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 November 22,2002
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
January 6, 2003 is: 7,153,428
1
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Environmental Tectonics Corporation
Consolidated Income Statements
(unaudited)
Thirteen Weeks Ended Thirty-Nine Weeks Ended
----------------------------- -----------------------------
November 22, November 23, November 22, November 23,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(in thousands, except share and per share information)
Net Sales $12,162 $ 8,230 $ 34,410 $ 23,984
Cost of goods sold 8,583 4,563 23,985 15,231
------- ------- -------- --------
Gross profit 3,579 3,667 10,425 8,753
------- ------- -------- --------
Operating expenses:
Selling and administrative 2,437 2,199 6,881 5,966
Research and development 268 117 487 441
------- ------- -------- --------
2,705 2,316 7,368 6,407
------- ------- -------- --------
Operating income 874 1,351 3,057 2,346
------- ------- -------- --------
Other expenses:
Interest expense 116 450 382 980
Other, net 174 96 324 128
------- ------- -------- --------
290 546 706 1,108
------- ------- -------- --------
Income before income taxes 584 805 2,351 1,238
Provision for
income taxes 154 141 631 62
------- ------- -------- --------
Income before minority interest 430 664 1,720 1,176
(Loss)/gain attributable to
minority interest (6) 2 (37) (7)
------- ------- -------- --------
Net income $ 436 $ 662 $ 1,757 1,183
======= ======= ======== ========
========================================================================================================
Per share information:
Income available to common
stockholders $ 436 $ 662 $ 1,757 $ 1,183
Income per share: basic $ 0.06 $ 0.09 $ 0.25 $ 0.17
Income per share: diluted $ 0.06 $ 0.09 $ 0.23 $ 0.16
Number of shares: basic 7,153,000 7,143,000 7,153,000 7,143,000
Number of shares: diluted 7,481,000 7,497,000 7,493,000 7,496,000
The accompanying notes are an integral part of the consolidated financial
statements.
2
Environmental Tectonics Corporation
Consolidated Balance Sheets
November 22, February 22,
2002 2002
---------------------------
(unaudited)
-------------
(amounts in thousands,
except share information)
Assets
Current assets:
Cash and cash equivalents $ 1,078 $ 2,261
Cash equivalents restricted for letters of credit 5,810 569
Accounts receivable, net 17,307 19,856
Costs and estimated earnings in excess of billings on
uncompleted long-term contracts 5,813 9,391
Inventories 8,766 7,161
Deferred tax asset 715 715
Prepaid expenses and other current assets 973 921
------- -------
Total current assets 40,462 40,874
Property, plant and equipment, at cost, net of accumulated depreci-
ation of $9,803 at November 22, 2002 and $9,303 at February 22,
2002 5,256 5,318
Software development costs, net of accumulated amortization
of $6,651 at November 22, 2002 and $6,166 at February 22, 2002 2,149 1,684
Other assets 487 606
------- -------
Total assets $48,354 $48,482
======= =======
Liabilities and Stockholders' Equity
Liabilities
Current liabilities:
Current portion of long-term debt $ 15,283 $ 281
Accounts payable - trade 1,916 3,438
Billings in excess of costs and estimated earnings on
uncompleted long-term contracts 878 499
Customer deposits 4,933 3,684
Accrued income taxes 77 731
Accrued liabilities 1,762 1,558
------- -------
Total current liabilities 24,849 10,191
------- -------
Long-term debt, less current portion:
Credit facility payable to banks 0 11,755
Long-Term Bonds, net 0 4,920
Other 12 13
------- -------
12 16,688
------- -------
Deferred income taxes 735 735
------- -------
Total liabilities 25,596 27,614
------- -------
Minority interest 49 86
------- -------
Stockholders' Equity
Common stock; $.05 par value; 20,000,000 shares authorized;
7,153,428 and 7,142,946 issued and outstanding at
November 22, 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 (22) (172)
Retained earnings 15,651 13,894
------- -------
Total stockholders' equity 22,709 20,782
------- -------
Total liabilities and stockholders' equity $48,354 $48,482
======= =======
The accompanying notes are an integral part of the consolidated financial
statements.
3
Environmental Tectonics Corporation
Consolidated Statements of Cash Flows
(unaudited)
Thirty-Nine Weeks Ended
November 22, November 23,
2002 2001
------------- ------------
(amounts in thousands)
Cash flows from operating activities:
Net income $ 1,757 $ 1,183
Adjustments to reconcile net income to net cash
provided by/(used in) operating activities:
Depreciation and amortization 1,113 1,106
Provision for losses on accounts receivable and inventories 801 82
Minority interest (37) (4)
Changes in operating assets and liabilities:
Accounts receivable 1,829 (2,807)
Costs and estimated earnings in excess of billings on uncom-
pleted long-term contracts 3,578 (2,235)
Inventories (2,536) (2,283)
Prepaid expenses and other assets (84) (153)
Other assets 23 -
Accounts payable (1,522) 1,294
Billings in excess of costs and estimated earnings on uncom-
pleted long-term contracts 379 (813)
Customer deposits 1,249 1,731
Accrued income taxes (654) 146
Other accrued liabilities 204 (500)
-------- --------
Net cash provided by/(used in) operating activities 6,100 (3,253)
-------- --------
Cash flows from investing activities:
Acquisition of equipment (212) (616)
Capitalized software development costs (326) (381)
-------- --------
Net cash used in investing activities (538) (997)
-------- --------
Cash flows from financing activities:
Borrowings under credit facility 24,024 7,275
Payments under credit facility (25,417) (3,059)
Repayment of long-term bonds (275) (275)
Cash equivalents restricted for letters of credit (5,241) (152)
Proceeds from issuance of common stock/warrants 20 191
Capital leases repayments/other (6) (358)
-------- --------
Net cash (used in)/provided by financing activities (6,895) 3,622
-------- --------
Effect of exchange rate changes on cash 150 -
-------- --------
Net decrease in cash and cash equivalents (1,183) (628)
Cash and cash equivalents at beginning of period 2,261 851
-------- --------
Cash and cash equivalents at end of period $ 1,078 $ 223
======== ========
Supplemental schedule of cash flow information:
Interest paid 351 701
Income taxes paid 1,567 195
Supplemental information on noncash operating and investing activities:
During the thirty-nine weeks ended November 22, 2002, the Company reclassified
$226 from inventory to property, plant and equipment and $624 from inventory
to capitalized software.
