UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
[x] Annual report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
for the fiscal year ended February 28, 2003
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ____________ to ____________.
Commission File Number 1-10655
ENVIRONMENTAL TECTONICS CORPORATION
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(Exact name of small business issuer in its charter)
Pennsylvania 23-1714256
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
County Line Industrial Park
Southampton, Pennsylvania 18966
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(Address of principal executive offices, Zip Code)
Registrant's telephone number, including area code (215) 355-9100
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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Common Stock, par value $.05 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
As of August 23, 2002, the aggregate market value of the registrant's
common stock held by non-affiliates of the registrant was approximately
$29,201,000 based upon the closing sale price of the registrant's common stock
on the American Stock Exchange of $6.15 on such date. See footnote (1) below.
As of May 23, 2003, there were 7,157,239 shares of the registrant's
common stock issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE. Portions of Registrant's 2003
Annual Report to Stockholders are incorporated by reference in Part II, Items 5,
6, 7, and 8.
Index to Exhibits appears after page 21 of this Report
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(1) The information provided is not an admission that any person whose holdings
are excluded from the figure is not an affiliate or that any person whose
holdings are included is an affiliate and any such admission is hereby
disclaimed. The information provided is solely for recordkeeping purposes
of the Securities and Exchange Commission.
ENVIRONMENTAL TECTONICS CORPORATION
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED
FEBRUARY 28, 2003
TABLE OF CONTENTS
PART I
ITEM 1 - BUSINESS........................................................................................... 1
ITEM 2 - PROPERTIES......................................................................................... 10
ITEM 3 - LEGAL PROCEEDINGS.................................................................................. 11
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................................................ 11
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS............................... 11
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA............................................................... 11
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..............
11
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK......................................... 11
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................................................ 11
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...............
11
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................................................. 12
ITEM 11 - EXECUTIVE COMPENSATION............................................................................. 14
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS..... 14
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS..................................................... 16
ITEM 14 - CONTROLS AND PROCEDURES............................................................................ 16
PART IV
ITEM 16 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.................................... 16
SIGNATURES .............................................................................................. 19
CERTIFICATIONS ........................................................................................ 20
(i)
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements are based on our current expectations and projections
about future events. These forward-looking statements are subject to known and
unknown risks, uncertainties and assumptions about us and our subsidiaries that
may cause our actual results, levels of activity, performance or achievements to
be materially different from any future results, levels of activity, performance
or achievements expressed or implied by such forward-looking statements.
These forward-looking statements include statements with respect to our
vision, mission, strategies, goals, beliefs, plans, objectives, expectations,
anticipations, estimates, intentions, financial condition, results of
operations, future performance and business, including but not limited to, (i)
projections of revenues, costs of raw materials, income or loss, earnings or
loss per share, capital expenditures, growth prospects, dividends, the effect of
currency fluctuations, capital structure and other financial items, (ii)
statements of our plans and objectives including the introduction of new
products, or estimates or predictions of actions by customers, suppliers,
competitors or regulating authorities, (iii) statements of future economic
performance, (iv) statements of assumptions and other statements about our
business, and (v) statements preceded by, followed by or that include the words,
"may," "could," "should," "pro forma," "looking forward," "would," "believe,"
"expect," "anticipate," "estimate," "intend," "plan," or similar expressions.
These forward-looking statements involve risks and uncertainties which are
subject to change based on various important factors. Some of these risks and
uncertainties in whole or in part, are beyond our control. Factors that might
cause or contribute to such a material difference include, but are not limited
to, those discussed elsewhere in this Annual Report on Form 10-K, including the
section entitled "Risks Particular to Our Business." Shareholders are urged to
review these risks carefully prior to making an investment in our common stock.
We do not undertake to update any forward-looking statement, whether
written or oral, that we may make from time to time or that may be made on our
behalf from time to time.
PART I
Item 1. Business
We were incorporated in 1969 in Pennsylvania and are principally
engaged in the design, manufacture and sale of software driven products used to
create and monitor the physiological effects of motion on humans and equipment
and to control, modify, simulate and measure environmental conditions. These
products include aircrew training systems, entertainment products, sterilizers,
environmental and hyperbaric chambers and other products that involve similar
manufacturing techniques and engineering technologies.
Segments
We operate in two primary business segments, Aircrew Training Systems
("ATS") and the Industrial Group.
Aircrew Training Systems. This segment includes three primary product
groups: aircrew training devices, entertainment products and disaster management
simulation.
Aircrew Training Devices. Our aircrew training devices are
used for medical research, advanced tactical and physiological
flight training, and for the indoctrination and testing of
military and commercial pilots. The major devices which we
sell in this business segment are military and commercial
flight simulators, night vision trainers, water survival
training equipment, disorientation training equipment, human
centrifuges, ejection seat trainers and vehicle and tank
simulators. We provide operational and maintenance services
for installed equipment that we manufacture as well as for
equipment produced by others.
Entertainment Products. Our entertainment products consist of
motion-based simulation rides and other products.
Disaster Management Simulation. Our Disaster Management
Simulation line includes real-time interactive training
programs that provide instruction on various disaster
situations.
The Aircrew Training System segment generated 73%, 70% and 73% of our
consolidated revenues for the fiscal years ended February 28, 2003, February 22,
2002 and February 23, 2001, respectively.
Industrial Group. This segment includes three primary product lines:
sterilizers, environmental systems and other products, and hyperbarics.
Sterilizers. We manufacture steam and gas sterilizers for
various industrial and pharmaceutical applications. We
concentrate on marketing larger custom-designed sterilizers to
the pharmaceutical and medical device industries.
Environmental Systems and Other Products. Our environmental
systems business consists of the design and fabrication of
sampling and analysis systems, and test equipment and systems.
The simulation systems generally consist of an enclosed
chamber with instrumentation and equipment which enable the
customer to control and modify environmental factors such as
temperature, pressure, humidity, wind velocity and gas content
to produce desired conditions. These products include
controlled air systems for automotive companies and
environmental chambers for HVAC and other applications.
Hyperbarics. Our hyperbarics product line includes monoplace
(single person) and multiplace (multiple persons) chambers for
high altitude training, decompression and wound care
applications.
Sales of Industrial Group products generated 27%, 30% and 27% of our
consolidated revenues for the years ended February 28, 2003, February 22, 2002
and February 23, 2001, respectively.
We also provide control upgrades, maintenance and repair services and spare
parts for equipment which we manufacture and for equipment made by other
manufacturers.
For a more complete description of financial information regarding our business
segments, see "Note 9. Business Segment Information" to our consolidated
financial statements in the Annual Report to Stockholders attached hereto as
Exhibit 13 and incorporated herein by reference.
Marketing
We currently market our products and services primarily through our sales
offices and employees. At February 28, 2003, approximately 21 employees were
committed to sales and marketing functions. We use branch offices in the United
Kingdom, the Middle East, and Asia as well as the services of approximately 100
independent sales organizations in seeking foreign orders for our products.
Product Development
We are continually developing new products and improvements in existing products
in response to inquiries from customers and in response to our determination
that particular products should be produced or significantly improved. Although
we do not have a separate research and development group, we have several
technical personnel whose main activity is the development and integration of
new technologies into our existing products. These personnel include the
Vice-President Engineering Manager and the Vice-President of Development whose
additional activity is the introduction of product extensions and new
applications of existing technology.
Within the Aircrew Training Systems segment, product development emphasizes
enhancing control systems and software graphics and exploring commercial
possibilities. Our product development efforts focus on two areas:
- Disaster Management Simulation. We are in production of a major
contract from the City of Chicago to develop, install and maintain a
computer-based Incident Command Simulator. Additionally, we are
completing orders from respected fire schools throughout the world for
simulation products. We will continue to explore product applications
and extensions to our intelligent virtual reality products.
