10KSB 1 tenksb.txt U.S. SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-KSB X ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 __ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . ----------------- ----------------- Commission File No. 1-07109 SERVOTRONICS, INC. --------------------------------------------------------- (Name of small business issuer as specified in its charter) Delaware 16-0837866 ------------------------------- ---------------------- (State or other jurisdiction of (I. R. S. Employer incorporation or organization) Identification No.) 1110 Maple Street, Elma, New York 14059 -------------------------------------- ------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number: 716-655-5990 Securities registered pursuant to Section 12(b) of the Act: Name of each exchange on Title of each class which registered ------------------- ----------------------- Common Stock, $.20 par value American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ---- Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 . --- --- Check if disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. X --- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X. ---- ---- Issuer's revenues for its most recent fiscal year: $23,126,000 As of March 27, 2006 the aggregate market value of the voting common stock held by non-affiliates of the registrant was $14,617,768.22 based on the average of sales prices reported by the American Stock Exchange on that day. As of March 27, 2006 the number of $.20 par value common shares outstanding was 2,481,752. DOCUMENTS INCORPORATED BY REFERENCE Document Part of Form 10-KSB -------- ------------------- 2006 Proxy Statement Part III Transitional Small Business Disclosure Format. Yes . No X. ---- ---- TABLE OF CONTENTS PART I Item 1. Description of Business............................................3 Item 2. Description of Properties..........................................7 Item 3. Legal Proceedings..................................................7 Item 4. Submission of Matters to a Vote of Security Holders................8 PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities................8 Item 6. Management's Discussion and Analysis or Plan of Operation..........9 Item 7. Financial Statements..............................................15 Item 8. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.............................15 Item 8A. Controls and Procedures...........................................16 Item 8B. Other Information.................................................16 PART III Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act...............17 Item 10. Executive Compensation............................................17 Item 11. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters......................17 Item 12. Certain Relationships and Related Transactions....................17 Item 13. Exhibits..........................................................18 Item 14. Principal Accountant Fees and Services............................23 Signatures....................................................................24 Consolidated Financial Statements.........................................F1-F21 -2- PART I ------ Item 1. Description of Business ------ ----------------------- General ------- Servotronics, Inc. and its subsidiaries (collectively the "Registrant" or the "Company") design, manufacture and market advanced technology products consisting primarily of control components and consumer products consisting of knives and various types of cutlery. The Registrant was incorporated in New York in 1959. In 1972, the Registrant was merged into a wholly-owned subsidiary organized under the laws of the State of Delaware, thereby changing the Registrant's state of incorporation from New York to Delaware. Products -------- Advanced Technology Products ---------------------------- The Registrant designs, manufactures and markets a variety of servo-control components which convert an electrical current into a mechanical force or movement and other related products. The principal servo-control components produced include torque motors, electromagnetic actuators, hydraulic valves, pneumatic valves and similar devices, all of which perform the same general function. These are sold principally to the commercial aerospace, missile, aircraft and government related industries. To fill most of its orders for components, the Registrant must either modify a standard model or design a new item in order to satisfy the customer's particular requirements. The Registrant also produces unique products based on specifications provided by its customers. The Registrant produces under long-term contracts and other types of orders. The Registrant also produces metallic seals of various cross-sectional configurations. These seals fit between two surfaces, usually metal, to produce a more secure and leak-proof joint. The Registrant manufactures these seals to close tolerances from standard and special alloy steels. Ductile coatings are often applied to the seals in order to increase their effectiveness. From time to time, the Registrant has also produced other products of its own and/or of a given design to meet customers' requirements. -3- Consumer Products ----------------- The Registrant designs, manufactures and sells a variety of cutlery products. These products include a wide range of kitchen knives such as steak, carving, bread, butcher and paring knives for household use and for use in restaurants, institutions and private industry, and pocket and other types of knives for hunting, fishing and camping. The Registrant sells cutlery products to the U.S. Government and related agencies. These products include machetes, bayonets and other types of knives that are primarily for military use. The Registrant also produces and markets other cutlery items such as various specialty tools, putty knives, linoleum sheet cutters and field knives. The Registrant manufactures its cutlery products from stainless or high carbon steel in numerous styles, designs, models and sizes. Substantially all of the Registrant's commercial cutlery related products are intended for the medium to premium priced markets. The Registrant sells many of its cutlery products under its own brand names including "Old Hickory" and "Queen." Sales, Marketing and Distribution --------------------------------- Advanced Technology Products ---------------------------- The Registrant's advanced technology products are marketed throughout the United States and are essentially non-seasonal in nature. These products are sold to the United States Government, government prime contractors, government subcontractors, commercial manufacturers and end users. Sales are made primarily by the Registrant's professional staff and field engineering representatives. During the Registrant's last fiscal year, sales of advanced technology products pursuant to subcontracts with prime or subcontractors for various branches of the United States Government or pursuant to prime contracts directly with the government accounted for approximately 23% of the Registrant's total revenues as compared to 22% in 2004. In 2005 and 2004, the Registrant had sales of advanced technology products to two customers (including their respective subsidiaries and/or divisions) that each exceeded 10% of Registrant's total revenues. No other single customer represented more than 10% of the Company's revenues in 2005 or 2004. The Registrant's prime contracts and subcontracts with the United States Government are subject to termination for the convenience of the Government. In the event of such termination, the Registrant is ordinarily entitled to receive payment for its costs and profits on work done prior to termination. Since the inception of the Registrant's business, less than 1% of its Government contracts have been terminated for convenience. -4- Consumer Products ----------------- The Registrant's consumer products are marketed throughout the United States. Consumer sales are moderately seasonal. Sales are to hardware, supermarket, variety, department, discount, gift and drug stores. The Registrant's Consumer Products Group also sells its cutlery products (principally machetes, bayonets, survival knives and kitchen knives) to various branches of the United States Government which accounted for approximately 16% of the Registrant's total sales in 2005 as compared to 23% in 2004. No other single customer represented more than 10% of the Company's revenues in 2005. The Registrant sells its products through its own sales personnel and through independent manufacturers' representatives. Business Segments ----------------- Business segment information is presented in Note 10 of the accompanying consolidated financial statements. Intellectual Properties ----------------------- The Company has rights under certain copyrights, trademarks, patents, and registered domain names. In the view of management, the Registrant's competitive position is not dependent on patent protection. Research Activities ------------------- The amount spent by the Registrant in research and development activities during its 2005 and 2004 fiscal years was not significant. Environmental Compliance ------------------------ The Registrant does not anticipate that the cost of compliance with current environmental laws will be material. Manufacturing ------------- The Registrant manufactures its consumer products in Franklinville, New York and Titusville, Pennsylvania and its advanced technology products in Elma, New York. Raw Materials and Other Supplies -------------------------------- The Registrant purchases raw materials and certain components for its products from outside vendors. The Registrant is not generally dependent upon a single source of supply for any raw material or component used in its operations. -5- Competition ----------- Although no reliable industry statistics are available to enable the Registrant to determine accurately its relative competitive position with respect to any of its products, the Registrant believes that it is a significant factor with respect to certain of its servo-control components. The Registrant's share of the overall cutlery market is not significant. The Registrant encounters active competition with respect to its products from numerous companies, many of which are larger in terms of manufacturing capacity, financial resources and marketing organization. Its principal competitors vary depending upon the customer and/or the products involved. The Registrant believes that it competes primarily with more than 20 companies with respect to its consumer products, in addition to foreign imports. To the Registrant's knowledge, its principal competitors with regard to cutlery include World Kitchen, Inc., Tramontina, Inc., Dexter-Russell Inc., W. R. Case & Sons Cutlery Company, Lifetime Hoan Corp., Gerber and Camillus Cutlery Company. The Registrant has many different competitors with respect to servo-control components because of the nature of that business and the fact that these products also face competition from other types of control components which, at times, can accomplish the desired result. The Registrant markets most of its products throughout the United States and to a lesser extent in selected foreign markets. The Registrant believes that it competes in marketing its consumer products primarily on the basis of price, quality and delivery, and its control products primarily on the basis of operating performance, adherence to rigid specifications, quality, price and delivery. Employees --------- The Registrant, at December 31, 2005, had approximately 245 employees of which approximately 230 are full time; 189 in Western New York and 41 in Pennsylvania. In excess of 83% of its employees are engaged in production, inspection, packaging or shipping activities. The balance are engaged in executive, engineering, administrative, clerical or sales capacities. -6- Item 2. Description of Properties ------ ------------------------- The Registrant's executive offices are located on premises leased by the Registrant at 1110 Maple Street, Elma, a suburb of Buffalo, New York. The Registrant owns and/or leases real property as set forth in the following table:
