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Notes to Consolidated Financial Statements
(In thousands of dollars, except per share data)
NOTE 1. SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations. The Titan Corporation provides engineering, technical, management and consulting services in the areas of national security, software systems, communication systems, advanced research and development, sterilization and the environment. The Company also develops, designs, manufactures and markets satellite communications subsystems, secure television security systems, pulse power products including linear accelerators, and hardened electronic subsystems.Principles of Consolidation. The consolidated financial statements include the accounts of The Titan Corporation ("Titan" or "the Company") and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Also, certain prior year amounts have been reclassified to conform to the 1995 presentation.
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 date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Start-up Activities. The Company is involved in a number of start-up ventures, most notably secure television, commercial satellite communications and medical device sterilization. Certain investments made in these start-up ventures are reflected in the balance sheet, primarily within the captions of Property and Equipment and Other Assets, which includes capitalized software costs. These capitalized investments aggregate approximately $12,500 at December 31, 1995. These start-up ventures are in various early growth stages and have not yet generated sufficient revenues to achieve profitability. At this time, management plans to continue to invest in these ventures and will review and evaluate the realizability of the related assets.
Revenue Recognition. A majority of the Company's revenue, both commercial and government, is derived from products manufactured and services performed under cost-reimbursement and fixed-price contracts wherein revenues are generally recognized using the percentage-of-completion method. Certain other revenues are recognized as units are delivered. Estimated contract losses are fully charged to operations when identified.
Cash Equivalents. All highly liquid investments purchased with a maturity of three months or less are classified as cash equivalents. Inventories. Inventories include the cost of material, labor and overhead, and are stated at the lower of cost, determined on the first-in, first-out (FIFO) and weighted average methods, or market.
Property and Equipment. Property and equipment are stated at cost. Depreciation is provided using the straight-line method, with estimated useful lives of 2 to 15 years for leasehold improvements and 3 to 7 years for machinery and equipment and furniture and fixtures. Certain machinery and equipment in the Company's medical sterilization business is depreciated based on units of production.
Goodwill. The excess of the cost over the fair value of net assets of purchased businesses ("goodwill") is amortized on a straight-line basis over varying lives ranging from 5 to 20 years. The Company periodically re-evaluates the original assumptions and rationale utilized in the establishment of the carrying value and estimated lives of these assets. The criteria used for these evaluations include management's estimate of the asset's continuing ability to generate positive income from operations and positive cash flow in future periods as well as the strategic significance of the intangible asset to the Company's business objectives.
Capitalized Software Costs. The Company's policy is to amortize capitalized software costs over the greater of (a) the ratio that current gross revenues for a product bears to the total of current and amortized future gross revenues for that product, or (b) the straight-line method over the remaining estimated economic life of the product including the period being reported on. Notwithstanding the above, the maximum amortization period is four years. It is reasonably possible that those estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both, could be reduced in the future which could significantly impact the carrying amount of the capitalized software costs. Income Taxes. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109), which requires the use of the liability method of accounting for deferred income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences on future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end. If it is more likely than not that some portion or all of a deferred tax asset will not be realized, a valuation allowance is recognized.
Per Share Information. Per share information is based on the weighted average number of common shares and all dilutive common share equivalents outstanding (13,445,000 in 1995, 13,288,000 in 1994, and 11,739,000 in 1993). Common stock equivalents consist primarily of shares issuable upon the exercise of stock options. Conversion of preferred stock has not been assumed as the effect of the conversion would not be dilutive in any of the periods presented.
Recent Accounting Pronouncements. The Financial Accounting Standards Board ("FASB") has issued Statement of Financial Accounting Standards ("SFAS") No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of". This statement establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, goodwill related to those assets to be held and used, and for long-lived assets and certain identifiable intangibles to be disposed of. The FASB has also issued SFAS No. 123 "Accounting for Stock-Based Compensation". This Statement (No. 123) provides companies the option to account for employee stock compensation awards based on their estimated fair value at the date of grant, resulting in a charge to income in the period the awards are granted, or to present pro forma footnote disclosure describing the effect to the Company's net income and net income per share data as if the Company had adopted SFAS 123. SFAS 121 and SFAS 123 are effective for companies with fiscal years beginning after December 15, 1995. The Company has not yet determined what impact, if any, the adoption of SFAS 121 or SFAS 123 will have on the Company's financial statements or related disclosures thereto.
