Item 1. BUSINESS
QuesTech, Inc. (the Company), provides a broad spectrum of professional services to customers within several high technology communities. Corporate products include scientific, engineering, research, and management services in electronics, information warfare, information technology, computer software, systems integration, and industrial analysis.
A major portion of the Company's 1996 revenues were derived from competitively awarded contracts with U. S. Government clients, primarily within the Department of Defense.
Systems Engineering and Scientific Research
The Company performs a broad range of high technology services for agencies of the Department of Defense ("DOD") and the national security community. These services are provided through a number of operating units, each focused on a distinct market and specific customer base.
QuesTech Research Division ("QTRD")
QuesTech Research Division (QTRD) provides diversified, high technology engineering and management services to various industries and DOD agencies. QTRD performs engineering services from concept formulation and systems design, through engineering, technical and program management support, to research and development. QTRD solves complex problems for its customers, primarily in the fields of intelligence, electronic warfare, command, control, and industrial modernization.
QTRD services also include engineering and management support to Government and industry in intelligence analysis, tactical and processing systems, software development, systems integration, industrial base analysis, technology assessments, manufacturing technology, and electronic warfare.
QuesTech Service Company ("QTSC")
This wholly-owned subsidiary of the Company provides engineering field services, including equipment installation, test monitoring, and operations and maintenance. QTSC also provides cost-effective program support services, including system analyses, integrated logistics support, equipment procurement, failure analysis, maintenance provisioning, training and inspections to customers in the Department of Defense and intelligence communities. QTSC deploys personnel to locations from coast to coast and around the world to perform on programs involving electronic warfare, computer control and communication, signal intelligence and communications systems.
QuesTech Packaging, Inc. ("QTPI", formerly QuesTech Ventures, Inc.)
QuesTech Packaging, Inc. is a wholly-owned subsidiary which manufactures plastic containers utilizing scrapless, melt-phase thermoforming technology. Its main product line consists of drop-in, thermoformed infant bottle liners, which are another alternative to bag-type liners produced by its competitors.
U. S. Government Contracts
The Company's business is primarily derived from competitively awarded U. S. Government contracts.
United States Government contracts and related customer orders are generally subject to termination at the convenience of the United States Government whenever it believes that such termination would be in its best interests. Under contracts terminated for the convenience of the United States Government, the Company may be entitled to receive payment for work completed and allowable termination costs. Whether the occurrence of any such termination would have an adverse effect on the Company would depend upon the particular contract and the nature of the termination.
The Company's business is conducted pursuant to three types of contracts: cost reimbursable, time and materials, and fixed price. Certain of the Company's incurred costs are reimbursable under cost-reimbursable type contracts. These costs are subject to incurred cost audits in which the government may disallow some of the costs claimed for contract costing purposes. Management is not aware of any adjustments that will result in a material charge to current or future operations, as a result of these audits.
U. S. Government contracting activity involves procurement by formal advertising or by sole source procedures. The Government is authorized to forego formal advertising for the procurement of professional, experi- mental, developmental or research services when the availability of supplies or services from only one source or other circumstances render it impractical to secure competitive bids.
Backlog
The term "backlog" includes the aggregate contract revenues remaining to be earned at the stated time. The following table reflects the Company's backlog as of December 31, 1996 and December 31, 1995:
The term "funded" refers to the portion of aggregate contract revenues remaining to be earned that is covered by funding appropriations and allotments to the contract by the procuring agency; the term "unfunded" refers to the excess of the value of the contract award over the funded value. Management cannot provide any assurance that the customer will authorize funding amounts in addition to funding commitments existing as of the end of 1996. However, the Company historically has received the funding for substantially all of its unfunded backlog.
Personnel
The Company and its subsidiaries, as of December 31, 1996, had approximately 600 employees on a regular full-time and part-time basis.
The nature of the services provided by the Company requires the employment of large numbers of professional and technical personnel, including engineers, analysts, scientists, computer software specialists, computer programmers and skilled technicians. The Company's future success will depend to a substantial extent on its ability to continue to attract and retain qualified personnel.
Competition
The Company has many competitors, including large, diversified firms having greater financial resources and larger technical staffs. Other competitors, although smaller, are highly qualified in specialized areas and may offer price advantages or may receive greater benefits under the Small Business Set-Aside Program, which includes small and disadvantaged businesses. Furthermore, the U. S. Government's own in-house capabilities and federally sponsored, not-for profit contract research centers compete with the Company. The Government contracting industry is faced with changes such as global and political influences on the DOD budget, changes in labor conditions, and the emergence of new competing companies, any of which could have a material effect on the Company's efforts and profits.
Patents
U. S. Patent No. 4,539,625, entitled LIGHTING SYSTEM COMBINING DAYLIGHT CONCENTRATORS AND AN ARTIFICIAL SOURCE, issued September 3, 1985. Corresponding foreign patent: Canadian Patent No. 1,236,808 issued May 17, 1988.
U. S. Patent No. 4,767,902, entitled METHOD & APPARATUS FOR THE MICROWAVE JOINING OF CERAMIC ITEMS, issued August 30, 1988. Corresponding foreign patents: None. However, applications have been filed in seven foreign countries: Canada, Japan, France, Great Britain, Italy, Sweden and Germany.
U. S. Patent No. 4,964,591, entitled PROJECTILE HAVING NONELECTRONIC INFRARED HEAT TRACKING DEVICE, issued October 23, 1990. European Patent No. 392,306 granted on December 28, 1994.
U. S. Patent No. 4,757,172, entitled METHOD & APPARATUS FOR THE MICROWAVE JOINING OF NON-OXIDE CERAMIC ITEMS, issued July 12, 1988. European Patent No. 308,593 granted February 26, 1992.
