Item 1. Business
General Overview
Hi-Shear Technology Corporation designs and manufactures high reliability pyrotechnic, mechanical and electronic products for the aerospace industry, national defense and other applications where pyrotechnic power is desirable. Its products are primarily used in space satellites and satellite launch vehicles, exploration missions, strategic missiles, tactical weapons, advanced fighter aircraft and military systems. Customers such as the military, satellite manufacturers, launch vehicle assemblers, U.S. Government departments and agencies (including NASA), foreign space agencies, and others in the aerospace and defense business widely use Hi-Shear's products.
The Company's executive offices are located at 24225 Garnier Street, Torrance, CA 90505-5355, Telephone (310) 784-2100 - Facsimile (310) 325-5354.
Hi-Shear Products
Hi-Shear’s products meet the specialized needs of both commercial and military satellites, the United States space program and defense applications. They consist primarily of pyrotechnic power cartridges and various types of separation devices designed to meet the demand for reliable high performance, with the strength to fasten two structures under rigorous conditions and then provide quick release upon command. Hi-Shear cartridges, cutters, pin pullers, separation nuts and separation bolts are used widely in the functioning of satellites and the vehicles which launch them into space. In addition, we design and manufacture electronic firing systems that control and sequentially fire the pyrotechnic devices according to pre-programmed parameters. These electronic devices and pyrotechnic products are used in missiles, launch vehicles, weapon systems, fighter aircraft ejection seats and other applications. We continually adapt our technology to produce products for other applications where pyrotechnic power is desirable and our unique product designs are suitable. Hi-Shear's products can be grouped into three product categories as follows:
Pyrotechnic Cartridges/Initiators. Satellites, missiles, weapon systems and other space vehicles require substantial stand-by power to perform certain timing-dependent functions such as separation, cutting and deployment. Hi-Shear designs, markets and manufactures pyrotechnic power cartridges/initiators and explosive detonators that have a high-energy output. These power cartridges are hermetically sealed electro-explosive devices that are compact, lightweight, environment and corrosion resistant and operate with ultra high reliability. The power cartridge provides the energy to operate the Company's separation devices, pin pullers, thrusters, actuators and cutters. These devices are used to separate rocket motors, nose cones, satellites, open satellite doors, payload fairings, operate valves, deploy solar panels, booms, communications antennae, missile fins, and stage separation on many of today's major launch vehicles. Hi-Shear manufactures the highest reliability NASA standard initiator used throughout its space exploration missions and the Space Shuttle.
Cartridge Actuated Devices. Hi-Shear's cartridge actuated devices are mechanical gas-activated products for use on satellites, launch vehicles, missiles and other space vehicles. These devices include separation nuts, separation bolts, thrusters, wing/fin actuators, cutters, valves, pin pullers and other devices. They are designed for use as standard high strength fastening hardware with the ability to separate and/or release components or structures on command. These devices provide the low shock
mechanical action required for rapid separation or deployment of structures or components in multistage launch vehicles, such as satellites, payload fairings, nose cones, capsules, booster rockets, tanks, solar arrays, antenna booms and other devices. We maintain an active program for new designs, including pyrotechnic and electric low shock deployment systems for the increasingly lighter satellites used in communications and intelligence gathering.
In addition to pyrotechnic cartridge activated devices, we manufacture a line of electrically driven ultra low shock separation nuts for satellite applications where an alternative to pyrotechnic activation is desirable. These high performance electric separation devices provide the strength and flight heritage identical to our cartridge activated separation nuts while providing the advantage of reduced shock and resettable usage for appropriate applications. Hi-Shear also manufactures sophisticated highly reliable mechanical sub-components used on satellites to aim the satellites onboard communications array and other components for space vehicles and weapons systems according to customer supplied detailed designs and testing requirements.
Electronic Products. Hi-Shear is a key supplier of electronic products that fire pyrotechnic and/or explosive charges while at the same time maintaining the utmost in safety.
Hi-Shear supplies electronic safe arm fuzes for various military programs. The Company's Patriot (PAC-3) missile system safe arm fuze is used to fire explosive elements contained in the PAC-3 missile. This dual function high reliability safe arm fuze is a key operational component onboard each missile launch. The PAC-3 high performance anti-missile batteries are deployed with the U.S. Army and its allies throughout the world to protect against enemy missile attack. We employ a proprietary initiator in the safe arm product that, when removed, permits full testing of the electronics without risk to personnel or damaging the integrity of the missile system. This allows for economical missile system safety checks, and an extended shelf life estimated at 30 years, which is among the longest in the industry.
Hi-Shear manufactures both the electronic Mark 58 Acoustic Firing Device and its master control unit, the Mark 92 Acoustic Firing Code Transmitter, for use by the U.S. Navy. This unique ordnance firing system utilizes acoustic signals for underwater demolition and is used by Navy divers to dispose of sea mines, limpet mines, sonobuoys and torpedoes. The acoustic firing device is specially constructed and tested to be non-magnetic equipment so that it may be used safely in the proximity of magnetic influenced ordnance. The acoustic firing device is consumed in each explosive disposal firing.
The Firing Code Transmitter is the compact portable electronic console that is operated on the oceans surface to remotely control the operation of the firing device. The firing code transmitter is programmed by its operator to effectively function the acoustic firing device, which is located underwater, at a significant distance from the code transmitter console. The transmitter is self contained in a briefcase sized weather proof case and has its own power supply. The transmitter unit is completely reusable and may efficiently signal the firing of many acoustic firing devices.
The Company supplies to the U.S. military and its allies around the world ejection seat components and ordnance devices that carry out key functions during ejection. These devices are sold for use on the U.S. Air Force ACES II crew ejection seat installed in many fighter and bomber aircraft, including the A-10, B-2, and. The ejection seats utilize multiple ordnance devices that deploy parachutes, rockets and other events crucially necessary for the pilot's ejection from the aircraft. Hi-Shear also manufactures various ejection seat modification kits and other items used to enhance the performance of the ejection system that are supplied to the military services according to their detailed specifications and requirements.
Customers and Contracts
Most of the Company's customers are large aerospace prime or subcontractors. In addition, Hi-Shear derives a significant amount of its revenue from contracts that it has directly with Government customers, including the U.S. Air Force, U.S. Navy, U.S. Army and NASA. Sales to Lockheed Martin, the United States Government and Boeing accounted for 39%, 14% and 2%, respectively, of the Company's revenues in fiscal year 2009, compared to 39%, 19% and 13%, respectively, of the Company’s revenues in fiscal year 2008. Contract awards and contract competition phases vary from year to year, and therefore sales distribution among customers during any one fiscal year should not be considered indicative of future sales to those customers.
In both fiscal years 2009 and 2008, all of the Company's contracts were on a fixed price contract basis where we agree to perform certain work for a fixed price. These fixed price contracts carry certain inherent risks, including the underestimation of costs, problems with new technologies, costly changes made by the customer for which it refuses to pay or the occurrence of adverse changes over the contract period. Due to economies that can be encountered over the period of the contract, these fixed price contracts can also offer significant profit potential. The Company's contracts that evolve from the U.S. Government or from its contractors are subject to termination for convenience by the customer or the U.S. Government. However, if this termination for convenience were exercised, the Company would be entitled to receive payment of its costs incurred up to the date of termination and a reasonable termination fee. U.S. Government contracts extending beyond one year are also conditioned upon the continuing availability of Congressional appropriations because Congress usually appropriates on a fiscal year basis even though contract performance may take several years.
Backlog
The average time to design, manufacture and ship our products is typical of the lead times required for highly engineered, custom manufactured aerospace products. The final negotiation of the detailed contract requirements together, with the purchase of long lead time material, manufacturing processes and testing take between 4 to 12 months or more to accomplish. During fiscal year 2009, we continued programs to reduce many of our manufacturing lead-times to help our customers reduce their product manufacturing time with more timely delivery. This is part of an overall strategy by Hi-Shear's aerospace customers to carry fewer components in inventory and to speed the construction of launch vehicles, satellites and weapon systems.
Total requirements included in contracts undertaken by us may contain options that extend beyond one year, and accordingly, portions are carried forward from one year to the next as part of the backlog. Some contracts with the U.S. Government and its prime contractors are supply contracts and/or multi-year options whose requirements are primarily based on the Government's demand for products on a periodic basis. Because many factors affect the scheduling of projects, no assurances can be given as to when revenue will be realized on projects that are included in backlog. Although backlog represents business that is considered to be firm, there can be no assurance that cancellation, changes in quantities, funding changes, or scope adjustments will not occur.
As of May 31, 2009, the Company's backlog of unrecognized revenue and unbilled amounts on open customers' orders was $15.0 million and $23.0 million, respectively, compared to unrecognized revenue and unbilled backlog amounts as of the end of the prior fiscal year of $21.3 million and $27.6 million, respectively. The decrease in unbilled backlog is the result of delays in anticipated new orders.
Competition
Hi-Shear’s aerospace and defense products are thoroughly tested individually, as well as tested in conjunction with the end product into which they are incorporated. After commencement of a given program, it is very costly for competitors to design new competitive components or for customers to change suppliers of the components since the customer would then be required to re-qualify the products. Therefore, due to the Company's extensive financial investment and years of involvement in the development of our products and the practical barriers to entry into the market by competitors, competition is not a critical factor for subsequent orders. In addition, local, state and federal permits and licenses that are required to manufacture such pyrotechnic and explosive devices as the Company produces are difficult to obtain and therefore provide further barriers to entry into the market by competitors. Hi-Shear currently qualifies as a small business entity for the purposes of obtaining small business set aside contracts and dealing with U.S. Government contracts or programs.
