SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

SCHEDULE 14A INFORMATION

Proxy Statement Pursuant to Section 14(a) of the Securities
Exchange Act of 1934 (Amendment No.           )

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o Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12

ENVIRONMENTAL TECTONICS CORPORATION

(Name of Registrant as Specified In Its Charter)

(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)

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ENVIRONMENTAL TECTONICS CORPORATION

 

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

 

          , 2009

 

TO THE SHAREHOLDERS OF ENVIRONMENTAL TECTONICS CORPORATION:

 

The Annual Meeting of the Shareholders of Environmental Tectonics Corporation (“ETC” or the “Company”) will be held at the executive offices of the Company, 125 James Way, County Line Industrial Park, Southampton, Pennsylvania on          , 2009, at 10:00 a.m. for the following purposes:

 

I. To elect five Directors to serve on the Board of Directors until their successors have been elected and qualified.

 

II. To approve the Company’s 2009 Employee, Director and Consultant Stock Plan.

 

III. To approve an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares.

 

IV. To approve the exchange of the $10,000,000 subordinated convertible promissory note held by H. F. Lenfest, together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by H. F. Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company.

 

V. To approve the restoration of the voting rights of certain securities currently held by or issuable to H. F. Lenfest as part of the financing transaction described herein.

 

VI. To transact such other business as may properly come before the Annual Meeting.

 

The Board of Directors has fixed the close of business on May 14, 2009 as the record date for the determination of shareholders entitled to notice of and to vote at the Annual Meeting.

 

WHETHER OR NOT YOU EXPECT TO ATTEND THE ANNUAL MEETING, PLEASE SIGN AND DATE THE ENCLOSED PROXY AND RETURN IT PROMPTLY IN ORDER THAT YOUR SHARES MAY BE VOTED. TO SIMPLIFY THIS PROCESS, YOUR VOTE MAY BE CAST BY MAIL AND IN MOST INSTANCES ALSO BY TELEPHONE OR THROUGH THE INTERNET. YOUR FAILURE TO VOTE MAY RESULT IN A “NO” VOTE UNDER CERTAIN CIRCUMSTANCES, REGARDLESS OF WHETHER YOU ARE ACTUALLY IN FAVOR OF A SPECIFIC PROPOSAL. IF YOU ATTEND THE ANNUAL MEETING, YOU MAY WITHDRAW YOUR PROXY AND VOTE IN PERSON.

 

Notice of Internet Availability of Proxy Materials: This notice of Annual Meeting, the accompanying proxy statement and proxy card are available on our website at http://www.etcusa.com.

 

THIS PROXY STATEMENT CONSTITUTES THE INFORMATION STATEMENT THAT IS REQUIRED TO BE DELIVERED TO THE SHAREHOLDERS OF ETC PURSUANT TO SECTION 2565 OF THE PENNSYLVANIA BUSINESS CORPORATION LAW, AS AMENDED.

 

 

By Order of the Board of Directors

 

ANN M. ALLEN, Secretary

 

          , 2009

 

TABLE OF CONTENTS

 

ENVIRONMENTAL TECTONICS CORPORATION
125 James Way
County Line Industrial Park
Southampton, Pennsylvania 18966

 

 

PROXY STATEMENT

 

          , 2009           

 

 

 

Solicitation of Proxies

 

This proxy statement is furnished in connection with the solicitation by the Board of Directors of Environmental Tectonics Corporation, a Pennsylvania corporation (“ETC” or the “Company”), and its agent, Laurel Hill Advisory Group, LLC (“Laurel Hill”), of proxies for use at the Annual Meeting of Shareholders to be held at 10:00 a.m. on          , 2009, at our executive offices at 125 James Way, County Line Industrial Park, Southampton, Pennsylvania 18966 and at any postponement or adjournment thereof. This proxy statement and accompanying form of proxy are being provided to shareholders on or about          , 2009, along with our 2009 Annual Report on Form 10-K. In addition to the use of the mails, proxies may be solicited personally or by telephone, e-mail or facsimile transmission by Directors, officers and employees of ETC or Laurel Hill who, with the exception of Laurel Hill, will not be specially compensated for such solicitation activities. The expense of soliciting proxies will be borne by the Company. The amount ETC will pay Laurel Hill for its proxy solicitation services is $10,000, plus certain out-of-pocket expenses. ETC will also make arrangements with brokers, dealers, nominees, custodians and fiduciaries to forward proxy soliciting materials to the beneficial owners of shares held of record by such persons, and ETC may reimburse them for their reasonable expenses incurred in forwarding materials.

 

Voting and Revocation of Proxies

 

When a proxy is properly executed and returned in time to be voted at the Annual Meeting, the shares represented thereby will be voted at the Annual Meeting in accordance with the instructions marked thereon.

 

Signed proxies not marked to the contrary will be voted “FOR” (i) the election of the Board of Directors’ nominees, (ii) the approval of the Company’s 2009 Employee, Director and Consultant Stock Plan, (iii) the amendment of the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares, (iv) the exchange of the $10,000,000 subordinated convertible promissory note held by H. F. Lenfest (“Lenfest”), together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company and (v) the restoration of the voting rights of certain securities currently held by or issuable to Lenfest as part of the financing transaction described herein. The Board of Directors knows of no matters other than those that are described in this Proxy Statement that may be brought before the Annual Meeting. Lenfest is a significant shareholder and a member of the Board of Directors of ETC.

 

Signed proxies will be voted “FOR” or “AGAINST” any other matter that properly comes before the Annual Meeting or any postponement or adjournment thereof, in the discretion of the persons named as proxyholders. Any such proxy may be revoked at any time before its exercise by (i) executing and delivering a later dated proxy to the Secretary of the Company or granting a subsequent proxy by telephone or Internet, (ii) giving written notice of revocation to the Secretary of the Company, or (iii) voting in person at the Annual Meeting. Our mailing address is 125 James Way, County Line Industrial Park, Southampton, Pennsylvania 18966.

Quorum and Voting Requirements

 

Each share of common stock outstanding is entitled to one vote on the matters on which shares of common stock are entitled to vote, except as noted below. For purposes of the discussion below regarding both quorum requirements and the votes necessary for Proposal V, shareholders of record who are present at the Annual Meeting and who abstain, including brokers holding customers’ shares of record who cause abstentions to be recorded at the Annual Meeting, are considered shareholders who are present for quorum purposes and who are entitled to vote. Except as expressly noted below, all holders of common stock of ETC are entitled to vote on all matters listed in the Annual Meeting notice.

 

Lenfest directly holds 2,395,037 shares of ETC common stock. Lenfest also holds 6,000 shares of Series B Preferred Stock, 3,300 shares of Series C Preferred Stock and 55 shares of Series D Preferred Stock, which are entitled under their respective terms, unless otherwise limited by law, to vote with the common shares on an as-converted basis. Lenfest’s shares of Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock are convertible into 2,202,781 shares of ETC common stock. As such, including his actual shares of common stock and his as-converted common shares resulting from his Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock, Lenfest holds a total of 4,597,818 shares of ETC common stock. However, due to the application of Subchapter 25G of the Pennsylvania Business Corporation Law (as described under Proposal V below), Lenfest can vote only 3,345,669 of these 4,597,818 shares for all of the proposals (1,591,989 actual shares and 1,753,680 of his equivalent shares under his preferred stock holdings). Further, with respect to Proposal V (restoration of the voting rights of certain securities currently held by or issuable to Lenfest as part of the financing transaction described herein), which involves two separate votes, Lenfest will not be entitled to vote any of his shares with respect to one of the two votes. In summary, Lenfest can vote an equivalent of 3,345,669 shares for Proposals I through IV and for the first vote under Proposal V. Lenfest cannot vote any of his shares for the second vote under Proposal V.

 

As of the record date for the Annual Meeting, there were 9,069,351 shares of ETC common stock outstanding. In addition, as described above, Lenfest holds Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock that are convertible into 2,202,781 shares of ETC common stock. However, due to a limitation under Pennsylvania law as described above, only 1,591,989 actual shares and 1,753,680 equivalent shares held by Lenfest can vote. Thus, a total of 10,019,983 shares (8,266,303 shares of ETC common stock outstanding and 1,753,680 equivalent shares held by Lenfest) will be eligible to vote at the Annual Meeting. However, with respect to Proposal V, which involves two separate votes, none of Lenfest, William F. Mitchell or Duane D. Deaner will be entitled to vote any of their shares with respect to one of the two votes. With respect to this vote, only 5,592,990 shares of ETC common stock will be eligible to vote.

 

Brokers holding shares of record for customers generally are not entitled to vote on certain matters unless they receive voting instructions from their customers. As used herein, “uninstructed shares” means shares held by a broker which has not received instructions from its customers and which has so notified the Company on a proxy form in accordance with industry practice or otherwise advised the Company that it lacks voting authority. Uninstructed shares with respect to any matter are not considered to be present for quorum purposes on that matter. As used herein, “broker non-votes” means the votes that could have been cast on the matter in question by brokers with respect to uninstructed shares if they had received their customers’ instructions. Although there are no controlling precedents under Pennsylvania law regarding the treatment of broker non-votes, the Company intends to apply the principles set forth herein.

 

Proposal I (Election of Directors):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast in the election. Directors are elected by a plurality and the five nominees who receive the most votes will be elected. Abstentions and broker non-votes will not be taken into account in determining the outcome of the election.

 

Proposal II (Approval of the Company’s 2009 Employee, Director and Consultant Stock Plan):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on the matter. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the

shares entitled to vote is present). The matter will be approved if the majority of votes cast at the Annual Meeting on Proposal II are FOR approval of the Company’s 2009 Employee, Director and Consultant Stock Plan. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal III (Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on the amendment. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the shares entitled to vote is present). The matter will be approved if the majority of votes cast are FOR approval of the amendment to the Company’s Articles of Incorporation. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal IV (Exchange of the $10,000,000 subordinated convertible promissory note held by Lenfest, together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on the exchange. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the shares entitled to vote is present). The matter will be approved if the majority of votes cast are FOR approval of the exchange. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal V (Restoration of the voting rights of certain securities held by Lenfest currently or issuable to Lenfest as part of the financing transaction described herein):  This proposal requires two votes (“Vote V-1” and “Vote V-2”). The quorum for Vote V-1 is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on approval of the restoration (i.e., a quorum represents more than 50% of all the shares that are entitled to vote on this matter). The quorum for Vote V-2 is the presence of shareholders (other than Lenfest, William F. Mitchell and Duane D. Deaner) that are entitled to cast a majority of the votes that all such shareholders are entitled to cast on the matter. Proposal V will be approved if, for V-1, the votes FOR Proposal V constitute a majority of the votes that all shareholders are entitled to cast and if, for V-2, the votes FOR Proposal V constitute a majority of the votes that all shareholders (other than Lenfest, William F. Mitchell and Duane D. Deaner) are entitled to cast (as described above). In determining whether the proposal is approved, abstentions and broker non-votes will have the same effect as negative votes.

 

Why am I receiving this proxy statement and proxy card?

 

Our Board of Directors is soliciting your proxy for our Annual Meeting of Shareholders scheduled to take place at 10:00 a.m. on          , 2009 at the executive offices of the Company, 125 James Way, County Line Industrial Park, Southampton, Pennsylvania. You are receiving a proxy statement and proxy card because our records indicate that you own shares of our common stock. This proxy statement describes the matters on which we would like you, as a shareholder, to vote. It also gives you information on these matters so that you can make an informed decision.

 

What information is contained in these materials?

 

The information included in this proxy statement relates to the proposals to be voted on at the Annual Meeting, the voting process, the compensation of Directors and our most highly paid executive officers, and other required information. Our Annual Report on Form 10-K for the fiscal year ended February 27, 2009 is also enclosed.

 

Who may vote at the Annual Meeting?

 

Common stock is the only class of stock that is entitled to vote at the Annual Meeting. Holders of ETC’s common stock and holders of other classes of stock which are entitled to vote on a common stock equivalent basis may vote their shares at the Annual Meeting. Other than shareholders who hold common stock, Lenfest is the only shareholder who can vote equivalent common shares. As noted above, Lenfest holds common stock and also holds Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock which are entitled to vote on an as-converted basis pursuant to their terms. However, due to the application of Subchapter 25G of the Pennsylvania Business Corporation Law (as described under Proposal V below), certain securities held by Lenfest are not entitled to vote on any matters to be voted on at the Annual Meeting. As of the record date, there were 9,069,351 shares of ETC common stock outstanding. In addition, the Series B Preferred Stock, Series C Preferred Stock and Series D Preferred Stock held by Lenfest are convertible into 2,202,781 shares of ETC common stock. Due to the limitations noted above, Lenfest can vote only 1,591,989 of his actual shares and 1,753,680 of his equivalent shares. Thus, a total of 10,019,983 shares (8,266,303 shares of ETC common stock outstanding and 1,753,680 equivalent shares held by Lenfest) will be eligible to vote at the Annual Meeting. However, with respect to Proposal V, which involves two separate votes, none of Lenfest, William F. Mitchell or Duane D. Deaner will be entitled to vote any of their shares with respect to one of the two votes. With respect to this vote, only 5,592,990 shares of ETC common stock will be eligible to vote.

 

What are the voting rights of ETC shareholders?

 

Each shareholder is entitled to one vote per common share on all matters.

 

What proposals will be voted on at the Annual Meeting?

 

You are voting on the following matters at the Annual Meeting:

 

I. To elect five Directors to serve on the Board of Directors until their successors have been elected and qualified.

 

II. To approve the Company’s 2009 Employee, Director and Consultant Stock Plan.

 

III. To approve an amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares.

 

IV. To approve the exchange of the $10,000,000 subordinated convertible promissory note held by Lenfest, together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company.

 

V. To approve the restoration of the voting rights of certain securities currently held by or issuable to Lenfest as part of the financing transaction described herein.

 

VI. To transact such other business as may properly come before the Annual Meeting.

 

Approval of Proposals III, IV and V will result in a change of control of ETC.

 

What happens if additional proposals are presented at the Annual Meeting?

 

Other than the proposals described in this proxy statement, we do not expect any matters to be presented for a vote at the Annual Meeting. If you grant a proxy, the persons named as proxy holders, Duane D. Deaner, our Chief Financial Officer, and James D. Cashel, our General Counsel, will have the discretion to vote your shares on any additional matters properly presented for a vote at the Annual Meeting. If for any unforeseen reason any of our nominees is not available as a candidate for Director, the persons named as proxy holders will vote your shares for such other candidate or candidates as may be nominated by the Board of Directors.

 

What is ETC’s voting recommendation?

 

Our Board of Directors recommends that you vote your shares “FOR” each of the nominees set forth in Proposal I and “FOR” each of Proposals II, III, IV, and V set forth in this proxy statement.

 

How many votes must be present to vote on the Proposals?

 

In order to vote on a Proposal, a certain number of shares of ETC common stock eligible to vote on the record date must be present at the Annual Meeting. The presence of such number of shares is called a quorum. Set forth below is the quorum requirement for each of the Proposals. Your shares are counted as present at the Annual Meeting if you attend and vote in person or if you properly return a proxy card. With respect to Lenfest, he can vote 1,591,989 actual shares and 1,753,680 of his equivalent shares under his preferred stock holdings for all of the Proposals except for Vote V-2 under Proposal V described below.

 

Except with respect to Vote V-2 described below, the quorum for each of the following proposals consists of the presence of more than 50% of all the votes that are entitled to vote on the matter. With respect to Vote V-2, the quorum is presence of shareholders (other than Lenfest, William F. Mitchell and Duane D. Deaner) that are entitled to cast a majority of the votes that all such shareholders are entitled to cast on the matter.

 

Proposal I (Election of Directors):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast in the election.

 

Proposal II (Approval of the Company’s 2009 Employee, Director and Consultant Stock Plan):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on approval of the plan. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the shares entitled to vote is present).

 

Proposal III (Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on approval of the amendment. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the shares entitled to vote is present).

 

Proposal IV (Exchange of the $10,000,000 subordinated convertible promissory note held by Lenfest, together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company):  On this matter, the quorum for the Annual Meeting is the presence of shareholders entitled to cast a majority of the votes that all

shareholders are entitled to cast on approval of the exchange. Shares held of record by brokers as uninstructed shares as defined above are not entitled to vote on this matter and, therefore, will not be taken into account in determining the presence of a quorum (i.e., will not be in the numerator or denominator in determining whether a majority of the shares entitled to vote is present).

 

Proposal V (Restoration of the voting rights of certain securities held by Lenfest currently or issuable to Lenfest as part of the financing transaction described herein):  This proposal requires two votes (“Vote V-1” and “Vote V-2”). The quorum for Vote V-1 is the presence of shareholders entitled to cast a majority of the votes that all shareholders are entitled to cast on approval of the restoration (i.e., a quorum represents more than 50% of all the shares that are entitled to vote on this matter). The quorum for Vote V-2 is the presence of shareholders (other than Lenfest, William F. Mitchell and Duane D. Deaner) that are entitled to cast a majority of the votes that all such shareholders are entitled to cast on the matter.

 

What vote is required to elect Directors?

 

The Board of Directors are elected by a plurality of votes which means that the five Directors receiving the highest number of votes will serve as members of the Board of Directors until their successors have been elected and qualified.

 

What vote is required on other matters?

 

The vote required for each of Proposals II, III, IV and V is set forth below.

 

Proposal II (Approval of the Company’s 2009 Employee, Director and Consultant Stock Plan):  This matter will be approved if the majority of votes cast are FOR approval of the Company’s 2009 Employee, Director and Consultant Stock Plan. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal III (Amendment to the Company’s Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 shares):  This matter will be approved if the majority of votes cast are FOR approval of the amendment to the Company’s Articles of Incorporation. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal IV (Exchange of the $10,000,000 subordinated convertible promissory note held by Lenfest, together with all accrued interest and warrants issuable pursuant to the terms of the subordinated note, and all Series B Preferred Stock and Series C Preferred Stock of the Company held by Lenfest, together with all accrued dividends thereon, for shares of a newly-created class of Series E Preferred Stock of the Company):  This matter will be approved if the majority of votes cast are FOR approval of the exchange. Abstentions and broker non-votes do not constitute votes cast and therefore will not affect the outcome of the vote.

 

Proposal V (Restoration of the voting rights of certain securities held by Lenfest currently or issuable to Lenfest as part of the financing transaction described herein):  This proposal requires two votes (“Vote V-1” and “Vote V-2”). Proposal V will be approved if, for V-1, the votes FOR Proposal V constitute a majority of the votes that all shareholders are entitled to cast and if, for V-2, the votes FOR Proposal V constitute a majority of the votes that all shareholders (other than Lenfest, William F. Mitchell and Duane D. Deaner) are entitled to cast. In determining whether the proposal is approved, abstentions and broker non votes will have the same effect as negative votes.

 

How do I vote?

 

You may vote your shares of common stock on matters that are properly presented at the Annual Meeting by any of the following methods:

 

 

For the Annual Meeting, ETC is offering record holders of common stock the opportunity to vote their shares electronically through the Internet or by telephone. Instead of submitting your vote for shares of common stock by mail on the enclosed proxy card, you may vote by telephone or via the Internet by following the procedures described on your proxy card. To vote via telephone or the Internet, please have the enclosed proxy card in hand, and call the number or access the website listed on the proxy card and follow the instructions. The telephone and Internet voting procedures are designed to authenticate shareholders’ identities, to allow shareholders to give their voting instructions, and to confirm that shareholders’ instructions have been properly recorded.

 

Can the proxy materials be accessed electronically?

 

The proxy statement for the Annual Meeting is available at www.etcusa.com. Additionally, ETC has sent the proxy materials for the Annual Meeting to shareholders on or about          , 2009 by first-class U.S. mail.

 

How do I vote if my shares of common stock are held in “street name”?

 

If you hold your shares of ETC common stock in “street name” with a broker, financial institution or another holder of record, then that entity is considered the shareholder of record for voting purposes and should give you instructions for voting your shares of common stock. As a beneficial owner of ETC common stock, you have the right to direct the record holder on how to vote the shares held on your behalf. If you hold your shares of common stock in “street name,” your record holder, or nominee, may be participating in a program that allows you to submit a proxy by telephone or via Internet. If so, the voting form your nominee sent you will provide instructions for submitting your proxy telephonically or electronically via the Internet.

 

If you hold your shares of common stock in “street name” and wish to attend the Annual Meeting and vote in person, you must bring an account statement or letter from your broker, financial institution or other holder of record authorizing you to vote on behalf of such record holder. The account statement or letter must show that you were the direct or indirect beneficial owner of shares of ETC common stock as of the close of business on May 14, 2009, the record date for voting at the Annual Meeting.

 

How do I change or revoke my proxy representing my shares of common stock?

