ITEM 1. BUSINESS
INTRODUCTION
Todd Shipyards Corporation (the "Company") was organized in 1916 and has operated a shipyard in Seattle, Washington (the "Shipyard") since incorporation. The Company is incorporated under the laws of the State of Delaware and operates the Shipyard through a wholly owned subsidiary, Todd Pacific Shipyards Corporation ("Todd Pacific"). Todd Pacific, historically, has been engaged in the repair/overhaul, conversion and construction of commercial and military ships. The Company's general offices are located at 1801 16th Avenue S.W., Seattle, Washington 98134-1089, and its telephone number is (206) 623-1635. Information about the Company is available to the public on the internet at www.toddpacific.com.
Throughout much of the Company's history, a substantial portion of its revenues and profits were attributable to long-term United States Government ("Government") contracts. However, in the late 1980's a significant decline in the annual shipbuilding budgets of the Department of the Navy (the "Navy") greatly reduced the Company's bidding opportunities for long-term Government contracts. To offset the downturn in long-term Government contracting opportunities, the Company entered into several new construction projects beginning in the mid 1990's. These new construction opportunities represented the Company's first new construction projects in 10 years.
As the Company neared completion on these new construction projects in fiscal year 2000, the Company shifted its main business focus to repair, maintenance and overhaul opportunities. This strategy resulted in the award of two major five year cost-type contracts for phased maintenance work. At the time, this work included three Navy aircraft carriers and six Navy surface combatant class vessels stationed in the Puget Sound area.
The maintenance work performed on the Navy aircraft carriers, which began during the first quarter of fiscal year 2000 is referred to as the Planned Incremental Availability ("PIA") contract. Fiscal year 2004 was the last year remaining on this contract. Subsequent to the end of fiscal year 2004, the Department of the Navy awarded the Company a five-year, cost-type contract for similar work on the NIMITZ CLASS aircraft carriers (CVN) home ported in Puget Sound.
The maintenance work performed on the Navy surface combatant vessels is referred to as the Combatant Maintenance Team ("CMT") contract. Work on the CMT contract began in the second quarter of fiscal year 2001.
In addition to these two long-term multi-ship contracts, in June 2001, the Company was awarded by the Navy, a six-year, cost-type contract, under which the Navy has options to have the Company perform maintenance work on the Auxiliary Oiler Explosive ("AOE") class vessels. This contract represents the fourth consecutive, multi-year contract that the Company has been awarded by the Navy on the AOE class vessels. The three previous AOE contracts, which were each five years in duration, were all awarded on a competitive basis. This cost type contract provides for phased maintenance repairs to four Navy AOE class supply ships stationed in the Puget Sound area. The original contract included options for thirteen repair availabilities to be performed between 2001 and 2007 and was expected to have a notional value of approximately $180 million if all of the options were exercised. Since the award, five repair availabilities have been accomplished.
During the first quarter of fiscal year 2003, the Navy announced its intention to transfer the USS Rainier (AOE 7) and the USS Bridge (AOE 10) to the Military Sealift Command ("MSC") which results in five availabilities that will not be exercised under this contract. AOE 7 was transferred to MSC in August 2003. AOE 10 is currently scheduled to be transferred in the summer of 2004. The Company anticipates that MSC will contract for future work on these two vessels on a competitive basis. The potential impact of these transfers on the Company's future revenues will depend on such factors as the expenditures for maintenance by MSC, the Company's capacity to bid on future AOE 7 and AOE 10 work, and the Company's bidding success if such bids are submitted.
During the fourth quarter of fiscal year 2004, the Company announced that it was informed by the Navy that the USS Sacramento (AOE 1) is scheduled to be decommissioned on or about October 1, 2004. Of the two remaining availabilities on AOE 1, one was exercised on a reduced scale as a five-week, pier-side availability. The availability, originally scheduled for 12 weeks in duration, was to include a dry docking of the ship. The other availability of AOE 1 will not occur due to its decommissioning. The Company does not know at this point if it will be involved in any of the work related to the decommissioning of AOE 1.
The AOE contract contains options for two remaining repair availabilities on the USS Camden (AOE 2) before the contract expires in 2007. There is no assurance that these two remaining options will be exercised by the Navy in whole or in part.
During the fourth quarter of fiscal year 2004, the Company was awarded by the United States Coast Guard, a cost plus incentive fee contract under which the Coast Guard has options to have the Company provide maintenance of two Polar class icebreakers. This contract extends through September 2008 and marks the first time the Coast Guard has used a long term phased-maintenance approach on these icebreakers. The Company has performed similar work for the Coast Guard over the past several years under individual, competitively bid, firm fixed price contracts.
Also during the fourth quarter of fiscal year 2004, the Company entered into a contract with Electric Boat Corporation of Groton, Connecticut to support work on the Trident submarines. The work is being performed under a cost plus incentive fee contract with Electric Boat for fabrication work, and a firm fixed price contract for the associated project management and quality assurance work.
During the fourth quarter of fiscal year 2004, the Company confirmed its expected participation, along with Southwest Marine, Inc., San Diego Division, on the team lead by Bath Iron Works, a subsidiary of General Dynamics (NYSE:GD), to perform Post Shakedown Availability work ("PSA") on DDG-51 Aegis Destroyers ("Destroyers"). The U.S. Navy contract for this work, which was awarded to Bath Iron Works, includes options for PSA work to be accomplished in Navy homeports of Everett, Washington and Pearl Harbor, HI. Any work that the Company performs for Bath Iron Works will be accomplished under a cost plus award fee subcontract still to be finalized between Bath Iron Works and the Company. Work will be performed between 2005 and 2007. The PSA work primarily involves the installation of system and equipment upgrades and/or ship alterations as required.
In addition to the above mentioned contracts and agreements, the Company engages in repair, overhaul and conversion work on other Navy vessels, other U.S. Coast Guard vessels, ferries, container vessels, tankers, fishing vessels, cruise ships, barges, and tug supply vessels.
Available Information The Company will make available its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act free of charge through the Company's internet website at www.toddpacific.com as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.
OPERATIONS OVERVIEW
Repair and Overhaul Operations The Company's repair and overhaul work ranges from relatively minor repairs to major overhauls and often involves the dry-docking of the vessel under repair. Since the late 1980's, repair and overhaul opportunities available to domestic, private-sector shipyards have been impacted by the downsizing and relocation of the active Navy fleet. The impact has had both positive and negative effects on domestic shipyards depending on their proximity to the affected Navy fleet operations. Also affecting private shipyards is the impact of stationing vessels at Navy home ports, the availability and scheduling of maintenance and overhauls, the location of marine accidents and conditions within the maritime industry as a whole.
Commercial repair and overhaul contracts are obtained by competitive bidding, awarded by negotiation or assigned by customers who have a preference for a specific shipyard. On jobs that are advertised for competitive bids, owners usually furnish specifications and plans which become the basis for an agreed upon contract. Repair and overhaul jobs are usually contracted on a fixed- price or time and material basis.
The majority of the Company's Government ship repair and overhaul contracts are awarded on an option basis under one of the Company's three cost-type contracts with the Navy and the Coast Guard. These contracts provide for reimbursement of costs, to the extent allocable and allowable under applicable government regulations, and payment of an incentive or award fee based on the Company's performance with respect to certain pre-established criteria. The Company also performs repair and overhaul work for the Navy and the Coast Guard on a fixed price basis through a formal bidding process.
The Company's commercial and Government ship repair and overhaul contracts contain customer payment terms that are determined by mutual agreement. Typically, the Company is periodically reimbursed through progress payments based on the achievement of certain agreed to benchmarks less a specified level of retention. Some vessel owners contracting for repair, maintenance, or conversion work also require some form and amount of performance and payment bonding, particularly state agencies. Because of these requirements the Company is bonded for certain projects in the cumulative amount of $2.1 million at March 28, 2004.
Construction Operations During the third quarter of fiscal year 2003, the Company began work on a $5.2 million new construction project to build two large steel structures called "cutting edges." The cutting edges are barge like structures used as floating work platforms for the construction of the caissons which will eventually support the new Tacoma Narrows Bridge. The first cutting edge was delivered in March 2003 and the second was delivered in April 2003.
Prior to the Tacoma Narrows project, the Company's last new construction project was completed during the first quarter of fiscal year 2000, with the delivery of the Margarita II, a floating electrical power plant.
While the Company may selectively pursue new construction opportunities in the future, its primary focus will remain on repair, maintenance and overhaul business opportunities.
Distribution of Work The approximate distribution of the Company's Shipyard revenues for each of the last three fiscal years is summarized as follows:
2004 2003 2002 Federal Government 84% 82% 79% Commercial 16% 18% 21% Total 100% 100% 100%
The distribution of the Company's revenues in fiscal year 2004 remains relatively unchanged from fiscal year 2003 and continues to be strongly influenced by the amount of repair, maintenance and overhaul work awarded under each of its three Navy cost-type contracts.
Future Operations The Company plans to continue to actively pursue Government and commercial repair, maintenance and overhaul opportunities. International opportunities are limited because shipyards in foreign countries are often subsidized by their governments and in some cases enjoy significantly lower labor costs. These subsidies allow foreign shipyards to enter into production contracts at prices below their actual production costs. Competition for domestic construction and repair opportunities will continue to be intense as certain of the Company's larger competitors have more modern facilities, lower labor cost structures, or access to greater financial resources. The Company intends to capitalize on the advantages of its geographic location, the skills of its experienced workforce and production efficiencies developed over the past several years as it competes for repair, maintenance and overhaul opportunities.
Employees The number of persons employed by the Company varies considerably depending primarily on the level of Shipyard activity. Employment averaged approximately 1,100 during fiscal year 2004 and totaled 867 employees on March 28, 2004.
During fiscal year 2004 an average of approximately 913 of the Company's Shipyard employees were covered by a union contract that became effective during the third quarter of fiscal year 2003. At March 28, 2004 approximately 685 Company employees were covered under this contract.
During the third quarter of fiscal year 2003, the Puget Sound Metal Trades Council (the bargaining umbrella for all unions at Todd Pacific Shipyards) and Todd Pacific Shipyards reached an agreement on a new collective bargaining agreement. The Todd Pacific Shipyards eligible workforce ratified the agreement on October 22, 2002. The parties had been operating under an extension of the old agreement, which expired on July 31, 2002. The three- year agreement, which was effective retroactively to August 1, 2002, includes an annual 3.5% wage and fringe benefit increase. Management considers its relations with the various unions to be stable.
Availability of Materials The principal materials used by the Company in its Shipyard are steel and aluminum plates and shapes, pipe and fittings, paint and electrical cable and associated fittings. Management believes that each of these items can presently be obtained in the domestic market from a number of different suppliers. In addition, the Company maintains a small on-site inventory of various materials that are available for emergency ship repairs.
Competition Competition in the domestic ship repair and overhaul industry is intense. The reduced size of the Government's active duty fleet has resulted in a significant decline in the total amount of Government business available to private sector shipyards, creating excess shipyard capacity and acute price competition. The Company competes for commercial and Government work with a number of other shipyards, some of which have more advantageous cost structures. The Company's competitors for repair, maintenance and overhaul work include non-union shipyards, shipyards with excess capacity and foreign government subsidized facilities. The Company's competitors for new construction work, in addition to West Coast competitors, include Gulf Coast and East Coast shipyards with lower wage structures, substantial financial resources or significant investments in productivity enhancing facilities.
Environmental and Bodily Injury Matters The Company is subject to federal, state and local environmental laws and regulations that impose limitations on the discharge of pollutants into the environment and establish standards for the treatment, storage and disposal of toxic and hazardous wastes. Fines and penalties may be imposed for non- compliance with these laws. Such laws and regulations may expose the Company to liability for its acts, which are or were in compliance with all applicable laws at the time such acts were performed.
Recurring costs associated with the Company's environmental compliance program are expensed as incurred. Capital expenditures in connection with environmental compliance include a stormwater system of approximately $4.0 million. See Item 7. Management's Discussion and Analysis and Note 1 to the Consolidated Financial Statements for further discussion of these costs.
The Company has an accrued liability of $32.0 million as of March 28, 2004 for environmental and bodily injury matters. As assessments of environmental matters and remediation activities progress, these liabilities are reviewed periodically and adjusted to reflect additional technical, engineering and legal information that becomes available. The Company's estimate of its environmental liabilities is affected by several uncertainties such as, but not limited to, the method and extent of remediation of contaminated sites, the percentage of material attributable to the Company at the sites relative to that attributable to other parties, and the financial capabilities of the other Potentially Responsible Parties ("PRP") at most sites. The Company's estimate of its bodily injury liabilities is also affected as additional information becomes known regarding alleged damages from past exposure to asbestos at Company facilities. The Company is covered under its various insurance policies for some, but not all, potential environmental and bodily injury liabilities.
As of March 28, 2004, the Company has recorded an insurance receivable of $29.2 million, which mitigates a major portion of its accrued environmental and bodily injury liability. See Item 3. Legal Proceedings, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 11 of the Notes to Consolidated Financial Statements for further information regarding the Company's environmental and bodily injury matters.
Safety Matters The Company is also subject to the federal Occupational Safety and Health Act ("OSHA") and similar state statutes. The Company has an extensive health and safety program and employs a staff of safety inspectors whose primary functions are to develop Company policies that meet or exceed the safety standards set by OSHA, train production supervisors and make periodic inspections of safety procedures to insure compliance with Company policies on safety and industrial hygiene. All Shipyard employees are required to attend regularly scheduled safety training meetings.
Backlog At March 28, 2004 the Company's backlog consists of approximately $19 million of repair, maintenance, and conversion work. This compares with backlogs of approximately $22 million and $46 million at March 30, 2003 and March 31, 2002, respectively. The Company's current backlog is primarily attributable to firm repair, maintenance and conversion work scheduled for completion during fiscal year 2005.
Since work under the Company's Navy and Coast Guard phased maintenance contracts is at the option of the Navy and the U.S. Coast Guard, the Company cannot provide assurance as to the timing or level of work that may be performed under these contracts. Therefore, the decrease in the backlog is primarily due to the timing of the availabilities for the phased maintenance contracts. Projected revenues from these contracts are not included in the Company's backlog until contract options are exercised by these customers.
INVESTMENTS AND ACQUISITIONS
The Company routinely evaluates suitable investment opportunities that it believes will appropriately utilize the Company's resources. However, the Company has no present plans to make any direct investments in other businesses, either related or unrelated to ship repair and overhaul activities.
ITEM 2.
ITEM 2. PROPERTIES
The Company is required to maintain Navy certification on its drydocks and cranes in order to be eligible to bid on and perform work under certain Navy and United States Coast Guard ("Coast Guard") contracts. Throughout fiscal year 2004, the Company maintained all required certifications.
The design capacities of the Company's two remaining drydocks, both of which are located at the Shipyard, are as follows:
Year Type Owned Leased Max.Design Date of Lease Name Built Capacity(in tons) Expiration Emerald Sea 1970 Steel X 40,000 - YFD-70 1945 Steel X 17,500 4/15/06
YFD-54, a 5700 ton capacity wooden drydock built in 1943 that the Company had leased from the Navy since November 2, 1994, sank in heavy weather on October 11, 2003. After considerable effort, Todd raised YFD-54 on October 28, 2003 but the drydock required continuous pumping to keep afloat and remains out of service. Based on the estimated costs of repairing the damage sustained in the sinking, the drydock was declared a total constructive loss as of November 20, 2003, and the lease was thereby terminated as of that date. The Company maintained insurance coverage on YFD-54 and the costs associated with raising the drydock, less the applicable deductible, were covered under the insurance policies. Insurance covering the total constructive loss of the drydock is payable to the Navy.
The Company evaluates its plans for future operations of its remaining leased dry dock when the lease expiration date falls within the next operating cycle. The lease terms on drydock YFD-70 contain a nominal annual lease payment and a minimum amount of annual maintenance that the Company must perform. The lease also includes minimum levels of maintenance that the Company must perform during the life of the lease. The Company has included the nominal annual lease payment and the average annual maintenance cost that must be performed over the life of the lease on drydock YFD-70 in Note 9 of the Notes to the Consolidated Financial Statements (Item 8).
The Company's current Navy drydock certifications are for amounts that are less than the drydocks' maximum design capacity, however they are sufficient to allow the Company to perform work on all non-nuclear Navy vessels homeported in Puget Sound, as well as on all Coast Guard and Washington State Ferry vessels.
The Company believes that its owned and leased properties at the Shipyard are in reasonable operating condition given their age and usage, although the Company has from time to time been required to incur substantial expenditures to ensure the continuing serviceability of certain owned and leased machinery and equipment.
Towards the end of fiscal year 2001, the Company determined that such serviceability repairs would be required on the Emerald Sea to maintain Navy certification on a long-term basis. Certain time sensitive repairs began early in fiscal year 2002, while the Company evaluated several alternative repair scenarios and management's plans for future operations.
Once the Company completed its evaluation in fiscal year 2002, a comprehensive, multi-year refurbishment plan was approved by management that would allow the Company to maintain Navy certification into the future. This multi-year plan included scheduled refurbishment periods so repairs did not interfere with the on-going shipyard operations. With the de-commissioning of the USS Sacramento, transfer of the USS Bridge and USS Rainier to the Military Sealift Command and the uncertainties concerning the Navy's intent to do future repairs on the USS Camden, the Company is re-evaluating its Emerald Sea refurbishment plan. The Company will continue to assess the plan in light of its future drydock requirements and will make appropriate changes as needed to support Shipyard operations. Also, the Company performed an impairment analysis of the Emerald Sea and determined that this dry dock is not impaired.
Early in fiscal year 2004, the Company announced a special capital budget of approximately $13 million for planned improvements to its Seattle shipyard facility during its fiscal years 2004 and 2005. These improvements include the replacement of a major pier, a stormwater collection and discharge system and significant upgrades to its electrical system and are in addition to the Company's routine annual capital expenditures. During fiscal year 2004, the Company spent approximately $10.0 million of the special facilities capital budget , and $4.6 million on other shipyard capital expenditures.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to federal, state and local environmental laws and regulations that impose limitations on the discharge of pollutants into the environment and establish standards for the treatment, storage and disposal of toxic and hazardous wastes. Fines and penalties may be imposed for non- compliance with these laws. Such laws and regulations may expose the Company to liability for acts of the Company, which are or were in compliance with all applicable laws at the time such acts were performed. The Company faces potential liabilities in connection with the alleged presence of hazardous waste materials at its Seattle shipyard and at several sites used by the Company for disposal of alleged hazardous waste.
The Company is identified as a potentially responsible party ("PRP") by the Environmental Protection Agency ("EPA") under the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA," commonly known as the "Superfund") in connection with matters pending at two Superfund sites. Additionally, the Company has received information requests in two Superfund cases where the Company has asserted that its liability was discharged when it emerged from bankruptcy in 1990.
Generally these environmental claims relate to sites used by the Company for disposal of alleged hazardous waste. The Company has also been named as a defendant in a number of civil actions alleging damages from past exposure to toxic substances, generally asbestos, at closed former Company facilities.
At March 28, 2004, the Company maintained aggregate reserves of $32.0 million for pending claims and assessments relating to environmental matters, including $23.1 million associated with the Harbor Island Superfund Site (the "Harbor Island Site") and $8.1 million for asbestos related claims.
Funding for costs and payments of claims represented by such reserves is expected to be provided to a significant extent by receivables due from insurance companies under policies and insurance in place agreements described below. At March 28, 2004, such receivables aggregated $29.2 million.
Included in the reserves are sediment remediation costs for Harbor Island of $13.5 million that are expected to occur in fiscal year 2005. These costs are reflected in the Company's balance sheet under current liabilities. Likewise, the insurance receivable of $13.5 million relating to these reserves is reflected in the Company's balance sheet under current assets.
For more information, see Note 11 of the Notes to the Consolidated Financial Statements (Item 8.) below and to the discussion under the heading "Environmental Matters and Contingencies" in Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7.) below.
Harbor Island Site
The Company and several other parties have been named as potentially responsible parties ("PRPs") by the Environmental Protection Agency (the "EPA") pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA" also known as "Superfund") in connection with the documented release or threatened release of hazardous substances, pollutants and contaminants at the Harbor Island Superfund Site (the "Harbor Island Site"), upon which the Shipyard is located.