NOTE 2. RESTRUCTURING
In early 1994, Titan sold its Applications Group (its Army training and simulation service business) as part of a formal plan of restructuring adopted at that time. The sale resulted in a pre-tax gain of approximately $12,700 and generated net cash proceeds of approximately $17,000. The gain on sale was substantially offset by provisions made for the estimated costs of planned disposals and/or consolidations of certain operations deemed not compatible with the Company's long range strategy at that time. Such strategy was primarily reliant upon Titan internally funding the product development efforts and commercialization activities relating to its start-up ventures.The Board of Directors adopted a new formal plan of restructuring for 1995 that redefined Titan's businesses into four business segments: Communications Systems, Software Systems, Defense Systems, and Emerging Technologies. Implementation of this restructuring plan provides for further disposition of businesses not central to the Company's long-term strategy as currently defined. Management believes these actions will better position the Company for growth and strategic transactions designed to increase shareholder value. The restructuring charge of $5,431 also provides for significant reorganization of the Software Systems and the sterilization business, reductions of personnel, and other actions associated with reorganizing the structure of the Company.
As explained above, Titan has historically funded growth for new business areas with internally generated funds, its bank line of credit and certain secured long-term debt. Presently, the Company intends to pursue various financing alternatives in order to provide additional funding for the development and commercialization of its emerging business areas. In management's opinion, the need for and the timing of these further restructuring activities were largely driven by management's plan to gain access to capital markets as a significant source of continued development funding. Should the Company be unable to successfully obtain outside funding, the level of investment in these emerging businesses could change.
The restructuring charge of $5,431 includes approximately $2,000 for severance which provides for the termination of a total of 84 employees throughout the Company. As of December 31, 1995, 12 employees had been terminated and a total of $318 had been charged against the accrual. The restructuring charge also includes approximately $3,400 for the exiting of businesses, which is net of a $1,450 pre-tax gain on the sale in September 1995 of the Company's shaped-charge munitions business. The charge includes estimates for direct costs of the planned disposals, termination of certain agreements, and other costs associated with selling or closing certain businesses. A total of $461 had been charged against the accrual as of December 31, 1995. This group of businesses had revenues of $19,384 and an operating loss of $298 in 1995.
NOTE 3. OTHER FINANCIAL DATA
Following are details concerning certain balance sheet accounts:1995 1994 __________________________________________________________________ Accounts Receivable: U.S. Government - billed $ 14,449 $ 20,176 U.S. Government - unbilled 10,758 9,224 Trade 14,447 7,176 Less allowance for doubtful accounts (294) (412) __________________________________________________________________ $ 39,360 $ 36,164 __________________________________________________________________Unbilled receivables include approximately $5,000 at December 31, 1995 and 1994 representing work-in-process which will be billed in accordance with contract terms and delivery schedules. Also included in unbilled receivables are amounts billable upon final execution of contracts, contract completion, milestones or completion of rate negotiations. Generally, unbilled receivables are expected to be collected within one year. Payments to the Company for performance on certain U.S. Government contracts are subject to audit by the Defense Contract Audit Agency. Revenues have been recorded at amounts expected to be realized upon final settlement.1995 1994 __________________________________________________________________ Inventories: Materials $ 3,152 $ 2,921 Work-in-process 4,159 1,287 Finished goods 3,088 2,947 __________________________________________________________________ $ 10,399 $ 7,155 __________________________________________________________________ Property and Equipment: Machinery and equipment $ 23,429 $ 21,619 Furniture and fixtures 3,207 3,307 Leasehold improvements 3,503 2,818 Construction in progress 6,041 1,968 __________________________________________________________________ 36,180 29,712 Less accumulated depreciation and amortization (17,885) (16,780) __________________________________________________________________ $ 18,295 $ 12,932 __________________________________________________________________Deferred income taxes of $5,904 and $5,501 and capitalized software costs of $3,088 and $1,345 are included in Other Assets at December 31, 1995 and 1994, respectively. At December 31, 1995 and 1994, respectively, other liabilities, current and non-current, include $958 and $2,185 related to estimated losses on contracts. In addition, these captions include liabilities for post-retirement benefits for employees of previously discontinued operations of $3,016 and $3,134 at December 31, 1995 and 1994, respectively. Also included in other accrued liabilities are customer advance payments of approximately $1,653 and $1,503 at December 31, 1995 and 1994, respectively, and $4,914 and $3,814 related to restructuring activities at December 31, 1995 and 1994, respectively.NOTE 4. SEGMENT INFORMATION