U. S. Patent No. 4,836,734, entitled MELT-PHASE THERMAL PRESSURE APPARATUS FOR FORMING OF PLASTIC BLANKS INTO RETORTABLE CONTAINERS, issued June 6, 1989. European Patent No. 330,721 granted on January 22, 1992.
U. S. Patent No. 4,997,691, entitled RETORTABLE CONTAINER I, issued March 5, 1991. European Patent No. 363,918 granted on May 24, 1995.
U. S. Patent No. 5,091,231, entitled RETORTABLE CONTAINER II, issued February 25, 1992. Corresponding foreign patents: None. However, applications have been filed in fifteen foreign countries: Australia, Canada, Austria, Belgium, France, Germany, Greece, Italy, Luxembourg, Netherlands, Spain, Sweden, Switzerland, Liechtenstein, and the United Kingdom.
Service Mark:
U. S. Service Mark Reg. No. 1,531,368, QuesTech, Inc., issued March 21, 1989.
U. S. Service Mark Reg. No. 1,931,615 issued on October 31, 1995.
Trademark
QuesTech, Inc. was issued U.S. Service Mark Registration No. 1,531,368 on March 21, 1989, No. 1,931,615 on October 31, 1995; and U.S. Trademark Registration No. 1,933,165 on November 7, 1995.
Item 2.
Item 2. PROPERTIES
As of the date of this report, the Company maintains leases throughout the United States, which includes the Falls Church, Virginia headquarters' lease for 25,939 square feet. In addition, there are material leases in five other locations totaling approximately 67,400 square feet. Management believes that its existing leases are suitable and adequate.
Item 3.
Item 3. LEGAL PROCEEDINGS
The following information is furnished regarding litigation involving the Company:
On January 2, 1996, the Company was named as a defendant in a lawsuit captioned 7600 Limited Partnership and Guy Beatty v. QuesTech, Inc. The plaintiffs (the Company's former landlord and its general partner) sought attorneys' fees incurred in two earlier landlord/tenant cases (a contract claim) plus damages for the tort of malicious prosecution, plus punitive damages.
In February 1997, the Company agreed to a settlement which has been accounted for in the financial statements. The settlement, which is subject to final documentation, disposes of all issues raised in the litigation and had no material impact on the Company's financial statements.
The Company has no other litigation pending which involves potential liability in excess of $10,000.
Other Claims
Since September 1996, the Company has been involved in a dispute with Munchkin, Inc., the sole customer at that time of its QTPI subsidiary. The dispute involved an alleged breach of contract and warranty issues, as well as claims for payment by QTPI.
In addition, in February, the Company filed a declaratory judgment action seeking to clarify the nature of the exclusivity granted to Munchkin under its contract.
The Company is currently in negotiations which if successful would resolve all outstanding disputes with Munchkin, Inc.
The Company has no other claims pending which involves potential liability in excess of $10,000.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The following matters shall be submitted to a vote of security holders at the Company's Annual Meeting on May 23, 1997:
Election of six directors to the Company's Board of Directors;
Ratification of the appointment of the Company's independent auditor; and
Amendment of the Company's Incentive Stock Option Plan (ISOP).
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's authorized capital stock consists of 3,000,000 shares at a par value of $0.05 per share. At December 31, 1996, there were 1,649,904 shares issued, of which 1,610,857 were outstanding and 39,047 shares were in Treasury. Of the shares outstanding, 176,131 shares are held by the Company's Stock Employee Compensation Trust. The Company's common stock is traded on NASDAQ. Set forth below are the high and low selling price 1 for the common stock for each full quarter of 1996 and 1995, during which the common stock has been publicly traded as reported by NASDAQ.
As of December 31, 1996 there were 275 accounts of record, representing approximately 800 beneficial stockholders, including individuals and persons whose stock is held in street name by stockbrokers.
The Company has not paid dividends on its Common Stock since its inception. The payment of dividends in the future, if any, will be determined by the Board of Directors.
1/ The high and low over-the-counter market quotation reflects inter-dealer prices, without retail mark-up, mark-down, or commission, and may not necessarily reflect actual transactions.
PART II
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial data with respect to the Company and is qualified by reference to the Consolidated Financial Statements and Notes thereto included in Part IV.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS: 1996 Compared With 1995
Revenues
During 1996, the Company's revenues were $72.4 million, up 25% over 1995. Both the government contracting and the commmercial packaging segments reported business growth compared to last year. The government contracting segment, which provides 99% of the Company's revenues, consists of two operating business units: QuesTech Research Division and QuesTech Service Company ("QTRD" and "QTSC" respectively). A significant portion of the revenues are derived from two major contracts with the Department of the Army. The commercial packaging segment has only one operating business unit, QuesTech Packaging, Inc. ("QTPI"). During 1996, QTPI had only one customer.
Government Contracts
Revenues from a large Army contract and its follow-on effort which commenced performance during 1996 have accounted for over 40% of the Company's revenue during each of the last four years. A significant portion of the revenue increase was derived from materials and subcontract-intensive work orders. Revenues from increased efforts on Navy contracts and a new 5-year $25 million Air Force contract also contributed to growth.
Commercial Packaging
During the first half of 1996, QTPI produced thermoformed infant bottle liners which were marketed under the "1-Step" Munchkin brand. Following a dispute on pricing terms and product specifications, QTPI drastically cut back its production and halted customer shipments during the third quarter. No sales were posted during the fourth quarter.
Operating Expenses
The Company's operating expenses during 1996 rose to $70.8 million, up 27% over 1995. Salaries, wages and employee benefits increased primarily as a result of increased direct labor staffing on government contracts. A major portion of the increase in operating expenses arose from materials-intensive delivery orders and subcontracting activities. Additionally, manufacturing costs increased during the production stages.