 

A proxy may be revoked at any time before a vote is taken or the authority granted is otherwise exercised. Unless revoked, the shares of common stock represented by a submitted proxy will be voted at the Annual Meeting and any adjournment thereof. You may revoke your proxy at any time before it is actually voted or exercised at the Annual Meeting by executing and delivering a later dated proxy, by executing a later casted telephone or Internet vote with regard to the same shares, by giving notice of revocation to the Secretary of ETC in writing, or by attending the Annual Meeting and giving notice of revocation in person. Any shareholder who attends the Annual Meeting and revokes his or her proxy may vote in person. However, your attendance at the Annual Meeting alone will not revoke your proxy. The last-dated proxy you submit (by any means) will supersede any previously submitted proxy. If you hold your common stock in “street name” and instructed your broker, financial institution or other record holder to vote your shares and you would like to revoke or change your vote, then you must follow the instructions provided by your record holder.

 

How do I vote in person?

 

If you plan to attend the Annual Meeting and wish to vote in person, we will give you a ballot when you arrive. If your shares are held in “street name,” you must bring an account statement or letter from the brokerage firm or bank showing that you were the beneficial owner of the shares on the record date for determining which of our shareholders are entitled to notice of, and to vote at, the Annual Meeting, in order to vote at the Annual Meeting. In addition, if you want to vote your shares that are held in street name, you must obtain a “legal proxy” from the holder of record and present it at the Annual Meeting.

 

Who will count the votes?

 

A representative of American Stock Transfer will serve as the Judge of Election and tabulate the votes.

Is my vote confidential?

 

Proxy instructions, ballots and voting tabulations that identify individual shareholders are handled in a manner that protects your voting privacy. An individual shareholder’s vote will not be disclosed either within the Company or to third parties except (i) as necessary to meet applicable legal requirements, (ii) to allow for the tabulation of votes and certification of the vote, or (iii) to facilitate a successful proxy solicitation by our Board of Directors.

 

Where can I find the voting results of the Annual Meeting?

 

The preliminary voting results will be announced at the Annual Meeting. We will announce the final voting results in a Current Report on Form 8-K that the Company will file with the United States Securities and Exchange Commission when the results are available. The SEC’s website may be accessed at www.sec.gov.

 

Who will bear the cost of soliciting votes for the Annual Meeting?

 

The Company will bear the cost of soliciting votes for the Annual Meeting. The Company has engaged Laurel Hill Advisory Group to assist in soliciting votes for the annual meeting. The amount ETC will pay Laurel Hill Advisory Group for its proxy solicitation services is $10,000, plus certain out-of-pocket expenses.

 

Where can I find more information?

 

We file annual, quarterly and current reports, proxy statements and other information with the United States Securities and Exchange Commission. You may access the SEC’s website at www.sec.gov.

 

Who can answer my questions about the Annual Meeting?

 

If you have additional questions about the Annual Meeting, you should contact:

 

Environmental Tectonics Corporation

125 James Way

County Line Industrial Park

Southampton, Pennsylvania 18966

Attention: Duane D. Deaner, Chief Financial Officer

Phone Number: (215) 355-9100

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

The following table sets forth, as of May 1, 2009, the number of shares and percentage of our common stock owned beneficially by each Director, each nominee for Director and each executive officer named in the Summary Compensation Table, and each person holding, to our knowledge, more than 5% of our outstanding common stock. The table also sets forth the holdings of all Directors and executive officers as a group.

 

 

 

 

 

General

 

Our Bylaws provide that the Board of Directors will consist of not less than five or more than thirteen Directors. Within the foregoing limits, the Board of Directors may, from time to time, fix the number of Directors. The Board of Directors has fixed the number of Directors at five Directors.

 

Vacancies in the Board of Directors occurring by reason of death, resignation or otherwise of a Director may be filled for the unexpired term by a majority vote of the remaining Directors of the Board of Directors although less than a quorum. Newly created directorships resulting from an increase in the authorized number of Directors by action of the Board of Directors may be filled by a majority vote of the Directors serving at the time of such increase. Each Director so elected to fill a vacancy or a newly created Directorship shall hold office until such Director’s successor is elected by the shareholders at the next annual or special meeting of shareholders or until the earlier death, resignation, removal or disqualification of each such Director.

At the Annual Meeting, five Directors will be elected to serve for a one-year term and until their successors are elected and qualified. Howard W. Kelley is not standing for re-election to the Board of Directors. George A. Sawyer is a nominee for Director. Messrs. Mitchell, Lenfest and Ryan and Dr. Anderson are Directors seeking re-election.

 

The Governance and Nominating Committee of the Board of Directors has unanimously nominated George K. Anderson, M.D., MPH, H. F. Lenfest, William F. Mitchell, Stephen F. Ryan and George A. Sawyer for election as Directors of the Company. Each of the nominees has consented to being named in this proxy statement and to serve if elected. If any of the nominees become unable to accept nomination or election, the persons named in the proxy may vote for a substitute nominee selected by the Board of Directors. The Company has no present reason to believe that any of the nominees will be unable to serve as a Director, if elected.

 

The five nominees who receive the highest number of votes cast at the Annual Meeting will be elected as Directors. Shares represented by properly executed proxies will be voted for the nominees named below unless otherwise specified in the proxy by the shareholder. Any shareholder who wishes to withhold authority from the proxyholders to vote for the election of Directors or to withhold authority to vote for any individual nominee may do so by marking his or her proxy to that effect. Shareholders cannot cumulate their votes for the election of Directors. No proxy may be voted for a greater number of persons than the number of nominees named.

 

Nominees for Election as Director

 

The Board of Directors unanimously recommends that the holders of our voting securities vote for the election of the following nominees:

 

 

 

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE FOR MESSRS. LENFEST, MITCHELL, RYAN AND SAWYER AND DR. ANDERSON.

 

Director Not Standing for Re-election

 

Howard W. Kelley, who is currently a Director of the Company, is not standing for re-election. Mr. Kelley has been a Director since 2002 and currently serves as the Chairman of the Company’s Audit Committee, as Acting Chairman of the Company’s Compensation Committee and as a member of the Company’s Governance and Nominating Committee.

 

Executive Officers

 

In addition to William F. Mitchell, who is a Director, Chief Executive Officer and President of the Company, Duane Deaner serves as an executive officer of the Company. Mr. Deaner has served as our Chief Financial Officer since January 1996. Mr. Deaner served as Vice President of Finance for Pennfield Precision Incorporated from September 1988 to December 1995. Mr. Deaner received an MBA in Finance from Temple University and a B.A. in Mathematics from Millersville University in Pennsylvania.

 

Information Concerning the Board of Directors, Board Committees and Corporate Governance

 

Director Compensation

 

During fiscal 2009, our Directors who did not serve as officers were paid a fee of $2,000 (either in cash or equivalent value of common stock of the Company) per quarter for attending Board of Directors and committee

meetings. During fiscal 2008, our Directors who did not serve as officers were paid a fee of $2,000 (either in cash or equivalent value of common stock of the Company) per quarter for attending Board of Directors and committee meetings. Additionally, under a plan approved by our shareholders at the 2005 Annual Meeting of Shareholders, non-employee Directors may be awarded options to purchase common stock of the Company at fair market value. No options were awarded to our Directors in fiscal 2008 or fiscal 2009.

 

The following table sets forth the compensation paid by the Company to each of its Directors for the fiscal years ended February 27, 2009 and February 29, 2008.

 

FISCAL 2009 DIRECTOR COMPENSATION TABLE

 

 

FISCAL 2008 DIRECTOR COMPENSATION TABLE

 

 

 

 

Committees of the Board of Directors

 

During the fiscal year ended February 27, 2009, the Board of Directors held two meetings. During the fiscal year ended February 29, 2008, the Board of Directors held five meetings. All members of the Board of Directors attended all of the Board of Directors meetings. The Company does not have a formal policy regarding Director attendance at annual meetings, but ETC does encourage Directors to attend all meetings. All members of the Board of Directors at the time of ETC’s most recent annual meeting of shareholders attended that meeting.

 

We have three standing Board Committees: Audit, Compensation and Governance and Nominating. Each committee has a charter which can be found on the Company’s website located at www.etcusa.com. The members and chairpersons of each committee during fiscal 2009 are identified in the following table and each committee, its function and the number of meetings held by each committee during ETC’s two most recent fiscal years are described below.

 

 

On February 25, 2009, Alan M. Gemmill resigned from the Board of Directors of ETC. The remaining members of the Board of Directors appointed Mr. Ryan to fill the vacancy created by Mr. Gemmill’s resignation on March 6, 2009.

 

During fiscal years 2009 and 2008, we had an Audit Committee consisting of Messrs. Kelley and Gemmill (until his resignation from the Board of Directors), and Dr. Anderson. Mr. Kelley serves as the Chairman and the “financial expert” (as defined by the NYSE AMEX LLC) and has been designated as the Audit Committee Financial Expert as defined by the rules of the Securities and Exchange Commission. In addition, all members of the Audit Committee meet the financial literacy requirements of the NYSE AMEX LLC and are independent under the rules of the NYSE AMEX LLC. Among other responsibilities, the Audit Committee meets (via face-to-face or via telephone) with the external auditors to review and make recommendations to management concerning (if appropriate) the quarterly and annual financial results and the reports on Forms 10-Q and 10-K. The Audit Committee is directly responsible for the appointment, compensation, retention and oversight of our independent accountants in their preparation or issuance of an audit report or the performance of other audit and review services.

 

Messrs. Kelley and Gemmill (until his resignation from the Board of Directors) and Dr. Anderson also served on our Compensation Committee during fiscal years 2009 and 2008, with Mr. Gemmill serving as Chairman until his resignation. Mr. Kelley was appointed to serve as Chairman on an interim basis. The Compensation Committee is charged with reviewing the compensation and incentive plans of officers and key personnel.

 

Messrs. Kelley and Gemmill (until his resignation from the Board of Directors) and Dr. Anderson also served on our Nominating and Governance Committee during fiscal years 2009 and 2008 with Dr. Anderson serving as Chairman. The Nominating and Governance Committee is charged with finding and recommending new Board of Directors members and with ensuring our compliance with all regulatory governance requirements. The Nominating and Governance Committee works closely with the Company’s Chief Executive Officer to identify potential Directors with skills and business experience that align with the Company’s particular needs. The Nominating and Governance Committee interviewed Mr. Ryan, investigated his background and determined that he is suitable to serve on the Company’s Board of Directors. The Nominating and Governance Committee has also interviewed Mr. Sawyer, investigated his background and determined that he is suitable to serve on the Company’s Board of Directors.

Communication with the Board of Directors

 

Interested parties should address all communications to the full Board of Directors or an individual Director to the attention of our corporate Secretary. Our corporate Secretary reviews all such communications to determine if they are related to specific products or services, are solicitations or otherwise relate to improper or irrelevant topics. All such improper communications receive a response in due course. Any communication directed to an individual Director relating solely to a matter involving such Director is forwarded to such Director. Any communication directed to an individual Director relating to a matter involving both such Director and ETC or the Board of Directors, as a whole, is forwarded to such Director and the Chairman of the Board of Directors. The balance of the communications are forwarded to the Chairman of the Board of Directors. Except for improper communications, all interested party communications to the Board of Directors or an individual Director received by the corporate Secretary are kept in confidence from management. These procedures were adopted unanimously by the independent Directors.

 

In April 2009, the Board of Directors approved the 2009 Employee, Director and Consultant Stock Plan described below (the “2009 Stock Plan”). Up to 1,000,000 shares of common stock (subject to adjustment in the event of stock splits and other similar events) may be issued pursuant to awards granted under the 2009 Stock Plan. The Board of Directors unanimously recommends that shareholders of ETC approve the 2009 Stock Plan. Approval of the 2009 Stock Plan is important to ETC’s ongoing efforts to create shareholder value. ETC’s Board of Directors believes that it must offer a competitive equity compensation plan in order to attract, retain and motivate the talent necessary to grow the Company.

 

Description of the 2009 Stock plan

 

The following is a brief summary of the 2009 Stock Plan, a copy of which is attached to this proxy statement as Annex A.

 

Types of Awards

 

The 2009 Stock Plan provides for the grant of incentive stock options intended to qualify under Section 422 of the Internal Revenue Code of 1986 (the “Code”), non-statutory stock options, restricted stock and other stock-based awards as described below (collectively, “awards”).

 

Incentive Stock Options and Non-statutory Stock Options.  Optionees receive the right to purchase a specified number of shares of common stock at a specified option price and subject to such other terms and conditions as are specified in connection with the option grant. Options must be granted at an exercise price that is at least equal to the fair market value of the common stock on the date of grant. Under present law, incentive stock options and options intended to qualify as performance-based compensation under Section 162(m) of the Code may not be granted at an exercise price less than 100% of the fair market value of the common stock on the date of grant (or less than 110% of the fair market value in the case of incentive stock options granted to optionees holding more than 10% of the voting power of ETC). Options may not be granted for a term in excess of ten years. The 2009 Stock Plan permits the following forms of payment of the exercise price of options: (i) payment by cash, check or through a broker, (ii) subject to certain conditions, delivery to ETC of shares of common stock, (iii) subject to certain conditions, delivery to ETC of a promissory note, (iv) any other lawful means, or (v) payment of such other consideration as the Board of Directors determines.

 

Restricted Stock Awards.  Restricted stock awards entitle recipients to acquire shares of common stock, subject to the right of ETC to repurchase all or part of such shares from the recipient in the event that the conditions specified in the applicable award are not satisfied prior to the end of the applicable restriction period established for such award.

 

Other Stock-Based Awards.  Under the 2009 Stock Plan, ETC’s Board of Directors has the right to grant other awards based upon the common stock having such terms and conditions as ETC’s Board of Directors may

determine, including the grant of shares based upon certain conditions, the grant of securities convertible into common stock, and the grant of stock appreciation rights, phantom stock awards or stock units.

 

Performance Conditions.  ETC’s Board of Directors may determine, at the time of grant, that a restricted stock award or other stock-based award granted to a recipient will vest solely upon the achievement of specified performance criteria.

 

Transferability of Awards

 

Except as ETC’s Board of Directors may otherwise determine or provide in an award agreement, awards may not be sold, assigned, transferred, pledged or otherwise encumbered by the person to whom they are granted, either voluntarily or by operation of law, except by will or the laws of descent and distribution. During the life of the recipient, awards are exercisable only by the recipient.

 

Eligibility to Receive Awards

 

Employees, officers, Directors, consultants and advisors of ETC and its subsidiaries are eligible to be granted awards under the 2009 Stock Plan. Under present law, however, incentive stock options may only be granted to employees of ETC and its subsidiaries.

 

Plan Benefits

 

The granting of awards under the 2009 Stock Plan is discretionary, and ETC cannot now determine the number or type of awards to be granted in the future to any particular person or group.

 

Administration

 

The 2009 Stock Plan is administered by ETC’s Board of Directors. ETC’s Board of Directors has the authority to adopt, amend and repeal the administrative rules, guidelines and practices relating to the 2009 Stock Plan and to interpret the provisions of any award agreements entered into under the 2009 Stock Plan. Pursuant to the terms of the 2009 Stock Plan, ETC’s Board of Directors may delegate authority under the 2009 Stock Plan to one or more committees of its Board of Directors.

 

Subject to any applicable limitations contained in the 2009 Stock Plan, ETC’s Board of Directors, or any committee to whom ETC’s Board of Directors delegates authority, as the case may be, selects the recipients of awards and determines (i) the number of shares of common stock covered by options and the dates upon which such options become exercisable, (ii) the exercise price of options, (iii) the duration of options (which may not exceed 10 years), and (iv) the number of shares of common stock subject to any restricted stock award or other stock-based awards and the terms and conditions of such awards, including conditions for repurchase, issue price and repurchase price.

 

ETC’s Board of Directors is required to make appropriate adjustments in connection with the 2009 Stock Plan and any outstanding awards to reflect stock splits, stock dividends, recapitalizations, spin-offs and other similar changes in capitalization. The 2009 Stock Plan also contains provisions addressing the consequences of any acquisition event, which is defined as (a) the sale of the Company by merger in which the shareholders of the Company in their capacity as such no longer own a majority of the outstanding equity securities of the Company (or its successor) or (b) any sale of all or substantially all of the assets or capital stock of the Company (other than in a spin-off or similar transaction) or (c) any other acquisition of the business of the Company, as determined by the Board of Directors. In connection with an acquisition event, ETC’s Board of Directors may take any one or more of the following actions as to all or any outstanding awards (other than restricted stock and restricted stock unit awards): (i) make appropriate provision for the continuation of such awards by the Company or the assumption of such awards by the surviving or acquiring entity and by substituting on an equitable basis for the shares then subject to such awards either (x) the consideration payable with respect to the outstanding shares of common stock in connection with the acquisition, (y) shares of stock of the surviving or acquiring corporation or (z) such other securities as the Board of Directors deems appropriate, the fair market value of which (as determined by the Board of Directors in its sole discretion) shall not materially differ from the fair market value of the shares of common

stock subject to such awards immediately preceding the acquisition and (ii) with respect to outstanding options, the Board of Directors may, upon written notice to the affected optionees, provide that (x) one or more options then outstanding shall become immediately exercisable in full and that such options must be exercised within a specified number of days of the date of such notice, at the end of which period such options shall terminate or (y) one or more options then outstanding shall become immediately exercisable in full and shall be terminated in exchange for a cash payment equal to the excess of the fair market value for the shares subject to such options over the exercise price thereof.

 

ETC’s Board of Directors may at any time provide that any award will become immediately exercisable in full or in part, free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case may be.

 

If any award expires or is terminated, surrendered, canceled or forfeited, the unused shares of common stock covered by such award will again be available for grant under the 2009 Stock Plan, subject, however, in the case of incentive stock options, to any limitations under the Code.

 

Amendment or Termination

 

No award may be made under the 2009 Stock Plan after April 15, 2019 but awards previously granted may extend beyond that date. ETC’s Board of Directors may at any time amend, suspend or terminate the 2009 Stock Plan; provided that, to the extent determined by ETC’s Board of Directors, no amendment requiring shareholder approval under any applicable legal, regulatory or listing requirement will become effective until such shareholder approval is obtained. No award will be made that is conditioned upon shareholder approval of any amendment to the 2009 Stock Plan.

 

If shareholders do not approve the adoption of the 2009 Stock Plan, the 2009 Stock Plan will not go into effect, and ETC will not grant any awards under the 2009 Stock Plan. In such event, ETC’s Board of Directors will consider whether to adopt alternative arrangements based on its assessment of the needs of ETC.

 

U.S. Federal Income Tax Consequences

 

The following is a summary of the U.S. federal income tax consequences that generally will arise with respect to awards granted under the 2009 Stock Plan. This summary is based on the federal tax laws in effect as of the date of this proxy statement. In addition, this summary assumes that all awards are exempt from, or comply with, the rules under Section 409A of the Code regarding nonqualified deferred compensation. The 2009 Stock Plan provides that no award will provide for deferral of compensation that does not comply with Section 409A of the Code, unless ETC’s Board of Directors, at the time of grant, specifically provides that the award is not intended to comply with Section 409A. Changes to these laws could alter the tax consequences described below.

 

Incentive Stock Options

 

A participant will not have income upon the grant of an incentive stock option. Also, except as described below, a participant will not have income upon exercise of an incentive stock option if the participant has been employed by ETC or a 50%-or-more-owned corporate subsidiary at all times beginning with the option grant date and ending three months before the date the participant exercises the option. If the participant has not been so employed during that time, then the participant will be taxed as described below under “Non-Statutory Stock Options.” The exercise of an incentive stock option may subject the participant to the alternative minimum tax.

 

A participant will have income upon the sale of the stock acquired under an incentive stock option at a profit (if sales proceeds exceed the exercise price). The type of income will depend on when the participant sells the stock. If a participant sells the stock more than two years after the option was granted and more than one year after the option was exercised, then all of the profit will be long-term capital gain. If a participant sells the stock prior to satisfying these waiting periods, then the participant will have engaged in a disqualifying disposition and a portion of the profit will be ordinary income and a portion may be capital gain. This capital gain will be long-term if the participant has held the stock for more than one year and otherwise will be short-term. If a participant sells the stock at a loss (meaning sales proceeds are less than the exercise price), then the loss will be a capital loss. This capital loss will be long-term if the participant held the stock for more than one year and otherwise will be short-term.

Non-Statutory Stock Options

 

A participant will not have income upon the grant of a non-statutory stock option. A participant will have compensation income upon the exercise of a non-statutory stock option equal to the value of the stock on the day the participant exercised the option less the exercise price. Upon sale of the stock, the participant will have capital gain or loss equal to the difference between the sales proceeds and the value of the stock on the day the option was exercised. This capital gain or loss will be long-term if the participant has held the stock for more than one year and otherwise will be short-term.