- G-force and Disorientation Trainers.
- We recently introduced the Authentic Tactical Flight Simulator
Model 400 (ATFS 400), which we believe is the world's first
ground-based simulator capable of creating an authentic simulated
tactical maneuvering environment. Utilizing proprietary centrifuge
and simulation technology, high-fidelity models of the airplane's
dynamic performance, the threats experienced by an aircraft in
combat and other battle space factors are integrated into the
motion controls to create a fully authentic flight environment for
any specific combat aircraft.
- Testing has continued on our high-end rapid onset Sustained G
Centrifuge, the G-FET II TFS.
2
- We continue to develop our GAT-II(R) General Aviation Trainers.
- We plan to incorporate additional advanced tactical flight
simulation (TFS) applications into additional products in the ATS
line.
Our wholly owned subsidiary, Entertainment Technology Corporation,
develops and manages all of our future entertainment projects. Product
development in this class will emphasize entertainment applications of our
proven ATS simulation technology.
We reported research and development expenses of $636,000, $600,000 and
$903,000 for the fiscal years ended February 28, 2003, February 22, 2002 and
February 23, 2001, respectively. However, most of the cost of our research
efforts, which were and continue to be a significant cost of our business, are
included in cost of sales for applied research for specific contracts, as well
as research for feasibility and technology updates.
Subsidiaries
We presently have three operating subsidiaries. Entertainment Technology
Corporation, our wholly-owned subsidiary, is a Pennsylvania corporation that
focuses on the development, manufacturing and distribution of our entertainment
products. ETC-PZL Aerospace Industries, our 95%-owned subsidiary, is a Polish
corporation that manufactures simulators. ETC-Europe, our 99%-owned subsidiary,
is a United Kingdom corporation that focuses on generating international sales.
We also have a wholly-owned subsidiary, ETC International Corporation, a
Barbados corporation that serves as a foreign sales corporation for federal
income tax purposes. ETC-Delaware, our wholly-owned subsidiary, is a Delaware
corporation that serves as a holding company.
Supplies
The components being used in the assembly of systems and the parts used to
manufacture our products are purchased from equipment manufacturers, electronics
supply firms and others. To date, we have had no difficulty in obtaining
supplies. Further, all raw materials, parts, components and other supplies which
we use to manufacture our products can be obtained at competitive prices from
alternate sources should existing sources of supply become unavailable.
Patents and Trademarks
We presently hold the following patents which we deem significant to
our operations:
Patent Number Title Expiration Date
------------- --------------------------------------------------- ---------------
4,710,120 "Spatial Disorientation Trainer - Flight Simulator" 12/1/04
4,818,001 "Chamber Door Lock" 4/4/06
5,051,094 "G-Force Trainer" 9/24/08
We also hold a trademark on our logo, ETC(R), as well as on the following
products:
BARA-MED(R): Medical hyperbaric chamber
CAS(R): Conditioned Air Supply
DATAPRINT(R): Digital printer for sterilizers
GAT-II(R): General Aviation Trainer
G-LAB(R): Human Centrifuge
GYROLAB(R): Spatal disorientation device
GYRO-1(R): Multi-purpose Basic Instrument Flight
Trainer
PRO-GENESIS(R): Control unit/column for sterilizers
THE RIDE WORKS(R): Facility for manufacturer of amusement and
entertainment rides to the order and
specification of others.
Customers
In the current year and throughout most of our history, we have made a
substantial portion of sales to a small number of customers that vary within any
given year. We do not depend upon repeat orders from these same customers. We
sell our aircrew training systems principally to U.S. and foreign governmental
agencies. We sell sterilizers and environmental systems to commercial and
governmental entities worldwide.
3
In fiscal 2003, our major customers included the Walt Disney Company and the
Royal Malaysian Air Force, generating revenues of $17,268,000 and $7,203,000, or
40.0% and 16.7%, respectively, of total net sales. These companies do not have
any relationship with us other than as customers. We expect to continue to
conduct business with each of these companies in fiscal 2004, although we expect
work with the Walt Disney Company to be significantly reduced.
Foreign and Domestic Operations and Export Sales
During the fiscal years ended February 28, 2003, February 22, 2002 and February
23, 2001, approximately $4,626,000 (11%), $1,194,000 (4%) and $2,064,000 (6%),
respectively, of our net revenues were attributable to contracts with agencies
of the U.S. government or with other customers who had prime contracts with
agencies of the U.S. government.
During the fiscal years ended February 28, 2003, February 22, 2002 and February
23, 2001, $14,805,000 (34%), $10,110,000 (31%) and $16,404,000 (51%),
respectively, of our net revenues were attributable to export sales. Our
customers' obligations to us with regards to export sales are normally secured
by irrevocable letters of credit based on the creditworthiness of the customer
and the geographic area of the world in which they are located.
During the fiscal years ended February 28, 2003, February 22, 2002 and February
23, 2001, $23,692,000 (55%), $21,223,000 (65%), and $15,131,000 (46%),
respectively, of our net revenues were attributable to domestic sales to
customers other than the U.S. government. (See "Note 9. Business Segment
Information" to our consolidated financial statements in the Annual Report to
Stockholders attached hereto as Exhibit 13 and incorporated herein by
reference).
We do not believe that the distribution of our sales between foreign and
domestic sales for any particular period is necessarily indicative of the
distribution expected for any other period.
We derive a large portion of our sales from long-term contracts requiring more
than one year to complete. We account for sales under long-term contracts on the
percentage of completion basis. See "Note 1. Summary of Significant Accounting
Policies" to our consolidated financial statements in the Annual Report to
Stockholders attached hereto as Exhibit 13 and incorporated herein by reference.
Our U.S. government contracts contain standard terms permitting termination for
the convenience of the U.S. government. In the event of termination of a
government contract, we are entitled to receive reimbursement on the basis of
work completed (cost incurred plus a reasonable profit), recording the amounts
anticipated to be recovered from termination claims in income as soon as those
amounts can be reasonably determined rather than at the time of final
settlement. All costs applicable to a termination claim are charged as an
offsetting expense concurrently with the recognition of income from the claim.
Backlog
Our sales backlog at February 28, 2003 and February 22, 2002, for work to be
performed and revenue to be recognized under written agreements after such
dates, was $21,454,000 and $28,148,000, respectively. In addition, our training,
maintenance and upgrade contracts backlog at February 28, 2003 and February 22,
2002, for work to be performed and revenue to be recognized after such dates
under written agreements, was $3,931,000 and $1,485,000, respectively. Of the
February 28, 2003 backlog, we have contracts for approximately $16,428,000 for
aircrew training systems and maintenance support, including $7,007,000 for the
Royal Malaysian Air Force. Approximately 91% of the February 28, 2003 backlog is
expected to be completed prior to February 27, 2004.
Competition
Our business strategy in recent years has been to seek niche markets in which
there are not numerous competitors. However, in some areas of our business we
compete with well-established firms, some of which have substantially greater
financial and personnel resources than we have.
Some competing firms have technical expertise and production capabilities in one
or more of the areas involved in the design and production of physiological
flight training equipment, environmental systems, and other specially designed
products, and compete with us for this business. The competition for any
particular project generally is determined by the technological requirements of
the project, with consideration also being given to a bidder's reliability,
product performance, past performance and price.
We face competition in the sale of the larger custom-designed industrial
sterilizers both from other manufacturers and from our customers' in-house
production capabilities.
4
We believe that we are a significant participant in the markets in which we
compete, especially in the market for aircrew training systems where we believe
that we are a principal provider of this type of equipment and training in our
market area.
Compliance with Environmental Laws
We have not incurred during fiscal 2003, nor do we anticipate incurring during
fiscal 2004, any material capital expenditures to maintain compliance with
federal, state and local statutes, rules and regulations concerning the
discharge of materials into the environment, nor do we anticipate that
compliance with these provisions will have a material adverse effect on our
earnings or competitive position.
