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 MARCH 31, 2006
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 April 30, 2006
[Common stock, $.01 par value per share] 25,790,112 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
March 31,
---------
2006 2005
---- ----
Net sales $ 122,884 106,160
Costs and expenses:
Cost of sales 80,514 68,909
Amortization of intangible assets 1,536 525
Selling, general and administrative 26,703 21,073
expenses
Interest income (100) (303)
Other (income) expense, net (1,548) (485)
------- -----
Total costs and expenses 107,105 89,719
Earnings before income taxes 15,779 16,441
Income tax expense 8,436 6,014
-------- --------
Net earnings $ 7,343 10,427
===== =====
Earnings per share:
Basic $ 0.29 0.41
==== ====
Diluted $ 0.28 0.40
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share amounts)
Six Months Ended
March 31,
----------
2006 2005
----- ----
Net sales $ 213,470 210,535
Costs and expenses:
Cost of sales 144,501 137,338
Amortization of intangible assets 2,049 1,024
Selling, general and administrative 50,189 40,697
expenses
Interest income (817) (783)
Other (income) expense, net (1,926) (1,169)
------- ------
Total costs and expenses 193,996 177,107
Earnings before income taxes 19,474 33,428
Income tax expense 9,926 12,479
-------- -------
Net earnings $ 9,548 20,949
====== ======
Earnings per share:
Basic $ 0.37 0.82
=== ===
Diluted $ 0.36 0.80
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
March 31, September 30,
2006 2005
---- ----
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 20,943 104,484
Accounts receivable, net 81,535 68,819
Costs and estimated earnings on
long-term contracts, less progress
billings of $5,865 and $7,033,
respectively 1,877 4,392
Inventories 52,878 48,645
Current portion of deferred tax 30,057 30,219
assets
Other current assets 10,840 8,394
------ -----
Total current assets 198,130 264,953
Property, plant and equipment, net 69,047 67,190
Goodwill 141,845 68,880
Other assets 59,669 27,697
------ ------
$ 468,691 428,720
========== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current
maturities of long-term debt $ - -
Accounts payable 43,461 29,299
Advance payments on long-term
contracts, less costs incurred of
$11,999 and $10,949,
respectively 5,648 6,773
Accrued salaries 10,960 12,024
Accrued other expenses 24,215 14,661
------ ------
Total current liabilities 84,284 62,757
Deferred income 4,924 3,134
Pension obligations 17,476 17,481
Other liabilities 16,298 14,324
Long-term debt - -
------ ------
Total liabilities 122,982 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 28,875,369 and
28,738,958 shares, respectively 289 287
Additional paid-in capital 233,032 228,317
Retained earnings 168,911 159,363
Accumulated other comprehensive loss (5,224) (5,566)
------ ------
397,008 382,401
Less treasury stock, at cost:
3,170,826 and 3,175,626 common
shares, respectively (51,299) (51,377)
------- -------
Total shareholders' equity 345,709 331,024
$ 468,691 428,720
========== =======
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Six Months Ended
March 31,
---------
2006 2005
---- ----
Cash flows from operating activities:
Net earnings $ 9,548 20,949
Adjustments to reconcile net earnings
to net cash provided by operating
activities:
Depreciation and amortization 7,219 6,080
Stock compensation expense 2,643 1,545
Changes in operating working capital 7,624 (1,504)
Effect of deferred taxes (1,563) 3,246
Other 718 1,316
--- -----
Net cash provided by operating
activities 26,189 31,632
Cash flows from investing activities:
Acquisition of businesses, less cash
acquired (90,862) -
Capital expenditures (4,296) (4,568)
Additions to capitalized software (18,095) (2,524)
------- ------
Net cash used by investing
activities (113,253) (7,092)
Cash flows from financing activities:
Borrowings from long-term debt 47,000 -
Principal payments on long-term debt (47,000) (81)
Purchases of common stock into treasury - (24,928)
Excess tax benefit from stock options
exercised 880 -
Proceeds from exercise of stock options 1,526 1,907
Other 1,117 848
----- ---
Net cash provided (used) by
financing activities 3,523 (22,254)
----- -------
Net (decrease) increase in cash and cash
equivalents (83,541) 2,286
Cash and cash equivalents, beginning of
period 104,484 72,281
------- ------
Cash and cash equivalents, end of period $ 20,943 74,567
======== ======
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 issued 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 and six-month periods ended March 31, 2006 are
not necessarily indicative of the results for the entire 2006 fiscal year.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This Summary of Significant Accounting Policies supplements the summary in
the Company's Annual Report on Form 10-K for the fiscal year ended
September 30, 2005.
(a) Revenue Recognition
Filtration / Fluid Flow Operating Unit: Within the Filtration / Fluid Flow
operating unit, approximately 75% of operating unit revenues (30% of
consolidated revenues) are recognized when products are delivered (when
title and risk of ownership transfers) or when services are performed for
unaffiliated customers.
Approximately 25% of operating unit revenues (10% of consolidated revenues)
are recorded under the percentage-of-completion provisions of SOP 81-1,
"Accounting for Performance of Construction-Type and Certain
Production-Type Contracts." Products accounted for under SOP 81-1 include
the design, development and manufacture of complex fluid control products,
quiet valves, manifolds and systems primarily for the aerospace and
military markets. For arrangements that are accounted for under SOP 81-1,
the Company estimates profit as the difference between total estimated
revenue and total estimated cost of a contract and recognizes these
revenues and costs based on units delivered. The percentage-of-completion
method of accounting involves the use of various techniques to estimate
expected costs at completion.
