UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2005
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 1-10596
ESCO TECHNOLOGIES INC.
(Exact name of registrant as specified in its charter)
MISSOURI 43-1554045
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9900A CLAYTON ROAD
ST. LOUIS, MISSOURI 63124-1186
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (314) 213-7200
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer X Accelerated filer Non-accelerated filer
--- --- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
Class Outstanding at January 31, 2006
- ---------------------------------------- -------------------------------
[Common stock, $.01 par value per share] 25,619,003 shares
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Three Months Ended
December 31,
-------------
2005 2004
------ -----
Net sales $ 90,586 104,375
Costs and expenses:
Cost of sales 64,027 68,509
Selling, general and administrative 23,619 19,813
expenses
Interest income (717) (481)
Other (income) expense, net (38) (453)
------- ------
Total costs and expenses 86,891 87,388
Earnings before income taxes 3,695 16,987
Income tax expense 1,491 6,464
------ -------
Net earnings $ 2,204 10,523
===== ======
Earnings per share:
Basic $ 0.09 0.41
==== ====
Diluted $ 0.08 0.40
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31, September 30,
2005 2005
---- ----
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 70,359 104,484
Accounts receivable, net 68,928 68,819
Costs and estimated earnings on
long-term contracts, less progress
billings of $10,369 and $7,033,
respectively 3,679 4,392
Inventories 52,774 48,645
Current portion of deferred tax assets 29,965 30,219
Other current assets 8,369 8,394
----- -----
Total current assets 234,074 264,953
Property, plant and equipment, net 66,962 67,190
Goodwill 92,606 68,880
Other assets 40,084 27,697
------ ------
$ 433,726 428,720
========== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current
maturities of long-term debt - $ -
Accounts payable 31,858 29,299
Advance payments on long-term
contracts, less costs incurred
of $11,356 and $10,949,
respectively 7,590 6,773
Accrued salaries 8,942 12,024
Accrued other expenses 19,556 14,661
------ ------
Total current liabilities 67,946 62,757
Deferred income 2,979 3,134
Pension obligations 17,478 17,481
Other liabilities 11,426 14,324
Long-term debt - -
------ ------
Total liabilities 99,829 97,696
Shareholders' equity:
Preferred stock, par value $.01 per share,
authorized 10,000,000 shares - -
------ ------
Common stock, par value $.01 per share,
authorized 50,000,000 shares, issued
28,756,327 and 28,738,958 shares,
respectively 288 287
Additional paid-in capital 229,693 228,317
Retained earnings 161,567 159,363
Accumulated other comprehensive loss (6,313) (5,566)
------ ------
Less treasury stock, at cost: 3,173,226
and 3,175,626 common shares, respectively (51,338) (51,377)
------- -------
Total shareholders' equity 333,897 331,024
$ 433,726 428,720
========== =======
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Three Months Ended
December 31,
------------
2005 2004
---- ----
Cash flows from operating activities:
Net earnings $ 2,204 10,523
Adjustments to reconcile net earnings to
net cash provided by operating
activities:
Depreciation and amortization 3,078 3,119
Stock compensation expense 1,273 749
Changes in operating working capital (532) (1,265)
Effect of deferred taxes (3,090) 1,122
Other (1,001) 1,205
------ -----
Net cash provided by operating
activities 1,932 15,453
Cash flows from investing activities:
Acquisition of business (28,833) -
Capital expenditures (2,320) (2,013)
Additions to capitalized software (5,724) (1,173)
------ ------
Net cash used by investing activities (36,877) (3,186)
Cash flows from financing activities:
Principal payments on long-term debt - (42)
Purchases of common stock into treasury - (24,928)
Other(including exercise of stock options) 820 779
--- ---
Net cash provided (used) by
financing activities 820 (24,191)
--- -------
Net decrease in cash and cash equivalents (34,125) (11,924)
Cash and cash equivalents, beginning of
period 104,484 72,281
------- ------
Cash and cash equivalents, end of period $ 70,359 $ 60,357
======== ========
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements, in the opinion of
management, include all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the results for the interim
periods presented. The consolidated financial statements are presented in
accordance with the requirements of Form 10-Q and consequently do not
include all the disclosures required by accounting principles generally
accepted in the United States of America (GAAP). For further information
refer to the consolidated financial statements and related notes included
in the Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 2005. During 2005, the Company had a 2-for-1 stock split
which was effected as a 100 percent stock dividend and was paid on
September 23, 2005. The prior years common stock and per share amounts have
been adjusted to reflect the stock split.
The results for the three month period ended December 31, 2005 are not
necessarily indicative of the results for the entire 2006 fiscal year.
2. EARNINGS PER SHARE (EPS)
Basic EPS is calculated using the weighted average number of common shares
outstanding during the period. Diluted EPS is calculated using the weighted
average number of common shares outstanding during the period plus shares
issuable upon the assumed exercise of dilutive common share options and
vesting of performance-accelerated restricted shares (restricted shares) by
using the treasury stock method. The number of shares used in the
calculation of earnings per share for each period presented is as follows
(in thousands):
Three Months Ended
December 31,
------------
2005 2004
---- ----
Weighted Average Shares
Outstanding - Basic 25,575 25,586
Dilutive Options and Restricted
Shares 759 822
--- ---
Adjusted Shares- Diluted 26,334 26,408
====== ======
Options to purchase 6,000 shares of common stock at prices ranging from
$49.74 - $50.26 and options to purchase 3,000 shares of common stock at a
price of $38.85 were outstanding during the three month periods ended
December 31, 2005 and 2004, respectively, but were not included in the
computation of diluted EPS because the options' exercise prices were
greater than the average market price of the common shares. The options
expire at various periods through 2013. Approximately 34,000 and 54,000
restricted shares were excluded from the respective computation of diluted
EPS based upon the application of the treasury stock method for the three
month periods ended December 31, 2005 and 2004, respectively.