Manufacturing and Production
Production consists of fabricating and assembling the mechanical and electronic hardware components and separately preparing the pyrotechnic charge used in the Company's cartridge devices. Production of the mechanical and electronic devices involves machining components in the precision machining center, the assembly of the components and the testing of the completed units. Throughout the entire process, strict quality assurance controls are maintained including customer and, where required, government inspection. After assembly, the products are functionally tested on a sample basis. At May 31, 2009, Hi-Shear had approximately 86 full time employees (including employees hired from temporary agencies), the majority of whom are engineers and technicians. The handling and processing of pyrotechnic materials requires extensive experience and expertise as well as the proper equipment, facilities and permits. We have been safely handling and processing these fuels and oxidizers for over forty years.
Additional Information
The Company files annual and quarterly reports and proxy statements with the Securities and Exchange Commission (the "Commission") pursuant to federal securities laws. You may inspect such reports, including the exhibits thereto, without charge, at the Public Reference Room of the Commission at 450 Fifth Street N.W., Washington, D.C. You may obtain information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330. You may also access such material electronically by means of the Commission's home page on the Internet at http://www.sec.gov.
We intend to make available to our stockholders annual reports containing financial statements audited by an independent certified public accounting firm. We may also make available to our stockholders, from time to time, other reports about material corporate developments.
Item 2.
Item 2. Properties
Hi-Shear's manufacturing and executive offices are located in Torrance, California, in a 76,000 square foot building organized for electronic, mechanical, and pyrotechnic manufacturing, testing and assembly operations. The Company leases these offices pursuant to a five (5) year lease through August 31, 2012. The Company also owns and operates a plant on twelve acres of land in Santa Clarita, California that it utilizes as a storage and powder-blending facility in addition to conducting manufacturing and testing. We believe that our current leased facilities in Torrance and the property in Santa Clarita are adequately covered by insurance and will adequately support the Company’s operations for the foreseeable future.
Item 3.
Item 3. Legal Proceedings
Hi-Shear filed suit against United Space Alliance, LLC, a Delaware limited liability company (“Alliance”), and USBI Co., a Delaware corporation (“USBI”), in November 2000 in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages in excess of $1,500,000, excluding interest, costs, and attorneys’ fees, alleging Alliance and USBI breached contracts for Hi-Shear to manufacture and deliver certain hardware for use on the Space Shuttle. Hi-Shear also sought damages based on claims alleging that Alliance and USBI fraudulently induced Hi-Shear to enter into certain contracts to manufacture and deliver certain hardware for use on the Space Shuttle. In addition, Hi-Shear sought damages for claims that defendants misappropriated Hi-Shear’s proprietary information and/or trade secrets in certain technical data and information. Hi-Shear also alleged a claim for a declaratory judgment. Alliance subsequently filed a counterclaim seeking damages of over $450,000, excluding interest, costs, and attorneys’ fees, alleging Hi-Shear breached its contracts to manufacture and deliver certain hardware for use on the Space Shuttle. Alliance also alleged a claim for conversion and an accounting relating to certain items of alleged government furnished equipment, and a claim for a declaratory judgment. As part of its defense in the litigation, Alliance claimed that it was coerced through duress to enter into a contract with Hi-Shear where Hi-Shear was the qualified successful lowest bidder. In addition, Alliance demanded that Hi-Shear ship uncertified flight hardware to it for use on the United States Space Shuttle, ahead of its normal certification schedule. USBI did not file a counterclaim against the Company.
In July 2004, Hi-Shear filed a separate but related suit against Pacific Scientific Energetic Materials Company, a Delaware corporation, in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages, alleging that defendant misappropriated Hi-Shear’s proprietary information and/or trade secrets in certain technical data and information, conspired to misappropriate trade secrets, and interfered with Hi-Shear’s advantageous business relationships. After defendant filed, and the court ruled on, a motion to dismiss, and Hi-Shear filed an amended complaint against Pacific Scientific, the court entered an order staying all further proceedings in the case until the appeals from the suit between Hi-Shear and Alliance and USBI were resolved, and the court entered a subsequent order lifting the stay.
Prior to the trial between Hi-Shear, Alliance, and USBI, the court made legal rulings that the Company did not have trade secrets in certain technical data and information, which the Company alleged had been misappropriated by Alliance and USBI. As a result, the court granted in part Alliance’s and USBI’s motions for summary judgment on that issue. Prior to trial, the court also made legal rulings that USBI did not fraudulently induce Hi-Shear to enter into a contract to manufacture and deliver certain flight hardware for use on the Space Shuttle. As a result, the court granted Alliance’s and USBI’s motions for summary judgment on that issue.
Trial before a jury of Hi-Shear’s remaining claims against Alliance and USBI, and Alliance’s counterclaim against Hi-Shear, commenced on July 5, 2005 in Titusville, Florida. Shortly after the trial began, the court made additional legal rulings, which resulted in its granting the remainder of Alliance’s and USBI’s motions for summary judgment on the trade secrets issues. As a consequence of those rulings and based on other circumstances, Hi-Shear dismissed its remaining claims against USBI. As a result, USBI was no longer a participant in the trial. The jury trial continued through September 2, 2005. Some of Hi-Shear’s claims were disposed of by the court based on legal rulings made during the course of trial. Of the remaining claims that the jury was asked to decide, the jury rendered a verdict in favor of Hi-Shear on one of its breach of contract claims, and awarded the Company damages of $57,781, exclusive of interest, costs, and attorneys’ fees. The jury found in favor of Alliance on Hi-Shear’s remaining breach of contract claims and thus awarded Hi-Shear no damages on those claims. The jury
also found in favor of Alliance on its counterclaim for breach of contracts but awarded it no damages. In addition, the jury determined that Hi-Shear converted certain government furnished equipment pursuant to Alliance’s conversion counterclaim. In August 2005, the court entered final judgment on Hi-Shear’s claims against USBI. After hearing and denying post-trial motions by both Hi-Shear and Alliance, in May 2006 the court entered final judgment on Hi-Shear’s and Alliance’s respective claims against each other.
In September 2005, Hi-Shear appealed the final judgment entered on its claims against USBI to Florida’s Fifth District Court of Appeal. Alliance participated in that appeal as an appellee based on its having joined in the trade secrets and fraudulent inducement summary judgment motions at the trial level. In February 2007, after hearing oral argument, the court of appeal affirmed the trial court’s rulings and final judgment in favor of USBI. The appellate court denied motions by Hi-Shear and Alliance to recover attorneys’ fees incurred on appeal.
In June 2006, Hi-Shear appealed the final judgment entered on its claims against Alliance, and Alliance’s counterclaims against Hi-Shear, to Florida’s Fifth District Court of Appeal, challenging the legal basis of the lower court’s final judgment including the amounts of the recovery of Hi-Shear’s damages on contracts for manufactured components and other claims at trial. The appeal encompassed issues evident throughout the court proceedings, including the legal basis of the trial court’s judgments and questionable adverse rulings by the court during the entire course of the trial. The Alliance filed a cross appeal. On November 14, 2008, the Florida Fifth District Court of Appeal issued its opinion, which affirmed the lower court's rulings, with one of the three appellate court judges dissenting. The Alliance’s cross appeal was denied, and the court also denied motions by Hi-Shear and Alliance to recover attorneys’ fees incurred on appeal. On December 19, 2008, Hi-Shear filed a motion regarding this appeal with the Florida Fifth District Court of Appeal seeking a rehearing, rehearing en banc, and certification. In February 2009, Hi-Shear was notified that the December 19, 2008 motion was denied in full.
In December 2006, the trial court entered an order denying Hi-Shear’s motion for entitlement to recover its attorneys’ fees and costs from Alliance, even though Hi-Shear was the only party to have been awarded damages by the jury. In that same order, the court determined that instead, Alliance had prevailed on its claims for breach on three of four contracts and thus was entitled to recover from Hi-Shear its reasonable attorneys’ fees incurred relating to count I of its counterclaim against Hi-Shear for breach of contracts. Alliance claimed the amount of reasonable attorneys’ fees it should recover from Hi-Shear was approximately $2,900,000. USBI never filed a motion to recover its attorneys' fees from Hi-Shear. Hi-Shear opposed those claims, believing that the amount sought by Alliance was excessive. On March 13-14, 2008, the trial court held an evidentiary hearing on the amount of reasonable attorneys’ fees to be awarded to Alliance. At the hearing, Hi-Shear offered evidence and expert testimony to establish that Alliance’s request for attorneys’ fees was excessive. On July 28, 2008, the trial court sent a letter to Alliance’s attorneys asking them to prepare a form of order regarding attorneys' fees. Hi-Shear received a copy of the letter on July 31, 2008. The letter quantified some attorneys' fees to be awarded to Alliance but did not specify the final amount of attorneys’ fees to be awarded, and also indicated that an additional hearing would be required on specific issues. However, the letter also indicated that the trial court would make additional favorable rulings for Alliance on several issues, and it appeared that the trial court would award to Alliance certain additional portions of the attorneys’ fees it sought.
Although Hi-Shear was unable to determine the precise amount of attorneys' fees that might ultimately have been awarded, it believed that it was appropriate under generally accepted accounting principles to accrue approximately $3,275,000 associated with the litigation for its year ended May 31, 2008. In addition, $76,000 had been accrued in each of the quarters ended November 30, 2008 and February 28, 2009 to reflect the current quarter's interest cost of the estimated fees and costs.
