $ 6,654 $ 6,281
U.S. commercial receivables billed 4,436 2,918
International receivables billed and unbilled contract costs
subject to negotiation 9,252 11,030
------- -------
20,342 20,229
Less allowance for doubtful accounts (373) (373)
------ -------
$19,969 $19,856
======= =======
U.S. Government receivables billed and unbilled contract costs subject to
negotiation:
Unbilled contract costs subject to negotiation represent claims made or to
be made against the U.S. Government under a contract for a centrifuge. These
costs were recorded beginning in fiscal year 1994, including $1,148,000 recorded
during the first quarter of fiscal 2001. The Company has recorded claims,
amounting to $3,898,000 to the extent of contract costs incurred, and accounts
receivable of $1,649,000 representing the balance due under the contract. On May
9,2002, the Company reached a final settlement agreement totaling approximately
$6.9 million with the U.S. Navy for all outstanding amounts. This amount was
collected in full on July 2, 2002. The gain resulting from the settlement, the
amount in excess of receivables and claims recorded to date and additional
subcontractor liabilities, will be reflected in future fiscal quarters.
International receivables and unbilled contract costs subject to negotiation:
International receivables billed includes $700,000 at May 24, 2002 and
February 22, 2002, respectively, related to a contract with the Royal Thai Air
Force.
6
In October 1993, the Company was notified by the Royal Thai Air Force
("RTAF") that the RTAF was terminating a certain $4,600,000 simulator contract
with the Company. Although the Company had performed in excess of 90% of the
contract, the RTAF alleged a failure to completely perform. In connection with
this termination, the RTAF made a call on a $230,000 performance bond, as well
as a draw on an approximately $1,100,000 advance payment letter of credit. Work
under this contract had stopped while under arbitration, but on October 1, 1996,
the Thai Trade Arbitration Counsel rendered its decision under which the
contract was reinstated in full and the Company was given a period of nine
months to complete the remainder of the work. Except as noted in the award, the
rights and obligations of the parties remained as per the original contract
including the potential invoking of penalties or termination of the contract for
delay. On December 22, 1997, the Company successfully performed acceptance
testing and the unit passed with no discrepancy reports. Although the contract
was not completed in the time allotted, the Company has requested an extension
on the completion time due to various extenuating circumstances, including
allowable "force majeure" events, one of which was a delay in obtaining an
export license to ship parts required to complete the trainers. On August 30,
2001, the Company received a payment of $230,000 representing the amount due on
the performance bond; the balance of $700,000 due on the contract is still under
review by the customer but it is probable that the Company will institute legal
proceedings to collect the balance. At this point the Company is not able to
determine what, if any, impact the extended completion period will have upon the
receipt of final payment.
Unbilled contract costs subject to negotiation represent claims made or to
be made against an international customer for two contracts covering 1996 to the
present. Claims receivables and resulting revenue aggregating $5,735,000 have
been recorded. Claim costs have been incurred in connection with customer caused
delays, errors in specifications and designs, other out-of-scope items and
exchange losses and may not be received in full during fiscal 2003. In
conformity with accounting principles generally accepted in the United States of
America, revenue recorded by the Company from a claim does not exceed the
incurred contract costs related to the claim. The Company has submitted a claim
for one of the contracts to the customer and has also submitted to the customer
requests for equitable contract price adjustments on the other contract. The
Company is currently updating and finalizing additional claims. As a related
item, during the third quarter of fiscal 2000, the aforementioned international
customer, citing failure to deliver product within contract terms, assessed
liquidated damages totalling approximately $1,600,000 on two contracts currently
in progress. The Company disputes the basis for these liquidated damages and
plans to contest them vigorously. However, following generally accepted
accounting principles, the Company has reduced contract values and corresponding
revenue recognition by approximately $1,600,000.
On July 20, 2001, the Company was notified by the international customer
that they were terminating the centrifuge contract, which was approximately 90%
complete. The termination included a request for the refund of advance milestone
payments made to date. At this point the Company is not able to assess the
ultimate impact of the termination on current operations and financial results.
The Company is currently in arbitration on this matter. As of May 24, 2002, the
Company had recorded on its books the following amounts for the contract
inception to date: revenue (including claims revenue) of $19,730,000, cost of
goods sold of $13,202,000, costs and estimated earnings in excess of billings on
uncompleted long term contracts of $16,605,000, claims receivables of
$3,125,000, and billings in excess of costs and estimated earnings on
uncompleted long term contracts of $10,099,000.