 

Restricted Stock Awards

 

A participant will not have income upon the grant of restricted stock unless an election under Section 83(b) of the Code is made within 30 days of the date of grant. If a timely 83(b) election is made, then a participant will have compensation income equal to the value of the stock less the purchase price, if any. When the stock is sold, the participant will have capital gain or loss equal to the difference between the sales proceeds and the value of the stock on the date of grant. If the participant does not make an 83(b) election, then when the stock vests the participant will have compensation income equal to the value of the stock on the vesting date less the purchase price. When the stock is sold, the participant will have capital gain or loss equal to the sales proceeds less the value of the stock on the vesting date. Any capital gain or loss will be long-term if the participant held the stock for more than one year and otherwise will be short-term.

 

Other Stock-Based Awards

 

The tax consequences associated with any other stock-based award granted under the 2009 Stock Plan will vary depending on the specific terms of such award. Among the relevant factors are whether or not the award has a readily ascertainable fair market value, whether or not the award is subject to forfeiture provisions or restrictions on transfer, the nature of the property to be received by the participant under the award and the participant’s holding period and tax basis for the award or underlying common stock.

 

Tax Consequences to ETC

 

There will be no tax consequences to ETC except that ETC will be entitled to a deduction when a participant has compensation income. Any such deduction will be subject to the limitations of Section 162(m) of the Code.

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE “FOR” THE APPROVAL OF THE 2009 STOCK PLAN. The affirmative vote of a majority of all votes cast at the Annual Meeting is required to approve the 2009 Stock Plan. Abstentions and broker non-votes will not constitute or be counted as “votes” cast and, therefore, will not affect the outcome of the vote on this proposal. All proxies will be voted “FOR” approval of the 2009 Stock Plan unless a shareholder specifies to the contrary on such shareholder’s proxy card.

 

We are principally engaged in the design, manufacture and sale of (1) software driven products and services used to create and monitor the physiological effects of flight; (2) steam and gas sterilization products; (3) testing and simulation devices for the automotive industry; (4) hyperbaric and hypobaric chambers; and (5) driving and disaster simulation systems. ETC considers its business activities to operate in two segments: the Training Services Group (TSG) and the Control Systems Group (CSG). Product categories included in TSG are pilot training and flight simulators, disaster management systems and entertainment applications. CSG includes sterilizers, environmental control devices and hyperbaric chambers along with parts and service support.

 

Starting in fiscal 2003, ETC’s financial performance began deteriorating as a result of many factors, all of which had a significant negative impact on the Company’s results. Initially, the aftermath of the terrorist attacks on September 11, 2001 constricted ETC’s core business, aeromedical and high performance jet pilot training simulators. By fiscal 2003, significant unreimbursed cost overruns on a large hyperbaric chamber project with the U.S. Navy reduced our gross manufacturing margins. Litigation costs associated with this U.S. Navy contract

and a contract dispute with Walt Disney Company further reduced our operating profits. Most recently, a settlement with the U.S. Navy in fiscal 2008, and related legal and accounting fees, added to the Company’s losses. ETC’s net loss in fiscal 2007 (the year ended February 23, 2007) was $11,944,000. In fiscal 2008 (the year ended February 29, 2008), ETC’s net loss was $13,895,000. ETC’s performance improved significantly in fiscal 2009 (the year ended February 27, 2009). Reflecting higher contract bookings, a favorable job mix and lower legal costs, revenues for the period were up almost $14,000,000 from $22,700,000 in fiscal 2008 to $36,700,000 in fiscal 2009 and ETC’s net loss was reduced to approximately $2,000,000. Also, in the fourth quarter of fiscal 2009, ETC was awarded a $19,000,000 contract for a disorientation simulator from the U.S. Navy (the “NAMRL Contract”). However, as of February 27, 2009, the Company was technically insolvent with negative equity of $11,752,000.

 

Beginning in February 2003, as described in detail below, Lenfest has provided a substantial portion of the capital necessary for ETC to operate its business, through a combination of loans in the form of a $10,000,000 senior subordinated convertible promissory note, direct investments in the form of $6,000,0000 of Series B Preferred Stock and $3,300,000 of Series C Preferred Stock, and the personal guarantee of all of ETC’s obligations under its $15,000,000 commercial credit facility with PNC Bank, National Association (“PNC Bank”).

 

Notwithstanding ETC’s significant improvement in performance during fiscal 2009, and in particular the second half of fiscal 2009, ETC’s business is not yet cash flow positive on a consistent basis. Management currently projects capital shortfalls at various times during fiscal 2010 (the year ending February 26, 2010).

 

ETC has the opportunity to bid on, and potentially win, a number of significant U.S. and foreign government contracts during fiscal 2010. In order to bid successfully on and perform under these significant contracts, ETC needs significantly more working capital than it currently generates from operations. In addition, ETC requires more capital in order to continue to operate its business and attempt to return ETC to consistent profitability. The Company has worked diligently to secure additional financing, either in the form of debt or equity, and Lenfest has agreed to provide the additional capital that ETC needs to achieve these objectives. As part of the proposed transactions which are the subject of Proposals III, IV and V (the “Lenfest Financing Transaction”), Lenfest has agreed to provide up to an additional $12,500,000 in capital to ETC, through a $7,500,000 credit facility and the personal guarantee of an additional $5,000,000 of borrowings from PNC Bank. To support a pre-award financial capability requirement for one of the aforementioned government contracts, on February 20, 2009, Lenfest loaned $2,000,000 to ETC as an advance under the Lenfest Credit Facility (as defined below). On April 24, 2009, in connection with the signing of the agreements to which Proposals III, IV and V relate, Lenfest made available an additional $1,000,000, which ETC may draw down to be used for general working capital. A material condition to the completion of the proposed transactions, including the borrowing of further funds and the guarantee of additional borrowings from PNC Bank, is the approval of our shareholders to the proposed transactions described in Proposals III, IV and V (as more fully described below, the “Shareholder Approvals”).

 

If the Company is unable to obtain the Shareholder Approvals and complete the proposed transactions with Lenfest, the Company will have approximately $30,000,000 in debt owed to PNC Bank and Lenfest due between August 20, 2009 and June 30, 2010. Given the Company’s prior financial performance, current financial condition and the condition of the credit and capital markets, it is unlikely that the Company will be able to obtain the necessary capital that it needs from alternative sources, on reasonable or any terms, to repay these obligations. Without the necessary capital to operate its business, service current jobs, place bids on new projects and repay its various debt obligations to PNC Bank and Lenfest as they become due, ETC will need to consider other alternatives, such as the sale of one or more of the Company’s operating divisions. If the Company is unable to raise sufficient additional capital through the sale of one or more of its operating divisions, it may be forced to consider other alternatives, ranging from terminating certain lines of business, eliminating workforce or seeking relief from its creditors.

 

In connection with Proposals III, IV and V that follow, we have set forth below the background relating to these proposals. Specifically, we have set forth:

 

 

 

Prior Transactions between ETC and Lenfest

 

$10,000,000 Senior Subordinated Convertible Note

 

In connection with financing provided by PNC Bank in February 2003, the Company entered into a Convertible Note and Warrant Purchase Agreement with Lenfest pursuant to which the Company issued to Lenfest (i) a senior subordinated convertible promissory note (the “Subordinated Note”) in the original principal amount of $10,000,000 and (ii) warrants to purchase 803,048 shares of the Company’s common stock. The warrants were subsequently exercised by Lenfest on February 14, 2005.

 

The Subordinated Note accrues interest at the rate of 10% per annum (Lenfest reduced the rate to 8% per annum for the period December 1, 2004 through November 30, 2007) and originally had a maturity date of February 18, 2009. At the Company’s option, the quarterly interest payments may be deferred and added to the outstanding principal. Pursuant to the terms of the Subordinated Note, Lenfest may convert all or a portion of the outstanding principal of, and accrued and unpaid interest on, the Subordinated Note into shares of ETC common stock at a conversion price of $6.05 per share. Upon the occurrence of certain events set forth in the Subordinated Note, the Company will be obligated to issue additional warrants to Lenfest. Any additional warrants issued under the Subordinated Note may be exercised into shares of ETC common stock at an exercise price equal to the lesser of $4.00 per share or two-thirds of the average of the high and low sale prices of the ETC common stock for the 25 consecutive trading days immediately preceding the date of exercise. If warrants were issued as of May 8, 2009, the exercise price for such warrants would be $0.62 per share.

 

On March 11, 2008, the Company entered into Amendment No. 1 to the Convertible Note and Warrant Purchase Agreement (the “Purchase Agreement Amendment”) and First Amendment to Senior Subordinated Convertible Note (the “Note Amendment”). Under the terms of the Purchase Agreement Amendment, ETC and Lenfest agreed to amend the financial covenants set forth in the Convertible Note and Warrant Purchase Agreement so that they are similar to the financial covenants set forth in the 2007 PNC Credit Agreement between ETC and PNC Bank described below. Under the terms of the Note Amendment, the maturity date of the Subordinated Note was extended from February 18, 2009 to March 1, 2010. The effective date of the Purchase Agreement Amendment and the Note Amendment was February 19, 2008. There can be no assurance that Lenfest will agree to extend the maturity date of the Subordinated Note again in the event the Shareholder Approvals are not obtained or, if he would agree to extend further the maturity date, what terms would be required for such extension.

 

Lenfest Guaranty

 

In October 2004, Lenfest guaranteed a $5,000,000 Letter of Credit Facility between ETC and PNC Bank. In connection with Lenfest’s guarantee of ETC’s obligations to PNC Bank, ETC issued a warrant to Lenfest which entitled Lenfest to purchase up to 200,000 shares of ETC common stock. Lenfest exercised this warrant on February 14, 2005.

 

Series B Preferred Stock

 

In April 2006, the Company entered into a Preferred Stock Purchase Agreement (the “Lenfest Equity Agreement”) with Lenfest. The Lenfest Equity Agreement permitted ETC to draw down up to $15,000,000 in exchange for shares of the Company’s Series B Preferred Stock. The Series B Preferred Stock provided for a dividend equal to 6% per annum. On August 23, 2007, the dividend was amended to 10% per annum. The Series B Preferred Stock is convertible, at Lenfest’s option, into shares of ETC common stock at a conversion price, which was set on the date of each draw down. The conversion price was equal to the closing price of the Company’s

common stock on the trading day immediately preceding the day in which the draw down occurs, subject to a floor price of $4.95 per share. Pursuant to the rules of the NYSE AMEX LLC, drawdowns were not permitted on any day when the conversion price would be less than the $4.95 per share floor price. On the sixth anniversary of the Lenfest Equity Agreement, any issued and outstanding Series B Preferred Stock is mandatorily converted into ETC common stock at each set conversion price. Pursuant to its terms, the Series B Preferred Stock is entitled to vote with the ETC common stock on an as converted basis.

 

In connection with the execution of the Lenfest Equity Agreement in April 2006, the Company drew down $3,000,000 by issuing 3,000 shares of Series B Preferred Stock with a conversion price equal to $4.95 per share. Additionally, on July 31, 2006, the Company drew down an additional $3,000,000 by issuing 3,000 shares of Series B Preferred Stock at a conversion price equal to $6.68 per common share. The Lenfest Equity Agreement was terminated on July 31, 2007.

 

On March 29, 2007, Lenfest agreed to permit the Company to defer until April 6, 2012, or earlier if demanded, the payment of accruing dividends on the Series B Preferred Stock issued under the Lenfest Equity Agreement.

 

Series C Preferred Stock

 

On August 23, 2007, the Company entered into the Series C Preferred Stock Purchase Agreement (the “Series C Purchase Agreement”) with Lenfest, pursuant to which, among other things, ETC issued and sold 3,300 shares of Series C Preferred Stock to Lenfest for $3,300,000. The Series C Preferred Stock is convertible by Lenfest at any time into shares of ETC common stock at a conversion price of $3.03 per share (the closing price for ETC’s common stock on the date of the Series C Purchase Agreement). Pursuant to its terms, the Series C Preferred Stock is entitled to vote with ETC’s common stock on an as-converted basis. The Series C Preferred Stock automatically converts into ETC common shares on August 23, 2012, the fifth anniversary of Lenfest’s acquisition of the Series C Preferred Stock. The Series C Preferred Stock provides for a dividend equal to 10% per annum.

 

On May 12, 2008, Lenfest agreed to permit the Company to defer until August 23, 2012, or earlier if demanded, the payment of accruing dividends on the Series C Preferred Stock.

 

2007 PNC Credit Facility

 

On July 31, 2007, ETC completed a refinancing of its indebtedness with PNC Bank in the aggregate amount of up to $15,000,000. This refinancing by ETC was an extension of the credit facility originally entered into with PNC Bank in February 2003.

 

Pursuant to the terms of a Credit Agreement, dated as of July 31, 2007, between ETC and PNC Bank (the “2007 PNC Credit Agreement”), ETC established a revolving line of credit with PNC Bank in the maximum aggregate principal amount of $15,000,000 to be used for ETC’s working capital or other general business purposes and for issuances of letters of credit (the “2007 PNC Credit Facility”). Pursuant to the terms of the 2007 PNC Credit Agreement, ETC executed a promissory note in favor of PNC Bank, in the maximum principal amount of $15,000,000, to evidence ETC’s obligation to repay the line of credit (the “PNC Note”). Amounts borrowed under the 2007 PNC Credit Agreement may be borrowed, repaid and reborrowed from time to time until June 30, 2010.

 

Borrowings made pursuant to the 2007 PNC Credit Agreement bear interest at either the prime loan rate (as described in the PNC Note) minus 1.00% or the London Interbank Offered Rate (as described in the PNC Note) as determined under the PNC Note plus 0.90%. Under the 2007 PNC Credit Agreement, ETC is obligated to pay a fee of 0.125% per annum for unused available funds.

 

ETC’s obligations under the 2007 PNC Credit Agreement are secured by a personal guarantee from Lenfest under a Restated Guaranty, dated July 31, 2007, made by Lenfest in favor of PNC Bank (the “Restated Guaranty”). ETC is obligated to pay Lenfest an annual cash fee of 1% of the loan commitment under the 2007 PNC Credit Agreement in connection with this guarantee.

Lenfest Acquisition Proposal

 

On February 20, 2008, ETC received a proposal from an affiliate of Lenfest to purchase all of the publicly traded shares of the common stock of the Company not owned by Lenfest. Following receipt of the acquisition proposal, the Company’s Board of Directors delegated authority to the Audit Committee to analyze the transaction and engage in negotiations with Lenfest. ETC retained Navigant Consulting, Inc. (“Navigant Consulting”), a well respected investment banking firm, to act as financial advisor to the Audit Committee in connection with such proposal. On September 11, 2008, Lenfest withdrew his proposal.

 

$2 Million Loan

 

On February 20, 2009, Lenfest made a loan to ETC in the principal amount of $2,000,000 (the “$2 Million Loan”). The $2 Million Loan is to be used by ETC solely to support ETC’s bid on, and performance under, a contract (the “Government Contract”) with the United States government. The terms of the $2 Million Loan are set forth in a Secured Promissory Note, dated February 20, 2009, by ETC in favor of Lenfest (the “$2 Million Note”). The $2 Million Note will mature on the earlier of (i) three days following the date ETC is informed by the Government or otherwise learns that it has been denied or will not be awarded the Government Contract, (ii) August 20, 2009 if ETC has not obtained the Shareholder Approvals on or before the Shareholder Approval Date (as defined below) (the $2 Million Loan Early Maturity Date”) or (iii) three years following the date of the $2 Million Note. ETC’s obligations under the $2 Million Loan are secured by the grant of a first and prior security interest in all of the personal property of ETC pursuant to the terms of a Security Agreement, dated as of February 20, 2009, made by ETC in favor of Lenfest.

 

In connection with the $2 Million Loan, ETC issued to Lenfest a warrant (the “$2 Million Loan Warrant”) to purchase 143,885 shares of ETC common stock, at an exercise price per share equal to $1.39, which is equal to the average price of ETC common stock for the 120 trading days immediately preceding the date of this warrant. If the $2 Million Loan is not repaid in full on or before the $2 Million Loan Early Maturity Date or ETC does not obtain the Shareholder Approvals by the Shareholder Approval Date, then Lenfest will be entitled to purchase an additional 575,539 shares of ETC stock for a total of 719,424 shares of ETC common stock under such warrant and the exercise price per share of such warrant will be decreased by 50% to $0.69 for all shares. The $2 Million Loan Warrant was amended and restated on April 24, 2009 to conform its definition of the Shareholder Approval Date with the definition set forth in the Lenfest Credit Agreement (as defined below).

 

Current Financial Status of ETC and Need for Lenfest Financing Transaction

 

Starting in fiscal 2004, ETC’s financial performance began deteriorating as a result of many factors, all of which had a significant negative impact on the Company’s results. ETC’s net loss in fiscal 2007 (the year ended February 23, 2007) was $11,944,000. In fiscal 2008 (the year ended February 29, 2008), ETC’s net loss was $13,895,000. ETC’s performance improved significantly in fiscal 2009 (the year ended February 27, 2009). Reflecting higher contract bookings, a favorable job mix and lower legal costs, revenues for the period were up almost $14,000,000 from $22,700,000 in fiscal 2008 to $36,700,000 in fiscal 2009 and ETC’s net loss was reduced to approximately $2,000,000. Also, in the fourth quarter of fiscal 2009, ETC was awarded the $19,000,000 NAMRL Contract for a disorientation simulator from the U.S. Navy. However, as of February 27, 2009 the Company had negative equity of $11,752,000.

 

The Board of Directors believes that it is in the best interests of ETC and its shareholders to approve the Lenfest Financing Transaction as set forth in Proposals III, IV and V. In reaching this conclusion, the Board of Directors consulted with ETC’s management and its legal and financial advisors, and considered the Company’s short-term and long-term interests and prospects along with the interests of ETC’s shareholders.

 

In reaching the foregoing determinations, the Board of Directors considered the following factors that it believed supported its determinations:

 

 

 

The Board of Directors also considered a variety of risks and other potentially negative factors concerning the Lenfest Financing Transaction and Proposals III, IV and V. These factors included the following:

 

 

The foregoing discussion of the information and factors considered by the Board of Directors is not intended to be exhaustive but, we believe, includes the material factors considered by the Board of Directors. Based on the factors outlined above, the Board of Directors unanimously determined that the Lenfest Financing Transaction and

Proposals III, IV and V are fair to and in the best interests of our shareholders. Lenfest did not participate in the discussions relating to the Lenfest Financing Transaction and did not vote on the Lenfest Financing Transaction.

 

Proposed Transactions

 

On May 20, 2008, Lenfest committed to fund requests by ETC to support its operations through June 30, 2009, on terms and conditions to be mutually agreed upon by Lenfest and ETC, provided that ETC was not permitted to request more than an aggregate of $10,000,000 in financing. ETC and Lenfest have agreed to the terms of the Lenfest Financing Transaction, which include the following:

 

 

The terms of the Lenfest Financing Transaction are described in more detail below.

 

Lenfest Credit Facility

 

As part of the Lenfest Financing Transaction, on April 24, 2009, the Company established a credit facility in the maximum amount of $7,500,000 with Lenfest (the “Lenfest Credit Facility”). The Lenfest Credit Facility is to be used to finance certain government projects that ETC is seeking to be awarded (the “Projects”), including the NAMRL Contract. The terms of the Lenfest Credit Facility are set forth in a Secured Credit Facility and Warrant Purchase Agreement between the Company and Lenfest (the “Lenfest Credit Agreement”), attached hereto as Annex B. In connection with the Lenfest Credit Agreement, the Company has executed, and will upon borrowing under the Lenfest Credit Facility in the future execute, promissory notes in favor of Lenfest, in the aggregate principal amount of up to $7,500,000 (each, a “Lenfest Credit Facility Note”). Each Lenfest Credit Facility Note issued prior to ETC obtaining the Shareholder Approvals accrues interest at the rate of 15% per annum, payable in cash, or at the election of Lenfest, in shares of Series D Preferred Stock, the terms of which are described below. The interest rate under any such notes will retroactively reduce to 10% per annum upon receipt of the Shareholder Approvals. All Lenfest Credit Facility Notes issued after ETC obtains the Shareholder Approvals accrue interest at the rate of 10% per annum, payable in cash or, at the election of Lenfest, in shares of Series D Preferred Stock.

 

In connection with the execution of the Lenfest Credit Agreement on April 24, 2009, the Company is initially entitled to drawdown $1,000,000 under the Lenfest Credit Agreement prior to obtaining the Shareholder Approvals and satisfying certain other conditions (the “Initial $1 Million Loan”). The Initial $1 Million Loan will have a maturity date of five business days after the Shareholder Approval Date (the “Initial $1 Million Loan Early Maturity Date”), unless the Company receives the Shareholder Approvals, in which event the maturity date will be extended until three years from the date of issuance. Additional Lenfest Credit Facility Notes, none of which will be issued unless the Company receives the Shareholder Approvals, will mature on the earlier of (i) December 31, 2012, or (ii) three years after their issuance.

