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, 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 classes
of common stock, as of the latest practicable date.
Class Outstanding at January 31, 2007
----- -------------------------------
[Common stock, $.01 par value per share] 25,890,425 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,
------------
2006 2005
------ ------
Net sales $ 98,813 90,586
Costs and expenses:
Cost of sales 71,344 63,986
Selling, general and administrative
expenses 29,384 23,487
Amortization of intangible assets 2,137 513
Interest (income) expense, net (338) (717)
Other (income) and expenses, net (513) (378)
----- -----
Total costs and expenses 102,014 86,891
------- ------
(Loss) earnings before income taxes (3,201) 3,695
Income tax (benefit) expense (1,820) 1,491
------- -----
Net (loss) earnings $ (1,381) 2,204
===== =====
(Loss) earnings per share:
Basic $ (0.05) 0.09
==== ====
Diluted $ (0.05) 0.08
==== ====
See accompanying notes to consolidated financial statements.
ESCO TECHNOLOGIES INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31, September 30,
2006 2006
---- ----
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 27,998 36,819
Accounts receivable, net 75,430 83,816
Costs and estimated earnings on
long-term contracts, less progress
billings of $12,063 and $4,405,
respectively 1,208 1,345
Inventories 55,292 50,984
Current portion of deferred tax
assets 24,921 24,251
Other current assets 11,296 10,042
------ ------
Total current assets 196,145 207,257
Property, plant and equipment, net 69,227 68,754
Goodwill 143,399 143,450
Intangible assets, net 61,658 59,202
Other assets 9,083 10,031
----- ------
Total assets $ 479,512 488,694
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current
maturities of long-term debt $ - -
Accounts payable 32,122 39,496
Advance payments on long-term
contracts, less costs
incurred of $8,818 and $19,532,
respectively 8,055 7,367
Accrued salaries 10,297 13,932
Accrued other expenses 20,105 15,100
------ ------
Total current liabilities 70,579 75,895
Deferred revenue 3,997 7,458
Pension obligations 13,138 13,143
Other liabilities 14,556 15,764
Long-term debt - -
------- -------
Total liabilities 102,270 112,260
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 29,044,285 and
29,030,995 shares, respectively 290 290
Additional paid-in capital 237,521 236,390
Retained earnings 191,665 193,046
Accumulated other comprehensive loss (1,051) (2,070)
------ ------
428,425 427,656
Less treasury stock, at cost:
3,163,626 and 3,166,026 common
shares, respectively (51,183) (51,222)
------- -------
Total shareholders' equity 377,242 376,434
------- -------
Total liabilities and shareholders'
equity $ 479,512 488,694
========== =======
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,
------------
2006 2005
---- ----
Cash flows from operating activities:
Net (loss) earnings $ (1,381) 2,204
Adjustments to reconcile net (loss)
earnings to net cash provided by
operating activities:
Depreciation and amortization 4,909 3,078
Stock compensation expense 1,486 1,273
Changes in operating working capital 1,325 (532)
Effect of deferred taxes (1,259) (3,090)
Change in deferred revenue and
costs, net (2,278) 285
Other (756) (1,286)
---- ------
Net cash provided by operating
activities 2,046 1,932
Cash flows from investing activities:
Acquisition of businesses, less cash acquired - (28,833)
Capital expenditures (2,787) (2,320)
Additions to capitalized software (8,344) (5,724)
------ ------
Net cash used by investing
activities (11,131) (36,877)
Cash flows from financing activities:
Excess tax benefit from stock
options exercised 20 112
Proceeds from exercise of stock options 301 267
Other (57) 441
--- ---
Net cash provided by
financing activities 264 820
--- ---
Net decrease in cash and cash equivalents (8,821) (34,125)
Cash and cash equivalents, beginning of period 36,819 104,484
------ -------
Cash and cash equivalents, end of period $ 27,998 $ 70,359
======== ========
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, 2006.