7
4. Inventories
Inventories are valued at the lower of cost or market using the first in,
first out (FIFO) method and consist of the following (net of reserves):
May 24, February 22,
2002 2002
---------- ------------
(amounts in thousands)
Raw materials $ 48 $ 110
Work in Process 5,402 4,470
Finished Goods 2,553 2,581
------ ------
Total $8,003 $7,161
5. Stockholders' Equity
The components of stockholders' equity at February 22, 2002 and May 24,
2002 were as follows:
(amounts in thousands, except share information)
Common Stock Additional Accumulated
------------------ Paid in other comp. Retained
Shares Amount Capital income Earnings Total
--------- ------ ---------- -------- -------- --------
Balance, February 22,
2002 7,142,946 $357 $6,703 $ (172) $13,894 $20,782
Net income for three
month period ended
May 24, 2002 - - - - 585 585
Foreign Currency Translation
Adjustment - - - (52) - (52)
--------- ---- ------ ------ ------- -------
Total comprehensive income - - - (52) 585 533
Shares issued in con-
nection with employee
stock option plans 4,150 1 19 - - 20
--------- ---- ------ ------ ------- -------
Balance at May 24,
2002 7,147,096 $358 $6,722 $ (224) $14,479 $21,335
========= ==== ====== ====== ======= =======
8
6. Business Segment Presentation:
The Company primarily manufactures under contract various types of
high-technology equipment that it has designed and developed. The Company
considers its business activities to be divided into two segments: Aircrew
Training Systems (ATS) and Industrial Simulation. The ATS business segment
produces devices which create and monitor the physiological effects of motion,
including spatial disorientation and centrifugal forces for the medical,
training, research and entertainment markets. The Industrial Group produces
chambers that create environments that are used for sterilization, research, and
medical applications. The following segment information reflects the accrual
basis of accounting:
Industrial
ATS Group Total
---------- ---------- ----------
(amounts in thousands)
Three months ended
May 24, 2002
-------------------
Net Sales $ 7,792 $3,415 $11,207
Interest Expense 125 16 141
Deprec. and Amort. 205 122 327
Operating Income/(loss) 1,543 (135) 1,408
Income Tax Prov. 468 (49) 419
Identifiable Assets 34,314 4,505 38,819
Expend. for Seg. Assets 31 4 35
Three months ended
May 25, 2001
-------------------
Net Sales $ 5,545 $2,795 $ 8,340
Interest Expense 214 44 258
Deprec. and Amort. 220 87 307
Operating Income (49) 693 644
Income Tax Prov/Benefit 108 (124) (16)
Identifiable Assets 28,575 5,915 34,490
Expend. for Seg. Assets 393 81 474
Reconciliation to 2002 2001
consolidated amounts ------- ------
Segment operating income $ 1,408 $ 644
Less interest expense (141) (258)
Less income taxes (419) (16)
------- ------
Total profit for segments $ 848 $ 370
Corporate home off. exps. (333) (185)
Interest and other exps. (103) (33)
Income tax benefit 146 77
Minority interest (27) (5)
------- ------
Net income $ 585 $ 224
======= ======
9
Segment operating income consists of net sales less applicable costs and
expenses related to those revenues. Unallocated general corporate expenses and
other miscellaneous fees have been excluded from total profit for segments.
General corporate expenses are primarily central administrative office expenses
including executive salaries, stockholders expenses and legal and accounting
fees. Other miscellaneous expenses include banking and letter of credit fees.
Property, plant and equipment are not identified with specific business
segments, as these are common resources shared by all segments.
Approximately 56.0% of sales totaling $6,276,000 in the first quarter of fiscal
2003 were made to one domestic customer in the ATS segment. Approximately 48% of
sales totaling $4,028,000 in the first quarter of fiscal 2002 were made to one
domestic customer in the ATS segment.
Included in the segment information for the first quarter of fiscal 2003 are
export sales of $2,687,000. Of this amount, there are sales to commercial or
government accounts in China of $1,512,000. Sales to the US government and its
agencies aggregate $580,000 for the period.
