SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended May 31, 2002 Commission File No. 0-1738
GENERAL KINETICS INCORPORATED
(Exact Name of Registrant as specified in its Charter)
Virginia 54-0594435
(State of Incorporation) (IRS Employer Identification No.)
10688-D Crestwood Drive, Manassas, VA 20109
(Address of principal executive offices) (Zip Code)
Registrant's telephone number (703) 331-8033
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class
-------------------
Common Stock with par value of 25 cents per share
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 the 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 [_].
Aggregate market value of the voting stock held by non-affiliates $ 261,437*
of the Registrant as of August 14, 2002
(* Executive officers, directors, and Registrant's ESOP were considered
affiliates, solely for purposes of this item.)
The number of shares outstanding of Registrant's Common Stock,
$.25 par value, as of August 14, 2002, was 6,718,925
Documents Incorporated by Reference
Certain portions of the Registrant's Proxy Statement to be filed with the
Securities and Exchange Commission not later than 120 days after the end of the
Registrant's 2002 fiscal year are incorporated into Part III hereof.
CAUTIONARY STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements contained in this Annual Report on Form 10-K, including without
limitation, as set forth under the caption "Management's Discussion and Analysis
of Financial Condition and Results of Operations", as well as oral statements
that may be made by the Company or by officers, directors or employees of the
Company acting on the Company's behalf, that are not historical fact may contain
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements involve risks and
uncertainties. They are not historical facts or guarantees of future performance
or events. They are based on current expectations, estimates, beliefs,
assumptions, goals and objectives, and are subject to uncertainties that are
difficult to predict. In particular, certain risks and uncertainties may
include, but are not limited to, the risk that the Company may not be able to
maintain its present financing facility, or obtain additional financing if
necessary; the risk that the Company may not be able to continue the necessary
development of its operations, including maintaining or increasing sales and
production levels, on a profitable basis; the risk the Company may in the future
have to comply with more stringent environmental laws or regulations or more
vigorous enforcement policies of regulatory agencies, and that such compliance
could require substantial expenditures by the Company; the risk that U.S.
defense spending may be substantially reduced; and the risk that the Company's
Common Stock will not continue to be quoted on the NASD OTC Bulletin Board
services. Forward looking statements included in this annual report are based on
information known to GKI as of the date of this annual report and GKI accepts no
obligation (and expressly disclaims any obligations) to update these forward
looking statements and does not intend to do so. Certain of these risks and
uncertainties are described in the Company's reports and statements filed from
time to time with the Securities and Exchange Commission, including this report.
PART I
ITEM 1 - BUSINESS
(a) General Development of Business
General Kinetics Incorporated (the "Company" or "GKI"), through its Electronic
Enclosure Division (the "EED"), designs and manufactures high-quality precision
enclosures for electronic systems, principally for sale to the U.S. Department
of Defense
2
and the U.S. Navy.
The Company was founded as a Virginia corporation in 1954 and its common stock
became publicly traded in November 1961.
Beginning in December 1992, and ending in August 1994, the Company's operations
were financed to a significant extent by debt and equity investments made by
clients of Gutzwiller & Partner, A.G.("Gutzwiller"), a corporation formed under
the laws of Switzerland, now known as Rabo Investment Management Ltd. (the
"Manager"). At May 31, 2002 convertible debentures initially issued to clients
of Gutzwiller are outstanding in an aggregate principal amount of approximately
$9.0 million, mature in August 2004, are convertible into common stock at a
conversion price of 50 cents per share, and bear interest at 1% per annum, which
is payable annually. Shares issuable upon conversion are also subject to certain
rights to registration under the Securities Act of 1933, as amended.
In a filing with the SEC dated November 9, 2001, the Manager indicated that it
may be deemed to be the beneficial owner of debentures having an aggregate
principal amount of $7,885,000, including 585,000 which were purchased by the
manager to which the Manager is the economic beneficial owner of and holds sole
voting and dispositive power, and $7,300,000 held in client accounts managed by
the Manager on behalf of various clients who hold beneficial economic ownership
thereof to which the Manager holds voting and dispositive power. That SEC filing
also indicated that the Manager may be deemed to be the beneficial owner of an
aggregate of 1,715,000 outstanding shares of the Company's common stock,
including 242,700 shares purchased by the Manager to which the Manager is the
economic beneficial owner of and holds sole voting and dispositive power and
1,472,300 shares held in client accounts.
As of December 5, 1996, GKI completed the sale of its Secure Communications
Division ("SCD") to Cryptek Secure Communications, LLC ("Cryptek"), a Delaware
limited liability company, the majority of whose equity interests are owned by
affiliates of Angelo Gordon & Co., L.P. As of May 30, 1997, the Company sold the
stock in its then wholly owned Food Technology Corporation ("FTC") subsidiary to
the former vice president and general manager of FTC.
(b) Financial Information About Industry Segments
3
Due to the sales of SCD and FTC during fiscal 1997, the Company is currently
operating in a single industry segment.
(c) Narrative Description of Business
Electronic Enclosure Business
General
The Electronic Enclosure Division designs and manufactures high-quality
precision enclosures for sophisticated electronic systems. The EED is a
manufacturing and engineering services group which produces build-to-print as
well as custom engineered products. The EED has manufactured electronics-ready
enclosures and mounting systems for over 40 years. Products include both
standard and made-to-order racks, cabinets and kits. These products are
precision-manufactured to enclose and protect sensitive electronic communication
and detection equipment from shock and vibration. The principal customer for
these products is the U.S. Navy which, directly or indirectly through its prime
contractors, accounted for 94%, 91%, and 83% of the Company's revenues in fiscal
2002, 2001 and 2000, respectively. The EED sells these products as a prime
contractor and also as a subcontractor to major prime contractors such as
Lockheed Martin, SAIC, Northrop Grumman, and DRS Laurel Technologies.
Strategy
The Company's long-term goals for the EED are to increase market penetration
with the Department of Defense, and to expand into the non-government
marketplace by targeting build-to-print or engineering design opportunities for
enclosures and related products. The Company entered the commercial enclosure
marketplace in fiscal 2000. The current strategy for these products is to
concentrate on selling high-end precision enclosures through a small network of
U.S. sales representatives. The Company does not expect the non-government
marketplace to provide a significant portion of the Company's sales during
fiscal 2003. Management intends to use its current sales force and build on its
reputation for quality to expand sales to the U.S. Navy and other agencies
within the government.
The Company plans to finance its strategy for Fiscal 2003 through cash on hand
as of May 31, 2002, careful management of operating expenses, factoring accounts
receivable to alleviate short-term cash requirements, and cash flow generated
through operations. The Company may also look for additional sources of
financing to
4
provide a cushion to handle variances in cash requirements if sales and shipment
levels fluctuate throughout the fiscal year.
Products
The EED's principal products are enclosures, such as racks, cabinets, consoles,
and mounting platforms for sophisticated electronic systems generally made in
accordance with specific client requirements. The EED has developed a series of
consoles and enclosures to offer as commercial-off-the-shelf ("COTS") products
to be sold to prime contractors for contracts in the defense community that
require this type of enclosure. These consoles and enclosures provide an
environment that makes it possible to use commercial electronics while meeting
the need for combat ready systems.
The EED's production processes cover a wide range of operations, including high
volume production using tight tolerance, military-specified engineering
requirements. Military specifications for metal fabrication and machinery
require geometric dimensioning to and from fabricated areas to datums within ten
thousandths of an inch (.0001) of their true fabricated position, and the
machining of parts to a size of plus or minus one thousandth of an inch (.001)
of their specified dimension. Furthermore, the EED has in-plant facilities to
test for radio frequency interference (R.F. testing) as it is required to
certify certain products. The EED fabricates metal cabinets and other products
from sheet aluminum and steel and other metal components, all of which are
readily available from numerous domestic suppliers. The manufactured products
must satisfy the close-tolerance specifications of its customers and are
subjected to in-house sound testing to ensure that the levels of noise emanating
from the enclosures at various frequencies are within customer specifications.
The EED's products have high visibility in such programs as AEGIS and other
major U.S. Government programs.
Customers
During fiscal years 2002, 2001, and 2000, the Company sold 94%, 91%, and 83%,
respectively, of its products to the U.S. Government, principally to the U.S.
Navy, either as a prime contractor or a subcontractor to major prime
contractors. Therefore, a material decline in spending by the Department of
Defense, in particular spending by the U.S. Navy, could have a
5
material adverse effect on the operations of the EED, unless offset by greater
market penetration or new sales to other government and commercial customers. In
addition, the Company's U.S. Government contracts and, in general, its
subcontracts with the U.S. Government's prime contractors provide that such
contracts may be terminated by the U.S. Government or prime contractor for
convenience at any time. The Company considers its relationships with the U.S.
Navy and its major prime contractor customers to be good.
Marketing and Sales
The EED currently markets its products through a direct sales force and through
outside agencies. The EED also participates in industry trade shows as a means
of contacting new and existing customers and introducing new products.
Backlog
The EED sells its products pursuant to both long and short-term contracts with
scheduled backlog and delivery orders. Amounts are not carried in backlog until
the related contracts receive government funding (in the case of government
contracts) and, in any event, delivery orders are released to the Company. Once
an order is received, production and delivery can be scheduled, but in some
instances dates can be delayed by changing requirements of government or
commercial customers.
The EED's contract backlog as of May 31, 2002 and May 31, 2001 was approximately
$1.9 million and $4.3 million, respectively. All of the $1.9 million backlog at
May 31, 2002 is expected to be shipped during fiscal 2003. The Company does not
believe that seasonal fluctuations play a significant role in the backlog for
its business.
6
Competition
The EED operates in a mature, highly fragmented market with intense competition.
The principal elements of competition are price, the ability to deliver products
in accordance with major U.S. Government and prime contractor production
schedules, technical expertise, quality, service and support. The Company
believes that the EED competes with approximately 25 other manufacturers of
electronic enclosures, including, in some instances, major prime contractors,
which are also customers of the Company. Certain of the EED's competitors have
significantly greater financial, marketing and technological resources than the
Company.
Research and Development
The Company expects research and development activities to total less than
$50,000 during fiscal 2003. No material research and development expenses were
incurred in fiscal 2002, 2001 or 2000.
The U.S. Government Procurement Process
The majority of the Company's fiscal 2002 revenue was generated from sales
directly to departments and agencies of the U.S. Government, and to prime
contractors reselling to the U.S. Government market, principally to the U.S.
Navy. Revenue from these sales represented approximately 94% of the Company's
total revenue in fiscal 2002. The Company sells to the U.S. Government through a
wide variety of contract procurement mechanisms that include formal
solicitations and requests for quotes. The Company's sales to U.S. Government
prime contractors are typically made through contracts secured by formal
competitive bidding.
The Company's U.S. Government contracts and, in general, its subcontracts with
the U.S. Government's prime contractors, provide that such contracts may be
terminated by the U.S. Government or prime contractor for convenience at any
time. The Company estimates that substantially all of the Company's fiscal 2002
revenue was derived from contracts that are subject to termination for
convenience. In the event of such a termination, the Company is normally
entitled to receive the purchase price for delivered items, reimbursement for
allowable costs for work in process, and an allowance for profit thereon or
adjustment for loss if completion of performance would have resulted in a loss.