3. SHARE-BASED COMPENSATION
Prior to October 1, 2005, the Company accounted for its stock option plans
using the intrinsic value method of accounting provided under APB Opinion
No. 25, "Accounting for Stock Issued to Employees," (APB 25) and related
interpretations, as permitted by FASB Statement No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123) under which no compensation expense
was recognized for stock option grants. Accordingly, share-based
compensation for stock options was included as a pro forma disclosure in
the financial statement footnotes and continues to be provided for periods
prior to fiscal 2006.
Effective October 1, 2005, the Company adopted the fair value recognition
provisions of FASB Statement No. 123 (R), "Share-Based Payment," (SFAS
123(R)) using the modified-prospective transition method. Under this
transition method, compensation cost recognized in the first quarter of
fiscal 2006 includes:
a) compensation cost for all share-based payments granted through
September 30, 2005, for which the requisite service period had not
been completed as of September 30, 2005, based on the grant date fair
value estimated in accordance with the original provisions of SFAS
123, and
b) compensation cost for all share-based payments granted subsequent to
September 30, 2005, based on the grant date fair value estimated in
accordance with the provisions of SFAS 123(R). Results for prior
periods have not been restated.
As a result of adopting SFAS 123(R) on October 1, 2005, the Company's
earnings before income taxes and net earnings for the first quarter ended
December 31, 2005 are $0.5 million lower than if it had continued to
account for share-based compensation under APB 25. Diluted earnings per
share for the first quarter of fiscal 2006 would have been $0.10 if the
company had not adopted SFAS 123(R), compared to reported diluted earnings
per share of $0.08.
The Company provides compensation benefits to certain key employees under
several share-based plans providing for employee stock options and/or
performance-accelerated restricted shares (restricted shares), and to
non-employee directors under a non-employee directors compensation plan.
Stock Option Plans
The Company has various stock option plans that permit the Company to grant
key Management employees (1) options to purchase shares of the Company's
common stock or (2) stock appreciation rights with respect to all or any
part of the number of shares covered by the options. All outstanding
options were granted at prices equal to fair market value at the date of
grant. The options granted prior to September 30, 2003 have a ten-year
contractual life from date of issuance, expiring in various periods through
2013. Beginning in fiscal 2004, the options granted have a five-year
contractual life from date of issuance. No stock appreciation rights have
been awarded to date. The Company's stock option awards are subject to
graded vesting over a three year service period. Beginning with fiscal 2006
awards, the Company recognizes compensation cost on a straight-line basis
over the requisite service period for the entire award. Prior to fiscal
2006, the Company calculated the pro forma compensation cost using the
graded vesting method (FIN 28 approach).
The fair value of each option award is estimated as of the date of grant
using a Black-Scholes option pricing model. The weighted average
assumptions for the periods indicated are noted below. Expected volatility
is based on historical volatility of ESCO's stock calculated over the
expected term of the option. The expected term was calculated in accordance
with Staff Accounting Bulletin No. 107 using the simplified method for
"plain-vanilla" options. The risk-free rate for the expected term of the
option is based on the U.S. Treasury yield curve in effect at the date of
grant.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in the three month period ended December 31,
2005 and 2004, respectively: expected dividend yield of 0% in both periods;
expected volatility of 28.6% and 28.3%; risk-free interest rate of 4.5% and
3.6%; and expected term of 3.5 years and 4.2 years. Pre-tax compensation
expense related to the stock option awards was $0.5 million for the first
quarter of fiscal 2006.
The following summary presents information regarding outstanding stock
options as of December 31, 2005 and changes during the first quarter then
ended with regard to options under the option plans:
Aggregate
Intrinsic Weighted-Average
Value Remaining
Weighted (in Contractual
Shares Avg.Price millions) Life
------ --------- --------- ----
Outstanding at
October 1, 2005 1,324,548 $20.48
Granted 263,130 $42.99
Exercised (20,188) $14.39
Cancelled (5,152) $35.38
------ ------
Outstanding at
December 31, 2005 1,562,338 $24.31 $30.9 4.5 years
Exercisable at
December 31, 2005 904,423 $15.91 $25.5
The weighted-average grant-date fair value of options granted during the
first quarter ended December 31, 2005 was $11.74.
During fiscal 2004, the Board of Directors authorized and the shareholders
approved, the 2004 Incentive Compensation Plan, which states, in part, that
on February 5, 2004, there shall be added to the authorized shares
allocated 2,000,000 shares for the grant of stock options, stock
appreciation rights, performance-accelerated restricted stock, or other
full value awards. Of these, shares up to 600,000 may be utilized for
performance-accelerated restricted stock or other full value awards.