Communications Segment: Within the Communications segment, approximately
95% of the segment's revenue arrangements (30% of consolidated revenues)
contain software components. Revenue under these arrangements is recognized
in accordance with Statement of Position 97-2 (SOP 97-2), "Software Revenue
Recognition," as amended by SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition, with Respect to Certain Transactions." The segment's
software revenue arrangements generally include multiple products and
services, or "elements" consisting of meter and substation hardware, meter
reading system software, software support (post-contract customer support,
"PCS") and program management support. These arrangements typically require
the Company to deliver software at the inception of the arrangement while
the hardware, software support and program management support are delivered
over the contractual deployment period. The hardware element included in
such arrangements is essential to the functionality of the software and
therefore, is considered to be software-related. Hardware is considered a
specified element in the software arrangement and vendor-specific objective
evidence of fair value ("VSOE") has been established for this element. VSOE
for the hardware element is determined based on the price when sold
separately to customers. These revenue arrangements are divided into
separate units of accounting if the delivered item(s) has value to the
customer on a stand-alone basis, there is objective and reliable evidence
of the fair value of the undelivered item(s) and delivery/performance of
the undelivered item(s) is probable. For multiple element arrangements,
revenue is allocated to the individual elements based on VSOE of the
individual elements.
The application of these principles requires judgment, including the
determination of whether a software arrangement includes multiple elements
and estimates of the fair value of the elements. The VSOE of the
undelivered elements is determined based on the historical evidence of
stand-alone sales of these elements to customers. Hardware revenues are
generally recognized at the time of shipment or receipt by customer
depending upon contract terms. VSOE generally does not exist for the
software element, therefore, the Company uses the residual method to
recognize revenue when VSOE exists for all other undelivered elements.
Under the residual method, the fair value of the undelivered elements is
deferred and the remaining portion of the arrangement fee is recognized as
revenue.
SOP 97-2 requires the seller of software that includes post-contract
customer support (PCS) to establish VSOE of the undelivered element of the
contract in order to account separately for the PCS revenue. The Company
determines VSOE by a consistent pricing of PCS and PCS renewals as a
percentage of the software license fees and by reference to contractual
renewals, when the renewal terms are substantive. Revenues for PCS are
recognized ratably over the maintenance term specified in the contract
(generally in 12 monthly increments). Revenues for program management
support are recognized when services have been provided. The Company
determines VSOE for program management support based on hourly rates when
services are performed separately.
Deferred revenue is recorded for products or services that have not been
provided but have been invoiced under contractual agreements or paid for by
a customer, or when products or services have been provided but the
criteria for revenue recognition have not been met. If there is a customer
acceptance provision or there is uncertainty about customer acceptance,
revenue is deferred until the customer has accepted the product or service.
Approximately 5% of segment revenues (1% of consolidated revenues) are
recognized when products are delivered (when title and risk of ownership
transfers) or when services are performed for unaffiliated customers.
Products include the SecurVision digital video surveillance systems.
Test Segment: Within the Test segment, approximately 60% of revenues (20%
of consolidated revenues) are recognized when products are delivered (when
title and risk of ownership transfers) or when services are performed for
unaffiliated customers. Certain arrangements contain multiple elements
which are accounted for under the provisions of EITF 00-21, "Revenue
Arrangements with Multiple Deliverables." The multiple elements generally
consist of materials and installation services used in the construction and
installation of standard shielded enclosures to measure and contain
magnetic and electromagnetic energy. The installation process does not
involve changes to the features or capabilities of the equipment and does
not require proprietary information about the equipment in order for the
installed equipment to perform to specifications. There is objective and
reliable evidence of fair value for each of the units of accounting, as a
result, the arrangement revenue is allocated to the separate units of
accounting based on their relative fair values. Typically, fair value is
the price of the deliverable when it is regularly sold on a stand-alone
basis.
Approximately 40% of the segment's revenues (9% of consolidated revenues)
are recorded under the percentage-of-completion provisions of SOP 81-1,
"Accounting for the Performance of Construction-Type and Certain
Production-Type Contracts" due to the complex nature of the enclosures that
are designed and produced under these contracts. Products accounted for
under SOP 81-1 include the construction and installation of complex test
chambers to a buyer's specifications that provide its customers with the
ability to measure and contain magnetic, electromagnetic and acoustic
energy. As discussed above, for arrangements that are accounted for under
SOP 81-1, the Company estimates profit as the difference between total
estimated revenue and total estimated cost of a contract and recognizes
these revenues and costs based on either (a) units delivered or (b)
contract milestones.
If a reliable measure of output cannot be established (which applies in
less than 8% of Test segment revenues or 2% of consolidated revenues),
input measures (e.g., costs incurred) are used to recognize revenue. Given
the nature of the Company's operations related to these contracts, costs
incurred represent an appropriate measure of progress towards completion.
The percentage-of-completion method of accounting involves the use of
various techniques to estimate expected costs at completion. These
estimates are based on Management's judgment and the Company's substantial
experience in developing these types of estimates.
