1 SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q Quarterly Report under Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the three months ended January 31, 1998 Commission file number 0-13880 ENGINEERED SUPPORT SYSTEMS, INC. (Exact name of Registrant as specified in its charter) Missouri 43-1313242 (State of Incorporation) (IRS Employer Identification Number) 1270 North Price Road, St. Louis, Missouri 63132 (Address of principal executive offices) (Zip Code) Registrant's telephone number including area code: (314) 993-5880 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 --- --- The number of shares of the Registrant's common stock, $.01 par value, outstanding at February 28, 1998 was 3,160,669. 2 ENGINEERED SUPPORT SYSTEMS, INC. INDEX Page Part I - Financial Information Item 1. Financial Statements (Unaudited) Condensed Consolidated Balance Sheets as of January 31, 1998 and October 31, 1997 3 Condensed Consolidated Statements of Income for the three months ended January 31, 1998 and 1997 4 Condensed Consolidated Statements of Cash Flows for the three months ended January 31, 1998 and 1997 5 Notes to Condensed Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8 Part II - Other Information Items 1-6 10 Signatures 11 Exhibits 12 2 3 ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED BALANCE SHEETS January 31 October 31 1998 1997 ----------- ---------- (Unaudited) ASSETS Current Assets Cash and cash equivalents $ 4,486,393 $ 8,313,160 Accounts receivable 4,646,402 3,398,973 Contracts in process and inventories 7,167,724 7,072,377 Other current assets 1,427,854 1,423,620 ----------- ----------- Total Current Assets 17,728,373 20,208,130 Property, plant and equipment, less accumulated depreciation of $15,163,034 and $14,767,236 14,167,373 14,490,049 Intangible assets 756,788 825,406 Other assets 1,341,174 1,560,469 ----------- ----------- Total Assets $33,993,708 $37,084,054 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current maturities of long-term debt $ $ 73,273 Accounts payable 3,962,909 5,596,760 Other current liabilities 2,166,922 2,978,407 ----------- ----------- Total Current Liabilities 6,129,831 8,648,440 Long-term debt 1,194,433 Deferred income taxes 2,642,295 2,642,295 ESOP guaranteed bank loan 836,400 873,300 Shareholders' Equity Common stock, par value $.01 per share; 10,000,000 shares authorized; 3,781,873 and 3,772,573 shares issued 37,819 37,726 Additional paid-in capital 9,784,979 9,698,665 Retained earnings 18,902,241 18,026,195 ----------- ----------- 28,725,039 27,762,586 Less ESOP guaranteed bank loan 836,400 873,300 Less treasury stock at cost, 619,358 and 598,858 shares 3,503,457 3,163,700 ----------- ----------- 24,385,182 23,725,586 ----------- ----------- Total Liabilities and Shareholders' Equity $33,993,708 $37,084,054 =========== =========== See notes to condensed consolidated financial statements. 3 4 ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) Three Months Ended January 31 ----------------------------- 1998 1997 ----------- ----------- Net revenues $16,238,139 $20,730,840 Cost of revenues 12,934,370 17,615,553 ----------- ----------- Gross profit 3,303,769 3,115,287 Selling, general and administrative expense 1,844,460 1,744,628 ----------- ----------- Income from operations 1,459,309 1,370,659 Interest expense (income) (72,852) 37,828 ----------- ----------- Income before income taxes 1,532,161 1,332,831 Income tax provision 613,000 530,000 ----------- ----------- Net income $ 919,161 $ 802,831 =========== =========== Basic earnings per share $.29 $.25 =========== =========== Diluted earnings per share $.28 $.24 =========== =========== See notes to condensed consolidated financial statements. 