Restricted Share Awards
At December 31, 2005, the maximum number of restricted shares available for
issue under the 2004 Incentive Compensation Plan and the 2001 Stock
Incentive Plan was 600,000 and 361,162 shares, respectively. These shares
vest over five years with accelerated vesting over three years if certain
performance targets are achieved. In these cases, if it is probable that
the performance condition will be met, the Company recognizes compensation
cost on a straight-line basis over the shorter performance period;
otherwise, it will recognize compensation cost over the longer service
period. Compensation cost for all outstanding restricted share awards is
being recognized over the shorter performance period as it is probable the
performance condition will be met. The restricted share award grants were
valued at the stock price on the date of grant. Compensation expense
related to the restricted share awards was $0.6 million for the three-month
periods ended December 31, 2005 and 2004, respectively.
The following summary presents information regarding outstanding restricted
share awards as of December 31, 2005 and changes during the first quarter
then ended:
Three months ended
December 31, 2005
-----------------
Weighted
Shares Avg. Price
------ ----------
October 1 238,436 $23.78
Granted 60,630 $42.62
------ ------
December 31, 299,066 $27.60
======= ======
Non-Employee Directors Plan
The non-employee directors compensation plan includes a retainer of 800
common shares per quarter. Compensation expense related to the non-employee
directors was $0.2 million and $0.1 million for the three-month period
ended December 31, 2005 and 2004, respectively.
The total share-based compensation cost that has been recognized in results
of operations and included within SG&A was $1.3 million and $0.8 million
for the first quarter of fiscal 2006 and 2005, respectively. The total
income tax benefit recognized in results of operations for share-based
compensation arrangements was $0.4 million and $0.3 million for the first
quarter of fiscal 2006 and 2005, respectively. As of December 31, 2005,
there was $10.2 million of total unrecognized compensation cost related to
share-based compensation arrangements. That cost is expected to be
recognized over a weighted-average period of 4 years.
Pro Forma Net Earnings
The following table provides pro forma net earnings and earnings per share
had the Company applied the fair value method of SFAS 123 for the first
quarter ended December 31, 2004:
(Unaudited)
(Dollars in thousands, except per
share amounts)
Three Months Ended
December 31,
------------
2004
----
Net earnings, as reported $ 10,523
Add: stock-based employee compensation
expense included in reported net
earnings, net of tax 369
Less: total stock-based employee
compensation expense determined
under fair value based methods,
net of tax
(918)
----
Pro forma net earnings $ 9,974
========
Net earnings per share:
Basic - as reported $ 0.41
Basic - pro forma 0.39
====
Diluted - as reported $ 0.40
Diluted - pro forma 0.38
====
4 ACQUISITION
Effective November 29, 2005, the Company acquired Nexus Energy Software,
Inc. (Nexus) through an all cash for shares merger transaction for
approximately $29 million in cash plus contingent cash consideration over
the four year period following the merger if Nexus exceeds certain sales
targets. Nexus is a software company headquartered in Wellesley,
Massachusetts with annual revenues in excess of $10 million. The operating
results for Nexus, since the date of acquisition, are included within the
Communications segment. The Company recorded approximately $24 million of
goodwill as a result of the transaction, subject to post-closing
adjustments including finalization of purchase accounting. The Company also
recorded $2.7 million of identifiable intangible assets consisting of
customer contracts and backlog value which will be amortized on a
straight-line basis over a period not to exceed three years. The
post-closing purchase accounting items are expected to be completed prior
to September 30, 2006.
5 INVENTORIES
Inventories consist of the following (in thousands):
December 31, September 30,
2005 2005
---- ----
Finished goods $ 17,011 14,361
Work in process, including
long- term contracts 13,496 12,512
Raw materials 22,267 21,772
------ ------
Total inventories $ 52,774 48,645
========= ======
6. COMPREHENSIVE INCOME
Comprehensive income for the three-month periods ended December 31, 2005
and 2004 was $1.5 million and $13.9 million, respectively. For the
three-month period ended December 31, 2005, the Company's comprehensive
income was negatively impacted by foreign currency translation adjustments
of $0.7 million. For the three-month period ended December 31, 2004, the
Company's comprehensive income was positively impacted by foreign currency
translation adjustments of $3.4 million.
7. BUSINESS SEGMENT INFORMATION
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company operates in three
segments: Filtration/Fluid Flow, Communications and Test.
Management evaluates and measures the performance of its operating segments
based on "Net Sales" and "EBIT", which are detailed in the table below.
EBIT is defined as earnings from continuing operations before interest and
taxes.
($ in thousands) Three Months ended
December 31,
------------
NET SALES 2005 2004
--------- ---- ----
PTI $ 10,697 10,222
VACCO 8,054 10,615
Filtertek 22,695 23,167
------ ------
Filtration/Fluid Flow 41,446 44,004
Communications 19,133 33,533
Test 30,007 26,838
------ ------
Consolidated totals $ 90,586 104,375
======== =======
EBIT
PTI 1,199 1,130
VACCO 1,891 3,564
Filtertek 997 2,365
--- -----
Filtration/Fluid Flow 4,087 7,059
Communications (959) 9,622
Test 2,916 2,082
Corporate (3,066) (2,257)
------ ------
Consolidated EBIT 2,978 16,506
Add: Interest income 717 481
--- ---
Earnings before income
taxes $ 3,695 16,987
======== ======
8. RETIREMENT AND OTHER BENEFIT PLANS
A summary of net periodic benefit expense for the Company's defined benefit
plans and postretirement healthcare and other benefits for the three-month
periods ended December 31, 2005 and 2004 are shown in the following tables.
