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EXHIBIT 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto.
Introduction
ESCO Electronics Corporation (ESCO, the Company) is engaged in
the design, manufacture, sale and support of engineered products
used principally in filtration/fluid flow applications,
electromagnetic compatibility (EMC) testing, and electric utility
communications and control systems. Filtration/fluid flow and EMC
testing products are supplied to a broad base of industrial and
commercial customers worldwide. At the present time, electric
utility communication systems are marketed primarily to customers in
North America.
ESCO operates principally in four business segments:
Filtration/Fluid Flow, Test, Communications and Other. As part of
Management's strategy to narrow the Company's product/market focus,
ESCO's last major defense business, Systems & Electronics Inc. was
sold on September 30, 1999 to Engineered Support Systems, Inc.
(ESSI) for $85 million in cash, less working capital adjustments.
In conjunction with this divestiture, the Company has taken a
number of additional actions at September 30, 1999 to further
sharpen its focus on its primary served markets. ESCO is actively
pursuing the sale of its microwave antenna business, which was
operated as a part of Rantec Microwave & Electronics, Inc. Other
actions include abandoning the active pursuit of certain business
areas, exiting non-core, underperforming businesses, and
restructuring the corporate overhead of the Company. Specifically,
the Company plans to discontinue its investment in High Pressure Air
Reducing Quiet Manifolds for surface ships (Filtration/Fluid Flow
segment) as well as its Vehicle Location Systems (Other segment),
and has reduced ongoing operating costs. These items are discussed
in detail on page 12.
The actions outlined above, taken collectively, mark a
significant milestone in the transformation of ESCO from a primarily
defense-oriented business to a supplier of engineered products used
primarily in industrial and commercial applications.
The ongoing business segments are comprised of the following
operating entities;
- Filtration/Fluid Flow: PTI Technologies Inc. (PTI) and
Filtertek Inc. (Filtertek);
- Test: EMC Test Systems, L.P. (ETS),
- Communications: Distribution Control Systems, Inc. (DCSI),
- Other: Rantec Microwave & Electronics, Inc. (Rantec) and
Comtrak Technologies, L.L.C. (Comtrak): the ongoing
portions of this segment will include Rantec Power Systems
and Comtrak Securvision(R) product lines;
- Systems & Electronics Inc. (SEI) is included as a divested
business.
ESCO enters the new millennium with meaningful growth prospects
in its primary served markets, a substantially lower risk profile,
more focused and with considerable financial flexibility.
Management will deliver shareholder value through internal
growth, selective acquisitions and share repurchase when warranted.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Reconciliation of adjusted net income
The following table is not intended to present net earnings as
defined within generally accepted accounting principles (GAAP), and
is presented for informational purposes only.
The table provides a reconciliation between the reported
financials and what Management believes the 1999 operating results
may have been after removing certain nonrecurring items and assuming
that all of the actions taken during 1999 to reorient the business
were complete at the beginning of the period. Management believes
the estimated 1999 adjusted operating results provide a meaningful
presentation for purposes of analyzing ESCO's ongoing financial
performance. The estimated adjusted net earnings may not be
indicative of future performance.
1999 Elimination Adjusting 1999
(Dollars in millions, rounded) As Reported of SEI (a) Items As Adjusted
-----------------------------------------------------------------------------------------------------------------------
Net sales $416.1 172.8 - $243.3
------- ---- ---- ------
Cost of sales 317.7 139.6 (2.0) (b) 176.1
Other charges related to cost of sales 3.9 - (3.9) (c) -
SG&A expenses 74.4 21.6 .8 (d) 53.6
Interest expense (income) 6.5 .6 (8.2) (e) (2.3)
Other, net 4.9 .3 (.3) (c) 4.3
Restructuring charges 5.1 - (5.1) (c) -
Gain on sale of SEI (59.9) - 59.9 (c) -
------- ---- ---- ------
Total costs and expenses 352.6 162.1 41.2 231.7
------- ---- ---- ------
Earnings before tax 63.5 10.7 (41.2) 11.6
Income tax expense 13.0 3.7 (5.4) (f) 3.9
------- ---- ---- ------
Net earnings before accounting change 50.5 7.0 (35.8) 7.7
------- ---- ---- ------
Cumulative effect of accounting change, net of tax (25.0) - 25.0 (c) -
------- ---- ---- ------
Net earnings $25.5 7.0 (10.8) $ 7.7
------- ---- ---- ------
Diluted EPS $2.02 $ .61
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(a) Represents the operations of SEI which were included in the 1999
GAAP reported results of operations.
(b) Represents the 1999 operating results of Rantec's microwave
antenna business which is being offered for sale. Fiscal
1999 net sales included $7.5 million related to Rantec's
microwave antenna business.
(c) Represents the elimination of the nonrecurring items: includes
the gain related to the divestiture of SEI, other charges
related to the strategic initiatives described below, and the
accounting change (SOP 98-5) adopted in the 1999 first quarter.
(d) Represents the net amount of the remaining corporate office
operating expenses after the divestiture of SEI. This amount
reflects a $4.2 million cost reduction from the $5 million
amount recorded in 1999 and previously absorbed by the
operations of SEI.
(e) Represents the estimated net interest impact of the SEI
transaction proceeds and the cash impact of the other cost
saving actions noted above, assuming that they occurred at the
beginning of the period. The amount noted assumes all
outstanding debt was repaid and the excess cash proceeds were
invested with a 6% yield.
(f) Represents the amount necessary to reflect the adjusted
effective tax rate at 33%, which represents the Company's
estimated 1999 effective tax rate excluding the nonrecurring
items.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
Other charges related to cost of sales, restructuring charges and gain on sale
of SEI
During the fourth quarter of fiscal 1999, the Company
implemented a major portion of its strategic operating plan. Its
previously communicated strategy was to transform the Company from a
primarily defense-oriented business to a supplier of engineered
products used in industrial and commercial applications. As a result
of implementing Management's strategic actions, the Company
recognized certain nonrecurring items in its fourth quarter results
of operations.
These 1999 defined actions resulted in $3.9 million of other
charges related to cost of sales and $5.1 million of restructuring
charges. In addition, the Company recorded a gain on the sale of SEI
of $59.9 million.
The 1999 other charges related to cost of sales represent the
write-off of inventory related to the abandonment of the High
Pressure Air Reducing Quiet Manifolds for surface ships ($2.2
million) and the Vehicle Location Systems ($.6 million) business
areas. Additionally, the Company wrote down the Rantec microwave
antenna product line inventory ($1.1 million) to net realizable
value as a result of that business area being offered for sale.
The 1999 restructuring charges are comprised of the following:
costs related to exiting the microwave antenna business area ($1.1
million); a write-off of the license agreement ($1.8 million)
related to the abandonment of the Vehicle Location System business;
and certain personnel separation costs ($2.2 million).
The gain on sale of SEI of $59.9 million is calculated as: The
gross proceeds of $85 million; less SEI's net book value of $30.6
million; less working capital adjustments of $4.0 million; less
transaction related expenses of $4.9 million; plus the $14.4 million
curtailment gain related to pension and retiree medical liabilities
transferred to the buyer.
The $2.5 million of other charges related to cost of sales in
1998 related to the settlement of a long-standing contract dispute
on the original M1000 tank transporter program at SEI.
The other charges related to cost of sales noted above are
included in the calculation of gross profit discussed below.
Results of operations
NET SALES
Net sales of $416.1 million in 1999 increased $51 million (14%)
over net sales of $365.1 million in 1998. SEI, which is included in
the Divested Business segment, accounted for $38 million of the
increase. Filtration/Fluid Flow, Test and Communications all had
increased sales volume in 1999 while the Other segment had a $7
million decrease in sales.
Acquisitions, which occurred in 1998, also contributed to sales
growth in 1999.
Net sales of $365.1 million in 1998 decreased $13.4 million
(3.5%) from net sales of $378.5 million in 1997, primarily due to a
decrease in sales at SEI, which was divested on September 30, 1999.
Filtration/Fluid Flow
Net sales of $168.9 million in 1999 were $10.6 million (6.7%)
higher than net sales of $158.3 million in 1998. The increase was
primarily the result of new product introductions at Filtertek and
PTI and increases in microfiltration sales at PTI. Blood filters for
medical applications, increased shipments of disposable water filter
cartridges, and automotive transmission sump filters and fuel
filters all contributed to the growth at Filtertek. PTI's
microfiltration businesses contributed approximately $8.3 million of
additional sales in 1999. PTI's aerospace and industrial products
experienced some softening in demand during 1999.
Net sales of $158.3 million in 1998 increased $34.8 million
(28.2%) from net sales of $123.5 million in 1997, primarily due to
the February 1997 acquisition of Filtertek being included in the
1998 results for the entire year. PTI's sales increased in 1998 over
1997 due to increased aerospace and industrial shipments.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
TEST
Net sales of $34.9 million in 1999 were $4.3 million (14.1%)
higher than net sales of $30.6 million in 1998. The 1998 sales
increased $4.5 million over the $26.1 million in sales recorded in
1997. The increase in 1999 over 1998, as well as the 1998 increase
over 1997 primarily is the result of additional EMC test chamber
business at ETS. The 1999 sales were significantly impacted by
additional revenue relating to the $20 million contract awarded in
1999 by General Motors to design and build an electromagnetic
compatibility (EMC) test complex in Milford, Michigan. This $20
million contract is expected to be completed late in 2001 or early
in 2002.
COMMUNICATIONS
Net sales of $24.7 million in 1999 were $5.7 million (30.0%)
higher than net sales of $19.0 million in 1998. The 1998 sales
increased $5.6 million over the $13.4 million in sales recorded in
1997. The increase in 1999 over 1998, as well as the 1998 increase
over 1997, primarily is the result of increased shipments to the
Puerto Rico Electric Power Authority (PREPA). The current contract
with PREPA to provide Automatic Meter Reading (AMR) systems using
proprietary power line communications technology is valued at more
than $50 million over a three-year period. At September 30, 1999,
$33.2 million of the PREPA contract remains in backlog.