 

On February 20, 2009, Lenfest made the $2 Million Loan to ETC. As discussed above, Lenfest has agreed to advance the Initial $1 Million Loan upon ETC’s request at any time prior to the Shareholder Approval Date. Additional advances on the Lenfest Credit Facility are subject to the satisfaction of certain conditions, in addition to the condition that the Shareholder Approvals have been obtained, including the award of one or more of the Projects to ETC and that at least one such Project remains in effect, the satisfaction of the other Financing Transaction Conditions described below and the determination by Lenfest, in his sole discretion, that ETC’s prospects in the long-term for reaching consistent cash positive operations are continuing to improve. ETC can make requests under the Lenfest Credit Facility up to December 31, 2010.

The Company paid to Lenfest an origination fee of one percent (1%) of the committed (but not yet advanced) amount of the Lenfest Credit Facility. The origination fee was paid through the issuance of 55 shares of Series D Preferred Stock with a stated par value of $1,000 per share. The Series D Preferred Stock is described under the caption “Series D Preferred Stock.”

 

In connection with each Lenfest Credit Facility Note issued by ETC, ETC will issue to Lenfest a warrant to purchase a number of shares of ETC common stock equal to (i) 10% of the principal amount of the Lenfest Credit Facility Note divided by (ii) the closing price of ETC common stock for the day immediately preceding the date of issuance of this warrant. The exercise price for the warrants will be equal to such closing price. The warrants will be exercisable for seven years following issuance.

 

If the $1 Million Loan is drawn down but not repaid in full on or before the Initial $1 Million Loan Early Maturity Date or ETC does not obtain the Shareholder Approvals by July 2, 2009 (which date will be extended up to August 13, 2009 if the Securities and Exchange Commission provides comments to this Proxy Statement) (the “Shareholder Approval Date”), then Lenfest will be entitled to purchase under the foregoing warrant a number of shares of ETC Common Stock equal to $500,000 divided by the closing price of ETC’s common stock for the day immediately preceding the date of issuance of the warrant, at an exercise price equal to 50% of the initial exercise price.

 

In addition, in connection with the $2 Million Loan, ETC issued to Lenfest the $2 Million Loan Warrant to purchase 143,885 shares of ETC common stock, at an exercise price per share equal to $1.39, which is equal to the average price of ETC common stock for the 120 trading days immediately preceding the date of this warrant. If the $2 Million Loan is not repaid in full on or before the $2 Million Loan Early Maturity Date or ETC does not obtain the Shareholder Approvals by the Shareholder Approval Date, then Lenfest will be entitled to purchase an additional 575,539 shares of ETC common stock for a total of 719,424 shares of ETC common stock under such warrant, and the exercise price per share of such warrant will be decreased by 50% to $0.69 for all shares underlying the warrant. The $2 Million Loan Warrant was amended and restated on April 24, 2009 to conform its definition of the Shareholder Approval Date with the definition set forth in the Lenfest Credit Agreement.

 

The Lenfest Credit Agreement contains customary affirmative and negative covenants for transactions of this type, including limitations with respect to indebtedness, liens, investments, distributions, dispositions of assets, change of business and transactions with affiliates. The Lenfest Credit Agreement also contains financial covenants that are identical to the financial covenants set forth in the proposed Amended and Restated PNC Credit Agreement discussed below.

 

The Lenfest Credit Facility Notes provide for customary events of default with corresponding grace periods, including the failure to pay any principal or interest when due, failure to comply with covenants, material misrepresentations, certain bankruptcy, insolvency or receivership events, imposition of judgments and the liquidation of ETC.

 

The obligations of the Company to Lenfest under the Lenfest Credit Facility are secured by (i) the grant of a security interest in all personal property of the Company and certain subsidiaries of the Company and (ii) the Company’s grant of a mortgage on all of the Company’s real property in favor of Lenfest.

 

Exchange of Existing Instruments for Series E Preferred Stock

 

As part of the Lenfest Financing Transaction, the Subordinated Note, together with all accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, and all Series B Preferred Stock and Series C Preferred Stock, together with all accrued dividends thereon, will be exchanged (the “Series E Exchange”) for shares of a newly-created class of Series E Preferred Stock, subject to ETC’s receipt of the Shareholder Approvals as described below under “Financing Transaction Conditions”. The Statement with Respect to Shares for the Series E Preferred Stock, which is attached to this proxy statement as Annex C, will not be filed with the Pennsylvania Department of State unless and until the Shareholder Approvals are received. Accordingly, ETC will not be able to complete the Series E Exchange unless it obtains the Shareholder Approvals.

 

The Series E Preferred Stock will provide for a dividend equal to 10% per annum. The dividend will be payable on the liquidation of ETC, on the conversion of the Series E Preferred Stock to common stock or following

declaration by the Board of Directors of ETC. Upon liquidation, dissolution or winding up of ETC, the Series E Preferred Stock will have the right to receive the original investment amount plus accrued dividends. To the extent of any remaining funds or assets, the Series E Preferred Stock will participate on an as-converted basis in additional distributions. Assuming that ETC’s shareholders approve the Lenfest Financing Transaction, the Series E Preferred Stock will vote with the ETC common stock on an as converted basis on all matters that require the vote of ETC’s shareholders. The Series E Preferred Stock will rank pari passu with the Series D Preferred Stock.

 

The Series E Preferred Stock will be convertible, at Lenfest’s request, into shares of ETC common stock at a conversion price equal to $2.00 per common share.

 

The Series E Exchange will effectively reduce the conversion price on each of the Subordinated Note (conversion price of $6.05 per common share), Series B Preferred Stock (conversion price of $4.95 per common share with respect to $3,000,000 of Series B Preferred Stock and conversion price of $6.68 per common share with respect to $3,000,000 of Series B Preferred Stock) and Series C Preferred Stock (conversion price of $3.03 per common share) to $2.00 per common share. The Series E Exchange will have a dilutive effect on the shareholders of the Company as described below under “Effect Upon Existing Holders of Common Stock.” The closing sale price for ETC common stock on April 23, 2009, the date prior to the date that the Lenfest Credit Agreement was executed, was $0.94 per share and the average closing sale prices for ETC’s common stock for the 60 and 120 calendar days prior to April 23, 2009 were $0.94 and $0.98, respectively.

 

The Series E Preferred Stock contains anti-dilution protection for issuances of ETC’s common stock or securities convertible into ETC’s common stock at prices below the conversion price of the Series E Preferred Stock.

 

ETC has granted Lenfest demand and “piggy back” registration rights pursuant to a Registration Rights Agreement with respect to the shares of common stock issuable upon conversion of the Series E Preferred Stock.

 

The Series E Preferred Stock will be classified in the Company’s balance sheet as permanent equity.

 

Increased PNC Bank Credit Facility and Issuance of New Guarantee

 

On April 24, 2009, PNC Bank agreed to increase the amount of financing available under the 2007 PNC Credit Agreement from $15,000,000 to $20,000,000, subject to the condition that Lenfest continues to personally guaranty all of ETC’s obligations to PNC Bank (the “Lenfest Guaranty”) and that Lenfest pledges $10,000,000 in marketable securities as collateral security for his guaranty (the “Lenfest Pledge”). Lenfest is only obligated to provide the Lenfest Guaranty and the Lenfest Pledge in the event that the Company obtains the Shareholder Approvals.

 

The terms of PNC Bank’s agreement to increase the amount of financing under the 2007 PNC Credit Facility are set forth in a letter agreement, dated April 24, 2009, between ETC and PNC Bank (the “PNC Letter Agreement”). If the Shareholder Approvals are obtained on or before August 6, 2009, ETC and PNC Bank shall enter into the Amended and Restated Credit Agreement (the “Amended and Restated PNC Credit Agreement”) and the Second Amended and Restated Reimbursement Agreement for Letters of Credit (the “Amended and Restated Reimbursement Agreement”) in the forms attached to the PNC Letter Agreement. The PNC Note would also be cancelled and replaced with the Amended and Restated Promissory Note in the principal amount of $20,000,000 in the form attached to the PNC Letter Agreement (the “Amended and Restated PNC Note”). Lenfest would execute and deliver to PNC Bank the following agreements, the forms of which are attached to the PNC Letter Agreement: (i) an Amended and Restated Guaranty Agreement, which would replace the Restated Guaranty (the “Amended and Restated Guaranty”), (ii) a Pledge Agreement, pursuant to which Lenfest shall make the Lenfest Pledge, and (iii) a Notification and Control Agreement. These agreements, together with the Amended and Restated PNC Credit Agreement, the Amended and Restated Reimbursement Agreement and the Amended and Restated PNC Note are collectively referred to herein as the “2009 PNC Financing Documents.”

 

In the event that the Shareholder Approvals are not obtained or ETC and Lenfest fail to enter into the 2009 PNC Financing Documents on or before August 6, 2009, PNC Bank will no longer be obligated to enter into these agreements and increase the amount of financing available to ETC to $20,000,000.

Borrowings under the Amended and Restated PNC Bank Credit Facility will be required to be used for ETC’s working capital or other general business purposes and for issuances of letters of credit. Amounts borrowed under the Amended and Restated PNC Bank Credit Agreement may be borrowed, repaid and reborrowed from time to time until June 30, 2010. Borrowings made under the Amended and Restated PNC Credit Agreement will bear interest at the London Interbank Offered Rate (as described in the Amended and Restated PNC Note) plus 2.50%. Additionally, ETC will be obligated to pay a fee of 0.125% per annum for unused available funds.

 

The Amended and Restated PNC Bank Credit Agreement will contain customary affirmative and negative covenants, including limitations with respect to indebtedness, liens, investments, distributions, dispositions of assets, change of business and transactions with affiliates. Under the Amended and Restated PNC Bank Credit Agreement, the Company will be required to maintain a minimum Consolidated Tangible Net Worth (which, as defined, is total assets excluding intangibles less liabilities excluding the Subordinated Note) of $3,500,000 for each fiscal quarter. Under the Amended and Restated PNC Bank Credit Agreement, the Company will also be required to maintain a minimum EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) of (a) $300,000 for the fiscal quarter ended May 31, 2009, (b) $1,200,000 for the fiscal quarter ended August 31, 2009, (c) $1,000,000 for the fiscal quarter ended November 30, 2009, (d) $900,000 for the fiscal quarter ended February 28, 2010 and (e) $1,300,000 for the fiscal quarter ending March 1, 2010 and thereafter.

 

The Amended and Restated Reimbursement Agreement will govern letters of credit issued pursuant to the Amended and Restated PNC Credit Agreement.

 

All of ETC’s indebtedness to Lenfest shall be subordinated to the indebtedness under the 2009 PNC Financing Documents pursuant to the terms of the Second Amended and Restated Subordination and Intercreditor Agreement, dated April 24, 2009, by and among the Company, Lenfest and PNC Bank.

 

If the 2009 PNC Financing Documents are entered into, ETC will pay Lenfest an origination fee equal to 1% of the market value of the Lenfest Pledge and annual interest equal to 2% of the market value of the Lenfest Pledge, each payable in shares of Series D Preferred Stock, the terms of which are described below. In consideration of Lenfest entering into the Amended and Restated Guaranty, ETC will issue to Lenfest warrants to purchase shares of ETC common stock equal to 10% of the amount of the $5,000,000 increase in funding available under the Amended and Restated PNC Bank Credit Agreement. The warrants will be exercisable for seven years following issuance at an exercise price per share equal to the closing price of ETC’s common stock on the day prior to issuance.

 

At May 1, 2009, ETC’s availability under the 2007 PNC Credit Facility was approximately $1,027,000. This reflects borrowings under the 2007 PNC Credit Agreement of $11,210,000 and outstanding letters of credit of $2,763,000.

 

If ETC does not obtain the Shareholder Approvals by August 6, 2009, Lenfest will not extend the Amended and Restated Guaranty and the Lenfest Pledge, and PNC Bank will not enter into the Amended and Restated PNC Bank Credit Agreement, in which event ETC will not receive the additional $5,000,000 of borrowing availability for its working capital needs, in addition to the remaining amounts that it may have been eligible to receive under the new $7,500,000 Lenfest Credit Facility. In addition, the $2 Million Loan and the Initial $1 Million Loan, if drawn, under the Lenfest Credit Facility will be due five business days after the Shareholder Approval Date. Moreover, the Subordinated Note is due on March 1, 2010 and all borrowings under the 2007 PNC Credit Facility are due June 30, 2010. Given the current state of the economy and the capital markets and the financial condition and current projections of ETC, there can be no assurance that ETC will be able to refinance these obligations on reasonable terms, if at all, let alone obtain additional funding for working capital or expansion capital. If ETC is unable to refinance its debt as it becomes due, it may be required to sell one or more divisions at what may not be favorable terms, if any sale could be consummated under any terms, or it may be forced to consider other alternatives, ranging from terminating certain lines of business, eliminating workforce or seeking relief from its creditors.

 

Series D Preferred Stock

 

ETC has created a new class of Series D Convertible Preferred Stock (the “Series D Preferred Stock”) pursuant to filing of a Statement with Respect to Shares of Series D Convertible Preferred Stock with the Pennsylvania Department of State, which is attached to this proxy statement as Annex D. The Series D Preferred Stock will be

issued as described above. The Series D Preferred Stock will provide for a dividend equal to 10% per annum. The dividend will be paid on the liquidation of ETC, on the conversion of the Series D Preferred Stock to common stock or following declaration by the Board of Directors of ETC. Upon liquidation, dissolution or winding up of ETC, the Series D Preferred Stock will have the right to receive the original investment amount plus accrued dividends. To the extent of any remaining funds or assets, the Series D Preferred Stock will participate on an as-converted basis in additional distributions. The Series D Preferred Stock will rank pari passu with the Series E Preferred Stock. The Series D Preferred Stock will vote with the ETC common stock on an as converted basis on all matters that require the vote of ETC’s shareholders.

 

The Series D Preferred Stock will be convertible, at Lenfest’s request, into ETC common shares at a conversion price equal to the fair market value of ETC’s common stock on the date of issuance.

 

The Series D Preferred Stock contains anti-dilution protection for issuances of ETC’s common stock or securities convertible into ETC’s common stock at prices below the conversion price of the Series D Preferred Stock.

 

ETC has granted Lenfest demand and “piggy back” registration rights pursuant to a Registration Rights Agreement with respect to the shares of common stock issuable upon conversion of the Series D Preferred Stock.

 

The Series D Preferred Stock will be classified on the Company’s balance sheet as permanent equity.

 

Financing Transaction Conditions

 

Additional advances under the Lenfest Credit Facility, the Series E Exchange and Lenfest’s execution of the Lenfest Guaranty and Lenfest Pledge are subject to certain conditions (the “Financing Transaction Conditions”). These conditions include the following:

 

 

Pursuant to a Shareholders Voting Agreement, dated April 24, 2009, William F. Mitchell Sr. has agreed to vote all of his shares of ETC common stock in favor of Proposals III, IV and V.

 

Effect Upon Existing Holders of Common Stock

 

Approval of Proposal IV (the Series E Exchange) will have a dilutive effect on the shareholders of the Company. Approval of Proposal III (increase in authorized shares) is necessary to permit the Company to complete the Series E Exchange and satisfy its contractual obligations with respect to the Subordinated Note, together with all accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, and the Series B Preferred Stock and the Series C Preferred Stock, together with all accrued dividends thereon. The Series E Preferred Stock has a lower conversion price than any of the instruments currently held by Lenfest.

 

On April 23, 2009, Lenfest had a 49% beneficial ownership interest in the Company on a fully-diluted basis. As of that same date, Lenfest had a 52% beneficial ownership interest in the Company on a fully-diluted basis if all accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, and all accrued dividends on the Series B Preferred Stock and Series C Preferred Stock, were converted into ETC common stock. As a result of the completion of the Lenfest Financing Transaction, Lenfest may beneficially own up to 70.1% of ETC common stock on a fully-diluted basis.

 

Opinion of the Financial Advisor

 

The Company retained Navigant Consulting to act as financial advisor to the Audit Committee of the Board of Directors in connection with the Lenfest Financing Transaction. Navigant Consulting is a well respected financial

advisory firm, which is regularly engaged in the valuation of businesses and securities in connection with mergers and acquisitions, private placements and valuations for corporate and other purposes. The Audit Committee of the Board of Directors selected Navigant Consulting to act as its financial advisor in connection with the Lenfest Financing Transaction on the basis of Navigant Consulting’s experience, qualifications, its reputation and its familiarity with the Company.

 

On April 15, 2009, at a meeting of the Board of Directors held to consider and evaluate the Lenfest Financing Transaction, Navigant Consulting delivered to the Audit Committee of the Board of Directors an oral opinion, which was confirmed by delivery of a written opinion dated April 24, 2009 to the Audit Committee of the Board of Directors, to the effect that, as of the date of the opinion and based on and subject to various assumptions and limitations described in its opinion, the modification of the existing capital structure of ETC in connection with the Lenfest Financing Transaction was fair, from a financial point of view, to the minority shareholders of the Company (defined as shareholders of the Company other than Lenfest and his affiliates and their affiliates (the “Minority Shareholders”)).

 

The full text of Navigant Consulting’s written opinion to the Audit Committee of the Board of Directors, which describes, among other things, the assumptions made, procedures followed, factors considered and limitations on the review undertaken, is attached as Annex E to this document and is incorporated by reference herein in its entirety. The following summary of Navigant Consulting’s opinion is qualified in its entirety by reference to the full text of the opinion. Navigant Consulting delivered its opinion to the Audit Committee of the Board of Directors for the benefit and use of the Audit Committee of the Board of Directors in connection with and for purposes of their evaluation of the Lenfest Financing Transaction from a financial point of view. Navigant Consulting’s opinion does not address any other aspect of the Lenfest Financing Transaction and does not constitute a recommendation to any shareholder as to how to vote or act in connection with the matters set forth herein.

 

On April 15, 2009, Navigant Consulting, the Financial Advisor to the Audit Committee of the Board of Directors, rendered its oral Opinion (the “Opinion”) that, as of that date and based on and subject to the factors and assumptions set forth in its Opinion, the modification to the existing capital structure in the proposed Lenfest Financing Transaction with its major shareholder, Lenfest was fair from a financial point of view to the Minority Shareholders of ETC. On April 24, 2009, in connection with the approval of the Audit Committee and the full Board of Directors of the proposed Lenfest Financing Transaction, Navigant Consulting delivered its written Opinion. The Audit Committee of the Board of Directors did not limit the investigations made or procedures followed by Navigant Consulting in giving its oral or written Opinion.

 

The summary of Navigant Consulting’s Opinion set forth in this document is qualified in its entirety by reference to the full text of the document. You should read this Opinion carefully and in its entirety in connection with this proxy statement. However, we have also included the following summary of Navigant Consulting’s Opinion, which is qualified by reference to the full text of the Opinion.

 

Navigant Consulting’s Opinion is directed to ETC’s Audit Committee of the Board of Directors. It does not constitute a recommendation to you on how to vote with respect to Proposals III, IV and V. The Opinion addresses only the financial fairness of the modification to the existing capital structure of ETC. The Opinion does not address the relative merits of the proposed Lenfest Financing Transaction or any alternatives to the proposed transaction, the underlying decision of ETC’s Board of Directors to proceed with or effect the proposed Lenfest Financing Transaction or any other aspect of the proposed Lenfest Financing Transaction. In furnishing its Opinion, Navigant Consulting did not represent that it is an expert within the meaning of the term “expert” as used in the Securities Act, nor did it represent that its Opinion constitutes a report or valuation within the meaning of the Securities Act.

 

As part of Navigant Consulting’s analysis for this Opinion, Navigant Consulting made such reviews, analyses and inquiries as it deemed necessary and appropriate under the circumstances. Navigant Consulting also took into account its experience in connection with similar transactions. Among other things as part of its analysis, Navigant Consulting has:

 

1. Reviewed the March 16, 2009 version of the Company’s draft Proxy Statement soliciting the vote of the Company’s common shareholders for the approval of the proposed Lenfest Financing Transaction;

 

2. Reviewed certain draft transaction documents, including but not limited to loan documents and documents covering conversion of convertible subordinated debt and existing preferred stock to Series E Preferred Stock;

 

3. Reviewed ETC’s audited financial statements for the fiscal years ended February 2004 through 2008, as well as unaudited financial statements for the fiscal year ended February 2009;

 

4. Evaluated management-prepared projections of ETC, as well as financial and market performance of companies deemed to be reasonable guideline companies to ETC;

 

5. Reviewed ETC’s publicly available SEC filings, including its annual reports for the periods ended February 2004 through 2008, which include audited financial statements for the fiscal years ended 2004 through 2008, as well as unaudited financial reports for fiscal 2009;

 

6. Discussed the current backlog and expected revenue and profitability of various projects with management of ETC;

 

7. Discussed the markets for the Company’s products and services with the management of ETC;

 

8. Visited ETC headquarters in Southampton, PA;

 

9. Toured the physical plant at the Company’s headquarters;

 

10. Evaluated market performance and current stock price, EPS and book value of ETC; and

 

11. Conducted such other studies, analyses and inquiries as deemed appropriate.

 

In rendering its Opinion, Navigant Consulting has assumed the accuracy and completeness of all of the information that has been supplied to it with respect to ETC, its business, and its industry. With respect to the financial forecast information furnished to or discussed with Navigant Consulting by ETC management, it was assumed that such information has been reasonably prepared and that it reflects the best currently available estimates and judgment of ETC’s management as to the expected future financial performance of ETC.