Effective December 31, 2003, the Company's defined benefit plan was frozen
and no additional benefits will be accrued after that date. Net periodic
benefit cost for each period presented is comprised of the following:
Three Months Ended
December 31,
------------
(Dollars in thousands) 2005 2004
---- ----
Defined benefit plans
Service cost $ - -
Interest cost 650 663
Expected return on assets (675) (713)
Amortization of:
Prior service cost - -
Actuarial (gain) loss 125 125
--- ---
Net periodic benefit cost $ 100 75
====== ==
Net periodic postretirement (retiree medical) benefit cost for each period
presented is comprised of the following:
Three Months Ended
December 31,
------------
(Dollars in thousands) 2005 2004
---- ----
Service cost $ 9 8
Interest cost 10 10
Amortization of actuarial gain (9) (8)
---- ----
Net periodic postretirement
benefit cost $ 10 10
==== ====
9. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued FASB Staff Position FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (FSP 109-2)." The
American Jobs Creation Act of 2004, (the "Act") provides for a special
one-time deduction of 85 percent of certain foreign earnings repatriated
into the U.S. from non-U.S. subsidiaries through September 30, 2006. The
Company is currently evaluating the merits of repatriating funds under the
Act. At December 31, 2005, the range of reasonably possible amounts of
unremitted earnings that are being considered for repatriation is between
zero and $39.5 million, which would require the Company to pay income taxes
in the range of zero to $3.1 million. Federal income taxes on the
repatriated amounts would be based on the 5.25% effective statutory rate as
provided in the Act, plus applicable withholding taxes. To date, the
Company has not provided for income taxes on unremitted earnings generated
by non-U.S. subsidiaries given the Company's historical intent to
permanently invest these earnings abroad. As a result, additional taxes may
be required to be recorded for any funds repatriated under the Act. The
Company expects to complete its evaluation of the repatriation provision of
the Act by September 30, 2006.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
The following discussion refers to the Company's results from continuing
operations, except where noted. References to the first quarters of 2006
and 2005 represent the fiscal quarters ended December 31, 2005 and 2004,
respectively.
NET SALES
Net sales decreased $13.8 million, or 13.2%, to $90.6 million for the first
quarter of 2006 from $104.4 million for the first quarter of 2005,
primarily due to a decrease in sales in the Communications segment of $14.4
million. Unfavorable foreign currency values resulted in approximately $1.0
million of the sales decrease realized in the 2006 first quarter.
-Filtration/Fluid Flow
Net sales decreased $2.5 million, or 5.7%, to $41.5 million for the first
quarter of 2006 from $44.0 million for the first quarter of 2005. The sales
decrease during the fiscal quarter ended December 31, 2005 as compared to
the prior year quarter is mainly due to the following: lower defense spares
and T-700 shipments at VACCO of $2.5 million; a net sales decrease at
Filtertek of $0.5 million driven by lower automotive shipments and lower
volumes in France; partially offset by higher commercial aerospace
shipments at PTI of $0.5 million.
-Communications
Net sales decreased $14.4 million, or 43.0%, to $19.1 million for the first
quarter of 2006 from $33.5 million for the first quarter of 2005. The sales
decrease in the first quarter of 2006 as compared to the prior year period
was due to $11.0 million of lower shipments of DCSI's automatic meter
reading (AMR) products and $4.6 million of lower shipments of Comtrak's
SecurVision video security products. The Nexus acquisition contributed
$1.2 million in sales in the first quarter of fiscal 2006 which represented
one month of sales.
The decrease in sales of AMR products for the three month period ended
December 31, 2005 as compared to the prior year quarter was due to the
following items: $9.9 million of lower AMR product sales to the COOP market
due to the weakness in orders entered during the latter half of fiscal
2005; $2.2 million of lower sales to legacy customers such as Wisconsin
Public Service (WPS), Bangor Hydro, Puerto Rico Power Authority (PREPA),
and PPL Electric Utilities Corporation (PPL). These decreases were
partially offset by sales to TXU Electric Delivery Company (TXU) of $1.5
million in the first quarter of 2006. During the first quarter of 2006,
DCSI's sales to COOP and public power (Municipal) customers were $11.5
million compared to $21.4 million in the first quarter of 2005.
Sales of SecurVision products were $2.5 million for the first quarter of
2006 as compared to $7.1 million for the prior year first quarter. The
decrease in sales was due to an acceleration of shipments in the prior year
quarter to catch up on backlog resulting from certain software
modifications.
-Test
For the first quarter of 2006, net sales of $30.0 million were $3.2
million, or 11.9% higher than the $26.8 million of net sales recorded in
the first quarter of 2005. The sales increase as compared to the prior year
quarter was mainly due to the following: a $4.8 million increase in net
sales from the Company's U.S. operations driven by additional test chamber
installations and higher component sales; partially offset by a $1.5
million decrease in net sales from the Company's European operations due to
the prior year completion of several large test chamber projects.