(b) Capitalized Software
The costs incurred for the development of computer software that will be
sold, leased, or otherwise marketed are charged to expense when incurred as
research and development until technological feasibility has been
established for the product. Technological feasibility is typically
established upon completion of a detailed program design. Costs incurred
after this point are capitalized on a project-by-project basis in
accordance with SFAS No. 86, "Accounting for the Costs of Computer Software
to be Sold, Leased or Otherwise Marketed." Costs that are capitalized
primarily consist of external development costs. Upon general release of
the product to customers, the Company ceases capitalization and begins
amortization, which is calculated on a project-by-project basis as the
greater of (1) the ratio of current gross revenues for a product to the
total of current and anticipated future gross revenues for the product or
(2) the straight-line method over the estimated economic life of the
product. The Company generally amortizes the software development costs
over a three to seven year period based upon the estimated future economic
life of the product. Factors considered in determining the estimated future
economic life of the product include anticipated future revenues, and
changes in software and hardware technologies. The carrying values of
capitalized costs are evaluated for impairment on an annual basis to
determine if circumstances exist which indicate the carrying value of the
asset may not be recoverable. If expected cash flows are insufficient to
recover the carrying amount of the asset, then an impairment loss is
recognized to state the asset at its net realizable value.
3. 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 Six Months Ended
March 31, March 31,
--------- ---------
2006 2005 2006 2005
---- ---- ---- ----
Weighted Average
Shares Outstanding
- Basic 25,659 25,266 25,620 25,444
Dilutive Options
and Restricted
Shares 789 768 782 792
--- --- --- ---
Adjusted Shares-
Diluted 26,448 26,034 26,402 26,236
====== ====== ====== ======
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 March
31, 2006 and 2005, 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 19,000 and 48,000 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
March 31, 2006 and 2005, respectively.
4. 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 six months 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 net
earnings for the three and six-months periods ended March 31, 2006 are $0.6
million and $1.1 million lower respectively, than if it had continued to
account for share-based compensation under APB 25. Diluted earnings per
share for the second quarter and first six months of 2006 would have been
$0.30 and $0.40, respectively, if the company had not adopted SFAS 123(R),
compared to reported diluted earnings per share of $0.28 and $0.36,
respectively.
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 March 31, 2006
and 2005, respectively: expected dividend yield of 0% in both periods;
expected volatility of 28.0% and 20.3%; risk-free interest rate of 4.5% and
4.2%; and expected term of 3.5 years and 4.25 years. Pre-tax compensation
expense related to the stock option awards was $0.6 million and $1.1
million for the second quarter of 2006 and the first six months of 2006,
respectively.
The following summary presents information regarding outstanding stock
options as of March 31, 2006 and changes during the first six months then
ended with regard to options under the option plans:
Aggregate Weighted-Average
Intrinsic Remaining
Weighted Value (in Contractual
Shares Avg. Price millions) Life
------ ---------- --------- ----
Outstanding at
October 1, 2005 1,324,548 $20.48
Granted 285,130 $43.22
Exercised (154,007) $15.43 $5.0
Cancelled (10,321) $35.30
------- ------
Outstanding at
March 31, 2006 1,445,350 $25.41 $35.7 4.2 years
=========
Exercisable at
March 31, 2006 803,616 $16.13 $27.3
=======
The weighted-average grant-date fair value of options granted during the
first six months of fiscal 2006 was $11.73.
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 March 31, 2006, 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. Pre-tax compensation
expense related to the restricted share awards was $0.6 million and $1.2
million for the three and six-month periods ended March 31, 2006,
respectively, and $0.6 million and $1.2 million for the respective prior
year periods.
The following summary presents information regarding outstanding restricted
share awards as of March 31, 2006 and changes during the six-month period
then ended:
Weighted
Shares Avg. Price
------ ----------
Nonvested at October 1, 2005 238,436 $23.78
Granted 60,630 $42.62
Vested (118,736) $17.41
---------
Nonvested at March 31, 2006 180,330 $34.31
======
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 $0.4 million for the three and six-month
periods ended March 31, 2006, respectively, and $0.2 million and $0.3
million for the respective prior year periods.
The total share-based compensation cost that has been recognized in results
of operations and included within SG&A was $1.3 million and $2.6 million
for the three and six-month periods ended March 31, 2006, respectively, and
$0.8 million and $1.5 million for the three and six-month periods ended
March 31, 2005, respectively. The total income tax benefit recognized in
results of operations for share-based compensation arrangements was $0.3
million and $0.7 million for the three and six-month periods ended March
31, 2006, respectively and $0.3 million and $0.6 million for the three and
six-month periods ended March 31, 2005, respectively. As of March 31, 2006,
there was $9.4 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 4.0 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 three and
six-month periods ended March 31, 2005:
(Unaudited)
(Dollars in thousands,
except per share amounts)
Three Months Ended Six Months Ended
March 31, March 31,
--------- ---------
2005 2005
---- ----
Net earnings, as reported $ 10,427 $ 20,949
Add: stock-based employee
compensation expense
included in reported
net earnings, net of
tax 381 750
Less: total stock-based
employee compensation
expense determined
under fair value based
methods, net of tax (927) (1,844)
---- ------
Pro forma net earnings $ 9,881 $ 19,855
======== ========
Net earnings per share:
Basic - as reported $ 0.41 $ 0.82
Basic - pro forma 0.39 0.78
==== ====
Diluted - as reported $ 0.40 $ 0.80
Diluted - pro forma 0.38 0.76
==== ====
5. ACQUISITIONS
Effective February 1, 2006, the Company acquired the capital stock of
Hexagram, Inc. (Hexagram) for a purchase price of $67.5 million subject to
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 RF fixed network automatic meter reading (AMR)
company headquartered in Cleveland, Ohio. Hexagram's annual revenue over
the past three years has been in the range of $20 million to $35 million.
The operating results for Hexagram, since the date of acquisition, are
included within the Communications segment. The Company recorded
approximately $53 million of goodwill and trademarks as a result of the
transaction, subject to post-closing adjustments including finalization of
purchase accounting. The Company also recorded $6.6 million of identifiable
intangible assets consisting primarily of patents and proprietary know-how,
customer contracts, and order backlog which will be amortized on a
straight-line basis over periods ranging from six months to seven years.