 

For purposes of the Opinion, it has been represented to Navigant Consulting that ETC has not consummated and does not contemplate any material transaction other than the proposed Lenfest Financing Transaction and those activities undertaken in the ordinary course of business. Navigant Consulting does not assume any responsibility for any independent verification of any information provided to it, and has further relied upon the assurance of management of ETC that it is not aware of any facts or circumstances that would make such information inaccurate or misleading in any respect material to Navigant Consulting’s analysis.

 

Navigant Consulting employed accepted valuation practices and methods in reaching its conclusion described in its Opinion. The following summarizes Navigant Consulting’s material financial analyses used in developing its Opinion. The discussion herein does not constitute a complete description of Navigant Consulting’s analyses, including the assumptions and methodologies that underlie the analyses that comprise the Opinion.

 

In arriving at its Opinion, Navigant Consulting considered all of the financial analyses it performed and did not attribute any particular weight to any specific analysis, nor did it reach a conclusion based on any single analysis. Consequently, no single analysis should be considered independently as it may lead to a misleading conclusion about the transaction. Instead, Navigant Consulting developed its conclusion on the fairness of the transaction from a financial point of view based on its experience and professional judgment after considering the results of its analyses taken as a whole.

 

In performing its valuation of the Company, which operates in two segments, Training Services Group (“TSG”) and Control Systems Group (“CSG”) (collectively “business units”), and arriving at a range of common stock values on a going concern basis, Navigant Consulting considered the following valuation analyses:

 

 

Discounted Cash Flow Analysis.  Discounted cash flow (“DCF”) analysis estimates the value based upon a company’s projected future free cash flow discounted at a rate reflecting risks inherent in its business and capital structure. Unlevered free cash flow represents the amount of cash generated and available for principal, interest and

dividend payments after providing for ongoing business operations. While the DCF analysis is the most scientific of the methodologies used, it is dependent on projections and is further dependent on numerous industry-specific and macroeconomic factors.

 

This analysis utilized the projected cash flows of TSG and CSG, discounted back to present value. For purposes of this DCF analysis, Navigant Consulting relied upon the financial projections of ETC’s segments for fiscal years ending February 26, 2010 through February 24, 2012, provided by ETC management. These include projections related to revenue, cost of goods sold, SG&A, other expenses, capital expenditure, and depreciation and amortization. Navigant Consulting reviewed these projections against market participant results and closely discussed the results of these forecasts with management to ensure an understanding of the underlying assumptions. Management’s analysis relied, in part, on the use of net operating loss carryforwards following the completion of the proposed Lenfest Financing Transaction. Navigant Consulting did not independently test for built-in gains that would allow use of the NOL carryforwards.

 

DCF analysis is a method of valuing an asset as the present value of the sum of (i) its unlevered free cash flows over a forecast period and (ii) its theoretical terminal value at the end of the forecast period. Navigant Consulting relied upon ETC’s forecasted cash flows according to the financial projections for the fiscal years 2010 through 2012, as provided by ETC’s management. These assumptions did not include strategic acquisitions nor material changes in the legal or regulatory environment governing ETC’s key businesses. The terminal values of TSG and CSG were calculated based on projected normalized revenue for fiscal 2012.

 

The management-prepared forecasts documented expected performance from fiscal years ending February 26, 2010 through February 29, 2012 for each of the Company’s segments. The revenue and expense forecasts assumed no major changes in the regulatory or legal environment in which the Company operates. The underlying expectation for the projected performance of the Company was an increase in revenue as the Company expects significant demand for its products from the United States military as well as other customers.

 

Overall, the Company projected annual revenue for TSG and CSG of $28.3 million and $11.4 million for the fiscal year ending February 28, 2010, $36.5 million and $23.8 million in fiscal 2011, and $47.8 million and $30.8 million in fiscal 2012, respectively. EBITDA for TSG and CSG was projected at $4.4 million and $1.4 million for the fiscal year ending February 28, 2010, $4.4 million and $4.2 million in fiscal 2011, and $13.9 million and $5.9 million in fiscal 2012, respectively.

 

The projections essentially assume the Company is an emerging growth company and will be able to apply its NOL carryforwards. These NOLs are expected to be consumed during the discrete projection period (fiscal years 2010 through fiscal 2012). Management’s expectation is that the NOLs are large enough that the Company will not be in a taxable situation.

 

A discount rate was used in the analysis of 25.0% for TSG and 13.0% for CSG based on a weighted average cost of capital (“WACC”) analysis and an assessment of the specific risks associated with each segment of the Company. WACC measures the costs of debt and equity weighted by the percentage of debt and percentage of equity in a company’s estimated target capital structure. The pretax cost of debt capital was determined as LIBOR plus 250 bps, which is based on the Company’s borrowing arrangement with its existing lender. In addition, since interest expense is deductible for income tax purposes, the pretax cost of debt was tax-affected.

 

The estimated proportion of debt and equity financing utilized a market participant capital structure of 23.0% debt and 77.0% equity for TSG and 30.0% debt and 70.0% equity for CSG. This capital structure was then used to weight the cost of debt and equity financing. The final cash flows include estimated working capital needs. The working capital need was based on a comparison of a normalized level of working capital determined by considering comparable companies compared to the working capital the business units had as of the date of the analysis.

 

Combining the sum of the discounted cash flows, including the terminal value, and the working capital adjustment resulted in the business enterprise value (“BEV”) of ETC on a marketable, controlling basis.

 

Navigant Consulting performed a sensitivity analysis on the results of the DCF. In assessing terminal year values, Navigant Consulting elected to consider terminal growth rates from 0.0% to 5.0% in a DCF sensitivity analysis with a central focus on a 3.0% expected terminal growth rate.

 

Navigant Consulting developed a matrix of business enterprise values for ETC based on an assumption that the Company would remain operating as a going concern. Given this matrix, presented below, Navigant Consulting estimated a range of business enterprise values between $12 million and $23.1 million for TSG and $20.8 million and $46.9 million for CSG.

 

 

The Company indicated that without shareholder approval for the modification of the existing capital structure, ETC may not have adequate capital structure and sufficient working capital to be able to bid on certain contracts. Navigant Consulting stress-tested management-prepared projections by excluding the contracts identified by management as “at risk” from each of the TSG and CSG projections.

 

Navigant Consulting developed a matrix of BEV for ETC based on an assumption that the Company would remain operating as a going concern. Given this matrix, presented below, Navigant Consulting estimated that the value of the TSG and CSG business units, excluding these major contracts, would decline significantly, as presented below.

 

 

Comparative Transactions Analysis.  Navigant Consulting completed a transactions search of companies whose industry classification is similar to that of ETC. Navigant Consulting’s initial review considered 66 transactions that have taken place since 2005 for possible evaluation to determine an indicated value from actual sales of similar companies.

 

Navigant Consulting’s view is that the majority of the companies that appeared in the transaction search are not truly comparable to ETC. Also, these companies have significant differences in profitability and revenue prospects as compared to ETC. Because of these critical differences, Navigant Consulting elected not to use a transaction comparable method.

 

Guideline Company Analysis.  Navigant Consulting considered a group of publicly traded companies and selected guideline companies based on multiple factors including, but not limited to, business description, financial risk, and geographic diversification.

 

Navigant Consulting assessed the merits and drawbacks of the guideline company analysis and noted that the guideline companies have different long-term margin and revenue prospects and this approach could produce biased results. In addition, this approach could also produce biased results since there are differences in depreciation expense and associated capital expenditure requirements between ETC and the guideline companies. In consideration of these factors, amongst others, Navigant Consulting elected not to use this approach and considered it an unreliable indicator of value.

 

For the rendering of its Opinion, Navigant Consulting was paid $225,000. ETC agreed to reimburse Navigant Consulting for out-of-pocket expenses, including legal fees, and to indemnify Navigant Consulting against certain liabilities, including any such liabilities that may arise under federal securities law.

 

No portion of Navigant Consulting’s fee or reimbursement of its expenses is contingent on consummation of the transaction, nor is any of Navigant Consulting’s fee or expense reimbursement contingent on the conclusions reached in the Opinion.

 

Unaudited Pro Forma Balance Sheet

 

The following unaudited pro forma balance sheet as of February 27, 2009 gives effect to the Series E Exchange as if it occurred on that date. ETC’s fiscal year is composed of 52 or 53 weeks ending on the Saturday closest to February 28.

 

The unaudited pro forma balance sheet shown under this heading is presented for informational purposes only, is not necessarily indicative of the financial position that would actually have occurred had the Series E Exchange been consummated as of the date presented, nor is it necessarily indicative of the financial position of ETC. The unaudited pro forma financial information under this heading and the accompanying notes should be read together with the historical financial statements and related notes contained in the annual report and other information that ETC has filed with the SEC.

 

 

 

Pro forma adjustments:

 

 

The Board of Directors has approved an amendment to Article 6 of ETC’s Articles of Incorporation which, if adopted, would increase the number of authorized shares of ETC’s common stock from 20,000,000 to 50,000,000 shares. The Board of Directors unanimously recommends that shareholders approve this amendment to ETC’s Articles of Incorporation. Lenfest did not participate in the discussions of the Board of Directors relating to the amendment and did not vote, in his capacity as a Director of ETC, on the amendment. Please review “Background for Proposals III, IV and V” for a discussion of this Proposal.

 

As of April 24, 2009, there were 9,069,351 shares of ETC’s common stock issued and outstanding.

 

In 2003, ETC issued the Subordinated Note to Lenfest, which together with accrued interest and warrants issuable as of February 27, 2009 pursuant to the terms of the Subordinated Note, are convertible into 2,240,491 shares of ETC common stock based on a conversion price of $6.05 per share.

 

In 2006, ETC issued an aggregate of $6,000,000 of Series B Preferred Stock, $3,000,000 of which is convertible into 606,060 shares of ETC common stock based on a conversion price of $4.95 per share and $3,000,000 of which is convertible into 449,101 shares of common stock based on a conversion price of $6.68 per share. As of February 27, 2009, Lenfest is also entitled to receive 238,499 shares of ETC common stock on account of dividends accrued on the Series B Preferred Stock.

 

In 2007, ETC issued $3,300,000 of Series C Preferred Stock which is convertible into 1,089,109 shares of ETC common stock based on a conversion price of $3.03 per share. As of February 27, 2009, Lenfest is also entitled to receive 165,007 shares of ETC common stock on account of dividends accrued on the Series C Preferred Stock.

 

In 2009, ETC issued 55 shares of Series D Preferred Stock which is convertible into 58,511 shares of ETC common stock based on a conversion price of $0.94 per share. In connection with the $2 Million Loan, ETC also issued to Lenfest the $2 Million Loan Warrant to purchase 143,887 share of ETC common stock.

 

ETC also has reserved for issuance 157,652 shares of ETC common stock to be issued upon exercise of stock options granted to employees and members of ETC’s Board of Directors and 1,000,000 shares of ETC common stock that may be issued under the 2009 Stock Plan.

 

ETC has reserved for issuance a total of 4,990,661 shares of common stock on account of the Subordinated Note, the accrued interest and warrants issuable pursuant to the Subordinated Note, the Series B Preferred Stock and accrued dividends thereon, the Series C Preferred Stock and accrued dividends thereon, the Series D Preferred Stock, the $2 Million Loan Warrant and outstanding stock options. ETC also has 9,069,351 shares of common stock issued and outstanding. As a result, ETC has 14,060,012 shares issued and outstanding or reserved for issuance.

 

In connection with the Lenfest Financing Transaction, the Subordinated Note, together with accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, will be exchanged for shares of Series E Preferred Stock with a conversion price of $2.00 per share in the event that ETC receives the Shareholder Approvals and satisfies the other Lenfest Financing Transaction conditions. Following the Series E Exchange, the Series E Preferred Stock held by Lenfest on account of the Subordinated Note, together with accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, will be convertible into 6,411,355 shares of ETC common stock. The Series B Preferred Stock and Series C Preferred Stock, together with accrued dividends thereon, will also be exchanged for shares of Series E Preferred Stock with an exercise price of $2.00 per share in the event that ETC receives the Shareholder Approvals and satisfies the other Lenfest Financing Transaction conditions. Following the Series E Exchange, the Series E Preferred Stock held by Lenfest on account of the Series B Preferred Stock and the Series C Preferred Stock, together with accrued dividends thereon, will be convertible into 5,573,712 shares of ETC common stock. The Series E Preferred Stock will be convertible into an aggregate of 11,985,067 shares of ETC common stock, which, when added to the 9,069,351 shares of common stock issued and outstanding, the 58,511 shares of common stock issuable upon conversion of the Series D Preferred Stock, the 143,885 shares of ETC common stock issuable upon exercise of the $2 Million Loan Warrant and the outstanding stock options, exceeds the 20,000,000 of authorized shares of ETC common stock.

ETC does not currently have sufficient shares of common stock authorized to effectuate the Series E Exchange and the issuance of shares of common stock under the 2009 Stock Plan. The exchange of these instruments for Series E Preferred Stock is a condition to the Lenfest Financing Transaction, pursuant to which Lenfest will make available to ETC additional funds and guarantee ETC’s obligations under the Amended and Restated PNC Credit Agreement, subject to the condition that ETC receive the Shareholder Approvals and meet the other Financing Transaction Conditions, each of which is described above. In addition to the Series E Preferred Stock, the Company will also be obligated to issue Series D Preferred Stock in connection with the Lenfest Financing Transaction, which shares are also convertible into common stock.

 

Proposal III is being proposed because an increase in the number of shares of ETC common stock is necessary to complete the Lenfest Financing Transaction and because the Board of Directors believes that it is advisable to have a greater number of authorized but unissued shares of common stock available for various corporate initiatives and general corporate purposes. ETC from time to time may consider public or private financings to provide ETC with capital, which may involve the issuance of additional shares of common stock or securities convertible into shares of common stock. ETC may also consider acquisitions or other business transactions that may require the issuance of common stock or securities convertible into shares of common stock. Also, additional shares of common stock may be necessary to meet anticipated future obligations under ETC’s employee benefit plans. The Board of Directors believes that having the authority to issue additional shares of common stock will avoid the possible delay and significant expense of calling and holding a special meeting of shareholders to increase the number of authorized shares of common stock.

 

ETC has no present agreement or understanding involving the issuance of its common stock except for issuances of common stock:

 

 

An increase in the number of authorized shares of ETC’s common stock is required to permit ETC to meet these obligations.

 

If Proposal III is approved, the Board of Directors will not solicit shareholder approval to issue additional authorized shares of common stock, except to the extent that such approval may be required by law, and such shares may be issued for such consideration, cash or otherwise, at such times and in such amounts as the Board of Directors may determine.

 

Article 6 of ETC’s Articles of Incorporation also authorizes the issuance of 1,000,000 shares of preferred stock, which the Board of Directors has the power to issue as a class or in series and to determine the voting power, if any, dividend rates, conversion or redemption prices, designations, rights, preferences and limitations of the shares in the class or in each series. The proposed amendment to Article 6 of ETC’s Articles of Incorporation will not increase or otherwise affect ETC’s authorized preferred stock. As of April 24, 2009, ETC had 6,000 shares of Series B Preferred Stock and 3,300 shares of Series C Preferred Stock issued and outstanding.

 

The amendment of the Articles of Incorporation to increase the number of authorized shares of common stock from 20,000,000 to 50,000,000 will consist of a revision of Article 6 of the Articles of Incorporation to read in its entirety as follows:

 

“ARTICLE 6. The aggregate number of shares of capital stock which the Corporation shall have authority to issue is 51,000,000 shares, divided into two classes consisting of 50,000,000 shares of common stock having a par

value of $.05 per share (“Common Stock”) and 1,000,000 shares of preferred stock having a par value of $.05 per share (“Preferred Stock”).

 

The Preferred Stock may be issued from time to time as a class without series or, if so determined by the Board of Directors of the Corporation, either in whole or in part, in one or more series. There is hereby expressly granted to and vested in the Board of Directors of the Corporation authority to fix and determine (except as fixed and determined herein), by resolution, the par value, voting powers, full or limited, or no voting powers, and such designations, preferences and relative, participating, optional or other special rights, if any, and the qualifications, limitations or restrictions thereof, if any, including specifically, but not limited to, the dividend rights, conversion rights, redemption rights and liquidation preference, if any, of any wholly unissued series of Preferred Stock (or the entire class of Preferred Stock if none of such shares have been issued), the number of shares constituting any such series and the terms of the conditions of the issue thereof. Prior to the issuance of any shares of Preferred Stock, a statement setting forth a copy of each such resolution or resolutions and the number of shares of Preferred Stock of each such class or series shall be executed and filed in accordance with the Pennsylvania Business Corporation Law of 1988, as amended. Unless otherwise provided in any such resolution or resolutions, the number of shares of capital stock of any such class or series so set forth in such resolution or resolutions may thereafter be increased or decreased (but not below the number of shares then outstanding), by a statement likewise executed and filed setting forth a statement that a specified increase or decrease therein had been authorized and directed by a resolution or resolutions likewise adopted by the Board of Directors of the Corporation. In case the number of such shares shall be decreased, the number of shares so specified in the statement shall resume the status they had prior to the adoption of the first resolution or resolutions.”

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE “FOR” THIS AMENDMENT TO ETC’S ARTICLES OF INCORPORATION TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF ETC COMMON STOCK. The affirmative vote of a majority of all votes cast at the Annual Meeting is required to approve this amendment. Abstentions and broker non-votes will not constitute or be counted as “votes” cast and, therefore, will not affect the outcome of the vote on this proposal. All proxies will be voted “FOR” approval of the amendment to ETC’s Articles of Incorporation unless a shareholder specifies to the contrary on such shareholder’s proxy card.

 

The Board of Directors has approved the Series E Exchange described above under “Background for Proposals III, IV and V.” The Board of Directors unanimously recommends that shareholders of ETC approve the Series E Exchange. Lenfest did not participate in the discussions of the Board of Directors relating to the Series E Exchange and did not vote, in his capacity as a Director of ETC, on the Series E Exchange. Please review “Background for Proposals III, IV and V” for a discussion of this Proposal.

 

As part of the Lenfest Financing Transaction, the Subordinated Note, together with all accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, and all Series B Preferred Stock and Series C Preferred Stock, together with all accrued dividends thereon, will be exchanged (the “Series E Exchange”) for shares of a newly-created class of Series E Preferred Stock, subject to the Company obtaining the Shareholder Approvals. The Statement with Respect to Shares for the Series E Preferred Stock is attached to this proxy statement as Annex C and the following description of the Series E Preferred Stock is qualified by reference to Annex C. The Series E Preferred Stock will provide for a dividend of 10% per annum. The dividend will be payable on the liquidation of ETC, on the conversion of the Series E Preferred Stock to common stock or following declaration by the Board of Directors of ETC. Upon liquidation, dissolution or winding up of ETC, the Series E Preferred Stock will have the right to receive the original investment amount plus accrued dividends. To the extent of any remaining funds or assets, the Series E Preferred Stock will participate on an as-converted basis in additional distributions. The Series E Preferred Stock will rank pari passu with the Series D Preferred Stock. The Series E Preferred Stock will vote with the ETC common stock on an as converted basis on all matters that require the vote of ETC’s shareholders. ETC has granted Lenfest demand and “piggy back” registration rights pursuant to a Registration Rights Agreement with respect to the shares of common stock issuable upon conversion of the Series E Preferred Stock.

The Series E Preferred Stock will be convertible, at Lenfest’s request, into ETC common shares at a conversion price equal to $2.00 per common share.

 

The Series E Exchange will effectively reduce the conversion price on each of the Subordinated Note ($6.05 per common share), Series B Preferred Stock ($4.95 per common share with respect to $3,000,000 of Series B Preferred Stock and $6.68 per common share with respect to $3,000,000 of Series B Preferred Stock) and Series C Preferred Stock ($3.03 per common share) to $2.00 per ETC common share. The Series E Exchange will have a dilutive effect on the shareholders of the Company as described above under “Effect Upon Existing Holders of Common Stock.” However, on April 23, 2009, the date on which ETC’s Board of Directors approved the Lenfest Financing Transaction, the trading price of ETC’s common stock was $0.94. Therefore, the $2.00 conversion price of the Series E Preferred Stock represents a 113% premium over the April 23, 2009 trading price.

 

As of February 27, 2009, the Series B and Series C Preferred Stock were classified as mezzanine or temporary equity on the Company’s balance sheet. The Series D and Series E Preferred Stock will be classified as permanent equity on the Company’s balance sheet.