OTHER
Sales were $14.8 million, $22.2 million and $20.9 million in
1999, 1998 and 1997, respectively. The decrease in 1999
results from lower sales at Rantec.
ORDERS AND BACKLOG
Firm order backlog, excluding SEI, was $142.9 million at
September 30, 1999, compared to $139.3 million at September 30,
1998. Orders, excluding SEI, totaling $247.5 million were received
in 1999, compared with $264.2 million in 1998. The decrease is the
result of the 1998 amount having included the large PREPA contract
($50 million) received by DCSI.
GROSS PROFIT
The Company computes gross profit as: net sales, less cost of
sales, less other charges related to cost of sales. The gross profit
margin is the gross profit divided into net sales, expressed as a
percentage.
The gross profit margin was 22.7%, 26.1% and 24.2% in 1999, 1998
and 1997, respectively. The decrease in 1999 versus 1998 is
primarily the result of operating inefficiencies experienced at
Rantec. The power supply business at Rantec experienced cost growth
on certain development contracts in 1999, which also contributed to
the lower gross margin. Most of these development contracts are now
in production, and the related cost problems have been recognized.
The 1998 gross margin increase over 1997 is the result of a more
favorable sales mix. The 1997 gross margin was negatively impacted
by the operations of SEI, which was sold on September 30, 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses (SG&A) for 1999
were $74.4 million, or 17.8% of net sales, compared with $68.3
million, or 18.7% of net sales, for 1998. The 1999 SG&A included
$3.2 million of additional expenses related to Advanced Membrane
Technology, Inc. (consolidated within PTI) and Euroshield OY
(consolidated within ETS) which were acquired in 1998 and are
included in 1999 for the entire year versus a partial year in 1998.
The percentage decrease in 1999 is the result of higher sales
throughout the Company available to cover certain fixed costs.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
SG&A for 1998 was $68.3 million, or 18.7% of net sales, compared
with $64.1 million, or 16.9% of net sales, for 1997. The 1998 SG&A
expenses included $4.6 million of additional expense at Filtertek as
a result of their operations being included in 1998 for the entire
year versus eight months of 1997. The percentage increase in 1998 is
the result of lower sales.
OPERATING PROFIT
Operating Profit of $14.9 million in 1999 decreased from $26.9
million in 1998. SEI, which is included in the Divested Business
segment, accounted for $0.8 million of the decrease.
Filtration/Fluid Flow, Communications, and Test all had increased
operating profit in 1999 while the Other segment had a $13.4 million
decrease in operating profit. The 1999 amounts were adversely
affected by the $3.9 million of other charges related to cost of
sales, and the $5.1 million of restructuring charges.
Operating profit of $26.9 million in 1998 decreased $0.7 million
from operating profit of $27.6 million in 1997 primarily due to the
1997 other charges related to cost of sales at SEI, which was
divested on September 30, 1999.
FILTRATION/FLUID FLOW
Operating profit of $11.9 million in 1999 was $1.4 million
(13.3%) higher than operating profit of $10.5 million in 1998. The
filtration/fluid flow amounts include the $2.2 million of
nonrecurring charges related to the abandonment of the surface ship
manifolds mentioned earlier. The recurring increase was primarily
the result of new product introductions at Filtertek and PTI and
increases in microfiltration profitability at PTI. Blood filters for
medical applications, increased shipments of disposable water filter
cartridges, and automotive transmission sump filters and fuel
filters, all contributed to the growth in profitability at
Filtertek. PTI's aerospace and industrial products experienced a
slight decline during 1999 due to weaker demand in these markets.
Operating profit of $10.5 million in 1998 increased $0.9 million
(9.4%) from operating profit of $9.6 million in 1997, primarily as a
result of PTI's increased operating profit in 1998 due to increased
aerospace and industrial contributions.
TEST
Operating profit of $4.0 million in 1999 was $1.1 million
(37.9%) higher than operating profit of $2.9 million in 1998. The
1998 operating profit increased $0.3 million over the $2.6 million
of operating profit recorded in 1997. The increase in 1999 over
1998, as well as the 1998 increase over 1997, primarily is the
result of additional EMC test chamber business at ETS, and an
overall improvement in sales mix.
COMMUNICATIONS
Operating profit of $4.0 million in 1999 was $2.0 million (100%)
higher than operating profit of $2.0 million in 1998. The 1998
operating profit increased $1.0 million over the $1.0 million in
operating profit recorded in 1997. The increase in 1999 over 1998,
as well as the 1998 increase over 1997, primarily is the result of
increased sales leverage.
OTHER
Operating profit was ($13.2) million, $0.3 million and $0.6
million in 1999, 1998 and 1997, respectively. The decrease in 1999
is the result of the nonrecurring charges related to Rantec's
microwave antenna product line which is being offered for sale,
Comtrak's nonrecurring charges and significant cost growth on
certain development programs at Rantec power systems as mentioned
above.
INTEREST EXPENSE
Interest expense decreased to $6.5 million in 1999 from $7.7
million in 1998, primarily as a result of lower outstanding average
borrowings throughout 1999. A significant amount of the outstanding
borrowings in 1999 and 1998 were incurred with the February 1997
acquisition of Filtertek. The timing of operating cash flows
throughout 1999 also decreased the average outstanding borrowings.
Interest expense increased to $7.7 million in 1998 from $5.2
million in 1997, primarily as a result of higher outstanding average
borrowings throughout 1998. The timing of operating cash flows
throughout 1998 increased the average outstanding borrowings.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
OTHER COST AND EXPENSES, NET
Other costs and expenses, net, increased in 1999 to $4.9 million
from $2.9 million in 1998. The increase is primarily due to the
impact in 1998 of PTI receiving a $1.6 million lease surrender
payment (recorded as other miscellaneous income) for agreeing to
vacate its current manufacturing facility in Newbury Park,
California. PTI received $1.6 million immediately upon signing the
agreement and will receive an additional $2.9 million on December
31, 2000, or earlier, upon vacating the property. PTI has begun its
relocation to new facilities in Oxnard, California. This relocation
should be completed by September 30, 2000. The remainder of other
costs and expenses, net, increased due to additional goodwill
amortization related to the 1998 acquisitions discussed above.
Other costs and expenses, net, decreased in 1998 to $2.9 million
from $4.5 million in 1997, primarily due to the $1.6 million PTI
lease surrender payment recorded in 1998. The remainder of other
costs and expenses, net, were consistent in both periods presented.
INCOME TAX EXPENSE
Income tax expense of $13.0 million for 1999 reflects deferred
tax expense of $11.6 million and foreign, state and local tax
expense of $1.4 million. Income tax expense of $5.1 million for 1998
reflects deferred tax expense of $6.1 million and foreign, state and
local tax benefits of ($1) million. Income tax expense of $6.1
million for 1997 reflects current Federal tax expense of $.2
million, deferred tax expense of $4.8 million and foreign, state and
local taxes of $1 million.
Based on the Company's historical pretax income, together with
the projection of future taxable income based upon its shift in
strategic direction, Management believes it is more likely than not
that the Company will realize the benefits of the net deferred tax
asset existing at September 30, 1999. In order to realize the
aforementioned net deferred tax asset before valuation allowance,
the Company will need to generate future taxable income of
approximately $221 million, of which $146 million is required to be
realized prior to the expiration of the net operating loss (NOL)
carryforward, of which $33 million will expire in 2006; $6 million
will expire in 2007; $23 million will expire in 2009; $38 million
will expire in 2010; $4 million will expire in 2011; $7 million will
expire in 2018; and $35 million will expire in 2019. The net
operating loss carryforward may be used to reduce future income tax
cash payments.
As a result of the sale of SEI in 1999, the Company will utilize
approximately $35 million of the $77 million capital loss
carryforward available from the sale of Hazeltine in 1996. At
September 30, 1999, the Company had a capital loss carryforward for
tax purposes of approximately $42 million. This capital loss
carryforward may be used as a reduction of future capital gains
recognized by the Company, at which time the Company may realize
additional tax benefits. Any unused capital loss carryforward will
expire in 2001.
The Company's deferred tax valuation allowance of $32.5 million
at September 30, 1999, was comprised of $17.7 million, which
represents Management's best estimate of the portion of the deferred
tax asset associated with temporary differences and NOLs which may
not be realized, and a full valuation reserve in the amount of $14.8
million for the portion of the deferred tax asset represented by the
capital loss carryforward.
The effective tax rate in 1999 was 20.5% compared with 30.9% in
1998. The 1999 effective tax rate was favorably impacted by the
utilization of the capital loss carryforward resulting from the
divestiture of SEI. An analysis of the effective tax rates for 1999,
1998 and 1997 is included in the notes to consolidated financial
statements.
CHANGE IN ACCOUNTING PRINCIPLE
In April 1998, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 98-5,
"Reporting on the Costs of Start-up Activities." This SOP is
applicable to all non-governmental entities and provides guidance on
accounting for start-up activities, including precontract start-up
costs and organization costs.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
The Company had previously accounted for these costs under the
guidance provided by SOP 81-1, "Accounting for Performance of
Construction-type Contracts." SOP 98-5 amended SOP 81-1 by requiring
precontract, start-up and organization costs to be expensed as
incurred.
The Company adopted the provisions of SOP 98-5 in the first
quarter of fiscal year 1999 which resulted in a non-cash, after-tax
charge of approximately $25 million, which was recognized as a
cumulative effect of an accounting change.
The after-tax charge related to precontract, start-up and
organization costs incurred in anticipation of specific future
contract awards which were based on specific customer identified
requirements. The after-tax charge is comprised of the following
programs: the Tunner 60K aircraft cargo loader at SEI ($17.2
million), the Automatic Vehicle Location System at the Comtrak
division of SEI ($2 million), the advanced video surveillance system
(Securvision(R)) at Comtrak ($2 million), the Seawolf (U.S. Navy
attack submarine) valve and manifold ship set program at VACCO
Industries ($1.9 million), and other minor programs which aggregated
to $1.9 million.