Income from Operations
Income from operations for 1996 was approximately $1.6 million, which declined by 22% compared to 1995. Operating income was negatively impacted by reduced margins arising from the costs of certain contractual requirements. Continuing losses at QTPI, which included unabsorbed production overhead in the absence of sales, and reserves for inventory and receivable write-downs, contributed to the decrease in operating income.
Interest Expense
Interest expense increased 46% over 1995. Interest costs associated with construction in progress at the manufacturing plant were charged to operations, instead of capitalized.
Taxes
The Company's 1996 effective tax rate declined to 18.5% from 42.8% during 1995. The decrease in tax rate resulted from a tax benefit arising from non-recurring adjustments to deferred taxes associated with depreciation and other favorable tax deductions.
Net Earnings
For 1996, primary and fully diluted earnings per share were $.54 on earnings of $818,300; these amounts reflected a 54% increase over per share earnings of $.35 during 1995.
Financial Condition
The following table compares selected financial data that measure the Company's liquidity and capital resources at December 31, 1996, 1995 and 1994 (in thousands of dollars, except for ratios):
(1) Current assets over current liabilities.
The Company's financial condition improved through continued profitability on consolidated operations. Working capital remained at $1.9 million, which was approximately the same as last year, despite highly leveraged activities. Operating cash flows provided by the government contract segment were consumed by the commercial packaging segment's operating cash requirements. Inventories, which were twice last year's levels despite a write-down, increased pending shipment of finished goods that are subject to a contract dispute. The increase in accounts receivable resulted mainly from revenue growth. Capital expenditures, primarily related to manufacturing build-out, were financed initially by the line of credit facility, and subsequently refinanced with $2.1 million of proceeds from a long-term capital lease. During the next two years, the Company will incur costs associated with the relocation of its contract efforts from Vint Hill to Fort Monmouth. Some of these amounts may be mitigated through certain state grants.
The Company intends to implement a wide-area network covering twelve sites. The cost of setting up three pilot sites is expected to exceed $300,000. Of this amount, approximately $60,000 was expended in 1996.
Outlook
Forward looking statements contained in this report are made pursuant to the safe harbor provisions of the Private Securities Litigation Report Act of 1995. Certain factors could cause actual results to differ materially from the statements. These factors include but are not limited to: continuity of contract funding and customer relationships; retention of key personnel, particularly those involved in technical efforts; interest rates; changes in technology; and potential impact of industry consolidation.
The current business environment for the defense contracting industry continues to be characterized by a general atmosphere of uncertainty. This uncertainty is the result of several factors including: 1) defense budget cuts; 2) base closures and consolidations; and 3) increased competitive pressures. These factors will continue to shape the defense contracting industry over the next several years. However, given the emergence of regional threats and ease with which leading edge technologies can be acquired by potential adversaries, there is the possibility these trends may be curtailed or reversed. In addition, several segments within the industry, such as the area of application programming and Information Warfare, will provide growth opportunities for contractors.
Management anticipates that there will be little impact on the Company's existing contracts during 1997 due to base closures. Vint Hill Farms Station, the site of QTRD's major Army support contract, is one of the bases scheduled to be closed by the DOD in late 1997. However, the mission being supported at Vint Hill -- high technology engineering services -- has been relocated to Fort Monmouth. The Company will continue to provide support to this mission under its current contract. It is anticipated that Army work will continue to remain a significant percentage of the Company's overall business over the next several years.
As a result of the decreased defense appropriations, competition among contractors has increased considerably. Large contractors who typically targeted only large programs, now pursue programs of any size. Therefore, bigger contractors have become the Company's direct competitors. Further, competitive pressures have caused many firms to merge with other companies. The competitors who remain often gain increased expertise and experience through the mergers, resulting in formidable competition for the Company. Management believes the Company is positioned well to withstand the rigors of the current environment through a superior technical track record and competitive pricing.
The Company has invested over $3 million in manufacturing equipment, plant build-out and refitting costs at its Newport News facility. Marketing efforts have elicited interest from prospective customers, one of which has provided funding for a prototype mold to produce samples for testing. Based on internal cash flow forecasts, management has determined that no impairment has occurred for its plant equipment and manufacturing technology. Results of operations, financial condition, and liquidity for 1997 may be negatively affected by factors such as: the timing of the execution of any new agreements, and the lead time for machine retooling and testing in accordance with new customer specifications. The Company is unable to provide assurance that actual sales to other customers will be in line with forecasts.
RESULTS OF OPERATIONS: 1995 Compared With 1994
Revenues
During 1995, the Company's revenues were $57.9 million, up 6% over 1994. The Company's business base is made up of the government contract segment and the commmercial packaging segment. The government contract segment consists of QuesTech Research Division ("QTRD") and QuesTech Service Company ("QTSC"); the packaging segment consists of QuesTech Packaging, Inc. ("QTPI"). The growth during 1995 was the result of a 10% increase in revenues at QTRD, which sustained the same growth rate during each of the last two years, despite continued business contraction at QTSC. QTPI posted sales during late December, 1995, as a result of an initial shipment to its customer under a supply contract.
Operating Expenses
The Company's operating expenses during 1995 rose to $56 million, up 5.88% over 1994. Salaries, wages and employee benefits remained constant as a percentage of sales, primarily as a result of heightened direct labor activity on government contracts. The increase in other operating expenses also included the cost of subcontract teaming efforts, travel related to performance on government contracts, and start-up production and engineering costs at QTPI. Excluding corporate expense allocations, the cost of maintaining QTPI's operations in 1995 was approximately $1.2 million, up from approximately $546,000 during 1994. Most of the cost increase was related to technical management and engineering support (not associated with equipment fabrication), prior to the manufacturing equipment being placed in service.