ORDERS AND BACKLOG
Backlog was $268.7 million at December 31, 2005 compared with $233.1
million at September 30, 2005. The Company received new orders totaling
$126.1 million in the first quarter of 2006 (including $2.0 million of new
orders and $9.0 million of acquired backlog from Nexus). New orders of
$41.1 million were received in the first quarter of fiscal 2006 related to
Filtration/Fluid Flow products, $59.2 million related to Communications
products and $25.8 million related to Test products.
Within the Communications segment, DCSI received $45.6 million of new
orders for its AMR products in the first quarter of 2006, which included a
$9.4 million follow-on order from TXU for a 100,000 endpoint expansion of
the existing program.
In addition, in November 2005, DCSI signed an agreement with PG&E with an
anticipated contract value of approximately $300 million covering five
million endpoints over a five year deployment period beginning in late
fiscal 2006. The Company received a $0.4 million order from PG&E under this
agreement during the first quarter of 2006. See "Recent Development."
GROSS PROFIT
The Company computes gross profit as net sales less cost of sales. The
gross profit margin is the gross profit divided by net sales, expressed as
a percentage. The gross profit margin was 29.3% and 34.4% in the first
quarters of fiscal 2006 and 2005, respectively. The decrease in the gross
profit margin in the first quarter of 2006 as compared to the prior year
quarter is mainly due to the lower sales volumes in the Communications
segment and $1.0 million of pre-tax charges at DCSI consisting of a $0.4
million write-off of assets related to a terminated subcontract
manufacturer and $0.6 million of warranty costs related to a commercial
transponder. In addition, VACCO's and Filtertek's gross profit margins were
negatively impacted by lower defense spares shipments and the softness in
the automotive market, respectively.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (SG&A) expenses for the first quarter
of fiscal 2006 were $23.6 million (26.1% of net sales), compared with $19.8
million (19.0% of net sales) for the prior year quarter. The increase in
SG&A spending in the first quarter of 2006 as compared to the prior year
quarter is primarily due to the following items: an increase of
approximately $1.0 million associated with engineering, marketing and new
product development within the Communications segment; $0.7 million of SG&A
expenses related to the Nexus acquisition; and $0.5 million related to
stock option expense.
OTHER (INCOME) EXPENSES, NET
Other (income) expenses, net, were $(0.1) million for the first quarter of
2006 compared to $(0.5) million for the prior year quarter. Principal
components of other (income) expenses, net, for the first quarter of 2006
included $(0.6) million of royalty income; partially offset by $0.3 million
of amortization expense of identifiable intangible assets (primarily
patents, licenses and software); and a $0.2 million write off of assets
related to a terminated subcontract manufacturer. Principal components of
other (income) expenses, net, for the first quarter of 2005 included $(0.6)
million of royalty income and $0.2 million of amortization expense of
identifiable intangible assets (primarily patents, licenses and software).
EBIT
The Company evaluates the performance of its operating segments based on
EBIT, defined below. EBIT was $3.0 million (3.3% of net sales) for the
first quarter of 2006 and $16.5 million (15.8% of net sales) for the first
quarter of 2005. The decrease in EBIT for the first quarter of 2006 as
compared to the prior year quarter is primarily due to the sales decrease
in the Communications segment.
This Form 10-Q contains the financial measure "EBIT", which is not
calculated in accordance with generally accepted accounting principles in
the United States of America (GAAP). EBIT provides investors and Management
with an alternative method for assessing the Company's operating results.
The Company defines "EBIT" as earnings from continuing operations before
interest and taxes. Management evaluates the performance of its operating
segments based on EBIT and believes that EBIT is useful to investors to
demonstrate the operational profitability of the Company's business
segments by excluding interest and taxes, which are generally accounted for
across the entire Company on a consolidated basis. EBIT is also one of the
measures Management uses to determine resource allocations within the
Company and incentive compensation. The following table represents a
reconciliation of EBIT to net earnings from continuing operations.
Three Months ended
($ in thousands) December 31,
------------
2005 2004
---- ----
EBIT $ 2,978 16,506
Interest income 717 481
Less: Income taxes 1,491 6,464
----- -----
Net earnings $ 2,204 10,523
====== ======
-Filtration/Fluid Flow
EBIT was $4.1 million (9.9% of net sales) and $7.1 million (16.0% of net
sales) in the first quarters of 2006 and 2005, respectively. For the first
quarter of 2006 as compared to the prior year quarter, EBIT decreased $3.0
million due to the following: a $1.7 million decrease at VACCO due to lower
defense spares shipments; a $1.4 million net decrease at Filtertek
primarily due to softness in the automotive market and increase in raw
material costs (e.g. petroleum based resins). Additionally, Filtertek's
prior year first quarter included $0.6 million of cost reimbursement
related to a supply agreement with a medical device customer which was
terminated in fiscal 2005.
-Communications
EBIT in the first quarter of 2006 was a loss of $1.0 million compared to
EBIT of $9.6 million (28.7% of net sales) in the prior year period. The
decrease in EBIT in the first quarter of 2006 was due to the following
items: a $6.9 million decrease at DCSI due to lower shipments of AMR
products; a $1.0 million increase in DCSI's SG&A expenses related to
additional engineering, marketing and new product development; $1.0 million
in charges at DCSI related to the subcontractor and warranty issues noted
above; a $1.8 million decrease at Comtrak due to lower shipments of its
video security products; partially offset by a $0.2 million contribution
from the Nexus acquisition for its one month of operations.
