-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KTUwO8xL7l/2U904HZmvazoljc3uBAYNteTgNSFwT0SMYdgKN2+1fuB/V2GXIvNi 1Md7p7/qdmCINMICN/lIiw== 0000950116-04-001739.txt : 20040527 0000950116-04-001739.hdr.sgml : 20040527 20040527170623 ACCESSION NUMBER: 0000950116-04-001739 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 20040227 FILED AS OF DATE: 20040527 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ENVIRONMENTAL TECTONICS CORP CENTRAL INDEX KEY: 0000033113 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS ELECTRICAL MACHINERY, EQUIPMENT & SUPPLIES [3690] IRS NUMBER: 231714256 STATE OF INCORPORATION: PA FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-10655 FILM NUMBER: 04835703 BUSINESS ADDRESS: STREET 1: COUNTY LINE INDUSTRIAL PARK CITY: SOUTHAMPTON STATE: PA ZIP: 18966 BUSINESS PHONE: 2153559100 MAIL ADDRESS: STREET 1: COUNTYLINE INDUSTRIAL PARK CITY: SOUTHAMPTON STATE: PA ZIP: 18966 FORMER COMPANY: FORMER CONFORMED NAME: ENVIRONMENTAL TECHNOLOGY CORP DATE OF NAME CHANGE: 19730208 10-K 1 ten-k.txt 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 - -------------------------------------------------------------------------------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended February 27, 2004 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 Number 1-10655 ENVIRONMENTAL TECTONICS CORPORATION ----------------------------------- Pennsylvania 23-1714256 - ------------------------------------------------ ------------------------------------ (State or other jurisdiction of incorporation or (I.R.S. Employer Identification No.) organization)
County Line Industrial Park Southampton, Pennsylvania 18966 -------------------------------------------------------- (Address of principal executive offices, Zip Code) Registrant's telephone number, including area code (215) 355-9100 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: Title of Each Class Name of Each Exchange on Which Registered - -------------------------------------- ----------------------------------------- Common Stock, par value $.05 per share American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE 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 the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X] As of May 14, 2004, the aggregate market value of the registrant's common stock held by non-affiliates of the registrant was approximately $46,503,000 based upon the closing sale price of the registrant's common stock on the American Stock Exchange of $8.59 on such date. See footnote (1) below. As of May 14, 2004, there were 7,634,910 shares of the registrant's common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE. Portions of Registrant's 2004 Annual Report to Stockholders are incorporated by reference in Part II, Items 5, 6, 7, and 8. Index to Exhibits appears after page 20 of this Report - -------------------------------------------------------------------------------- (1) The information provided is not an admission that any person whose holdings are excluded from the figure is not an affiliate or that any person whose holdings are included is an affiliate and any such admission is hereby disclaimed. The information provided is solely for recordkeeping purposes of the Securities and Exchange Commission. ENVIRONMENTAL TECTONICS CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED FEBRUARY 27, 2004
TABLE OF CONTENTS PART I ITEM 1 - BUSINESS........................................................................................... 1 ITEM 2 - PROPERTIES......................................................................................... 10 ITEM 3 - LEGAL PROCEEDINGS.................................................................................. 11 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................ 11 PART II ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS........................... 11 ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA............................................................... 11 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.............. 11 ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................................... 11 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................................ 12 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE............... 12 ITEM 9A CONTROLS AND PROCEDURES ........................................................................... 12 PART III ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................................. 13 ITEM 11 - EXECUTIVE COMPENSATION............................................................................. 15 ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS..... 15 ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................................... 16 ITEM 14 - INFORMATION REGARDING THE COMPANY'S INDEPENDENT PUBLIC ACCOUNTANTS................................. 17 PART IV ITEM 16 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.................................... 17 SIGNATURES ................................................................................................... 20
(i) FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on our current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about us and our subsidiaries that may cause 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 our vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of the company, including but not limited to, (i) projections of revenues, costs of raw materials, income or loss, earnings or loss per share, capital expenditures, growth prospects, dividends, capital structure, other financial items and the effects of currency fluctuations, (ii) statements of our plans and objectives, including the introduction of new products, or estimates or predictions of actions of customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, (iv) statements of assumptions and other statements about us or our business, and (v) statements preceded by, followed by or that include the words, "may," "could," "should," "looking forward," "would," "believe," "expect," "anticipate," "estimate," "intend," "plan," or the negative of such terms or similar expressions. These forward-looking statements involve risks and uncertainties which are subject to change based on various important factors. Some of these risks and uncertainties, in whole or in part, are beyond our control. Factors that might cause or contribute to such a material difference include, but are not limited to, those discussed in this Annual Report on Form 10-K, in the section entitled "Risks Related to Our Business." Shareholders are urged to review these risks carefully prior to making an investment in the Company's common stock. We do not undertake to update any forward-looking statement, whether written or oral, that we may make from time to time or that may be made on our behalf from time to time. PART I ITEM 1. BUSINESS We were incorporated in 1969 in Pennsylvania and are principally engaged in the design, manufacture and sale of software driven products used to create and monitor the physiological effects of motion on humans and equipment and to control, modify, simulate and measure environmental conditions. These products include aircrew training systems, entertainment products, sterilizers, environmental and hyperbaric chambers and other products that involve similar manufacturing techniques and engineering technologies. SEGMENTS We operate in two primary business segments, Aircrew Training Systems ("ATS") and the Industrial Group. Aircrew Training Systems. This segment includes three primary product groups: aircrew training devices, entertainment products and disaster management simulation. Aircrew Training Devices. Our aircrew training devices are used for medical research, advanced tactical and physiological flight training, and for the indoctrination and testing of military and commercial pilots. The major devices that we sell in this business segment are military and commercial flight simulators, night vision trainers, water survival training equipment, disorientation training equipment, human centrifuges, ejection seat trainers and vehicle and tank simulators. We provide operational and maintenance services for installed equipment that we manufacture as well as for equipment produced by others. Entertainment Products. Our entertainment products consist of motion-based simulation rides and other products for the education and amusement industries. Disaster Management Simulation. Our Disaster Management Simulation line includes real-time interactive training programs that provide instruction on various disaster situations. The Aircrew Training System segment generated 61%, 73% and 70% of our consolidated revenues for the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002, respectively. Industrial Group. This segment includes three primary product lines: sterilizers, environmental systems and other products, and hyperbarics. Sterilizers. We manufacture steam and gas sterilizers for various industrial and pharmaceutical applications. We concentrate on marketing larger custom-designed sterilizers to the pharmaceutical and medical device industries. Environmental Systems and Other Products. Our environmental systems business consists of the design and fabrication of sampling and analysis systems, and test equipment and systems. The simulation systems generally consist of an enclosed chamber with instrumentation and equipment which enable the customer to control and modify environmental factors such as temperature, pressure, humidity, wind velocity and gas content to produce desired conditions. These products include controlled air systems for automotive companies and environmental chambers for HVAC and other applications. Hyperbarics. Our hyperbarics product line includes monoplace (single person) and multiplace (multiple persons) chambers for high altitude training, decompression and wound care applications. Sales of Industrial Group products generated 39%, 27% and 30% of our consolidated revenues for the years ended February 27, 2004, February 28, 2003 and February 22, 2002, respectively. We also provide control upgrades, maintenance and repair services and spare parts for equipment which we manufacture and for equipment made by other manufacturers. For a more complete description of financial information regarding our business segments, see "Note 9. Business Segment Information" to our consolidated financial statements in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. MARKETING We currently market our products and services primarily through our sales offices and employees. At February 27, 2004, approximately 21 employees were committed to sales and marketing functions. We use branch offices in the United Kingdom, the Middle East, and Asia as well as the services of approximately 100 independent sales organizations in seeking foreign orders for our products. PRODUCT DEVELOPMENT We are continually developing new products and improving existing products in response to inquiries from customers and in response to our determination that particular products should be produced or significantly improved. Although we do not have a separate research and development group, we have several technical personnel whose main activity is the development and integration of new technologies into our existing products. These personnel include the Vice-President Engineering Manager and the Vice-President of Development whose additional responsibility is the introduction of product extensions and new applications of existing technology. Within the Aircrew Training Systems segment, product development emphasizes enhancing control systems and software graphics and exploring commercial possibilities. Our product development efforts focus on two areas: - Disaster Management Simulation. We are nearing completion of a major contract from the City of Chicago to develop, install and maintain a computer-based Incident Command Simulator. Additionally, we are completing orders from respected fire schools throughout the world for simulation products. We will continue to explore product applications and extensions to our intelligent virtual reality products. - G-force and Disorientation Trainers. - We recently introduced the Authentic Tactical Flight Simulator Model 400 (ATFS 400), which we believe is the world's first ground-based simulator capable of creating an authentic simulated tactical maneuvering environment. Utilizing proprietary centrifuge and simulation technology, high-fidelity models of the airplane's dynamic performance, the threats experienced by an aircraft in combat and other battle space factors are integrated into the motion controls to create a fully authentic flight environment for any specific combat aircraft. - Testing has continued on our high-end rapid onset Sustained G Centrifuge, the G-FET II TFS. - We continue to develop our GAT-II(R) General Aviation Trainers. 2 - We plan to incorporate additional advanced tactical flight simulation (TFS) applications into additional products in the ATS line. Our wholly owned subsidiary, Entertainment Technology Corporation ("EnTCo"), develops and manages our entertainment projects. Product development in this class emphasizes the educational and amusement entertainment applications of our ATS simulation technology. We reported research and development expenses of $358,000, $636,000 and $600,000 for the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002, respectively. However, most of the cost of our research efforts, which were and continue to be a significant cost of our business, are included in cost of sales for applied research for specific contracts, as well as research for feasibility and technology updates. SUBSIDIARIES We presently have three operating subsidiaries. Entertainment Technology Corporation, our wholly owned subsidiary, is a Pennsylvania corporation that focuses on the development, manufacturing and distribution of our entertainment products. ETC-PZL Aerospace Industries, our 95%-owned subsidiary, is a Polish corporation that manufactures simulators. ETC-Europe, our 99%-owned subsidiary, is a United Kingdom corporation that focuses on generating international sales. We also have a wholly-owned subsidiary, ETC International Corporation, a Barbados corporation that serves as a foreign sales corporation for federal income tax purposes. ETC-Delaware, our wholly-owned subsidiary, is a Delaware corporation that serves as a holding company. SUPPLIES The components being used in the assembly of systems and the parts used to manufacture our products are purchased from equipment manufacturers, electronics supply firms and others. Historically, we have had no difficulty in obtaining supplies. Further, all raw materials, parts, components and other supplies which we use to manufacture our products can be obtained at competitive prices from alternate sources should existing sources of supply become unavailable. PATENTS AND TRADEMARKS We presently hold the following patents which we deem significant to our operations:
Patent Number Title Expiration Date ------------- ----- --------------- 4,710,128 "Spatial Disorientation Trainer - Flight Simulator" 12/1/04 4,818,001 "Chamber Door Lock" 4/4/06 5,051,094 "G-Force Trainer" 9/24/08
We also hold a trademark on our logo, ETC(R), as well as on the following products: BARA-MED(R): Medical hyperbaric chamber CAS(R): Conditioned Air Supply DATAPRINT(R): Digital printer for sterilizers GAT-II(R): General Aviation Trainer G-LAB(R): Human Centrifuge GYROLAB(R): Spatal disorientation device GYRO-1(R): Multi-purpose Basic Instrument Flight Trainer PRO-GENESIS(R): Control unit/column for sterilizers THE RIDE WORKS(R): Facility for manufacture of amusement and entertainment rides to the order and specification of others.
CUSTOMERS In the current fiscal year and throughout most of our history, we have made a substantial portion of sales to a small number of customers that vary within any given fiscal year. We do not depend upon repeat orders from these same customers. We sell our aircrew training systems principally to U.S. and foreign governmental agencies. We sell sterilizers and environmental systems to commercial and governmental entities worldwide. 3 In fiscal 2004, our major customers included the Royal Malaysian Air Force and the United Kingdom, generating revenues of $2,874,000 and $2,840,000, respectively. These companies do not have any relationship with us other than as customers. We expect to continue to conduct business with these customers in fiscal 2005. FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES During the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002, approximately $1,717,000 (7%), $4,626,000 (11%) and $1,194,000 (4%), respectively, of our net revenues were attributable to contracts with agencies of the U.S. government or with other customers who had prime contracts with agencies of the U.S. government. During the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002, $15,421,000 (59%), $14,805,000 (34%) and $10,110,000 (31%), respectively, of our net revenues were attributable to export sales. Our customers' obligations to us with regards to export sales are normally secured by irrevocable letters of credit based on the creditworthiness of the customer and the geographic area of the world in which they are located. During the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002, $8,857,000 (34%), $23,692,000 (55%), and $21,223,000 (65%), respectively, of our net revenues were attributable to domestic sales to customers other than the U.S. government. (See "Note 9. Business Segment Information" to our consolidated financial statements in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference). We do not believe that the distribution of our sales between foreign and domestic sales for any particular period is necessarily indicative of the distribution expected for any other period. We derive a large portion of our sales from long-term contracts requiring more than one year to complete. We account for sales under long-term contracts on the percentage of completion basis. See "Note 1. Summary of Significant Accounting Policies" to our consolidated financial statements in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. Our U.S. government contracts contain standard terms permitting termination for the convenience of the U.S. government. In the event of termination of a government contract, we are entitled to receive reimbursement on the basis of work completed (cost incurred plus a reasonable profit). We customarily record the amounts that we anticipate to be recovered from termination claims in income as soon as those amounts can be reasonably determined rather than at the time of final settlement. All costs applicable to a termination claim are charged as an offsetting expense concurrently with the recognition of income from the claim. BACKLOG Our sales backlog at February 27, 2004 and February 28, 2003, for work to be performed and revenue to be recognized under written agreements after such dates, was $16,914,000 and $21,454,000, respectively. This decline primarily reflected continued production and corresponding percentage of completion revenue recognition in the current fiscal year on two large contracts. In addition, our training, maintenance and upgrade contracts backlog at February 27, 2004 and February 28, 2003, for work to be performed and revenue to be recognized after such dates under written agreements, was $2,637,000 and $3,931,000, respectively. Of the February 27, 2004 backlog, we have contracts for approximately $14,417,000 for aircrew training systems and maintenance support, including $3,798,000 for the Royal Malaysian Air Force. We expect to complete approximately 89% of the February 27, 2004 backlog prior to February 25, 2005, the end of our 2005 fiscal year. Of the February 28, 2003 backlog, we completed approximately 64% by February 27, 2004. COMPETITION Our business strategy in recent years has been to seek niche markets in which there are not numerous competitors. However, in some areas of our business we compete with well-established firms, some of which have substantially greater financial and personnel resources than we have. Some competing firms have technical expertise and production capabilities in one or more of the areas involved in the design and production of physiological flight training equipment, environmental systems, and other specially designed products, and compete with us for this business. The competition for any particular project generally is determined by the technological requirements of the project, with consideration also being given to a bidder's reliability, product performance, past performance and price. We face competition in the sale of the larger custom-designed industrial sterilizers both from other manufacturers and from our customers' in-house production capabilities. 4 We believe that we are a significant participant in the markets in which we compete, especially in the market for aircrew training systems where we believe that we are a principal provider of this type of equipment and training in our market area. COMPLIANCE WITH ENVIRONMENTAL LAWS We have not incurred during fiscal 2004, nor do we anticipate incurring during fiscal 2005, any material capital expenditures to maintain compliance with federal, state and local statutes, rules and regulations concerning the discharge of materials into the environment, nor do we anticipate that compliance with these provisions will have a material adverse effect on our earnings or competitive position. EMPLOYEES On February 27, 2004, we had 241 full-time employees, of which five were employed in executive positions, 78 were engineers, engineering designers, or draftspeople, 64 were administrative (sales, sales support, accounting, etc.) and clerical personnel, and 94 were engaged principally in production, operations and field support. RISKS RELATED TO OUR BUSINESS OUR SOURCES OF REVENUES ARE NOT CONSISTENT; IN ANY GIVEN FISCAL YEAR A SUBSTANTIAL PORTION OF OUR REVENUES IS DERIVED FROM A SMALL NUMBER OF CUSTOMERS THAT MAY NOT BE RECURRING CUSTOMERS IN FUTURE YEARS. In any given fiscal year, a substantial portion of our revenues is typically derived from a small number of customers. For example, in fiscal 2004 we generated approximately 22% of our revenues from sales to two customers, the Royal Malaysian Air Force and the United Kingdom Ministry of Defense. In fiscal 2003, we generated approximately 57% of our revenues from sales to two customers, the Walt Disney Company and the Royal Malaysian Air Force. In fiscal 2002, we generated approximately 59% of our revenues from sales to two customers, the Walt Disney Company and the Royal Thai Air Force. We cannot be certain that our most significant customers will continue to order our products and services at the same level at which they have ordered them in the past. Due to the expensive nature and highly specialized market for our products and services, if any of these customers stops purchasing our products and services and we are unable to identify new customers in a timely manner, our business will be adversely affected. OUR SIGNIFICANT DEBT COULD ADVERSELY AFFECT OUR FINANCIAL RESOURCES AND PREVENT US FROM SATISFYING OUR DEBT SERVICE OBLIGATIONS. We have a significant amount of indebtedness and may also incur additional indebtedness in the future. We may not generate sufficient cash flow from operations, or have future borrowings available to us, sufficient to pay our debt. At May 14, 2004, our total indebtedness was approximately $14.5 million and our total stockholders' equity was approximately $25.1 million. Our ability to make debt payments depends on future performance, which, to a certain extent, is subject to general economic, financial, competitive and other factors, some of which are beyond our control. Based upon our current level of operations and anticipated growth, management believes that available cash flow, together with available credit, will be adequate to meet our financial needs. There can be no assurance, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available in an amount sufficient to enable us to pay our debts or to make necessary capital expenditures, or that any refinancing of debt would be available on commercially reasonable terms or at all. Our substantial indebtedness could have important consequences including: o our ability to obtain additional financing for working capital, capital expenditures, acquisitions or other purposes may be impaired or unavailable; o a portion of cash flow will be used to pay interest expense, which will reduce the funds that would otherwise be available for operations and future business opportunities; o a substantial decrease in net operating cash flows or an increase in expenses could make it difficult for us to meet our debt service requirements and force us to modify our operations; o making us more highly leveraged than our competitors, which may place us at a competitive disadvantage; o making us more vulnerable to a downturn in our business or in the economy generally; and o some of our existing debt contains financial and restrictive covenants that limit our ability to borrow additional funds, acquire and dispose of assets, and pay cash dividends. 5 A portion of our outstanding indebtedness bears interest at variable rates. Any increase in interest rates will reduce funds available to us for our operations and future business opportunities and will adversely affect our leveraged capital structure. Subsequent to the end of fiscal 2004, our senior lender advised us that it was considering certain changes to the revolving credit facility including reducing the total facility and requiring us to cash collateralize some or all of the facility. As of the filing date of this Annual Report on Form 10-K, these discussions were still ongoing. (Reference the Liquidity and Capital Resources section of the Annual Report to Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K.) COVENANTS AND RESTRICTIONS IN OUR CREDIT FACILITY, AND CHANGES IN THE FACILITY AMOUNT OR STRUCTURE, COULD LIMIT OUR ABILITY TO TAKE CERTAIN ACTIONS OR UTILIZE THE FACILITY TO FUND OPERATIONS. Our credit facility contains significant financial and operating covenants that limit the discretion of management with respect to certain business matters. These covenants include, among others, restrictions on our ability to: o declare or pay dividends or any other distributions to our securities holders; o redeem or repurchase capital stock; o incur certain additional debt; o grant liens on our assets; o make certain payments and investments; o sell or otherwise dispose of assets; and o acquire or be acquired by other entities. We must also meet certain financial ratios and tests under our credit facility. If we do not comply with the obligations set forth in the credit facility, it could result in an event of default, and possibly the acceleration of the related debt and the acceleration of debt under other instruments evidencing debt that may contain cross-acceleration or cross-default provisions. Negative operating results would impact our future compliance with these covenants and could adversely affect our business. Subsequent to the end of fiscal 2004, our senior lender advised us that it was considering certain changes to the revolving credit facility including reducing the total facility and requiring us to cash collateralize some or all of the facility. As of the filing date of this Annual Report on Form 10-K, these discussions were still ongoing. (Reference the Liquidity and Capital Resources section of the Annual Report to Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K.) OUR OPERATIONS INVOLVE RAPIDLY EVOLVING PRODUCTS AND TECHNOLOGICAL CHANGE. The rapid change of technology is a key feature of all of the industries in which our businesses operate. To succeed in the future, we will need to continue to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. Historically, our technology has been developed through both customer-funded and internally funded research and development, and we expect this practice will continue to be required in the future. We cannot guarantee that we will continue to maintain comparable levels of research and development nor that this development will be customer-funded in the same ratio going forward. Reinvestment of operating funds and profits in an amount greater than currently earned may be required. Even so, we cannot assure you that we will successfully identify new opportunities and continue to have the financial resources required to develop new products profitably. At the same time, products and technologies developed by others may render our products and systems obsolete or non-competitive. DELAYS IN THE DELIVERY OF OUR PRODUCTS MAY PREVENT US FROM INVOICING OUR COSTS AND ESTIMATED EARNINGS ON UNCOMPLETED CONTRACTS. In accordance with generally accepted accounting principles for long-term contracts, we record an asset for our costs and estimated earnings that exceed the amount we are able to bill our customers on uncompleted contracts. At February 27, 2004, $5.0 million of our costs and estimated earnings that exceeded our billings on uncompleted contracts related to three contracts with three different customers. We are not able to bill these amounts unless we meet certain contractual milestones related to the production, delivery and integration of our products. Thus, there will be a lag normally ranging from 24 to 36 months between performance and associated costs for these types of projects and billing and collection of payments. Our failure to meet these milestones by delivering and integrating our products in a timely manner may impact our ability to recover our costs and estimated earnings that exceeded our billings on uncompleted contracts, which could severely impact our cash flow. 6 IN THE EVENT WE SUFFER PRODUCTION DELAYS, WE MAY BE REQUIRED TO PAY CERTAIN CUSTOMERS SUBSTANTIAL LIQUIDATED DAMAGES AND OTHER PENALTIES. The variety and complexity of our high technology product lines require us to deal with suppliers and subcontractors supplying highly specialized parts, operating highly sophisticated equipment in performing highly technical calculations. The processes of planning and managing production, inventory levels and delivery schedules are also highly complex and specialized. Many of our products must be custom designed and manufactured, which is not only complicated and expensive, but can also require long periods of time to accomplish. Slight errors in design, planning and managing production, inventory levels, delivery schedules, or manufacturing can result in unsatisfactory products that may not be correctable. If we are unable to meet our delivery schedules, we may be subject to penalties, including liquidated damages that are included in some of our customer contracts. While our actual losses have been minimal, we may incur substantial liquidated damages in the future in connection with product delays. IF THE COMMERCIAL SIMULATION BUSINESS CONDUCTED BY OUR AIRCREW TRAINING SYSTEMS SEGMENT DECLINES, OUR SALES WILL DECREASE. We have no assurance that our commercial simulation business will continue to succeed. Although our commercial simulation business was minimal in fiscal 2004, this segment historically contributes to our gross revenues in each fiscal year. This business is subject to many risks including: o the uncertainty of economic conditions; o increased competition; o changes in technology; and o the need for timely performance by subcontractors located throughout the world on contracts for which we are the prime contractor. If we do not adequately address these risks, then our commercial simulation business may decline, adversely affecting our business. OUR FIXED-PRICE AND COST-REIMBURSABLE CONTRACTS MAY COMMIT US TO UNFAVORABLE TERMS. We provide our products and services primarily through fixed-price or cost-reimbursable contracts. Fixed-price contracts provided