During the thirty-nine weeks ended November 23, 2001, the Company purchased
for $100 a 99% ownership in ETC Europe, resulting in goodwill of $26.
The accompanying notes are an integral part of the consolidated financial
statements.
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
thirteen and thirty-nine week periods ended November 22, 2002 and November 23,
2001.
5
Thirteen Weeks Ended Thirty-Nine Weeks Ended
---------------------------- ---------------------------
November 22, November 23, November 22, November 23,
2002 2001 2002 2001
----------------------------- ----------------------------
(amounts in thousands, except
share and per share information)
Net income $436 $662 $1,757 $1,183
Income available to common
stockholders $436 $662 $1,757 $1,183
========= ========= ========= =========
Basic earnings per share:
Weighted average shares 7,153,000 7,143,000 7,153,000 7,143,000
Per share amount $0.06 $0.09 $0.25 $0.17
========= ========= ========= =========
Diluted earnings per share:
Weighted average shares 7,153,000 7,143,000 7,153,000 7,143,000
Effect of dilutive securities:
Stock options 23,000 43,000 32,000 43,000
Stock warrants 305,000 311,000 308,000 310,000
--------- --------- --------- ---------
7,481,000 7,497,000 7,493,000 7,496,000
Per share amount $0.06 $0.09 $0.23 $0.16
========= ========= ========= =========
At November 22, 2002 and November 23, 2001, there were stock options to purchase
the Company's stock totaling 329,000 and 0 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:
November 22, February 22,
2002 2002
------------ ------------
(amounts in thousands)
U.S. Government receivables billed and unbilled contract costs
subject to negotiation $ 1,848 $ 6,281
U.S. commercial receivables billed 2,622 2,918
International receivables billed and unbilled contract costs
subject to negotiation 13,928 11,030
------- -------
18,398 20,229
Less allowance for doubtful accounts (1,091) (373)
------- -------
$17,307 $19,856
======= =======
U.S. Government receivables billed and unbilled contract costs subject to
negotiation:
At February 22, 2002, billed and unbilled contract costs subject to
negotiation included claims made against the U.S. Government under a contract
for a centrifuge. These costs totaled $5,547,000. On May 9,2002, the Company
reached a final settlement agreement totaling approximately $6,900,000 with the
U.S. Navy for all outstanding amounts. This amount was collected in full on July
2, 2002. The results of operations for the thirty-nine weeks ended November 22,
2002 includes sales of $300,000 as part of this settlement. As of November 22,
2002, there were two additional claims in process totaling $1,014,000 for U.S.
government projects.
6
International receivables billed and unbilled contract costs subject to
negotiation:
International receivables billed includes $700,000 at November 22, 2002
and February 22, 2002, respectively, related to a contract with the Royal Thai
Air Force ("RTAF").
In October 1993, the Company was notified by the RTAF that the RTAF was
terminating a $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 stated in 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 open balance of $700,000 due on the contract represents the total
net exposure to the Company on this contract. As of the date of this Quarterly
Report on Form 10-Q, the Company has authorized its Thai attorneys to commence
and prosecute arbitration proceedings, and it is anticipated that this will
occur in the near future. However, since the circumstances that caused a delay
are commonly considered "force majeure" events, and since the contract under
question allows for consideration of "force majeure" events, the Company
believes that the open balance related to this contract is collectible and will
continue to treat this balance as collectible until a final unappealable legal
decision is rendered by a competent Thai tribunal. The Company has enjoyed a
favorable relationship with the RTAF. It currently has both maintenance and
upgrade contracts with the RTAF for the trainers that are the subject of the
dispute, and it is not anticipated that the initiation of legal action against
the RTAF will have any material adverse impact on future sales to the RTAF. At
this point the Company is not able to determine what, if any, impact the
extended completion period will ultimately 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 $9,582,000
7
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 or at
all. 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
claims for the contracts to the customer. 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 it was terminating the centrifuge contract, which was
approximately 90% complete. The termination included a request for the refund of
advance milestone payments made to date. As of November 22, 2002, the Company
had recorded on its books claims receivables (and corresponding revenue)
totaling $6,972,000, representing the aforementioned contract issues. The
Company has been paid $10,100,000 to date on this contract.