Employees
On February 28, 2003, we had 261 full-time employees, of which six were employed
in executive positions, 92 were engineers, engineering designers, or
draftspeople, 57 were administrative (sales, accounting, etc.) and clerical
personnel, and 106 were engaged principally in production and operations.
RISKS RELATED TO OUR BUSINESS
Our sources of revenues are not consistent; in any given fiscal year a
substantial portion of our revenues is derived from a small number of customers
that may not be recurring customers in future years.
In any given fiscal year, a substantial portion of our revenues is
typically derived from a small number of customers. For example, in fiscal 2003
we generated approximately 56.7% of our revenues from sales to two customers,
the Walt Disney Company and the Royal Malaysian Air Force. In fiscal 2002, we
generated approximately 59% of our revenues from sales to two customers, the
Walt Disney Company and the Royal Thai Air Force. In fiscal 2001, we generated
approximately 43% of our revenues from sales to two customers, the Walt Disney
Company and the United Kingdom Ministry of Defense. We expect the amount of work
we do for the Walt Disney Company to decrease in fiscal 2004. We cannot be
certain that our most significant customers will continue to order our products
and services at the same level at which they have ordered them in the past. Due
to the expensive nature and highly specialized market for our products and
services, if any of these customers stops purchasing our products and services
and we are unable to identify new customers in a timely manner, then our
business will be adversely affected.
Our significant debt could adversely affect our financial resources and prevent
us from satisfying our debt service obligations.
We have a significant amount of indebtedness and may also incur
additional indebtedness in the future. We may not generate sufficient cash flow
from operations, or have future borrowings available to us, sufficient to pay
our debt. At May 29, 2003, our total indebtedness was approximately $15.5
million and our total stockholders' equity was approximately $25.9 million.
Our ability to make debt payments depends on future performance, which,
to a certain extent, is subject to general economic, financial, competitive and
other factors, some of which are beyond our control. Based upon our current
level of operations and anticipated growth, management believes that available
cash flow, together with available credit, will be adequate to meet our
financial needs. There can be no assurance, however, that our business will
generate sufficient cash flow from operations or that future borrowings will be
available in an amount sufficient to enable us to pay our debts or to make
necessary capital expenditures, or that any refinancing of debt would be
available on commercially reasonable terms or at all.
Our substantial indebtedness could have important consequences
including:
o our ability to obtain additional financing for working capital,
capital expenditures, acquisitions or other purposes may be
impaired or unavailable;
o a portion of cash flow will be used to pay interest expense, which
will reduce the funds that would otherwise be available for
operations and future business opportunities;
o a substantial decrease in net operating cash flows or an increase
in expenses could make it difficult for us to meet our debt
service requirements and force us to modify our operations;
o making us more highly leveraged than our competitors, which may
place us at a competitive disadvantage;
o making us more vulnerable to a downturn in our business or in the
economy generally; and
o some of our existing debt contains financial and restrictive
covenants that limit our ability to borrow additional funds,
acquire and dispose of assets, and pay cash dividends.
5
A portion of our outstanding indebtedness bears interest at variable
rates. Any increase in interest rates will reduce funds available to us for our
operations and future business opportunities and will worsen the consequences of
our leveraged capital structure.
Covenants and restrictions in our credit facility limit our ability to take
certain actions.
Our credit facility contains significant financial and operating
covenants that limit the discretion of management with respect to certain
business matters. These covenants include, among others, restrictions on our
ability to:
o declare or pay dividends or any other distributions to our
securities holders;
o redeem or repurchase capital stock;
o incur certain additional debt;
o grant liens on our assets;
o make certain payments and investments;
o sell or otherwise dispose of assets; and
o acquire or be acquired by other entities.
We must also meet certain financial ratios and tests under our credit
facility. If we do not comply with the obligations contained in the credit
facility, it could result in an event of default, and possibly the acceleration
of the related debt and the acceleration of debt under other instruments
evidencing debt that may contain cross-acceleration or cross-default provisions.
While we are currently in compliance with our financial covenants, negative
operating results would impact our future compliance with these covenants and
could adversely affect our business.
Our operations involve rapidly evolving products and technological change.
The rapid change of technology is a key feature of all of the
industries in which our businesses operate. To succeed in the future, we will
need to continue to design, develop, manufacture, assemble, test, market and
support new products and enhancements on a timely and cost-effective basis.
Historically, our technology has been developed through both customer-funded and
internally funded research and development. We cannot guarantee that we will
continue to maintain comparable levels of research and development. This
practice will continue to be required in the future. Even so, we cannot assure
you that we will successfully identify new opportunities and continue to have
the financial resources required to develop new products profitably. At the same
time, products and technologies developed by others may render our products and
systems obsolete or non-competitive.
Delays in the delivery of our products may prevent us from invoicing our costs
and estimated earnings on uncompleted contracts.
In accordance with generally accepted accounting principles for
long-term contracts, we record an asset for our costs and estimated earnings
that exceed the amount we are able to bill our customers on uncompleted
contracts. At February 28, 2003, $5.4 million of our costs and estimated
earnings that exceeded our billings on uncompleted contracts related to four
contracts with four different customers. We are not able to bill these amounts
unless we meet certain contractual milestones related to the production,
delivery and integration of our products. Thus, there will be a lag normally
ranging from 24 to 36 months between performance and associated costs for these
types of projects and billing and collection of payments. Our failure to meet
these milestones by delivering and integrating our products in a timely manner
may impact our ability to recover our costs and estimated earnings that exceeded
our billings on uncompleted contracts, which could severely impact our cash
flow.
In the event we suffer production delays, we may be required to pay certain
customers substantial liquidated damages and other penalties.
The variety and complexity of our high technology product lines require
us to deal with suppliers and subcontractors supplying highly specialized parts,
operating highly sophisticated equipment in performing highly technical
calculations. The processes of planning and managing production, inventory
levels and delivery schedules are also highly complex and specialized. Many of
our products must be custom designed and manufactured, which is not only
complicated and expensive, but can also require long periods of time to
accomplish. Slight errors in design, planning and managing production, inventory
levels, delivery schedules, or manufacturing can result in unsatisfactory
products that may not be correctable. If we are unable to meet our delivery
schedules, we may be subject to penalties, including liquidated damages that are
included in some of our customer contracts. While our actual losses have been
minimal, we may incur substantial liquidated damages in the future in connection
with product delays.
6
If the commercial simulation business conducted by our Aircrew Training Systems
Segment declines, our sales will decrease.
We have no assurance that our commercial simulation business will
continue to succeed. Although our commercial simulation business was minimal in
fiscal 2003, this segment historically contributes to our gross revenues in each
fiscal year. This business is subject to many risks including:
o the uncertainty of economic conditions;
o increased competition;
o changes in technology; and
o the need for timely performance by subcontractors located
throughout the world on contracts for which we are the prime
contractor.
If we do not adequately address these risks, then our commercial simulation
business may decline, adversely affecting our business.
Our fixed-price and cost-reimbursable contracts may commit us to unfavorable
terms.
We provide our products and services primarily through fixed-price or
cost-reimbursable contracts. Fixed-price contracts provided approximately 60% of
our sales for the fiscal year ended February 28, 2003. Under a fixed-price
contract, we agree to perform the scope of work required by the contract for a
predetermined contract price. Although a fixed-price contract generally permits
us to retain profits if the total actual contract costs are less than the
estimated contract costs, we bear the risk that increased or unexpected costs
may reduce our profit or cause us to sustain losses on the contract. Therefore,
unless there are customer-requested changes in scope or other changes in
specifications which are reimbursable, we fully absorb cost overruns on
fixed-price contracts and this reduces our profit margin on the contract. These
cost overruns may result in us recognizing a loss on the contract. A further
risk associated with fixed-price contracts is the difficulty of estimating sales
and costs that are related to performance in accordance with contract
specifications. Our failure to anticipate technical problems, estimate costs
accurately or control costs during performance of a fixed-price contract may
reduce our profitability or cause a loss.