 

Among the factors considered by the Board of Directors in approving and recommending to the shareholders this Proposal were (i) the Company’s short-term and long-term financial needs as described under “Current Financial Status of ETC” above, (ii) the significant positive impact of the Series E Exchange on ETC’s balance sheet, (iii) the lack of other available financing alternatives and (iv) the terms of the Lenfest Financing Transaction require shareholder approval of the Series E Exchange.

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE “FOR” THE SERIES E EXCHANGE. The affirmative vote of a majority of all votes cast at the Annual Meeting is required to approve the Series E Exchange. Abstentions and broker non-votes will not constitute or be counted as “votes” cast and, therefore, will not affect the outcome of the vote on this proposal. All proxies will be voted “FOR” approval of the Series E Exchange unless a shareholder specifies to the contrary on such shareholder’s proxy card.

 

The Board of Directors believes that the restoration of Lenfest’s voting rights with respect to all preferred and common shares owned by Lenfest currently or issuable to Lenfest as part of the Lenfest Financing Transaction is in the best interests of the Company and its shareholders. The Board of Directors unanimously recommends that shareholders approve this proposal. Lenfest did not participate in the discussions of the Board of Directors relating to such restoration of voting rights and did not vote, in his capacity as a Director of ETC, on such matter. Please review “Background for Proposals III, IV and V” for a discussion of this Proposal.

 

Pennsylvania Law

 

Subchapter 25G of the Pennsylvania Business Corporation Law of 1988, as amended (the “Pennsylvania BCL”), provides that a person who acquires 20% or more, 331/3% or more, or 50% or more (the “Control Share Thresholds”) of the voting power of a corporation for the first time loses the right to vote those “control” shares unless and until its voting rights are reinstated by a vote of the shareholders at an annual or special meeting. Such resolution may be approved only be the affirmative vote of the holders of a majority of the voting power entitled to vote in two separate votes as follows: (i) a majority of all voting shares of such corporation and (ii) a majority of the disinterested voting shares of such corporation.

 

Prior Transactions

 

In connection with a financing provided by PNC Bank in February 2003, the Company entered into a Convertible Note and Warrant Purchase Agreement with Lenfest, pursuant to which the Company issued to Lenfest the Subordinated Note in the principal amount of $10,000,000 and (ii) warrants to purchase 803,048 shares of the Company’s common stock, which were exercised by Lenfest on February 14, 2005. The Subordinated Note entitles Lenfest to convert all or a portion of the outstanding principal of, and accrued and unpaid interest on, the Subordinated Note into shares of ETC common stock at a conversion price of $6.05 per share.

In October 2004, Lenfest guaranteed a $5,000,000 Letter of Credit Facility between ETC and PNC Bank. In connection therewith, ETC issued a Stock Purchase Warrant to Lenfest pursuant to which Lenfest was entitled to purchase up to 200,000 shares of common stock. Lenfest exercised this warrant on February 14, 2005.

 

In April 2006, the Company and Lenfest entered into the Lenfest Equity Agreement. The Lenfest Equity Agreement permitted ETC to unilaterally draw down up to $15,000,000 in exchange for shares of the Company’s Series B Preferred Stock. In connection with the execution of the Lenfest Equity Agreement, the Company drew down $3,000,000 by issuing 3,000 shares of Series B Preferred Stock with a conversion price equal to $4.95 per share. Additionally, in July 2006, the Company drew down an additional $3,000,000 by issuing 3,000 shares of Series B Preferred Stock at a conversion price equal to $6.68 per common share.

 

On August 23, 2007, the Company and Lenfest entered into the Series C Purchase Agreement, pursuant to which ETC issued and sold 3,300 shares of Series C Preferred Stock to Lenfest for $3,300,000. The Series C Preferred Stock is convertible by Lenfest at any time into shares of ETC’s common stock at a conversion price of $3.03 per share.

 

In addition to the foregoing transactions, Lenfest purchased or received shares of ETC’s common stock on various dates and beneficially owns the following securities:

 

 

 

 

 

Transactions 1 and 5 above caused Lenfest to cross certain of the Control Share Thresholds. As a result, the shares of ETC preferred stock and common stock acquired by Lenfest in connection with such transactions are not be entitled to vote on any matters. The loss of Lenfest’s voting rights with respect to such shares was not intentional, but rather was an unintended consequence of the issuance to Lenfest, in connection with capital raising transactions that were essential to the Company’s survival, of shares of common stock or securities exercisable or convertible into shares of common stock in numbers that exceeded the foregoing Control Share Thresholds. Subchapter 25G of the Pennsylvania BCL was enacted to provide anti-takeover protections to corporations. Based on the legislative history of Subchapter 25G, it does not appear that the capital raising transactions entered into with Lenfest were the type of transactions that Subchapter 25G of the Pennsylvania BCL was designed to protect against. For the past six years, Lenfest has been the Company’s principal source of capital that has been necessary for the Company to continue its operations. All transactions between Lenfest and ETC have been approved by ETC’s Board of Directors or Audit Committee. For this reason, the Board of Directors of the Company believes that it is fair to and in the best interests of the Company and its shareholders (other than Lenfest) that Lenfest’s voting rights be restored.

 

Current Transactions

 

As part of the Lenfest Financing Transaction, on April 24, 2009, the Company established the Lenfest Credit Facility in the maximum amount of $7,500,000 with Lenfest and Lenfest agreed to provide to the Company the Initial $1 Million Loan at the Company’s request under the Lenfest Credit Facility to fund the Company’s operations. Lenfest also previously funded $2,000,000 of the Lenfest Credit Facility pursuant to the $2 Million Loan on February 20, 2009. The terms of the Lenfest Credit Facility are set forth in the Lenfest Credit Agreement. ETC needs to obtain the Shareholder Approvals in order to receive any further advances under the Lenfest Credit Facility. In addition, if ETC does not receive the Shareholder Approvals by the Shareholder Approval Date, the $2 Million Loan will be due and payable on August 20, 2009 and the Initial $1 Million Loan, if issued, will be due and payable five business days after the Shareholder Approval Date. Each Lenfest Credit Facility Note issued prior to ETC obtaining the Shareholder Approvals accrues interest at the rate of 15% per annum, payable in cash, or at the election of Lenfest, in shares of Series D Preferred Stock, the terms of which are described below. The interest rate under any of these notes will retroactively reduce to 10% per annum upon receipt of the Shareholder Approvals. All Lenfest Credit Facility Notes issued after ETC obtains the Shareholder Approvals shall accrue interest at the rate of 10% per annum, payable in cash or, at the election of Lenfest, in shares of Series D Preferred Stock.

 

The Company paid to Lenfest an origination fee of one percent (1%) of the committed (but not advanced yet) amount of the Lenfest Credit Facility. The origination fee was paid in 55 shares of Series D Preferred Stock with a stated value of $1,000 per share.

 

In connection with each Lenfest Credit Facility Note issued by ETC, ETC will issue to Lenfest a warrant to purchase a number of shares of ETC common stock equal to (i) 10% of the principal amount of the Lenfest Credit Facility Note divided by (ii) the closing price of ETC common stock for the day immediately preceding the date of issuance of this warrant. The exercise price for the warrants will be equal to such closing price. The warrants will be exercisable for seven years following issuance.

 

If the $1 Million Loan is drawn down but not repaid in full on or before the Initial $1 Million Loan Early Maturity Date or ETC does not obtain the Shareholder Approvals by the Shareholder Approval Date, then Lenfest will be entitled to purchase under the foregoing warrant a number of shares of ETC common stock equal to $500,000 divided by the closing price of ETC’s common stock for the day immediately preceding the date of issuance of the warrant, at an exercise price equal to 50% of the initial exercise price.

 

In addition, in connection with the $2 Million Loan, ETC issued to Lenfest the $2 Million Loan Warrant to purchase 143,885 shares of ETC common stock, at an exercise price per share equal to $1.39, which is equal to the average price of ETC common stock for the 120 trading days immediately preceding the date of this warrant. If the $2 Million Loan is not repaid in full on or before the $2 Million Loan Early Maturity Date or ETC does not obtain the Shareholder Approvals by the Shareholder Approval Date, then Lenfest will be entitled to purchase an

additional 575,539 shares of ETC common stock for a total of 719,424 shares of ETC common stock under such warrant, and the exercise price per share of such warrant will be decreased by 50% to $0.69 for all shares underlying the warrant.

 

As part of the Lenfest Financing Transaction, the Subordinated Note, together with all accrued interest and warrants issuable pursuant to the terms of the Subordinated Note, and all Series B Preferred Stock and Series C Preferred Stock, together with all accrued interest thereon, will be exchanged for Series E Preferred Stock if the Shareholder Approvals are obtained. The Series E Preferred Stock will be convertible, at Lenfest’s request, into ETC common shares at a conversion price equal to $2.00 per common share.

 

On April 24, 2009, PNC Bank agreed to increase the amount of financing available under the 2007 PNC Credit Agreement from $15,000,000 to $20,000,000, subject to the condition that Lenfest provides the Lenfest Guaranty and the Lenfest Pledge. Lenfest is only obligated to provide the Lenfest Guaranty and the Lenfest Pledge in the event that the Company obtains the Shareholder Approvals. If the 2009 PNC Financing Documents are entered into, ETC will pay Lenfest an origination fee equal to 1% of the market value of the Lenfest Pledge and annual interest equal to 2% of the market value of the Lenfest Pledge, each payable in shares of Series D Preferred Stock. In consideration of Lenfest entering into the Amended and Restated Guaranty, ETC will issue to Lenfest warrants to purchase shares of ETC common stock equal to 10% of the amount of the $5,000,000 increase in funding available under the Amended and Restated PNC Bank Credit Agreement. The warrants will be exercisable for seven years following issuance at an exercise price per share equal to the closing price of ETC’s common stock on the day prior to issuance.

 

The instruments issued or issuable in connection with the Lenfest Financing Transaction (i.e., the Series D Preferred Stock, the Series E Preferred Stock and the applicable warrants) will cause Lenfest to cross a Control Share Threshold. Therefore, these instruments, if issued, will not be entitled to vote on any matters if shareholders do not approve this proposal.

 

Vote Required

 

The affirmative vote of at least a majority of all voting shares of ETC and a majority of the disinterested voting shares of ETC is necessary to grant and restore voting rights to all shares of preferred stock and common stock beneficially owned by, and to be issued to, Lenfest. This includes:

 

 

As stated above, the affirmative vote of at least a majority of the “disinterested voting shares” of ETC is necessary to approve this proposal. “Disinterested voting shares” is defined in Section 2562 of the Pennsylvania BCL. For purposes of this vote, “disinterested voting shares” does not include any voting shares beneficially owned by Lenfest or any executive officers of the Company or directors who are also officers of the Company (William F. Mitchell and Duane D. Deaner). With respect to this vote, only 5,592,990 shares of ETC common stock will be eligible to vote.

 

Effect of Proposal to Reinstate Voting Rights

 

If the voting rights are reinstated on all shares of preferred stock and common stock described above, following the Series E Exchange, Lenfest will beneficially own and be entitled to vote 70.1% of the common stock of the Company (including shares of common stock issuable upon conversion of all shares of preferred stock that would then be outstanding) and Lenfest will, therefore, control the Company’s Board of Directors, its management and its operations.

 

If the voting rights are not reinstated on the shares of preferred stock and common stock that Lenfest can not currently vote, and any shares of common stock or preferred stock that may be issued in the Series E Exchange,

Lenfest will not extend the Lenfest Guaranty and the Lenfest Pledge, and PNC Bank will not close the Amended and Restated PNC Bank Credit Agreement. In this event, ETC will not receive the additional $5,000,000 of borrowing availability for its working capital needs, in addition to the remaining amounts that it may have been eligible to receive under the new Lenfest Credit Facility. In addition, the $2 Million Loan will be due on August 20, 2009 and the Initial $1 Million Loan, if issued, will be due five business days after the Shareholder Approval Date. Moreover, the Subordinated Note is due on March 1, 2010 and the 2007 PNC Credit Facility is due June 30, 2010. Given the current state of the economy and the capital markets and the financial condition and current projections of ETC, there can be no assurance that ETC will be able to refinance these obligations on reasonable terms, if at all, let alone obtain additional funding for working capital or expansion capital. If ETC is unable to refinance its debt as it becomes due, it may be required to sell one or more divisions at what may not be favorable terms, if any sale could be consummated under any terms, or it may be forced to consider other alternatives, ranging from terminating certain lines of business, eliminating workforce or seeking relief from its creditors.

 

Among the factors considered by the Board of Directors in approving and recommending this proposal to the shareholders were: (i) the Company’s short-term and long-term financial needs and current debt obligations as described under “Background for Proposals III, IV and V” and “Current Financial Status of ETC” above, (ii) the lack of other available financing alternatives and (iii) the terms of the Lenfest Financing Transaction require reinstatement of the voting rights of the preferred stock and common stock as described above.

 

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS A VOTE “FOR” restoration of voting rights with respect to all preferred and common shares owned by Lenfest currently or issuable to Lenfest as part of the Lenfest Financing Transaction. The affirmative vote of at least (i) a majority of all voting shares of ETC and (ii) a majority of the disinterested voting shares of ETC is required to approve this proposal. Abstentions and broker non-votes will have the same effect as negative votes for purposes of this proposal. All proxies will be voted “FOR” approval of this proposal unless a shareholder specifies to the contrary on such shareholder’s proxy card.

 

The Audit Committee has reviewed and discussed the Company’s consolidated financial statements for the fiscal year ended February 27, 2009 with management and Friedman LLP, the Company’s independent accountants. The Audit Committee discussed with the independent accountants the matters required to be discussed by Statement on Auditing Standards No. 61, as amended, “Communication with Audit Committees.”

 

The Company’s independent accountants also provided to the Audit Committee the written disclosures and the letter required by Independence Standards Board Standard No. 1, “Independence Discussions with Audit Committees,” and the Audit Committee has discussed the independent accountants’ independence with the independent accountants.

 

Based on the review and discussions referred to above, the Audit Committee recommended to the Company’s Board of Directors that the Company’s audited consolidated financial statements be included in the Company’s Annual Report on Form 10-K for the year ended February 27, 2009 filed with the Securities and Exchange Commission.

 

The Audit Committee also reviewed the fees paid to Friedman LLP during fiscal year 2009 and determined that the services provided by Friedman LLP are compatible with maintaining its independence.

 

THE AUDIT COMMITTEE

 

Howard W. Kelley, Chairman
George K. Anderson, M.D., MPH
Stephen F. Ryan

 

Objectives and Philosophy of Executive Compensation

 

ETC’s executive compensation program is administered by the Compensation Committee of the Board of Directors. The Compensation Committee is currently composed of Howard W. Kelley who serves as acting Chairman, George K. Anderson, M.D., MPH, and Stephen F. Ryan, each of whom is independent under the relevant rules of the Securities and Exchange Commission and NYSE AMEX LLC. Prior to his resignation in February 2009, Alan M. Gemmill served as Chairman of the Compensation Committee. The Compensation Committee is responsible for developing and implementing an executive compensation program that takes into account ETC’s business strategy, the need for highly qualified management and other relevant factors. The executive compensation program is structured to link executive compensation to the overall performance of ETC to more closely align the interests of the executive management team with the interests of ETC’s shareholders.

 

The Compensation Committee’s philosophy in establishing its compensation policies is to maximize the possibilities for enhancing shareholder value by closely aligning compensation for ETC’s executive officers with the profitability of ETC. In this regard, it is considered essential to the success of ETC that its compensation policies enable ETC to attract, retain and satisfactorily reward executive officers who are contributing to the long-term growth and success of ETC. William F. Mitchell, President and Chief Executive Officer, and Duane D. Deaner, Chief Financial Officer, are ETC’s Named Executive Officers under applicable Securities and Exchange Commission regulations.

 

Primary Components of Executive Compensation

 

In 2004, the Board of Directors adopted and approved a Compensation Committee Charter which sets forth the principles and policies followed by the Compensation Committee in connection with executive compensation. A copy of ETC’s Compensation Charter is available on ETC’s corporate website (http://www.etcusa.com).

 

In April 2009, the Compensation Committee incorporated into its charter a policy statement which defined its specific responsibilities and established a set of generic evaluation criteria for developing and rewarding goals and objectives for the CEO and executive officers.

 

The primary components of ETC’s executive compensation program consist of base salary, annual cash bonus incentive opportunities and long-term incentive opportunities in the form of options to acquire common stock.

 

Base Salary

 

Base salary levels for ETC’s executive officers are set at or below the average base salary levels paid by other companies within ETC’s peer group. William F. Mitchell, President and Chief Executive Officer, received a base salary of $225,000 in the 2009 fiscal year and the 2008 fiscal year. Duane D. Deaner, Chief Financial Officer, received a base salary of $102,000 in the 2009 fiscal year and the 2008 fiscal year. The Compensation Committee has responsibility for setting Mr. Mitchell’s base salary and approved Mr. Mitchell’s employment agreement at the time it was entered into. Mr. Mitchell has responsibility for setting the base salary of the other officers and employees, including the base salary of Mr. Deaner.

 

Short-term Incentive Compensation

 

Based on the Compensation Committee’s review of ETC’s performance for the fiscal years ended February 27, 2009 and February 29, 2008, and the performance of its management team, no discretionary cash incentive compensation awards were made to any officers or key employees for overall Company performance.

 

During the fiscal years ended February 27, 2009 and February 29, 2008, certain members of the executive management team, including Mr. Deaner, were given the opportunity to earn additional compensation of up to approximately 10% of their base salary by completing specific accomplishments tailored to their individual areas of responsibility. Under this program, in fiscal 2009, a total of $46,000 was paid to three key employees, including $15,000 paid to Mr. Deaner. In fiscal 2008, a total of $6,375 was paid to four key employees, including $1,500 paid to Mr. Deaner. This program must be re-authorized by the CEO on an annual basis and is subject to cancellation at any time.

 

Long-Term Incentive Compensation

 

ETC’s 1998 Incentive Stock Option Plan, which expired in October 2008, was a long-term plan designed not only to provide incentives to management, but also to align a significant portion of the executive compensation

program with shareholder interests. The 1998 Incentive Stock Option Plan permitted ETC to grant certain officers and employees a right to purchase shares of stock at the fair market value per share at the date the option was granted. No options were granted to executive officers and employees in fiscal 2009 or 2008. In granting stock options to officers and employees, the Compensation Committee takes into account ETC’s financial performance, its long-term strategic goal of increasing shareholder value, the employee’s level of responsibility and his continuing contributions to ETC. Mr. Mitchell has never received any options to purchase shares of ETC’s common stock.

 

In April 2009, our Board of Directors approved the 2009 Employee, Director and Consultant Stock Plan, which is subject to shareholder approval under Proposal II of this Proxy Statement.

 

Option Grant Date Pricing

 

The Compensation Committee administered ETC’s 1998 Incentive Stock Option Plan until it expired in October 2008 and will administer the 2009 Stock Plan. Mr. Mitchell may make recommendations with respect to option grants but all other determinations to award options to purchase ETC’s common stock are made by the Compensation Committee and in all instances the exercise price is equal to ETC’s stock price on the date the Compensation Committee approves such option grants.

 

Given the relatively low amount of option grants made by ETC (no options were awarded in fiscal 2009 or 2008), the Compensation Committee does not actively attempt to coordinate option grants based on the presence or absence of material non-public information.

 

Chief Executive Officer Employment Agreement

 

On July 24, 2006, ETC entered into an employment agreement with William F. Mitchell (the “CEO Plan”) pursuant to which Mr. Mitchell is employed as the President and Chief Executive Officer. Mr. Mitchell has been the Chairman of the Board of Directors, President and Chief Executive Officer of ETC since 1969, except for the period from January 24, 1986 to January 24, 1987 during which he was engaged principally in soliciting sales for ETC’s products in the overseas market. Under Mr. Mitchell’s employment agreement, he is entitled to receive a base salary of $225,000, which is subject to increase annually based on a review of Mr. Mitchell’s performance by ETC’s Board of Directors. Mr. Mitchell is also entitled to receive a bonus based on a formula and targets set forth in the CEO Plan.

 

The term of the employment agreement is three years, and, if ETC does not renew the employment agreement for additional three-year periods, Mr. Mitchell is entitled to terminate the employment agreement and receive certain benefits under the terms of the employment agreement including, without limitation, three years of base salary, bonuses and participation in various benefit plans. The employment agreement also provides Mr. Mitchell with three years of base salary, bonuses, and participation in various benefit plans of ETC if his employment is terminated due to a disability, by ETC without cause, or if Mr. Mitchell terminates his employment with ETC for good reason, including a change in control of ETC (other than a change of control in connection with an acquisition by Lenfest), each as defined in the employment agreement.