The Company's business is typically not impacted by seasonality, however, the
results for the three-month period ended December 31, 2006 are not necessarily
indicative of the results for the entire 2007 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,
------------
2006 2005
---- ----
Weighted Average Shares
Outstanding - Basic 25,874 25,575
Dilutive Options and
Restricted Shares - 759
------ ------
Adjusted Shares- Diluted 25,874 26,334
====== ======
The Company incurred a net loss in the first quarter of fiscal 2007,
therefore, the dilutive options and restricted shares are not included if
the result would be antidilutive and therefore, diluted EPS is computed in
the same manner as basic EPS. Options to purchase 574,418 shares of common
stock at prices ranging from $42.10 - $54.88 and options to purchase
166,420 shares of common stock at prices ranging from $38.85 - $50.26 were
outstanding during the three month periods ended December 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 34,000 restricted shares were excluded from the
computation of diluted EPS based upon the application of the treasury stock
method for the three-month period ended December 31, 2005.
3. SHARE-BASED COMPENSATION
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's stock option awards are generally subject to graded vesting
over a three year service period. 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. 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,
2006 and 2005, respectively: expected dividend yield of 0% in both periods;
expected volatility of 27.2% and 28.6%; risk-free interest rate of 4.6% and
4.5%; and expected term of 3.5 years for both periods. Pre-tax compensation
expense related to the stock option awards was $0.8 million and $0.5
million for the three-month periods ended December 31, 2006 and 2005,
respectively.
Information regarding stock options awarded under the option plans is as
follows:
Weighted-
Aggregate Average
Intrinsic Remaining
Weighted Value Contractual
Shares Avg. Price (in millions) Life
------ ---------- ------------- ----
Outstanding at
October 1, 2006 1,387,348 $26.60
Granted 284,780 $45.76
Exercised (14,381) $24.28 $0.3
Cancelled (3,168) $41.36
------ ------
Outstanding at
December 31, 2006 1,654,579 $29.89 $26.2 3.7 years
========= =====
Exercisable at
December 31, 2006 979,281 $21.14 $23.8
======= =====
The weighted-average grant-date fair value of options granted during the
three-month period ended December 31, 2006 and 2005 was $12.25 and $11.74,
respectively.
Performance-accelerated Restricted Share Awards
-----------------------------------------------
The performance-accelerated restricted shares (restricted shares) vest over
five years with accelerated vesting 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 $0.5 million and $0.6 million for the three-month periods ended
December 31, 2006 and 2005, respectively.
The following summary presents information regarding outstanding restricted
share awards as of December 31, 2006 and changes during the three-month
period then ended:
Weighted
Shares Avg. Price
Nonvested at October 1, 2006 155,730 $34.33
Granted 62,030 $45.69
------ ------
Nonvested at December 31, 2006 217,760 $37.56
======= ======
Non-Employee Directors Plan
---------------------------
Pursuant to the non-employee directors compensation plan, each non-employee
director receives a retainer of 800 common shares per quarter. Pre-tax
compensation expense related to the non-employee director grants was $0.2
million and $0.2 million for the three-month periods ended December 31,
2006 and 2005, respectively.
The total share-based compensation cost that has been recognized in results
of operations and included within SG&A was $1.5 million and $1.3 million
for the three-month periods ended December 31, 2006 and 2005, respectively.
The total income tax benefit recognized in results of operations for
share-based compensation arrangements was $0.4 million and $0.4 million for
the three-month periods ended December 31, 2006 and 2005, respectively. As
of December 31, 2006, there was $13.6 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 3.5
years.
4. INVENTORIES
Inventories consist of the following (in thousands):
December 31, September 30,
2006 2006
---- ----
Finished goods $ 15,971 12,834
Work in process, including long-term
contracts 14,343 13,211
Raw materials 24,978 24,939
------ ------
Total inventories $ 55,292 50,984
========= ======
5. COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income for the three-month periods ended December 31,
2006 and 2005 was $(0.4) million and $1.5 million, respectively. For the
three-month period ended December 31, 2006, the Company's comprehensive
loss was positively impacted by foreign currency translation adjustments of
$1.0 million. For the three-month period ended December 31, 2005, the
Company's comprehensive income was negatively impacted by foreign currency
translation adjustments of $0.7 million.