The Company is arbitrating disputes which have arisen under this
contract in the United Kingdom but is unable to assess the ultimate impact of
the termination of the contract on current operations and financial condition.
The U.K. Ministry of Defense has submitted its points of claim and the Company
has responded with its points of defense and counterclaim. A limited hearing is
scheduled in Great Britain for late January 2003 to review certain threshold
contractual interpretation issues related to performance and safety. A full
hearing on all issues is tentatively scheduled for October and November 2003.
Based on witness statements, expert reports and other facts, the
Company believes that it has a reasonable basis to refute the safety concerns of
the U.K. Ministry of Defense. The Company has installed seven centrifuges in the
last 15 years throughout the world and none of these centrifuges have caused any
accidents or injuries. The Company does not plan to reduce the carrying value of
the claim of $6,972,000 until all unresolved matters have been properly
adjudicated in the arbitration proceedings.
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):
8
November 22, February 22,
2002 2002
------------ ------------
(amounts in thousands)
Raw materials $ 66 $ 110
Work in Process 6,199 4,470
Finished Goods 2,501 2,581
------ ------
Total $8,766 $7,161
====== ======
5. Stockholders' Equity
The components of stockholders' equity at February 22, 2002 and
November 22, 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 thirty
nine weeks ended
November 22, 2002 - - - - 1,757 1,757
Foreign Currency Translation
Adjustment - - - 150 - 150
--------- ---- ------ ---- ------- -------
Total comprehensive income 150 1,757 1,907
Shares issued in con-
nection with employee
stock option plans 10,482 1 19 - - 20
--------- ---- ------ ---- ------- -------
Balance at November 22,
2002 7,153,428 $358 $6,722 $(22) $15,651 $22,709
========= ==== ====== ==== ======= =======
6. Long Term Debt and Other Long Term Obligations
The following table lists the long term debt and other long term
obligations of the Company as of November 22, 2002.
Payments due by Period
Obligation Total Less than 1 Year 1-3 Years 4-5 Years After 5 Years
---------- ----- ---------------- --------- --------- -------------
Current Portion of
Long Term Debt $ 15,282 $ 15,282 $ - $ - $ -
Capital Leases 13 1 12 - -
Operating Lease 447 51 352 44 -
Other Long Term - - - - -
--------- ---------- -------- -------- --------
Total Obligations $ 15,742 $ 15,334 $ 364 $ 44 $ -
========= ========== ======== ======== ========
The Company's Revolving Credit Agreement expires on February 28, 2003.
The amounts that are due upon expiration of the Revolving Credit Agreement are
recorded as Current Portion of Long Term Debt. For a detailed discussion
regarding the status of the Revolving Credit Agreement and the Company's
liquidity, see "Liquidity and Capital Resources" beginning on page 22 of this
Quarterly Report on Form 10-Q.
9
7. 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 The Industrial Group. 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)
Thirteen weeks ended
November 22, 2002
-------------------
Net Sales 10,137 $2,025 $12,162
Interest Expense 87 29 116
Deprec. And Amort. 330 98 428
Operating Income/(loss) 1,730 (489) 1,241
Income Tax Provision (benefit) 427 (135) 292
Identifiable Assets 26,350 7,579 33,929
Expend. For Seg. Assets 82 21 103
Thirteen weeks ended
November 23, 2001
-------------------
Net Sales $5,809 $2,421 $ 8,230
Interest Expense 380 70 450
Deprec. And Amort. 335 184 519
Operating Income 1,335 287 1,622
Income Tax Provision 206 36 242
Identifiable Assets 32,732 6,584 39,316
Expend. For Seg. Assets 16 4 20
Reconciliation to 2002 2001
consolidated amounts ----- -----
Corporate Assets $14,425 $ 8,198
Total Assets 48,354 47,514
Segment operating income $ 1,241 $ 1,622
Less interest expense (116) (450)
Less income taxes (292) (242)
----- -----
Total profit for segments $ 833 $ 930
Corporate home off. exps. (366) (271)
Other Expenses (174) (96)
Income tax benefit 137 101
Minority interest 6 (2)
----- -----
Net income $ 436 $ 662
===== =====
10
Industrial
ATS Group Total
---------- ---------- ----------
(amounts in thousands)
Thirty-nine weeks ended
November 22, 2002
-------------------
Net Sales $27,255 $7,155 $ 34,410
Interest Expense 319 63 382
Deprec. And Amort. 788 272 1,060
Operating Income/(loss) 4,735 (764) 3,971
Income Tax Provision/(benefit) 1,192 (219) 973
Identifiable Assets 26,350 7,579 33,929
Expend. For Seg. Assets 174 38 212
Thirty-nine weeks ended
November 23, 2001
-------------------
Net Sales $16,395 $7,589 $23,984
Interest Expense 822 158 980
Deprec. And Amort. 748 358 1,106
Operating Income 1,679 1,390 3,069
Income Tax Provision/(benefit) 333 (47) 286
Identifiable Assets 32,732 6,584 39,316
Expend. For Seg. Assets 510 106 616
Reconciliation to 2002 2001
consolidated amounts ----- -----
Corporate Assets $14,425 $8,198
Total Assets 48,354 47,514
Segment operating income $ 3,971 $3,069
Less interest expense (382) (980)
Less income taxes (973) (286)
------- ------
Total profit for segments $ 2,616 $1,803
Corporate home off. exps. (914) (723)
Other Expenses (324) (128)
Income tax benefit 342 224
Minority interest 37 7
------- -------
Net income $ 1,757 $ 1,183
======= =======
11
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, stockholder 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 72% of sales totaling $8,815,000 in the third quarter of
fiscal 2003 were made to one domestic and one international customer in the ATS
segment. Approximately 69% of sales totaling $5,709,000 in the third quarter of
fiscal 2002 were made to one international and one domestic customer in the ATS
segment.