Capital resources & liquidity
With the sale of SEI at September 30, 1999, the Company
continued to successfully transition its business base from defense
to commercial, and thereby dramatically lowered the operating risk
profile of the Company. The significant working capital commitments
previously required by the defense business of SEI no longer exist
throughout the balance of ESCO.
Net cash provided by operating activities increased in 1999 to
$25.9 million from $20.3 million in 1998.The increase in 1999 is
driven by the improvement in cash flow from working capital,
primarily the lower investment in inventory.
Net cash provided by operating activities was $20.3 million in
1998, compared to $25.3 million in 1997 due to SEI related operating
cash requirements.
In 1999, 1998 and 1997, capital expenditures of $8.3 million,
$12.9 million and $10.5 million, respectively, included
manufacturing equipment at Filtertek and PTI. Capital expenditures
related to SEI were $1.1 million, $1.5 million and $2.4 million in
1999, 1998 and 1997, respectively. There were no commitments
outstanding that were considered material for capital expenditures
at September 30, 1999.
At September 30, 1999, the Company had available a net operating
loss (NOL) carryforward for tax purposes of approximately $146
million. This NOL will expire beginning in year 2006 and ending in
year 2019, and will be used to reduce future Federal income tax cash
payments.
ACQUISITIONS/DIVESTITURES
On September 30, 1999, the Company sold SEI to Engineered
Support Systems, Inc. for $85 million in cash, less working capital
adjustments.
On July 1, 1998, the Company completed the acquisition of
Advanced Membrane Technology, Inc. (AMT) headquartered in San Diego,
California. AMT was consolidated within PTI and was made a part of a
newly formed business, PTI Advanced Filtration Inc., which designs
and manufactures several types of filtration membrane and provides
filtration systems for a variety of applications in the process
industries. The transaction involved the purchase of AMT common
stock for approximately $7 million in cash plus approximately
450,000 shares of ESCO common stock valued at $8.6 million. The cash
portion was financed with the Company's bank credit facility.
On December 31, 1997, the Company completed the purchase of
Euroshield OY for consideration which included $3.5 million in cash.
Euroshield, located in Eura, Finland, designs and manufactures high
quality radio frequency (RF) shielding products used in the
electromagnetic compatibility (EMC) industry.
On February 7, 1997, the Company completed the acquisition of
the filtration and the thermoform packaging businesses (Filtertek)
of Schawk, Inc. The fiscal 1997 transaction involved the purchase of
assets and stock of certain subsidiary corporations
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MANAGEMENT'S DISCUSSION AND ANALYSIS
of Schawk, Inc. for $92 million in cash plus working capital
adjustments. The purchase was financed with cash and borrowings from
the Company's bank credit facility. Filtertek is a leader in the
manufacture of plastic insert injection molded filter assemblies.
BANK CREDIT FACILITY
The Company's $122 million bank credit facility was amended on
August 30, 1999 to allow for the sale of SEI. Upon receipt of the
proceeds from the sale of SEI, the outstanding principal amount of
the Term Loan and a portion of the outstanding revolving credit
facility were to be repaid. On September 30, 1999, the Company
received the gross proceeds of $85 million from the sale of SEI and
on October 1, 1999, the Company repaid all outstanding debt.
Subsequent to the sale of SEI and the repayment of all
outstanding debt on October 1, 1999, the credit facility was
adjusted to a $40 million revolving credit facility. The revolving
credit facility (subject to borrowing base asset limitations) is
available for direct borrowings and/or the issuance of letters of
credit. The maturity of the bank credit facility is September 30,
2000. These credit facilities are provided by a group of banks, led
by Morgan Guaranty Trust Company of New York.
Cash flow from operations and borrowings under the bank credit
facility are expected to provide adequate resources to meet the
Company's capital requirements and operational needs for the
foreseeable future.
All of the Company's debt, prior to full repayment on October 1,
1999, was priced at a percentage over LIBOR. The Company had reduced
this risk through a rate swap agreement that provided a cap on LIBOR
of 7% on $50 million of the long-term debt through September 30,
1998, reducing to $40 million through September 30, 1999.
SHARE REPURCHASE
In 1996, the Company authorized an open market share repurchase
program for up to two million shares of common stock over a period
ended September 30, 1998. Approximately 180,000 shares were
repurchased throughout that two-year period. During 1999, the
Company authorized an additional open market repurchase program of
up to 1.3 million shares, which is subject to market conditions and
other factors and will cover a period ending September 29, 2000.
Approximately 177,000 shares were repurchased in 1999. Subsequent to
September 30, 1999, and with a portion of the available proceeds of
the SEI sale, the Company is continuing its share repurchase
program.
OTHER
Management believes that, for the periods presented, inflation
has not had a material effect on the Company's results of
operations.
The Company is currently involved in various stages of
investigation, remediation and litigation relating to environmental
matters. Based on current information available, Management does not
believe the aggregate costs involved in the resolution of these
matters will have a material adverse effect on the Company's
operating results, capital expenditures or competitive position.
Year 2000 issues
The Year 2000 ("Y2K") issue refers to the inability of a
date-sensitive computer program to recognize a two-digit date field
designated as "00" as the year 2000. Mistaking "00" for 1900 could
result in a system failure or miscalculations causing disruptions to
operations including manufacturing, a temporary inability to process
transactions, send invoices, or engage in other normal business
activities. This is a significant issue for most, if not all,
companies with far-reaching implications, some of which cannot be
anticipated or predicted with any degree of certainty.
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MANAGEMENT'S DISCUSSION AND ANALYSIS
STATE OF READINESS
The Company has designated a corporate Y2K coordination team
comprised of various senior management members. Each operating unit
has identified a Y2K coordinator responsible for planning and
monitoring their Y2K program and reporting on a regular basis to the
corporate team. The Company has assessed the magnitude of its Y2K
issue and has already determined the requirements necessary to
modify or replace certain portions of its software and hardware so
that its computer systems, including information technology and
non-information technology, would be able to function properly
beyond December 31, 1999. This required replacement, reprogramming
or other remedial action. The Company has communicated with its
suppliers and customers to determine the extent of the Company's
vulnerability to the failure of third parties to remediate their own
Y2K issue. In conjunction with this assessment, the Company has
finalized its action plans to address the Y2K issue, including
contingencies to address unforeseen problems. The Company has used
both internal and external resources to complete Y2K reprogramming,
software replacement and testing.
COSTS TO ADDRESS THE Y2K ISSUE
The Company's plans anticipate completion of the Y2K remedial
work by December 31, 1999. To date, the Company has incurred
approximately $3 million related to the Y2K remedial work, of which
$2 million is related to SEI. The total expected costs of the
project and the date on which the Company plans to complete the Y2K
remediation work are based on Management's best estimates, which
were derived from numerous assumptions about future events,
including the availability of certain resources, third-party
modification plans, and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results
could differ materially from those plans. Specific factors that
might cause material differences include, but are not limited to,
the availability and cost of personnel trained in this area and the
ability to identify and correct all relevant computer codes.
RISK ANALYSIS
Like most large business entities, the Company is dependent upon
its own internal technology and relies upon timely performance by
its business partners. The Company's Y2K program is designed to
identify and minimize its Y2K risk and includes significant testing
and refinement of its internal systems to ensure, to the extent
feasible, all systems will function before and after the Year 2000.
The Company is continually updating its understanding of the Y2K
risks posed to its business partners based on information obtained
through surveys and interviews. This review was completed in
calendar year 1999.
CONTINGENCY PLANS
Following its risk analysis as described above, the Company's
Y2K program includes a contingency planning phase in which
appropriate plans were made to attempt to minimize disruption to the
Company's operations in the event of a Y2K failure. The Company has
formulated plans to handle a variety of failure scenarios, including
failures of its internal systems, as well as failures of significant
business partners. The level of planning required is a function of
the risks ascertained through the Company's investigating efforts.
The Company completed its contingency planning across the enterprise
in calendar year 1999.
While no assurances can be given, because of the Company's
extensive efforts to formulate and carry-out an effective Y2K
program, the Company believes its program should effectively
minimize disruption to the Company's operations due to the Year 2000
issue.
Market risk analysis
MARKET RISK EXPOSURE
Market risks relating to the Company's operations result
primarily from changes in interest rates and changes in foreign
currency exchange rates. Based on the current holdings of fixed-rate
notes, the exposure to interest rate risk is not material. The
Company is subject to foreign currency exchange rate risk relating
to receipts from customers and payments to suppliers in foreign
currencies. The Company hedges foreign currency commitments by
purchasing foreign currency forward contracts. The Company does not
consider the market risk exposure relating to currency exchange to
be material.
