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Saturday, September 10, 2005

Edac Technologies (EDAC) 10-K

This company (website) designs, manufactures, and services aerospace precision tooling, fixtures, molds, jet engine components, assemblies, and machine spindles. Their focus is on design and repair of precision spindles, which requires clean room technology. This seems like a good business to be in.

Today, I'm looking at their 10-K and report to shareholders.
To Our Shareholders: “Profits, like sausages.....are esteemed most by those who know least about what goes into them”.
Alvin Toffler

Our primary objective for 2004 was to build on the prior year’s achievements and start delivering profits to our shareholders. This proved to be a more elusive goal than anticipated. While our order backlog and sales increased during the first two quarters, our operating profits did not grow proportionately. However.....we continued to change and by the fourth quarter we felt that we had finally transitioned EDAC into a better balanced and profitable business.

The result is that with the increased sales in 2004 compared to 2003, our operating profit improved by $1,559,000, from a loss of ($143,000) in 2003, to income of $1,416,000 in 2004. During the year we significantly improved our cash flow position, established a new banking relationship and in January 2005, refinanced substantially all our debt, including the addition of a $1.5 million equipment line of credit that will provide for our continued growth. Similarly our balance sheet has also shown a dramatic improvement — net working capital increased by approximately $6.4 million, the ratio of current assets to current liabilities almost doubled from 0.92 to 1.83 and net worth increased by 90% to $5.2 million

Order activity continues to remain strong in all of our product lines. Sales backlog has increased from $18.3 million at January 1, 2005 to $20.2 million at the end of February 2005.

In a little over two years, EDAC has risen from the ashes... changed to ensure survival, we continue to refine our recipe, to ensure that we remain positioned for growth and for delivering profits to our shareholders. The entire team at EDAC remains committed to maximizing the value of our Company for you, our shareholders.

Sincerely yours,

Dominick A. Pagano
President and Chief Executive Officer
Year ends Jan 1, 2005, full year report. Incorp Wisconsin. Offices in Farmington, Conn.
There was a restructuring in Q4 2002 to Q1 2003.
No patents or trademarks. Not really needed.
One single customer is 34% of sales.
One single customer is 39% of sales. Warning.
They benefit from the outsourcing trend.
They have some moat due to experience, reputation, fast turnaround.
Backlog $18.3 million vs $18.0 million end of prior year. Increased spindle orders, decreased aerospace orders.
200 employees.
Properties, all in Farmington, Conn:
47,000 sq ft, owned, mfg and design
20,800 sq ft, owned, design+mfg spindles
19,200 sq ft, owned, mfg corporate offices
44,000 sq ft, owned, mfg warehouse
All real estate is mortgaged.
No legal proceedings.

William B. Bayne, Jr., 40, joined 2003, CEO and founder of BBB Corp and 23rd Street Corp (restaurant businesses)
John Moses, 60, joined 2001, private investor
Dominick A. Pagano, 61, CEO of EDAC and CEO of Dapco Industries (ultrasonic inspection equip for steel and railroad)
Stephen J. Raffay, 77, joined 2000, retired Vice Chair of Emhart Corp (mahcinery mfg)
Ross C. Towne, 61, joined 2001, CEO of The Washington Source (precision sheet metal fab and integration)
Daniel C. Tracy, 64, joined 1999, Chairman and business consultant
Joseph Lebel, 74, since 1961, retired QC mgr for EDAC

Mr. Bayne founded BBB Corporation and 23rd Street Corporation in 1988 and 1994 respectively.
Mr. Pagano became President and Chief Executive Officer of the Company in August 2002 and also serves as President and Chief Executive Officer of Dapco Industries, Inc., a company that he founded in 1972. Mr. Pagano served as Chairman of the Board of Directors of American Environmental Technologies, Inc. from 1988 until 1999. Mr. Pagano has been a director of the Company since July 2001, provided, however, that he did not serve as a director from April 2002 to October 2002.
Mr. Raffay served as a senior executive and as a director of Emhart Corporation until his retirement as Vice Chairman in 1987. Since then he has done consulting work and serves as a member of the boards of directors of a number of companies.
Mr. Towne owned Management Partners, Inc., a management consulting firm, from 1990 to 2000, specializing in business planning, organizational restructuring and operational audits. He has served as President and Chief Financial Officer of The Washington Source, Inc. since 2000.
Mr. Tracy was employed by Arthur Andersen LLP from 1963 until his retirement in 1998, serving since 1975 as a partner. Mr. Tracy is also a director of Great Western Land and Recreation, Inc.
Mr. Lebel was the Quality Control manager for the Company from 1961 until he retired in 1995. He was a director of the Company from 2001 to 2002.

he Audit Committee is comprised of three members of the Company’s Board of Directors, Messrs. Raffay, Towne and Tracy. All independent. Tracy is the financial "expert".

non-board executive:
Glenn L. Purple, 49, CFO
Mr. Purple joined the Company in February 1982 as Controller. He served as Controller until November 2002, when he was appointed as Vice President – Finance, Chief Financial Officer and Secretary of the Company. Mr. Purple also served as Vice President – Finance and Chief Financial Officer of the Company from 1989 through 1996.