Approximately 67% of sales totaling $23,198,000 in the thirty-nine
weeks ended November 22, 2002 were made to one domestic and one international
customer in the ATS segment. Approximately 60% of sales totaling $14,265,000 in
the thirty-nine weeks ended November 23, 2001 were made to one international and
one domestic customer in the ATS segment.
Included in the segment information for the third quarter of fiscal
2003 are export sales of $8,113,000. A significant portion of this amount
consisted of sales to a government account in Malaysia of $6,345,000. In
addition, sales to the U.S. government and its agencies aggregated $1,150,000
for the period.
Included in the segment information for the third quarter of fiscal
2002 are export sales of $2,941,000. A significant portion of this amount
consisted of sales to commercial or government accounts in Thailand of
$1,729,000. In addition, sales to the U.S. government and its agencies
aggregated $122,000 for the period.
Included in the segment information for the thirty-nine weeks ended
November 22, 2002 are export sales of $12,150,000. A significant portion of this
amount consisted of sales to commercial or government accounts in Malaysia of
$6,345,000 and China of $2,301,000. In addition, sales to the U.S. government
and its agencies aggregated $2,585,000 for the period.
12
Included in the segment information for the thirty-nine weeks ended
November 23, 2001 are export sales of $8,200,000. A significant portion of this
amount consisted of sales to commercial or government accounts in Thailand of
$2,971,000, Great Britain of $1,033,000 and Japan of $1,103,000. In addition,
sales to the U.S. government and its agencies aggregated $939,000 for the
period.
8. Recent Accounting Pronouncements
Rescission of FASB Statements No. 4,44 and 64, Amendment of FASB
No. 13, and Technical Corrections.
In April 2002 the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4,44 and 64, Amendment of FASB No. 13, and Technical Corrections.
SFAS No. 145 changes the accounting principles governing extraordinary items by
clarifying and, to some extent, modifying the existing definition and criteria,
specifying disclosure for extraordinary items and specifying disclosure
requirements for other unusual or infrequently occurring events and transactions
that are not extraordinary items. SFAS No. 145 is effective for financial
statements issued for fiscal years beginning after June 15, 2002, with early
adoption encouraged. The adoption of this statement is not expected to have a
significant impact on the financial condition or results of operations of the
Company.
Accounting for Costs Associated with Exit or Disposal Activities.
In June 2002, the FASB issued SFAS 146, Accounting for Costs Associated
with Exit or Disposal Activities. This Statement provides financial accounting
and reporting guidance for costs associated with exit or disposal activities and
nullifies EITF Issue 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 is effective for exit or
disposal activities initiated after December 31, 2002, with early adoption
encouraged. The adoption of the statement is not expected to have a significant
impact on the financial condition or results of operations of the Company.
13
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 these
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 preceded 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.
14
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 Company's ability to refinance or extend its
existing Revolving Credit Agreement; (2) 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; (3) the effects of, and changes in,
U.S. and foreign governmental trade, monetary and fiscal policies and laws; (4)
the impact of domestic or foreign military or political conflicts and turmoil;
(5) the timely development of competitive new products and services by the
Company and the acceptance of such products and services by customers; (6)
willingness of customers to substitute competitors' products and services and
vice versa; (7) the impact on operations of changes in U.S. and governmental
laws and public policy, including environmental regulations; (8) 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; (9) technological changes; (10) regulatory or
judicial proceedings; (11) the impact of any current or future litigation
involving the Company; and (12) the success of the Company at managing the risks
involved in the foregoing.
The Company cautions that the foregoing list of important factors is
not exclusive. The Company does not undertake to update any forward-looking
statement, whether written or oral, that may be made from time to time by or on
behalf of the Company.
Revenue Recognition Policies
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 to the Company. 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 retention of a portion of amounts billed until contract completion.
Retention 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 the collection of additional
contract revenue and if the amount can be reliably estimated.
15
Revenue recorded on a contract claim cannot exceed the incurred
contract costs related to that claim. Significant claims that were outstanding
at February 22, 2002 included the U.S. Navy ($5.5 million recorded) and two
claims against an international customer (an aggregate of $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
results of operations for the thirty-nine weeks ended November 22, 2002 include
sales of $300,000 as part of this settlement. Although claim receivables are
recorded as current assets in the financial statements, collection may not be
received in full during fiscal 2003 or at all. Claims against the international
customer have been filed. As of November 22, 2002, claims recorded against the
U.S. government totaled $1,014,000 and claims recorded against an international
customer totaled $9,582,000.
Critical Accounting Policies
The discussion and analysis of the Company's financial condition and
results of operations are based upon the Company's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and judgments that
affect the reported amount of assets and liabilities, revenues and expenses, and
related disclosure of contingent assets and liabilities at the date of the
Company's financial statements. Actual results may differ from these estimates
under different assumptions or conditions.