Harbor Island Site Insurance In the fourth quarter of fiscal year 2001, the Company entered into a 30-year agreement with an insurance company that provides the Company with broad-based insurance coverage for the remediation of all of the Company's operable units at the Harbor Island Superfund Site.
The agreement provides coverage for the known liabilities in an amount exceeding the Company's current booked reserves of $23.1 million. Additionally, the Company entered into a 15-year agreement for coverage of any new environmental conditions discovered at the Seattle shipyard property that would require environmental remediation.
The Company funded this insurance premium from cash reserves in two installments. The first payment was made in the Company's fourth quarter of fiscal year 2001 and the second payment was made in the first quarter of fiscal year 2002. The Company recorded a non-current asset in the form of an insurance receivable in accordance with its environmental accounting policies at the time it entered into this agreement. This transaction did not have a material effect on the Company's results of operations, nor did the transaction have a material effect on stockholders' equity.
Harbor Island Site History
To date, the EPA has separated the Harbor Island Site into three operable units that affect the Company: the Soil and Groundwater Unit (the "Soil Unit"), the Shipyard Sediments Operable Unit (the "SSOU") and the Sediments Operable Unit (the "SOU"). The Company, along with a number of other Harbor Island PRPs, received a Special Notice Letter from the EPA on May 4, 1994 pursuant to section 122 (e) of CERCLA. The Company entered into a Consent Decree for the Soil Unit in September 1994 under which the Company has agreed to remediate the designated contamination on its property. Removal of floating petroleum product from the water table began in October 1998 and is anticipated to continue through fiscal year 2009. The Company and the EPA are currently negotiating the extent and methodology of the soil remediation.
During the third quarter of fiscal year 1997, the EPA issued its Record of Decision ("ROD") for the SSOU. The ROD identifies four alternative solutions for the SSOU remediation and identifies the EPA's selected remedy. During the third quarter of fiscal year 2000, the EPA expanded the boundaries of the SSOU issuing their Phase 1B Data Report and resulting Explanation of Significant Differences outlining the changes to the ROD. During the fourth quarter of fiscal year 2000, the Company and the EPA entered into an Administrative Order on Consent for the development of the remedial design for the SSOU.
During the fourth quarter of fiscal year 2003, the company and the EPA entered into a Consent Decree for the cleanup of the SSOU, which, along with the associated Remedial Design Statement of Work for Remedial Action ("SOW"), was subsequently approved by the Department of Justice. The Consent Decree provides for the submittal of the Remedial Action Work Plan to the EPA subsequent to the approval by the EPA of the final design. The Remedial Action Work Plan will provide for construction and implementation of the remedy set forth in the ROD, the two Explanation of Significant Differences (issued in fiscal years 2000 and 2003), the SOW, and the design plans and specifications developed in accordance with the Remedial Action Work Plan and approved by the EPA. During the fourth quarter of fiscal year 2004 the Company submitted its Final Design Report to the EPA for the SSOU. The Final Design Report provides for the following actions to take place at the SSOU:
Piers 2 and 4 South (located on the Duwamish Waterway) will be demolished and removed from the site to achieve more complete cleanup in those areas.
Dredging of all contaminated sediments and shipyard waste in the open areas of the SSOU (surrounding the shipyard) and in the areas beneath Piers 2 and 4 South. The total estimated volume of sediments to be removed is 195,200 cubic yards.
Disposal of all recovered sediment and shipyard waste at an appropriate upland disposal facility.
Backfilling of portions of the areas dredged to create inter-tidal habitat where feasible.
Capping of areas beneath the piers that are not scheduled for demolition to an average thickness of one foot.
Pursuant to the current schedule, remediation of the SSOU is expected to begin in the second quarter of fiscal 2005. Current environmental regulations limit the period of time during the year that dredging may occur. Given these limits, dredging in the SSOU will require several years to complete. The current estimated cost of the SSOU cleanup is included in the environmental reserve.
During January 1998, the Company was notified by the EPA that testing would be required in the West Waterway of the Duwamish River outside the borders of the SSOU as part of the SOU. During May 1998, the Company entered into an Administrative Order on Consent to perform certain limited testing as part of the SOU investigation. After an evaluation of the results, the EPA issued a draft "no action" ROD on the SOU for public comment which if issued in final form would end the investigation of the SOU, requiring no remedial action. The public comment period closed during the Company's fourth quarter of fiscal year 2000. In September 2003, the EPA issued the final "no action" ROD on the SOU. Given the EPA's issuance of the draft "no action" ROD in fiscal year 2000, the Company had not established a reserve for any remediation on the SOU.
Under the Federal Superfund law, potentially responsible parties may have liability for damages to natural resources in addition to liability for remediation. During the second quarter of fiscal year 2003, the Company began discussions with the natural resource trustees ("Trustees") for the Harbor Island Superfund Site ("Site") and continued these discussions during the remainder of fiscal year 2003. The Company anticipates that the Trustees will file a claim against the Company at some future date alleging damages to the natural resources at the Site caused by the release of hazardous substances. The best estimate of a potential natural resource damage claim has been included in the environmental reserve. The payment of any eventual claim is covered by the aforementioned insurance policy, except for the policy deductible, provided that aggregate policy limits have not been exceeded. The amount of the policy deductible payment is reflected in the Company's environmental reserve at March 28, 2004.
Other Environmental Remediation Matters
In January 2001, the EPA issued Special Notice letters naming the PRPs on the Hylebos Waterway Operable Unit of the Commencement Bay Superfund Site in Tacoma, Washington. The Company was not included on the EPA's list. Todd has been notified by other PRPs of their intent to bring a contribution action against the Company. Subsidiaries of the Company had a presence on the site from 1917-1925 and again from 1939-1946, for the most part, coinciding with World Wars I and II when the Company built war ships at the direction of the United States government. Several parties in 2000 hired an allocator to assign percentages of responsibility to all parties, historical and present, notwithstanding potential defenses or contractual claims. While the Company did not participate in the allocation process, the allocator's findings were taken into account in including an estimate of potential liability in the Company's reserve discussed below.
The Company has further been notified by the Commencement Bay Natural Resource Trustees ("Trustees") that the parties occupying the aforementioned property subsequent to 1946 have been allocated liability for natural resource damages. While the Trustees have not submitted a claim against the Company for natural resource damages, they have invited the Company to participate in a mediation with the PRPs to resolve intra-facility allocation issues. The Company is investigating the potential of any liability it may currently have for its presence on the site during World Wars I and II when it built war ships at the direction of the United States government.
The Company entered into a Consent Decree with the EPA for the clean up of the Casmalia Resources Hazardous Waste Management Facility in Santa Barbara County, California under the Resource Conservation and Recovery Act. The Company has included an estimate of the potential liability for this site in environmental reserves as discussed below. Immaterial payments began in fiscal year 1997 and will extend for up to ten years.
Asbestos Related Claims and Insurance
The Company has been named as a defendant in civil actions by parties alleging damages from past exposure to toxic substances, generally asbestos, at closed former Company facilities.
The cases generally include as defendants, in addition to the Company, other ship builders and repairers, ship owners, asbestos manufacturers, distributors and installers, and equipment manufacturers and arise from injuries or illnesses allegedly caused by exposure to asbestos or other toxic substances. The Company assesses claims as they are filed and as the cases develop, dividing them into two different categories based on severity of illness. Based on current fact patterns, certain diseases including mesothelioma, lung cancer and fully developed asbestosis are categorized by the Company as "malignant" claims. All other claims of a less medically serious nature are categorized as "non-malignant". The Company is currently defending approximately 25 "malignant" claims and approximately 563 "non-malignant" claims.
The relief sought in all cases varies greatly by jurisdiction and claimant. Included in the approximate 409 cases open as of March 28, 2004 are approximately 588 claimants. The exact number of claimants is not determinable as approximately 150 of the open cases include multiple claimant filings against 30-100 defendants. The filings do not indicate which claimants allege liability against the Company. The previously stated 588 claimants is the Company's best estimate taking known facts into consideration.
Approximately 373 claimants do not assert any specific amount of relief sought.
Approximately 160 claims contain standard boilerplate language asserting on behalf of each claimant a claim for compensatory damages of $2 million and punitive damages of $20 million against approximately 100 defendants. Approximately 20 claims set forth the same boilerplate language asserting $10-$20 million in compensatory and $10-$20 million in punitive damages on behalf of each claimant against approximately 30-100 defendants. Approximately 20 cases assert $1-$15 million in compensatory and $5-$10 million in punitive damages on behalf of each claimant against approximately 30-100 defendants.
Approximately 10 claimants seek compensatory damages of less than $100,000 per claim and approximately 5 claimants seek compensatory damages between $1 million and $15 million. The claims involved in the foregoing cases do not specify against which defendants which claims are made or alleged dates of exposure.
Based upon settled or concluded claims to date, the Company has not identified any correlation between the amount of the relief sought in the complaint and the final value of the claim. The Company and its insurers are vigorously defending these actions.
As a result of claims resolution during fiscal year 2004, bodily injury reserves declined from $9.4 million at March 30, 2003 to $8.1 million at March 28, 2004. Likewise, bodily injury insurance receivables declined from $7.1 million to $5.8 million. These bodily injury liabilities and receivables are classified within the Company's Consolidated Balance Sheets as environmental and other reserves, and insurance receivables, respectively.
The Company has entered into agreements with several of its insurers to provide coverage for a significant portion of settlements and awards related to these bodily injury claims. These agreements have aggregate limits on amounts to be paid overall and formulas for amounts of payment on individual claims. The two most significant agreements provide coverage applicable to claims of exposure to asbestos occurring between 1949 and 1976 and occurring between 1976 through 1987. Insurance coverage for exposures to asbestos was no longer available from the insurance industry after 1987. Due to changes in federal regulations in the 1970's that resulted in the swift decline in commercial and military application of asbestos and increased regulation over the handling and removal of asbestos, there exists minimal risk of claims arising from exposure after 1987. Contractual formulas are utilized to determine the amount of coverage from each agreement on each claim settled or litigated. Once the initial date of alleged exposure to asbestos is determined, all contractual years subsequent to that date participate in the settlement. Since all known claims involve alleged exposure prior to 1976, the 1976 through 1987 agreement will participate in the settlement or judgment of all outstanding claims that are settled or litigated. As a result, and as the years remaining calculation set forth below indicates, the 1976 through 1987 agreement will exhaust prior to the 1949 through 1976 agreement. Based on historical claims settlement data only, the Company projects that at March 28, 2004, the 1949 through 1976 agreement will provide coverage for an additional 21.6 years and the 1976 through 1987 agreement will provide coverage for an additional 5.4 years. At March 30, 2003, the Company projected that these agreements would provide coverage for an additional 20.4 years and 5.2 years, respectively. The Company resolved 15 malignant claims in 2004 compared with 13 in 2003 and 20 in 2002. If historical settlement patterns or the rate of filing for new cases change in future periods, these estimated coverage periods could be shorter or longer than anticipated. Moreover, if one or both of these coverages are exhausted at some future date, the Company's costs related to subsequent claims and for legal expenses previously covered by these insurance agreements may increase. In addition to providing coverage for assessments or settlements of claims, the agreements also provide for costs of defending and processing such claims.
The following chart indicates the number of claims filed and resolved in the past three fiscal years, including the number of claims yet to be resolved at the end of each fiscal year. (Resolution includes settlements, adjudications and dismissals). The claims are further categorized as either malignant or non-malignant.
Bodily Injury Claims Non- Malignant Malignant Total
Outstanding, April 1, 2001 35 551 586 Claims filed 20 52 72 Claims resolved (20) (68) (88) Outstanding, March 31, 2002 35 535 570 Claims filed 14 72 86 Claims resolved (13) (73) (86) Outstanding, March 30, 2003 36 534 570 Claims filed 4 70 74 Claims resolved (15) (41) (56) Outstanding, March 28, 2004 25 563 588
Due to uncertainties of the number of cases, the extent of alleged damages, the population of claimants and size of any awards and/or settlements, there can be no assurance that the current reserves will be adequate to cover the costs of resolving the existing cases. Additionally, the Company cannot predict the eventual number of cases to be filed against it or their eventual resolution and does not include in its reserve amounts for cases that may be filed in the future. However, it is probable that if future cases are filed against the Company it will result in additional costs arising either from its share of costs under current insurance in place arrangements or due to the exhaustion of such coverage. The Company reviews the adequacy of existing reserves periodically based upon developments affecting these claims, including new filings and resolutions, and makes adjustments to the reserve and related insurance receivable as appropriate.
As the Company is not able to estimate its potential ultimate exposure for filed and unfiled claims against the Company, it cannot predict whether the ultimate resolution of the bodily injury cases will have a material effect on the Company's results of operations or stockholders' equity.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders, through solicitation of proxies or otherwise during the fourth quarter of the fiscal year ended March 28, 2004.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's stock is listed on the New York Stock Exchange (the "NYSE"). The following table sets forth, by quarter, the high and low composite sales prices of the stock as reported by the NYSE.
Quarter Ended High Low June 30, 2002 17.12 11.10 September 29, 2002 15.20 11.45 December 29, 2002 15.85 11.65 March 30, 2003 14.43 12.70 June 29, 2003 16.03 12.56 September 28, 2003 17.24 14.90 December 29, 2003 18.26 15.82 March 28, 2004 17.80 17.70
On May 21, 2004 the high and low prices of the Company's common stock on the NYSE were $17.40 and $17.10, respectively.
At May 21, 2004 there were 1,658 holders of record of 5,402,656 outstanding shares of common stock. During fiscal year 2004, the Company declared a ten cents ($0.10) per share cash dividend to be paid each quarter. The first dividend payment commenced on June 23, 2003 to shareholders of record as of June 2, 2003. Subsequent dividend payments were made each quarter, on September 23, 2003, December 23, 2003 and March 23, 2004.
On March 19, 2004, the Company declared a dividend of ten cents ($0.10) per shared to be paid June 23, 2004 to all shareholders of record as of June 8, 2004. On May 21, 2004, the Company declared a dividend of ten cents ($0.10) per share to be paid September 23, 2004 to all shareholders of record as of September 8, 2004.
It is the intent of the Company to consider and act upon the payment of future dividends on a regular quarterly basis. Future dividend declarations will depend, among other factors, on the Company's earnings and prospects, its cash position and investment needs.
ITEM 5C. TREASURY STOCK
The following table summarizes the purchases of the Company's common stock to be held in treasury for the past two fiscal years. Maximum Total Shares Number of Purchased as Shares that Period Total Number of Average Price part of publicly may yet be Shares Purchased Paid per Share announced plan purchased Authorized 500,000 Oct 2002 10,000 $12.04 10,000 490,000 Jan 2003 400 12.84 400 489,600 Feb 2003 7,200 12.84 7,200 482,400 Mar 2003 1,900 12.98 1,900 480,500 Apr 2003 22,400 12.94 22,400 458,100
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA (In thousands of dollars, except for share data)
The following table summarizes certain selected consolidated financial data of the Company, which should be read in conjunction with the accompanying consolidated financial statements of the Company included in Item 8.
March 28, March 30, March 31, April 1, April 2, 2004 2003 2002 2001 2000
Operations: Revenue $147,794 $151,811 $121,945 $116,545(6) $123,851 Operating income 2,166(1) 5,098(4) 6,902 11,950(7) 5,610(8) Net income 4,032(2) 4,110(4) 7,018 16,727 8,132
Net income per share of common stock
Basic EPS 0.76 0.78 1.05 1.74 0.83 Diluted EPS 0.72 0.74 1.03 1.73 0.82
Financial position: Working capital 36,362(3) 42,525 37,129(5) 59,293 64,880 Fixed assets 28,244(3) 16,634 16,595 17,358 17,356 Total assets 147,902 141,580 133,680(5) 164,900 139,209
Stockholders' equity $ 71,371 $ 69,534 $ 65,997(5) $ 93,081 $ 76,185
(1) Operating income was impacted unfavorably by reduced commercial and other non-Navy volumes, higher direct costs on a fixed priced project, a non-cash charge arising from the provision for anticipated workers compensation claims costs due to the bankruptcy of one of the Company's previous insurance carriers, and higher overhead expenses.
(2) Net income was favorably impacted by a decrease in federal income tax expense due to the decrease in income before income taxes and the decrease in income tax expense of $1.1 million resulting from the resolution in the fourth quarter of certain income tax contingencies that were established in previous years.
(3) Early in fiscal year 2004, the Company announced a special capital budget of approximately $13 million for improvements to its Seattle shipyard facility during its fiscal years 2004 and 2005. These improvements include the replacement of a major pier, a stormwater collection and discharge system and significant upgrades to its electrical system and are in addition to the Company's routine annual capital expenditures. During fiscal year 2004, the Company spent approximately $10.0 million of the special facilities capital budget and $4.6 million on other shipyard capital expenditures.
(4) Operating income was impacted unfavorably by a non-recurring, non-cash charge of $0.8 million arising from the settlement of a portion of the Company's pension liabilities. This settlement transferred a portion of the Company's pension liability to an international labor union organization. Under the provisions of pension accounting, the settlement of these liabilities triggered recognition of certain cumulative differences between pension plan assumptions and actual results.
(5) In fiscal year 2002, the Company repurchased an aggregate of 4,136,124 shares of its common stock at a price of $8.25 per share through its tender offer ("Dutch Auction") that was completed as of July 31, 2001. The Company's working capital, total assets, and stockholders' equity declined approximately $34 million as a result of the share repurchases and related transactions.
(6) The Company's 2001 revenues were impacted favorably by an agreement reached with the U.S. Navy to share in certain environmental insurance costs. Under terms of the agreement, the Company was able to invoice and record revenue of $3.9 million during the fourth quarter of fiscal year 2001. The agreement also allowed the Company to invoice and recognize an additional $1.7 million in fiscal years 2002, 2003 and 2004, respectively. In addition, the Company received a favorable arbitration award on the Margarita II, a floating electrical power plant that was completed in fiscal year 2000. The award allowed the Company to recognize $1.9 million of revenue in the fourth quarter of fiscal year 2001.
(7) During fiscal year 2001, the Company recorded a net insurance settlement of $2.1 million, which was partially offset by a $1.5 million environmental and other reserve charge, resulting in an increase to income from operations of $0.6 million.
(8) During fiscal year 2000, the Company recorded an additional $5.6 million operating charge for environmental and other reserves. This charge was partially offset by a $0.9 million insurance settlement the Company reached with one of its insurance carriers.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Notes to the Consolidated Financial Statements are an integral part of Management's Discussion and Analysis of Financial Condition and Results of Operations and should be read in conjunction herewith. The following discussion and analysis of financial condition and results of operations contain forward-looking statements, which involve risks and uncertainties. The Company's actual results in future periods may differ significantly from the results discussed in or anticipated by such forward looking statements. Certain factors, which may impact results for future periods, are discussed below under the captions "Overview - Profitability," and "Environmental Matters." Readers should also consider the statements and factors discussed under the caption "Operations Overview" in Item 1 and the discussion of environmental matters and related bodily injury claims set forth in Item 3 of this Annual Report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended March 28, 2004, together with the Notes to the Company's Consolidated Financial Statements for the fiscal year then ended.
Overview
Fiscal year 2004 started slowly, primarily because the Company's scheduled work for the Navy during the first quarter was postponed by ship deployments in support of military operations in Iraq. However, the Company's revenue increased significantly during the second quarter of the year. This increase was primarily attributable to a large concentration of repair, maintenance and overhaul work that was awarded under each of the Company's three U.S. Navy phased maintenance contracts as the previously deployed ships returned home. During this same period, the Company's commercial and non-Navy repair business was somewhat reduced, in part due to drydock maintenance projects that removed two of the company's docks from service for approximately 30 days each.
During the first half of fiscal year 2004, the Company recorded $65.6 million, or 44% of its full year revenue. The Company's operating and net income during the six month period were unfavorable because of the limited amount of Navy work in the first quarter, the impact of the reduced work on the Company's commercial and non-Navy results, and the impact of the $2.5 million provision for workers compensation claims arising from the bankruptcy of Fremont Indemnity Company, the Company's former workers compensation insurance carrier.