18
10
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended September 30,
(Dollars in thousands, except per share amounts) 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Net sales $416,102 365,083 378,524
Costs and expenses:
Cost of sales 317,681 267,332 286,790
Other charges related to cost of sales 3,927 2,500 -
Selling, general and administrative expenses 74,429 68,326 64,142
Interest expense 6,460 7,703 5,220
Other, net 4,871 2,875 4,522
Restructuring charges 5,145 - -
Gain on sale of SEI (59,867) - -
--------- ------ -------
Total costs and expenses 352,646 348,736 360,674
--------- ------ -------
Earnings before income tax 63,456 16,347 17,850
Income tax expense 13,001 5,051 6,053
--------- ------ -------
Net earnings before accounting change $50,455 11,296 11,797
Cumulative effect of accounting change, net of tax (25,009) - -
--------- ------ -------
Net earnings $25,446 11,296 11,797
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Net earnings before accounting change:
Basic $ 4.09 .94 1.00
Diluted 4.00 .90 .96
--------- ----- -----
Net earnings:
Basic $ 2.06 .94 1.00
Diluted 2.02 .90 .96
--------- ----- -----
Average common shares outstanding:
Basic 12,332 12,015 11,805
Diluted 12,614 12,550 12,274
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
19
11
CONSOLIDATED BALANCE SHEETS
Years ended September 30,
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $87,709 4,241
Accounts receivable, less allowance for doubtful accounts of $574 and $664
in 1999 and 1998, respectively 38,669 51,530
Costs and estimated earnings on long-term contracts, less progress
billings of $11,778 and $51,529 in 1999 and 1998, respectively 4,019 26,995
Inventories 39,590 81,579
Other current assets 3,559 2,776
-------- -------
Total current assets 173,546 167,121
-------- -------
PROPERTY, PLANT AND EQUIPMENT:
Land and land improvements 10,582 14,318
Buildings and leasehold improvements 29,007 47,940
Machinery and equipment 65,988 83,356
Construction in progress 4,186 4,718
-------- -------
109,763 150,332
Less accumulated depreciation and amortization 38,445 52,323
-------- -------
Net property, plant and equipment 71,318 98,009
Excess of cost over net assets of purchased businesses, less accumulated
amortization of $6,631 and $4,557 in 1999 and 1998, respectively 68,950 72,512
Deferred tax assets 44,783 44,740
Other assets 19,788 26,920
-------- -------
$378,385 409,302
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
20
12
CONSOLIDATED BALANCE SHEETS
Years ended September 30,
(Dollars in thousands) 1999 1998
- ----------------------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term borrowings and current maturities of long-term debt $20,598 30,111
Accounts payable 26,339 39,908
Advance payments on long-term contracts, less costs incurred
of $479 and $5,046 in 1999 and 1998, respectively 682 11,442
Accrued expenses 30,598 25,346
------- -------
Total current liabilities 78,217 106,807
------- -------
Other liabilities 9,583 28,339
Long-term debt 41,896 50,077
------- -------
Total liabilities 129,696 185,223
------- -------
Commitments and contingencies - -
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 12,782,663 and 12,641,664 shares in 1999 and 1998, respectively 128 126
Additional paid-in capital 201,719 200,913
Retained earnings since elimination of deficit at September 30, 1993 52,723 27,277
Accumulated other comprehensive loss (1,870) (1,740)
------- -------
252,700 226,576
Less treasury stock, at cost (404,625 and 234,025 common shares in 1999
and 1998, respectively) (4,011) (2,497)
------- -------
Total shareholders' equity 248,689 224,079
------- -------
$378,385 409,302
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
21
13
CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
Accumulated
Years ended September 30, Common Stock Additional Other
--------------------- Paid-in Retained Comprehensive Treasury
(in thousands) Shares Amount Capital Earnings Income (Loss) Stock Total
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1996 12,415 $124 192,967 4,184 (1,762) (4,380) 191,133
--------
Comprehensive income:
Net earnings - - - 11,797 - - 11,797
Translation adjustments - - - - 89 - 89
Minimum pension liability, net - - - - 1,688 - 1,688
--------
Comprehensive income - - - - - - 13,574
Stock options and stock compensation plans 63 1 1,696 - - 45 1,742
Purchases into treasury - - - - - (1,486) (1,486)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1997 12,478 125 194,663 15,981 15 (5,821) 204,963
--------
Comprehensive income:
Net earnings - - - 11,296 - - 11,296
Translation adjustments - - - - 324 - 324
Minimum pension liability, net - - - - (2,079) - (2,079)
--------
Comprehensive income - - - - - - 9,541
--------
Stock options and stock compensation plans 164 1 1,137 - - 405 1,543
Acquisitions of business - - 5,113 - - 3,496 8,609
Purchases into treasury - - - - - (577) (577)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1998 12,642 126 200,913 27,277 (1,740) (2,497) 224,079
--------
Comprehensive income:
Net earnings - - - 25,446 - - 25,446
Translation adjustments - - - - (2,390) - (2,390)
Minimum pension liability, net - - - - 2,260 - 2,260
--------
Comprehensive income - - - - - - 25,316
-------
Stock options and stock compensation plans 141 2 806 - - 48 856
Purchases into treasury - - - - - (1,562) (1,562)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1999 12,783 $128 201,719 52,723 (1,870) (4,011) 248,689
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements
22
14
CONSOLIDATED STATEMENTS OF CASH FLOW
Years ended September 30,
(Dollars in thousands) 1999 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net earnings $25,446 11,296 11,797
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 17,021 17,460 14,423
Changes in operating working capital 11,271 (8,594) (2,666)
Write-off of assets related to accounting change, net of tax 25,009 - -
Gain on sale of SEI (59,867) - -
Effect of deferred taxes on tax provision 11,560 6,121 4,816
Other (4,550) (5,971) (3,033)
-------- ----- -------
Net cash provided by operating activities 25,890 20,312 25,337
-------- ----- -------
Cash flows from investing activities:
Capital expenditures (8,291) (12,896) (10,526)
Divestiture (acquisition) of businesses 85,000 (11,323) (93,200)
-------- ----- -------
Net cash provided (used) by investing activities 76,709 (24,219) (103,726)
-------- ----- -------
Cash flows from financing activities:
Proceeds from long-term debt 96 7,000 60,000
Principal payments on long-term debt (8,297) (7,504) (15,675)
Net increase (decrease) in short-term borrowings (9,494) 3,476 18,500
Purchases of common stock into treasury (1,562) (695) (1,486)
Other 126 53 659
-------- ----- -------
Net cash provided (used) by financing activities (19,131) 2,330 61,998
-------- ----- -------
Net increase (decrease) in cash and cash equivalents 83,468 (1,577) (16,391)
Cash and cash equivalents at beginning of year 4,241 5,818 22,209
-------- ----- -------
Cash and cash equivalents at end of year $87,709 4,241 5,818
- ----------------------------------------------------------------------------------------------------------------------------------
Changes in operating working capital:
Accounts receivable, net $ 5,150 (1,745) (2,997)
Costs and estimated earnings on long-term contracts, net 12,891 7,358 (3,048)
Inventories (9,230) (17,737) 18,618
Other current assets (1,402) 143 734
Accounts payable 734 245 (8,522)
Advance payments on long-term contracts, net (6,821) 5,094 (1,988)
Accrued expenses 9,949 (1,952) (5,463)
-------- ----- -------
$11,271 (8,594) (2,666)
- ----------------------------------------------------------------------------------------------------------------------------------
Supplemental cash flow information:
Interest paid $6,579 7,521 4,981
Income taxes paid 254 353 720
- ----------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
23
15
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of significant accounting policies
(A) PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of ESCO
Electronics Corporation (ESCO) and its wholly owned subsidiaries (the Company).
All significant intercompany transactions and accounts have been eliminated in
consolidation. Certain prior year amounts have been reclassified to conform with
the 1999 presentation.
(B) BASIS OF PRESENTATION
Effective September 30, 1990, Emerson Electric Co. (Emerson) transferred
the stock of certain of its subsidiaries, primarily related to its government
and defense business, to ESCO and distributed all of the issued and outstanding
ESCO common stock to Emerson shareholders (the spin-off). Effective September
30, 1993, the Company implemented an accounting readjustment in accordance with
the accounting provisions applicable to a "quasi-reorganization" which restated
assets and liabilities to fair values and eliminated the deficit in retained
earnings. Fair values of the Company's financial instruments are estimated by
reference to quoted prices from market sources and financial institutions, as
well as other valuation techniques. The estimated fair value of each class of
financial instruments approximated the related carrying value at September 30,
1999 and 1998.
(C) NATURE OF OPERATIONS
The Company is engaged in the design, manufacture, sale and support of
engineered products used principally in filtration/fluid flow applications,
electromagnetic compatibility (EMC) testing, and electric utility communications
and control systems. Filtration/fluid flow and EMC testing products are supplied
to a broad base of industrial and commercial customers worldwide. At the present
time, electric utility communication systems are marketed primarily to customers
in North America. The Company operates in four principal industry segments:
Filtration/Fluid Flow, Test, Communications and Other.
(D) USE OF ESTIMATES AND BUSINESS RISKS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions, including estimates of anticipated contract costs and revenues
utilized in the earnings process, that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(E) ACCOUNTING CHANGE
During the first quarter of 1999, the Company adopted Statement of Position
(SOP) 98-5, "Reporting on the Costs of Start-up Activities." Precontract costs
were incurred by the Company and capitalized under the previous guidance
provided by SOP 81-1, "Accounting for Performance of Construction-type
Contracts." As a result of adopting SOP 98-5 in 1999, the Company expensed these
costs which were recognized as a cumulative effect of an accounting change.
(F) REVENUE RECOGNITION
Revenue is recognized on commercial sales when products are shipped or when
services are performed. Revenue on production contracts is recorded when
specific contract terms are fulfilled, usually by delivery or acceptance (the
units of production or delivery methods). Revenues from cost reimbursement
contracts are recorded as costs are incurred, plus fees earned. Revenue under
long-term contracts for which units of production or delivery are inappropriate
measures of performance is recognized on the percentage-of-completion method
based upon incurred costs compared to total estimated costs under the contract,
or are based upon equivalent units produced. Revenue under engineering contracts
is generally recognized as milestones are attained.
(G) CASH AND CASH EQUIVALENTS
Cash equivalents include temporary investments that are readily convertible
into cash, such as certificates of deposit, commercial paper and treasury bills
with original maturities of three months or less.
(H) COSTS AND ESTIMATED EARNINGS ON LONG-TERM CONTRACTS
Costs and estimated earnings on long-term contracts represent unbilled
revenues, including accrued profits on long-term contracts accounted for under
the percentage-of-completion method, net of progress billings.
(I) INVENTORIES
Inventories are carried at the lower of cost (first-in, first-out) or
market.
24
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventories under long-term contracts reflect accumulated
production costs, factory overhead, initial tooling and other
related costs less the portion of such costs charged to cost of
sales and any progress payments received. In accordance with
industry practice, costs incurred on contracts in progress include
amounts relating to programs having production cycles longer than
one year, and a portion thereof will not be realized within one
year.
(J) PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are recorded at cost. Depreciation
and amortization are computed primarily on a straight-line basis
over the estimated useful lives of the assets: buildings, 10-40
years; machinery and equipment, 5-10 years; and office furniture and
equipment, 5-10 years. Leasehold improvements are amortized over the
remaining term of the applicable lease or their estimated useful
lives, whichever is shorter.