approximately 92% of our sales for the fiscal year ended February 27, 2004. Under a fixed-price contract, we agree to perform the scope of work required by the contract for a predetermined contract price. Although a fixed-price contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Therefore, unless there are customer-requested changes in scope or other changes in specifications which are reimbursable, we fully absorb cost overruns on fixed-price contracts and this reduces our profit margin on the contract. These cost overruns may result in us recognizing a loss on the contract. A further risk associated with fixed-price contracts is the difficulty of estimating sales and costs that are related to performance in accordance with contract specifications. Our failure to anticipate technical problems, estimate costs accurately or control costs during performance of a fixed-price contract may reduce our profitability or cause a loss. Cost-reimbursable contracts provided 0% of our sales for the fiscal year ended February 27, 2004. On a cost-reimbursable contract, we are paid up to predetermined funding levels determined by our customers our allowable incurred costs and generally a fee representing a profit on those costs, which can be fixed or variable depending on the contract's pricing arrangement. Therefore, on a cost-reimbursable contract we do not bear the risks of unexpected cost overruns. U.S. government regulations require that we notify our customer of any cost overruns or underruns on a cost-reimbursable contract on a timely basis. If we incur costs in excess of the funding limitation specified in a cost-reimbursable contract, we may not be able to recover those cost overruns. We record sales and profits on a significant portion of our contracts using percentage-of-completion methods of accounting. As a result, revisions made to our estimates of sales and profits are recorded in the period in which the conditions that require such revisions become known and can be estimated. Although we believe that adequate provisions for losses for our fixed-prices contracts are recorded in our financial statements as required under generally accepted accounting principles, we cannot assure you that our contract loss provisions, which are based on estimates, will be adequate to cover all actual future losses. OUR CONTRACTS AND SUBCONTRACTS THAT ARE FUNDED BY THE U.S. GOVERNMENT OR FOREIGN GOVERNMENTS ARE SUBJECT TO GOVERNMENT REGULATIONS AND AUDITS AND OTHER REQUIREMENTS. Government contracts require compliance with various contract provisions and procurement regulations. The adoption of new or modified procurement regulations could have a material adverse effect on our business, financial condition or results of operations or increase the costs of competing for or performing government contracts. If we violate any of these regulations, 7 then we may be subject to termination of these contracts, imposition of fines or exclusion from government contracting and government-approved subcontracting for some specific time period. In addition, our contract costs and revenues are subject to adjustment as a result of audits by government auditors. We reflect any adjustments required by government auditors in our financial statements. Although we have thus far not been required to make any material audit adjustments, adjustments may be required in the future. In connection with our government contracts, we have been required to obtain bonds, letters of credit or similar credit enhancements. We cannot assure that we will be successful in obtaining these types of credit enhancements or that the credit enhancements available will be affordable in the future. OUR CONTRACTS THAT ARE FUNDED BY THE U.S. GOVERNMENT OR FOREIGN GOVERNMENTS ARE SUBJECT TO A COMPETITIVE BIDDING PROCESS THAT MAY AFFECT OUR ABILITY TO WIN CONTRACT AWARDS OR RENEWALS IN THE FUTURE. Government contracts generally are awarded to us through a formal competitive process in which we may have many competitors. Upon expiration, government contracts may be subject, once again, to the competitive process. We cannot assure that we will be successful in winning contract awards or renewals in the future. Our failure to renew or replace government contracts when they expire could have a material adverse effect on our business, financial condition or results of operations. Our contracts with domestic or foreign government agencies are subject to competition and are awarded on the basis of technical merit, personnel qualifications, experience and price. Our business, financial condition and results of operations could be materially adversely affected to the extent that government agencies believe our competitors offer a more attractive combination of the foregoing factors. In addition, new government contract awards also are subject to protest by competitors at the time of award that can result in the re-opening of the competition or evaluation process, the award of a contract to a competitor, or the reopening of the competitive bidding process. We consider bid protests to be a customary element in the process of procuring government contracts. Other characteristics of the government contract market that may affect our operating results include the complexity of designs, the difficulty of forecasting costs and schedules when bidding on developmental and highly sophisticated technical work, and the speed with which product lines become obsolete due to technological advances and other factors characteristic of the market. Our earnings may vary materially on some contracts depending upon the types of government long-term contracts undertaken, the costs incurred in their performance, and the achievement of other performance objectives. OUR COMMERCIAL CONTRACTS ARE SUBJECT TO COMPETITION AND STRICT PERFORMANCE AND OTHER REQUIREMENTS. Although significant portions of our revenues are generated from the sale of our services and products in commercial markets, we cannot assure that we will continue to compete successfully in these markets. Many of our commercial contracts contain fixed pricing. This subjects us to substantial risks relating to unexpected cost increases and other factors outside of our control. We may fail to anticipate technical problems, estimate costs accurately, or control costs during performance of a fixed-price contract. Any of these failures may reduce our profit or cause a loss under our commercial contracts. In addition, a significant portion of our revenues on fixed-price contracts is recognized on a percentage-of-completion basis. This means that we calculate a ratio of costs incurred to costs expected to be incurred for each fixed-price job and then multiply that same ratio by the fixed-price contract value to determine total revenue to be recognized to date for each fixed-price job. As a result, contract price and cost estimates on fixed-price contracts are reviewed periodically as the work progresses, and adjustments are reflected in income in the period when the estimates are revised. To the extent that these adjustments result in a loss, reduction or elimination of previously reported profits, we would recognize a charge against current earnings, which could be material and have a negative effect on our business, financial condition or results of operations. In connection with certain commercial contracts, we have been required to obtain bonds, letters of credit, or similar credit enhancements. We cannot assure that we will be successful in obtaining these types of credit enhancements or that the credit enhancements available will be affordable in the future. Under the terms of our commercial contracts, we typically must agree to meet strict performance obligations and project milestones, which we may not be able to satisfy. Our failure to meet these performance obligations and milestones permits the other party to terminate the contract and, under certain circumstances, recover liquidated damages or other penalties from us which could have a negative effect on our business, financial condition or results of operations. THERE ARE CERTAIN RISKS INHERENT IN OUR INTERNATIONAL BUSINESS ACTIVITIES, WHICH CONSTITUTE A SIGNIFICANT PORTION OF OUR BUSINESS. Our international business activities expose us to a variety of risks. Our international business accounted for approximately 59% of our sales in fiscal 2004 and 34% of our sales in fiscal 2003. We expect that international sales will continue to be a significant portion of our overall business in the foreseeable future. Our international business experiences many of the same risks our domestic business encounters as well as additional risks such as: o the effects of terrorism; 8 o a general decline in the strength of the global economy; o the effect of foreign military or political conflicts and turmoil; o U.S. foreign policy decisions; o changes in foreign governmental trade, monetary and fiscal policies and laws; o export controls; o exchange rate fluctuations; and o political and economic instability. The majority of our contracts are denominated in U.S. Dollars. Despite our exposure to currency fluctuations, we are not engaged in any material hedging activities to offset the risk of exchange rate fluctuations. Our international transactions frequently involve increased financial and legal risks arising from stringent contractual terms and conditions and widely differing legal systems, customs and standards in foreign countries. In addition, our international sales often include sales to various foreign government armed forces, with many of the same inherent risks associated with U.S. government sales discussed in this Annual Report on Form 10-K. LEGISLATIVE ACTIONS, HIGHER DIRECTOR AND OFFICER INSURANCE COSTS AND POTENTIAL NEW ACCOUNTING PRONOUNCEMENTS ARE LIKELY TO CAUSE OUR GENERAL AND ADMINISTRATIVE EXPENSES TO INCREASE AND IMPACT OUR FUTURE FINANCIAL CONDITION AND RESULTS OF OPERATIONS. In order to comply with the Sarbanes-Oxley Act of 2002, as well as changes to the American Stock Exchange listing standards and rules adopted by the Securities and Exchange Commission, we may be required to strengthen our internal controls, hire additional personnel and retain additional outside legal, accounting and advisory services, all of which may cause our general and administrative costs to increase. Although we have not experienced any claims, insurers have increased and are likely to continue to increase premiums as a result of the high claims rates they have incurred with other companies over the past year, and so our premiums for our directors' and officers' insurance policies are likely to increase. Changes in the accounting rules and auditing standards, including legislative and other proposals to account for employee stock options as a compensation expense among others, could materially increase the expenses that we incur and report under generally accepted accounting principles and adversely affect our operating results. OUR SALES BACKLOG IS NOT NECESSARILY INDICATIVE OF REVENUES THAT WE WILL ACTUALLY REALIZE IN FISCAL YEAR 2005 OR AT ALL. We may not actually generate revenues in fiscal 2005 for all items included in our estimated backlog at the end of our 2004 fiscal year. At February 27, 2004, our sales backlog was $19.6 million. While we estimate that approximately 89% of this backlog is expected to be completed prior to the end of our 2005 fiscal year, we are not certain that these projects will be completed so that we can record these revenues by such date, or at all. During fiscal 2004 we shipped approximately 64% of our February 28, 2003 backlog. Our backlog includes the total value of all contracts less the revenue earned on those contracts through the measurement date. Many of our government contracts are multi-year contracts and contracts with option years, and portions of these contracts are carried forward from one year to the next as part of our backlog. Certain of our large contracts provide that we will not receive payment until the services under those contracts are requested and performed. We cannot assure that cancellations or adjustments in the terms of these contracts might not occur. OUR OPERATIONS COULD BE HURT BY TERRORIST ATTACKS, WAR, DISEASE AND OTHER ACTIVITIES OR OCCURRENCES THAT MAKE AIR TRAVEL DIFFICULT OR REDUCE THE WILLINGNESS OF OUR COMMERCIAL AIRLINE CUSTOMERS TO PURCHASE OUR SIMULATION PRODUCTS. The demand for our various commercial simulation products and services is heavily dependent upon new orders from our commercial airline customers. In the event terrorist attacks, war or other activities or occurrences make air travel difficult or reduce the demand or willingness of our customers to purchase our commercial simulation products, our revenue may decline THERE IS LIMITED TRADING ACTIVITY IN OUR COMMON STOCK WHICH COULD MAKE IT MORE DIFFICULT FOR OUR INVESTORS TO SELL THEIR SHARES OF OUR COMMON STOCK. Our common stock is listed on the American Stock Exchange. However, our average daily trading volume during fiscal 2004 was less than 5,000 shares. This limited trading activity may make it more difficult for investors to sell larger blocks of our common stock at prevailing prices as there are generally a small number of participants in the market for our common stock and such sales may lower the market price of our common stock. 9 THE MARKET PRICE OF OUR COMMON STOCK MAY BE VOLATILE. The market price of securities of thinly traded public companies has historically faced significant volatility. Although our common stock is traded on the American Stock Exchange, it does not experience a significant average daily trading volume. Accordingly, if one stockholder elects to either purchase or sell a block of our common stock, it may have an effect on the price of our common stock. In addition, the stock market in recent years has experienced significant price and volume fluctuations that often have been unrelated or disproportionate to the operating performance of particular companies. Many factors that have influenced trading prices will vary from period to period, including: o actual or anticipated operating results; o changes in estimates by analysts; o market conditions in the industry; o changes in our earning and revenues or quarterly operating results; o announcements by competitors; o regulatory actions; and o general economic conditions. Any of these events would likely affect the market price of our common stock. OUR QUARTERLY OPERATING RESULTS MAY VARY SIGNIFICANTLY FROM QUARTER TO QUARTER. Our revenues and earnings may fluctuate from quarter to quarter based on factors that include the following: o the number, size and scope of our projects; o equipment purchases and other expenditures required for our business; o the number of bid and proposal efforts undertaken; o delays in sales or production; o the level of employee productivity; o the adequacy of our provisions for losses; o the accuracy of our estimate of resources required to complete ongoing projects; and o general economic conditions. Demand for our products and services in each of the markets we serve can vary significantly from quarter to quarter due to revisions in customer budgets or schedules and other factors beyond our control. Due to all of the foregoing factors, our results of operations may fall below the expectations of securities analysts and investors in a particular period. In this event, the price of our common stock may decline. OUR OFFICERS AND DIRECTORS OWN A SIGNIFICANT AMOUNT OF OUR COMMON STOCK WHICH PERMITS THEM TO EXERT SIGNIFICANT INFLUENCE OVER THE DIRECTION OF OUR BUSINESS AND AFFAIRS. As of May 14, 2004, our directors and executive officers own an aggregate of approximately 47% of our outstanding common stock. Accordingly, these persons, if they act together, will be able to exert control over the direction of our business and affairs. ITEM 2. PROPERTIES We own our executive offices and principal production facilities located on a five acre site in the County Line Industrial Park, Southampton, Pennsylvania in an approximately 100,000 square foot steel and masonry building. Approximately 85,000 square feet of the building is devoted to manufacturing and 15,000 square feet of this building is devoted to office space. The original building was erected in 1969 and additions were most recently made in 2001. We have pledged this property as collateral to secure the performance of our obligations under our revolving credit facility with PNC Bank, National Association and our subordinated debt financing with H.F. Lenfest. Additionally, we rent office space at various sales and support locations throughout the world and at ETC-PZL Aerospace Industries, our Polish subsidiary. 10 We consider our machinery and plant to be in satisfactory operating condition. Increases in the level of operations beyond what we expect in the current fiscal year might require us to obtain additional facilities and equipment. ITEM 3. LEGAL PROCEEDINGS In April 2003, Boenning & Scattergood, Inc. ("B&S") filed suit against us in the Court of Common Pleas in Philadelphia, Pennsylvania, seeking payment of $901,843.46 for financing fees allegedly due to B&S pursuant to the terms of an agreement for investment banking services that we entered into with a predecessor of B&S (the "B&S Agreement"). B&S alleges that it contacted the investors in our February 2003 financing transaction and that it earned the claimed financing fees pursuant to the terms of the B&S agreement. We have responded to the complaint and have filed a counterclaim for breach of contract and professional malpractice. We believe that we have valid defenses to each of the claims of B&S and we intend to vigorously defend itself against these claims. At this time, however, discovery is ongoing and we are unable to predict the outcome of this matter. In June 2003, Associated Mezzanine investors, LLC ("AMI") filed suit against the Company in the United States District Court for the Eastern District of Pennsylvania seeking payment of $196,000 for costs, fees and expenses allegedly due to AMI pursuant to the terms of an agreement which the Company entered into with AMI (the "AMI Agreement"). AMI claimed that it located suitable investors for the Company's February 2003 financing transaction and that it earned the claimed fees and is entitled to reimbursement of the claimed costs and expenses pursuant to the terms of the AMI Agreement. In March 2004, this suit was settled without any material impact on the Company's results of operations. In June 2003, EnTCo, our wholly-owned subsidiary, filed suit against Walt Disney World Co. and other entities ("Disney") in the United States District Court for the Eastern District of Pennsylvania, alleging breach of contract for, among other things, failure to pay all amounts due under a contract for the design and production of the amusement park ride "Mission:Space" located in Disney's Epcot Center. In response, in August 2003, Disney filed counterclaims against EnTCo and us (under a guarantee) for, among other things, alleged failures in performance and design in the contract. Disney is seeking damages in excess of $150,000. We believe that we have valid defenses to each of Disney's counterclaims against us and EnTCo and we intend to vigorously defend against these counterclaims. At this time, the parties are engaged in the discovery process. The parties have exchanged self-executing disclosures and responses to interrogatories, and will be producing documents shortly, after which depositions will occur. Accordingly, as of the date of this report, we are unable to predict the outcome of this matter. Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against us. In the opinion of management, all such matters are reserved for or are adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts as would not have a material adverse effect on our financial position if resolved unfavorably. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were presented to our stockholders during the fourth quarter of fiscal 2004. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS See information appearing under the heading "Market for the Registrant's Common Stock and Related Stockholder Matters" in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA See information appearing under the heading "Financial Review" in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS See information appearing under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. 11 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to various market risks, including changes in interest rates. Market risk is the potential loss arising from adverse changes in market rates and prices, such as interest rates and foreign currency exchange rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes. We also have not entered into financial instruments to manage and reduce the impact of changes in interest rates and foreign currency exchange rates although we may enter into such transactions in the future. A portion of our indebtedness bears interest at rates that vary with the prime rate of interest. Accordingly, any increases in the applicable prime rate of interest will reduce our earnings. With respect to currency risk, where we have a contract which is denominated in a foreign currency, we often establish local in-country bank accounts and fund in-country expenses in the local currency, thus creating a "natural" currency hedge for a portion of the contract. . ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See the information appearing under the headings "Consolidated Financial Statements" and "Notes to Consolidated Financial Statements" in the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of February 27, 2004 (the "Evaluation Date"), and, based on this evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures were effective as of the Evaluation Date. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the Evaluation Date. Disclosure controls and procedures (as defined in Rules 13a-14(c) and 15(d)-14(c) under the Securities Exchange Act of 1934, as amended) are our internal controls and other procedures that are designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act 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 us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure. 12 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information, as of May 14, 2004, with respect to our directors and executive officers:
Served as Director Name Age or Officer Since(1) Positions and Offices - ---- --- ------------------- --------------------- William F. Mitchell (2) 62 1969 Chairman of the Board, President and Director Pete L. Stephens, M.D. (3) 66 1974 Director Howard W. Kelley (4) 62 2002 Director George K. Anderson, M.D. (5) 58 2003 Director H.F. Lenfest (6) 74 2003 Director Duane D. Deaner (7) 56 1996 Chief Financial Officer
(1) Directors are elected for one-year terms. (2) Mr. Mitchell has been our Chairman of the Board, President and Chief Executive Officer since 1969, except for the period from January 24, 1986 through January 24, 1987, when he was engaged principally in soliciting sales for our products in the overseas markets. Mr. Mitchell received a Bachelor of Science degree in physics from Drexel University and has completed graduate work in mechanical and electrical engineering. He is a member of the ASME and Drexel University engineering advisory boards. Additionally, he is a member of the Society of Automotive/Aerospace Engineering, the International Society of Pharmaceutical Engineering, the Undersea and Hyperbaric Medical Society, the Aerospace Medical Association, the American Society of Mechanical Engineering and the Institute of Environmental Sciences. (3) Dr. Stephens is a retired physician who engaged in the practice of medicine for 30 years. Dr. Stephens graduated from Bethany College and the Medical College of Virginia. He presently serves as Chairman of the Board of Directors of Lowcountry Block and Paver, a manufacturing company located in South Carolina. (4) Mr. Kelley is President of Sally Industries, Inc., Jacksonville, Florida, which is one of the oldest and largest designers and fabricators of animation robotics and dark ride attractions used worldwide in theme parks, museums and entertainment attractions. He is also President of Aspergantis, LLC, an Internet and communications consulting business. He previously spent over 25 years in the broadcasting industry, including ten years in television management as a news director and later as Vice President and General Manager of Channel 12 WTLV (NBC) in Jacksonville, Florida. He is the former Chairman of the Board of Tempus Software, a medical software development firm located in Jacksonville, Florida. He has also previously served as broadcast strategic planner for a major U.S. communications company and as director of several U.S. technology firms with international business activities. In the academic arena, Mr. Kelley serves as an executive professor at the University of North Florida College of Business Administration, and is a college adjunct instructor on Internet technology and E-commerce on the internet. He is a graduate of the University of Florida and Harvard Business School PMD. (5) Dr. Anderson is an experienced physician executive and preventive medicine leader. He began his professional career as an Air Force flight surgeon, serving overseas medical duty in Korea and Germany as well as aerospace medicine leadership positions in the United States. Following 30 years of military service, he transitioned to physician executive positions in the private sector. Subsequent to his retirement from the military, he served as Chief Executive Officer of the Koop Foundation from 1997 to 1998 and as President and Chief Executive Officer at Oceania, Inc., a medical software company, from 1999 to 2001. He is presently a principal and member of the board of directors of New World Healthcare Solutions, a medical consulting and executive search firm. Dr. Anderson's positions in the Air Force include serving as Deputy Assistant Director of Defense (Health Services Operations and Readiness), Commander of the Human Systems Center, Air Force Material Command, which included the Armstrong Laboratory, the School of Aerospace Medicine and the Human Systems Program Office. He retired from active duty in the grade of Major General. 13 (6) Mr. Lenfest practiced law with Davis Polk & Wardwell before joining Triangle Publications, Inc., in Philadelphia as Associate Counsel in 1965. In 1970, Mr. Lenfest was placed in charge of Triangle's Communications Division, serving as Editorial Director and Publisher of Seventeen Magazine and President of the CATV Operations. In 1974, Mr. Lenfest, with the support of two investors, formed Lenfest Communications, Inc., which purchased Suburban Cable TV Company and Lebanon Valley Cable TV Company from Triangle with a total of 7,600 subscribers. In January 2000, Mr. Lenfest sold his cable television operations, which by then served 1.2 million subscribers, to Comcast Corporation but still retains interests in companies principally involved in national satellite promotion of cable programming and software for marketing cable advertising and marketing promotions. Additionally, Mr. Lenfest is the owner of various other businesses in Pennsylvania and Maryland and is active in many philanthropic activities including the Chairman of the Board of the Philadelphia Museum of Art and the Lenfest Foundation. Mr. Lenfest is a graduate of Washington and Lee University and Columbia Law School. (7) Mr. Deaner has served as our Chief Financial Officer since January 1996. Mr. Deaner served as Vice President of Finance for Pennfield Precision Incorporated from September 1988 to December 1995. Mr. Deaner received an MBA in Finance from Temple University and a B.A. in Mathematics from Millersville University in Pennsylvania. COMMITTEES OF THE BOARD OF DIRECTORS During the fiscal year ended February 27, 2004, the Board of Directors held three meetings. All members of the Board of Directors attended all of the meetings of the Board of Directors held while they were members of the Board of Directors. During the fiscal year ended February 27, 2004, we had an Audit Committee consisting of Messrs. Kelley, Stephens and Andersen. Mr. Kelley serves as the Chairman and the "financial expert" (as defined by the American Stock Exchange) and has been designated as the Audit Committee Financial Expert as defined by the rules of the Securities and Exchange Commission. In addition, all members of the Committee meet the financial literacy requirements of the American Stock Exchange and are independent. The Audit Committee held four meetings during the year ended February 27, 2004. Among other responsibilities, the Audit Committee meets (via face-to face or via telephone) with the external auditors to review and make recommendations to management concerning (if appropriate) the quarterly and annual financial results and the reports on Forms 10-Q and 10-K. The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of our independent accountants in their preparation or issuance of an audit report or the performance of other audit and review services. Messrs. Kelley, Stephens and Andersen also served on our Compensation Committee during the year ended February 27, 2004, with Dr. Stephens serving as Chairman. The Compensation Committee is charged with reviewing the compensation and incentive plans of officers and key personnel. This Committee met for its annual review in February 2004. Messrs. Kelley, Stephens and Andersen also served on our Committee to Recommend Directors Compensation. Our directors who do not serve as officers are paid a fee of $2,000 (either in cash or equivalent value of common stock of the Company) per quarter for attending Board of Directors and committee meetings. CODE OF ETHICS We have adopted a Code of Ethics, which applies to our chief executive officer, chief financial officer, controller and other senior financial officers. We have also adopted a Company Code of Conduct that applies to our directors, officers and employees. The Code of Ethics and the Company Code of Conduct were each approved and adopted by our Board of Directors in April 2004. The Code of Ethics and the Company Code of Conduct are each included as an exhibit to this Annual Report on Form 10-K, and are posted on our website, which is located at www.etcusa.com. We will also disclose any amendments or waivers to the Code of Ethics or the Company Code of Conduct on our website. In addition, we have adopted a Whistleblower Policy and an Insider Trading Policy, both of which are posted on our website. COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than ten percent of a registered class of our equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission ("SEC") and the American Stock Exchange. Officers, directors and greater than ten percent shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file. The rules of the SEC regarding the filing of Section 16(a) reports require that "late filings" of Section 16(a) reports be disclosed in our proxy statement. Based solely on our review of the copies of such forms which we received, or written representations from reporting persons that no Section 16(a) reports were required for those persons, we believe that, during the fiscal year ended February 27, 2004, our officers, directors and greater than ten percent beneficial owners complied with all applicable filing requirements except for Mr. Kelley who had one late filing, Mr. Stephens who had three late filings (two of which were one day late), and Mr. Mitchell, who had one late filing. 14 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The following table sets forth the compensation we paid to our Chief Executive Officer for services rendered during fiscal years 2004, 2003 and 2002. There are no other executive officers whose total annual salary and bonus exceeds $100,000. The footnotes to the table provide additional information concerning our compensation and benefit programs.