The financial results for the third and fourth quarters of this year were significantly stronger as revenues for the second half of the year increased to $82.2 million, an increase of 25% from the volumes experienced during the first half of the year. A significant portion of the increased revenues, operating income and net income experienced in the second half of the year was attributable to the high volume of Navy work that had been previously deferred due to military operations in Iraq. In spite of the improvement in the financial results for the second half, the Company's results were somewhat diminished by the Navy's decision to reduce the scope of work the Company performed on the USS Sacramento because of the ship's pending decommissioning. In addition, the Company experienced higher direct costs than planned on a fixed priced project that commenced in the third quarter and was completed early in the Company's fiscal year 2005. The impact of these cost increases, which had no corresponding revenue associated with them, reduced operating income by approximately $0.8 million.
For the full year ended March 28, 2004, the Company recorded revenue of $147.8 million, a decrease of $4.0 million, or approximately 3%, from fiscal year 2003 reported revenue of $151.8 million. This revenue decrease is primarily attributable to reduced commercial and other non-Navy work volumes.
During fiscal year 2004, the Company recorded operating income of $2.2 million on revenue of $147.8 million, or approximately 1% of revenue. This represents a decrease in operating income of $2.9 million, or approximately 58% from fiscal year 2003 operating income of $5.1 million. The decline in operating income was due to the previously mentioned reduced commercial and other non- Navy volumes, higher direct costs on a fixed priced project, a non-cash charge arising from the provision for anticipated workers compensation claim costs due to the bankruptcy of the Company's former workers compensation insurance carrier, and higher overhead expenses.
In addition, the Company recognized a $0.6 million gain on available for sale securities and $1.7 million in non-operating investment income for the year ended March 28, 2004. These amounts in addition to the operating income reported, resulted in fiscal year 2004 income before income tax expense of $4.5 million.
Auxiliary Oiler Explosive ("AOE") Contract
In June 2001, the Company was awarded by the Navy, a six-year, cost-type contract, under which the Navy has options to have the Company perform maintenance work on the Auxiliary Oiler Explosive ("AOE") class vessels. This contract represents the fourth consecutive, multi-year contract that the Company has been awarded by the Navy on the AOE class vessels. The three previous AOE contracts, which were each five years in duration, were all awarded on a competitive basis. This cost type contract provides for phased maintenance repairs to four Navy AOE class supply ships stationed in the Puget Sound area. The original contract included options for thirteen repair availabilities to be performed between 2001 and 2007 and was expected to have a notional value of approximately $180 million if all of the options were exercised. Since the award, five repair availabilities have been accomplished.
During the first quarter of fiscal year 2003, the Navy announced its intention to transfer the USS Rainier (AOE 7) and the USS Bridge (AOE 10) to the Military Sealift Command ("MSC") which results in five availabilities that will not be exercised under this contract. AOE 7 was transferred to MSC in August 2003. AOE 10 is currently scheduled to be transferred in the summer of 2004. The Company anticipates that MSC will contract for future work on these two vessels on a competitive basis. The potential impact of these transfers on the Company's future revenues will depend on such factors as the expenditures for maintenance by MSC, the Company's capacity to bid on future AOE 7 and AOE 10 work, and the Company's bidding success if such bids are submitted.
During the fourth quarter of fiscal year 2004, the Company announced that it was informed by the Navy that the USS Sacramento (AOE 1) is scheduled to be decommissioned on or about October 1, 2004. Of the two remaining availabilities on AOE 1, one was exercised on a reduced scale as a five-week, pier-side availability. The availability, originally scheduled for 12 weeks in duration, was to include a dry docking of the ship. The other availability of AOE 1 will not occur due to its decommissioning. The Company does not know at this point if it will be involved in any of the work related to the decommissioning of AOE 1.
The AOE contract contains options for two remaining repair availabilities on the USS Camden (AOE 2) before the contract expires in 2007. There is no assurance that these two remaining options will be exercised by the Navy in whole or in part.
Combatant Maintenance Team ("CMT") Contract
During the first quarter of fiscal year 2001, the Company was awarded, by the Department of the Navy on a sole source basis, a five year, cost-type contract for the repair and maintenance which at the time included six surface combatant class vessels (frigates and destroyers) stationed in the Puget Sound area. Although the Navy has not released a notional value of the maintenance work, the Company believes that the value may be approximately $60 million to $75 million if all options are exercised. Work on this contract is being performed primarily in the Company's Seattle shipyard.
Planned Incremental Availability ("PIA")
Subsequent to the end of fiscal year 2004, the Department of the Navy awarded the Company a five-year, cost-type contract with the long-term overhaul and maintenance to the NIMITZ CLASS aircraft carriers (CVN) home ported in Puget Sound. The contract consists of multiple contract options for planned incremental availabilities (PIA's), docking planned incremental availabilities (DPIA's) and continuous maintenance and upkeep for the USS LINCOLN (CVN-72), USS STENNIS (CVN-74), USS NIMITZ (CVN-68) and USS VINSON (CVN-70) when they are in Puget Sound. The work includes all types of non-nuclear ship repair, alteration and maintenance. All on-board work is accomplished by the Company workforce at Puget Sound Naval Shipyard in Bremerton, Washington, or Naval Station Everett. The work is performed under a cost plus award fee with performance incentive fee contract and represents the second contract for aircraft carrier maintenance awarded to the Company. The first such contract, recently expired, was awarded in 1999. The Company is supported in this effort by various regional suppliers and subcontractors. Significant support is provided by the Company's two teaming partners for this contract, Pacific Ship Repair and Fabrication ("PacShip") and AMSEC LLC ("AMSEC"). The notional value for this five-year contract is approximately $133 million if all options are exercised. There is no assurance that all options will be exercised, in whole or in part. United States Coast Guard - Multi-ship; Multi-options (MSMO contract).
During the fourth quarter of fiscal year 2004, the United States Coast Guard awarded the Company a contract to provide maintenance of two Polar Class icebreakers. The contract consists of multiple contract options for planned maintenance availabilities (PMA's) and docking planned maintenance availabilities (DPMA's) for the POLAR STAR (WAGB-10) and POLAR SEA (WAGB-11). The availabilities, and their companion planning options, extend through the last DPMA ending August 2008, and the last PMA ending on September 2008. The work to be performed includes availability planning and generalized ship maintenance and repairs as needed, with emphasis on propulsion and deck machinery work. The Company expects to team with the Coast Guard to identify the appropriate best value work scope and technical solutions for support of the two icebreakers. The Company will be supported in this effort by various regional suppliers and subcontractors. The work will be performed under a cost plus incentive fee contract. The Company has performed similar work for the Coast Guard over the past several years under individual, competitively bid, firm fixed priced contracts. This current award marks the first time the Coast Guard has used a long term phased-maintenance approach on the two Polar Class icebreakers home ported in Seattle. The notional value of all options, if exercised by the Coast Guard, is approximately $50 million. There is no assurance that all options will be exercised, in whole or in part. Electric Boat
During the fourth quarter of fiscal year 2004, the Company entered into a contract with Electric Boat Corporation of Groton, Connecticut ("Electric Boat") to support work on Trident submarines. During the period from May to September 2003, the Company completed planning and preparation work for Electric Boat. The Company has begun work on a follow-on contract to fabricate components and to accomplish associated steel outfitting, project management and quality assurance functions. This contract is associated with the retrofit work being accomplished by Electric Boat on the USS OHIO (SSBN 726) at the Puget Sound Naval Shipyard.
The Company's work is being performed under a cost plus incentive fee contract with Electric Boat for the fabrication work, and a firm fixed price contract for the associated project management and quality assurance work. The total value of these contracts is approximately $5.3 million and the work is scheduled to be completed in May 2004.
Bath Iron Works
During the fourth quarter of fiscal year 2004, the Company confirmed its expected participation, along with Southwest Marine, Inc., San Diego Division, on the team lead by Bath Iron Works, a subsidiary of General Dynamics (NYSE:GD), to perform Post Shakedown Availability work ("PSA") on DDG-51 Aegis Destroyers ("Destroyers"). The U.S. Navy contract for this work, which was awarded to Bath Iron Works, includes options for PSA work to be accomplished in Navy homeports of Everett, Washington and Pearl Harbor, HI.
The Company's expected participation will include the performance of the PSA work on between one and three Destroyers that are expected to be home ported in Everett, Washington. The first option, if exercised by the Navy, is anticipated to require work in the first quarter of calendar 2005 and would have a value of approximately $9 million. Any work that the Company performs for Bath Iron Works will be accomplished under a cost plus award fee subcontract still to be finalized between Bath Iron Works and the Company. If the Navy stations the second and third Destroyers at Everett, Washington and exercises options for PSA work on those ships, the anticipated contract value to the Company for its expected work on all three ships will be approximately $30 million between 2005 and 2007. The PSA work primarily involves the installation of system and equipment upgrades and/or ship alterations as required.
Business Volume and Backlog
At March 28, 2004 the Company's backlog consists of approximately $19 million of repair, maintenance, and conversion work. This compares with backlogs of approximately $22 million and $46 million at March 30, 2003 and March 31, 2002, respectively. The Company's current backlog is primarily attributable to firm repair, maintenance and conversion work scheduled for completion during fiscal year 2005.
Since work under the Company's Navy and Coast Guard phased maintenance contracts is at the option of the Navy and the U.S. Coast Guard, the Company cannot provide assurance as to the timing or level of work that may be performed under these contracts. Therefore, the decrease in the backlog is primarily due to the timing of the availabilities for the phased maintenance contracts. Projected revenues from these contracts are not included in the Company's backlog until contract options are exercised by these customers.
Profitability
The Company's future profitability depends largely on the ability of the Shipyard to maintain an adequate volume of ship repair, overhaul and conversion business to augment its longer-term contracts. The variables affecting the Company's business volume include public support provided to competing Northwest shipyards, excess west coast and industry-wide shipyard capacity, foreign competition, governmental legislation and regulatory issues, activity levels of the U.S. Navy, competitors' pricing behavior, and Company labor efficiencies, work practices and estimating abilities. Other factors that can contribute to future profitability include the amounts of annual expenditures needed to ensure continuing serviceability of the Company's owned and leased machinery and equipment.
The Company continues to respond aggressively to the increasingly competitive shipbuilding and repair industry. In addition to management's focus on the profitability of existing Shipyard operations through reduced operating costs, improved production efficiencies, customer needs and the pursuit of new business volume, management continues to evaluate options for deployment of assets with a view to improving the Company's return on investment.
Critical Accounting Policies
The Company's established accounting policies are outlined in the footnotes to the Consolidated Financial Statements (contained in Part II, Item 8. of this Form 10-K) entitled "Principal Accounting Policies." As part of its reporting responsibilities, management continually evaluates and reviews the adequacy of its accounting policies and methods as new events occur. Management believes that its policies are applied in a consistent manner that provides the user of the Company's financial statements with a current, accurate and complete presentation of information in accordance with accounting principles generally accepted in the United States.
The preparation of financial statements requires the use of judgments and estimates. The Company's critical accounting policies are described below to provide a better understanding of how these judgments and estimates can impact the Company's financial statements. A critical accounting policy is one that management believes may contain difficult, subjective or complex estimates and assessments and is fundamental to the Company's results of operation. The Company has identified its most critical accounting policies as those which relate to: 1) Revenue Recognition, 2) Environmental Remediation, Bodily Injury, Other Reserves, and Insurance Receivable and 3) Deferred Pension Asset and Accrued Post Retirement Health Benefits. This discussion and analysis should be read in conjunction with the consolidated statements and related notes included elsewhere in this report.
Revenue Recognition The Company recognizes revenue, contract costs, and profit on the percentage- of completion method based upon direct labor hours incurred. Using the percentage-of-completion method requires the Company to make certain estimates of the total cost to complete a project, estimates of project schedule and completion dates, estimates of the percentage at which the project is complete, estimates of annual overhead rates and estimates of amounts of any probable unapproved claims and/or change orders. These estimates are continuously evaluated and updated by experienced project management and accounting personnel assigned to these activities, and senior management also reviews them on a periodic basis. When adjustments in contract value or estimated costs are determined, any changes from prior estimates are generally reflected in revenue in the current period.
The Company has considerable experience in managing multiple projects simultaneously and in preparing accurate cost estimates, schedules and project completion dates. However, many factors, including but not limited to weather, fluctuations in material prices, labor shortages, and timely availability of materials can affect the accuracy of these estimates and may impact future revenues either favorably or unfavorably.
U.S. Government procurement standards are followed to determine the allowability as well as the allocability of costs charged to Government contracts. Costs incurred and allocated to contracts with the U.S. Government are closely scrutinized for compliance with underlying regulatory standards by Shipyards personnel, and are subject to audit by the Defense Contract Audit Agency ("DCAA"). Other than normal cost accounting issues raised by the DCAA as a result of their regular, ongoing reviews, the Company is not aware of any outstanding issues with the DCAA.
Environmental Remediation, Bodily Injury, Other Reserves and Insurance Receivable The Company faces potential liabilities in connection with the alleged presence of hazardous waste materials at its Seattle shipyard and at several sites used by the Company for disposal of alleged hazardous waste. The Company has also been named as a defendant in a number of civil actions alleging damages from past exposure to toxic substances, generally asbestos, at former Company facilities that are now closed. At March 28, 2004, the Company maintained aggregate reserves of $32.0 million for pending claims and assessments relating to these environmental matters, including $23.1 million associated with the Company's Seattle shipyard site and $8.1 million for asbestos or bodily injury related claims.
The Company has various insurance policies and agreements that provide coverage on the costs to remediate these environmental sites and for the defense and settlement of bodily injury claims. At March 28, 2004, the Company had recorded an insurance receivable of $29.2 million relating to these environmental and bodily injury matters, including $23.1 million associated with the Company's Seattle shipyard site and $5.8 million for bodily injury related claims.
Included in the reserves are sediment remediation costs for Harbor Island of $13.5 million that are expected to occur in fiscal year 2005. These costs are reflected in the Company's balance sheet under current liabilities. Likewise, the insurance receivable of $13.5 million relating to these reserves is reflected in the Company's balance sheet under current assets.
The Company reviews these matters on a continual basis and revises its estimates of known liabilities and insurance recoveries when appropriate. The Company follows guidance provided in Statement of Position 96-1, "Environmental Remediation Liabilities" for recording its environmental liabilities and recoveries. The Company accounts for bodily injury liabilities in accordance with Financial Accounting Standards Board No. 5, "Accounting for Contingencies."
Estimating environmental remediation liabilities requires judgments and assessments based upon independent professional knowledge, the experience of Company management and legal counsel. Environmental liabilities are based on judgments that include calculating the cost of alternative remediation methods and disposal sites, changes in the boundaries of the remediation areas, and the impact of regulatory changes. Bodily injury liabilities are based on judgments that include the number of outstanding claims, the expected outcome of claim litigation and anticipated settlement amounts for open claims based on historical experience. The Company does not accrue liabilities for unknown bodily injury claims that may be asserted in the future due to uncertainties of the number of cases that may be filed and the extent of damages that may be alleged.
The development of liability estimates that support both environmental remediation and bodily injury reserves involve complex matters that include the development of estimates and the use of judgments. The actual outcome of these matters may differ from Company estimates. To the extent not covered by insurance, increases to environmental remediation and bodily injury liabilities would unfavorably impact future earnings.
The Company's insurance recoveries for environmental remediation and bodily injury claims are estimated independently from the associated liabilities and are based on insurance coverages or contractual agreements negotiated with its former insurance companies. These policies and agreements are primarily with two insurance companies. Based upon the current credit rating of both of these companies, the Company anticipates that both insurance companies will be able to satisfy their respective obligations under the policy or agreement. However, if this assumption is incorrect and either of these companies is unable to meet its future financial commitments, the Company's financial condition and results of operation could be adversely affected.
Pension Asset and Accrued Post Retirement Health Benefits The Company's employee pension and other post retirement benefit costs and obligations are governed by Financial Accounting Standards No.87 and No. 106. Under these rules, management determines appropriate assumptions about the future, which are used by actuaries to estimate net costs and liabilities. These assumptions include discount rates, health care cost trends, inflation rates, long-term rates of return on plan assets, retirement rates, mortality rates and other factors. Management bases these assumptions on historical results, the current environment and reasonable expectations of future events. Actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, generally affect the recognized expense and recorded obligation in such future periods. While management believes the assumptions used are appropriate, significant differences in actual experience or significant changes in assumptions would affect pension and other post retirement benefits costs and obligations. See Note 7. To the Financial Statements for more information regarding costs and assumptions for employee pension and other post retirement benefits.
YEAR TO YEAR COMPARISONS 2004 COMPARED WITH 2003
Net income for fiscal year 2004 decreased by $0.1 million, or 2% from fiscal year 2003 levels. This decrease was attributable to the reduced volume of commercial and non-Navy work, higher overhead expenses, and the non-cash charge arising from the provision for anticipated workers compensations claims due to the bankruptcy of one of the Company's previous insurance carriers. This decrease was mostly offset by a decrease in federal income tax expense of $1.1 million resulting from the resolution in the fourth quarter of certain income tax contingencies that were established in previous years.
Revenues The Company recorded revenue of $147.8 million during fiscal year 2004, which represents a decrease of $4.0 million, or approximately 3%, from fiscal year 2003 reported revenue of $151.8 million. This is primarily attributable to reduced commercial and other non-Navy work volumes.
Cost of Revenues Cost of revenues for fiscal year 2004 decreased by $1.6 million, or approximately 2% from fiscal year 2003. The majority of this decrease was attributable to decreases in work volumes experienced in fiscal year 2004 when compared to fiscal year 2003. Cost of revenues as a percentage of revenues was 73% and 72% for fiscal years 2004 and 2003, respectively.
The increase in cost of revenues as a percentage of revenue in fiscal year 2004 is primarily attributable to a charge recorded in the first quarter related to the unanticipated bankruptcy of one of the Company's previous insurance carriers. This charge, which reflects the Company's best estimate of the known liabilities associated with unpaid workers compensation claims arising from the two-year coverage period commencing October 1, 1998 is subject to change as additional facts are uncovered. Although the Company expects to recover a least a portion of these costs from the liquidation and other sources, the amount and the timing of any such recovery cannot be estimated currently and therefore no estimate of amounts recoverable is included in the current financial results.
Administrative and Manufacturing Overhead Overhead costs for administrative and manufacturing activities increased by $1.3 million, or 3% from fiscal year 2003. Administrative and manufacturing overhead as a percentage revenue was approximately 26% and 24% for fiscal years 2004 and 2003, respectively. The increase in administrative and manufacturing overhead costs and as a percentage of revenue is attributable to increases in repair and maintenance expenses for the Company's dry docks, and expenses associated with recovery and maintaining the condition of the smaller of the Company's two dry docks that are leased from the U.S. Navy.
Provision for Environmental Reserves and Other During fiscal year 2004 and fiscal year 2003, the Company received partial reimbursement of $0.2 million and $0.1 million, respectively from another Harbor Island potentially responsible party for certain past environmental costs incurred by the Company. This partial reimbursement is reflected in other insurance settlements in the Consolidated Statement of Income for the years ended March 28, 2004 and March 30, 2003.
During fiscal year 2003, the Company estimated that the expected remediation costs associated with the Company's operable units at the Harbor Island Superfund Site would increase by approximately $9.1 million. This increase in environmental reserves was offset by a $8.5 million increase in the Company's insurance receivable. The net amount of $0.6 million is reflected in the Company's operating results for fiscal year 2003 and is shown in the Consolidated Statements of Income under Provision for environmental and other reserves.
Investment and Other Income Investment and other income in fiscal year 2004 increased by $0.5 million or approximately 38% when compared to fiscal year 2003. The increase in investment and other income reported during fiscal year 2004 is primarily attributable to accelerated lease payments of $0.8 million received by the Company from one of its warehouse tenants under the terms of a negotiated lease buyout initiated by the tenant.
In both fiscal year 2004 and fiscal year 2003, the Company's average funds available for investment purposes were $36.6 million.