Critical accounting policies are defined as those that reflect
significant judgments and uncertainties, and potentially result in materially
different results under different assumptions and conditions. The Company
believes that its critical accounting policies include those described below.
For a detailed discussion on the application of these and other accounting
policies, see Note 1 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 above, when the performance of a contract which requires a
customer to pay the Company more than $100,000 will extend beyond a 12-month
period, revenue and related costs are recognized on the percentage-of-completion
method of accounting. Profits expected to be realized on such contracts are
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 to the Company.
16
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.
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
Thirteen weeks ended November 22, 2002 compared to thirteen weeks ended November
23, 2001.
Net Income.
-----------
The Company had net income of $436,000, or $.06 per share (diluted),
during the third quarter of fiscal 2003, versus net income of $662,000 or $.09
per share (diluted), for the corresponding third quarter of fiscal 2002.
Sales.
------
Sales for the third quarter of fiscal 2003 were $12,162,000, an
increase of $3,932,000 or 47.8%, over the corresponding third quarter of fiscal
2002. The primary contributors to the sales increase were additional
international revenues for Aircrew Training Systems, which benefited from a
centrifuge project in Malaysia, and government sales in the hyperbaric area for
work on a large U.S. Navy submarine rescue project. Providing partial offsets
were reductions in domestic entertainment and environmental sales and
international hyperbaric systems, which in the prior period benefited from a
large project in Thailand.
17
Domestic Sales.
---------------
Overall, domestic sales in the third quarter of fiscal 2003 decreased
$2,492,000, or 46.2% from the third quarter of fiscal 2002, primarily reflecting
the aforementioned entertainment sales decrease, and represented 23.8% of the
Company's total sales, down from 65.5% for the third quarter of fiscal 2002.
Sales to the U.S. Government in the third quarter of fiscal 2003 increased to
$1,150,000, as compared to $122,000 during the third quarter of fiscal 2002, and
represented 9.5% of total sales in the third quarter of fiscal 2003 versus 1.5%
for the third quarter of fiscal 2002.
International Sales.
--------------------
International sales for the third quarter of fiscal 2003 were up
$5,396,000 or 198.6%, versus the third quarter of fiscal 2002, and represented
66.7% of total sales, as compared to 33.0% in the third quarter of fiscal 2002.
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 thirteen
weeks ended November 22, 2002, international sales totaling at least ten percent
of total sales were made to Malaysia ($6,345,000). In the thirteen weeks ended
November 23, 2001, international sales totaling at least ten percent of total
sales were made to Thailand ($1,729,000). 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.
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.
18
Gross Profit.
-------------
Gross profit for the third quarter of fiscal 2003 decreased by $88,000
or 2.4% as compared to the third quarter of fiscal 2002 as the sales increase
was completely offset by a 15.2 percentage point reduction in the rate as a
percent of sales. The prior period gross profit reflected higher performance for
the entertainment group. As previously reported, a settlement with a major
customer in the prior period generated additional contract revenue and
corresponding gross profit in the quarter. Acting as a partial offset in the
current fiscal period was an increase in gross profit for Aircrew Training
Systems reflecting the aforementioned sales increase.
Selling and Administrative Expenses.
------------------------------------
Selling and administrative expenses for the third quarter of fiscal
2003 increased $238,000 or 10.8% as compared to the third quarter of fiscal
2002, primarily reflecting increased legal, accounting and banking expenses
associated with the Company's ongoing refinancing efforts, and increased claims
expenses.
Research and Development Expenses.
----------------------------------
Research and development expenses, which are charged to operations as
incurred, increased by $151,000 or 129.1% for the third quarter of fiscal 2003
as compared to the third quarter of fiscal 2002, reflecting increased product
development costs 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.
-----------------
Interest expense for the third quarter of fiscal 2003 decreased
$334,000 or 74.2% as compared to the third quarter of fiscal 2002. This
reduction reflected lower interest rates on a lower average loan balance in the
current period and reduced amortization of deferred finance costs as most of
these balances were charged off in the third quarter of fiscal 2002.
Provision for Income Taxes.
---------------------------
The Company's tax provision for the third quarter of fiscal 2003
reflected an estimated 20% rate domestically and a consolidated estimated rate
of 26.4%. The lower than statutory effective tax rate reflects the ongoing
effect of offsetting research and development tax credits. The consolidated rate
for the third quarter of fiscal 2002 reflected an estimated rate of 30% offset
by a $100,000 research tax credit.
19
During the second quarter of fiscal 2003, the Company reached a
settlement with Inland Revenue in Great Britain which resulted in a small
additional tax assessment of $15,000. Additionally, the U. S. Internal Revenue
Service is currently performing a routine audit of the Company's fiscal 2000 tax
filing. The Company is currently not able to assess whether any additional tax
liability will result from the audit.
Results of Operations
Thirty-nine weeks ended November 22, 2002 compared to thirty-nine weeks ended
November 23, 2001.
Net Income.
-----------
The Company had net income of $1,757,000, or $.23 per share (diluted),
for the thirty-nine weeks ended November 22, 2002 versus net income of
$1,183,000, or $.16 per share (diluted), for the corresponding period of fiscal
2002.
Sales.