In October 2008, over Hi-Shear's opposition, the trial court issued orders and judgments for litigation costs to be awarded to the Alliance and USBI in the total amount of approximately $580,000, which included amounts for pre-judgment interest. On December 1, 2008, Hi-Shear appealed the award of costs to Alliance to the Florida Fifth District Court of Appeal.
In February 2009, a notice was served that set a hearing on June 9, 2009 regarding the final amount of attorneys' fees to be awarded to Alliance. Hi-Shear was prepared to challenge the final amount of fees sought by Alliance and subsequently filed a motion with the trial court seeking to strike the Alliance's pending motion for entry of a final attorney fee judgment, but Hi-Shear also believed that it was appropriate under generally accepted accounting principles to accrue an estimate of a potential fee award, previously-awarded costs, and pre-judgment interest on fees and costs based on the court's previous rulings.
In April 2009, Hi-Shear filed a petition for a writ of certiorari seeking review by the United States Supreme Court of certain issues from the trial that had been affirmed by the Florida court of appeal.
During May of 2009, settlement discussions ensued between the Company and United Space Alliance. As a result, the June 9, 2009 fee hearing was canceled, and on July 7, 2009, the Company and Alliance completed a Settlement Agreement to settle the Company’s pending litigation with Alliance. Pursuant to the Agreement, the Company shall pay Alliance the sum of $1,600,000 in four separate installments of $400,000. The first payment was made July 8, 2009 with the subsequent payments due on September 30, 2009, December 31, 2009 and March 31, 2010. The Company deemed satisfied its judgment against Alliance, and dismissed its pending actions against Alliance in the Florida court of appeal and the United States Supreme Court, and also dismissed its amended complaint against Pacific Scientific Energetic Materials Company in a related case pending in Brevard County, Florida. The Settlement Agreement provides for mutual releases and resolves all ongoing disputes between the Company and Alliance. To reflect the settlement, previous accruals will be reduced to the net settlement amount resulting in an increase to operating income in the fourth quarter of fiscal year ended May 31, 2009.
In addition, the Company is subject to other claims and legal actions that may arise in the ordinary course of business. In the opinion of the Company, after consultation with counsel, the ultimate liability, if any, with respect to these other claims and legal actions, will not have a material effect on the financial position or on the results of operations.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for Common Equity, Related Stockholder Matters and Small Business Issuer Purchases of Equity Securities
Hi-Shear's Common Stock is traded on the NYSE American Stock Exchange under the symbol "HSR". The following table reflects the high and low sales prices of the Company's Common Stock, as reported by the NYSE American Stock Exchange composite tape, for the periods set forth below:
High
Low
Fiscal Year 2009 ending May 31, 2009
4th Quarter
$
8.45
$
6.15
3rd Quarter
9.84
7.75
2nd Quarter
11.50
6.85
1st Quarter
12.92
11.10
Fiscal Year 2008 ending May 31, 2008
4th Quarter
$
11.94
$
10.50
3rd Quarter
13.64
11.11
2nd Quarter
13.34
9.07
1st Quarter
10.59
7.00
The Board of Directors approved and the Company paid three dividends during the fiscal years ended May 31, 2008 and May 31, 2009. On September 21, 2007 the Company declared a cash dividend of $0.35 per share (or approximately $2,383,000) that was paid October 8, 2007 to shareholders of record as of the close of business October 5, 2007. The ex-dividend date was October 3, 2007. On March 19, 2008 the Company declared a cash dividend of $0.40 per share (or approximately $2,726,000) that was paid April 11, 2008 to shareholders of record as of the close of business April 1, 2008. The ex-dividend date was March 27, 2008. On October 9, 2008 the Company declared a cash dividend of $0.50 per share (or approximately $3,410,000) that was paid October 27, 2008 to shareholders of record as of the close of business October 24, 2008. The ex-dividend date was October 22, 2008. These dividends were not special and did not represent that the Company will pay dividends on a scheduled basis. Dividends will be determined by the Board of Directors in light of the conditions then existing, including earnings, financial requirements and conditions, opportunities for reinvesting earnings, business conditions and other factors.
Subsequent to year-end 2009, on July 16, 2009 the Company’s Board of Directors approved a cash dividend. A dividend of approximately $5,139,000 or $0.75 per share will be paid on or about August 21, 2009 to shareholders of record as of the close of business August 14, 2009. The ex-dividend date is August 12, 2009.
The number of holders of record of Hi-Shear's Common Stock was 54 and the number of beneficial shareholders was approximately 1,300 as of June 4, 2009.
The securities authorized for issuance under the Company’s equity compensation plan are as follows:
Plan category
Number of securities to be issued upon exercise of outstanding options, warrants and rights
(a)
Weighted-average price of outstanding options, warrants and rights
(b)
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
(c)
Equity compensation plans approved by security holders
48,719
$7.84
424,171
Equity compensation plans not approved by security holders
$0.00
TOTAL
48,719
$7.84
424,171
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
General Overview
The following discussion of Hi-Shear's financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included elsewhere in this report. This report, including this discussion, contains forward-looking statements about business strategies, market potential, and product launches and future financial performance that involve risks and uncertainties. The Company's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. These factors include the acceptance and pricing of its new products, the development and nature of its relationship with key strategic partners, the allocation of the federal budget for government sponsored military and aerospace programs and the economy in general.
Critical Accounting Policies
Hi-Shear's revenues are derived principally from fixed-price contracts that are accounted for on the percentage-of-completion method. Revenues for those contracts are calculated on the basis of the relationship between costs incurred and total estimated costs at completion of the contracts (“cost-to-cost” type of percentage-of-completion method of accounting).
Because of the large amount of contracts in process at any point in time, changes in estimated costs to complete can have a significant impact on profitability of the Company. We estimate that each 1% change in the total estimated costs to complete the contracts in process at May 31, 2009 would change both the amount of revenue and earnings recognized by approximately $79,000. We evaluate and update estimated costs to complete for open contracts on a regular basis. Those evaluations and updates include the participation of management and other key employees from all operational areas. Changed estimates to complete the contracts are then incorporated in the calculations of revenues and profits.
Included in the inventories recorded and maintained by the Company are purchased and manufactured component parts and finished goods that relate to previously completed contracts. The Company’s management periodically assesses the likelihood that those inventory items will be used in future
contracts, since many of the Company’s past contracts relate to on-going programs, for which it will be awarded similar contracts. The current method utilized in management’s assessment is to evaluate individual items in the inventories and assess current or future contract requirements which may use inventory parts. A reserve is established for individual inventory parts based on said analysis. Since the inventory reserve methodology is subjective, and subject to changes in estimates based upon updated information, changes in those estimates can be substantial.
Results of Operations
Fiscal Year Ended May 31, 2009 compared with Fiscal Year Ended May 31, 2008
Revenues recognized during fiscal year 2009 were $25,933,000 compared to the $27,628,000 of revenues recognized during fiscal year 2008. Some customer delays in releasing their requirements to the company resulted in the revenue decrease for the year. Although these orders were subsequently placed with the Company later during the fiscal year, the delays extended some recognition of revenue on those orders to fiscal year 2010. The Company serviced approximately 200 separate space and defense projects during the year including space and national missile defense applications accounting for 66% of total revenues and tactical weapon applications accounting for 19% of total revenues.
Cost of revenues for the fiscal year 2009 was $12,285,000, or 47% of revenues, compared to $14,827,000, or 54% of revenues, for the prior fiscal year. Cost containment programs, including utilization of new equipment, absorption of fixed overhead expenses and continuing improvements in manufacturing procedures contributed to the reduction in cost of revenues.
Gross margin continued to improve in both total amount and as a percentage of revenues. Satellite and missile defense products experienced increased profitability and contributed to gross margin percentage growth year over year. Gross margin for fiscal year 2009 increased $847,000 to $13,648,000, or 53% of revenues, from $12,801,000, or 46% of revenues, in fiscal year 2008. Consistent with year over year reductions to cost of revenues, the Company continues to realize gross margin improvement.
Selling, general and administrative expenses were $2,513,000 for fiscal year 2009, compared to $7,259,000 in fiscal year 2008. The 65% decrease or $4,746,000 results from the Company’s favorable litigation settlement offset by some increases in executive compensation and consulting expenses.
Reduction in the amounts previously accrued for litigation resulted from the Company entering into a settlement agreement to close the ongoing litigation with United Space Alliance. The outstanding accrual in the amount of $3,275,000 in addition to accrued interest totaling $152,000, has been reduced to the settlement amount of $1,600,000. Also, the judgment amount of $57,800 owed to the Company by Alliance was forgiven as part of the agreement. In addition, $252,000 was expended during the year on attorney fees related to this litigation. The net effect of these adjustments resulting from the settlement is a reduction of selling, general and administrative expenses and an increase to operating income.
Operating income increased to $11,135,000 compared to the $5,542,000 for the prior year. The increase in operating income was the result of improvements in gross margin and the favorable effect of the litigation settlement.
The Company realized pre-tax income of $11,095,000, or 43% of revenues, for the fiscal year ended May 31, 2009, compared to pre-tax income of $5,586,000, or 20% of revenues, for the previous fiscal year. The increase of 99% was driven by the improvements to gross margin and the favorable litigation settlement.