(K) EXCESS OF COST OVER NET ASSETS OF PURCHASED BUSINESSES
Assets and liabilities related to business combinations
accounted for as purchase transactions are recorded at their
respective fair values. Excess of cost over the fair value of net
assets purchased (goodwill) is amortized on a straight-line basis
over the periods estimated to be benefited, not exceeding 40 years.
The Company assesses the recoverability of this intangible asset by
determining whether the amortization of the asset balance over its
remaining life can be recovered through undiscounted future
operating cash flows.
(L) INCOME TAXES
Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income in the years in which those temporary differences
are expected to be recovered or settled. Deferred tax assets are
reduced by a valuation allowance if it is more likely than not that
some portion or all of the deferred tax assets will not be realized.
The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the
enactment date.
(M) RESEARCH AND DEVELOPMENT COSTS
Company-sponsored research and development costs include
research and development and bid and proposal efforts related to the
Company's products and services. Company-sponsored product
development costs are charged to expense when incurred.
Customer-sponsored research and development costs incurred pursuant
to contracts are accounted for similar to other program costs.
(N) FOREIGN CURRENCY TRANSLATION
The financial statements of the Company's foreign operations are
translated into U.S. dollars in accordance with SFAS No. 52,
(SFAS 52) "Foreign Currency Translation." The resulting translation
adjustments are recorded as a separate component of accumulated
other comprehensive income.
(O) EARNINGS PER SHARE
Basic earnings per share is calculated using the weighted
average number of common shares outstanding during the period.
Diluted earnings per share 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 performance shares by using the treasury stock method. The
number of shares used in the calculation of earnings per share for
each year presented is as follows:
(In thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Weighted Average Shares Outstanding - Basic 12,332 12,015 11,805
Dilutive Options and Performance Shares 282 535 469
------- ----- -----
Adjusted Shares - Diluted 12,614 12,550 12,274
----------------------------------------------------------------------------------------------------------------------
Options to purchase 176,000, 84,000 and 94,800 shares of common
stock at per share prices of $11.44 - $19.22 in 1999, $18.00 -
$19.22 in 1998 and $12.38 in 1997 were outstanding during the years
ended September 30, 1999, 1998 and 1997, respectively, but were not
included in the respective computations of diluted EPS because the
options' exercise price was greater than the average market price of
the common shares. These options expire in 2007, 2008, and 2009.
Approximately 190,000, 166,000 and 338,000 performance shares were
outstanding but unearned at September 30, 1999, 1998 and 1997,
respectively, and therefore, were not included in the respective
computations of diluted EPS. The unearned performance shares expire
in 2001.
25
17
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(P) STOCK-BASED COMPENSATION
The Company measures its compensation cost of equity instruments
issued under employee compensation plans under the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for
Stock Issued to Employees," and related Interpretations.
(Q) COMPREHENSIVE INCOME (LOSS)
On October 1, 1998, ESCO adopted SFAS No. 130 (SFAS
130),"Reporting Comprehensive Income." SFAS 130 established
standards for reporting and presentation of comprehensive income or
loss and its components in a full set of financial statements. This
Statement requires the Company to report separately the translation
adjustments of SFAS 52 defined above, and changes to the minimum
pension liability as components of comprehensive income or loss.
Management has chosen to disclose the requirements of this Statement
within the consolidated statements of shareholders' equity.
2. Acquisitions/divestitures (unaudited)
On September 30, 1999, the Company completed the sale of its
Systems & Electronics Inc. (SEI) subsidiary to Engineered Support
Systems, Inc. (ESSI). The Company sold 100% of the common stock of
SEI for $85 million in cash, less working capital adjustments,
resulting in a $59.9 million gain recorded in the 1999 results of
operations. Certain assets and liabilities of SEI were retained by
the Company, including the net operating loss carryforward.
Included in the consolidated statements of operations are the
operating results of SEI prior to its divestiture as follows:
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Net sales $172.8 135.0 194.6
Cost of sales 139.6 98.7 157.3
Selling, general and administrative expenses 21.6 22.6 23.5
Other costs and expenses, net .9 1.1 .7
------- ---- ----
Earnings before income taxes $ 10.7 12.6 13.1
----------------------------------------------------------------------------------------------------------------------
On July 1, 1998, the Company completed the acquisition of
Advanced Membrane Technology, Inc. (AMT) and consolidated AMT within
PTI. The transaction involved the purchase of AMT common stock for
approximately $7 million in cash plus approximately 450,000 shares
of ESCO common stock valued at $8.6 million.
On December 31, 1997, the Company completed the purchase of
Euroshield OY for consideration which included $3.5 million in cash.
On February 7, 1997, the Company completed the acquisition of
the filtration and the thermoform packaging businesses (Filtertek)
of Schawk, Inc. The transaction involved the purchase of assets and
stock of certain subsidiary corporations of Schawk, Inc. for $92
million in cash plus working capital adjustments.
All of the Company's acquisitions have been accounted for using
the purchase method of accounting and accordingly, the respective
purchase prices were allocated to the assets (including intangible
assets) acquired and liabilities assumed based on estimated fair
values at the date of acquisition. The excess cost of the
acquisitions over the estimated fair value of the net assets
acquired is being amortized on a straight-line basis over periods
ranging from 15-40 years, depending on Management's assessment of
its useful life. The financial results from these acquisitions have
been included in the Company's financial statements from the date of
acquisition.
3. Accounts receivable
Accounts receivable consist of the following at September 30,
1999 and 1998:
(Dollars in thousands) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Commercial $35,287 38,371
U. S. Government and prime contractors 3,382 10,801
Other - 2,358
------ -----
Total $38,669 51,530
----------------------------------------------------------------------------------------------------------------------
26
18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The decrease in U. S. Government and prime contractors accounts
receivable is primarily due to the sale of SEI at September 30,
1999. The 1998 accounts receivable included $11.2 million related to
SEI.
4. Inventories
Inventories consist of the following at September 30, 1999 and
1998:
(Dollars in thousands) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Finished goods $11,387 9,491
Work in process - including long-term contracts 14,517 54,754
Raw materials 13,686 17,334
------- -----
Total $39,590 81,579
----------------------------------------------------------------------------------------------------------------------
During 1999, approximately $38.5 million of inventories were
written off as a result of the adoption of SOP 98-5. The 1998
inventory balance included $31.3 million of inventories related to
SEI.
5. Property, plant and equipment
Depreciation and amortization of property, plant and equipment
for the years ended September 30, 1999, 1998 and 1997 were
$13,598,000, $14,589,000 and $12,441,000, respectively.
The Company leases certain real property, equipment and
machinery under noncancelable operating leases. Rental expense under
these operating leases for the years ended September 30, 1999, 1998
and 1997 amounted to $6,324,000, $5,675,000 and $4,502,000,
respectively. Future aggregate minimum lease payments under
operating leases that have initial or remaining noncancelable lease
terms in excess of one year as of September 30, 1999 are:
(Dollars in thousands) Years ending September 30:
----------------------------------------------------------------------------------------------------------------------
2000 $3,189
2001 2,744
2002 1,716
2003 1,259
2004 and thereafter 613
-----
Total $9,521
----------------------------------------------------------------------------------------------------------------------
6. Income tax expense
The principal components of income tax expense for the years
ended September 30, 1999, 1998 and 1997 consist of:
(Dollars in thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Federal:
Current $ - - 223
Deferred 11,560 6,121 4,816
State, local and foreign 1,441 (1,070) 1,014
--------- ------ -----
Total $13,001 5,051 6,053
----------------------------------------------------------------------------------------------------------------------
27
19
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The actual income tax expense for the years ended September
30, 1999, 1998 and 1997 differs from the expected tax expense for
those years (computed by applying the U.S. Federal statutory rate)
as follows:
1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Federal corporate statutory rate 35.0% 35.0% 35.0%
Change in tax valuation allowance:
Utilization of capital loss carryforward (19.3) - -
Other 5.9 3.0 (6.8)
Income taxes, net of Federal benefits:
State and local 1.1 (2.8) 2.7
Foreign 1.2 .4 (1.1)
Other, net (3.4) (4.7) 4.1
----- ---- ----
Effective income tax rate 20.5% 30.9% 33.9%
----------------------------------------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and liabilities at
September 30, 1999, 1998 and 1997 are presented below:
(Dollars in thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Deferred tax assets:
Inventories, long-term contract accounting,
contract cost reserves and others $4,169 4,283 10,008
Pension and other postretirement benefits 3,576 10,177 10,134
Net operating loss carryforward 51,097 38,989 36,608
Capital loss carryforward 14,824 27,074 27,074
Other compensation-related costs and other cost accruals 5,262 6,703 6,254
-------- -------- --------
Total deferred tax assets 78,928 87,226 90,078
Deferred tax liabilities:
Plant and equipment, depreciation methods
and acquisition asset allocations (1,671) (1,516) (2,005)
-------- ------- -------
Net deferred tax asset before valuation allowance 77,257 85,710 88,073
Less valuation allowance (32,474) (40,970) (39,563)
-------- -------- --------
Net deferred tax assets $44,783 44,740 48,510
----------------------------------------------------------------------------------------------------------------------
Management believes it is more likely than not that with its
projections of future taxable income, its shift in strategic
direction, and after consideration of the valuation allowance, the
Company will generate sufficient taxable income to realize the
benefits of the net deferred tax assets existing at September 30,
1999.
In order to fully realize the net deferred tax assets before
valuation allowance existing at September 30, 1999, the Company will
need to generate future taxable income of approximately $221 million
of which $146 million is required to be realized prior to the
expiration of the net operating loss (NOL) carryforward, of which
$33 million will expire in 2006; $6 million will expire in 2007; $23
million will expire in 2009; $38 million will expire in 2010; $4
million will expire in 2011; $7 million will expire in 2018; and $35
million will expire in 2019. Also, the Company will need to generate
future capital gains of approximately $42 million prior to 2001, at
which time the capital loss carryforward will expire.