-Test
EBIT in the first quarter of 2006 was $2.9 million (9.7% of net sales) as
compared to $2.1 million (7.8% of net sales) in the prior year period. In
the first quarter of 2006, EBIT increased $0.8 million due to the favorable
changes in sales mix resulting from additional test chamber installations,
and sales of antennas and other components. EBIT in the prior year quarter
was adversely affected by $0.3 million of installation cost overruns
incurred on certain government shielding projects in foreign locations, as
well as increased material costs (steel and copper).
-Corporate
Corporate costs included in EBIT were $3.1 million for the first quarter of
fiscal 2006 compared to $2.3 million for the prior year quarter. The
increase in Corporate costs in the first quarter of fiscal 2006 as compared
to the prior year quarter is primarily due to the implementation of SFAS
123(R) which resulted in $0.5 million of incremental expense related to
stock options.
INTEREST INCOME, NET
Interest income, net, was $0.7 million and $0.5 million for the three month
periods ended December 31, 2005 and 2004, respectively. The increase in
interest income in the first quarter of 2006 as compared to the prior year
quarter is due to favorable interest rates in fiscal 2006.
INCOME TAX EXPENSE
The first quarter 2006 effective income tax rate was 40.4% compared to
38.1% in the first quarter of 2005. The increase in the effective income
tax rate in the first quarter of fiscal 2006 as compared to the prior year
period is primarily due to the timing and volume of profit contributions of
the Company's foreign operations (primarily Puerto Rico). The Company
estimates the annual effective tax rate for fiscal 2006 to be approximately
39%.
CAPITAL RESOURCES AND LIQUIDITY
Working capital (current assets less current liabilities) decreased to
$166.1 million at December 31, 2005 from $202.2 million at September 30,
2005. During the first quarter of 2006, cash decreased $34.1 million, which
included $28.8 million paid for the Nexus acquisition. Inventories
increased by $4.1 million in the first quarter of 2006, of which $2.7
million related to the Filtration segment due to the timing of expected
sales and $0.9 million related to the Communications segment (new product
offerings and safety stock to satisfy customer requirements).
Net cash provided by operating activities was $1.9 million and $15.5
million for the three-month periods ended December 31, 2005 and 2004,
respectively. The decrease in the first quarter of 2006 as compared to the
prior year quarter was a result of the lower earnings and working capital
requirements.
Capital expenditures were $2.3 million and $2.0 million in the first
quarter of 2006 and 2005, respectively. Major expenditures in the current
period included manufacturing equipment used in the Filtration/Fluid Flow
businesses.
At December 31, 2005, other assets (non-current) of $40.1 million included
$26.0 million of capitalized software. Approximately $22.9 million of the
capitalized software balance represents external development costs on new
software development called "TNG" within the Communications segment to
further penetrate the investor owned utility market. TNG is being developed
in conjunction with a third party software contractor. TNG is being
deployed to efficiently handle the additional levels of communications
dictated by the size of the service territories and the frequency of reads
that are required under time-of-use or critical peak pricing scenarios
needed to meet the requirements of large IOUs. At December 31, 2005, the
Company had approximately $11 million of commitments related to TNG
versions 1.5 and 1.6 which is expected to be spent over the next nine
months. The Company expects to spend up to $5 million in fiscal 2007.
Amortization of TNG will be on a straight-line basis over seven years and
will begin in February 2006.
The closure and relocation of the Filtertek Puerto Rico facility was
completed in March 2004. The Puerto Rico facility is included in other
current assets with a carrying value of $3.6 million at December 31, 2005.
The facility is being marketed for sale.
In October 2004, the Company entered into a $100 million five-year
revolving bank credit facility with a $50 million increase option that has
a final maturity and expiration date of October 6, 2009. At December 31,
2005, the Company had approximately $98.6 million available to borrow under
the credit facility in addition to $70.4 million cash on hand. At December
31, 2005, the Company had no borrowings, and outstanding letters of credit
of $2.5 million. Cash flow from operations and borrowings under the
Company's bank credit facility are expected to meet the Company's capital
requirements and operational needs for the foreseeable future.
Acquisition
Effective November 29, 2005, the Company acquired Nexus Energy Software,
Inc. (Nexus) through an all cash for shares merger transaction for
approximately $29 million in cash plus contingent cash consideration over
the four year period following the merger if Nexus exceeds certain sales
targets. Nexus is a software company headquartered in Wellesley,
Massachusetts with annual revenues in excess of $10 million. The operating
results for Nexus, since the date of acquisition, are included within the
Communications segment. The Company recorded approximately $24 million of
goodwill as a result of the transaction, subject to post-closing
adjustments including finalization of purchase accounting. The Company also
recorded $2.7 million of identifiable intangible assets consisting of
customer contracts and backlog value which will be amortized on a
straight-line basis over a period not to exceed three years. The
post-closing purchase accounting items are expected to be completed prior
to September 30, 2006.
