Item 1. Business.
A. GENERAL
Precision Standard, Inc. ("the Company") is a diversified aerospace company with executive offices in Denver, Colorado. The Company is composed of two operating groups, the Aircraft Maintenance and Modification Group and the Manufacturing and Overhaul Group.
The Aircraft Maintenance and Modification Group, which maintains and modifies large transport aircraft for the U.S. and foreign governments and commercial customers, includes the Aeroplex Group of Pemco Aeroplex, Inc. ("Pemco" or the "Aeroplex") and Pemco World Air Services, A/S, located in Copenhagen, Denmark. The primary military element of the Aircraft Maintenance and Modification Group is located in Birmingham, Alabama and operates as the Birmingham division of the Aeroplex. The primary commercial element of the Aircraft Maintenance and Modification Group, which operates under the name Pemco World Air Services, includes the Dothan, Alabama division of the Aeroplex and Pemco World Air Services, A/S.
The Manufacturing and Overhaul Group includes the Hayes Targets division of Pemco Aeroplex, Inc., which designs and manufactures aerial target systems for domestic and foreign military customers; Space Vector Corporation, which develops and manufactures rocket launch vehicles and guidance systems for the U.S. Government as well as foreign and commercial customers; Pemco Engineers Aircraft Cargo Systems division, which designs and manufactures aircraft cargo handling systems; Pemco Engineers Springs and Components division, which designs and manufactures precision springs and components; Pemco Air Support Services, Inc. ("PASS"), which sells parts for large transport aircraft and provides support of aircraft which have been converted or modified by Company affiliates; and Pemco Nacelle Services, Inc. ("Nacelle"), which maintains and overhauls engine nacelles and thrust-reversers for large jet transport aircraft.
B. SIGNIFICANT DEVELOPMENTS
Conversion of a Boeing 727 to a "Combi" Configuration
The Company received Federal Aviation Administration ("FAA") certification and Transport Canada certification in 1995 for the conversion of a Boeing 727-200 to a configuration that incorporates main deck compartments for both passengers and cargo. The aircraft can be dispatched as a full passenger aircraft, a full freighter or a "combi" aircraft, having up to six different combinations of cargo pallets plus corresponding passenger loads. The Company is the first to accomplish a conversion that incorporates a multi- position, passenger and cargo compartment, with variable smoke detection and fire suppression systems. First Air of Ottawa, Ontario, the world's foremost Artic air carrier, was the Company's launch customer for this program.
Agreement with Bombardier Business Aircraft
In the second quarter of 1995, the Company reached an agreement with Bombardier Business Aircraft for the development and marketing of a Cargo Variant ("CV") of the Canadair Challenger widebody business jet. Under the terms of the agreement, Pemco World Air Services will design and install the cargo conversions while Canadair will provide the technical documentation and support for the aircraft. Both companies will work to market the Challenger CV and are currently seeking a launch customer for this program.
Lease Renewal of the Company's Birmingham Facility
The Company accepted an offer from the Birmingham Airport Authority for a twenty year extension of its lease for the facility located at the Birmingham International Airport. The lease extension offer sets a new expiry date of September 30, 2019 and provides for the release of certain, limited parcels to the Authority but otherwise contains the same terms and conditions as are in effect under the Company's present lease. Formal documentation of this renewal is currently in progress.
Agreement with San Bernardino International Airport Authority
In May of 1995, the Company entered into a memorandum of understanding for the lease of hangar, manufacturing and warehouse space on the former Norton Air Force Base at San Bernardino, California. The memorandum provides for a lease under which approximately 650,000 square feet would be used by the Company as an aircraft maintenance and modification center. The facility would allow the Company to add substantially to its wide-body aircraft maintenance capabilities and broaden the range of military and commercial aircraft that it can service. The parties continue to negotiate appropriate terms under an exclusive option arrangement.
C. BUSINESS OUTLOOK
In general, demand for aircraft maintenance and modification services is increasing. As aircraft operators strive to reduce their operating expenses, both military and commercial operators are looking to independent service providers. These operators are also delaying expensive fleet renewal programs which results in the need to keep aging fleets in flight-worthy condition. For both reasons, signs are positive that the third-party maintenance and modification industry will be the beneficiary of these trends over the next few years.
Military Maintenance and Modification Industry
The amount and type of military maintenance and modification work required by the U.S. Armed Services depends primarily upon the nation's national security objectives in view of perceived global political instability. Recently American personnel strength in Europe has decreased from over 500,000 at the height of the Cold War to approximately 100,000 presently. The growing integration of Europe and the rise of new security structures competing with NATO may cause that number to decrease even further in the future. The clear pattern seems to be one of global retrenchment and the inevitable return of most forward deployed forces to the United States.
However, while the U.S. is being compelled by budget cuts and other imperatives to pull back its forces, its vital interests and obligations around the world are not undergoing a corresponding decline. The U.S. still has commitments or vital interests in Europe, the Middle East, throughout the Pacific region, and the Western Hemisphere. Without globally deployed forces close to the scene of potential conflicts, the U.S. must replace withdrawn forward deployed forces with the ability to rapidly re-deploy armament, equipment and supplies to these future trouble spots. This strategic plan depends ultimately on the overall heavy air lift capability of the U.S. Military.
This need for immediate rapid deployment of force has insulated the military maintenance and modification industry from many of the effects of the shrinking defense budget. In fact, it can be argued that the budget cuts have actually aided the sector in certain ways. By limiting future expenditures, the military has been unable to initiate programs to replace substantial portions of their aging transport fleets. These aging aircraft require more service than newer aircraft, generating greater revenue for the military maintenance and modification sector of the industry.
Furthermore, budget cutbacks have forced the military to close a number of its bases and depots. As major repair depots are closed, the military is less capable of maintaining and servicing its aircraft internally. As a result, the military has stated its intention to contract a greater portion of the maintenance and service of its air fleet with the private sector. As a means to reduce overall costs, the military has begun to privatize many of the services that were traditionally provided internally. This too, has expanded the demand for government contract services such as those provided by the Company. Additionally, the Company benefits from its forty-plus years of experience as a systems integrator for both military and commercial customers.
Commercial Maintenance Industry
On the commercial maintenance front, there are many indicators that point to the increasing use of third-party maintenance businesses in the foreseeable future, as airlines continue to search for ways to reduce costs without compromising their competitive edge or reducing profitability. A number of airlines have discovered that the work done by third-party companies is in many instances relatively faster and cheaper, as compared with similar work performed in-house. According to "Overhaul Maintenance Quarterly, September 1995", America West contracted approximately 40% of its maintenance in 1994, Continental 44% and industry trendsetter Southwest Airlines contracted 73%.
Moreover, across the industry, the demand for contract overhaul, maintenance and modification services is escalating. This increased flow has been partially driven by the airlines' reluctance to ramp up their fleet renewal programs. As a result, the airlines are forced to have their aging fleets maintained more frequently to keep them in flight-worthy condition.
Commercial Modification Industry
The rapid increase in worldwide freight movements has spawned a demand for dedicated cargo aircraft. Few companies have the capital to purchase factory new all-cargo aircraft, and thus the majority of air cargo planes have been converted from a pure passenger configuration. Overnight package delivery, a service which has experienced much growth in the last fifteen years in the U.S., is beginning to blossom in Europe. These package carriers are a driving force in commercial modification, and their anticipated success in Europe and elsewhere is expected to increase the demand for cargo conversions.
Air cargo traffic is forecasted to grow at a rate of approximately (7%) annually through the year 2013 and the number of all-cargo planes is expected to approximately double over the next two decades, increasing the demand for aircraft modification commensurately. Passenger to freighter conversions are typically performed on aircraft which offer high cargo capacity and low capital costs. These include the DC-8, DC-9, DC-10, B-707, B-727, B-747, L-1011 and the BAe-146, making the potential market for this type work quite substantial.
However, new aircraft such as the B-737, B-757 and MD-80, which offer favorable operating and maintenance cost trade-offs, are also attractive candidates for conversion. As an example, passenger-to- quick-change conversions have been performed solely on new or late model B-737 aircraft. The passenger-to-quick-change conversion, which was innovated by the Company, enables the carrier to convert the aircraft from passenger to freighter configuration in approximately thirty minutes, allowing the carrier to supplement its passenger business with cargo operations.
D. PRINCIPAL PRODUCTS AND SERVICES
AIRCRAFT MAINTENANCE AND MODIFICATION
General
The Company's aircraft maintenance and modification services include custom airframe design and modification and complete airframe maintenance and repair together with technical publications. A majority of the services are provided under multi- year contracts for both military and commercial customers. The Company's military customers include the United States Armed Forces ("Armed Forces") and certain foreign military services. The Company's commercial customers include the major global lessors of aircraft as well as airlines, couriers and air-freight carriers.
The Company employs a large skilled work force and a permanent engineering, design and analysis staff. The principal services performed are Programmed Depot Maintenance ("PDM"), Scheduled Depot Level Maintenance ("SDLM"), commercial C-level and D-level heavy maintenance checks, passenger-to-freighter conversions, passenger- to-quick-change conversions, aircraft stripping and painting, component overhaul, rewiring, parts fabrication and engineering support. Some of these services are performed exclusively for the military while others are performed for the Company's commercial customers; however, most of these services are offered to both customer groups.
The Company's competition for military aircraft maintenance contracts includes Boeing Military Aircraft, Aerocorp, Lockheed- Martin Aeromod, Raytheon-E Systems and Chrysler Technologies. The Company's competition for its commercial work in the United States consists of approximately 10 to 15 independent, unlimited repair and modification stations ranging from $10 million to $150 million in annual revenues. However, while many of the Company's domestic competitors tend to specialize on specific portions of the aircraft, the Company focuses on total airframe repair, maintenance and conversion. Outside the United States, the majority of the Company's competitors are affiliated with an airline.
The Company considers its competitive strengths to be its product support, proprietary products, engineering and systems integration capability, trained labor force, substantial capacity and strong customer base. Additionally, the Company believes itself to be the first U.S. independent operator to have established a base in Europe. This will allow the Company to expand its relationships with aircraft leasing companies and to offer its conversion products and support capabilities to leasing companies' fleets on two continents simultaneously.
Military Maintenance and Modification
The Company provides aircraft maintenance and modification services on a contract basis to the Armed Forces and other agencies of the U.S. Government, as well as foreign military services. The majority of the aircraft that the Company services are large transport planes used to move troops, supplies, equipment and armor, such as the C-130 "Hercules", or are logistical in nature, such as the KC-135 in-flight refueling aircraft. These planes provide the Armed Forces with the ability to quickly move troops and forces to areas of conflict. These aircraft are essential to the Armed Forces' "Global Reach, Global Power" concept, which places an emphasis on the military's ability to rapidly mobilize its forces and equipment on foreign land when needed. Due to the focus on this new strategy, the Company is confident that these aircraft will remain the military's work horses well into the future. As this role will put tremendous demand and strain on these aircraft, they will continually require the Company's maintenance services.