Income tax expense for fiscal year 2009 was $4,419,000 and 40% of pre-tax income, compared to $2,046,000 and 37% of pre-tax income for fiscal year 2008. The increase in income tax expense occurred primarily as a result of the increase in pre-tax income, upon which reported income tax expense is principally based. The increase as a percentage relates to an increase in non-deductable compensation expense associated with share based awards.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on deregulation, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on June 1, 2007. The adoption of FIN 48 did not have a significant effect on the Company’s financial position and results of operations for the year ended May 31, 2009. Further, the Company is currently under audit by the Internal Revenue Service. The Company’s management has considered the various tax positions subject to examination in accordance with FIN 48, and as a result, the Company’s management does not anticipate any material adjustments that may arise as the result of the examination. Accordingly, no adjustments have been made to the accompanying financial statements.
Net income for the fiscal year ended May 31, 2009 was $6,676,000, or $0.98 per share and 26% of revenues, compared to $3,540,000, or $0.52 per share and 13% of revenues, for the previous fiscal year. The net income increased significantly over last year and is driven by the growth in product gross margins and a favorable litigation settlement. The Company's positive earnings supported the distribution of dividends to shareholders, of a $0.50 per share dividend to shareholders in October, 2008.
Subsequent to May 31, 2009 on July 16, 2009 the Board of Directors approved a cash dividend of $0.75 per share payable on or about August 21, 2009.
Revenues in the fourth quarter were $7,234,000 compared to $9,102,000 for the same quarter in fiscal year 2008. Some order delays experienced earlier in the fiscal year resulted in the revenues associated with those orders being extended into 2010 and resulted in the lower fourth quarter revenues compared to the prior year. Improvements in manufacturing processes and lower variable overhead expenses contributed to growth in gross margins and higher operating margins. Gross margin in the fourth quarter of fiscal year 2009 was 53% compared to 47% for the same period last year. The implementation of new automated equipment, operating efficiencies and lower variable overhead costs contributed to a strong gross margin. Operating margin in the fourth quarter of fiscal year 2009 was 63% compared to 5% for the same period last year due to improved gross profitability and the favorable litigation settlement described above. All operating expenses are covered by current cash balances and thus, there is no borrowing on the revolving line of credit the Company maintains with its commercial bank.
Financial Condition
Accounts receivable balances, which consist of billed and unbilled amounts were $2,769,000 and $7,977,000 respectively at the end of fiscal year 2009. The billed and unbilled amounts at the completion of fiscal year 2008 were $8,111,000 and $6,363,000 respectively. The accounts receivable balances at both May 31, 2009 and May 31, 2008 were not reduced for reserves on doubtful accounts. The decrease in billed receivables of $5,342,000 can be attributed to the delays in delivering customer hardware resulting in reduced billing opportunities. In addition, the billed balance at fiscal year end 2008 included a $1.2 million progress billing on an Air Force contract that did not have a corresponding billing
at the end of the fiscal year 2009. Also, contributing to the higher fiscal year 2008 balance was the final billing of $1.3 million for delivery of hardware on a completed contract that did not have a corresponding event at the end of fiscal year 2009.
Unbilled receivables represent revenues recognized from fixed priced contracts based upon percentage-of-completion, but in advance of completing billable events for which invoices are submitted to customers. As billing events occur for such contracts (generally tied to delivery of hardware), previously unbilled receivables are converted to billed accounts receivable with the preparation and submission of invoices to customers. Unbilled receivables at May 31, 2009 were $7,977,000, compared to $6,363,000 at the end of fiscal year 2008. The increase in unbilled receivables at May 31, 2009 can be attributed to continuing efforts on on-going projects not yet delivered.
Inventories, net of reserves, increased to $1,512,000 at May 31, 2009 from $1,345,000 at May 31, 2008. Inventory reserves, which are established in accordance with management’s estimates regarding the extent to which inventory items will ultimately be used to generate future revenues, were $553,000 at May 31, 2009, compared to $526,000 at May 31, 2008.
Trade accounts payable decreased to $611,000 at the end of fiscal year 2009 compared to $740,000 at the end of fiscal year 2008. Timing of receipts submitted to Hi-Shear for payment at the end of any fiscal month/year will directly impact the outstanding balance for invoices due. There are no disputed amounts included in accounts payable at May 31, 2009.
At both May 31, 2009 and May 31, 2008, the Company did not have any bank debt and has available borrowing of up to $5,000,000 available from its commercial bank under a revolving line of credit maturing December 15, 2009 (See Note 8). The Company also had available a $1,000,000 equipment letter of credit that expired March 2, 2009, and bore interest under the same terms as the revolving line of credit. The equipment line of credit was not renewed based on projections of short term needs but can be re-instated if necessary.
Liquidity and Capital Resources
Net cash of $9,679,000 was provided by operating activities during fiscal year 2009, compared to net cash of $5,994,000 that was provided by operating activities during fiscal year 2008. The increase in net operating cash flows between the two fiscal years was primarily the result of increases in net income and collections of accounts receivables.
To supplement cash provided by operating activities, the Company maintains a business loan agreement including a revolving line of credit with a commercial bank, for the purpose of having sufficient cash to meet its cash obligations. There was no outstanding balance under this line of credit at May 31, 2009. Since the maximum borrowing limit under the line of credit is $5,000,000, the amount available for borrowing at May 31, 2009 was $5,000,000. The line of credit is available to the Company through December 15, 2009, which is the maturity date of the business loan agreement covering the line of credit. Outstanding amounts under the line of credit bear interest at prime less .25% (3.00% at May 31, 2009) or at the Company's option LIBOR plus 2% (3.22% at May 31, 2009).
The Company’s $1,000,000 equipment letter of credit matured March 2, 2009 and was not renewed.
The business loan agreement contains various financial covenants that have not been modified during the fiscal year. At May 31, 2009, the Company was compliant with all of the financial covenants.
The Company’s management believes that the current line of credit is sufficient to enable the Company to meet its projected needs for cash throughout the period of time during which the revolving line of credit is available for its use.
The Company and bank executives assigned to Hi-Shear accounts continue to keep current on banking regulatory changes that have been evolving during current economic times. During the fourth quarter of fiscal year 2009, the Company moved its funds from a “sweep” account insured by government backed securities to a “passbook” account FDIC insured to $250 million. Cash and cash equivalents at the end of the fiscal year 2009 was $7,502,000.
With the approval of its Board of Directors, the Company paid a cash dividend of $3,410,000, or $0.50 per share to shareholders of record as of the close of business October 24, 2008. Subsequent to May 31, 2009 on July 16, 2009 the Board of Directors approved a cash dividend of $0.75 per share payable on or about August 21, 2009. The ex-dividend date is August 12, 2009.
Item 8.
Item 8. Financial Statements
The reports of the independent certified public accountants and financial statements and notes listed in the accompanying index are part of this report. See "Index to Financial Statements" on page 18.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company carried out an evaluation of the effectiveness of the design and operation of disclosure controls and procedures as of May 31, 2009, being the date of the most recently completed fiscal year. This evaluation was carried out under the supervision and with the participation of George W. Trahan, Chief Executive Officer and Jan L. Hauhe, Chief Financial Officer. Based upon that evaluation, both the Chief Executive Officer and Chief Financial Officer concluded that current disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that are filed or submitted under the Exchange Act are recorded, processed, summarized and reported within the time periods specified by the rules and forms of the Securities and Exchange Commission (SEC).
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in reports filed under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.
The term “internal control over financial reporting” is defined as a process designed by, or under the supervision of, the registrant’s principal executive and principal financial officers, or persons performing similar functions, and effected by the registrant’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
(a) Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the registrant;
(b)
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the registrant are being made only in accordance with authorizations of management and directors of the registrant; and
(c)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the registrant’s assets that could have a material effect on the financial statements.
During the fiscal year ended May 31, 2009, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to affect, our internal control over financial reporting during the fiscal year ended May 31, 2009. Improvements to strengthen internal controls have been made during the current fiscal year and will continue to be made to address the identified weakness.
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. We assessed the effectiveness of our internal control over financial reporting as of May 31, 2009, using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control - Integrated Framework. Because of the material weakness described in the following paragraph, management is required to conclude that, as of May 31, 2009, the Company’s internal control over financial reporting was not effective based on those criteria. Management believes however that internal controls over financial reporting is adequate to ensure that the Company’s financial statements included in this annual report on form 10-K present fairly in all material respects the Company’s financial position, results of operation, and cash flows as of the dates and for the periods presented in conformity with Generally Accepted Accounting Principles (GAAP).
In connection with the preparation of our financial statements for the year ended May 31, 2009, an internal control weakness relating to monitoring and risk assessment was identified. To be removed from the material weakness category, further improvements in monitoring and risk assessment related to control activities performed by management will be required.
As part of the communications by Raimondo Pettit Group, with respect to their audit procedures for fiscal year 2009, Raimondo Pettit Group informed the CFO and CEO of this material weakness as defined by Auditing Standard No. 5, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements,” established by the Public Company Accounting Oversight Board (PCAOB).
In accordance with Section 404 of the Sarbanes-Oxley Act of 2002, the Company intends to take appropriate and reasonable steps to make the necessary improvements to remediate this material weakness. We intend to consider the results of our remediation efforts and related testing as part of our fiscal year-end 2010 assessment of the effectiveness of our internal control over financial reporting.
This Form 10-K does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only the management’s report in this Form 10-K.
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
Information required by this item will be contained in the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after May 31, 2009 and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation
The information required by this item will be contained in the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after May 31, 2009 and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this item will be contained in the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after May 31, 2009 and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information required by this item will be contained in the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after May 31, 2009 and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item will be contained in the Company’s Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after May 31, 2009 and is incorporated herein by reference.
Item 15.