 

Chief Financial Officer Employment Agreement

 

On November 1, 2005, ETC entered into an employment agreement with Duane D. Deaner pursuant to which Mr. Deaner continues to be employed as the Chief Financial Officer. Mr. Deaner has been the Chief Financial Officer of ETC since 1996. Under Mr. Deaner’s employment agreement, he is entitled to receive a base salary of $102,000, which is subject to increase annually based on a review of his performance. Mr. Deaner is also entitled to receive a bonus based on specific annual objectives tailored to his individual area of responsibility.

 

The original term of the employment agreement was two years and has been renewed. If ETC does not renew the employment agreement for additional two-year periods, Mr. Deaner is entitled to terminate the employment agreement and receive certain benefits under the terms of the employment agreement including, without limitation, two years of base salary, bonuses and participation in various benefit plans. The employment agreement also provides Mr. Deaner with two years of base salary, bonuses, and participation in various benefit plans of ETC if his employment is terminated due to a disability, by ETC without cause, or if Mr. Deaner terminates his employment with ETC for good reason, including a change in control of ETC, each as defined in his employment agreement.

 

The following Summary Compensation Table sets forth the compensation of our Named Executive Officers for the fiscal years ended February 27, 2009 and February 29, 2008.

 

 

 

 

This table summarizes the equity awards held by our Named Executive Officers as of February 27, 2009.

 

Potential Payments Upon Termination or Change-In-Control

 

As discussed in the Compensation Discussion and Analysis above, we entered into an employment contract with Mr. Mitchell, our Chief Executive Officer, on July 24, 2006, which provides Mr. Mitchell with three years of base salary, bonuses and participation in various benefit plans of ETC if his employment is terminated due to a disability, by ETC without cause, or if Mr. Mitchell terminates his employment with ETC for good reason, including a change in control of ETC (other than a change of control in connection with an acquisition by Lenfest), each as defined in his employment agreement.

 

Also, as discussed in the Compensation Discussion and Analysis above, we entered into an employment contract with Mr. Deaner, our Chief Financial Officer, on November 1, 2005, which provides Mr. Deaner with two years of base salary, bonuses and participation in various benefit plans of ETC if his employment is terminated due to a disability, by ETC without cause, or if Mr. Deaner terminates his employment with ETC for good reason, including a change in control of ETC, each as defined in his employment agreement.

 

Transactions Completed in Fiscal 2009 and Prior Years

 

On February 19, 2003, ETC completed a refinancing of its indebtedness with PNC Bank and Lenfest in the aggregate amount of $29,800,000. Pursuant to the terms of a Convertible Note and Warrant Purchase Agreement, dated February 19, 2003, between ETC and Lenfest, ETC issued to Lenfest (i) a 10% senior subordinated convertible promissory note in the original principal amount of $10,000,000 and (ii) warrants to purchase 803,048 shares of common stock. As a condition to closing the financing, ETC appointed Lenfest to its Board of Directors. On October 25, 2004, Lenfest executed a Limited Guaranty Agreement which guaranteed ETC’s $5 million Letter of Credit facility with PNC Bank, and in connection therewith, ETC issued a warrant to Lenfest pursuant to which Lenfest was entitled to purchase up to 200,000 shares of common stock at an exercise price equal to the lesser of $4.00 per share or 2/3 of the average daily high and low of common stock during the 25 day trading period immediately preceding the date of exercise. On February 14, 2005, Lenfest exercised all of his outstanding warrants and received 1,003,048 shares of unregistered common stock and purchased an additional 373,831 shares of unregistered common stock for approximately $2 million. Shareholder approval of this transaction was received at ETC’s 2005 annual meeting of shareholders.

 

On April 7, 2006, ETC entered into the Lenfest Equity Agreement with Lenfest. The Lenfest Equity Agreement permitted ETC to unilaterally draw down up to $15 million in exchange for shares of Series B Preferred Stock. The Series B Preferred Stock originally provided for a dividend equal to six percent per annum. After three years, the Series B Preferred Stock was convertible, at Lenfest’s request, into ETC common shares at the conversion price set on the day of each draw down. The conversion price equaled the closing price of ETC’s common stock on the trading day immediately preceding the day in which the draw down occurred, subject to a floor price of $4.95 per common share. On the sixth anniversary of the Lenfest Equity Agreement, any issued and outstanding Series B Preferred Stock will be mandatorily converted into ETC common stock at each set conversion price. The Series B Preferred Stock will vote with the ETC common stock on an as converted basis. In connection with the execution of the Lenfest Equity Agreement, the Company drew down $3 million by issuing 3,000 shares of Series B Preferred Stock with a conversion price equal to $4.95 per share. Additionally, on July 31, 2006, ETC drew down an additional $3 million by issuing 3,000 shares of Series B Preferred Stock at a conversion price equal to $6.68 per common share.

 

Effective May 9, 2007, the Company entered into a letter agreement with Lenfest (the “Lenfest Letter Agreement”) pursuant to Lenfest agreed to provide financial support to the Company in the form of a guarantee and/or provide access to funding until June 30, 2008.

 

On July 31, 2007, ETC completed a refinancing of its indebtedness with PNC Bank in the aggregate amount of up to $15,000,000. This refinancing by ETC is an extension of a credit facility originally entered into with PNC Bank in February 2003. ETC’s obligations under the Credit Agreement are secured by a personal guarantee from

Lenfest under a Restated Guaranty, dated July 31, 2007, made by Lenfest in favor of PNC Bank. ETC pays Lenfest an annual cash fee of 1% of the loan commitment for his guarantee.

 

On August 23, 2007, ETC entered into the Series C Purchase Agreement with Lenfest, pursuant to which, among other things, ETC issued and sold 3,300 shares of its newly-created class of Series C Preferred Stock to Lenfest for $3,300,000. The Series C Preferred Stock is convertible into shares of ETC’s common stock at a conversion price of $3.03 per share based on the closing price for ETC’s common stock on August 22, 2007, the trading day immediately prior to the transaction. The Series C Preferred Stock is convertible into 1,089,108 shares of ETC common stock. The Series C Preferred Stock provides for a dividend equal to 10% per annum. The Series C Preferred Stock is immediately convertible, at Lenfest’s request, into shares of ETC common stock at a conversion price equal to $3.03 per share. On the fifth anniversary of the Series C Purchase Agreement, any issued and outstanding Series C Preferred Stock will be mandatorily converted into ETC common stock at $3.03 per share. The Series C Preferred Stock is entitled to vote with the ETC common stock on an as converted basis.

 

ETC granted Lenfest certain demand and “piggy back” registration rights pursuant to a Registration Rights Agreement with respect to the shares of common stock issuable upon conversion of the Series C Preferred Stock.

 

In connection with Lenfest’s investment in the Series C Preferred Stock, ETC agreed to amend the terms of ETC’s Series B Preferred Stock to (i) increase the dividend rate to 10% per annum, (ii) provide for immediate conversion at the option of Lenfest, and (iii) to remove ETC’s right to redeem the Series B Preferred Stock.

 

In connection with the restatement of the Company’s previously issued financial statements for the year ended February 20, 2007, the Company has reclassified the Series B and C Preferred Stock (the “instruments”) from equity to mezzanine. The reclassification is due to the preferential redemption feature of the instruments in which redemption would be triggered by a change in ownership outside the Company’s control.

 

On February 20, 2008, ETC received a proposal from an affiliate of Lenfest to purchase all of the publicly traded shares of the common stock of the Company not owned by Lenfest at the time the acquisition is consummated. Following receipt of the acquisition proposal, the Company’s Board of Directors focused the audit committee to analyze the transaction. On September 11, 2008, Lenfest withdrew his proposal to purchase all of the publicly traded shares of the common stock of the Company not already owned by Lenfest.

 

On March 11, 2008, ETC entered into Amendment No. 1 to Convertible Note and Warrant Purchase Agreement (the “Purchase Agreement Amendment”) and First Amendment to Senior Subordinated Convertible Note (the “Note Amendment”) with Lenfest with respect to that certain Convertible Note and Warrant Purchase Agreement, dated as of February 18, 2003, by and between ETC and Lenfest (the “Convertible Note and Warrant Purchase Agreement”). Under the terms of the Purchase Agreement Amendment, ETC and Lenfest agreed to amend the financial covenants set forth in the Convertible Note and Warrant Purchase Agreement so that they are similar to the financial covenants contained in ETC’s credit agreement with PNC Bank, dated as of July 31, 2007. Under the terms of the Note Amendment, the maturity date of the convertible promissory note in the principal amount of $10,000,000 issued by ETC to Lenfest pursuant to the Convertible Note and Warrant Purchase Agreement was extended from February 18, 2009 to March 1, 2010. The effective date of the Purchase Agreement Amendment and the Note Amendment was February 19, 2008.

 

On May 20, 2008, Lenfest committed to fund requests by ETC to support its operations through June 30, 2009, on terms and conditions to be mutually agreed upon by Lenfest and ETC, provided that ETC was not permitted to request more than an aggregate of $10,000,000 in financing.

 

On February 20, 2009, Lenfest made a loan to ETC in the principal amount of $2,000,000. This loan is to be used by ETC solely in connection with working capital funding to support ETC’s bid on a contract with the United States government. The obligations of ETC to Lenfest with respect to this loan are secured by the grant of a first and prior security interest in all of the personal property of ETC pursuant to the terms of a Security Agreement, dated as of February 20, 2009, made by ETC in favor of Lenfest. In connection with this loan, ETC issued to Lenfest a warrant to purchase 143,885 shares of ETC common stock, at an exercise price per share equal to $1.39, which was equal to the average price of ETC common stock for the 120 trading days immediately preceding the date of the warrant.

Transactions Completed Post Fiscal 2009

 

For a discussion of the transactions of ETC that were completed post fiscal 2009, please see “Background of Proposals III, IV and V” above.

 

Other Related Party Transactions

 

ETC purchases industrial products from Industrial Instruments Corp., which is owned by Christine and Charles Walter, the daughter and son-in-law of William F. Mitchell, ETC’s President and Chief Executive Officer. During fiscal 2009, 2008 and 2007, the Company purchased $325,000, $315,000 and $265,000, respectively, from Industrial Instruments. ETC also rents office space to Industrial Instruments at ETC’s corporate headquarters. During fiscal 2009, 2008 and 2007, Industrial Instruments paid to ETC rent in the amounts of $8,450, $8,450 and $7,750, respectively.

 

ETC purchases travel accommodations from Jet Set, a company that employs Kathleen Mahon, the daughter of Mr. Mitchell. During fiscal 2009, 2008 and 2007, ETC purchased travel through Jet Set totaling $237,000, $254,000 and $217,000, respectively, and Ms. Mahon received approximately $12,000 from her employer in each fiscal period in commissions on account of such purchases. Ms. Mahon is also engaged by ETC as a consultant to review expense reports submitted by Company employees. During fiscal 2009, 2008 and 2007, Ms. Mahon received $16,000, $11,000 and $10,000, respectively in consideration of such services.

 

ETC also employs William F. Mitchell, Jr., the son of Mr. Mitchell, as its Vice President, Contracts/Purchasing, and David Mitchell, the son of Mr. Mitchell, as its Business Unit Manager for Sterilizers. In fiscal 2009, William F. Mitchell, Jr. received $115,000 and David Mitchell received $112,000 in compensation from ETC.

 

Review, Approval or Ratification of Transactions with Related Parties.

 

We have not adopted any formal policies or procedures for the review, approval or ratification of certain related-party transactions. However, such transactions, if and when they are proposed or have occurred, have traditionally been, and will continue to be, reviewed by our Audit Committee on a case-by-case basis. The Audit Committee may consider any relevant factors when reviewing the appropriateness of a related-party transaction, including, but not limited to, the following: (i) the importance of the transaction to ETC; (ii) the amount involved in the proposed transaction; (iii) the specific interest of the Director or executive officer (or immediate family members of same) in the proposed transaction; and (iv) the overall fairness of the terms of the transaction to ETC.

 

Director Independence.

 

NYSE AMEX LLC rules require that a majority of our Board of Directors be composed of “independent directors,” which is defined generally as a person other than an officer or employee of a company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company’s board of directors, would interfere with the director’s exercise of independent judgment in carrying out the responsibilities of a director. Messrs. Kelley and Ryan and Dr. Anderson are our independent Directors and constitute a majority of our Board of Directors. On April 23, 2009, ETC’s Board of Directors approved the voluntarily delisting of ETC’s common stock from NYSE AMEX LLC and notified NYSE AMEX LLC of its decision. The delisting is expected to be effective May 29, 2009. The Company intends to have its common stock quoted for trading on the Over-the-Counter Bulletin Board. Upon the effectiveness of the delisting, ETC will no longer be required to comply with the rules of NYSE AMEX LLC.

 

Section 16(a) of the Securities Exchange Act of 1934 requires our officers and Directors, and persons who own more than ten percent of a registered class of our equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission (“SEC”) and the NYSE AMEX LLC. Officers, Directors and greater than ten percent shareholders are required by SEC regulations to furnish us with copies of all Section 16(a) reports they file. The rules of the SEC regarding the filing of Section 16(a) reports require that “late filings” of Section 16(a) reports be disclosed in our proxy statement.

Based solely on our review of the copies of such forms which we received, or written representations from reporting persons that no Section 16(a) reports were required for those persons, Mr. Mitchell had six late filings covering a total of 7,400 shares spanning a three week period in January and February 2009. We believe that our greater than ten percent beneficial owners complied with all applicable filing requirements.

 

Under the Company’s Bylaws and the Charter of the Audit Committee of the Board of Directors, authority to select the Company’s auditors rests with the Audit Committee of the Board of Directors. Such selection is made through the formal act of the Audit Committee. It has not been and is not the Company’s policy to submit selection of its auditors to the vote of the shareholders because there is no legal requirement to do so.

 

Principal Accountant

 

Friedman LLP has been selected as the Company’s auditor for the fiscal year ended February 27, 2009. A representative of Friedman LLP is expected to attend the Annual Meeting. That representative will have an opportunity to make a statement at the Annual Meeting if he desires to do so and will be available to respond to appropriate shareholder questions.

 

Former Accountant

 

On November 28, 2007, Grant Thornton LLP (“Grant”), who had been the Company’s independent registered public accounting firm since 1995, resigned. In connection with its resignation, Grant advised the Audit Committee of the Company’s Board of Directors that the reason for its resignation is that information had come to Grant’s attention that had led it to no longer be able to rely on management’s representations and had made it unwilling to be associated with the financial statements prepared by management. In July 2007, the Audit Committee commenced an internal investigation after the Company was notified in June 2007 of the Department of the Navy’s counterclaims related to the Company’s claim in connection with the contract for its submarine rescue decompression project. In November 2007, the Audit Committee and its counsel informed Grant of certain results of that investigation, including that members of the Company’s management were aware in November 2006, but did not make Grant aware, that the Government’s trial attorney had expressed an intent to seek authorization to assert counterclaims against the Company in the absence of a settlement.

 

On November 20, 2007, the Company stated in its Form 8-K, Item 4.02(a) filing that the financial statements for the fiscal years ended February 28, 2003 through February 23, 2007 should no longer be relied upon. Therefore, the audit reports previously issued by Grant for the fiscal years ended February 28, 2003 through February 23, 2007 also should no longer be relied upon. Grant’s reports, as previously issued, on the Company’s financial statements for the fiscal years ended February 23, 2007 and February 24, 2006 did not contain an adverse opinion or a disclaimer of opinion, nor were such reports qualified or modified as to uncertainty, audit scope or accounting principles.

 

During the fiscal years ended February 23, 2007 and February 24, 2006 and the subsequent interim periods up through the date of Grant’s resignation (November 28, 2007), there were no disagreements with Grant on any matter of accounting principles on practices, financial statement disclosure or auditing scope or procedure, which disagreements, if not resolved to the satisfaction of Grant, would have caused Grant to make reference to the subject matter of the disagreements in its report.

 

Grant was replaced on January 30, 2008 with Friedman LLP, who was the Company’s independent registered public accounting firm for the fiscal years ended February 27, 2009 and February 29, 2008.

 

Accounting Fees

 

The following table presents fees for professional audit services rendered by Grant Thornton LLP for professional services rendered before their resignation. No fees for Friedman LLP, after they were engaged, were

paid in fiscal 2008. The fees include charges for quarterly financial statement reviews and the annual audit, employee benefit plans, and tax services for the fiscal years ended February 27, 2009 and February 29, 2008.

 

 

 

 

The Company’s 2010 Annual Meeting of Shareholders is expected to be held on or about September 24, 2010.

 

Proposals which shareholders desire to have included in the Proxy Statement for the 2010 Annual Meeting of Shareholders must conform to the applicable rules of the Securities and Exchange Commission concerning the submission and content of proposals and must be received in writing at the Company’s executive offices, 125 James Way, County Line Industrial Park, Southampton, Pennsylvania 18966 on or before July 30, 2010.

 

In accordance with Section 4.03(a)(i) of the Company’s Bylaws, shareholders may nominate candidates for election as Director by submitting nominations in writing to the Secretary of the Company no later than the close of business on the twentieth business day immediately preceding the date of the annual shareholders meeting.

 

Any such proposal must also comply with the other provisions contained in our Bylaws relating to shareholder proposals.

 

Notice of a proposed item of business must include:

 

 

Any Director nomination by a shareholder must include the following information about the nominee:

 

 

The Company knows of no other business which will be presented for consideration at the Annual Meeting. However, if other matters come before the Annual Meeting, it is the intention of the proxyholders to vote upon such matters as they, in their discretion, may determine.

 

The Company’s Annual Report on Form 10-K for the fiscal year ended February 27, 2009 is enclosed. Each person solicited hereunder can obtain a copy of the Company’s Annual Report on Form 10-K for the fiscal year ended February 27, 2009, as filed with the Securities and Exchange Commission on May 12, 2009, without charge by sending a written request to Environmental Tectonics Corporation, 125 James Way, County Line Industrial Park, Southampton, Pennsylvania 18966, Attention: Ann M. Allen, Secretary. In addition, the Company’s Annual Report on Form 10-K is accessible on the Internet at the Company’s website located at www.etcusa.com and at the Securities and Exchange Commission’s website located at www.sec.gov.

 

ANNEX A

 

ENVIRONMENTAL TECTONICS CORPORATION
2009 EMPLOYEE, DIRECTOR AND CONSULTANT STOCK PLAN

 

 

The purpose of this 2009 Stock Option and Stock Incentive Plan (the ‘‘Plan”) of Environmental Tectonics Corporation, a Pennsylvania corporation (the “Company”), is intended to promote the future success and growth of the Company by providing stock options and other equity interests in the Company (each an “Award”) to employees, officers, directors, consultants and advisors of the Company and its Subsidiaries, all of whom are eligible to receive Awards under the Plan. Any person to whom an Award has been granted under the Plan is called a “Participant.” Additional definitions are contained in Section 8 hereof.

 

 

a. Types of Awards.  This Plan is intended to provide: (i) officers and other employees of the Company opportunities to purchase shares of common stock, par value $0.05, of the Company (the “Common Stock”) pursuant to options granted hereunder which qualify as “incentive stock options” under Section 422(b) of the Code (“Incentive Stock Options”); (ii) directors, officers, employees, consultants and advisors of the Company opportunities to purchase Common Stock pursuant to options granted hereunder which do not qualify as Incentive Stock Options (“Non-Qualified Options” and, together with Incentive Stock Options, “Options”); and (iii) to directors, officers, employees, consultants and advisors of the Company by providing them with awards of Common Stock (“Stock Awards”).

 

b. Administration by Board of Directors.  The Plan will be administered by the Board of Directors of the Company (the “Board”) or by a committee appointed under the Board as provided by subsection (c) hereunder, whose construction and interpretation of the terms and provisions of the Plan shall be final and conclusive on all parties. The Board, in its sole discretion, shall have the authority to: (i) grant and amend Awards; (ii) adopt, amend and repeal rules relating to the Plan; (iii) interpret and correct the provisions of the Plan and any Award; and (iv) amend the Plan and any Award issued hereunder in order to assure that such Awards do not provide a deferral of compensation that would be subject to Code Section 409A, and otherwise to administer the Plan so as to comply with applicable provisions of Code Section 409A or any regulations or IRS guidance issued thereunder. All decisions by the Board shall be final and binding on all interested persons. Neither the Company nor any member of the Board shall be liable for any action or determination relating to the Plan.

 

c. Appointment of Committees.  To the extent permitted by applicable law, the Board may delegate any or all of its powers under the Plan to one or more committees or subcommittees of the Board (a “Committee”). All references in the Plan to the “Board” shall mean such Committee or the Board.

 

d. Delegation to Executive Officers.  To the extent permitted by applicable law, the Board may delegate to one or more executive officers of the Company the power to grant Awards and exercise such other powers under the Plan as the Board may determine, provided that the Board shall fix the maximum number of Awards to be granted and the maximum number of shares issuable to any one Participant pursuant to Awards granted by such executive officers.