During the year ended September 30, 1999, and as a result of the
Company utilizing $35 million of capital loss carryforward relating
to the sale of SEI, the Company decreased its deferred tax valuation
allowance to $32.5 million. A full valuation allowance of $14.8
million is being maintained against the deferred tax asset
associated with the capital loss. The remaining balance of $17.7
million represents Management's best estimate of the portion of
deferred tax asset associated with temporary differences and NOLs
which may not be realized. As a result of adopting SOP 98-5, in
1999, the Company recorded a tax benefit of $13.5 million.
Additionally, a net deferred tax asset of $3.7 million was recorded
after taking into effect the sale of SEI.
28
20
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Debt
Long-term debt consists of the following at September 30, 1999
and 1998:
(Dollars in thousands) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Term loan $49,000 57,000
Other debt 988 1,188
Less current maturities (8,092) (8,111)
------- ------
Long-term debt $41,896 50,077
----------------------------------------------------------------------------------------------------------------------
The Company's $122 million bank credit facility was amended on
August 30, 1999 to allow for the sale of SEI. Upon receipt of the
proceeds from the sale of SEI, the outstanding principal amount of
the Term Loan and a portion of the outstanding revolving credit
facility were to be repaid. On September 30, 1999, the Company
received the gross proceeds of $85 million from the sale of SEI and
on October 1, 1999, the Company repaid all outstanding debt.
Subsequent to the sale of SEI the credit facility was adjusted to a
$40 million revolving credit facility. The revolving credit facility
(subject to borrowing base asset limitations) is available for
direct borrowings and/or the issuance of letters of credit. The
maturity of the bank credit facility is September 30, 2000. These
credit facilities are provided by a group of banks, led by Morgan
Guaranty Trust Company of New York.
The amended credit facility requires, as determined by certain
financial ratios, a commitment fee ranging from 5/16% to 7/16% per
annum on the unused portion. The terms of the credit facility
provide that interest on borrowings may be calculated at a spread
over the London Interbank Offered Rate (LIBOR), or certificate of
deposit rates for various maturities, or based on the prime rate, at
the Company's election. Substantially all of the assets of the
Company are pledged under the credit facility. The most restrictive
financial covenants of the credit facility include minimum interest
coverage, limitations on leverage and minimum tangible net worth.
Dividends may not exceed 25% of the Company's consolidated net
earnings.
During 1999 and 1998, the maximum aggregate short-term
borrowings at any month-end were $42.0 million and $55.5 million,
respectively; the average aggregate short-term borrowings
outstanding based on month-end balances were $32.5 million and $39.8
million, respectively; and the weighted average interest rates were
6.3% in 1999 and 6.9% in both 1998 and 1997. The letters of credit
issued and outstanding under the credit facility totaled $4.8
million and $2.7 million at September 30, 1998 and 1997,
respectively. Borrowings under the revolving credit facility were
$12.5 million at September 30, 1999.
8. Capital stock
The 12,782,663 and 12,641,664 common shares as presented in the
accompanying consolidated balance sheets at September 30, 1999 and
1998 represent the actual number of shares issued at the respective
dates. The Company held 404,625 and 234,025 common shares in
treasury at September 30, 1999 and 1998, respectively.
Pursuant to a Deposit and Trust Agreement (the Trust Agreement),
all of the outstanding shares of the Company's common stock are held
in trust by a trustee on behalf of the persons otherwise entitled to
hold the Company's common stock, and such persons, instead, hold
common stock trust receipts (Receipts) representing the Company's
common stock and associated preferred stock purchase rights (the
Rights). Although the trustee is the record holder of the Company's
common stock, each holder of a Receipt is generally entitled to all
of the rights of a holder of the Company's common stock (including
the right to vote and to receive dividends or other distributions),
except in certain circumstances. Prior to the September 30, 1999
sale of SEI, if the Company would have failed in certain
circumstances to collateralize its obligations to indemnify Emerson
with respect to Emerson's guarantees of certain of the Company's
government contracts and for so long as such failure continues,
Emerson would have had the right to direct the trustee how to vote
in the election of directors and certain related matters. In
conjunction with the sale of SEI, The Trust Agreement is being
dissolved.
During 1995, the Company adopted the 1994 Stock Option Plan, and
in 1991, the Company adopted the 1990 Stock Option Plan (the Option
Plans). The Option Plans permit the Company to grant key management
employees (1) options to purchase shares of the Company's common
stock (or Receipts representing such shares) or (2) stock
appreciation rights with respect to all or any part of the number of
shares covered by the options. As long as the Trust Agreement is in
effect, an optionee will receive Receipts in lieu of shares. All
outstanding options were granted at prices equal to fair market
value at the date of grant.
29
21
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information regarding stock options awarded under the Option
Plans is as follows:
1999 1998 1997
------------------------- -------------------- -------------------
ESTIMATED Estimated Estimated
SHARES AVG. PRICE Shares Avg. Price Shares Avg. Price
----------------------------------------------------------------------------------------------------------------------
October 1, 953,716 $ 8.61 998,486 $ 6.18 889,930 $6.04
Granted 522,600 $10.76 89,500 $18.14 227,450 $10.78
Exercised (17,270) $ 7.72 (107,964) $ 7.58 (68,371) $6.87
Cancelled (21,604) $12.00 (26,306) $ 7.20 (50,523) $9.28
----------------------------------------------------------------------------------------------------------------------
September 30, 1,437,442 $9.35 953,716 $ 8.61 998,486 $ 6.18
At September 30,
Reserved for future grant 242,725
Exercisable 698,464 $9.36 509,559 $ 7.46 404,387 $6.18
----------------------------------------------------------------------------------------------------------------------
During 1996, the Company announced a stock repurchase program.
Under this program, the Company was authorized to purchase up to two
million shares of its common stock in the open market through
September 30, 1998. Approximately 180,000 shares were repurchased
throughout that two-year period. In October 1998, the Company
authorized an additional open market repurchase program of up to 1.3
million shares, which is subject to market conditions and other
factors and will cover a period ending September 29, 2000.
Approximately 177,000 shares were repurchased in 1999.
During 1993 and 1997, the Board of Directors authorized, and the
shareholders approved, the Performance Share Plans (the Plans). The
maximum number of shares available for issue under the Plans is
875,000 shares. As of September 30, 1999, 856,000 shares have been
awarded and 666,522 shares have been earned.
At September 30, 1999, there were 50,000 shares of restricted
stock outstanding and held by certain key executives. These shares
will be earned ratably through the period ending September 30, 2001.
The Company has a Preferred Stock Purchase Rights Plan pursuant
to which a dividend of one Right was declared for each outstanding
share of the Company's common stock. Each Right entitles the holder
to purchase one one-hundredth of a share of preferred stock at an
initial purchase price of $25. Approximately 120,000 preferred
shares are reserved for issuance under this plan. Under certain
conditions involving the acquisition of, or an offer for, 20% or
more of the Company's common stock, all holders of Rights, except an
acquiring entity, would be entitled (1) to purchase, at a defined
price, common stock of the Company or an acquiring entity at a value
twice the defined price, or (2) at the option of the Board, to
exchange each Right for one share of common stock. The Rights remain
in existence until September 30, 2000, unless renewed, redeemed
earlier (at one cent per Right), exercised or exchanged under the
terms of the plan.
The Company adopted the disclosure-only provisions of SFAS No.
123. Under APB No. 25, no compensation cost was recognized for the
Company's stock option plans. Had compensation cost for the
Company's stock option plans and performance share plans been
determined based on the fair value at the grant date for awards in
1999 and 1998 consistent with the provisions of this Statement, the
Company's net earnings and net earnings per share would have been as
follows:
Pro forma (Unaudited)
(Dollars in thousands, except per share amounts) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Net earnings $24,779 11,221
Net earnings per share:
Basic 2.01 .93
Diluted 1.96 .89
----------------------------------------------------------------------------------------------------------------------
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 1999 and
1998, respectively: expected dividend yield of 0% in both periods;
expected volatility of 35.3% and 37.2%, risk-free interest rate of
5.89% and 4.42%, and expected life based on historical exercise
periods of 4.05 years and 4.11 years.
30
22
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
To determine the fair value of grants under the Performance
Share Plans, the probability that performance milestones would be
met were applied to the ESCO stock price on the date of grant. This
probability was based on an estimated average annual growth rate of
10.0% and an annualized volatility of 38.4% and 32.5% in 1999 and
1998, respectively.
9. Retirement and other benefit plans
Substantially all employees are covered by defined benefit or
defined contribution pension plans maintained by the Company for the
benefit of its employees. Benefits are provided to employees under
defined benefit pay-related and flat-dollar plans, which are
primarily noncontributory. Annual contributions to retirement plans
equal or exceed the minimum funding requirements of the Employee
Retirement Income Security Act or applicable local regulations.
Net periodic benefit cost for the years ended September 30,
1999, 1998 and 1997 is comprised of the following:
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Defined benefit plans:
Service cost $4.1 3.5 3.3
Interest cost 6.7 6.1 5.4
Expected return on plan assets (7.5) (6.7) (5.8)
Amortization of service costs .3 .2 .1
Net actuarial loss .8 .1 .2
Curtailment gain (8.5) - -
Settlement loss 2.9 - -
--- --- ---
--- --- ---
Net periodic benefit cost (1.2) 3.2 3.2
Defined contribution plans .7 .4 .4
--- --- ---
Total $(.5) 3.6 3.6
----------------------------------------------------------------------------------------------------------------------
The Company recognized a curtailment gain and a settlement loss
in 1999 as a result of the sale of SEI on September 30, 1999.
The projected benefit obligation, accumulated benefit
obligation, and fair value of plan assets for defined benefit
pension plans with accumulated benefit obligations in excess of plan
assets were $1.5 million, $1.1 million and zero, respectively, as of
September 30, 1999, and $26.3 million, $25.7 million and $20.7
million, respectively, as of September 30, 1998.