Gain on Sale of available-for-sale securities During fiscal year 2004, the Company reported a net gain of $0.6 million on the sale of available-for-sale securities, which is an increase of $0.6 million. The significant increase in gains on the sale of available-for-sale securities reported in fiscal year 2004 is primarily attributable to market conditions that were more favorable during fiscal year 2004 as compared to fiscal year 2003.
Income Taxes In fiscal year 2004, the Company recognized federal income tax expense of $0.5 million. This represents a decrease of $1.7 million, or approximately 79% in federal tax expense when compared to fiscal year 2003. This decrease is attributable to the decrease in income before taxes in fiscal year 2004 and the decrease in income tax expense of $1.1 million resulting from the resolution in the fourth quarter of certain income tax contingencies that were established in previous years.
The effective income tax rates recorded in fiscal years 2004 and 2003 were 10% and 35%, respectively. The statutory income tax rates for both fiscal years 2004 and 2003 were 34% and 34%, respectively.
2003 COMPARED WITH 2002
Net income for fiscal year 2003 decreased by $2.9 million, or 42% from fiscal year 2002 levels. This decrease was primarily attributable to a decrease in income before taxes of $4.6 million offset by a decrease in income taxes payable of $1.7 million. Net income for fiscal year 2003 was influenced as a result of the following components:
Revenues The Company recorded revenue of $151.8 million during fiscal year 2003, which represents an increase of $29.9 million, or approximately 24%, over fiscal year 2002 reported revenue of $121.9 million. U.S. Navy phased maintenance contracts accounted for approximately $16.0 million of this increase, while increases in other commercial and government repair and overhaul activities, and new construction activities accounted for $8.9 million and $4.9 million, respectively.
Cost of Revenues Cost of revenues for fiscal year 2003 increased by $24.6 million, or approximately 29% from fiscal year 2002. The majority of this increase was attributable to increases in work volumes experienced in fiscal year 2003 when compared to fiscal year 2002. Cost of revenues as a percentage of revenues was 72% and 70% for fiscal years 2003 and 2002, respectively. The increase in cost of revenues as a percentage of revenue in fiscal year 2003 is primarily attributable to higher direct costs on two fixed priced projects that commenced and were completed in the third quarter, as well as underestimating the direct costs to complete a third project that commenced later in the third quarter but was not completed until April 2003. The impact of these cost increases, which had no corresponding revenue, increased cost of revenues by approximately $3.7 million.
Also contributing, but to a lesser extent, was a non-recurring, non-cash charge of $0.8 million arising from the settlement of a portion of the Company's pension liabilities. This settlement transferred a portion of the Company's pension liability to an international labor union organization. Under the provisions of pension accounting, the settlement of these liabilities triggered recognition of certain cumulative differences between pension plan assumptions and actual results.
Administrative and Manufacturing Overhead Administrative and manufacturing overhead increased $6.1 million, or approximately 20% from fiscal year 2002. This increase was attributable to an overall increase in production volumes as well as planned maintenance expenses and Company initiated process improvement costs. Administrative and manufacturing overhead as a percentage of revenue was approximately 24% in fiscal year 2003, which was consistent with the 25% rate experienced in the prior fiscal year.
Provision for Environmental Reserves and Other During fiscal year 2003, the Company estimated that the expected remediation costs associated with the Company's operable units at the Harbor Island Superfund Site would increase by approximately $9.1 million. This increase in environmental reserves was offset by a $8.5 million increase in the Company's insurance receivable. The net amount of $0.6 million is reflected in the Company's operating results for fiscal year 2003 and is shown in the Consolidated Statements of Income under Provision for environmental and other reserves.
Also, in fiscal year 2003 the Company received partial reimbursement from another Harbor Island potentially responsible party for certain past environmental costs incurred by the Company. This partial reimbursement in the amount of $0.1 million is reflected in other insurance settlements in the Consolidated Statement of Income for the year ended March 30, 2003.
In fiscal year 2002, the Company estimated that the remediation costs associated with its Harbor Island site would increase approximately $3.2 million. This amount was fully offset by a similar increase in the Company's insurance receivable. The Company also received $0.5 million in reimbursements from another potentially responsible party during fiscal year 2002.
Investment and Other Income Investment and other income in fiscal year 2003 decreased by $0.6 million or approximately 32% when compared to fiscal year 2002. The decrease in investment and other income reported during fiscal year 2003 primarily reflects the reduction in the average funds available for investment purposes during the fiscal year, as well as lower investment yields generally available in the market.
In fiscal year 2002, the Company's average funds available for investment purposes were $44.8 million. In fiscal year 2003, the average funds available for investment purposes declined $8.2 million, or 18%, to $36.6 million. This decline reflects the results of the Company's Dutch Auction share repurchase of 4.1 million shares of its common stock that occurred during the second quarter of fiscal year 2002. This repurchase only affected a portion of the average funds available for investment purposes in fiscal year 2002, but affected the average funds available for the entire fiscal year 2003.
Gain on Sale of available-for-sale securities During fiscal year 2003, the Company reported a net loss of $9 thousand on the sale of available-for-sale securities, which is a decrease of $2.2 million, or approximately 100% from fiscal year 2002. The significant decrease in gains on the sale of available-for-sale securities reported in fiscal year 2003 is primarily attributable to market conditions that were more favorable during fiscal year 2002. .
Income Taxes In fiscal year 2003, the Company recognized federal income tax expense of $2.2 million. This represents a decrease of $1.7 million, or approximately 43% in federal tax expense when compared to fiscal year 2002. This decrease is attributable to the decrease in income before taxes in fiscal year 2003. The effective income tax rates recorded in fiscal years 2003 and 2002 remained relatively unchanged at 35% and 36%, respectively. The statutory income tax rates for fiscal years 2003 and 2002 were 34% and 35%, respectively. Differences between effective rates and statutory rates reflect certain non- deductible expenses in both years.
Environmental Matters and Other Contingencies
The Company has provided total aggregate reserves of $32.0 million as of March 28, 2004 for its contingent environmental and bodily injury liabilities. Due to the complexities and extensive history of the Company's environmental and bodily injury matters, the amounts and timing of future expenditures is uncertain. As a result, there can be no assurance that the ultimate resolution of these environmental and bodily injury matters will not have a material adverse effect on the Company's financial position, cash flows or results of operations.
The Company has various insurance policies and agreements that provide coverage of the costs to remediate environmental sites and for the defense and settlement of bodily injury cases. These policies and agreements are primarily with two insurance companies. Based upon the current credit rating of both of these companies, the Company anticipates that both parties will be able to perform under their respective policy or agreement. As of March 28, 2004, the Company has recorded an insurance receivable of $29.2 million to reflect the contractual arrangements with several insurance companies to share costs for certain environmental and other matters.
Included in the reserves are sediment remediation costs for Harbor Island of $13.5 million that are expected to occur in fiscal year 2005. These costs are reflected in the Company's balance sheet under current liabilities. Likewise, the insurance receivable of $13.5 million relating to these reserves is reflected in the Company's balance sheet under current assets.
The Company continues to negotiate with its insurance carriers and certain prior landowners and operators for past and future remediation costs. The Company has not recorded any receivables for any amounts that may be recoverable from such negotiations or other claims.
Ongoing Operations Recurring costs associated with the Company's environmental compliance program are not material and are expensed as incurred. Capital expenditures in connection with environmental compliance are not material to the Company's financial statements.
Past Activities - Environmental The Company faces significant potential liabilities in connection with the alleged presence of hazardous waste materials at its Seattle shipyard (the "Harbor Island Site") and at several sites used by the Company for disposal of alleged hazardous waste. The Company has also been named as a defendant in civil actions by parties alleging damages from past exposure to toxic substances at Company facilities. Information with respect to these contingencies and claims is provided in Item 3 in this report.
The Company's policy is to accrue costs for environmental matters in the accounting period in which the responsibility is established and the cost is estimable. The Company's estimates of its liabilities for environmental matters are based on evaluations of currently available facts with respect to each individual situation and take into consideration factors such as existing technology, presently enacted laws and regulations, and the results of negotiations with regulatory authorities. The Company does not discount these liabilities.
In fiscal year 2004, the Company spent $0.3 million for environmental site remediation. All of these costs are reimbursable to the Company through its insurance coverages. An additional $1.1 million in environmental site remediation was spent by third party vendors under the direction of the Company's management. These costs were paid directly to the third party vendors under the Company's insurance policies. Most of these expenditures were related to the Harbor Island Site.
The Company spent approximately $0.5 million and $0.2 million on environmental site remediation in fiscal years 2003 and 2002, respectively. Of these amounts, approximately $0.5 million and $0.2 million, respectively, were reimbursable to the Company under the Company's insurance policies.
In addition to environmental site remediation costs, the Company spent a net $2 thousand on bodily injury cases after reimbursement under the Company's insurance policies in fiscal year 2004. In fiscal year 2003 and 2002, the Company spent $25 thousand and $0.5 million, respectively for bodily injury cases after reimbursement under the Company's insurance policies.
Actual costs to address the Harbor Island Site and other environmental sites and matters will depend upon numerous factors, including the number of parties found liable at each environmental site, the method of remediation, outcome of negotiations with regulatory authorities, outcome of litigation, technological developments and changes in environmental laws and regulations. The Company entered into a Consent Decree with the EPA during the fourth quarter of fiscal year 2003. As a result the company increased its Harbor Island Site reserves by an additional $9.1 million at the end of fiscal year 2003.
In the fourth quarter of fiscal year 2001, the Company entered into a 30-year agreement with an insurance company that will provide the Company with broad- based insurance coverage for the remediation of the Company's operable units at the Harbor Island Superfund Site.
The agreement provides coverage for the known liabilities in an amount exceeding the Company's current booked reserves of $23.1 million. Additionally, the Company has entered into a 15-year agreement for coverage of any new environmental conditions discovered at the Seattle shipyard property that would require environmental remediation.
The Company funded this insurance premium from cash reserves in two installments. The first payment was made in the Company's fourth quarter of fiscal year 2001 and the second payment was made in the first quarter of fiscal year 2002. The Company recorded a non-current asset in the form of an insurance receivable in accordance with its environmental accounting policies at the time it entered into this agreement. This transaction did not have a material effect on the Company's results of operations, nor did the transaction have a material effect on stockholders' equity.
Past Activities - Asbestos and Related Claims The Company has been named as a defendant in civil actions by parties alleging damages from past exposure to toxic substances, generally asbestos, at closed former Company facilities.
The cases generally include as defendants, in addition to the Company, other ship builders and repairers, ship owners, asbestos manufacturers, distributors and installers, and equipment manufacturers and arise from injuries or illnesses allegedly caused by exposure to asbestos or other toxic substances. The Company assesses claims as they are filed and as the cases develop, dividing them into two different categories based on severity of illness. Based on current fact patterns, certain diseases including mesothelioma, lung cancer and fully developed asbestosis are categorized by the Company as "malignant" claims. All other claims of a less medically serious nature are categorized as "non-malignant". The Company is currently defending approximately 25 "malignant" claims and approximately 563 "non-malignant" claims.
The relief sought in all cases varies greatly by jurisdiction and claimant. Included in the approximate 409 cases open as of March 28, 2004 are approximately 588 claimants. The exact number of claimants is not determinable as approximately 150 of the open cases include multiple claimant filings against 30-100 defendants. The filings do not indicate which claimants allege liability against the Company. The previously stated 595 claimants is the Company's best estimate taking known facts into consideration.
Approximately 373 claimants do not assert any specific amount of relief sought.
Approximately 160 claims contain standard boilerplate language asserting on behalf of each claimant a claim for compensatory damages of $2 million and punitive damages of $20 million against approximately 100 defendants. Approximately 20 claims set forth the same boilerplate language asserting $10-$20 million in compensatory and $10-$20 million in punitive damages on behalf of each claimant against approximately 30- 100 defendants. Approximately 20 cases assert $1-$15 million in compensatory and $5-$10 million in punitive damages on behalf of each claimant against approximately 30-100 defendants.
Approximately 10 claimants seek compensatory damages of less than $100,000 per claim and approximately 5 claimants seek compensatory damages between $1 million and $15 million. The claims involved in the foregoing cases do not specify against which defendants which claims are made or alleged dates of exposure.
Based upon settled or concluded claims to date, the Company has not identified any correlation between the amount of the relief sought in the complaint and the final value of the claim. The Company and its insurers are vigorously defending these actions.
As a result of claims resolution during fiscal year 2004, bodily injury reserves declined from $9.4 million at March 30, 2003 to $8.1 million at March 28, 2004. Likewise, bodily injury insurance receivables declined from $7.1 million to $5.8 million. These bodily injury liabilities and receivables are classified within the Company's Consolidated Balance Sheets as environmental and other reserves, and insurance receivables, respectively.
The Company has entered into agreements with several of its insurers to provide coverage for a significant portion of settlements and awards related to these bodily injury claims. These agreements have aggregate limits on amounts to be paid overall and formulas for amounts of payment on individual claims. The two most significant agreements provide coverage applicable to claims of exposure to asbestos occurring between 1949 and 1976 and occurring between 1976 through 1987. Insurance coverage for exposures to asbestos was no longer available from the insurance industry after 1987. Due to changes in federal regulations in the 1970's that resulted in the swift decline in commercial and military application of asbestos and increased regulation over the handling and removal of asbestos, there exists minimal risk of claims arising from exposure after 1987. Contractual formulas are utilized to determine the amount of coverage from each agreement on each claim settled or litigated. Once the initial date of alleged exposure to asbestos is determined, all contractual years subsequent to that date participate in the settlement. Since all known claims involve alleged exposure prior to 1976, the 1976 through 1987 agreement will participate in the settlement or judgement of all outstanding claims that are settled or litigated. As a result, and as the years remaining calculation set forth below indicates, the 1976 through 1987 agreement will exhaust prior to the 1949 through 1976 agreement. Based on historical claims settlement data only, the Company projects that at March 28, 2004, the 1949 through 1976 agreement will provide coverage for an additional 21.6 years and the 1976 through 1987 agreement will provide coverage for an additional 5.4 years. At March 30, 2003, the Company projected that these agreements would provide coverage for an additional 20.4 years and 5.2 years, respectively. The Company resolved 15 malignant claims in 2004 compared with 13 in 2003 and 20 in 2002. If historical settlement patterns or the rate of filing for new cases change in future periods, these estimated coverage periods could be shorter or longer than anticipated. Moreover, if one or both of these coverages are exhausted at some future date, the Company's share of responsibility will increase for any subsequent claims and for legal expenses previously covered by these insurance agreements. In addition to providing coverage for assessments or settlements of claims, the agreements also provide for costs of defending and processing such claims.
Due to uncertainties of the number of cases, the extent of alleged damages, the population of claimants and size of any awards and/or settlements, there can be no assurance that the current reserves will be adequate to cover the costs of resolving the existing cases. Additionally, the Company cannot predict the eventual number of cases to be filed against it or their eventual resolution and does not include in its reserve amounts for cases that may be filed in the future. However, it is probable that if future cases are filed against the Company it will result in additional costs arising either from its share of costs under current insurance in place arrangements or due to the exhaustion of such coverage. The Company reviews the adequacy of existing reserves periodically based upon developments affecting these claims, including new filings and resolutions, and makes adjustments to the reserve and related insurance receivable as appropriate.
As the Company is not able to estimate its potential ultimate exposure for filed and unfiled claims against the Company, it cannot predict whether the ultimate resolution of the bodily injury cases will have a material effect on the Company's results of operations or stockholders' equity.
Other Reserves During the first quarter of fiscal year 2004, the Company recorded a reserve of $2.5 million related to the unanticipated bankruptcy of one of its previous insurance carriers. The reserve, which reflects the Company's best estimate of the known liabilities associated with unpaid workers compensation claims arising from the two-year coverage period commencing October 1, 1998, is subject to change as additional facts are uncovered. These claims have reverted to the Company due to the liquidation of the insurance carrier. Although the Company expects to recover at least a portion of these costs from the liquidation and other sources, the amount and the timing of any such recovery cannot be estimated currently and therefore no estimate of amounts recoverable is included in the current financial results.
Since establishing the reserve during the first quarter, the Company has paid approximately $0.2 million in claims, which have been charged against the reserve.
Liquidity, Capital Resources and Working Capital
At March 28, 2004, the Company's cash and cash equivalents, and securities available-for-sale balances were $1.3 million and $30.7 million, respectively, for a total of $32.0 million. At March 30, 2003 the Company's cash and cash equivalents, and securities available for sale balances were $9.1 million and $32.1 million, respectively, for a total of $41.2 million.
The Company anticipates that its cash, cash equivalents and marketable securities position, anticipated fiscal year 2005 cash flow, access to credit facilities and capital markets, taken together, will provide sufficient liquidity to fund operations for fiscal year 2005. Accordingly, shipyard capital expenditures are expected to be financed from working capital. A change in the composition or timing of projected work could cause planned capital expenditures and repair and maintenance expenditures to change.
Net Cash Provided by Operating Activities Net cash provided by operating activities was $7.0 million for the year ended March 28, 2004. This amount was primarily attributable to fiscal year net income adjusted for depreciation, an increase in accounts payable and accruals, a decrease in the insurance receivable offset by an increase in costs and estimated profits in excess of billings on incomplete contracts and a decrease in environmental and other reserves.
Net cash provided by operating activities was $13.1 million for the year ended March 30, 2003 and was primarily attributable to fiscal year net income adjusted for environmental and other reserves and accounts receivable, offset by increases in insurance receivables.
Investing Cash Flows Net cash used in investing activities was $13.2 million for the year ended March 28, 2004 and consisted primarily of purchases of marketable securities and capital expenditures offset by sales and maturities of marketable securities.
Net cash used in investing activities was $21.6 million for the year ended March 30, 2003 and consisted primarily of purchases of marketable securities and capital expenditures offset by sales and maturities of marketable securities.
Capital Expenditures Early in fiscal year 2004, the Company announced a special capital budget of approximately $13.0 million for planned improvements to its Seattle shipyard facility during its fiscal years 2004 and 2005. These improvements include the replacement of a major pier, a stormwater collection and discharge system and significant upgrades to its electrical system and are in addition to the Company's routine annual capital expenditures. During fiscal year 2004, the Company spent approximately $10.0 million of the special facilities capital budget and $4.6 million on other shipyard capital expenditures.
The Company plans to finance these capital projects from its projected future cash flows and existing working capital.
During fiscal year 2003, the Company spent approximately $2.8 million on new capital assets.
The capital expenditures for fiscal year 2004 are in addition to ongoing repair and maintenance expenditures in the Shipyard of $4.8 million, $5.4 million, and $3.9 million in fiscal years 2004, 2003, and 2002, respectively. The decrease in fiscal year 2004 repair and maintenance costs when compared to fiscal year 2003 is primarily attributable to a decrease in direct labor costs associated with the Company's multi-year refurbishment plan of its owned dry dock.
Financing Activities Net cash used in financing activities for fiscal year 2004 was $1.5 million. This consisted primarily of dividends paid on common stock, offset by proceeds from the exercise of stock options.
On March 19, 2004, the Company declared a dividend of ten cents ($0.10) per share, payable on June 23, 2004, to shareholders of record as of June 8, 2004. Based on the current number of outstanding shares, the impact of this dividend will be approximately $0.5 million.
Net cash provided by financing activities for fiscal year 2003 was $14 thousand. This consisted primarily of a reduction in restricted cash and proceeds from the exercise of stock options, offset by the purchase of treasury stock.
Credit Facility In fiscal year 2002, Todd Pacific Shipyards Corporation, a wholly owned subsidiary of the Company, negotiated a $10.0 million revolving credit facility with interest payable at the prime rate. The credit facility, which is renewable on a bi-annual basis, provides Todd Pacific with greater flexibility in funding its operational cash flow needs. Todd Pacific had no outstanding borrowings as of March 28, 2004 and March 30, 2003, respectively.
Commitments The Company is subject to certain minimum operating lease payments on one of its dry docks that are charged to expense. These operating leases contain renewal options and minimum annual maintenance requirements. The minimum lease commitments are summarized in Note 9 of the Notes to Consolidated Financial Statements.