Included in the segment information for the first quarter of fiscal 2002 are
export sales of $2,834,000, none of which when aggregated by geographic area
exceeded 10% of total sales for the quarter. Sales to the U.S. government and
its agencies aggregated $786,000 for the period.
7. Recent Accounting Pronouncements
Derivative Financial Instruments
In January 2001, FASB issued SFAS No. 133, " Accounting for Derivative
Instruments and Hedging Activity." SFAS No. 133 requires the recognition of all
derivative financial instruments as either assets or liabilities in the
Consolidated Balance Sheet, and the periodic adjustment of those instruments to
fair value. The classification of gains and losses resulting from changes in the
fair value of derivatives is dependent on the intended use of the derivative and
its resulting designation. Adjustments to reflect changes in fair values of
derivatives that are not considered highly effective hedges are reflected in
earnings. Adjustments to reflect changes in fair values of derivatives that are
considered highly effective hedges are either reflected in earnings and largely
offset by corresponding adjustments related to the fair values of the hedged
items, or reflected in other comprehensive income until the hedged transaction
matures and the entire transaction is recognized in earnings. The change in fair
value of the ineffective portion of a hedge is immediately recognized in
earnings. SFAS No. 133 is effective for periods beginning after June 15, 1999.
This effective date was later deferred to all periods beginning after June 15,
2000 by SFAS No. 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement Number 133" The
adoption of SFAS No. 133 had no impact on the Company's consolidated financial
position or results of operations.
10
Business Combinations and Goodwill and Intangible Assets
On July 20, 2001, the FASB issued SFAS No. 141, "Business Combinations",
and SFAS No. 142, "Goodwill and Intangible Assets". SFAS 141 is effective for
all business combinations completed after June 30, 2001. SFAS 142 is effective
for fiscal years beginning after December 15, 2001; however, certain provisions
of this Statement apply to goodwill and other intangible assets acquired between
July 1, 2001, and the effective date of SFAS 142. Major provisions of these
Statements and their effective dates are as follows:
o all business combinations initiated after June 30, 2001 must use
the purchase method of accounting. The pooling of interest
method of accounting is prohibited except for transactions
initiated before July 1, 2001.
o intangible assets acquired in a business combination must be
recorded separately from goodwill if they arise from contractual
or other legal rights or are separable from the acquired entity
and can be sold, transferred, licensed, rented or exchanged,
either individually or as part of a related contract, asset or
liability.
o goodwill, as well as intangible assets with indefinite lives,
acquired after June 30, 2001, will not be amortized. Effective
February 23, 2002, all previously recognized goodwill and
intangible assets with indefinite lives are no longer subject to
amortization.
o effective February 23, 2002, goodwill and intangible assets with
indefinite lives are to be tested for impairment annually and
whenever there is an impairment indicator.
o all acquired goodwill must be assigned to reporting units for
purposes of impairment testing and segment reporting.
The adoption of SFAS No. 141 and 142 did not have a material impact on the
Company's financial position or results of operations.
11
Asset Retirement Obligations
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS No. 143 applies to all entities, including
rate-regulated entities, that have legal obligations associated with the
retirement of a tangible long-lived asset that result from acquisition,
construction or development and (or) normal operations of the long-lived asset.
The application of this statement is not limited to certain specialized
industries, such as the extractive or nuclear industries. This Statement also
applies, for example, to a company that operates a manufacturing facility and
has a legal obligation to dismantle the manufacturing plant and restore the
underlying land when it ceases operation of that plant. A liability for an asset
retirement obligation should be recognized if the obligation meets the
definition of a liability and can be reasonably estimated. The initial recording
should be at fair value. SFAS No. 143 is effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. The provisions of this statement are not expected to have a material
impact on the financial condition or results of operations of the Company.
Impairment or Disposal of Long-Lived Assets
In August 2001, the FASB issued SFAS No. 144,"Accounting for the Impairment
or Disposal of Long-Lived Assets". SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. However, SFAS No. 144 makes changes
to the scope and certain measurement requirements of existing accounting
guidance. SFAS No. 144 also changes the requirements related to reporting the
effects of a disposal or discontinuance of a segment of a business. SFAS No. 144
is effective for financial statements issued for fiscal years beginning after
December 15, 2001 and interim periods within those fiscal years. The adoption of
this statement did not have a significant impact on the financial condition or
results of operations of the Company.