The post-closing purchase accounting items are expected to be completed
prior to September 30, 2006.
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
primarily of customer contracts and order backlog which will be amortized
on a straight-line basis over periods ranging from one year to three years.
The post-closing purchase accounting items are expected to be completed
prior to September 30, 2006.
6. INVENTORIES
Inventories consist of the following (in thousands):
March 31, September 30,
2006 2005
---- ----
Finished goods $ 13,446 14,361
Work in process, including long-
term contracts 15,978 12,512
Raw materials 23,454 21,772
------ ------
Total inventories $ 52,878 48,645
========= ======
7. COMPREHENSIVE INCOME
Comprehensive income for the three-month periods ended March 31, 2006 and
2005 was $8.4 million and $8.9 million, respectively. Comprehensive income
for the six-month periods ended March 31, 2006 and 2005 was $9.9 million
and $22.8 million, respectively. For the three and six-month periods ended
March 31, 2006, the Company's comprehensive income was positively impacted
by foreign currency translation adjustments of $1.1 million and $0.3
million, respectively. For the three and six-month periods ended March 31,
2005, the Company's comprehensive income was negatively impacted by foreign
currency translation adjustments of $1.6 million and positively impacted by
foreign currency translation adjustments of $1.8 million, respectively.
8. BUSINESS SEGMENT INFORMATION
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company operates in three
segments: Filtration/Fluid Flow, Communications and Test. The components of
the Filtration/Fluid Flow segment are presented separately due to differing
long-term economics.
Management evaluates and measures the performance of its operating segments
based on "Net Sales" and "EBIT", which are detailed in the table below.
EBIT is defined as earnings from continuing operations before interest and
taxes. During the second quarter of fiscal 2006, the Company changed its
reporting of goodwill and acquired intangible assets (including related
amortization) from operating segments to Corporate as they are excluded by
management in assessing the segment's operating performance. There was no
impact on EBIT in the prior periods.
($ in thousands) Three Months ended Six Months ended
March 31, March 31,
--------- ---------
NET SALES 2006 2005 2006 2005
--------- ---- ---- ---- ----
PTI $ 11,711 10,137 $ 22,408 20,359
VACCO 8,325 8,556 16,379 19,171
Filtertek 25,012 22,282 47,707 45,449
------ ------ ------ ------
Filtration/Fluid Flow 45,048 40,975 86,494 84,979
Communications 43,239 36,085 62,372 69,618
Test 34,597 29,100 64,604 55,938
------ ------ ------ ------
Consolidated totals $122,884 106,160 $213,470 210,535
======== ======= ======== =======
EBIT
----
PTI 1,583 1,106 2,782 2,236
VACCO 1,441 2,192 3,332 5,756
Filtertek 1,699 1,743 2,696 4,108
----- ----- ----- -----
Filtration/Fluid Flow 4,723 5,041 8,810 12,100
Communications 9,728 10,632 8,844 20,254
Test 4,338 3,338 7,254 5,420
Corporate (3,110) (2,873) (6,251) (5,129)
------ ------ ------ ------
Consolidated EBIT 15,679 16,138 18,657 32,645
Add: Interest income 100 303 817 783
--- --- --- ---
Earnings before
income taxes $ 15,779 16,441 $ 19,474 33,428
========= ====== ========= ======
9. 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 March 31, 2006 and 2005 are shown in the following tables.
Net periodic benefit cost for each period presented is comprised of the
following:
Three Months Ended Six Months Ended
March 31, March 31,
--------- ---------
(Dollars in thousands) 2006 2005 2006 2005
---- ---- ---- ----
Defined benefit plans
Interest cost $650 663 $1,300 1,325
Expected return on
assets (675) (713) (1,350) (1,425)
Amortization of:
Actuarial (gain)
loss 125 125 250 250
--- --- --- ---
Net periodic benefit
cost $100 75 $200 150
==== == ==== ===
Net periodic postretirement (retiree medical) benefit cost for each period
presented is comprised of the following:
Three Months Ended Six Months Ended
March 31, March 31,
--------- ---------
(Dollars in thousands) 2006 2005 2006 2005
---- ---- ---- ----
Service cost $ 9 8 $18 15
Interest cost 10 10 20 20
Prior service cost (2) - (2) -
Amortization of
actuarial gain 2 (2) (7) (9)
- -- -- --
Net periodic
postretirement
benefit cost $19 16 $29 26
10. 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. During
the second quarter ended March 31, 2006, the Company repatriated $28.7
million of foreign earnings which qualify for the special one-time
deduction. Tax expense of $1.7 million was recorded in the second quarter
of fiscal 2006 as a result of this repatriation.
The Company is currently evaluating the merits of repatriating additional
funds under the Act. At March 31, 2006, the range of reasonably possible
amounts of unremitted earnings that are being considered for repatriation
is between zero and $13.9 million, which would require the Company to pay
income taxes in the range of zero to $1.5 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 these unremitted earnings
generated by non-U.S. subsidiaries. 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 these additional funds 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 second quarters of 2006 and
2005 represent the fiscal quarters ended March 31, 2006 and 2005, respectively.
NET SALES
Net sales increased $16.7 million, or 15.8%, to $122.9 million for the second
quarter of 2006 from $106.2 million for the second quarter of 2005 including
$6.5 million from acquisitions. Net sales increased $3.0 million, or 1.4% to
$213.5 million for the first six months of fiscal 2006 from $210.5 for the first
six months of fiscal 2005. Unfavorable foreign currency values decreased sales
by approximately $0.8 million and $1.8 million in the second quarter of 2006 and
in the first six months of fiscal 2006, respectively.