4 5 ENGINEERED SUPPORT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) Three Months Ended January 31 ----------------------------- 1998 1997 ----------- ----------- From operating activities: Net income $ 919,161 $ 802,831 Depreciation and amortization 464,417 473,146 ----------- ----------- Cash provided (used) before changes in operating assets and liabilities 1,383,578 1,275,977 Net (increase) decrease in non-cash current assets (1,347,010) 2,458,814 Net increase (decrease) in non-cash current liabilities (2,445,336) (2,541,198) (Increase) decrease in other assets 219,295 (23,192) ----------- ----------- Net cash provided by (used in) operating activities (2,189,473) 1,170,401 ----------- ----------- From investing activities: Additions to property, plant and equipment (73,122) (131,219) ----------- ----------- Net cash provided by (used in) investing activities (73,122) (131,219) ----------- ----------- From financing activities: Payments of long-term debt (1,267,706) (197,396) Purchase of treasury stock (339,758) (205,255) Exercise of stock options 86,407 312,372 Cash dividends (43,115) (37,019) ----------- ----------- Net cash provided by (used in) financing activities (1,564,172) (127,298) ----------- ----------- Net increase (decrease) in cash and cash equivalents (3,826,767) 911,884 Cash and cash equivalents at beginning of period 8,313,160 1,415,773 ----------- ----------- Cash and cash equivalents at end of period $ 4,486,393 $ 2,327,657 =========== =========== See notes to condenses consolidated financial statements. 5 6 ENGINEERED SUPPORT SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) JANUARY 31, 1998 NOTE A - BASIS OF PRESENTATION The accompanying condensed consolidated financial statements have been prepared by the Company without audit. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended January 31, 1998 are not necessarily indicative of the results to be expected for the entire fiscal year. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report to shareholders for the year ended October 31, 1997. NOTE B - EARNINGS PER SHARE Basic earnings per share for the three months ended January 31, 1998 and 1997 is based on average basic common shares outstanding of 3,174,755 and 3,182,114, respectively. Diluted earnings per share for the three months ended January 31, 1998 and 1997 is based on average diluted common shares outstanding of 3,311,577 and 3,309,956, respectively. NOTE C - CONTRACTS IN PROCESS AND INVENTORIES Contracts in process and inventories of Engineered Air Systems, Inc. represent accumulated contract costs, estimated earnings thereon based upon the percentage of completion method and contract inventories reduced by the contract value of delivered items. Inventories of Engineered Specialty Plastics, Inc. are valued at the lower of cost or market using the first-in, first-out method. Contracts in process and inventories are comprised of the following: 6 7 January 31, 1998 October 31, 1997 ---------------- ---------------- Raw materials $1,853,363 $1,535,860 Work-in-process 114,449 167,043 Finished goods 963,660 804,956 Inventories substantially applicable to government contracts in process, less progress payments of $10,811,121 and $9,333,930 4,236,252 4,564,518 ---------- ---------- $7,167,724 $7,072,377 ========== ========== NOTE D - SUBSEQUENT EVENT On February 9, 1998, the Company agreed to acquire substantially all of the net assets of Nuclear Cooling, Inc., d/b/a/ Marlo Coil, a manufacturer of heat transfer and air movement equipment used in commercial, industrial, U.S. Navy and OEM markets. This transaction was completed on February 20, 1998. For the fiscal year ended June 30, 1997, sales of Marlo Coil were approximately $25.8 million and assets, which consist primarily of manufacturing facilities and working capital, were $11.5 million. The purchase price of $25.3 million was financed with $2.8 million of available cash resources and bank borrowings of $22.5 million. Further details of the transaction will be provided in Form 8-K to be filed with the Securities and Exchange Commission. 7 8 ENGINEERED SUPPORT SYSTEMS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Revenues decreased 22% in the first quarter of 1998 to $16.2 million from $20.7 million in the first quarter of 1997. The decrease in revenues was a result of lower shipments of production items at Engineered Air Systems, Inc. (Engineered Air) as several major contracts, primarily the Chemical/Biological Protected Shelter System (CBPSS) and the Chemically/Biologically Hardened Air Mangement Plant (CHAMP), are in the engineering and development phases. Also contributing to the revenue decrease was a reduction in shipments of houseware products at Engineered Specialty