6. BUSINESS SEGMENT INFORMATION
The Company is organized based on the products and services that it offers.
Under this organizational structure, the Company operates in three
segments: Communications, Filtration/Fluid Flow and Test. The components of
the Filtration/Fluid Flow segment are presented separately due to differing
long-term economics.
Management evaluates and measures the performance of its operating segments
based on "Net Sales" and "EBIT", which are detailed in the table below.
EBIT is defined as earnings from continuing operations before interest and
taxes.
($ in thousands) Three Months ended
December 31,
------------
NET SALES 2006 2005
--------- ---- ----
Communications $ 30,034 19,133
PTI 11,619 10,697
VACCO 6,681 8,054
Filtertek 22,277 22,695
------ ------
Filtration/Fluid Flow 40,577 41,446
Test 28,202 30,007
------ ------
Consolidated totals $ 98,813 90,586
======== ======
EBIT
----
Communications (2,782) (959)
PTI 1,103 1,199
VACCO 338 1,891
Filtertek 376 997
Filtration/Fluid Flow 1,817 4,087
----- -----
Test 2,143 2,916
Corporate (4,717) (3,066)
------ ------
Consolidated EBIT (3,539) 2,978
Add: Interest income 338 717
--- ---
Earnings (loss)
before income taxes $ (3,201) 3,695
======== =====
7. 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, 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
December 31,
------------
(Dollars in thousands) 2006 2005
---- ----
Defined benefit plans
Interest cost $ 688 650
Expected return on assets (700) (675)
Amortization of:
Prior service cost 2 -
Actuarial loss 98 125
-- ---
Net periodic benefit cost $ 88 100
== ===
Net periodic postretirement (retiree medical) benefit cost for each period
presented is comprised of the following:
Three Months Ended
December 31,
------------
(Dollars in thousands) 2006 2005
---- ----
Service cost $ 10 9
Interest cost 12 10
Prior service cost (1) -
Amortization of actuarial
gain (11) (9)
--- --
Net periodic postretirement
benefit cost $ 10 10
== ==
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 158, "Employer's Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS 158), which
amends SFAS 87 and SFAS 106 to require recognition of the overfunded or
underfunded status of pension and other postretirement benefit plans on the
balance sheet. Under SFAS 158, gains and losses, prior service costs and
credits, and any remaining transition amounts under SFAS 87 and SFAS 106
that have not yet been recognized through net periodic benefit cost will be
recognized in accumulated other comprehensive income, net of tax effects.
The measurement date - the date at which the benefit obligation and plan
assets are measured - is required to be the Company's fiscal year-end,
which is the date the Company currently uses. SFAS 158 is effective for
publicly-held companies for fiscal years ending after December 15, 2006.
The adoption of SFAS 158 is not expected to have a material impact to the
Company's financial position or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109."
This Interpretation is effective for the Company beginning October 1, 2007.
This Interpretation prescribes a recognition threshold and measurement
process for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. The Company is
currently evaluating the adoption of this Interpretation and does not
currently have an estimate of the impact on the consolidated financial
statements.
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, 2006 and 2005,
respectively.
NET SALES
Net sales increased $8.2 million, or 9.1%, to $98.8 million for the first
quarter of 2007 from $90.6 million for the first quarter of 2006 due to the 2006
acquisitions of Hexagram and Nexus. Favorable foreign currency values resulted
in approximately $1.1 million of the sales increase realized during the 2007
first quarter.