Item 15. Exhibits, Financial Statement Schedules
Exhibits: See “Exhibit Index”, page 17.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934 (the "Exchange Act"), the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
HI-SHEAR TECHNOLOGY CORPORATION
Date: August 5, 2009
By:
/s/ George W. Trahan
George W. Trahan
President, Chief Executive Officer and Chairman
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: August 5, 2009
By:
/s/ George W. Trahan
George W. Trahan
President, Chief Executive Officer and Chairman
By:
/s/ Jan L. Hauhe
Jan L. Hauhe
Chief Financial Officer
By:
/s/ Jack Bunis
Jack Bunis
Director
By:
/s/ Lawrence Moreau
Lawrence Moreau
Director
By:
/s/ John Zaepfel
John Zaepfel
Director
(1)
Previously filed and incorporated by reference to the Company's Form SB-2 Registration Statement No. 33-73972 filed with the Securities and Exchange Commission on January 10, 1994.
(2)
Previously filed and incorporated by reference to the Company's Form SB-2 Registration Statement No. 33-73972 filed with the Securities and Exchange Commission on February 1, 1994.
(3)
Previously filed and incorporated by reference to the Company's Form SB-2 Registration Statement No. 33-73972 filed with the Securities and Exchange Commission on March 23, 1994.
(4)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 12, 1998.
(5)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 17, 1999.
(6)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 24, 2000.
(7)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on October 10, 2002.
(8)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 29, 2002.
(9)
Previously filed and incorporated by reference to Exhibit 16.2 to Form 8-K/A filed with the Securities and Exchange Commission on January 24, 2003.
(10)
Previously filed and incorporated by reference to Exhibit 16.3 to Form 8-K/A filed with the Securities and Exchange Commission on August 8, 2003.
(11)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on September 19, 2003.
(12)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 30, 2004.
(13)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on September 13, 2005.
(14)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on July 28, 2006.
(15)
Previously filed and incorporated by reference to the Company's Form 10-QSB filed with the Securities and Exchange Commission on January 16, 2007.
(16)
Previously filed and incorporated by reference to the Company's Form 10-QSB filed with the Securities and Exchange Commission on April 13, 2007.
(17)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 10, 2007.
(18)
Previously filed and incorporated by reference to the Company's Form 10-KSB filed with the Securities and Exchange Commission on August 29, 2008.
Page
Independent Auditors' Report
Balance Sheet
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
-
Raimondo Pettit Group
A PARTNERSHIP INCLUDING PROFESSIONAL CORPORATIONS
CERTIFIED PUBLIC ACCOUNTANTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
Hi-Shear Technology Corporation
We have audited the accompanying balance sheet of Hi-Shear Technology Corporation as of May 31, 2009, and the related statements of operations, stockholders’ equity, and cash flows for the years ended May 31, 2009 and 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our 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 Hi-Shear Technology Corporation as of May 31, 2009 and the results of its operations and its cash flows for the two year period then ended in conformity with accounting principles generally accepted in the United States of America
/s/ Raimondo Pettit Group
Torrance, California
August 3, 2009
HI-SHEAR TECHNOLOGY CORPORATION
BALANCE SHEET
May 31, 2009
ASSETS:
Current Assets:
Cash and cash equivalents
$
7,502,000
Accounts receivable, net (Note 4)
10,746,000
Inventories, net (Note 5)
1,512,000
Deferred income taxes (Note 12)
972,000
Prepaid expenses and other current assets
229,000
Total current assets
$
20,961,000
Land (Note 7)
846,000
Equipment, net (Note 6)
1,977,000
Total assets
$
23,784,000
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Trade accounts payable
611,000
Accrued liabilities (Note 9)
4,353,000
Deferred revenue (Note 10)
182,000
Current portion of obligations under capital leases (Note 11)
35,000
Total current liabilities
$
5,181,000
Deferred income taxes (Note 12)
347,000
Obligation under capital leases (less current portion) (Note 11)
28,000
Total liabilities
$
5,556,000
Commitments and Contingencies (Notes 8, 13 and 16)
Stockholders' Equity
Preferred stock, $1.00 par value; 500,000 shares
authorized; no shares issued
Common stock, $.001 par value - 25,000,000 shares
authorized; 6,832,416 at May 31, 2009
7,000
Additional paid-in capital
8,055,000
Retained earnings
10,166,000
Total stockholders' equity
$
18,228,000
Total liabilities and stockholders' equity
$
23,784,000
See Notes to Financial Statements.
HI-SHEAR TECHNOLOGY CORPORATION
STATEMENTS OF OPERATIONS
Year Ended May 31,
Revenues
$
25,933,000
$
27,628,000
Cost of Revenues
12,285,000
14,827,000
Gross Margin
13,648,000
12,801,000
Selling, General and Administrative Expenses
2,513,000
7,259,000
Operating Income
11,135,000
5,542,000
Interest Income (Expense), Net
(40,000)
44,000
Income before Income Tax Expense
11,095,000
5,586,000
Income Tax Expense
4,419,000
2,046,000
Net Income
$
6,676,000
$
3,540,000
Earnings per Common Share - Basic
$
0.98
$
0.52
Earnings per Common Share - Diluted
$
0.98
$
0.52
Weighted # Common Shares Outstanding:
Basic
6,822,000
6,808,000
Diluted
6,835,000
6,825,000
See Notes to Financial Statements.
HI-SHEAR TECHNOLOGY CORPORATION
HI-SHEAR TECHNOLOGY CORPORATION
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies
Nature of Business:
Hi-Shear Technology Corporation designs and manufactures power cartridges, separation devices, electronic firing units and other special components used by the worldwide aerospace industry, the military and the National Aeronautics and Space Administration (NASA). The Company’s aerospace products are procured under both long and short-term contracts with numerous aerospace contractors, subcontractors and agencies of the United States Government. The Company is dependent on the continuation of the satellite industry and government sponsored military and aerospace programs in order to maintain its revenues.
A Summary of the Company's Significant Accounting Policies is as follows:
Use of Estimates:
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 both assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by management are used for, but not limited to, the realization of claims receivable and certain inventories, costs to complete contracts, and the carrying value of long-lived assets. Actual results could differ from those estimates, and such changes could be material.
Revenue Recognition:
The Company's revenues are derived principally from fixed-price contracts that are accounted for on the percentage-of-completion method. Revenues for those contracts are calculated on the basis of the relationship between costs incurred and total estimated costs to complete the contracts (cost-to-cost type of percentage-of-completion method of accounting).
Provisions for estimated total contract losses on uncompleted contracts are made in the period in which such losses are determined. Amounts representing contract change orders are included in revenues only when the amounts can reliably be estimated and realization is probable. Changes in estimates of revenues, costs and profits are recognized in the period such changes are made.
The Company submits claims for cost reimbursement related to contract requirement changes not yet incorporated into its contract or other contract costs in negotiation. These claims for reimbursement result from changes to specifications, additional work required to be performed by the Company to satisfy customer requests beyond contract scope, failure of customer designed components, and adjustments to contract pricing due to the customer reducing unit quantities. Claims receivable are recorded to the extent of costs incurred, and when, in management's opinion, it is probable that the claim will be collected in full and the amount of the claim can be reasonably estimated.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (continued)
Accounts Receivable:
Included are amounts billed and currently due from customers under all types of contracts, plus amounts earned but unbilled on long-term contracts accounted for under the cost-to-cost type of percentage-of-completion method of accounting.
The Company evaluates all outstanding billed accounts receivable to assess the potential need for an allowance for doubtful accounts. In that assessment, the Company considers the financial condition of its customers and the legal and contractual bases underlying the accounts receivable.
Inventories:
Inventories are composed of raw materials and component parts, work-in-process, and finished goods available for sale. Raw materials and component parts consists of purchased and manufactured parts that are not allocated to an existing production job and are expected to be utilized in anticipated future customer contracts. Work-in-process consists of costs incurred for non-contract jobs in process for manufacturing components and sub-assemblies that do not relate to existing production contracts, but are built in anticipation of future customer contracts. Finished goods consist of completed manufactured products to fulfill future anticipated customer contracts.
Inventory costs for component parts, work-in-process and finished goods include costs for material, direct labor, sub-contracting for manufacturing processes and testing, and manufacturing and engineering overhead. Selling, general and administrative costs are not included in inventory, and are charged to expense as incurred. In accordance with industry practice, inventories are classified as a current asset, and include items that may be allocated to contracts that will not be completed within twelve months. Inventory is valued at the lower of cost or estimated market value, and is determined on a “first-in, first-out” basis.
Equipment:
Equipment is recorded at cost. The Company also capitalizes certain material and labor incurred in connection with the construction of assets. Depreciation and amortization are charged against income using the straight-line method over the estimated useful service lives of the related assets. The principal lives used in determining depreciation and amortization rates are as follows: machinery and equipment, 3 to 10 years; autos, 5 years; tooling, 3 years; furniture and fixtures, 5 to 10 years.
Land:
Investment in land is recorded at the lower of cost or net realizable value.
Impairment on Long-Lived Assets:
The Company records impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by those assets are less than the carrying amounts of those assets. Assets deemed impaired are recorded to the lower of carrying value or fair value.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (continued)
Income Taxes:
Deferred income taxes are provided using the liability method whereby deferred income tax assets are recognized for deductible temporary differences and operating loss carry forwards and deferred income tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred income tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Deferred income tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FAS 109, Accounting for Income Taxes” (“FIN 48”), to create a single model to address accounting for uncertainty in tax positions. FIN 48 clarifies the accounting for income taxes by prescribing a minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on deregulation, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted the provisions of FIN 48 on June 1, 2007. The adoption of FIN 48 did not have a significant effect on the Company’s financial position and results of operations for the year ended May 31, 2009. Further, the Company is currently under audit by the Internal Revenue Service. The Company’s management has considered the various tax positions subject to examination in accordance with FIN 48, and as a result, the Company’s management does not anticipate any material adjustments that may arise as the result of the examination. Accordingly, no adjustments have been made to the accompanying financial statements.