Annual Compensation - ---------------------------------------------------------------------------------------------------------------------------------- Other Annual All Other Name and Principal Position Fiscal Year Salary ($) Bonus ($)(1) Compensation (2) Compensation ($)(3) - --------------------------- ----------- ---------- ------------ ---------------- ------------------- William F. Mitchell, 2004 225,000 9,172 -- 4,707 President and Chief 2003 225,000 0 -- 4,493 Executive Officer 2002 225,000 10,051 -- 4,413
(1) These amounts represent a portion of a deferred bonus from fiscal 1999 due 75% in 1999 and 5% in each of the five following fiscal years. No bonus awards for fiscal 2002, 2003 or 2004 were paid. No deferred bonus amounts from fiscal 1999 were paid in fiscal 2003. (2) Our executive officers receive certain perquisites. For fiscal years 2002, 2003 and 2004, the perquisites received by Mr. Mitchell did not exceed the lesser of $50,000 or 10% of his salary and bonus. (3) These amounts represent our contribution to ETC's Retirement Savings Plan. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The following table sets forth as of May 14, 2004, the number of shares and percentage of our common stock owned beneficially by each director, each executive officer named in the Summary Compensation Table, and each person holding, to our knowledge, more than 5% of our outstanding common stock. The table also sets forth the holdings of all directors and executive officers as a group. AMOUNT AND NATURE OF PERCENT NAME AND ADDRESS BENEFICIAL OF OF BENEFICIAL OWNER OWNERSHIP(1) COMMON STOCK ------------------- ------------ ------------ William F. Mitchell (2) 1,526,398 20.0% C/o Environmental Tectonics Corporation County Line Industrial Park Southampton, PA 18966 Pete L. Stephens, M.D. (3) 693,500(4) 9.1% 31 Ribaut Drive Hilton Head Island, SC 29926 Howard W. Kelley (3) 1,359 * C/o Sally Corporation 745 West Forsyth Street Jacksonville, FL 32204 T. Todd Martin, III 1,258,220(5) 16.5% 50 Midtown Park East Mobile, AL 36606 H.F. Lenfest (3) 2,621,230(6) 25.6% C/o The Lenfest Group 1332 Enterprise Drive West Chester, PA 19380 Emerald Advisors, Inc. 1,278,317(7) 16.7% 1703 Oregon Pike Suite 101 Lancaster, PA 17601 George K. Anderson, M.D. (3) 1,000 * 8034 Kidwell Hill Court Vienna, VA 22182 All directors and executive officers as a group (6 persons) 4,855,647(8) 47.3% 15 - -------------------------------------------------------------------------------- * less than 1% (1) Beneficial ownership has been determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934. Unless otherwise noted, we believe that all persons named in the table have sole voting and investment power with respect to all shares of our common stock beneficially owned by them. (2) Chairman of the Board, President and Director of the Corporation. Includes 133,200 shares of common stock held by Mr. Mitchell's wife. (3) Director of the Company. (4) Includes 292,330 shares of common stock held by or for the benefit of Dr. Stephens' wife and two of his children. (5) Includes 1,057,720 shares of common stock owned by Advanced Technology Asset Management, LLC (formerly ETC Asset Management, LLC) ("ATAM"), a limited liability company of which T. Todd Martin, III is manager. Also includes 135,300 shares of common stock owned by Mr. Martin, 26,900 shares owned by Allied Williams Co, Inc., a corporation of which Mr. Martin is an officer and director, 17,000 shares owned by Equity Management, LLC, a limited liability company of which Mr. Martin is manager, 14,300 shares owned by Mr. Martin jointly with his spouse, and 7,000 shares owned by trusts of which Mr. Martin is trustee. (6) These shares consist of 2,621,230 shares of common stock issuable upon conversion of a promissory note in the principal amount of $10,000,000 and exercise of warrants to purchase shares of common stock. (7) Emerald Advisors, Inc. has sole voting power with respect to 711,639 shares of common stock and sole dispositive power over 1,278,317 shares of common stock. (8) Includes 12,160 shares of common stock which may be acquired by Duane Deaner, our chief financial officer, upon the exercise of options granted under our Incentive Stock Option Plan that are presently exercisable and 2,621,230 shares of common stock which may be acquired by H.F. Lenfest upon conversion of a promissory note in the principal amount of $10,000,000 that is presently convertible and the exercise of warrants to purchase shares of common stock which are presently exercisable. For information regarding our equity compensation plans, please see the Equity Compensation Plan Information section of the Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On February 19, 2003, we completed a refinancing of our indebtedness with the PNC Bank, National Association and H.F. Lenfest in the aggregate amount of $29,800,000. Pursuant to the terms of a Convertible Note and Warrant Purchase Agreement, dated February 18, 2003, between us and Mr. Lenfest, we issued to Mr. Lenfest (i) a 10% senior subordinated convertible promissory note in the original principal amount of $10,000,000 and (ii) warrants to purchase 803,048 shares of our common stock. As a condition to closing the financing, we appointed Mr. Lenfest to our Board of Directors. (For a more detailed description of the financing provided by Mr. Lenfest and PNC, see the Liquidity and Capital Resources section of the Annual Report to Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K and incorporated herein by reference). 16 Prior to the consummation of the refinancing, ATAM, a shareholder and a holder of warrants to purchase 332,820 shares of our common stock, consented to the financing transactions with PNC and Lenfest including the below market issuance of warrants to Mr. Lenfest. As a result of its consent, ATAM waived, solely in connection with such issuance, the anti-dilution rights contained in its warrant. In exchange for ATAM's consent and waiver, we issued to ATAM warrants to purchase an additional 105,000 shares of common stock. Except for the number of shares issuable upon exercise of the warrants, the new ATAM warrants had substantially the same terms as the warrants issued to Mr. Lenfest. As of the date that these warrants were issued to ATAM, it was the beneficial owner of greater than 5% of our common stock as determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934. Subsequent to fiscal year end ATAM exercised all its warrants and received a total of 437,820 shares of common stock of the Company. For a more detailed description of the financing provided by Mr. Lenfest and PNC, see the Liquidity and Capital Resources section of the Annual Report to Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K as incorporated herein by reference. ITEM 14. INFORMATION REGARDING THE COMPANY'S INDEPENDENT PUBLIC ACCOUNTANTS Under the Company's Bylaws and the governing body, authority to select the Company's auditors rests with the Board of Directors. Such selection is made through formal act of the Board of Directors. It has not been and is not the Company's policy to submit selection of its auditors to the vote of the shareholders because there is no legal requirement to do so. Grant Thornton LLP was the Company's auditors for the fiscal year ended February 27, 2004. Auditors have not been selected for the current fiscal year. A representative of Grant Thornton is expected to be present at the Annual Meeting and will be given an opportunity to make a statement to the shareholders, if he or she desires to do so. Grant Thornton's representative will also be available to answer appropriate questions from shareholders. Set forth below is information relating to the aggregate Grant Thornton LLP fees for professional services provided to the Company for the fiscal year ended February 27, 2004: Audit Fees The following table presents fees for professional audit services rendered by Grant Thornton LLP for the audit of the Company's annual financial statements for the fiscal years ended February 28, 2003 and February 27, 2004, respectively, and fees billed for other services rendered by Grant Thornton LLP. FY 2003 FY 2004 Audit Fees $ 81,980 $ 89,530 Audit related fees (1) $ 40,455 $ 15,143 -------- -------- Audit and audit related fees $122,435 $104,673 Tax fees (2) $ 34,868 $ 37,646 All other fees (3) $ 21,268 $ - -------- -------- Total fees $178,571 $142,319 (1) Audit related fees consist primarily of audits of the Company's financial statements, employee benefit plan audits, and assistance with foreign statutory financial statements. (2) Tax fees consist of tax compliance services and other consultations on miscellaneous tax matters. (3) All other fees consist of compliance services and fees associated with the Company's refinancing in fiscal year 2003. 17 PART IV ITEM 16. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, 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. 4.1 $10,000,000 Senior Subordinated Convertible Note, dated February 18, 2003, issued by the Registrant in favor of H.F. Lenfest was filed on February 25, 2003 as Exhibit 4.1 to Form 8-K and is incorporated herein by reference. 4.2 Stock Purchase Warrant, dated February 18, 2003, issued by the Registrant in favor of H.F. Lenfest was filed on February 25, 2003 as Exhibit 4.2 to Form 8-K and is incorporated herein by reference. 4.3 Stock Purchase Warrant, dated February 18, 2003, issued by the Registrant in favor of ETC Asset Management, LLC was filed on February 25, 2003 as Exhibit 4.3 to Form 8-K and is 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, was 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. * 10.4 Stock Purchase Warrant dated as of December 26, 2001, issued by the Registrant to the Registrant Asset Management, LLC was filed as Exhibit 10.7 to the Registrant's Form 10-K for the fiscal year ended February 22, 2002 and is incorporated herein by reference. 10.5 Credit Agreement, dated as of February 18, 2003 between the Registrant and PNC Bank, National Association was filed on February 25, 2003 as Exhibit 10.1 to Form 8-K and is incorporated herein by reference. 10.6 Amendment to Credit Agreement, dated as of April 30, 2003, between the Registrant and PNC Bank was filed as Exhibit 10.6 to the Registrant's Form 10-K for the fiscal year ended February 28, 2003 and is incorporated herein by reference. 10.7 Amended and Restated Revolving Credit Note, dated April 30, 2003, issued by the Registrant in favor of PNC Bank was filed as Exhibit 10.6 to the Registrant's Form 10-K for the fiscal year ended February 28, 2003 and is incorporated herein by reference. 10.8 Security Agreement, made and entered into as of February 18, 2003, by and between the Registrant, Entertainment Technology Corporation, ETC Delaware, Inc. and PNC Bank was filed on February 25, 2003 as Exhibit 10.3 to Form 8-K and is incorporated herein by reference. 10.9 Pledge Agreement, dated as of February 18, 2003, made by the Registrant in favor of PNC Bank was filed on February 25, 2003 as Exhibit 10.4 to Form 8-K and is incorporated herein by reference. 10.10 Pledge Agreement (Bank Deposits), dated as of February 18, 2003, made by the Registrant in favor of PNC Bank was filed on February 25, 2003 as Exhibit 10.5 to Form 8-K and is incorporated herein by reference. 10.11 Guaranty, dated as of February 18, 2003, made by Entertainment Technology Corporation and ETC Delaware, Inc. in favor of PNC Bank was filed on February 25, 2003 as Exhibit 10.6 to Form 8-K and is incorporated herein by reference. 10.12 Open-End Mortgage and Security Agreement, made as of February 18, 2003, by the Registrant in favor of PNC Bank was filed on February 25, 2003 as Exhibit 10.7 to Form 8-K and is incorporated herein by reference. 10.13 Convertible Note and Warrant Purchase Agreement, dated February 18, 2003, by and between the Registrant and Lenfest was filed on February 25, 2003 as Exhibit 10.8 to Form 8-K and is incorporated herein by reference. 10.14 Registration Rights Agreement, dated as of February 18, 2003, by and between the Registrant and H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.9 to Form 8-K and is incorporated herein by reference. 10.15 Security Agreement, made and entered into as of February 18, 2003, by and among the Registrant, Entertainment Technology Corporation, ETC Delaware, Inc. and H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.10 to Form 8-K and is incorporated herein by reference.
18
Number Item - ------ ---- 10.16 Guaranty, dated as of February 18, 2003, made by Entertainment Technology Corporation and ETC Delaware, Inc. in favor of H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.11 to Form 8-K and is incorporated herein by reference. 10.17 Open-End Mortgage and Security Agreement, made as of February 18, 2003, by the Registrant in favor of H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.12 to Form 8-K and is incorporated herein by reference. 10.18 Subordination and Intercreditor Agreement, dated as of February 18, 2003, among PNC Bank, H.F. Lenfest and the Registrant was filed on February 25, 2003 as Exhibit 10.13 to Form 8-K and is incorporated herein by reference. 13 Portions of Registrant's 2004 Annual Report to Shareholders which are incorporated by reference into this Form 10-K 14.1 Code of Ethics - Chief Executive Officer and Senior Financial Officers 14.2 Company Code of Conduct 21 Subsidiaries of the Registrant. 23 Consent of Grant Thornton LLP. 31.1 Certification dated May 27, 2004 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by William F. Mitchell, Chief Executive Officer. 31.2 Certification dated May 27, 2004 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 made by Duane D. Deaner, Chief Financial Officer. 32 Certification dated May 27, 2004 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 and Duane D. Deaner, Chief Financial Officer.