12
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
(amounts in dollars, except where noted and share and per share amounts)
Forward Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements are based on the Company's current expectations and
projections about future events. These forward-looking statements are subject to
known and unknown risks, uncertainties and assumptions about the Company and its
subsidiaries that may cause actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by such
forward-looking statements.
These forward-looking statements include statements with respect to the
Company's vision, mission, strategies, goals, beliefs, plans, objectives,
expectations, anticipations, estimates, intentions, financial condition, results
of operations, future performance and business of the Company, including but not
limited to, (i) projections of revenue, costs of raw materials, income or loss,
earnings or loss per share, capital expenditures, growth prospects, dividends,
the effects of currency fluctuations, capital structure and other financial
items, (ii) statements of plans and objectives of the Company or its management
or Board of Directors, including the introduction of new products, or estimates
or predictions of actions of customers, suppliers, competitors or regulating
authorities, (iii) statements of future economic performance, (iv) statements of
assumptions and other statements about the Company or its business, and (v)
statements preceeded by, followed by or that include the words "may", "could",
"should", "proforma", "looking forward", "would", "believe", "expect",
"anticipate", "estimate", "intend", "plan", or the negative of such terms or
similar expressions.
These forward-looking statements involve risks and uncertainties, which
are subject to change based on various important factors (some of which, in
whole or in part, are beyond the Company's control). The following factors,
among others, could cause the Company's financial performance to differ
materially from the goals, plans, objectives, intentions and expectations
expressed in such forward-looking statements: (1) the strength of the United
States and global economies in general and the strength of the regional and
local economies in which the Company conducts operations; (2) the effects of,
and changes in, U.S. and foreign governmental trade, monetary and fiscal
policies and laws; (3) the impact of domestic or foreign military or political
conflicts and turmoil; (4) the timely development of competitive new products
and services by the Company and the acceptance of such products and services by
customers; (5) willingness of customers to substitute competitors' products and
services and vice versa; (6) the impact on operations of changes in U.S. and
governmental laws and public policy, including environmental regulations; (7)
the level of export sales impacted by export controls, changes in legal and
regulatory requirements, policy changes affecting the markets, changes in tax
laws and tariffs, exchange rate fluctuations, political and economic
instability, and accounts receivable collection; (8) technological changes; (9)
regulatory or judicial proceedings; (10) the impact of any current or future
litigation involving the Company, and; (11) the success of the Company at
managing the risks involved in the foregoing.
13
The Company cautions that the foregoing list of important factors is not
exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amount of assets and liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities at the date of the Company's financial
statements. Actual results may differ from these estimates under different
assumptions or conditions.
Critical accounting policies are defined as those that are reflective of
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. The Company
believes that its critical accounting policies include those described below.
For a detailed discussion on the application of these and other accounting
policies, see Note 1 in the Notes to the Consolidated Financial Statements
included in the Company's Annual Report on Form 10-K for the fiscal year ended
February 22, 2002.
Revenue Recognition on Long-Term Contracts
As discussed below, when the performance of a contract will extend beyond a
12-month period (and is greater than $100,000), revenue and related costs are
recognized on the percentage-of-completion method of accounting. Profits
expected to be realized on such contracts are based on total estimated sales for
the contract compared to total estimated costs at completion of the contract.
These estimates are reviewed periodically throughout the lives of the contracts,
and adjustments to profits resulting from such revisions are made cumulative to
the date of the change. Estimated losses on long-term contracts are recorded in
the period in which the losses become known.
Some of the Company's largest contracts, including its contracts with the
U.S. and other foreign governments, are accounted for using the
percentage-of-completion method. If the Company does not accurately estimate the
total sales and related costs on such contracts, or if the Company is
unsuccessful in the ultimate collection of associated contract claims, the
estimated gross margins may be significantly impacted or losses may need to be
recognized in future periods. Any such resulting reductions in margins or
contract losses could be material to the Company's results of operations and
financial position.
14
Accounts Receivable
The Company performs ongoing credit evaluations of its customers and adjusts
credit limits based on payment history and the customer's current credit
worthiness, as determined by a review of their current credit information. The
Company continuously monitors collections and payments from its customers and
maintains a provision for estimated credit losses based on historical experience
and any specific customer collection issues that have been identified. While
such credit losses have historically been within the Company's expectations and
the provisions established, the Company cannot guarantee that it will continue
to experience the same credit loss rates that it has in the past. Additionally,
as a result of the concentration of international receivables, the Company
cannot predict the effect, if any, which geopolitical risk and uncertainty will
have on the ultimate collection of such receivables.