Plastics, Inc. (ESP) in the months of November and December 1997. (However, by the end of the quarter, ESP sales were exceeding 1997 peak levels). In spite of the decrease in the net revenues, gross profit increased $ 0.2 million, or 6%, over that for the comparable 1997 period reflecting a significant margin expansion at both Engineered Air and at ESP. The gross margin for the first quarter of 1998 was 20.3% as compared to 15.0% for the first quarter of 1997. (The gross margin for the preceding quarter ended October 31, 1997 was 18.5%). This margin increase was due to a more profitable mix of contracts and the impact of favorable contract cost experience at Engineered Air, and the impact of targeted cost reductions at ESP. Selling, general and administrative expense was $1.84 million and $1.74 million in the first quarters of 1998 and 1997, respectively. As a percent of net revenues, selling, general and administrative expense increased from 8.4% in 1997 to 11.3% in 1998 as a result of the decrease in consolidated revenues. Interest expense decreased $111,000 in the first quarter of 1998 as compared with the first quarter of 1997. This was the result of higher average cash balances and lower debt levels during the first quarter of 1998. In this regard, the Company retired its remaining term debt in January 1998. LIQUIDITY AND CAPITAL RESOURCES At January 31, 1998, the Company's working capital and ratio of current assets to current liabilities were $11.6 million and 2.89 to 1 as compared to $11.6 million and 2.34 to 1 at October 31, 1997 . As of January 31, 1998, the Company had $6.4 million of unused credit related to its existing loan agreement. 8 9 BUSINESS AND MARKET CONSIDERATIONS As of January 31, 1998 , Engineered Air's funded backlog of defense orders was $37 million compared to $77 million a year ago. Options to existing contracts totaled approximately $152 million as of the end of the first quarter compared to $154 million in the prior year. Historically, the Company has been heavily dependent on the U.S. government for business. Approximately 70% of consolidated net revenues for the three months ended January 31, 1998 were derived from the U.S. government and its agencies. The Company began a plan of diversification in 1993 with the acquisition of ESP. This acquisition provided expansion into the commercial marketplace. As indicated in Note D, the Company acquired substantially all of the net assets of Nuclear Cooling, Inc., d/b/a Marlo Coil on February 20, 1998. Management is continuing to pursue new acquisitions, primarily within the defense industry. 9 10 PART II OTHER INFORMATION Items 1-5 Not applicable. Item 6 (a) Exhibits 4. (i) Registration Statement Number 33-14504 on Form S-8 dated May 22, 1987 for the registration of 340,000 shares of Engineered Support Systems, Inc. common stock, $.01 par value, pursuant to the Amended and Restated Engineered Air Systems, Inc. Employee Equity Plan, is incorporated herein by reference. (ii) Registration Statement Number 33-77338 on Form S-8 dated March 25, 1994 for the registration of 150,000 shares of Engineered Support Systems, Inc. common stock, $.01 par value, pursuant to the Engineered Support Systems, Inc. Inc. 1993 Stock Option Plan, is incorporated herein by reference. (iii) Registration Statement Number 333-27695 on Form S-8 dated May 23, 1997 for the registration of 50,000 shares of Engineered Support Systems, Inc. common stock, $.01 par value, pursuant to the Engineered Support Systems, Inc. 1997 Stock Option Plan for Non-employee Directors, is incorporated herein by reference. 11. Statement Re: Computation of Earnings Per Share. 27. Statement Re: Summary Financial Information (b) No reports on Form 8-K were filed during the three months ended January 31, 1998. 10 11 SIGNATURES 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. ENGINEERED SUPPORT SYSTEMS, INC. Date: March 6, 1998 By: Michael F. Shanahan Sr. ----------------------- -------------------------------- Michael F. Shanahan Sr. Chairman of the Board, President and Chief Executive Officer Date: March 6, 1998 By: Gary C. Gerhardt ----------------------- -------------------------------- Gary C. Gerhardt Executive Vice President and Chief Financial Officer 11