Number of Principal buildings and Approx. Approx. product type of floor area Location acreage manufactured construction (sq. feet) ----------------------------------------------------------------------------------------------------- Elma, New York 38.4 Advanced 1-concrete block/ 82,000 technology steel products Franklinville, 12.7 Cutlery products 1-tile/wood New York 1 concrete/metal 1 concrete block 154,000 Titusville, Pennsylvania .4 Cutlery products 2-brick 25,000
In Elma, New York, the Registrant leases approximately 38.4 acres of land and a facility from a local industrial development agency. The lease is accounted for as a capital lease and entitles the Registrant to purchase the property for a nominal amount. See the consolidated financial statements, including Note 8 thereto, for further information with respect to the Registrant's lease commitments. The Registrant possesses modern precision manufacturing and testing equipment suitable for the development, manufacture, assembly and testing of its advanced technology products. The Registrant uses computer-aided technology throughout its processes, procedures, designs, manufacturing and administrative functions. The Registrant designs and makes substantially all of the tools, dies, jigs and specialized testing equipment necessary for the production of the advanced technology products. The Registrant also possesses automatic and semi-automatic grinders, tumblers, presses and miscellaneous metal finishing machinery and equipment for use in the manufacture of consumer products. Item 3. Legal Proceedings ------ ----------------- There are no legal proceedings which are material to the Company currently pending by or against the Company other than ordinary routine litigation incidental to the business which is not expected to materially adversely affect the business or earnings of the Company. -7- Item 4. Submission of Matters to a Vote of Security Holders ------ --------------------------------------------------- Not applicable. PART II Item 5. Market for Common Equity, Related Stockholder Matters and Small ------ --------------------------------------------------------------- Business Issuer Purchases of Equity Securities ---------------------------------------------- (a) Price range of common stock --------------------------- The following table shows the range of high and low prices for the Registrant's common stock as reported by the American Stock Exchange for 2005 and 2004. High Low ---- --- 2005 Fourth Quarter $ 4.75 $ 3.85 Third Quarter 5.05 4.10 Second Quarter 5.00 4.10 First Quarter 5.00 4.41 2004 Fourth Quarter $ 4.99 $ 3.70 Third Quarter 5.90 3.50 Second Quarter 4.98 2.72 First Quarter 3.54 2.75 (b) Approximate number of holders of common stock --------------------------------------------- Title Approximate number of of record holders (as of class December 31, 2005) ----- ------------------ Common Stock, $.20 par value per share 605 (c) Dividends on common stock ------------------------- No cash dividends were paid in 2005 or 2004. (d) Securities Authorized for Issuance Under Equity Compensation Plans ------------------------------------------------------------------
Number of securities Number of securities remaining available for to be issued upon Weighted-average future issuance under exercise of outstanding exercise price of equity compensation options, warrants outstanding options, plans (excluding securities and rights warrants and rights reflected in column (a)) Plan category (a) (b) (c) ------------- ------------------------- --------------------- -------------------------- Equity compensation plans approved by security holders 333,000 $3.503 17,000 Equity compensation plans not approved by security holders 180,900 $6.072 16,300 ------- ------ Total 513,900 $4.407 33,300 ======= ======
-8- (e) Company Re-purchases of Equity Securities During 2005, the Company did not purchase any shares of Servotronics, Inc. common stock. In January 2006, the Board of Directors authorized the purchase of up to 250,000 shares of the Company's outstanding common stock. The shares may be purchased in the open market or in privately negotiated transactions; and at times and in amounts that the Company deems appropriate. Item 6. Management's Discussion and Analysis or Plan of Operation ------ --------------------------------------------------------- Management Discussion --------------------- During the years ended December 31, 2005 and 2004, approximately 39% and 45% respectively of the Company's revenues were derived from contracts with agencies of the U.S. Government or their prime contractors and their subcontractors. Sales of products sold for government applications have decreased a net of approximately $560,000 when comparing the results of 2005 to 2004 as the result of the previously reported scheduled completion of a significant order to the Consumer Products Group (CPG). The Company believes that government involvement in military operations overseas will continue to have a direct impact on the financial results in both the Advanced Technology and Consumer Products markets. While the Company remains optimistic in relation to these opportunities, it recognizes that sales to the government are affected by defense budgets, the foreign policies of the U.S. and other nations, the level of military operations and other factors and, as such, it is difficult to predict the impact on future financial results. The Company's commercial business is affected by such factors as uncertainties in today's global economy, global competition, the vitality and ability of the commercial aviation industry to purchase new aircraft, market demand and acceptance both for the Company's products and its customers' products which incorporate Company-made components. See also Note 10 to the consolidated financial statements for information concerning business segment operating results. Results of Operations - Year 2005 as Compared to 2004 ----------------------------------------------------- The following table sets forth for the period indicated the percentage relationship of certain items in the consolidated statement of operations to net revenues and the period to period dollar and percentage increase or decrease of such items as compared to the indicated prior period. -9-
Period to Period to Relationship to period period net revenues $ increase % increase year ended (decrease) (decrease) December 31, year ended year ended 2005 2004 2005-2004 2005-2004 ---- ---- --------- --------- Net revenues and other income: Advanced technology products 59.8% 51.3% $ 2,480 21.8% Consumer products 40.2 48.7 (1,467) (13.6) ---- ---- --------- --------- 100.0 100.0 1,013 4.6 Cost of goods sold, exclusive of depreciation 73.7 73.9 703 4.3 ---- ---- --------- --------- Gross profit 26.3 26.1 310 5.4 ---- ---- --------- --------- Selling, general and administrative 16.5 17.1 15 0.4 Interest 1.0 0.7 74 46.0 Depreciation and amortization 2.9 3.0 24 3.7 Insurance proceeds, net (3.4) - 795 - ---- ---- --------- --------- 17.0 20.8 682 50.1 Income before income tax provision 9.3 5.3 992 85.3 Income tax provision 3.4 2.0 363 84.6 ---- ---- --------- --------- Net income 5.9% 3.3% $ 629 85.7% ==== ==== ========= =========
Revenues increased by approximately $1,013,000 or 4.6% with an increase in net income of $629,000 or 85.7%. The increase in revenues is primarily attributed to an increase in government and commercial shipments as well as price increases under certain long-term agreements at the Advanced Technology Group (ATG) partially off-set by a decrease in government shipments at the Consumer Products Group as a result of the aforementioned scheduled completion of a significant government order. Gross margins for the twelve month period ended December 31, 2005 increased 5.4% when compared to the same period in 2004 primarily due to the aforementioned price increases offset by increased costs associated with certain retirement obligations (See Note 5 Consolidated Financial Statements). Other factors affecting margins include the mix of products sold. The Company continues to incur costs associated with prototype and preproduction activities that are expensed in the period incurred. Selling, general and administrative (SG&A) costs increased approximately 0.4% when compared to the same period in 2004. The increase in SG&A costs is attributed to an increase in administrative and professional costs as well as increase in costs attributed to expanded marketing and sales efforts and continuing compliance-related costs under federal securities laws and regulations applicable to registrant companies. -10- Interest expense increased for the year ended December 31, 2005 when compared to the same period in 2004. Although average debt outstanding was lower and will continue to decline as the Company continues to repay its scheduled debt obligations, the increase in interest expense was primarily due to an increase in market driven interest rates. See also Note 4 to the consolidated financial statements for information on long-term debt. Depreciation and amortization expense increased approximately 3.7% for the year ended December 31, 2005 when compared to the same period in 2004 due to variable estimated useful lives of depreciable property as identified in Note 1 to the consolidated financial statements. In December 2005, the Company received $1,000,000, equal to the policy limit, from its insurance carrier in partial recovery of a defalcation by a former employee. As of December 31, 2005, the Company incurred approximately $205,000 in professional, legal and related