Results of Operations
Three months ended May 24, 2002 compared to May 25, 2001.
The Company had net income of $585,000, or $.08 per share (diluted), during
the first quarter of fiscal 2003, versus net income of $224,000 or $.03 per
share (diluted), for the corresponding first quarter of fiscal 2002. Sales for
the first quarter were $11,207,000, an increase of $2,867,000 or 34.4%, over the
corresponding first quarter of fiscal 2002. The primary contributors to the
sales increase were additional revenues in domestic entertainment, which
benefited from continued full production on a large entertainment project, and
worldwide sales for the environmental line, with significant activity on two
large projects for automotive manufacturers in China. Providing partial offsets
were reductions in domestic sterilizer sales, U. S. government and international
hyperbaric sales, and international Aircrew Training Systems (ATS) sales which
have been negatively impacted by global economic conditions. Overall, domestic
sales increased $3,350,000, or 73.0% from the first quarter of fiscal 2002,
primarily reflecting the aforementioned entertainment increase, and represented
70.9% of the Company's total sales, up from 55.0% for the first quarter of
fiscal 2002. Sales to the U.S. Government decreased $204,000, or 26.0%, as
compared to the first quarter of fiscal 2002, and represented 5.2% of total
sales versus 9.4% for the first quarter of fiscal 2002. International sales were
down $274,000 or 9.3%, versus the first quarter of fiscal 2002, and represented
24.0% of total sales, down from 35.5% in the first quarter of fiscal 2002,
reflecting the aforementioned global economic downturn. Throughout the Company's
history, most of the sales for Aircrew Training Products have been made to
international customers. The Company has subsidiaries in the United Kingdom,
Poland and Turkey, maintains regional offices in the Middle East, Asia, and
Canada, and uses the services of approximately 100 independent sales
organizations and agents throughout the world. In the three months ended May 24,
2002, international sales totaling at least ten percent of total sales for the
quarter were made to China. In the three months ended May 25, 2001, there were
no international sales to any country, which totaled at least ten percent of
total sales for the quarter. 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.
15
Risks associated with international operations that might be different
from those domestically include the strength of global economies in general and
the strength of the regional and local economies in which the Company conducts
operations, the effect of foreign military or political conflicts and turmoil,
changes in foreign government trade, monetary and fiscal policies and laws,
export controls, exchange rate fluctuations and political and economic
instability. Unusual risks that might be associated with sales to less developed
nations include U.S. Dollar and monetary system controls and a heightened risk
of political, economic and civil turmoil.
The Company recognizes revenue utilizing three methods. On long-term
contracts, the percentage of completion method is applied based on costs
incurred as a percentage of estimated total costs. Revenue recognized on
uncompleted long-term contracts in excess of amounts billed to customer is
reflected as an asset. Amounts billed to customers in excess of revenue
recognized on uncompleted long-term contracts are reflected as a liability. When
it is estimated that a contract will result in a loss, the entire amount of the
loss is accrued. The effect of revisions in cost and profit estimates for
long-term contracts is reflected in the accounting period in which the facts
requiring the revisions become known. Contract progress billings are based upon
contract provisions for customer advance payments, contract costs incurred, and
completion of specified contract milestones. Contracts may provide for customer
retainage of a portion of amounts billed until contract completion. Retainage is
generally due within one year of completion of the contract. Revenue recognition
under the percentage of completion method requires significant judgment and
therefore involves significant estimates, which are reasonably subject to
change. Revenue for contracts under $100,000, or to be completed in less than
one year, and where there are no post shipment services included in the
contract, and revenue on parts and services, is recognized as shipped. Revenue
on contracts under $100,000, or to be completed in less than one year, and where
post shipment services (such as installation and customer acceptance) are
required, is recognized after customer acceptance. Revenue for service contracts
is recognized ratably over the life of the contract with related material costs
expensed as incurred.
In accordance with accounting principles generally accepted in the United
States of America, revenue on contract claims and disputes, for customer caused
delays, errors in specifications and designs, and other unanticipated causes,
and for amounts in excess of contract value, is generally appropriate if it is
probable that the claim will result in additional contract revenue and if the
amount can be reliably estimated.