Military modification and maintenance contracts average three to five years in term. The contracts are originally set for a certain number of aircraft for the duration of the program. In addition to the number of aircraft originally agreed to in the program, the military typically increases this number as aircraft that were not scheduled for maintenance require servicing. These "drop-in" aircraft generally increase the value of each contract. The Company has a successful history with the military and expects this history to help it retain the contracts that it currently holds as well as increase the likelihood of securing additional contracts in the future.
The principal services performed under military contracts are PDM, SDLM, systems integration and modification of fixed and rotary wing aircraft. The PDM/SDLM is the most thorough scheduled maintenance "check-up" for a military aircraft, entailing a bolt-by-bolt, wire- by-wire and section-by-section examination of the entire aircraft. The process can average up to 148 days per aircraft. The typical PDM program involves a nose to tail inspection and a repair program on a four or five-year cycle. In addition to heavy maintenance, the program can include airframe corrosion prevention and control, rewiring, component overhauls and structural, avionics and various other system modifications.
PDMs are performed primarily at the Birmingham division of the Aeroplex on a flow-through system. Throughout the duration of the maintenance procedure, the aircraft moves through the facility from one work station to the next. Each station is responsible for certain objectives, and once these tasks are completed, the aircraft is moved to the next bay.
At the onset of the PDM, the aircraft is completely defueled and, generally, stripped of paint in an acidic wash. The entire airframe, including the ribbings, skins and wings undergoes a thorough structural examination which can result in modifications to the airframe. The plane's avionics, which essentially are the electronics that control the flight of the aircraft, receive examination and repair or modification as required. At the completion of the overhaul, the aircraft is repainted.
In order for the Company to efficiently complete its maintenance procedures, it maintains hydraulics, sheet metal and machine shops to satisfy all of its hydraulic testing and assembly needs and to fabricate, repair and restore parts and components for aircraft structural modification. The Company also performs in-house heat- treatment on alloys used in aircraft modifications and repairs and has complete non-destructive testing capabilities and test laboratories.
The Company's skilled work force and engineering staff are familiar with all aspects of aerodynamics, propulsion, fluid mechanics, flight operations, fuel and induction systems, controls, communications, radar, instrumentation and support research and development functions.
The Company has provided quality maintenance, integration and modification work on a wide variety of military aircraft over the past 45 years, including C-130, KC-135, C-9, P-3, T-34, A-10,,,, T-38 and U.S. Navy H-2 and H-3 helicopters.
KC-135 Aircraft Contract
The KC-135 is a United States Air Force ("USAF") tanker aircraft which is used primarily for the in-flight refueling of combat and combat-support aircraft. Currently, the U.S. KC-135 tanker fleet is understood to number in the hundreds, and the aircraft is projected to be serviceable through 2030.
In August of 1994, the USAF awarded the Company a new contract for the PDM of its KC-135 aircraft. The contract is expected to last seven years and involve the maintenance of as many as 389 aircraft. The KC-135 PDM program involves a nose to tail inspection and repair program on a scheduled five-year cycle. The funding approved by the USAF under the first year of the contract is projected to be $54.9 million and $49.0 million has been awarded under the second year of the contract. The total value of the contract over a seven year period, if fully funded, is expected to be over $307.0 million. The Company first performed PDM on the KC- 135 in 1968 and has since processed 2,067 such aircraft.
In addition to the KC-135 PDM maintenance contract, the USAF also awarded the Company a KC-135 battery system modification contract in August 1995. As the USAF continues to upgrade and modernize the KC-135 fleet to ensure its viability through 2030, the KC-135 PDM program is anticipated to further expand to include additional upgrades such as new cockpit and avionics systems. The Company has performed other major upgrades in the past including wing re-skin, major re-wire, corrosion prevention control and flight director, auto pilot and fuel savings advisory system modifications.
C-130 Aircraft Contract
The C-130 is a four-engine, turboprop all-purpose military transport and utility cargo aircraft. The aircraft has been built by Lockheed since the mid-1950's and is still in production. The current U.S. C-130 fleet is also understood to number in the hundreds, and the aircraft is also projected to be serviceable through 2030.
In 1991, the USAF awarded the Company a five year contract for the PDM of its C-130 aircraft. The PDM program involves a nose to tail inspection and repair program on a four-year cycle. The contract expires in 1996, at which time the Company intends to vigorously pursue its re-award. However, the government's re-bid process is behind schedule which will likely result in the current contract being extended through early 1997. The new contract is expected to run for five years and will potentially involve 40 aircraft per year versus an average of 12 aircraft under the current contract. The increase in aircraft is anticipated due to depot closures and the repatriation of work from foreign depots.
The Company has held the C-130 contract for approximately 30 years and has provided service to approximately 1,844 aircraft.
H-3 Helicopter Contract
The H-3 helicopter is a utility, search and rescue, anti-submarine warfare and VIP transport helicopter. The helicopter was built by Sikorsky and is projected to be serviceable through 2010.
In 1994, the Navy awarded the Company a five year contract for SDLM work of its H-3 aircraft. This contract is for a nose to tail inspection and repair program on a four-year cycle. The Navy input only two aircraft in the first year of the contract, the contract minimum number. The Navy was still performing in-house SDLM work during the first year of the contract, prior to its closing the Naval Aviation Depot in Pensacola, Florida. The Company anticipates working eleven aircraft in the second year of the contract.
Commercial Aircraft Maintenance and Modification
The Company provides commercial aircraft maintenance and modification services on a contract basis to both the owners and operators of large commercial transport aircraft (i.e. leasing companies, banks, airlines, air cargo carriers). Contracts for commercial maintenance can range from the single aircraft which might be in-house for a few days, to multi-plane efforts that can span a year or longer. Modification contracts involve greater effort per aircraft and often involve multiple units which range in term from six months to three years. The principal services performed under commercial maintenance and modification contracts are "C" and "D" checks, which are similar to the PDM and SDLM programs performed by the Company for military aircraft, passenger- to-freighter conversions, passenger-to-quick-change conversions, combination passenger and freighter conversions (combi), and strip and paint.
The "C" check is an intermediate level service inspection that, depending upon the FAA approved maintenance program being used, includes systems operational tests, thorough exterior cleaning, and cursory interior cleaning and servicing. It also includes engine and operation systems lubrication and filter servicing. Visual inspection of the external structure and the internal structure through access panels is part of the "C" check. The normal intervals between "C" checks can be as little as 1,000 flight hours and as many as 5,000 flight hours, depending upon the type of aircraft and the requirements of the operator's approved FAA maintenance program.
The "D" check requires a more intense inspection. The "D" check includes all of the work accomplished in the "C" check but places a more detailed emphasis on the integrity of the systems and structural functions. In the "D" check, the aircraft is disassembled to the point where the whole structure can be inspected and tested. Once the structure has been inspected and repaired, the aircraft and its various systems are reassembled to the detailed tolerances demanded in each system's functional test series. The normal intervals between "D" checks can be as little as 10,000 flight hours and as many as 25,000 flight hours, depending upon the type of aircraft and the requirements of the approved FAA maintenance program.
The form, function and interval of the "C" and "D" check is different with each operator's program. Each operator must have their particular maintenance program approved by the FAA and there are a number of variables which dictate the final form of a given program. Those variables include the age of the aircraft, the environment in which the aircraft flies, the number of hours that the aircraft regularly flies, the number of take-offs and landings (called flight cycles) that the aircraft regularly endures and the technical abilities of the entities performing the maintenance. In particular, flight cycles can effect the intervals required for major components to be changed or overhauled, thus effecting the amount of work required during any given check.
In addition to the tasks required in the "C" and "D" check, there are other associated tasks that are accomplished with these checks. There are structural inspections, which focus on known problem areas, that are required by the manufacturers. These are called Supplemental Structure Inspections (SSI). With the recent institution of the Aging Aircraft Programs by the manufacturers, there are also inspection programs for areas of known corrosion problems that are called Corrosion Prevention and Control Programs ("CPCP"). These additional inspections supplement and, in some cases, overlay the "C" and "D" check tasks.
The process of converting a passenger plane to freighter configuration entails completely stripping the interior; strengthening the load-bearing capacity of the flooring; installing the bulkhead or cargo net; cutting into the fuselage for the installation of a large cargo door; reinforcing the surrounding structures for the new door; replacing windows with metal plugs; and fabricating and installing the cargo door itself. The aircraft interior may also need to be lined to protect cabin walls from pallet damage, the air conditioning system modified and smoke detection system installed. Additionally, the Company installs the on-board cargo handling system. Conversion contracts also typically require "C" or "D" maintenance checks as these converted aircraft have often been out of service for some time and maintenance is required to bring the plane up to current FAA standards. In addition, while the conversion and maintenance work is being completed, many aircraft are fitted with hush-kits to enable their engines to comply with FAA noise regulations.
The Company also regularly provides other modification and integration services for its commercial customers under its own or customer-provided Supplementary Type Certificates ("STC") including integration of new avionics systems, installation of new galleys and airstairs and reconfiguration of interior layouts and seating. The Company believes that its facilities, tooling, engineering capabilities and experienced labor force enable it to perform virtually any air frame modification a commercial customer may require.
Contracts for commercial aircraft are performed primarily at the Dothan division of the Aeroplex and Pemco World Air Services, A/S in Copenhagen, Denmark. The commercial aircraft are typically docked and serviced in one bay for the duration of their particular program.
The Company has performed maintenance work on a wide variety of commercial aircraft and has approximately a 40% share of the after- market cargo conversion business for large transport aircraft. The Company has converted over 130 Boeing 727s, 29 BAe-146s, and 33 Boeing 737's.
The Company holds STCs from the FAA for the conversion of various aircraft from passenger-to-freighter, passenger-to-quick-change, and combination passenger and freighter conversions. Each type of aircraft is certified by the FAA under a specific certificate. Subsequent modifications to the aircraft require the review, flight-testing and approval of the FAA and are then certified by an additional STC. The Company holds passenger-to-freighter configuration STCs for the conversion of Boeing 727-100, 727-200, 737-200, 737-300, and 747 aircraft, C-9 aircraft, and BAe-146 aircraft. Additionally, the Company holds a passenger-to-quick- change configuration STC for the conversion of Boeing 737-300 aircraft and a combi configuration STC for the conversion of Boeing 727 aircraft.
SUPERSONIC AND SUBSONIC AERIAL TOW TARGETS AND WING TIP INFRARED PODS
The Company designs and manufactures supersonic and subsonic aerial tow targets and wing tip infrared pods. The family of low cost, high speed targets is known as the Hayes Universal Tow Target System (HUTTS). The targets can be flown from any commercial or military aircraft capable of carrying external stores as well as from most drone aircraft. The targets are available in various detection configurations: 1) visual smoke 2) visual light 3) infrared (simulates a jet aircraft engine) 4) radar and 5) visual fiber streamer. A maneuvering tow target and a low altitude sea-skimming target are also available in each of the above configurations. The various targets and equipment associated with the HUTTS are fully-developed and operational in the U.S. military services and in the services of many foreign countries.