* Represents a management contract or a compensatory plan or arrangement. (b) Reports on Form 8-K: On January 16, 2004, we filed a Current Report on Form 8-K reporting that we issued a press release announcing our financial results for the third quarter of fiscal 2004. A copy of the press release was attached as an exhibit to this Current Report on Form 8-K. 19 SIGNATURES Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. ENVIRONMENTAL TECTONICS CORPORATION By /s/ William F. Mitchell ------------------------------------- William F. Mitchell, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. NAME POSITION DATE - ---- -------- ---- /s/ William F. Mitchell Chairman of the Board, May 27, 2004 - ------------------------- Chief Executive Officer, William F. Mitchell President and Director (Principal Executive Officer) /s/ Duane D. Deaner Chief Financial May 27, 2004 - ------------------------- Officer (Principal Financial and Duane D. Deaner Accounting Officer) /s/ Pete L. Stephens Director May 27, 2004 - ------------------------- Pete L. Stephens /s/ Howard W. Kelley Director May 27, 2004 - ------------------------- Howard W. Kelley /s/ H.F. Lenfest Director May 27, 2004 - ------------------------- H.F. Lenfest /s/ George K. Anderson Director May 27, 2004 - ------------------------- George K. Anderson, M.D. 20 EXHIBIT INDEX Exhibit No. Item - ------- ---- 13 Portions of Registrant's 2003 Annual Report to Shareholders which are incorporated by reference into this Form 10-K. 14.1 Code of Ethics - Chief Executive Officer and Senior Financial Officers 14.2 Company Code of Conduct 21 Subsidiaries of the Registrant. 23 Consent of Grant Thornton LLP. 31.1 Certification dated May 27, 2004 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. 31.2 Certification dated May 27, 2004 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 Certification dated May 27, 2004 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 and Duane D. Deaner, Chief Financial Officer. EX-13 2 ex13.txt EXHIBIT 13 EXHIBIT 13 ---------- PORTIONS OF ENVIRONMENTAL TECTONICS CORPORATION 2004 ANNUAL REPORT TO STOCKHOLDERS FINANCIAL REVIEW ($ in thousands, except share and per share data) FISCAL YEAR END 2004 2003 2002 2001 2000 --------------- ------- ------- ------- ------- ------- Net sales $25,995 $43,123 $32,527 $32,452 $34,920 Gross profit 9,943 14,198 11,465 13,075 12,798 Operating income 131 4,116 2,873 4,122 5,327 Net (loss)/income (793) 2,493 1,741 2,021 2,873 (Loss)/earnings per common share: Basic (.11) .35 .24 .29 .40 Diluted (.11) .33 .23 .27 .36 Working capital 29,907 31,216 30,683 25,070 16,306 Long-term obligations 12,157 12,643 16,688 12,778 4,455 Total assets 48,696 47,698 48,482 40,705 31,897 Total stockholders' equity 25,054 25,907 20,782 18,796 16,245 Weighted average common shares: Basic 7,163,000 7,153,000 7,143,000 7,087,000 6,604,000 Diluted 7,163,000 7,497,000 7,499,000 7,499,000 7,319,000 All earnings per share and share amounts have been restated to reflect a 2-for-1 stock split effective May 28, 1999. No cash dividends have ever been paid on the Company's common stock, and the Company is prohibited from declaring any cash dividends on its common stock under the terms of its existing credit facilities. 1 FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are based on the Company's current expectations and projections about future events. These forward-looking statements are subject to known and unknown risks, uncertainties and assumptions about the Company and its subsidiaries that may cause actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements include statements with respect to the Company's vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of the company, including but not limited to, (i) projections of revenues, costs of raw materials, income or loss, earnings or loss per share, capital expenditures, growth prospects, dividends, capital structure, other financial items and the effects of currency fluctuations, (ii) statements of our plans and objectives of the Company or its management or Board of Directors, including the introduction of new products, or estimates or predictions of actions of customers, suppliers, competitors or regulatory authorities, (iii) statements of future economic performance, (iv) statements of assumptions and other statements about the Company or its business, and (v) statements preceded by, followed by or that include the words, "may," "could," "should," "looking forward," "would," "believe," "expect," "anticipate," "estimate," "intend," "plan," or the negative of such terms or similar expressions. These forward-looking statements involve risks and uncertainties which are subject to change based on various important factors. Some of these risks and uncertainties, in whole or in part, are beyond the Company's control. Factors that might cause or contribute to such a material difference include, but are not limited to, those discussed in the Company's Annual Report on Form 10-K, in the section entitled "Risks Particular to Our Business." Shareholders are urged to review these risks carefully prior to making an investment in the Company's common stock. The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW We are principally engaged in the design, manufacture and sale of software driven products used to create and monitor the physiological effects of motion on humans and equipment and to control, modify, simulate and measure environmental conditions. These products include aircrew training systems, entertainment products, sterilizers, environmental and hyperbaric chambers and other products that involve similar manufacturing techniques and engineering technologies. The following factors had an adverse impact on our performance for the fiscal year ended February 27, 2004: o Unfavorable global economic and political conditions; o Completion in the prior period of a major entertainment contract; o Increased product development costs; o Integration costs of new personnel in environmental business; o Higher costs of capital; o Customer induced shipping delays. During fiscal 2004, our sales efforts were hampered by continuing unfavorable global economic and political conditions. We saw many of our potential new contracts delayed by budget constraints and delays of our customers located throughout the world. This was especially true in our Aircrew Training Systems business, where most of the sales are to international customers. Sales in our entertainment business declined as a result of the completion in fiscal 2003 of our contract with Walt Disney World for the amusement ride Mission:Space for Epcot Center in Florida. Disputes related to this contract, which was reduced in scope and prematurely terminated by the customer, are the subject of current litigation. In fiscal 2004, our entertainment business did not replace this business with new projects to offset the decrease in revenues from fiscal 2003. In fiscal 2005, our entertainment business has started several new projects that will result in increased revenues over fiscal 2004. However, we do not at this point have sales backlog in this segment of our business to ensure that revenues from our entertainment business will return to the levels we experienced in fiscal 2003. We believe that our entertainment business remains one of the areas where we will continue to experience growth in our business. 2 In many of our product lines, especially sterilizers and environmental products, we must wait for new building or major plant expansion construction to finalize our contracts. Delays in construction schedules lead to delays in our ability to ship and install what are basically complete devices. Fiscal 2004 saw numerous examples of these and other customer delays, including government paperwork complications and procedural issues. In the environmental line, we made a significant investment in new personnel, hiring the key former employees from a competitor, although under a legal settlement we were restricted from any major sales effort until January 1, 2004. Since the restriction has been lifted, we have seen an increase in new business generated by the new sales employees. Additionally, given the highly technical skills of the new service and installation staff, we anticipate an increase in efficiency that will result in faster, less costly installations of environmental equipment. Fiscal 2004 also saw the culmination of over 30 years of our work with aeromedical technology with the introduction of our Authentic Tactical Flight Simulator ("ATFS") and significant enhancements to our GAT and Gyro-IPT family of flight trainers. The evolution of these exciting and state-of-the-art technologies is an important step in our goal of integrating flight and aeromedical training in a simulator device. This technology allows a fighter pilot to practice tactical air combat maneuvers such as dodging enemy missiles, ground fire and aircraft obstacles while experiencing the real life environment of a high-G Force fighter aircraft. These flight trainers provide a low cost and extremely less risky alternative to actual air flight. We believe that armed forces agencies of various governments will appreciate the efficiency of these technologies, especially in this time of fiscal conservatism and budgetary constraints throughout the world. One of the greatest challenges we face is adequately capitalizing our business. Many of our projects are capital intensive and our business requires us to have a substantial amount of available capital in order to increase our sales. As a result of our February 2003 financing, we received a sufficient amount of capital to allow us to operate and continue to grow our business. However, in fiscal 2004, as a result of this refinancing, our costs of capital, namely interest payments on our subordinated debt, increased dramatically over fiscal 2003. Our liquidity and capitalization improved in fiscal 2004 when we reached a final settlement on a long-standing contract dispute with an international customer pursuant to which we received $10.5 million subsequent to February 27, 2004. This settlement contributed approximately $2.3 million to our pre-tax income for fiscal 2004. Subsequent to fiscal year end, PNC Bank advised us that it was considering certain changes to the revolving credit facility including reducing the total facility and requiring us to cash collateralize some or all of the facility. As of the filing date of this Annual Report on Form 10-K, these discussions were still ongoing. In the event that PNC Bank takes these actions, we may need to obtain additional sources of capital in order to continue growing our business. We believe that we will be able to locate such additional sources of capital and that any such action by PNC Bank will not have a long-term material adverse effect on our business. In addition, we face the following challenges and business goals in order to make fiscal 2005 a successful year: o Sell through all the products we technologically enhanced in fiscal 2004. During fiscal 2004 we invested heavily in enhancing functionality and product capability of three ATS products: - our centrifuge-based flight simulator - our General Aviation Trainer (GAT) and - our Gyro-IPT. Repeat sales of these state-of-the-art simulators will allow us to recoup non-recurring engineering and design effort. o Continue to evolve Advanced Tactical Flight Simulation (ATFS). Our challenge will be to find funding to continue this critical development objective, either through U.S. government grants or a customer order. o Re-engineer the products in our ATS group to remain competitive. The initial development and engineering required to integrate the latest technology into existing products is a costly process. We need to follow through to evaluate and eliminate duplicate processes, materials, etc., in order to remain cost competitive. o Standardize the environmental line of products. Estimating the engineering effort and production costs of custom products is risky and often significantly under budgeted. To alleviate some of the variables in the process, we need to, as much as is possible given the technology and application, develop and sell standard modular-based offerings with a range of functionality. o Expand the entertainment line by repeat sales and the introduction of story line enhancements. Fiscal 2004 saw the introduction of a new amusement ride directed towards the location-based entertainment and educational markets. Initial reaction from customers has been very favorable with multiple units sold. In fiscal 2005, we need to aggressively pursue the large venues of zoos and museums and to expand our story line based offerings. o Expand the South American market. 3 In the mid-1980's we sold many altitude chambers and other ATS products in South America. Since then, deteriorating political and economic conditions have severely restricted international business with most countries in this continent. In fiscal 2004, we received the first new significant order from this area since many years ago. We need to find creative financing alternatives for our customers in this area if we are to properly cultivate this market. o Settle at least one major claim. At February 27, 2004, we had two significant claims outstanding totaling $5.5 million. To the extent we can settle either or both of these claims, we may receive significant cash payments that will improve our liquidity position and allow us to grow our business. REVENUE RECOGNITION We currently market our products and services primarily through our sales offices and employees. In addition, we also utilize the services of approximately 100 independent sales agents and organizations in seeking foreign orders for our products. We generally customize our products using our proprietary software based on specifications provided by our customers. Many of these products are capital intensive and take more than one year to manufacture and deliver to the customer. In the ATS segment, we sell our Aircrew Training Devices to military and commercial airline operators both in the United States and internationally. We sell our Entertainment products to amusement parks, zoos and museums. We sell our Disaster Management Simulation products to state and local governments. In our Industrial Group, we sell our sterilizers to pharmaceutical and medical device manufacturers. We sell our Environmental systems primarily to commercial automobile manufacturers and heating, ventilation and air conditioning (HVAC) manufacturers and our Hyperbaric products to the military (mainly larger chambers) and hospitals and clinics (mainly monoplace chambers). To a lesser degree, we provide upgrade, maintenance and repair services for our products and for products manufactured by other parties. . The Company recognizes revenue using three methods: On long-term contracts, the percentage of completion method is applied based on costs incurred as a percentage of estimated total costs. This percentage is multiplied by the total estimated revenue under a contract to calculate the amount of revenue recognized in an accounting period. Revenue recognized on uncompleted long-term contracts in excess of amounts billed to customers is reflected as an asset. Amounts billed to customers in excess of revenue recognized on uncompleted long-term contracts are reflected as a liability. When it is estimated that a contract will result in a loss, the entire amount of the loss is accrued. The effect of revisions in cost and profit estimates for long-term contracts is reflected in the accounting period in which the Company learns the facts which require it to revise its cost and profit estimates. Contract progress billings are based upon contract provisions for customer advance payments, contract costs incurred, and completion of specified contract milestones. Contracts may provide for customer retainage of a portion of amounts billed until contract completion. Retainage is generally due within one year of completion of the contract. Revenue recognition under the percentage of completion method involves significant estimates. Revenue for contracts under $100,000, or to be completed in less than one year, and where there are no post-shipment services included in the contract, is recognized on the date that the finished product is shipped to the customer. Revenue derived from the sale of parts and services is also recognized on the date that the finished product is shipped to the customer. Revenue on contracts under $100,000, or to be completed in less than one year, and where post-shipment services (such as installation and customer acceptance) are required, is recognized following customer acceptance. Revenue for service contracts is recognized ratably over the life of the contract with related material costs expensed as incurred. In accordance with accounting principles generally accepted in the United States of America, recognizing revenue on contract claims and disputes, related to customer caused delays, errors in specifications and designs, and other unanticipated causes, and for amounts in excess of contract value, is generally appropriate if it is probable that the claim will result in additional contract revenue and if the Company can reliably estimate the amount of additional contract revenue. However, revenue recorded on a contract claim cannot exceed the incurred contract costs related to that claim. Claims are subject to negotiation, arbitration and audit by the customer or governmental agency. The Company has operating subsidiaries in the United Kingdom and Poland, maintains regional offices in the Middle East, Asia and Canada, and uses the services of approximately 100 independent sales organizations and agents throughout the world. ETC International Corporation is a holding company established for federal income tax purposes and is not an operating subsidiary. The Company considers its business activities to be divided into two segments: Aircrew Training Systems (ATS) and the Industrial Group. 4 CRITICAL ACCOUNTING POLICIES The discussion and analysis of the Company's financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of the Company's financial statements. Actual results may differ from these estimates under different assumptions or conditions. Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company believes that its critical accounting policies include those described below. For a detailed discussion on the application of these and other accounting policies, see Note 1 to the Consolidated Financial Statements, Summary of Significant Accounting Policies. Revenue Recognition on Long-Term Contracts When the performance of a contract requires a customer to pay the Company more than $100,000 and will extend beyond a twelve-month period, revenue and related costs are recognized on the percentage-of-completion method of accounting. Profits expected to be realized on such contracts are recognized based on total estimated sales for the contract compared to total estimated costs at completion of the contract. These estimates are reviewed periodically throughout the lives of the contracts, and adjustments to profits resulting from any revisions are made cumulative to the date of the change. Estimated losses on long-term contracts are recorded in the period in which the losses become known to the Company. The Company accounts for some its largest contracts, including its contracts with the U.S. and other foreign governments, using the percentage-of-completion method. If the Company does not accurately estimate the total cost to be incurred on this type of contract, or if the Company is unsuccessful in the ultimate collection of associated contract claims, estimated gross margins may be significantly impacted or losses may need to be recognized in future periods. Any resulting reductions in margins or contract losses could be material to the Company's results of operations and financial position. Accounts Receivable The Company performs ongoing credit evaluations of its customers and adjusts credit limits based on payment history and the customer's current creditworthiness. The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses based on historical experience and any specific customer collection issues that have been identified. While the Company's credit losses have historically been within its expectations and the provisions established, the Company cannot guarantee that it will continue to experience the same credit loss rates that it has in the past. Additionally, as a result of the concentration of international receivables, the Company cannot predict the effect, if any, which geopolitical risk and uncertainty will have on the ultimate collection of its international receivables. In accordance with accounting principles generally accepted in the United States of America, recognizing revenue on contract claims and disputes related to customer caused delays, errors in specifications and designs, and other unanticipated causes, and for amounts in excess of contract value, is generally appropriate if it is probable that the claim will result in additional contract revenue and if the Company can reliably estimate the amount of additional contract revenue. However, revenue recorded on a contract claim cannot exceed the incurred contract costs related to that claim. Claims are subject to negotiation, arbitration and audit by the customer or governmental agency. RESULTS OF OPERATIONS Fiscal 2004 versus Fiscal 2003 - ------------------------------ The Company had a net loss of $793,000 or $.11 per share (diluted) in 2004 versus net income of $2,493,000 or $.33 per share (diluted) in fiscal 2003. Operating income was $131,000, a decrease of $3,985,000 or 96.8% over 2003. This decrease was primarily the result of reduced gross profits due to lower sales volume, primarily in domestic entertainment sales, partially offset by lower research and development expenses. 5 Sales ($000 except for %)
Domestic Government International Total $ % $ % $ % $ % Fiscal Year 2004 8,856 34.1 1,717 6.6 15,422 59.3 25,995 100.0 Fiscal Year 2003 23,692 54.9 4,626 10.8 14,805 34.3 43,123 100.0
Total sales in fiscal 2004 were $25,995,000, a decrease of $17,128,000 or 39.7% over 2003, representing decreases in entertainment ($16,998,000), hyperbaric ($1,519,000) and environmental ($1,701,000). Entertainment suffered from the completion in fiscal 2003 of a large project. Hyperbaric sales reflected reduced effort on a large US government submarine decompression chamber project. Environmental sales were down in the current period as fiscal 2003 reflected significant sales for large chamber projects in China. Providing partial offsets were increased sales for domestic sterilizers (up $1,662,000) and higher International Aircrew Training Systems (up $1,702,000) primarily for International Logistics Services (equipment upgrades and maintenance on various aeromedical equipment). Geographically, domestic sales were down $14,835,000 or 62.6%, and represented 34.1% of total sales, down from 54.9% in fiscal 2003, primarily reflecting decreased entertainment activity. U.S. government sales decreased to $1,717,000, as compared to $4,626,000 in fiscal 2003, and represented 6.6% of total sales, down from 10.8% of total sales in fiscal 2003. International sales, including those from the Company's foreign subsidiaries, were up $616,000 or 4.2%, and represented 59.3% of total sales, up from 34.3% in fiscal 2003, primarily reflecting an increase in ATS sales. Throughout the Company's history, most of the sales for Aircrew Training products have been made to international customers. Customers representing 10% or more of sales in fiscal 2004 were the Royal Malaysian Air Force, $2,874,000 or 11.1%, and the United Kingdom Ministry of Defense, $2,840,000 or 10.9%. In fiscal 2004, international sales totaling at least $500,000 per country were made to customers in Malaysia, the United Kingdom, Indonesia, Venezuela, Egypt, Nigeria, Thailand, China and Norway. Fluctuations in sales to international countries from year to year primarily reflect percentage of completion revenue recognition on the level and stage of development and production on multi-year long-term contracts. Open orders for the Royal Malaysian Air Force and a foreign customer constituted 19.4% and 20.0% respectively of the Company's backlog at February 27, 2004. For a discussion of the additional risks associated with our international operations, see "Risks Related to Our Business--There are certain risks inherent in our international business activities, which constitute a significant portion of our business," in our Annual Report on Form 10-K. Segment Sales ($000 except for %)
Aircrew Training Systems Industrial Group Total $ % $ % $ % Fiscal 2004 15,880 61.1 10,115 38.9 25,995 100.0 Fiscal 2003 31,612 73.3 11,511 26.7 43,123 100.0
On a segment basis, sales of the Company's ATS products, which create and monitor the physiological effects of motion (including spatial disorientation and centrifugal forces) on humans and equipment for medical, training, research and entertainment markets, were $15,880,000 in fiscal 2004, a decrease of $15,732,000, or 49.8% over fiscal 2003. Sales of these products accounted for 61.1% of the Company's sales compared to 73.3% in fiscal 2003. The decrease in ATS product sales primarily reflected the completion in the prior period of a major entertainment contract. Sales in the Company's other segment, the Industrial Group, which designs and produces chambers that create environments that are used for sterilization, research and medical applications, decreased $1,396,000 to $10,115,000, a decrease of 12.1%, and constituted 38.9% of the Company's total sales compared to 26.7% in fiscal 2003. Significant claims outstanding at February 27, 2004 included a claim with the U.S. Navy for a submarine decompression chamber ($2.9 million recorded) and a claim with an international customer ($2.6 million recorded). Significant claims outstanding at February 28, 2003 included $2.1 million for the aforementioned U.S. Navy claim and $9.5 million for two claims with an international customer. Effective February 27, 2004 the Company reached an agreement totaling $10.5 million on one of these international claims, thus resolving all outstanding amounts related to this claim. Although recorded as a current asset in the financial statements, all claim revenues may not be received in full during fiscal 2005. For a more complete discussion of outstanding claims, see "Note 2. Accounts Receivable" to our consolidated financial statements in the Annual Report to Stockholders following. Gross profit for fiscal 2004 decreased by $4,255,000 or 30.0% from fiscal 2003 reflecting the aforementioned sales decrease which was partially offset by a 5.3 percentage point increase in the rate as a percentage of sales. Product development costs, both to enhance functionality of existing products and to develop product extensions, negatively impacted gross profit as these costs are primarily charged directly to the cost of sales for specific orders. Increased rates were evidenced in all business groups except environmental and entertainment, but the primary positive impact came from the ATS group primarily reflecting the aforementioned settlement of an international claim. 