- -Filtration/Fluid Flow
Net sales increased $4.1 million, or 9.9%, to $45.0 million for the second
quarter of 2006 from $40.9 million for the second quarter of 2005. Net sales
increased $1.5 million, or 1.8%, to $86.5 million for the first six months of
fiscal 2006 from $85.0 million for the first six months of fiscal 2005. The
sales increase during the fiscal quarter ended March 31, 2006 as compared to the
prior year quarter is mainly due to the following: a net sales increase at
Filtertek of $2.7 million driven by higher automotive, medical and commercial
shipments; higher commercial aerospace shipments at PTI of $1.6 million;
partially offset by a decrease in defense spares and T-700 shipments at VACCO of
$0.2 million. The sales increase for the first six months of fiscal 2006 as
compared to the prior year period is mainly due to the following: a net sales
increase at Filtertek of $2.3 million; higher commercial aerospace shipments at
PTI of $2.0 million; partially offset by a decrease in defense spares and T-700
shipments at VACCO of $2.8 million.
- -Communications
Net sales increased $7.2 million, or 19.8%, to $43.2 million for the second
quarter of 2006 from $36.1 million for the second quarter of 2005. Net sales
decreased $7.2 million, or 10.4%, to $62.4 million for the first six months of
fiscal 2006 from $69.6 million in the prior year period. The sales increase in
the second quarter of 2006 as compared to the prior year quarter was due to the
following: $3.8 million of higher shipments of DCSI's automatic meter reading
(AMR) products partially offset by $3.1 million of lower shipments of Comtrak's
SecurVision video security products; and the Hexagram and Nexus acquisitions
contributed $3.8 million and $2.7 million, respectively. The sales for Hexagram
represented two months of sales.
The sales decrease in the first six months of fiscal 2006 as compared to the
prior year period was due to the following: $7.2 million of lower shipments of
DCSI's AMR products; $7.7 million of lower shipments of Comtrak's video security
products; partially offset by $3.8 million in sales from Hexagram and $3.9
million in sales from Nexus.
The decrease in sales of AMR products of $7.2 million for the first six months
of fiscal 2006 as compared to the prior year period was due to the following
items: $16.3 million of lower AMR product sales to the COOP market due to the
decrease in orders entered during the latter half of fiscal 2005; and $3.3
million of lower sales to Puerto Rico Power Authority (PREPA). These decreases
were partially offset by an increase in sales to TXU Electric Delivery Company
(TXU) of $14.0 million in the first six months of fiscal 2006. The Company
expects AMR product sales to the COOP market to increase during the second half
of fiscal 2006 due to the increase in orders received during the first six
months of 2006.
Sales of SecurVision products were $0.4 million for the second quarter of 2006
as compared to $3.5 million for the prior year second quarter and $2.9 million
for the first six months of fiscal 2006 as compared to $10.6 million in the
prior year six-month period. The decrease in sales in the second quarter and
first six months of fiscal 2006 was due to an acceleration of shipments in the
prior year periods.
- -Test
For the second quarter of 2006, net sales of $34.6 million were $5.5 million, or
18.9%, higher than the $29.1 million of net sales recorded in the second quarter
of fiscal 2005. Net sales increased $8.7 million, or 15.5%, to $64.6 million for
the first six months of fiscal 2006 from $55.9 million for the first six months
of fiscal 2005. The sales increase in the second quarter of 2006 as compared to
the prior year quarter was mainly driven by sales of additional test chambers
and higher component sales.
The sales increase for the first six months of fiscal 2006 compared to the prior
year period was primarily due to the following: a $10.4 million increase in net
sales from the Company's U.S. operations driven by sales of additional test
chambers and higher component sales; partially offset by a $1.4 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 $274.5 million at March 31, 2006 compared with $233.1 million at
September 30, 2005. The Company received new orders totaling $128.7 million in
the second quarter of 2006 (including $4.0 million of new orders and $6.0
million of acquired backlog from Hexagram). New orders of $43.2 million were
received in the second quarter of 2006 related to Filtration/Fluid Flow
products, $55.5 million related to Communications products and $30.0 million
related to Test products.
Within the Communications segment, DCSI received $38.8 million of new orders for
its AMR products in the second quarter of 2006, which included an $8.7 million
follow-on order from TXU for a 100,000 endpoint expansion of the existing
program and a $5.8 million order from Florida Power & Light (FPL) for
approximately 60,000 load control transponders.
The Company received new orders totaling $254.8 million in the first six months
of 2006 compared to $215.4 million in the prior year period. New orders of $84.4
million were received in the first six months of 2006 related to
Filtration/Fluid flow products, $114.6 million related to Communications
products (including $4.0 million of new orders and $6.0 million of acquired
backlog from Hexagram and $2.0 million of new orders and $9.0 million of
acquired backlog from Nexus) and $55.8 million related to Test products. New
orders of $99.8 million were received in the first six months of 2005 related to
Filtration/Fluid flow products, $62.7 million related to Communications products
(included $55.7 million related to AMR products) and $53.0 million related to
Test products.
In addition, in November 2005, DCSI signed an agreement with Pacific Gas &
Electric (PG&E) with an anticipated contract value of approximately $300 million
covering five million endpoints over a five year deployment period currently
scheduled to begin in late fiscal 2006. The Company received orders totaling
$1.2 million from PG&E under this agreement during the first six months of 2006.
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. See
"Recent Developments."