Salaries are modest: CEO makes $180K. CFO makes $108K. Very little bonus or stock compensation (15,000 shares TOTAL in 2004). Pagano has 150K shares in total options.

Pension plan frozen in 1993. Only for Purple.

Beneficial Ownership
Bayne owns 10%
Lebel owns 3%
Moses owns 12%
Pagano owns 7.5% (half as options)
Purple owns very little
Towne and Tracy each own about 2-3% (half or less as options)
All directors and officers own 34.29%

247K stock options outstanding total.

No related party transations.
Audit fees: $74.5K, auditing employee benefits: $14K by same auditors (was done outside in prior year)
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements as of and for the years ended January 1, 2005 and January 3, 2004, taken as a whole, presents fairly, in all material respects, the information set forth therein
Carlin, Charron & Rosen, LLP, Mar 4, 2005
prior year auditors were D&T in Hartford

Allowances are spelled out in excellent detail each year going back to 2002. Wonderful! They cover doubtful AR, excess and obsolete inventory, and deferred taxes. Very conservative allowances. Very well managed.

Revenues increased 29.5% in 2004.
Aerospace customers decreased from $17.5 million to $16.9 million
"Other" customers increased from $8.2 million to $16.4 million, due to new sales to the machine tool industry.
Gross margins up from 10.7% to 12.2% due to increased sales, partially offset by higher expendable tool and repair maintenance costs.
SG&A decreased 8.3% from a drop in professional expenses.
$250K gain from forgiveness of debt.

Jan 1, 2005, decided that Company will realize $1.5 million in deferred tax assets (SFAS 109). So they reduced the valuation allowance (aka contra asset) by $1.432 million.

During 2003, sales to non-aerospace customers increased 28.3%, same reason. Aerospace decreased 10.2%, decline of jet engine market. Gross margins improved, with and without the restructuring events. Consolidation. SG&A decreased slightly due to reduced prof expenses (it decreased even more due to one-time costs in 2002).

$7.3 million gain on restructuring of debt. Chewed up some NOLs.

Excellent table on the debt. Mostly revolver and mortgages. Terms are 30-day paper index + 3.75% to 4%. Primary lender secured by AR, inventory, equipment, etc.

As of Jan 5, 2005: new refinancing. $5 million revolver (with formula limitations) plus $5 million term loan plus equipment line up to $1.5 million. All pretty much prime + 1. Equipment loan converts to a term note, 60 months, FHLBB5 + 2.5.

Cash flow 2004: operations cash earnings, increase in AP partially offset by an increase in AR. Investments were machinery to increase capacity. Finance repayment of long-term bank loan, net of borrowings on revolver.

2005 capex estimate: $1.5 million to $3 million to increase capacity

Pension frozen in 1993. Rate of return assumption is 7% (not terrible, but on the optimistic side). They beat 7% in 2004. Discount rate 6%. Decreasing the return by 0.5% would increase pension expense by $17K for 2004. $200K contributed in 2004, they expect more contributions in the future (good). Expect $300K in 2006.

Balance Sheet:
Current assets are mostly AR and inventory. Long term assets are mostly machinery and buildings. 66% depreciated. Total assets $22 million (only $5.2 million equity).

AR doubled during 2004. Inventories decreased somewhat.
Deferred income taxes $766K (up from $259K at end of 2003).

Current liabilities are mostly AP with some current debt and salaries etc. Current ratio is $12.7 million / $7.0 million.

Net income was $2.9 million with $1.83 million benefit from income taxes.

Cash flow from ops was only $990K. $250K gain on forgiveness of debt, $1.5 million deferred income taxes, $3.4 million increase in AR. Partially offset by $1.8 million deprec, $1.2 million AP, $427K other. Capex was $202K.

So they basically had $800K in free cash flow in 2004.

Changes in Equity: Glorious lack of extensive stock options.

Inventory is mostly work-in-prog, then finished goods, then raw materials. 14.4% reserves for excess and obsolete.

In 2004, the largest customer paid $1.8 million in connection to contracts that had been put on hold in 2002. Inventory was reduced by $1.0 million.

Depreciation: 3-12 years for machinery, 25 years for buildings.

All kinds of stuff happened in 2002 and 2003. Humorous example of screwyness of accounting: the Company decides to sell a building, an auction was held, it went for more than book value, Company changed their mind about selling it, then realized a gain of $177K.

Total share count including all potentially dilutive shares: 4.7 million

37% of AR is from one company. It was far higher in prior years (54%). 32% is from another company. This one has increased over the years.

Pension obligation: $6.3 million, $424K paid in 2004, $393 paid in 2003. Return on assets was $446K in 2004, $553K in 2003. Assets at end of year $4.6 million.

Deferred tax assets are mostly goodwill writeoffs and NOL. Deferred tax liabilities are essentially all PP&E.

Lease commitments are not an issue.

Thanks to JB.

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