Recent Development
On November 7, 2005, the Company announced that DCSI had entered into a
contract to provide equipment, software and services to Pacific Gas &
Electric (PG&E) in support of the electric portion of PG&E's Advanced
Metering Infrastructure (AMI) project. PG&E's current AMI project plan
calls for the purchase of TWACS communication equipment for approximately
five million electric customers over a five-year period after the
commencement of full deployment. The total anticipated contract value from
commencement through the five-year full deployment period is expected to be
approximately $300 million. PG&E has the right to purchase additional
equipment and services to support existing and new customers through the
twenty to twenty-five year term of the contract. Equipment will be
purchased by PG&E only upon issuance of purchase orders and release
authorizations. PG&E will continue to have the right to purchase products
or services from other suppliers for the electric portion of the AMI
project. Full deployment is contingent upon satisfactory system testing,
regulatory approval and final PG&E management approval all of which are
currently scheduled to be concluded during fiscal 2006. DCSI has agreed to
deliver to PG&E versions of its newly developed TNG software as they become
available and are tested. Acceptance of the final version for which DCSI
has committed is currently anticipated in the latter portion of fiscal
2007. Until such acceptance is obtained, the Company will be required under
U.S. financial accounting standards to defer revenue recognition. The
contract provides for liquidated damages in the event of DCSI's late
development or delivery of hardware and software, and includes
indemnification and other customary provisions. The contract may be
terminated by PG&E for default, for its convenience and in the event of a
force majeure lasting beyond certain prescribed periods. The Company has
guaranteed the obligations of DCSI under the contract. If PG&E terminates
the contract for its convenience, DCSI will be entitled to recover certain
costs.
Subsequent Event
On February 2, 2006, the Company announced the acquisition of the capital
stock of Hexagram, Inc. (Hexagram) for cash consideration of $67.5 million
and a potential working capital adjustment. The acquisition agreement also
provides for contingent consideration of up to $6.25 million over the five
year period following the acquisition if Hexagram exceeds certain sales
targets. Hexagram is a well established RF fixed network AMR company
headquartered in Cleveland, Ohio. The Company's annual revenue over the
past three years has been in the range of $20 million to $35 million.
On November 3, 2005, Hexagram entered into a contract to provide equipment,
software and services to PG&E in support of the gas utility portion of
PG&E's AMI project. The total anticipated contract revenue from
commencement through the five-year full deployment is expected to be
approximately $225 million. As with DCSI's contract with PG&E, discussed
above, equipment will be purchased only upon issuance of purchase orders
and release authorizations, and PG&E will continue to have the right to
purchase from other suppliers for the gas utility portion of the AMI
project. Full deployment is contingent upon satisfactory system testing,
regulatory approval and final PG&E management approval, which are expected
to be concluded during fiscal 2006. The contract provides for liquidated
damages in the event of late deliveries, includes indemnification and other
customary provisions, and may be terminated by PG&E for default, for its
convenience and in the event of a force majeure lasting beyond certain
prescribed periods. The Company has guaranteed the performance of the
contract by Hexagram.
CRITICAL ACCOUNTING POLICIES
Management has evaluated the accounting policies used in the preparation of
the Company's financial statements and related notes and believes those
policies to be reasonable and appropriate. Certain of these accounting
policies require the application of significant judgment by management in
selecting appropriate assumptions for calculating financial estimates. By
their nature, these judgments are subject to an inherent degree of
uncertainty. These judgments are based on historical experience, trends in
the industry, information provided by customers and information available
from other outside sources, as appropriate. The most significant areas
involving management judgments and estimates may be found in the Critical
Accounting Policies Section of Management's Discussion and Analysis and in
Note 1 to the Consolidated Financial Statements contained in the Company's
Annual Report on Form 10-K for the fiscal year ended September 30, 2005 at
Exhibit 13.
OTHER MATTERS
Contingencies
As a normal incident of the businesses in which the Company is engaged,
various claims, charges and litigation are asserted or commenced against
the Company. In the opinion of Management, final judgments, if any, which
might be rendered against the Company in current litigation are adequately
reserved, covered by insurance, or would not have a material adverse effect
on its financial statements.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued FASB Staff Position FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (FSP 109-2)." The
American Jobs Creation Act of 2004, (the "Act") provides for a special
one-time deduction of 85 percent of certain foreign earnings repatriated
into the U.S. from non-U.S. subsidiaries through September 30, 2006. The
Company is currently evaluating the merits of repatriating funds under the
Act. At December 31, 2005, the range of reasonably possible amounts of
unremitted earnings that are being considered for repatriation is between
zero and $39.5 million, which would require the Company to pay income taxes
in the range of zero to $3.1 million. Federal income taxes on the
repatriated amounts would be based on the 5.25% effective statutory rate as
provided in the Act, plus applicable withholding taxes. To date, the
Company has not provided for income taxes on unremitted earnings generated
by non-U.S. subsidiaries given the Company's historical intent to
permanently invest these earnings abroad. As a result, additional taxes may
be required to be recorded for any funds repatriated under the Act. The
Company expects to complete its evaluation of the repatriation provision of
the Act by September 30, 2006.