The infrared wing tip pods are utilized on sub and full scale drones or droned excess military aircraft. Hayes Targets has supplied 100% of infrared augmentation for the U.S. Air Force for the last 21 years. Hayes Targets is presently designated as an Air Force "Blue Ribbon Contractor".
The targets and pods are produced by the Company's Hayes Targets division at Leeds, Alabama. The principal markets for the targets are the U.S. armed forces as well as markets in Europe, the Middle East, Australia and South America. The Company's competition consists of one competitor on the west coast of the United States and two foreign entities. The Company considers its competitive strength in this market to be its patented and proprietary products, its superior product performance and its innovative engineering capabilities.
SPACE VEHICLES AND SUPPORT SYSTEMS
The Company maintains a large research, development and engineering staff dedicated to the design and manufacture of space related systems such as sounding rockets, launch vehicles, guidance and control subsystems, vehicle structures and recovery systems. The staff serves in the capacity of a subcontractor on most of the large U.S. Government Department of Defense programs with which it is involved. The staff has prime contracts with NASA in support of space science and does a limited amount of commercial space work.
The Company's largest current contract in this arena is the HERA program which will provide realistic ballistic targets for Theater Missile Defense (TMD) interceptor deployment. The HERA program, initiated in 1992, provides for twenty-five target vehicles to be utilized during interceptor testing of various TMD systems through the year 1997. Options to provide an additional fifty target vehicles to continue Army testing and to accommodate Air Force and Navy TMD missions through the year 2000 are part of the long-range HERA program. The Company successfully completed its third HERA test flight in February, 1996 and is well positioned to support the upcoming intercept tests for the Theater High Altitude Area Defense missile and radar system. The HERA program is sponsored by the U.S. Army Space and Strategic Defense Command. Its contractor team is comprised of Coleman Research Corporation as the system prime contractor, Space Vector Corporation as the booster subcontractor, and Aerotherm Corporation as the ballistic reentry target subcontractor.
This product line is produced by the Company's Space Vector subsidiary, which is located at Chatsworth, California with a satellite office at Fountain Valley, California. The Company's principal markets for its space and missile products are the U.S. Government, prime contractors to the U.S. Government, and the scientific community in general. The Company's competition ranges from very small organizations for the component subsystems to major corporations for the design and manufacture of spacecraft and launch vehicles. The Company considers its competitive strength to be its technical and managerial competence. The Company's contracts are awarded in accordance with the government's competitive bidding practices.
CARGO HANDLING SYSTEMS
The Company designs and manufactures on-board cargo-handling systems for all types of large transport aircraft, including B-747, B-727, B-737, DC-8, DC-9/C-9B, DC-10/KC-10, L-1011, L-100 and L-188, and certain other military aircraft. Robotics and fully-computerized machinery are used to produce a wide variety of aircraft cargo handling systems as well as individual parts used in the Company's proprietary systems and in other systems. These cargo systems represent state-of-the-art technology in their design, efficient use of floor space and maximum strength, with a minimum of added weight. The systems meet all of the FAA and JAA Quality Assurance Standards, MIL-I and MIL-Q qualifications as required.
This product line is produced by the Company's Pemco Engineers Aircraft Cargo Systems division located at Corona, California. The Company's principal markets for the cargo handling system are all major United States and foreign airlines and aircraft manufacturers. The Company has approximately eight competitors and considers its strength in this industry to be its innovation, quality and response time.
PRECISION SPRINGS AND COMPONENTS
The Company manufactures precision springs and components and employs custom design, tooling and precision stamping in the production of these high tolerance parts. The springs and components are used in a variety of industrial, commercial and residential applications.
This product line is produced by the Company's Pemco Engineers Springs and Components division. This division is also located at Corona, California and shares state-of-the-art equipment with Pemco Engineers Aircraft Cargo System division. The Company markets its precision springs and components to a wide range of manufacturers in numerous industries. There are approximately 500 manufacturers of springs and components in the United States making it a $1 billion industry. The Company's competitors range in size from "single-machine" shops to companies with revenues exceeding $20 million. Most of the competitors, however, produce a broader mix of products while the Company focuses on the manufacture of precision springs and components.
PARTS SUPPORT AND COMPONENT OVERHAULS
The Company's Parts Support and Component Overhaul service provides a comprehensive source for aircraft spares and component overhauls. The Company uses its inventory and on-line tracking and sales system to provide support to the cargo conversion customers of Pemco World Air Services as well as to users and owners of a wide range of commercial and military aircraft. This service provides the Company with the capability of locating spare parts for its customers virtually anywhere in the world, an inventory of critical spare parts for the Company's conversion programs and 24 hour "Aircraft on Ground" service.
This service is provided by Pemco Air Support Services, Inc. ("PASS"). PASS has three locations. PASS facilities at Denver, Colorado and Clearwater, Florida serve North and South America as well as the Pacific Rim. The PASS facility in Copenhagen, Denmark serves Europe, Africa, and the Middle East. The Company markets its parts support and component overhaul service to commercial carriers worldwide as well as to foreign armed services.
In the area of supporting and selling the Company's designed and manufactured parts, the Company often benefits from a captive market situation. In the second area of competition, which is the brokerage of non-proprietary parts, the industry is comprised of several large companies and as many as a thousand smaller companies. While the Company is still a small player in this market segment, its goal is to market quality products that interest the users of the Company's products, thus creating a sales synergy. To this end, the Company has obtained several European distributorships for U.S. based companies and expects to increase the number of distributorships to 15-20 over the next few years. Its future market strength will depend on the Company's ability to create innovative pricing structures, provide higher quality service and the acquisition of parts inventories or teaming arrangements upon beneficial terms.
NACELLE OVERHAUL AND REPAIR
The Nacelle Overhaul and Repair service provides a comprehensive source for the overhaul, repair and modification to nacelles and thrust reversers for engines supplied by General Electric, Pratt & Whitney and Rolls-Royce.
This service is provided by Pemco Nacelle Services, Inc. which is located at Clearwater, Florida. The Company markets its nacelle overhaul and repair service to commercial carriers worldwide and supports turbofan-powered aircraft manufactured by Airbus, Boeing and McDonnell Douglas. There are approximately five competitors in the United States and abroad. The Company entered this line of business in March of 1993 and is building its competitive strength on turnaround time, the convenience of customer exchange in lieu of repair, quality, and price.
E. RESEARCH AND DEVELOPMENT
The Company charged the cost it incurred for company sponsored research and development costs, which totalled $0.5 million in 1995, $0.8 million in 1994 and $0.4 million in 1993 directly to earnings. The research and development activities in 1995 were principally in support of the Company's aircraft and Targets programs. In 1996, research and development costs are expected to be in the $0.5 to $1.0 million range, principally in support of the same programs. The Company was not engaged in any customer sponsored research and development efforts in 1993, 1994, or 1995.
F. SALES
Foreign and Domestic Operations and Export Sales
The majority of the Company's revenues were generated in the United States and the majority of the Company's assets are located in the United States. The Company has two foreign operations, Pemco World Air Services, A/S, which is registered as a Danish limited liability company and Pemco Air Support Services, which is registered as a Danish branch of a U.S. company. These foreign operations contributed less than six percent of the Company's consolidated revenue in 1995 and own less than five percent of the Company's identifiable consolidated assets.
The Company provides maintenance and modification services to foreign-based aircraft owners and operators at its U.S. facilities and its Copenhagen, Denmark facility. The Company's Targets, Space Vector, Nacelle and Aircraft Cargo Systems divisions also sell in export markets. The services and products sold at the Company's U.S. locations are payable only in U.S. dollars. The Company's Copenhagen locations accept payments in Danish kroner and U.S. dollars, as well as other foreign currencies.
The following table presents the percentages of total sales for each principal product and service rendered for the last three fiscal years and the percentage of export sales for the last three fiscal years. (See also footnote number 13 to the accompanying financial statements of the Company which are included under Item 8 hereof):
Major Customers
G. BACKLOG
As of December 31, 1995, 89% of the Company's backlog was for the U.S. Government versus 65% for the period ending December 31, 1994. The Company's U.S. Government backlog increased primarily due to an increase in backlog under the Company's KC-135 contract. In September of 1995, the U.S. Air Force exercised its option for the second year of a seven year contract for KC-135 PDM aircraft. The Company's KC-135 backlog at December 31, 1995 was $91.0 million versus $79.8 million in 1994. Also in September of 1995, the U.S. Air Force exercised its option for the fifth and final year of its contract for C-130 PDM aircraft. The Company's C-130 backlog at the end of 1995 was $10.4 million versus $13.5 million in 1994. Other changes in the Company's U.S. Government backlog include an increase of $2.4 million for the targets product line, an increase of $3.1 million associated with the H-3 Helicopter contract, and an increase of $0.7 million under the Company's HERA contract.
The Company's commercial backlog at December 31, 1995 changed from prior year primarily due to a reduction of $38.5 million under the Company's 737 cargo conversion program. Approximately $11.3 million is due to revenues recognized over the past twelve months. The Company believes at least some of these ships eventually will be converted under new or renegotiated contracts. Other changes in the Company's commercial backlog include an increase of $2.1 million of backlog at the Company's Copenhagen facility, offset by a $7.8 million decrease in 727 cargo conversion backlog. Approximately $27.2 million of the reduction is due to the elimination of assumed option ships, some of which were under contracts that have expired.
Approximately $8.9 million of commercial backlog at December 31, 1995 (compared to $27.2 million at December 31, 1994) may not be considered firm orders because it pertains to maintenance and modification work to be performed under contracts that are approaching their expiry. Additionally, the Company has approximately $203 million of firm but unfunded backlog associated with the five follow-on years of the KC-135 contract, which is not included in the figures cited above. Approximately $99.8 million of the December 31, 1995 backlog is expected to be filled in 1996.
H. RAW MATERIALS
The Company purchases a variety of raw materials including aluminum sheets and plates, extrusion, alloy steel and forgings. Excepting as noted below, the Company experienced no significant shortages of raw material essential to its business during 1995 and does not anticipate any shortages of critical commodities over the longer term; although, this is difficult to assess because many factors causing such possible shortages are outside its control.
The Company procures many components, parts and equipment items from various domestic companies. The Company faces some dependence on suppliers for certain types of parts involving highly technical processes; however, this risk has lessened in the past few years as additional high technology suppliers have entered the market. The Company does not believe this dependence has significance for its business as a whole; rather, any adverse consequence that might result from the failure of a sole supplier to provide a particular part would be felt on an individual contract basis.
A significant portion of the equipment and components used by the Company in the fulfillment of its services under United States Government contracts is furnished without charge to the Company by the U.S. Government. The Company is dependent upon U.S. Government furnished material to meet delivery schedules, and untimely receipt of such material adversely affects production schedules and contract profitability. The Company has encountered late delivery of Government-Furnished Material (GFM) in 1993, 1994, 1995 and 1996 and as a result, has experienced a disruption in scheduled work flow.