The net benefit obligation of the Company's defined benefit
pension plans as of September 30, 1999 and 1998 is shown below:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Change in benefit obligation -
Net benefit obligation at beginning of year $96.0 77.6
Service cost 4.1 3.4
Interest cost 6.7 6.1
Plan amendments .8 .1
Actuarial (gain) loss (5.5) 11.7
Gross benefits paid (3.2) (2.9)
Divestitures (27.9) -
Curtailments (10.6) -
Settlements (33.3) -
--- ---
Net benefit obligation at end of year $27.1 96.0
----------------------------------------------------------------------------------------------------------------------
31
23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The plan assets of the Company's defined benefit pension plans
at September 30, 1999 and 1998 are shown below:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of year $77.9 78.9
Actual return on plan assets 16.9 (.8)
Employer contributions 3.7 2.7
Divestitures (66.8) -
Gross benefits paid (3.2) (2.9)
--- ---
Fair value of plan assets at end of year $28.5 77.9
----------------------------------------------------------------------------------------------------------------------
The Company's defined benefit pension plans recognized the
following net amounts at September 30, 1999 and 1998:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Funded status at end of year $1.3 (18.1)
Unrecognized prior service cost .4 1.9
Unrecognized net actuarial (gain) loss (5.6) 7.3
--- ---
Accrued benefit cost $(3.9) (8.9)
--- ---
Amounts recognized in the balance sheet consist of:
Prepaid benefit cost $ - .5
Accrued benefit cost (3.9) (9.4)
Additional minimum liability (.1) (4.1)
Intangible asset .1 1.8
Accumulated other comprehensive income - 2.3
--- ---
Accrued benefit liability $(3.9) (8.9)
----------------------------------------------------------------------------------------------------------------------
Pension plan assets consist principally of marketable securities
including common stocks, bonds, and interest-bearing deposits.
The benefit obligations of the defined benefit plans as of
September 30, 1999 and 1998 were based on discount rates of 7.75%
and 6.75%, respectively, and an assumed rate of increase in
compensation levels of 4%. The 1999, 1998 and 1997 pension expense
for the defined benefit plans was based on a 7.75%, 6.75% and 7.50%
discount rate, respectively, a 4% increase in compensation levels,
and a 10% expected long-term rate of return on plan assets.
In addition to providing retirement income benefits, the Company
provides unfunded postretirement health and life insurance benefits
to certain retirees. To qualify, an employee must retire at age 55
or later and the employee's age plus service must equal or exceed
75. Retiree contributions are defined as a percentage of medical
premiums. Consequently, retiree contributions increase with
increases in the medical premiums. The life insurance plans are
noncontributory and provide coverage of a flat dollar amount for
qualifying retired employees.
Net periodic postretirement benefit cost is comprised of the
following:
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Service cost $ .2 .2 .2
Interest cost .7 1.1 1.2
Net amortization and deferral (.3) - -
Curtailment gain recognized (8.7) - -
--- --- ---
Net periodic postretirement benefit cost $(8.1) 1.3 1.4
----------------------------------------------------------------------------------------------------------------------
32
24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The net benefit obligation for postretirement benefits at
September 30, 1999 and 1998 is shown below:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Net benefit obligation at beginning of year $16.0 15.5
Service cost .2 .2
Interest cost .7 1.1
Actuarial (gain) loss (5.8) 1.5
Curtailments (8.7) -
Gross benefits paid (1.4) (2.3)
---- ---
Net benefit obligation at end of year $1.0 16.0
----------------------------------------------------------------------------------------------------------------------
The plan assets for postretirement benefits at September 30,
1999 and 1998 are shown below:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at beginning of year $ - -
Employer contributions 1.4 2.3
Gross benefits paid (1.4) (2.3)
--- --
Fair value of plan assets at end of year $ - -
----------------------------------------------------------------------------------------------------------------------
The Company recognized the following net amounts for
postretirement benefits at September 30, 1999 and 1998:
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
Funded status at end of year $(1.0) (16.0)
Unrecognized prior service cost - (.1)
Unrecognized net actuarial (gain) loss (4.6) 1.1
---- ---
Accrued benefit costs $(5.6) (15.0)
---- ---
Amounts recognized in the balance sheet consist of -
Accrued benefit liability $(5.6) (15.0)
----------------------------------------------------------------------------------------------------------------------
The net benefit obligation of the plans as of September 30, 1999
and 1998 were based on discount rates of 7.75% and 6.75%,
respectively. The September 30, 1999 net benefit obligation was
based on a health care cost trend of 6.5% for fiscal 1998, gradually
grading down to an ultimate rate of 5.5% by 2002. The September 30,
1998 net benefit obligation was based on a health care cost trend of
7% for fiscal 1997, gradually grading down to an ultimate rate of
5.5% by 2002. A 1% increase in the health care cost trend rate for
each year would increase the September 30, 1999 net benefit
obligation by approximately $30,000, while a 1% decrease in the
health care cost trend rate for each year would decrease the
September 30, 1999 net benefit obligation by approximately $35,000.
The fiscal 1999 and 1998 net periodic benefit costs were based
on discount rates of 7.75% and 6.75%, respectively. The net periodic
benefit cost was based on an assumed health care cost trend of 6.5%
and 7.0% for 1999 and 1998, respectively, gradually grading down to
5.5% by fiscal year 2002. A 1% increase in the health care cost
trend rate for each year would increase the aggregate of the service
cost and interest cost components of the fiscal 1999 net periodic
benefit cost by approximately $3,600, while a 1% decrease in the
health care cost trend rate for each year would decrease the
aggregate of the service cost and interest cost components of the
fiscal 1999 net periodic benefit cost by approximately $4,400.
33
25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Other financial data
Items charged to operations during the years ended September 30,
1999, 1998 and 1997 included the following:
(Dollars in thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Maintenance and repairs $7,078 6,751 5,828
Salaries and wages 132,671 133,507 113,953
--------- ------ -------
Research and development costs:
Company-sponsored $7,716 5,866 6,161
Customer-sponsored 8,332 10,201 6,341
--------- ------ -------
Total $16,048 16,067 12,502
----------------------------------------------------------------------------------------------------------------------
The increase in 1998 research and development costs is due to
the inclusion of Filtertek for the full year and additional
expenditures at Rantec.
Accrued expenses included accrued employee compensation of $6.0
million and $10.2 million at September 30, 1999 and 1998,
respectively.
11. Business segment information
The Company is organized based on the products and services that
it offers. Under this organizational structure, on an ongoing basis,
the Company will operate in four principal segments:
Filtration/Fluid Flow, Test, Communications and Other.
Filtration/Fluid Flow operations consist of PTI Technologies Inc.
(PTI) and Filtertek Inc. (Filtertek). PTI develops and manufactures
a wide range of filtration products and is a leading supplier of
filters to the commercial aerospace market. Filtertek develops and
manufactures a broad range of high-volume, original equipment
manufacturer (OEM) filtration products at its facilities in North
America, South America and Europe. Test operations consist of EMC
Test Systems, L.P. (ETS) and principally involve the design and
manufacture of EMC test equipment, test chambers, shielded rooms for
high security data processing and secure communication, and
electromagnetic absorption materials. Communications operations
consist of Distribution Control Systems, Inc. (DCSI) and are
principally involved in providing two-way power line communication
systems for the utility industry. These systems provide the electric
utilities with a patented communication technology for demand-side
management, distribution automation and automatic meter reading
capabilities. The Divested Business segment consists of Systems &
Electronics Inc. (SEI). As of September 30, 1999, ESCO sold SEI to
Engineered Support Systems, Inc. to pursue the Company's strategy of
focusing on its commercial businesses. SEI was in the defense
systems and electronics business and principally supplied
high-capacity aircraft cargo loaders and transportation systems and
weapon subsystems to the armed forces. In addition, SEI designed and
manufactured launching and guidance systems and airborne radar
systems. The Other segment is principally comprised of Rantec
Microwave & Electronics, Inc. (Rantec) which designs and
manufactures antennas and antenna feeds for wireless communications
systems and produces power supplies widely used in high performance
displays, such as cockpit instrumentation, engineering workstations
and medical imaging. Rantec's microwave antenna business is being
offered for sale. Other also includes the operations of Comtrak.
Accounting policies of the segments are the same as those
described in the summary of significant accounting policies in Note
1. The Company evaluates the performance of its operating segments
based on operating profit (loss), which is defined as: net sales,
less cost of sales, less other charges related to cost of sales,
less SG&A expenses and less restructuring charges. Intersegment
sales and transfers are not significant. Segment assets consist
primarily of customer receivables, inventories and fixed assets
directly associated with the production processes of the segment.
Segment assets also include goodwill. Segment depreciation and
amortization is based upon the direct assets listed above.
34
26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NET SALES
Year ended September 30,
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Filtration/Fluid Flow $168.9 158.3 123.5
Test 34.9 30.6 26.1
Communications 24.7 19.0 13.4
Other 14.8 22.2 20.9
Divested Business 172.8 135.0 194.6
------- ----- -----
Consolidated totals $416.1 365.1 378.5
----------------------------------------------------------------------------------------------------------------------
OPERATING PROFIT (LOSS)
Year ended September 30,
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Filtration/Fluid Flow $11.9 10.5 9.6
Test 4.0 2.9 2.6
Communications 4.0 2.0 1.0
Other (13.2) .3 .6
Divested Business 10.4 11.2 13.8
Reconciliation to consolidated totals (Corporate) (2.2) - -
------- ----- -----
Consolidated totals $14.9 26.9 27.6
----------------------------------------------------------------------------------------------------------------------
The 1999 operating profit (loss) includes $3.9 million of other
charges related to cost of sales and $5.1 million of restructuring
charges described earlier.
The filtration/fluid flow segment in 1999 includes $2.2 million
of other charges related to cost of sales attributable to the
write-off of inventory resulting from the abandonment of the High
Pressure Air Reducing Quiet Manifold for surface ships. The
remaining $1.7 million balance relates to Rantec and Comtrak, and is
included in the Other segment.
The 1999 restructuring charges of $5.1 million are included in
the following segments: the $1.1 million of costs related to exiting
the Rantec microwave antenna business area, and the $1.8 million
write-off of the license agreement related to the abandonment of the
Vehicle Location System at Comtrak are included in the Other
segment. The $2.2 million of personnel separation costs are included
as a Corporate expense.