- -Communications
- ---------------
Net sales increased $10.9 million, or 57.1%, to $30.0 million for the first
quarter of 2007 from $19.1 million for the first quarter of 2006. The sales
increase in the first quarter of 2007 as compared to the prior year quarter was
due to: $7.6 million in sales from Hexagram; an increase in sales of $2.4
million from Nexus (due to a full quarter of sales compared to one month
included in prior year quarter); an additional $0.8 million of sales of DCSI's
automatic meter reading (AMR) products to COOP customers and investor-owned
utilities (IOUs); and $0.1 million of higher shipments of Comtrak's SecurVision
video security products. In the first quarter of 2007, DCSI's sales to COOP and
public power (Municipal) customers were $11.7 million compared to $11.4 million
in the first quarter of 2006.
Sales of SecurVision products were $2.6 million for the first quarter of 2007 as
compared to $2.5 million for the prior year first quarter.
- -Filtration/Fluid Flow
- ----------------------
Net sales decreased $0.9 million, or 2.2%, to $40.6 million for the first
quarter of 2007 from $41.5 million for the first quarter of 2006. The sales
decrease during the fiscal quarter ended December 31, 2006 as compared to the
prior year quarter is mainly due to: a decrease in defense spares and T-700
shipments at VACCO of $1.4 million; a net sales decrease at Filtertek of $0.4
million driven by lower automotive shipments; partially offset by higher
commercial aerospace shipments at PTI of $0.9 million.
- -Test
- -----
For the first quarter of 2007, net sales of $28.2 million were $1.8 million, or
6.0%, lower than the $30.0 million of net sales recorded in the first quarter of
fiscal 2006. The sales decrease in the first quarter of 2007 as compared to the
prior year quarter was mainly due to: a $1.5 million decrease in net sales from
the Company's European operations due to the timing of test chamber sales; a
$1.0 million decrease in net sales from the Company's U.S. operations driven by
the timing of sales of test chambers and components; partially offset by a $0.7
million increase in net sales from the Company's Asian operations due to several
chamber projects in Japan. Approximately $3 million of test chamber and
component sales were delayed due to site readiness issues ("parent building"
general contracting delays) at several locations.
ORDERS AND BACKLOG
Backlog was $300.9 million at December 31, 2006 compared with $253.4 million at
September 30, 2006. The Company received new orders totaling $146.3 million in
the first quarter of 2007 compared to $126.1 million ($117.1 million of new
orders and $9.0 million of Nexus acquired backlog) in the prior year quarter.
New orders of $61.8 million were received in the first quarter of 2007 related
to Communications products, $45.3 million related to Filtration/Fluid Flow
products and $39.3 million related to Test products. Significant orders received
in the first quarter of 2007 included: $15.5 million of orders from Pacific Gas
& Electric (PG&E) mentioned below; a $6.3 million automotive test chamber order
in India; a $3.4 million aerospace filtration order with Boeing; a $1.0 million
chamber order in Korea; and a $1.0 million chamber order in Canada to test
handheld communications devices
In November 2005, DCSI signed an agreement with PG&E with an anticipated
contract value of up to approximately $310 million covering up to five million
endpoints over a five year deployment period beginning in fiscal 2007. Also, in
November 2005, Hexagram entered into an agreement 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 for this Hexagram contract is expected to be up to
approximately $225 million. The Company received orders totaling $15.5 million
from PG&E under these agreements during the first quarter of fiscal 2007.