Cost-reimbursable contracts provided approximately 40% of our sales for
the fiscal year ended February 28, 2003. On a cost-reimbursable contract, we are
paid up to predetermined funding levels determined by our customers our
allowable incurred costs and generally a fee representing a profit on those
costs, which can be fixed or variable depending on the contract's pricing
arrangement. Therefore, on a cost-reimbursable contract we do not bear the risks
of unexpected cost overruns. U.S. government regulations require that we notify
our customer of any cost overruns or underruns on a cost-reimbursable contract
on a timely basis. If we incur costs in excess of the funding limitation
specified in a cost-reimbursable contract, we may not be able to recover those
cost overruns.
We record sales and profits on a significant portion of our contracts
using percentage-of-completion methods of accounting. As a result, revisions
made to our estimates of sales and profits are recorded in the period in which
the conditions that require such revisions become known and can be estimated.
Although we believe that adequate provisions for losses for our fixed-prices
contracts are recorded in our financial statements as required under generally
accepted accounting principles, we cannot assure you that our contract loss
provisions, which are based on estimates, will be adequate to cover all actual
future losses.
Our contracts and subcontracts that are funded by the U.S. government or foreign
governments are subject to government regulations and audits and other
requirements.
Government contracts require compliance with various contract
provisions and procurement regulations. The adoption of new or modified
procurement regulations could have a material adverse effect on our business,
financial condition or results of operations or increase the costs of competing
for or performing government contracts. If we violate any of these regulations,
then we may be subject to termination of these contracts, imposition of fines or
exclusion from government contracting and government-approved subcontracting for
some specific time period. In addition, our contract costs and revenues are
subject to adjustment as a result of audits by government auditors. We reflect
any adjustments required by government auditors in our financial statements.
Although we have thus far not been required to make any material audit
adjustments, adjustments may be required in the future. In connection with our
government contracts, we have been required to obtain bonds, letters of credit
or similar credit enhancements. We cannot assure that we will be successful in
obtaining these types of credit enhancements or that the credit enhancements
available will be affordable in the future.
7
Our contracts that are funded by the U.S. government or foreign governments are
subject to a competitive bidding process that may affect our ability to win
contract awards or renewals in the future.
Government contracts generally are awarded to us through a formal
competitive process in which we may have many competitors. Upon expiration,
government contracts may be subject, once again, to the competitive process. We
cannot assure that we will be successful in winning contract awards or renewals
in the future. Our failure to renew or replace government contracts when they
expire could have a material adverse effect on our business, financial condition
or results of operations. Our contracts with domestic or foreign government
agencies are subject to competition and are awarded on the basis of technical
merit, personnel qualifications, experience and price. Our business, financial
condition and results of operations could be materially adversely affected to
the extent that government agencies believe our competitors offer a more
attractive combination of the foregoing factors. In addition, new government
contract awards also are subject to protest by competitors at the time of award
that can result in the re-opening of the competition or evaluation process, the
award of a contract to a competitor, or the reopening of the competitive bidding
process. We consider bid protests to be a customary element in the process of
procuring government contracts. Other characteristics of the government contract
market that may affect our operating results include the complexity of designs,
the difficulty of forecasting costs and schedules when bidding on developmental
and highly sophisticated technical work, and the speed with which product lines
become obsolete due to technological advances and other factors characteristic
of the market. Our earnings may vary materially on some contracts depending upon
the types of government long-term contracts undertaken, the costs incurred in
their performance, and the achievement of other performance objectives.
Our commercial contracts are subject to competition and strict performance and
other requirements.
Although a significant portion of our revenues are generated from the
sale of our services and products in commercial markets, we cannot assure that
we will continue to compete successfully in these markets. Many of our
commercial contracts contain fixed pricing. This subjects us to substantial
risks relating to unexpected cost increases and other factors outside of our
control. We may fail to anticipate technical problems, estimate costs
accurately, or control costs during performance of a fixed-price contract. Any
of these failures may reduce our profit or cause a loss under our commercial
contracts. In addition, a significant portion of our revenues on fixed-price
contracts are recognized on a percentage-of-completion basis. This means that we
calculate a ratio of costs incurred to costs expected to be incurred for each
fixed-price job and then multiply that same ratio by the fixed-price contract
value to determine total revenue to be recognized to date for each fixed-price
job. As a result, contract price and cost estimates on fixed-price contracts are
reviewed periodically as the work progresses, and adjustments are reflected in
income in the period when the estimates are revised. To the extent that these
adjustments result in a loss, reduction or elimination of previously reported
profits, we would recognize a charge against current earnings, which could be
material and have a negative effect on our business, financial condition or
results of operations.
In connection with certain commercial contracts, we have been required
to obtain bonds, letters of credit, or similar credit enhancements. We cannot
assure that we will be successful in obtaining these types of credit
enhancements or that the credit enhancements available will be affordable in the
future.
Under the terms of our commercial contracts, we typically must agree to
meet strict performance obligations and project milestones, which we may not be
able to satisfy. Our failure to meet these performance obligations and
milestones permits the other party to terminate the contract and, under certain
circumstances, recover liquidated damages or other penalties from us which could
have a negative effect on our business, financial condition or results of
operations.
There are certain risks inherent in our international business activities, which
constitute a significant portion of our business.
Our international business activities expose us to a variety of risks.
Our international business accounted for approximately 34.7% of our sales in
fiscal 2003 and 31.0% of our sales in fiscal 2002. We expect that international
sales will continue to be a significant portion of our overall business in the
foreseeable future. Our international business experiences many of the same
risks our domestic business encounters as well as additional risks such as:
o a general decline in the strength of the global economy;
o the effect of foreign military or political conflicts and turmoil;
o U.S. foreign policy decisions;
o changes in foreign governmental trade, monetary and fiscal
policies and laws;
o export controls;
o exchange rate fluctuations; and
8
o political and economic instability.
The majority of our contracts are denominated in U.S. Dollars. Despite
our exposure to currency fluctuations, we are not engaged in any material
hedging activities to offset the risk of exchange rate fluctuations.
Our international transactions frequently involve increased financial
and legal risks arising from stringent contractual terms and conditions and
widely differing legal systems, customs and standards in foreign countries. In
addition, our international sales often include sales to various foreign
government armed forces, with many of the same inherent risks associated with
U.S. government sales discussed in this Annual Report on Form 10-K.
Legislative actions, higher director and officer insurance costs and potential
new accounting pronouncements are likely to cause our general and administrative
expenses to increase and impact our future financial condition and results of
operations.
In order to comply with the newly adopted Sarbanes-Oxley Act of 2002,
as well as changes to the American Stock Exchange listing standards and rules
adopted by the Securities and Exchange Commission, we may be required to
strengthen our internal controls, hire additional personnel and retain
additional outside legal, accounting and advisory services, all of which may
cause our general and administrative costs to increase. Although we have not
experienced any claims, insurers have increased and are likely to continue to
increase premiums as a result of the high claims rates they have incurred with
other companies over the past year, and so our premiums for our directors' and
officers' insurance policies are likely to increase. Changes in the accounting
rules and auditing standards, including legislative and other proposals to
account for employee stock options as a compensation expense among others, could
materially increase the expenses that we incur and report under generally
accepted accounting principles and adversely affect our operating results.
Our estimated sales backlog is not necessarily indicative of revenues that we
will actually realize in fiscal year 2004 or at all.