costs associated with the recovery and the Company continues to seek additional restitution. The Company's effective tax rate was 37% in 2005 and 2004. The effective tax rate in both years reflects state income taxes, permanent non-deductible expenditures and the tax benefit for extraterritorial sales as well as manufacturing deductions allowable under the American Jobs Creation Act of 2004. See also Note 6 to the consolidated financial statements for information concerning income tax rates. Net income increased $629,000 after the aforementioned increase in costs associated with certain retirement obligations. The increase in net income is primarily attributed to the net after tax insurance proceeds of approximately $500,000 and the increase in gross profits generated from approximately $1 million increase in net revenues for 2005. Results of Operations - Year 2004 as Compared to 2003 ----------------------------------------------------- The Company's consolidated results of operations for the year ended December 31, 2004 showed an approximate $4,539,000 or 25.8% increase in net revenues with an increase in income before taxes of approximately $757,000. The increase in revenues is primarily attributed to increased government shipments. Gross profit increased 28.0% for the twelve month period ended December 31, 2004. The variation in gross profit can be attributed to several factors including year-to-year variations in the previously discussed front-end costs associated with new products and changes in design on existing products. The timing of such costs directly contributes to the fluctuation in gross profit -11- from period to period as these costs are expensed as they occur and, as such, are not matched to their future revenues and benefits. As previously reported, while 2004 revenues from Consumer Products Group's combination combat knife and bayonet increased, a substantial amount of front-end costs associated with these revenues were expensed in prior periods. The Company continues to incur such costs on an ongoing basis associated with products for both the ATG and CPG. Another factor contributing to the increase in gross profit for the reported period is product mix. Selling, general and administrative (SG&A) costs increased approximately 15.8% when compared to the same period in 2003. The increase in SG&A costs is attributed to increased marketing and sales efforts of the ATG and CPG, however, the most significant impact has been increased costs for professional services and corporate governance necessitated by the Sarbanes-Oxley Act. The Company estimates that it has incurred in excess of $200,000 on related expenses in 2004 and expects to incur significant expenses in the future. Interest expense remained consistent for the year ended December 31, 2004 when compared to the same period in 2003. Despite the decrease in the average outstanding balances on institutional debt, average market driven interest rates increased when comparing the twelve month period ending December 31, 2004 to the same period of 2003. See also Note 4 to the consolidated financial statements for information on long-term debt. Depreciation and amortization expense decreased approximately 2.1% for the year ended December 31, 2004 when compared to the same period in 2003 due to variable estimated useful lives of depreciable property as identified in Note 1 to the consolidated financial statements. The Company's effective tax rate was 37% in 2004 and 2003. The effective tax rate in both years reflects state income taxes, permanent non-deductible expenditures and the tax benefit on certain foreign sales. See also Note 6 to the consolidated financial statements for information concerning income tax rates. Liquidity and Capital Resources ------------------------------- The Company's primary liquidity and capital requirements relate to the working capital needs; primarily inventory, accounts receivable, capital investments in facilities, machinery, tools/dies and equipment and principal/interest payments on indebtedness. At December 31, 2005, the Company has approximately $4.6 million in cash on hand and working capital of approximately $13 million. The Company's primary sources of liquidity in 2005 have been from positive cash flows from operations. For fiscal 2005, the Company generated approximately $3.3 million in cash flow from operations, an increase of approximately $2.2 million over fiscal 2004. The increase was primarily funded through an increase in net income as discussed above and a lower use of cash to fund working capital. -12- During the year ended December 31, 2005, the Company expended $421,000 on capital expenditures as compared to $622,000 in 2004. At December 31, 2005, there are no material commitments for capital expenditures. The Company also has a $1,000,000 line of credit on which there is no balance outstanding at December 31, 2005. This will be used to fund cash flow required for operations if needed. Principal maturities of long-term debt are as follows: 2006 - $382,000, 2007 - $386,000, 2008 - $387,000, 2009 - $539,000, 2010 - $321,000 and thereafter - $3,383,000. In January of 2006, the Company's Board of Directors authorized the purchase by the Company of up to 250,000 shares of its common stock in the open market or in privately negotiated transactions. As of March 27, 2006, the Company has purchased or committed to purchase 77,757 shares for a total of $679,300 under this program. Off Balance Sheet Arrangements ------------------------------ None. Critical Accounting Policies ---------------------------- The Company prepares its consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP). As such, we are required to make certain estimates, judgments and assumptions that the Company believes are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes that the following discussion addresses our most critical accounting policies, which are those that are most important to the portrayal of our financial condition and results of operations and which require our most difficult and subjective judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Notes 1 and 7 to the accompanying consolidated financial statements include a summary of the significant accounting policies used in the preparation of the consolidated financial statements. -13- New Accounting Pronouncements ----------------------------- Management reviewed recent accounting pronouncements and has not determined the effect these pronouncements will have on Financial Statement results. See Notes 1 and 7 to the accompanying consolidated financial statements for further discussion of new accounting pronouncements. Revenue Recognition ------------------- Revenues are recognized as servies are rendered or as units are shipped and at the designated FOB point consistent with the transfer of title, risks and rewards of ownership. Such purchase orders generally include specific terms relative to quantity, item description, specifications, price, customer responsibility for in-process costs, delivery schedule, shipping point, payment and other standard terms and conditions of purchase and may provide for progress payments based on in-process costs as they are incurred. Inventories ----------- Inventories are stated at the lower of standard cost or net realizable value. Cost includes all cost incurred to bring each product to its present location and condition, which approximates actual cost (first-in, first-out). Market provisions in respect to net realizable value and obsolescence are applied to the gross value of the inventory. Pre-production and start-up costs are expensed as incurred. Employee Benefit Plans ---------------------- As discussed in Note 5 to the financial statements, the Company provides a range of benefits to its employees and retired employees, including pension and post retirement benefits. The Company records annual amounts relating to these plans based on calculations specified by GAAP, which includes various actuarial assumptions, such as discount rates, assumed rates of return on plan assets and health care cost trend rates. The Company believes that the assumptions utilized in recording its obligations under its plans are reasonable based on advice from its actuaries. Use of Estimates ---------------- The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Such estimates include, but are not limited to, reserves and allowances for inventories and trade receivables. Actual results could differ from those estimates. -14- Item 7. Financial Statements ------ -------------------- The financial statements of the Registrant which are included in this Form 10-KSB Annual Report are described in the accompanying Index to Consolidated Financial Statements on Page F1. Item 8. Changes in and Disagreements with Accountants on Accounting and ------ ---------------------------------------------------------------- Financial Disclosure -------------------- As previously disclosed on Form 8-K, on September 7, 2005, the Audit Committee of the Company's Board of Directors terminated PricewaterhouseCoopers LLP ("PWC") as the Company's independent registered public accounting firm. The audit reports of PWC on the Company's consolidated financial statements as of and for the two most recent fiscal years ended December 31, 2004 did not contain any adverse opinion or disclaimer of opinion, nor were these opinions modified as to uncertainty, audit scope or accounting principles. During the Company's two fiscal years ended December 31, 2004 and through September 7, 2005, there were no disagreements between the Company and PWC on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of PWC, would have caused it to make a reference to the subject matter of the disagreement in connection with its audit report which did not occur. The Company provided PWC with a copy of its Form 8-K disclosure and requested that PWC furnish the Company with a letter addressed to the Securities and Exchange Commission stating whether PWC agreed with the Company's statements. PWC agreed that there were no disagreements, and issued the letter which is incorporated by reference as Exhibit 16.1 to this Form 10-KSB. In connection with obtaining consent from PWC to the inclusion of their audit report dated March 31, 2005 in this Form 10-KSB for the year ended December 31, 2004, the Company agreed to indemnify PWC against any legal costs and expenses incurred by PWC in the successful defense of any legal action that arises as a result of such inclusion. Such indemnification will be void if a court finds PWC liable for professional malpractice. As stated in the Division of Corporate Finance's Accountant Disclosure Rules and Practices Training Manual, the Securities and Exchange Commission does not object to a domestic or foreign registrant's indemnification of predecessor auditors for costs incurred in successful defense of claims. -15- On September 7, 2005, the Audit Committee