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, 2006
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
--- OF 1934
For the transition period from to .
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Commission File No. 1-07109
SERVOTRONICS, INC.
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(Name of small business issuer as specified in its charter)
Delaware 16-0837866
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(State or other jurisdiction of (I. R. S. Employer
incorporation or organization) Identification No.)
1110 Maple Street, Elma, New York 14059
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(Address of principal executive offices) (Zip Code)
Issuer's telephone number: 716-655-5990
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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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.
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Issuer's revenues for its most recent fiscal year: $24,548,000
As of February 28, 2007 the aggregate market value of the voting common
stock held by non-affiliates of the registrant was $13,552,829.65 based on the
average of sales prices reported by the American Stock Exchange on that day.
As of February 28, 2007 the number of $.20 par value common shares
outstanding was 2,359,102.
DOCUMENTS INCORPORATED BY REFERENCE
Document Part of Form 10-KSB
-------- -------------------
2007 Proxy Statement Part III
Transitional Small Business Disclosure Format. Yes . No X .
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TABLE OF CONTENTS
PART I
Item 1. Description of Business................................................................3
Item 2. Description of Properties..............................................................7
Item 3. Legal Proceedings......................................................................8
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 Small Business Issuer Purchases of Equity Securities.....................8
Item 6. Management's Discussion and Analysis or Plan of Operation..............................9
Item 7. Financial Statements..................................................................17
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.................................................17
Item 8A. Controls and Procedures...............................................................18
Item 8B. Other Information.....................................................................18
PART III
Item 9. Directors, Executive Officers, Promoters and Control Persons
and Corporate Governance; Compliance with Section 16(a)
of the Exchange Act.................................................................19
Item 10. Executive Compensation................................................................19
Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters..........................................19
Item 12. Certain Relationships and Related Transactions, and
Director Independence...............................................................20
Item 13. Exhibits..............................................................................20
Item 14. Principal Accountant Fees and Services................................................25
Signatures........................................................................................26
Consolidated Financial Statements.............................................................F1-F23
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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 Company was incorporated in New York in 1959. In 1972, the Company
was merged into a wholly-owned subsidiary organized under the laws of the State
of Delaware, thereby changing the Company's state of incorporation from New York
to Delaware.
PRODUCTS
ADVANCED TECHNOLOGY PRODUCTS
The Company 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, as well as medical and industrial
markets.
To fill most of its orders for components, the Company must either modify
a standard model or design a new item in order to satisfy the customer's
particular requirements. The Company also produces unique products based on
specifications provided by its customers. The Company produces under long-term
contracts and other types of orders.
The Company 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 Company 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 Company has also produced other products of its
own and/or of a given design to meet customers' requirements.
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CONSUMER PRODUCTS
The Company 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 Company 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
Company also produces and markets other cutlery items such as various specialty
tools, putty knives, linoleum sheet cutters and field knives. The Company
manufactures its cutlery products from stainless or high carbon steel in
numerous styles, designs, models and sizes. Substantially all of the Company's
commercial cutlery related products are intended for the medium to premium
priced markets.
The Company sells many of its cutlery products under its own brand names
including "Old Hickory" and "Queen."
SALES, MARKETING AND DISTRIBUTION
ADVANCED TECHNOLOGY PRODUCTS
The Company's advanced technology products are marketed throughout the
United States and in selected foreign markets. Products 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 Company's
professional staff and a field engineering representative.
During the Company'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 18% of the Company's total sales
as compared to 23% in 2005. In 2006 and 2005, the Company's sales of advanced
technology products to one customer, including various divisions and
subsidiaries of a common parent company, amounted to approximately 14% in 2006
and 13% in 2005. The Company also had sales to another customer that amounted to
approximately 23% of total sales in 2006 and 18% in 2005. No other single
customer represented more than 10% of the Company's sales in any of these years.
The Company'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 Company is ordinarily entitled to receive
payment for its costs and profits on work done prior to termination. Since the
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inception of the Company's business, less than 1% of its Government contracts
have been terminated for convenience.
CONSUMER PRODUCTS
The Company'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 Company's
Consumer Products Group (CPG) 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 13% of the
Company's total sales in 2006 as compared to 16% in 2005. No other single
customer of the CPG represented more than 10% of the Company's sales in 2006.
The Company 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 Company's competitive
position is not dependent on patent protection.
RESEARCH ACTIVITIES
The amount spent by the Company in research and development activities
during its 2006 and 2005 fiscal years was not significant.
ENVIRONMENTAL COMPLIANCE
The Company does not anticipate that the cost of compliance with current
environmental laws will be material.
MANUFACTURING
The Company manufactures its consumer products in Franklinville, New York
and Titusville, Pennsylvania and its advanced technology products in Elma, New
York.
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RAW MATERIALS AND OTHER SUPPLIES
The Company purchases raw materials and certain components for its
products from outside vendors. The Company is not generally dependent upon a
single source of supply for any raw material or component used in its
operations.
COMPETITION
Although no reliable industry statistics are available to enable the
Company to determine accurately its relative competitive position with respect
to any of its products, the Company believes that it is a significant factor
with respect to certain of its servo-control components. The Company's share of
the overall cutlery market is not significant.
The Company 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
Company believes that it competes primarily with more than 20 companies with
respect to its consumer products, in addition to foreign imports. To the
Company's knowledge, its principal competitors with regard to cutlery include
World Kitchen, Inc., Benchmade Knife Company, Inc., Tramontina, Inc.,
Dexter-Russell Inc., W. R. Case & Sons Cutlery Company, Lifetime Hoan Corp., and
Gerber.