A surety company has issued contract bonds totaling $2.1 million for current repair, maintenance and conversion jobs as of March 28, 2004. Todd Pacific's trade accounts receivable on certain bonded jobs secure these various contract bonds.
Stock Repurchase During the third quarter of fiscal year 2003, the Board of Directors approved the repurchase of up to 500,000 shares of the Company's common stock from time to time in open market or negotiated transactions. Under this authorization, the Company repurchased during the first quarter of fiscal year 2004 an aggregate of 22,400 shares in open market transactions. The shares were purchased at an average price of $12.94 per share for total consideration of $289,887.
Also during fiscal year 2004, 154,000 shares of treasury stock were reissued pursuant to the exercise of stock options held by four officers of the Company. 6,553,377 shares were held as treasury stock as of March 28, 2004.
The Company repurchased an aggregate of 19,500 shares during fiscal year 2003 in open market transactions at an average price of $12.44 per share for total consideration of $242,592. Also during fiscal year 2003, 7,334 shares of treasury stock were reissued pursuant to the exercise of stock options held by two officers of the Company. 6,684,977 shares were held as treasury stock as of March 30, 2003.
Labor Relations Todd Pacific Shipyards currently operates under the terms and conditions of a collective bargaining agreement with the Puget Sound Metal Trades Council (the bargaining umbrella for all unions at Todd Pacific Shipyards). The three-year agreement is in effect from August 1, 2002 to July 31, 2005. The Company believes its relationship with its labor unions to be stable.
Accounting Changes Beginning in fiscal year 2003, the Company elected to apply the expense recognition provisions of FAS No. 123. The recognition provisions are applied to stock option grants awarded subsequent to March 31, 2002. The Company has adopted FAS No. 123 as it is designated as the preferred method of accounting for stock-based compensation.
Previously, the Company had applied the disclosure only provisions of FAS No. 123 and accounted for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock Issued to Employees" and related interpretations. Under APB No. 25, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the stock option price.
Note 1, item (J) to the Consolidated Financial Statements includes pro forma information as if the expense recognition provisions of FAS No. 123 were applied to stock option grants for all periods presented, based on the valuation of the option as of the date of the grants.
Recent Accounting Pronouncements In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("FAS No. 143), which is effective for fiscal years beginning after June 15, 2002 (fiscal year 2004 for the Company). FAS No. 143 provides accounting and reporting standards for recognizing obligations related to asset retirement costs associated with the retirement of tangible long-lived assets. Under FAS No. 143, legal obligations associated with the retirement of long-lived assets are to be recognized at fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and expensed using a systematic and rational method over the assets' useful lives. Any subsequent changes to the fair value of the liability will be expensed. The adoption of FAS No. 143 did not have a material impact on the Company's financial position, results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("FAS No. 146"), which is effective for exit or disposal activities that are initiated after December 31, 2002. Under FAS No. 146, a liability for a cost associated with an exit or disposal activity will be recognized and measured initially at fair value only when the liability is incurred. FAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) ("Issue 94-3"). The principal difference between FAS No. 146 and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. FAS No. 146 will only impact the Company if it incurs exit or disposal activities. If and when an exit or disposal activity occurs, management will record such activity under the rules of FAS No. 146.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements of FIN 46 apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Disclosure requirements apply to financial statements issued after January 31, 2003. FIN 46 applies to any business enterprise, public or private, that has a controlling interest, contractual relationship or other business relationship with a variable interest entity. Since the Company has no contractual relationship or other business relationship with a variable interest entity, the adoption of FIN 46 did not have any effect on its consolidated financial position or results of operations.
On May 15, 2003, the FASB issued SFAS No. 150 (FAS No. 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. FAS No. 150 requires that certain financial instruments, which under previous guidance could be accounted for as equity, be classified as liabilities in statements of financial position. FAS No. 150 represents a significant change in practice in accounting for a number of financial instruments, including mandatorily redeemable equity instruments and certain equity derivatives that frequently are used in connection with share repurchase programs. FAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and was effective for the Company at the beginning of our second quarter ended September 28, 2003. The adoption of SFAS No. 150 had no material impact on the Company's financial position, results of operations, or cash flows.
Organizational Change On May 27, 2003, the Company announced the resignation of Roland H. Webb, President and Chief Operating Officer of Todd Pacific Shipyards Corporation, a wholly owned subsidiary of Todd Shipyards Corporation. Mr. Webb's resignation was effective May 30, 2003. The Company also announced on June 4, 2003, that Thomas V. Van Dawark would succeed Mr. Webb as President and Chief Operating Officer of Todd Pacific Shipyards Corporation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK
The Company does not own any derivative financial instruments as of March 28, 2004, nor does it presently plan to in the future. However, the Company is exposed to interest rate risk. The Company's interest income is most sensitive to changes in the general level of U.S. interest rates. In this regard, changes in U.S. interest rates affect the interest earned on the Company's cash equivalents and certain marketable securities. The Company's marketable securities are also subject to the inherent market risks and exposures of the related debt and equity securities in both U.S. and foreign markets. The Company employs established policies and procedures to manage its exposure to changes in the market risk of its marketable securities. The Company believes that the risk associated with interest rate and market fluctuations related to these marketable securities is not a material risk based on a 1% sensitivity analysis.
The Company is exposed to potential interest rate risk on its revolving credit facility. Interest charged on the Company's credit facility is based on the prime lending rate, which may fluctuate based on changes in market interest rates. Increases in the prime lending rate could increase the Company's borrowing costs under its existing credit facility. The Company believes that the risk associated with interest rate fluctuations related to its credit facility is not a material risk.
The Company is also exposed to potential increases in future health care cost trend rates. Increases in these trend rates could have a significant affect on the amounts reported by the Company for its health care plans. The Company reports in Note 7 to the financial statements the effects of a 1% change in the health care cost trend rates.
ITEM 8.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders Todd Shipyards Corporation
We have audited the accompanying consolidated balance sheets of Todd Shipyards Corporation and subsidiaries (the "Company") as of March 28, 2004 and March 30, 2003, and the related consolidated statements of income, cash flows and stockholders' equity, for each of the three years in the period ended March 28, 2004. Our audits also included the financial statement schedule listed in the index at item 15(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Todd Shipyards Corporation and subsidiaries at March 28, 2004 and March 30, 2003 and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 28, 2004 in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 16 to the financial statements, beginning March 31, 2002, the Company changed its method of accounting for stock-based employee compensation.
Seattle, Washington /s/Ernst & Young LLP May 14, 2004
REPORT OF MANAGEMENT
The management of Todd Shipyards Corporation is responsible for the preparation, fair presentation, and integrity of the information contained in the financial statements in this Annual Report on Form 10-K. These statements have been prepared in accordance with accounting principles generally accepted in the United States of America and include amounts determined using management's best estimates and judgments.
The company maintains a system of internal controls to provide reasonable assurance that assets are safeguarded and that transactions are recorded properly to produce reliable financial records. The system of internal controls includes appropriate divisions of responsibility, established policies and procedures (including a code of conduct to promote strong ethics) that are communicated throughout the company, and careful selection, training and development of our people. The company conducts a corporate audit program to provide assurance that the system of internal controls is operating effectively.
Our independent registered public accounting firm has performed audit procedures deemed appropriate to obtain reasonable assurance that the financial statements are free of material misstatement.
The Board of Directors provides oversight to the financial reporting process through its Audit and Compliance Committee, which meets regularly with management, corporate audit, and the independent registered public accounting firm to review the activities of each and to ensure that each is meeting its responsibilities with respect to financial reporting and internal controls.
Finally, each of the undersigned has personally certified that the information contained in this Annual Report on Form 10-K is accurate and complete in all material respects, and that there are in place sound disclosure controls designed to gather and communicate material information to appropriate personnel within the company.
/s/ Stephen G. Welch Stephen G. Welch President and Chief Executive Officer
/s/ Scott H. Wiscomb Scott H. Wiscomb Chief Financial Officer
TODD SHIPYARDS CORPORATION CONSOLIDATED BALANCE SHEETS MARCH 28, 2004 and MARCH 30, 2003 (In thousands of dollars) 2004 2003 ASSETS Cash and cash equivalents $ 1,328 $ 9,053 Securities available-for-sale 30,682 32,126 Accounts receivable, less allowance for doubtful accounts of $48 and $98 U.S. Government 5,591 4,322 Other 2,039 3,928 Costs and estimated profits in excess of billings on incomplete contracts 14,367 6,251 Inventory, less obsolescence reserve of $139 and $237 1,223 1,434 Insurance receivable - current 13,500 - Other current assets 1,233 1,268 Deferred taxes 867 - Total current assets 70,830 58,382
Property, plant and equipment, net 28,244 16,634
Restricted cash 2,936 3,030 Deferred pension asset 28,725 29,709 Insurance receivable 15,748 32,427 Other long-term assets 1,419 1,398 Total assets $147,902 $141,580
LIABILITIES AND STOCKHOLDERS' EQUITY: Accounts payable and accruals $ 14,616 $ 9,244 Accrued payroll and related liabilities 2,032 2,606 Billings in excess of costs and estimated profits on incomplete contracts 1,924 1,357 Environmental and other reserves - current 13,500 - Taxes payable other than income taxes 2,298 1,417 Income taxes payable 98 787 Deferred taxes - 446 Total current liabilities 34,468 15,857
Environmental and other reserves 18,511 35,055 Accrued post retirement health benefits 15,791 16,588 Deferred taxes 4,930 3,025 Other non-current liabilities 2,831 1,521 Total liabilities 76,531 72,046
Stockholders' equity: Common stock $.01 par value-authorized 19,500,000 shares, issued 11,956,033 shares at March 28, 2004 and March 30, 2003, and outstanding 5,402,656 at March 28, 2004 and 5,271,056 at March 30, 2003 120 120 Paid-in capital 38,114 38,405 Retained earnings 79,918 78,573 Accumulated other comprehensive income 393 429 Treasury stock (6,553,377 shares at March 28, 2004 and 6,684,977 shares at March 30, 2003) (47,174) (47,993) Total stockholders' equity 71,371 69,534 Total liabilities and stockholders' equity $147,902 $141,580
The accompanying notes are an integral part of this statement. TODD SHIPYARDS CORPORATION CONSOLIDATED STATEMENTS OF INCOME Years Ended March 28, 2004, March 30, 2003, and March 31, 2002 (in thousands, except per share amounts)
2004 2003 2002 Revenues $147,794 $151,811 $121,945
Operating Expenses: Cost of revenues 107,758 109,406 84,787
Administrative and manufacturing overhead 38,115 36,832 30,721
Provision for environmental and other reserves - 600 -
Other insurance settlements (245) (125) (465)
Total operating expenses 145,628 146,713 115,043
Operating income 2,166 5,098 6,902
Investment and other income 1,717 1,240 1,816
Gain (loss) on available-for-sale securities 619 (9) 2,216
Income before income tax expense 4,502 6,329 10,934
Income tax expense (470) (2,219) (3,916)
Net income $ 4,032 $ 4,110 $ 7,018
Net income per Common Share:
Basic $ 0.76 $ 0.78 $ 1.05 Diluted $ 0.72 $ 0.74 $ 1.03
Dividends declared, per common share $ 0.50 $ 0.00 $ 0.00
Weighted Average Shares Outstanding Basic 5,306 5,283 6,677 Diluted 5,569 5,553 6,827
The accompanying notes are an integral part of this statement. TODD SHIPYARDS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended March 28, 2004, March 30, 2003, and March 31, 2002 (in thousands of dollars) 2004 2003 2002 OPERATING ACTIVITIES: Net income $ 4,032 $ 4,110 $ 7,018 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation 2,996 2,774 3,020 Deferred pension asset 984 1,114 (65) Post retirement health benefits (797) (816) (783) Deferred income taxes 592 951 3,339 Decrease (increase) in operating assets: Costs and estimated profits in excess of billings on incomplete contracts (8,116) (603) 3,971 Inventory 211 55 42 Accounts receivable 620 7,574 321 Insurance receivable 3,179 (5,629) (696) Other (net) 219 (787) 6 Increase (decrease) in operating liabilities: Accounts payable and accruals 4,590 88 (9,691) Accrued payroll and related liabilities 736 295 1,377 Billings in excess of costs and estimated profits on incomplete contracts 567 (1,507) 1,231 Environmental and other reserves (3,044) 6,588 737 Income taxes payable (689) (1,130) 263 Other (net) 881 20 475 Net cash provided by operating activities 6,961 13,097 10,565
INVESTING ACTIVITIES: Purchases of marketable securities (11,435) (29,741) (9,491) Sales of marketable securities 5,504 7,663 35,863 Maturities of marketable securities 7,339 3,300 5,550 Capital expenditures (14,606) (2,825) (2,171) Net cash provided by (used in) investing activities (13,198) (21,603) 29,751
FINANCING ACTIVITIES: Restricted cash 94 210 878 Purchase of treasury stock (290) (243) (34,631) Proceeds from exercise of stock options 853 47 246 Dividends paid on common stock (2,145) - - Collection of notes receivable from officers for common stock - - 415 Net cash provided by (used in) financing activities (1,488) 14 (33,092)
Net increase (decrease) in cash and cash equivalents (7,725) (8,492) 7,224 Cash and cash equivalents at beginning of year 9,053 17,545 10,321 Cash and cash equivalents at end of year $ 1,328 $ 9,053 $ 17,545 Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 23 $ - $ 5 Income taxes 950 2,133 319 Non-cash investing and financing activities: Impairment of available-for-sale securities $ - $ 260 $ - The accompanying notes are an integral part of this statement.
TODD SHIPYARDS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Years Ended March 28, 2004, March 30, 2003, and March 31, 2002 (in thousands of dollars, except for shares)
2004 2003 2002
Shares Amount Shares Amount Shares Amount Common Stock Balance at beginning of the year 5,271,056 $ 120 5,283,222 $ 120 9,362,680 $ 120 Purchase of treasury stock (22,400) - (19,500) - (4,136,124) - Exercise of stock options 154,000 - 7,334 - 56,666 - Balance at end of the year 5,402,656 $ 120 5,271,056 $ 120 5,283,222 $ 120
Paid-in Capital Balance at beginning of the year - $38,405 - $38,295 - $38,186 Stock based compensation - 205 - 116 - 217 Proceeds from exercise of stock options - (256) - (6) - (108) Reclass of put option liability - (240) - - - - Balance at end of the year - $38,114 - $38,405 - $38,295
Retained Earnings Balance at beginning of the year - $78,573 - $74,463 - $67,445 Net income for the year - 4,032 - 4,110 - 7,018 Dividends declared - (2,687) - - - - Balance at end of the year - $79,918 - $78,573 - $74,463
Accumulated Other Comprehensive Income Balance at beginning of the year - $ 429 - $ 922 - $ 1,271 Net change in unrealized gains (losses) on available-for-sale securities, (net of tax) - (36) - (493) - (349) Balance at end of the year - $ 393 - $ 429 - $ 922
Treasury Stock Balance at beginning of the year - $(47,993) -$(47,803) -$(13,526) Purchase of treasury stock - (290) - (243) - (34,631) Exercise of stock options - 1,109 - 53 - 354 Balance at end of the year - $(47,174) -$(47,993) -$(47,803)
Notes from Officers Balance at beginning of the year - $ - - $ - - $ (415) Notes Receivable from officers for common stock - $ - - $ - - $ 415 Balance at end of the year - $ - - $ - - $ -
Comprehensive Income Net income - $ 4,032 - $ 4,110 - $ 7,018 Other comprehensive income (loss) per above - $ (36) - $ (493) - $ (349) Total comprehensive income - $ 3,996 - $ 3,617 - $ 6,669
The accompanying notes are an integral part of this statement. TODD SHIPYARDS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended March 28, 2004, March 30, 2003, and March 31, 2002
1. PRINCIPAL ACCOUNTING POLICIES
(A) Basis of Presentation - The Consolidated Financial Statements include the accounts of Todd Shipyards Corporation (the "Company") and its wholly owned subsidiaries Todd Pacific Shipyards Corporation ("Todd Pacific") and TSI Management, Inc. ("TSI"). All inter-company transactions have been eliminated. The Company's policy is to end its fiscal year on the Sunday nearest March 31. Certain reclassifications of prior year amounts in the Consolidated Financial Statements have been made to conform to the current year presentation, including the classification of certain other reserves and the related insurance receivable.
(B) Business - The Company's primary business is ship overhaul, conversion and repair for the United States Government, state ferry systems, and domestic and international commercial customers. The majority of the Company's work is performed at either its Seattle, Washington facility (the "Shipyard") or at the Puget Sound Naval Shipyard in Bremerton, Washington, by a unionized production workforce.
(C) Property, Plant and Equipment - Property, plant and equipment is carried at cost, net of accumulated depreciation. The Company capitalizes certain major overhaul activities when such activities are determined to increase the useful life or operating capacity of the asset. Depreciation and amortization are determined on the straight-line method based upon estimated useful lives (5-31 years) or lease periods; however, for income tax purposes, depreciation is determined on both the straight-line and accelerated methods, and on shorter periods where permitted.
(D) Revenue Recognition - The Company recognizes revenue, costs, and profit on construction contracts in accordance with Statement of Position No. 81-1 (SOP No. 81-1), "Accounting for Performance of Construction-Type and Certain Production-Type Contracts". Revenue, costs, and profit on contracts are recognized on the percentage-of-completion method (determined based on direct labor hours). Revenue, costs, and profits on time-and-material contracts are recorded based upon direct labor hours at fixed hourly rates and cost of materials as incurred. Certain contracts provide for rights of audit of costs by the customer. Estimated inputs of pending audits are included in the estimates of contract revenue. When the current estimates of total contract revenue and contract cost indicate a loss, a provision for the entire loss on the contract is recorded. Revisions to contract estimates are recorded as the estimating factors are refined. The effect of these revisions is included in income in the period the revisions are identified.
(E) Estimates - The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.
(F) Income Taxes - Income taxes are determined in accordance with an asset and liability approach for financial accounting and reporting of income taxes. A valuation allowance is recorded to reduce deferred tax assets when realization of the tax benefit is uncertain.
(G) Inventory - Inventories, consisting of materials and supplies, are valued at lower of cost (principally average) or market. The Company has many available sources of supply for its commonly used materials.
(H) Cash and Cash Equivalents - The Company considers all highly liquid debt instruments with a stated maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of money market instruments, investment grade commercial paper and U.S. Government securities. The carrying amounts reported in the balance sheet are stated at cost, which approximates fair value.
(I) Securities Available-for-Sale - The Company includes all debt instruments purchased with a maturity of more than three months as securities available- for-sale. Securities available-for-sale consist primarily of U.S. Government securities, investment grade commercial paper and equities and are valued based upon market quotes.
Company management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates such designation as of each balance sheet date. All of the Company's investments are classified as available-for-sale as of the balance sheet date and are reported at fair value, with unrealized gains and losses, excluded from earnings and presented as accumulated other comprehensive income or loss, net of related deferred income taxes. Realized gains and losses are recorded based on historical cost of individual securities
The Company continually monitors its investment portfolio for other than temporary impairment of securities. When an other than temporary decline in the value below cost or amortized cost is identified, the investment is reduced to its fair value, which becomes the new cost basis of the investment. The amount of reduction is reported as a realized loss in the Consolidated Statements of Income. Any recovery of value in excess of the investment's new cost basis is recognized as a realized gain only on sale, maturity or other disposition of the investment.
Factors that the Company evaluates in determining the existence of an other than temporary decline in value include (1) the length of time and extent to which the fair value has been less than cost or carrying value, (2) the circumstances contributing to the decline in fair value (including a change in interest rates or spreads to benchmarks), (3) recent performance of the security, (4) the financial strength of the issuer, and (5) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for anticipated recovery. Additionally, for asset-backed securities, the Company considers the security rating and the amount of credit support available for the security.
(J) Stock Based Compensation - Beginning in fiscal year 2003, the Company elected to apply the expense recognition provisions of FAS No. 123. The recognition provisions are applied to stock option grants awarded subsequent to March 31, 2002. The Company has adopted FAS No. 123 as it is designated as the preferred method of accounting for stock-based compensation.