In 1995, Titan classified its businesses in four industry segments, Communications Systems, Software Systems, Defense Systems and Emerging Technologies. This change from prior years more clearly reflects the nature of the Company's operations after restructuring. All prior year segment data have been restated to conform to the 1995 presentation. The Communications Systems segment contains two start-up business units, both targeting rapidly growing commercial markets. The first business unit, secure television, specializes in providing complete turnkey security for television delivery systems. The second business unit is satellite communications, which develops, manufactures and sells satellite earth station networks and related subsystems. The Software Systems segment provides custom and semi-custom software development services to assist customers in moving from older, mainframe systems to distributed computing systems utilizing client/server software. The Defense Systems segment, serving primarily the U.S. Government, includes satellite communications products; test and evaluation of complex systems; management and technical consulting; training and simulation support; and other consulting and engineering services. The Defense Systems segment also provides militarized computers. The Emerging Technologies segment contains a group of businesses including the start-up medical product sterilization services and systems and environmental consulting services businesses as well as several established businesses generally involved in broad-based technology development primarily for the U.S. Government. Substantially all operations are located in the United States. Export revenues amounted to approximately $14,240, $8,498, and $16,289 in 1995, 1994 and 1993, respectively, primarily to countries in Western Europe and the Far East.The following tables summarize industry segment data for 1995, 1994 and 1993.
1995 1994 1993 __________________________________________________________________ Revenues: Communications Systems $ 7,490 $ 6,319 $ 6,492 Software Systems 33,175 28,868 13,713 Defense Systems 67,948 78,780 103,071 Emerging Technologies 25,354 22,239 26,138 __________________________________________________________________ $ 133,967 $ 136,206 $ 149,414 __________________________________________________________________Sales to the United States Government, including both defense and non-defense agencies, and sales as a subcontractor as well as direct sales, aggregated approximately $81,632 in 1995, $93,107 in 1994, and $112,001 in 1993. In the Defense Systems segment, revenues in 1995 and 1994 included approximately $18,300 and $9,700, respectively, for work subcontracted to the buyer of the Applications Group which was sold in April 1994. There was no operating profit associated with these revenues. This contract is expected to conclude in mid-1996. Furthermore, 1995 Defense Systems revenues and operating profit included approximately $1,400 recovered from a termination for convenience claim with the U.S. Government for work performed in prior years. Within the Software Systems segment, sales to one customer, a telephone company, totalled $24,451, $24,323, and $9,712, in 1995, 1994 and 1993, respectively. No other single customer accounted for 10% or more of the consolidated revenues for these years. Intersegment sales were not significant in any year.
1995 1994 1993 __________________________________________________________________ Operating Profit (Loss): Communications Systems $ (4,488) $ (7,927) $ (7,413) Software Systems 3,803 6,237 915 Defense Systems 4,456 4,725 (2,804) Emerging Technologies 14 (305) 947 Corporate (7,740) 6,905 (6,292) __________________________________________________________________ $ (3,955) $ 9,635 $ (14,647) __________________________________________________________________The Defense Systems segment includes Applications Group revenue of $11,913 and $31,700 and operating profit of $919 and $3,300 in 1994 through the date of sale and in the full year 1993, respectively. Corporate includes corporate general and administrative expenses, certain Corporate restructuring charges, and gains or losses from the sale of businesses. Corporate general and administrative expenses are generally recoverable from contract revenues by allocation to operations.