------
Sales for the thirty-nine weeks ended November 22, 2002 were
$34,410,000, an increase of $10,426,000 or 43.5%, over the corresponding third
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, increased Aircrew Training
Systems which benefited from a centrifuge project in Malaysia, increased
international environmental sales primarily in China, and higher U.S. government
sales for Aircrew Training Systems, including sales of $300,000 from the
aforementioned settlement with the U.S. Navy. Providing partial offsets were a
reduction in international hyperbaric sales and across the board reductions in
sterilizers.
Domestic Sales.
---------------
Overall, domestic sales for the thirty-nine weeks ended November 22,
2002 increased $4,703,000, or 31.4% from the prior period of fiscal 2002,
primarily reflecting the aforementioned entertainment increase, and represented
57.2% of the Company's total sales, down from 62.4% in the prior period. Sales
to the U.S. Government for the thirty-nine weeks ended November 22, 2002
increased $1,552,000, or 150.2%, and represented 7.5% of total sales versus 4.3%
for the prior period.
International Sales.
--------------------
International sales for the thirty-nine weeks ended November 22, 2002
were up $4,171,000 or 52.3%, versus the prior period, and represented 35.3% of
total sales, up from 33.3% in the prior period, reflecting the aforementioned
centrifuge project in Malaysia. Throughout the Company's history, most of the
sales for Aircrew Training Products have been made to international customers.
20
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 thirty-nine weeks ended November 22, 2002, international sales
totaling at least ten percent of total sales were made to Malaysia ($6,345,000).
In the thirty-nine weeks ended November 23, 2001, international sales totaling
at least ten percent of total sales were made to Thailand ($2,827,000).
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.
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.
Gross Profit.
-------------
Gross profit for the thirty-nine weeks ended November 22, 2002
increased by $1,672,000 or 19.1% reflecting the increased sales volume partially
offset by a 6.2 percentage point reduction in the rate as a percent of sales.
The increase in gross profit dollars reflected the aforementioned sales
increases in entertainment and international Aircrew Training Systems. Rate
decreases were evidenced primarily in the environmental, hyperbaric and domestic
simulation sales areas.
Selling and Administrative Expenses.
------------------------------------
Selling and administrative expenses for the thirty-nine weeks ended
November 22, 2002 increased $915,000 or 15.3% as compared to the corresponding
prior period of fiscal 2002, primarily reflecting increased commissions, legal,
accounting and banking expenses associated with the Company's ongoing
refinancing efforts, and increased claims expenses.
Research and Development Expenses.
----------------------------------
Research and development expenses, which are charged to operations as
incurred, increased by $46,000 or 10.4% for the thirty-nine weeks ended November
22, 2002 as compared to the prior period in fiscal 2002, reflecting increased
product development costs 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.
21
Interest Expense.
-----------------
Interest expense for the thirty-nine weeks ended November 22, 2002 was
down $598,000 or 61.0% as compared to the corresponding period in fiscal 2002.
This reduction reflected lower interest rates on a lower average loan balance in
the current period and reduced amortization of deferred finance costs as most of
these balances were charged off in the third quarter of fiscal 2002.
Provision for Income Taxes.
---------------------------
The Company's tax provision for the thirty-nine weeks ended November
22, 2002 reflected an estimated 23% rate domestically and a consolidated
estimated rate of 27%. The lower effective tax rate reflects the ongoing effect
of offsetting research and development tax credits. The consolidated rate for
the thirty-nine weeks ended November 23, 2001 reflected an estimated rate of 30%
offset by a $300,000 research tax credit.
During the thirty-nine weeks ended November 22, 2002 the Company
reached a settlement with Inland Revenue in Great Britain which resulted in an
additional tax assessment of $15,000. Additionally, the U. S. Internal Revenue
Service is currently performing a routine audit of the Company's fiscal 2000 tax
filing. The Company currently is not able to assess whether any additional tax
liability will result from the audit.
Liquidity and Capital Resources
During the thirty-nine week period ended November 22, 2002, the Company
generated $6,100,000 of cash from operating activities. This was primarily the
result of cash received from the collection of the aforementioned $6,900,000
settlement agreement with the U.S. Navy. A partial offset was an increase in
inventories evidencing a contract mix shift to non-POC projects, whose costs are
accumulated in inventory, and a reduction in accounts payable. Net cash from
operations for the thirty-nine week period reflected an increase of $9,353,000
from last year's corresponding period.
Investing activities in the thirty-nine weeks ended November 22, 2002
consisted of net cash used of $538,000 for capital equipment and capitalized
software. Total spending in these categories was down 46.0%, from $997,000 in
the thirty-nine weeks ended November 21, 2001 reflecting a basic maintenance
level of capital replacement.
Financing activities consisted primarily of net repayments on the
Company's revolving bank line and long-term bonds and an increase in cash
required to secure international letters of credit. Since the Company's
revolving bank line expires February 28, 2003 (see below), in the third quarter
of fiscal 2003, the Company's bank required the Company to borrow under the
Revolving Credit Agreement to cash collateralize most of the Company's
international letters of credit. Accordingly, Cash Equivalents Restricted for
Letters of Credit increased from $569,000 at February 22, 2002 to $5,810,000 on
November 22, 2002. The Company is not permitted to use this cash to fund its
operations.