One example of late GFM is the government's failure to provide the Company with production break fittings that are used in the performance of the KC-135 PDM contract. Late availability of parts caused the average production time required per KC-135 to increase substantially. The disruption and subsequent acceleration impacts on the Company's production line which resulted from these parts shortages negatively impacted the profitability of the contract from 1993-1995. The Company requested equitable adjustment of approximately $10.3 million to compensate it for some of the costs caused by the delay. In February 1996, the Company received $7.7 million plus $0.4 million in related interest in a negotiated settlement with the government. The Company and the government are working on ways to minimize the likelihood of a repetition of such delays in the future, but there can be no assurance that such delays will not recur. The Company anticipates submitting one or more additional Requests for Equitable Adjustment (REAs) to cover other cost impacts of late GFM not included in the REA settled in February of 1996. (See Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations under the heading "KC-135 Contract" for a detailed discussion.)
I. PATENTS, TRADEMARKS, COPYRIGHTS AND STCs
The Company holds 50 FAA-issued Supplementary Type Certificates (STCs) which authorize it to perform certain modifications to aircraft. These modifications include air-stair installation and the conversion of commercial aircraft from passenger-to-freighter or passenger-to-Quick Change configurations. The STCs are applicable to Boeing 707, 727, 737, 747, Douglas DC-6, DC-8, DC-9, BAe-146 and Convair 580 Series Aircraft. The Company also holds 21 STCs related to its cargo handling systems for various types of large transport aircraft. STCs are not patentable; rather, they indicate a procedure that is acceptable to the FAA to perform a given air-worthiness modification.
The Company also holds FAA-issued Parts Manufacturing Approvals (PMAs) which give it authorization to manufacture parts of its own design or that of other manufacturers related to its cargo handling system. The Company holds numerous other PMAs which give the Company authority to manufacture certain parts used in the conversion of aircraft from passenger-to-freighter and passenger- to-Quick Change configurations.
The Company holds two active utility patents and three active design patents related to the Hayes Targets product line. Three of the patents (one utility expiring in 2001 and two designs expiring in 1998) concern infrared augmentation. The second utility patent is a British patent (expiring in 1997) and concerns visual augmentation. The remaining design patent (expiring in 1998) concerns a portable ground scoring unit developed for the purpose of scoring ground-based target emplacements on ground-to-air gunnery ranges. All of the patents except the British patent are U.S. patents. The Company does not believe that the expiration or invalidation of any or all of these patents would have a material adverse impact upon its financial condition.
The Company holds copyrights to the computer software developed in-house for the operation of the Power Drive Unit System and Cargo Door Electro-Mechanical System used in the conversion of commercial aircraft, as well as copyrights to the software for the development of the control computer codes for the TLX-1 sea-skimming, height-keeping tow target, and the TMX class maneuvering target. These copyrights are not registered and will begin to expire after the year 2028.
The Company firmly believes that the value of its patents, trademarks, copyrights and STCs exceed the amounts of its related intangibles and deferred inventory.
J. ENVIRONMENTAL COMPLIANCE
The Company has requirements to comply with environmental regulations at the federal, state and local levels. These requirements apply especially to the stripping, cleaning and painting of aircraft. The requirements to comply with environmental regulations have not had, and are not expected to have, a material effect on the Company's capital expenditures, earnings and competitive position.
The Company has been designated as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. It is difficult to estimate the total cleanup costs and to predict the method that will be used to allocate such costs among the responsible parties. However, based upon presently known facts, the Company does not believe that the resolution of this matter will have a material adverse effect on the Company's financial position, results of operations or cash flows.
K. EMPLOYEES
At February 29, 1996, the Company employed approximately 2,012 persons, of whom approximately 1,395 were covered by collective bargaining agreements. Approximately 20 of these employees are employed on a part-time basis.
The two primary collective bargaining agreements are with the International Association of Machinists at the Company's Dothan, Alabama location and the United Auto Workers at the Company's Birmingham, Alabama and Leeds, Alabama locations.
The collective bargaining agreement with the International Association of Machinists was successfully negotiated without a work stoppage in August of 1992 and was extended for five years to August 1997. The collective bargaining agreement with the United Auto Workers was successfully negotiated without a work stoppage in July of 1993 and was extended for three years to July of 1996. Good relations continue between labor and management at each of the facilities.
Item 2.

Item 2. Properties.
All of the Company's properties are generally well maintained and in good operating condition. All facilities were adequately utilized during 1995 except the Company's Clearwater, Florida facility. The Company suspended aircraft maintenance operations in Clearwater during the second quarter of 1994 in order to adjust its overall staffing to anticipated work levels. The Company continued, however, to operate the PASS aircraft parts distribution center at the Clearwater facility. In the second quarter of 1995, the Company relocated Pemco Nacelle Services to the Clearwater facility in an effort to accommodate the current and anticipated needs of Nacelle. The relocation of Nacelle to Clearwater increased the utilization of the Clearwater facility but did not bring it to a level of full utility.
Pemco World Air Services Marketing Offices and Precision Standard, Inc. Executive Offices - Denver, Colorado
Pemco World Air Services relocated its marketing staff to Denver, Colorado from Birmingham, Alabama in the first quarter of 1995 and Precision Standard, Inc. established executive offices at the same location later in 1995. The lease for this office space expires in May, 2001.
Pemco Aeroplex, Inc. - Birmingham, Alabama
The Birmingham division of the Aeroplex is located at the Birmingham International Airport, at Birmingham, Alabama. The facility is located on 208 acres of land with approximately 1,935,000 square feet of production and administrative floor space. The facility includes ten flow-through bays, each 40 feet high, 160 feet wide and 725 feet long, permitting continual production line operation. The facility also includes a number of ancillary buildings such as a paint hangar, a shipping and receiving warehouse, a wing rehabilitation shop, a sheet metal shop and a 54,904 square foot general office building which houses the Aeroplex administrative staff. Available ramp area exceeding 3,000,000 square feet is adjacent to the municipal airport runways. Additionally, the facility operates a control tower which supplements the FAA-managed municipal air control tower and a fire fighting unit which supplements fire fighting equipment operated by both the City of Birmingham and the Alabama Air National Guard.
The Birmingham facility is in every material respect a complete aircraft modification and maintenance center. The facility is an approved FAA and JAA Repair Station and maintains Department of Defense "SECRET" security clearance.
The facility is leased from the Birmingham Airport Authority. During 1995, the Company accepted an offer from the Birmingham Airport Authority for a twenty year extension of its lease for the facility. The lease extension offer sets a new expiry date of September 30, 2019 and provides for the release of certain, limited parcels to the Authority but otherwise contains the same terms and conditions as are currently in effect under Pemco's present lease. Formal documentation of this renewal is currently in progress.
Pemco Aeroplex, Inc. - Dothan, Alabama
The Dothan division of the Aeroplex is located at the Dothan Municipal Airport, at Dothan, Alabama. The facility is located on 91.5 acres of land with approximately 521,000 square feet of production and administrative floor space. The facility includes 352,000 square feet of aircraft hangar space which is comprised of 13 bays and one wide-body aircraft hangar. The facility also includes four warehouses, two paint hangars, support shops and 26,000 square feet of administrative offices. The facility has 850,000 square feet of aircraft flight line and parking ramp space and is served by an airport consisting of two runways of 5,600 and 8,500 feet, a FAA Flight Service Station and a control tower.
The facility is leased from the Dothan/Houston County Airport Authority under a lease agreement which, inclusive of a five year option period, expires in June of 2015.
Pemco World Air Services A/S - Copenhagen, Denmark
Pemco World Air Services, A/S is located at the Copenhagen Airport. The facility is located on 87 acres of land with approximately 252,000 square feet of production and administrative floor space. The facility was built in 1988 and has two large, modern hangars comprised of four bays. The hangars can accommodate DC10/MD11- sized aircraft and are equipped with overhead work platforms. Each hangar also includes stockroom, backshop and office space. The JAA and FAA approved facility has 103,300 square feet of ramp space and is served by an airport consisting of three runways.
The facility is leased from the bankruptcy estate of Sterling Airways under a five year lease agreement that includes a purchase option at the end of the lease term. The five year lease expires in May of 1999.
The Clearwater Facility
The Company's Clearwater facility is located at the St. Petersburg/Clearwater International Airport at Clearwater, Florida. The facility is located on 22 acres of land with approximately 133,000 square feet of production and administrative floor space. The facility includes 2 bays of approximately 92,000 square feet as well as supply and support shops and administrative offices. The facility has 782,000 square feet of ramp space and is served by airport facilities consisting of five runways (from 4,000 to 8,500 feet), a FAA Flight Service Station and a control tower. The facility houses Pemco Nacelle Services, Inc. and administrative staff of PASS. PASS also utilizes a warehouse at the Clearwater facility.
The facility is leased from Pinellas County, a political subdivision of the State of Florida, under a lease agreement that expires in September 2000, exclusive of four optional renewal periods of five years each which would extend the lease until September 2020.
The Targets Division
The Targets division is located at Leeds, Alabama. The facility is located on 4 acres of land and consists of one metal building with approximately 32,000 square feet of manufacturing and office floor space. The Targets division occupies this building under a lease agreement which, inclusive of a twelve year option period, expires in December of 2006.
Pemco Nacelle Services, Inc.
Pemco Nacelle Services is located at the Clearwater, Florida facility (see description under "The Clearwater Facility").
Space Vector Corporation
Space Vector Corporation is located at Chatsworth, California. The Company relocated its operations in February, 1994 due to irreparable earthquake damage to the buildings it had been leasing previously. The new location is in close proximity of its former Chatsworth location and consists of two industrial buildings of approximately 67,000 square feet. Space Vector Corporation occupies these buildings under a lease agreement which expires in April, 1999.
Space Vector also leases a 3,400 square foot research and development and administrative office in Fountain Valley, California. This lease expires in October of 1997.
Pemco Engineers Aircraft Cargo Systems and Springs and Components Divisions
Pemco Engineers is located at Corona, California. The facility consists of 28,000 square feet of production and administrative floor space. The facility is under a lease agreement which, inclusive of a five year option period, expires in December of 2001.
Pemco Air Support Services (PASS)
PASS has three locations: administrative offices at the Denver, Colorado location, a warehouse at the Clearwater facility, and administrative offices and a warehouse at the Pemco World Air Services A/S facility in Copenhagen, Denmark.
Item 3.

Item 3. Legal Proceedings.
Various claims of employment discrimination, including race, sex, age and disability, have been made against the Company's subsidiary, Pemco Aeroplex, Inc., in proceedings before the Equal Employment Opportunity Commission and, in some cases, in U.S. District Court in Alabama by several current and former employees at its Birmingham, Alabama and Dothan, Alabama facilities. The Company is also defending several workers compensation claims brought by employees in Alabama state court. The Company believes that these claims, no one of which is material to the Company as a whole, are more reflective of the general increase in employment related litigation in the U.S. and in Alabama than of any actual discriminatory employment practices by the Company. The Company believes that these claims have no merit and intends to vigorously defend itself in all litigation arising therefrom.
The Company is also a party to other, non-employee related litigation, the results of which are not expected to be material to the Company's financial condition.