We may not actually generate revenues in fiscal 2004 for all items
included in our estimated backlog at the end of our 2003 fiscal year. At
February 28, 2003, our sales backlog was $25.4 million. While we estimate that
approximately 91% of this backlog is expected to be completed prior to the end
of our 2004 fiscal year, we are not certain that these projects will be
completed so that we can record these revenues by such date, or at all. Our
backlog includes the total value of all contracts less the revenue earned on
those contracts through the measurement date. Many of our government contracts
are multi-year contracts and contracts with option years, and portions of these
contracts are carried forward from one year to the next as part of our backlog.
Certain of our large contracts provide that we will not receive payment until
the services under those contracts are requested and performed. We cannot assure
that cancellations or adjustments in the terms of these contracts might not
occur.
Our operations could be hurt by terrorist attacks, war, disease and other
activities or occurrences that make air travel difficult or reduce the
willingness of our commercial airline customers to purchase our simulation
products.
The demand for our various commercial simulation products and services
is heavily dependent upon new orders from our commercial airline customers. In
the event terrorist attacks, war or other activities or occurrences make air
travel difficult or reduce the demand or willingness of our customers to
purchase our commercial simulation products, our revenue may decline.
In addition, the occurrence of Severe Acute Respiratory Syndrome
("SARS") has had an adverse effect on travel to countries such as China,
Singapore and Thailand and has negatively impacted commerce and economic
activity in these countries. We have experienced delays in the performance of
our contracts in these countries as our employees and other contractors are
unwilling to travel to these countries while the threat of contracting SARS is
present. Accordingly, if the SARS epidemic persists, then our business may be
adversely affected.
There is limited trading activity in our common stock which could make
it more difficult for our investors to sell their shares of our common stock.
Our common stock trades on the American Stock Exchange, but our average
daily trading volume during fiscal 2003 was less than 5,000 shares. This limited
trading activity may make it more difficult for investors to sell larger blocks
of our common stock at prevailing prices as there are generally a small number
of participants in the market for our common stock and such sales may lower the
market price of our common stock.
9
The market price of our common stock may be volatile.
The market price of securities of thinly traded public companies has
historically faced significant volatility. Although our common stock is traded
on the American Stock Exchange, it does not experience a significant average
daily trading volume. Accordingly, if one stockholder elects to either purchase
or sell a block of our common stock, it may have an effect on the price of our
common stock. In addition, the stock market in recent years has experienced
significant price and volume fluctuations that often have been unrelated or
disproportionate to the operating performance of particular companies. Many
factors that have influenced trading prices will vary from period to period,
including:
o actual or anticipated operating results;
o changes in estimates by analysts;
o market conditions in the industry;
o changes in our earning and revenues or quarterly operating
results;
o announcements by competitors;
o regulatory actions; and
o general economic conditions.
Any of these events would likely affect the market price of our common stock.
Our quarterly operating results may vary significantly from quarter to quarter.
Our revenues and earnings may fluctuate from quarter to quarter based
on factors that include the following:
o the number, size and scope of our projects;
o equipment purchases and other expenditures required for our
business;
o the number of bid and proposal efforts undertaken;
o delays in sales or production;
o the level of employee productivity;
o the adequacy of our provisions for losses;
o the accuracy of our estimate of resources required to complete
ongoing projects; and
o general economic conditions.
Demand for our products and services in each of the markets we serve can vary
significantly from quarter to quarter due to revisions in customer budgets or
schedules and other factors beyond our control. Due to all of the foregoing
factors, our results of operations may fall below the expectations of securities
analysts and investors in a particular period. In this event, the price of our
common stock may decline.
Our officers and directors own a significant amount of our common stock which
permits them to exert significant influence over the direction of our business
and affairs.
As of May 15, 2003, our directors and executive officers own an
aggregate of approximately 32% of our common stock. Accordingly, these persons,
if they act together, will be able to exert significant influence over the
direction of our business and affairs.
Item 2. Properties
We own our executive offices and principal production facilities located on a
five acre site in the County Line Industrial Park, Southampton, Pennsylvania in
an approximately 100,000 square foot steel and masonry building. Approximately
85,000 square feet of the building is devoted to manufacturing and 15,000 square
feet of this building is devoted to office space. The original building was
erected in 1969 and additions were most recently made in 2001. We have pledged
this property as collateral to secure the performance of our obligations under
our revolving credit facility with PNC Bank, National Association and our
subordinated debt financing with H.F. Lenfest. Additionally, we rent office
space at various sales and support locations throughout the world and at ETC-PZL
Aerospace Industries, our Polish subsidiary.
We consider our machinery and plant to be in satisfactory operating condition.
Increases in the level of operations beyond what we expect in the current fiscal
year might require us to obtain additional facilities and equipment.
10
Item 3. Legal Proceedings
In April 2003, Boenning & Scattergood, Inc. ("B&S") filed suit against us in the
Court of Common Pleas in Philadelphia, Pennsylvania, seeking payment of
$901,843.46 for financing fees allegedly due to B&S pursuant to the terms of an
agreement for investment banking services which we entered into with a
predecessor of B&S (the "B&S Agreement"). We have not yet responded to the
complaint but believe that we have valid defenses to each of the claims of B&S
and intend to vigorously defend ourselves against these claims. At this time,
however, we are unable to predict the outcome of this matter.
Certain claims, suits and complaints arising in the ordinary course of business
have been filed or are pending against us. In the opinion of management, all
such matters are reserved for or are adequately covered by insurance or, if not
so covered, are without merit or are of such kind, or involve such amounts as
would not have a material adverse effect on our financial position if resolved
unfavorably.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were presented to our stockholders during the fourth quarter of
fiscal 2003.
PART II
Item 5. Market for the Registrant's Common Stock and Related Security Holder
Matters
See information appearing under the heading "Market for the
Registrant's Common Stock and Related Stockholder Matters" in the Annual Report
to Stockholders attached hereto as Exhibit 13 and incorporated herein by
reference.
Item 6. Selected Consolidated Financial Data
See information appearing under the heading "Financial Review" in the
Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated
herein by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
See information appearing under the heading "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in the Annual
Report to Stockholders attached hereto as Exhibit 13 and incorporated herein by
reference.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
See the information appearing under the headings "Consolidated
Financial Statements" and "Notes to Consolidated Financial Statements" in the
Annual Report to Stockholders attached hereto as Exhibit 13 and incorporated
herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
11
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table sets forth certain information, as of May 15, 2003, with
respect to our directors and executive officers:
Served as Director
Name Age or Officer Since(1) Positions and Offices
---- --- ------------------- ---------------------
William F. Mitchell (2) 61 1969 Chairman of the Board, President and
Director
Richard E. McAdams (3) 67 1985 Executive Vice President and Director
Pete L. Stephens, M.D. (4) 65 1974 Director
Howard W. Kelley (5) 61 2002 Director
George K. Anderson, M.D. (6) 57 2003 Director
H.F. Lenfest (7) 73 2003 Director
Duane D. Deaner (8) 55 1996 Chief Financial Officer
(1) Directors are elected for one-year terms.
(2) Mr. Mitchell has been our Chairman of the Board, President and Chief
Executive Officer since 1969, except for the period from January 24,
1986 through January 24, 1987, when he was engaged principally in
soliciting sales for our products in the overseas markets. Mr. Mitchell
received a Bachelor of Science degree in physics from Drexel University
and has completed graduate work in mechanical and electrical
engineering. He is a member of the ASME and Drexel University
engineering advisory boards. Additionally, he is a member of the
Society of Automotive/Aerospace Engineering, the International Society
of Pharmaceutical Engineering, the Undersea and Hyperbaric Medical
Society, the Aerospace Medical Association, the American Society of
Mechanical Engineering and the Institute of Environmental Sciences.