The Company 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 Company markets most of its products throughout the United States and
to a lesser extent in selected foreign markets. The Company 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 Company, at December 31, 2006, had approximately 247 employees of
which approximately 234 are full time; 196 in Western New York and 38 in
Pennsylvania. In excess of 82% of its employees are engaged in production,
inspection, packaging or shipping activities. The balance are engaged in
executive, engineering, administrative, clerical or sales capacities.
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ITEM 2. DESCRIPTION OF PROPERTIES
The Company's executive offices are located on premises leased by the
Company at 1110 Maple Street, Elma, a suburb of Buffalo, New York. The Company
owns, leases and/or has options on 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 Company leases and/or has options on 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 Company to
purchase the property for a nominal amount. The balance outstanding on the
capital lease at December 31, 2006 was approximately $3.8 million. All of the
above properties are covered by insurance.
See the consolidated financial statements, including Note 8 thereto, for
further information with respect to the Company's lease commitments.
The Company possesses modern precision manufacturing and testing
equipment suitable for the development, manufacture, assembly and testing of its
advanced technology products. The Company uses computer-aided technology
throughout its processes, procedures, designs, manufacturing and administrative
functions. The Company designs and makes most of the tools, dies, jigs and
specialized testing equipment necessary for the production of the advanced
technology products. The Company also possesses automatic and semi-automatic
grinders, tumblers, presses and miscellaneous metal finishing machinery and
equipment for use in the manufacture of consumer products.
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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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S 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 Company's common stock as reported by the American
Stock Exchange (symbol SVT) for 2006 and 2005.
HIGH LOW
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2006
Fourth Quarter $ 9.90 $ 6.15
Third Quarter 7.20 6.05
Second Quarter 9.25 5.80
First Quarter 10.30 4.70
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
(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK
Title Approximate number of
of record holders (as of
class December 31, 2006)
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Common Stock, $.20 par value per share 578
(c) DIVIDENDS ON COMMON STOCK
No cash dividends were paid in 2006 or 2005.
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(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 84,100
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Total 513,900 $4.407 101,100
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(e) COMPANY RE-PURCHASES OF EQUITY SECURITIES
Total Number of
Shares Purchased as Maximum Number of
Total Number Part of Publicly Shares that may yet
of Shares Average Price $ Announced Plans or be Purchased under
Period Purchased Paid Per Share Programs the Plans or Programs
--------------------------------------- --------------- -------------------- ---------------------- -----------------------
Fourth Quarter of 2006 550 6.35 550 139,509
--------------------------------------- --------------- -------------------- ---------------------- -----------------------
2006 Total 110,491 8.32 110,491 139,509
--------------------------------------- --------------- -------------------- ---------------------- -----------------------
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. As of February
28, 2007, the Company has purchased 114,357 shares and there
remain 135,643 shares available to purchase under this
program.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
MANAGEMENT DISCUSSION
During the years ended December 31, 2006 and 2005, approximately 32% and
39% 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 $1,475,000 when comparing the results of 2006
to 2005 as the result of the previously reported scheduled completion of a
significant order by the Consumer Products Group (CPG) as well as expected
differences in timing of government order placement and required shipping
schedules at both the CPG and Advanced Technology Group (ATG). The Company
believes that government involvement in military operations overseas will
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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.
The Aerospace Industry Association (AIA) reported that 2006 was a year in
which the U. S. aerospace industry projected total deliveries to be up more than
8% for 2006. AIA also stated that the civil aircraft sector was particularly
strong and that, based on the current backlog of commercial aircraft orders,
they believe this upward trend will continue in 2007. The Company's Advanced
Technology Group's increase in revenue for 2006 reflects this upward trend and
the Company anticipates, based on the ATG's current backlog, that the ATG's
shipments should be strong for 2007.
The Company's Consumer Products Group has developed products for
government and military applications. Forecasted procurements for certain of
these items are forming the basis for projected deliveries in 2007. Procurement
proposals and product development activities are ongoing. Certain initial
procurements have been received. Also, expanded ATG and CPG foreign marketing
activities are resulting in early positive responses.
See also Note 10 to the consolidated financial statements for information
concerning business segment operating results.
RESULTS OF OPERATIONS - YEAR 2006 AS COMPARED TO 2005
The following table sets forth for the period indicated the percentage
relationship of certain items in the consolidated statement of operations to
revenues and the period to period dollar and percentage increase or decrease of
such items as compared to the indicated prior period. Certain balances for the
year ended December 31, 2005 were reclassified to conform with classifications
adopted in the current year.