1995 1994 1993 __________________________________________________________________ Identifiable Assets: Communications Systems $ 8,287 $ 4,813 $ 3,649 Software Systems 8,945 6,084 3,458 Defense Systems 39,587 38,859 58,625 Emerging Technologies 19,191 12,165 9,866 General corporate assets 19,160 19,982 17,616 __________________________________________________________________ $ 95,170 $ 81,903 $ 93,214 __________________________________________________________________General corporate assets are principally cash, prepaid expenses, deferred income taxes, and other assets.
1995 1994 1993 __________________________________________________________________ Depreciation and Amortization of Property and Equipment, Goodwill, and Other Assets: Communications Systems $ 366 $ 387 $ 177 Software Systems 1,044 533 715 Defense Systems 1,744 1,838 2,813 Emerging Technologies 712 630 756 Corporate 251 36 34 __________________________________________________________________ $ 4,117 $ 3,424 $ 4,495 __________________________________________________________________ Capital Expenditures: Communications Systems $ 697 $ 397 $ 56 Software Systems 1,709 1,784 562 Defense Systems 1,431 2,003 1,598 Emerging Technologies 5,007 1,963 4,046 Corporate 144 97 39 __________________________________________________________________ $ 8,988 $ 6,244 $ 6,301 __________________________________________________________________NOTE 5. INCOME TAXES
Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS 109). This statement changed the criteria for the recognition and measurement of deferred tax assets and liabilities, including net operating loss carryforwards. Prior years' financial statements were not restated to apply the provisions of SFAS 109. The cumulative effect of the adoption of the accounting change was an increase in 1993 net income of $1,700 ($0.14 per share) relating to the recognition of additional net deferred tax assets.The components of the income tax provision (benefit) are as follows:
1995 1994 1993 __________________________________________________________________ Current: Federal $ (2,232) $ 1,377 $ (2,334) State (220) 203 -- __________________________________________________________________ (2,452) 1,580 (2,334) Deferred 1,245 1,470 (4,213) __________________________________________________________________ $ (1,207) $ 3,050 $ (6,547) __________________________________________________________________Following is a reconciliation of the income tax provision (benefit) expected (based on the United States federal income tax rate applicable in each year) to the actual tax provision (benefit) on income (loss):1995 1994 1993 _______________________________________________________________________________ Expected Federal tax provision (benefit) $ (1,705) $ 3,061 $ (5,492) State income taxes, net of Federal income tax benefits (44) 450 (540) Loss carryforwards/carrybacks -- (216) -- Research credit -- (338) (570) Goodwill amortization 160 149 15 Alternative minimum tax 100 -- -- Keyman life insurance 75 83 60 Other 207 (139) (20) _______________________________________________________________________________ Actual tax provision (benefit) $ (1,207) $ 3,050 $ (6,547) _______________________________________________________________________________During 1993, the Revenue Reconciliation Act of 1993 was signed into law which reinstated research tax credits retroactive to July 1, 1992. The retroactive application of the law increased the Company's 1992 research credit by $570 which is reflected in the income tax provision for the year ended December 31, 1993. The deferred tax assets as of December 31, 1995 and 1994, result from the following temporary differences:
1995 1994 __________________________________________________________________ Inventory and contract loss reserves $ 3,005 $ 4,102 Employee benefits 4,289 4,518 Restructuring 2,786 2,534 Tax credit carryforwards 815 1,315 Depreciation (1,875) (1,664) Loss carryforward 1,680 429 Other 1,213 236 __________________________________________________________________ 11,913 11,470 Valuation allowance (1,200) (1,200) __________________________________________________________________ Net deferred tax assets $ 10,713 $ 10,270 __________________________________________________________________Realization of certain components of the net deferred tax asset is dependent on Titan generating sufficient taxable income prior to expiration of loss and credit carryforwards. Although realization is not assured, management believes it is more likely than not that the net deferred tax asset will be realized. The amount of the net deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are changed. Also, under Federal tax law, certain potential changes in ownership of the Company which may not be within the Company's control may limit annual future utilization of these carryforwards.