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets was $1.5 million and $2.0 million for the
three and six-month periods ended March 31, 2006, respectively, compared to $0.5
million and $1.0 million for the respective prior year periods. Amortization of
intangible assets in the second quarter of 2006 and first six months of fiscal
2006 includes $0.8 million and $0.9 million, respectively, of amortization of
acquired intangible assets related to the Nexus and Hexagram acquisitions, as
described in Note 5 to the consolidated financial statements. The amortization
of acquired intangible assets related to Nexus and Hexagram are included in
Corporate's operating results. The remaining amortization expenses consist of
other identifiable intangible assets (primarily software, patents and licenses).
During the second quarter of 2006, the Company recorded $0.3 million of
amortization related to DCSI's TNG capitalized software which represented one
month of amortization.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (SG&A) expenses for the second quarter of
2006 were $26.7 million (21.7% of net sales), compared with $21.1 million (19.9%
of net sales) for the prior year quarter. For the first six months of 2006, SG&A
expenses were $50.2 million (23.5% of net sales) compared with $40.7 million
(19.3% of net sales) for the prior year period. The increase in SG&A spending in
the fiscal quarter ended March 31, 2006 as compared to the prior year quarter
was primarily due to the following items: $2.2 million of SG&A expenses related
to Nexus; $1.5 million of SG&A expenses related to Hexagram; and $0.6 million of
stock option expense. The increase in SG&A spending in the first six months of
2006 as compared to the prior year period was primarily due to the following
items: $2.9 million of SG&A expenses related to Nexus; $1.5 million of SG&A
expenses related to Hexagram; and $1.1 million of stock option expense.
OTHER (INCOME) EXPENSES, NET
Other (income) expenses, net, were $(1.5) million for the second quarter of 2006
compared to $(0.5) million for the prior year quarter. Other (income) expenses,
net, were $(1.9) million for the first six months of fiscal 2006 compared to
$(1.2) million for the prior year period. Principal components of other (income)
expenses, net, for the first six months of 2006 included the following items:
$(1.8) million non-cash gain representing the release of a reserve related to an
indemnification obligation with respect to a previously divested subsidiary;
$(1.1) million of royalty income; partially offset by a $0.2 million write off
of assets related to a terminated subcontract manufacturer. The principal
component of other (income) expenses, net, for the first six months of fiscal
2005 was $(1.2) million of royalty income.
EBIT
The Company evaluates the performance of its operating segments based on EBIT,
defined below. EBIT was $15.7 million (12.8% of net sales) for the second
quarter of 2006 and $16.1 million (15.2% of net sales) for the second quarter of
2005. For the first six months of fiscal 2006, EBIT was $18.7 million (8.7% of
net sales) and $32.6 million (15.5% of net sales) for the first six months of
fiscal 2005. The decrease in EBIT for the first six months of 2006 as compared
to the prior year period is primarily due to the sales decrease in the
Communications segment.
This Form 10-Q contains the financial measure "EBIT", which is not calculated in
accordance with generally accepted accounting principles in the United States of
America (GAAP). EBIT provides investors and Management with an alternative
method for assessing the Company's operating results. The Company defines "EBIT"
as earnings from continuing operations before interest and taxes. Management
evaluates the performance of its operating segments based on EBIT and believes
that EBIT is useful to investors to demonstrate the operational profitability of
the Company's business segments by excluding interest and taxes, which are
generally accounted for across the entire Company on a consolidated basis. EBIT
is also one of the measures Management uses to determine resource allocations
within the Company and incentive compensation. The following table represents a
reconciliation of EBIT to net earnings.
Three Months ended Six Months ended
($ in thousands) March 31, March 31,
--------- ---------
2006 2005 2006 2005
---- ---- ---- ----
EBIT $15,679 16,138 $18,657 32,645
Interest income 100 303 817 783
Less: Income taxes 8,436 6,014 9,926 12,479
----- ----- ----- ------
Net earnings $ 7,343 10,427 $ 9,548 20,949
======= ====== ======= ======
- -Filtration/Fluid Flow
EBIT was $4.7 million (10.5% of net sales) and $5.0 million (12.3% of net sales)
in the second quarters of 2006 and 2005, respectively, and $8.8 million (10.2%
of net sales) and $12.1 million (14.2% of net sales) in the first six months of
fiscal 2006 and 2005, respectively. For the second quarter of 2006 as compared
to the prior year quarter, EBIT decreased $0.3 million due to the following: a
$0.8 million decrease at VACCO due to lower defense spares shipments; partially
offset by a $0.5 million increase at PTI due to continued strengthening of the
commercial aerospace market. For the first six months of fiscal 2006 as compared
to the prior year period, EBIT decreased $3.3 million due to the following: a
$2.4 million decrease at VACCO due to lower defense spares shipments; a $1.4
million decrease at Filtertek primarily due to softness in the automotive market
and increase in raw material costs (e.g. petroleum based resins); partially
offset by a $0.5 million increase at PTI. Additionally, Filtertek's second
quarter and first six months of fiscal 2005 included $0.3 million and $0.9
million, respectively, of cost reimbursement related to a supply agreement with
a medical device customer which was terminated in fiscal 2005.