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Period to Period to
Relationship to period period
revenue $ increase % increase
year ended (decrease) (decrease)
December 31, year ended year ended
2006 2005 2006-2005 2006-2005
---- ---- --------- ---------
Revenue:
Advanced technology products 64.2% 59.7% $ 2,107 15.4%
Consumer products 35.8 40.3 (454) (4.9)
------ ------ --------- -------
100.0 100.0 1,653 7.2
Cost of goods sold, exclusive of depreciation 76.4 74.5 1,715 10.1
------ ------ --------- -------
Gross profit 23.6 25.5 (62) (1.1)
------ ------ --------- -------
Selling, general and administrative 14.7 16.6 (189) (5.0)
Interest 1.1 1.0 31 13.2
Depreciation and amortization 2.5 3.0 (62) (9.1)
Other income, net (1.8) (4.5) (585) (57.0)
------ ------ --------- -------
16.5 16.1 365 9.9
Income before income tax provision 7.1 9.4 (427) (19.8)
Income tax provision 2.6 3.4 (160) (20.2)
------ ------ --------- -------
Net income 4.5% 5.9% $ (267) (19.6)%
====== ====== ========= =======
The Company's consolidated revenues increased approximately $1,653,000 or
7.2% for the 12 month period ended December 31, 2006 when compared to the same
period in 2005. Increases in commercial shipments in combination with certain
price increases at the Company's ATG more than offset the decreases in revenue
at the Company's CPG. The decrease in revenues at the CPG resulted from the
scheduled and previously reported essential completion of a significant
government contract. Continued demand for the Company's ATG products drive
increases in revenues.
Gross margins for the twelve month period ended December 31, 2006
decreased by 1.1% as compared to 2005. This drop is directly related to the
reduction in revenues and margins at the CPG segment as shown above. In 2007,
the CPG received a $3 million order from a government prime contractor for
deliveries into early 2008. This order is expected to have a positive effect on
total revenues and margins in 2007. Gross margins are affected by many factors
including the mix of products sold in the period within the ATG and CPG as well
as the composition of ATG and CPG sales to the total consolidated sales and,
consistent with accounting principles generally accepted in the United States of
America (GAAP), the expensing of preproduction and development costs as they are
incurred.
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Selling, general and administrative (SG&A) expenses include variable
costs such as legal and professional. Although certain General and
Administrative costs (i.e., professional, legal, salary and Section 404 related
expenses,) decreased by approximately $360,000 in 2006, there were expanded
sales/marketing activities which increased costs that partially offset these
reductions at both the ATG and the CPG. Also, consistent with GAAP, these costs
are expensed as they are incurred and because of this may result in timing
differences and fluctuations from period to period. Therefore, these costs are
not necessarily matched to their respective benefits.
Interest expense increased for the year ended December 31, 2006 when
compared to the same period in 2005 because of increases in the market driven
interest rates. Average debt outstanding was lower and will continue to decline
as the Company repays its scheduled debt obligations and assuming the Company
does not incur additional debt. See also Note 4 to the consolidated financial
statements for information on long-term debt.
Depreciation and amortization expense decreased approximately 9.1% for
the year ended December 31, 2006 when compared to the same period in 2005 due to
variable estimated useful lives of depreciable property as identified in Note 1
to the consolidated financial statements and the reduction in capital
expenditures over the last three years.
Other income in 2006 includes approximately $220,000 of net recovery,
from a previously reported defalcation; the amount of net recovery in 2005 was
$795,000. Components of other income also include; interest income on cash and
cash equivalents, and other minor amounts not directly related to the sale of
the Company's products.
The Company's effective tax rate was 37% in 2006 and 2005. 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 decreased $267,000 when comparing the year ended December 31,
2006 to the same period of 2005 due to the decrease of $369,000 in after tax,
other income received in 2006 not related to the sale of the Company's products.
This decrease was offset by the positive results of increased consolidated
revenues and the effects of cost containment activities that directly affect the
after-tax reported income.
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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
revenues and the period to period dollar and percentage increase or decrease of
such items as compared to the indicated prior period. The following chart
balances for the year ended December 31, 2005 were not reclassified to conform
with the 2006 financial statements.
Period to Period to
Relationship to period period
net revenue $ increase % increase
year ended (decrease) (decrease)
December 31, year ended year ended
2005 2004 2005-2004 2005-2004
---- ---- --------- ---------
Net revenue 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 ATG partially off-set
by a decrease in government shipments at the CPG 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.
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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.
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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary liquidity and capital requirements relate to
working capital needs; primarily inventory, accounts receivable, capital
expenditures for property, plant and equipment and principal and interest
payments on debt.
-14-
At December 31, 2006 the Company had working capital of approximately
$13.3 million of which $4.1 million was comprised of cash and cash equivalents.
The Company generated approximately $1 million in cash from operations in 2006.
The most significant use of cash included cash used to fund and pay employee
benefit/pension obligations, payment of income taxes as well as increases in
inventory levels related to timing of shipments of product.
At December 31, 2006, there are no material commitments for capital
expenditures.
The Company had an increase in the uses of cash in its financing and
investing activities in 2006 primarily related to capital expenditures for
equipment, principle payments on long-term debt and investment in treasury
shares of approximately $920,000. 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
February 28, 2007, the Company has purchased or committed to purchase 114,357
shares for a total of $951,896 under this program.
The Company also has a $1,000,000 line of credit on which there is no
balance outstanding at December 31, 2006. If needed, this can be used to fund
cash flow required for operations.
Principal maturities of long-term debt are as follows: 2007 - $384,000,
2008 - $387,000, 2009 - $539,000, 2010 - $321,000, 2011 - $323,000 and
thereafter - $3,059,000.
OFF BALANCE SHEET ARRANGEMENTS
None.
CRITICAL ACCOUNTING POLICIES
The Company prepares its consolidated financial statements in accordance
with GAAP. As such, the Company is 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 the Company's most critical accounting policies, which are
those that are most important to the portrayal of the Company's financial
condition and results of operations and which require the Company's 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.