New orders of $59.2 million were received in the first quarter of 2006 related
to Communications products (including the $9.0 million of Nexus acquired
backlog), $41.1 million related to Filtration/Fluid Flow products and $25.8
million related to Test products.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets was $2.1 million and $0.5 million for the
three-month periods ended December 31, 2006 and 2005, respectively. Amortization
of intangible assets for the three-month periods ended December 31, 2006 and
2005, included $0.7 million and $0.1 million, respectively, of amortization of
acquired intangible assets related to the Nexus and Hexagram acquisitions. The
amortization of acquired intangible assets related to Nexus and Hexagram are
included in Corporate's operating results, see "EBIT - Corporate". The remaining
amortization expenses consist of other identifiable intangible assets (primarily
software, patents and licenses). During the three-month periods ended December
31, 2006 and 2005, the Company recorded $0.9 million and zero, respectively, of
amortization related to DCSI's TNG capitalized software.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (SG&A) expenses for the first quarter of
2007 were $29.4 million (29.7% of net sales), compared with $23.5 million (25.9%
of net sales) for the prior year quarter. The increase in SG&A spending in the
quarter ended December 31, 2006 as compared to the prior year quarter was
primarily due to: $2.8 million of SG&A expenses related to Hexagram; an increase
of $1.9 million in SG&A expenses related to Nexus (due to a full quarter of SG&A
expenses compared to one month included in the prior year quarter); $0.8 million
of sales and marketing expenses incurred in the Test segment to further expand
its Asian presence; and $0.4 million increase at Corporate due to an increase in
professional fees incurred to support a research tax credit project.
OTHER (INCOME) AND EXPENSES, NET
Other income, net, was $0.5 million for the first quarter of 2007 compared to
$0.4 million for the prior year quarter. Principal components of other income,
net, for the first quarter of 2007 included $0.6 million of royalty income. The
principal components of other income, net, for the first quarter of fiscal 2006
included the following items: $0.6 million of royalty income; partially offset
by a $0.2 million charge related to the termination of a subcontract
manufacturer.
EBIT
The Company evaluates the performance of its operating segments based on EBIT,
defined below. EBIT was $(3.5) million (3.6% of net sales) for the first quarter
of 2007 and $3.0 million (3.3% of net sales) for the first quarter of 2006. The
decrease in EBIT for the first quarter of 2007 as compared to the prior year
period is primarily due to the decrease in margins in the Communications segment
described below.
This Form 10-Q contains the financial measure "EBIT", which is not calculated in
accordance with generally accepted accounting principles in the United States of
America (GAAP). EBIT provides investors and Management with an alternative
method for assessing the Company's operating results. The Company defines "EBIT"
as earnings from continuing operations before interest and taxes. Management
evaluates the performance of its operating segments based on EBIT and believes
that EBIT is useful to investors to demonstrate the operational profitability of
the Company's business segments by excluding interest and taxes, which are
generally accounted for across the entire Company on a consolidated basis. EBIT
is also one of the measures Management uses to determine resource allocations
within the Company and incentive compensation. The following table presents a
reconciliation of EBIT to net (loss) earnings.
Three Months ended
($ in thousands) December 31,
------------
2006 2005
---- ----
EBIT $ (3,539) 2,978
Add: Interest income 338 717
Income taxes (1,820) 1,491
------ -----
Net (loss) earnings $ (1,381) 2,204
===== =====
- -Communications
- ---------------
EBIT in the first quarter of 2007 was a loss of $(2.8) million compared to a
loss of $(1.0) million in the prior year quarter. The additional loss for the
first quarter of 2007 was due to: a $1.7 million increase in loss at DCSI
resulting from the amortization expenses of its TNG software and PG&E related
program support costs; a $0.3 million loss at Hexagram due to development costs
incurred on new products; a $0.2 million increase in loss at Nexus due to
additional SG&A spending related to marketing and new product initiatives;
partially offset by an EBIT contribution of $0.3 million at Comtrak. The Company
does not expect an EBIT loss in the Communications segment to continue during
the remainder of fiscal 2007 due to the projected increase in sales supported by
the orders received during the first quarter of 2007.
- -Filtration/Fluid Flow
- ----------------------
EBIT was $1.8 million (4.5% of net sales) and $4.1 million (9.9% of net sales)
in the first quarters of 2007 and 2006, respectively. For the first quarter of
2007 as compared to the prior year quarter, EBIT decreased $2.3 million due to:
a $1.6 million decrease at VACCO due to lower defense spares shipments and
additional engineering costs on new Space programs; a $0.6 million decrease at
Filtertek due to lower sales volumes and higher raw material costs; and a $0.1
million decrease at PTI resulting from changes in sales mix and higher material
costs.