22
Revolving Credit Agreement
--------------------------
Assuming that it is able to obtain an extension of or replacement for
its Revolving Credit Agreement, the Company believes that cash generated from
operating activities and available borrowings under its Revolving Credit
Agreement or any replacement facility will be sufficient to meet its future
obligations. However, if the Company is unable to obtain an extension of or
replacement for its Revolving Credit Agreement, then, subsequent to its
expiration on February 28, 2003, the Company will rely on cash collections from
its operations to fund its operations. This reliance may have a material adverse
effect on the Company's operations in that these collections may not provide the
Company with sufficient cash to meet its future obligations.
The Company is in discussions with new lenders regarding a financing
package which will allow the Company to refinance all of its existing bank debt
on a long term basis. While the Company believes that this refinancing will be
completed by April 30, 2003, there can be no assurance that a new financing
transaction will be completed by such date, if at all.
On March 29, 2002, the Company signed an amendment to its Revolving
Credit Agreement which extended the expiration date of the Revolving Credit
Agreement to November 30, 2002 and increased the interest rate from (i) the
bank's prime rate less a factor ranging from 0% to 0.5% based on the Company's
leverage ratio or adjusted LIBOR to (ii) the bank's prime rate plus 1% for
adjusted base rate loans or adjusted LIBOR plus 3.5% for adjusted LIBOR rate
loans. The amendment also increased the required minimum Funds Flow Ratio
through the expiration date of the Revolving Credit Agreement.
On November 8, 2002, the Company signed an additional amendment to its
Revolving Credit Agreement which further extended the expiration date of the
Agreement to February 28, 2003 and increased the interest rate to the bank's
prime rate plus 1.5% for adjusted base rate loans or adjusted LIBOR plus 4.0%
for adjusted LIBOR rate loans. The Amendment also further increased the required
minimum Funds Flow Ratio through the expiration date of the Revolving Credit
Agreement. Substantially all of the Company's short-term financing is provided
by this bank. As of January 8, 2003, the Company had approximately $5.2 million
available for borrowing under its Revolving Credit Agreement.
At November 22, 2002, the Company was in violation of one of its
Revolving Credit Agreement loan covenants, specifically the requirement to
maintain a specified minimum Funds Flow Ratio. This ratio had been increased in
the
23
amendment signed November 8, 2002. The violation resulted from the impact on the
Company's operations of three items associated with its refinancing efforts and
the February 28, 2003 expiration date of the Company's Revolving Credit
Agreement. Specifically, (i) legal and accounting costs associated with the
refinancing of the Revolving Credit Agreement were charged to the income
statement in the current quarter, reducing net income, (ii) cash borrowings
under the Revolving Credit Agreement were increased by $4.9 million in the
quarter to cash collaterialize the Company's international letters of credit,
and (iii) all of the cash borrowings under the Revolving Credit Agreement and
the balance of bonds outstanding had to be reclassified as short-term debt.
As of the date of this Quarterly Report on Form 10-Q, the Company has not
received a waiver for this violation. Under the terms of the Revolving Credit
Agreement, violation of the covenant is an event of default which allows the
bank certain remedies including the right to refuse to make any further advances
or loans, declare the unpaid principal balance and all other obligations
immediately due and payable, offset any of the Company's cash balances against
any open obligations, and exercise other legal remedies to protect and enforce
its rights. As of the date of this Quarterly Report on Form 10-Q, the bank has
not notified the Company that it intends to pursue any of these remedies.
However, there can be no assurance that the bank will not elect to pursue any of
these remedies at some time in the future. If the bank elects to exercise any of
these remedies, then such event may have a material adverse effect on the
Company's liquidity and the ability to conduct its future operations.
Contract Claims
---------------
Historically, the Company has had good experience with regard to its
contract claims in that recoveries have exceeded the carrying value of claims.
On May 9, 2002, the Company reached a final settlement agreement totaling
approximately $6,900,000 with the U.S. Navy for all outstanding amounts. The
Company received this settlement payment on July 2, 2002. The carrying value of
this claim at the time of settlement was $5,500,000. As of November 22, 2002,
claims recorded against the U.S. government totaled $1,014,000 and claims
recorded against an international customer totaled $9,582,000.
The Company is arbitrating disputes which have arisen under a contract
with one of its international customers in the United Kingdom but is unable to
assess the ultimate impact of the termination on current operations and
financial condition. The U.K. Ministry of Defense has submitted its points of
claim and the Company has responded with its points of defense and counterclaim.
A limited hearing is scheduled in Great Britain for late January 2003 to review
certain threshold contractual interpretation issues related to performance and
safety. A full hearing on all issues is tentatively scheduled for October and
November 2003.
Based on witness statements, expert reports and other facts, the
Company believes that it has a reasonable basis to refute the safety concerns of
the U.K. Ministry of Defense. The Company has installed seven centrifuges in the
last 15 years throughout the world and none of these centrifuges have caused any
accidents or injuries. 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. The Company does not plan
to reduce the carrying value of the claim until all unresolved matters have been
properly adjudicated in the arbitration proceedings.