Previously, the Company had applied the disclosure only provisions of FAS No. 123 and accounted for stock-based compensation using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for Stock Issued to Employees" and related interpretations. Under APB No. 25, compensation cost for stock options is measured as the excess, if any, of the fair value of the Company's common stock at the date of grant over the stock option price.
If the Company had elected to apply the expense recognition provision of FAS No. 123 to options granted prior to March 31, 2002, then the net income would have been adjusted as follows (the estimated fair value of the options is amortized to expense over the options' vesting period):
(in thousands, Year Ended except per share data) 2004 2003 2002 Net income: As reported $ 4,032 $ 4,110 $ 7,018 add: Stock Compensation as recorded 205 116 217 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (407) (340) (445) Pro forma $ 3,830 $ 3,886 $ 6,790
Net income per share: Basic As reported $ 0.76 $ 0.78 $ 1.05 Pro forma 0.72 0.73 1.02
Diluted As reported 0.72 0.74 1.03 Pro forma $ 0.69 $ 0.70 $ 0.99
(K) Environmental Remediation, Bodily Injury, Other Reserves, and Insurance Receivable - The Company accounts for environmental remediation liabilities in accordance with Statement of Position 96-1, "Environmental Remediation Liabilities," which provides the accounting and reporting standards for the recognition and disclosure of environmental remediation liabilities.
For current operating activities, costs of complying with environmental regulations are immaterial and expensed as incurred. Environmental costs are capitalized if the costs extend the life of the property and/or increase its capacity.
For matters associated with past practices and closed operations, accruals for environmental matters are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based upon the projected scope of the remediation, current law and existing technologies. These accruals are adjusted periodically as assessment and remediation efforts progress or as additional technical or legal information becomes available. As applicable, accruals include the Company's share of the following costs: engineering costs to determine the scope of the work and the remediation plan, testing costs, project management costs, removal of contaminated material, disposal of contaminated material, treatment of contaminated material, capping of affected areas and long term monitoring costs.
Accruals for environmental liabilities are not discounted and exclude legal costs to defend against claims of other parties. Insurance or other third party recoveries for environmental liabilities are recorded separately at undiscounted amounts in the financial statements as insurance receivables when it is probable that a claim will be realized.
The Company accounts for bodily injury liabilities and other reserves in accordance with Financial Accounting Standards Board No.5, "Accounting for Contingencies". Accruals for bodily injury liabilities are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated based on the known facts. Civil actions relating to toxic substances vary according to the case's fact patterns, jurisdiction and other factors. Accordingly, any potential expenses for claims that may be filed in the future related to alleged damages from past exposure to toxic substances are not estimable and as such are not included in the Company's reserves.
Accruals for bodily injury liabilities are adjusted periodically as new information becomes available. Such accruals are included in the environmental and other reserves at undiscounted amounts and exclude legal costs to defend against claims of other parties. Insurance or other third party recoveries for bodily injury liabilities are recorded undiscounted in the financials statements as insurance receivables when it is probable that a claim will be realized.
(L) Earnings per Share - Basic earnings per share is computed based on weighted average shares outstanding. Diluted earnings per share includes the effect of dilutive securities (options and warrants) except where their inclusion is antidilutive.
(M) Comprehensive Income - Unrealized gains or losses on the Company's available-for-sale securities, are reported as other comprehensive income (loss) in the Consolidated Balance Sheets and Statement of Stockholders' Equity.
(N) Long-lived Assets - The Company's policy is to recognize impairment losses relating to long-lived assets in accordance with Financial Accounting Standards Board No.144, "Accounting for the Impairment or Disposal of Long- Lived Assets" based on several factors, including, but not limited to, management's plans for future operations, recent operating results and projected cash flows. To date no such impairment has been indicated.
(O) Concentration of Risk -The Company is subject to concentration of credit risk from investments and cash balances on hand with banks and other financial institutions, which may be in excess of the Federal Deposit Insurance Corporation's insurance limits. Risk for investments is managed by purchase of investment grade securities and diversification of the investment portfolio among issuers and maturities.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations" ("FAS No. 143), which is effective for fiscal years beginning after June 15, 2002 (fiscal year 2004 for the Company). FAS No. 143 provides accounting and reporting standards for recognizing obligations related to asset retirement costs associated with the retirement of tangible long-lived assets. Under FAS No. 143, legal obligations associated with the retirement of long-lived assets are to be recognized at fair value in the period in which they are incurred if a reasonable estimate of fair value can be made. The fair value of the asset retirement costs is capitalized as part of the carrying amount of the long-lived asset and expensed using a systematic and rational method over the assets' useful lives. Any subsequent changes to the fair value of the liability will be expensed. The adoption of FAS No. 143 did not have a material impact on the Company's financial position, results of operations, or cash flows.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("FAS No. 146"), which is effective for exit or disposal activities that are initiated after December 31, 2002. Under FAS No. 146, a liability for a cost associated with an exit or disposal activity will be recognized and measured initially at fair value only when the liability is incurred. FAS No. 146 nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring) ("Issue 94-3"). The principal difference between FAS No. 146 and Issue 94-3 relates to its requirements for recognition of a liability for a cost associated with an exit or disposal activity. FAS No. 146 will only impact the Company if it incurs disposal activities. If and when a disposal activity occurs, management will record such activity under the rules of FAS No. 146.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46 establishes accounting guidance for consolidation of variable interest entities that function to support the activities of the primary beneficiary. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements of FIN 46 apply to older entities in the first fiscal year or interim period ending after December 15, 2003. Disclosure requirements apply to financial statements issued after January 31, 2003. FIN 46 applies to any business enterprise, public or private, that has a controlling interest, contractual relationship or other business relationship with a variable interest entity. Since the Company has no contractual relationship or other business relationship with a variable interest entity, the adoption of FIN 46 did not have any effect on its consolidated financial position or results of operations.
On May 15, 2003, the FASB issued SFAS No. 150 (FAS No. 150), Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. FAS No. 150 requires that certain financial instruments, which under previous guidance could be accounted for as equity, be classified as liabilities in statements of financial position. FAS No. 150 represents a significant change in practice in accounting for a number of financial instruments, including mandatorily redeemable equity instruments and certain equity derivatives that frequently are used in connection with share repurchase programs. FAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and was effective for the Company at the beginning of our second quarter ended September 28, 2003. The adoption of SFAS No. 150 had no material impact on the Company's financial position, results of operations, or cash flows.
3. RESTRICTED CASH AND SURETY LINE
A surety company has issued contract bonds totaling $2.1 million for current repair, maintenance and conversion jobs as of March 28, 2004. Todd Pacific's trade accounts receivable on certain bonded jobs secure these various contract bonds.
The long-term restricted cash relates primarily to the Harbor Island Superfund site clean up and will be released upon the Company satisfying certain remediation provisions. Also included is $0.2 million and $0.3 million as of March 28, 2004 and March 30, 2003, respectively, of restricted cash which will be released upon completion or acceptance of the contracted work and completion of related warranty periods and consists primarily of amounts related to work for the Washington State Ferry System.
4. SECURITIES AVAILABLE FOR SALE
Securities available-for-sale are carried at fair value. The following is a summary of available-for-sale securities:
Amor- Gross Gross tized Unrealized Unrealized Fair (In thousands) Cost Gains Losses Value
March 28, 2004
Debt securities:
U.S. Treasury securities and agency obligations $ 2,865 $ 18 $ - $ 2,883
U.S. corporate securities 20,197 297 (12) 20,482
Mortgage-backed securities 6,288 98 - 6,386
Total debt securities 29,350 413 (12) 29,751
Equity securities:
U.S. securities 360 76 - 436
Foreign stock 366 129 - 495
Total equity securities 726 205 - 931
Total securities $30,076 $ 618 $ (12) $30,682
March 30, 2003
Debt securities:
U.S. Treasury securities and agency obligations $ 4,949 $ 53 $ - $ 5,002
U.S. corporate securities 14,122 354 - 14,476
Mortgage-backed securities 9,876 166 - 10,042
Total debt securities 28,947 573 - 29,520
Equity securities:
U.S. securities 2,153 186 (200) 2,139
Foreign stock 365 102 - 467
Total equity securities 2,518 288 (200) 2,606
Total securities $31,465 $ 861 $ (200) $32,126
The Company had gross realized gains of $683 thousand, $255 thousand, and $2.4 million on sales of available-for-sale securities for fiscal years 2004, 2003 and 2002 respectively.
The Company had gross realized losses of $64 thousand, $264 thousand, and $156.6 thousand on sales of available-for-sale securities for fiscal year 2004, 2003 and 2002, respectively.
The amortized cost and estimated fair value of the Company's available-for- sale debt, mortgage-backed and equity securities are shown below:
Amortized Fair (In thousands) Cost Value March 28, 2004
Debt securities: Due in one year or less $ 4,957 $ 5,048 Due after one year through three years 18,105 18,317 Subtotal 23,062 23,365
Mortgage-backed securities 6,288 6,386 Equity securities 726 931 Total $ 30,076 $ 30,682
March 30, 2003
Debt securities: Due in one year or less $ 4,025 $ 4,090 Due after one year through three years 15,046 15,388 Subtotal 19,071 19,478
Mortgage-backed securities 9,876 10,042 Equity securities 2,518 2,606 Total $ 31,465 $ 32,126
5. CONTRACTS
Auxiliary Oiler Explosive ("AOE") Contract In June 2001, the Company was awarded by the Navy, a six-year, cost-type contract, under which the Navy has options to have the Company perform maintenance work on the Auxiliary Oiler Explosive ("AOE") class vessels. This contract represents the fourth consecutive, multi-year contract that the Company has been awarded by the Navy on the AOE class vessels. The three previous AOE contracts, which were each five years in duration, were all awarded on a competitive basis. This cost type contract provides for phased maintenance repairs to four Navy AOE class supply ships stationed in the Puget Sound area. The original contract included options for thirteen repair availabilities to be performed between 2001 and 2007 and was expected to have a notional value of approximately $180 million if all of the options were exercised. Since the award, five repair availabilities have been accomplished.
During the first quarter of fiscal year 2003, the Navy announced its intention to transfer the USS Rainier (AOE 7) and the USS Bridge (AOE 10) to the Military Sealift Command ("MSC") which results in five availabilities that will not be exercised under this contract. AOE 7 was transferred to MSC in August 2003. AOE 10 is currently scheduled to be transferred in the summer of 2004. The Company anticipates that MSC will contract for future work on these two vessels on a competitive basis. The potential impact of these transfers on the Company's future revenues will depend on such factors as the expenditures for maintenance by MSC, the Company's capacity to bid on future AOE 7 and AOE 10 work, and the Company's bidding success if such bids are submitted.
During the fourth quarter of fiscal year 2004, the Company announced that it was informed by the Navy that the USS Sacramento (AOE 1) is scheduled to be decommissioned on or about October 1, 2004. Of the two remaining availabilities on AOE 1, one was exercised on a reduced scale as a five-week, pier-side availability. The availability, originally scheduled for 12 weeks in duration, was to include a dry docking of the ship. The other availability of AOE 1 will not occur due to its decommissioning. The Company does not know at this point if it will be involved in any of the work related to the decommissioning of AOE 1.
The AOE contract contains options for two remaining repair availabilities on the USS Camden (AOE 2) before the contract expires in 2007. There is no assurance that these two remaining options will be exercised by the Navy in whole or in part.
Combatant Maintenance Team ("CMT") Contract During the first quarter of fiscal year 2001, the Company was awarded, by the Department of the Navy on a sole source basis, a five year, cost-type contract for the repair and maintenance which at the time included six surface combatant class vessels (frigates and destroyers) stationed in the Puget Sound area. Although the Navy has not released a notional value of the maintenance work, the Company believes that the value may be approximately $60 million to $75 million if all options are exercised. Work on this contract is being performed primarily in the Company's Seattle shipyard, as well as at Naval Station Everett, depending on the type of work to be performed.
Planned Incremental Availability ("PIA") Subsequent to the end of fiscal year 2004, the Department of the Navy awarded the Company a five-year, cost-type contract with the long-term overhaul and maintenance to the NIMITZ CLASS aircraft carriers (CVN) home ported in Puget Sound. The contract consists of multiple contract options for planned incremental availabilities (PIA's), docking planned incremental availabilities (DPIA's) and continuous maintenance and upkeep for the USS LINCOLN (CVN-72), USS STENNIS (CVN-74), USS NIMITZ (CVN-68) and USS VINSON (CVN-70) when they are in Puget Sound. The work includes all types of non-nuclear ship repair, alteration and maintenance. All on-board work is accomplished by the Company workforce at Puget Sound Naval Shipyard in Bremerton, Washington, or Naval Station Everett.
The work is performed under a cost plus award fee with performance incentive fee contract and represents the second contract for aircraft carrier maintenance awarded to the Company. The first such contract, recently expired, was awarded in 1999. The Company is supported in this effort by various regional suppliers and subcontractors. Significant support is provided by the Company's two teaming partners for this contract, Pacific Ship Repair and Fabrication ("PacShip") and AMSEC LLC ("AMSEC"). The notional value for this five-year contract is approximately $133 million if all options are exercised.
United States Coast Guard - Multi-ship; Multi-options (MSMO contract) During the fourth quarter of fiscal year 2004, the United States Coast Guard awarded the Company a contract to provide maintenance of two Polar Class icebreakers. The contract consists of multiple contract options for planned maintenance availabilities (PMA's) and docking planned maintenance availabilities (DPMA's) for the POLAR STAR (WAGB-10) and POLAR SEA (WAGB-11). The availabilities, and their companion planning options, extend through the last DPMA ending August 2008, and the last PMA ending on September 2008. The work to be performed includes availability planning and generalized ship maintenance and repairs as needed, with emphasis on propulsion and deck machinery work. The Company expects to team with the Coast Guard to identify the appropriate best value work scope and technical solutions for support of the two icebreakers. The Company will be supported in this effort by various regional suppliers and subcontractors. The work will be performed under a cost plus incentive fee contract. The Company has performed similar work for the Coast Guard over the past several years under individual, competitively bid, firm fixed priced contracts. This current award marks the first time the Coast Guard has used a long term phased-maintenance approach on the two Polar Class icebreakers home ported in Seattle. The notional value of all options, if exercised by the Coast Guard, is approximately $50 million. There is no assurance that all options will be exercised, in whole or in part. Electric Boat During the fourth quarter of fiscal year 2004, the Company entered into a contract with Electric Boat Corporation of Groton, Connecticut ("Electric Boat") to support work on Trident submarines. During the period from May to September 2003, the Company completed planning and preparation work for Electric Boat. The Company has begun work on a follow-on contract to fabricate components and to accomplish associated steel outfitting, project management and quality assurance functions. This contract is associated with the retrofit work being accomplished by Electric Boat on the USS OHIO (SSBN 726) at the Puget Sound Naval Shipyard.
The Company's work is being performed under a cost plus incentive fee contract with Electric Boat for the fabrication work, and a firm fixed price contract for the associated project management and quality assurance work. The total value of these contracts is approximately $5.3 million and the work is scheduled to be completed in May 2004.
Unbilled Receivables - Certain unbilled items on completed contracts (costs and estimated profits in excess of billings) included in accounts receivable were approximately $2.5 million at March 28, 2004 and $1.0 million at March 30, 2003.
Customers - Revenues from the U.S. Government were $123.8 million (84%), $123.9 million (82%) and $96.1 million (79%) in fiscal years 2004, 2003, and 2002, respectively. Revenues from the Washington State Ferry System were $4.4 million (3%), $4.9 million (3%) and $10.3 million (8%) in fiscal year 2004, 2003 and 2002, respectively.
6. PROPERTY, PLANT AND EQUIPMENT
Property, plant, and equipment and accumulated depreciation at March 28, 2004 and March 30, 2003 consisted of the following (in thousands):
2004 2003 Land $ 1,151 $ 1,151 Buildings 13,457 12,151 Piers, shipways and drydocks 29,326 24,516 Machinery and equipment 46,881 38,492 Total plant and equipment, at cost 90,815 76,310
Less accumulated depreciation (62,571) (59,676) Plant, property and equipment, net $ 28,244 $ 16,634
The Company recognized $3.0 million, $2.8 million, and $3.0 million of depreciation expense in fiscal years 2004, 2003 and 2002, respectively.
7. PENSIONS AND OTHER POSTRETIREMENT BENEFIT PLANS
The Company provides defined pension benefits and postretirement benefits to employees as described below.
Nonunion Pension Plans - The Company sponsors the Todd Shipyards Corporation Retirement System (the "Retirement System"), a noncontributory defined benefit plan under which all nonunion employees are covered. The benefits are based on years of service and the employee's compensation before retirement. The Company's funding policy is to fund such retirement costs as required to meet allowable deductibility limits under current Internal Revenue Service regulations. The Retirement System plan assets consist principally of common stocks and Government and corporate obligations.
Under a provision of the Omnibus Budget Reform Act of 1990 ("OBRA `90") the Company transferred approximately $1.6 million and $1.7 million in excess pension assets from its Retirement System into a fund to pay fiscal year 2004 and 2003 retiree medical benefit expenses, respectively. OBRA `90 was modified by the Work Incentives Improvement Act of 1999 to extend annual excess asset transfers through the fiscal year ending April 2, 2006.
Post Retirement Group Health Insurance Program - The Company sponsors a defined benefit retirement health care plan that provides post retirement medical benefits to former full-time exempt employees, and their spouses, who meet specified criteria. The Company terminated post retirement health benefits for any employees retiring subsequent to May 15, 1988. The retirement health care plan contains cost-sharing features such as deductibles and coinsurance. These benefits are funded monthly through the payment of group health insurance premiums.
Because such benefit obligations do not accrue to current employees of the Company, there is no current year service cost component of the accumulated post retirement health benefit obligation.
On July 1, 2002, the Todd Galveston Metal Trades Council Pension Fund liability and assets were transferred from the Todd Shipyards Corporation Retirement System to an international labor union organization. This transfer resulted in a non-recurring, non-cash charge of $0.8 million.
The following is a reconciliation of the benefit obligation, plan assets, and funded status of the Company's sponsored plans. Other Postretirement Pension Benefits Benefits 2004 2003 2004 2003 Change in Benefit Obligation (in thousands of dollars) Benefit obligation at beginning of year $27,870 $33,376 $15,396 $15,592 Service cost 562 550 - - Interest cost 1,701 1,887 961 1,046 Actuarial (gain)/loss 1,093 (109) 4,679 474 Benefits paid (1,923) (2,086) (1,634) (1,716) Plan Settlement - (5,748) - - Benefit obligation at end of year $29,303 $27,870 $19,402 $15,396
Other Postretirement Pension Benefits Benefits 2004 2003 2004 2003 Change in Plan Assets (in thousands of dollars) Fair value of plan assets at beginning of year $48,824 $60,799 $ - $ - Actual gain (loss) on plan assets 7,103 (2,268) - - Employer contribution - - 51 48 Asset transfer (1,634) (1,668) 1,634 1,668 Benefits paid (1,923) (2,086) (1,685) (1,716) Plan Settlement - (5,953) - - Fair value of plan assets at end of year $52,370 $48,824 $ - $ -
Other Postretirement Pension Benefits Benefits 2004 2003 2004 2003 Funded Status Reconciliation (in thousands of dollars) Funded status of plans $23,067 $20,954 $(19,402) $(15,396) Unrecognized prior service cost 126 363 - - Unrecognized (gain)/loss 5,532 8,392 2,095 (2,684) Deferred pension asset (accrued liability) 28,725 29,709 (17,307) (18,080) Less: current portion included in "Accounts payable and accruals" - - 1,516 1,492 Long-term accrued postretirement health benefits $ - $ - $(15,791) $(16,588)
Other Postretirement Pension Benefits Benefits 2004 2003 2004 2003 Weighted Average Assumptions Discount rate (1) 5.75% 6.50% 5.75% 6.50% Expected return on plan assets(2) 7.25% 7.50% - - Rate of compensation increase 4.50% 4.50% - - Medical trend rate (retirees) (3) - - 10.50% 9.00%
(1) The Company reduced its discount rate assumption in fiscal year 2004 to reflect the overall decrease in long term interest rates generally available in the market.