Income from Operations
Income from operations for 1995 was approximately $2.0 million, up 8% over 1994, as a result of favorable margins and increased billable hours on government contracts. Favorable margins from the government contracts business segment allowed the Company to support the start-up operations of QTPI, and achieve modest growth in operating income.
Interest Expense
Interest expense in 1995 increased 2% over 1994, primarily because of increased borrowings under the line of credit. The line of credit interest expense was partially mitigated by reduced interest cost associated with curtailments of other long-term borrowings.
Charges Arising from Settlements of Litigation
During 1995, other expense was $722,100, down from $843,100 during 1994, resulting from cost savings made possible by the conclusion of significant litigation activities, including a re-structuring of its case planning and strategy. Based on its assessment of the expected outcome of outstanding litigation, management believed that it had provided adequate allowances in the financial statements.
Taxes
During 1995, the Company's effective tax rate was 42.8% of pre-tax income, compared to 50.9% during 1994. For tax purposes, the Company benefited from an increase in certain non-taxable income.
Net Earnings
For 1995, primary and fully diluted earnings per share were $.35 and $.34 on earnings of $520,100; these amounts reflected a 52% and 48% increase over per share earnings of $.23 (primary and fully diluted, respectively) during 1994. The increase in per share amounts was less than the 64% net earnings growth due to the dilutive impact of common stock equivalents.
IMPACT OF INFLATION
The impact of inflation on the Company's costs is minimal due to the fact that increased costs are normally included in its pricing structure or otherwise recovered through reimbursement of contract costs incurred.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Included under Item 14.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors
Vincent L. Salvatori - Chairman of the Board and Chief Executive Officer, QuesTech, Inc.
Dr. Robert B. Costello - Chairman, Costello Group
Edward G. Broenniman - President and Chief Executive Officer, Piedmont Group, Chief Operating Officer and Chief Financial Officer, Hemex, Inc.
Gerald F. Mayefskie - President and Chief Operating Officer, QuesTech, Inc.
Sebastian P. Musco - Chairman of the Board and Chief Executive Officer, Gemini Industries, Inc.
Lt. General Vincent M. Russo (Ret.) - Independent Consultant in Logistics
Executive Officers
Vincent L. Salvatori - Chairman of the Board and Chief Executive Officer
Gerald F. Mayefskie - President and Chief Operating Officer
Joseph P. O'Connell - Vice President and Chief Financial Officer
Christina M. Burkholder - Vice President and General Counsel
Item 11.
Item 11. EXECUTIVE COMPENSATION
Reference is made to the material under the caption, "Remuneration of Directors and Officers" in the Registrant's definitive Proxy Statement.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Reference is made to the material under the captions, "Stock Ownership" and "Additional Inside Interests of Beneficial Security Ownership" in the Registrant's definitive proxy statement.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of this report:
1. Financial Statements. Attached.
2. Financial Statement Schedules. Attached.
3. Exhibits
(3) Articles of Incorporation and Bylaws, filed on December 27, 1983 with the Company's Registration Statement on Form S-1 are incorporated herein by reference.
(4) None
(9) None
(10) Material Contracts
(a) Stock Option Plans. (i) 1996 Stock Option Plan (ii) Stock Option Plan for Non-Employee Directors
(b) Agreement dated between Vincent L. Salvatori and QuesTech. Incorporated herein by reference.
(c) Agreement dated between Gerald F. Mayefskie and QuesTech. Incorporated herein by reference.
(d) Confidential Settlement Agreement dated February 2, 1994 between William E. Bigler, Jr. and Jerome M. Raffel and QuesTech, Inc. (redacted in part). Incorporated herein by reference.
(e) Confidential Settlement Agreement with Oscar E. Hayes, dated August, 1995. Incorporated herein by reference.
11. Earnings per share: Reference is made to Registrant's financial statements.
12. Statement re computation of ratios: Reference is made to Registrant's financial statements.
13. Reference is made to Registrant's definitive 1997 proxy statement to be filed in connection with the Annual Stockholders' Meeting.
21. Subsidiaries of the registrant
27. Financial Data Schedule
(b) Reports on Form 8-K.
No reports on Form 8-K were required to be filed during 1996.
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.
QUESTECH, INC.
Date: ________________________ By: ____________________________________ Vincent L. Salvatori Chief Executive Officer and Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signatures Title Date
CEO and Chairman of ________________________ the Board (Principal ______________________ Vincent L. Salvatori Executive Officer)
President, ________________________ Chief Operating Officer ______________________ Gerald F. Mayefskie and Director
Chief Financial Officer ________________________ (Principal Financial and ______________________ Joseph P. O'Connell, Jr. Accounting Officer)
________________________ Director ______________________ Robert B. Costello
Director Vincent M. Russo
Supplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d) of the Act
The registrant shall furnish to the Commission, its annual report to security holders covering the registrant's last fiscal year, and the proxy statement, form of proxy, or other proxy soliciting material sent to more than ten of the registrant's security holders with respect to its 1996 Annual Stockholders' Meeting.
ANNUAL REPORT ON FORM 10-K
ITEM 14(a)(1), (2), (3), (10), (11)
LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
CERTAIN EXHIBITS
FINANCIAL STATEMENT SCHEDULES
YEAR ENDED DECEMBER 31, 1996
QUESTECH, INC. FALLS CHURCH, VIRGINIA
QUESTECH, INC. AND SUBSIDIARIES CONSOLIDATED FINANCIAL STATEMENTS AND REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS December 31, 1996, 1995 and 1994
C O N T E N T S
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS 3
CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS - DECEMBER 31, 1996 AND 1995 4
CONSOLIDATED STATEMENTS OF EARNINGS - YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY - YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 7
CONSOLIDATED STATEMENTS OF CASH FLOWS - YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 11-42
SUPPLEMENTAL INFORMATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS 44
Report of Independent Certified Public Accountants Stockholders QuesTech, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of QuesTech, Inc. (a Virginia corporation) and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of earnings, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of QuesTech, Inc. and Subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996 in conformity with generally accepted accounting principles.