(3) Mr. McAdams has been an employee since 1970. He became a Vice President
in 1978 with responsibility for contract administration. He joined our
Board of Directors in 1985. Mr. McAdams became Executive Vice President
of the Company in 1990. His educational background includes attendance
at Rider College and Rutgers University B.S./Business Administration
Programs, as well as Contract Administration courses at the College of
William and Mary, Temple University and the American Management
Association. Mr. McAdams has also served as president and director of
the Greater Philadelphia Chapter of the National Contracts Management
Association.
(4) Recently retired from the practice of medicine, Dr. Stephens had been a
physician engaged in private practice for 30 years. Dr. Stephens
graduated from Bethany College and the Medical College of Virginia. He
presently serves as Chairman of the Board of Directors of Lowcountry
Block and Paver, a manufacturing company located in South Carolina.
(5) Mr. Kelley is President of Sally Corporation, Jacksonville, Florida,
which is one of the oldest and largest designers and fabricators of
animation robotics and dark ride attractions used worldwide in theme
parks, museums and entertainment attractions. He previously spent over
25 years in the broadcasting industry, including ten years in
television management as a news director and later as Vice President
and General Manager of Channel 12 WTLV (NBC) in Jacksonville, Florida.
He is the former Chairman of the Board of Tempus Software, a medical
software development firm located in Jacksonville, Florida. He has also
previously served as broadcast strategic planner for a major U.S.
communications company and as director of several U.S. technology firms
with international business activities. In the academic arena, Mr.
Kelley serves as an executive professor at the University of North
Florida College of Business Administration, and is a college adjunct
instructor on Internet technology and E-commerce on the internet. He is
a graduate of the University of Florida and Harvard Business School
PMD.
12
(6) Dr. Anderson is an experienced physician executive and preventive
medicine leader. He began his professional career as an Air Force
flight surgeon, serving overseas medical duty in Korea and Germany as
well as aerospace medicine leadership positions in the United States.
Following 30 years of military service, he transitioned to physician
executive positions in the private sector. Subsequent to his retirement
from the military, he served as Chief Executive Officer of the Koop
Foundation from 1997 to 1998 and as President and Chief Executive
Officer at Oceania, Inc., a medical software company, from 1999 to
2001. Dr. Anderson's positions in the Air Force include serving as
Deputy Assistant Director of Defense (Health Services Operations and
Readiness), Commander of the Human Systems Center, Air Force Material
command, which included the Armstrong Laboratory, the School of
Aerospace Medicine and the Human Systems Program Office. He retired
from active duty in the grade of Major General.
(7) Mr. Lenfest practiced law with Davis Polk & Wardwell before joining
Triangle Publications, Inc., in Philadelphia as Associate Counsel in
1965. In 1970, Mr. Lenfest was placed in charge of Triangle's
Communications Division, serving as Editorial Director and Publisher of
Seventeen Magazine and President of the CATV Operations. In 1974, Mr.
Lenfest, with the support of two investors, formed Lenfest
Communications, Inc., which purchased Suburban Cable TV Company and
Lebanon Valley Cable TV Company from Triangle with a total of 7,600
subscribers. In January 2000, Mr. Lenfest sold his cable television
operations, which by then served 1.2 million subscribers, to Comcast
Corporation but still retains interests in companies principally
involved in national satellite promotion of cable programming and
software for marketing cable advertising and marketing promotions.
Additionally, Mr. Lenfest is the owner of various other businesses in
Pennsylvania and Maryland and is active in many philanthropic
activities including the Chairman of the Board of the Philadelphia
Museum of Art and the Lenfest Foundation.
(8) Mr. Deaner has served as our Chief Financial Officer since January
1996. Mr. Deaner served as Vice President of Finance for Pennfield
Precision Incorporated from September 1988 to December 1995. Mr. Deaner
received an MBA in Finance from Temple University and a B.A. in
Mathematics from Millersville University in Pennsylvania.
Committees of the Board of Directors
During the fiscal year ended February 28, 2003, the Board of Directors held five
meetings. All members of the Board of Directors attended all of the meetings of
the Board of Directors held while they were members of the Board of Directors.
During the fiscal year ended February 28, 2003, we had an Audit Committee
consisting of Mr. David Lazar and Mr. Stephens. Although the Audit Committee did
not hold formal meetings, both members of the Audit Committee reviewed our
Quarterly Reports on Form 10-Q and our Annual Report on Form 10-K with
management and our external auditors. Although not formally elected the Chairman
of the Audit Committee, Mr. Lazar did satisfy the financial sophistication
requirements of the American Stock Exchange. In addition, Mr. Stephens satisfied
the financial literacy requirements of the American Stock Exchange. Mr. Lazar
resigned from the Board of Directors in December 2002.
Mr. Howard Kelley has replaced Mr. Lazar on the Audit Committee and we expect
that he will be elected the Chairman of the Audit Committee and that Dr.
Anderson will be appointed to the Audit Committee at a future meeting of our
Board of Directors. We believe that Mr. Kelley satisfies the financial
sophistication requirements of the American Stock Exchange and that Dr. Anderson
satisfies the financial literacy requirements of the American Stock Exchange.
The Audit Committee is directly responsible for the appointment, compensation,
retention and oversight of our independent accountants in their preparation or
issuance of an audit report or the performance of other audit and review
services.
Mr. Stephens also served on our Compensation Committee during the year ended
February 28, 2003. The Compensation Committee is charged with reviewing the
compensation and incentive plans of officers and key personnel. Since no changes
were contemplated in the compensation and incentive plans of our officers and
key personnel, the Compensation Committee did not hold any formal meetings. We
expect that Mr. Kelley and Dr. Anderson will also be appointed to the
Compensation Committee at a future meeting of our Board of Directors.
Our directors who do not serve as officers are paid $1,000 for meetings of the
Board of Directors which they attend. No additional compensation is paid for
attending committee meetings.
Compliance With Section 16(a) of the Exchange Act
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and
directors, and persons who own more than ten percent of a registered class of
our equity securities to file reports of ownership and changes in ownership with
the Securities and Exchange Commission ("SEC") and the American Stock Exchange.
Officers, directors and greater than ten percent shareholders are required by
SEC regulations to furnish us with copies of all Section 16(a) reports they
file. The rules of the SEC regarding the filing of Section 16(a) reports require
that "late filings" of Section 16(a) reports be disclosed in our proxy
statement.
Based solely on our review of the copies of such forms which we received, or
written representations from reporting persons that no Section 16(a) reports
were required for those persons, we believe that, during the fiscal year ended
February 28, 2003, our officers, directors and greater than ten percent
beneficial owners complied with all applicable filing requirements except for
Mr. McAdams, who had one late filing, Mr. Kelley who had two late filings, Mr.
Stephens who had three late filings, and Mr. Mitchell, who had three late
filings, two of which reported gifts of common stock to his family members.
13
Item 11. Executive Compensation
SUMMARY COMPENSATION TABLE
The following table sets forth the compensation we paid to our Chief Executive
Officer for services rendered during fiscal years 2003, 2002 and 2001. There are
no other executive officers whose total annual salary and bonus exceeds
$100,000. The footnotes to the table provide additional information concerning
our compensation and benefit programs.
Annual Compensation
------------------------------------------------------------------------------------------------------------------------------------
Other Annual All Other
Name and Principal Position Fiscal Year Salary ($) Bonus ($)(1) Compensation (2) Compensation ($)(3)
--------------------------- -------------------- ----------------- -------------------- ---------------- ---------------------
William F. Mitchell, 2003 225,000 0 -- 4,493
President and Chief 2002 225,000 10,051 -- 4,413
Executive Officer 2001 225,000 10,969 -- 4,000
(1) These amounts represent a portion of a deferred bonus from fiscal 1999
due 75% in 1999 and 5% in each of the five following fiscal years. No
bonus awards for fiscal 2001, 2002 or 2003 were paid. No deferred bonus
amounts from fiscal 1999 were paid in fiscal 2003.