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NEW ACCOUNTING PRONOUNCEMENTS
Management reviewed recent accounting pronouncements and has not
determined the effect these pronouncements will have on Financial Statement
results. See Note 1 in the accompanying consolidated financial statements for
further discussion of new accounting pronouncements.
REVENUE RECOGNITION
Revenues are recognized as services are rendered or as units are shipped
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 consolidated 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. As discussed in Note 5, the
Company's defined benefit plans are anticipated to be settled in 2007 with no
future costs associated with them after 2007.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect the
-16-
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.
ITEM 7. FINANCIAL STATEMENTS
The financial statements of the Company 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
On September 7, 2005, the Audit Committee of the Company's Board of
Directors of 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 most recent fiscal
years audited by PWC 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 the 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 registrant's
indemnification of predecessor auditors for costs incurred in successful defense
of claims.
-17-
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. During the Company's two most recent fiscal years, and
subsequently through the effective date of the engagement of Freed Maxick,
neither the Company nor any person acting on behalf of the Company consulted
with Freed Maxick with respect to the application of accounting principals to a
specific completed or contemplated transaction, or the type of audit opinion
that might be rendered on the Company's consolidated financial statements or any
other matters or reportable events listed in Item 304 (a)(1)(iv) of Regulation
S-B.
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, 2006. 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
There were no changes in the Company's internal control over financial
reporting during the fourth quarter of 2006 that have materially affected, or
are reasonably likely to affect, the Company's internal control over financial
reporting.
ITEM 8B. OTHER INFORMATION
None.
-18-
PART III
Item 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS AND
CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16(A) OF THE
EXCHANGE ACT
Information regarding directors and executive officers of the Company,
compliance with Section 16(a) of the Securities Exchange Act and the Company's
Audit Committee, its members and the Audit Committee financial expert is
incorporated herein by reference to the information included in the Company's
definitive proxy statement if it is filed with the Commission within 120 days
after the end of the Company's 2006 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 Company's definitive proxy
statement if it is filed with the Commission within 120 days after the end of
the Company's 2006 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 Company's definitive proxy statement if it is filed with the Commission
within 120 days after the end of the Company's 2006 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.
-19-
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information regarding certain relationships and related transactions and
director independence is incorporated herein by reference to the information
included in the Company's definitive proxy statement if it is filed with the
Commission within 120 days after the end of the Company's 2006 fiscal year or
such information will be included by amendment to this form 10-KSB.
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
--------------------------------------------------------------
*Incorporated herein by reference (File No. 1-07109)
**Indicates management contract or compensatory plan or arrangement
-20-
Exhibit
Number Presentation Reference
------- ------------ ---------
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
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*
--------------------------------------------------------------
*Incorporated herein by reference (File No. 1-07109)
**Indicates management contract or compensatory plan or arrangement
-21-
Exhibit
Number Presentation Reference
------- ------------ ---------
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**
10(A)(2) Amendment to employment Exhibit 10(A)(2) to Form
contract for Dr. Nicholas D. 8-K filed August 9,
Trbovich, Chief Executive 2006**
Officer
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(A)(5) Amendment to employment Exhibit 10(A)(5) to Form
contract for Nicholas D. 8-K filed August 9,
Trbovich, Jr., Vice President 2006**
10(A)(6) Amendment to employment Exhibit 10(A)(6) to Form
contract for Nicholas D. 8-K filed August 9,
Trbovich, Jr., Vice President 2006**
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**
--------------------------------------------------------------
*Incorporated herein by reference (File No. 1-07109)
**Indicates management contract or compensatory plan or arrangement
-22-
Exhibit
Number Presentation Reference
------- ------------ ---------
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**
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
--------------------------------------------------------------
*Incorporated herein by reference (File No. 1-07109)
**Indicates management contract or compensatory plan or arrangement
-23-
Exhibit
Number Presentation Reference
------- ------------ ---------
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
10(D)(13) 2001 Long-Term Stock Appendix A to 2001
Incentive Plan Proxy**
16.1 Letter from Exhibit 16.1 to
PricewaterhouseCoopers Form 8-K/A
regarding dismissal filed September 21, 2005
21 Subsidiaries of the Exhibit 21 to 2005
Registrant 10-KSB*
23.1 Consent of Freed Maxick & Filed herewith
Battaglia, CPAs, P.C.
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.
--------------------------------------------------------------
*Incorporated herein by reference (File No. 1-07109)
**Indicates management contract or compensatory plan or arrangement
-24-
Exhibit
Number Presentation Reference
------- ------------ ---------
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.
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.
The Company 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.
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 Company's
definitive proxy statement if it is filed with the Commission within 120 days
after the end of the Company's 2006 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.
-25-
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
SERVOTRONICS, INC.
March 27, 2007 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 Company and in the
capacities and on the dates indicated.
/s/ Nicholas D. Trbovich President, Chief Executive March 27, 2007
------------------------
Nicholas D. Trbovich Officer, Chairman of the
Board and Director
/s/ Cari L. Jaroslawsky Chief Financial Officer, March 27, 2007
-----------------------
Cari L. Jaroslawsky Treasurer
/s/ Donald W. Hedges Director March 27, 2007
--------------------
Donald W. Hedges
/s/ William H. Duerig Director March 27, 2007
---------------------
William H. Duerig
/s/ Nicholas D. Trbovich Jr. Director March 27, 2007
---------------------------
Nicholas D. Trbovich Jr.