engaged Freed Maxick & Battaglia, CPAs, P.C., effective September 8, 2005, to serve as the Company's independent registered public accounting firm for the fiscal year ending December 31, 2005. Item 8A. Controls and Procedures ------- ----------------------- (i) Disclosure Controls and Procedures The Company carried out an evaluation under the supervision and with the participation of its management, including the Company's Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of the Company's disclosure controls and procedures as of December 31, 2005. Based upon that evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures are effective in timely alerting them to the material information relating to the Company (or the Company's consolidated subsidiaries) required to be included in the Company's periodic filings with the SEC, such that the information relating to the Company, required to be disclosed in SEC reports (i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company's management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. (ii)Changes in Internal Controls The Company reviewed its internal control policy and procedures and during the period ended December 31, 2005 it developed and implemented additional measures designed to insure that information is recorded, processed, summarized and reported accurately. These measures include additional procedures relative to the review and reconciliation of bank statements for payroll and operating accounts. Item 8B. Other Information ------- ----------------- None. -16- PART III -------- Item 9. Directors, Executive Officers, Promoters and Control Persons; ------ -------------------------------------------------------------- Compliance with Section 16(a) of the Exchange Act ------------------------------------------------- Information regarding directors and executive officers of the Registrant is incorporated herein by reference to the information included in the Registrant's definitive proxy statement if it is filed with the Commission within 120 days after the end of the Registrant's 2005 fiscal year or such information will be included by amendment to this form 10-KSB. Code of Ethics -------------- The Company has adopted a Code of Ethics and Business Conduct that applies to all directors, officers and employees of the Company as required by the listing standards of the American Stock Exchange. The Code is available on the Company's website at www.servotronics.com and the Company intends to disclose on this website any amendment to the Code. Waivers under the Code, if any, will be disclosed under the rules of the SEC and the American Stock Exchange. Item 10. Executive Compensation ------- ---------------------- Information regarding executive compensation is incorporated herein by reference to the information included in the Registrant's definitive proxy statement if it is filed with the Commission within 120 days after the end of the Registrant's 2005 fiscal year or such information will be included by amendment to this form 10-KSB. Item 11. Security Ownership of Certain Beneficial Owners and Management and ------- ------------------------------------------------------------------- Related Stockholder Matters --------------------------- Information regarding security ownership of certain beneficial owners and management is incorporated herein by reference to the information included in the Registrant's definitive proxy statement if it is filed with the Commission within 120 days after the end of the Registrant's 2005 fiscal year or such information will be included by amendment to this form 10-KSB. Also incorporated by reference is the information in the table under the heading "Securities Authorized for Issuance Under Equity Compensation Plans" included in Item 5 of this Form 10-KSB. Item 12. Certain Relationships and Related Transactions ------- ---------------------------------------------- Information regarding certain relationships and related transactions is incorporated herein by reference to the information included in the Registrant's definitive proxy statement if it is filed with the Commission within 120 days after the end of the Registrant's 2005 fiscal year or such information will be included by amendment to this form 10-KSB. -17- Item 13. Exhibits ------- --------
(a) Exhibits -------- Exhibit ------- number Presentation Reference ------ ------------ --------- 3(A)(1) Certificate of Incorporation Exhibit 3(A)(1) to 1996 Form 10-KSB* 3(A)(2) Amendments to Certificate Exhibit 3(A)(2) to 1996 of Incorporation dated Form 10-KSB* August 27, 1984 3(A)(3) Certificate of designation Exhibit 4(A) to 1987 regarding Series I Form 10-K* preferred stock 3(A)(4) Amendments to Certificate Exhibit 3(A)(4) to 1998 of Incorporation dated Form 10-KSB* June 30, 1998 3(B) By-laws Exhibit 3(B) to 1986 Form 10-K* 4.1(A) First amended and restated Exhibit 4(A) to 1993 term loan agreement with Form 10-KSB* Fleet Bank of New York dated October 4, 1993 4.1(B) Second amended and restated Exhibit 4.1(B) to 1999 term loan agreement with Form 10-KSB* Fleet Bank of New York dated February 26, 1999 4.1(C) First amendment to second Exhibit 4.1(C) to 1999 amended and restated term Form 10-KSB* loan agreement with Fleet Bank of New York dated December 17, 1999 4.1(D) Second amendment to a second Exhibit 4.1(D) to 2004 amended and restated term Form 10-KSB* loan agreement with Fleet National Bank dated December 20, 2004
-------------------------------------------------------------- *Incorporated herein by reference (File No. 1-07109) **Indicates management contract or compensatory plan or arrangement -18-
Exhibit ------- number Presentation Reference ------ ------------ --------- 4.2(A) Letter of Credit Reimbursement Exhibit 4(B)(1) to Agreement with Fleet Bank 1994 10-KSB* dated December 1, 1994 4.2(B) First Amendment and Exhibit 4.2(B) to 1999 Extension to Letter of Form 10-KSB* Credit and Reimbursement Agreement with Fleet Bank of New York dated as of December 17, 1999 4.2(C) Second Amendment and Exhibit 4.2(C) to 2004 Extension to Letter of Form 10-KSB* Credit and Reimbursement Agreement originally dated December 1, 1994, with Fleet National Bank, dated as of December 20, 2004 4.3 Agency Mortgage and Security Exhibit 4(B)(2) to Agreement dated as of 1994 10-KSB* December 1, 1994 from the Registrant and its subsidiaries 4.4 Guaranty Agreement dated as Exhibit 4(B)(3) to of December 1, 1994 from 1994 10-KSB* the Registrant and its subsidiaries to the Erie County Industrial Development Agency ("ECIDA"), Norwest Bank Minnesota, N.A., as Trustee, and Fleet Bank 4.5 Shareholder Rights Plan Exhibit 4 to Form dated as of August 27, 8-K filed August 27, 2002 2002* 10(A)(1) Employment contract for Exhibit 10(A)(1) to Form Dr. Nicholas D. Trbovich, 8-K filed August 18, Chief Executive Officer 2005**
-------------------------------------------------------------- *Incorporated herein by reference (File No. 1-07109) **Indicates management contract or compensatory plan or arrangement -19-
Exhibit ------- number Presentation Reference ------ ------------ --------- 10(A)(4) Employment contract for Exhibit 10(A)(1) to Form Nicholas D. Trbovich, Jr. 8-K filed August 18, Vice President 2005** 10(B) Form of Indemnification Exhibit 10(E) to 1986 Agreement between the Form 10-K* Registrant and each of its Directors and Officers** 10(C)(1) Loan agreement between Exhibit 10(C)(1) the Company and its to 1991 Form 10-K* employee stock ownership trust, as amended 10(C)(2) Stock purchase agreement Exhibit 10(D)(2) to between the Company 1988 Form 10-K* and its employee stock ownership trust 10(D)(1)(a) 1989 Employees Stock Exhibit A to Form 8: Option Plan** Amendment No. 1 to 1988 Form 10-K* 10(D)(1)(b) Amendment to 1989 Exhibit 10(D)(1)(b) to 1990 Employees Stock Option Form 10-K* Plan** 10(D)(1)(c) Amendment No. 2 to 1989 Exhibit 10(D)(1)(d) to 1991 Employees Stock Option Form 10-K* Plan** 10(D)(1)(d) 2000 Employees Stock Exhibit 10(D)(1)(a) to 2000 Option Plan** Form 10-KSB* 10(D)(2) Stock Option Agreement Exhibit 10(D)(2) to 1998 for Donald W. Hedges Form 10-KSB* dated March 24, 1998**
-------------------------------------------------------------- *Incorporated herein by reference (File No. 1-07109) **Indicates management contract or compensatory plan or arrangement -20-
Exhibit ------- number Presentation Reference ------ ------------ --------- 10(D)(2)(a) Stock Option Agreement Exhibit 10(D)(2)(a) to 2000 for Donald W. Hedges Form 10-KSB* dated July 7, 2000** 10(D)(3)(b) Stock Option Agreement Exhibit 10(D)(3)(b) to 1998 for Nicholas D. Form 10-KSB* Trbovich dated March 24, 1998** 10(D)(3)(c) Stock Option Agreement Exhibit 10(D)(3)(c) to 2000 for Nicholas D. Form 10-KSB* Trbovich dated July 7, 2000** 10(D)(4) Stock Option Agreement Exhibit 10(D)(4) to 1998 for William H. Duerig Form 10-KSB* dated March 24, 1998** 10(D)(4)(a) Stock Option Agreement Exhibit 10(D)(4)(a) to 2000 for William H. Duerig Form 10-KSB* dated July 7, 2000** 10(D)(9) Land Lease Agreement Exhibit 10(D)(9) to 1992 between TSV, Inc. Form 10-KSB* (wholly-owned subsidiary of the Registrant) and the ECIDA dated as of May 1, 1992, and Corporate Guaranty of the Registrant dated as of May 1, 1992 10(D)(10) Amendment to Land Lease Exhibit 10(D) (11) to 1993 Agreement and Interim Form 10-KSB* Lease Agreement dated November 19, 1992 10(D)(11) Lease Agreement dated as of Exhibit 10(D)(11) to December 1, 1994 between 1994 10-KSB* the Erie County Industrial Development Agency ("ECIDA") and TSV, Inc. 10(D)(12) Sublease Agreement dated Exhibit 10(D)(12) to as of December 1, 1994 1994 10-KSB* between TSV, Inc. and the Registrant
-------------------------------------------------------------- *Incorporated herein by reference (File No. 1-07109) **Indicates management contract or compensatory plan or arrangement -21-
Exhibit ------- number Presentation Reference ------ ------------ --------- 10(D)(13) 2001 Long-Term Stock Appendix A to 2001 Incentive Plan Proxy** 16 Letter from PricewaterhouseCoopers Exhibit 16.1 to Form 8-K/A regarding dismissal filed September 21, 2005 21 Subsidiaries of the Filed herewith Registrant 23.1 Consent of Freed Maxick & Filed herewith Battaglia, CPAs, P.C. 23.2 Consent of Filed herewith PricewaterhouseCoopers LLP 31.1 Certification of Chief Financial Filed herewith Officer pursuant to Rule 13a-14 or 15d-14 of the Securities Exchange act of 1934, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. 31.2 Certification of Chief Executive Filed herewith Officer pursuant to Rule 13a-14 or 15d-14 of the Securities Exchange act of 1934, as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002. 32.1 Certification of Chief Financial Filed herewith Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. The Registrant hereby agrees that it will furnish to the Securities and Exchange Commission upon request a copy of any instrument defining the rights of holders of long-term debt not filed herewith.