The Company has been designated as a potentially responsible party under The Comprehensive Environmental Response, Compensation and Liability Act for contamination associated with a site near its Clearwater facility. See Item 1. Business, Environmental Compliance, for further disclosure.
Item 4.

Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted for a vote of the Company's shareholders in the fourth quarter of fiscal 1995.
Item 5.

Item 5. Market for Company's Common Equity and Related Stockholder Matters.
The Company's common stock trades on The NASDAQ National Market System under the symbol "PCSN." Approximately 67% of the outstanding shares of the Company's common stock is held by Matthew L. Gold, the Company's Chairman, President and Chief Executive Officer.
The following table sets forth what the Company believes to be the range of high and low bid quotations for its common stock on a quarterly basis for each of the Company's last two fiscal years. Quotations represent prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions.
On December 31, 1995, there were 12,793,215 shares of common stock issued. There are 12,455,955 shares outstanding held by 230 owners of record, which the Company believes were held by more than 500 beneficial owners. The Company also granted a warrant to its primary lender in connection with its Senior Subordinated Loan to purchase 4,215,753 shares of the Company's common stock at an exercise price of approximately $.24 per share. The warrants have not been exercised and expire on September 9, 2000.
The Company has never paid cash dividends on its common stock and currently intends to continue its policy of retaining all of its earnings for use in its business.
Item 6.

Item 6. Selected Financial Data.
Item 7.

Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations.
INTRODUCTION
The following discussion should be read in conjunction with the Company's consolidated financial statements and notes thereto included herein as Item 8.

Item 8. Financial Statements and Supplemental Data.
The following financial statements and financial statement schedules are submitted herewith:
Financial Statements:
Reports of Independent Accountants
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholder's Equity
Consolidated Statements of Cash Flow
Notes to Consolidated Financial Statements
Financial Statement Schedules:
Report of Independent Accountants
Schedule II - Amounts Receivable From Related Parties, and Underwriters, Promoters and Employees Other Than Related Parties
Schedule II - Valuation and Qualifying Accounts
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders Precision Standard, Inc.
We have audited the accompanying consolidated balance sheets of Precision Standard, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1995. 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 generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Precision Standard, Inc. and Subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995 in conformity with generally accepted accounting principles.
As discussed in Notes 1, 9 and 11 to the consolidated financial statements, in 1993 the Company changed its method of accounting for income taxes and certain postretirement benefits.
COOPERS & LYBRAND L.L.P.
Birmingham, Alabama March 31, 1996, except for Notes 6 and 7 as to which the date is April 15, 1996
PRECISION STANDARD, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION, OPERATIONS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Operations - Precision Standard, Inc. (the Company) is primarily engaged in the maintenance and modification of large transport aircraft; the design, development, and manufacture of aerial target systems; the development and manufacture of rocket launch vehicles and guidance systems; the design and manufacture of cargo handling systems; and the manufacture of precision springs and components.
Principles of Consolidation - The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.
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 assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.
Contract Accounting - The Company recognizes revenue on aircraft and aerial target system programs principally under the percentage-of-completion method of accounting, using an output measure of progress, units of delivery for contracts with provisions for multiple deliveries, and an input measure by which the extent of progress is measured by the ratio of cost incurred to date to the estimated total cost of the contract (cost to cost) for contracts which the units of delivery method is not appropriate. The Company's contracts for its rocket launch vehicles and guidance systems are primarily cost reimbursement contracts. As such, revenues are recorded as costs are incurred and as fees are earned. Provision is made to recognize estimated losses in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues. An amount equal to contract costs attributable to claims is included in revenues when realization is probable and the amount can be reliably estimated.
Inventories - Materials and supplies are stated at the lower of average cost or market (replacement cost). Work in process includes materials, direct labor, manufacturing overhead, and other indirect costs incurred under each contract, less progress payments, amounts in excess of estimated realizable value, and amounts charged to cost of goods sold on units delivered or progress completed. Inventoried costs on long- term commercial programs and U.S. Government fixed price contracts include direct engineering, production and tooling costs, and applicable overhead. In addition, inventoried costs on U.S. Government fixed price contracts include research and development and general and administrative expenses estimated to be recoverable. In accordance with industry practice, inventoried costs are classified as current assets and include amounts related to contracts having production cycles longer than one year.
Property, Plant, and Equipment - Leasehold improvements and machinery and equipment are stated at cost, less accumulated depreciation. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives:
Maintenance and repairs are charged to expense as incurred, while major renewals and improvements are capitalized.
The cost and related accumulated depreciation of assets sold or otherwise disposed of are deducted from the related accounts and resulting gains or losses are reflected in operations. Depreciation charged to operations was $2,499,774, $2,493,948, and $2,336,694 for the years ended December 31, 1995, 1994, and 1993, respectively.
Intangible Assets - Intangible assets are being amortized using the following methods and estimated useful lives:
Supplemental type certificates are granted by the Federal Aviation Administration in order to allow certain modifications to be made to a particular model of aircraft for commercial use. All intangible assets associated with the acquisition of Hayes International Corporation have been reduced to zero as net operating loss carryforwards not established as deferred tax assets in the initial purchase price allocation have been utilized. The debt issuance costs are amortized over the life of the related debt.
Income Taxes - The Company accounts for income taxes under the liability method in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, ACCOUNTING FOR INCOME TAXES.
Nonpension Postretirement Benefits - In the first quarter of 1993, the Company adopted SFAS No. 106, EMPLOYERS' ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred. Prior years' financial statements have not been restated for the accounting change (see Note 11).
Provision for Warranty Expenses - The Company warranties certain work performed for a given time period, in accordance with the terms of each specific contract. The Company provides for future warranty expenses based on actual warranty history, company practice, and specific warranty terms. In 1995, the Company decreased its warranty reserve by $340,043 to $1,178,636 due to warranties expiring and the payment of warranty items, partially offset by warranties related to new deliveries and the modification of terms on certain outstanding warranties. This reserve is management's best estimate of anticipated costs related to aircraft that were under warranty at December 31, 1995. Actual experience may be different than that anticipated for warranty work.
Cash Equivalents - For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.
Earnings Per Common Share - The 1995 primary and fully diluted earnings per share is based on the weighted average number of outstanding common shares, excluding restricted shares and stock options, as this presentation was the most dilutive. The 1994 primary and fully diluted earnings per share is based on the weighted average number of outstanding common shares including restricted shares and assuming the exercise of certain stock options. Stock warrants were treated as equity rather than debt, as this presentation was the most dilutive. The 1993 primary and fully diluted earnings per share is based on weighted average number of outstanding common shares assuming the exercise of certain stock options. Stock warrants were treated as debt rather than equity, as this presentation was the most dilutive. The shares used in the computations for the three years were as follows (in thousands):
Foreign Currency Translation - The financial position and results of operations of the Company's foreign operations in Copenhagen, Denmark are measured using local currency as the functional currency. Assets and liabilities of this foreign subsidiary are translated at the exchange rate in effect at each year-end. Income statement accounts are translated at the average rate of exchange prevailing during the year. Translation adjustments arising from differences in exchange rates from period to period are included in the accumulated foreign currency translation adjustments account in shareholders' equity. The cash flows from foreign operations are translated at the average rate of exchange prevailing during the year. These translated cash flows are combined with the U.S. domestic company's cash flows to arrive at amounts reported on the Consolidated Statements of Cash Flows for the year ended December 31, 1995.
Recently Issued Accounting Standards - Statement of Financial Accounting Standards No. 121 (SFAS No. 121), ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS, establishes guidance beginning in 1996, for recognizing and measuring impairment losses and would require that the carrying amount of impaired assets be reduced to fair value. Management does not believe that the adoption of SFAS No. 121 will have a material effect on the consolidated financial statements of the Company.
Statement of Financial Accounting Standards No. 123 (SFAS No. 123), ACCOUNTING FOR STOCK-BASED COMPENSATION, establishes fair value-based financial accounting and reporting standards for all transactions involving, or relating to the Company's equity instruments. The Company will adopt SFAS No. 123 and will, accordingly, comply with the disclosure requirements set forth in the statement. Management does not believe that the effect of SFAS No. 123 will be material to the Company's pro forma net income or pro forma earnings per share.
Reclassifications - Certain prior year amounts have been reclassified to conform with the presentation used in 1995.
2. TRADE ACCOUNTS RECEIVABLE
Recoverable costs and accrued profit not billed consist principally of amounts of revenue recognized on contracts, for which billings had not been presented to the contract owners because the amounts were not billable at December 31, 1995 and 1994.
3. INVENTORIES
A portion of the above inventory balances relates to U.S. Government contracts. The Company receives progress payments on the majority of its government contracts. The title to all inventory on which the Company receives these payments is vested in the government to the extent of the progress payment balance.
Included in work in process are unrecovered costs at the estimated recoverable value of $1,331,891 and $516,439 at December 31, 1995 and 1994, respectively. These costs relate primarily to certain over-and-above type work performed on government contracts. Recoverability of these costs is subject to future determination through negotiation or other procedures not complete at the balance sheet dates. These unrecovered costs relate to contracts under which all goods have been delivered at December 31, 1995 and 1994, respectively. All of the unrecovered costs at December 31, 1994 were settled during 1995. Management expects to recover the 1995 costs in accordance with past experience.
Also included in work in process is $2,683,124 and $3,160,586 of deferred production, initial tooling, and related nonrecurring costs (collectively referred to as deferred costs) at December 31, 1995 and 1994, respectively. The recovery of a significant portion of these deferred costs is dependent on the number of conversions performed and actual contract prices. Sales significantly under estimates or costs significantly over estimates could result in the realization of substantial losses. Realization of approximately $507,531 and $1,352,082 of deferred costs at December 31, 1995 and 1994, respectively, is dependent on the profitability of firm contracts. Recoverability of the remaining $2,175,593 and $1,808,504 of deferred costs at December 31, 1995 and 1994, respectively, is dependent upon the profitability of anticipated contracts. Based on studies by the Company, management believes there exists a sufficient market to enable the Company to recover these costs.
The aggregate amounts of general and administrative costs incurred during 1995, 1994, and 1993 were $18,956,954, $14,560,608, and $15,684,055, respectively. The amounts of general and administrative costs remaining in inventories at December 31, 1995 and 1994 were $1,786,373 and $1,508,537, respectively, and are associated with government contracts.
Inventory related to modification and maintenance of aircraft is subject to technological obsolescence and potential decertification due to failure to meet design specifications. The Company actively reserves for obsolete inventory. However, future technological changes could render some inventory obsolete. No estimate can be made of a range of amounts of loss that are reasonably possible should current design specifications change.
4. INTANGIBLE ASSETS
Amortization charged to operations was $204,331, $210,168 and $1,283,366 for the years ended December 31, 1995, 1994, and 1993, respectively.
5. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
6. Standby Financing Commitment
The financial statements of the Company have been prepared contemplating the realization of assets and the satisfaction of liabilities in the normal course of business. During the year the Company experienced disruption in scheduled work flow which occurred as a result of the late delivery of government- furnished material. This disruption inhibited the ability of the Company to meet current obligations as they became due; as a result, the Company failed to timely pay interest and principal on its Term Credit facility, Revolving Credit facility and Senior Subordinated Loan, payroll taxes and payroll tax penalties, certain vendor payables and other obligations. In February of 1996 the Company realized its Request for Equitable Adjustment (see Note 12) and was able to settle the majority of its obligations exclusive of debt service. In April the Company's primary lender extended the maturity date of all accrued interest and principal to March 31, 1997 (see Note 7). The Company has also arranged a standby financing commitment with its principal shareholder which provides for the extension by the principal shareholder of up to $2.0 million in short-term advances upon demonstration of certain need factors by the Company. The commitment which contains cross default provisions to the Company's principal loan agreements, expires in January 1997 and bears a fee of two percentage points. Advances under the commitment bear interest at prime plus three percentage points, have maturities of six months and are secured by a subordinated security interest in the Company's assets and the pledge of stock issuance to the extent of ninety percent of the amount advanced. To date no advances have been made under this commitment.
7. LONG-TERM DEBT
The rates of interest applicable under the Revolving and Term Credit facilities are variable, depending upon the general level of interest rates and the timing and nature of elections which the Company is entitled to make in respect to renewals of outstanding debt or increments of additional debt.
The Senior Subordinated Loan payable bears interest at 14.5 percent.
For the years ended December 31, 1995 and 1994, the effective interest rate for the Revolving Credit facility was 10.04 percent and 6.97 percent, respectively. For the years ended December 31, 1995 and 1994, the effective interest rate for the Term Credit facility was 9.88 percent and 6.99 percent, respectively.
The Company defaulted on its Credit facility and Senior Subordinated Loan monthly interest payments from July through December of 1995 in the aggregate, approximate amount of $1,500,000. In addition, the Company defaulted on its third and fourth quarter 1995 principal payments in the aggregate amount of $9,000,000.
On April 15, 1996 the Company received an Amended and Restated Credit facility and an Amended and Restated Senior Subordinated Loan. In accordance with these amendments, interest accrued through March 1996 in the amount of $2,207,799 is capitalized into the principal balance of the debt. In accordance with the amendments, the maturity date of the Credit facility and the Senior Subordinated Debt has been extended to March 31, 1997, at which date the unpaid principal and deferred interest balance is due in its entirety.
The above loans are collateralized by substantially all of the assets of the Company and have various covenants which limit the Company to incur or prohibit the Company from incurring additional indebtedness, dispose of assets, merge with other entities, declare dividends, or make capital expenditures in excess of certain amounts in any fiscal year. Additionally, the Company is required to maintain various financial ratios and minimum net worth amounts. At December 31, 1995, the Company was in violation of its tangible net worth requirement for the fourth quarter of 1995 and was in violation of its leverage ratio and fixed charge coverage ratio requirements for the second, third, and fourth quarter of 1995. On April 15, 1996, the Company's primary lender issued waivers regarding these covenants and modified certain financial and nonfinancial covenants for each of the four quarters in 1996.
At December 31, 1994, the Company was in violation of both of its leverage ratio and fixed charge coverage ratio requirements for the third and fourth quarter of 1994. In addition, the Company was in violation of certain nonfinancial covenants in the fourth quarter of 1994. On April 14, 1995, the Company's primary lender issued waivers regarding these covenants and modified certain financial covenants for the first six months of 1995. In addition, the primary lender issued a Sixth Amendment to the Amended and Restated Credit Agreement (the Amendment).
The Company reached an agreement in March 1994 with its primary lender to extend the maturity date of both the Revolving Credit facility and Term Credit facility. Both of these instruments were previously due in September 1994. The restated credit agreement provided that the maturity date of the Revolving Credit facility is September 30, 1995. The agreement also provided that the maturity date of the Revolving Credit facility could be extended to March 31, 1996 pursuant to the payment of the extension fee specified in the agreement. The provisions of the Revolving Credit facility agreement required a commitment fee of one-half of one percent per annum on the unused portion. The restated Term Credit facility provided for six equal quarterly installments of $2.0 million beginning on March 31, 1994 and continuing through June 30, 1995 and a final payment of $7.0 million on September 30, 1995. The agreement provided that the maturity date of the Term Credit facility could be extended pursuant to the payment of the extension fee specified in the agreement. This extension would allow the Company to repay the balance in two installments of $2.0 million each on September 30 and December 31, 1995 and a final payment equal to the remaining unpaid balance on March 31, 1996. At December 31, 1994, the Company had assumed this extension and, accordingly, the debt has been classified as long term in accordance with the agreement.
At December 31, 1993, the Company had failed to assign certain leasehold interests to the bank. In addition, the Company was in violation of both of its tangible net worth requirements at December 31, 1993. Subsequently, the bank issued waivers regarding these covenants.
In connection with the Senior Subordinated Loan, the Company granted a warrant to the bank to purchase 4,215,753 shares of the Company's common stock at an exercise price of approximately $.24 per share. The warrant provided for mandatory repurchase periods between June 15 and December 14 during 1991, 1992, and 1993. Upon written notice from the warrant holder during the mandatory repurchase periods, the Company was required to repurchase the warrant for the per share difference between the then current appraised value of the Company's common stock and the exercise price of the warrant (put price). At December 31, 1994, the estimated aggregate put price for all shares, pursuant to the warrant, of $4,200,000, is included in the mezzanine section of the Company's consolidated financial statements.
Changes in the estimated put price prior to the first put date (June 15, 1991) were accreted; changes in the estimated put price after the first put date were recorded directly to interest expense. The $2,300,000 accretion in 1993 was recorded as an increase to interest expense.
During the periods January 15, 1993 through April 14, 1993 and January 15, 1994 through September 14, 1994, the Company had the option to repurchase the warrants for the then current put price, if the warrants had not been previously exercised or repurchased. Additionally, the warrant holders had rights to demand registration of the warrants under certain circumstances. In accordance with the eighth amendment to the Revolving Credit facility the expiration date of the warrants has been extended to September 9, 2000.
The warrant was neither put nor exercised by the lender as of December 31, 1993. On April 1, 1993, pursuant to the provisions of the warrant agreement, the Company called the warrant for repurchase. The call was rescindable and subject to negotiation pursuant to the terms of the warrant agreement. The amount included in the mezzanine section of the balance sheet as of December 31, 1994 represented management's estimate of the amount to be paid to the lender.
As one of the conditions to the granting of the 1994 waivers and the Amendment necessary to cure the debt covenant violations at September 30, 1994 and December 31, 1994, the primary lender required rescission of the Company's call of the warrant. In conjunction with the recision of the Company's call of the warrant during 1995, the Company has reclassified the warrant from the mezzanine section of the balance sheet to additional paid-in capital at December 31, 1995. The warrant otherwise remains as a binding and enforceable agreement between the Company and its primary lender.
8. ESTIMATED LOSSES ON CONTRACTS IN PROGRESS
The Company provides for losses on uncompleted contracts in the period in which it is determined that the estimated total contract costs will exceed the estimated total contract revenues. These estimates are reviewed periodically and any revisions are charged or credited to operations in the period in which the change is determined.
Management expects that the losses provided for in the allowance for future losses on uncompleted contracts at December 31, 1995 will be incurred in 1996.
At December 31, 1995 the Company had twenty-one KC-135 aircraft in process from the first year of the 1994 contract, all at various stages of completion. These aircraft in process continue to be impacted by late government furnished material (GFM), excess major structural repairs and other direct and constructive changes to the contract (see Note 12). The Company's independent management consultant has determined a preliminary rough order magnitude of the cost impact of late GFM and excess major structural repairs for the twenty-one aircraft in work under the first year of the 1994 contract. Based on this preliminary rough order magnitude, the Company has considered the impact of this assessment in determining that a provision for losses on the contract is not needed. Should the Company not ultimately receive an equitable adjustment from the U.S. Government, the Company's management estimates a contract loss of approximately $1,000,000.
In addition to the twenty-one KC-135 aircraft in process from the first year of the 1994 contract there are also six aircraft in process as of December 31, 1995 from the second year. It is the opinion of management that the U.S. Government has changed the work scope beginning with the second year of the contract. This change in work scope relates to the fact that the U.S. Government has increased the PDM cycle from a 48-month PDM cycle to a 60-month PDM cycle. As a result of this change in work scope, the Company has submitted a significant contract price revision proposal to the U.S. Government. The Company has obtained an opinion from outside legal counsel specializing in government procurement law that there is a reasonable basis to support this proposed contract price revision. Due to this price revision and the low, aggregate percent complete of ships delivered to the Company under the second year of the contract, it is the opinion of management that the profitability or range of loss on aircraft delivered, and to be delivered, is neither probable, nor estimable.
Included in the allowance for estimated losses on contracts in progress is a provision at December 31, 1995 of $542,550 related to a certain contract on which it is more likely than not that a total contract loss will be recognized on the remaining units to deliver. Of the $542,550 allowance, $438,628 relates to recoverability of work in process and $103,922 relates to aircraft to be delivered to the Company during 1996.
Included in the allowance for future losses on uncompleted contracts is a provision of $690,788 at December 31, 1994, for a certain contract. These losses were dependent upon the number of aircraft delivered to the Company prior to December 31, 1995, as specified in the contract. At December 31, 1995, this reserve was removed due to the expiration of the delivery time period, as specified in the contract.
Also included in the allowance for future losses on uncompleted contracts at December 31, 1994 is a provision of $654,388 that relates to a certain contract on which the Company has agreed to perform additional work. At December 31, 1995, it is management's best estimate that the likelihood of this additional work being performed is only reasonably possible, not probable, and has accordingly removed this reserve.
During 1995, 1994, and 1993, a provision for estimated losses on contracts in progress in the amount of $203,922, $849,843 and $583,122, respectively, was recognized through a charge to operations to provide for reserves on specific contracts in progress at December 31, 1995, 1994, and 1993, respectively.
9. INCOME TAXES
The Company follows SFAS No. 109, ACCOUNTING FOR INCOME TAXES, which accounts for income taxes under the liability method.
SFAS No. 109 specifies that deferred tax assets are to be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has established valuation allowances primarily for certain state net operating loss carryforwards and foreign tax losses of which the realization is uncertain. Based on the Company's projected taxable income, management believes it is more likely than not that the Company will realize the benefit of the net deferred tax assets existing at December 31, 1995.
During 1994, the Company reduced its valuation allowance resulting in an increase of net deferred tax assets and an increase in the benefit for income taxes of approximately $10.5 million. This reduction in the valuation allowance was attributable to the award of a significant seven-year governmental contract which was in negotiation at December 31, 1993. Upon receipt of this award, realization of certain deferred tax assets became, in the opinion of management, more likely than not.
In 1993, the Company utilized approximately $10 million of preacquisition loss carryforwards associated with the purchase of Hayes, and, in accordance with SFAS No. 109, the utilization of these carryforwards was first used to offset all of the unamortized intangible assets associated with the acquisition. This resulted in a $2,756,755 reduction in intangible assets. The remaining operating loss carryforwards utilized during the year ended December 31, 1993 were used to reduce tax expense.