Earnings Per Share:
Earnings per share (EPS) are computed as net income divided by the weighted-average number of common shares outstanding for the period. EPS assuming dilution reflects the potential dilution that could occur from common shares issuable through stock options and grants. The dilutive effect from outstanding options for fiscal years 2009 and 2008 did not change earnings per share.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (continued)
The following is a reconciliation of the numerators and denominators used to calculate earnings per common share, as presented in the statements of operations:
Cash and Cash Equivalents:
For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with a maturity date of three months or less to be cash equivalents.
The Company does not have cash on deposit with its bank that exceeds the insurance limits of the FDIC due to “passbook” increases to insured limits now at $250 million.
Stock-Based Compensation:
The Company accounts for stock-based employee and non employee transactions under the requirements of SFAS No. 123R "Share Based Payment" which requires compensation to be recorded based on the fair value of the securities issued or the services received, whichever is more reliably measurable.
The Company uses the Black-Scholes option-pricing model to calculate the fair value of the stock options. The fair value of grants is determined by published market values at the date of grant. The adoption of SFAS 123R resulted in additional stock-based compensation of $227,000 for the year ended May 31, 2009 and $110,000 for the year ended May 31, 2008.
New Accounting Pronouncements:
In September 2006, the FASB issued Statement of Financial Accounting Standard 157 (SFAS 157), Fair Value Measurements. SFAS 157 addresses how companies should measure fair value when required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (GAAP). As a result of SFAS 157, a common definition exists of fair value to be used throughout GAAP. The FASB believes that the new standard will make the measurement of fair value more consistent and comparable and improve disclosures about those measures. This statement does not require any new fair value measurements, but provides guidance on how to measure fair value by
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 1. Nature of Business and Significant Accounting Policies (continued)
providing a fair value hierarchy used to classify the source of the information. SFAS 157 is effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No. 157, which delays the effective date of SFAS No. 157 to fiscal years beginning after November 15, 2008 for all nonfinancial assets and nonfinancial liabilities (except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis or at least annually). In April 2009, the FASB issued FSP FAS 157-4 “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” This FSP provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. The adoption of SFAS 157 did not have a material impact on the Company's financial position, results of operations or cash flows as a result of the adoption of SFAS 157.
In September, 2006, the FASB issued Statement of Financial Accounting Standard 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities-Including an amendment of FASB Statement No. 115. SFAS 159 is effective for fiscal years beginning after November, 15, 2007. SFAS No. 159 provides the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis with the difference between the carrying value before election of the fair value option and the fair value recorded upon election as an adjustment to beginning retained earnings. The adoption of SFAS 159 did not have a material impact on the Company’s financial position, results of operations or cash flow.
In May 2009, the FASB issued SFAS 165, Subsequent Events (SFAS 165) which establishes general standards for accounting for and disclosure of events that occur after the balance sheet date but before financial statement are issued or available to be issued. In particular, SFAS 165 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements' and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 is effective for interim and annual periods ending after June 15, 2009. The Company is currently reviewing the effect, if any, the proposed guidance will have on its financial statements.
Note 2. Fourth Quarter Adjustments
The only material fourth quarter adjustment was the reversal of the legal accrual from fiscal year 2008 discussed in Note 13.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 3. Major Customers and Supplier Concentration
The Company derives a major portion of its revenues directly from sales to certain large companies that have operations associated with satellite, launch vehicle and/or government defense contracts, as well as directly from departments and agencies of the United States Government. Sales to these major customers, which provided revenues during fiscal year 2009 in excess of 10% of total revenues, consist of the following:
At May 31, 2009, billed and unpaid accounts receivable included totals of $840,000, or 30% of total billed and unpaid accounts receivable, due from Lockheed Martin companies and $435,000, or 16% of total billed and unpaid accounts receivable, due from the U.S. Government entities. There were no outstanding billings to Boeing at fiscal year end 2009.
Note 4. Accounts Receivable
Billed and unpaid receivables at May 31, 2008
$
8,111,000
Billed receivables for fiscal year 2009
23,647,000
31,758,000
Collected receivables for fiscal year 2009
28,931,000
Receivable forgiven as part of litigation settlement
58,000
Billed and unpaid receivables at May 31, 2009
2,769,000
Unbilled receivables at May 31, 2009:
Unbilled receivables on contracts in process
7,965,000
Accrued losses on uncompleted contracts
(58,000)
Unbilled receivables on completed contracts
70,000
7,977,000
Total gross accounts receivable at May 31, 2009
10,746,000
Allowance for doubtful accounts
Total net accounts receivable at May 31, 2009
$
10,746,000
Accounts receivable consists of billed and unbilled amounts due from the United States Government, prime and subcontractors under long-term contracts. Billed and unbilled accounts receivables at May 31, 2009 were $2,769,000 and $7,977,000 , respectively.
The billed accounts receivable balance at the end of fiscal year 2008 included $58,000 for damages awarded to the Company by the jury of a concluded trial of the Company’s lawsuit against the United Space Alliance, LLP for alleged breaches of contracts. As part of the settlement with United Space Alliance (described in Note 13), the Company agreed to waive collection of this outstanding balance as a result of said agreement; this entry was removed as an element of billed receivables at May 31, 2009.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 4. Accounts Receivable (continued)
The Company submits claims for cost reimbursement related to contract requirement changes not yet incorporated into its contract or other contract costs in negotiation. At the end of fiscal year 2009, the Company did not have any outstanding claims.
Unbilled receivables include revenues recognized from fixed priced contracts under the percentage-of-completion method, but in advance of completing billable events for which invoices are submitted to customers. The total costs and earnings recognized from inception-to-date on contracts in process at May 31, 2009 are as follows:
Total Contracts in process
$
43,377,000
Total cost incurred
$
19,682,000
Add estimated earnings
10,613,000
Total revenue recognized
30,295,000
Less amounts billed
22,442,000
$
7,853,000
Unbilled receivables on contracts in process
$
8,035,000
Deferred revenue on contracts in process
(182,000)
$
7,853,000
Because of the large amount of contracts in process at any point in time, changes in estimates to complete can have a significant impact on the profitability of the Company. Management estimates that each 1% change in the total estimated costs to complete the contracts in process at May 31, 2009 would change both the recognized revenue and earnings by approximately $79,000.
During the fiscal years 2009 and 2008, the Company generated revenues of approximately $2,099,000 and $2,785,000, respectively, from sources outside of the United States.
Note 5. Inventories
Raw materials and component parts
$
361,000
Work-in-process
1,175,000
Finished goods
529,000
2,065,000
Less inventory reserves
(553,000)
Total net inventory
$
1,512,000
Included in inventories recorded and maintained by the Company are purchased and manufactured component parts and finished goods that relate to previously completed contracts. The Company’s management periodically assesses the likelihood that those inventory items will be used in future contracts, since many of the Company’s past contracts relate to on-going programs, for which it will be awarded similar contracts. The current method utilized in management’s assessment is to evaluate items in the inventories and assess current or future contract requirements which may use inventory parts. A reserve is established based on said analysis. Since the inventory reserve methodology is subjective, and subject to changes in estimates based upon updated information, changes in those estimates can be substantial.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 6. Equipment
Machinery and equipment
$
5,544,000
Office equipment and furniture
602,000
Leasehold improvements
456,000
Production and test tooling
338,000
Automobiles/delivery vehicle
188,000
Projects in process
13,000
7,141,000
Less accumulated depreciation and amortization
(5,164,000)
Total net equipment
$
1,977,000
For fiscal year 2009, the Company capitalized costs amounting to $113,000 that were incurred in the purchase or manufacture of production and test tooling related primarily to new products designed and qualified for production by the Company during fiscal year 2009. Each tool, for which costs are capitalized, is expected to be used repeatedly in the production or test of similar parts for multiple orders over an extended period of time of at least three years. Accordingly, capitalized tooling costs are depreciated on a straight-line basis over three years.
Included in automobiles is $165,000 in capital leases, which is reduced by accumulated depreciation of $101,000 at May 31, 2009.
Note 7. Land
The Company owns twelve acres of land located in the Santa Clarita Business Park in Santa Clarita, California, on which it has several buildings that it uses for storage and blending of pyrotechnic powders utilized in many of its manufactured products.
Note 8. Bank Line of Credit and Notes Payable
The Company has a business loan agreement with a bank for the purpose of obtaining a revolving line of credit and term loans. Borrowings under this business loan agreement are collateralized by the Company's assets.
At May 31, 2009 and throughout fiscal year 2009, the Company did not have outstanding balances on the revolving line of credit.
The revolving line of credit, under which the Company can borrow up to a maximum limit of $5,000,000, is set to mature on December 15, 2009. Outstanding balances under the line of credit bear interest based on prime less .25% (3.00% at May 31, 2009) or at the Company's option LIBOR plus 2% (3.22% at May 31, 2009).
The Company’s $1,000,000 equipment letter of credit matured March 2, 2009 and was not renewed.