7
There were no terminations for convenience in fiscal 2002, 2001, or 2000. Upon
termination of a U.S. Government contract for contractor default, the U.S.
Government may seek to recover from the defaulting contractor the increased
costs of procuring the specified goods and services from a different contractor.
The U.S. Government to date has not terminated for default of any contract
awarded to the Company.
In connection with its efforts to compete for U.S. Government business, the
Company has enjoyed certain statutory advantages as a consequence of its size,
location and the American-made character of its products. Such advantages may
not be available to the Company in the future. Although the Company believes
that it will continue to qualify under these statutory provisions for the
foreseeable future, the Company does not believe that the loss of such status
would be likely to have a material adverse effect upon the Company.
The Company's sales to the U.S. Government are subject to numerous other factors
beyond the Company's control that generally apply to other U.S. Government
contractors, including fluctuations and delays resulting from the appropriations
process, the outcome of competition for contracts, and reductions in levels of
military and other agencies' spending.
Employees and Labor Agreements
As of May 31, 2002, the Company had 92 employees, all located in the United
States. Of the 92 employees, 26 were salaried and 66 were paid by the hour. At
that date, on a Company-wide basis, there were 5 employees in engineering, 1
employee in sales and marketing, 72 employees in manufacturing and assembly
operations, and 14 employees in an executive capacity or in finance and
administration. Fifty-eight of the Company's employees were represented by the
International Brotherhood of Electrical Workers Union in Johnstown,
Pennsylvania. The Company and the Union are working under a five-year collective
bargaining agreement that will expire on May 31, 2004. The Company considers its
employee relations to be good.
8
Environmental Matters
The EED uses limited amounts of hazardous materials in its production process,
primarily in the treatment of metal components. All such materials are disposed
of by independent certified carriers. The Company believes it operates its
facilities in compliance, in all material respects, with all existing federal,
state and local environmental regulations.
Pursuant to the requirements of applicable federal, state, and local statutes
and regulations, the Company believes it has received all of the environmental
permits and approvals necessary for the operations of its facilities.
Secure Communications Division
In December 1996, GKI completed the sale of SCD to Cryptek, the majority of
whose equity interests are owned by affiliates of Angelo Gordon & Co., L.P. The
SCD had been in the business of manufacturing and selling secure facsimile
machines and secure local area network products for customers handling
classified information. The division incurred significant operating losses
during fiscal 1997 and in each of the prior three fiscal years. Management
believed that the resources likely to be involved in returning the division to
profitability could more effectively be generated and utilized in connection
with the development of the EED and other activities. In addition, the $1.75
million in cash proceeds received from the sale of the division at closing
provided the Company with operating capital for its continuing business.
In December 1998, the Company entered into a settlement agreement with Cryptek,
resolving differences arising out of its purchase of GKI's former secure
communications business. Pursuant to such settlement, Cryptek made an immediate
principal payment of $25,000 on its outstanding promissory note to the Company
and agreed to forego sublease rent owed by the Company through November 1998.
The remaining principal amount of the Cryptek promissory note was reduced to
$550,000 and the payment schedule for such note was revised and extended through
2002. In addition, the face value of the preferred membership interest in
Cryptek held by the Company was reset at $900,000, and the requirement for
redemption of such interest by Cryptek was extended through December 2002.
9
In October 1999, the Company entered into an agreement that amended the
settlement agreement the Company had reached with Cryptek in December 1998. The
October 1999 agreement reduced the face amount of the promissory note payable to
the Company by Cryptek from $550,000 to $400,000 in exchange for accelerating
the payment schedule. The Company received $200,000 upon execution of the new
agreement. In addition, the October 1999 agreement gave Cryptek the option to
pay the remainder of the promissory note and redeem the preferred interest in
Cryptek held by the Company (with a face amount of $900,000 and a requirement
for mandatory redemption in December 2002) for an additional $488,750, if that
option were exercised within six months after the execution of the October 1999
Agreement.
At November 30, 1999, the $150,000 reduction in the face amount of the note was
offset against an existing valuation reserve related to the Cryptek promissory
note. In December 1999, Cryptek exercised its option and paid the Company
$478,800, representing a discount of $10,000 in consideration of a closing in
December 1999 rather than at the end of the six-month option period in April
2000. The $478,800 was first applied to settle the note receivable with a
carrying value of $200,000, and the excess of $278,800 is recorded in fiscal
year 2000 financial statements as a non-recurring gain in non-operating income.
This gain was recognized because GKI did not attribute any value to the
preferred interest in Cryptek for financial reporting purposes due to
uncertainty over valuation at the time of the original sale transaction.
(d) Foreign and Domestic Operations and Export Sales
The EED has not had significant foreign operations or export sales.
ITEM 2 - PROPERTIES
The Company maintains its executive offices in a leased facility in Northern
Virginia that is approximately 1,850 square feet.
The Company's manufacturing facilities are presently located in a building owned
by the Company, a 56,000 square foot industrial
10
manufacturing plant in Johnstown, Pennsylvania that is owned by the Company. A
small portion of the Johnstown facility is leased to unrelated third parties.
The Johnstown facility is subject to a mortgage held by a local banking
institution. The real estate mortgage agreement contains a subjective covenant
that could allow the bank to accelerate the maturity of the debt if the bank
determines that a material adverse change in the financial or business condition
of the Company has occurred.
The Company believes that its present facilities are adequate to meet its
current production requirements.
ITEM 3 - LEGAL PROCEEDINGS
As of the date hereof, there are no material pending legal proceedings, to which
the Company is a party or of which any of its property is the subject.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None
PART II
ITEM 5 - MARKET FOR GKI COMMON STOCK AND RELATED SECURITY HOLDER MATTERS
The Company's Common Stock, $.25 par value per share, is quoted in the Over the
Counter ("OTC") Bulletin Board service, under the symbol "GKIN". The table below
presents the high and low sales prices as reported for the fiscal quarters
within the two most recent fiscal years:
Quarter Ended High Low
May 31, 2002 .055 .045
February 28, 2002 .06 .045
November 30, 2001 .07 .04
August 31, 2001 .08 .05
May 31, 2001 .08 .05
11
February 28, 2001 .08 .04
November 30, 2000 .09 .05
August 31, 2000 .28 .07
The number of holders of record of the Company's Common Stock, $.25 par value,
as of August 14, 2002, was 1,004.
The Company has not paid any dividends during the last five fiscal years and has
no present plans to pay dividends in the foreseeable future.
ITEM 6 - SELECTED FINANCIAL DATA
The following sets forth certain selected financial data for each of the years
in the five-year period ended May 31, 2002. The statement of operations data for
the fiscal years ended May 31, 2002, 2001, 2000 and the balance sheet data at
May 31, 2002 and 2001 are derived from and are qualified by reference to the
financial statements of the Company audited by BDO Seidman, LLP, the Company's
independent certified public accountants, included elsewhere, herein. The
statement of operations data for the fiscal years ended May 31, 1999 and 1998
and the balance sheet data at May 31, 2000, 1999 and 1998 are derived from
financial statements of the Company also audited by BDO Seidman, LLP, but not
included herein. The financial data should be read in conjunction with, and are
qualified by reference to, the financial statements and related notes and other
financial information and Management's Discussion and Analysis of Financial
Condition and Results of Operations included elsewhere herein.
12
Years ended May 31
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands, except per share data)
--------------------------------------------------------------------------------
Statement of Operations Data:
--------------------------------------------------------------------------------
Net Sales $6,739 $7,490 $8,833 $8,259 $8,870
Cost of sales 5,013 6,429 7,828 6,736 7,691
------ ------ ------ ------ ------
Gross profit 1,726 1,061 1,005 1,523 1,179
Selling, general,
and administrative
expenses 1,153 1,723 1,514 1,565 1,559
Product R&D, and
improvement 0 0 0 43 0
Manufacturing
Start-Up Costs 0 0 0 0 265
Provision for Note
Receivable 442 13 0 0 0
------ ------ ------ ------ ------
Operating income
(loss) 131 (675) (509) (85) (645)
Gain on sale of
building 192 0 0 0 0
Gain on Note Settlement 0 0 279 0 0
Other Income 0 0 0 175 37
Interest expense, net (250) (241) (299) (220) (227)
------ ------ ------ ------- ------
Income (loss) before
extraordinary item 73 (916) (529) (130) (835)
Extraordinary gain from
debt extinguishment 187 67 0 0 0
------- ------ ------ ------ -----
Income (loss)
before income taxes 260 (849) (529) (130) (835)
Provision for
income taxes 6 0 0 0 0
------ ------ ------ ------ ------
Net Income (Loss) $ 254 $ (849) $ (529) $ (130) $ (835)
====== ====== ====== ====== ======
Basic Earnings Per Share:
Income (loss) before
extraordinary item .01 (.136) (.079) (.019) (.124)
Income from extra-
ordinary item .03 .010 .000 .000 .000
Basic Earnings(loss)
Per share .04 (.126) (.079) (.019) (.124)
Weighted average common
shares outstanding 6,719 6,719 6,719 6,719 6,719
13
Diluted Earnings Per Share:
Income (loss) before
extraordinary item .005 (.136) (.079) (.019) (.124)
Income from extra-
ordinary item .008 .010 .000 .000 .000
Diluted Earnings(loss)
Per share .013 (.126) (.079) (.019) (.124)
Weighted average common
shares and dilutive
equivalents
outstanding 24,909 6,719 6,719 6,719 6,719
Cash dividends
per common share 0 0 0 0 0
Balance Sheet and Other Data:
May 31,
1998 1999 2000 2001 2002
---- ---- ---- ---- ----
(in thousands)
Working capital $ 2,492 $1,570 $ 1,381 $ 1,351 $ 606
Cash 1,923 307 958 388 185
Total assets 4,770 4,685 4,130 4,009 2,918
Net property, plant
& equipment 1,015 1,016 925 802 800
Capital
expenditures 288 174 93 34 46
Long-term
liabilities 9,646 9,580 9,570 9,551 9,597
Total Stockholders'
Deficit (5,788) (6,638) (7,166) (7,296) (8,132)
14
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
The following table sets forth items from the Company's statements of operations
for fiscal years 2000, 2001 and 2002 (each ended May 31), as a percentage of
revenue.
Percent of Revenue
------------------
2000 2001 2002
---- ---- ----
Net sales 100.0% 100.0% 100.0%
------- ------- -------
Gross profit 11.4% 18.4% 13.3%
Operating expenses (17.1%) (19.4%) (20.6%)
------- ------- -------
Operating loss (5.7%) (1.0%) (7.3%)
Interest expense (3.4%) (2.7%) (2.5%)
Gain on settlement of Cryptek Note 3.2% 0.0% 0.0%
Other Income 0.0% 2.1% 0.4%
------- ------- -------
Net loss (5.9%) (1.6%) (9.4%)
======= ======= =======
Fiscal Year 2002 Compared to Fiscal Year 2001
Net sales for fiscal 2002 were approximately $8.9 million as compared with $8.3
million for fiscal 2001, representing an increase of 7.4%. The increase was due
primarily to sales totaling $3.5 million under a large contract with a prime
contractor to the U.S. Navy in fiscal 2002 as compared to sales of $1.3 million
in fiscal 2001 for the same Navy program.