(2) Our executive officers receive certain perquisites. For fiscal years
2001, 2002 and 2003, the perquisites received by Mr. Mitchell did not
exceed the lesser of $50,000 or 10% of his salary and bonus.
(3) These amounts represent our contribution to ETC's Retirement Savings
Plan.
Item 12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
The following table sets forth as of May 15, 2003, the number of shares and
percentage of our common stock owned beneficially by each director, each
executive officer named in the Summary Compensation Table, and each person
holding, to our knowledge, more than 5% of our outstanding common stock. The
table also sets forth the holdings of all directors and executive officers as a
group.
Amount and
Nature of Percent
Name and Address Beneficial of
of Beneficial Owner Ownership(1) Common Stock
--------------------------------------- ------------ ------------
William F. Mitchell (2) 1,624,398 22.7%
c/o Environmental Tectonics Corporation
County Line Industrial Park
Southampton, PA 18966
Pete L. Stephens, M.D. (3) 684,600(4) 9.6%
31 Ribaut Drive
Hilton Head Island, SC 29926
Richard E. McAdams (3) 51,037(5) *
c/o Environmental Tectonics Corporation
County Line Industrial Park
Southampton, PA 18966
Howard W. Kelley (3) 685 *
c/o Sally Corporation
745 West Forsyth Street
Jacksonville, FL 32204
14
Amount and
Nature of Percent
Name and Address Beneficial of
of Beneficial Owner Ownership(1) Common Stock
--------------------------------------- ------------ ------------
T. Todd Martin, III 1,120,520(6) 14.8%
50 Midtown Park East
Mobile, AL 36606
H.F. Lenfest (3) 2,621,230(7) 26.8%
c/o The Lenfest Group
1332 Enterprise Drive
West Chester, PA 19380
Emerald Advisors, Inc. 1,440,200(8) 20.1%
1703 Oregon Pike
Suite 101
Lancaster, PA 17601
George K. Anderson, M.D. (3) 0 *
8034 Kidwell Hill Court
Vienna, VA 22182
All directors and executive
officers as a group (7 persons) 4,993,391(9) 50.8%
--------------------------------------------------------------------------------
* less than 1%
(1) Beneficial ownership has been determined in accordance with Rule 13d-3
under the Securities Exchange Act of 1934. Unless otherwise noted, we
believe that all persons named in the table have sole voting and
investment power with respect to all shares of our common stock
beneficially owned by them.
(2) Chairman of the Board, President and Director of the Corporation.
Includes 155,200 shares of common stock held by Mr. Mitchell's wife.
(3) Director of the Company.
(4) Includes 292,770 shares of common stock held by or for the benefit of
Dr. Stephens' wife and two of his children.
(5) Includes options to purchase 36,550 shares of common stock held under
our stock option plan which are presently exercisable.
(6) Includes 537,700 shares of common stock and 437,820 shares of common
stock underlying presently exercisable warrants to purchase shares of
common stock owned by ETC Asset Management, LLC, a limited liability
company of which T. Todd Martin, III is manager. Also includes 79,800
shares of common stock owned by Mr. Martin, 26,900 shares owned by
Allied Williams Co, Inc., a corporation of which Mr. Martin is an
officer and director, 17,000 shares owned by Equity Management, LLC, a
limited liability company of which Mr. Martin is manager, 14,300 shares
owned by Mr. Martin jointly with his spouse, and 7,000 shares owned by
trusts of which Mr. Martin is trustee.
(7) These shares consist of 2,621,230 shares of common stock issuable upon
conversion of a promissory note in the principal amount of $10,000,000
and exercise of warrants to purchase shares of common stock.
(8) As of May 15, 2003, Emerald Advisors, Inc. has a sole voting power with
respect to 866,560 shares of common stock and sole dispositive power
over 1,440,200 shares of common stock.
(9) Includes 36,550 shares of common stock which may be acquired by Mr.
McAdams upon the exercise of options granted under our stock option
plan that are presently exercisable, 11,441 shares of common stock
which may be acquired by Duane Deaner, our chief financial officer,
upon the exercise of options granted under our Incentive Stock Option
Plan that are presently exercisable and 2,621,230 shares of common
stock which may be acquired by H.F. Lenfest upon conversion of a
promissory note in the principal amount of $10,000,000 that is
presently convertible and the exercise of warrants to purchase shares
of common stock which are presently exercisable.
For information regarding our equity compensation plans, please see the Equity
Compensation Plan Information section of the Annual Report to Stockholders
attached hereto as Exhibit 13 and incorporated herein by reference.
15
Item 13. Certain Relationships and Related Transactions
On February 19, 2003, we completed a refinancing of our indebtedness
with the PNC Bank, National Association and H.F. Lenfest in the aggregate amount
of $29,800,000. Pursuant to the terms of a Convertible Note and Warrant Purchase
Agreement, dated February 18, 2003, between us and Mr. Lenfest, we issued to Mr.
Lenfest (i) a 10% senior subordinated convertible promissory note in the
original principal amount of $10,000,000 and (ii) warrants to purchase 803,048
shares of our common stock. As a condition to closing the financing, we
appointed Mr. Lenfest to our Board of Directors. (For a more detailed
description of the financing provided by Mr. Lenfest and PNC, see the Liquidity
and Capital Resources section of the Annual Report to Stockholders attached as
Exhibit 13 to this Annual Report on Form 10-K and incorporated herein by
reference).
Prior to the consummation of the refinancing, ETC Asset Management,
LLC, a shareholder and a holder of warrants to purchase 332,820 shares of our
common stock, consented to the financing transactions with PNC and Lenfest
including the below market issuance of warrants to Mr. Lenfest. As a result of
its consent, ETC Asset Management waived, solely in connection with such
issuance, the anti-dilution rights contained in its warrant. In exchange for ETC
Asset Management's consent and waiver, we issued to ETC Asset Management
warrants to purchase an additional 105,000 shares of common stock. Except for
the number of shares issuable upon exercise of the warrants, the new ETC Asset
Management warrants have substantially the same terms as the warrants issued to
Mr. Lenfest. As of the date that these warrants were issued to ETC Asset
Management, it was the beneficial owner of greater than 5% of our common stock
as determined in accordance with Rule 13d-3 under the Securities Exchange Act of
1934. (For a more detailed description of the financing provided by Mr. Lenfest
and PNC, see the Liquidity and Capital Resources section of the Annual Report to
Stockholders attached as Exhibit 13 to this Annual Report on Form 10-K as
incorporated herein by reference).
Item 14. Controls and Procedures
Under the supervision and with the participation of our management,
including our chief executive officer and chief financial officer, we have
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures within 90 days of the filing date of this Annual Report
on Form 10-K, and, based on their evaluation, our chief executive officer and
chief financial officer have concluded that these controls and procedures were
effective as of the date of the evaluation. There were no significant changes in
our internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
Disclosure controls and procedures are our internal controls and other
procedures that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms. Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by us in the reports that we
file under the Securities Exchange Act of 1934 is accumulated and communicated
to our management, including our chief executive officer and chief financial
officer, as appropriate to allow timely decisions regarding required disclosure.
PART IV
Item 16. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Exhibits:
Number Item
------ ----
3.1 Registrant's Articles of Incorporation, as amended, were filed as Exhibit 3.1. to Registrant's Form 10-K for the year
ended February 28, 1997 and are incorporated herein by reference.
3.2 Registrant's By-Laws, as amended, were filed as Exhibit 3(ii) to Registrant's Form 10-K for the year ended
February 25, 1994 and are incorporated herein by reference.