We have also audited Schedule II as of December 31, 1996 and for each of the three years in the period then ended. In our opinion, this schedule presents fairly the information required to be set forth therein.
Grant Thornton LLP
Vienna, Virginia February 6, 1997
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
QuesTech, Inc. and Subsidiaries
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these financial statements.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES
1. Nature of Operations
The Company performs a broad range of high technology services for industry and agencies of the United States Department of Defense ("DOD") and the national security community. These services are provided through two business units, QuesTech Research Division ("QTRD") and QuesTech Service Company ("QTSC"). Revenues from government contracts account for 99% of the Company's revenues. A third subsidiary, QuesTech Packaging, Inc. ("QTPI", formerly QuesTech Ventures, Inc.), is in the business of manufacturing plastic containers.
2. Use of Estimates in the Preparation of Financial Statements
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 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.
3. Principles of Consolidation
The accompanying financial statements include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions have been eliminated in consolidation.
4. Income Recognition
The Company provides services, primarily for the United States Government, under three types of contracts: cost-reimbursement, fixed price and time-and-materials. Substantially all of the Company's revenue is derived from these contracts. Approximately 40% of the Company's consolidated revenues
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
during each of the last three years was generated by a major contract with the Department of the Army. Income is recognized for cost-reimbursement and fixed-price type contracts using the percentage-of-completion method based on costs incurred; for time-and-materials contracts, income is based on contractually defined billing rates applied to services performed and materials delivered. Anticipated losses on contracts are recognized as soon as they become known.
Certain of the Company's contracts include provisions permitting the government to withhold a defined amount or percentage of a contract price until certain conditions have been satisfactorily met. These conditions primarily relate to uncompleted indirect cost rate negotiations and substantial completion of contract performance. The inclusion of these amounts in income is consistent with the revenue recognition policy stated above. The inclusion of the retainages and costs subject to audit in income is consistent with common industry practice.
A portion of the Company's revenues related to performance on certain cost-reimbursement type contracts is subject to audit by the United States Defense Contract Audit Agency (DCAA). Such contract audits have been completed through December 31, 1991. Contract costs for the government contract segment for 1992 through 1995 are expected to be audited during 1997. Contract revenue has been recorded in amounts that are expected to be realized upon final settlement.
5. Operating Expenses
Operating expenses presented in the accompanying statements of operations reflect the allocation of overhead and general and administrative expenses.
6. Statement of Cash Flows
For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
7. Inventories
Inventories consist principally of raw materials and certain finished goods and are stated at the lower of cost or market. Cost is determined principally under the average cost method.
8. Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:
Cash and cash equivalents, accounts receivable, accounts payable, line of credit, and other accrued liabilities - The carrying amounts approximate fair value because of the short maturity of these instruments. The Company's receivables arise primarily in connection with its performance on government contracts and therefore have negligible credit risk.
Investment in a partnership - The fair value is based on the maximum amount of proceeds expected to be realized by the Company, upon liquidation of the partnership.
Cash Values of Insurance Policies - The fair value is based on the cash values accumulated in these policies, net of borrowings. Surrender charges are not reflected in the fair value amount unless cash withdrawals or loans are made against these policies. On August 12, 1994, Confederation Life Insurance Company (CLIC), one of the insurance carriers for these policies, became subject to an Order of Rehabilitation and was placed under the regulatory supervision of the Michigan Commissioner of Insurance. As a result, Confederation Life policies will be subject to certain restrictions, one of which is a limitation on access to cash values during the lifetime of the insured. Surrenders, loans and other withdrawals are limited to the lesser of the net cash flow paid into a policy since August 12, 1994, or the net cash value of the policy. At December 31, 1996, the
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
carrying amount of the cash values of these policies was approximately $477,400.
Letter of credit - The fair value is based on the estimated cost to terminate or otherwise settle these obligations with the counter-parties.
Following is a summary of the estimated fair value at December 31, 1996, of the Company's financial instruments other than those on which the carrying amount approximates fair value.
9. Property, Plant and Equipment and Related Depreciation
Property, plant and equipment are recorded at cost. Cost includes expenditures for major improvements and replacements and the net amount of interest cost associated with significant capital additions. Construction in progress costs and specialized manufacturing equipment in service are stated at the lower of cost or fair value, based on expected future cash flows from the capital investment. During 1996 and 1995, interest cost associated with construction in progress was expensed due to immaterial amounts. The cost of properties held under capital leases is equal to the lower of the net present value of the minimum lease payments or the fair value of the leased property at the inception of the lease.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
Depreciation is provided for in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives (generally five to ten years), using both the straight-line and declining-balance methods. Amortization of computer software costs developed for internal use is over five years, based on a double-declining balance method. Leasehold improvements are amortized over the lives of the respective leases or the service lives of the improvements, whichever is the shorter period. Amortization of capitalized leased assets is included with depreciation expense.
During 1995, the Financial Accounting Standards Board issued SFAS 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of," effective for financial statements with fiscal years beginning after December 15, 1995. In accordance with the Statement, long-lived assets and certain intangibles, including goodwill, are required to be reviewed for impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. An impairment loss is recognized when the estimated undiscounted future cash flows generated by assets held for use are less than the underlying carrying amount. The Company has determined that no impairment loss need be recognized for applicable assets of continuing operations.
10. Goodwill
The excess of the acquisition costs over the fair value of the net assets of the businesses acquired is being amortized on a straight-line basis over periods ranging from 19 to 20 years.