The principal customer for the Company's products is the U.S. Government,
principally the U.S. Navy, which, directly or through its prime contractors,
accounted for 94% of the Company's revenues in fiscal year 2002. The Company's
sales to the United States Government and its prime contractors represented
approximately 91% and 83% of total net sales during the Company's fiscal years
ended May 31, 2001 and May 31, 2000, respectively, and are expected to continue
to account for a substantial portion of the Company's revenues for the
foreseeable future. The
15
Company's contracts with the United States Government are subject to the
availability of funds through annual appropriations, may be terminated by the
government for its convenience at any time and generally do not require the
purchase of a fixed quantity of products. Reductions in United States Government
defense spending could adversely affect the Company's operating results. While
the Company is not aware of present or anticipated reductions in United States
Government spending on specific programs or contracts pursuant to which the
Company has sold material quantities of its products, there can be no assurance
that such reductions will not occur or that decreases in United States
Government defense spending in general will not have an adverse effect on sales
of the Company's products in the future.
Gross profit for fiscal 2002 was approximately $1.2 million compared with
approximately $1.5 million for fiscal 2001. Gross profit as a percentage of
sales decreased from 18.4% in fiscal 2001 to 13.3% in fiscal 2002. The primary
reasons for the decrease in gross profit margins were changes in the mix of jobs
produced in the year ended May 31, 2002 as compared to the job mix in the year
ended May 31, 2001. The mix of jobs produced in the year ended May 31, 2002
required more machine shop hours than the prior year, and a larger amount of the
machine shop work was outsourced to subcontractors, at a higher cost per hour,
during the current period. In order to increase machine shop capacity and reduce
the amount of outsourcing for machined parts, the Company entered into a lease
purchase agreement for a new vertical machining center that was put into service
in December 2001.
Operating expenses for fiscal 2002 were approximately $1.8 million compared with
$1.6 million for fiscal 2001. The increase in fiscal 2002 was principally due to
the Company recognizing $265,100 in start-up costs related to a large blanket
contract with a U.S. Navy prime contractor. The Company incurred significant
costs in planning, implementing, and training employees for the new production
process related to this contract. In accordance with generally accepted
accounting principles, the Company has expensed these start-up costs. During the
fiscal year ended May 31, 2001, the Company incurred $42,800 in Product
Research, Development & Improvement costs related to the initial development
work on a new enclosure product. No such costs were incurred in fiscal 2002.
During fiscal 2002, the Company recorded $37,400 in "other income" related to
stock issued to the Company in December 2001 by Prudential Financial upon its
conversion from a mutual company to a stock company. During the fiscal year
ended May 31 2001,
16
the Company recorded $175,000 in "other income" related to the collection of
notes receivable due from Link2It, LLC that had been fully reserved in the prior
fiscal year (see Note 4 to the financial statements).
Interest Expense
Interest expense increased slightly to approximately $227,800 in fiscal 2002 as
compared to approximately $219,700 in fiscal 2001. This increase occurred
principally because interest expense from factoring accounts receivable was
$29,500 in fiscal 2002 as compared to $9,300 in fiscal 2001.
The overall net loss was $835,400 for fiscal 2002 as compared to a net loss of
$129,800 in fiscal 2001. The increased loss was primarily due to the decrease in
gross profits and the manufacturing start-up costs discussed above.
Income Taxes
The Company had no income tax provision in fiscal 2002 or fiscal 2001 due to the
net losses. Under Statement of Accounting Standards No. 109 (FAS 109), deferred
tax assets and liabilities are determined based on differences between financial
reporting and tax basis of assets and liabilities and are measured using enacted
tax rates and laws that will be in effect when the differences are expected to
reverse. The Company has provided a full valuation allowance against its net
deferred tax asset due to uncertainties of its ultimate realization. If the
Company achieves profitable operations, it will be subject to alternative
minimum taxes, which have a lower effective tax rate than the statutory rate of
34%.
Fiscal Year 2001 Compared to Fiscal Year 2000
Net sales for fiscal 2001 were approximately $8.3 million as compared with $8.8
million for fiscal 2000, representing a decrease of 6.5%. The decrease in sales
was due primarily to normal fluctuations in the timing of appropriations for
government spending.
The principal customer for the EED's products is the U.S. Government,
principally the U.S. Navy, which, directly or through its prime contractors,
accounted for 91% of the EED's revenues in fiscal year 2001. The Company's sales
to the United States government and its prime contractors represented
approximately
17
83% and 92% of total net sales during the Company's fiscal years ended May 31,
2000 and May 31, 1999, respectively.
Gross profit for fiscal 2001 was approximately $1.5 million compared with
approximately $1.0 million for fiscal 2000. Gross profit as a percentage of
sales increased from 11.4% in fiscal 2000 to 18.4% in fiscal 2001. The primary
reasons for the increase in gross profit margins were the steps taken to address
production issues identified during fiscal 2000 as the Company faced large
fluctuations in shipping volume due to the timing of appropriations for
government spending.
Operating expenses for fiscal 2001 were approximately $1.6 million compared with
$1.5 million for fiscal 2000. During the fiscal year ended May 31, 2001, the
Company incurred $42,800 in Product Research, Development & Improvement costs
related to the initial development work on a new enclosure product.
During the fiscal year ended May 31 2001, the Company recorded $175,000 in
"other income" related to the collection of notes receivable due from Link2It,
LLC that had been fully reserved in the prior fiscal year.
During fiscal 2000 the Company recorded a non-recurring gain of $278,800 on the
settlement of the Cryptek note and preferred interest.
Interest Expense
Interest expense decreased to approximately $219,700 in fiscal 2001 as compared
to approximately $298,900 in fiscal 2000. This decrease occurred principally
because interest expense from factoring accounts receivable was $9,300 in fiscal
2001 as compared to $70,800 in fiscal 2000.
The overall net loss was $129,800 for fiscal 2001 as compared to a net loss of
$528,800 in fiscal 2000. The improvement was primarily due to the increase in
gross profits discussed above.
18
Liquidity and Capital Resources
The Company relies upon internally generated funds and accounts receivable
financing to finance its operations. During fiscal years 2002 and 2001, the
Company showed a net loss of approximately $835,400 and $129,800, respectively.
In order to generate the working capital required for operations, the Company
must continue to generate orders, increase its gross margins, and effectively
manage operating expenses during fiscal 2003.
The Company must continue to market electronic enclosure products to government
and commercial markets, enter into contracts which the Company can complete with
favorable profit margins, ship the orders in a timely manner, and control its
costs in order to recover from its liquidity problems and seek to operate
profitably in fiscal 2003.
As of May 31, 2002, the Company had cash and marketable securities totaling
$222,500. The Company has faced production issues that have contributed to
losses from operations in the last two fiscal years. The Company has taken and
is continuing to take steps to address these production issues through changes
and additions to plant supervision, regularly updating scheduling and planning
procedures, and adding new production machinery. The Company is trying to
stabilize the level of shipments at a profitable level through these changes.
Management believes that cash on hand, borrowings from the factoring of accounts
receivable, and careful management of operating costs and cash disbursements can
enable the Company to meet its cash requirements through the next twelve months.
The Company may also seek additional funding sources to provide a cushion to
handle variances in cash requirements if sales, gross profits and shipment
levels fluctuate throughout the fiscal year, or if the Company purchases capital
equipment to increase production capacity due to any possible increased sales
opportunities. However, there is no assurance the Company will be successful in
pursuing its plans or in obtaining additional financing to meet those cash
requirements. The Company must continue to maintain or increase its level of
sales, consistently make timely shipments and produce its products at adequate
profit margins, or the Company will continue to face liquidity problems, and may
be left without sufficient cash to meet its ongoing requirements.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company sustained operating losses
in fiscal 2002, 2001 and 2000, and in
19
addition, the Company has significant short-term cash commitments, the funding
of which is limited to cash flow from operations and the factoring of certain
accounts receivable. These factors raise significant doubt about the Company's
ability to continue as a going concern. The financial statements do not contain
any adjustment that might result from the outcome of these uncertainties.
In recent years, the Company had been party to a factoring agreement with
Reservoir Capital Corporation ("Reservoir") that provides for advances (or
loans) of up to 80% of specified accounts receivable. In August 2001, Link2It
Corporation, a company formed by Larry Heimendinger and Richard McConnell, both
directors of the Company, entered into a new factoring agreement with the
Company on terms substantially similar to those of the Reservoir facility, but
more favorable to the Company in certain respects, including provision for
advances at a rate of up to 85% of specified accounts receivable. A new
factoring agreement with Link2It Corporation, on similar terms, was entered into
in April 2002. The Company expects to draw on this facility, or a similar
facility, throughout fiscal 2003 as necessary to help alleviate liquidity
problems, although, as discussed above, the Company will also need to control
expenses, maintain the sales backlog at appropriate levels, and keep shipment
levels in line with booked orders in order to meet these requirements. At May
31, 2002 there were no outstanding advances due to Link2It Corporation. At some
point during fiscal 2003 the factoring of accounts receivable may no longer be
available from Link2It Corporation. The Company believes that a facility similar
to that previously provided by Reservoir should be available from commercial
factors, however, there can be no assurance whether, or on what terms, the
Company can obtain such a facility in the future.
The Company had significant amounts payable to trade creditors at May 31, 2002.
Current maturities of long-term debt amount to $108,500 in fiscal 2003.
The Company has outstanding debentures originally issued to clients of
Gutzwiller, now known as Rabo Investment Management Ltd. (the "Manager")
totaling approximately $9.0 million. The debentures mature in August 2004, are
convertible into common stock at a conversion price of 50 cents per share, and
bear interest at 1% per annum payable annually. In a filing with the SEC dated
November 9, 2001, the Manager indicated that it may be deemed to be the
beneficial owner of debentures having an aggregate principal amount of
$7,885,000, including 585,000 which were purchased by the manager to which the
Manager is the economic beneficial owner of and holds sole voting and
20
dispositive power, and $7,300,000 held in client accounts managed by the Manager
on behalf of various clients who hold beneficial economic ownership thereof to
which the Manager holds voting and dispositive power.
Analysis of Cash Flows
Operating activities used $71,400 in cash in fiscal 2002. This reflects a net
loss of $835,400 offset by $217,500 in net non-cash income and expenses, and
$546,500 in cash to fund changes in working capital items. The cash used to fund
changes in working capital items includes a decrease in inventories of $562,300
and a decrease in accounts receivable of $381,300, partially offset by an
decrease in accounts payable of $338,200. The decrease in inventories was
primarily due to the decrease in backlog at May 31, 2002 as compared to May 31,
2001.
Investing activities used $45,600 in fiscal 2002. These activities consisted of
acquiring property, plant and equipment.
Financing activities used $86,200 in fiscal 2002. These activities consisted of
the repayment of certain long-term debt, and factoring accounts receivable
netting to $0.