Revenue recorded on a contract claim cannot exceed the incurred contract
costs related to that claim. Significant claims outstanding at May 24, 2002
included the U.S. Navy ($5.5 million recorded) and two claims against an
international customer ($5.7 million recorded). On May 9, 2002, the Company
reached a final settlement agreement totaling approximately $6.9 million with
the U.S. Navy for all outstanding amounts. The Company received this settlement
payment on July 2, 2002. The gain resulting from the settlement, the amount in
excess of receivables and claims recorded to date and additional subcontractor
liabilities, will be reflected in future fiscal quarters. Although claim
receivables are recorded as current assets in the financial statements, claim
revenues may not be received in full during fiscal 2003. Claims against the U.S.
Navy totaling approximately $12.0 million were filed in previous years. One of
the claims against the international customer was filed in March 2001, and the
other is being developed.
16
Gross profit for the first quarter of fiscal 2003 increased by $890,000 or
33.0% reflecting the increased sales volume partially offset by a 0.3 percentage
point reduction in the rate as a percent of sales. Rate increases were evidenced
in entertainment and international hyperbaric and ATS sales.
Selling and administrative expenses for the first quarter of fiscal 2003
increased $326,000 or 15.7% as compared to the first quarter of fiscal 2002,
primarily reflecting increased commissions and professional fees. When adjusted
for these items, as a percent of total revenues, selling and administrative
expenses on a pro-forma basis decreased from 21.6% in 2002 to 17.2% in the
current quarter.
Research and development expenses, which are charged to operations as
incurred, decreased by $62,000 or 36.9% for the first quarter of fiscal 2003 as
compared to the first quarter of fiscal 2002 reflecting reduced product
development primarily in the Company's Turkish operation. Most of the Company's
research efforts, which were and continue to be a significant cost of its
business, are included in cost of sales for applied research for specific
contracts, as well as research for feasibility and technology updates.
Interest expense compared to the first quarter of fiscal 2002 was down
$117,000 or 45.3%. This reflected lower interest rates in the current quarter
and reduced amortization of deferred finance costs as most of these balances
were charged off in the third quarter of fiscal 2002.
The Company's tax provision for the first quarter of fiscal 2003 reflected
an estimated 30% rate domestically and a consolidated estimated rate of 33%. The
rate for the first quarter of fiscal 2002 reflected an estimated rate of 30%,
which was, offset by a $100,000 research tax credit.
During fiscal 2002, the Company received inquiries and tax assessments for
the years 1995 through 1999 from Inland Revenue in Great Britain related to the
Company's Great Britain operation. The Company expects to resolve these
assessments in the near future without any significant financial impact.
Additionally, the U. S. Internal Revenue Service is currently performing a
routine audit of the Company's fiscal 2000 tax filing. At this point the Company
is not able to assess whether any additional tax liability will result from the
audit.
17
Liquidity and Capital Resources
During the three-month period ended May 24,2002, the Company generated
$12,000 of cash from operating activities. This was primarily a result of cash
from net income and non-cash expenditures and an increase in customer deposits
partially offset by an increase in inventories and prepaid expenses. Versus last
year's corresponding period, net cash from operations reflected an increase of
$2,420,000.
Investing activities, consisting of minimal purchases for capital equipment
and capitalized software in the first quarter of fiscal 2003, as a total were
down significantly from the first quarter of fiscal 2002.
Financing activities consisted primarily of net repayments on the Company's
bank line and long term bonds and an increase in cash required to secure
international letters of credit.
The Company believes that cash generated from operating activities,
available borrowings under its Credit Agreement, and the proceeds of $6.9
million from the recent settlement with the U. S. Navy will be sufficient to
meet its future obligations.
With respect to the Company's outstanding claims with an international
customer, to the extent the Company is unsuccessful in further recovery of
contract costs, such an event could have a material adverse effect on the
Company's liquidity and results of operations. Historically, the Company has had
good experience in that recoveries have exceeded the carrying value of claims.