Net tax refunds in 1995 were $828. Cash paid for income taxes was $1,252 and $309 in 1994 and 1993, respectively.
NOTE 6. DEBT
At December 31, 1995, the Company had debt outstanding of $9,200 under an unsecured bank line of credit at a weighted average interest rate of 8.13%. The Company also had commitments under letters of credit at December 31, 1995 of $1,070 which reduced availability of the line of credit. In May 1995, this bank line of credit was increased to $17,000 from $10,000 and the maturity date was extended from May 1996 to May 1997. The Company has the option to borrow at prime or at LIBOR plus 2 percent. The line of credit agreement requires Titan to have annual net income, as defined, prohibits two consecutive quarterly losses and contains other financial covenants which require the Company to maintain stipulated levels of tangible net worth, a minimum debt service coverage ratio and a specified quick ratio. A waiver was received relating to the 1995 net loss. No borrowings were outstanding under this agreement at December 31, 1994. Borrowings under the Company's lines of credit averaged $6,400, $4,180, and $14,200 at weighted average interest rates of 8.8%, 7.6% and 5.5% during 1995, 1994 and 1993, respectively.At December 31, 1995 and 1994 the Company had $5,300 and $1,321, respectively, outstanding under two promissory notes, secured by certain machinery and equipment. The interest rates of the notes are 8.5% and 8.56%. In January 1996, the Company entered into another loan agreement for $2,500 at an interest rate of 7.42%, also secured by machinery and equipment. Part of the proceeds from this agreement were used to repay one of the promissory notes outstanding at December 31, 1995 with a principal balance of $765.
Cash paid for interest, primarily on these borrowings, was $572, $578, and $1,274 in 1995, 1994 and 1993, respectively.
NOTE 7. COMMITMENTS AND CONTINGENCIES
Titan is obligated for aggregate rentals of $41,609 under operating lease agreements, principally for facilities. These leases generally include renewal options and require minimum payments of $5,426 in 1996, $4,936 in 1997, $4,452 in 1998, $3,810 in 1999, $3,475 in 2000 and $19,510 for the years thereafter. Rental expense under these leases was $7,496 in 1995, $7,367 in 1994 and $6,294 in 1993. The Company has entered into a long-term lease agreement for facilities which are owned by an entity in which the Company has a minority ownership interest. Rental expense in 1995, 1994 and 1993 includes $868, $838, and $824, respectively, paid under this agreement.The Company is a party to four separate lawsuits filed by former employees claiming, among other things, wrongful termination and discrimination. The cases are scheduled for trial in March, April and June of 1996. The Company intends to continue to defend the cases vigorously. While it is not feasible to predict the outcome of these cases, management believes that their ultimate disposition will not have a material adverse effect on the financial position or results of operations of the Company.
In the ordinary course of business, defense contractors are subject to many levels of audit and investigation by various government agencies. Further, the Company and its subsidiaries are subject to claims and from time to time are named as defendants in legal proceedings. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.
NOTE 8. PREFERRED STOCK
Each share of $1.00 cumulative convertible preferred stock is entitled to 1/3 vote, annual dividends of $1 per share and is convertible at any time into 2/3 share of the Company's common stock. Common stock of 463,248 shares has been reserved for this purpose. Upon liquidation, the $1.00 cumulative convertible preferred stockholders are entitled to receive $20 per share, plus cumulative dividends in arrears, before any distribution is made to the common stockholders.NOTE 9. COMMON STOCK
At December 31, 1995, aggregate common shares reserved for future issuance for conversion of preferred stock, all stock incentive plans and warrants were 2,792,568.On August 17, 1995, the Board of Directors adopted a Shareholder Rights Agreement and subsequently distributed one preferred stock purchase right ("Right") for each outstanding share of the Company's common stock. Each Right entitles the registered holder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock, par value $1.00 per share (the "Preferred Shares") at a price of $42.00 per one one-hundredth of a Preferred Share, subject to adjustment. The Rights become exercisable if a person or group acquires, in a transaction not approved by the Company's Board of Directors ("Board"), 15% or more of the Company's common stock or announces a tender offer for 15% or more of the stock.