Contractual Obligations and Commercial Commitments
The Company's commitments through May 31, 2006 are comprised of the following at
May 31, 2002 (in thousands):
Through May 31,
----------------------------------------------------
2003 2004 2005 2006 2007+ Total
---- ---- ---- ---- ----- -----
Convertible debentures $ 0 $ 0 $8,995 $ 0 $ 0 $ 8,995
Other notes payable 0 0 40 0 0 40
Real estate mortgage 90 96 101 108 56 451
Capital leases 26 26 26 26 15 119
Operating leases 22 2 2 2 1 29
Total $138 $124 $9,164 $136 72 $9,634
====================================================
Inflation
The Company believes the effects of inflation currently do not have a material
impact on its operations, financial position, or cash flows.
Critical Accounting Policies
21
The Company's significant accounting policies are more fully described in the
notes to the financial statements. The preparation of financial statements in
conformity with accounting principles generally accepted within the United
States requires management to make estimates and assumptions in certain
circumstances that affect amounts reported in the accompanying financial
statements and related notes. In preparing these financial statements,
management has made its best estimates and judgments of certain amounts included
in the financial statements, giving due consideration to materiality. The
Company does not believe there is a great likelihood that materially different
amounts would be reported related to the accounting policies described below;
however, application of these accounting policies involves the exercise of
judgment and the use of assumptions as to future uncertainties and, as a result,
actual results could differ from these estimates.
Work in process inventory represents actual production costs, including
manufacturing overhead incurred to date, reduced by amounts identified with
revenue recognized on units delivered. The costs attributable to units delivered
are based on the estimated average costs of all units expected to be produced
under multi-unit orders. Estimated costs to complete are based on historical
experience and knowledge of building similar products. On an on-going basis, the
Company evaluates the estimates of total costs to complete a multi-unit order.
Work in process is reduced by charging any amounts in excess of estimated net
realizable value to cost of sales as soon as they become known. Interim
inventories are determined by application of estimated gross profit margins to
sales.
The Company provides an allowance for uncollectible receivables based on
experience with customers and individual review of any past due accounts.
Although it is reasonably possible that that management's estimate could change
in the near future, management is not aware of any events that would result in a
change to its estimate which would be material to the Company's financial
position or its results of operations. At May 31, 2002, the Company had an
allowance for doubtful accounts of $70,900.
Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141").
SFAS 141 changed the accounting for business combinations, requiring that all
business
22
combinations be accounted for using the purchase method and that intangible
assets be recognized as assets apart from goodwill if they arise from
contractual or other legal rights, or if they are separable or capable of being
separated from the acquired entity and sold, transferred, licensed, rented or
exchanged. SFAS 141 is effective for all business combinations initiated after
June 30, 2001.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Accounting for Goodwill" ("SFAS 142"). SFAS 142 establishes accounting
standards for existing goodwill related to purchase business combinations. Under
SFAS 142, the Company would discontinue the periodic amortization of goodwill
effective with adoption of the SFAS 142. Also, the Company would have to test
any remaining goodwill for possible impairments within six months of adoption of
SFAS 142, and periodically thereafter, based on new valuation criteria set forth
in SFAS 142. Further, SFAS 142 has new criteria for purchase price allocation.
SFAS 142 becomes effective June 1, 2002.
The Company believes that the adoption of these pronouncements will not have a
material impact of its financial position or results of operations.
In August 2001, the FASB approved Statement on Financial Accounting Standards
No. 144. "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived assets and for Long-Lived assets to be disposed Of" and the
accounting and reporting provisions of the Accounting Principles Board Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS No. 144 establishes a single accounting
model, based on the framework established in SFAS No. 121, for long-lived assets
to be disposed of by sale and resolved significant implementation issues related
to SFAS No. 121. SFAS No. 144 retains the requirements of SFAS No. 121 to
recognize an impairment loss only if the carrying amount of a long-lived asset
is not recoverable from its undiscounted cash flows and measure an impairment
loss as the difference between the carrying amount and fair value of the asset.
SFAS No. 144 excludes goodwill from its scope, describes a probability-weighted
cash flow estimation approach, and establishes a "primary-asset" approach to
determine the cash flow estimation for groups of assets and liabilities. SFAS
No. 144 is effective for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years, with early adoption encouraged. The
Company plans to adopt SFAS No. 144 in the first
23
quarter of fiscal year 2003 and believes it will not have a material impact of
its financial position or results of operations.
In May 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
statement changes certain accounting related to the extinguishment of debt, and
eliminates inconsistencies between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. SFAS No.
14 also amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability under
changed conditions. The statement is effective after May 15, 2002 and early
application is encouraged as of the beginning of the fiscal year or as of the
beginning of the interim period in which the statement is issued. The adoption
of the statement is not expected to have an impact on the Company's present
financial condition or results of operations.
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities." SFAS No. 146 provides guidance on the timing of
the recognition of costs associated with exit or disposal activities. The new
guidance requires costs associated with exit or disposal activities be
recognized when incurred. Previous guidance required recognition of costs at the
date of commitment to an exit or disposal plan. The provisions of the statement
are to be adopted prospectively after December 31, 2002. Although SFAS No. 146
may impact the accounting for costs related to exit or disposal activities the
Company may enter into in the future, particularly the timing of the recognition
of these costs, the adoption of the statement will not have an impact on the
Company's present financial condition or results of operations.
24
ITEM 7A - Quantitative and Qualitative Disclosures About Market Risk
Market Risk - The Company is exposed to market risk from adverse changes in
interest rates.
Interest Rate Risks - The Company is exposed to risk from changes in interest
rates as a result of its borrowing activities. At May 31, 2002, the Company had
total debt of $9.39 million, of which $0.40 million represents borrowing for its
real estate mortgage, which is at a variable interest rate. Interest on the
Company's debt is directly affected by changes in the prime interest rate, and
therefore fluctuations may have an impact on the Company's financial results.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
25
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors And Stockholders
General Kinetics Incorporated
Chantilly, Virginia
We have audited the accompanying balance sheets of General Kinetics Incorporated
as of May 31, 2002 and 2001, and the related statements of operations,
stockholders' deficit, and cash flows for each of the three years in the period
ended May 31, 2002. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of General Kinetics Incorporated
as of May 31, 2002 and 2001, and the results of its operations and its cash
flows for each of the three years in the period ended May 31, 2002 in conformity
with accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Company
will continue as a going concern. The Company has sustained recurring operating
losses in fiscal 2002, 2001, and 2000. In addition, the Company has significant
short-term cash commitments and funding is limited to cash flow from operations
and loans collateralized by certain accounts receivable. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
Management's plans in regards to these matters are described in Note 1. The
financial statements do not contain any adjustments that might result from the
outcome of these uncertainties.
/s/ BDO Seidman, LLP
BDO Seidman, LLP
Washington, DC
August 2, 2002
26
General Kinetics Incorporated
Balance Sheets
May 31, May 31,
2002 2001
---- ----
Assets
------
Current Assets:
Cash and cash equivalents $ 185,100 $ 388,300
Marketable securities - trading 37,400 -
Accounts receivable, net of allowance of $70,900 and $72,700 872,100 1,251,600
Inventories 906,300 1,452,300
Prepaid expenses and other 56,800 13,100
------------ ------------
Total Current Assets 2,057,700 3,105,300
------------ ------------
Property, Plant and Equipment 2,925,100 2,786,100
Less: Accumulated Depreciation and Amortization (2,124,700) (1,984,400)
------------ ------------
800,400 801,700
Patent - 38,000
Other Assets 59,400 64,400
------------ ------------
Total Assets $ 2,917,500 $ 4,009,400
============ ============
Liablilities and Stockholders' Deficit
--------------------------------------
Current Liabilities:
Current maturities of long-term debt $ 90,000 $ 75,100
Current maturities of capital lease 18,500
Accounts payable, trade 765,900 1,104,100
Accrued expenses and other payables 577,500 575,000
------------ ------------
Total Current Liabilities 1,451,900 1,754,200
------------ ------------
Long-Term debt - less current maturities (including
$8,855,800 and $8,793,900 of convertible debentures) 9,256,700 9,288,300
Captial lease - less current maturities 82,000 -
Other long-term liabilities 258,400 263,000
------------ ------------
Total Long-Term Liabilities 9,597,100 9,551,300
------------ ------------
Total Liabilities 11,049,000 11,305,500
------------ ------------
Commitments and Contingencies
Stockholders' Deficit:
Common Stock, $0.25 par value, 50,000,000 shares authorized 1,811,500 1,811,500
7,245,557 shares issued, 6,718,925 shares outstanding
Additional Contributed Capital 7,239,400 7,239,400
Accumulated Deficit (16,732,200) (15,896,800)
------------ ------------
(7,681,300) (6,845,900)
Less:
Treasury Stock, at cost (526,632 shares) (450,200) (450,200)
------------ ------------
Total Stockholders' Deficit (8,131,500) (7,296,100)
------------ ------------
Total Liabilities and Stockholders' Deficit $ 2,917,500 $ 4,009,400
============ ============
The accompanying notes are an integral part of the financial statements.
Page 27
General Kinetics Incorporated
Statements of Operations
For the Years Ended May 31, 2002, and 2000
2002 2001 2000
---- ---- ----
Net Sales $ 8,870,000 $ 8,258,500 $ 8,833,000
Cost of Sales 7,691,100 6,735,800 7,827,500
----------- ----------- -----------
Gross Profit 1,178,900 1,522,700 1,005,500
----------- ----------- -----------
Selling, General & Administrative 1,558,800 1,565,000 1,514,200
Product Research, Development & Improvement - 42,800 -
Manufacturing Start-Up Costs 265,100 - -
----------- ----------- -----------
Total Operating Expenses 1,823,900 1,607,800 1,514,200
----------- ----------- -----------
Operating Loss (645,000) (85,100) (508,700)
Gain on settlement of Cryptek note - - 278,800
Other Income 37,400 175,000 -
Interest Expense (227,800) (219,700) (298,900)
----------- ----------- -----------
Net Loss $ (835,400) $ (129,800) $ (528,800)
=========== =========== ===========
Basic and diluted loss per share ($0.124) ($0.019) ($0.079)
------ ------ ------
Weighted Average Number of Common Shares
Outstanding 6,718,925 6,718,925 6,718,925
The accompanying notes are an integral part of the financial statements.
Page 28
General Kinetics Incorporated
Statements of Stockholders' Deficit
For the Years Ended May 31, 2002, 2001, and 2000
Additional Total
Common Stock Contributed Accumulated Treasury Stockholders'
Shares Amount Capital Deficit Stock Equity
------ ------ ------- ------- ----- ------
Balance 5/31/99 7,245,557 $ 1,811,500 $ 7,239,400 $(15,238,200) $ (450,200) $ (6,637,500)
Net Loss (528,800) (528,800)
------------ ------------ ------------ ------------ ------------ ------------
Balance 5/31/00 7,245,557 1,811,500 7,239,400 (15,767,000) (450,200) (7,166,300)
Net Loss (129,800) (129,800)
------------ ------------ ------------ ------------ ------------ ------------
Balance 5/31/01 7,245,557 1,811,500 7,239,400 (15,896,800) (450,200) (7,296,100)
Net Loss (835,400) (835,400)
------------ ------------ ------------ ------------ ------------ ------------
Balance 5/31/02 7,245,557 $ 1,811,500 $ 7,239,400 $(16,732,200) $ (450,200) $ (8,131,500)
============ ============ ============ ============ ============ ============
The accompanying notes are an integral part of the financial statements.