4.1 $10,000,000 Senior Subordinated Convertible Note, dated
February 18, 2003, issued by the Registrant in favor of H.F.
Lenfest was filed on February 25, 2003 as Exhibit 4.1 to Form
8-K and is incorporated herein by reference.
4.2 Stock Purchase Warrant, dated February 18, 2003, issued by the Registrant in favor of H.F. Lenfest was filed on
February 25, 2003 as Exhibit 4.2 to Form 8-K and is incorporated herein by reference.
4.3 Stock Purchase Warrant, dated February 18, 2003, issued by the Registrant in favor of ETC Asset Management, LLC was
filed on February 25, 2003 as Exhibit 4.3 to Form 8-K and is incorporated herein by reference.
10.1 Registrant's 1998 Stock Option Plan was filed on October 8, 1998 on Form S-8 and is incorporated herein by reference.*
16
Number Item
------ ----
10.2 Registrant's Employee Stock Purchase Plan was filed on July 6, 1988 as Exhibit A to the Prospectus included in
Registrant's Registration Statement (File No. 33-42219) on Form S-8 and is incorporated herein by reference. *
10.3 Registrant's Stock Award Plan adopted April 7, 1993, was filed as Exhibit 10(ix) to the Registrant's Form 10-K for
the fiscal year ended February 25, 1994 and is incorporated herein by reference. *
10.4 Stock Purchase Warrant dated as of December 26, 2001, issued by the Registrant to the Registrant Asset Management,
LLC was filed as Exhibit 10.7 to the Registrant's Form 10-K for the fiscal year ended February 22, 2002 and is
incorporated herein by reference.
10.5 Credit Agreement, dated as of February 18, 2003 between the Registrant and PNC Bank, National Association was filed
on February 25, 2003 as Exhibit 10.1 to Form 8-K and is incorporated herein by reference.
10.6 Amendment to Credit Agreement, dated as of April 30, 2003, between the Registrant and PNC Bank.
10.7 Amended and Restated Revolving Credit Note, dated April 30, 2003, issued by the Registrant in favor of PNC Bank.
10.8 Security Agreement, made and entered into as of February 18, 2003, by and between the Registrant, Entertainment
Technology Corporation, ETC Delaware, Inc. and PNC Bank was filed on February 25, 2003 as Exhibit 10.3 to Form 8-K
and is incorporated herein by reference.
10.9 Pledge Agreement, dated as of February 18, 2003, made by the Registrant in favor of PNC Bank was filed on
February 25, 2003 as Exhibit 10.4 to Form 8-K and is incorporated herein by reference.
10.10 Pledge Agreement (Bank Deposits), dated as of February 18, 2003, made by the Registrant in favor of PNC Bank was
filed on February 25, 2003 as Exhibit 10.5 to Form 8-K and is incorporated herein by reference.
10.11 Guaranty, dated as of February 18, 2003, made by Entertainment Technology Corporation and ETC Delaware, Inc. in favor of
PNC Bank was filed on February 25, 2003 as Exhibit 10.6 to Form 8-K and is incorporated herein by reference.
10.12 Open-End Mortgage and Security Agreement, made as of February 18, 2003, by the Registrant in favor of PNC Bank was
filed on February 25, 2003 as Exhibit 10.7 to Form 8-K and is incorporated herein by reference.
10.13 Convertible Note and Warrant Purchase Agreement, dated February 18, 2003, by and between the Registrant and Lenfest was
filed on February 25, 2003 as Exhibit 10.8 to Form 8-K and is incorporated herein by reference.
10.14 Registration Rights Agreement, dated as of February 18, 2003, by and between the Registrant and H.F. Lenfest was
filed on February 25, 2003 as Exhibit 10.9 to Form 8-K and is incorporated herein by reference.
10.15 Security Agreement, made and entered into as of February 18, 2003, by and among the Registrant, Entertainment
Technology Corporation, ETC Delaware, Inc. and H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.10 to
Form 8-K and is incorporated herein by reference.
10.16 Guaranty, dated as of February 18, 2003, made by Entertainment Technology Corporation and ETC Delaware, Inc. in favor
of H.F. Lenfest was filed on February 25, 2003 as Exhibit 10.11 to Form 8-K and is incorporated herein by reference.
10.17 Open-End Mortgage and Security Agreement, made as of February 18, 2003, by the Registrant in favor of H.F. Lenfest
was filed on February 25, 2003 as Exhibit 10.12 to Form 8-K and is incorporated herein by reference.
10.18 Subordination and Intercreditor Agreement, dated as of February 18, 2003, among PNC Bank, H.F. Lenfest and the Registrant
was filed on February 25, 2003 as Exhibit 10.13 to Form 8-K and is incorporated herein by reference.
13 Portions of Registrant's 2003 Annual Report to Shareholders which are incorporated by reference into this Form 10-K
21 Subsidiaries of the Registrant
23 Consent of Grant Thornton LLP
99.1 Certification dated May 29, 2003 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 made by William F. Mitchell, Chief Executive Officer.
Number Item
------ ----
99.2 Certification dated May 29, 2003 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 made by Duane D. Deaner, Chief Financial Officer.
* Represents a management contract or a compensatory plan or arrangement.
(b) Reports on Form 8-K:
(i) A Current Report on Form 8-K was filed on December 24, 2002,
reporting the termination of a refinancing arrangement and the reclassification
of our existing indebtedness from long term debt to current liabilities.
(ii) A Current Report on Form 8-K was filed February 25, 2003,
reporting the completion of a refinancing of our indebtedness with PNC Bank,
National Association, and H.F. Lenfest.
18
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the registrant caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ENVIRONMENTAL TECTONICS CORPORATION
By William F. Mitchell
--------------------------------------
William F. Mitchell,
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Name Position Date
---- -------- ----
William F. Mitchell Chairman of the Board, May 29, 2003
----------------------- Chief Executive Officer,
William F. Mitchell President and Director (Principal
Executive Officer)
Duane D. Deaner Chief Financial May 29, 2003
------------------- Officer (Principal Financial and
Duane D. Deaner Accounting Officer)
Richard E. McAdams Director May 29, 2003
----------------------
Richard E. McAdams
Pete L. Stephens Director May 29, 2003
--------------------
Pete L. Stephens
Howard W. Kelley Director May 29, 2003
--------------------
Howard W. Kelley
H.L. Lenfest Director May 29, 2003
----------------
H.L. Lenfest
George K. Anderson Director May 29, 2003
------------------------
George K. Anderson, M.D.
19
CERTIFICATION
I, William F. Mitchell, certify that:
1. I have reviewed this annual report on Form 10-K of Environmental Tectonics
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 29, 2003
By: William F. Mitchell
-------------------------------------
William F. Mitchell
President and Chief Executive Officer
20
CERTIFICATION
I, Duane D. Deaner, certify that:
1. I have reviewed this annual report on Form 10-K of Environmental Tectonics
Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report
is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this annual report (the "Evaluation Date"); and
c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 29, 2003
By: Duane D. Deaner
------------------------
Duane D. Deaner
Chief Financial Officer
21
EXHIBIT INDEX
Exhibit
No. Item
------- ----
10.6 Amendment to Credit Agreement, dated as of April 30, 2003, between the Registrant and PNC Bank.
10.7 Amended and Restated Revolving Credit Note, dated April 30, 2003, made by the Registrant in favor of PNC Bank.
13 Portions of Registrant's 2003 Annual Report to Shareholders which are incorporated by reference into this Form 10-K.
21 Subsidiaries of the Registrant.
23 Consent of Grant Thornton LLP.
99.1 Certification dated May 29, 2003 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 made by William F. Mitchell, Chief Executive Officer.
99.2 Certification dated May 29, 2003 pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 made by Duane D. Deaner, Chief Financial Officer.