6 Operating income for fiscal 2004 was $131,000, a decrease of $3,985,000 or 96.8% over fiscal 2003. On a segment basis, ATS had an operating income of $1,231,000, a decrease of $3,748,000 or 75.3% from fiscal 2003, while the Industrial Group had an operating loss of $248,000 in fiscal 2004 compared to an operating income of $52,000 in fiscal 2003. These segment operating results were offset, in part, by unallocated corporate expenses of $852,000, a decrease of $63,000 from fiscal 2003. The decrease in operating income for the ATS segment in fiscal 2004 reflected the aforementioned sales decrease partially offset by higher gross margins as a percentage of sales. The segment also experienced higher selling and marketing expenses including commissions. The Industrial Group segment's decrease in operating income in fiscal 2004 reflected the aforementioned slight reduction in sales coupled with a 2.9 percentage point drop in the gross profit rate as a percentage of sales partially offset by reduced selling and marketing expenses. Selling and administrative expenses were flat between the two periods as increases in legal and accounting costs and sales commissions were offset by reduced claims expenses. Approximately 41% of selling and administrative costs in the current fiscal were related to legal and accounting fees, claim costs and sales commissions. As a percentage of sales, selling and administrative expenses were 36.4% in fiscal 2004 compared to 21.9% in fiscal 2003. Research and development expenses decreased $278,000 or 43.7% in fiscal 2004 as compared to fiscal 2003. This decrease reflected government grants in our Turkish subsidiary under a government research award for work on our multi-axis centrifuge tactical flight simulator. Most of the Company's research efforts, which were and continue to be a significant cost of its business, are included in cost of sales for applied research for specific contracts, as well as research for feasibility and technology updates. Capitalized software development costs for fiscal 2004 were $1,716,000 compared to $1,193,000 in fiscal 2003. Amortization of software costs, which was charged to cost of sales, was $851,000 and $653,000 for fiscal 2004 and fiscal 2003, respectively. Interest expense (net of interest income) increased $1,088,000 or 210.0% in fiscal 2004 from fiscal 2003 reflecting higher average borrowings at higher rates and increased amortization of both deferred finance expenses from the Company's February 2003 refinancing and subordinated debt discount associated with the Company's subordinated debt. Letter of credit and other income/expenses decreased $208,000 or 61.5% in fiscal 2004 over fiscal 2003 reflecting reduced letter of credit fees on a lower balance and the net receipt of insurance proceeds for a stolen simulator. Given the Company's pre-tax loss for the fiscal period and the impact of some large permanent book/tax differences for some accounts, the Company experienced a domestic tax benefit based on an effective rate of 55.4% and a consolidated rate of 50.5%. Part of the reduction in the effective rate reflected the impact of research and experimentation tax credit refunds. The Company intends to continue to use research and experimentation tax credits, if applicable, to reduce its federal income tax. During the second quarter of fiscal 2003, the Company reached a settlement with Inland Revenue in Great Britain which resulted in an additional tax assessment of $15,000. Additionally, during fiscal 2004 the Company successfully concluded an Internal Revenue Service routine audit of the Company's fiscal 2000 tax filing with no additional liability. Fiscal 2003 versus Fiscal 2002 - ------------------------------ The Company had net income of $2,493,000 or $.33 per share (diluted) in 2003 versus net income of $1,741,000 or $.23 per share (diluted) in fiscal 2002. Operating income was $4,116,000, an increase of $1,243,000 or 43.3% over 2002. This increase was primarily the result of increased gross profits due to higher sales volumes, partially offset by higher general and administrative expenses and research and development expenses. Total sales in fiscal 2003 were $43,123,000, an increase of $10,596,000 or 32.6% over fiscal 2002, representing increases in all segments except hyperbaric. Primary contributors were additional international revenues for Aircrew Training Systems (ATS) (increased by $5,404,000) which benefited from a human centrifuge project in Southeast Asia, higher government sales for ATS (increased $2,099,000) reflecting the impact of the settlement with the U.S. Navy on the centrifuge contract and hyperbaric sales for a large U.S. Navy submarine rescue project, higher domestic sterilizer sales (increased by $1,245,000), and additional sales for domestic entertainment (increased by $1,409,000) which was involved in full production of a large project. Geographically, domestic sales were up $2,468,000 or 11.6%, and represented 54.9% of total sales, down from 65.2% in fiscal 2002, primarily reflecting sterilizer and entertainment activity. U.S. government sales increased to $4,626,000, as compared to $1,194,000 in fiscal 2002, and represented 10.8% of total sales, up from 3.7% of total sales in fiscal 2002. International sales, including those from the Company's foreign subsidiaries, were up $4,695,000 or 46.4%, and represented 34.3% of total sales, up from 31.1% in fiscal 2002, primarily reflecting an increase in ATS sales. Throughout the Company's history, most of the sales for Aircrew Training products have been made to international customers. 7 Customers representing 10% or more of sales in fiscal 2003 were the Walt Disney Company, $17,268,000 or 40.0%, and the Royal Malaysian Air Force, $7,203,000 or 16.7%. In fiscal 2003, international sales totaling at least $500,000 per country were made to customers in Malaysia, Thailand and China. Fluctuations in sales to international countries from year to year primarily reflect percentage of completion revenue recognition on the level and stage of development and production on multi-year long-term contracts. Open orders for the Royal Malaysian Air Force and a domestic sterilizer customer constituted 27.6% and 11.8% respectively of the Company's backlog at February 28, 2003. For a discussion of the additional risks associated with our international operations, see "Risks Related to Our Business--There are certain risks inherent in our international business activities, which constitute a significant portion of our business," in our Annual Report on Form 10-K. On a segment basis, sales of the Company's ATS products, which create and monitor the physiological effects of motion (including spatial disorientation and centrifugal forces) on humans and equipment for medical, training, research and entertainment markets, were $31,612,000 in fiscal 2003, an increase of $8,983,000, or 39.7% over fiscal 2002. Sales of these products accounted for 73.3% of the Company's sales compared to 69.6% in fiscal 2002. Sales in the Company's other segment, the Industrial Group, which designs and produces chambers that create environments that are used for sterilization, research and medical applications, increased $1,613,000 to $11,511,000, an increase of 16.3%, and constituted 26.7% of the Company's total sales compared to 30.4% in fiscal 2002. Significant claims outstanding at February 28, 2003 included a new claim with the U.S. Navy ($2.1 million recorded) and two claims with an international customer ($9.6 million recorded). On May 9, 2002, the Company reached a final settlement agreement totaling approximately $6.9 million with the U.S. Navy for a claim on a centrifuge contract completed in 1996 to resolve all outstanding amounts related to this claim. The outstanding claims with the international customer are both in arbitration. Although recorded as a current asset in the financial statements, all claim revenues may not be received in full during fiscal 2004. Gross profit for fiscal 2003 increased by $2,733,000 or 23.8% from fiscal 2002 as the increased sales volume was only partially offset by a 2.3 percentage point reduction in the rate as a percentage of sales. Reduced rates as a percentage of sales were primarily evidenced in international environmental, government hyperbaric and domestic simulation. Acting as a partial offset was an increase in gross profit dollars and rate as a percentage of sales for Aircrew Training Systems. Operating income for fiscal 2003 was $4,116,000, an increase of $1,243,000 or 43.3% over fiscal 2002. On a segment basis, ATS had an operating income of $4,979,000, an increase of $2,348,000 or 89.2% from fiscal 2002, while the Industrial Group had an operating income of $52,000 in fiscal 2003 compared to an operating income of $1,347,000 in fiscal 2002. These segment operating incomes were offset, in part, by unallocated corporate expenses of $915,000, a decrease of $190,000 from fiscal 2002. The improvement in operating income for the ATS segment in fiscal 2003 was due to increased international sales at a higher gross profit rate as a percentage of revenues partially offset by higher general and administrative expenses including commissions. The Industrial Group segment's decrease in operating income in fiscal 2003 reflected increased sales offset by a 13.2 percentage point reduction in the gross profit rate as a percentage of sales and additional general and administrative expenses. Both the environmental and hyperbaric product lines experienced reduced gross profit percentages. Selling and administrative expenses increased $1,454,000 or 18.2% in fiscal 2003 as compared to fiscal 2002 primarily reflecting increased commissions on the sales increase and increased claims expenses associated with the Company's ongoing claims activity. As a percentage of sales, selling and administrative expenses were 21.9% in fiscal 2003 compared to 24.6% in fiscal 2002. Research and development expenses increased slightly, up $36,000 or 6.0% in fiscal 2003 as compared to fiscal 2002, reflecting slightly higher activity at the Company's Turkish branch. Most of the Company's research efforts, which were and continue to be a significant cost of its business, are included in cost of sales for applied research for specific contracts, as well as research for feasibility and technology updates. Capitalized software development costs for fiscal 2003 were $1,193,000 compared to $989,000 in fiscal 2002. Amortization of software costs, which was charged to cost of sales, was $653,000 and $496,000 for fiscal 2003 and fiscal 2002, respectively. Interest expense (net of interest income) decreased $576,000 or 52.7% in fiscal 2003 from fiscal 2002 reflecting reduced average borrowings at lower rates and reduced amortization of deferred finance expenses. During fiscal 2002, deferred finance costs associated with the Company's refinancing in March 1997, which debt was subsequently paid off in March 2000, were charged off. Letter of credit and other expenses increased $194,000 or 134.7% in fiscal 2003 over fiscal 2002, principally due to increased banking fees associated with the Company's former lender. The Company's provision for taxes in fiscal 2003 was calculated based on a consolidated rate of 24.7%, primarily reflecting the impact of research and experimentation tax credit refunds. The Company intends to continue to use research and experimentation tax credits, if applicable, to reduce its federal income tax. 8 During the second quarter of fiscal 2003, the Company reached a settlement with Inland Revenue in Great Britain which resulted in an additional tax assessment of $15,000. Additionally, the Internal Revenue Service is currently performing a routine audit of the Company's fiscal 2000 tax filing. The Company is currently not able to assess whether any additional tax liability will result from the audit, although at this point the Company believes that any additional taxes, if any, will be immaterial. LIQUIDITY AND CAPITAL RESOURCES During fiscal 2004, the Company used $2,864,000 of cash to support operating activities. Cash usages included the net operating loss, increases in current assets, most notably receivables, inventories and prepaids and a decrease in billings in excess of costs and estimated earnings on uncompleted long-term contracts. Acting as partial offsets were non-cash expenses such as depreciation and amortization and increases in current liability accounts, primarily accounts payable, customer deposits and other accrued liabilities. The primary impact on cash usage was an increase in an international receivable to reflect a $10.5 million claim settlement that was subsequently paid to us in March 2004, a build-up in inventories reflecting pre-engineering costs on the Authentic Tactical Flight Simulator and customer induced delays on shipping completed products. The Company's investing activities used $1,695,000 in fiscal 2004 and consisted of purchases of capital equipment ($475,000) and capitalized software ($1,220,000). Given the nature of the Company's market and products, the continued development of generic control and core software and software tools is a critical objective of management. The Company's financing activities generated $1,780,000 of cash during fiscal 2004. This primarily reflected a significant decrease in restricted cash to cash collateralize international letters of credit (reflecting both the nature and amount of new contracts, outstanding international letters of credit decreased $2,277,000 during the fiscal year) which was only partially offset by net repayments under the Company's bank facility. (See "Note 6. Long-Term Obligations and Credit Arrangements" to the Consolidated Financial Statements.) The Company has historically financed operations through a combination of cash generated from operations, equity offerings and bank debt. On February 19, 2003, the Company completed a refinancing of its indebtedness with PNC Bank, National Association and H.F. Lenfest in the aggregate amount of $29,800,000. The Company used a portion of the proceeds from the financing to satisfy its existing debt obligations to Wachovia Bank, the Company's former lender, and to permit PNC Bank to issue a letter of credit to support outstanding bonds issued by Company. The transaction resulted in net proceeds (after transaction expenses and repayment of existing debt) to the Company of approximately $3,600,000. The net proceeds have been used by the Company for working capital purposes, and general corporate purposes directly related to growth. In accordance with the terms of an amendment dated April 30, 2003, the PNC Bank facility was increased and, as of the date of this Annual Report on Form 10-K, includes: (i) a revolving credit facility in the maximum aggregate principal amount of $14,800,000 to be used for the Company's working capital and general corporate purposes, including capital expenditures, with a sublimit for issuances of letters of credit in the maximum amount of $10,300,000, and (ii) a standby letter of credit in the amount of $5,025,410 as credit support for the Company's bonds. The terms and conditions of the revolving loan and the line of credit are set forth in a Credit Agreement, as amended, between the Company and PNC Bank. Availability under the facility is determined each month based on a borrowing base consisting of a portion of the Company's receivables, inventory and costs and estimated earnings in excess of billings, net of billings in excess of costs and estimated earnings on uncompleted long-term contracts. As of February 27, 2004, availability under the $14,800,000 revolving facility was $7,567,000. The obligations of the Company to PNC Bank under the Credit Agreement are secured by a senior security interest in all of the assets of the Company, including all real property owned by the Company. Subsequent to fiscal year end, PNC Bank advised the Company that it was considering certain changes to the revolving credit facility including reducing the total facility and requiring the Company to cash collateralize some or all of the facility. As of the filing date of this Form 10-K, these discussions were still ongoing. In the event that PNC Bank takes these actions, we may need to obtain additional sources of capital in order to continue growing our business. We believe that we will be able to locate such additional sources of capital and that any such action by PNC Bank will not have a long-term material adverse effect on our business. As of April 30, 2004 the Company had used approximately $5,426,000 of the facility for international letters of credit and as collateral for a portion of the PNC Bank letter of credit that serves as collateral for the Company's long-term bonds. 9 In connection with the financing provided by Mr. Lenfest, the Company entered into a Convertible Note and Warrant Purchase Agreement with Mr. Lenfest, pursuant to which the Company issued to Mr. Lenfest (i) a senior subordinated convertible promissory note in the original principal amount of $10,000,000 and (ii) warrants to purchase 803,048 shares of the Company's common stock. Upon the occurrence of certain events, the Company will be obligated to issue additional warrants to Mr. Lenfest. The note accrues interest at the rate of 10% per annum and matures on February 18, 2009. The note entitles Mr. Lenfest to convert all or a portion of the outstanding principal of, and accrued and unpaid interest on, the note into shares of common stock at a conversion price of $6.05 per share. The warrants may be exercised into shares of common stock at an exercise price equal to the lesser of $4.00 per share or two-thirds of the average of the high and low sale prices of the common stock for the 25 consecutive trading days immediately preceding the date of exercise. The obligations of the Company to Mr. Lenfest under the Convertible Note and Warrant Purchase Agreement are secured by a second lien on all of the assets of the Company, junior in rights to the lien in favor of PNC Bank, including all real property owned by the Company. Prior to the consummation of the refinancing, Advanced Technology Asset Management, LLC ("ATAM") (formerly ETC Asset Management, LLC), a shareholder of the Company and a holder of warrants to purchase 332,820 shares of the Company's common stock, consented to the transactions contemplated under the Credit Agreement and the financing provided by Mr. Lenfest, including the below market issuance of warrants to Mr. Lenfest. As a result of its consent, ATAM waived, solely in connection with such issuance, the anti-dilution rights contained in its warrant. In exchange for ATAM's consent, the Company issued to ATAM warrants to purchase an additional 105,000 shares of common stock. Except for the number of shares issuable upon exercise of the warrants, the new ATAM warrants have substantially the same terms as the warrants issued to Mr. Lenfest. In March, 2004, ATAM exercised all its warrants and received a total of 437,820 shares of common stock of the Company. The Company received proceeds of $586,410 from the exercise of these warrants. The Company believes that cash generated from operating activities (including claim settlements) as well as future availability under its credit agreement will be sufficient to meet its future obligations through at least May 31, 2005. However, as was noted above, the Company is in discussions with PNC Bank concerning the Company's revolving credit facility. In reference to the Company's outstanding claims with both the U.S. Navy and an international customer, to the extent the Company is unsuccessful in further recovery of contract costs, such an event could have a material adverse effect on the Company's liquidity and results of operations. Historically, the Company has had a favorable experience in that recoveries have exceeded recorded claims, including significant settlement agreements in fiscal 2003 and 2004. (See Note 2 to the Consolidated Financial Statements, Accounts Receivable). The following table presents our contractual cash flow commitments on long-term debt and operating leases. See Notes 6 and 7 to the consolidated financial statements for additional information on our long-term debt and operating leases.
PAYMENTS DUE BY PERIOD (IN THOUSANDS) -------------------------------------------------------------------------------------------- TOTAL LESS THAN 1 YEAR 1-3 YEARS 4-5 YEARS AFTER 5 YEARS ---------- ---------------- --------- --------- ------------- (IN THOUSANDS) Long-term debt, including current maturities* $12,474 $317 $946 $11,211 - Operating leases 384 159 225 - - Total ------- ---- ------ ------- ------- 12,858 $476 $1,171 $11,211 -
* Long-term debt is reported net of unamortized discount of $2,334 on the company's subordinated debt. See "Note 6. Long-Term Obligations and Credit Arrangements" to the Consolidated Financial Statements. The Company's sales backlog at February 27, 2004 and February 28, 2003, for work to be performed and revenue to be recognized under written agreements after such dates, was $16,914,000 and $21,454,000, respectively. This decline primarily reflected continued production and corresponding percentage of completion revenue recognition in the current fiscal year on two significant contracts. In addition, the Company's training, maintenance and upgrade contracts backlog at February 27, 2004 and February 28, 2003, for work to be performed and revenue to be recognized after such dates under written agreements, was approximately $2,637,000 and $3,931,000, respectively. Of the February 27, 2004 backlog, approximately $14,417,000 was under contracts for ATS and maintenance support including $3,798,000 for the Royal Malaysian Air Force. Approximately 89% of the February 27, 2004 backlog is expected to be completed prior to February 25, 2005. The Company's order flow does not follow any seasonal pattern as the Company receives orders in each fiscal quarter of its fiscal year. OFF-BALANCE SHEET ARRANGEMENTS There were no off-balance sheet arrangements during the fiscal year ended February 27, 2004 that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to the Company's investors. 10 RECENT ACCOUNTING PRONOUNCEMENTS Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB No. 13, and Technical Corrections: In April 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 145, "Rescission of FASB statements No. 4, 44, and 64, Amendment of FASB No. 13, and Technical Corrections." SFAS No. 145 changes the accounting principles governing extraordinary items by clarifying, and to some extent, modifying, the existing definition and criteria, specifying disclosure for extraordinary items and specifying disclosure requirements for other unusual or infrequently occurring events and transactions that are not extraordinary items. SFAS No. 145 is effective for financial statements issued for fiscal years beginning after June 15, 2002, with early adoption encouraged. The adoption of this statement did not have a significant impact on the Company's consolidated financial position, results of operations, or cash flows. Accounting for Costs Associated with Exit or Disposal Activities: In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." This statement provides financial accounting and reporting guidance for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force (EITF) Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring." SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. The adoption of this statement did not have a significant impact on the Company's consolidated financial position, results of operations, or cash flows. Accounting and Disclosure Requirements for Guarantees: In November 2002, FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45), was issued. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company previously did not record a liability when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. FIN 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002, but has certain disclosure requirements effective for interim and annual periods ending after December 15, 2002. The Company has not historically issued guarantees and adoption of this statement did not have a significant impact on the Company consolidated financial position, results of operations, or cash flow. Consolidation of Variable Interest Entities: In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise acquires an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The adoption of this statement did not have a significant impact on the Company's consolidated financial position, results of operations, or cash flows since the Company currently has no VIEs. In December 2003, the FASB issued FIN 46R with respect to VIEs created before January 31, 2003, which, among other things, revised the implementation date to the first fiscal year or interim period ending after March 15, 2004, with the exception of Special Purpose Entities (SPE). The consolidation requirements apply to all SPEs in the first fiscal year or interim period ending after December 15, 2003. The Company adopted the provision of FIN 46R effective February 27, 2004, and such adoption did not have a material impact on the consolidated financial statements since the Company currently has no SPEs. Accounting for Certain Financial Instruments: On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. SFAS No. 150 affects the issuer's accounting for three types of freestanding financial instruments. 11 o mandatorily redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets o instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets; includes put options and forward purchase contracts, and o obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers' shares. SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement did not have a material effect on the Company's consolidated financial position, results of operations or cash flows. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Company's common stock is traded on the American Stock Exchange under the symbol "ETC." As of May 14, 2004, the Company had 281 shareholders of record. The following table sets forth the quarterly ranges of high and low sale prices for shares of the common stock for the periods indicated. SALE PRICES ----------- HIGH LOW ---- --- FISCAL 2004 First Quarter $6.00 $5.00 Second Quarter 6.10 5.00 Third Quarter 8.70 6.08 Fourth Quarter 9.95 7.00 FISCAL 2003 First Quarter $9.15 $6.20 Second Quarter 7.85 6.00 Third Quarter 6.45 5.80 Fourth Quarter 6.40 5.86 On May 14, 2004, the closing price of the Company's common stock was $8.59. The Company has never paid any cash dividends on its common stock and does not anticipate that any cash dividends will be declared or paid in the foreseeable future. The Company's current credit facilities prohibit the payment of any dividends by the Company without the lender's prior written consent. EQUITY COMPENSATION PLAN INFORMATION
NUMBER OF SECURITIES REMAINING AVAILABLE NUMBER OF SECURITIES TO BE FOR FUTURE ISSUANCE UNDER ISSUED UPON EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A)) - ------------- -------------------------- ----------------------------- ------------------------ (a) (b) (c) EQUITY COMPENSATION PLANS APPROVED BY SECURITY HOLDERS 376,002 $7.21 623,998 EQUITY COMPENSATION PLANS NOT APPROVED BY SECURITY HOLDERS - N/A 209,058 ------- ----- ------- TOTAL 376,002 $7.21 833,056 ======= ===== =======
12 The following plans have not been approved by our stockholders: Employee Stock Purchase Plan - ---------------------------- The Company has an Employee Stock Purchase Plan which was adopted by the Board of Directors on November 3, 1987. All employees meeting service requirements, except officers, directors and 10% stockholders, are eligible to voluntarily purchase common stock through payroll deductions up to 10% of salary. The Company makes a matching contribution of 20% of the employee's contribution. 13 Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders of Environmental Tectonics Corporation We have audited the accompanying consolidated balance sheets of Environmental Tectonics Corporation and Subsidiaries as of February 27, 2004 and February 28, 2003, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for each of the three fiscal years in the period ended February 27, 2004. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Environmental Tectonics Corporation and Subsidiaries as of February 27, 2004 and February 28, 2003, and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended February 27, 2004, in conformity with accounting principles generally accepted in the United States of America. We have also audited the accompanying Schedule II of Environmental Tectonics Corporation and Subsidiaries as of February 27, 2004 and February 28, 2003 and for each of the three fiscal years in the period ended February 27, 2004. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth herein. As discussed in Note 1 to the consolidated financial statements, the Company has recorded receivables in the amount of $5.5 million related to claims made to or against the United States government and an international customer for contract costs incurred through February 27, 2004. The total net claims amount made is approximately $26.9 million based on costs incurred through February 27, 2004, and is subject to negotiation, arbitration and audit by the United States government and the international customer. As discussed in note 1 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, on February 23, 2002. /s/ Grant Thornton LLP - -------------------------- Philadelphia, Pennsylvania April 28, 2004 14 CONSOLIDATED BALANCE SHEETS ($ IN THOUSANDS, EXCEPT SHARE DATA)
FEBRUARY 27, 2004 FEBRUARY 28, 2003 ASSETS Cash and cash equivalents $ 1,366 $ 4,305 Cash equivalents restricted for letters of credit 784 3,189 Accounts receivable, net 19,233 16,193 Costs and estimated earnings in excess of billings on uncompleted long-term contracts 5,333 5,441 Inventories 9,843 8,494 Deferred tax asset 1,337 689 Prepaid expenses and other current assets 1,949 983 -------- -------- Total current assets 39,845 39,294 Property, plant and equipment, net 4,886 5,086 Software development costs, net of accumulated amortization of $7,494 and $6,819 in 2004 and 2003, respectively 3,089 2,224 Goodwill 477 477 Other assets, net 399 617 -------- -------- Total assets $ 48,696 $ 47,698 ======== ======== LIABILITIES Current portion of long-term obligations $ 317 $ 281 Accounts payable - trade 2,431 1,778 Billings in excess of costs and estimated earnings on uncompleted long-term contracts 945 1,463 Customer deposits 3,657 3,000 Other accrued liabilities 2,588 1,556 -------- -------- Total current liabilities 9,938 8,078 -------- -------- Long-term obligations, less current portion: Credit facility payable to banks 30 600 Long term bonds 4,370 4,645 Subordinated debt 7,666 7,391 Capitalized lease obligations 91 7 -------- -------- 12,157 12,643 -------- -------- Deferred tax liability 1,502 1,022 -------- -------- Total liabilities $ 23,597 $ 21,743 -------- -------- Minority Interest 45 48 STOCKHOLDERS' EQUITY Commonstock - authorized 20,000,000 shares, $.05 par value; 7,176,552 and 7,157,239 shares issued and outstanding in 2004 and 2003, respectively $ 359 $ 358 Capital contributed in excess of par value of common stock 9,430 9,331 Accumulated other comprehensive loss (329) (169) Retained earnings 15,594 16,387 -------- -------- Total stockholders' equity $ 25,054 $ 25,907 -------- -------- Total liabilities and stockholders' equity $ 48,696 $ 47,698 ======== ======== The accompanying notes are an integral part of the consolidated financial statements.