- -Communications
EBIT in the second quarter of 2006 was $9.7 million (22.5% of net sales)
compared to EBIT of $10.6 million (29.5% of net sales) in the prior year
quarter. For the first six months of fiscal 2006, EBIT was $8.8 million (14.1%
of net sales) compared to $20.3 million (29.1% of net sales) in the prior year
period. The decrease in EBIT in the second quarter of 2006 was due to the
following items: a $1.4 million decrease at Comtrak due to lower shipments of
its video security products; a $0.3 million decrease related to Nexus and
Hexagram resulting from additional SG&A spending related to marketing and new
product development initiatives; partially offset by an $0.8 million increase at
DCSI resulting from increased sales. The decrease in EBIT for the first six
months of fiscal 2006 compared to the prior year period was mainly due to the
following items: an $8.1 million decrease at DCSI due to lower shipments of AMR
products; and a $3.2 million decrease at Comtrak due to lower shipments of its
video security products.
During the second quarter of 2006, DCSI entered into contracts with two new
suppliers for its products. The new suppliers offer a broader range of
capabilities as well as an opportunity for cost reductions.
- -Test
EBIT in the second quarter of 2006 was $4.3 million (12.5% of net sales) as
compared to $3.3 million (11.5% of net sales) in the prior year quarter. For the
first six months of fiscal 2006, EBIT was $7.3 million (11.2% of net sales) as
compared to $5.4 million (9.7% of net sales) in the prior year period. EBIT
increased $1.0 million and $1.9 million over the prior year quarter and six
month period, respectively, due to the favorable changes in sales mix resulting
from additional sales of test chambers, antennas and other components. In
addition, EBIT in the first six months of fiscal 2005 was adversely affected by
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 and $6.2 million for the
three and six-month periods ended March 31, 2006, respectively, compared to $2.9
million and $5.1 million for the respective prior year periods. In the second
quarter of 2006, Corporate costs included the following: a $1.8 million non-cash
gain representing the release of a reserve related to an indemnification
obligation with respect to a previously divested subsidiary; $0.8 million of
pre-tax amortization of acquired intangible assets related to Nexus and
Hexagram; and $0.6 million of pre-tax stock option expense.
INTEREST INCOME, NET
Interest income, net, was $0.1 million and $0.8 million for the three and
six-month periods ended March 31, 2006, respectively, compared to interest
income, net, of $0.3 million and $0.8 million for the respective prior year
periods. The decrease in interest income in the second quarter of 2006 as
compared to the prior year quarter was due to outstanding borrowings prior to
the foreign cash repatriation during the second quarter of 2006 and lower
average cash balances on hand.
INCOME TAX EXPENSE
The second quarter 2006 effective income tax rate was 53.5% compared to 36.6% in
the second quarter of 2005. The effective income tax rate in the first six
months of fiscal 2006 was 51.0% compared to 37.3% in the prior year period. The
increase in the effective income tax rate in the second quarter of 2006 and in
the first six months of fiscal 2006 as compared to the prior year periods is
primarily due to the impact of repatriating $28.7 million of cash held by
foreign subsidiaries into the United States under the tax provisions of the
American Jobs Creation Act of 2004. The effect of the repatriation impacted the
fiscal 2006 second quarter effective income tax expense by $1.7 million and the
effective rate by 10.9%. In addition, lower volume of profit contributions of
the Company's foreign operations (primarily Puerto Rico due to the lower sales
to PREPA) impacted the tax rate. The Company estimates the annual effective tax
rate for fiscal 2006 to be approximately 42%.
CAPITAL RESOURCES AND LIQUIDITY
Working capital (current assets less current liabilities) decreased to $113.8
million at March 31, 2006 from $202.2 million at September 30, 2005. During the
first six months of 2006, cash decreased $83.5 million, largely due to the
approximately $91 million, net, paid for the Nexus and Hexagram acquisitions.
Accounts receivable increased by $12.7 million in the first six months of 2006,
of which $5.7 million related to the acquisitions of Nexus and Hexagram and $4.0
million related to the Filtration segment due to timing of sales. Accounts
payable increased by $14.2 million in the first six months of 2006, of which
$1.8 million related to the acquisitions of Nexus and Hexagram and $7.0 million
related to DCSI due to timing of vendor payments. Accrued other expenses
increased by $9.6 million in the first six months of 2006, of which $4.9 million
related to the acquisitions of Nexus and Hexagram and an increase in Company's
current income tax accrual.
Net cash provided by operating activities was $26.2 million and $31.6 million
for the six-month periods ended March 31, 2006 and 2005, respectively. The
decrease in the first six months of 2006 as compared to the prior year period
was a result of the lower earnings.
Capital expenditures were $4.3 million and $4.6 million in the first six months
of fiscal 2006 and 2005, respectively. Major expenditures in the current period
included manufacturing equipment used in the Filtration/Fluid Flow businesses.
At March 31, 2006, other assets (non-current) of $59.7 million included $35.2
million of capitalized software. Approximately $31.2 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 (IOU) 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 March 31, 2006, the Company had approximately $10 million of
commitments related to TNG versions 1.6 and 2.0 which is expected to be spent
over the next six months. The Company expects to spend up to $5 million in
fiscal 2007 on TNG. Amortization of TNG is on a straight-line basis over seven
years and began in March 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 March 31, 2006. 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 March 31, 2006, the Company
had approximately $98.6 million available to borrow under the credit facility in
addition to $20.9 million cash on hand. At March 31, 2006, the Company had no
borrowings, and outstanding letters of credit of $2.5 million ($1.4 million
outstanding under the credit facility). On February 1, 2006, the Company
borrowed $47 million to partially fund the acquisition of Hexagram which was
subsequently repaid from the foreign cash repatriation by March 31, 2006. The
interest rate on this debt was approximately 5.3%. 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.