The alternative minimum tax credit carryforwards of $709,291 included in the deferred tax assets above do not expire.
10. STOCK OPTIONS AND RESTRICTED SHARE PLANS
On September 8, 1989, the stockholders approved an Incentive Stock Option and Appreciation Rights Plan and a Nonqualified Stock Option Plan, pursuant to which a maximum aggregate of 2,000,000 shares of common stock have been reserved for grant to key personnel. The plans expire by their terms on July 10, 1999 and September 8, 1999, respectively.
Under both plans, the option price may not be less than the fair market value of the stock at the time the options are granted. Generally, these options become exercisable over staggered periods but may not be exercised after ten years after the date of grant.
Deferred Compensation - In December 1994, the Company adopted a Restricted Share Plan (the Plan) designed to attract, retain, and motivate executive officers of the Company. The Plan authorizes the issuance of 105,657 common shares of beneficial interest pursuant to restricted shares issued under the Plan. In connection with the grant of shares under the Plan, the Compensation Committee determines any vesting requirements. In December of 1994 the Company issued $175,000 of restricted shares which will be amortized over the period earned by the employee. In December 1994, the Company also established certain other nonvested cash bonuses which will be amortized to compensation expense over the vesting period of two years.
11. EMPLOYEE BENEFIT PLANS
Pension - The Company has a defined benefit pension plan in effect, which covers substantially all employees at its Birmingham, Dothan, and Leeds, Alabama facilities who meet minimum eligibility requirements. Benefits for nonunion employees are based on salary and years of service, while benefits for union employees are based upon a fixed benefit rate and years of service. The funding policy is consistent with the funding requirements of federal law and regulations concerning pensions. Pursuant to this practice, the Company made contributions of $1,250,002, $1,271,740, and $908,496 in 1995, 1994, and 1993, respectively. Plan assets consist primarily of stocks, bonds, and cash equivalents.
Pursuant to the requirements of SFAS No. 87, EMPLOYERS' ACCOUNTING FOR PENSIONS, an additional minimum pension liability of $12,659,525 and $14,444,846, representing the excess of the accumulated benefit obligation over plan assets plus prepaid pension cost, was recognized at December 31, 1995 and 1994, respectively. The additional liability has been offset by intangible assets to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost are recorded as a reduction of stockholders' equity. The intangible asset and reduction of stockholders' equity are $4,171,287 and $7,017,031 (net of tax) and $4,750,776 and $7,748,850 (net of tax) at December 31, 1995 and 1994, respectively.
The discount rate decreased from 8.75% at December 31, 1994 to 7.25% at December 31, 1995 resulting in an increase to the accumulated benefit obligation of $11,000,000. The additional minimum liability adjustment decreased primarily due to higher than anticipated returns on plan assets in 1995.
Although the discount rate increased from 7.5 percent at December 31, 1993 to 8.75 percent at December 31, 1994 (which reduced the accumulated benefit obligation by $9,260,000), the additional minimum liability adjustment increased primarily due to lower than anticipated returns on plan assets attributable to rising interest rates.
The projected benefit obligation is the actuarial present value of that portion of the projected benefits attributable to employee service rendered to date. Service cost is the actuarial present value of the portion of the projected benefits attributable to employee service rendered during the year.
Increases in benefit obligations due to plan amendments are amortized over the average future service of active participants. Cumulative net actuarial gains and losses in excess of the 10 percent corridor amount are amortized over the average future service of active participants.
Liabilities related to pension benefits are calculated using actuarial assumptions which are estimates. Actual experience may differ from estimated assumptions and the Company's liability may change based on actual experience. A decrease in the weighted-average discount rate used at December 31, 1995 from 7.25% to 7.00% would have increased the accumulated benefit obligation and thus the minimum pension liability adjustment and change to equity $1,950,000.
Nonpension Postretirement Benefits - Effective January 1, 1993, the Company adopted SFAS No. 106, EMPLOYER'S ACCOUNTING FOR POSTRETIREMENT BENEFITS OTHER THAN PENSIONS. SFAS No. 106 requires the Company to accrue the estimated cost of retiree benefit payments, other than pensions, during employees' active service period. The Company previously expensed the cost of retiree health care benefits as claims were incurred.
The Company provides health care benefits to both salaried and hourly retired employees at its Birmingham, Leeds, and Dothan facilities. The retirees' spouse and eligible dependents are also entitled to coverage under this defined benefit plan, as long as the retiree remains eligible for benefits. To be eligible for coverage the retiree must have attained age 62 and the benefits cease once age 65 is reached.
The retirees pay premiums based on the full active coverage rates. These premiums are assumed to increase at the same rate as health care costs. Benefits under the plan are subject to certain deductibles, co-payments, and yearly and lifetime maximums. Currently, the plan is unfunded.
The health care cost trend rate assumption has a significant effect on the amounts reported. Rates listed above represent assumed increases in per capita cost of covered health care benefits for 1995, 1994 and 1993, respectively. For future years the rate was assumed to decrease gradually and remain at the ultimate trend rate thereafter.
The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25 and 8.75 percent at December 31, 1995 and 1994, respectively. At January 1, 1994, the weighted average discount rate used was 7.5 percent. At January 1, 1993, the date of adoption of SFAS No. 106, the weighted average discount rate used was 8.5 percent. In addition to these changes in assumption, the mortality, retirement ages, and termination rates were also changed. These changes in assumptions were the primary cause of the $(83,000), $176,000 and $211,000 unrecognized (gains)/losses at December 31, 1995, 1994 and 1993, respectively.
The Company recognized $123,000, $91,000 and $120,000 of expense associated with the plan in 1995, 1994 and 1993, respectively.
Liabilities related to postretirement benefits are calculated using actuarial assumptions which are estimates. Actual experience may differ from estimated assumptions and the Company's liability may change based on actual experience. A decrease of the discount rate used at December 31, 1995 from 7.25% to 7.0% would have increased the accumulated postretirement benefit obligation by $18,000.
Self-Insurance - It is generally the policy of the Company to act as a self-insurer for certain insurable risks consisting primarily of employee health insurance programs and workers' compensation. Losses and claims are accrued as incurred. The Company maintains a self-insured health insurance plan for the Birmingham, Leeds, and Dothan divisions of its Pemco Aeroplex subsidiary. The Company has reserves established in the amounts of $1,435,251 and $1,964,176 for reported and incurred but not reported claims at December 31, 1995 and 1994, respectively. Expense incurred for this plan was $8,748,411, $8,121,138, and $6,561,761 for 1995, 1994, and 1993, respectively.
The Company also has a self-insured workers' compensation program. The Company has a self-insured retention of $250,000 per occurrence. Claims in excess of this amount are covered by insurance. Included in deposits and other, at December 31, 1995 and 1994, is $850,000 that has been placed on deposit with the state of Alabama in connection with the Company's self-insured workers' compensation plan. Use of these funds is limited by the state. The Company has reserves of $4,868,000 and $4,780,716 for reported and incurred but not reported claims at December 31, 1995 and 1994, respectively. Expense incurred on this plan was $1,650,901, $1,399,100, and $3,351,608 for 1995, 1994, and 1993, respectively. The workers' compensation liability at December 31, 1995 does not include the effect of the settlement of numerous claims regarding an issue for which no estimate can be made of a range of amounts of loss that are reasonably possible should these claims be settled unfavorably.
Self-insurance reserves are developed based on prior experience and actuarial assumptions to predict future experience. These reserves are estimates and actual experience may differ from these estimates.
Defined Contribution Plan - Effective November 1, 1990, the Company adopted a 401(k) savings plan for employees who are not covered by any collective bargaining agreement, have attained age 21, and have completed one year of service. Employee and Company matching contributions are discretionary. The Company made no matching contributions during 1995, 1994, or 1993. Employees are always 100 percent vested in their contributions.
12. COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company's manufacturing and service operations are performed principally on leased premises owned by municipal units or authorities. Remaining lease terms range from two to eighteen years and provide for basic rentals, plus contingent rentals based upon a graduated percentage of sales. The Company also leases vehicles and equipment under various leasing arrangements.
Total rent expense charged to operations for the years ended December 31, 1995, 1994, and 1993 amounted to $3,909,557, $3,128,796, and $3,116,118, respectively. Contingent rental amounts included in rent expense amounted to $934,731, $1,196,481, and $1,443,128 for the years ended December 31, 1995, 1994, and 1993, respectively.
United States Government Contracts - The Company, as a U.S. Government contractor, is subject to audits, reviews, and investigations by the government related to its negotiation and performance of government contracts and its accounting for such contracts. Failure to comply with applicable U.S. Government standards by a contractor may result in suspension from eligibility for award of any new government contract and a guilty plea or conviction may result in debarment from eligibility for awards. The government may, in certain cases, also terminate existing contracts, recover damages, and impose other sanctions and penalties. The Company believes, based on all available information, that the outcome of the U.S. Government's audits, reviews, and investigations will not have a materially adverse effect on the Company's consolidated results of operations, financial position, or cash flows.
U.S. Government Request for Equitable Adjustment (REA) - During 1995 the Company recorded revenue and a current receivable of $4,200,000 in anticipation of settlement of a contract REA involving the KC-135 Programmed Depot Maintenance (PDM) contract. This amount relates to, and is in addition to, the $3,500,000 REA receivable recorded in 1994. The REA, which was certified by the Company and submitted to the U.S. Government, was for equitable adjustment of the cost effect of late delivery of government-furnished materials (GFM). The disruption in scheduled work flow which occurred as a result of the late delivery of GFM began in the second quarter of 1993 and continues to impact ships in work at December 31, 1995. This total equitable adjustment is classified as a current receivable at December 31, 1995 and was received in its entirety subsequent to December 31, 1995.
In addition to the receivable mentioned above, the Company has recorded revenue and a long-term unbilled receivable of $4,100,000 in anticipation of the submission and settlement of another contract REA involving the KC-135 PDM contract. The receivable is for equitable adjustment of the cost effect of late delivery of GFM, excess major structural repairs on certain KC-135 aircraft and other direct and constructive changes to the contract. The Company feels strongly that the evidence in support of the REA is objective and verifiable, and the costs associated with the REA are reasonable in view of the work performed and are not the result of any deficiencies in the Company's performance. The Company has obtained an opinion from outside legal counsel specializing in government procurement law which states that the Company is entitled to compensation for additional costs associated with late GFM and excess major structural repairs. The Company's independent management consultant has determined a preliminary rough order magnitude of the cost impact of the late GFM and excess structural repairs, and the Company has recorded this receivable based on this rough order magnitude, net of reserves. The reserves are deemed necessary by the Company due to uncertainties inherent in the process of receiving equitable adjustment. The Company cannot reasonably estimate the length of time before the formal filing of this REA nor can it reasonably estimate the length of time before its realization. Should the Company not ultimately receive an equitable adjustment from the U.S. Government, the Company would realize a pre-tax reduction of revenue of $4,100,000.