The Company regularly performs a reassessment of the continuing value of the acquired goodwill associated with the acquisitions of American Defense Systems, Inc. (ADSI) and DHR, Inc. which at December 31, 1996 aggregated $1.4 million. To the extent that the future cash flows based on the contracts' expected operating profits will exceed the carrying cost of the asset, an impairment loss is not recognized. Contract termination or non-renewal of the contract are events or changes in circumstances that
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
indicate that the carrying amount of the goodwill asset may not be recoverable, thereby requiring the recognition of an impairment loss at that time.
11. Accounting for Postretirement Benefits
Effective in 1993, the Company adopted "Employers' Accounting for Postretirement Benefits Other Than Pensions" (SFAS 106) and elected to recognize the transition obligation on a delayed recognition basis. The transition obligation represents the unfunded portion of the accrued postretirement benefit obligation (the "APBO") as of the transition date less any accrued postretirement benefit cost. The accrued postretirement benefit cost as of the balance sheet date reflects the net periodic cost attributed to the current year, net of benefit payments, plus the accrued amount as of the beginning of the year. The cost measurement principles and required disclosures of SFAS 106 are applied separately to each identifiable postretirement benefit plan. The accrued postretirement benefit cost obligation is reported as an aggregate amount in the financial statements.
12. Accounting for Post-Employment Benefits
The Company periodically re-evaluates its projected obligations under post-employment agreements when the subject officers receive compensation increases during their years of active employment. The projected cost of additional compensation payable during the post-employment years is discounted at present value and charged to operations. Periodic increases in the balances due each of the officers also reflect the accrued interest on the discounted cost of the liability.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued
13. Accounting for Stock-based Compensation
The Financial Accounting Standards Board recently issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-based Compensation," effective for fiscal years that begin after December 15, 1995. The new standard encourages but does not require all entities to adopt a fair value based method of accounting for all employee stock option plans. Under this method, compensation cost is measured at the grant date based on the value of the stock option award and is recognized over the service period, which is usually the vesting period. The Company has chosen to use the intrinsic value based method, as prescribed by Opinion 25, that measures compensation cost only to the extent that the option price is lower than the quoted market price of the stock at the date of the award. Pro forma disclosures of net income, and earnings per share have been made, as if the fair value based method of accounting defined in SFAS 123 had been applied. Refer to Note I.
14. Reclassifications
Certain amounts in the 1995 and 1994 financial statements have been reclassified to conform to the presentation in the 1996 financial statements.
15. Earnings per share
The computation of earnings per common share is based on the weighted average number of common shares outstanding. When dilutive, stock options are included as share equivalents using the treasury stock method. At December 31, 1996 and 1995, the Company's Stock Employee Compensation Trust (SECT), which had acquired 221,792 shares of the Company's stock from its previous founders, held 176,131 and 183,392 shares, respectively. Although outstanding, the SECT shares are excluded from the base of the earnings per share calculation.
Of the December 31, 1996 billed and unbilled amounts, approximately $9.7 million is expected to be collected in 1997 and the remainder in subsequent years.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE B - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS - Continued
Included in machinery and equipment, and construction in progress above is equipment with a carrying value of approximately $3.5 million which is to be used in the Company's plastics manufacturing business. These carrying values are based upon the Company's plans and intentions to expand its business in this area by attracting new customers for various applications of its patented container forming technology. In addition, during 1996, the Company received financing for certain of this equipment in the amount of $2,000,000 as described in Note D.
If future economic conditions result in changes in management's plans or intentions, the carrying values of the affected assets will be reviewed and adjustments, if necessary, will be made.
As of December 31, 1996, the aggregate net book value of leased office equipment and certain leased assets included in construction in progress was $2.3 million.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE B - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS - Continued
Other assets include cash values of corporate-owned participating life insurance policies which the Company purchased as a means of investing salary deferrals of the employees covered under the Officers and Managers' Deferred Compensation Plan.
The Company expects to hold the related life insurance policies through terms varying between 10 to 20 years. Earlier surrender of these policies could cost the Company approximately $442,200 pre-tax, as a result of surrender charges. See also Note A8.
Accounts Payable
During 1996 and 1995, included in accounts payable are $1,879,900 and $1,470,200, resulting principally from the Company's use of zero balance bank accounts where funds are transferred to these accounts from the Company's line of credit when disbursements are presented for payment.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE B - COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS - Continued
NOTE C - LINE OF CREDIT
At December 31, 1996, the Company's remaining available line of credit (LOC) through Signet Bank of Virginia was $4.8 million. The underlying credit agreement permits borrowings up to $6.0 million. The Company was in compliance with various financial covenants, which require the maintenance of a maximum debt-to-net worth ratio of 5.0 and a minimum tangible net worth of $3.0 million. The Company's borrowing rate at December 31, 1996 was 8.5% which was one percentage point above the bank's prime rate. All borrowings are secured by a first lien security interest in all receivable accounts, contract rights, chattel paper, instruments, general intangibles, equipment, inventory, and documents now owned and hereafter acquired by the Company.
As part of the borrowing arrangements, the Company is required to pay a commitment fee of 3/8 of one percent of the average daily amount of the unused portion of the credit facility.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE C - LINE OF CREDIT - Continued
The agreement provides for the issuance of letters of credit by the bank on the Company's behalf.
The current agreement expires on May 31, 1997. Management expects the commitment to be extended by an amendment at that time.