On March 29, 2002, the Company signed an amendment to its Revolving Credit
Agreement which extended the expiration date of the of the agreement to November
30, 2002 and increased the interest rate from (i) the bank's prime rate less a
factor ranging from 0% to 0.5% based on the Company's leverage ratio or adjusted
LIBOR to (ii) the bank's prime rate plus 1% for adjusted base rate loans or
adjusted LIBOR plus 3.5% for adjusted LIBOR rate loans. The amendment also
adjusts the Funds Flow Ratio through the expiration date of the Credit
Agreement. On June 5, 2002 the Company's bank agreed to extend the expiration
date of the Credit Agreement to February 28, 2003. Substantially all of the
Company's short-term financing is provided by this bank. On July 2, 2002, the
settlement payment of approximately $6.9 million (see Footnote 3, Accounts
Receivable) was received in full. As of July 3 2002, the Company had
approximately $8.8 million available under its Revolving Credit Agreement.
The Company's current bank agreement is scheduled to expire on February 28,
2003. The accompanying balance sheet as of May 24, 2002 classifies the Company's
bank borrowings under the line as long term debt, in accordance with FASB No. 6.
The Company has received signed term sheets from two new lenders which will
allow for all the Company's bank debt to be refinanced on a long term basis.
This refinancing is currently expected to be completed by the end of August
2002. Under the guidelines of FASB SFAS No. 6, short term obligations which the
Company intends to refinance on a long term basis and which are supported by a
financing agreement(s) that clearly permits the Company to refinance all the
short-term obligation on a long term basis on readily determinable terms may be
properly classified as long-term at the balance sheet date.
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Backlog
The Company's sales backlog at May 24, 2002, and February 22, 2002, for
work to be performed and revenue to be recognized under written agreements after
such dates was approximately $21,631,000 and $28,148,000 respectively. In
addition, the Company's training, maintenance and upgrade contracts backlog at
May 24, 2002, and February 22, 2002, for work to be performed and revenue to be
recognized after that date under written agreements was approximately $3,215,000
and $1,485,000 respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
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Part II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
The constituent instruments defining the rights of the holders of any class
of securities were not modified nor were the rights evidenced by any class of
registered securities materially limited or qualified during the period covered
by this report.
Item 3. Defaults Upon Senior Securities
No defaults occurred during the period covered in this report.
Item 4. Submission of Matters to Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Number Item
------ ----
3.1 Registrant's Articles of Incorporation, as amended, were filed as
Exhibit 3.1 to Registrant's Form 10-K for the year ended February 28,
1997 and are incorporated herein by reference.
3.2 Registrant's By-Laws, as amended, were filed as Exhibit 3 (ii) to
Registrant's Form 10-K for the year ended February 25, 1994, and are
incorporated herein by reference.
10.1 Registrant's 1998 Stock Option Plan was filed on October 8, 1998 on
Form S-8 and is incorporated herein by reference.
10.2 Registrant's Employee Stock Purchase Plan was filed on July 6, 1988 as
exhibit A to the Prospectus included in Registrant's Registration
Statement (File No. 33-42219) on Form S-8 and is incorporated herein by
reference.*
10.3 Registrant's Stock Award Plan adopted April 7, 1993, filed as Exhibit
10(ix) to the Registrant's Form 10-K for the fiscal year ended February
25, 1994 and is incorporated herein by reference.*
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10.5 Revolving Credit Agreement, dated as of march 27, 1997, between the
Registrant and First Union National Bank was filed as Exhibit 10.6 to
Registrant's Form 10-K for the year ended February 28, 1997, and is
incorporated herein by reference.
10.6 Amendment to Revolving Credit Agreement dated as of March 29, 2002 was
filed as Exhibit 10.6 to Registrant's Annual Report on Form 10-K for
the year ended February 22, 2002, and is incorporated herein by
reference.
10.7 Stock Purchase Warrant dated as of December 26, 2001, issued by the
Registrant to ETC Asset Management, LLC was filed as Exhibit 10.7 to
Registrant's Annual Report on Form 10-K for the year ended February 22,
2002, and is incorporated herein by reference.
* Represents a management contract or a compensatory plan or arrangement.
(b) Reports on Form 8-K
The Company did not file any current Reports on Form 8-K during the fiscal
quarter ended May 24, 2002.
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Signatures
Pursuant to the requirements of the Securities Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
Date: July 8, 2002 ENVIRONMENTAL TECTONICS CORPORATION
(Registrant)
By:/s/Duane Deaner
--------------------------------
Duane Deaner,
Chief Financial Officer
(authorized officer and
principal financial officer)
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