The business loan agreement contains various financial covenants that have not been modified during the fiscal year. At May 31, 2009, the Company was compliant with all of the financial covenants.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 9. Accrued Current Liabilities
As of May 31, 2009, accrued current liabilities consist of the following:
Accrued vacation
$
1,260,000
Accrued salaries, wages and bonus
1,124,000
Deferred compensation
109,000
Accrued commissions
65,000
Accrued facilities rent
74,000
Accrued professional fees
47,000
Accrued Alliance litigation costs
1,600,000
Accrued income taxes
59,000
Miscellaneous
15,000
Total accrued current liabilities
$
4,353,000
Note 10. Deferred Revenue
Deferred revenue is composed of amounts billed to customers in excess of revenues earned and recognized on the related contracts at the end of a financial period. As the Company continues to perform work on those contracts in process, revenue is earned and “deferred revenue” on the balance sheet is reclassified to earned “revenue” on the statements of operations. Deferred revenue was $182,000 at May 31, 2009.
Note 11. Capital Leases
The Company leases vehicles under capital leasing agreements which expire at various dates through June, fiscal year 2014. Future minimum lease payments are as follows:
Year ending May 31,
$
38,000
11,000
10,000
8,000
1,000
Total minimum lease payments
68,000
Amounts representing interest
5,000
Present value of net minimum lease payments
63,000
Current maturities
(35,000)
$
28,000
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 12. Income Taxes
Realization of deferred income tax assets is primarily dependent upon generating sufficient taxable income to absorb the tax benefit of the deferred income tax assets. Although realization is not assured, management believes it is more likely than not that the net deferred income tax assets will be realized prior to expiration. That assessment is based upon the Company's expectations for a continuation of profitable operations. The amount of the deferred income tax assets considered realizable, however, could be increased or reduced in the near term if estimates of future taxable income during the carryover periods are increased or reduced, or if certain changes in the ownership structure of the Company occur.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 12. Income Taxes (continued)
The provision for income taxes consists of the following:
Current tax expense:
Federal
$
2,249,000
$
2,681,000
State
680,000
799,000
$
2,929,000
$
3,480,000
Deferred tax expense (benefit)
Federal
$
1,162,000
$
(1,134,000)
State
328,000
(300,000)
$
1,490,000
$
(1,434,000)
Total tax provision
$
4,419,000
$
2,046,000
A reconciliation of actual tax (credit) to the amount computed by applying the federal statutory income tax rates to income before income taxes is as follows:
Federal income tax computed at statutory rate
$
3,772,000
$
1,899,000
Permanent differences
(18,000)
(175,000)
State taxes, net of federal benefit
665,000
322,000
Other state tax and minimum taxes
Tax Credits
$
4,419,000
$
2,046,000
Note 13. Commitments and Contingencies
The Company leases its facilities, automobiles and certain equipment under operating lease agreements that expire at various dates through 2014. Rental expense under operating leases for the years ended May 31, 2009 and 2008 was approximately $677,000 and $656,000 respectively.
Maximum annual rentals under all non-cancelable operating leases are as follows:
648,000
666,000
685,000
183,000
$
2,182,000
$1,974,000 of the above lease commitment is for rent of the Company’s offices and production facility in Torrance. The lease agreement for the facility extends through August 31, 2012.
Hi-Shear filed suit against United Space Alliance, LLC, a Delaware limited liability company (“Alliance”), and USBI Co., a Delaware corporation (“USBI”), in November 2000 in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages in excess
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 13. Commitments and Contingencies - (continued)
of $1,500,000, excluding interest, costs, and attorneys’ fees, alleging Alliance and USBI breached contracts for Hi-Shear to manufacture and deliver certain hardware for use on the Space Shuttle. Hi-Shear also sought damages based on claims alleging that Alliance and USBI fraudulently induced Hi-Shear to enter into certain contracts to manufacture and deliver certain hardware for use on the Space Shuttle. In addition, Hi-Shear sought damages for claims that defendants misappropriated Hi-Shear’s proprietary information and/or trade secrets in certain technical data and information. Hi-Shear also alleged a claim for a declaratory judgment. Alliance subsequently filed a counterclaim seeking damages of over $450,000, excluding interest, costs, and attorneys’ fees, alleging Hi-Shear breached its contracts to manufacture and deliver certain hardware for use on the Space Shuttle. Alliance also alleged a claim for conversion and an accounting relating to certain items of alleged government furnished equipment, and a claim for a declaratory judgment. As part of its defense in the litigation, Alliance claimed that it was coerced through duress to enter into a contract with Hi-Shear where Hi-Shear was the qualified successful lowest bidder. In addition, Alliance demanded that Hi-Shear ship uncertified flight hardware to it for use on the United States Space Shuttle, ahead of its normal certification schedule. USBI did not file a counterclaim against the Company.
In July 2004, Hi-Shear filed a separate but related suit against Pacific Scientific Energetic Materials Company, a Delaware corporation, in the Circuit Court of the Eighteenth Judicial Circuit, Brevard County, Florida. Hi-Shear sought to recover damages, alleging that defendant misappropriated Hi-Shear’s proprietary information and/or trade secrets in certain technical data and information, conspired to misappropriate trade secrets, and interfered with Hi-Shear’s advantageous business relationships. After defendant filed, and the court ruled on, a motion to dismiss, and Hi-Shear filed an amended complaint against Pacific Scientific, the court entered an order staying all further proceedings in the case until the appeals from the suit between Hi-Shear and Alliance and USBI were resolved, and the court entered a subsequent order lifting the stay.
Prior to the trial between Hi-Shear, Alliance, and USBI, the court made legal rulings that the Company did not have trade secrets in certain technical data and information, which the Company alleged had been misappropriated by Alliance and USBI. As a result, the court granted in part Alliance’s and USBI’s motions for summary judgment on that issue. Prior to trial, the court also made legal rulings that USBI did not fraudulently induce Hi-Shear to enter into a contract to manufacture and deliver certain flight hardware for use on the Space Shuttle. As a result, the court granted Alliance’s and USBI’s motions for summary judgment on that issue.
Trial before a jury of Hi-Shear’s remaining claims against Alliance and USBI, and Alliance’s counterclaim against Hi-Shear, commenced on July 5, 2005 in Titusville, Florida. Shortly after the trial began, the court made additional legal rulings, which resulted in its granting the remainder of Alliance’s and USBI’s motions for summary judgment on the trade secrets issues. As a consequence of those rulings and based on other circumstances, Hi-Shear dismissed its remaining claims against USBI. As a result, USBI was no longer a participant in the trial. The jury trial continued through September 2, 2005. Some of Hi-Shear’s claims were disposed of by the court based on legal rulings made during the course of trial. Of the remaining claims that the jury was asked to decide, the jury rendered a verdict in favor of Hi-Shear on one of its breach of contract claims, and awarded the Company damages of $57,781, exclusive of interest, costs, and attorneys’ fees. The jury found in favor of Alliance on Hi-Shear’s remaining breach of contract claims and thus awarded Hi-Shear no damages on those claims. The jury also found in favor of Alliance on its counterclaim for breach of contracts but awarded it no damages. In addition, the jury determined that Hi-Shear converted certain government furnished equipment pursuant
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 13. Commitments and Contingencies - (continued)
to Alliance’s conversion counterclaim. In August 2005, the court entered final judgment on Hi-Shear’s claims against USBI. After hearing and denying post-trial motions by both Hi-Shear and Alliance, in May 2006 the court entered final judgment on Hi-Shear’s and Alliance’s respective claims against each other.
In September 2005, Hi-Shear appealed the final judgment entered on its claims against USBI to Florida’s Fifth District Court of Appeal. Alliance participated in that appeal as an appellee based on its having joined in the trade secrets and fraudulent inducement summary judgment motions at the trial level. In February 2007, after hearing oral argument, the court of appeal affirmed the trial court’s rulings and final judgment in favor of USBI. The appellate court denied motions by Hi-Shear and Alliance to recover attorneys’ fees incurred on appeal.
In June 2006, Hi-Shear appealed the final judgment entered on its claims against Alliance, and Alliance’s counterclaims against Hi-Shear, to Florida’s Fifth District Court of Appeal, challenging the legal basis of the lower court’s final judgment including the amounts of the recovery of Hi-Shear’s damages on contracts for manufactured components and other claims at trial. The appeal encompassed issues evident throughout the court proceedings, including the legal basis of the trial court’s judgments and questionable adverse rulings by the court during the entire course of the trial. The Alliance filed a cross appeal. On November 14, 2008, the Florida Fifth District Court of Appeal issued its opinion, which affirmed the lower court's rulings, with one of the three appellate court judges dissenting. The Alliance’s cross appeal was denied, and the court also denied motions by Hi-Shear and Alliance to recover attorneys’ fees incurred on appeal. On December 19, 2008, Hi-Shear filed a motion regarding this appeal with the Florida Fifth District Court of Appeal seeking a rehearing, rehearing en banc, and certification. In February 2009, Hi-Shear was notified that the December 19, 2008 motion was denied in full.
In December 2006, the trial court entered an order denying Hi-Shear’s motion for entitlement to recover its attorneys’ fees and costs from Alliance, even though Hi-Shear was the only party to have been awarded damages by the jury. In that same order, the court determined that instead, Alliance had prevailed on its claims for breach on three of four contracts and thus was entitled to recover from Hi-Shear its reasonable attorneys’ fees incurred relating to count I of its counterclaim against Hi-Shear for breach of contracts. Alliance claimed the amount of reasonable attorneys’ fees it should recover from Hi-Shear was approximately $2,900,000. USBI never filed a motion to recover its attorneys' fees from Hi-Shear. Hi-Shear opposed those claims, believing that the amount sought by Alliance was excessive. On March 13-14, 2008, the trial court held an evidentiary hearing on the amount of reasonable attorneys’ fees to be awarded to Alliance. At the hearing, Hi-Shear offered evidence and expert testimony to establish that Alliance’s request for attorneys’ fees was excessive. On July 28, 2008, the trial court sent a letter to Alliance’s attorneys asking them to prepare a form of order regarding attorneys' fees. Hi-Shear received a copy of the letter on July 31, 2008. The letter quantified some attorneys' fees to be awarded to Alliance but did not specify the final amount of attorneys’ fees to be awarded, and also indicated that an additional hearing would be required on specific issues. However, the letter also indicated that the trial court would make additional favorable rulings for Alliance on several issues, and it appeared that the trial court would award to Alliance certain additional portions of the attorneys’ fees it sought.