NOTE D - LONG-TERM OBLIGATIONS
Long-term obligations consist of the following at December 31:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE D - LONG-TERM OBLIGATIONS - Continued
The following is a schedule of future minimum lease payments under capitalized lease obligations together with the present value of the net minimum lease payments:
During 1996, the Company refinanced certain construction in progress in its Newport News manufacturing plant under a sale/leaseback arrangement. The machines were sold for a sum amount in excess of $2 million. The transaction was accounted for as lease financing, wherein the property remains on the books subject to depreciation. A financing obligation representing the proceeds was recorded and is reduced based on payments under the lease.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE E - INCOME TAXES
A reconciliation of the effective tax rate and the Federal statutory income tax rate applied to income from continuing operations follows:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE E - INCOME TAXES - Continued
The tax effect of significant temporary differences that gave rise to deferred income taxes as of December 31, 1996:
Based on an analysis of future operating income for the purpose of realizing deferred tax assets, management believes that its net deferred tax asset will be recoverable in future returns and that its valuation allowance requires no further adjustment.
To date, none of the Company's federal income tax returns for years open under the statute of limitations have been examined by the Internal Revenue Service.
NOTE F - EMPLOYEE BENEFIT PLANS
1. Profit-Sharing and Pension Plan
The Company has a profit-sharing plan pursuant to Section 401 of the Internal Revenue Code, whereby participants may contribute up to 20% of their compensation, but not in excess of a ceiling amount determined by the Secretary of the Treasury during each year. Under the plan, the Company
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
may make two types of contributions subject to the discretion of the Board of Directors: (1) Employer matching contributions and (2) Profit-Sharing contributions. In order to share in either contribution, an employee must complete 1,000 hours of service during the Plan Year when the contribution is made. Generally, contributions vest in the employees' accounts based on their length of service.
During 1996, the employer contribution to the 401K plan was $103,700 compared to $72,200 for 1995. No employer contribution was made by the Company during 1994.
2. Discretionary Bonus Plan
Under the Officers and Managers Discretionary Bonus Plan for QuesTech and subordinate units ("the Bonus Plan"), officers and managers of the Company and its subsidiaries are selected by management for participation in the Bonus Plan. Bonuses are apportioned as a percentage of the recipient's salary and are based upon the Company's overall performance and upon the performance of the business unit to which the recipient is assigned, subject to review and approval by the Chief Executive Officer and/or Chief Operating Officer and the Board of Directors.
Amounts charged to expense under this plan were $452,200, $393,500 and $292,500 at December 31, 1996, 1995 and 1994, respectively.
3. Postretirement Benefits
The company has identified three separate postretirement benefit plans which fall within the purview of SFAS 106: the Group Health Plan, the Executive Life Insurance Plan, and the Deferred Compensation Plan.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
a. Group Health Plan
The Group Health Plan extends medical and dental benefit coverage to employees, who upon retirement at the age of 65, have completed 20 years of full-time employment with the Company, or retire with an individual employment agreement which specifically grants coverage approved by the insurance carrier of the subject group health policy. The Plan is contributory and contains cost-saving features, such as deductibles and coinsurance. The accumulated postretirement benefit obligation (APBO) represents the present value of insurance claims expected to be presented by eligible employees during their retirement years, based on the net premiums paid by the Company on behalf of active employees.
For measurement purposes, the annual health care cost trend for 1996 benefits was 9%, grading down to 5% over five years. The 1% increase in health care cost trend was 10% in 1996, grading down to 6% over five years. During 1995, a 10% medical inflation rate was assumed, grading down to 5% over six years. The measurement of the APBO for 1996 and 1995 was based on an assumed discount rate of 7.5%.
b. Executive Life Insurance
The Company maintains life insurance policies, covering certain of its officers, both former and active, through their lifetime, in accordance with their respective employment agreements. The cost of the insurees' premiums is treated as compensation expense.
c. Officers and Managers Deferred Compensation Plan (DEF COM)
DEF COM allows eligible employee participants to defer current compensation and provides supplemental postretirement benefits along with certain specified death benefits to the participants' beneficiaries. Postretirement benefits under DEF COM are payable upon the participant's termination of employment (including retirement), and are paid in equal installments over a period equal to the length of time the employee deferred compensation, but no longer than ten years. Termination or retirement benefits are based
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
upon the employee's actual deferrals plus interest credited annually, as set by the Administrator. Supplemental death benefits are payable in some cases over a period of ten years provided death occurs while the employee participant is actively employed with the Company.
The Company invests the amounts deferred by employees in life insurance policies. Since DEF COM is a defined contribution plan, the accumulated postretirement benefit obligation as of the transition date has been based on the actual balances in each participant's account, which consists of contributions and accrued interest.
The following tables present the funded status of the Company's benefit plans and the 1996 periodic expense:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
The following tables present the funded status of the Company's benefit plans and the 1995 periodic expense:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE F - EMPLOYEE BENEFIT PLANS - Continued
4. Stock Employee Compensation Trust
On February 1, 1994, the Company established a Stock Employee Compensation Trust ("SECT") and financed the SECT's repurchase of 221,792 shares of common stock owned by two of the Company's former founders. The Company's loan to the SECT will be paid down from time to time as the employees exercise and pay for their options under the Company's Incentive Stock Option Plan. At December 31, 1996 and 1995, there were 176,131 and 183,392 unallocated and uncommitted shares respectively held by the SECT.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE G - OTHER LONG-TERM OBLIGATIONS
Amounts due to certain founders (no longer affiliated with the Company), under a Confidential Settlement Agreement, are included in Other Long-Term Obligations. Payments under the agreements will continue until 2004. During 1995, the Company entered into a similar agreement with another former founder. Amounts under the latter agreement payable through 2006 are included in Other Long-Term Obligations as well. The cost of the latter agreement was included in Other Expense in the 1995 financial statements.
NOTE H - COMMITMENTS AND CONTINGENCIES
1. Future Minimum Rental Commitments
The following is a schedule by years of the approximate future minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms of one year or more as of December 31, 1996:
Year ending December 31,
1997 1,667,600 1998 1,374,200 1999 625,600 2000 631,200 2001 and thereafter 433,800
Future minimum rental payments $4,732,400
Net rent expense under operating leases amounted to approximately $1,744,000, $1,739,900, and $2,042,600 for the years ended December 31, 1996, 1995 and 1994, respectively, after being reduced by rental income which was not material during the last three years.