Litigation - The Company is involved in various legal proceedings arising in the normal course of business. Management does not believe the ultimate outcome of such litigation will have a material adverse effect on the consolidated financial position, results of operations or cash flows of the Company.
13. RELATED PARTY TRANSACTIONS
The Company has arranged a standby financing commitment with its principal shareholder which provides for the extension by the principal shareholder of up to $2.0 million in short-term advances upon demonstration of certain need factors by the Company. (See Note 6).
The related party receivable reflected in the consolidated balance sheet consists of various notes receivables from Matthew L. Gold, who is an officer, director, and majority stockholder of the Company.
14. GEOGRAPHIC SEGMENTS AND MAJOR CUSTOMERS
The Company's operations are primarily concentrated in one industry segment, the maintenance and modification of large transport aircraft. Aggregate sales to customers in foreign countries, principally in Europe, account for approximately 15 percent, 7 percent, and 10 percent of the Company's net sales for the years ended December 31, 1995, 1994, and 1993, respectively. Sales to major customers which accounted for 10 percent or more of the Company's net sales were as follows:
15. CONCENTRATION OF CREDIT RISK
The Company provides aircraft modification and maintenance, as well as engineering services, primarily to the United States Government, various cargo companies, leasing companies, and commercial airlines. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains an adequate allowance for potential credit losses. When the Company grants credit, with the exception of the United States Government, it is primarily to customers whose ability to pay is dependent upon the economics prevailing in the air passenger and cargo traffic industries.
The Company invests its excess cash in deposits with major banks with strong credit ratings. These investments are typically overnight repurchase agreements and, therefore, bear minimal risk. The Company has not experienced any losses on these investments.
16. EXTRAORDINARY ITEM
In June 1989, Rolando F. Sablon, a former stockholder and director of the Company, named the Company and other related defendants in a suit alleging theories of breach of contract, breach of fiduciary duty, common law fraud, violations of the Racketeer Influenced and Corrupt Organization Act, and violations of the Securities and Exchange Act of 1934, as well as corresponding violations of certain Florida state statutes. During 1993, this claim was settled out of court by the Company for $1.3 million. The Company's remaining indebtedness under this settlement is $-0- at December 31, 1995 and 1994. At December 31, 1993, the settlement was recorded as an extraordinary item and reduced net income by $1,274,000, net of the income tax benefit of $26,000.
17. FOURTH QUARTER ADJUSTMENTS
In the fourth quarter of 1995, the Company recorded year-end adjustments to the Company's inventory and inventory reserves, uncollectible accounts receivable, warranty reserve, year-end bonuses, deferred tax asset valuation allowance and Request for Equitable Adjustment which, in the aggregate, increased net income for the quarter and the year ended December 31, 1995 by approximately $2,084,000.
In the fourth quarter of 1994, the Company recorded year-end adjustments to the Company's inventory and inventory reserves, uncollectible accounts receivable, warranty reserve, year-end bonuses, and deferred tax asset valuation allowance which, in the aggregate, increased net income for the quarter and the year ended December 31, 1994 by approximately $9,916,900.
In the fourth quarter of 1993, the Company recorded year-end adjustments to the Company's self-insured workers' compensation reserve, common stock purchase warrant, inventory, and inventory reserves which, in the aggregate, increased net income for the quarter and year ended December 31, 1993 by approximately $700,000.
18. LABOR CONTRACT
In June of 1993, the Birmingham Division of Pemco Aeroplex and the Targets Division negotiated a three year labor contract with Local 1155 of the United Automobile Aerospace Workers of America. The agreement currently covers approximately 934 employees or 76% of the Company's work force.
This contract expires in June of 1996. In the past, the Company has been affected by work stoppages in the course of contract negotiations; however, they have always been short in duration, and none have had a significant effect on the Company's consolidated financial position, results of operations or cashflows. Management does not anticipate that the June 1996 contract negotiations will have a significant effect on the Company's consolidated financial position, results of operations or cashflows. No estimate can be made of a range of amounts of loss that are reasonably possible should a work stoppage occur during contract negotiations.
SUPPLEMENTARY INFORMATION
REPORT OF INDEPENDENT ACCOUNTANTS ON SUPPLEMENTARY INFORMATION
Board of Directors and Stockholders Precision Standard, Inc.
Our report on the consolidated financial statements of Precision Standard, Inc. and Subsidiaries is included on page of this Form 10-K. In connection with our audit of such financial statements, we have also audited the related financial statement schedules listed in the index on page __ of this Form 10-K.
In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
Birmingham, Alabama March 31, 1996, except for Notes 6 and 7 as to which the date is April 15, 1996
Item 9.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
Not applicable.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Company.
Information regarding the directors and executive officers of the Company is incorporated by reference from the "ELECTION OF DIRECTORS" section of the Company's definitive 1996 Proxy Statement.
Item 11.

Item 11. Executive Compensation.
Information regarding management remuneration and transactions is incorporated by reference from the "EXECUTIVE COMPENSATION" section of the Company's definitive 1996 Proxy Statement.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information regarding the security ownership of certain beneficial owners and management is incorporated by reference from the "SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT" section of the Company's definitive 1996 Proxy Statement.
Item 13.

Item 13. Certain Relationships and Related Transactions.
Information regarding certain relationships and related transactions is incorporated by reference from the "TRANSACTIONS WITH MANAGEMENT AND OTHERS" section of the Company's definitive 1996 Proxy Statement.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
Financial Statement Schedules. The Financial Statement Schedules listed below appear in Part II, Item 8 hereof.
a. Financial Statements: Report of Independent Accountants Consolidated Balance Sheets Consolidated Statements of Operations Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements
Schedule II. Valuation and Qualifying Accounts.
All other financial statement schedules have been omitted, as the required information is inapplicable or the information is presented in the financial statements or the notes thereto.
b. Reports on Form 8-K. No Reports on Form 8-K were filed with the Commission during the quarter ended December 31, 1995.
c. Exhibits.
2 Not applicable.
3.1 Amended and First Restated Articles of Incorporation of the Company. (1)
3.2 Amended and First Restated Bylaws of the Company. (1)
3.3 Articles of Amendment to the Articles of Incorporation. (2)
4.1 Asset Sales and Purchase Agreement dated July 19, 1984, among Monarch Equities, Inc., Pemco Engineers, Inc., Robert D. Lang, Georgia L. Lang and Monarch Aviation, Inc. (3)
4.2 Promissory Note dated July 17, 1987, from Monarch Equities, Inc., to Pemco Engineers, Inc. (3)
4.3 Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated September 5, 1988. (1)
4.4 Amended and Restated U.S. $10,000,000 Senior Subordinated Loan Agreement dated as of September 9, 1988, among Precision Standard, Inc., as Borrower, and the Financial Institutions listed on the Signature Pages hereof as Lender. (1)
4.5 Amended and Restated Credit Agreement among Precision Standard, Inc., the Lenders Named Herein and Bank of America National Trust and Savings Association, Agent, dated November 30, 1988. (1)
4.6 First Amendment to Amended and Restated Credit Agreement dated as of June 14, 1989. (1)
4.7 First Amendment to Amended and Restated Senior Subordinated Loan Agreement dated June 14, 1989. (1)
4.8 Specimen Certificate for Common Stock. (4)
Pursuant to Paragraph (b)(4)(iii) of Item 601 of Regulation S-K, the Company has not filed certain instruments with respect to other long-term debt of the Company or its consolidated subsidiaries. Copies of such documents will be furnished to the Commission upon request.
9 Not applicable.
10.1 Sale of Assets Agreement dated June 2, 1986 among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., Rolando Sablon and Matthew Gold. (3)
10.2 Amendment to Sale of Assets Agreement and Closing Statement dated June 3, 1986, among Monarch Equities, Inc., Pemco Engineers, Inc., Monarch Aviation, Inc., and SG Trading Corp. (3)
10.3 Assignment and Assumption Agreement executed July 30, 1987, effective June 4, 1986, between SG Trading Corp. and Matthew Gold. (3)
10.4 Purchase Agreement dated December 31, 1986, between the Company and Matthew Gold. (3)
10.5 Purchase Agreement executed August 6, 1987, effective April 30, 1987, between the Company and Matthew Gold. (3)
10.6 Contract No. N68520-87-0007 between Monarch Aviation, Inc., and the United States Navy. (3)
10.7 Novation Agreement between Monarch Aviation, Inc., and the Company dated August 6, 1987. (5)
10.8 Lease dated November 1, 1986, between Monarch Properties and Pemco Engineers, Inc. (3)
10.9 Amended and Restated Incentive Stock Option and Appreciation Rights Plan. (6)
10.10 Amended and Restated Nonqualified Stock Option Plan. (6)
10.11 Amended Executive Employment Agreement between the Company and Walter M. Moede effective June 1, 1993, as amended March 11, 1994. (7)
10.12 Amended Executive Employment Agreement between the Company and Matthew L. Gold effective June 1, 1993, as amended March 11, 1994. (7)
10.13 Executive Employment Agreement between the Company and C. Fredrik Groth effective June 1, 1993. (7)
11 Not applicable. 12 Not applicable.
13 Not applicable.
16 Not applicable.
18 Not applicable.
21 Subsidiaries of the Company.
22 Not applicable.
23 Consent of Coopers & Lybrand to the incorporation by reference of their report in Company's Form S-8 Registration Statement (File No. 33-34206 and 33-79676).
24 Not applicable.
27 Financial Data Schedule - Electronic Data Gathering Analysis and Retrieval (EDGAR).
28 Not applicable.
99 Not applicable. ____________________
(1) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, and incorporated by reference herein.
(2) Filed as an exhibit to the Company's Registration Statement on Form S-8 dated June 1, 1994, and incorporated by reference herein.
(3) Filed as exhibits to the Company's Annual Report on Form 10-K for the fiscal year ended April 30, 1987, and incorporated by reference herein.
(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, and incorporated by reference herein.
(5) Filed as an exhibit to the Company's Annual Report on Form 10- K for the fiscal year ended April 30, 1988, and incorporated by reference herein.
(6) Filed as exhibits to the Company's Definitive Proxy Statement for the 1994 Annual Meeting of Shareholders, and incorporated by reference herein.
(7) Filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, and incorporated by reference herein.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
PRECISION STANDARD, INC.
Dated: April 15, 1996 By: /s/Matthew L. Gold Matthew L. Gold, President (Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.
Signature Capacity Date
/s/Matthew L. Gold Chairman, President 4/15/96 Matthew L. Gold Chief Executive Officer and Director (Principal Executive Officer)
/s/Walter M. Moede Executive Vice President 4/15/96 Walter M. Moede Chief Financial Officer, Secretary and Director (Principal Financial Officer)
/s/Donald C. Hannah Director 4/15/96 Donald C. Hannah
/s/George E.R. Kinnear II Director 4/15/96 George E. R. Kinnear II
/s/Thomas C. Richards Director 4/15/96 Thomas C. Richards
/s/Ben J. Shapiro, Jr. Director 4/15/96 Ben J. Shapiro, Jr.