15 CONSOLIDATED STATEMENTS OF OPERATIONS ($ IN THOUSANDS, EXCEPT SHARE DATA)
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002 ----------------- ----------------- ----------------- Net sales $25,995 $43,123 $32,527 Cost of goods sold 16,052 28,925 21,062 ------- ------- ------- Gross profit 9,943 14,198 11,465 Operating expenses: Selling and administrative 9,454 9,446 7,992 Research and development 358 636 600 ------- ------- ------- 9,812 10,082 8,592 ------- ------- ------- Operating income 131 4,116 2,873 ------- ------- ------- Other expenses: Interest expense (net) 1,606 518 1,094 Letter of credit fees 127 154 102 Other, net 3 184 42 ------- ------- ------- 1,736 856 1,238 ------- ------- ------- (Loss)/income before (benefit from)/provision for income taxes and minority interest (1,605) 3,260 1,635 (Benefit from)/provision for income taxes (810) 805 (93) ------- ------- ------- (Loss)/income before minority interest (795) 2,455 1,728 Loss attributable to minority interest (2) (38) (13) ------- ------- ------- Net (loss)/income $(793) $2,493 $1,741 ======= ======= ======= Per share information: (Loss)/earnings per common share: Basic $(.11) $.35 $.24 Diluted $(.11) $.33 $.23 (Loss)/income applicable to common stockholders $(793) $2,493 $1,741 Weighted average common shares: Basic 7,163,000 7,153,000 7,143,000 Diluted 7,163,000 7,497,000 7,499,000 The accompanying notes are an integral part of the consolidated financial statements.
16 CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY ($ IN THOUSANDS, EXCEPT SHARE DATA) For the years ended February 27, 2004, February 28, 2003 and February 22, 2002
COMMON STOCK CAPITAL ---------------------- CONTRIBUTED ACCUMULATED IN EXCESS OF OTHER TOTAL PAR VALUE OF COMPREHENSIVE RETAINED STOCKHOLDERS' SHARES AMOUNT COMMON STOCK INCOME (LOSS) EARNINGS EQUITY ------ ------ ------------ ------------- -------- ------ Balance, February 23, 2001 7,110,546 $355 $6,514 $(226) $12,153 $18,796 Net income for the year - - - - 1,741 1,741 Foreign currency translation adjustment 54 - 54 ------- Total comprehensive income 1,795 Shares issued in connection with employee stock purchase and stock option plans 32,400 2 189 - - 191 --------- ---- ------ ----- ------- ------- Balance, February 22, 2002 7,142,946 357 6,703 (172) 13,894 20,782 Net income for the year - - - - 2,493 2,493 Foreign currency translation adjustment 3 - 3 ----- ------- ------- Total comprehensive income 2,496 Value of beneficial conversion option - - 1,400 - - 1,400 associated with issuance of subordinated convertible debt Value of warrants issued in connection - - 1,209 - - 1,209 with issuance of subordinated convertible debt Shares issued in connection with employee stock purchase and stock option plans 14,293 1 19 - - 20 --------- ---- ------ ----- ------- ------- Balance, February 28, 2003 7,157,239 358 9,331 (169) 16,387 25,907 Net loss for the year - - - - (793) (793) Foreign currency translation adjustment (160) - (160) ----- ------- ------- Total comprehensive loss (953) Shares issued in connection with employee stock purchase and stock option plans 19,313 1 99 - - 100 --------- ---- ------ ----- ------- ------- Balance, February 27, 2004 7,176,552 $359 $9,430 $(329) $15,594 $25,054 ========= ==== ====== ===== ======= ======= The accompanying notes are an integral part of the consolidated financial statements.
17 CONSOLIDATED STATEMENTS OF CASH FLOWS ($ IN THOUSANDS)
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED FEBRUARY 27, FEBRUARY 28, FEBRUARY 22, 2004 2003 2002 -------------- -------------- -------------- Cash flows from operating activities: Net (loss)/income $(793) $2,493 $1,741 Adjustments to reconcile net (loss)/income to net cash (used in)/provided by operating activities Depreciation and amortization 1,847 1,401 1,475 Deferred financing costs 275 - - (Decrease)/increase in allowance for accounts receivable and (149) (19) 111 inventory Loss attributable to minority interest (2) (38) (13) Deferred income taxes (benefit) (168) 313 (39) Changes in operating assets and liabilities: (Increase) decrease in assets Accounts receivable (2,973) 3,590 (3,083) Costs and estimated earnings in excess of billings on uncompleted long-term contracts 108 3,950 204 Inventories (1,763) (2,091) (2,645) Prepaid expenses and other current assets (720) 62 (530) Other assets (103) 32 (136) Increase (decrease) in liabilities: Accounts payable 653 (1,660) 1,509 Billings in excess of costs and estimated earnings on uncompleted long-term contracts (518) 964 (1,213) Customer deposits 657 (684) 2,241 Accrued income taxes (247) (731) (23) Other accrued liabilities 1,032 (2) (319) ------ ------ ------ Net cash (used in)/provided by operating activities (2,864) 7,580 (720) Cash flows from investing activities: Acquisition of equipment (475) (215) (649) Software development costs (1,220) (569) (989) ------ ------ ------ Net cash used in investing activities (1,695) (784) (1,638) Cash flows from financing activities: Borrowings under credit facility 2,514 26,396 10,899 Payments under credit facility (3,084) (37,551) (6,708) Payments on long-term bonds (275) (275) (275) Proceeds from subordinated debt - 7,391 - Deferred financing costs - (719) - Increase/(decrease) in restricted cash 2,405 (2,620) (25) Net increase/(decrease) in other long-term obligations 120 (6) (368) Proceeds from issuance of common stock/warrants 100 2,629 191 ------ ------ ------ Net cash provided by/(used in) financing activities 1,780 (4,755) 3,714 Effect of exchange rates on cash (160) 3 54 ------ ------ ------ Net (decrease)/increase in cash and cash equivalents (2,939) 2,044 1,410 Cash and cash equivalents at beginning of year 4,305 2,261 851 ------ ------ ------ Cash and cash equivalents at end of year $1,366 $4,305 $2,261 ====== ====== ====== Supplemental schedule of cash flow information: Interest paid $854 $480 $766 Income taxes paid $78 $1,720 $582
Supplemental information on non-cash operating and investing activities: During the year ended February 27, 2004, the Company reclassified $496 from inventory to capitalized software. During the year ended February 28, 2003, the Company reclassified $226 from inventory to property, plant and equipment and $624 from inventory to capitalized software. The accompanying notes are an integral part of the consolidated financial statements. 18 Notes to Consolidated Financial Statements ($ in thousands, except share data) 1. Summary of Significant Accounting Policies: Nature of Business: Environmental Tectonics Corporation ("ETC" or the "Company") is primarily engaged in the development, marketing and manufacturing of Aircrew Training Systems (ATS) and industrial simulation equipment. The Company utilizes its internally developed software systems in virtually all of its products. ETC focuses on software enhancements, product extensions, new product development and new marketplace applications. Sales of ATS products are made principally to U.S. and foreign government agencies and to the entertainment market. Sales of industrial simulation equipment, which includes sterilizers, environmental systems and hypo/hyperbaric equipment, are made to both commercial customers and governmental agencies worldwide. On April 21, 1998, the Company acquired a 65% ownership in MP-PZL Aerospace Industries, Ltd. ("MP-PZL"), a simulation and advanced training device manufacturing company located in Warsaw, Poland, for $375 in cash, an 8% interest-only three-year note payable for $350 and 55,000 shares of the Company's common stock valued at $495. MP-PZL was subsequently renamed ETC-PZL Aerospace Industries SP. Z O.O. ("ETC-PZL"). The Company's cost for this acquisition was $1,220 and has been recorded in the balance sheet under the purchase method of accounting for business combinations. In connection with the acquisition, the Company recorded goodwill of $662. On September 9, 2000, the Company purchased an additional 30% ownership interest in ETC-PZL for $300 cash, bringing the Company's total ownership to 95%. This transaction resulted in a reduction in goodwill of $101. During the fiscal quarter ended November 24, 2000, the Company purchased the assets of the "Pro-Pilot" flight simulation game for $400. This purchase was classified as an asset purchase (and not a business combination) and thus no goodwill resulted from the transaction. Principles of Consolidation: The consolidated financial statements include the accounts of Environmental Tectonics Corporation, Entertainment Technology Corporation and ETC Delaware, its wholly owned subsidiaries, ETC International Corporation, its 95% owned subsidiary, ETC-PZL Aerospace Industries SP. Z 0.0, and its 99% owned subsidiary, ETC Europe. All material inter-company accounts and transactions have been eliminated in consolidation. The Company's fiscal year is the 52-or 53-week annual accounting period ending the last Friday in February. Use of Estimates: In preparing financial statements in conformity with accounting principles generally accepted in the United States, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates are made for revenue recognition under the percentage of completion method (see Note 1, Revenue Recognition), claims receivable, inventories and computer software costs. At February 27, 2004, the Company had recorded receivables in the amount of $5.5 million for claims made or to be made against the U.S. government and an international customer for contract costs incurred through February 27, 2004. The total net claims amount filed with the U.S. government and an international customer at February 27, 2004, was approximately $26.9 million based on costs incurred through February 27, 2004. Effective February 27, 2004, the Company reached a final settlement agreement totaling $10.5 million on one of its claims with a foreign customer. This settlement was paid to the Company in March 2004. On May 9, 2002, the Company reached a final settlement agreement on one of its prior claims totaling approximately $6.9 million with the U.S. government. This settlement was paid to the Company in July 2002. The international claims are subject to negotiation, arbitration and audit by the international customer. Total claims outstanding at February 27, 2004 was approximately $26.9 million based on costs incurred through February 27, 2004. However, under generally accepted accounting principles, the Company had recorded only $5.5 million or 20.5% of this amount on its books. 19 Notes to Consolidated Financial Statements ($ in thousands, except share data) Revenue Recognition: Revenue is recognized on long-term contracts utilizing the percentage of completion method based on costs incurred as a percentage of estimated total costs. Revenue recognized on uncompleted long-term contracts in excess of amounts billed to customers is reflected as an asset. Amounts billed to customers in excess of revenue recognized on uncompleted long-term contracts are reflected as a liability. When it is estimated that a contract will result in a loss, the entire amount of the loss is accrued. The effect of revisions in cost and profit estimates for long-term contracts is reflected in the accounting period in which the facts requiring the revisions become known. Contract progress billings are based upon contract provisions for customer advance payments, contract costs incurred and completion of specified contract milestones. Contracts may provide for customer retainage of a portion of amounts billed until contract completion. Retainage is generally due within one year of completion of the contract. Revenue for contracts under $100, or to be completed in less than one year, and where there are no post-shipment services included in the contract, and revenue on parts and services, are recognized as shipped. Under these contracts, title passes at shipment. Revenue on those types of contracts where post-shipment services (such as installation and acceptance) are required is recognized upon customer acceptance. Revenue for service contracts is recognized ratably over the life of the contract with related material costs expensed as incurred. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB 101) which addresses certain criteria for revenue recognition. SAB 101, as amended by SAB 101A and SAB 101B, outlines the criteria that must be met to recognize revenue and provides guidance for disclosures related to revenue recognition policies. The Company implemented the applicable provisions of SAB 101 for the fiscal year ending February 23, 2001, with no material impact on the Company's results of operations. In September 2000, the Emerging Issues Task Force reached a consensus on Issue 00-10, "Accounting for Shipping and Handling Fees and Costs" (Issue 00-10). Issue 00-10 requires that all amounts billed to customers related to shipping and handling be classified as revenues. In addition, Issue 00-10 specifies that the classification of shipping and handling costs is an accounting policy decision that should be disclosed pursuant to APB 22, "Disclosure of Accounting Policies". The Company's product costs include amounts for shipping and handling. Therefore, the Company charges its customers shipping and handling fees at the time the products are shipped or when its services are performed. The cost of shipping products to the customer is recognized at the time the products are shipped to the customer and is included in cost of goods sold. Adoption of this consensus opinion had no effect on the Company's current and previous classifications. Cash and Cash Equivalents: Cash and cash equivalents include short-term deposits at market interest rates with original maturities of three months or less. The Company maintains cash balances at several financial institutions located in the Northeast United States and at some locations internationally. Accounts in each domestic institution are insured by the Federal Deposit Insurance Corporation up to $100. During each fiscal year, the Company periodically has cash and cash equivalents in excess of insured amounts. However, significant portions of the Company's funds are with one financial institution, which has had no experience of significant customer losses to date. Inventories: Inventories are valued at the lower of cost or market. Cost is determined principally by the first-in, first-out method. The costs of finished goods and work-in-process inventories include material, direct engineering, manufacturing labor and overhead components. The Company periodically reviews the net realizable value of the inventory and, if necessary, writes down the recorded costs. Depreciation of Property, Plant and Equipment: Property, plant and equipment are depreciated over their estimated useful lives by the straight-line method for financial reporting purposes. Accelerated depreciation methods are used for tax purposes. Upon sale or retirement of property, plant and equipment, the costs and related accumulated depreciation are eliminated from the accounts. Any resulting gains or losses are included in the determination of net income. Amortization of Goodwill: Goodwill of $662 was recorded in fiscal 1999 for the Company's 65% ownership purchase of ETC-PZL Aerospace Industries, SP. Z O.O. On September 27, 2000, the Company purchased an additional 30% ownership for $300 cash, bringing the Company's total ownership to 95%. This transaction resulted in a reduction in goodwill of $101. Amortization expense was $0, $0, and $17 in fiscal years 2004, 2003 and 2002, respectively, and accumulated amortization was $113 as of February 27, 2004 and February 28, 2003. 20 Notes to Consolidated Financial Statements ($ in thousands, except share data) 1. Summary of Significant Accounting Policies (Continued): On February 23, 2002, we adopted SFAS No. 142 "Goodwill and Intangible Assets" (SFAS No. 142). SFAS No. 142 includes requirements to annually test goodwill and indefinite lived intangible assets for impairment rather than amortize them. Accordingly, we no longer amortize goodwill, thereby eliminating an annual amortization charge of approximately $29. We have completed documentation of our transitional goodwill impairment tests and have not recorded any transitional goodwill impairment loss as a result of our adoption of SFAS No. 142. Additionally, we did not record any transitional intangible asset impairment loss upon adoption of SFAS No. 142. Reported net income, exclusive of amortization expense that is related to goodwill that is no longer being amortized, would have been:
FISCAL YEAR ENDED ----------------- FEBRUARY FEBRUARY FEBRUARY 2004 2003 2002 -------- -------- -------- Reported net (loss)/earnings $ (793) $2,493 $1,741 Goodwill amortization - - 17 Adjusted net (loss)/earnings $ (793) $2,493 $1,758 Basic (loss)/earnings per share: Reported net (loss)/earnings $(0.11) $ 0.35 $ 0.24 Goodwill amortization - - .01 Adjusted net (loss)/earnings $(0.11) $ 0.35 $ 0.25 Diluted (loss)/earnings per share: Reported net (loss)/earnings $(0.11) $ 0.33 $ 0.23 Goodwill amortization - - - Adjusted net (loss)/earnings $(0.11) $ 0.33 $ 0.23
Capitalized Software Development Costs: The Company capitalizes the qualifying costs of developing software contained in certain products. Capitalization of costs requires that technological feasibility has been established. When the software is fully documented and tested, capitalization of development costs cease and amortization commences on a straight-line basis over a period ranging from 36 to 60 months, depending upon the life of the product, which, at a minimum, approximates estimated sales. Realization of capitalized software costs is subject to the Company's ability to market the related product in the future and generate cash flows to support future operations. Capitalized software costs totaled $1,716 and $1,193, respectively, for the fiscal years ended February 27, 2004 and February 28, 2003. Related software amortization totaled $851, $653 and $496, respectively, for fiscal 2004, 2003 and 2002. Research and Development: Research and development expenses are charged to operations as incurred. During fiscal 2004, 2003 and 2002, the Company incurred research and development costs of approximately $358, $636 and $600, respectively. Amortization of Deferred Financing Costs: During fiscal 2002, all remaining capitalized costs relating to the March 1997 financing of the Company were expensed. Capitalized costs relating to the Company's bond issuance on March 15, 2000 and costs associated with the February 2003 PNC/Lenfest financing are being amortized over the relevant term. Amortization expense relating to deferred financing costs was $321, $75 and $293 in fiscal 2004, 2003 and 2002, respectively (see "Note 6. Long-Term Obligations and Credit Arrangements" to Consolidated Financial Statements). 21 Notes to Consolidated Financial Statements ($ in thousands, except share data) 1. Summary of Significant Accounting Policies (Continued): Subordinated Debt Discount During fiscal 2003, the Company had recorded $2,609 in additional paid-in capital representing an allocation of the proceeds from the convertible debt element of its financing with PNC and Lenfest. This allocation represents the value assigned to the beneficial conversion option of the Lenfest promissory note and the value of the associated warrants. Such values were derived pursuant to an independent appraisal of these financial instruments obtained by the Company. Accreted interest expense related to the beneficial conversion option and the warrants was $275 in fiscal 2004 and $0 in fiscal 2003. Income Taxes: The Company accounts for income taxes using the liability method, which reflects the impact of temporary differences between values recorded for assets and liabilities for financial reporting purposes and values utilized for measurement in accordance with applicable tax laws. Long-Lived Assets: The Company followed the provisions of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which provided guidance on when to recognize and how to measure impairment losses of long-lived assets and certain identifiable intangibles, and how to value long-lived assets to be disposed of. This involved a review of goodwill and other intangibles to assess recoverability from future operations using undiscounted future cash flows. Any impairments were recognized in operating results to the extent that carrying value exceeded fair value, which was determined based on the net present value of estimated future cash flows. Effective February 22, 2002, the Company adopted SFAS No. 144, "Impairment or Disposal of Long-Lived Assets" which requires additional impairment testing for long-lived assets. Stock Options: The Company accounts for stock options under the alternate provisions of SFAS No. 123 (discussed below), "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, SFAS No. 123 permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board (APB) Opinion 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB Opinion No. 25 are required to make pro-forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. At February 28, 2004, the Company has one stock-based employee compensation plan, which is described more fully in Note 10 to Consolidated Financial Statements. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation. 22 Notes to Consolidated Financial Statements ($ in thousands, except share data) 1. Summary of Significant Accounting Policies (Continued):
Fiscal Year Ended ------------------------------------------------------------- February 27, 2004 February 28, 2003 February 22, 2002 ----------------- ----------------- ----------------- Net (loss)/income, as reported $ (793) $ 2,493 $ 1,741 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (27) (275) (456) ------ ------- ------- Pro forma net (loss)/income $ (820) $ 2,218 $ 1,285 ====== ======= ======= (Loss)/earnings per share: Basic--as reported $(0.11) $.35 $.24 Basic--pro forma $(0.11) $.31 $.18 Diluted--as reported $(0.11) $.33 $.23 Diluted--pro forma $(0.11) $.30 $.17
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted average assumptions used for grants in fiscal 2002: expected volatility of 30.1%; risk-free interest rate of 5.01%; and an expected life of 10 years. There were no grants in fiscal 2003 and fiscal 2004. Advertising Costs: The Company expenses advertising costs, which include trade shows, as incurred. Advertising expense was $324, $464 and $438 in fiscal 2004, 2003, and 2002, respectively. Earnings Per Common Share: The Company has adopted SFAS No. 128, "Earnings Per Share." This standard requires presentation of basic and diluted earnings per share together with disclosure describing the computation of the per share amounts. Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The following table illustrates the reconciliations of the numerators and denominators of the basic and diluted earnings per share computations.
FISCAL YEAR ENDED FEBRUARY 27, 2004 --------------------------------------------- WEIGHTED LOSS AVERAGE PER SHARE ($000) SHARES AMOUNT ------ ------ ------ (NUMERATOR) (DENOMINATOR) Net loss $793 Basic loss per share Loss applicable to common stockholders $793 7,163,000 $.11 ==== ========= ==== Effective of dilutive securities Stock options - Convertible Debt - Stock warrants - --------- Diluted loss per share Loss applicable to common stockholders plus effect of dilutive securities $793 7,163,000 $.11 ==== ========= ====
23 Notes to Consolidated Financial Statements ($ in thousands, except share data) 1. Summary of Significant Accounting Policies (Continued): At February 27, 2004, there were stock options to purchase the Company's common stock totaling 376,002 shares that were not included in the computation of diluted loss per share as the effect of such would be anti-dilutive. Additionally, there was subordinated debt with a face value of $10,000,000, which was convertible at an exercise price of $6.05 per share, equating to 1,652,893 shares of common stock if fully converted. Upon each conversion of the subordinated note, the holder would be entitled to receive a warrant to purchase additional shares of common stock equal to ten percent of the shares issued pursuant to such conversion. If the entire face value of the subordinated note is converted into shares of common stock, then warrants to purchase an additional 165,289 shares of common stock will be issued, bringing the total shares of common stock to be issued to 1,818,182. Additionally, at February 27, 2004, there were outstanding warrants to purchase the Company's stock totaling 1,240,868 shares. None of these shares were included in the computation of diluted earnings per share as the effect would be anti-dilutive.
FISCAL YEAR ENDED FEBRUARY 28, 2003 --------------------------------------------------------- WEIGHTED AVERAGE PER SHARE INCOME ($000) SHARES AMOUNT ------------- -------- --------- (NUMERATOR) (DENOMINATOR) Net income $2,493 Basic earnings per share Income available to common stockholders $2,493 7,153,000 $.35 ====== ========= ==== Effective of dilutive securities Stock options 22,717 Convertible Debt 4,151 Stock warrants 317,407 --------- Diluted earnings per share Income available to common stockholders plus effect of dilutive securities $2,493 7,497,275 $.33 ====== ========= ====
At February 28, 2003, options to purchase the Company's common stock totaling 421,614 shares were outstanding, 341,314 of which were not included in the computation of diluted earnings per share as the effect of such inclusion would be anti-dilutive.