Page 29
General Kenetics Incorporated
Statements of Cash Flows
For the years ended May 31, 2002, 2001, and 2000
2002 2001 2000
---- ---- ----
Cash Flows From Operating Activities:
Net Loss $ (835,400) $ (129,800) $ (528,800)
Adjustments to reconcile net income
to net cash used in operating activities:
Depreciation and amortization 155,000 157,400 184,000
Amortization of bond discount 61,900 61,900 61,900
Write-off of patent 38,000 - -
Gain from distribution of stock (37,400) - -
Bad debt recovery - (175,000) -
Provision for doubtful accounts (1,800) (2,300) (196,500)
Provision for inventory obsolescence 101,200 85,000 95,000
Write-off of inventory (117,500) (125,000) (55,000)
(Increase) Decrease in Assets:
Accounts Receivable 381,300 (118,700) 506,200
Inventories 562,300 (429,500) 262,800
Prepaid Expenses (2,900) 23,100 23,100
Other assets (35,800) (4,700) (71,000)
Increase (Decrease) in Liabilities:
Accounts Payable - Trade (338,200) 230,400 (85,100)
Accrued Expenses and other payables 2,500 (164,300) 100,500
Other Long Term Liabilities (4,600) (6,000) (6,400)
----------- ----------- -----------
Net cash provided by (used) in Operating Activites (71,400) (597,500) 290,700
----------- ----------- -----------
Cash Flows from Investing Activities:
Acquisition of property, plant and equipment (45,600) (34,200) (93,000)
Collection of notes recievable - 175,000 550,000
----------- ----------- -----------
Net cash provided by (used) in Investing Activities (45,600) 140,800 457,000
----------- ----------- -----------
Cash Flows from Financing Activities:
Advances from Factor/Borrowings
on Demand Notes Payable 1,305,700 132,700 600,000
Repayments of Advances from Factor/
Demand Notes Payable (1,305,700) (176,800) (634,900)
Principal payments under capital lease (7,600)
Repayments on Long Term Debt (78,600) (69,000) (62,100)
----------- ----------- -----------
Net cash used in Financing Activities (86,200) (113,100) (97,000)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents (203,200) (569,800) 650,700
Cash and Cash Equivalents: Beginning of Period 388,300 958,100 307,400
----------- ----------- -----------
Cash and Cash Equivalents: End of Period $ 185,100 $ 388,300 $ 958,100
=========== =========== ===========
Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest $ 162,600 $ 151,300 $ 200,900
Income Taxes $ 800 $ 800 $ 800
Non-cash investing and financing activities:
Assets acquired under capital lease $ 108,100 $ - $ -
The accompanying notes are an integral part of the financial statements.
Page 30
GENERAL KINETICS INCORPORATED
NOTES TO FINANCIAL STATEMENTS
1. FUTURE PROSPECTS AND RECENT OPERATIONS:
General Kinetics Incorporated (the "Company" or "GKI") has relied upon
internally generated funds and accounts receivable financing to finance its
operations. During fiscal years 2002 and 2001, the Company showed a net loss of
approximately $835,400 and $129,800, respectively. In order to generate the
working capital required for operations, the Company must continue to generate
orders, increase its gross margins, and begin to operate profitably during
fiscal 2003.
The Company must continue to market electronic enclosure products to government
and commercial markets, enter into contracts which the Company can complete with
favorable profit margins, ship the orders in a timely manner, and control its
costs in order to recover from its liquidity problems and seek to operate
profitably in fiscal 2003.
As of May 31, 2002, the Company had cash of $185,100. The Company has faced
production issues that have contributed to losses from operations in the last
two fiscal years. The Company has taken and is continuing to take steps to
address these production issues through changes and additions to plant
supervision, regularly updating scheduling and planning procedures, and adding
new production machinery. The Company is trying to stabilize the level of
shipments at a profitable level through these changes.
Management believes that cash on hand, borrowings from the factoring of accounts
receivable, and careful management of operating costs and cash disbursements can
enable the Company to meet its cash requirements through the next twelve months.
The Company may also seek additional funding sources to provide a cushion to
handle variances in cash requirements if sales, gross profits and shipment
levels fluctuate throughout the fiscal year, or if the Company purchases capital
equipment to increase production capacity due to any possible increased sales
opportunities. However, there is no assurance the Company will be successful in
pursuing its plans or in obtaining additional financing to meet those cash
requirements. The Company must continue to maintain or increase its level of
sales, consistently make timely shipments and produce its products at adequate
profit margins, or the Company will continue to face liquidity problems,
31
and may be left without sufficient cash to meet its ongoing requirements.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company sustained operating losses
in fiscal 2002, 2001 and 2000, and in addition, the Company has significant
short-term cash commitments, the funding of which is limited to cash flow from
operations and the factoring of certain accounts receivable. These factors raise
significant doubt about the Company's ability to continue as a going concern.
The financial statements do not contain any adjustment that might result from
the outcome of these uncertainties.
In recent years, the Company had been party to a factoring agreement with
Reservoir Capital Corporation ("Reservoir") that provides for advances (or
loans) of up to 80% of specified accounts receivable. In August 2001, Link2It
Corporation, a company formed by Larry Heimendinger and Richard McConnell, both
directors of the Company, entered into a new factoring agreement with the
Company on terms substantially similar to those of the Reservoir facility, but
more favorable to the Company in certain respects, including provision for
advances at a rate of up to 85% of specified accounts receivable. A new
factoring agreement with Link2It Corporation, on similar terms, was entered into
in April 2002. The Company expects to draw on this facility, or a similar
facility, throughout fiscal 2003 as necessary to help alleviate liquidity
problems, although, as discussed above, the Company will also need to control
expenses, maintain the sales backlog at appropriate levels, and keep shipment
levels in line with booked orders in order to meet these requirements. At some
point during fiscal 2003 the factoring of accounts receivable may no longer be
available from Link2It Corporation. The Company believes that a facility similar
to that previously provided by Reservoir should be available from commercial
factors, however, there can be no assurance whether, or on what terms, the
Company can obtain such a facility in the future.
2. SIGNIFICANT ACCOUNTING POLICIES:
The Company's significant accounting policies are described below.
32
NATURE OF BUSINESS:
The Company designs, manufactures and sells specialty metal products such as
precision enclosures and rack mounting systems for the installation of
electronics.
Cash and Cash Equivalents
The Company classifies all temporary investments purchased with a maturity of
less than three months as cash equivalents.
Revenue Recognition and Profit Determination
Revenues, sales, and cost of sales on fixed-price contracts are generally
recorded when units are delivered based on the profit rate anticipated on the
contracts at completion. The Company's contracts are primarily fixed price.
Sales and cost of sales from cost reimbursable and time-and-materials contracts
are recognized as costs are incurred. Profits expected to be realized on
contracts are based on total sales value and estimated costs at completion.
These estimates are reviewed and revised periodically throughout the lives of
the contracts and adjustments to profits resulting from such revisions are made
cumulative to the date of change. Amounts in excess of the agreed-upon contract
price for customer caused delays, errors, and change orders are recognized in
contract value if it is probable that the claim will result in additional
revenue and the amount can be reasonably estimated. Losses on contracts are
recorded in full as soon as they become known.
Marketable Securities
Investments in equity securities with readily determinable fair values are
reported at fair value, with gains and losses reported in the statement of
operations.
Inventories
Inventories are valued at the lower of cost (first-in, first-out method) or
market (net realizable value).
33
Property, Plant, and Equipment
Property, plant and equipment are recorded at cost. The Company provides for
depreciation and amortization on an accelerated basis for machinery and
equipment and furniture and fixtures and on a straight-line basis for all other
assets over the following estimated useful lives:
Buildings and improvements 18 to 45 years
Machinery and equipment 3 to 7 years
Furniture and fixtures 5 to 7 years
Transportation equipment and other 3 years
Leasehold improvements are amortized on a straight-line basis over the shorter
of the useful life of the improvement or the remaining term of the lease.
Expenditures for maintenance and repairs are charged against income as incurred;
betterments which increase the value or materially extend the life of the asset
are capitalized. When assets are sold or retired, the cost and accumulated
depreciation are removed from the accounts, and any gain or loss is included in
income.
In accordance with SFAS 121, the Company periodically evaluates the carrying
value of long-lived assets when events and circumstances warrant such a review.
The carrying value of a long-lived asset is considered impaired when the
anticipated undiscounted cash flow from such asset is separately identifiable
and is less than the carrying value. In that event, a loss is recognized based
on the amount by which the carrying value exceeds the fair market value of the
long-lived asset. Fair market value is determined primarily using the
anticipated cash flows discounted at a rate commensurate with the risk involved.
Product Research, Development and Improvements
Costs associated with product research, development and improvements are
expensed as incurred.
Income Taxes
The Company accounts for income taxes under the asset and liability method which
requires that deferred tax assets and liabilities be recognized for the
estimated future tax consequences attributable to differences between the
financial
34
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The recognition of net deferred tax assets is reduced, if
necessary, by a valuation allowance for the amount of any tax benefits that,
based on available evidence, are not expected to be realized. Deferred tax
assets and liabilities are measured using enacted tax rates in effect for the
year in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income tax expense in the period that includes the
enactment date.
Basic and Diluted Earnings Per Share
Earnings per share is based on the weighted average number of shares of common
stock and dilutive common stock equivalents outstanding. Basic earnings per
share includes no dilution and is computed by dividing income available to
common shareholders by the weighted average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution of
securities that could share in the earnings of an entity. Common stock
equivalents consist of convertible debentures (see Note 9) and stock options
(see Note 13). Basic and diluted earnings per share are the same in fiscal 2002,
2001, and 2000 because the impact of dilutive securities is anti-dilutive.
Estimates and Assumptions
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the 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. Certain estimates used by
management are particularly susceptible to significant changes in the economic
environment. These include estimates of inventory obsolescence, valuation
allowances for trade receivables and deferred tax assets. Each of these
estimates, as well as the related amounts reported in the financial statements,
are sensitive to near term changes in the factors used to determine them. A
significant change in any one of those factors could result in the determination
of amounts different than those reported in the financial statements. Management
believes that as of May 31, 2002, the estimates used in
35
the financial statements are adequate based on the information currently
available.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS 141").
SFAS 141 changed the accounting for business combinations, requiring that all
business combinations be accounted for using the purchase method and that
intangible assets be recognized as assets apart from goodwill if they arise from
contractual or other legal rights, or if they are separable or capable of being
separated from the acquired entity and sold, transferred, licensed, rented or
exchanged. SFAS 141 is effective for all business combinations initiated after
June 30, 2001.
In June 2001, the FASB issued Statement of Financial Accounting Standards No.