2. Litigation
The following information is furnished regarding litigation involving the Company:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE H - COMMITMENTS AND CONTINGENCIES - Continued
On January 2, 1996, the Company was named as a defendant in a lawsuit captioned 7600 Limited Partnership and Guy Beatty v. QuesTech, Inc. The plaintiffs (the Company's former landlord and its general partner) sought attorneys' fees incurred in two earlier landlord/tenant cases (a contract claim) plus damages for the tort of malicious prosecution, plus punitive damages.
In February 1997, the Company agreed to a settlement which has been accounted for in the financial statements. The settlement, which is subject to final documentation, disposes of all issues raised in the litigation, and had no material impact on the Company's financial statements.
The Company has no other litigation pending which involves potential liability in excess of $10,000.
Other Claims
Since September 1996, the Company has been involved in a dispute with Munchkin, Inc., the sole customer at that time of its QTPI subsidiary. The dispute involved an alleged breach of contract and warranty issues, as well as claims for payment by QTPI.
In addition, in February, the Company filed a declaratory judgment action seeking to clarify the nature of the exclusivity granted to Munchkin under its contract.
The Company is currently in negotiations which, if successful, would resolve all outstanding disputes with Munchkin.
The Company has no other claims pending which involves potential liability in excess of $10,000.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE H - COMMITMENTS AND CONTINGENCIES - Continued
3. Employment Agreements
The Company has employment agreements with two executive officers which stipulate salary continuation for a period of five years and two years, as a result of voluntary or involuntary termination, regardless of the change in control of the Company. The cost of accrued interest and the present value of compensation changes for these agreements aggregated ($106,700 and $191,600) during 1996 and 1995, respectively. None of these costs will be paid until the subject officers terminate their employment with the Company.
NOTE I - STOCK OPTIONS
The Company accounts for its incentive stock options under APB No. 25. The 1996 Plan allows the Company to grant options to officers and key employees for up to 200,000 shares of common stock. These options, which have five year terms, vest at a rate of 20% per year from the date of grant. The exercise price of each option equals the market price of the Company's stock on the date of grant. At December 31, 1996, the Company had options outstanding for 220,200 shares of common stock. Options to purchase 40,000 shares were issued out of the 1996 Plan. The remainder of the outstanding options were issued under the 1994 Plan. Options to purchase 160,000 shares are available for future grants under the 1996 Plan. There are no options available for future grants under the 1994 Plan.
Accordingly, no compensation cost has been recognized for the plan. Had compensation cost for the plan been determined based on the fair value of the options at the grant dates consistent with the method of SFAS 123, the Company's net income and earnings per share would have been:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE I - STOCK OPTIONS - Continued
The fair value of each option grant is estimated on the date of the grant using the Black-Scholes options-pricing model with the following weighted-average assumptions used for grants in 1996 and 1995: expected volatility of 71%; risk free interest rate of 6%; and expected lives of four years.The pro forma effect on net income for 1996 or 1995 is not representative of the pro forma effect on net income in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE I - STOCK OPTIONS - Continued
A summary of the status of the Company's Incentive Stock Option Plans as of December 31, 1996 and 1995, and changes during the years ending on those dates is presented below.
The following information applies to options outstanding at December 31, 1996:
Number outstanding 224,200 Range of exercise prices $4 to $7.25 Weighted-average exercise price $4.62 Weighted-average remaining contractual life 3.55
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE I - STOCK OPTIONS - Continued
The Company has also provided for the grant of non-qualified stock options to the Company's non-employee directors. These options were granted to purchase 15,000, 3,000 and 20,000 shares during 1996, 1990 and 1991, at the stock's then fair market value, which were $7.25, $1.875 and $1.75 respectively. Of these options, 15,000 shares were outstanding at December 31, 1996, and 23,000 shares at December 31, 1995.
NOTE J - FINANCIAL INFORMATION FOR BUSINESS SEGMENTS
The Company derived all of its revenues under contracts with agencies of the United States Government, either as a prime contractor or as a subcontractor.
Currently, the Company operates in two industry segments: government contracting and commercial (plastic container manufacturing). Performance under government contracts includes scientific, engineering, and program management services, primarily in the defense and intelligence arenas. Sales provided by the commercial segment were in fulfillment of a multi- year supply contract for thermoformed infant bottle liners. Since the third quarter, operations were disrupted by a dispute on pricing and technical specifications.
Operating Profit/Loss is income from operations before general corporate expense. General corporate expense consists primarily of headquarters administrative costs and provisions for reserves and other allowances.
Identifiable assets by industry segment are those assets that are used in the Company's operations in each industry segment. Corporate assets are principally cash and cash equivalents, the deferred income tax asset, certain fixed assets and leasehold improvements in the corporate office, patents, and cash values of corporate-owned life insurance policies. In the commercial packaging segment, some manufacturing equipment was placed in service during 1996 and 1995; however, a significant portion remained under construction in progress as of year-end.
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE J - FINANCIAL INFORMATION FOR BUSINESS SEGMENTS - Continued
A summary of the Company's operations by industry segment follows:
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE J - FINANCIAL INFORMATION FOR BUSINESS SEGMENTS - Continued
QuesTech, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE J - FINANCIAL INFORMATION FOR BUSINESS SEGMENTS - Continued
SUPPLEMENTAL INFORMATION
QuesTech, Inc. and Subsidiaries
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Years ended December 31, 1996, 1995 and 1994
(1) Included in accounts receivable - trade. (2) Included in deferred tax asset - long-term.