-------------------------------------------------------------- *Incorporated herein by reference (File No. 1-07109) **Indicates management contract or compensatory plan or arrangement -22-
Exhibit ------- number Presentation Reference ------ ------------ --------- 32.2 Certification of Chief Executive Filed herewith Officer pursuant to 18 U.S.C. 1350 as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.
Item 14. Principal Accountant Fees and Services ------- -------------------------------------- Information regarding principal accountant fees and services is incorporated herein by reference to the information included in the Registrant's definitive proxy statement if it is filed with the Commission within 120 days after the end of the Registrant's 2005 fiscal year or such information will be included by amendment to this Form 10-KSB. FORWARD-LOOKING STATEMENTS In addition to historical information, certain sections of this Form 10-KSB contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, such as those pertaining to the Company's capital resources and profitability. Forward-looking statements involve numerous risks and uncertainties. The Company derives a material portion of its revenues from contracts with agencies of the U.S. Government or their prime contractors. The Company's business is performed under fixed price contracts and the following factors, among others discussed herein, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements: uncertainties in today's global economy, global competition, difficulty in predicting defense appropriations, the vitality of the commercial aviation industry and its ability to purchase new aircraft, the willingness and ability of the Company's customers to fund long-term purchase programs and market demand and acceptance both for the Company's products and its customers' products which incorporate Company-made components. The success of the Company also depends upon the trends of the economy, including interest rates, income tax laws, governmental regulation, legislation, population changes and those risk factors discussed elsewhere in this Form 10-KSB. Readers are cautioned not to place undue reliance on forward-looking statements, which reflect management's analysis only as the date hereof. The Company assumes no obligation to update forward-looking statements. -23- SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SERVOTRONICS, INC. March 28, 2006 By /s/ Nicholas D. Trbovich, President ----------------------------------- Nicholas D. Trbovich President, Chief Executive Officer and Chairman of the Board In accordance with 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. /s/ Nicholas D. Trbovich President, Chief Executive March 28, 2006 ------------------------ Officer, Chairman of the Nicholas D. Trbovich Board and Director /s/ Cari L. Jaroslawsky Chief Financial Officer, March 28, 2006 ----------------------- Treasurer Cari L. Jaroslawsky /s/ Donald W. Hedges Director March 28, 2006 -------------------- Donald W. Hedges /s/ William H. Duerig Director March 28, 2006 --------------------- William H. Duerig /s/ Nicholas D. Trbovich Jr. Director March 28, 2006 --------------------------- Nicholas D. Trbovich Jr. -24- SERVOTRONICS, INC. AND SUBSIDIARIES ----------------------------------- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ Page ---- Reports of Independent Registered Public Accounting Firms F2 Consolidated balance sheet at December 31, 2005 F4 Consolidated statement of operations for the years ended December 31, 2005 and 2004 F5 Consolidated statement of cash flows for the years ended December 31, 2005 and 2004 F6 Notes to consolidated financial statements F7-F21 Consolidated financial statement schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or the notes thereto. -F1- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors Servotronics, Inc. and Subsidiaries We have audited the consolidated balance sheet of Servotronics, Inc. and Subsidiaries (the "Company") as of December 31, 2005, and the related consolidated statements of operations and cash flows for the year then ended. 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 audit. The consolidated financial statements of the Company for the year ended December 31, 2004 were audited by other auditors whose report dated March 31, 2005 expressed an unqualified opinion on those statements. We conducted our audit 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. 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 audit provided a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Servotronics, Inc. and Subsidiaries as of December 31, 2005, and the results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles. /s/ Freed Maxick & Battaglia, CPAs, P.C. Buffalo, New York March 28, 2006 -F2- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Servotronics, Inc. and Subsidiaries: In our opinion, the consolidated statements of operations and cash flows for the year ended December 31, 2004 appearing on pages F-5 through F-6 of the Servotronics, Inc. 2005 Annual Report to Shareholders which has been incorporated by reference in this Form 10-KSB, present fairly, in all material respects, the results of operations and cash flows of Servotronics, Inc. and its subsidiaries for the year ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. 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 audit. We conducted our audit of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. PricewaterhouseCoopers LLP Buffalo, New York March 31, 2005 -F3-
SERVOTRONICS, INC. AND SUBSIDIARIES ----------------------------------- CONSOLIDATED BALANCE SHEET -------------------------- ($000's omitted except share and per share data) December 31, Assets 2005 ------------ Current assets: Cash $ 4,637 Accounts receivable 3,775 Inventories 6,558 Deferred income taxes 391 Other assets 930 ------------ Total current assets 16,291 Property, plant and equipment, net 6,270 Other non-current assets 648 ------------ $ 23,209 ============ Liabilities and Shareholders' Equity Current liabilities: Current portion of long-term debt $ 382 Accounts payable 890 Accrued employee compensation and benefit costs 1,116 Accrued income taxes 329 Other accrued liabilities 279 ------------ Total current liabilities 2,996 Long-term debt 5,016 Deferred income taxes 386 Other non-current liabilities 386 Shareholders' equity: Common stock, par value $.20; authorized 4,000,000 shares; issued 2,614,506 shares 523 Capital in excess of par value 13,033 Retained earnings 3,609 Accumulated other comprehensive loss (186) ------------- 16,979 Employee stock ownership trust commitment (2,034) Treasury stock, at cost 121,605 shares (520) ------------- Total shareholders' equity 14,425 ------------ $ 23,209 ============ See notes to consolidated financial statements -F4-
SERVOTRONICS, INC. AND SUBSIDIARIES ----------------------------------- CONSOLIDATED STATEMENT OF OPERATIONS ------------------------------------ ($000's omitted except per share data) Year Ended December 31, 2005 2004 ---- ---- Net revenues $ 23,126 $ 22,113 Costs, expenses and other: Cost of goods sold, exclusive of depreciation 17,047 16,344 Selling, general and administrative 3,805 3,790 Interest 235 161 Depreciation and amortization 679 655 Insurance proceeds, net (Note 11) (795) - ---------- ---------- 20,971 20,950 ---------- ---------- Income before income tax provision 2,155 1,163 Income tax provision 792 429 ---------- ---------- Net income $ 1,363 $ 734 ========== ========== Income per share: Basic ----- Net income per share $ 0.66 $ 0.36 ========= ========== Diluted ------- Net income per share $ 0.64 $ 0.35 ========= ========== See notes to consolidated financial statements -F5-
SERVOTRONICS, INC. AND SUBSIDIARIES ----------------------------------- CONSOLIDATED STATEMENT OF CASH FLOWS ------------------------------------ ($000's omitted) Year Ended December 31, 2005 2004 ---- ---- Cash flows related to operating activities: Net income $ 1,363 $ 734 Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization 679 655 Deferred income taxes (39) (16) Change in assets and liabilities - Accounts receivable (441) (846) Inventories 283 (31) Prepaid income taxes - 73 Other assets 614 42 Other non-current assets (111) 13 Accounts payable 95 246 Accrued employee compensation and benefit costs 311 73 Other accrued liabilities 127 (23) Accrued income tax 262 67 Other non-current liabilities 90 27 Employee stock ownership trust payment 101 101 --------- --------- Net cash provided by operating activities 3,334 1,115 --------- --------- Cash flows related to investing activities: Capital expenditures - property, plant & equipment (421) (622) ---------- ---------- Net cash used in investing activities (421) (622) ---------- ---------- Cash flows related to financing activities: Proceeds from demand loan - 572 Proceeds from long-term debt issuance - 750 Payments on demand loan - (572) Principal payments on long-term debt (382) (643) ---------- ---------- Net cash provided by (used in) provided by financing activities (382) 107 ---------- --------- Net increase in cash 2,531 600 Cash at beginning of year 2,106 1,506 --------- --------- Cash at end of year $ 4,637 $ 2,106 ========= ========= Supplemental disclosures: ------------------------- Income taxes paid $ 419 $ 306 ========= ======= Interest paid $ 222 $ 153 ========= ======= See notes to consolidated financial statements -F6-
SERVOTRONICS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Summary of significant accounting policies ------------------------------------------ Principles of consolidation --------------------------- The consolidated financial statements include the accounts of Servotronics, Inc. and its wholly-owned subsidiaries (the "Company"). Cash and cash equivalents ------------------------- The Company considers cash and cash equivalents to include all cash accounts and short-term investments purchased with an original maturity of three months or less. Revenue recognition ------------------- Revenues are recognized as services are rendered or as units are shipped and at the designated FOB point consistent with the transfer of title, risks and rewards of ownership. Such purchase orders generally include specific terms relative to quantity, item description, specifications, price, customer responsibility for in-process costs, delivery schedule, shipping point, payment and other standard terms and conditions of purchase and may provide for progress payments based on in-process costs as they are incurred. Inventories ----------- Inventories are stated at the lower of standard cost or net realizable value. Cost includes all cost incurred to bring each product to its present location and condition, which approximates actual cost (first-in, first-out). Market provisions in respect of net realizable value and obsolescence are applied to the gross value of the inventory. Pre-production and start-up costs are expensed as incurred. Shipping and handling costs --------------------------- Shipping and handling costs are classified as a component of cost of goods sold. Property, plant and equipment ----------------------------- Property, plant and equipment is carried at cost; expenditures for new facilities and equipment and expenditures which substantially increase the useful lives of existing plant and equipment are capitalized; expenditures for maintenance and repairs are expensed as incurred. Upon disposal of properties, the related cost and accumulated depreciation are removed from the respective accounts and any profit or loss on disposition is included in income. -F7- Depreciation is provided on the basis of estimated useful lives of depreciable properties, primarily by the straight-line method for financial statement purposes and by accelerated methods for tax purposes. Depreciation expense includes the amortization of capital lease assets. The estimated useful lives of depreciable properties are generally as follows: Buildings and improvements 5-39 years Machinery and equipment 5-15 years Tooling 3-5 years Income taxes ------------ The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes". SFAS No. 