142, "Accounting for Goodwill" ("SFAS 142"). SFAS 142 establishes accounting
standards for existing goodwill related to purchase business combinations. Under
SFAS 142, the Company would discontinue the periodic amortization of goodwill
effective with adoption of the SFAS 142. Also, the Company would have to test
any remaining goodwill for possible impairments within six months of adoption of
SFAS 142, and periodically thereafter, based on new valuation criteria set forth
in SFAS 142. Further, SFAS 142 has new criteria for purchase price allocation.
SFAS 142 becomes effective June 1, 2002.
The Company believes that the adoption of these pronouncements will not have a
material impact of its financial position or results of operations.
In August 2001, the FASB approved Statement on Financial Accounting Standards
No. 144. "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS
144"). SFAS No. 144 supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived assets and for Long-Lived assets to be disposed Of" and the
accounting and reporting provisions of the Accounting Principles Board Opinion
No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS No. 144 establishes a single accounting
model, based on the framework established in SFAS No. 121, for long-lived assets
to be disposed of by sale and resolved significant implementation issues related
to SFAS No. 121. SFAS No.
36
144 retains the requirements of SFAS No. 121 to recognize an impairment loss
only if the carrying amount of a long-lived asset is not recoverable from its
undiscounted cash flows and measure an impairment loss as the difference between
the carrying amount and fair value of the asset. SFAS No. 144 excludes goodwill
from its scope, describes a probability-weighted cash flow estimation approach,
and establishes a "primary-asset" approach to determine the cash flow estimation
for groups of assets and liabilities. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001, and interim periods within those fiscal
years, with early adoption encouraged. The Company plans to adopt SFAS No. 144
in the first quarter of fiscal year 2003 and believes it will not have a
material impact of its financial position or results of operations.
In May 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." This
statement changes certain accounting related to the extinguishment of debt, and
eliminates inconsistencies between the required accounting for sale-leaseback
transactions and the required accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions. SFAS No.
14 also amends other existing authoritative pronouncements to make various
technical corrections, clarify meanings, or describe their applicability under
changed conditions. The statement is effective after May 15, 2002 and early
application is encouraged as of the beginning of the fiscal year or as of the
beginning of the interim period in which the statement is issued. The adoption
of the statement is not expected to have an impact on the Company's present
financial condition or results of operations.
In July 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities." SFAS No. 146 provides guidance on the timing of
the recognition of costs associated with exit or disposal activities. The new
guidance requires costs associated with exit or disposal activities be
recognized when incurred. Previous guidance required recognition of costs at the
date of commitment to an exit or disposal plan. The provisions of the statement
are to be adopted prospectively after December 31, 2002. Although SFAS No. 146
may impact the accounting for costs related to exit or disposal activities the
Company may enter into in the future, particularly the timing of the recognition
of these costs, the adoption of the statement will not have an impact on the
Company's present financial condition or results of operations.
37
3. SETTLEMENT OF CRYPTEK NOTE RECEIVABLE
In December 1998, the Company entered into a settlement agreement with Cryptek
Secure Communications, LLC ("Cryptek"), resolving differences arising out of
Cryptek's purchase of GKI's former secure communications business. Pursuant to
such settlement, Cryptek made an immediate principal payment of $25,000 on its
outstanding promissory note to the Company and agreed to forego sublease rent
owed by the Company through November 1998. The remaining principal amount of the
Cryptek promissory note was reduced to $550,000 and the payment schedule for
such note was revised and extended through 2002. In addition, the face value of
the preferred membership interest in Cryptek held by the Company was reset at
$900,000, and the requirement for redemption of such interest by Cryptek was
extended through December 2002.
In October 1999, the Company entered into an agreement that amended the
settlement agreement the Company had reached with Cryptek in December 1998. The
October 1999 agreement reduced the face amount of the promissory note payable to
the Company by Cryptek from $550,000 to $400,000 in exchange for accelerating
the payment schedule. The Company received $200,000 upon execution of the new
agreement. In addition, the October 1999 agreement gave Cryptek the option to
pay the remainder of the promissory note and redeem the preferred interest in
Cryptek held by the Company (with a face amount of $900,000 and a requirement
for mandatory redemption in December 2002) for an additional $488,750, if that
option was exercised within six months after the execution of the October 1999
agreement.
At November 30, 1999, the $150,000 reduction in the face amount of the note was
offset against an existing valuation reserve related to the Cryptek promissory
note. In December 1999, Cryptek exercised its option and paid the Company
$478,800, representing a discount of $10,000 in consideration of a closing in
December 1999 rather than at the end of the six-month option period in April
2000. The $478,800 was first applied to settle the note receivable with a
carrying value of $200,000, and the excess of $278,800 is recorded in the
accompanying financial statements as a non-recurring gain in non-operating
income. This gain was recognized because GKI did not attribute any value to the
preferred interest in Cryptek for financial reporting purposes due to
uncertainty over valuation at the time of the original sale transaction.
38
4. - RELATED PARTY TRANSACTIONS
At May 31, 2000, the Company had a membership interest in Link2It, LLC, a
company formed by Larry Heimendinger and Richard McConnell, both GKI board
members. The financial statements at May 31, 2000 included a note receivable of
$175,000 from Link2It. This note receivable was fully reserved due to the
uncertainty of its ultimate collection.
During January 2001, Link2It LLC merged into Link2It Corporation and completed a
sale of equity securities in a private transaction. The $175,000 principal
amount of the notes was repaid in full and recognized as "other income" on the
accompanying statement of operations. GKI also retained approximately 5.7% of
Link2It Corporation's then current outstanding common stock, which it accounts
for using the cost method. The Company has assigned no value to this investment
due to its speculative nature. The entire value was assigned to the note
receivable.
In August 2001, Link2It entered into a factoring agreement with the Company,
intended to supplement or replace the Company's prior agreement with Reservoir.
The new agreement, which was negotiated at arms length and approved by unanimous
vote of the Company's Board or Directors, is on terms substantially similar to
those of the Reservoir facility, but more favorable to the Company in certain
respects. A new factoring agreement with Link2It Corporation, on similar terms,
was entered into in April 2002. Interest expense related to the Link2It
factoring agreement was $30,500 in fiscal 2002.
5. CREDIT RISK
For the years ended May 31, 2002, 2001, and 2000, the Company's net sales to the
U.S. government and/or subcontractors accounted for 94%, 91%, and 83%,
respectively, of net sales. Accounts receivable from those customers amounted to
$.84 million and $1.13 million as of May 31, 2002 and 2001, respectively. A
substantial portion of the Company's sales are to the U.S. government and/or
subcontractors, and consequently a material decline in Department of Defense
spending could have a material adverse effect on the operations of the Company.
Competition in the Company's electronic enclosure business is intense as it
primarily operates in a mature industry. The Company's uncollectible receivables
have historically not been material. The Company has a cash balance with a bank
in excess of the federally insured limit. The Company
39
minimizes the risk by placing these funds with high-quality financial
institutions.
6. INVENTORIES
Inventories consist of the following:
May 31,
---------------
2002 2001
---- ----
Work in process $ 692,900 $1,119,000
Finished Goods 27,700 -
Raw materials 328,500 492,400
Valuation reserve (142,800) (159,100)
---------- ----------
Total $ 906,300 $1,452,300
========== ==========
Work in process inventory represents actual production costs, including
manufacturing overhead incurred to date, reduced by amounts identified with
revenue recognized on units delivered. The costs attributable to units delivered
are based on the estimated average costs of all units expected to be produced
under multi-unit orders. Estimated costs to complete are based on historical
experience and knowledge of building similar products. On an on-going basis, the
Company evaluates the estimates of total costs to complete a multi-unit order.
Work in process is reduced by charging any amounts in excess of estimated net
realizable value to cost of sales as soon as they become known. Interim
inventories are determined by application of estimated gross profit margins to
sales.
7. PROPERTY, PLANT AND EQUIPMENT:
Major classes of property, plant and equipment consist of the following at May
31:
2002 2001
------- -------
Machinery and equipment $ 1,300,700 $ 1,266,300
Equipment under capital lease 108,100 0
Buildings and improvements 919,000 920,000
40
Furniture and fixtures 523,200 510,100
Transportation equipment and other 74,100 89,700
---------- ----------
2,925,100 2,786,100
Less-Accumulated depreciation and
amortization 2,124,700 1,984,400
---------- ----------
Net property, plant and equipment $800,400 $ 801,700
========== ==========
Depreciation and amortization expense for the years ended May 31, 2002, 2001,
and 2000 was $155,000, $157,400, and $184,000, respectively. Included in
depreciation and amortization expense was $10,600 of amortization expense
related to the assets under capital lease.
8. ACCRUED EXPENSES AND OTHER PAYABLES:
Accrued expenses and other payables consists of the following at May 31:
2002 2001
---- ----
Employee vacations $ 278,500 $ 271,200
Salaries and wages 60,700 105,100
Other 238,300 198,700
---------- ----------
$ 577,500 $ 575,000
========== ==========
41
9. DEMAND NOTES PAYABLE AND LONG-TERM DEBT:
Demand notes payable and long-term debt consists of the following on May 31:
2002 2001
-------- -------
Subordinated Debt Originally Issued to
--------------------------------------
Clients of Gutzwiller and Partner, A.G.
---------------------------------------
and its successor, Rabo Investment Management Ltd.
--------------------------------------------------
1994 Convertible Subordinated
Debentures $8,995,000 $8,995,000
Other
-----
Real estate mortgage collateralized
by first deed of trust and security
interest in certain real property.
Payable in 180 equal installments
through November 2006, plus interest
at prime plus 1.0% (9.5% at May 31, 450,900 529,500
2002).
Other notes payable with interest rates at
1% at May 31, 2002, and payable August 2004. 40,000 40,000
---------- ----------
$9,485,900 $9,564,500
Less: Current Maturities (90,000) (75,100)
Unamortized discount
On Debentures (139,200) (201,100)
---------- ----------
Long-term debt $9,256,700 $9,288,300
========== ==========
The amount of unamortized discount on Convertible Debentures originally issued
to clients of Gutzwiller and its successor at May 31, 2002, is as follows:
42
Face Unamortized Carrying
Amount Due Discount Amount
---------- -------- ------
Convertible Debentures $8,995,000 $139,200 $8,855,800
In connection with the restructuring of the debt in 1994, the Company recorded a
discount of approximately $646,000 representing the difference between the cash
proceeds and the face amount of the debt. The total amount of discount
amortization was $61,900 for each of the years ending May 31, 2002, 2001, and
2000.
The convertible debentures mature in August 2004, are convertible into common
stock at a conversion price of 50 cents per share, and bear interest at 1% per
annum payable annually in arrears. The conversion feature of the financing was
approved by the Company's shareholders at an Annual Meeting of Shareholders held
in October 1994 through a motion to increase the number of authorized shares of
the Company. The convertible debentures are subject to the terms of a Pledge and
Security Agreement dated as of August 14, 1994 providing for a security interest
in substantially all the assets of the Company, with certain exceptions
(including, without limitation, exceptions for accounts receivable and other
financing), to secure the obligations in respect of the convertible debentures.