The total nonrecurring charges included in 1999 operating profit
(loss) amounted to $9.1 million. The Other segment also includes
$3.8 million of charges related to cost growth on certain
development programs at Rantec power systems.
The $2.5 million of other charges related to cost of sales in
1998 related to SEI and is included in Divested Business.
IDENTIFIABLE ASSETS
Year ended September 30,
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Filtration/Fluid Flow $195.0 203.0 177.2
Test 22.2 21.5 17.0
Communications 13.9 14.6 9.7
Other 19.2 36.1 34.0
Divested Business - 80.3 89.5
Reconciliation to consolidated totals (Corporate assets) 128.0 53.8 50.8
------- ---- ----
Consolidated totals $378.3 409.3 378.2
----------------------------------------------------------------------------------------------------------------------
Corporate assets consist primarily of deferred taxes and cash
balances.
35
27
DEPRECIATION AND AMORTIZATION
Year ended September 30,
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Filtration/Fluid Flow $10.7 10.5 7.5
Test 0.9 0.9 0.7
Communications 1.2 1.2 1.1
Other 1.2 1.2 1.0
Divested Business 3.0 3.6 4.1
----- ---- ----
Consolidated totals $17.0 17.4 14.4
----------------------------------------------------------------------------------------------------------------------
CAPITAL EXPENDITURES, NET
Year ended September 30,
(Dollars in thousands) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
Filtration/Fluid Flow $6.3 7.3 6.4
Test 0.2 0.3 0.4
Communications 0.3 2.5 0.3
Other 0.4 1.3 1.0
Divested Business 1.1 1.5 2.4
---- ---- ----
Consolidated totals $8.3 12.9 10.5
----------------------------------------------------------------------------------------------------------------------
ESCO'S GEOGRAPHIC INFORMATION FOR 1999, 1998 AND 1997 FOLLOWS:
Net sales to customers
(Dollars in millions) 1999 1998 1997
----------------------------------------------------------------------------------------------------------------------
North America $346.9 313.0 319.7
Europe 37.0 37.6 31.0
Middle East 3.1 3.9 6.0
Far East 23.5 8.6 17.8
Other 5.6 2.0 4.0
------ ----- -----
Consolidated totals $416.1 365.1 378.5
----------------------------------------------------------------------------------------------------------------------
LONG-LIVED ASSETS
(Dollars in millions) 1999 1998
----------------------------------------------------------------------------------------------------------------------
North America $63.8 89.2
Europe 7.5 8.8
----- ----
Consolidated totals $71.3 98.0
----------------------------------------------------------------------------------------------------------------------
Net sales are attributed to countries based on location of
customer. Long-lived assets are attributed to countries based on
location of the asset.
12. Emerson contract guarantees
Emerson had directly or indirectly guaranteed or was otherwise
liable for the performance of most of the Company's contracts with
its customers which existed at September 30, 1990 (the Guaranteed
Contracts). The Guaranteed Contracts and any potential liability
related to these contracts were assumed by the purchaser of SEI at
September 30, 1999.
36
28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Commitments and Contingencies
At September 30, 1999, the Company had $7.3 million in letters
of credit outstanding as guarantees of contract performance.
Subsequent to the sale of SEI, $2.7 million of this amount which
relates to SEI will be transferred to the acquirer.
In 1994, an action was commenced against the Company's Hazeltine
subsidiary alleging injury caused by Hazeltine's purported release
of hazardous materials. The Company believes that no one and no
property were injured by any release of hazardous substances from
Hazeltine's plant. In 1996, the plaintiffs filed a motion to be
certified as a class. The motion was denied and the plaintiffs
appealed. The appellate court affirmed the denial. Based upon the
current facts, the Company is not able to estimate the probable
outcome. Therefore, no provision for this litigation has been made
in the accompanying consolidated financial statements. Management
believes the Company will be successful in defending this action and
that the outcome will not have a material adverse effect on the
Company's financial statements. This contingent liability was
retained by the Company when Hazeltine was divested in 1996.
As a normal incidence 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.
14. Other Charges related to cost of sales
Other charges related to cost of sales of $3.9 million in 1999
represent the write-off of inventory related to the strategic
abandonment of the High Pressure Air Reducing Quiet Manifolds for
surface ships ($2.2 million) and the Vehicle Location Systems ($.6
million) business areas. Additionally, the Company wrote down the
Rantec microwave antenna product line inventory ($1.1 million) to
net realizable value as a result of the anticipated sale of that
business area.
Other charges related to cost of sales of $2.5 million in 1998
resulted from the Company's settlement of a long-standing contract
dispute on the original M1000 tank transporter program at SEI.
15. Quarterly financial information (Unaudited)
(Dollars in thousands, First Second Third Fourth Fiscal
except per share amounts) Quarter Quarter Quarter Quarter Year
----------------------------------------------------------------------------------------------------------------------
1999
Net sales $ 88,193 96,214 113,978 117,717 416,102
Gross profit 22,894 25,036 27,951 18,613 94,494
Net earnings before accounting change 1,515 2,047 4,072 42,821 50,455
Net earnings (23,494) 2,047 4,072 42,821 25,446
Earnings per share before accounting change:
Basic .12 .17 .33 3.46 4.09
Diluted .12 .16 .32 3.36 4.00
----------------------------------------------------------------------------------------------------------------------
1998
Net sales $ 78,077 86,030 98,236 102,740 365,083
Gross profit 22,029 24,596 25,641 22,985 95,251
Net earnings 2,610 3,240 3,847 1,599 11,296
Earnings per share:
Basic .22 .27 .32 .13 .94
Diluted .21 .26 .31 .12 .90
----------------------------------------------------------------------------------------------------------------------
Gross profit is computed as net sales, less cost of sales, less
other charges related to cost of sales. The 1999 first quarter
reflects the impact of adopting SOP 98-5. The 1999 fourth quarter
reflects the impact of the SEI divestiture and the nonrecurring
costs incurred.
37
29
INDEPENDENT AUDITOR'S REPORT
THE BOARD OF DIRECTORS AND SHAREHOLDERS
ESCO ELECTRONICS CORPORATION:
We have audited the accompanying consolidated balance sheets of
ESCO Electronics Corporation and subsidiaries as of September 30,
1999 and 1998, and the related consolidated statements of
operations, shareholders' equity, and cash flows for each of the
years in the three-year period ended September 30, 1999. These
consolidated financial statements are the responsibility of the
Company's Management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of ESCO Electronics Corporation and subsidiaries as of
September 30, 1999 and 1998, and the results of their operations and
their cash flows for each of the years in the three-year period
ended September 30, 1999, in conformity with generally accepted
accounting principles.
As discussed in note 1 to the consolidated financial statements,
the Company adopted Statement of Position 98-5, "Reporting on the
Costs of Start-Up Activities," in 1999.
KPMG LLP
St. Louis, Missouri
November 10, 1999
39
30
FIVE-YEAR FINANCIAL SUMMARY
(Dollars in millions, except per share amounts) 1999 (1) 1998 (2) 1997 (3) 1996 (4) 1995 (5)
----------------------------------------------------------------------------------------------------------------------
For years ended September 30:
Net sales $416.1 365.1 378.5 438.5 441.0
Interest expense 6.5 7.7 5.2 4.8 5.5
Earnings (loss) before income taxes 63.5 16.3 17.9 14.8 (29.5)
Net earnings (loss) before accounting change 50.5 11.3 11.8 26.1 (30.3)
Net earnings (loss) 25.5 11.3 11.8 26.1 (30.3)
Earnings (loss) per share:
Earnings (loss) before accounting change:
Basic 4.09 .94 1.00 2.32 (2.76)
Diluted 4.00 .90 .96 2.26 (2.76)
Net earnings (loss)
Basic 2.06 .94 1.00 2.32 (2.76)
Diluted 2.02 .90 .96 2.26 (2.76)
As of September 30:
Working capital 95.3 60.3 62.3 86.2 71.4
Total assets 378.4 409.3 378.2 307.8 378.0
Long-term debt 41.9 50.1 50.0 11.4 23.5
Shareholders' equity 248.7 224.1 205.0 191.1 182.3
----------------------------------------------------------------------------------------------------------------------
(1) Includes the gain on sale of SEI, accounting change, $5.1
million of restructuring charges, and $3.9 million of other
charges related to cost of sales.
(2) Includes the acquisitions of Euroshield (December 31,1997) and
AMT (July 1, 1998) (see Footnote 2 of Notes to Consolidated
Financial Statements).
(3) Includes the acquisition of Filtertek in February 1997 (see
Footnote 2 of Notes to Consolidated Financial Statements).
(4) Includes the sale of Hazeltine; $25.3 million of other charges
related to cost of sales; and includes an adjustment to the
income tax valuation reserve.
(5) Includes $16.5 million of other charges related to cost of sales
and a change in accounting estimate.
- --------------------------------------------------------------------------------
COMMON STOCK MARKET PRICES
The Company's common stock trust receipts and the underlying
common stock and associated preferred stock purchase rights
(subsequently referred to as common stock) are listed on the New
York Stock Exchange under the symbol "ESE." The following table
summarizes the high and low prices of the Company's common stock for
each quarter of 1999 and 1998.
1999 1998
-------------------------------------------------------------------
Quarter HIGH LOW High Low
-------------------------------------------------------------------
First 11 3/4 8 3/4 19 15/16 163/16
Second 11 1/4 9 3/16 18 7/16 16
Third 11 7/8 10 1/8 20 3/4 165/8
Fourth 13 3/8 11 3/4 19 5/16 85/8
-------------------------------------------------------------------
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SHAREHOLDER'S SUMMARY
CAPITAL STOCK INFORMATION
ESCO Electronics Corporation common stock trust receipts (and
the underlying common stock and associated preferred stock purchase
rights) (symbol ESE) are listed on the New York Stock Exchange.
There were approximately 8,178 holders of record of trust
receipts representing shares of common stock at September 30, 1999.
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