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of operating loss and credit carryforwards and temporary differences between the carrying amounts and the tax bases of assets and liabilities. The Company and its subsidiaries file a consolidated federal income tax return and separate state income tax returns. Employee stock ownership plan ----------------------------- Contributions to the employee stock ownership plan are determined annually by the Company according to plan formula. Impairment of long-lived assets ------------------------------- The Company reviews long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable based on undiscounted future operating cash flow analyses. If an impairment is determined to exist, any related impairment loss is calculated based on fair value. Impairment losses on assets to be disposed of, if any, are based on the estimated proceeds to be received, less costs of disposal. Use of estimates ---------------- The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. -F8- New accounting pronouncements ----------------------------- During the year ended December 31, 2005, the Financial Accounting Standards Board (FASB) issued a revision to SFAS 123 entitled SFAS 123 R - "Share-Based Payment", requiring companies to include the fair value of stock options granted as an expense in the statement of operations. This revision will become effective for the Company commencing January 1, 2006. See Note 7 for the expected impact of recording the fair value of options granted. During the year ended December 31, 2004, the FASB issued SFAS 151, "Inventory Costs". This Statement amends the guidance in Accounting Research Bulletin (ARB) No. 43, Chapter 4, "Inventory Pricing", to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). SFAS 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "abnormal". In addition, this Statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. Statement 151 is effective for inventory costs incurred during fiscal years beginning after June 15, 2005, with earlier application permitted in certain circumstances. The Company will adopt SFAS 151 effective January 1, 2006 and does not expect the adoption of this new standard to have a significant impact on the Company's financial statements. Risk Factors ------------ The aviation and aerospace industries as well as markets for the Company's consumer products are facing new and evolving challenges on a global basis. The success of the Company depends upon the trends of the economy, including interest rates, income tax laws, governmental regulation, legislation, and other risk factors. In addition, uncertainties in today's global economy, competition from expanding manufacturing capabilities and technical sophistication of low-cost developing countries, particularly in South and East Asia, currency policies in relation to the U.S. dollar of some major foreign exporting countries so as to maintain or increase a pricing advantage of their exports vis-a-vis U.S. manufactured goods, the effect of terrorism, difficulty in predicting defense and other government appropriations, the vitality of the commercial aviation industry and its ability to purchase new aircraft, the willingness and ability of the Company's customers to fund long-term purchase programs, volatile market demand and the continued market acceptance of the Company's advanced technology and cutlery products make it difficult to predict the impact on future financial results. -F9- Fair Value of Financial Instruments ----------------------------------- The carrying amount of cash and cash equivalents, accounts receivable, inventories, accounts payable and accrued expenses are reasonable estimates of their fair value due to their short maturity. Based on variable interest rates and the borrowing rates currently available to the Company for loans similar to its long-term debt, the fair value approximates its carrying amount. 2. Inventories ----------- December 31, 2005 ----------------- ($000's omitted) Raw materials and common parts $ 3,055 Work-in-process 3,278 Finished goods 548 ---------- 6,881 Less: common parts expected to be used after one year (classified as long-term) (323) ----------- $ 6,558 =========== 3. Property, plant and equipment ----------------------------- December 31, 2005 ----------------- ($000's omitted) Land $ 25 Buildings 6,537 Machinery, equipment and tooling 10,717 ---------- 17,279 Less accumulated depreciation and amortization (11,009) ----------- $ 6,270 =========== Property, plant and equipment includes land and building under a $5,000,000 capital lease which can be purchased for a nominal amount at the end of the lease term. As of December 31, 2005, accumulated amortization on the building amounted to approximately $1,500,000. The associated current and long-term liabilities are discussed in footnote 4 to the consolidated financial statements. The Company believes that it maintains property and casualty insurance in amounts adequate for the risk and nature of its assets and operations and which are generally customary in its industry. -F10-
4. Long-term debt December 31, 2005 -------------- ----------------- ($000's omitted) Industrial Development Revenue Bonds; secured by an equivalent letter of credit from a bank with interest payable monthly at a floating rate (3.71% at December 31, 2005) (A) $ 3,980 Term loan payable to a financial institution; interest at LIBOR plus 2% (6.00% at December 31, 2005); quarterly principal payments of $17,500 commencing January 1, 2005; payable in full in the fourth quarter of 2009 430 Term loan payable to a financial institution; interest at LIBOR plus 2% (6.41% at December 31, 2005); quarterly principal payments of $26,786 through the fourth quarter of 2011 643 Secured term loan payable to a government agency; monthly payments of approximately $1,455 with interest waived payable through second quarter of 2012 145 Secured term loan payable to a government agency; monthly payments of $1,950 including interest fixed at 3% payable through fourth quarter of 2015 200 ---------- 5,398 Less current portion (382) ----------- $ 5,016 ===========
(A) The Industrial Development Revenue Bonds were issued by a government agency to finance the construction of the Company's headquarters/Advanced Technology facility. Annual sinking fund payments of $170,000 commenced December 1, 2000 and continue through 2013, with a final payment of $2,620,000 due December 1, 2014. The Company has agreed to reimburse the issuer of the letter of credit if there are draws on that letter of credit. The Company pays the letter of credit bank an annual fee of 1% of the amount secured thereby and pays the remarketing agent for the bonds an annual fee of .25% of the principal amount outstanding. The Company's interest under the facility capital lease has been pledged to secure its obligations to the government agency, the bank and the bondholders. Principal maturities of long-term debt are as follows: 2006 - $382,000, 2007 - $386,000, 2008 - $387,000, 2009 - $539,000, 2010 - $321,000 and thereafter - $3,383,000. -F11- The Company also has a $1,000,000 line of credit on which there is no balance outstanding at December 31, 2005. Certain lenders require the Company to comply with debt covenants as described in the specific loan documents, including a debt service ratio. At December 31, 2005, the Company was in compliance with all of its debt covenants. 5. Employee benefit plans ---------------------- Employee stock ownership plan (ESOP) ------------------------------------ Under the Company's ESOP adopted in 1985, participating employees are awarded shares of the Company's common stock based upon eligible compensation and minimum service requirements. Upon inception of the ESOP, the Company borrowed $2,000,000 from a bank and lent the proceeds to the trust established under the ESOP to purchase shares of the Company's common stock. The Company's loan to the trust is at an interest rate approximating the prime rate and is repayable to the Company over a 40-year term ending in December 2024. During 1987 and 1988, the Company loaned an additional $1,942,000 to the trust under terms similar to the Company's original loan. Each year the Company makes contributions to the trust which the plan's trustees use to repay the principal and interest due the Company under the trust loan agreement. Shares held by the trust are allocated in the aggregate to participating employees in proportion to the amount of the loan repayment made by the trust to the Company. Since inception of the ESOP, approximately 419,000 shares have been allocated, exclusive of shares distributed to ESOP participants. At December 31, 2005 and 2004, approximately 397,000 and 422,000 shares, respectively, purchased by the ESOP remain unallocated. Related compensation expense associated with the Company's ESOP, which is equal to the principal reduction on the loans receivable from the trust, amounted to $101,000 in 2005 and 2004. Included as a reduction to shareholders' equity is the employee stock ownership trust commitment which represents the remaining indebtedness of the trust to the Company. Employees are entitled to vote allocated shares and the ESOP trustees are entitled to vote unallocated shares and those allocated shares not voted by the employees. Defined benefit plan -------------------- The Company has noncontributory frozen defined benefit pension plans. Plan benefits are based on stated amounts for each year of service and funding is in accordance with statutory requirements. The Company uses -F12- a measurement date of December 1 for its pension plans. The plan assets consist of cash and cash equivalents. NARRATIVE DESCRIPTION OF DEVELOPMENT OF LONG-TERM RATE OF RETURN The Company uses historical performance in the market blended with consideration for inflation and a risk-free rate of return. NARRATIVE DESCRIPTION OF INVESTMENT POLICY STRATEGIES The Company seeks to maximize income, growth of income, and long-term appreciation and preservation of capital. The assets must be invested with care and diligence with the overriding prudent man rule as a guide to investment management. The Company will, as a general guideline, make occasional disbursements and care is taken to ensure available funds.