Although Hi-Shear was unable to determine the precise amount of attorneys' fees that might ultimately have been awarded, it believed that it was appropriate under generally accepted accounting principles to accrue approximately $3,275,000 associated with the litigation for its year ended May 31, 2008. In
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 13. Commitments and Contingencies - (continued)
addition, $76,000 had been accrued in each of the quarters ended November 30, 2008 and February 28, 2009 to reflect the current quarter's interest cost of the estimated fees and costs.
In October 2008, over Hi-Shear's opposition, the trial court issued orders and judgments for litigation costs to be awarded to the Alliance and USBI in the total amount of approximately $580,000, which included amounts for pre-judgment interest. On December 1, 2008, Hi-Shear appealed the award of costs to Alliance to the Florida Fifth District Court of Appeal.
In February 2009, a notice was served that set a hearing on June 9, 2009 regarding the final amount of attorneys' fees to be awarded to Alliance. Hi-Shear was prepared to challenge the final amount of fees sought by Alliance and subsequently filed a motion with the trial court seeking to strike the Alliance's pending motion for entry of a final attorney fee judgment, but Hi-Shear also believed that it was appropriate under generally accepted accounting principles to accrue an estimate of a potential fee award, previously-awarded costs, and pre-judgment interest on fees and costs based on the court's previous rulings.
In April 2009, Hi-Shear filed a petition for a writ of certiorari seeking review by the United States Supreme Court of certain issues from the trial that had been affirmed by the Florida court of appeal.
During May of 2009, settlement discussions ensued between the Company and United Space Alliance. As a result, the June 9, 2009 fee hearing was canceled, and on July 7, 2009, the Company and Alliance completed a Settlement Agreement to settle the Company’s pending litigation with Alliance. Pursuant to the Agreement, the Company shall pay Alliance the sum of $1,600,000 in four separate installments of $400,000. The first payment was made July 8, 2009 with the subsequent payments due on September 30, 2009, December 31, 2009 and March 31, 2010. The Company deemed satisfied its judgment against Alliance, and dismissed its pending actions against Alliance in the Florida court of appeal and the United States Supreme Court, and also dismissed its amended complaint against Pacific Scientific Energetic Materials Company in a related case pending in Brevard County, Florida. The Settlement Agreement provides for mutual releases and resolves all ongoing disputes between the Company and Alliance. To reflect the settlement, previous accruals will be reduced to the net settlement amount resulting in an increase to operating income in the fourth quarter of fiscal year ended May 31, 2009. The reduction of the accrued settlement decreased selling, general and administrative expenses by $1,679,000 as well as reduced previously recorded interest expense associated with the accrual by $90,000.
In addition, the Company is subject to other claims and legal actions that may arise in the ordinary course of business. In the opinion of the Company, after consultation with counsel, the ultimate liability, if any, with respect to these other claims and legal actions, will not have a material effect on the financial position or on the results of operations.
Note 14. Stockholders' Equity
The Company had a non-statutory stock option plan, which was in effect from December 23, 1993 through its termination date of December 23, 2003. Under the plan, options to purchase common stock, with a maximum term of 10 years, were granted and vested as determined by the Company’s Stock Option Committee. Options for up to 500,000 shares could be granted to employees or directors. Termination of the stock option plan did not nullify stock options previously granted, but not exercised. Those options continue to be exercisable through their expiration dates, which occur ten years after their grant dates.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 14. Stockholders' Equity (continued)
On July 31, 2006 the Company's Board of Directors approved the 2006 Stock Award Plan, which was subsequently accepted by Company's shareholders for adoption at the October 16, 2006 annual shareholders' meeting. Under the plan, options to purchase common stock, with a maximum term of 10 years, are granted and vested as determined by the Company’s Stock Option Committee. Grants and/or options for up to 500,000 shares could be issued to employees or directors.
Stock options are valid for ten years and have various vesting schedules. Current options have 2 year, 3 year and 4 year vesting schedules. There were no options granted during fiscal year 2009.
Stock grants have various vesting schedules. There were 18,610 grants issued during fiscal year 2009. The fair value of grants is determined by published market values at the date of grant.
The fair value of each option is estimated at the issue date using the Black-Scholes option-pricing model. The Black-Scholes option pricing model requires the use of certain assumptions, including fair value, expected terms, expected volatility, expected dividends, risk-free interest rate and expected forfeiture rate to calculate the fair value of stock-based payment awards. The assumptions used in calculating the fair value of stock option awards involve inherent uncertainties and the application of management judgment. As a result, if factors change and the Company uses different assumptions, the computed fair value and resulting stock-based compensation expense could be different in the future. Furthermore, the Company is required to estimate the expected forfeiture rate and recognize expense only for those shares expected to vest. If the actual forfeiture rate is materially different from the estimate, the stock based compensation expense could be different from what is recorded in the current period. There were no options issued in fiscal year 2009. The fair value of the options granted in 2008 was calculated by using the following weighted-average assumptions: dividend rates of 2.47% and 3.1%; price volatility of 68.93% and 86.5%; risk-free interest rates of 4.21% and 3.28%; and expected life of five years.
The Company does not have information available which is indicative of future exercise and post-vesting behavior to estimate the expected term. The Company adopted the simplified method of estimating the expected term of a stock option, as permitted by SAB 107. Under this method, the expected term is presumed to be the mid-point between the vesting date and the contractual end of the term.
The expected volatility is derived from historical volatility of the Company’s common stock.
The dividend rate is based on the Company’s historic dividend rate.
The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with a remaining term approximately equal to the expected life of the Company’s stock options.
As the Company has little to no history of actual forfeitures, nor any indication of pending forfeitures, the pre-vesting forfeiture rate is estimated to be zero.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 14. Stockholders' Equity (continued)
A summary of the status of the option plan and changes during fiscal years 2009 and 2008 is as follows:
A summary of the status of the grant plan and changes during fiscal year 2009 is as follows:
Fixed Grants
Shares
Shares
Outstanding at beginning of year
9,750
Granted
18,610
9,750
Issued
(13,125)
Forfeited
(3,000)
Outstanding at end of year
12,235
9,750
The Company recorded stock-based compensation of $227,000 during the year ended May 31, 2009. Current year stock-based compensation expense includes $97,000 for options and $130,000 for grants. The Company elected to recognize stock-based compensation expense on a straight-line basis over the requisite service period for the entire award.
As of May 31, 2009, total unrecognized compensation costs related to stock options of $53,000 is expected to be recognized over a weighted-average period of 2 years. As of May 31, 2009, total unrecognized compensation costs related to stock grants of $79,000 is expected to be recognized over a weighted-average period of 2 years.
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 14. Stockholders' Equity (continued)
Information relating to stock options at May 31, 2009 summarized by exercised price is as follows:
Information relating to stock grants at May 31, 2009 summarized by exercised price is as follows:
Information related to non-vested stock options at May 31, 2009 is as follows:
Weighted Average
Number of
Issue Date
Shares
Fair Value Per Share
Non-Vested Options at May 31, 2008
35,500
$
9.75
Issued
0.00
Vested
17,750
9.75
Forfeited
0.00
Non-Vested Options at May 31, 2009
17,750
$
9.75
HI-SHEAR TECHNOLOGY CORPORATION
NOTES TO FINANCIAL STATEMENTS
Note 14. Stockholders' Equity (continued)
Information relating to non-vested stock grants at May 31, 2009 is as follows:
Weighted Average
Number of
Issue Date
Shares
Fair Value Per Share
Non-Vested Grants at May 31, 2008
4,875
$
11.76
Issued
18,610
9.51
Vested
8,250
10.83
Forfeited
3,000
9.48
Non-Vested Grants at May 31, 2009
12,235
$
9.53
Note 15. Related Parties
A director of the Company performed consulting services for the Company under a two-year contract that expired February 28, 2009. The Company incurred $200,000 and $254,000 of consulting fees for the years ended May 31, 2009 and 2008, respectively.
Note 16. 401(k) Retirement Plan
The Company has a 401(k) Retirement Savings Plan (the “401(k) Plan”) that covers substantially all employees. Employees may elect to contribute a percentage of compensation to the maximum deferred amount allowed by tax laws. The Company may make a matching contribution to the 401(k) Plan and/or a profit sharing contribution which is allocated to all eligible participants, whether they made deferral contributions or not. Contributions are made solely at the discretion of the Company’s Board of Directors. The Company did not make a matching contribution or a profit sharing contribution to the 401(k) Plan for the fiscal years ended May 31, 2009 and 2008.
Note 17. Subsequent Events
Subsequent to year-end 2009, on July 16, 2009 the Company’s Board of Directors approved a cash dividend. The dividend of approximately $5,139,000 or $.75 per share will be paid on or about August 21, 2009 to shareholders of record as of the close of business August 14, 2009. The ex-dividend date is August 12, 2009.