If a person or group acquires 15% or more of the Company's common stock, each Right (other than Rights held by the acquiring person or group which become void) will entitle the holder to receive upon exercise a number of shares of Company common stock having a market value of twice the Right's exercise price. If the Company is acquired in a transaction not approved by the Board, each Right may be exercised for common shares of the acquiring company having a market value of twice the Right's exercise price. The Company may redeem the Rights at $.01 per Right, subject to certain conditions. The Rights expire on August 17, 2005.
In September 1995, the Company completed a private placement of 300,000 shares of its common stock, receiving net proceeds of $2,325. Treasury shares were used for the issuance. The Company's shares were placed with offshore institutional investors pursuant to Regulation S under the Securities Act of 1933, as amended.
NOTE 10. STOCK INCENTIVE PLANS
At December 31, 1995, 1,218,811 shares of common stock were reserved for options granted under Titan's stock option plans for officers, directors and key employees. Options vest ratably over 4 years and expire up to 10 years from the date granted. The option price must not be less than the fair market value on the date of grant, and the provisions covering exercise are established at the date of grant by the option committee.A summary of changes in the shares under option is shown below:
Shares Issuable Under Options Outstanding Price Range ______________________________________________________________________ Balance at December 31, 1992 1,837,014 $ 1.63 - 4.25 Options granted 536,500 2.63 - 3.50 Options exercised (129,716) 1.63 - 3.25 Options terminated (223,436) 1.63 - 4.25 ______________________________________________________________________ Balance at December 31, 1993 2,020,362 1.63 - 4.25 Options granted 369,000 2.63 - 6.63 Options exercised (855,212) 1.63 - 4.25 Options terminated (104,694) 1.63 - 4.25 ______________________________________________________________________ Balance at December 31, 1994 1,429,456 1.63 - 6.63 Options granted 429,000 5.75 - 9.50 Options exercised (454,629) 1.63 - 7.13 Options terminated (185,016) 1.63 - 6.63 ______________________________________________________________________ Balance at December 31, 1995 1,218,811 2.13 - 9.50 ______________________________________________________________________At December 31, 1995, and 1994, respectively, options for 451,521 and 568,816 shares were exercisable, and 509,944 and 814,706 shares were reserved for the granting of additional options in the future.
NOTE 11. BENEFIT PLANS
The Company has various defined contribution benefit plans covering certain employees. The Company's contributions to these plans were $2,514, $2,291, and $2,713 in 1995, 1994 and 1993, respectively. The Company's discretionary contributions to its Employee Stock Ownership Plan were $339 and $487 in 1994 and 1993, respectively. There were no discretionary contributions for 1995. During 1995, 1994 and 1993, the Company utilized treasury stock of $871, $1,267, and $1,551, respectively, for benefit plan contributions.The Company has a non-qualified executive deferred compensation plan for certain officers and key employees. The Company's expense for this plan was $970, $668, and $680 in 1995, 1994, and 1993, respectively. At December 31, 1995 and 1994, respectively, Other Non-current Liabilities include $2,975 and $2,466 for obligations under this plan. Interest expense for the years ended December 31, 1995, 1994, and 1993 includes $486, $229, and $191, respectively, related to the plan. The Company also has performance bonus plans for certain of its employees. Related expense amounted to approximately $2,679, $5,220 and $1,708 in 1995, 1994 and 1993, respectively.
The Company has previously provided for post-retirement benefit obligations of operations discontinued in prior years. The Company has no post-retirement benefit obligations for any of its continuing operations.