Shares issuable upon conversion of such convertible debentures are also subject
to certain rights to registration under the Securities Act of 1933, as amended.
Other Real Estate Mortgage Loans
The Company has a real estate mortgage agreement on the Company's Johnstown
facility that contains certain covenants which include restrictions on capital
expenditures and dividend payments. Additionally, the real estate mortgage
agreement contains a subjective covenant which could allow the bank to
accelerate the maturity of the debt if the bank determines that a material
adverse change in the financial or business condition of the Company has
occurred.
Future principal maturities of debt are as follows:
43
Year Ending
May 31,
2003 90,000
2004 95,600
2005 9,136,400
2006 107,700
2007 56,200
Thereafter 0
----------
Total $ 9,485,900
==========
10. INCOME TAXES:
Due to the net losses in fiscal 2002, 2001, and 2000 and the available net
operating loss carryforwards, there was no income tax expense for fiscal 2002,
2001, or 2000, nor were any additional income tax benefits available from the
carryback of net operating losses. Under Statement of Accounting Standards No.
109 (FAS 109) deferred tax assets and liabilities are determined based on
differences between financial reporting and tax basis of assets and liabilities
and are measured using enacted tax rates and laws that will be in effect when
the differences are expected to reverse. The Company has provided a full
valuation allowance against its net deferred tax assets due to uncertainties of
its ultimate realization. If the Company achieves profitable operations, it will
be subject to alternative minimum taxes, which has a lower effective tax rate
than the statutory rate of 34%. As of May 31, 2002, there are no additional
income tax benefits available from the carryback of net operating losses.
The difference between the Federal income tax provision (benefit) at the
statutory rate and the effective income tax provision (benefit) for the years
ended May 31, 2002, 2001, and 2000, is as follows:
2002 2001 2000
---- ---- ----
Tax provision (benefit) at
statutory rates $(291,000) $( 44,000) $(180,000)
Non-deductible related party
interest expense 32,000 31,000 18,000
Change in valuation allowance 259,000 13,000 162,000
--------- --------- ---------
$ - $ - $ -
========= ========= =========
44
The primary difference between income (loss) for financial reporting purposes
and income tax purposes is the recognition of reserves for uncollectible
accounts receivable and obsolete inventory, accrued professional fees, deferred
compensation, vacation accruals, and research and development expenses, which
are currently non-deductible for income tax purposes.
Principal items comprising deferred income tax assets and liabilitities, at May
31, are as follows:
2002 2001
----- -----
Net operating loss carryforward $ 4,538,000 $4,268,000
R & D and other credit carryforwards 380,000 380,000
Purchased R & D costs 63,000 81,000
Inventory reserves 55,000 48,000
Allowance for doubtful accounts 27,000 28,000
Excess financial statement depreciation (14,000) (11,000)
Accrued Vacations 106,000 103,000
Other accrued liabilities 4,000 102,000
Accrued professional fees 16,000 6,000
Allowance for Note Receivable - -
Deferred compensation 98,000 100,000
Total deferred tax assets 5,273,000 5,105,000
Valuation allowance (5,273,000) (5,105,000)
----------- ----------
Net deferred tax asset $ - $ -
=========== ==========
A valuation allowance is provided as management has determined that it is more
likely than not that the deferred tax assets will not be realized.
As of May 31, 2002, the Company has net operating loss carryforwards for Federal
and state income tax reporting purposes of approximately $11,943,000, which
expire at various dates through 2012. The Company has research and development
and other credit carryforwards for Federal income tax reporting purposes of
approximately $380,000.
45
11. COMMITMENTS:
Leases:
The Company maintains its executive offices in Northern Virginia.
The Company also leases certain equipment under noncancelable operating leases
which expire at various dates through 2002.
At May 31, 2002, approximate future minimum rental commitments for all
noncancelable operating leases are as follows:
Year Ending
May 31,
2003 $ 22,100
2004 2,400
2005 2,400
2006 2,400
2007 400
---------
$ 29,700
Less-sublease
income(through
Dec 31, 2002) 33,800
---------
$ (4,100)
=========
Amounts charged to operations for rent expense amounted to $27,100, $63,600, and
$90,500, for the years ended May 31, 2002, 2001 and 2000, respectively. These
amounts were offset by annual sublease income of approximately $57,900, $57,900,
and $21,200, respectively.
The Company is committed under a capital lease for equipment expiring in 2007:
Future minimum payments under the capital lease are as follows at May 31, 2002:
2003 $ 26,000
2004 $ 26,000
2005 $ 26,000
2006 $ 26,000
2007 $ 15,200
--------
46
Total future minimum lease payments $ 119,200
Less amount representing interest at 7.5% $ (18,700)
---------
Present value of future minimum lease payments $ 100,500
12. RETIREMENT PLANS:
The Company has the following retirement plans at May 31, 2002:
Defined Contribution Plans
In 2000, the Company adopted a 401(k) plan covering its union employees. The
Company makes matching contributions of up to 5% of the individual union
employee's pretax salary deferral. This plan replaced a defined contribution
plan in effect prior to August 2000. Total related pension expense was
approximately $78,400, $70,600, and $71,900, in fiscal 2002, 2001 and 2000,
respectively.
In addition, the Company has a 401(k) plan covering its nonunion employees.
Participants can make pretax salary deferrals up to certain limitations. Company
contributions are discretionary. Total related expenses were approximately
$21,100, $21,300, and $25,200, for fiscal years 2002, 2001 and 2000,
respectively.
Employee Stock Ownership Plan ("ESOP") and Trust Agreement
The Company has a noncontributory, qualified ESOP plan covering its nonunion,
full-time employees, who are at least 21 years of age. On April 19, 1991, the
Company funded the ESOP through a borrowing with its principal bank in the
amount of $1,500,000. The ESOP used the proceeds of a $1,500,000 loan from the
Company to purchase approximately 171,500 newly issued common shares of the
Company. The shares are shown as outstanding in the consolidated balance sheet.
These shares were earned and allocated to eligible employees over a five-year
period. As of May 31, 1997, all of the shares were earned and allocated.
47
Deferred Compensation Retirement Plan
The Company has an unfunded deferred compensation plan under which it is
committed to provide two retired officers and one surviving spouse of a retired
officer with joint and survivor's lifetime annuity payments, beginning upon
retirement at age 65. The lifetime annuity provides the retired officer with an
annual stipend of 16 percent of base salary at the time of retirement. Upon the
officer's death, a surviving spouse is entitled to receive one-half of that
amount for such spouse's lifetime. The Company provides, on an annual basis, for
anticipated payments under this plan, using an average discount rate of 10
percent and the most recent life expectancy of each individual covered.
Compensation related to this plan totaled approximately $38,400, $38,400, and
$32,100, in fiscal 2002, 2001 and 2000, respectively. As of May 31, 2002, 2001
and 2000, deferred compensation recorded in the consolidated balance sheets was
approximately $258,400, $263,000, and $269,000, and was all attributable to
retirees currently receiving benefits.
13. STOCK OPTIONS:
The Company has two incentive stock option plans under which stock options may
be granted. The Company has reserved 1,950,000 common shares for issuance under
these plans. Both plans have a ten year life and options are granted at the fair
market value at the date of grant. Options vest 50% upon grant and 50% after one
year, unless otherwise stated. Canceled options become available for new grants
upon cancellation.
The 1989 Stock Option Plan was approved by the stockholders on November 30,
1989. All options under the 1989 stock option plan expired during fiscal 2001.
The 1990 Stock Option Plan was approved by the stockholders on November 13,
1990. The 1990 Stock Option Plan expired in Fiscal 2001.
The 1991 Stock Option Plan was approved by the stockholders on November 19,
1991. All options under the 1991 stock option plan expired during fiscal 2002.
The Company adopted the 1991 Nonemployee and Directors Stock Option Plan on
November 19, 1991. The 1991 Nonemployee and Directors Stock Option Plan expired
in Fiscal 2002.
48
The 1994 Stock Option Plan was approved by stockholders on October 28, 1994.
Under the 1994 plan, 525,000 options are available for grant through October 28,
2004, with no more than 225,000 options granted in any one fiscal year.
The 1994 Nonemployee and Directors Stock Option Plan was adopted by the Company
on October 28, 1994. This plan provides for grants to nonemployees (consultants
and advisors) and to nonemployee directors of options to purchase up to 850,000
shares of the Company's common stock. During 1995, the Company issued 325,000
incentive stock options to non-employees and directors under this plan. These
incentive options become vested based on the increase of the Company stock price
over the average stock price during the base period from March 8, 1994 through
October 27, 1994. Vesting begins when the stock price reaches 300% of the base
period price and the options become fully vested when the stock price reaches
600% of the base period price. This stock option arrangement is accounted for as
a variable plan and accordingly the measurement date for compensation expense is
delayed until the Company's stock price meets the initial target price. The
Company recorded no Compensation expenses in 2000 through 2002, and no options
have as yet vested.
The summary of the option plans for the years ended May 31, is as follows:
2002 2001 2000
------ ------ ------
Options outstanding June 1, 813,027 774,527 752,777
Granted 42,500 42,500 42,500
Exercised 0 0 0
Canceled (27,250) (4,000) (20,750)
--------- ---------- ----------
Options outstanding at end of period 828,277 813,027 774,527
--------- ---------- ----------
Price range of options granted $ 0.05 $ 0.08 $ 0.25
========= ========== ==========
Price range of options exercised - - -
========= ========== ==========
Exercise price range of outstanding
options $.05-$.69 $.06-$2.50 $.06-$2.50
========= ========== ==========
49
The summary of stock options outstanding and exercisable as of May 31, 2002 is
as follows:
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Options Exercise
Prices Outstanding Life Price Exercisable Price
--------------------------------------------------------------------------------
1994 Stock Option Plan
$0.38 - $0.56 38,277 3 0.51 38,277 0.51
1994 Non-employees and Directors Stock Option Plan
$0.05 - $0.09 142,500 3 0.07 121,500 0.07
$0.15 - $0.19 85,000 3 0.17 85,000 0.17
$0.25 - $0.38 75,000 3 0.30 75,000 0.30
$0.69 487,500 3 0.69 162,500 0.69
--------------------------------------------------------------------------------
$0.05 - $ .69 828,277 3 $0.49 482,227 $0.37
================================================================================
The Company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock Based Compensation", but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its stock
plans. For SFAS 123 purposes, the weighted average fair value of each option
grant has been estimated as of the date of the grant using the Black-Scholes
option pricing model with the following assumptions; Risk-free interest rate of
5.02%, 4.94%, and 5.96% and expected volatility of 114%, 95%, and 60% for the
years ended May 31, 2002, 2001 and 2000, respectively, a dividend payment rate
of zero for each year and an expected option life of five years. Using these
assumptions, the weighted average fair value of the stock options granted is
$.05, $.06, and $.16, for fiscal 2002, 2001 and 2000, respectively. There were
no adjustments made in calculating the fair value to account for vesting
provisions or for non-transferability or risk of forfeiture.
If the Company had elected to recognize compensation expense based on the fair
value at the grant dates consistent with the method prescribed by SFAS 123, net
loss and loss per share would have been changed to the pro forma amounts
indicated below.