-26-
SERVOTRONICS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
Report of Independent Registered Public Accounting Firm F2
Consolidated balance sheet at December 31, 2006 F3
Consolidated statement of operations for the years ended
December 31, 2006 and 2005 F4
Consolidated statement of cash flows for the years ended
December 31, 2006 and 2005 F5
Notes to consolidated financial statements F6-F23
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, 2006, and the related
consolidated statements of operations and cash flows for the two years in the
period 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 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. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits 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 audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Servotronics, Inc.
and Subsidiaries as of December 31, 2006, and the results of their operations
and their cash flows for the two years in the period then ended, in conformity
with U.S. generally accepted accounting principles.
As discussed in Notes 1 and 7 to the consolidated financial statements,
effective January 1, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 123 (revised 2004), SHARE-BASED PAYMENT.
Also, as discussed in Notes 1 and 5 to the consolidated financial statements,
effective December 31, 2006, the Company adopted the provisions of Statement of
Financial Accounting Standards No. 158, EMPLOYERS' ACCOUNTING FOR DEFINED
BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS -- AN AMENDMENT OF FASB
STATEMENTS NO. 87, 88, 106, AND 132(R).
/s/ Freed Maxick & Battaglia, CPAs, P.C.
Buffalo, New York
March 27, 2007
-F2-
SERVOTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
($000's omitted except share and per share data)
ASSETS December 31, 2006
-----------------
Current assets:
Cash and cash equivalents $ 4,104
Accounts receivable 4,226
Inventories 6,861
Deferred income taxes 545
Other assets 563
------------
Total current assets 16,299
Property, plant and equipment, net 5,940
Other non-current assets 399
------------
$ 22,638
LIABILITIES AND SHAREHOLDERS' EQUITY ============
Current liabilities:
Current portion of long-term debt $ 384
Accounts payable 1,205
Accrued employee compensation and benefit costs 1,089
Other accrued liabilities 320
Accrued income taxes 47
------------
Total current liabilities 3,045
Long-term debt 4,630
Deferred income taxes 515
Shareholders' equity:
Common stock, par value $.20; authorized
4,000,000 shares; issued 2,614,506 shares;
outstanding 1,991,600 shares 523
Capital in excess of par value 13,033
Retained earnings 4,703
Accumulated other comprehensive loss (278)
------------
17,981
Employee stock ownership trust commitment (1,933)
Treasury stock, at cost 251,538 shares (1,600)
------------
Total shareholders' equity 14,448
------------
$ 22,638
============
See notes to consolidated financial statements
-F3-
SERVOTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
($000's omitted except per share data)
Year Ended
December 31,
2006 2005
---- ----
Revenue $ 24,548 $ 22,895
Costs, expenses:
Cost of goods sold, exclusive of depreciation 18,762 17,047
Selling, general and administrative 3,616 3,805
Interest 266 235
Depreciation and amortization 617 679
Other income, net (441) (1,026)
---------- ----------
22,820 20,740
---------- ----------
Income before income tax provision 1,728 2,155
Income tax provision 632 792
---------- ----------
Net income $ 1,096 $ 1,363
========== ==========
Income per share:
BASIC
Net income per share $ 0.55 $ 0.66
========= ==========
DILUTED
Net income per share $ 0.51 $ 0.64
========= ==========
See notes to consolidated financial statements
-F4-
SERVOTRONICS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
($000's omitted)
Year Ended
December 31,
2006 2005
---- ----
CASH FLOWS RELATED TO OPERATING ACTIVITIES:
Net income $ 1,096 $ 1,363
Adjustments to reconcile net income to net
cash provided by operating activities -
Depreciation and amortization 617 679
Receipt of treasury shares (160) -
Deferred income taxes (124) (39)
Change in assets and liabilities -
Accounts receivable (451) (441)
Inventories (303) 283
Other assets 367 614
Other non-current assets 249 (111)
Accounts payable 315 95
Accrued employee compensation and benefit costs (27) 311
Other accrued liabilities 41 127
Non-current pension liabilities (386) 90
Accrued income tax (282) 262
Employee stock ownership trust payment 101 101
--------- ---------
Net cash provided by operating activities 1,053 3,334
--------- ---------
CASH FLOWS RELATED TO INVESTING ACTIVITIES:
Capital expenditures - property, plant and equipment (282) (421)
---------- ---------
Net cash used in investing activities (282) (421)
---------- ---------
CASH FLOWS RELATED TO FINANCING ACTIVITIES:
Principal payments on long-term debt (384) (382)
Purchase of treasury shares (920) -
---------- ---------
Net cash used in financing activities (1,304) (382)
---------- ---------
Net (decrease) increase in cash and cash equivalents (533) 2,531
Cash and cash equivalents at beginning of year 4,637 2,106
--------- ---------
Cash and cash equivalents at end of year $ 4,104 $ 4,637
========= =========
SUPPLEMENTAL DISCLOSURES:
=========================
Income taxes paid $ 553 $ 419
========= =======
Interest paid $ 262 $ 222
========= =======
See notes to consolidated financial statements
-F5-
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
-F6-
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.
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 basis 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. The Company has
determined that no impairment of long lived assets existed at December
31, 2006 and 2005.
-F7-
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity
with accounting principles generally accepted in the United States of
America (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. Actual results could differ from those estimates.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred as defined in
SFAS No. 2, Accounting for Research and Development Costs.
RECLASSIFICATIONS
Certain balances as of December 2005 were reclassified to conform with
classifications adopted in the current year.