 

 

a. Number of Shares.  Subject to adjustment under Section 3(b) hereof, the maximum number of shares of Common Stock that may be issued pursuant to the Plan is 1,000,000 shares. If any Award expires, or is terminated, surrendered or forfeited, in whole or in part, the unissued Common Stock covered by such Award shall again be available for the grant of Awards under the Plan. If shares of Common Stock issued pursuant to the Plan are repurchased by, or are surrendered or forfeited to, the Company at no more than cost, such shares of Common Stock shall again be available for the grant of Awards under the Plan; provided that the cumulative number of such shares that may be so reissued under the Plan will not exceed 1,000,000 shares. Shares issued under the Plan may consist in whole or in part of authorized but unissued shares or treasury shares.

b. Adjustment to Common Stock.  In the event of any stock split, stock dividend, extraordinary cash dividend, recapitalization, reorganization, merger, consolidation, combination, exchange of shares, liquidation, spin-off, split-up, or other similar change in capitalization or event, (i) the number and class of securities available for Awards under the Plan and the per Participant share limit, (ii) the number and class of securities, vesting schedule and exercise price per share subject to each outstanding Option, (iii) the repurchase price per security subject to repurchase, and (iv) the terms of each other outstanding stock-based Award shall be adjusted by the Company (or substituted Awards may be made) to the extent the Board shall determine, in good faith, that such an adjustment (or substitution) is appropriate. If Section 7(e)(i) hereof applies for any event, this Section 3(b) shall not be applicable. Notwithstanding the foregoing, these adjustments shall be made to the extent necessary, in such a manner as to avoid any Award granted hereunder being classified as a deferral of compensation within the meaning of Code Section 409A, and the regulations or IRS guidance issued thereunder.

 

 

a. General.  The Board may grant Options and determine the number of shares of Common Stock to be covered by each Option, the exercise price of each Option and the conditions and limitations applicable to the exercise of each Option and the Common Stock issued upon the exercise of each Option, including vesting provisions, repurchase provisions and restrictions relating to applicable federal or state securities laws, as it considers advisable.

 

b. Incentive Stock Options.  An Option that the Board intends to be an Incentive Stock Option shall be granted only to employees and officers of the Company and shall be subject to and shall be construed consistently with the requirements of Section 422 of the Code. The Board and the Company shall have no liability if an Option or any part thereof that is intended to be an Incentive Stock Option does not qualify as such. An Option or any part thereof that does not qualify as an Incentive Stock Option shall be a Non-Qualified Option. Incentive Stock Options granted under the Plan shall be subject to the following additional terms and conditions:

 

(i) Each Incentive Stock Option granted under the Plan shall, at the time of grant, be specifically designated as such in the Award Agreement (as such term is defined herein) covering such Incentive Stock Option.

 

(ii) If any individual to whom an Incentive Stock Option is to be granted under the Plan is, at the time of the grant of such Incentive Stock Option, the owner of stock possessing more than 10% of the total combined voting power of all classes of stock of the Company (after taking into account the attribution of stock ownership rules of Section 424(d) of the Code), then the following special provisions shall be applicable to the Incentive Stock Option granted to such individual:

 

(A) The purchase price per share of the Common Stock subject to such Incentive Stock Option shall not be less than 110% of the Fair Market Value of a share of Common Stock at the time of grant; and

 

(B) the Option exercise period shall not exceed five (5) years from the date of grant.

 

(iii) For as long as the Code shall so provide, Options granted to any individual under the Plan which are intended to constitute Incentive Stock Options shall not constitute Incentive Stock Options to the extent that such Options, in the aggregate, become exercisable for the first time in any one (1) calendar year for shares of Common Stock with an aggregate Fair Market Value (determined as of the respective date or dates of grant) of more than $100,000.

 

(iv) No Incentive Stock Option may be exercised unless, at the time of such exercise, the Participant is, and has been continuously since the date of grant of his or her Option, employed by the Company, except that:

 

(A) an Incentive Stock Option may be exercised within the period of three (3) months after the date the Participant ceases to be an employee or officer of the Company (or within such lesser period as may be specified in the applicable Award Agreement) if and only to the extent that the Incentive Stock Option was exercisable at the date of employment termination, provided that the agreement with respect to such Option may designate a longer exercise period, and any exercise after such three-month period shall be treated as the exercise of a Non-Qualified Option under the Plan;

(B) if the Participant dies while in the employ of the Company, or within three (3) months after the Participant ceases to be in such employ, the Incentive Stock Option may be exercised by the person to whom it is transferred by will or the laws of descent and distribution within the period of one year after the date of death (or within such lesser period as may be specified in the applicable Award Agreement) if and only to the extent that the Incentive Stock Option was exercisable at the date of death; and

 

(C) if the Participant becomes disabled (within the meaning of Section 22(e)(3) or any successor Section of the Code) while in the employ of the Company, the Incentive Stock Option may be exercised within the period of one (1) year after the date the Participant ceases to be in such employ because of such disability (or within such lesser period as may be specified in the applicable Award Agreement) if and only to the extent that the Incentive Stock Option was exercisable at the date of employment termination.

 

Notwithstanding the foregoing provisions, no Incentive Stock Option may be exercised after its expiration date.

 

c. Exercise Price.  The Board shall establish the exercise price (the “Exercise Price”) at the time each Option is granted and specify it in the applicable Award Agreement. Notwithstanding the immediately preceding sentence, the Exercise Price shall not be less than the Fair Market Value of a share of the Common Stock on the date of grant of such option. Notwithstanding anything in this Plan to the contrary, the price per share of Common Stock shall be determined in such a manner as not to be a deferral of compensation within the meaning of Code Section 409A and the regulations or IRS guidance issued thereunder.

 

d. Duration of Options.  Each Option shall be exercisable at such times and subject to such terms and conditions as the Board may specify in the applicable Award Agreement, except that, in the case of an Incentive Stock Option, such date shall not be later than ten (10) years after the date on which the Option is granted and, in all cases, Options shall be subject to earlier termination as provided in the Plan.

 

e. Exercise of Option.  Options may be exercised in full or in installments. Options may be exercised only by delivery to the Company of (i) a written notice of exercise signed by the proper person, and (ii) payment in full as specified in Section 4(f) hereof for the number of shares for which the Option is exercised.

 

f. Payment Upon Exercise.  Common Stock purchased upon the exercise of an Option shall be paid for by one or any combination of the following forms of payment:

 

(i) by check payable to the order of the Company;

 

(ii) except as otherwise explicitly provided in the applicable Award Agreement, and only if the Common Stock is then publicly traded, delivery of an irrevocable and unconditional undertaking by a creditworthy broker (as determined in the reasonable discretion of the Board) to deliver promptly to the Company sufficient funds to pay the exercise price, or delivery by the Participant to the Company of a copy of irrevocable and unconditional instructions to a creditworthy broker to deliver promptly to the Company cash or a check sufficient to pay the exercise price; or

 

(iii) to the extent explicitly provided in the applicable Award Agreement, by (x) delivery of shares of Common Stock owned by the Participant valued at Fair Market Value, (y) delivery of a promissory note of the Participant to the Company (and delivery to the Company by the Participant of a check in an amount equal to the par value of the shares purchased), or (z) payment of such other lawful consideration as the Board may determine in its reasonable discretion.

 

 

a. Grants.  The Board may grant Awards entitling recipients to acquire shares of Common Stock, subject to (i) delivery to the Company by the Participant of a check in an amount at least equal to the par value of the shares purchased, and (ii) the right of the Company to repurchase all or part of such shares at their issue price or other stated or formula price from the Participant in the event that conditions specified by the Board in the applicable Award are not satisfied prior to the end of the applicable restriction period or periods established by the Board for such Award (each, a ‘‘Restricted Stock Award”).

b. Terms and Conditions.  The Board shall determine the terms and conditions of any such Restricted Stock Award. Any stock certificates issued in respect of a Restricted Stock Award shall be registered in the name of the Participant and, unless otherwise determined by the Board, deposited by the Participant, together with a stock power endorsed in blank, with the Company (or its designee). After the expiration of the applicable restriction periods, the Company (or such designee) shall deliver the certificates no longer subject to such restrictions to the Participant or, if the Participant has died, to the beneficiary designated by a Participant, in a manner determined by the Board, to receive amounts due or exercise rights of the Participant in the event of the Participant’s death (the “Designated Beneficiary”). In the absence of an effective designation by a Participant, Designated Beneficiary shall mean the Participant’s estate.

 

c. Rights.  Participants shall have full shareholder rights with respect to Restricted Stock Awards shares upon issuance and delivery of a stock certificate representing such shares, whether or not a Participant’s interest in such shares is vested. Accordingly, Participants shall have the right to vote such shares and, subject to this Section 5, to receive any dividends or non-cash distributions with respect to such shares. No adjustment shall be made for dividends or other rights for which the record date is prior to the date any such stock certificate is issued.

 

 

The Board shall have the right to grant other Awards based upon the Common Stock having such terms and conditions as the Board may determine, including, without limitation, the grant of shares based upon certain conditions, the grant of securities convertible into Common Stock and the grant of stock appreciation rights, phantom stock awards or stock units.

 

 

a. Transferability of Awards.  Except as the Board may otherwise determine or provide in an Award, Awards shall not be sold, assigned, transferred, pledged or otherwise encumbered by the person to whom they are granted, either voluntarily or by operation of law, except by will or the laws of descent and distribution, and, during the life of the Participant, shall be exercisable only by the Participant. References to a Participant, to the extent relevant in the context, shall include references to authorized transferees.

 

b. Documentation.  Each Award under the Plan shall be evidenced by a written instrument (an “Award Agreement”) in such form as the Board shall determine or as executed by an officer of the Company pursuant to authority delegated by the Board. Each Award Agreement may contain terms and conditions in addition to those set forth in the Plan provided that such terms and conditions do not contravene the provisions of the Plan. The Board may amend or modify each Award Agreement in any manner to the extent that the Board would have had the authority to grant such Award under the Award Agreement as so modified or amended, including without limitation changing the dates as of which an Award becomes exercisable or restrictions on shares of the Common Stock lapse. The foregoing notwithstanding, no modification of an Award Agreement may be made that would materially, adversely affect a Participant without the approval of the Participant; provided that the Board may modify any Award Agreement if such modification is required by applicable law or as necessary or appropriate in order to assure that no Award granted hereunder would be classified as a deferral of compensation under Code Section 409A and the regulations or IRS guidance issued thereunder.

 

c. Board Discretion.  The terms of each type of Award need not be identical, and the Board need not treat Participants uniformly.

 

d. Termination of Status.  The Board shall determine the effect on an Award of the disability, death, retirement, authorized leave of absence or other change in the employment or other status of a Participant and the extent to which, and the period during which, the Participant, or the Participant’s legal representative, conservator, guardian or Designated Beneficiary, may exercise rights under the Award. Notwithstanding the foregoing, if a Participant’s employment or other relationship with the Company is terminated for “Cause,” the Options issued to such Participant shall terminate on the date of such termination and shall thereupon not be exercisable to any extent whatsoever. For purposes of the Plan, “Cause” is conduct, as determined by the Board, involving one or more of the following: (i) willful misconduct by the Participant which is injurious to the Company; or (ii) the commission of an act of embezzlement, fraud or deliberate disregard of the rules or policies of the Company which results in

economic loss, damage or injury to the Company; or (iii) the unauthorized disclosure of any trade secret or confidential information of either the Company or any third party who has a business relationship with the Company; or (iv) a violation of any noncompetition covenant or assignment of inventions obligation with the Company; or (v) the commission of an act which induces any party to break a contract with the Company or to decline to do business with the Company; or (vi) the conviction of the Participant of a felony; or (vii) the failure of the Participant to perform in any material respect his or her employment or engagement obligations without proper cause therefor.

 

e. Acquisition of the Company

 

(i) Consequences of an Acquisition.

 

(A) Acquisition Defined.  An “Acquisition” shall mean: (x) the sale of the Company by merger in which the shareholders of the Company in their capacity as such no longer own a majority of the outstanding equity securities of the Company (or its successor); or (y) any sale of all or substantially all of the assets or capital stock of the Company (other than in a spin-off or similar transaction) or (z) any other acquisition of the business of the Company, as determined by the Board.

 

(B) Acquisition Consequences.  Unless otherwise expressly provided in the applicable Award Agreement, upon the occurrence of an Acquisition, the Board or the board of directors of the surviving or acquiring entity (as used in this Section 7(e)(i)(B), also the “Board”), shall, as to outstanding Awards (on the same basis or on different basis, as the Board shall specify), make appropriate provision for the continuation of such Awards by the Company or the assumption of such Awards by the surviving or acquiring entity and by substituting on an equitable basis for the shares then subject to such Awards either (a) the consideration payable with respect to the outstanding shares of Common Stock in connection with the Acquisition, (b) shares of stock of the surviving or acquiring corporation or (c) such other securities as the Board deems appropriate, the fair market value of which (as determined by the Board in its sole discretion) shall not materially differ from the Fair Market Value of the shares of Common Stock subject to such Awards immediately preceding the Acquisition. In addition to, or in lieu of the foregoing, with respect to outstanding Options, the Board may, upon written notice to the affected optionees, provide that one or more Options then outstanding shall become immediately exercisable in full and that such Options must be exercised within a specified number of days of the date of such notice, at the end of which period such Options shall terminate; or provide that one or more Options then outstanding shall become immediately exercisable in full and shall be terminated in exchange for a cash payment equal to the excess of the Fair Market Value for the           shares subject to such Options over the exercise price thereof. Any conversion described in subsections (a), (b) or (c) hereof shall conform to the requirements of Treasury Department Regulation Section 1.424-1, construed as if the options under the Plan were statutory options, and any other requirements the satisfaction of which the Board determines to be necessary or appropriate to avoid classification as a deferral of compensation under Code Section 409A and the regulations or IRS guidance issued thereunder.

 

(ii) Assumption of Awards Upon Certain Events.  In connection with a merger or consolidation of an entity with the Company or the acquisition by the Company of property or stock of an entity, the Board may grant Awards under the Plan in substitution for stock and stock based awards issued by such entity or an affiliate thereof. The substitute Awards shall be granted on such terms and conditions as the Board considers appropriate in the circumstances.

 

(iii) Parachute Awards.  Notwithstanding the provisions of Section 7(e)(i)(B) hereof, if, in connection with an Acquisition described therein, a tax under Section 4999 of the Code would be imposed on the Participant (after taking into account the exceptions set forth in Sections 280G(b)(4) and 280G(b)(5) of the Code), then the number of Awards which shall become exercisable, realizable or vested as provided in such section shall be reduced (or delayed), to the minimum extent necessary, so that no such tax would be imposed on the Participant (the Awards not becoming so accelerated, realizable or vested, the “Parachute Awards”); provided that if the “aggregate present value” of the Parachute Awards would exceed the tax that, but for this sentence, would be imposed on the Participant under Section 4999 of the Code in connection with the Acquisition, then the Awards shall become immediately exercisable, realizable and vested without regard to the provisions of this sentence. For purposes of the preceding sentence, the “aggregate present value” of an Award shall be calculated on an after-tax basis (other than taxes imposed by Section 4999 of the Code) and shall be based on economic principles rather than the principles set forth

under Section 280G of the Code and the regulations promulgated thereunder. All determinations required to be made under this Section 7(e)(iii) shall be made by the Company in its reasonable discretion.

 

f. Withholding.  Each Participant shall pay to the Company, or make provisions satisfactory to the Company for payment of, any taxes required by law to be withheld in connection with Awards to such Participant no later than the date of the event creating the tax liability. The Board may allow Participants to satisfy such tax obligations in whole or in part by transferring shares of Common Stock, including shares retained from the Award creating the tax obligation, valued at their Fair Market Value. The Company may, to the extent permitted by law, deduct any such tax obligations from any payment of any kind otherwise due to a Participant.

 

g. Amendment of Awards.  The Board may amend, modify or terminate any outstanding Award including, but not limited to, substituting therefor another Award of the same or a different type, changing the date of exercise or realization, and converting an Incentive Stock Option to a Non-Qualified Option, provided that, the Participant’s consent to such action shall be required unless the Board determines that the action, taking into account any related action, would not materially and adversely affect the Participant.

 

h. Conditions on Delivery of Stock.  The Company will not be obligated to deliver any shares of Common Stock pursuant to the Plan or to remove restrictions from shares previously delivered under the Plan until (i) all conditions of the Award have been met or removed to the satisfaction of the Company, (ii) in the opinion of the Company’s counsel, all other legal matters in connection with the issuance and delivery of such shares have been satisfied, including any applicable securities laws and any applicable stock exchange or stock market rules and regulations, and (iii) the Participant has executed and delivered to the Company such representations or agreements as the Company may consider appropriate to satisfy the requirements of any applicable laws, rules or regulations.

 

i. Acceleration.  The Board may at any time provide that any Options shall become immediately exercisable in full or in part, that any Restricted Stock Awards shall be free of some or all restrictions, or that any other stock-based Awards may become exercisable in full or in part or free of some or all restrictions or conditions, or otherwise realizable in full or in part, as the case may be, despite the fact that the foregoing actions may (i) cause the application of Sections 280G and 4999 of the Code if a change in control of the Company occurs, or (ii) disqualify all or part of the Option as an Incentive Stock Option.

 

j. Maintenance of Exemption From Code Section 409A.  Awards issued under this Plan are intended to meet the requirements for exemption from coverage under Code Section 409A and all grants shall be construed and administered accordingly.

 

 

a. Definitions.

 

(i) “Company,”  for purposes of eligibility under the Plan, shall include any present or future subsidiary corporations of Environmental Tectonics Corporation, as defined in Section 424(f) of the Code (a ‘‘Subsidiary”), and any present or future parent corporation of Environmental Tectonics Corporation, as defined in Section 424(e) of the Code. For purposes of Awards other than Incentive Stock Options, the term ‘‘Company” shall include any other business venture in which the Company has a direct or indirect significant interest, as determined by the Board in its sole discretion.

 

(ii) “Code”  means the Internal Revenue Code of 1986, as amended, and any regulations promulgated thereunder.

 

(iii) “employee”  for purposes of eligibility under the Plan (but not for purposes of Section 4(b) hereof) shall include a person to whom an offer of employment has been extended by the Company.

 

(iv) “Fair Market Value”  if shares of the Common Stock are not then publicly traded, shall be determined by any reasonable method chosen by the Board, including, for example, any valuation method described in Treasury Regulation Sec. 20.2031-2, or as determined pursuant to the applicable Award Agreement.

 

b. No Right To Employment or Other Status.  No person shall have any claim or right to be granted an Award, and the grant of an Award shall not be construed as giving a Participant the right to continued employment or any

other relationship with the Company. The Company expressly reserves the right at any time to dismiss or otherwise terminate its relationship with a Participant, with or without cause, free from any liability or claim under the Plan.

 

c. No Rights As Shareholder.  Subject to the provisions of the applicable Award, no Participant or Designated Beneficiary shall have any rights as a shareholder with respect to any shares of Common Stock to be distributed with respect to an Award until becoming the record holder thereof.

 

d. Effective Date and Term of Plan.  The Plan shall become effective on the date on which it is adopted by the Board and the shareholders of the Company (the “Effective Date”). No Awards shall be granted under the Plan after the completion of ten years from the Effective Date, but Awards previously granted may extend beyond that date.

 

e. Amendment of Plan.

 

(i) The Board may amend, suspend or terminate the Plan or any portion thereof at any time, except that if at any time the approval of the shareholders of the Company is required for any modification or amendment under Section 422 or any successor section of the Code with respect to Incentive Stock Options or under Rule 16b-3 (“Rule 16b-3”) or any successor rule promulgated under the Securities Exchange Act of 1934, as amended, or otherwise under applicable law or regulations, the Board may not effect such modification or amendment without such approval.

 

(ii) The termination or any modification or amendment of the Plan shall not, without the consent of a Participant, affect his or her rights under Awards previously granted to him or her. With the consent of the affected Participant, the Board may amend outstanding Award Agreements in a manner not inconsistent with the Plan. The Board shall have the right to amend or modify (i) the terms and provisions of the Plan and of any outstanding Incentive Stock Options granted under the Plan, to the extent necessary to qualify any or all such Options for such favorable federal income tax treatment (including deferral of taxation upon exercise) as may be afforded incentive stock options under Section 422 of the Code, and (ii) the terms and provisions of the Plan and of any outstanding Option to the extent necessary to ensure the qualification of the Plan under Rule 16b-3.

 

f. Governing Law.  The provisions of the Plan and all Awards made hereunder shall be governed by and interpreted in accordance with the laws of the Commonwealth of Pennsylvania, without regard to any applicable conflicts of law.

ANNEX B

 

 

SECURED CREDIT FACILITY AND WARRANT PURCHASE AGREEMENT
by and between
ENVIRONMENTAL TECTONICS CORPORATION
and
H.F. LENFEST
Dated as of
April 24, 2009

 

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