(2) The Company reduced its expected return on plan assets assumption in 2004 to reflect the overall decrease in the expected performance of its plan assets due to market conditions.
(3) Postretirement benefit medical trend rate in fiscal year 2004 is 10.5% graded to 6.00% over 9 years. Fiscal year 2003 is 9.00% graded to 6.00% over 3 years. The increase in the medical trend rate is due to the increasing cost of prescription drugs and the age of the plan participants.
Other Postretirement Pension Benefits Benefits 2004 2003 2002 2004 2003 2002 Components of Net Periodic Benefit Cost (in thousands of dollars) Service Cost $ 562 $ 550 $ 480 $ - $ - $ - Interest cost on projected benefit obligation 1,701 1,887 2,283 961 1,046 1,046 Expected return on plan assets (3,538) (4,004) (4,660) - - - Amortization of prior service cost 238 233 245 - - - Recognized actuarial (gain)/loss 388 - - (100) (162) (174) Plan Settlement - 780 - - - - Net periodic (benefit) cost before OBRA '90 (649) (554) (1,652) 861 884 872 Transfer of assets for payment of retiree medical benefits (401(h) Plan) 1,634 1,668 1,587 (1,634) (1,668) (1,587) Net periodic cost (benefit)$ 985 $ 1,114 $ (65) $(773) $(784) $ (715)
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage point change in assumed health care cost trend rates would have the following effects: Other Postretirement Benefits 2004 2003 Effect of a 1% Increase in the Health Care Cost Trend On: (in thousands of dollars) Service cost plus interest cost $ 76 $ 83 Accumulated postretirement benefit obligation 1,466 1,165
Effect of a 1% Decrease in the Health Care Cost Trend On: (in thousands of dollars) Service cost plus interest cost (67) (73) Accumulated postretirement benefit obligation $(1,308) $(1,040)
Union Pension Plans - Operating Shipyard - The Company participates in several multi-employer plans, which provide defined benefits to the Company's collective bargaining employees. The expense for these plans totaled $3.8 million, $3.4 million and $2.6 million, for fiscal years 2004, 2003 and 2002, respectively.
Union Pension Plans - Previously Operated Shipyards - The Company no longer sponsors union pension plans attributable to the prior operation of other shipyards. The ongoing operation and management of these plans has either been terminated or transferred to other parties.
Savings Investment Plan - The Company sponsors a Savings Investment Plan (the "Savings Plan"), under Internal Revenue Code Section 401, covering all non- union employees. Under the terms of the Savings Plan, which were modified in fiscal year 2001, the Company now contributes an amount up to 2.4% of each participant's annual salary depending on the participant's Savings Plan contributions. These Company contributions are subject to a two-year cliff- vesting. The Company incurred expenses related to this plan of $0.2 million, $0.1 million, and $0.1 million in fiscal years 2004, 2003, and 2002, respectively.
Asset allocations - The weighted-average asset allocations for the pension plan by asset categories are as follows.
Fiscal year ending 2004 2003
Asset Category Equity Securities 29% 23% Fixed Income 32 40 Convertible Securities 39 37
Total 100% 100%
Investment strategy - The general investment objective is to obtain a rate of return and sufficient liquidity that will allow the plan to meet required benefit payments. Emphasis is placed on long-term performance and not short- term market aberrations. The assets are diversified among the following asset categories within allocation ranges approved by the Company's Board of Directors. These asset categories and respective allocation ranges are as follows.
Equities 15-35% Fixed Income 30-50% Convertible Securities 20-40%
Future Cash Flow Information - Due to the well-funded status of the Company's pension plan, no contributions are required for the subsequent plan year. No funding of the Company's post-retirement benefit plan is anticipated in the subsequent plan year except to pay premium costs which are covered by the transfer of excess pension assets.
The estimated pension benefit payments and post-retirement premiums are as follows. Other Post-retirement Plan Year Pension Benefits Benefits 7/03-6/04 $2,523 $1,712 7/04-6/05 2,360 1,744 7/05-6/06 2,336 1,782 7/06-6/07 2,411 1,798 7/07-6/08 2,444 1,809 7/08-6/13 11,799 8,562
Medicare Drug Act - On December 8, 2003, the Medicare Prescription, Improvement and Modernization Act of 2003 (Medicare Drug Act) was signed into law. The Act introduces a prescription drug benefit under Medicare Part D as well as a Federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. Specific authoritative guidance on the accounting for the Federal subsidy was not finalized until May 19, 2004.. Therefore, at this time the Company has elected to not recognize the impact of the Federal subsidy on our accumulated postretirement benefit obligation and net postretirement benefit costs. The future impact of this subsidy is estimated to be an actuarial gain of approximately $2.0 million to be amortized over the average service life of the plan participants.
8. INCOME TAXES
Components of the income tax expense (benefit) are as follows (in thousands)
2004 2003 2002
Current tax expense $ (141) $ 1,002 $ 390 Deferred tax expense (benefit) 611 1,217 3,526 Total income tax expense (benefit) $ 470 $ 2,219 $ 3,916
The provision for income taxes differs from the amount of tax determined by applying the federal statutory rate and is as follows (in thousands): (percentages represent income tax expense (benefit) as a percent of income before income tax expense):
2004 2003 2002 Tax provision at federal statutory tax rate $ 1,531 34.0% $ 2,152 34.0% $ 3,827 35.0% Reduction in current tax liability (1,128)(25.1)% - 0.0% - 0.0% Other - net 67 1.5% 67 1.1% 89 0.8% Income tax expense (benefit) $ 470 10.4% $ 2,219 35.1% $ 3,916 35.8%
This decrease in valuation allowance of $1.1 million is due to the resolution in the fourth quarter of certain income tax contingencies that were established in prior years.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred income tax assets and liabilities at March 28, 2004 and March 30, 2003 were as follows (in thousands):
2004 2003 Deferred income tax assets:
Alternative minimum tax credit carryforwards $ 835 $ 1,597 Accrued employee benefits 7,750 7,174 Environmental and other reserves 11,204 12,269 Inventory reserves 49 83 Reserve for doubtful accounts 15 34 Other 559 610 Total deferred income tax assets 20,412 21,767
Deferred income tax liabilities: Insurance receivable (10,233) (11,349) Deferred pension income (10,054) (10,398) Accelerated depreciation (3,591) (1,740) Contract deferrals 145 (1,020) Securities available-for-sale (192) (231) Other (550) (500) Total deferred income tax liabilities (24,475) (25,238)
Net deferred tax liability $ (4,063) $ (3,471)
The realization of deferred income tax assets is dependent upon the ability to generate taxable income in future periods. The Company has evaluated evidence supporting the realization of its deferred income tax assets and determined it is more likely than not that its deferred income tax assets will be realized.
During fiscal year 2004, the Company utilized approximately, $0.8 million in alternative minimum tax credits. The Company has approximately $0.8 million in remaining alternative minimum tax credit carryforwards that can be used in the future and have no expiration date.
9. LEASES
Operating lease payments charged to expense were $0.8 million, $0.8 million and $0.9 million for fiscal years 2004, 2003 and 2002, respectively. Certain leases contain renewal options and minimum amounts of annual maintenance clauses. Minimum lease commitments at March 28, 2004 are summarized below (in thousands):
Operating Leases 2005 $ 823 2006 794 2007 71 2008 43 2009 42 Thereafter 157
Total minimum lease commitments $ 1,930
10. FINANCING ARRANGEMENTS
During fiscal year 2002, the Company negotiated a $10.0 million revolving credit facility with interest payable at the prime rate. The credit facility, which is renewable on a bi-annual basis, provides the Company with greater flexibility in funding its operational cash flow needs. The Company had no outstanding borrowings as of March 28, 2004 and March 30, 2003, respectively.
11. ENVIRONMENTAL AND OTHER RESERVES
The Company faces potential liabilities in connection with the alleged presence of hazardous waste materials at its Seattle shipyard and at several sites used by the Company for disposal of alleged hazardous waste. The Company continues to analyze environmental matters and associated liabilities for which it may be responsible. No assurance can be given as to the existence or extent of any environmental liabilities until such analysis has been completed. The eventual outcome of all environmental matters cannot be determined at this time, however, the analysis of some matters have progressed sufficiently to warrant establishment of reserve provisions in the accompanying consolidated financial statements.
Harbor Island Site
The Company and several other parties have been named as potentially responsible parties ("PRPs") by the Environmental Protection Agency (the "EPA") pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA" also known as "Superfund") in connection with the documented release or threatened release of hazardous substances, pollutants and contaminants at the Harbor Island Superfund Site (the "Harbor Island Site"), upon which the Shipyard is located.
Harbor Island Site Insurance
In the fourth quarter of fiscal year 2001, the Company entered into a 30-year agreement with an insurance company that will provide the Company with broad- based insurance coverage for the remediation of the Company's operable units at the Harbor Island Superfund Site.
The agreement provides coverage for the known liabilities in an amount exceeding the Company's current booked reserves of $23.1 million. Additionally, the Company has entered into a 15-year agreement for coverage of any new environmental conditions discovered at the Seattle shipyard property that would require environmental remediation.
The Company recorded a non-current asset in the form of an insurance receivable in accordance with its environmental accounting policies at the time it entered into this agreement. This transaction did not have a material effect on the Company's results of operations, nor did the transaction have a material effect on stockholders' equity.
Harbor Island Site History
To date, the EPA has separated the Harbor Island Site into three operable units that affect the Company: the Soil and Groundwater Unit (the "Soil Unit"), the Shipyard Sediments Operable Unit (the "SSOU") and the Sediments Operable Unit (the "SOU"). The Company, along with a number of other Harbor Island PRPs, received a Special Notice Letter from the EPA on May 4, 1994 pursuant to section 122 (e) of CERCLA. The Company entered into a Consent Decree for the Soil Unit in September 1994 under which the Company has agreed to remediate the designated contamination on its property. Removal of floating petroleum product from the water table began in October 1998 and is anticipated to continue through fiscal year 2006. The Company and the EPA are currently negotiating the extent and methodology of the soil remediation.
During the third quarter of fiscal year 1997, the EPA issued its Record of Decision ("ROD") for the SSOU. The ROD identifies four alternative solutions for the SSOU remediation and identifies the EPA's selected remedy. During the third quarter of fiscal year 2000, the EPA expanded the boundaries of the SSOU issuing their Phase 1B Data Report and resulting Explanation of Significant Differences outlining the changes to the ROD. During the fourth quarter of fiscal year 2000, the Company and the EPA entered into an Administrative Order on Consent for the development of the remedial design for the SSOU.
During the fourth quarter of fiscal year 2003, the company and the EPA entered into a Consent Decree for the cleanup of the SSOU, which, along with the associated Remedial Design Statement of Work for Remedial Action ("SOW"), was subsequently approved by the Department of Justice. The Consent Decree provides for the submittal of the Remedial Action Work Plan to the EPA subsequent to the approval by the EPA of the final design. The Remedial Action Work Plan will provide for construction and implementation of the remedy set forth in the ROD, the two Explanation of Significant Differences (issued in fiscal years 2000 and 2003), the SOW, and the design plans and specifications developed in accordance with the Remedial Action Work Plan and approved by the EPA. During the fourth quarter of fiscal year 2004 the Company submitted its Final Design Report to the EPA for the SSOU. The Final Design Report provides for the following actions to take place at the SSOU:
Piers 2 and 4 South (located on the Duwamish Waterway) will be demolished and removed from the site to achieve more complete cleanup in those areas.
Dredging of all contaminated sediments and shipyard waste in the open areas of the SSOU (surrounding the shipyard) and in the areas beneath Piers 2 and 4 South. The total estimated volume of sediments to be removed is 195,200 cubic yards.
Disposal of all recovered sediment and shipyard waste at an appropriate upland disposal facility.
Backfilling of portions of the areas dredged to create intertidal habitat where feasible.
Capping of areas beneath the piers that are not scheduled for demolition to an average thickness of one foot.
Pursuant to the current schedule, remediation of the SSOU is expected to begin in the second quarter of fiscal 2005. Current environmental regulations limit the period of time during the year that dredging may occur. Given these limits, dredging in the SSOU will require several years to complete. The current estimated cost of the SSOU cleanup is included in the environmental reserve resulting in an increase in that reserve of $6.1 million during fiscal year 2003. $5.7 million of that reserve is covered by the environmental insurance policy procured by the Company in fiscal year 2001.
During January 1998, the Company was notified by the EPA that testing would be required in the West Waterway of the Duwamish River outside the borders of the SSOU as part of the SOU. The Company in May 1998 entered into an Order on Consent to perform certain limited testing as part of the SOU investigation. After an evaluation of the results, the EPA issued a draft "no action" ROD on the SOU for public comment which if issued in final form would end the investigation of the SOU requiring no remedial action. The public comment period closed during the Company's fourth quarter of fiscal year 2000. In September 2003, the EPA issued the final "no action" ROD on the SOU. Given the EPA's issuance of the draft "no action" ROD in fiscal year 2000, the Company had not established a reserve for any remediation on the SOU. The Company's environmental reserves for the entire Harbor Island Site aggregated $23.1 million at March 28, 2004.
Under the Federal Superfund law, potentially responsible parties may have liability for damages to natural resources in addition to liability for remediation. During the second quarter of fiscal year 2003, the Company began discussions with the natural resource trustees ("Trustees") for the Harbor Island Superfund Site ("Site") and continued these discussions during the third quarter. The Company anticipates that the Trustees will file a claim against the Company at some future date alleging damages to the natural resources at the Site caused by the release of hazardous substances. The best estimate of a potential natural resource damage claim has been included in the environmental reserve. The payment of any eventual claim is covered by the aforementioned insurance policy, provided that aggregate policy limits have not been exceeded.
Other Environmental Remediation Matters
In January 2001, the EPA issued Special Notice letters naming the PRPs on the Hylebos Waterway Operable Unit of the Commencement Bay Superfund Site in Tacoma, Washington. The Company was not included on the EPA's list. Todd has been notified by other PRPs of their intent to bring a contribution action against the Company. Subsidiaries of the Company had a presence on the site from 1917-1925 and again from 1939-1946, for the most part, coinciding with World Wars I and II when the Company built war ships at the direction of the United States government. Several parties in 2000 hired an allocator to assign percentages of responsibility to all parties, historical and present, notwithstanding potential defenses or contractual claims. While the Company did not participate in the allocation process, the allocator's findings were taken into account in including an estimate of potential liability in the Company's reserve discussed below.
The Company has further been notified by the Commencement Bay Natural Resource Trustees ("Trustees") that the parties occupying the aforementioned property subsequent to 1946 have been allocated liability for natural resource damages. While the Trustees have not submitted a claim against the Company for natural resource damages, they have invited the Company to participate in a mediation with the PRPs to resolve intra-facility allocation issues. The Company is investigating the potential of any liability it may currently have for its presence on the site during World Wars I and II when it built war ships at the direction of the United States government.
The Company entered into a Consent Decree with the EPA for the clean up of the Casmalia Resources Hazardous Waste Management Facility in Santa Barbara County, California under the Resource Conservation and Recovery Act. The Company has included an estimate of the potential liability for this site in its below stated reserves. Immaterial payments began in fiscal year 1997 and will extend for up to ten years.
Asbestos-Related Claims and Insurance
The Company has been named as a defendant in civil actions by parties alleging damages from past exposure to toxic substances, generally asbestos, at closed former Company facilities.
The cases generally include as defendants, in addition to the Company, other ship builders and repairers, ship owners, asbestos manufacturers, distributors and installers, and equipment manufacturers and arise from injuries or illnesses allegedly caused by exposure to asbestos or other toxic substances. The Company assesses claims as they are filed and as the cases develop, analyzing them in two different categories based on severity of illness. Based on current fact patterns, certain diseases including mesothelioma, lung cancer and fully developed asbestosis are categorized by the Company as "malignant" claims. All others of a less medically serious nature are categorized as "non-malignant". The Company is currently defending approximately 25 "malignant" claims and approximately 563 "non-malignant" claims.
The relief sought in all cases varies greatly by jurisdiction and claimant. Included in the approximate 409 cases open as of March 28, 2004 are approximately 588 claimants. The exact number of claimants is not determinable as approximately 150 of the open cases include multiple claimant filings against 30-100 defendants. The filings do not indicate which claimants allege liability against the Company. The previously stated 599 claimants is the Company's best estimate taking known facts into consideration.
Approximately 373 claimants do not assert any specific amount of relief sought.
Approximately 160 claims contain standard boilerplate language asserting on behalf of each claimant a claim for damages of $2 million compensatory and $20 million punitive against approximately 100 defendants. Approximately 20 claims set forth the same boilerplate language asserting $10-$20 million in compensatory and $10-$20 million in punitive damages on behalf of each claimant against approximately 30- 100 defendants. Approximately 20 cases assert $1-$15 million in compensatory and $5-$10 million in punitive damages on behalf of each claimant against approximately 30-100 defendants.
Approximately 10 claimants seek compensatory damages of less than $100,000 per claim and approximately 5 claimants seek compensatory damages between $1 million and $15 million. The claims involved in the foregoing cases do not specify against which defendants which claims are made or alleged dates of exposure.
Based upon settled or concluded claims to date, the Company has not identified any correlation between the amount of the relief sought in the complaint and the final value of the claim. The Company and its insurers are vigorously defending these actions.
As a result of claims resolution during fiscal year 2004, bodily injury reserves declined from $9.4 million at March 30, 2003 to $8.1 million at March 28, 2004. Likewise, bodily injury insurance receivables declined from $7.1 million to $5.8 million. These bodily injury liabilities and receivables are classified within the Company's Consolidated Balance Sheets as environmental and other reserves, and insurance receivables, respectively.
The Company has entered into agreements with several of its insurers to provide coverage for a significant portion of settlements and awards related to these bodily injury claims. These agreements have aggregate limits on amounts to be paid overall and formulas for amounts of payment on individual claims. The two most significant agreements provide coverage applicable to claims of exposure to asbestos occurring between 1949 and 1976 and occurring between 1976 through 1987. Insurance coverage for exposures to asbestos was no longer available from the insurance industry after 1987. Due to changes in federal regulations in the 1970's which resulted in the swift decline in commercial and military application of asbestos and increased regulation over the handling and removal of asbestos, there exists minimal risk of claims arising from exposure after 1987. Contractual formulas are utilized to determine the amount of coverage from each agreement on each claim settled or litigated. Once the initial date of alleged exposure to asbestos is determined, all contractual years subsequent to that date participate in the settlement. Since all known claims involve alleged exposure prior to 1976, the 1976 through 1987 agreement will participate in the settlement or judgement of all outstanding claims that are settled or litigated. As a result, and as the years remaining calculation set forth below indicates, the 1976 through 1987 agreement will exhaust prior to the 1949 through 1976 agreement. Based on historical claims settlement data only, the Company projects that at March 28, 2004, the 1949 through 1976 agreement will provide coverage for an additional 21.6 years and the 1976 through 1987 agreement will provide coverage for an additional 5.4 years. At March 30, 2003, the Company projected that these agreements would provide coverage for an additional 20.4 years and 5.2 years, respectively. The Company resolved 15 malignant claims in 2004 compared with 13 in 2003 and 20 in 2002. If historical settlement patterns or the rate of filing for new cases change in future periods, these estimated coverage periods could be shorter or longer than anticipated. Moreover, if one or both of these coverages are exhausted at some future date, the Company's share of responsibility will increase for any subsequent claims' and legal expense previously covered by these insurance agreements. In addition to providing coverage for assessments or settlements of claims, the agreements also provide for costs of defending and processing such claims.
Due to uncertainties of the number of cases, the extent of alleged damages, the population of claimants and size of any awards and/or settlements, there can be no assurance that the current reserves will be adequate to cover the costs of resolving the existing cases. Additionally, the Company cannot predict the eventual number of cases to be filed against it or their eventual resolution and does not include in its reserve amounts for cases that may be filed in the future. However, it is probable that if future cases are filed against the Company it will result in additional costs arising either from its share of costs under current insurance in place arrangements or due to the exhaustion of such coverage. The Company reviews the adequacy of existing reserves periodically based upon developments affecting these claims, including new filings and resolutions, and makes adjustments to the reserve and related insurance receivable as appropriate.