NEW ACCOUNTING PRONOUNCEMENTS
In September 2006, the Financial Accounting Standards Board (FASB) issued
Statement No. 157 "Fair Value Measurement". This Statement defines fair
value, establishes a framework for measuring fair value in GAAP, and
expands disclosures about fair value measurements. This Statement applies
under other accounting pronouncements that require or permit fair value
measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute.
Accordingly, this Statement does not require any new fair value
measurements. This Statement is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Company will adopt this statement by
January 1, 2008 and the implementation of this Statement is not expected
to have a significant effect on the Company's financial statements.
In June 2006, the FASB issued Interpretation No. 48 "Accounting for
Uncertainty in Income Taxes", an interpretation of FAS109 "Accounting for
Income Taxes" (FIN 48), to create a single model to address accounting
for uncertain tax positions. FIN 48 clarifies the accounting for income
taxes, by prescribing a minimum recognition threshold a tax position is
required to meet before being recognized in the financial statements. FIN
48 also provides guidance on derecognition, measurement, classification,
interest and penalties, accounting in interim periods, disclosure and
-F8-
transition. FIN 48 is effective for fiscal years beginning after December
15, 2006. The Company will adopt FIN 48 as of January 1, 2007, as
required. The cumulative effect of adopting FIN 48 will be recorded in
retained earnings. The Company has not determined the effect, if any, the
adoption of FIN 48 will have on the Company's financial position and
results of operations.
During the year ended December 31, 2005, the 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 became effective
and was adopted by the Company on January 1, 2006. The adoption of this
standard did not have a significant impact on the Company's financial
statements. See note 7, Common shareholders' equity.
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 adopted SFAS
151 on January 1, 2006 and the adoption of this new standard did not have
a significant impact on the Company's financial statements.
Statement No. 158, Employers' Accounting for Defined Benefit Pension
and Other Postretirement Plans--an amendment of FASB Statements No. 87,
88, 106, and 132(R). This Statement improves financial reporting by
requiring an employer to recognize the over funded or under funded status
of a defined benefit postretirement plan (other than a multiemployer
plan) as an asset or liability in its statement of financial position and
to recognize changes in that funded status in the year in which the
changes occur through comprehensive income of a business entity or
changes in unrestricted net assets of a not-for-profit organization. The
implementation of this Statement did not have a significant impact on the
Company's financial statements. See note 7, Common shareholders' equity.
-F9-
In May 2005, the FASB issued SFAS 154. SFAS 154 replaces APB 20 and
SFAS 3 and changes the requirements for the accounting for and reporting
of a change in accounting principle. The Company is required to adopt
SFAS 154 for accounting changes and corrections of errors that occur in
2007. The Company's financial condition and results of operations will
only be impacted by SFAS 154 if there are any accounting changes or
corrections of errors in the future.
During the year, the Company adopted the SEC Staff issued Staff
Accounting Bulletin (SAB) No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements", which addresses how the effects of prior-year uncorrected
misstatements should be considered when quantifying misstatements in
current year financial statements. The adoption of this standard did not
have an impact on the Company's financial statements.
Other recently issued FASB Statements or Interpretations, SEC Staff
Accounting Bulletins, and AICPA Emerging Issue Task Force Consensuses
have either been implemented or are not applicable to the Company.
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.
Financial instruments that potentially subject the Company to
concentration of credit risks principally consist of cash accounts in
-F10-
financial institutions. Although the accounts exceed the federally
insured deposit amount, management does not anticipate nonperformance by
the financial institutions.
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, 2006
-----------------
($000's omitted)
Raw materials and common parts $ 2,417
Work-in-process 3,655
Finished goods 945
----------
7,017
Less: common parts expected to be used
after one year (classified as long-term) (156)
----------
$ 6,861
==========
3. PROPERTY, PLANT AND EQUIPMENT December 31, 2006
-----------------
($000's omitted)
Land $ 25
Buildings 6,553
Machinery, equipment and tooling 10,963
----------
17,541
Less accumulated depreciation and amortization (11,601)
----------
$ 5,940
==========
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, 2006, accumulated
amortization on the building amounted to approximately $1,700,000. The
associated current and long-term liabilities are discussed in footnote 4
to the consolidated financial statements. Depreciation expense for the
year ended December 31, 2006 amounted to $617,000 and $679,000 for the
same period in 2005. 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.
-F11-
4. LONG-TERM DEBT December 31, 2006
-----------------
($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 (4.11% at December 31, 2006) (A) $ 3,810
Term loan payable to a financial institution; interest at LIBOR plus 2%,
not to exceed 6.00% (6.00% at December 31, 2006); quarterly principal
payments of $17,500; payable in full in the fourth quarter
of 2009; partially secured by equipment 360
Term loan payable to a financial institution; interest at LIBOR plus 2%
(7.24% at December 31, 2006); quarterly principal payments of $26,786
through the fourth quarter of 2011 535
Secured term loan payable to a government agency;
monthly payments of approximately $1,455 with
interest waived payable through second quarter of 2012 126
Secured term loan payable to a government agency;
monthly payments of $1,950 including interest
fixed at 3% payable through fourth quarter of 2015 183
----------
5,014
Less current portion (384)
----------
$ 4,630
==========
(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: 2007 - $384,000,
2008 - $387,000, 2009 - $539,000, 2010 - $321,000, 2011 - $323,000 and
thereafter - $3,059,000.
-F12-
The Company also has a $1,000,000 line of credit on which there is no
balance outstanding at December 31, 2006.