FISCAL YEAR ENDED FEBRUARY 22, 2002 --------------------------------------------------------- WEIGHTED AVERAGE PER SHARE INCOME ($000) SHARES AMOUNT ------------- -------- --------- (NUMERATOR) (DENOMINATOR) Net income $1,741 Basic earnings per share Income available to common stockholders $1,741 7,142,946 $.24 ====== ========= ==== Effective of dilutive securities Stock options 44,180 Stock warrants 311,460 --------- Diluted earnings per share Income available to common stockholders plus effect of dilutive securities $1,741 7,498,586 $.23 ====== ========= ====
At February 22, 2002, options to purchase the Company's common stock totaling 448,514 shares were outstanding, 313,750 of which were not included in the computation of diluted earnings per share as the effect of such inclusion would be anti-dilutive. 24 Notes to Consolidated Financial Statements ($ in thousands, except share data) 2. Accounts Receivable: The components of accounts receivable at February 27, 2004 and February 28, 2003 are as follows:
2004 2003 ---- ---- U.S. government receivables billed and unbilled contract costs subject to negotiation $ 3,128 $ 2,719 U.S. commercial receivables billed 1,508 2,002 International receivables billed and unbilled contract costs subject to negotiation 14,976 11,918 ------- ------- 19,612 16,639 Less allowance for doubtful accounts (379) (446) ------- ------- $19,233 $16,193 ======= =======
U.S. government receivables billed and unbilled contract costs subject to negotiation: Unbilled contract costs subject to negotiation as of February 27, 2004 represent claims made against the U.S. government under a contract for a submarine decompression chamber project. These costs, totaling $2,899, were recorded beginning in fiscal 2002, and include $1,691 recorded during fiscal 2003 and $833 recorded during fiscal 2004. In November 2003, the U.S. Government completed an audit of the claim, rejecting most of the items due to audit or engineering reasons. The Company was not provided a copy of the Government's Technical Report that questioned approximately half of the claim costs. The Company has submitted a written rebuttal to the draft report and has formally requested a copy of the Technical Report. The U.S. Government has agreed to issue a final decision on September 15, 2004. The Company considers the recorded costs to be realizable due to the fact that they relate to customer caused delays, errors and changes in specifications and designs, disputed liquidated damages and other out of scope items. Subsequent to fiscal year end, the Company submitted a supplement to the claim incorporating additional cost items. During the fiscal 2004 third quarter, the U.S. Government, citing failure to deliver product within contract terms, began assessing liquidated damages by offsetting progress payments due the Company under the contract. Subsequent to fiscal 2004 year end, citing "substantial material progress" on the project, the U.S. Government agreed to release all outstanding invoice payments which had previously been withheld for liquidated damages. The Company disputes the basis for these liquidated damages, noting that applicable U.S. Government purchasing regulations allow for a waiver of these charges if the delay is beyond the control and not due to the fault or negligence of the Company. However, in accordance with accounting principles generally accepted in the United States of America, the Company has reduced contract values and corresponding revenue recognition for an estimated amount of $330 to cover a delay through the extended delivery period. International receivables billed and unbilled contract costs subject to negotiation: The Royal Thai Air Force: In October 1993, the Royal Thai Air Force (RTAF) notified the Company that the RTAF was terminating a certain $4,600 simulator contract with the Company. Although the Company had performed in excess of 90% of the contract, the RTAF alleged a failure to completely perform. In connection with the termination, the RTAF made a call on a $230 performance bond, as well as a draw on an approximately $1,100 advance payment letter of credit. Work under this contract had stopped while under arbitration, but on October 1, 1996, the Thai Trade Arbitration Counsel rendered its decision under which the contract was reinstated in full and the Company was given a period of nine months to complete the remainder of the work. Except as noted in the award, the rights and obligations of the parties remain as per the original contract including the potential invoking of penalties or termination of the contract for delay. On December 22, 1997, the Company successfully performed acceptance testing and the unit passed the testing with no discrepancy reports. Although the contract was not completed in the time allotted, the Company has requested an extension on the completion time due to various extenuating circumstances, including allowable "force majeure" events, one of which was a delay in obtaining an export license to ship parts required to complete the trainers. On August 30, 2001, the Company received a payment of $230 representing the amount due on the performance bond. 25 Notes to Consolidated Financial Statements ($ in thousands, except share data) The open balance of $700 at February 27, 2004 and February 28, 2003 due on the contract represents the total net exposure to the Company on this contract. As of February 27, 2004, the Company has authorized its Thai attorneys to commence and prosecute arbitration proceedings, and it is anticipated that this will occur in the near future. However, since the circumstances that caused a delay are commonly considered "force majeure" events, and since the contract under question allows for consideration of "force majeure" events, the Company believes that the open balance related to this contract is collectible and will continue to treat this balance as collectible until a final unappealable legal decision is rendered by a competent Thai tribunal. The Company has enjoyed a favorable relationship with the RTAF. It currently has both maintenance and upgrade contracts with the RTAF for the trainers that are the subject of the dispute, and it is not anticipated that the initiation of legal action against the RTAF will have any material adverse impact on future sales to the RTAF. A date for arbitration has not been set as of yet, although the parties are currently in the process of choosing their individual arbitrators. As of the date of this Annual Report on Form 10-K, the Company is not able to determine what, if any, impact the extended completion and payment period will have upon the receipt of the total amount due. International customer: Unbilled contract costs subject to negotiation as of February 27, 2004 included a claim ($2,600 recorded) made against an international customer for a contract covering 1997 to the present. Claim costs have been incurred in connection with customer caused delays, errors in specifications and designs, and other out-of-scope items and exchange losses and may not be received in full during fiscal 2005. In conformity with accounting principles generally accepted in the United States, revenue recorded by the Company from a claim does not exceed the incurred contract costs related to the claim. The Company and the customer are currently in the arbitration process. The Company has filed its "Points of Claim" to which the customer has replied and also the customer has filed a counterclaim, which the Company expects to respond to shortly. Additionally, the discovery process is continuing. The customer, citing failure to deliver product within contract terms, has assessed liquidated damages totaling approximately $400 on the contract. The Company disputes the basis for these liquidated damages and is vigorously contesting them. However, following generally accepted accounting principles, the Company has reduced contract values and corresponding revenues by approximately $400. Effective February 27, 2004, the Company reached an agreement totaling $10.5 million with the same international customer on another claim of which $6.8 million was included in unbilled contract costs subject to negotiation as of February 28, 2003, thus resolving all outstanding amounts related to this claim. Claim bookings and settlements in fiscal 2004 increased operating income by $1,802. Claim bookings in fiscal 2003 and 2002 decreased operating income by $675 and $661 respectively. All amounts are net of associated manufacturing costs and legal expenses. Net claims receivables were $5,508 and $11,700 at February 27, 2004 and February 28, 2003, respectively. 26 Notes to Consolidated Financial Statements ($ in thousands, except share data) 3. Costs and Estimated Earnings on Uncompleted Contracts: Unbilled costs Amounts not billed or yet billable totaled $16,638 at February 27, 2004. Under most of the Company's contracts, invoices are issued upon the attainment of certain contract milestones, for example upon receipt of order, upon engineering drawing submittal, upon design acceptance, or upon shipment. Service contracts are billed monthly or quarterly. Parts and service are billed as shipped or completed. The following is a summary of long-term contracts in progress at February 27, 2004 and February 28, 2003:
2004 2003 ---- ---- Costs incurred on uncompleted long-term contracts $28,802 $23,941 Estimated earnings 5,508 9,757 ------- ------- 34,310 33,698 Less billings to date (29,922) (29,720) ------- ------- $ 4,388 $ 3,978 ======= =======
2004 2003 ---- ---- Included in accompanying balance sheets under the following captions: Costs and estimated earnings in excess of billings on uncompleted long-term contracts $5,333 $5,441 Billings in excess of costs and estimated earnings on uncompleted long-term contracts (945) (1,463) ------ ------ $4,388 $3,978 ====== ======
Included in billings in excess of costs and estimated earnings on uncompleted long-term contracts is a provision for anticipated losses on contracts of $200 in fiscal 2004, 2003 and 2002. 4. Inventories: Inventories consist of the following:
WORK IN RAW MATERIAL PROCESS FINISHED GOODS TOTAL ------------ ------- -------------- ----- February 27, 2004 $311 $7,803 $1,729 $9,843 February 28, 2003 322 5,629 2,543 8,494
Inventory is presented above net of an allowance for obsolescence of $564 and $646 in fiscal 2004 and 2003, respectively. 27 Notes to Consolidated Financial Statements ($ in thousands, except share data) 5. Property, Plant and Equipment: The following is a summary of property, plant and equipment, at cost, and estimated useful lives at February 27, 2004 and February 28, 2003:
ESTIMATED USEFUL 2004 2003 LIVES ---- ---- ----- Land $100 $100 Building and building additions 3,763 3,763 40 years Machinery and equipment 9,019 8,611 3-5 years Office furniture and equipment 1,195 1,195 10 years Building improvements 1,460 1,393 5-10 years ------- ------ 15,537 15,062 Less accumulated depreciation (10,651) (9,976) ------- ------ Property, plant and equipment, net $4,886 $5,086 ====== ======
Depreciation expense for the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002 was $675, $673 and $668, respectively. 6. Long-Term Obligations and Credit Arrangements: Long-term obligations at February 27, 2004 and February 28, 2003 consist of the following:
2004 2003 ---- ---- Credit facility payable to banks $ 30 $ 600 Long term bonds 4,645 4,920 Subordinated debt, net of unamortized discount of $2,334 and $2,609 for 2004 and 2003, respectively 7,666 7,391 Term loans payable, accruing interest at between 9% and 9.9% collateralized by priority liens on certain equipment 6 13 Capitalized lease obligations 127 - -------- ------- 12,474 12,924 Less current portion (317) (281) -------- ------- $ 12,157 $12,643 ======== =======
The amounts of future long-term obligations maturing in each of the next five fiscal years are as follows: 2005 $317 2006 343 2007 314 2008 289 2009 and thereafter 11,211 ------- Total future obligations $12,474 ======= The approximate average loan balance, maximum aggregate borrowings outstanding at any month-end payable under the credit facility and subordinated debt during the fiscal years, and weighted average interest rate computed by the day's outstanding method as of February 27, 2004 and February 28, 2003 are as follows: 2004 2003 ---- ---- Approximate average loan balance 10,401 8,219 Maximum aggregate 11,200 11,445 Weighted average interest rate 8.45%* 4.37% * The weighted average interest rate calculation for fiscal 2004 reflects the impact of the $10,000 senior subordinated debt obtained as part of the February 19, 2003 financing. 28 Notes to Consolidated Financial Statements ($ in thousands, except share data) The Company established a senior credit facility with PNC Bank, National Association on February 19, 2003 and amended the facility on April 30, 2003. The PNC facility includes: (i) a revolving credit facility in the maximum aggregate principal amount of $14,800 to be used for the Company's working capital and general corporate purposes, including capital expenditures, with a sublimit for issuances of letters of credit in the maximum amount of $10,300, and (ii) a standby letter of credit in the amount of $5,025 as credit support for the Company's bonds. Interest is charged on direct borrowings at the bank's prime rate plus 0.75% for a base rate loan or for a Eurodollar loan, LIBOR plus 3.25% or adjusted LIBOR in 2003 and 2002. The interest rates ranged from 4.75% to 5.00% during fiscal 2004 and from 4.00% to 5.00% during fiscal 2003. The terms and conditions of the revolving loan and the line of credit are set forth in a credit agreement between the Company and PNC. Availability under the facility is determined each month based on a borrowing base consisting of a portion of the company's receivables, inventory and costs and estimated earnings in excess of billings net of billings in excess of costs and estimated earnings on uncompleted long-term contracts. As of February 27, 2004, availability under the $14,800 revolving facility was $7,567 all of which was available for borrowing. As part of our Bank and Subordinated agreements, the Company must also meet certain financial covenants including a Leverage Ratio, a Fixed Charge Ratio, a Tangible Net Worth Ratio, and maintain a full year profit. As of year end the Company failed to meet all of these covenants and has obtained waivers from both of its lenders. The PNC credit facility is secured by (i) the grant of a first and prior security interest in all of the personal property of the Company, Entertainment Technology Corporation ("Entertainment"), and ETC Delaware, Inc. ("ETC Delaware"), each a wholly-owned subsidiary of the Company, in favor of PNC; (ii) the Company's grant of a first and prior security interest in all of the Company's accounts, deposits and all other negotiable and non-negotiable instruments owned by the Company in favor of PNC; (iii) the Company's grant of a first and prior mortgage on all of the Company's real property in favor of PNC; and (iv) the Company's grant of a first and prior security interest in all of the Company's rights to (a) all of the shares of capital stock of each of Entertainment and ETC Delaware and (b) 65% of the shares of capital stock owned by the company of each of its foreign subsidiaries in favor of PNC. In addition, the PNC credit agreement requires that Entertainment and ETC Delaware guarantee the Company's obligations under the PNC facility. Subsequent to fiscal year end, PNC advised the Company that it was considering certain changes to the revolving credit facility including reducing the total facility and requiring the Company to cash collateralize some or all of the facility. As of the filing date of this Annual Report on Form 10-K, these discussions were still ongoing. As of April 30, 2004, the Company had utilized approximately $5,426 of the facility for international letters of credit and as collateral for a portion of the long-term bonds. (Reference the Liquidity and Capital Resources Section of the Annual Report to Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K.) Also on February 19, 2003, the Company entered into a Convertible Note and Warrant Purchase Agreement with H.F. Lenfest ("Lenfest") for $10,000 face value of senior subordinated debt. The note accrues interest at the rate of 10% per annum and matures on February 18, 2009. The note allows Lenfest to convert all or part of the outstanding principal thereunder into shares of common stock at a conversion price of $6.05 per share. The promissory note allows for quarterly interest payments in arrears with the principal due on February 18, 2009. At the Company's option, the quarterly interest payments may be deferred and added to the outstanding principal. At Lenfest's option, any deferred interest amounts may be converted into shares of common stock under the same terms and conditions as the convertible note. The Company has obtained a valuation from an independent valuation firm of the convertible note and the associated warrant. Based on the results of this valuation, at February 28, 2003, $1,400 of value had been assigned to the beneficial conversion feature of the convertible note and $1,209 had been assigned to the value of the associated warrants. Both of these amounts have been credited to additional paid-in capital as of February 28, 2003. Accreted interest expense related to the note and warrants was $275 in fiscal 2004. The Company used a portion of the proceeds from the financing to satisfy its existing obligations to Wachovia Bank, the Company's former lender, and to permit PNC to issue a letter of credit to support the Company's bonds. The Company's letter of credit limit under the revolving credit facility is $10,300, subject to borrowing base availability. The balance outstanding under these facilities at February 27, 2004 was $4,083. Fees on letters of credit outstanding were 1.75% at February 27, 2004 and February 28, 2003. 29 Notes to Consolidated Financial Statements ($ in thousands, except share data) On March 15, 2000, the Company issued approximately $5,500 of unregistered Taxable Variable Rate Demand/Fixed Rate Revenue Bonds (Series of 2000). Net proceeds from these bonds were used to repay a $4,100 advance taken on the Company's revolving credit facility and to finance construction of an addition to the Company's main plant in Southampton, Pennsylvania. The bonds are secured by a $5,000 irrevocable direct pay Letter of Credit issued by the Company's main lender which expires on March 15, 2005 and which is secured by all assets of the Company. The bonds carry a maturity date of April 1, 2020, bear a variable interest rate which adjusts each week to a rate required to remarket the bonds at full principal value (currently at 1.20% on May 12, 2004) with a cap of 17%, and are subject to mandatory redemption of $275 per year for 19 years and $245 for the 20th year. The carrying value of these financial instruments approximates their fair values at February 27, 2004. 7. Leases: Operating Leases The Company leases certain premises and office equipment under operating leases, which expire over the next five years. Future minimum rental payments required under noncancellable operating leases having a remaining term expiring after one fiscal year as of February 27, 2004 are $159 in 2005; $125 in 2006; $86 in 2007; $14 in 2008; and $0 in 2009 and thereafter. Total rental expense for all operating leases for the fiscal years ended February 27, 2004, February 28, 2003 and February 22, 2002 was $241, $255 and $197, respectively. 8. Income Taxes: The components of the provision for income taxes are as follows:
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002 ----------------- ----------------- ----------------- Currently payable: Federal $(738) $285 $42 State - 188 134 Foreign taxes 96 19 (230) ----- ---- ---- (642) 492 (54) ----- ---- ---- Deferred: Federal (101) 282 (36) State (67) 31 (3) ----- ---- ---- (168) 313 (39) ----- ---- ---- $(810) $805 $(93) ===== ==== ====
A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows:
52 WEEKS ENDED 53 WEEKS ENDED 52 WEEKS ENDED FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002 ----------------- ----------------- ----------------- Statutory income tax (34.0)% 34.0% 34.0% State income tax, net of federal tax benefit (4.1) 3.7 5.4 Benefit of foreign sales corporation And extraterritorial income (9.1) (4.5) (3.4) Research and experimentation tax credit refunds attributable to open tax years (0.0) (0.0) (37.8) Research and experimentation and Other tax credits (9.2) (5.0) (9.2) Benefit of foreign and foreign-source Income or loss (0.0) (0.0) (1.0) Other, net 6.0 (3.5) 6.4 ----- ---- ---- (50.4%) 24.7% (5.6)% ===== ==== ====
The tax effects of the primary temporary differences are as follows:
2004 2003 2002 ---- ---- ---- Deferred tax assets: Net products liability settlement - 75 75 Vacation reserve 44 44 58 Inventory reserve 212 244 275 Receivable reserve 8 168 139 Warranty reserve 142 47 46 Net operating loss and credits 302 - - Other, net 629 111 122 ------ ------ ---- Total current deferred tax asset $1,337 $689 $715 ------ ------ ---- Deferred tax liabilities: Amortization of capitalized software $1,166 $724 $488 ------ ------ ---- Depreciation 336 298 247 ------ ------ ---- Total noncurrent deferred tax liability $1,502 $1,022 $735 ------ ------ ----
30 Notes to Consolidated Financial Statements ($ in thousands, except share data) 9. Business Segment Information: The Company primarily manufactures, under contract, various types of high-technology equipment which it has designed and developed. The Company considers its business activities to be divided into two segments: Aircrew Training Systems (ATS) and the Industrial Group. The ATS business produces devices which create and monitor the physiological effects of motion, including spatial disorientation and centrifugal forces for medical, training, research and entertainment markets. The Industrial Group business produce chambers that create environments that are used for sterilization, research and medical applications. The following segment information reflects the accrual basis of accounting:
ATS INDUSTRIAL GROUP TOTAL --- ---------------- ----- FISCAL 2004 ----------- Net sales $15,880 $10,115 $25,995 Interest expense 1,293 313 1,606 Depreciation and amortization 881 966 1,847 Operating income/(loss) 1,231 (248) 983 Income tax provision/(benefit) 62 (318) (256) Goodwill 477 - 477 Identifiable assets 30,002 7,496 37,498 Expenditures for segment assets 380 95 475 FISCAL 2003 ----------- Net Sales $31,612 $11,511 $43,123 Interest expense 423 95 518 Depreciation and amortization 1,136 265 1,401 Operating income 4,979 52 5,031 Income tax provision/(benefit) 1,139 (11) 1,128 Goodwill 477 - 477 Identifiable assets 26,481 6,348 32,829 Expenditures for segment assets 406 35 441 FISCAL 2002 ----------- Net Sales $22,629 $9,898 $32,527 Interest expense 950 144 1,094 Depreciation and amortization 1,041 434 1,475 Operating income 2,631 1,347 3,978 Income tax provision 164 118 282 Goodwill 477 - 477 Identifiable assets 33,160 5,408 38,568 Expenditures for segment assets 557 92 649 2004 2003 2002 ---- ---- ---- Reconciliation to consolidated amounts: ------- ------- ------- Corporate assets 10,721 14,869 9,914 Total assets $48,696 $47,698 $48,482 Segment operating income $983 $5,031 $3,978 Less interest expense (1,606) (518) (1,094) Income taxes (benefit)/provision (256) 1,128 282 ------- ------- ------- Total loss for segments (367) 3,385 2,602 Corporate home office expense (852) (915) (1,105) Interest and other expenses (130) (338) (144) Income tax benefit 554 323 375 Minority interest 2 38 13 ------- ------- ------- Net (loss)/income $(793) $2,493 $1,741 ======= ======= =======
Segment operating income consists of net sales less applicable costs and expenses relating to these revenues. Unallocated expenses including general corporate expenses, letter of credit fees, interest expense, and income taxes have been excluded from the determination of the total profit for segments. General corporate expenses are primarily central administrative office expenses. Property, plant, and equipment are not identified with specific business segments because most of these assets are used in each of the segments. Approximately 22% of sales totaling $5,714 in 2004 were made to two international customers in the ATS segment. Approximately 57% of sales totaling $24,471 in fiscal 2003 were made to one international and one domestic customer in the ATS segment. Approximately 59% of sales totaling $19,143 in fiscal 2002 were made to one international and one domestic customer in the ATS segment. Included in the segment information for the year ended February 27, 2004, are export sales of $15,421. Of this amount, there are sales to or relating to governments or commercial accounts in Malaysia of $2,874 and the United Kingdom of $2,840. Sales to the U.S. government and its agencies aggregated $1,717 for the year ended February 27, 2004. Included in the segment information for the year ended February 28, 2003 are export sales of $14,805. Of this amount, there are sales to or relating to governments or commercial accounts in Malaysia of $7,203. Sales to the U.S. government and its agencies aggregated $4,626 for the year ended February 28, 2003. 31 Notes to Consolidated Financial Statements ($ in thousands, except share data) Included in the segment information for the year ended February 22, 2002 are export sales of $10,110. Of this amount, there are sales to or relating to governments or commercial accounts in Thailand of $3,284. Sales to the U.S. government and its agencies aggregated $1,194 for the year ended February 22, 2002. 10. Stock Options: A summary of the status of the Incentive Stock Option Plan as of and for the fiscal years ended:
FEBRUARY 27, 2004 FEBRUARY 28, 2003 FEBRUARY 22, 2002 --------------------------- ---------------------------- --------------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE -------- -------------- -------- -------------- -------- -------------- Outstanding at beginning of year 421,614 $7.20 448,514 $7.04 464,350 $6.95 Granted -- -- - - 27,564 7.38 Exercised (17,800) 5.12 (4,150) 4.73 (32,400) 5.89 Forfeited (27,812) 7.74 (22,750) 4.52 (11,000) 7.43 ------- ------- ------- Outstanding at end of year 376,002 7.21 421,614 7.20 448,514 7.04 ======= ======= ======= Options exercisable at year end 370,564 - 408,981 - 240,325 - Weighted average fair value of options granted during the year - - - - - $7.01
The following information applies to options outstanding at February 27, 2004:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------- ------------------------------------------------ WEIGHTED NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE FEBRUARY 27, CONTRACTUAL EXERCISE FEBRUARY 27, EXERCISE RANGE OF EXERCISE PRICES 2004 LIFE (YEARS) PRICE 2004 PRICE ------------------------ -------------- ------------- -------- -------------- -------- $2.25 to $3.38 9,200 2.45 years $2.25 9,200 $2.25 $5.00 to $7.50 82,302 5.01 years $5.67 76,864 $5.55 $7.81 284,500 4.65 years $7.81 284,500 $7.81 ------- ------- Total 376,002 370,564
32 Notes to Consolidated Financial Statements ($ in thousands, except share data) 11. Claims and Litigation: In April 2003, Boenning & Scattergood, Inc. ("B&S") filed suit against the Company in the Court of Common Pleas in Philadelphia, Pennsylvania, seeking payment of $902 for financing fees allegedly due to B&S pursuant to the terms of an agreement for investment banking services which was entered into with a predecessor of B&S (the "B&S Agreement). B&S alleged that it contacted the investors in the Company's February 2003 financing transaction and that it earned the claimed financing fees pursuant to the terms of the B&S agreement. The Company responded to the complaint and also filed a counterclaim for breach of contract and professional malpractice. The Company believes that it has valid defenses to each of the claims of B&S and intends to vigorously defend itself against these claims. At this time, however, the Company is unable to predict the outcome of this matter. In June 2003, Associated Mezzanine investors, LLC ("AMI") filed suit against the Company in the United States District Court for the Eastern District of Pennsylvania seeking payment of $196 for costs, fees and expenses allegedly due to AMI pursuant to the terms of an agreement which the Company entered into with AMI (the "AMI Agreement"). AMI claimed that it located suitable investors for the Company's February 2003 financing transaction and that it earned the claimed fees and is entitled to reimbursement of the claimed costs and expenses pursuant to the terms of the AMI Agreement. In March 2004, this suit was settled without any material impact on the Company's results of operations. In June 2003 Entertainment Technology Corporation, a wholly-owned subsidiary of the Company, filed suit against Walt Disney World Co. and other entities ("Disney") in the United States District Court for the Eastern District of Pennsylvania, alleging breach of contract for, among other things, failure to pay all amounts due under a contract for the design and production of the amusement park ride "Mission:Space" located in Disney's Epcot Center. In response, in August 2003, Disney filed counterclaims against both Entertainment Technology Corporation and the Company (under a guarantee) for, among other things, alleged failures in performance and design in the contract. Disney is seeking damages in excess of $150. Entertainment Technology Corporation and the Company believe that they have valid defenses to each of Disney's counterclaims and intend to vigorously defend against these counterclaims. At this time, the parties are engaged in the discovery process. The parties have exchanged self-executing disclosures and responses to interrogatories, and will be producing documents shortly, after which depositions will occur. Accordingly, Entertainment Technology Corporation and the Company are unable to predict the outcome of this matter. Certain other claims, suits, and complaints arising in the ordinary course of business have been filed or are pending against the Company. In the opinion of management, after consultation with legal counsel handling these specific maters, all such matters are reserved for or adequately covered by insurance or, if not so covered, are without merit or are of such kind, or involve such amounts, as would not have a significant effect on the financial position or results of operations of the Company if disposed of unfavorably. 12. Employee Benefit Plan: The Company maintains a retirement savings 401(k) plan for eligible employees. The Company's contributions to the plan are based on a percentage of the employees' qualifying contributions. The Company's contributions totaled $107, $112 and $114 in fiscal 2004, fiscal 2003, and fiscal 2002, respectively. The Company has an Employee Stock Purchase Plan which was adopted by the Board of Directors on November 3, 1987. All employees meeting service requirements, except officers, directors and 10% shareholders, are eligible to voluntarily purchase common stock through payroll deductions up to 10% of salary. The Company makes a matching contribution of 20% of the employee's contribution. The Company has reserved 270,000 shares for issuance under the plan. 33 Notes to Consolidated Financial Statements ($ in thousands, except share data) 13. Quarterly Consolidated Financial Information (Unaudited): Financial data for the interim periods of fiscal 2004, 2003 and 2002 were as follows:
QUARTER ENDED ------------- FISCAL YEAR 2004 MAY 30 AUGUST 29 NOVEMBER 28 FEBRUARY 27 Net sales $6,130 $4,752 $7,115 $7,998 Gross profit 2,287 1,786 1,774 4,096 Operating income/(loss) 520 (395) (700) 706 Income/(loss) before income taxes 133 (862) (987) 111 Minority interest (4) (2) (3) 6 Net income/(loss) 70 (622) (704) 463 Earnings/(loss) per common share: Basic .01 (.09) (.10) .06 Diluted .01 (.09) (.10) .06 QUARTER ENDED ------------- FISCAL YEAR 2003 MAY 24 AUGUST 23 NOVEMBER 22 FEBRUARY 23 Net sales $11,207 $11,041 $12,162 $8,713 Gross profit 3,583 3,263 3,579 3,773 Operating income 1,075 1,108 874 1,059 Income before income taxes 831 936 584 909 Minority interest (27) (5) (6) - Net income 585 736 436 736 Earnings per common share: Basic .08 .10 .06 .10 Diluted .08 .10 .06 .10 QUARTER ENDED ------------- FISCAL YEAR 2002 MAY 25 AUGUST 24 NOVEMBER 23 FEBRUARY 22 Net sales $8,340 $7,414 $8,230 $8,543 Gross profit 2,693 2,393 3,667 2,712 Operating income 449 546 1,351 527 Income before income taxes 58 275 805 398 Minority interest (5) (4) 2 (6) Net income 224 297 662 558 Earnings per common share: Basic .03 .04 .09 .08 Diluted .03 .04 .09 .07
34 Notes to Consolidated Financial Statements ($ in thousands, except share data) ENVIRONMENTAL TECTONICS CORPORATION AND SUBSIDIARIES SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS ($ in thousands)
Column A Column B Column C Column D Column E -------- -------- -------- -------- -------- Charges/ Balance at (Credits) Balance At Beginning to Costs/ End of Description of Period Expenses Reductions (1) Period - ----------- --------- -------- -------------- ------ Year ended February 27, 2004: Valuation and qualifying accounts related to: Accounts receivable $446 $43 $110 $379 Inventory $646 $200 $282 $564 Property, plant and equipment $9,976 $675 $-- $10,651 Software development costs $6,819 $851 $-- $7,670 Other assets $113 $321 $-- $434 Year ended February 28, 2003 Valuation and qualifying accounts related to: Accounts receivable $373 $137 $64 $446 Inventory $738 $108 $200 $646 Property, plant and equipment $9,303 $673 $-- $9,976 Software development costs $6,166 $653 $-- $6,819 Other assets $113 $-- $-- $113 Year ended February 22, 2002 Valuation and qualifying accounts related to: Accounts receivable $370 $3 $-- $373 Inventory $630 $108 $-- $738 Property, plant and equipment $8,635 $668 $-- $9,303 Software development costs $5,670 $496 $-- $6,166 Other assets $96 $311 $294 $113
(1) Amounts written off or retired 35 EX-14 3 ex14-1.txt EXHIBIT 14.1 EXHIBIT 14.1 ------------ [LOGO] ENVIRONMENTAL TECTONICS CORPORATION CODE OF ETHICS CHIEF EXECUTIVE OFFICER AND SENIOR FINANCIAL OFFICERS The Company's Chief Executive Officer ("CEO") and senior financial officers hold important and elevated roles in corporate governance in that they are uniquely capable and empowered to ensure that shareholders, creditors and other stakeholders' interests are appropriately balanced, protected and preserved. This policy emphasizes the role of the CEO and senior financial officers in the conduct and practice of financial management and provides that the CEO and senior financial officers shall follow and advocate. SENIOR FINANCIAL OFFICERS Senior financial officers include the Company's Chief Financial Officer ("CEO"), Controller, and the chairperson of the Company's disclosure committee should those positions exist by name or responsibility. HONESTY AND INTEGRITY The CEO and senior financial officers shall observe high standards of business and personal ethics and practice honesty and integrity in every respect of dealing with the public, the business community, stockholders and government authorities. COMPLIANCE WITH LAWS AND REGULATIONS The CEO and senior financial officers shall comply with applicable laws, regulations and related rules and are prohibited from engaging in any activities that could involve the Company in any unlawful practice. AVOIDANCE OF CONFLICTS OF INTERESTS The CEO and senior financial officers shall not engage in apparent, potential or actual conflicts of interest, improper solicitation of business, conflicts based on outside interests and political contributions of Company funds. FULL, FAIR, ACCURATE, TIMELY AND UNDERSTANDABLE FINANCIAL DISCLOSURE The CEO and senior financial officers are responsible for the Company's accounting controls and procedures, and the protection of shareholder interests. The responsibility includes the full, fair, accurate, timely and understandable disclosure in reports and documents filed or submitted to the Securities and Exchange Commission, American Stock Exchange, public communications made by the Company, other regulatory or required reports and internal reports. COMPLIANCE The CEO and senior financial officers shall comply with this Code and the ETC Code of Conduct. Failure to comply with this Code or the ETC Code of Conduct will result in appropriate sanctions administered with principles of fairness and equity, up to and including termination of employment. EX-14 4 ex14-2.txt EXHIBIT 14.2 EXHIBIT 14.2 ------------ ENVIRONMENTAL TECTONICS CORPORATION COMPANY CODE OF CONDUCT STATEMENT OF PRINCIPLES ETC is committed to quality, innovation and above all integrity. Meeting this commitment is only possible because each employee of ETC follows high standards of ethical conduct and business practices. Individual integrity supported by a dedicated corporate culture is the pledge that enforces the company's code of conduct. All members of ETC - directors, officers, employees, subsidiaries and affiliates - strive to protect the ethical regard of the company. The Code of Conduct is the foundation for creating customer-focused quality. The pursuit of quality is the driving force of our company. This pursuit leads to profitability which sustains us. At the heart of our success is a trust placed in us by our stakeholders - customers, employees, suppliers, shareholders as well as the countries and communities in which we live and work. There shall never be question about ETC's trust or integrity. This means all ETC people throughout the world shall commit to the following: o Strict abeyance to the law o Honesty in personal and business dealings o Fairness and respect to all o Concern about ETC's affects on others o Proactive in taking initiative to address issues before they become problems o Personal responsibility as an employee and citizen o Exercise of good judgment in business dealings and operational decisions affecting the conduct of ETC On rare occasions, these principles may mean loss of business. However, the company's principles of integrity and trust are not available for compromise. Violations of the Code of Conduct at any level are not tolerated and may result in disciplinary action as well as civil or criminal process. Management and supervisors are to be consulted at any time violations to the code are observed or suspected. Employees may feel free to report their concerns without fear of retribution. The company assures that such reports will be kept in strictest confidence. Reports may be made in person or anonymously or in writing, via email or telephone to the Human Resources Department or the company's Legal Department. SPECIFIC AREAS OF CONDUCT CUSTOMER SATISFACTION ETC is dedicated to meeting or exceeding the expectations of our customers better than are any competitor. We provide our customers with products, information and support yielding them a competitive advantage. Customer satisfaction and repeat business is a measure of our success. At every opportunity we take the steps to truly satisfy our customers. ETC'S PRODUCTS ETC's products are an extension of the company itself. In all aspects of design, manufacture, sale and support the company provides the highest level of quality and innovation. ETC is committed to safe products meeting or exceeding performance, durability and reliability needs of our customers. As part of our dedication to environmental stewardship, our products meet or surpass applicable environmental standards. TERMS OF COMMERCIAL TRANSACTIONS ETC competes commercially throughout the world within all regulatory and legal requirements. At all times ETC employees practice the high standards of business ethics; never permitting the reputation or legal standing of the company to be jeopardized or questioned. ETC'S COMPETITORS ETC competes vigorously with companies who provide similar products and services. The competition is based on fairness and marketplace integrity. Employees do not disparage competitors or their products. Employees do not fraternize with the competitors if such conduct may give the appearance of collusion or unfair trading practices. ETC respects confidential information about its competitors and does not solicit or accept confidential or proprietary competitor data. Employees, who inadvertently receive any confidential information or become aware of an offer of such information, should immediately contact the Legal Department. SUPPLIER SELECTION/CONFLICTS OF INTEREST All of ETC's employees use non-discriminatory practices throughout the supplier and vendor selection process. Every employee avoids any situation in which personal or family interests may conflict with the interests of the company. Any employee with a financial interest in an actual or potential supplier or customer must disclose that interest to management. RECEIPT AND GIVING OF GIFTS In general, employees should neither accept nor offer gifts to customers or suppliers unless the gifts are designated as part of a recognized business event. Gifts exceeding US $50 in value may be given or accepted only with the concurrence of an employee's supervisor. All gifts (except minor promotional token items) not approved by the employee's supervisor must be turned in to the Human Resources Department for further disposition. ANTITRUST AND COMPETITION LAWS Employees comply with the antitrust laws of the United States and similar laws of other countries in which the company does business. These laws may cover agreements among competitors, agreements with sales agents/representatives, price discrimination, and other acts that may unfairly reduce competition. GOVERNMENT CONTRACTS Because ETC is a supplier to federal, state and local governments in the U.S. and around the world, ETC employees are expected to comply with all laws and regulations relating to government contracting and to cooperate fully with authorized government representatives who require information in connection with such contracts. IMPORT/EXPORT CONTROLS, BOYCOTTS AND BRIBES ETC transacts business on a global basis. Each ETC employee involved with the sale or shipment of products across international borders is expected to know and comply with applicable import/export control laws and regulations of the U.S. Government. Questions in this regard, should be directed to ETC's Export Administrator. U.S. Anti-Boycott regulations prohibit any agreement by a U.S. company to comply with certain boycott activities of foreign countries. In this connection, ETC may be required to report boycott requests to relevant government authorities. The U.S. Foreign Corrupt Practices Act (FCPA) prohibits the offering of bribes to foreign customers or government agents for the purpose of obtaining business or receiving special treatment. Any questions regarding boycott activities or the FCPA should be directed to ETC's Contracts or Legal departments. EQUAL EMPLOYMENT OPPORTUNITY/DIVERSITY ETC is an equal opportunity employer. We make employment decisions without regard to race, color, religion, sex, age, national origin, disability or any other characteristic irrelevant to the job. The company's recruitment, hiring, transfer, promotion and compensation policies are non-discriminatory. Quite apart from legal requirements, diversity of backgrounds makes ETC stronger and is essential to our operating as a world-class competitor. TREATMENT OF OTHERS IN WORK SITUATIONS Each employee treats every other employee, customer, vendor or those dealt with in the course of business with dignity and respect. Harassment of any type in the workplace is not tolerated. SAFE WORKING ENVIRONMENT ETC is devoted to maintaining a workplace free from hazards which could cause physical harm to anyone. Prevention of occupationally related injuries and illnesses is the responsibility of every ETC employee. All employees are expected to report unsafe or hazardous working conditions immediately to their supervisors. No retaliatory action or other reprisal shall be taken as a result of an employee's making a good faith report. DRUG, ALCOHOL AND SMOKING POLICY Possession, sale, use or being under the influence of illegal drugs (including prescription drugs, except in strict adherence to the prescription) or alcohol while on company property, or during work hours, is strictly prohibited. Likewise, use of tobacco products within ETC facilities or property is prohibited. COMPANY TIME Full-time, regular exempt employees may not hold full or part-time positions or directorships outside the company without expressed permission from their manager. CONDUCT OF MEETING COMPLIANCE SHAREHOLDER VALUE ETC is committed to providing a sustainable long-term financial return to our shareholders and to protecting and improving the value of their investment through prudent application of corporate resources, and by observing high standards of legal and ethical conduct in all company business dealings. SECURITIES LAW COMPLIANCE All employees are bound by the company's INSIDER TRADING POLICY. (SEE ETC INSIDER TRADING POLICY) ACCURACY OF FINANCIAL RECORDS/FINANCIAL REPRESENTATIONS All employees are bound by the company's WHISTLE BLOWER POLICY. (SEE ETC WHISTLE BLOWER POLICY) RESPONSIBLE CITIZENSHIP ETC is a responsible corporate citizen committed to improving the communities in which we operate. ETC entities actively support initiatives designed to improve the communities in which they reside. ETC encourages employees to take part in community activities. In doing so, employees act only on behalf of themselves and not as representatives of the company unless authorized to do so by management. CONDUCT REGARDING ETC FACILITIES AND PROPERTY ENVIRONMENTAL COMPLIANCE ETC manages its business in ways protective of the environment and conservation of energy and natural resources. In addition to complying with applicable environmental laws and regulations, ETC recognizes excellence in environmental management as being among the highest corporate priority. COMPUTER EQUIPMENT/COPYRIGHTS Company computer hardware, software and data may be used only by authorized personnel and for only company business. Likewise, provisions and copyright restrictions of others are respected and protected as company assets. Company computer assets may be used on a limited basis in support of community service work only with the approval of a supervisor. OTHER COMPANY PROPERTY Company property, equipment and facilities are not used for anything other than company business without prior permission of the employee's supervisor. CONFIDENTIAL AND PROPRIETARY INFORMATION Consistent with the ETC Employee Agreement, which is executed at the time of hiring, no employee discloses confidential or proprietary information to anyone other than those within the Company who have a "need to know." Employees use every effort to protect and safeguard such information. Similarly, ETC employees respect confidentiality obligations stemming from their former employers. CONDUCT REGARDING POLITICAL CAMPAIGNS AND GOVERNMENT OFFICIALS PERSONAL PARTICIPATION Personal participation in political activities is separate from corporate activities. The company's name, trademarks and other property, i.e., stationery, business cards, etc., and work time are not to be used in connection with such activities. Political campaigning on company property is prohibited. PAYMENTS TO GOVERNMENT OFFICIALS ETC employees do not offer, promise, authorize or arrange any payment or gift of any kind to a political party or candidate, government or military employee or agent, or their families anywhere in the world. Nominal gratuities may be permissible in limited situations, but not without first consulting with appropriate management personnel. EX-21 5 ex21.txt EXHIBIT 21 EXHIBIT 21 ---------- List of Subsidiaries -------------------- % NAME JURISDICTION OWNERSHIP - ---- ------------ --------- Entertainment Technology Corporation PA 100% ETC International Corporation Barbados 100% ETC-PZL Aerospace Industries Poland 95% ETC-Europe Great Britain 99% ETC-Delaware Delaware 100% EX-23 6 ex23.txt EXHIBIT 23 EXHIBIT 23 ---------- Consent of Independent Certified Public Accountants --------------------------------------------------- We have issued our report dated April 28, 2004, accompanying the consolidated financial statements included in the Annual Report of Environmental Tectonics Corporation and Subsidiaries on Form 10-K for the year ended February 27, 2004 and Part II of this form. We hereby consent to the incorporation by reference of said report in the Registration Statement of Environmental Tectonics Corporation and Subsidiaries of Form S-8 (File No. 333-65469, effective October 8, 1998), Form S-3A (File No. 333-29083, effective July 2, 1997), Form S-3 (File No. 333-29083, effective June 12, 1997), Form S-8 (File No 2-92407, effective August 14, 1984) and on Form S-3 (File No. 33-42219, effective September 4, 1991). /s/ Grant Thornton LLP - -------------------------- Philadelphia, Pennsylvania April 28, 2004 EX-31 7 ex31-1.txt EXHIBIT 31.1 EXHIBIT 31.1 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002. I, William F. Mitchell, certify that: 1. I have reviewed this Annual Report on Form 10-K of Environmental Tectonics Corporation; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 27, 2004 By: /s/ William F. Mitchell ---------------------------------------- William F. Mitchell President and Chief Executive Officer EX-31 8 ex31-2.txt EXHIBIT 31.2 EXHIBIT 31.2 ------------ CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002. I, Duane D. Deaner, certify that: 1. I have reviewed this Annual Report on Form 10-K of Environmental Tectonics Corporation; 2. Based on my knowledge, this 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 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-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 27, 2004 By: /s/ Duane D. Deaner ---------------------------- Duane D. Deaner Chief Financial Officer EX-32 9 ex32.txt EXHIBIT 32 EXHIBIT 32 ---------- CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report on Form 10-K of Environmental Tectonics Corporation (the "Company") for the fiscal year ended February 27, 2004 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, William F. Mitchell, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ William F. Mitchell ----------------------- William F. Mitchell Chief Executive Officer /s/ Duane D. Deaner ------------------- Duane D. Deaner Chief Financial Officer May 27, 2004 This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act 0f 2002 and shall not, except to the extent required by the Sarbanes-Oxley Act of 2002, be deemed to be filed by the company for purpose of Section 18 of the Securities Exchange Act of 1934, as amended. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----