- -Test
- -----
EBIT in the first quarter of 2007 was $2.1 million (7.6% of net sales) as
compared to $2.9 million (9.7% of net sales) in the prior year quarter. EBIT
decreased $0.8 million as compared to the prior year quarter due to timing
delays in chamber projects, reduced component sales, additional sales and
marketing costs to support near-term sales growth opportunities and increased
material costs.
- -Corporate
- ----------
Corporate costs included in EBIT were $4.7 million and $3.1 million for the
three-month periods ended December 31, 2006 and 2005, respectively. The increase
in Corporate costs in the first quarter of 2007 as compared to the prior year
quarter was due to: $0.6 million of additional pre-tax amortization of acquired
intangible assets related to Nexus and Hexagram; $0.4 million of additional
professional fees incurred to support a research tax credit project; $0.2
million of additional expense related to stock compensation, and an increase in
headcount. In the first quarter of 2007, Corporate costs included $1.5 million
of pre-tax stock compensation expense and $0.7 million of pre-tax amortization
of acquired intangible assets related to Nexus and Hexagram.
INTEREST INCOME, NET
Interest income, net, was $0.3 million and $0.7 million for the three-month
periods ended December 31, 2006 and 2005, respectively. The decrease in interest
income in the first quarter of 2007 as compared to the prior year quarter was
due to lower average cash balances on hand.
INCOME TAX EXPENSE
The first quarter 2007 effective income tax rate was a benefit of 56.9% compared
to an expense of 40.4 % in the first quarter of 2006. The first quarter 2007
income tax benefit was favorably impacted by a $0.9 million, net, research tax
credit. The effect of the research tax credit positively impacted the first
quarter 2007 rate by 27.9%. The first quarter 2007 rate was unfavorably impacted
by 8.5% due to additional state and foreign tax liabilities and by 1.9% due to
non-deductible stock option expense related to foreign optionees. The Company
estimates the fiscal 2007 tax rate to be approximately 39%.
In December 2006, the President signed into law the "Tax Relief and Health Care
Act of 2006" (The Act). The Act extended the expiration date for the research
tax credit from December 31, 2005 to December 31, 2007. The Company expects an
additional research credit claim of approximately $1.0 million, net, to be
recorded for the year ending September 30, 2007.
CAPITAL RESOURCES AND LIQUIDITY
Working capital (current assets less current liabilities) decreased to $125.6
million at December 31, 2006 from $131.4 million at September 30, 2006. Accounts
receivable decreased by $8.4 million in the first quarter of 2007, of which $6.3
million related to DCSI due to customer collections; and $2.9 million related to
the Filtration segment due to timing and volume of sales. The $4.3 million
increase in inventories at December 31, 2006 is mainly due to a $3.4 million
increase within the Communications segment due to the timing of expected sales.
Accounts payable decreased by $7.4 million in the first quarter of 2007, of
which $3.2 million related to DCSI due to timing of vendor payments.
Net cash provided by operating activities was $2.0 million and $1.9 million for
the three-month periods ended December 31, 2006 and 2005, respectively.
In December 2006, DCSI signed an agreement with an additional independent
manufacturer to produce and supply a significant portion of DCSI's end-products.
Capital expenditures were $2.8 million and $2.3 million in the first quarter of
fiscal 2007 and 2006, respectively. Major expenditures in the current period
included manufacturing equipment used in the Filtration/Fluid Flow businesses.
At December 31, 2006, intangible assets, net, of $61.7 million included $48.5
million of capitalized software. Approximately $42.6 million of the capitalized
software balance represents software development costs on the TNG software
within the Communications segment to further penetrate the IOU market. 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 to meet the
requirements of large IOUs. At December 31, 2006, the Company had approximately
$8 million of commitments related to the development of TNG version 2.0 which is
expected to be spent over the next seven months. Amortization of TNG is on a
straight-line basis over seven years and began in March 2006. The Company
recorded $0.9 million in amortization expense related to TNG in the first
quarter of 2007.