Acquisitions
Effective February 1, 2006, the Company acquired the capital stock of Hexagram,
Inc. (Hexagram) for a purchase price of $67.5 million subject to 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 RF fixed network AMR company headquartered in Cleveland, Ohio. Hexagram's
annual revenue over the past three years has been in the range of $20 million to
$35 million. The operating results for Hexagram, since the date of acquisition,
are included within the Communications segment. The Company recorded
approximately $53 million of goodwill and trademarks as a result of the
transaction, subject to post-closing adjustments including finalization of
purchase accounting. The Company also recorded $6.6 million of identifiable
intangible assets consisting primarily of patents and proprietary know-how,
customer contracts, and order backlog which will be amortized on a straight-line
basis over periods ranging from six months to seven years. The post-closing
purchase accounting items are expected to be completed prior to September 30,
2006.
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 periods ranging from one year to three years. The
post-closing purchase accounting items are expected to be completed prior to
September 30, 2006.
Recent Developments
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 expected 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.
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 products or services 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, as supplemented by Note 2 to the Consolidated Financial
Statements in Item 1 hereof.
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. During the second quarter ended March 31, 2006, the
Company repatriated $28.7 million of foreign earnings which qualify for the
special one-time deduction. Tax expense of $1.7 million was recorded in the
second quarter of fiscal 2006 as a result of this repatriation.
The Company is currently evaluating the merits of repatriating additional funds
under the Act. At March 31, 2006, the range of reasonably possible amounts of
unremitted earnings that are being considered for repatriation is between zero
and $13.9 million, which would require the Company to pay income taxes in the
range of zero to $1.5 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 these unremitted earnings generated by non-U.S. subsidiaries. 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 of these additional funds 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, expected future sales to the COOP market, costs
related to share-based compensation, outcome of current claims and litigation,
future cash flow, capital requirements and operational needs for the foreseeable
future, 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, timing
of spending for TNG commitments, completion of Hexagram and Nexus post-closing
purchase accounting items, the amounts, if any, and timing of additional 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 March 31, 2006, the Company had 1,152,966 shares remaining for
repurchase under this program. There were no stock repurchases during the first
six months of fiscal 2006.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of the Company's shareholders was held on Thursday, February
2, 2006. The voting for directors was as follows:
For Withheld Broker Non-Votes
C. J. Kretschmer 22,034,467 1,499,256 0
J. M. McConnell 22,838,705 695,018 0
D. C. Trauscht 21,811,160 1,722,563 0
The terms of W.S. Antle III, V.L. Richey, Jr., L.W. Solley, J.M. Stolze, and
J.D. Woods continued after the meeting.
The voting on the proposal to approve the Incentive Compensation Plan for
Executive Officers was as follows:
For Against Abstain
21,219,466 264,814 30,343
In addition, the voting to ratify the Company's selection of KPMG LLP as
independent auditors for the fiscal year ending September 30, 2006 was as
follows:
For Against Abstain
22,553,306 969,067 11,350
ITEM 6. EXHIBITS
a) Exhibits
Exhibit
Number
2.1 Stock Purchase Agreement Incorporated by reference
dated February 1, 2006 to Current Report on Form
among ESCO Technologies 8-K dated February 1,
Holding Inc. and the 2006 at Exhibit 2.1
shareholders of Hexagram,
Inc.
3.1 Restated Articles of Incorporated by reference
Incorporation to Form 10-K for the
fiscal year ended
September 30, 1999, at
Exhibit 3(a)
3.2 Amended Certificate of Incorporated by reference
Designation Preferences and to Form 10-Q for the
Rights of Series A fiscal quarter ended
Participating Cumulative March 31, 2000, at
Preferred Stock of the Exhibit 4(e)
Registrant
3.3 Articles of Merger Incorporated by reference
effective July 10, 2000 to Form 10-Q for the
fiscal quarter ended June
30, 2000, at Exhibit 3(c)
3.4 Bylaws, as amended and Incorporated by reference
restated. to Form 10-K for the
fiscal year ended
September 30, 2003, at
Exhibit 3.4
4.1 Specimen Common Stock Incorporated by reference
Certificate to Form 10-Q for the
fiscal quarter ended June
30, 2000, at Exhibit 4(a)
4.2 Specimen Rights Certificate Incorporated by reference
to Current Report on Form
8-K dated February 3,
2000, at Exhibit B to
Exhibit 4.1
4.3 Rights Agreement dated as Incorporated by reference
of September 24, 1990 (as to Current Report on Form
amended and Restated as of 8-K dated February 3,
February 3, 2000) between 2000, at Exhibit 4.1
the Registrant and
Registrar and Transfer
Company, as successor
Rights Agent
4.4 Credit Agreement dated as Incorporated by reference
of October 6, 2004 among to Form10-K for the
the Registrant, Wells Fargo fiscal year ended
Bank, N.A., as agent, and September 30, 2004, at
the lenders listed therein Exhibit 4.4
4.5 Consent and waiver to Incorporated by reference
Credit Agreement (listed as to Current Report on Form
4.4, above) dated as of 8-K dated February 2,
January 20, 2006 2006 at Exhibit 4.1
10.1 Incentive Compensation Plan Incorporated by reference
for Executive Officers to Notice of Annual
(approved by Stockholders Meeting of the
February 2, 2006) Stockholders and Proxy
Statement dated December
21, 2005 at Appendix A
31.1 Certification of Chief
Executive Officer relating
to Form 10-Q for period
ended March 31, 2006
31.2 Certification of Chief
Financial Officer relating
to Form 10-Q for period
ended March 31, 2006
32 Certification of Chief
Executive Officer and Chief
Financial Officer relating
to Form 10-Q for period
ended March 31, 2006
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: May 10, 2006