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, 2006, 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 415,700 shares have been
allocated, exclusive of shares distributed to ESOP participants. At
December 31, 2006 and 2005, approximately 371,000 and 397,000 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 2006 and 2005. 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.
-F13-
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 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 of its plan assets 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 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. The following tables summarize
the benefit obligations, funded status, expenses and other related
disclosures related to the Plans:
December 1,
MEASUREMENT DATE 2006 2005
---- ----
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at prior measurement date $526,265 $437,926
Interest cost 28,918 24,479
Actuarial (gain)/loss 8,265 96,907
Benefits paid (exclusive of settlements) (17,375) (15,908)
Settlements (34,025) (17,139)
-------- --------
Benefit obligation at current measurement date $512,048 $526,265
======== ========
CHANGE IN FAIR VALUE OF PLAN ASSETS
Plan assets at prior measurement date $388,623 $364,636
Actual return (net of investment expenses) 11,600 4,119
Employer contributions 223,395 50,471
Benefits paid (exclusive of settlements) (17,375) (15,908)
Settlements (37,841) (14,695)
-------- --------
Plan assets at current measurement date $568,402 $388,623
======== ========
FUNDED STATUS
Funded status $56,354 ($137,642)
Unrecognized prior service cost 44,313 45,874
Unrecognized net loss 272,421 295,269
Unrecognized net transition obligation 29,638 44,458
Intangible asset - (90,332)
Accumulated other comprehensive loss - (295,269)
-------- --------
Prepaid/(accrued) pension cost $402,726 ($137,642)
======== ========
-F14-
NET PERIODIC PENSION COST
Interest cost $28,918 $24,479
Expected return on assets (16,475) (30,212)
Amortization of transition obligation 14,820 14,820
Recognized loss 19,190 12,414
Amortization of prior service cost 1,561 1,561
Recognized settlement loss 20,614 10,704
Decrease in additional minimum liability (385,601) 33,272
------- ------
Net periodic pension (income) cost ($316,973) $67,038
======== =======
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate prior measurement date 5.75% 5.75%
Discount rate current measurement date 5.75% 5.75%
Rate of compensation increase n/a n/a
Long-term rate of return 4.00% 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 2005 Plan Year - $32,157
Installments for the subsequent Plan Year - 61,014
-------- ------
Total - $93,171
======== =======
ACCUMULATED BENEFIT OBLIGATION
Projected benefit obligation (PBO) $512,048 $526,265
Accumulated benefit obligation (ABO) $512,048 $526,265
Plan assets $568,402 $388,623
Plan assets (over) under ABO ($56,354) $137,642
Amounts recognized in the December 31, 2006 balance sheet include a net
prepaid pension asset of $56,354 and $346,372 of accumulated other
comprehensive loss, before tax. The impact on the balance sheet and the
statement of operations was to recognize pension income of $316,213 for
the reversal of the additional minimum pension liability and the
reduction of the intangible assets.
During the forth quarter of 2006, the Company gave notice of its intent
to terminate its qualified defined benefit plans with a proposed
termination date of October 31, 2006. The termination is expected to be
settled during 2007 and, at such time, the Company will appropriately
recognize expenses related to plan termination. No additional Company
contributions are anticipated in 2007. Benefits expected to be paid in
the form of annuity and lump sum payments are approximately $560,000 in
2007, which will be disbursed from the plans' funded assets.
-F15-
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 $148,575 and is
being amortized into expense at a rate of approximately $20,000 per year.
Estimated future annual expenses associated with the plan are immaterial.
Included in accumulated other comprehensive loss for 2006 is
approximately $92,000, net of deferred taxes, associated with the
unrecognized service cost of the plan. The amount also approximated the
impact of adopting SFAS 158.
6. INCOME TAX PROVISION
The provision (benefit) for income taxes included in the consolidated
statement of operations consists of the following:
2006 2005
---- ----
($000's omitted)
Current:
Federal income tax provision $ 470 $ 764
State income tax provision 135 67
------ ------
605 831
Deferred: ------ ------
Federal income tax provision (benefit) 194 (61)
State income tax provision (benefit) (167) 22
------ ------
27 (39)
------ ------
$ 632 $ 792
====== ======
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:
2006 2005
---- ----
Federal statutory rate 34% 34%
State income taxes (less federal effect) 3% 3%
----- -----
Effective tax rate 37% 37%
===== =====
-F16-
At December 31, 2006, the deferred tax assets (liabilities) were
comprised of the following:
($000's omitted)
Inventories $ 174
Accrued employee compensation and benefit costs 172
Operating loss and credit carryforwards 165
Minimum pension liability 53
Other 2
-------
Total deferred tax assets 566
Property, plant and equipment (536)
-------
Total deferred tax liabilities (536)
-------
Net deferred tax asset $ 30
=======
At December 31, 2006, the Company has New York State net operating loss
carryforwards of approximately $1,492,000 (approximately a $75,000 net
tax benefit) that begin to expire in 2019. The Company also has a State
of Pennsylvania net operating loss carryforward of approximately
$1,540,000 (approximately a $77,000 net tax benefit) that began to expire
in 2006.