As the Company is not able to estimate its potential ultimate exposure for filed and unfiled claims against the Company, it cannot predict whether the ultimate resolution of the bodily injury cases will have a material effect on the Company's results of operations or stockholders' equity.
The Company has recorded $0, $0.6 million and $0 in charges against earnings in fiscal years 2004, 2003, and 2002, respectively relating to additional reserves for environmental and bodily injury matters. These charges are classified in the Company's Consolidated Statements of Income as a Provision for environmental and other reserves. The Company's remediation costs and bodily injury claims paid are charged against the reserves recorded when paid. In certain cases, amounts paid by the Company are reimbursable under its existing contractual arrangements with several insurance companies. These reimbursements are recorded against the environmental insurance asset when collected. In other cases, the Company manages work conducted by third party vendors and submits invoices to its insurance companies for reimbursement on behalf of the third party vendor. In these cases, the insurance companies reimburse the third party vendor directly. These expenses and payments associated with third party vendors are taken into consideration when estimating the Company's environmental and bodily injury liabilities and amounts available for reimbursement under its contractual arrangements. In addition to providing coverage for assessments or settlements of claims, the agreements also provide for costs of defending and processing such claims.
The Company continues to negotiate with its insurance carriers and prior landowners and operators for certain past and future remediation costs. The Company has reached various agreements with its insurance carriers regarding the carriers' obligations for property damage occurring in previous fiscal years. These settlements were recorded as income and totaled $0.2 million, $0.1 million and $0.5 million in fiscal years 2004, 2003 and 2002, respectively. These settlements are classified in the Company's Consolidated Statements of Income as Other insurance settlements.
The Company has provided total aggregate reserves of $32.0 million as of March 28, 2004 for the above, described contingent environmental and bodily injury liabilities. Due to the complexities and extensive history of the Company's environmental and bodily injury matters, the amounts and timing of future expenditures is uncertain. As a result, there can be no assurance that the ultimate resolution of these environmental and bodily injury matters will not have a material adverse effect on the Company's financial position, cash flows or results of operations.
The Company has various insurance policies and agreements that provide coverage on the costs to remediate environmental sites and for the defense and settlement of bodily injury cases. These policies and agreements are primarily with two insurance companies. Based upon the current credit rating of both of these companies, the Company anticipates that both parties will be able to perform under the policy or agreement. As of March 28, 2004, the Company has recorded an insurance receivable asset of $29.2 million to reflect contractual arrangements with several insurance companies to share costs for certain environmental matters.
Included in the reserves are sediment remediation costs for Harbor Island of $13.5 million that are expected to occur in fiscal year 2005. These costs are reflected in the Company's balance sheet under current liabilities. Likewise, the insurance receivable of $13.5 million relating to these reserves is reflected in the Company's balance sheet under current assets.
Other Reserves During the first quarter of fiscal year 2004, the Company recorded a reserve of $2.5 million related to the unanticipated bankruptcy of one of its previous insurance carriers. The reserve, which reflects the Company's best estimate of the known liabilities associated with unpaid workers compensation claims arising from the two-year coverage period commencing October 1, 1998, is subject to change as additional facts are uncovered. These claims have reverted to the Company due to the liquidation of the insurance carrier. Although the Company expects to recover at least a portion of these costs from the liquidation and other sources, the amount and the timing of any such recovery cannot be estimated currently and therefore no estimate of amounts recoverable is included in the current financial results.
Since establishing the reserve during the first quarter, the Company has paid approximately $0.2 million in claims, which have been charged against the reserve.
12. OTHER CONTINGENCIES
The Company is subject to various risks and is involved in various claims and legal proceedings arising out of the ordinary course of its business. These include complex matters of contract performance specifications, employee relations, union proceedings, tax matters and Government procurement regulations. In addition, the Company is subject to various risks from natural disasters such as the earthquake that struck the Puget Sound area during fiscal year 2001. Only a portion of these risks and legal proceedings involving the Company are covered by insurance, because the availability and coverage of such insurance generally has declined or the cost has become prohibitive.
The Company does not believe these risks or legal matters will have a material adverse impact on its financial position, results of operations, or cash flows. However, the Company continues to evaluate its exposures in each of these areas and may revise its estimates as necessary.
As a general practice within the defense industry, the Defense Contract Audit Agency ("DCAA") and other government agencies continually review the cost accounting practices of Government contractors. In the course of these reviews, cost accounting issues are identified, discussed and settled or resolved through agreements with the government's authorized contracting officer or through legal proceedings. Other than normal cost accounting issues raised by the DCAA as a result of their regular, ongoing reviews, the Company is not aware of any outstanding issues with the DCAA.
13. COLLECTIVE BARGAINING AGREEMENT
Todd Pacific Shipyards currently operates under the terms and conditions of a collective bargaining agreement with the Puget Sound Metal Trades Council (the bargaining umbrella for all unions at Todd Pacific Shipyards). The three-year agreement is in effect from August 1, 2002 to July 31, 2005. The Company believes its relationship with its labor unions to be stable.
During fiscal year 2004, an average of approximately 913 of the Company's Shipyard employees were covered by the collective bargaining agreement. At March 28, 2004 approximately 685 Company employees were covered under this contract.
14. TREASURY STOCK
During the third quarter of fiscal year 2003, the Board of Directors approved the repurchase of up to 500,000 shares of the Company's common stock from time to time in open market or negotiated transactions. Under this authorization, during the first quarter of fiscal year 2004, the Company repurchased an aggregate of 22,400 shares in open market transactions. The shares were purchased at an average price of $12.94 per share for a total consideration of $289,887.
The Company repurchased an aggregate of 19,500 shares during fiscal year 2003 in open market transactions at an average price of $12.44 per share for total consideration of $242,592.
During the first quarter of fiscal year 2002, the Company announced a tender offer for up to 4.0 million shares of the Company's Common Stock at a price of not in excess of $8.25 or less than $7.00 per share. The exact price was determined by a procedure commonly referred to as a "Dutch Auction." This offer to repurchase up to 4.0 million shares from existing stockholders was approximately 42.7% of the total number of shares outstanding at that time.
Following verification of the tenders and receipt of shares tendered subject to guarantees of delivery, an aggregate of 4,136,124 shares were validly tendered at a price of $8.25 per share. The Company elected to increase the number of shares to be purchased in order to avoid proration procedures otherwise applicable to the offer, resulting in an aggregate purchase price of $34.1 million. The Company incurred expenses in connection with this offer of approximately $0.5 million. The Company utilized available cash and proceeds from available-for-sale securities to fund the share repurchases completed through the offer.
The following table summarizes the total number of common shares outstanding, held in treasury and issued by the Company during the past three fiscal years.
Total Shares of Common Stock Held in Outstanding Treasury Issued As of April 1, 2001 9,362,680 2,593,353 11,956,033 Shares Repurchased Through Dutch Auction (4,136,124) 4,136,124 - Options Exercised 56,666 (56,666) - As of March 31, 2002 5,283,222 6,672,811 11,956,033 Shares repurchased (19,500) 19,500 - Options Exercised 7,334 (7,334) - As of March 30, 2003 5,271,056 6,684,977 11,956,033 Shares repurchased (22,400) 22,400 - Options Exercised 154,000 (154,000) - As of March 28, 2004 5,402,656 6,553,377 11,956,033
15. INCOME PER SHARE
The following table sets forth the computation of basic and diluted net income per share:
March 28, March 30, March 31, 2004 2003 2002 (in thousands, except per share amount) Numerator: Numerator for basic and diluted net income per share: Net income $ 4,032 $ 4,110 $ 7,018
Denominator: Denominator for basic net income per share - weighted average common shares outstanding 5,306 5,283 6,677 Effect of dilutive securities Stock options based on the treasury stock method using average market price 263 270 150 Denominator for diluted net income per share 5,569 5,553 6,827
Basic income per share $ 0.76 $ 0.78 $ 1.05 Diluted income per share $ 0.72 $ 0.74 $ 1.03
16. STOCK BASED COMPENSATION
The Company's Incentive Stock Compensation Plan (the "Plan"), approved by the Board of Directors in 1993 and subsequently ratified by the shareholders, provided for the granting of incentive stock options, non-qualified stock options, and restricted stock or any combination of such grants to directors, officers and key employees of the Company. An aggregate of 1,000,000 shares of common stock had been authorized for issuance under the Plan. Options issued under that Plan generally vest ratably over three years and expire not more than ten years from the date of grant and were granted at prices equal to the fair value on the date of grant. The Plan expired in 2003. At the time of expiration, there were 135,000 options that had not been granted under the Plan and they expired as well.
In anticipation of the expiration of the Plan, the Board of Directors approved the Todd Shipyards Corporation 2003 Incentive Stock Option Plan ("2003 Plan") in 2003 and it was ratified by the shareholders at the 2003 Annual Meeting. The 2003 Plan provides for the granting of incentive stock options, non- qualified stock options, performance share awards and restricted stock grants or any combination of such grants or awards to directors, officers and key employees of the Company to purchase shares of the Class A Common Stock of the Company. An aggregate of 250,000 shares of common stock has been authorized for issuance under the 2003 Plan.
A summary of stock option transactions for the years ended March 28, 2004, March 30, 2003 and March 31, 2002 is as follows: Weighted Average Shares Number Option Price Exercise Exercisable of Shares Per Share Price Outstanding, April 1, 2001 625,000 4.25 to 7.94 6.01 Exercisable, April 1, 2001 218,333 - 4.25 to 7.94 4.85 Exercised (116,666) 4.25 to 6.00 4.61 Outstanding, March 31, 2002 508,334 4.25 to 7.94 6.33 Exercisable, March 31, 2002 245,001 - 4.25 to 7.94 6.00 Exercised (7,334) 4.38 to 7.94 6.32 Outstanding, March 30, 2003 501,000 4.25 to 7.94 6.33 Exercisable, March 30, 2003 374,335 - 4.25 to 7.94 6.22 Granted 100,000 14.19 14.19 Exercised (154,000) 4.25 to 7.94 5.53 Outstanding, March 28, 2004 447,000 6.55 to 14.19 8.37 Exercisable, March 28, 2004 347,000 - 6.55 to 7.94 6.69
At March 28, 2004, the Company has reserved 697,000 shares of its common stock for issuance under the Plan and the 2003 Plan.
As described in Note 1, the Company accounts for stock-based compensation to its employees and directors based on the expense recognition provisions of Financial Accounting Standards Board (FASB) Statement No. 123 (FAS No. 123), "Accounting for Stock-Based Compensation." The recognition provisions are applied to stock option grants awarded subsequent to March 31, 2002.
The outstanding stock options have a contractually weighted-average life of 4.8 years as of March 28, 2004. No options were granted during fiscal year 2002 or fiscal year 2003. The weighted average fair value of options granted in 2004 was $3.94.
The fair value of options granted in 2004 was calculated using a Black-Scholes option pricing model with the following weighted-average assumptions on the option grant date: Pa Employee Stock Option Year Ended Expected life (years) 4 Expected volatility 38% Risk-free interest rate 4% Expected dividend yield 3%
17. SUBSEQUENT EVENTS
On April 1, 2004, the Company announced the U.S. Navy had awarded to its wholly owned subsidiary, Todd Pacific Shipyards, a five-year contract under which the Navy has options to have the Company provide long-term overhaul and maintenance to the NIMITZ CLASS aircraft carriers (CVN) homeported in Puget Sound.
18. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Financial results by quarter for the fiscal years ended March 28, 2004 and March 30, 2003 and are as follows. Each quarter is 13 weeks in length. (in thousands, except per share data):
Operating Net Net income(loss) income income per Share Revenues (loss) (loss) Basic Diluted
1st Qtr 2004 $ 21,138 $ (3,720) $ (2,220) $ (0.42) $(0.42) 2nd Qtr 2004 44,433 2,619 1,980 0.37 0.35 3rd Qtr 2004 40,305 1,518 1,736 0.32 0.31 4th Qtr 2004 41,918 1,749 2,536 0.47 0.45
1st Qtr 2003 49,260 3,240 2,306 0.44 0.41 2nd Qtr 2003 40,583 2,743 1,973 0.37 0.36 3rd Qtr 2003 31,840 (613) (117) (0.02) (0.02) 4th Qtr 2003 30,128 (272) (52) (0.01) (0.01)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None
PART III
** The information for the below items will be provided in, and is incorporated by reference to the 2004 Proxy Statement.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT **
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION **
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ** AND RELATED STOCKHOLDERS MATTERS
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS **
ITEM 14.
ITEM 14. CONTROLS AND PROCEDURES
The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's "disclosure controls and procedures" (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely making known to them material information relating to the Company and the Company's consolidated subsidiaries required to be disclosed in the Company's reports filed or submitted under the Exchange Act.
There has been no change in the Company's internal control over financial reporting.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1 & 2. Financial Statements
The financial statements and financial statement schedule listed in the accompanying index to financial statements and financial statement schedules are filed as part of this annual report.
TODD SHIPYARDS CORPORATION INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm.................................................*
Report of Management ............................................*
Consolidated Balance Sheets at March 28, 2004
and March 30, 2003 ............................................*
Consolidated Statements of Income For the years ended March 28, 2004, March 30, 2003 and March 31, 2002. .............................*
Consolidated Statements of Cash Flows For the years ended March 28, 2004, March 30, 2003 and March 31, 2002. .............................*
Consolidated Statements of Stockholders' Equity For the years ended March 28, 2004, March 30, 2003 and March 31, 2002. .............................*
Notes to Consolidated Financial Statements For the years ended March 28, 2004, March 30, 2003 and March 31, 2002. .............................*
Consolidated Financial Statement Schedule II-Valuation and Qualifying Reserves.......................... *
All other schedules have been omitted because the required information is included in the Consolidated Financial Statements, or the notes thereto, or is not applicable or required.
3. Exhibits
The exhibits listed below are filed as part of, or furnished with, this annual report. Exhibits 32.1, 32.2, 99.1 are furnished rather than filed for purposes of the Securities Exchange Act of 1934 and shall not be deemed incorporated into any other filing by the Registrant unless such filing specifically provides for such incorporation.
Exhibit Number 3-1 Certificate of Incorporation of the Company * dated November 29, 1990 filed in the Company's Form 10-K Report for 1997 as Exhibit 3-1.
3-2 By-Laws of the Company dated November 29, 1990, * as amended October 1, 1992 filed in the Company's Form 10-K Report for 1993 as Exhibit 3-2.
10-1 Savings Investment Plan of the Company effective * April 1, 1989 filed in the Company's Form 10-K Report for 1995 as Exhibit 10-9.
10-2 Todd Shipyards Corporation Retirement System Plan * and Amendments thereto filed in the Company's Form 10-K Report for 1995 as Exhibit 10-10.
10-3 Todd Shipyards Corporation Incentive Stock * Compensation Plan effective September 12, 2003, approved by the shareholders of the Company at the 2003 Annual Meeting of Shareholders filed as an appendix in the Company's definitive proxy statement for 2003 Annual Meeting of the shareholders.
10-4 Employment contract between the Company and Stephen G. * Welch dated February 7, 2001.
10-5 Grant of Incentive Stock Option dated February 7, 2001 * to Stephen G. Welch pursuant to the Incentive Stock Compensation Plan
10-6 Put Agreement between the Company and Stephen G. * Welch dated February 7, 2001.
10-7 Todd Shipyards Corporation Incentive Stock * Compensation Plan effective October 1, 1993, approved by the shareholders of the Company at the 1994 Annual Meeting of Shareholders filed in the Company's Form 10-K Report for 1995 as Exhibit 10-19.
10-8 Employment contract between the Company and Thomas V * dated June 4, 2003 filed in the Company's 10-K Report for 2003.
10-9 Todd Shipyards Corporation Executive Incentive # Compensation Plan effective March 31, 2003. (filed herewith)
22-1 Subsidiaries of the Company. *
23 Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm #
31.1 Certification of Chief Executive Officer pursuant # to Rule 13a-14 (filed herewith)
31.2 Certification of Chief Financial Officer pursuant # to Rule 13a-14a(filed herewith)
32.1 Certification of Chief Executive Officer pursuant to Rule 13a- # 14(b) and section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code. (furnished herewith)
32.2 Certification of Chief Financial Officer pursuant to Rule 13a- # 14(b) and section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code. (furnished herewith)
99.1 Press Release dated May 25, 2004 announcing financial results # for the Company's quarterly and nine month periods ending March 28, 2004. (furnished herewith)
Note: All Exhibits are in SEC File Number 1-5109. * Incorporated herein by reference. # Filed or furnished herewith.
(b) Reports on Form 8-K
On December 29, 2003, the Registrant filed a form 8-K, item 5, announcing that the U.S. Navy has reduced the scope of work requested to be performed by its wholly owned subsidiary, Todd Pacific Shipyards, on the AOE 1 during an upcoming availability.
On December 30, 2003, the Registrant filed a form 8-K, item 5, announcing that the U.S. Navy has awarded to its wholly owned subsidiary, Todd Pacific Shipyards, a $7,084,130 modification to previously awarded contract (N00024- 00-C-8514).
On January 14, 2004, the Registrant filed a form 8-K, item 5, announcing that it had been informed by the US Navy that the AOE 1 is scheduled to be decommissioned on or about October 1, 2004.
On January 29, 2004, the Registrant filed a form 8-K, item 5, announcing that its wholly owned subsidiary, Todd Pacific Shipyards, had entered into a contract with Electric Boat Corporation to support their work on Trident submarines.
On February 6, 2004, the Registrant filed a form 8-K, item 5, announcing that its wholly owned subsidiary, Todd Pacific Shipyards, confirmed its expected participation, along with Southwest Marine, Inc., San Diego Division, on the team lead by Bath Iron Works, a subsidiary of General Dynamics (NYSE:GD), to perform Post Shakedown Availability work on DDG-51 Aegis Destroyers.
On March 1, 2004, the Registrant filed a form 8-K, item 5, announcing that it had been notified that its wholly owned subsidiary, Todd Pacific Shipyards, had been awarded a contract with the United States Coast Guard to provide long-term maintenance of two Polar Class icebreakers.
On April 1, 2004, the Registrant filed a form 8-K, item 5, announcing that its wholly owned subsidiary, Todd Pacific Shipyards, had been awarded a five-year contract with the United States Navy to provide long-term maintenance to the NIMITZ CLASS aircraft carriers (CVN) home ported in the Puget Sound.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934 the registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.
TODD SHIPYARDS CORPORATION Registrant
By: /s/ Scott H. Wiscomb Scott H. Wiscomb Chief Financial Officer, Principal Financial Officer, Principal Accounting Officer, and Treasurer May 21, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
/s/ Brent D. Baird /s/ Steven A. Clifford Brent D. Baird, Director Steven A. Clifford, Director May 21, 2004 May 21, 2004
/s/ Patrick W.E. Hodgson David F. Jeremiah Patrick W.E. Hodgson, /s/David F. Jeremiah, Director Chairman, May 21, 2004 and Director May 21, 2004
/s/ Joseph D. Lehrer /s/ Philip N. Robinson Joseph D. Lehrer, Director Philip N. Robinson, Director May 21, 2004 May 21, 2004
/s/ Stephen G. Welch Stephen G. Welch President, Chief Executive Officer, and Director May 21, 2004
Todd Shipyards Corporation Schedule II - Valuation and Qualifying Reserves For years ending March 28, 2004, March 30, 2003 and March 31, 2002 (in thousands)
Reserves deducted from assets to which they apply - Allowance for doubtful accounts: Year Ended March 28, March 30, March 31 2004 2003 2002 Balance at beginning of period $ 98 $ 150 $ 100 Charged to costs and expenses - - 13 (Deductions) recoveries from reserves (1) (55) (52) 37 Balance at close of period $ 43 $ 98 $ 150
Reserves deducted from assets to which they apply - Allowance for obsolete inventory:
Balance at beginning of period $ 237 $ 280 $ 280 Charged to costs and expenses - - - (Deductions) recoveries from reserves (2) (98) (43) - Balance at close of period $ 139 $ 237 $ 280
Notes: (1) Deductions from reserves represent uncollectible accounts written off less recoveries.
(2) Deductions from reserves represent obsolete inventory written off.