FORWARD LOOKING STATEMENTS
Statements in this report that are not strictly historical are "forward
looking" statements within the meaning of the safe harbor provisions of the
federal securities laws. Forward looking statements include those relating
to the estimates or projections made in connection with the Company's
accounting policies, annual effective tax rate, timing of Communications
segment commitments and expenditures, costs related to share-based
compensation, outcome of current claims and litigation, future cash flow,
and capital requirements and operational needs for the foreseeable future
and the ultimate value of the DCSI / PG&E contract and the Hexagram / PG&E
contract, the future delivery and acceptance of the TNG software by PG&E,
completion of Nexus post-closing purchase accounting items, the amounts, if
any, and timing of foreign earnings repatriated into the U.S. and the
additional taxes resulting from such repatriation. Investors are cautioned
that such statements are only predictions, and speak only as of the date of
this report. The Company's actual results in the future may differ
materially from those projected in the forward-looking statements due to
risks and uncertainties that exist in the Company's operations and business
environment including, but not limited to: actions by the California Public
Utility Commission, PG&E's Board of Directors and PG&E's management
impacting PG&E's AMI projects; the timing and success of DCSI's software
development efforts; the timing and content of purchase order releases
under PG&E's contracts; the Company's successful performance under the PG&E
contracts; weakening of economic conditions in served markets; changes in
customer demands or customer insolvencies; competition; intellectual
property rights; successful execution of the planned sale of the Company's
Puerto Rico facility; material changes in the costs of certain raw
materials including steel, copper and petroleum based resins; delivery
delays or defaults by customers; termination for convenience of customer
contracts; timing and magnitude of future contract awards; performance
issues with key suppliers, customers and subcontractors; collective
bargaining and labor disputes; changes in laws and regulations including
changes in accounting standards and taxation requirements; changes in
foreign or U.S. business conditions affecting the distribution of foreign
earnings; costs relating to environmental matters; litigation uncertainty;
and the Company's successful execution of internal operating plans.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to the Company's operations result primarily from
changes in interest rates and changes in foreign currency exchange rates.
There has been no material change to the Company's risks since September
30, 2005. Refer to the Company's Annual Report on Form 10-K for the fiscal
year ended September 30, 2005 for further discussion about market risk.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of Management, including the Company's Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures as of the end
of the period covered by this report. Based upon that evaluation, the
Company's Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures were effective as of
that date. Disclosure controls and procedures are controls and procedures
that are designed to ensure that information required to be disclosed in
Company reports filed or submitted under the Securities Exchange Act of
1934 (the "Exchange Act") is recorded, processed, summarized and reported
within the time periods specified in the Securities and Exchange
Commission's rules and forms. There has been no change in the Company's
internal control over financial reporting (as defined in Rule 13a-15(f)
under the Exchange Act) during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In August 2004, the Company's Board of Directors approved the extension of
the previously authorized (February 2001) open market common stock
repurchase program originally authorizing up to 2.6 million shares, which
is subject to market conditions and other factors and covers the period
through September 30, 2006. At December 31, 2005, the Company has 1,152,966
shares remaining for repurchase under this program. There were no stock
repurchases during the first quarter of fiscal 2006.
ITEM 6. EXHIBITS
a) Exhibits
Exhibit
Number
3.1 Restated Articles of Incorporated by reference to
Incorporation Form 10-K for the fiscal year
ended September 30, 1999, at
Exhibit 3(a)
3.2 Amended Certificate of Incorporated by reference to
Designation Preferences Form 10-Q for the fiscal
and Rights of Series A quarter ended March 31, 2000,
Participating Cumulative at Exhibit 4(e)
Preferred Stock of the
Registrant
3.3 Articles of Merger Incorporated by reference to
effective July 10, 2000 Form 10-Q for the fiscal
quarter ended June 30, 2000, at
Exhibit 3(c)
3.4 Bylaws, as amended and Incorporated by reference to
restated. Form 10-K for the fiscal year
ended September 30, 2003, at
Exhibit 3.4
4.1 Specimen Common Stock Incorporated by reference to
Certificate Form 10-Q for the fiscal
quarter ended June 30, 2000, at
Exhibit 4(a)
4.2 Specimen Rights Incorporated by reference to
Certificate Current Report on Form 8-K
dated February 3, 2000, at
Exhibit B to Exhibit 4.1
4.3 Rights Agreement dated Incorporated by reference to
as of September 24, 1990 Current Report on Form 8-K
(as amended and Restated dated February 3, 2000, at
as of February 3, 2000) Exhibit 4.1
between the Registrant
and Registrar and
Transfer Company, as
successor Rights Agent
4.4 Credit Agreement dated Incorporated by reference to
as of October 6, 2004 Form10-K for the fiscal year
among the Registrant, ended September 30, 2004, at
Wells Fargo Bank, N.A., Exhibit 4.4
as agent, and the
lenders listed therein
4.5 Consent and Waiver to Incorporated by reference to
Credit Agreement (listed Form 8-K dated February 2, 2006
as 4.4 above) dated as at Exhibit 4.1
of January 20, 2006
10.1 Summary of Non-Employee
Directors' Compensation
(Revised as of January
1, 2006
31.1 Certification of Chief
Executive Officer
relating to Form 10-Q
for period ended
December 31, 2005
31.2 Certification of Chief
Financial Officer
relating to Form 10-Q
for period ended
December 31, 2005
32 Certification of Chief
Executive Officer and
Chief Financial Officer
relating to Form 10-Q
for period ended
December 31, 2005
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ESCO TECHNOLOGIES INC.
/s/ Gary E. Muenster
Gary E. Muenster
Senior Vice President and Chief Financial Officer
(As duly authorized officer and principal accounting
officer of the registrant)
Dated: February 8, 2006