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, 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 December 31, 2006, the
Company had approximately $99.2 million available to borrow under the credit
facility in addition to $28.0 million cash on hand. At December 31, 2006, the
Company had no borrowings, and outstanding letters of credit of $2.2 million
($0.8 million outstanding under the credit facility). 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.
Pacific Gas & Electric
- ----------------------
In November 2005, DCSI 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 up to
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 up
to approximately $310 million. PG&E also has the right to purchase additional
equipment and services to support existing and new customers through the twenty
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. On July 20, 2006, the California Public
Utilities Commission approved PG&E's AMI project. DCSI has agreed to deliver to
PG&E versions of its newly developed TNG software as they become available and
are tested. Delivery of the final version for which DCSI has committed is
currently anticipated in the fourth quarter of fiscal 2007. In accordance with
U.S. generally accepted accounting standards, the Company will defer all revenue
related to the DCSI arrangement until all software is delivered and acceptance
criteria have been met. 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.
In November 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 up to approximately $225
million. As with DCSI's contract with PG&E, 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. On July 20, 2006, the California
Public Utilities Commission approved PG&E's AMI project. 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,
2006 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 September 2006, the FASB issued SFAS No. 158, "Employer's Accounting for
Defined Benefit Pension and Other Postretirement Plans" (SFAS 158), which amends
SFAS 87 and SFAS 106 to require recognition of the overfunded or underfunded
status of pension and other postretirement benefit plans on the balance sheet.
Under SFAS 158, gains and losses, prior service costs and credits, and any
remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been
recognized through net periodic benefit cost will be recognized in accumulated
other comprehensive income, net of tax effects. The measurement date - the date
at which the benefit obligation and plan assets are measured - is required to be
the Company's fiscal year-end, which is the date the Company currently uses.
SFAS 158 is effective for publicly-held companies for fiscal years ending after
December 15, 2006. The adoption of SFAS 158 is not expected to have a material
impact to the Company's financial position or results of operations.
In June 2006, the FASB issued FASB Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109." This
Interpretation is effective for the Company beginning October 1, 2007. This
Interpretation prescribes a recognition threshold and measurement process for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. The Company is currently evaluating the
adoption of this Interpretation and does not currently have an estimate of the
impact on the consolidated financial statements.
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, SFAS 158, FASB Interpretation No. 48, annual effective tax rate,
research tax credits, timing of Communications segment commitments and
expenditures, outcome of current claims and litigation, future cash flow,
capital requirements and operational needs for the foreseeable future, the
ultimate values and timing of revenues under the DCSI / PG&E contract and the
Hexagram / PG&E contract, the start of deployment under the Company's PG&E
contracts, the future delivery and acceptance of the TNG software by PG&E, and
timing of spending for TNG commitments. 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 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; 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 market risks since September 30, 2006. Refer
to the Company's Annual Report on Form 10-K for the fiscal year ended September
30, 2006 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 2006, the Company's Board of Directors authorized an open market
common stock repurchase program for up to 1.2 million shares, subject to market
conditions and other factors, which covers the period through September 30,
2008. There were no stock repurchases during the three-month period ended
December 31, 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 as of July 10, Form 10-K for the fiscal year
2000. ended September 30, 2003, at
Exhibit 3.4
3.5 Amendment to Bylaws
effective as of February
2, 2007.
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 Current Report on Form 8-K
as 4.4, above) dated as dated February 2, 2006 at
of January 20, 2006 Exhibit 4.1
31.1 Certification of Chief
Executive Officer
relating to Form 10-Q
for period ended
December 31, 2006
31.2 Certification of Chief
Financial Officer
relating to Form 10-Q
for period ended
December 31, 2006
32 Certification of Chief
Executive Officer and
Chief Financial Officer
relating to Form 10-Q
for period ended
December 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: February 8, 2007