24
The Company has an open receivable balance of $700,000 due from the
RTAF. This amount represents the total net exposure to the Company on this
contract. As of the date of this Quarterly Report on Form 10-Q, the Company has
authorized its Thai attorneys to commence and prosecute arbitration proceedings,
and it is anticipated that this will occur in the near future. However, since
the circumstances that caused a delay are commonly considered "force majeure"
events, and since the contract under question allows for consideration of "force
majeure" events, the Company believes that the open balance related to this
contract is collectible and will continue to treat this balance as collectible
until a final unappealable legal decision is rendered by a competent Thai
tribunal. The Company has enjoyed a favorable relationship with the RTAF. It
currently has both maintenance and upgrade contracts with the RTAF for trainers
that are the subject of the dispute, and it is not anticipated that the
initiation of legal action against the RTAF will have any material adverse
impact on future sales to the RTAF. At this point the Company is not able to
determine what, if any, impact the extended completion period will ultimately
have upon the receipt of final payment under this contract.
Backlog
-------
The Company's sales backlog at November 22, 2002, and February 22,
2002, for work to be performed and revenue to be recognized under written
agreements after such dates was approximately $22,121,000 and $28,148,000
respectively. In addition, the Company's training, maintenance and upgrade
contracts backlog at November 22, 2002, and February 22, 2002, for work to be
performed and revenue to be recognized after that date under written agreements
was approximately $3,728,000 and $1,485,000 respectively.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable.
Item 4. Controls and Procedures.
Under the supervision and with the participation of the Company's
management, including the Company's principal executive officer and principal
financial officer, we have evaluated the effectiveness of the design and
operation of the Company's disclosure controls and procedures within 90 days of
the filing date of this report, and, based on their evaluation, the Company's
principal executive officer and principal financial officer have concluded that
these controls and procedures are effective. There were no significant changes
in the Company's internal controls or in other factors that could significantly
affect these controls subsequent to the date of their evaluation.
25
Disclosure controls and procedures are the Company's internal controls
and other procedures that are designed to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934, as amended, is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files under the
Exchange Act is accumulated and communicated to the Company's management,
including the Company's principal executive officer and principal financial
officer, as appropriate to allow timely decisions regarding required disclosure.
26
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
As of November 22, 2002, the Company was in default of its Revolving
Credit Agreement with its bank. This default occurred due to the breach of a
covenant to maintain a specified Funds Flow Ratio. As of the date of this
Quarterly Report on Form 10-Q, the Company remains in default of this covenant.
Pursuant to the terms of the Revolving Credit Agreement, upon an Event of
Default, the bank may, in its discretion, elect to pursue various remedies
including:
o refusing to make any further advances or loans to the Company;
o declaring the unpaid balance and all other obligations of the
Company under the Revolving Credit Agreement immediately due and
payable;
o offsetting any of the Company's cash balances deposited at the bank
against any open obligations; and
o exercising any other legal remedies to protect and enforce its
rights.
As of the date of this Quarterly Report on Form 10-Q, the bank has not notified
the Company that it intends to pursue any of these remedies. However, there can
be no assurance that the bank will not elect to pursue any of these remedies at
some time in the future. If the bank elects to exercise any of these remedies,
then such event may have a material adverse effect on the Company's liquidity
and the ability to conduct its future operations.
Item 4. Submission of Matters to Vote of Security Holders
At the Company's Annual Meeting of Stockholders held on September 5,
2002 the following proposal was adopted by the vote specified below. No other
matters were submitted to a vote of security holders at the Annual Meeting.
27
Proposal one: To elect five directors to serve until successors have
been elected and qualified.
Abstentions and
Nominee For Withheld Broker Non-votes
------- --------- ----------- ---------------
Howard W. Kelley 6,313,883 626,105 0
David Lazar 6,313,883 626,105 0
Richard McAdams 6,833,263 106,725 0
William F. Mitchell 6,833,263 106,725 0
Pete L. Stephens 6,900,458 39,530 0
In December 2002, Mr. Lazar resigned from his position as a director of the
Company for personal reasons.
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 re
incorporated herein by reference.
10.1 Amendment to Revolving Credit Agreement dated as of November 8, 2002.
99.1 Certification dated January 13, 2003 pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
made by William F. Mitchell, Chief Executive Officer.
99.2 Certification dated January 13, 2003 pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
made by Duane D. Deaner, Chief Financial Officer.
(b) Reports on Form 8-K
The Company did not file a current Report on Form 8-K during the fiscal
quarter ended November 22, 2002.
28
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.
ENVIRONMENTAL TECTONICS CORPORATION
(Registrant)
Date: January 13, 2003 By:/s/ William F. Mitchell
-------------------------------------
William F. Mitchell
President and Chief Executive
Officer
(Principal Executive Officer)
Date: January 13, 2003 By:/s/ Duane Deaner
-------------------------------------
Duane Deaner,
Chief Financial Officer
(Principal Financial and
Accounting Officer)
29
CERTIFICATION
I, William F. Mitchell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Environmental
Tectonics Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of the quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: January 13, 2003
By:/s/ William F. Mitchell
------------------------------------------
William F. Mitchell
President and Chief Executive Officer
30
CERTIFICATION
I, Duane D. Deaner, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Environmental
Tectonics Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: January 13, 2003
By:/s/ Duane D. Deaner
--------------------------------
Duane D. Deaner
Chief Financial Officer
31
INDEX OF EXHIBITS
-----------------
10.1 Eighth Amendment to Revolving Credit Agreement dated as of June 5,
2002.
99.1 Certification dated January 13, 2003 pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
made by William F. Mitchell, Chief Executive Officer.
99.2 Certification dated January 13, 2003 pursuant to 18 U.S.C. Section 1350
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
made by Duane D. Deaner, Chief Financial Officer.
32