-F17-
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, 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
Retirement benefits
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
========= ==== ======= ====== ======== ======== ======= ========
Comprehensive income:
Net income - - - $1,096 - - - $ 1,096
Other comprehensive
loss, net of tax
Retirement benefits
adjustment - - - - - - (92) (92)
--------
Total comprehensive income - - - - - - - 1,004
Compensation expense - - - - 101 - - 101
Purchase/receipt of
treasury shares - - - - - (1,080) - (1,080)
Other - - - (2) - - - (2)
--------- ---- ------- ------- -------- -------- ------ --------
Balance December
31, 2006 2,614,506 $523 $13,033 $4,703 ($ 1,933) ($ 1,600) ($ 278) $ 14,448
========= ==== ======= ====== ======== ======== ======= ========
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 February
28, 2007, the Company has purchased or committed to purchase 114,357
shares for a total of $951,896 under this program.
OTHER COMPREHENSIVE LOSS
The only component of other comprehensive loss included in equity is
$278,000 of unrecognized prior service cost, actuarial losses and net
transition obligations for the Company's defined benefit plans and other
post retirement benefits. These amounts are shown net of income tax of
$163,000 and are consistent with the adoption of SFAS No. 158, Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans.
-F18-
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.
Year Ended
December 31,
2006 2005
---- ----
($000's omitted
except per share data)
Net income $ 1,096 $ 1,363
======= =======
Weighted average common shares
outstanding (basic) 2,004 2,075
Incremental shares from assumed
conversions of stock options 136 64
------- -------
Weighted average common
shares outstanding (diluted) 2,140 2,139
BASIC
Net income per share $ 0.55 $ 0.66
======= =======
DILUTED
Net income per share $ 0.51 $ 0.64
======= =======
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 options to certain Directors, Officers and employees. In December
2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) 123R, Share-Based Payment ("SFAS
123R"). SFAS 123R supersedes SFAS 123, Accounting for Stock Based
Compensation, and Accounting Principles Board Opinion 25, Accounting for
Stock Issued to Employees ("APB 25") and its related implementation
guidance. Prior to the adoption of SFAS 123R, the Company applied APB
Opinion No. 25 and related interpretations in accounting for these Plans
-F19-
and the separate option agreements. Accordingly, no compensation expense
has been charged to earnings in 2006 or prior years as stock options
granted have an exercise price equal to the market price on the date of
grant. For the year ended December 31, 2006, there was no impact of
adopting FAS 123R. At December 31, 2006, 101,000 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.
A summary of the status of options granted under all employee plans is
presented below:
Weighted
Weighted Average Aggregate
Average Remaining Intrinsic
Options Exercise Contractual Value
Outstanding Price ($) Life ($)
---------------------------------------------------
Outstanding as of December 31, 2004 464,200 4.01 6.61
====
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 6.29
====
Granted in 2006 - -
Exercised in 2006 - -
Forfeited in 2006 - -
------- ----
Outstanding as of December 31, 2006 513,900 4.41 5.29 2,039,134
======= ==== ==== =========
Exercisable as of December 31, 2006 511,900 4.41 5.28 2,026,524
======= ==== ==== =========
The aggregate intrinsic value in the preceding table represents the total
pretax intrinsic value based on the closing stock price of $8.35 at
December 31, 2006.
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 year ended
December 31, 2005 is as follows:
-F20-
2005
----
Net income:
As reported $1,363,000
Pro forma $1,171,778
Earnings per common share:
As reported - basic $0.66
As reported - diluted $0.64
Pro forma - basic $0.56
Pro forma - diluted $0.55
There were no options granted in 2006. There were 80,000 options granted
in 2005. 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%. To determine the expected volatility, the Company used
the historical volatility based on monthly closing prices of the stock
over a period that correlates with the expected term of the options
granted. The risk free rate is based on the 10 year United States
Treasury yield. 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
-F21-
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 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 2006 and 2005 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 portion of finished products are for
foreign end use.
-F22-
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,
2006 2005 2006 2005 2006 2005
---- ---- ---- ---- ---- ----
Revenues from unaffiliated customers $15,766 $13,603 $ 8,782 $ 9,292 $ 24,548 $ 22,895
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Profit (loss) $ 3,428 $ 2,743 $ (592) $ 48 $ 2,836 $ 2,791
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Depreciation and amortization $ (445) $ (508) $ (172) $ (171) (617) (679)
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Interest expense $ (239) $ (206) $ (27) $ (29) (266) (235)
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Other income, net $ 335 $ 970 $ 106 $ 56 441 1,026
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General corporate expense (666) (748)
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Income before income tax provision $ 1,728 $ 2,155
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Identifiable assets $15,396 $16,046 $ 7,242 $ 7,163 $ 22,638 $ 23,209
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Capital expenditures $ 111 $ 192 $ 171 $ 229 $ 282 $ 421
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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 $4,700,000 in 2006 and $5,600,000 in 2005. Similar
contracts by the Consumer Products Group accounted for revenues of
approximately $3,300,000 in 2006 and $3,800,000 in 2005. Sales of
advanced technology products to one customer, including various divisions
and subsidiaries of a common parent company, amounted to approximately
14% in 2006 and 13% in 2005. The Company also had sales to another
customer that amounted to approximately 23% of total revenues in 2006 and
18% in 2005. No other single customer represented more than 10% of the
Company's revenues in any of these years.
11. OTHER INCOME
Other income in 2006 includes approximately $220,000 of net recovery
before tax, from a previously reported defalcation; the amount of net
recovery in 2005 was $795,000 before tax. Components of other income also
include; interest income on cash and cash equivalents, and other minor
amounts not directly related to the sale of the Company's products.
-F23-