50
2002 2001 2000
-------------------------------
Net Income(Loss):
As reported $(835,400) $(129,800) $(528,800)
Pro forma (838,900) (134,500) (532,200)
Basic and Diluted Loss per share:
As reported $ (0.12) $ (0.02) $ (0.08)
Pro forma $ (0.12) $ (0.02) $ (0.08)
14. MARKET VALUE DISCLOSURE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures About Fair
Value of Financial Instruments" ("SFAS 107"), requires all entities to disclose
the fair value of financial instruments; however, this information does not
represent the aggregate net fair value of the Company. Some of the information
used to determine fair value is subjective and judgmental in nature; therefore,
fair value estimates, especially for less marketable securities, may vary. The
amounts actually realized or paid upon settlement or maturity could be
significantly different.
Unless quoted market price indicates otherwise, the fair values of cash and cash
equivalents generally approximate market values because of the short maturity of
these instruments. The Company has estimated the fair value of bonds payable
based on the present value using interest rates of similar debt instruments.
The estimated fair values of the Company's financial instruments, none of which
are held for trading purposes, are summarized as follows:
(000's)
May 31, 2002 May 31, 2001
------------ ------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ------ ----------
Bonds Payable $ 8,995 $ 1,800 $ 8,995 $ 3,000
51
15. Quarterly Financial Data (Unaudited)
Summarized quarterly financial data for 2002 and 2001 is as follows:
Quarter
--------------------------------------------------
First Second Third Fourth
----- ------ ----- ------
Fiscal Year 2002:
Net sales $2,068,500 $2,620,700 $2,051,700 $2,129,100
Gross Profit 464,200 495,600 52,700 166,400
Net income (loss) 13,400 13,800 (612,600) (250,000)
Basic earnings
(loss) per share $ 0.00 $ 0.00 $ (0.09) $ (0.04)
Diluted earnings
(loss) per share $ 0.00 $ 0.00 $ (0.09) $ (0.04)
Fiscal Year 2001:
Net sales $2,266,600 $2,447,300 $1,526,900 $2,017,700
Gross Profit 346,800 601,200 288,200 286,500
Net income (loss) (132,000) 87,400 96,100 (181,300)
Basic earnings
(loss) per share $ (0.020) $ 0.010 $ 0.014 $ (0.030)
Diluted earnings
(loss) per share $ (0.020) $ 0.004 $ 0.004 $ (0.030)
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE MATTERS
None
52
PART III
The information required by Part III (Items 10 through 13) is hereby
incorporated by reference from the Company's definitive proxy statement to be
filed with the Commission under Section 14A of the Securities Exchange Act of
1934 not later than 120 days after the end of the 2002 fiscal year or shall be
filed by amendment to this Form 10-K not later than such 120 day period.
53
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Included in Part II, Item 8 of this report:
Balance Sheets as of May 31, 2002 and 2001
Statements of Operations for the years ended May 31, 2002, 2001 and
2000
Statements of Stockholders' Deficit for the years ended May 31, 2002,
2001 and 2000
Statements of Cash Flows for the years ended May 31, 2002, 2001 and
2000
Notes to the Financial Statements
2. Financial Statement Schedule
Included in Part IV of this report:
Financial Statements and Supplementary Data for the years ended May
31, 2002, 2001, and 2000:
Schedule II - Schedule of Valuation and Qualifying
Accounts
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the fiscal quarter
ended May 31, 2002.
(c) Exhibits
Exhibit Number Description Note No.
-------------- ----------- --------
3.1 Articles of Incorporation (1)
54
3.2 Articles of Incorporation, as amended (7)
at the Annual Meeting of GKI
shareholders on November 19, 1991
3.3 Articles of Incorporation, as amended (16)
at the Annual Meeting of GKI
shareholders on October 28, 1994
3.4 By-Laws (1)
3.5 By-Laws, as amended at a Board of (7)
Directors meeting on September 24, 1992
3.6 By-Laws, as amended at a Board of (12)
Directors meeting on March 2, 1994
3.7 By-Laws, as amended at a Board of (16)
Directors meeting on January 19, 1995
4.1 Agreement by and between GKI and (7)
Gutzwiller & Partner, A.G., dated
October 20, 1992, and a letter of
clarification regarding such agreement
from Edward J. Stucky to David A. Shaw,
dated October 23, 1992
4.2 Form of Convertible Subordinated (8)
Debentures Issued to Gutzwiller &
Partner, A.G., on December 14, 1992
with an effective date of October 20,
1992
4.3 Form of 4% Subordinated Debentures, (9)
Series A, due March 30, 1994
4.4 Form of 4% Subordinated Debentures, (9)
Series B, due March 30, 1995
55
4.5 Form of 4% Subordinated (9)
Debentures, Series C, due August
15, 1994
4.6 Form of Convertible Debentures (14)
Issued to Gutzwiller & Partner,
A.G., dated August 14, 1994.
4.7 Form of Pledge and Security (19)
Agreement dated as of August 14,
1994 with respect to Convertible
Debentures
10.1* 1988 Stock Option Plan (2)
10.2 Agreement and Plan of Merger (1)
and Reorganization dated
August 31, 1990
10.3* 1991 Executive Bonus Plan (5)
10.4* 1991 Stock Option Plan (4)
10.5* 1991 Nonemployee and Directors (4)
Stock Option Plan
10.6* 401(k) Retirement, Investment & (7)
Savings Plan
10.7* 1989 Stock Option Plan (5)
10.8* 1990 Stock Option Plan (5)
10.9* 1994 Stock Option Plan (15)
10.10* 1994 Nonemployee and Directors (15)
Stock Option Plan
10.11 Verdix Asset Purchase Agreement (10)
dated October 1, 1993
10.12 Amendment to Verdix Asset (11)
Purchase Agreement dated January
26, 1994
56
10.13 Asset Purchase Agreement between (18)
General Kinetics Incorporated
and Cryptek Secure
Communications, LLC, a Delaware
limited liability company, dated
as of November 1, 1996
10.14 Agreement between GKI and (17)
Link2It, L.L.C. dated as of
January 21, 1997
10.15 Form of Master Factoring (19)
Agreement between General
Kinetics Incorporated and
Link2It Corporation, dated
August 22, 2002.
16.0 Letter re Change in Certifying (3)
Accountants
16.1 Letter re Change in Certifying (13)
Accountants
21.1 List of Subsidiaries (16)
* Management contract, compensatory plan or arrangement
(1) Previously filed with the Securities and Exchange Commission
as an Exhibit to the Company's Annual Report on Form 10-K for
the year ended May 31, 1990, and incorporated herein by
reference.
(2) Previously filed with the Securities and Exchange Commission
as an Exhibit to the Company's Annual Report on Form 10-K for
the year ended May 31, 1989, and incorporated herein by
reference.
(3) Previously filed with the Securities and Exchange Commission
as an Exhibit to the Company's Current Report on Form 8-K
dated April 3, 1990, and incorporated herein by reference.
57
(4) Previously filed with Securities and Exchange Commission as an Exhibit
to the Company's Proxy Statement for the 1991 Annual Shareholders'
Meeting, and incorporated herein by reference.
(5) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 1991, and incorporated herein by reference.
(6) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Amendment No. 2 to the Annual Report on Form
10-K for the year ended May 31, 1991, and incorporated herein by
reference.
(7) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 1992 and incorporated herein by reference.
(8) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended November 30, 1992 and incorporated herein by reference.
(9) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 1993 and incorporated herein by reference.
(10) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended August 31, 1993 and incorporated herein by reference.
(11) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Current Report on Form 8-K dated February 9,
1994 and incorporated herein by reference.
(12) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Current Report on Form 8-K dated March 17, 1994
and incorporated herein by reference.
(13) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's amended
58
Current Report on Form 8-K/A dated June 16, 1994, and incorporated
herein by reference.
(14) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 1994, and incorporated herein by reference.
(15) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Proxy Statement for the 1994 Annual
Shareholders' Meeting, and incorporated herein by reference.
(16) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 1995, and incorporated herein by reference.
(17) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Current Report on Form 8-K dated December 20,
1996 and incorporated herein by reference (Formerly designated Exhibit
2.1).
(18) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended February 28, 1997 and incorporated herein by reference.
(19) Previously filed with the Securities and Exchange Commission as an
Exhibit to the Company's Annual Report on Form 10-K for the year ended
May 31, 2001, and incorporated herein by reference.
(d) Schedule
59
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
General Kinetics Incorporated
The audits referred to in our report, dated August 2, 2002, which includes an
explanatory paragraph related to substantial doubt about the Company's ability
to continue as a going concern, relating to the financial statements of General
Kinetics, Inc. which is contained in Item 8 of this Form 10-K, included the
audits of the financial statement schedule listed in the accompanying index for
each of the three years in the period ended May 31, 2002. The financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on the financial statement schedule
based on our audits.
In our opinion, such schedule presents fairly, in all material respects, the
information set forth therein.
/s/ BDO Seidman, LLP
Washington, DC
August 2, 2002
60
Schedule II
General Kinetics Incorporated
Schedule of Valuation and Qualifying Accounts
For the Years Ended May 31, 2002, 2001, and 2000
Balance at Charged to Charged to Balance at
beginning of costs and other end of
Description period expenses accounts Deductions period
----------- ------ -------- -------- ---------- ------
FOR THE YEAR ENDED MAY 31, 2002:
Inventory Reserve 159,200 101,100 (117,500) 0 142,800
Allowance for doubtful accounts 72,700 0 (1,800) 0 70,900
FOR THE YEAR ENDED MAY 31, 2001:
Inventory Reserve 199,200 85,000 (125,000) 0 159,200
Allowance for doubtful accounts 75,000 0 (2,300) 0 72,700
Note Receivable Reserve 175,000 0 (175,000) 0 0
FOR THE YEAR ENDED MAY 31, 2000:
Inventory Reserve 159,200 95,000 (55,000) 0 199,200
Allowance for doubtful accounts 208,000 19,500 (152,500) 0 75,000
Note Receivable Reserve 237,500 87,500 (150,000) 0 175,000
Page 61
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
GENERAL KINETICS INCORPORATED
By: /s/ Larry M. Heimendinger
--------------------------------------------
Larry M. Heimendinger, Chairman of the Board
(Principal Executive Officer)
Date: August 29, 2002
--------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
/s/ Larry M. Heimendinger 8/29/02 /s/ Sandy B. Sewitch 8/29/02
--------------------------------- ----------------------------
Larry M. Heimendinger, Date Sandy B. Sewitch, Date
Chairman of the Board Chief Financial Officer
(Principal Executive Officer) (Principal Accounting Officer
and Principal Financial Officer)
62
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and dates indicated.
/s/ Marc E. Cotnoir August 29, 2002
------------------------------ ---------------
Marc E. Cotnoir, Director Date
/s/ Richard J. McConnell August 29, 2002
------------------------------ ---------------
Richard J. McConnell, Director Date
/s/ Thomas M. Hacala August 29, 2002
------------------------------ ---------------
Thomas M. Hacala, Director Date
63