December 1, MEASUREMENT DATE 2005 2004 ---- ---- CHANGE IN BENEFIT OBLIGATION Benefit obligation at prior measurement date $437,926 $429,351 Interest cost 24,479 25,121 Actuarial (gain)/loss 96,907 15,482 Benefits paid (exclusive of settlements) (15,908) (19,573) Settlements (17,139) (12,455) -------- -------- Benefit obligation at current measurement date $526,265 $437,926 ======== ======== CHANGE IN FAIR VALUE OF PLAN ASSETS Plan assets at prior measurement date $364,636 $345,256 Actual return (net of investment expenses) 4,119 2,523 Employer contributions 50,471 51,418 Benefits paid (exclusive of settlements) (15,908) (19,573) Settlements (14,695) (14,988) ------- ------- Plan assets at current measurement date $388,623 $364,636 ======== ======== FUNDED STATUS Funded status ($137,642) ($73,290) Unrecognized prior service cost 45,874 47,435 Unrecognized net loss 295,269 197,831 Unrecognized net transition obligation 44,458 59,278 Intangible asset (90,332) (106,713) Accumulated other comprehensive income (295,269) (197,831) -------- -------- Accrued pension cost ($137,642) ($73,290) ========= ======== NET PERIODIC PENSION COST Interest cost $24,479 $25,121 Expected return on assets (30,212) (28,823) Amortization of transition obligation 14,820 14,820 Recognized loss 12,414 9,849 Amortization of prior service cost 1,561 1,561 Recognized settlement loss 10,704 6,508 ------ ----- Net periodic pension cost $33,766 $29,036 ======= =======
-F13-
WEIGHTED AVERAGE ASSUMPTIONS Discount rate prior measurement date 5.75% 6.00% Discount rate current measurement date 5.75% 5.75% Rate of compensation increase n/a n/a Long-term rate of return 8.00% 8.00% ADDITIONAL FINANCIAL STATEMENT DISCLOSURES FOR SFAS NO. 132 (R) PLAN ASSETS Cash and cash equivalents 100.00% 100.00% ====== ====== REQUIRED EMPLOYER CONTRIBUTIONS Remaining Contributions for the 2004 Plan Year $32,157 $11,855 Installments for the subsequent Plan Year 61,014 38,616 ------ ------ Total $93,171 $50,471 ======= ======= ACCUMULATED BENEFIT OBLIGATION Projected benefit obligation (PBO) $526,265 $437,926 Accumulated benefit obligation (ABO) $526,265 $437,926 Plan assets $388,623 $364,636 Excess of ABO over plan assets $137,642 $73,290 ESTIMATED FUTURE BENEFIT PAYMENTS First plan year $23,349 $24,430 Second plan year $27,915 $25,569 Third plan year $27,116 $27,164 Fourth plan year $28,469 $27,824 Fifth plan year $29,956 $28,702 Sixth through tenth plan years $166,042 $147,998
Other Postretirement Benefit Plans ---------------------------------- The Company provides certain post retirement health and life insurance benefits for two executives of the Company. Upon retirement and after attaining at least the age of 65, the Company will pay the annual cost of health insurance for the retired executives and dependents and will continue the Company provided life insurance in force at the time of retirement. The retiree's health insurance benefits ceases upon the death of the retired executive. The actuarially calculated future obligation of the benefits at the date of adoption of the plan was $128,675 and is being amortized into expense at a rate of approximately $17,000 per year. Estimated future annual expenses associated with the plan are immaterial. -F14- 6. Income tax provision -------------------- The provision (benefit) for income taxes included in the consolidated statement of operations consists of the following: 2005 2004 ------- ------ ($000's omitted) Current: Federal income tax provision $ 764 $ 388 State income tax provision 67 57 ------- ------ 831 445 Deferred: Federal income tax (benefit) (61) (13) State income tax provision (benefit) 22 (3) ------- -------- (39) (16) $ 792 $ 429 ======= ======= The reconciliation of the difference between the Company's effective tax rate based upon the total income tax provision (benefit) and the federal statutory income tax rate is as follows: 2005 2004 ------- ------ Federal statutory rate 34% 34% State income taxes (less federal effect) 3% 3% ----- ----- Effective tax rate 37% 37% ===== ===== At December 31, 2005, the deferred tax assets (liabilities) were comprised of the following: ($000's omitted) Inventories $ 158 Accrued employee compensation and benefit costs 213 Operating loss and credit carryforwards 52 Minimum pension liability 126 Other 3 ---------- Total deferred tax assets 552 Property, plant and equipment (540) Other liabilities (7) ---------- Total deferred tax liabilities (547) ---------- Net deferred tax asset $ 5 ========= At December 31, 2005, the Company has New York State net operating loss carryforwards of approximately $279,000 (approximately a $9,000 net tax benefit) that begin to expire in 2019. -F15- The Company also has a State of Pennsylvania net operating loss carryforward of approximately $1,306,000 (approximately a $43,000 net tax benefit) that begins to expire in 2006. 7. Common shareholders' equity ---------------------------
Common stock Number Capital in Other Total of shares excess of Retained Treasury Comprehensive Shareholders issued Amount par value earnings ESOP stock Loss Equity ------------------------------------------------------------------------------------ ($000's omitted except share amounts) Balance December 31, 2003 2,614,506 $523 $13,033 $1,516 ($ 2,236) ($ 520) ($ 107) $ 12,209 ========= ==== ======= ====== ======== ======== ======== ======== Comprehensive income: Net income - - - 734 - - - $ 734 Other comprehensive loss, net of tax Minimum pension liability adjustment - - - - - - (18) (18) ------- Total comprehensive income - - - - - - - 716 Compensation expense - - - - 101 - - 101 Other - - - (4) - - - (4) -------- ---- ------- ------- ------ ------ ------- --------- Balance December 31, 2004 2,614,506 $523 $13,033 $2,246 ($ 2,135) ($ 520) ($ 125) $ 13,022 ========= ==== ======= ====== ======== ======== ======== Comprehensive income: Net income - - - 1,363 - - - $ 1,363 Other comprehensive loss, net of tax Minimum pension liability adjustment - - - - - - (61) (61) Total comprehensive income - - - - - - - 1,302 Compensation expense - - - - 101 - - 101 -------- ---- ------- ------ ------ ------ ------- -------- Balance December 31, 2005 2,614,506 $523 $13,033 $3,609 ($ 2,034) ($ 520) ($ 186) $ 14,425 ========= ==== ======= ====== ======== ======== ======= ========
In January of 2006, the Company's Board of Directors authorized the purchase by the Company of up to 250,000 shares of its common stock in the open market or in privately negotiated transactions. As of March 27, 2006, the Company has purchased or committed to purchase 77,757 shares for a total of $679,300 under this program. Earnings per share ------------------ Basic earnings per share is computed by dividing net earnings by the weighted average number of shares outstanding during the period. Diluted earnings per share is computed by dividing net earnings by the weighted average number of shares outstanding during the period plus the number of shares of common stock that would be issued assuming all contingently issuable shares having a dilutive effect on earnings per share were outstanding for the period. Incremental shares from assumed conversions are calculated as the number of shares that would be issued, net of the number of shares that could be purchased in the marketplace with the cash received upon stock option exercise. -F16- Year Ended December 31, 2005 2004 -------- -------- ($000's omitted) except per share data) Net income $ 1,363 $ 734 ======== ======== Weighted average common shares outstanding (basic) 2,075 2,052 Incremental shares from assumed conversions of stock options 64 46 Weighted average common shares outstanding (diluted) 2,139 2,098 Basic ----- Net income per share $ 0.66 $ 0.36 ======== ======= Diluted ------- Net income per share $ 0.64 $ 0.35 ======== ======= Other comprehensive loss ------------------------ The minimum pension liability of $186,000 ($125,000 - 2004), which is shown net of deferred income taxes of $109,000 ($73,000 - 2004), is the only component of other comprehensive loss. Stock options ------------- Under the Servotronics, Inc. 2000 Employee Stock Option Plan authorized by the Board of Directors and the 2001 Long-Term Stock Incentive Plan authorized by the Board of Directors and the Shareholders, and other separate agreements authorized by the Board of Directors, the Company has granted non-qualified options to certain Directors and Officers. The Company applies APB Opinion No. 25 and related interpretations in accounting for these Plans and the separate option agreements. Accordingly, no compensation expense has been charged to earnings in 2005 or prior years as stock options granted have an exercise price equal to the market price on the date of grant. At December 31, 2005, 33,300 shares of common stock were available under these plans. Options granted under these plans have durations of ten years and vesting periods ranging from immediate vesting to four (4) years. -F17- A summary of the status of options granted under all employee plans is presented below:
Weighted Average Options Exercise Outstanding Price ($) Outstanding as of December 31, 2003 464,200 4.01 Granted in 2004 - - Exercised in 2004 - - Forfeited in 2004 - - Outstanding as of December 31, 2004 464,200 4.01 Granted in 2005 80,000 4.70 Exercised in 2005 - - Forfeited in 2005 30,300 4.34 ------ ---- Outstanding as of December 31, 2005 513,900 4.41 ======= ====
The following tables summarize information about options outstanding at December 31, 2005: Remaining Exercise Number Contractual Options Prices ($) Outstanding Life Exercisable -------------------------------------------------------- 8.50 87,200 2 years 87,200 3.8125 93,700 5 years 93,700 4.38 117,000 6 years 117,000 2.045 136,000 8 years 133,000 4.70 80,000 10 years 80,000 ------ ------ Total 513,900 510,900 ======= ======= The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation". If the compensation cost for these plans had been determined based on the Black-Scholes calculated values at the grant dates for awards consistent with the method prescribed by SFAS No. 123, the pro forma effects on the years ended December 31, 2005 and 2004 are as follows: -F18- 2005 2004 ---- ---- Net income: As reported $1,363,000 $734,000 Pro forma $1,171,778 $703,781 Earnings per common share: As reported - basic $0.66 $0.36 As reported - diluted $0.64 $0.35 Pro forma - basic $0.56 $0.34 Pro forma - diluted $0.55 $0.34 There were 80,000 options granted in 2005. There were no options granted in 2004. The Black-Scholes calculated estimated value of the options granted in 2005 was $3.095. The assumptions used to calculate this value include a risk-free interest rate of 4.39%, an expected term of 10 years, a dividend yield of zero and an annual standard deviation (volatility) factor of 49.6%. The Black-Scholes option pricing model was developed for use in estimating values of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the use of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock options are restricted and have characteristics significantly different from those of traded options, and because changes in the subjective assumptions can materially affect the calculated estimated values, in the Company's opinion the existing models do not necessarily provide a reliable measure of the value of the Company's stock options. The estimated value calculated by the Black-Scholes methodology is hypothetical and does not represent an actual tangible Company expense or an actual tangible monetary transfer to the optionee. Further, for the reasons stated above (among others) and especially because of the volatility factor used in the Black-Scholes calculations for the Company's 2005 options, the derived estimated value may be, in the Company's opinion, substantially higher than the value which may be realized in an arms-length transaction under the above stated and existing conditions. Shareholders' rights plan ------------------------- During 2002, the Company's Board of Directors adopted a shareholders' rights plan (the "Rights Plan") and simultaneously declared a dividend distribution of one Right for each outstanding share of the Company's common stock outstanding at August 28, 2002. The Rights Plan replaced a previous shareholder right plan that was adopted in 1992 and expired on August 28, 2002. The Rights do not become exercisable until the -F19- earlier of (i) the date of the Company's public announcement that a person or affiliated group other than Dr. Nicholas D. Trbovich or the ESOP trust (an "Acquiring Person") has acquired, or obtained the right to acquire, beneficial ownership of 25% or more of the Company's common stock (excluding shares held by the ESOP trust) or (ii) ten business days following the commencement of a tender offer that would result in a person or affiliated group becoming an Acquiring Person. The exercise price of a Right has been established at $32.00. Once exercisable, each Right would entitle the holder to purchase one one-hundredth of a share of Series A Junior Participating Preferred Stock. In the event that any person becomes an Acquiring Person, each Right would entitle any holder other than the Acquiring Person to purchase common stock or other securities of the Company having a value equal to three times the exercise price. The Board of Directors has the discretion in such event to exchange two shares of common stock or two one-hundredths of a share of preferred stock for each Right held by any holder other than the Acquiring Person. 8. Commitments ----------- The Company leases certain equipment pursuant to operating lease arrangements. Total rental expense in 2005 and 2004 and future minimum payments under such leases are not significant. 9. Litigation ---------- There are no legal proceedings which are material to the Company currently pending by or against the Company other than ordinary routine litigation incidental to the business which is not expected to materially adversely affect the business or earnings of the Company. 10. Business segments ----------------- The Company operates in two business segments, Advanced Technology Group (ATG) and Consumer Products Group (CPG). The Company's reportable segments are strategic business units that offer different products and services. The segments are composed of separate corporations and are managed separately. Operations in ATG involve the design, manufacture, and marketing of servo-control components (i.e., torque motors, control valves, actuators, etc.) for government, commercial and industrial applications. CPG's operations involve the design, manufacture and marketing of a variety of cutlery products for use by consumers and government agencies. The Company derives its primary sales revenue from domestic customers, although a significant portion of finished products are for foreign end use. -F20- Information regarding the Company's operations in these segments is summarized as follows ($000's omitted):
Advanced Technology Consumer Products Group Group Consolidated ----- ----- ------------ Year ended Year ended Year ended December 31, December 31, December 31, 2005 2004 2005 2004 2005 2004 ---- ---- ---- ---- ---- ---- Revenues from unaffiliated customers $13,834 $11,354 $ 9,292 $ 10,759 $ 23,126 $ 22,113 ======= ======= ======== ======== ========= ======== Profit $ 2,974 $ 1,844 $ 48 $ 871 $ 3,022 $ 2,715 ======= ======= ========= ======== Depreciation and amortization $ (508) $ (506) $ (171) $ (149) (679) (655) ======== ======== ========= ========= Interest expense (235) (161) Insurance proceeds, net 795 - General corporate expense (748) (736) ---------- --------- Income before income taxes $ 2,155 $ 1,163 ========= ======== Identifiable assets $16,046 $14,519 $ 7,163 $ 6,841 $ 23,209 $ 21,360 ======= ======= ======== ======== ========= ======== Capital expenditures $ 192 $ 302 $ 229 $ 320 $ 421 $ 622 ======= ======= ======== ======== ========= ========
The Company engages in a significant amount of business with the United States Government through sales to its prime contractors and otherwise. Such contracts by the Advanced Technology Group accounted for revenues of approximately $5,600,000 in 2005 and $4,800,000 in 2004. Similar contracts by the Consumer Products Group accounted for revenues of approximately $3,800,000 in 2005 and $5,100,000 in 2004. Sales of advanced technology products to one prime contractor, including various divisions and subsidiaries of a common parent company, amounted to approximately 13% in 2005 and 14% in 2004. The Company also had sales to another customer that amounted to approximately 18% of total revenues in 2005 and 17% in 2004. No other single customer represented more than 10% of the Company's revenues in any of these years. 11. Insurance proceeds ------------------ As previously reported, in December of 2005, the Company received $1,000,000, equal to the policy limit, from its insurance carrier in partial recovery of a defalcation by a former employee. As of December 31, 2005, the Company incurred approximately $205,000 in professional, legal and related costs associated with the recovery and the Company continues to seek additional restitution. -F21-